Malcolm Surridge, Andrew Gillespie - Cambridge International As & A Level Business-Hodder Education (2021)

The Cambridge International AS & A Level Business series consist of a Student’s Book,
Boost eBook, Skills Workbook and Teacher’s Resource Pack.

Cambridge Cambridge Cambridge Cambridge
International AS & International AS & International AS & International AS &
A Level Business A Level Business A Level Business A Level Business
Second Edition Second Edition Skills Workbook Teacher’s Resource
Boost eBook Pack
9781398308114 9781398308206 9781398308152 9781398308138
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Practice and apply what you have studied and

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● Build confidence with extra practice to ensure that
a topic is thoroughly understood before moving on.
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the revised Cambridge International AS & A Level
Business syllabus (9609).
● Confidently deliver the revised syllabus with expert
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Cambridge
International AS & A Level
Business
Second edition
Malcolm Surridge
Andrew Gillespie
9781398308114.indb 1 05/03/21 11:06 AM

Acknowledgements
p.118 © Charlie Box/Dyson; p.131 © Courtesy of L’Oreal; p.262 © Abel, G. J. (2018). Estimates of global
bilateral migration flows by gender between 1960 and 2015. International Migration Review, 52(3), 809-852;
p.282 © Berkeley Earth. Retrieved from http://berkeleyearth.org/wp-content/uploads/2020/01/2019_Time_
Series.png; p.283 © Toshiba Corporation (2019). Environmental Report. Retrieved from https://www.toshiba.
co.jp/env/en/communication/report/pdf/env_report19_all_e.pdf; p.290 © Acha Leke, Mutsa Chironga, and
Georges Desvaux, Africa’s overlooked business revolution. McKinsey & Company. November 15, 2018. Retrieved
from https://www.mckinsey.com/featured-insights/middle-east-and-africa/africas-overlooked-business-
revolution; p.292 © Colgate-Palmolive Company. Retrieved from https://investor.colgatepalmolive.com/static-
files/a65490ac-2442-41e3-8751-e18a1471bd92; p.472 © BP p.l.c. Energy with Purpose. BP Annual Report and
Form 20-F 2019. Retrieved from https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/
investors/bp-annual-report-and-form-20f-2019.pdf
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ISBN: 978 1 3983 0811 4
© Malcolm Surridge and Andrew Gillespie 2021
First edition published in 2014.
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9781398308114.indb 2 05/03/21 11:06 AM

Contents
Introduction vii
AS LEVEL
1 Business and its environment

1.1 Enterprise 1
1.1.1 The nature of business activity 1
1.1.2 The role of entrepreneurs and intrapreneurs 8
1.1.3 Business plans 13
1.2 Business structure 16
1.2.1 Economic sectors 16
1.2.2 Business ownership 18
1.3 Size of business 27
1.3.1 Measurements of business size 27
1.3.2 Significance of small businesses 27
1.3.3 Business growth 30
1.4 Business objectives 33
1.4.1 Business objectives in the private sector and public sector 33
1.4.2 Objectives and business decisions 38
1.5 Stakeholders in a business 41
1.5.1 Business stakeholders 41
1.5.2 The relative importance and influence of stakeholders on
business activities 43
2 Human resource management

2.1 Human resource management 47
2.1.1 Purpose and roles of human resource management 47
2.1.2 Workforce planning 48
2.1.3 Recruitment and selection 50
2.1.4 Redundancy and dismissal 54
2.1.5 Morale and welfare 56
2.1.6 Training and development 59
2.1.7 Management and workforce relations 62
2.2 Motivation 66
2.2.1 Motivation as a tool for management and leadership 66
2.2.2 Human needs 66
2.2.3 Motivation theories 68
2.2.4 Motivation methods in practice 76
2.3 Management 83
2.3.1 Management and managers 83
3 Marketing
3.1 The nature of marketing 93
3.1.1 Role of marketing and its relationship with other
business activities 93
3.1.2 Demand and supply 95
3.1.3 Markets 98
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3.1.4 Consumer and industrial marketing 101
Contents
3.1.5 Mass marketing and niche marketing 102

3.1.6 Market segmentation 103
3.1.7 Customer-relationship marketing 104
3.2 Market research 106
3.2.1 Purposes of market research 106
3.2.2 Primary research and secondary research 107
3.2.3 Sampling 110
3.2.4 Market research data 111
3.3 The marketing mix 115
3.3.1 Elements of the marketing mix 115
3.3.2 Products 116
3.3.3 Product portfolio analysis 117
3.3.4 Pricing methods 123
3.3.5 Promotion methods 127
3.3.6 Place (channels of distribution) 134
4 Operations management
4.1 The nature of operations 142
4.1.1 The transformational process 142
4.1.2 Efficiency, effectiveness, productivity and sustainability 144
4.1.3 Capital-intensive and labour-intensive operations 148
4.1.4 Operations methods: job, batch, flow, mass customisation 149
4.2 Inventory management 151
4.2.1 Managing inventory 151
4.2.2 Just in time 155
4.3 Capacity utilisation and outsourcing 157
4.3.1 Significance and measurement of capacity utilisation 157
4.3.2 Outsourcing 160
5 Finance and accounting

5.1 Business finance 162
5.1.1 The need for business finance 162
5.1.2 Working capital 166
5.2 Sources of finance 169
5.2.1 Business ownership and sources of finance 169
5.2.2 Internal and external sources of finance 170
5.2.3 Factors affecting sources of finance 176
5.2.4 Selecting the source of finance 178
5.3 Forecasting and managing cash flows 180
5.3.1 Cash-flow forecasts 180
5.4 Costs 187
5.4.1 Cost information 187
5.4.2 Approaches to costing 189
5.4.3 Uses of cost information 194
5.4.4 Break-even analysis 199
5.5 Budgets 205
5.5.1 The meaning and purpose of budgets 205
5.5.2 Variances 209
iv
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A LEVEL
Contents
6.1 External influences on business activity 214
6.1.1 External influences on business activity: Political and legal 214
6.1.2 External influences on business activity: Economic 227
6.1.3 External influences on business activity: Social and
demographic 255
6.1.4 External influences on business activity: Technological 266
6.1.5 External influences on business activity: Competitors and
suppliers 271
6.1.6 External influences on business activity: International 274
6.1.7 External influences on business activity: Environmental 281
6.2 Business strategy 287
6.2.1 Developing business strategy 287
6.2.2 Corporate planning and implementation 304

7.1 Organisational structure 313
7.1.1 Relationship between business objectives and structure 313
7.1.2 Types of structure 316
7.1.3 Delegation and accountability 321
7.1.4 Control, authority and trust 323
7.1.5 Centralisation and decentralisation 324
7.1.6 Line and staff 325
7.2 Business communication 328
7.2.1 Purposes of communication 328
7.2.2 Methods of communication 330
7.2.3 Channels of communication 334
7.2.4 Barriers to communication 335
7.2.5 Role of management in facilitating communication 336
7.3 Leadership 341
7.3.1 Leadership 341
7.3.2 Theories of leadership 343
7.3.3 Emotional intelligence/emotional quotient 346
7.4 Human resource management strategy 349
7.4.1 Approaches to human resource management 349
7.4.2 Flexible workforces 352
7.4.3 Measurement, causes and consequences of poor employee
performance 358
7.4.4 Strategies for improving employee performance 360
7.4.5 Roles of IT and AI in human resource management 363
8 Marketing
8.1 Marketing analysis 366
8.1.1 Elasticity 366
8.1.2 Product development 371
8.1.3 Sales forecasting 375
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8.2 Marketing strategy 383
Contents
8.2.1 Planning the marketing strategy 383

8.2.2 Approaches to marketing strategy 384
8.2.3 Strategies for international marketing 387
9.1 Location and scale 394
9.1.1 Location 394
9.1.2 Scale of operations 400
9.2 Quality management 406
9.2.1 Quality control and quality assurance 406
9.2.2 Benchmarking 410
9.3 Operations strategy 412
9.3.1 Operations decisions 412
9.3.2 Flexibility and innovation 414
9.3.3 Enterprise resource planning 416
9.3.4 Lean production 417
9.3.5 Operations planning 422

10.1 Financial statements 430
10.1.1 Statement of profit or loss 430
10.1.2 Statement of financial position 435
10.1.3 Inventory valuation 438
10.1.4 Depreciation 440
10.2 Analysis of published accounts 444
10.2.1 Liquidity ratios 445
10.2.2 Profitability ratios 448
10.2.3 Financial efficiency ratios 450
10.2.4 Gearing ratios 452
10.2.5 Investment ratios 453
10.3 Investment appraisal 457
10.3.1 The concept of investment appraisal 457
10.3.2 Basic methods 458
10.3.3 Discounted cash-flow methods 460
10.3.4 Investment appraisal decisions 462
10.4 Finance and accounting strategy 467
10.4.1 Using accounting data to enable strategic
decision-making 467
10.4.2 Using accounting data and ratio analysis in strategic
decision-making 471
Index 481
Photo credits 488
vi
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Introduction
The syllabus (9609)

This book introduces you to Business. It has been written to
meet the requirements of the Cambridge International AS & Glossary terms
A Level Business syllabus (9609) for examination from 2023. These boxes contain descriptions of highlighted glossary
terms used throughout the book to help explain additional
The syllabus (9609) concepts.
The Cambridge International AS & A Level Business syllabus Handling data

is based on five topics which are studied at both AS Level
This feature is designed to help to develop relevant
and A Level. These are:
numerical skills such as conducting calculations and
» Business and its environment
interpreting numerical data.
» Human resource management (HRM)
» Marketing
» Operations management Case study
» Finance and accounting. There is a diverse range of case studies to illustrate how
The AS section of the syllabus gives you the opportunity to theories and concepts operate in the real world. These all
understand what happens inside businesses and introduces have questions to help you to develop the skills needed in
you to key business terminology. It also looks at the four preparation for your examinations.
internal functions of businesses providing an understanding
of how they operate and how businesses manage workforces, Study tip
research and satisfy customer needs, manage the process of These appear throughout the book and are designed to help
creating goods and services and manage their finances. You you to understand the material that you have studied and to
are encouraged to consider the working of these internal prepare for your examinations.
functions in different business contexts.
The A-Level material builds on AS content and is based around Test your learning
the concept of strategy. It looks in detail at the external At the end of each chapter there is a range of questions
influences on business activity and encourages you to take and activities to help you to reinforce your learning and to
account of what is happening in the real world. The syllabus develop the necessary skills.
looks at ways in which businesses can develop, plan and
implement corporate strategies. It also covers the strategic
elements of the four business functions introduced at AS and The key concepts
encourages you to think about these in business-wide contexts. The syllabus is based on the six key concepts set out
below which should underpin your study of the subject
The features of the book matter. Familiarity with these key concepts can help you to
understand the material in this resource and the syllabus,
The book will guide you through the Cambridge International
and help you think about how these can be applied to
AS & A Level Business programme of study, although you
diverse business scenarios and questions.
should supplement it with research into businesses in your
own and other countries. You are fortunate that there is an As these concepts are an essential aspect of the syllabus,
immense amount of information available about businesses, they have been signposted throughout the textbook using
their behaviour and the environments in which they operate. the associated icons. The syllabus definitions of these
The internet is an enormous and valuable resource and you key concepts can be found within the syllabus on the
will also find that newspapers, magazines and television Cambridge International website, but we discuss these
contain a lot of relevant information. However, business further here:
activity takes place around you all the time: when you
are shopping, travelling to and from school or college or Change
enjoying leisure activities such as visiting the cinema. There
All businesses are subject to change and have to respond to
are many opportunities for you to see the operation of some
it regularly and frequently. Change may be internal, perhaps
of the models and theories you will study.
following the appointment of a new leader which could,
This textbook includes the following features: for example, result in a new organisational culture, new
methods of production and the targeting of new markets.
Chapter overview Alternatively, it may be external, perhaps as a consequence
of a change in the business environment; the UK’s recent
At the outset of each chapter there is guidance on the
decision to leave the European Union is a prime example.
material that is covered in the chapter. This shows the
Managing change effectively contributes to business success.
knowledge that can be gained from studying this chapter.
vii
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• It comprises two data response questions which may be
Introduction
Context based on text and numerical data. Each question is split

Businesses operate in diverse contexts and these have a into six parts.
major influence on decision-making. A decision that might be • Each of the two data response questions will carry a
appropriate and successful for a small family-owned business maximum of 30 marks.
facing a drop in sales may be entirely unsuitable for a large
multinational manufacturer facing the same problem. You A Level Paper 3: Business Decision-Making
need to understand the importance and impact of context. • This paper carries a total of 60 marks and has a duration
of 1 hour 45 minutes.
Decision-making • It tests the entire A Level syllabus and builds on AS
knowledge and understanding.
Change can create a need for decision-making. Decisions • It is based on a case study which includes prose, tables
can be taken by stakeholders within the business as well as of data and numerical or diagrammatic appendices.
those outside of it. Decisions may be based on instinct or a • The case study will normally have five questions
‘hunch’, or on the analysis of the available quantitative and attached to it.
qualitative data. Decisions can be taken at different levels
within an organisation and may impact on part or all of it. A Level Paper 4: Business Strategy
• This paper carries a total of 40 marks and has a duration
Enterprise of 1 hour 15 minutes.
Enterprise is the ability to make new ideas work and thus
• It tests the entire A Level syllabus, and builds on AS
knowledge and understanding.
enables businesses to take advantages of opportunities that
may exist. Enterprise is not simply limited to start-ups; in a
• It comprises two questions, each worth 20 marks, based
on a series of numerical and non-numerical data relating
changing world, enterprise is vital for competitiveness.
to a case study.
Innovation The information in this section is based on the 9609 syllabus
Innovative businesses are more able to develop new products for examination from 2023. You should always refer to the
or better ways of producing them. This helps to enhance appropriate syllabus document for the year of your examination
competitiveness and strengthen performance by leading to confirm the details and for more information. The syllabus
the field rather than being a more passive follower. document is available on the Cambridge International website
at http://www.cambridgeinternational.org.
Strategy Preparing for Business examinations
A business’s strategy is its long-term plan to achieve its
objectives. Successful businesses are able to develop and The Business syllabus requires you to understand the
implement effective strategies through analysing the relevant theories and concepts set out in the syllabus
business environment and the opportunities available and and covered in this book. However, you will also need
making appropriate choices. to know how to organise ideas, construct arguments,
make decisions, solve problems, conduct calculations
and interpret data. Finally, it is important for you to
The structure of the AS- and ensure you know how to apply your knowledge to business
A-Level examinations scenarios, such as those set out in questions that relate to
data response materials or case studies.
There are two examination papers for AS and two for A Level
This textbook contains numerous questions throughout, and
Business. The subject content of AS Business is assumed
at the end of, each chapter which have been designed to
knowledge for the A-Level papers.
help you to develop these essential skills.
AS Level Paper 1: Business Concepts 1
Malcolm Surridge & Andrew Gillespie
• This paper carries a total of 40 marks and has a duration
of 1 hour 15 minutes. A note on the exam-style questions
• It tests the entire AS element of the syllabus. Exam-style questions (and sample answers) have been
• It comprises two sections: written by the authors. In examinations, the way marks
• Section A contains four short answer questions. The are awarded may be different. References to assessment
first three questions are split into two parts each. and/or assessment preparation are the publisher’s
• Section B contains two essay questions, one of interpretation of the syllabus requirements and may
which must be answered. The essays are split into not fully reflect the approach of Cambridge Assessment
two parts each. International Education. Cambridge International
• Section A and Section B each carry a maximum of recommends that teachers consider using a range of
20 marks. teaching and learning resources in preparing learners for
AS Level Paper 2: Business Concepts 2 assessment, based on their own professional judgement of
• This paper carries a total of 60 marks and has a duration their students’ needs. Third-party websites and resources
of 1 hour 30 minutes. referred to in this publication have not been endorsed by
• It tests the entire AS element of the syllabus. Cambridge Assessment International Education.
viii
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AS LEVEL
1.1 Enterprise
1.1.1 The nature of business activity

Chapter overview
In this chapter we examine:
★ the nature and purpose of business activity; for example, we look at factors of production, the business environment,
what businesses do and the concept of adding value
★ the differences between local, national, international and multinational businesses
★ the role of the entrepreneur and intrapreneur; for example, we consider why entrepreneurs are important to the
economy, and barriers to entrepreneurship
★ business risk and uncertainty
★ business plans; for example, we consider the purpose of business plans, their key elements and their limitations.
1.1.1 The nature of business activity and organising what they do in order to achieve targets,
such as helping people get better more quickly or improving
the quality of students’ education.
The purpose of business activity
What will you do this weekend? Have you got a part-time The transformation process
job to earn some money? Are you going to go out to a café
All businesses are involved in the transformation process.
or go shopping in the town centre? Whatever you do, you
They take inputs and transform them in some way to
will come into contact with many different businesses,
produce outputs that they hope consumers will want.
either as a consumer buying and using their products or
as an employee working to create them. Businesses are
INPUTS TRANSFORMATION OUTPUTS
everywhere! Just think of the last time you went shopping
• land PROCESS • goods
– the outlet where you shop is a business, it has bought
• labour • services
the products from a supplier, they were transported by
• capital • by-products
a delivery business and the firm probably uses another CREATES VALUE
business to help promote itself. In every transaction • enterprise
between a customer and a business, many other businesses
will have been involved to bring about that exchange.
There are many different definitions of a business, but what
they tend to have in common is the idea of someone (or a FEEDBACK
group of people) working in an organised way to achieve
a given target. Notice the key elements of this definition ▲ Figure 1.1 The transformation process
– firstly, the activities of those involved are organised in
some way and, secondly, the business is created with a Inputs
specific purpose in mind: often the business objective The inputs into a business are also called the factors of
is profit but, as we shall see later, there are many other production. These are:
reasons why people set up in business. Using a definition of » land
organised activities and a given target, many organisations » labour
such as hospitals and even schools could be classified as » capital
businesses. They may not have profit as a target, but they » enterprise.
do involve many different people working together, planning
GLOSSARY TERMS
Business objectives are measurable targets set by the The factors of production are the inputs into the
business, such as sales or profits that have to be achieved transformation process of a business; namely land, labour,
within a given time period. capital and enterprise.
The transformation process involves converting inputs into
outputs.
9781398308114.indb 1 05/03/21 11:06 AM

Land The choice of inputs
This involves choosing the location of the business. This is The choice of inputs into the business and who supplies
1.1 critically important for businesses such as shops and cafés.
For other businesses such as farming, what will matter
them can affect:
» the costs of a business
is the quality of the land in terms of the ability to grow » the quality of the final product (and therefore sales).
different crops or rear livestock. The success of a farming
business will be directly affected by changes to the quality In recent years, customers have become increasingly
of the land and the weather. For some businesses, what will interested in what resources are used in a production
matter is access to resources; for example, oil drilling and process and where they have come from. Firms may
mining businesses need to be near the natural resources. highlight the fact that they use recycled materials, that
AS LEVEL 1.1 Enterprise
The significance of land as an input will be particularly high their supplies come from local businesses or that their
in the primary sector. ingredients are ‘natural’ or ‘organic’.
Under the heading of land we also include premises. Firms will also face the choice of whether to buy in some
The amount of space available to a business can affect materials or produce them themselves. Tyrrells uses the fact
how much can be produced or how many customers can that it grows its own potatoes when it promotes its potato
physically fit in the restaurant or store. The nature of the crisp products. Most other crisp manufacturers buy in their
premises can also affect the working environment and potatoes.
people’s motivation. For example, working in a modern
office with a good canteen, parking spaces and a central Outputs
location might be appealing to employees.
The output of a business is a product. A product may be a
good or a service, or a combination of the two.
GLOSSARY TERM » A good (or a product) is a tangible physical item, such
The primary sector is the first stage of production and as a car or a laptop computer. Businesses can produce
includes extracting or growing resources. Farming, and stock them. This means that they can produce or
mining and fishing are all part of the primary sector. purchase the goods that they sell in advance of demand;
for example, a store may stockpile new electrical goods
before a busy selling period.
Labour » A service is intangible. Examples of services
Organisations will need staff. The quality of employees are education, creating music, hairdressing and
in terms of their skills, their attitudes (for example, to physiotherapy. Most businesses in more developed
customers), their willingness to work and their natural economies are in the service sector. Services cannot be
abilities will have an influence on the success of any stored; they have to be produced for customers as they
business. What makes a film a great success? The quality of are needed. This can create problems, because if there is
the writing, the acting and the production – people play a rush of customers, there are no products stockpiled and
a key role in the success of any film. Many films therefore so queues form or waiting lists have to be introduced.
promote themselves on the basis of who the actors are or
who the director is. Similarly, universities promote their In many cases, a business provides a combination of goods
professors. Music labels promote their bands. Publishers and services. For example, you may choose a restaurant
promote their author list. So people can be a crucial because of the food you can eat there (the goods) but also
element of the transformation process. because of the waiters, the environment and the way you
are treated (the service).
Capital
The word ‘capital’ has many meanings. In this instance, Most outputs are intended for sale. A firm produces
we mean the equipment used by businesses. The coffee goods and services to sell to customers. However, there
machines in the coffee shop, the ovens in the fast-food may also be by-products from the transformation process;
restaurants, and the scanning equipment in shops are all for example, a firm’s production may create waste and
examples of capital equipment. The amount and quality of pollution. Many customers pay attention to these issues
the capital equipment in a business can affect the service it and, increasingly, firms are considering the effects
provides. For example, the online retailer Amazon is admired of their production on other groups, such as the local
for the efficiency with which it processes an order and is community. Some by-products may also form the inputs
able to make suggestions to customers of what else they to other industries.
might like to buy. These rely on the quality of Amazon’s
warehousing facilities and computer programs. For most products there is a series of stages in the
transformation process which are involved in taking the
Enterprise initial materials and ending up with the final product. The
Enterprise refers to a set of skills that develops new ways author JK Rowling took her imagination and a computer
of doing things or new things to do. Enterprise refers to the and turned her ideas into magical manuscripts for her Harry
ability to be creative and innovative, to come up with new Potter books. The publishing company worked with the
ideas, to combine resources in different ways and to be willing author, designers, editors, a marketing team, a printing
to take risks. Enterprise brings together the other factors of business and a distribution business and turned the
production to create and make a business idea competitive.
2
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CASE STUDY
1.1
Dabbawalla
a ‘doer of something’ and a ‘dabba’ is a stainless steel
lunchbox. The lunchbox is picked up from the customer’s
home and taken to a sorting station. The lunchboxes are
then divided up according to destination and delivered
on bike, on foot or taken on the train. After lunch, the
box is collected and taken back to the customer’s home.

This is an incredibly efficient but very labour-intensive
and low-technology process, with almost no boxes going
missing or to the wrong address. The price is so low that it
is easier to pay for the delivery than to take your lunchbox
with you on your journey to and from work.
Questions
1 Explain one way in which the dabbawallas transform
▲ Figure 1.2 A busy dabbawalla delivery in Mumbai inputs into outputs. [3]
2 Evaluate how you would measure the success of
Every day in Mumbai, India, around 250 000 people get
this transformation process. [12]
their lunches delivered by ‘dabbawallas’. A ‘walla’ means
manuscripts into a series of books. Bookstores take a range For example, artists such as Andy Warhol, Vincent van Gogh,
of books and transform them into a retail experience for the David Hockney and Rembrandt took their imagination, paint
customer. A series of transformations has gone on to get and canvas and produced amazing works of art that now
the idea from the author’s mind into a book and into the sell for millions of dollars: far more than the cost of the
hands of the reader. items used up in their production. They added value via the
Managing the transformation process.
Managing the transformation Managing the
inputs process outputs
Jamie Oliver, a famous chef, takes standard ingredients
such as meat, herbs and vegetables, puts them together in
a unique way and comes up with a fantastic meal. He takes
ingredients that many others may use but transforms them
TRANSFORMATION in a way that appeals to customers, sells books and attracts
viewers for his TV series. Clearly, he has added value by
INPUTS OUTPUTS using his talent, creativity and personality.
PROCESS
GLOSSARY TERM
FEEDBACK
Adding value occurs in a transformation process when
▲ Figure 1.3 Chain of operations outputs are produced that are worth more than the inputs
brought in to provide them.
Businesses need to identify exactly what they want to
provide in terms of the range and quality of products they
offer. For example, do they want to specialise in a few types Adding value can be done in ways that may seem odd to
of items or provide a wide range of goods and services? some. Here are some examples:
Businesses also need to decide on the resources they will » Some companies buy new jeans and then stretch
need in order to provide the product to the standard they them, batter them and fray them to make them look
want for their customers. There are a number of questions distressed while, at the same time, more than doubling
involved here: How many people are needed? What skills are their price.
needed? Will they be trained? What materials will be used? » Bottled water that sells for $10 a bottle comes from
What equipment? And so on. Businesses need to find a way of King Island, near Tasmania. It is called ‘Cloud Juice’ and
generating a product that customers value so much that they is claimed to be the purest in the world. It is rainwater
will pay more for it than it costs the business to produce. that has been collected from a plastic roof and then
bottled. It is supposed to be so pure because it comes
from rain clouds that travel 7000 miles from South
Adding value America without passing over any land, and therefore
Adding value occurs in a transformation process when not encountering pollution.
outputs are produced that are worth more than the inputs » One of the most expensive coffees in the world is
brought in to provide them. Luwak Coffee. This is made from coffee cherries that
9781398308114.indb 3 05/03/21 11:06 AM

have been eaten and digested by common palm the brand or developing a unique selling proposition
civets (a type of animal). The civets use their keen (USP). A USP is a feature of the product that makes it
1.1 sense of smell to select the choicest and ripest beans.
The beans are supposed to be much sweeter as a
different from competitors’ products for the customer; for
example, a product may be perceived as better quality,
result of the digestion process and, having passed better designed, more reliable or more user-friendly than
through the animal, they are hand-collected from the competitors’ products.
jungle floor.
To increase the value it adds, a business might aim to:
STUDY TIP
» reduce the costs of producing the product. This means
cutting back on waste, ensuring the best price for the When answering questions, you may need to think about
how different firms create value. What can businesses do

supplies and making sure that mistakes are not made. All
to add more value? Should they focus on the benefits they
activities that do not create value need to be examined
are providing, or try to control costs more effectively?
to see if they are truly necessary.
» increase the perceived benefit of the product in the
eyes of the customer. This could be through building
CASE STUDY
FedEx
FedEx connects people with goods, services, ideas FedEx has over 180 000 vehicles and nearly 680 planes. It
and technologies. By doing this, FedEx says it creates delivers over 15 million packages on an average day and
opportunities that drive innovation, energise businesses deals with over 250 requests linked to package tracking
and help communities improve their standard of living. each day.
FedEx says it does far more than deliver packages. It says
Source: www.fedex.com/en-us/about/company-structure.html
it delivers joy in the holidays, provides hope to survivors
of natural disasters and solves business problems. Its Question
network extends to over 220 countries and territories.
1 Explain one way in which FedEx can add value in its
Its 490 000 team members are united behind the FedEx
transformation process. [3]
promise to ‘make every FedEx experience outstanding’.
CASE STUDY
IKEA
IKEA is a furniture producer and retailer. The value chain
of a product describes all the stages of operations, from
Listen to
the initial raw materials through to the sale of the actual
customers
goods. In IKEA’s case, it owns and manages nearly all the
stages of its value chain. IKEA says that the starting point
for any value chain is the product itself, and the idea for
this starts with ‘listening to people’s needs and dreams, Design and
Sell create
so we understand how we can make a difference’. the product
Typically, IKEA turns this initial idea based on customers’
needs into a sketch of how the product might look. This
sketch is then discussed with its suppliers, who consider
how it might be made, transported and stored in-store.
IKEA will be looking for ways of producing a product with Package and
a high-quality design and finish while keeping costs low. Manufacture
distribute to
IKEA is always trying to improve the product at each stage the product
stores
of discussion and review. Improvements are welcomed
from the various people involved in production; for
example, designers and technicians. One such suggestion ▲ Figure 1.4 The value chain of a product
might be using a more sustainable material.
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Much of IKEA’s furniture is produced and packaged in the Questions
form of a flat-pack, which lowers transport costs because
it is easy to put large quantities on lorries and on shelves
1 Analyse one way in which IKEA adds value in its
transformation process. [4]
1.1
in-store. This helps keep prices low for IKEA’s customers, 2 Evaluate the importance of the customer in IKEA’s
who then take the products home and build the products value chain. [12]
themselves. Collaboration between customers, partners
and co-workers aids IKEA’s pursuit ‘to add value to
people’s everyday lives’ by producing good-quality
furniture at low prices.
Source: https://about.ikea.com/en/about-us/the-ikea-value-chain

government may provide some or all of the health services,
GLOSSARY TERMS the transport system, the police or the education system in
A brand is a name, design, logo, symbol or indeed anything a country.
that makes a product recognisable and distinguishes it
from the competition in the eyes of the customer.
Governments tend to take control of goods and services
they think are vital to their economy and where they want
Market forces are the forces of supply and demand which
to ensure access for most people.
determine the price of a product and the quantity bought
and sold in a market. However, whenever decisions are made about what
Opportunity cost measures the sacrifice made by to produce – whether it be the free market or the
choosing one option in terms of the next best alternative government – it will involve an opportunity cost. Given
foregone. that resources are limited, if they are used to produce
more of one item, then this is at the expense of something
else. Opportunity cost measures the sacrifice you make if
Businesses and economic activity you choose one course of action in terms of the next best
Businesses make up an important part of any economy. alternative. For example, if a business decides to use its
They are important because they employ people, they pay labour force to increase output of soft drinks, then the
employees’ wages and salaries and they provide goods opportunity cost is what could have been produced if the
and services. Businesses provide the products we buy and labour force had been used to produce something different.
give us the jobs and earnings we need to buy them. When Whenever a business makes a decision it should consider the
businesses are doing well and expanding they employ opportunity cost. A project that earns a profit of $100 000
more people and generate more income for the economy. may seem attractive, but if the resources could have been
Businesses innovate to win more customers: they create used to earn $250 000 it is not so appealing. When judging
new goods and services and this can improve the quality the success of a business you should also consider the
of our lives, by providing better food, better clothes opportunity cost. If Walmart, the huge US retailer, made
and better electronic goods. Businesses therefore drive a profit of $10 million, this would not be that impressive
economies forward, and this is why governments are eager given the people, stores and equipment it has; these
to help new firms start up and compete, and why they often resources could be used elsewhere to earn more than that.
try to help businesses grow. Walmart’s profit before tax in 2020 was actually over $20
billion, so you can see why its investors wouldn’t be very
happy it if only made $10 million!
Choice and opportunity cost
In any economy there is a fixed amount of resources at any The dynamic business environment
moment and therefore decisions have to be made about how
these resources are used. Given the scarcity of resources, Businesses do not operate in isolation. Whatever they do
choices are inevitable in terms of what should be produced is linked to what other businesses do; for example, their
in the economy, how these products should be produced and suppliers, the firms that distribute and promote their
who should receive them. Some of these decisions will be products, the banks that lend them money. They are also
made by market forces of supply and demand: it will be the affected by many other external factors such as:
result of bargaining between consumers and businesses. If, » Political and legal issues For example, new laws by
for example, demand for a particular product increases, this a government can prevent the way some products are
will encourage businesses to use their resources to produce promoted (such as cigarettes) and can affect the way
this instead of something else. Imagine you were a farmer employees must be treated and the way a business
and had limited land. You have to decide what to grow on produces (perhaps to reduce its environmental impact).
it. This will depend in part on demand: if the demand for a » Economic issues For example, the amount of income
particular crop increases, you may switch to this and away in an economy can change over a period of time,
from something less in demand. affecting demand; the value of one currency in terms
of another can alter, affecting the cost of importing
Some decisions about what to produce and how to produce supplies; and the cost of borrowing can go up,
may be made by the government. For example, the increasing costs.
5
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» Social issues For example, an increase in the size of the and, if necessary, managers will need to change some of
population or the average age of the population in a their decisions about inputs, the transformation process or
1.1 country can affect the level of demand and the types of
products people buy.
the outputs they produce accordingly.
» Technological issues For example, changes in the Economic Social

availability and speed of the internet can make it easier
to find suppliers and sell across the world.
These external factors (known as PEST – political, economic,
social and technological) will continually be changing and Political Technological
this will affect what businesses produce and the resources
Business
they use. These factors can all have an impact on a business,
as shown in Figure 1.5. External factors can affect:
» the demand for products
» the costs and availability of inputs ▲ Figure 1.5 External influences on a business
» the nature of the transformation process.
If labour costs in one country become more expensive, for STUDY TIP
example, businesses might switch production to another Remember that the key external factors in the
country or start to use more machinery instead. If a environment of a business will vary between industries.
government signs a treaty with another country to make In the health sector, demographics may be very
trade easier, its businesses might start to sell more to significant; in the computer sector, technological changes
customers in the new partner country. New laws may make may be critical. You need to assess the key issues for any
certain products or production techniques impossible. given industry.
Businesses therefore need to monitor their external
business environment because it is dynamic (ever-changing)
CASE STUDY
Lockdown
In 2020, the Coronavirus (COVID-19) pandemic affected weeks of lockdown, there was often panic-buying, with
countries all over the world. Governments reacted in products such as hand sanitiser, toilet rolls and some
different ways, but in many countries shops were forced food products in high demand. When lockdown was over
to close and people were ‘locked down’ at home for there were concerns over how well economies would
several weeks. Many businesses such as restaurants recover. Businesses had closed down and people had lost
simply could not operate at all. Others such as food shops their jobs.
were forced to change the way they operated to ensure
that people kept a suitable distance from each other. A Questions
limited number of people would be allowed in shops and, 1 Evaluate the possible effects of the COVID-19 pandemic
once inside, they could not get too close to each other. on the transformation process of retail stores. [12]
Staff were often serving behind screens. In the first few
examined in the rest of this book. Even if a business does

What does a business need to do manage to become competitive, it cannot afford to be
to succeed? complacent because competitors will soon follow its lead;
To succeed, a business needs to be more competitive than this means it needs to keep improving and seeking ways of
its rivals. This means it needs to provide better value for becoming more competitive. Many once-famous businesses
money. Its ability to achieve this depends on: have now disappeared and those that are still successful can
» the benefits it offers. For example, what does its only stay that way by constantly improving.
product do relative to those of its competitors? Is it
faster? Easier to use? Smaller? Bigger? Longer lasting? STUDY TIP
» what price is being charged relative to the competition. Remember that businesses often compete in different
Businesses will aim to outperform their rivals by offering ways. Some may offer premium products and be able to
the same benefits for less, or more benefits for the justify high prices. Others may offer more basic products
same price. The difficult part is deciding what it is that at low prices. An important thing to think about is how
customers actually regard as a benefit, working out how sustainable this approach is in the long term – will others
to provide them and somehow doing this more cheaply be able to imitate the idea easily or can the business
than competitors, or finding additional benefits without protect its success?
increasing the price. How businesses try to do this is
6
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Why do businesses fail? Local, national, international and
Businesses fail when they stop being competitive. This
means that they stop providing good value for money
multinational businesses 1.1
relative to their competitors. This can be due to external The scope of business activity can vary significantly. Some
reasons (perhaps they have a high level of borrowing and businesses operate very much within a local market; for
so their costs are hit badly when the cost of borrowing example, a local hairdresser or local café. Their customers
rises) or internal reasons (such as poor training of staff will come from the local area. The success of these
leading to poor customer service). Businesses fail when businesses will be affected by the number of potential
they end up providing relatively low benefits given the customers in the local area and their spending power. A
price they charge. This can be because of their choice of shop in a rural area, for example, may struggle to attract

inputs, their choice of outputs or the way they manage the enough customers. Local laws introduced by the city or
transformation process. We hope that reading this book town will affect what the business can do.
will help you avoid some of these problems if you decide
Other businesses may have more of a national market. There
to manage a business. Having said that, while many of
may be a national bus company offering routes within the
the problems of business are avoidable, some – such as an
country or a national energy business. In this case, the
earthquake – may be more difficult to plan for!
business has a wider customer base that may be based
In fact, many businesses fail early on in their life. This is all over the country. These businesses will be affected by
because: national laws and by decisions of the national government.
» the people managing them may not have had much For example, changes in national government spending may
experience of business. Often people who start up a affect demand for products.
business have an interest in a product but have not
In other instances, businesses may operate around the
necessarily run a business before. They may be good at
world. These businesses are international – they export
making things, for example, but not so good at dealing
products to other countries. These businesses will be
with customers or managing money. It may also be
affected by changes in the value of their currency compared
difficult to recruit experienced staff to join the business
to other currency (this is known as the exchange rate) and
because they may want the security of a bigger business
by trading agreements between countries. For example,
that has been around for longer and has a track record
national governments may sign a treaty making it easier
of success. This means that those making the business
to sell products in each other’s countries. By becoming
decisions may not be very good at it.
an international business, an organisation may have more
» new businesses do not have much market power, which
places to find the best suppliers and resources; this can
can make it difficult to survive. For example, suppliers
allow it to access better quality supplies are a lower price.
may be worried whether they will be paid and demand
Going international means a business may also have more
payment in advance, which can cause cash-flow
markets to sell to; this can lead to faster growth and reduce
problems. Meanwhile, buyers may have a lot of power.
the risk of being dependent on one market. In recent
Imagine being a new small supplier trying to sell to a big
years there has tended to be more co-operation between
supermarket. The buyer (the supermarket) may push the
countries, making it easier to be an international business.
price down and be slow to pay, causing further financial
This has also been helped by better communications and
problems for the new business. Given its lack of power,
better transport systems.
it may have to pay more for supplies and advertising
than more established businesses, making it difficult to If businesses have bases abroad (for example, they have
compete on price. shops or factories in other countries) they are known as a
multinational. Whereas international businesses trade with
or buy from other countries, multinationals actually have
HANDLING DATA production bases or offices in these other countries. This
means multinationals can benefit from incentives (such as
Imagine 60 per cent of new businesses in a country fail
subsidies) provided by other governments to locate there.
in the first two years. Of those that survive, another 40
It also means the business is closer to its market, which
per cent fail in the next three years.
may mean it understands it better. In some cases, there are
Imagine 400 000 businesses start up in one year; how limits to the products coming from abroad into a country, or
many would you expect to be left after five years? a tax is placed on them which makes them more expensive;
by being based within a country these restrictions can be
overcome. Another benefit of being multinational is that it
spreads risk by having bases in different countries. If there
is a problem with production in one country – for example,
due to a natural disaster – production may be switched to
the other location.
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1.1.2 The role of entrepreneurs According to the Royal Bank of Scotland (RBS) a successful
entrepreneur is usually:
1.1 and intrapreneurs » well-rounded Someone who can make the product,
promote it, sell it and count the money
Entrepreneurs » able to bounce back A person who can cope with
An entrepreneur is someone who is willing to take a mistakes and have the confidence to try again
risk to start a new project or a new business. Enterprise » innovative Not an ‘inventor’ in the traditional sense,
refers to the skills needed to do this, such as creativity. but a person who is able to carve out a new niche in the
An entrepreneur has an idea and then tries to make it market, often a niche that is invisible to others
work. Entrepreneurs see the resources that are available » results-oriented To make a business successful requires
a drive that only comes from setting goals and targets
and the possibilities of combining them in a particular

way to provide a product or service. Entrepreneurs create and getting pleasure from achieving them
new businesses and in so doing provide new products and » a professional risk-taker To succeed means taking
services. Some entrepreneurs, such as Sir Richard Branson measured risks. Often, successful entrepreneurs use
of Virgin and Stelios Haji-Ioannou of easyGroup, continually a step-by-step approach to risk-taking, at each stage
have ideas for new businesses and set up many different exposing themselves to only a measured amount of
ones during their careers. Such people are called ‘serial personal risk and moving from one stage to the next
entrepreneurs’. only as each decision is proved
» totally committed Hard work, energy and single-
mindedness are essential elements in the entrepreneurial
GLOSSARY TERMS profile.
Entrepreneurs are individuals who take the risk to create
or start a new business or project.
Enterprise is the skill needed to make a new idea work.
CASE STUDY
Hirka
What qualities is an entrepreneur likely In 2017, an entrepreneur in Indonesia started a business
to need for success? that turned scraps of skin from chicken feet into leather,
which is then made into shoes. These ‘chicken’ shoes
There is no single set of qualities that has been identified are marketed as alternatives to ones made from reptile
that will definitely make someone a successful entrepreneur. skin, such as snake and crocodile, as ‘reptile’ shoes
Entrepreneurs can differ enormously in terms of their have been increasingly criticised by customers and
backgrounds, skills, interests and personalities. However, it animal rights supporters. The ‘chicken’ shoes do not
is likely that a successful entrepreneur is someone who: rely on breeding animals for purpose, as they are made
» is prepared to work very hard, especially in the initial from scraps and waste material that comes from dim-
stages of setting up the business. This means you need sum and fast-food restaurants.
determination and the ability to cope with stress and
The transformation process that turns these inputs
setbacks
into shoes begins by dyeing the chicken skins and then
» has a vision. Many entrepreneurs have stories about sewing pieces together. It takes about 10 days and up to
the various problems they encountered when they first 45 chicken feet to make a single pair of shoes. The
started up. Problems with money, suppliers, equipment business employs six people.
and so on are all fairly common. It is also quite usual
for others around you to be more cautious and less Hirka’s most popular style of shoes are sneakers, and
certain that your project will work than you are. To be the company makes only 70 pairs per month to ensure
successful, you need faith in your idea and a belief in quality is kept high. These sell for Rp500 000 ($31) and
your own vision, even when there are initial problems above.
» is willing to take a risk. It takes a lot of nerve to give up Questions
your existing job and start out on your own and yet this
1 Explain one reason why someone might set up in
is what many people do. You may have to give up the
business for themselves. [3]
salary, the company car, the support from head office and
2 Evaluate the factors that might determine the
the pension just to pursue your dream. You may also have success of this shoe business. [12]
to go through quite a long period of time with relatively
low rewards before you make it a success (if you ever do!).
9781398308114.indb 8 05/03/21 11:06 AM

Why become an entrepreneur? » You keep the rewards. If you work in a business for
someone else then the rewards belong to them. You may
There are many attractions to being an entrepreneur:
» You will experience a great feeling of satisfaction if your work very hard and very successfully and get a bonus,
but the major rewards will usually go to the owners. If
1.1
idea is successful. Imagine being able to look at a large
you are an entrepreneur, you are the owner and so any
business and know that you created it and helped it to
rewards belong to you. The downside is that if anything
grow.
goes wrong, the losses are yours as well.
» You will be your own boss. Fed up with being told what
to do? Dislike orders? Then being an entrepreneur may
» You have more control of what you do and when you do
it compared to working for someone else. Many people
be the way forward. Setting up on your own means it
become self-employed because of a desire for more
is your business, to do with as you wish. This can be
1.1.2 The role of entrepreneurs and intrapreneurs

flexible working and an improved balance between work
challenging and demanding but it does mean you are
and their social lives.
more in control of your own destiny. Some people prefer
this to working for others: they like their independence.
CASE STUDY
Awfully Chocolate
year. As people not from the baking industry, they tried
innovative methods to create a recipe they loved – and
Awfully Chocolate was born.
The first Awfully Chocolate store opened in 1998 in Katong
in Singapore, in an old side street. It offered only one type
of chocolate cake for sale. It was also unconventional
in that the cake was not displayed, so the store did not
look like a typical cake shop. This enhanced the quirky
character of how Awfully Chocolate made its mark.
Friends and family thought the business would not
last three months and even her supplier warned her
about over-ordering boxes. But Awfully Chocolate
gained a reputation for delicious handmade chocolate
cakes and quirky design, and demand proved high.
Cakes sold out every day and its reputation grew
beyond Singapore.
But Lyn wanted Awfully Chocolate to grow on its own
slowly, so she only opened her second store in 2004,
using the profits from her first shop. Awfully Chocolate’s
products now include more cakes, tarts, ice cream and
truffles. It also owns the brands Everything with Fries,
Sinpopo and Ninethirty by Awfully Chocolate, and now has
17 stores across Asia.
Lyn says that ‘every city has got its own bit of character,
bit of personality, its own quirks’, so you need to
understand these to make it work.
According to Lyn, although people say the success is due
to luck, it’s actually due mainly to hard work!
▲ Figure 1.6 Lyn Lee
Source: www.bbc.co.uk/news/business-11701575
Living in Singapore – a very cosmopolitan city – Lyn
Lee was amazed that she could not find a simple dark Questions
chocolate cake! Most chocolate cakes in the market were
1 Analyse one reason why demand for Awfully
either too sweet and creamy or not chocolatey enough.
Chocolate’s products may have been high. [4]
So she decided to set up a business to make the perfect
2 Evaluate whether the success of a new product is
everyday chocolate cake – soft, moist, very chocolatey
likely to be mainly due to luck. [12]
but not too sweet or creamy. With some friends, she tried
different recipes and techniques every weekend for a
9781398308114.indb 9 05/03/21 11:06 AM

ahead of competitors. To help people be intrapreneurs, the
CASE STUDY business needs to empower them to make decisions and give
1.1 them the resources they need to try things out. The business
needs to encourage an approach where it is perfectly
Government regulations
acceptable to try and fail in order to ensure that employees
Governments regulate businesses to protect different are willing to take risks. Intrapreneurship can be critical to
groups. For example, laws may be introduced to prevent
the ongoing success of a business.
employees from being exploited, to protect customers
from unsafe products and to protect businesses Entrepreneurs and intrapreneurs create change and
from other businesses using unfair tactics. However, challenge the way things are done. They find and create new
regulations can make it more difficult to set up and run markets, generate income and employment and bring about
a business, which can deter entrepreneurs or make it innovation. They are extremely important to the growth
difficult to do business. This can lead to entrepreneurs of an economy and to improving the quality and range of
not starting up a business or doing so in another goods and services on offer.
country. In Uruguay, for example, entrepreneurs have
to deposit a significant sum of money in the bank and a
new business has to pay many taxes. GLOSSARY TERM
Intrapreneurs are people within an established business
Questions
who think and act like entrepreneurs.
1 Explain one reason why people want to set up in
business. [3]
2 Evaluate the problems that regulations can play Barriers to entrepreneurship
in determining the success of a new business. [12]
Entrepreneurship may be limited in a country because of a
number of factors:
» The financial system may not be good at supporting
The role of intrapreneurs start-up businesses. Banks, for example, might think
An intrapreneur is an entrepreneur within an existing starts-ups are too risky and avoid them, or make it
business. As businesses get bigger, they often worry that difficult and expensive for them to borrow.
they lose some of the creativity and risk-taking that they » There may be many different regulations involved in
had when they first started. The danger is that to control setting up a business, which discourage people from
a larger business, the managers introduce many rules and doing this or make it complex and slow to do.
policies which potentially limit innovation. » The culture in the country may not favour entrepreneurs;
failure may not be accepted socially and those who do
Intrapreneurship occurs when the business encourages fail may find it difficult to find financial backers when
people within the organisation to think and act like they want to start a second venture.
entrepreneurs. The business wants existing staff to challenge » The government may prefer state provision and not
the way things are done, to question whether there are want to encourage entrepreneurs; there might be some
better ways of doing what they do and to take business goods or services that have to be provided by the
risks; they want intrapreneurs. The aim is to keep established government.
businesses moving forwards, being flexible and keeping
CASE STUDY
Ease of starting up
The Doing Business Index produced by the World Bank The table below shows the data for the top five and bottom
measures the number of procedures, such as the time five countries identified in May 2019. The top five are
and cost, involved for a small to medium-sized company to the countries where it is easiest to do business and the
start up and formally operate in each economy’s largest bottom five are the countries where it is most difficult to
business city. do business.
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▼ Table 1.1 Ease of doing business by country
Location Starting a business rank Starting a business score 1.1

New Zealand 1 100
Georgia 2 99.6
Canada 3 98.2
Singapore 4 98.2
Hong Kong, China 5 98.2
1.1.2 The role of entrepreneurs and intrapreneurs

Chad 186 52.5
Cambodia 187 52.4
Somalia 188 46.0
Haiti 189 36.4
Venezuela 190 25.0
Source: www.doingbusiness.org/en/rankings
Questions
1 Explain one factor that might influence the ease of 2 Evaluate the implications of the data above if you
doing business in a country. [3] were going to set up a business abroad. [12]
Business risk and uncertainty and they hire the wrong people, with the result that the
quality of service is not as good as hoped.
Uncertainty is a feature of business life. Businesses have to
make decisions based on what they know and, in many cases, Entrepreneurs may sometimes undertake a project ‘because
their best estimate of a situation. Decision-making is often it is there to be done’. They may be driven by a desire to
focused on preparing for the future and, obviously, we do do something new. This in itself may be a reward in terms
not know exactly what is going to happen then. Businesses of self-satisfaction or a sense of self-achievement: they
can look at what is happening now, what has happened in can hopefully look back on their career and be proud of
the past and they can research what different scenarios what they have achieved. However, entrepreneurs may also
might look like in the future, but they will not know with be interested in other rewards from setting up, such as
100 per cent certainty. This means decisions will involve a the financial gain from owning their own business. These
risk. Risk occurs when there is a danger that the outcomes rewards can be high! For example, YouTube was set up in
will be unfavourable. Businesses will want to assess the risk February 2005 by Chad Hurley, Steve Chen and Jawed Karim.
and, where they can, take actions to reduce the risk. The website includes music videos, movie and TV clips, as
well as material posted by the general public. In 2006, the
Entrepreneurs are people who are prepared to take risks founders of YouTube sold their business to Google for $1.65
to start up and develop a business. They are investing billion! Not a bad return in less than two years.
time, money and effort into a new project that may or may
not work. The danger is that it will not work and all their To go ahead with any venture, the expected rewards must
investment will be lost. Many new businesses fail. Look at justify the risk involved. In an ideal world, a project would
the main shopping street in your nearest village or town. have a high reward and low risk, but typically new ventures
How long have the shops been there? Have some opened are very risky because there are so many things that can
up recently? Have some closed down in the last year? The go wrong. In fact, many ideas do not even get launched.
landscape of the centre of most towns is changing all the Entrepreneurs hit so many setbacks or face so many
time as some business ideas fail and others rise to take difficulties that the project does not go ahead.
their place. The real risk to entrepreneurs is that they will ▼ Table 1.2 Risks and rewards matrix: analysing projects
lose much or even everything they have put into a project
because the business idea eventually fails. Risk
Some of the causes of risk are external. For example, there Reward Low High
could be a change in the economy, meaning people have Low These are safe projects These projects are not of
less money to spend than entrepreneurs had expected (and but do not generate interest because of the
so demand for their products is lower than they hoped), or high returns. high risk relative to the
competitors may have changed their behaviour, making it low rewards.
more difficult for similar businesses to survive.
High These projects are These projects are of
Alternatively, the causes of risk could be internal. It may be ideal: low risk but high interest but risky. To go
that an entrepreneur’s understanding of the market is not as rewards. However, it ahead, entrepreneurs
good as they had thought and they make some bad pricing may not be easy to find must believe the rewards
decisions. It may be that their judgement of people is poor projects like these! outweigh the risks.
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HANDLING DATA
1.1 If you estimate that a project has a 55 per cent
probability of succeeding, what is the probability of
failure?
CASE STUDY
Banyan Tree
Historically, a banyan tree gave shelter to weary a different type of hotel, designed to stand out from the
travellers. Its name is now the brand of a chain of competition, with a luxury spa and villa format instead
luxury hotels and resorts around the world, founded by of the typical hotel building with rooms. He insisted on
multimillionaire Ho Kwon Ping. decisions others thought would not work because he was
sure they would. For example, the staff at the spa did not
Ho Kwon Ping attended Stanford University after he left
wear shoes because being barefoot in Asia is a sign of
school, and later protested against the Vietnam War. In his
respect, and they wore Asian clothes rather than the white
time as a journalist for the Far East Economic Review, he
uniforms that staff in Europe tended to wear.
wrote controversial articles that resulted in him spending
two months in a Singapore jail. He continued working as Banyan Tree Hotels & Resorts has now grown into one of
a journalist after his release and settled with his wife the leading providers of resorts and spas, operating in 28
on an island off the shore of Hong Kong. He joined the countries with 47 resorts and hotels around the world,
family business after his father became ill, deciding that 64 spas, 72 retail centres and three championship golf
it needed to do more than manufacture products for other courses.
companies. Producing for others, he realised, limited your
profits and eliminated your brand presence. Questions
1 Analyse one external factor that might have helped the
This fuelled his decision to move the company into the
success of Banyan Tree. [4]
hotel industry, but he struggled to generate customer
2 Evaluate the features you think make a successful
interest in their planned new hotel in Phuket, Thailand.
entrepreneur. [12]
Ho Kwon Ping resolved that the Banyan Tree should offer
STUDY TIP The role of business enterprise in the

Remember that any decision has a risk attached to it, but development of a country
the key question is whether this risk is worth it. Managers
Enterprise involves taking risks to develop new ideas. This is
must try to assess the probability of any outcome and
decide whether the business should pursue any course of
important to businesses and the country as a whole because
action given the risk involved. a business enterprise finds solutions to problems, and new
and better ways of doing things. This can help the business
reduce costs and offer more benefits at a lower price than
competitors.
Why do governments like
For the country as a whole, enterprise leads to innovation,
entrepreneurs? which creates new products and economic growth.
Governments like entrepreneurs because they set up new Enterprise challenges established ways of doing things and
businesses in an economy. This means that entrepreneurs: provides competition to existing providers. This can lead to
» create jobs and help keep unemployment low in the economy more choice, better quality and lower prices for customers.
» earn money and pay taxes
» create competition for the existing providers in markets How can governments help
and provide new products and services. This is good for
customers, who get more choice, and this is likely to lead entrepreneurs?
to better service. There are many ways in which governments can help
entrepreneurs. They can provide:
Given the benefits of entrepreneurship, many governments
» access to advice and useful information to help them get
are willing to help entrepreneurs to start up and grow their
started. For example, a new entrepreneur may have little
businesses.
experience of financial matters and appreciate some
advice in this area
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» funding such as grants to help with the initial start-up
costs HANDLING DATA
» legal protection for new ideas. For example, a patent
provides legal protection for an invention. This means Imagine you need to raise $250 000 to start your
1.1
that inventors can make profits without their ideas business. The government will provide 3 per cent, and
being ‘stolen’ by others. your savings equal 6 per cent. How much money do you
still need to raise?
CASE STUDY
1.1.3 Business plans

EY World Entrepreneur of the Year
In 2020, Dr Kiran Mazumdar-Shaw of Biocon Limited, India, discovering, developing and producing medicines for
won the award for the EY World Entrepreneur of the Year. chronic diseases such as diabetes. Biocon has been
consistently ranked as one of the highest investors in
Kiran graduated from a brewing school in Australia in
research and development in India. Kiran is very focused
1975 and returned to India to begin her career. However,
on helping society. Through her business, she aims to
as a woman in a very male-dominated industry, she
develop affordable medicines that can help save millions
struggled to get a job. Instead, she started her own
of lives.
business and founded Biocon in 1978 with a mere $500
from investors. Today, Biocon is a leading biotech company Questions
and one of the largest employers in Asia, with a workforce
1 Analyse one factor that might have contributed to
of over 11 000. Kiran has been named on both the Forbes
the success of Kiran’s business. [4]
100 Most Powerful Women list and Time magazine’s 100
2 Evaluate the importance of spending on research
Most Influential People in the World list. She is known for
and development of new products to the success
her determination and proactive approach.
of Kiran’s business. [12]
Led by Kiran, Biocon has gone from manufacturing
pharmaceuticals, such as immunosuppressants, to
» a financial section which would include a cash-flow

1.1.3 Business plans forecast, a profit forecast and a statement of what the
A business plan is a written document that sets out business owns and owes
key aspects of a business idea. A business plan is often » details of the human resource requirements of the
produced by entrepreneurs when setting up a business to try business.
and anticipate any potential problems and opportunities,
and to put in place appropriate actions. A business plan The benefits and limitations of
is a useful document to have to show potential business
partners, investors or banks. This is because it shows the business plans
business is thinking ahead, is researching the risks and has To produce a business plan, an entrepreneur will undertake
suitable plans. A business plan should have information market research and make plans for the different functional
and data to support the ideas and plans of the business and areas of the business. To produce a business plan, managers
reduce the risks to those lending money to it. must think carefully about what has to be done. This will
help the business to identify the degree of risk involved in
A business plan should be a working document: as
any aspect of the business and take appropriate actions to
conditions change it should be updated to reflect this and
manage this risk. The plan is a way of co-ordinating all the
the plans changed accordingly. A business plan is not just
different activities of the business so that everyone knows
for when a business starts up; the business should keep it
what has to be done when, and how this fits with what is
relevant as the business grows.
happening elsewhere within the business. The plan sets
‘milestones’ of what is to be achieved by when. It can set
Key elements of business plans targets so everyone in the business knows how to measure
A business plan will typically have the following elements: success and understands how what they do contributes
» an outline of the owners and their background and to the overall success of the business. At any moment,
experience the progress of the plan can be checked and, if necessary,
» an overview of the business idea and its products action can be taken. Even if things start to go wrong,
» an analysis of market conditions and the positioning of having a plan is valuable because managers can assess
the business and its products within the market where they are compared to where they should be and then
» an outline of how the business is to be promoted decide what to do. Without a plan, they may not recognise
» an estimate of the sales of the business that things have gone wrong until far too late.
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However, a plan is simply a statement of what the business However, for all of these businesses, planning can
intends to do. How useful it is will depend on how accurate help prevent mistakes by identifying difficulties early,
1.1 its forecasts are, whether the right actions are planned in
the given circumstances and whether they are implemented
co-ordinating actions across departments and helping to
take action quickly to get back on track. Even so, plans
effectively. Simply having a plan does not guarantee must always be reviewed because external and internal
success – it depends how good it is and how well it is conditions will change, and therefore the plan may need to
carried out. be flexible to keep relevant and competitive.
The nature of the plan will differ for a start-up business
compared to an established business (for example, because STUDY TIP
the start-up will have limited experience compared to a Remember that producing a business plan is only part of
business that has been going for some time). Similarly, it the challenge of managers. To make it work, it has to be
will differ for a small business compared to a big business implemented effectively.
in that the latter’s plan is likely to be more complex and
involve more money, more products and more markets.
CASE STUDY
TikTok
TikTok, the 15-second video app, is a technology start-up Founder Zhang Yiming, who is in his thirties, was inspired
that has grown incredibly fast. Within two years, TikTok by the early success of China’s technology pioneers of the
was rivalling Netflix, YouTube, Snapchat and Facebook late 1990s, such as Robin Li of Baidu, Jack Ma of Alibaba,
with more than 1 billion downloads in 150 markets and Pony Ma of Tencent.
worldwide and operating in 75 languages. TikTok had a
TikTok makes money through adverts and from the sale
value of nearly $80 billion within two years of starting
of virtual goods, such as emojis and stickers, to fans. It is
up. Through the app, users create and share homemade
easy to use and is designed to exactly match what users
videos on their phones. This content has proved incredibly
want to see, rather than recommending content based on
attractive to young audiences all over the world.
people’s viewing habits and ‘likes’.
Virtually no translation is needed, as TikTok’s content is
primarily visual. This allows it to reach larger consumer Questions
audiences more easily than other successful Chinese 1 Analyse one factor that might determine the
apps, such as Tencent’s messaging app WeChat. WeChat success of a new app. [4]
is used extensively within China but is mainly used by 2 Evaluate the value of having a business plan to a
Chinese communities outside of China. Within China, business such as TikTok. [12]
TikTok is known as Douyin.
TEST YOUR LEARNING

b Explain one effect of business failure on an
Short answer questions
economy. [3]
1 Define the term ‘factors of production’. [2] 7 a Define the term ‘intrapreneurship’. [2]
2 a Explain one possible purpose of business apart b Explain one reason intrapreneurship is
from profit. [3] important to business. [3]
b Explain one reason a business might want to 8 a Define the term ‘adding value’. [2]
make a profit. [3]
b Explain one way a business might try to add
3 a Define the term ‘scarcity and choice’. [2] more value. [3]
b Define the term ‘opportunity cost’. [2] 9 a Define the term ‘multinational business’. [2]
4 a Define the term ‘business plan’. [2] b Explain one reason why a business might
b Explain one reason why producing a business become a national rather than a local business. [3]
plan is useful for a business. [3] 10 a Explain one likely feature of a successful
5 Explain one way in which growth in the economy entrepreneur. [3]
might affect the costs of a business. [3] b Explain one reason why entrepreneurs are
6 a Explain one reason why a business might fail. [2] important to an economy. [3]
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Data response question Bee Fearless, Dream Like a Kid. The business has some
Me & the Bees Lemonade was set up by Mikaila Ulmer
when she was aged four!
high-profile investors, including $800 000 from a group of
National Football League players. 1.1
From the very beginning, Mikaila invested some of the
Mikaila’s interest in bees started when she got stung
profits from the sale of her lemonade to organisations
twice within a week. She started to research bees to find
fighting hard to save bees. Me & the Bees encourages
out more about them and became fascinated. Around
everyone to ‘Buy a Bottle ... Save the Bees’.
that time, her family had encouraged her to enter some
children’s business competitions, and her grandmother Most recently, Mikaila launched her own non-profit,
had sent her a cookbook which contained a special Healthy Hive Foundation. Through research, education
1.1.3 Business plans

recipe for flaxseed lemonade. Mikaila decided to adapt and preservation, the Healthy Hive Foundation is
the recipe and use honey from the honeybee rather than dedicated to increasing bee awareness and the number of
sugar. That was the start of her business. It was originally safe environments for bees to survive and thrive.
going to be known as Be Sweet Lemonade but Mikaila
had to change the name as it was already being used by Questions
another business. She decided to call her business Me & 1 Explain one reason why Mikaila set up in business. [3]
the Bees Lemonade because a percentage of sales are 2 Explain one factor that influences demand for
donated to help save the bees. The company has now Mikaila’s products. [3]
been in ‘buzzness’ for more than 10 years! Its products
3 Analyse one skill that Mikaila would have needed
are sold in many different retailers, such as Whole Foods
to be such a successful entrepreneur. [4]
Market across Texas and Kroger stores in Houston. The
4 Evaluate the challenges that Mikaila’s business
product range now includes lip balm and different types
might face in the future. [12]
of lemonade.
Mikaila gives many talks about the importance of saving
the bee population. She has also written her first book,
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AS LEVEL
1.2 Business structure

AS LEVEL 1.2 Business structure
Chapter overview
★ the different economic sectors in an economy, that is, the difference between primary, secondary, tertiary and
quaternary sectors and the private and public sectors, including the concepts of unlimited liability and limited liability
★ the advantages and disadvantages of different forms of legal structure, such as sole traders, partnerships,
companies, co-operatives, franchises, joint ventures and social enterprises.
– Quaternary sector This is a subset of the tertiary

1.2.1 Economic sectors sector which represents organisations that are
There are many types of businesses and it is useful to be based on knowledge and the skills of employees;
able to categorise them to analyse their performance and for example, information service businesses, such
the different issues they face. Typical ways of categorising as management consultancies, and research and
business include by sector and by legal status. development businesses.
The more developed an economy is, the more resources are
Primary, secondary, tertiary and diverted into the tertiary and quaternary sectors. Economies
begin by being very agriculturally based (primary sector).
quaternary sector businesses Investment in capital equipment leads to more factories and
The many businesses that exist in an economy operate in equipment and the development of the secondary sector. As
one of three sectors: investment continues, resources tend to move away from
» Primary sector This is the first stage of production the mass-production processes towards higher value-adding
and involves acquiring or extracting raw materials. For sectors based on services and knowledge. For example,
example, oil has to be extracted from the under the developed economies may focus on sectors such as design,
ground, coal has to be mined, fish have to be caught programming, creative work, and research and development
and crops have to be grown. Oil, mining, fishing and more than mass production.
agriculture are all in the primary sector of the economy.
Raw materials can be renewable resources, such as fish
and wind power; this means they can be replenished. The public and private sectors
Or raw materials may be non-renewable, such as oil and We can also distinguish between businesses that are owned
coal; this means the total stock available is reduced as by private individuals, which are in the private sector,
they are consumed. and those that are owned by governments, which are in
» Secondary sector This is the part of the economy the public sector. Local supermarkets, clothes shops and
that manufactures and assembles products using hairdressers are likely to be in the private sector (although
raw materials. For example, cars are manufactured not always); the provision of electricity, water and health
using many different parts and materials, and so car services is often in the public sector (although, again, this
manufacturing is part of the secondary sector. Similarly, will vary from country to country). Some products may
the construction industry uses many parts to produce be provided by both the public and private sectors; for
houses and office space. example, there may be government-run schools and private
» Tertiary sector This is made up of businesses that schools.
provide services. These services are intangible – that If a government takes control of a private sector business,
is, the service they provide cannot be physically this is called nationalisation. If a government sells one
touched (unlike manufactured goods, for example). of its organisations to the private sector, this is called
Examples of businesses in the tertiary sector include privatisation.
retailers, transportation businesses and providers of
financial services, such as insurance. This is often the Typically the government is likely to run organisations:
biggest sector in developed economies in terms of both » that have a strategic importance to the country, such as
employment and the value of the output. defence, in order to protect the country
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» that provide essential services, such as energy and However, the role of government may change over time; for
water, that the government wants to make sure everyone example, in China the government has been intervening less
has access to regardless of income
» whose benefits may not be fully appreciated by
in the economy and the private sector has been growing in
recent years, whereas in Venezuela government intervention
1.2
individuals, such as education and health. These are has increased in the last 20 years.
called merit goods. The reasons why there might be less government
Public sector organisations can have social objectives, not intervention, and therefore a bigger private sector, include
just profit objectives. This means they may provide non- a desire that people own their own businesses. This is
profit-making services, such as transport to remote areas. A because it gives a great focus on running them well. If
private sector business would probably not be interested if individuals own all or part of an organisation, they will
1.2.1 Economic sectors

there were not enough passengers, but the government may want it to make a profit because they will benefit from
provide this service for the welfare of its citizens. this financially. This encourages people to identify and
meet customers’ needs – to provide them with the goods
GLOSSARY TERMS and services and the quality they need and want. It also
Nationalisation occurs when a government takes
encourages people to be efficient and not waste resources
ownership of a business from the private sector into the because they want to generate more profits. By comparison,
public sector (see Chapter 6.1.1). if an organisation is owned by the government, those
working within it may not be concerned with whether their
Privatisation occurs when a government transfers
products are in demand or not, and they may not be focused
ownership of a business from the public sector to the
private sector (see Chapter 6.1.1).
on increasing revenue or reducing costs because they do not
benefit directly.
Merit goods are goods or services, such as education
and health, whose benefits individuals may not fully The reasons why there might be more government
appreciate. For example, when thinking about how much intervention, and therefore a bigger public sector, is
to spend on healthcare, people will think of the benefits because people do not trust the private sector. For example:
to themselves rather than the benefits that being healthy » They may want more provision of healthcare and
also bring to those around them. education for everyone. In the private sector, this will
only be provided for those who can pay.
» They may want to provide a full range of services,
Reasons for the changing relative including some that are not profitable; for example, rail
importance of private and public or bus links to remote areas or a postal delivery service
to distant locations within the country.
sectors » They may want to use some businesses to help maintain
The extent to which a government intervenes and the public employment levels in a region or economy, even if it is
sector is involved in an economy will vary from country to not as efficient as it could be.
country and depends a great deal on political views about » They may worry that the private sector is misleading
the role of the state. In countries such as North Korea, customers, or selling products which are cheap to make
there has been a belief that the government should mostly but not safe, in order to make more profits.
decide how resources are allocated and so there is a large ▼ Table 1.3 Benefits of the private and public sectors
public sector and small private sector.
Cuba is one of the world’s most centrally planned Benefits of private sector Benefits of public sector
economies, meaning that the government still runs most of Focus on profits means Focus on what is beneficial
the organisations that exist on the island. According to the businesses want to provide for society rather than what
CIA World Factbook, the Cuban government employed nearly what is demanded and ensure is profitable
73 per cent of all Cuban workers in 2017. Although there quality is good
have been some changes in recent years to encourage more Focus on profits means Will not try to exploit or
private sector businesses, the number remains very small businesses want to be mislead customers
and the government still controls the majority of business efficient and not waste
activities. By comparison, countries such as the USA allow resources
market forces to allocate resources to a greater extent, so
the public sector is smaller and the private sector is bigger.
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CASE STUDY
1.2
Cuba
retail services to entrepreneurs. Over half a million Cuban
workers are now self-employed. Other changes include
the private ownership and sale of property, and private
farming and non-agricultural co-operatives.
Despite the increasing opportunities for UK companies in
Cuba, the market still offers challenges, which include:

l very slow decision-making, with most important
business decisions being referred to high-level
government
l all sales in Cuba are public sales, controlled by heavy
regulation
l commonality of payment delays
l the standard practice for the Cuban state to expect to
buy on credit terms of 1–2 years
▲ Figure 1.7 A street in Havana, Cuba l potentially increased market competition due to easing
of US sanctions, which will make it easier for Cubans
Since 1965, Cuba has been governed by the Communist to trade in the USA.
Party. It has been one of the most centrally planned,
state-run economies in the world since then. However, Sources: CIA World Factbook; UK government, Department for
although the government in Cuba retains a high level of International Trade
political control, it is gradually opening up markets to Questions
allow competition. For example, Cubans can now set up
1 Analyse one potential benefit of a centrally planned
private businesses to sell electronic devices and mobile
economy. [4]
phones, run hotels, and buy and sell used cars. The
2 Evaluate the possible impact for businesses in
government has reduced the number of state sector jobs
Cuba of having more privately owned businesses. [12]
as part of its reform process and has opened up some
1.2.2 Business ownership hairdressers are often sole traders. The people running these
businesses work for themselves. In some cases, sole traders
When setting up in business, the founders must consider hire other people to help them out, but they are the owners
the most appropriate legal form for their enterprise. There and remain responsible for the overall business. Sole traders
are several different types of business organisation, each are actively involved in the running of it on a daily basis.
of which has its own legal structure. These include sole
traders, partnerships, private limited companies and public What does it take to be a successful
limited companies, co-operatives, franchises, joint ventures sole trader?
and social enterprises.
As a sole trader you need to be someone who is willing
to work on your own, who has the confidence to make
Sole traders your own decisions and who can turn your hand to almost
any aspect of your business. As a sole trader, you may
have to serve customers, decide what equipment to buy,
deal with suppliers and keep accurate and up-to-date
business records. This requires a wide range of skills and an
enormous degree of flexibility.
Sole traders have to be used to working hard: running your
own business is no easy task. You must also be good at
managing stress. All the decisions of the business are yours
alone, so if you get it wrong the responsibility is yours. On
the other hand, if it is successful, the sense of achievement
and the rewards are yours too!
Becoming a sole trader requires a high level of self-
discipline, because you are your own boss: there is no one
▲ Figure 1.8 Sole traders run their own businesses to tell you what to do. This can be very exciting, because
When individuals run a business on their own, they are known you decide what is going to happen. However, it also means
as ‘sole traders’. Plumbers, decorators, window cleaners and that you have to motivate yourself to get things done. For
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example, you have to organise your day properly and use » receive a more regular income
your time effectively. » be able to call on experts to help you solve problems.
The advantages of being a sole trader

On the other hand, there is not quite the same sense of 1.2
achievement and satisfaction of having created something
One of the main advantages of being a sole trader is that for yourself.
it is so easy to start up in business. Unlike starting other
types of organisation, you do not need to register with ▼ Table 1.4 Advantages and disadvantages of being a sole
anyone or fill in any special forms: you can just start trading trader
(provided you declare your profits to the government tax Advantages Disadvantages
office at the end of each financial year!). If you suddenly
1.2.2 Business ownership

decide you want to be a gardener, a web designer, an artist, • Making your own • Sources of finance are
an interior decorator or a cleaner, you could start up in decisions can be limited.
business tomorrow. It may be wise, however, to do some motivating. • You rely heavily on your
planning and get some training first! • You can make decisions own ability to make
quickly and respond decisions.
Many people also enjoy not having to take orders from other rapidly to changes in the • You may work long hours
people. They like the freedom to make their own decisions, market. and have limited holidays,
to decide when and where to work, what to do and how to • You have direct contact leading to stress.
do it. You can also make decisions quickly as you don’t have with the market. • You are subject to
to check with anyone to get permission to do something. It • Setting up is easy. unlimited liability.
can be incredibly motivating to be your own boss. Another
important advantage of being a sole trader is that you keep
all the rewards of the business. You don’t have to share the GLOSSARY TERM
profits with anyone else. Unlimited liability occurs when an individual or groups of
individuals are personally responsible for all the actions
Many entrepreneurs begin as sole traders for these reasons.
of their business. With sole traders, there is no distinction
in law between the individuals and the business, and so
The challenges of being a sole trader they could lose their personal assets if the business has
While being a sole trader can be very fulfilling, it also financial problems.
brings with it many challenges. Making all the decisions can
be exciting, but you carry all the responsibility if anything
goes wrong. If you work for someone else and there is a
Partnerships
real problem, you have someone to work with to solve it. If you join with other people and set up a business together,
Being a sole trader can be quite lonely: some people find it this is known as a partnership. This is common in professions
difficult to cope with the pressure. The hours may be quite such as accountancy, medicine and law. The benefits of
demanding too. This is particularly likely to be an issue in forming a partnership over being a sole trader include:
the early years, when you are trying hard to build up enough » You have other people to share ideas with.
business. Also, you may not be able to take much time off » There are more people to invest in the business and help
for holidays because you may not be able to afford to close finance it.
the business and risk losing customers. » You can benefit from each other’s specialist skills; for
example, if you have a legal practice, you could have one
Another difficulty is raising finance to set up the business partner specialising in tax law, another in marital law,
and expand it. You generally have to rely on your own money another in company law, and so on. This enables you to
or money from friends and family (plus the money from offer a wide service to customers.
the business itself, once it is up and running). Of course, » You can cover for each other if someone is ill or on holiday.
it is possible to borrow from a bank or other financial
institution, but they often charge smaller businesses quite However, a partnership can present challenges:
high interest rates because they are worried about the risk » You need to consult with others and there may be
of failure and want to cover their losses. disagreements between the partners over the policies
and direction of the business.
» You are dependent on the actions of others. If, for
Unlimited liability and its importance example, one of the partners makes a mistake or brings
Being a sole trader is also quite risky if anything goes the partnership into disrepute, it will have an impact on
wrong. This is because sole traders have unlimited liability. all the partners. Each partner is liable for the actions of
The sole trader keeps any rewards the business makes, the other partners’ actions, which can be risky.
but is also personally responsible for any losses. If their » In most partnerships, the partners have unlimited
business has problems, a sole trader can lose their personal liability, which means that there is no distinction
possessions. between the individuals and the business. If the
In many ways, working for other people in a large business is sued, for example, the individuals may lose
organisation is much easier because you are likely to: their personal possessions. This is a risk that some
» have other people to share ideas with people may not be prepared to take.
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To reduce some of the possible problems of a partnership, Limited liability and its importance
the individuals involved are advised to write a ‘deed of
1.2 partnership’. This document sets out the ‘rules’ of the
partnership; for example, it sets out:
Limited liability means that a company is responsible for
the money it owes but that the personal possessions of its
» how the partnership would be dissolved if someone wanted owners are safe. This is different from a sole trader, who has
to leave. It would set out how the partnership would be unlimited liability and could lose everything if the business
valued and therefore what the person leaving would receive has financial problems.
» how to resolve disputes if the number voting for and Having limited liability is essential for companies to be able
against is equal to raise money by selling shares. Without it, investors would
» how profits will be divided up; if this is not specified, be far less likely to buy shares because of the risk to their
the profits are divided up equally.
personal possessions. If you invested in a business with

unlimited liability, it would mean giving money to others to
▼ Table 1.5 Advantages and disadvantages of setting up as
use and risking everything you owned. With limited liability,
a partnership
you know what the maximum amount is that you could lose;
Advantages Disadvantages this means that the risk is limited.
• Share resources, ideas and • Share profits Having company status means that:
workload • May disagree over decisions » the business must pay to have its accounts checked
• More sources of finance • Unlimited liability annually by independent accountants (called auditors)
than a sole trader » the company accounts must be made public, so that
• Cover if someone is ill or outsiders can see the revenue and profits of the
on holiday business, as well as what it owns. This means that there
is less privacy of affairs than if you are a sole trader.
HANDLING DATA Private limited companies

Private limited companies have ‘ltd’ after their names.
You have four other partners in your business. You have They are owned by shareholders and the owners can place
agreed to share profits. If your profits are $240 000, how restrictions on who the shares are sold to in the future.
much does each partner receive? For example, many (but not all) private limited companies
are owned by families who limit the sale of shares to other
Companies members of the family: this makes sure that outsiders do
To avoid some of the problems of being a sole trader or not become involved. Owners of shares in private limited
a partnership, you may decide to establish a company companies cannot advertise their shares for sale; they have
instead. To set up a company, the owners have to complete to sell them privately.
various documents. In the UK these documents are kept at
Companies House. This process is known as incorporation. Public limited companies
A company is owned by shareholders. Each share in the Public limited companies have ‘plc’ after their names.
business represents a part of the company. The more shares Once again, they are owned by shareholders but, unlike
someone owns, the more of the company belongs to them. private companies, restrictions cannot be placed on the
sale of these shares. Shareholders in public companies
A company has its own legal identity, separate from that of can sell their shares to whoever wants to buy them. This
its owners. The company can own property, equipment and can cause problems if another firm starts to buy up shares
other goods in its own right and is responsible for its own in the business in an attempt to gain control of it. Some
debts. If the company fails, the shareholders can lose the of the shareholders may want to resist this takeover,
money that they invested in the business when they bought but they cannot stop fellow shareholders from selling
shares, but they cannot lose more than this. This is because their shares.
shareholders have limited liability.
Another difference between plcs and ltd companies is that
shares in plcs can be advertised in the media. This is why
GLOSSARY TERMS you can see the share prices of public companies listed in
A company is a business organisation which has its own the newspapers, but not those of private companies. Most
legal identity and which has limited liability. companies become public because they want to advertise
Shareholders are persons or organisations that own a their shares to the general public and raise relatively large
part of a company. sums of money. Most public companies (but not all) are
Limited liability means that investors can lose the money bigger than most private companies.
they have invested into the business but their personal If the owners of a private company do not need to raise
possessions are safe. There is a limit to their risk.
large sums via the sale of shares and want to maintain
A franchise occurs when a franchisor sells the rights to control over their company then they probably would not
use or sell their products to a franchisee. want to make it a public company.
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HANDLING DATA
There are 250 000 shares in a company. You have 400
1.2
shares. What percentage of the company do you own?
CASE STUDY
UK dividends

In 2020, there was a massive drop in the amount of began, businesses such as high street stores were
dividends paid by companies in the UK – and indeed already under pressure from e-commerce. Oil companies
around the world – amid the Coronavirus (COVID-19) were trying to survive given the long-term decline in
pandemic. UK dividends were more than 60 per cent lower hydrocarbon consumption. Car makers and airlines were
in 2020 than in 2019. To give a context, dividend payments generally struggling in highly competitive industries for
globally fell by only 20 per cent during the financial crisis decades, making little, if any, profit. Even the industries
in 2008. which typically offered relatively high dividends, such as
utilities and telecommunications, now face increasing
Banks cancelled their dividend payments indefinitely to
regulation and weak long-term growth.
hold on to their cash. Retailers, hotel groups, airlines,
travel groups and many manufacturers did the same. However, even amidst such difficult times there were
The oil giants BP and Shell – which according to Citywire some business sectors that offered opportunities, such as
accounted for nearly 30 per cent of UK dividends in insurance businesses and delivery companies.
2020 between them – faced severe pressure to reduce
dividends because the oil price collapsed with less Questions
demand for energy from businesses because they had 1 Explain one factor that might influence the amount of
shut down. Shell announced it would stop dividends for dividends paid by a business. [3]
the first time since 1945. 2 An investor wants to know what shares to buy. Advise
her on an industry you think is likely to do well in your
The ability of many companies to pay dividends may be
country in the next few years. [12]
affected for years to come. Even before the pandemic
CASE STUDY
Tesla and Toyota
In 2020, the share price of Tesla, the electric car maker, ▼ Table 1.6 A comparison of Tesla and Toyota
went so high that the company became the world’s most
valuable car maker, overtaking Japan’s Toyota. Tesla’s Sales volume 2019 Sales revenue 2019 ($bn)
share price went to over $1100, which gave the company a Toyota 10.46 million 281.20
market capitalisation of $209.47 billion (£165 billion). This
meant that Tesla was worth approximately $4 billion more Tesla 367 000 24.6
than Toyota, even though the Japanese producer sold
Questions
around 30 times more cars in 2019 and its revenues were
more than ten times higher. The price of shares in Tesla 1 Analyse one factor that may determine the demand
increased as investors began to feel more confident about for electric cars. [4]
the future of electric vehicles. Many analysts believe 2 Evaluate the factors that affect the price of Tesla
that Tesla is significantly ahead of its rivals in terms of shares. [12]
its product range, capacity and technology. The value of
Tesla in 2020 was approximately three times the combined
value of General Motors and Ford.
fast-food business. You could sit down and develop your

Franchises own idea from scratch. However, it could prove to be
If you do not have an idea for your own business or do difficult to come up with something that would capture
not want to risk setting up completely on your own, you demand and then decide on a brand image, a way of
might want to buy a franchise. A franchise occurs when producing the food, a menu and decor for your stores. An
one business (the franchisor) sells the right to use and alternative would be to buy the rights to sell, for example,
sell its products and/or services to another business (the McDonald’s products in a given area. In this case, you would
franchisee). Imagine you were interested in setting up a be buying a McDonald’s franchise.
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How do franchises work? The problems of buying a franchise
There are many different forms of franchise, but the basic The most obvious problem with buying a franchise is that
1.2 elements of a franchise agreement are: it costs you money! This reduces the profits you make.
However, you hope that by buying a franchise you will do
» The franchisor sells the right to the product in return
for an initial fee and a percentage of the franchisee’s better than you would have done on your own. Whether
turnover. you are better off with a franchise therefore depends on its
» The franchisee receives the right to the name and the success and the terms and conditions of the contract.
systems used by the franchisor. This may include access Although one of the main benefits of buying a franchise is
to materials and training methods. that you are linked to other franchisees, this can also be
In the case of the McDonald’s example, the company will a problem. If, for example, the quality of service in other
want to keep close control over its brand name, products franchises falls, it may damage the overall brand and hit
and reputation. Therefore, if you buy a McDonald’s your sales as well. You become dependent on others and
franchise, you have to follow very close rules in terms of vulnerable if there are problems elsewhere.
what you sell, how you sell it, the pricing, the way the
food is cooked, where it is bought, how you use the logo, How much should you pay for a franchise?
and so on. Usually, there are several different types of payments
Well-known franchises include: involved in buying a franchise. For example, there may
» Ben and Jerry’s ice cream be an initial purchase fee plus a percentage of turnover
» Domino’s Pizza each year. On top of this there may be money you have
» McDonald’s fast-food restaurants. to invest each year to cover marketing and management
expenses. The amount you pay for a franchise will
depend on:
» the likely turnover of the business
» the typical profits
» whether you have the exclusive rights to a particular
geographical area and, if so, how big and attractive
this area is
▲ Figure 1.9 An example of a well-known franchise » the amount of training and support provided.
Buying a franchise HANDLING DATA

If you buy a franchise, you are buying a product that has
already been on sale and therefore has a track record. This A franchisor asks for a $12 000 fixed fee each year plus 2
means you can see whether or not it works. You can also per cent of profits after this fee and other costs are paid.
learn from other franchisees who are already established Your revenue this year is $650 000. Your costs (not
and benefit from their experience. including any costs associated with the franchise) are
The advantages of buying a franchise $420 000. What are the profits this year?
The advantages of buying a franchise include:
» Because you are joining other franchisees, as a group Selling a franchise
you may have more bargaining power than you would One advantage of being a franchisor is that you benefit
have on your own. This may mean you get better deals from the income generated from the franchisees. They will
with suppliers or when buying advertising space. pay a fee to buy the franchise and a percentage of turnover.
Franchisees will often pool money to promote the brand This generates earnings for the franchisor.
on a regional or national scale. Any advertisement for
the brand helps all the franchisees. Franchising is also a way of growing fast. If you were trying
» You have the support of the franchisor and this can to grow a business on your own, you would have to fund it
help you with decisions such as pricing, choosing all yourself; for example, you would have to find the funds
suppliers and planning ahead. This should reduce the to buy more premises and refurbish more shops. If you sell
risk of something going wrong because there is more franchises then the costs of opening a particular outlet falls
experience, joint power and support than if you were to the franchisee. This may make fast growth much more
setting up alone. feasible because individual franchisees are all funding their
» Buying a franchise may be less risky than setting up own enterprises. Domino’s Pizza, for example, was founded
completely on your own. This is because there is past in 1960 by Tom Monaghan. His ambition was to grow the
data for you to analyse before deciding whether or not business to three stores – that’s why there are three dots
to go ahead with the idea. At the same time, it will be on the company logo. However, through franchising, the
your own business and so there is still the incentive to business has grown to become the world leader in pizza
make it successful, as you will benefit directly. delivery.
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Another benefit of being a franchisor is that it may lead to
more motivated managers because they are running their STUDY TIP
‘own’ stores or businesses, rather than just being employees
of a bigger business. This may help the business as a whole
When studying franchises, you need to compare this way
of starting up your own business with the alternatives.
1.2
to be more successful. What are its advantages and disadvantages compared
to other ways of starting up? What would determine
whether an individual did this, rather than ‘going it alone’?
CASE STUDY

Toni&Guy
Together, Toni and Guy (whose real name was Gaetano)
continued to open more salons, and established the TIGI
brand in 1979. Under this brand name they launched
gel, rollers, scissors and many more products and sold
franchises to grow the business. The TONI&GUY video
library supports teaching in their salons, emphasising the
dedication of Toni and Guy to the development and further
education of their employees.
Toni&Guy’s business interests, apart from the salons
themselves, include:
l the production and distribution of products used and
sold in the salons
l the Toni&Guy branded products, which have been
developed with Alliance Boots
▲ Figure 1.10 Toni&Guy hairdressers, UK l another hairdressing chain called essensuals
Toni&Guy started in 1963, when Toni Mascolo opened a l hairdressing training academies
salon with his brother in Clapham, London. Today, the l a business that supplies the salons with fixtures and
company has over 475 salons in 48 different countries, fittings
many of which are franchises. l an IT business
l an in-house media agency.
Toni grew up in Italy. When he was a boy, he would walk
past his father’s hair salon every day on his way home The company has developed other brands which now
from school. ‘I had a stool where I would sit and would include TONI&GUY, label.m and essensuals.
wash hair, which made my father very proud. By the age of Source: www.independent.co.uk/news/people/profiles/
12, 13, I was doing perms. It was a hobby. It’s always been toni-mascolo-wash-and-grow-6230921.html
a hobby.’
Questions
Toni (whose real name was Giuseppe) had wanted to
become a lawyer, but that changed when the family 1 Analyse one factor you think is important to make a
migrated to London when he was 14. Although he had hairdressing business a success. [4]
excelled at school in Italy, he couldn’t speak English, so 2 A hairdresser has asked you whether they should
his only option was to work for his father. adopt the same model as Toni&Guy. Advise them
on whether to do this. [12]
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CASE STUDY
1.2
7-Eleven
7-Eleven is the world’s largest convenience retailer. Its l the initial franchise fee
business model is that of franchising its name and way of l the expenses to train staff according to the 7-Eleven way
operating; it is one of the biggest franchises in the world. l cost of inventory to open the store
The company has grown fast and says its success is based l spending on business supplies
around the saying of its founder Joe C Thompson Junior, l purchases of business licences and permits
which was: ‘Give the customers what they want, when and l insurance costs.
where they want it’.

Source: https://corp.7-eleven.com/corp/about#corp_about_intro;
7-Eleven says that it is ‘customer-obsessed. We always https://franchise.7-eleven.com/franchise/the-financials
poll customers to ensure we are bringing them solutions
they can’t even imagine.’ Questions
1 Analyse one reason why 7-Eleven might franchise
If you want to be a franchisee for 7-Eleven, the investment its business. [4]
required will include: 2 A friend has asked you whether they should buy a
franchise in 7-Eleven. Advise them on whether to
do this. [12]
Co-operatives CASE STUDY

Another form of business is known as a co-operative.
Co-operative businesses are owned and run by and for Co-operative facts and figures
their members, whether they are customers, employees or
‘At least 12 per cent of people on Earth [belong to one]
residents. The members of a co-operative have one vote
of the 3 million co-operatives on Earth. Co-operatives
each and so it is a democracy. Members, such as farmers or
provide jobs or work opportunities to 10 per cent of the
freelancers, tenants or taxi drivers, can often do better by
employed population, and the 300 largest co-operatives
working together. Sharing the profit is a way to keep it fair or mutuals generate $2034.98 billion in turnover ...’
and make it worthwhile.
Source: https://ica.coop/en/co-operatives/facts-and-figures
Rather than rewarding outside investors, a co-operative
shares its profits among the members. When someone leaves Questions
the co-operative they give up their shares. According to 1 Explain one benefit of being part of a co-operative.
the International Co-operative Alliance, nearly 300 million [3]
people around the world are employed by co-operatives, 2 Evaluate the reasons why the co-operative
while over 1 billion are members. approach is so popular around the world. [12]
There are different forms of co-operative, such as:
» Employee co-operatives These occur when the business
is owned equally by all the employees who work there. Joint ventures
Each employee has a vote in the business decisions A joint venture occurs when businesses collaborate on a
and shares in the profits. The advantage of this is project but do not formally join together all their activities.
that employees may be more motivated to make the For example, in the car industry a number of manufacturers
business a success because they are part-owners. One might share the research costs of developing an electric
of the problems, however, is that decision-making car but they would still compete with their other models.
may be difficult if everyone has an equal vote but In the pharmaceutical industry, two businesses may share
disagrees. Also, you cannot sell shares to those outside their research skills for a new medicine. When entering a
the business to raise finance, which might limit access new market overseas, a company may set up a venture with
to funds. a local business to help make the contacts and develop the
» Community co-operatives These are owned by members networks it needs to distribute its products.
of a community to provide a local service, such as a
post office. The benefits of a joint venture are that:
» Retail co-operatives These occur when independent » businesses can share skills, resources, expertise and
retailers join together. A group of independent stores experience; this can benefit both parties
may come together and operate under one brand name. » businesses can collaborate on projects that are
This means they can get better deals from suppliers by mutually beneficial without having to merge all their
buying in bulk and can share marketing costs. operations. This makes the process easier, less difficult
to manage and less expensive than a full joining
together (called a merger).
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However, there may still be difficulties, such as:
» agreeing on the division of the profits; there may be CASE STUDY
disagreements over the relative contribution of each
business
1.2
Wikipedia
» different views on how decisions should be made and
what the priorities are Wikipedia was created in 2001. It is a multilingual, web-
based, free-content encyclopedia project and is now
» different views on whether and how to end the venture.
one of the largest online encyclopedias. It is written by
volunteers all over the world. Its articles can be edited
Social enterprises by anyone with internet access. Articles are continually
Not all enterprises are set up to make a profit. Local sports updated and improved by online contributors. The

clubs, government organisations and charities, for example, website was created by the not-for-profit Wikimedia
do not have profit as the main objective. They are set up for Foundation, who says:
other purposes. ‘The Wikimedia Foundation provides the essential
Social enterprises are businesses that have social aims and infrastructure for free knowledge. We host Wikipedia,
which trade in order to benefit the community or society the free online encyclopedia, created, edited, and
verified by volunteers around the world, as well as many
in general. Examples of social aims are job creation and
other vital community projects. All of which is made
training, providing community services and ‘fair trade’ with
possible thanks to donations from individuals.’
developing countries. Well-known social enterprises in the
UK include Cafédirect, The Big Issue, The Co-operative Group Source: https://wikimediafoundation.org
and the Eden Project, but there are many others (more than
55 000) operating in a wide range of industries, from farmers’ Questions
markets and recycling companies to transport providers and 1 Explain one way in which Wikipedia transforms
childcare. The number of social enterprises is increasing as inputs into outputs. [3]
people become more concerned about issues such as the 2 Evaluate the ways in which the success of
environment and inequality. Wikipedia might be measured. [12]
CASE STUDY
The Big Issue
The Big Issue Group is a social enterprise in the UK aimed themselves and manage their money as well as interacting
at reducing poverty by creating opportunities for people. with the public to sell the magazine all help individuals to
The group has grown over the years and now includes: build up their self-confidence and self-reliance.
l a magazine which offers employment opportunities to
The magazine has won numerous awards and led to the
people living in poverty
creation of over 120 similar magazines in 35 different
l a fund that invests millions of pounds to support
countries.
enterprises that bring about social change
l a charity shop that sells social enterprise products. Key facts about The Big Issue include:
l over 200 million copies of the magazine have been sold
In 1991, The Big Issue magazine launched with the aim of
l 92 000 people have sold The Big Issue.
providing homeless people with an opportunity to earn
money by selling copies to the public. The magazine’s Source: www.bigissue.com/about
sellers are from a wide range of backgrounds, but all
of them struggle with poverty. Sellers buy The Big Issue Questions
magazine for £1.50 and then sell it on to their customers 1 Analyse one way in which The Big Issue helps
for £3. This means the seller is earning money and is not society. [3]
begging for it. Not only that, but the act of having to organise 2 Discuss the ways in which The Big Issue would
measure its success. [12]
» publish details of its accounts such as revenue and

Changing legal structure profits each year
It is relatively common for someone to set up in business as » publish administrative details, such the address of the
a sole trader and then to change the business into a private company and names of its directors.
limited company (ltd) later on, when they want to raise funds
from selling shares or want the benefits of limited liability. This means the business affairs of a private company are
more open than those of a sole trader. If you want to keep
To operate as a ltd company, a business must: your earnings private, you would want to remain as a sole
» have its accounts checked by an independent accountant trader.
(called an auditor) each year
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It may be that the owners of a private company want to legal and accountancy bills. However, it does enable its
make it public, as did Facebook in 2012. This gives the shares to be sold more easily on the stock exchange and this
1.2 company access to more potential investors. To do this,
the business must make more information available to the
makes the shares more attractive to more investors, because
they know they should be able to sell them, if needs be, to
public and there is greater regulation of the way it operates someone else (this means the shares of a plc are relatively
and the information it provides. Becoming a public company easy to sell).
opens a business to even greater scrutiny and even bigger
TEST YOUR LEARNING

with over 1.4 million copyrights, is one of the world’s

Short answer questions largest. Publishing is more secure and profitable than
1 Define the terms ‘primary sector’, ‘secondary sector’, recorded music, although the majority of Warner Music’s
‘tertiary sector’ and ‘quaternary sector’. [8] income is generated by the latter.
2 Define the term ‘public sector’. [2]
Warner Music had previously been bought by billionaire Sir
3 Explain one advantage of a partnership compared
Len Blavatnik for $3.3 billion (£2.5 billion) in 2011, when the
with a sole trader. [3]
industry was not doing well. The value of music companies
4 a Define the term ‘limited liability’. [2] rose after that, aided by the fast emergence and growth of
b Explain one way that limited liability can benefit paid streaming services such as Spotify. In 2019, its profit
a company. [3] was $256 million and its revenue was $4.5 billion. By 2020,
5 Explain one advantage of creating a company Warner Music was worth around $6 billion. Warner had
rather than operating as a sole trader. [3] initially intended to sell its shares in February 2020, but
6 a Define the term ‘franchise’. [2] when the Coronavirus (COVID-19) pandemic took hold, it
b Explain one reason for buying a franchise. [3] delayed the sale. It then intended to sell the shares on 3
7 Explain one benefit of being part of a co-operative June 2020, but delayed this for a few days because it did not
compared with a company. [3] want to distract attention away from the Black Lives Matter
movement that was in the news.
8 Explain one advantage of being a sole trader
compared with a partnership. [3] Questions
9 Explain one way a company can raise finance. [3]
1 Define the terms:
Data response question a ‘company’ [2]
In 2020, Warner Music Group decided to sell shares to b ‘private sector’. [2]
the general public. Warner Music included some of the 2 Calculate Warner Music’s profit as a percentage of
world’s biggest record labels including Warner, Atlantic, its revenue in 2019. [2]
Elektra and Parlophone. The company had many major 3 Analyse one reason why investors would buy
recording artists signed to it, including Ed Sheeran and shares in Warner Music. [4]
Katy Perry, representing over 80 000 songwriters and 4 Evaluate the extent to which the price of a share in
composers, from Beethoven to Madonna. The company Warner Music depends on when it is sold. [12]
also owns the music publisher Warner Chappell which,
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AS LEVEL
1.3 Size of business
1.3.2 Significance of small businesses

Chapter overview
★ how the size of a business can be measured
★ the significance of small and family businesses for the economy
★ business growth.
1.3.1 Measurements of HANDLING DATA

business size Your company has 30 000 shares. The share price
The size of a business can be measured in many ways such as: increases from $2.50 to $2.80.
» the turnover (revenue) of the business a Calculate the old and new market values.
» the number of employees b Calculate the percentage change in the market value
» the value of the assets of the business shown on its of the company.
statement of financial position
» the market value of the business (for example, the value
of all of its shares) 1.3.2 Significance of small
» other indicators such as the number of stores or even
the number of vehicles (for example, for a bus company). businesses
The best measure will depend on the sector you are Advantages and disadvantages of being
considering. For example, public sector organisations might
not generate revenue (for example, if the health service is a small business
provided for free) so it may be more appropriate to measure The advantages of small businesses are that:
the number of employees. » they are relatively easy to set up
» they are flexible because decisions can be made quickly
It is also important when considering the size of a business
(without having to consult lots of other people)
to think about its ownership. What seems like a ‘small’
» they are often run by very motivated individuals
business may actually be part of a much bigger ‘parent’
because they probably set up and own the business, and
organisation and therefore have access to its funds and
so they want it to succeed because they personally gain
expertise. When governments are considering policies,
the rewards
such as subsidies and tax allowances, they will examine the
» they are often very creative because it is easy for those
ownership of a business and whether it is part of a bigger
involved to communicate with each other and share
parent organisation.
ideas.
STUDY TIP
Note that profit measures the success of the activities
of a business. It is not in itself a measure of the size of a
business.
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CASE STUDY
1.3
Businesses in the EU
Shown below is the way in which the size of businesses annual turnover or the annual statement of financial
is categorised within the European Union (a grouping of position total.
27 European countries). This is important because it can
Micro, small and medium-sized businesses account for
affect the government support that is available and which
99 per cent of businesses in the European Union.
regulations apply to them.
Question
When determining a business’ size, the number of
AS LEVEL 1.3 Size of business
1 Analyse two benefits these businesses bring to the

employees is always taken into account and either the
EU economy. [8]
▼ Table 1.7 Measuring the size of businesses within the European Union
Enterprise category Number of employees Annual turnover (€m) OR Annual statement of financial
position total (€m)
Medium-sized < 250 ≤ 50 OR ≤ 43
Small < 50 ≤ 10 OR ≤ 10
Micro < 10 ≤2 OR ≤2
However, small businesses do have disadvantages: Family businesses have some strengths:
» They lack power in the market (for example, with suppliers » The family members may share values, leading to fewer
and customers) and so can find it difficult to survive. disagreements.
» They may lack much experience compared to more » Those involved may work hard so that the family as
established firms. a whole prospers; their ties to the business will be
» They may find it difficult to raise finance because of the emotional as well as financial, which may make them
high risk involved as so many small businesses fail. more committed to the survival and success of the
This is why governments sometimes try to help small business. This may mean they will work harder and for
businesses by providing advice, lower taxes and less longer than outsiders.
regulation to help them survive. » Individuals may be very supportive of each other
because they are family members.
» Family members may be willing to plan for the long term
CASE STUDY because they will be looking for the benefits they can
bring for future generations.
Small business finance » A number of family members may be involved in
Small and medium-sized enterprises (SMEs) face
providing finance and expertise.
challenges getting finance, said the Vietnam Chamber » There may be decreased costs as family members may be
of Commerce and Industry (VCCI). It said that finance willing to work for less than outside employees, at least
was expensive because the banks themselves are in the short term.
paying high interest rates of more than 13 per cent to
get savers to provide them with funds. The banks also
prefer to offer loans to large companies and state-run
enterprises as they are a safer investment.
The Vietnamese government has ordered the banks to
lend more to SMEs.
Questions
1 Analyse two ways that high interest rates might
make it difficult for SMEs to survive. [8]
2 Evaluate why the Vietnamese government might
beeager to lend more to SMEs. [12]
Strengths and weaknesses of family

businesses ▲ Figure 1.11 Family businesses are common in some
A number of businesses in an economy will be run by families. countries, such as India.
This is especially true in countries such as India, where the
culture tends to encourage families to work together.
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However, there may also be weaknesses: » It may be difficult to manage your relationship with
» Sometimes in a family business, decisions may be made others in the business easily because you will be
for emotional reasons rather than rational ones. It may
be that the correct thing is to do ‘A’ but because we
influenced by emotional issues as well as business
factors.
1.3
don’t want to upset a family member we do ‘B’ instead. » The biggest difficulty for any family-run business is
» The family members may lack the right experience handing over power to the next generation when the
but there may be reluctance to bring in outsiders. current head of the family retires.
Sometimes the wrong people may be doing jobs but
family ties keep them in that role.
1.3.2 Significance of small businesses

CASE STUDY
A family business
Nelson Assemany and his four brothers opened a shop Family businesses are also more likely to be focused on
together in Rio de Janeiro in 1967. Now employing their long-term growth, because the aim is to pass them on to
sons, today they have two shops: one selling fabrics, the the next generation, while large companies are often too
other selling imported consumer goods. concerned with short-term results and shareholder profits.
While outsiders often think Brazilian business is dominated Questions
by big companies such as the mining business Vale and
1 Define what is meant by the term ‘company’. [2]
oil group Petrobras, in reality 85 per cent of the country’s
2 Evaluate the advantages and disadvantages of family
companies are much smaller, family-run operations.
businesses. [12]
These businesses can adapt easily in a crisis compared to a
company managed by a board of directors, where you have
to consult other people and get approval for everything.
» better business and enterprise training at school and

The importance of small businesses university
and their role in the economy » access to support and advice
In most economies, the majority of businesses are quite » access to finance
small, often one-person businesses. For example, plumbers, » making it easier to start up and run a business; for
hairdressers, restaurateurs, lawyers and photographers example, by removing regulations that add to costs and
are often sole traders. Although these small businesses make it difficult to operate.
are the most significant in terms of number, the larger
businesses tend to dominate in terms of the total number The role of small businesses as part
of people they employ and the value of the output they
produce. There may only be one Google or one Ford, for
of the industrial structure in some
example, but they each employ a lot of people and have a industries
very high turnover! Nevertheless, the small business sector Small businesses are often very innovative. In industries
is very important to any economy. This is because small such as pharmaceuticals and computers, many of the
businesses: breakthroughs are made by small businesses; bigger
» create jobs, reducing unemployment businesses then often take over or work with the smaller
» provide competition for established businesses to ensure organisations to develop the ideas further. Bigger, more
they remain competitive established businesses often provide the finance and
» provide new sources of ideas. Small businesses are often capacity to produce and sell the product on a large scale.
very creative and many innovations start in smaller
organisations Small businesses can also provide specialist services
» can go on to grow in the future. that bigger organisations might not be interested in
providing for themselves; for example, while the larger
Small businesses and the economy firm concentrates on its core business, the small firm
Small businesses are important to economies because they might specialise in, say, digital marketing, specialist legal
help create jobs and are often sources of innovation. Many advice or provide expertise on a new market overseas.
new products or new ideas come from small businesses, Small businesses can concentrate on small segments of
so they are a source of entrepreneurial thinking. Small the market (called niches) and sell their services to bigger
businesses create competition and provide momentum to organisations who buy in this expertise.
an economy to promote economic growth. However, the
founders and owners often need support. Governments may GLOSSARY TERM
provide this support through: A niche is a small segment of a market.
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CASE STUDY
1.3
Businesses in the UK private sector
The data below shows the composition of the UK economy in 2019 in terms of the size of businesses.
▼ Table 1.8 Estimated number and size of businesses in the UK, 2019
Business Employment (thousands) Turnover (£ millions)

All businesses 5 867 770 27 498 4 149 973
SMEs (0–249 employees) 5 860 085 16 630 2 168 005

Small businesses (0–49 employees) 5 824 500 13 157 1 528 684
With no employees 4 457 820 4 835 304 508
All businesses with employees 1 409 950 22 663 3 845 465
of which:
1–9 employees 1 155 385 4 206 595 013
10–49 employees 211 295 4 116 629 163
50–249 employees 35 585 3 473 639 321
250+ employees 7 685 10 868 1 981 968
Source: UK government, Department for Business, Energy & Industrial Strategy
Question
1 Evaluate the contribution of small businesses to the UK economy in 2019. [12]
» develop new products for its customers

HANDLING DATA » find new markets where it can sell its existing
products.
The market as a whole is worth $960 000. Your niche is
worth $60 000. What percentage of the market is this?
External growth
External growth occurs when a business expands by buying
1.3.3 Business growth up another business or joining with another business. This
is known as integration. The process of integration is
Business growth is a common objective of any business. By sometimes called a merger and sometimes a takeover. In
growing: a merger, two or more businesses mutually agree to join
» a business can get more power over suppliers and together to form one new one. Alternatively, one business
customers, which might help it to make more profits may unilaterally decide to acquire another; this is known as
» a business can reach more customers and there is the a takeover.
possibility of more profit through more sales
In the case of a takeover, one business buys control of
» the owners can eventually own something that is worth
another one by gaining the majority of its shares. It can do
more
this by offering shares in its business (which is called a paper
» the owners can have a sense of achievement because
offer) or by paying to buy the shares (which is a cash offer) or
they can look back and be proud of having grown the
a combination of the two. The directors of the company being
business
targeted may welcome the bid and advise their shareholders
» a business can raise its profile.
to sell; this is a friendly takeover, which could be called a
merger. However, the directors of the target company may
Why and how a business might grow resist the bid and advise their shareholders not to sell; this
internally (organic growth) then becomes a hostile takeover.
The size of a business is not fixed – it can change over time. There are different forms of integration:
One way to grow is to expand your existing operations. This » Horizontal This occurs when one business joins with
is called internal or organic growth. another at the same stage of the same production
process; for example, a car manufacturer acquires
To do this a business may: another car manufacturer.
» try to grow sales of its existing products in its existing
markets
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» Vertical This occurs when a business acquires another Why a merger/takeover may or may not achieve
business at a different stage of the same production objectives
process. Backward vertical integration occurs when
the business joins with a supplier; forward vertical
Many businesses like the idea of external growth. This is 1.3
because it is a way of growing rapidly. By joining with
integration occurs when a business joins with a business
an existing business, it is possible to quickly enter a new
closer to the customer, such as a distributor or retailer.
market or to achieve a much bigger presence in a market.
» Conglomerate diversification This occurs when a
business joins with another business operating in a However, often these deals are not as successful as
different sector; for example, a car manufacturer joins expected. Problems of mergers and takeovers include:
with a confectionery business. » the costs of doing the deal itself. Integration may involve
1.3.3 Business growth

legal costs, finance costs and reorganisation costs
The motives for these different types of integration may
vary; likely reasons for them are shown in Table 1.9.
» the clashes that may occur when the businesses start
to try and work together. There can often be significant
▼ Table 1.9 Motives for different forms of integration differences in the way that people work, what they
prioritise and how they make decisions, and this can
Type of integration Likely motives lead to friction, higher costs and mistakes being made
Horizontal Greater market power; economies of » inefficiency because the business is too big. This can
scale cause problems co-ordinating it, communicating to staff
Forward vertical Gaining access to the market, for
and building a common sense of purpose.
example, by joining with retailer
Joint ventures and strategic alliances
Backward vertical Gaining control over supplies – this
may improve co-ordination, improve Another form of external growth occurs when a business
quality and reduce costs forms a joint venture or establishes a strategic alliance
with another business. This means they agree to co-operate
Conglomerate Spreading risks by operating in in specific areas but do not fully join together in all aspects
different markets; less vulnerable of their operations. In the case of a joint venture, the
to a change in conditions in one businesses create a new legal entity to collaborate together.
market The joint venture agreement will specify all the details of
the contract, including the rights of the partner businesses,
Integration and stakeholders the objective of the venture, how day-to-day operations
will be carried out and how profits will be distributed. In
The coming together of businesses will have an impact on the case of a strategic alliance, they remain completely
stakeholders. The precise effect will depend on the nature independent businesses but collaborate on a given project.
of and success of the deal. However, some of the potential
implications are: The advantage of joint ventures and strategic alliances is
» Investors The deal is likely to cost money initially that businesses share their expertise and assets in areas
but, if it works, bring higher returns in the long term. where they feel this will bring benefits. However, they
If investors generally approve of the deal, the share can avoid some of the problems that come with trying to
price of the bidder will rise and, if profits do increase, integrate whole businesses together. Strategic alliances will
dividends may as well. However, in reality many mergers often be used when co-operating on a project allows the
and takeovers do not do as well as expected, in which businesses involved to benefit from each other’s resources
case the shareholders of the bidding company may be and expertise and to make more profits.
disappointed. Joint ventures are often used when businesses enter
» Managers The effect on managers will depend on new markets. The ‘outside’ business can join with a local
the deal, but in some cases it will mean there is a business and use its expertise and contacts. In this
duplication of roles. Company A may have a marketing situation, a joint venture can reduce risks by making
manager and so might company B. With integration use of the local business’ inside knowledge, contacts
there may be an opportunity to save money by only and awareness of the country’s culture and business
having one marketing manager. environment. In some countries, foreign businesses can only
» Suppliers They may benefit if the combined business operate in conjunction with local ones and so joint ventures
does well and grows. However, the new, bigger business are a common way of entering the market.
may have more power to push down prices from suppliers.
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TEST YOUR LEARNING
1.3 l In Hong Kong, a row emerged over the future of
Short answer questions billionaire Stanley Ho’s Macau casino business, which
1 a State two ways of measuring the size of a led to Mr Ho arguing against some of his own children.
business. [2] l Winston Wong, eldest son of the late Taiwanese tycoon
b Explain one possible advantage of being a big Wang Yung-ching, sued to recover $4 billion worth
business compared with being a small business.[3] of disputed assets that he claimed were taken by
2 Explain one problem of being a small business. [3] members of his father’s third family. Wang founded
3 Explain one reason why a government might want Formosa Plastics, one of Taiwan’s biggest companies.
to support small businesses. [3]

Given that many of Asia’s most successful businesspeople
4 Define the term ‘internal growth’. [2] are now in their eighties and nineties, the next decade
5 State two ways in which a business might try to will probably see a number of contentious leadership
grow. [2] successions.
6 Explain one advantage of being a family business. [3]
7 a Explain one reason why a business might want
Asia’s biggest family businesses
to grow internally. [3] l Samsung Electronics (South Korea)
b Explain one problem of internal growth. [3] l Reliance Industries (India)
8 a Explain one reason why a business might want l Hon Hai Precision Industries/Foxconn (Taiwan)
to grow externally. [3] l Sun Hung Kai Properties (Hong Kong)
b Explain one benefit of horizontal integration. [3] l Tata Consulting (India)
9 Explain one reason why a merger or takeover may l Cheung Kong (Hong Kong)
not achieve its objective. [3] l Hutchison Whampoa (Hong Kong)
10 Explain one benefit of a using a joint venture to l Wilmar International (Singapore)
enter an overseas market. [3] l Bharti Airtel (India)
l Formosa Petrochemical (Taiwan)
Data response question
A recent study tracked the market performance of
Family businesses in Asia
250 family companies that underwent a succession. It
From Samsung in South Korea, Reliance Industries in found that, on average, these companies’ market values
India, to Hon Hai, the Taiwanese maker of the iPad, family declined by almost 60 per cent during the period starting
businesses dominate Asia’s (and increasingly the world’s) five years before the succession and up to three years
business environment. They make up half of Asia’s public afterwards. The performance of a family firm is often
limited companies and a third of the market capitalisation down to the skills, charisma and connections of the
value of all companies on the stock exchange, and they founder, something that subsequent generations may find
employ millions of people. However, many of these hard to replicate.
businesses are failing to plan for the transition to a public
limited company with external shareholders. This can Questions
lead to uncertainty, at best, and potentially ruinous family 1 Define the terms:
disputes. For example:
a ‘public limited company’ [2]
l Lee Kun-hee, the 70-year-old chairman of electronics
b ‘market capitalisation’. [2]
giant Samsung, was sued by both his brother and sister
over company shares left by their late father. 2 Explain two reasons why family businesses are so
important to the economy. [6]
l India’s richest man, Mukesh Ambani, was involved
in a five-year dispute with his brother Anil over their 3 Evaluate whether family businesses are ‘ultimately
father’s vast Reliance empire. doomed to fail; it is just a question of time’. [12]
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AS LEVEL
1.4 Business objectives
1.4.1 Business objectives in the private sector and public sector

Chapter overview
★ business objectives in the private and public sectors
★ objectives and business decisions.
1.4.1 Business objectives in the GLOSSARY TERMS

private sector and public sector An objective is a target that is measurable and has a given
timescale.
An objective is a target. A good objective will state what Labour productivity measures the output per time period
is to be achieved (for example, an increase in profit), how of an employee.
much the business wants it to be (for example, $25 000) A corporate objective is a target set for the business as a
and when it wants this to be done by (for example, in three whole.
years). This means a good objective should be:
» specific in terms of what the target is
» quantifiable (measurable) Business objectives in the private
» time-specific in terms of when it should be completed.
A business will have an overall objective, such as a target of
sector
doubling its profits within five years. This will then give the We saw in Chapter 1.2 that private sector businesses are
business’ managers the opportunity and information to set owned by individuals. Businesses in the private sector can
departmental targets. For example: have a number of objectives, including the following.
» The marketing department may have to increase sales by
40 per cent over an agreed period. Profits and profit maximisation
» The operations management department may need to Profits are maximised when the difference between sales
reduce costs by 20 per cent over the next three years. revenue and total costs is at its greatest. Some firms set
» The human resources department may have a target to objectives which involve achieving a minimum level of
increase labour productivity by 8 per cent over the profit, allowing the business and its managers to focus
same time period. on other objectives. This approach, known as satisficing,
Within each department every individual should also have may be pursued by smaller family-owned organisations.
their own objective. For example, to reduce costs by 20 per Satisficing allows the owners of these businesses to achieve
cent, the person responsible for ordering supplies for the other targets, such as entering new markets or increasing
business may be set a target of finding a supplier that is 5 per the size of the business.
cent cheaper. The manager in charge of sales for the south- Other businesses may seek to earn the greatest possible
east of the country may be asked to increase sales in their profits to satisfy their shareholders’ desire for high
area by 30 per cent to help overall sales rise by 40 per cent. dividends. This might be a shorter-term objective. Others
Those objectives which relate to the entire business, such may pursue the longer-term objective of providing acceptable
as growth, are also termed corporate objectives. levels of dividends, but they may also look for growth in the
value of the company and therefore in its share price. This
The setting and pursuit of objectives of a business helps can provide shareholders with long-term financial benefits.
it to co-ordinate its activities, whether it operates within
the private sector or the public sector. It provides goals for Growth
employees at all levels within the organisation and helps
managers to co-ordinate the activities of all employees. The Many businesses have an objective of growth because their
Starbucks case study on page 34 emphasises the importance managers believe that the organisation will not survive
of objectives within large and growing organisations. otherwise. If a firm grows, it should be able to exploit
its market position and earn higher profits. This benefits
Corporate Departmental Individual business owners (in the long term) by providing greater
objectives objectives objectives
dividends, as well as offering better salaries and more job
▲ Figure 1.12 Business objectives security to the employees and managers of the business.
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The case study on Starbucks shows that the company has in quantified objectives, possibly relating to sales figures or
set itself the aim of growth. This will have been expressed market share in other countries.
1.4
CASE STUDY
Starbucks’ objectives
Starbucks is an American multinational company. In 2019, at cafés open for at least a year have increased by 6 per
it operated 30 600 stores in 80 countries selling coffee, cent globally. In 2019, its sales reached a record figure of
other drinks and food. $6.8 billion.
AS LEVEL 1.4 Business objectives
Starbucks sets out its objectives clearly on its website and Questions
one of these is growth. Starbucks has put in place a range
1 Explain one reason why making Starbucks’ employees
of plans to achieve its growth objective. The company has
responsible for its marketing might help the company
opened new restaurants, improved its use of technology
to achieve its objective of growth. [3]
within its stores and developed new products for its
2 Evaluate the benefits that Starbucks might receive
customers.
from its clearly stated business objectives. [12]
These decisions appear to have been successful, as
Starbucks has improved its financial performance. Sales
Survival Diversification
This objective is for the business to continue to trade over a Diversification is an objective where a firm produces an
defined period of time, rather than to submit to some form increased range of unrelated goods and services. Adopting
of commercial pressure and be forced to cease trading. This this objective allows a business to spread its risk by selling
is an important objective, even for the largest of businesses a range of products (rather than one) or through trading in
at certain times. However, it is a more common one for different markets. Thus, if one product becomes obsolete
small and newly established businesses. Survival is likely to or a market becomes significantly more competitive, then
become a key objective during: the alternative products or markets will provide a secure
» periods of recession or intense competition source of revenue for the business while it seeks new
» times of crisis, such as during the 2020 Coronavirus projects. Diversification allows a business to avoid relying
(COVID-19) pandemic. on one or two products and has been the principle behind
the creation of conglomerate businesses – those that sell
Cash flow a range of products in different markets. PepsiCo Inc., the
For most businesses, cash flow is a vital element of success multinational soft drink and snack producer, has pursued
as it is essential to be able to pay debts on time. This is the objective of diversification to extend its product range
especially true of businesses that have long cash cycles. beyond soft drinks. This is intended to help it to compete
A cash cycle is the time that elapses between the outflow with its powerful rival, The Coca-Cola Company.
of cash to pay for the resources needed to produce a
product and the receipt of cash following the sale of the Business objectives in the public sector
product. Businesses in industries such as pharmaceuticals
and construction may have long cash cycles. Providing a service to the community
Businesses in the public sector are owned by the government.
Walt Disney, the global entertainment company, has an Usually a major objective of businesses in this sector is
objective to strengthen its cash-flow position. The failure to provide a service to all of the country’s population. For
to set an objective relating to cash flow could have dire example, if a transport system is owned by the government,
consequences for a business if it is unable to pay its debts it may operate bus services to remote areas where few
as they fall due. In the worst case, a shortage of cash could people live. Private sector businesses may not be willing to
result in a business having to cease trading. do this as it may not be profitable due to the low number of
passengers. In India, the government has set public sector
GLOSSARY TERMS businesses the target of constructing 11 000 kilometres of
The market share of a business measures its sales as a roads each year to improve transport services.
percentage of the total market sales. Similarly, it may be necessary for public sector businesses to
Cash flow is the movement of cash into and out of a provide some products that otherwise may not be available.
business over a time period. Private sector businesses may not be willing to make the
Ethics are moral principles that can shape the way a huge investments necessary to develop systems needed
business behaves. to supply utilities such as gas, water and electricity. In
Social responsibility is a philosophy under which many countries these services are supplied by the public
businesses consider the interests of all groups in society sector. For example, in Pakistan there are publicly owned
as a central part of their decision-making. businesses supplying electricity in many localities including
Lahore, Faisalabad and Multan.
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Financial objectives Social objectives
Businesses in the public sector do not seek to maximise Social objectives include targets that relate to matters
profits, unlike many of those in the private sector. In many such as providing employment for people or improving 1.4
countries, public sector organisations are expected to at facilities for local people (for example, building a play park
least cover their operating costs, to avoid needing financial for local children). Social enterprises frequently reinvest
support from the government. Public sector businesses in their profits to help to meet their social objectives. A study
some countries have an objective to generate a financial by the University of Pennsylvania showed that many social
surplus which is reinvested to improve the service offered enterprises have ambitious goals of having more clients and
by the business. In 2020, businesses in the public sector in expanding their operations but that few set quantifiable
Indonesia were reviewed by the government, and some were targets.

merged with others or closed due to very weak financial
performance. Ethical objectives
Ethical objectives are those that are based on moral
Development of relatively poor regions principles. Examples of ethical objectives include protecting
Many countries operate public sector businesses in regions the environment through the use of sustainable production
with low incomes. This can help to raise standards of living techniques and ensuring that suppliers receive fair and
in less affluent parts of the nation. In New Zealand, the prompt payment.
government is making changes to ensure that public sector
organisations meet the needs of the country’s indigenous The importance of business objectives
Maori population.
Business objectives set out what the business wants to
Private sector business achieve. This provides a focus for all decisions. Employees
(e.g. Lenovo, Tata Group) know what they are supposed to achieve and can then make
suitable decisions. Without objectives, employees do not
know the priorities and do not know how success will be
Profits and Growth Survival Cash flow Diversification measured. This can lead to a loss of focus and a wasteful
profit use of resources. Objectives can:
maximisation » motivate employees by providing targets
» provide a measure of control, as progress can be
Public sector businesses reviewed against these targets.
(e.g. electricity supply)
Corporate social responsibility as a

Providing a Financial Regional
service objectives development business objective
A business may have many objectives relating to different
areas. For example, it may want to boost profits but, at the
Social enterprises same time, may be aware of its impact on society as a whole
(e.g. Wikipedia) and the environment in particular. Any business will have
certain responsibilities to other groups by law. For example,
there are laws in many countries determining the minimum
an employee can be paid, the information businesses have
Social objectives Ethical objectives
to provide about their products, and the procedures to be
taken to make the working environment safe. All businesses
▲ Figure 1.13 Objectives for different business sectors
should have an objective of acting legally. However, some
may accept obligations to society over and above the legal
The objectives of social enterprises minimum; this type of behaviour is known as corporate
Social enterprises are businesses which operate to benefit social responsibility (CSR). For example, a business may
the community or society in general. As a result, they believe:
normally set themselves social and ethical objectives. » it should ensure that work is interesting and that
employees have a good career path within the
Social and ethical objectives have received much attention
organisation
recently. In part, this is the result of widespread access
» it has a responsibility to keep people in work as much as
to the internet, making it easier for the public to discover
possible and therefore be reluctant to force anyone to
information about the behaviour of businesses. Some
leave the business
investors will only invest in companies that trade with
» it is important to pay suppliers quickly rather than
ethical or social objectives. Importantly, a significant
taking as long as possible and holding on to money
proportion of customers seek to purchase products from
» it should invest in its local community to improve the
businesses with social and ethical objectives. Pursuing such
area and quality of life of the community where it is
objectives, and publicising the fact, can offer a business a
based.
distinctive and attractive image.
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CASE STUDY
1.4
The Good Hotel
The Good Hotel is part of the Good Group, set up by who really need it. According to its website, a one-night stay
Marten Dresen. The Good Group is a social enterprise, can finance one week’s education for a child in Guatemala.
offering customers luxury accommodation in wonderful
In its first year of trading, Good Group donated approximately
locations. In 2020, the business operated hotels in London
$80 000 to its causes in Guatemala, and is on target to
and Antigua de Guatemala. By 2021, it plans to open hotels
donate more than $500 000 per year. This has financed the
in five new locations.
building of three schools, providing quality education
The Good Hotel operates in an environmentally conscious for over 500 students in impoverished Guatemalan
way. It sources its food locally and treats suppliers fairly. communities.
It offers vegetarian and vegan meals and does not use
Source: www.good.community
plastic straws in any of its hotels. It does not put TVs in its
hotel rooms, opting to instead provide spaces that facilitate Questions
connection and conversation. The Good Hotel believes that
1 Explain one way in which operating as a social
‘conversation is the key to community’.
enterprise has shaped The Good Hotel’s objectives. [3]
All the business’ profits are invested into educational 2 Evaluate whether The Good Hotel can be expected to
projects in Guatemala to provide skills and training to those compete successfully with other hotels operated by
businesses in the private sector. [12]
A business that acts responsibly believes it is a corporate of people and its impact on the planet. This is known
citizen with obligations to society. This type of business as the triple bottom line (profit, planet, people) and it
will set targets to do more for society than it is obliged to encourages sustainable production, allowing it to continue
by law. in the long term without damaging the environment.
CSR and the triple bottom line

While many organisations see profit as important, they
may also be concerned about how this profit is made and Profit
the impact of the business on others. This means that
businesses often have social and environmental objectives
relating to how they treat suppliers, how they treat staff
and the impact of their activities on the environment and
other groups, such as the local community. A business may
be willing to accept lower profits if it significantly reduces
pollution, if it ensures only recycled resources are used and
if it helps the local community, for example.
Sustainable
This increasing interest in social and environmental Planet production People
issues may be because there is more information available
about such things and so managers are making better-
informed decisions. It may also be a response to the fact
that consumers, employees and investors are increasingly
interested in such issues. Not only that, if competitors are
demonstrating their environmental and social awareness,
then other businesses may have to follow in order to retain
their competitiveness. John Elkington, a business author
and advisor, suggested a business’ performance should be ▲ Figure 1.14 Elkington’s triple bottom line
measured by examining three Ps: its profits, its treatment
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CASE STUDY
1.4
Social objectives at Intel
Intel is one of the world’s largest manufacturers of Intel’s 2018 corporate social report states: ‘In celebration of
semiconductors, a component used in many electrical Intel’s 50th anniversary, we set a goal to engage 50 000 of our
products including telephones and computers. In 2019, employees to volunteer more than 1 million hours in 2018.
it employed more than 110 200 people across the world. We exceeded that goal, with more than 68 000 employees
The company’s mission statement is ‘to bring smart, (or 64 per cent of our employees) volunteering approximately
connected devices to every person on Earth.’ It believes 1.5 million hours of service throughout the year. To support

that technology can help to improve living standards. our goal, each business group achieved a participation rate
of over 50 per cent. Over the past 10 years, our employees
have generously donated their skills, technology expertise
and more than 10 million hours of service to tackle
environmental challenges, improve education and help
meet community needs around the world.’
Intel’s volunteer groups have worked in many countries
including Malaysia, Japan, Namibia and Puerto Rico.
Source: Corporate Social Responsibility at Intel, 2018–19 Report
Questions
1 Define the terms:
a ‘mission’ [2]
b ‘objectives’. [2]
▲ Figure 1.15 The Intel organisation believes in corporate 2 Evaluate the extent to which Intel benefits from
social responsibility having a widely publicised mission statement. [12]
Once these targets have been set, the business has to

Mission statement, aims, objectives, decide how to achieve them most effectively. The long-
strategy and tactics term plan to achieve an objective is known as a strategy.
The mission of a business is the fundamental reason why For example, if a business wanted to increase profits by
it exists. A mission statement sets out the purpose of 30 per cent in three years, the strategy might be to target
the business. For example, an airline may exist to be the overseas markets. However, this strategy has to be put
‘best airline in the world’; a computer manufacturer may into action; in this example, a decision has to be taken on
aim ‘to help people work more effectively’, and a cosmetics which countries will be targeted. However, other decisions
business may intend ‘to bring beauty to everyone’. The have to be made too: In what order will the new markets
mission will be determined by the owners of the business. be entered? What products will be offered in each? The
shorter-term action plans that combine to make up the
A business’ aims are its long-term goals and are often strategy are known as tactics.
referred to as its corporate aims, meaning that they
relate to the whole business. Businesses do not normally Mission Aims Objectives Target Strategy Tactics
state aims as numerical targets but rather in qualitative statement
terms. For example, a housebuilder might set itself an ▲ Figure 1.16 From mission to tactics
aim of building environmentally friendly homes. Both
corporate aims and mission statements are set by senior
managers within the business. They are designed to
GLOSSARY TERMS
provide guidance for setting objectives and to assist junior
managers in decision-making. A mission statement sets out the overall purpose of a
business.
The mission and aims are rather general statements and, An aim is a long-term goal that determines the objectives
unlike objectives, whether or not they have been achieved that an organisation sets itself.
cannot easily be measured. What exactly does a business
Strategy is the long-term plan to achieve the objective of a
measure to decide if it is the best airline? It could be the business.
number of planes it operates, or the number of passengers,
or perhaps the level of customer satisfaction. This is why Tactics are the short-term actions needed to implement
the strategy.
corporate objectives exist, to turn the mission and aims
into measurable, specific and time-related targets.
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1.4.2 Objectives and business want the business to grow faster, for example, or are
more concerned about the environmental record of the
1.4 decisions business than the previous owners.
» External Perhaps the economy has gone into decline and
The role of objectives in the stages of so the organisation needs to reduce its growth target.
Perhaps competitors have entered the market, which
business decision-making means the profit target was too ambitious and needs to
Managing a business involves many different decisions; be amended downwards.
for example, deciding on the objectives, deciding the best
Decision-making is a continuous process in which decisions
way of achieving these (which is set out in the company’s
are being taken and reviewed and new objectives are set.
strategy), and deciding how to bring the strategy about on
time and at an acceptable cost through use of appropriate

tactics. Making the right decisions is therefore an important Translating objectives into targets
part of good management. Decision-making involves:
» Setting the objectives This is essential because
and budgets
the success of a plan can only be judged against the The overall objectives of a business need to be cascaded
objectives that were set. Making a profit of $100 000 down into departmental and then individual targets for
may be disappointing if the objective was $300 000, people. Using objectives throughout the organisation helps
but not if the target was $80 000! It is important to set to ensure everyone is working towards the same aim. With
realistic and achievable targets. each objective there should be a strategy of how it is to be
» Gathering information Before you decide what to do, achieved and specific tactical targets showing the details of
you need information on where you are at the moment, the activities that need to be undertaken. A plan will show:
what else is happening and what your options are in » who is in charge of what
order to analyse the situation. » what they have to do
» Selecting a suitable strategy Having analysed the » when it must be done
information, you can decide on the best strategy; for » how much they have to spend; that is, what budget has
example, targeting domestic or overseas markets. been agreed.
» Implementing the strategy This is where the tactics A budget is a financial target that might set out expected
come in to make sure the plan works well. revenues and also anticipated expenditure. This helps with
» Reviewing This is essential to see how you have got financial planning. The size of the budget will depend on
on and what, if anything, needs to be changed. After what the objective is and what has to be done to achieve it.
the review you can consider whether the objectives are
still appropriate or not; you may need to set higher or GLOSSARY TERMS
different targets, for example. A target is a goal pursued by a business, such as achieving
a particular market share or rate of growth of sales.
Budgets are financial plans setting out a business’ future
Setting revenues and expenditure.
objectives
Ethical behaviour is behaviour that is thought to be
morally correct and not necessarily the most profitable.
Reviewing
Gathering
information The communication of objectives and
their likely impact on the workforce
When setting objectives, this should be done in discussion
with the people who will be responsible for achieving them.
This should help make sure the objectives are realistic and
that the people involved are committed to achieving them.
Implementing Selecting a If a target is forced on an employee, they may not try very
the suitable hard to achieve it because they may not think it is feasible
strategy strategy
or even possible to hit.
Having an objective can be very motivating because it
▲ Figure 1.17 The process of decision-making
provides a sense of direction, so that employees know
what they are doing and why, and how this fits in with
How objectives might change over time the overall strategy of the business. It can also motivate
Over time, the objectives of a business may change. This because it sets workers a target, so they have something to
can be for many reasons, both internal (inside the business) aim for and something that can be reviewed.
and external (outside the business): However, objectives may be demotivating if the person who
» Internal A business may have new owners or managers is set them does not believe in them and has no sense of
who want to achieve different things. Perhaps they ownership. If an employee feels they have been set a target
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that cannot be reached, or they do not have the budget to An example of a good objective might be ‘to increase profits
make it possible, they will probably feel demotivated. This by 25 per cent over the next four years’. By comparison, a
means that how an objective is set and what resources are
allocated to it are very important.
bad objective would be ‘to do much better’ – it is not clear
what ‘doing better’ actually means, how it will be measured
1.4
or how long you have to achieve it.
STUDY TIP
Remember that some of the businesses you will
How ethics may influence business
encounter in question papers may be large ones, and this objectives and activities
can pose a challenge for the business to communicate Business ethics refers to what is considered to be right
corporate objectives clearly. This problem can be more
1.4.2 Objectives and business decisions

or wrong in terms of business behaviour. For example, is
serious if the business operates in different countries
it ethical behaviour to sell cigarettes if you know they
with different languages and time zones.
can damage people’s health? Is it ethical to produce a
good or service if the process of producing it damages
the environment? Is it ethical to show advertisements for
SMART objectives children’s toys between children’s television programmes to
To be effective, objectives should be SMART. SMART get the children to pester their parents to buy them?
objectives must be:
» Specific They must define exactly what the firm is Managers face ethical issues all the time, in all areas
measuring, such as sales or profits. of business. Sometimes the objectives of the business
» Measurable They must include a quantifiable target; for can encourage unethical behaviour. If employees are set
example, a 10 per cent increase in sales revenues. extremely high sales targets, they might decide to sell
» Agreed If targets are simply imposed on people, they products to people who don’t really need them or to avoid
are likely to resent them. If, however, the targets are telling people some of the problems that might occur with
discussed and mutually agreed, people are more likely to the product if they don’t ask. The drive to boost sales can
be committed to them. lead a business’ employees to behave badly. In recent years
» Realistic If the objectives are unrealistic (for example, there have been many sales scandals; for example, insurance
they are too ambitious), people may not even bother to companies have sold people policies that were unlikely to
try and achieve them. To motivate people, the targets ever pay out and banks have not told people they could be
must be seen as attainable. earning higher returns if they changed to a different type
» Time-specific Employees need to know how long they of bank account. This behaviour is usually driven by a desire
have to achieve the target; for example, is it two or to hit high targets, in order either to keep a job or to earn
three years? bonuses.
CASE STUDY
Ethics at Texas Instruments
Texas Instruments (TI) is based in Dallas, Texas, and The company’s website makes its ethical position clear.
makes a diverse range of electrical products including ‘Our challenge ... is to provide the tools employees may
military equipment and calculators. In 2020, it employed need to make tough but appropriate decisions quickly.
30 000 people in 30 countries. We work to ensure they have a clear understanding of the
global rules and regulations that govern our operations, as
TI’s board of directors adopted ethical principles very
well as our own values, principles and ethical expectations.’
early. The company established an ethics office in 1987
and appointed the company’s first ethics director. Its Source: Adapted from www.ti.com
ethics director and staff have three primary functions:
l to ensure that business policies and practices are Questions
continuously aligned with ethical principles 1 Explain two reasons why Texas Instruments sets out
l to clearly communicate ethical expectations its ethical objectives on its website. [6]
l to provide multiple channels for feedback, through 2 Evaluate the case for and against Texas Instruments
which stakeholders may ask questions, voice concerns operating with ethical behaviour as a key objective at
and seek resolution of ethical issues. all levels in the business. [12]
Of course, unethical behaviour does not have to be the case, This is why some businesses have a ‘code of ethics’ or a
but businesses must be clear on the behaviour they expect ‘code of conduct’ to make it clear to employees what is and
from employees in terms of how they reach their targets. what is not regarded as acceptable behaviour.
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TEST YOUR LEARNING
1.4
Short answer questions Data response question
1 a Define the term ‘business objective’. [2] A different bank
b Explain one feature of a good objective. [3] New Zealand has four major banks which dominate its
2 a Define the term ‘mission statement’. [2] banking market, holding a market share of around 80 per
b Explain one benefit to a multinational business of cent. Two years ago, Provident Bank opened its first
having a mission statement. [3] branches in Auckland and Wellington amid great publicity.
The new bank’s corporate objectives include achieving high
3 a Define the term ‘corporate responsibility’. [2]

b Explain one reason why corporate responsibility rates of growth and establishing 20 branches through the
is important to an oil company such as BP. [3] country within its first three years of trading.
4 Explain two differences between strategy and The bank has a mission statement which sets out its
tactics. [6] commitment to a high standard of customer service. This
5 Explain one type of strategy a business that is figures prominently on its website and is used in much of
entering new markets overseas might adopt. [3] its publicity, including its recruitment materials.
6 a Explain one stage of decision-making. [3] Provident Bank has set out to differentiate itself from its
b Explain one reason why it is important to review rivals by adopting strongly ethical corporate objectives
decisions. [3] which influence its strategy and tactics. It does not invest
7 a Define the term ‘ethics’. [2] in businesses whose actions damage the environment
b Explain one reason why businesses try to take or those that supply armaments. It is a carbon-neutral
ethical decisions. [3] business. Its charges are higher than the large,
8 Explain one reason why a marketing manager might established banks, but its marketing is distinctive and
consider ethics when making a decision. [3] research suggests that it is appealing to wealthy New
9 a Define the term ‘budget’. [2] Zealanders.
b Explain one advantage to a business of setting a
Questions
budget. [3]
10 Explain two reasons why a growing business’ 1 Define the terms:
objectives might change over time. [6] a ‘corporate objectives’ [2]
b ‘tactics’. [2]
2 Analyse one reason why Provident Bank considers
its mission statement to be important. [4]
3 Evaluate the case for and against Provident Bank
adopting ethical corporate objectives. [12]
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AS LEVEL
1.5 Stakeholders in a business
1.5.1 Business stakeholders

Chapter overview
★ the different groups affected by business behaviour
★ the relative importance and influence of stakeholders on a business.
1.5.1 Business stakeholders

Individuals or groups with an interest in Internal and external stakeholders
the activities of a business The stakeholders of any business can be divided into two
categories: those who are part of the business and those
All businesses involve and affect many other people and who operate outside it.
groups by their activities. These individuals and groups are
called stakeholders. Stakeholders include: Internal stakeholders include:
» the owners of a business, such as the shareholders of a » the owners of the business – this covers sole traders,
company partners and shareholders
» the business’ employees » the business’ employees, such as managers and shop-
» the business’ managers, who take tactical and strategic floor workers.
decisions External stakeholders include:
» the suppliers of goods and services » suppliers. These are the individuals and other
» the banks and other organisations that provide finance organisations that provide businesses with the goods
» customers, who buy the products and services that are needed to carry out production
» the local community, which may be concerned about » customers who purchase the goods and services that are
issues such as employment and pollution sold by the business
» the government, which collects tax revenues and hopes » the government, both local and national
for high employment levels. » banks who provide businesses with a range of financial
Stakeholders may not have formal authority over a services, such as giving loans
business, but it may be in the business’ best interests to » the community, including people who live near to any of
take their needs into account when making decisions. It has the business’ facilities.
become more common for businesses to attempt to meet
the needs of as many of their stakeholders as possible in
order to generate a positive image.
External stakeholders
STUDY TIP Internal stakeholders
(e.g. owners, Stakeholders
(e.g. suppliers,
customers,
When responding to questions about stakeholders, do not managers, the government,
other employees) the bank,
be too ambitious and write about too many stakeholders. the community)
This will make it difficult to develop arguments fully and
to write analytically. Instead, you should select the two
or three stakeholder groups that are most relevant in the
circumstances and focus exclusively upon these.
▲ Figure 1.18 Internal and external stakeholders
GLOSSARY TERMS
Stakeholders are groups or individuals who have an interest Internal stakeholders are individuals and groups within a
in a business. business; for example, employees.
Authority is the power or ability to carry through a task or External stakeholders are groups outside a business; for
action. example, people who live near to the business’ premises.
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Roles, rights and responsibilities of Each stakeholder will have certain legal rights. Employees
may have an employment contract that the business must
1.5 the stakeholders
Each of the stakeholder groups above will have their own
adhere to, while the owners or shareholders are entitled
to be kept informed of the business’ activities. These
objectives. Some examples are: stakeholders may also have responsibilities to the business.
» Employees may want good rewards for the work done, In return for their wages, employees are expected to
job security, a safe working environment and some complete their tasks competently; in return for payment for
opportunities for promotion. their products, suppliers should supply goods and services
» Shareholders will want financial rewards in return for the of an appropriate quality and quantity. Businesses are
risk of their investment. therefore in a two-way relationship with their stakeholders.
» Suppliers will want to be paid on time and to be kept
AS LEVEL 1.5 Stakeholders in a business
well-informed of any changes in orders.

» The government will want the business to act legally; for
example, to pay its taxes on time.
▼ Table 1.10 Summary of stakeholders’ roles, rights and responsibilities
Stakeholders Possible rights include Possible responsibilities include

Employees • To be treated fairly • To work effectively
• To be paid fairly • To turn up for work on time
• To be kept informed
Suppliers • To be paid on time • To provide good quality products meeting the set
• To be informed of any potential changes in orders specifications at the time set
in the future
Owners/ • To receive a share of profits • To treat management fairly
shareholders • To be kept informed by management
Customers • To be supplied the right quality products on time • To pay on time
Government • To be paid taxes • To protect businesses, customers, employees and
• To have businesses obey the law the environment
Managers • To be rewarded appropriately for responsibilities • To carry out duties to best of ability
• To have duties commensurate with seniority • To be discrete in handling sensitive business data
Banks and other • To be repaid promptly and on time • Not to charge excessive interest rates or to
lenders withdraw loans without a reasonable period of
notice
The local • To live in an area that is free from excessive noise • To co-operate with the business in its daily
community or other forms of pollution activities
• To have a say in decisions which impact the local
community
• To benefit from employment
CASE STUDY
Gold Fields Limited engages stakeholders
Gold Fields Limited operates eight mines in Australia, Its investment focuses on education, health, water
Chile, South Africa, Peru and Ghana. The business’ and sanitation, and development. A world-class water
mining operations in Ghana make it the country’s largest treatment plant has recently been constructed at Tarkwa
producer of gold and the largest private sector employer and this provides communities with access to clean water.
with approximately 5200 direct and 83 000 indirect The company has also tried to employ locals wherever
employees. It uses a forum to discuss issues and listen to it can – a high proportion of the company’s workforce in
its stakeholders. The aim is to engage with and update key Ghana are locals.
stakeholders on its operations and activities.
Questions
Those invited include government ministers, members 1 Explain one reason why employees and customers
of the community, financial institutions, investors and might be Gold Fields’ major stakeholders in Ghana. [3]
the media. The company is committed to sustainable 2 Evaluate the extent to which Gold Fields Ghana
development and has invested in socio-economic may have benefited from holding its ‘stakeholder
development projects in the community where it operates. forum’. [12]
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Why become a shareholder? » The government may be affected by the creation of more
jobs and more taxes being paid.
By investing in a company, shareholders become the
owners of the business. This means that, if the business The impact of business activity can be positive or negative. 1.5
is successful, the value of their shares should increase. Sometimes one group may benefit and another may suffer.
Shareholders should also receive some of the profits that For example, a decision to cut wages would not be popular
the company makes each year. The part of the profits paid with staff but may enable higher rewards for the investors.
out to shareholders is called the dividends. The more profit A decision to shift production abroad would not benefit
a firm makes, the bigger the dividends are likely to be. the government of the original country but may benefit the
Each year the shareholders will decide on the amount of community where production now occurs.
dividends to be paid per share; the more shares a person
1.5.2 The relative importance and influence of stakeholders on business activities

If stakeholders do not welcome changes, they can take
has, the more dividends they receive in total.
various actions to avoid the effects of them. The following
Shareholders can also influence the policy of the business. are examples of possible responses from stakeholders:
Most types of shares grant their owners voting rights. Each » Shareholders can sell their shares and invest elsewhere.
share is worth one vote. By buying more shares, people can » Banks can refuse to lend more or charge more for
get more votes and have a greater influence over what the businesses to borrow.
firm actually does. If someone owns more than 51 per cent » Employees can leave and work elsewhere or, as a group,
of the shares, they control the business and, therefore, can they may take strike action, which means they withdraw
decide company policy. their labour, hoping to get the business to change its
policy.
All companies must have an annual general meeting (AGM)
to which the shareholders are invited and every shareholder
» Suppliers can refuse to supply the business or demand
better payment terms, such as payment on delivery.
must receive a copy of the company’s annual report. The
annual report reviews the performance of the business over
the last year. At the AGM, the directors and managers give The impact of stakeholder aims on
an overview of the company’s position and respond to any business decisions
questions that shareholders might have.
Most stakeholder groups have aims in their relationship with
In the UK, financial institutions such as banks, pension the business. We shall consider some examples.
funds and insurance companies own most company shares. 1 Employees This stakeholder group is likely to have aims
These organisations buy shares to make a profit through the such as improving working conditions, maximising pay
dividends they receive and by selling the shares at a higher and other benefits, and seeking secure employment.
price later on. They can then pass their profits on to their Businesses have to take these aims into account
own investors. when making decisions. For example, Google employs
many highly skilled people. When taking decisions on
GLOSSARY TERM investing in expansion, the company would ensure that
Dividends are money that is paid out of profits to it budgets for attractive pay rates, provides working
shareholders. It is a reward to the owners of the business. conditions that encourage and promote creativity and
that it offers job security. If Google failed to take these
decisions, it would experience difficulties in recruiting
1.5.2 The relative importance the most talented and productive employees.
2 Customers Arguably this stakeholder group has the
and influence of stakeholders on greatest impact on business decisions, particularly when
business activities the customer has a wide choice of suppliers of a product.
If, for example, a supermarket takes a decision to raise
prices, it may find that many of its customers buy
The interaction between a business’ their groceries elsewhere. The decisions taken by many
decisions and its stakeholders’ managers in businesses will be intended to provide the
best possible value and service to their customers. In
responses this way, customers are a major force shaping business
Any business decision can impact on stakeholders. Examples decisions.
include: 3 Suppliers Businesses depend on suppliers to deliver
» Employees may be affected by a decision to reduce the raw materials, components and other services.
size of the business. Without receiving the correct supplies at the right
» Shareholders will be affected if the profits of the time, a business may not be able to continue trading.
business are low. Businesses would normally seek to take decisions which
» Suppliers may be affected by an increase in orders and do not impact adversely on suppliers, such as delaying
be able to grow their businesses. payments or changing orders at short notice. A supplier
» The community may benefit from the expansion of the is more likely to have a significant impact on business
business and greater income being earned and spent in decisions if it is a major supplier and if there are few or
the area. no alternative sources of supply.
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4 Owners and shareholders Shareholders can be a they have any obligation to invest more in their region or
very influential group on business decisions taken by country. This is known as the shareholder concept, where
1.5 companies. Shareholders in the UK can vote to remove
directors of a company if the directors take decisions of
rewarding owners is the key business objective.
which the shareholders disapprove. The owners of small

The stakeholder concept
businesses (sole traders and partners) are more likely to
be the people who are taking the business decisions. However, increasingly, organisations are trying to work with
Thus, there is less chance of any disagreement occurring. their stakeholders and regard them much more as partners.
This co-operative approach is known as the stakeholder
concept. This view believes that it is better in the long
How and why a business needs to be term to treat stakeholders well.
accountable to its stakeholders For example, working closely with suppliers and paying
them a fair reward for their work (even if this is more
The shareholder concept than the business would have to pay) will lead to better
Businesses have certain legal responsibilities to their quality suppliers and much greater flexibility by suppliers
stakeholders. For example, there are laws controlling the to help out when needed. Focusing on employees’ careers
ways in which businesses can promote their products and, and showing concern about their welfare could lead to
for food manufacturers, the ingredients that can be used. greater loyalty and commitment and, as a result, a better
Some businesses simply do what they have to by law and no quality of work. Being interested in the environment could
more. They focus mainly on rewarding their owners. They help save costs through initiatives such as recycling,
will pay employees what they need to get the job done but it could also make the business more attractive to
but do not think they have any more responsibilities other employees, customers and investors. The stakeholder
than this. They will try to get the lowest price for supplies, concept fits in with corporate social responsibility in
perhaps by threatening to use different suppliers. They will that it stresses the benefits of accepting obligations to
pay governments the taxes they have to but will not think stakeholders over and above what the law requires.
CASE STUDY
Hitachi: contributing to a sustainable society as a good corporate citizen
Hitachi is a multinational company, based in Japan, was due to its stakeholders. The company has a good
that produces a range of products including trains, relationship with its different stakeholder groups such as
construction equipment and power tools. customers, suppliers and national governments.
Climate change is a priority for Hitachi, and we are Hitachi believes it is important to be a good corporate
striving to reduce CO2 [carbon dioxide] emissions ... We citizen. For example, it says that environmental issues
announced our long-term environmental targets, called such as climate change are becoming a priority, and there
Hitachi Environmental Innovation 2050, which include a CO2 is increasing awareness of the relationship between
reduction target of 80 per cent ... by 2050 (compared to 2010). businesses and human rights. The United Nations has
To achieve a resource efficient society, we are responding to asked companies to make broad contributions to society,
the issue of water scarcity and promoting the efficient use mainly through corporate activities, with an eye on the
of water and other resources. We are also promoting the environment but also alleviating poverty and protecting
effective use of plastic and other resources to minimise our human rights. Hitachi is eager to do just this.
impact on [the] natural [environment] ...
Source: Hitachi Sustainability Report 2019, www.hitachi.com/
Hitachi has faced a range of natural disasters, such as sustainability/download/pdf/en_sustainability2019.pdf
an earthquake in Japan in 2011. Hitachi City in north
Tokyo, which is the headquarters of the company, Questions
was particularly badly affected by the disaster. These 1 Explain two ways in which Hitachi could claim to be a
problems did disrupt the company’s supply chain but good corporate citizen. [6]
the business continued to achieve good results. The 2 ‘Working with stakeholders helps Hitachi.’ Evaluate
managers believe its ability to survive such disasters this statement. [12]
A business is made up of people with different opinions managers want to listen to them? Do managers need to
and, sometimes, very different views on what they want listen to them? What will happen if managers ignore them?
to achieve and how they think it should be achieved. Any This means the managers of a business need to think about
major decision is likely to make some better off and others their relative power. A well-organised workforce that is
worse off; it is therefore likely to meet with opposition from unionised, for example, may be able to negotiate for more
some stakeholders. consultation and participation in decision-making than
individual employees could on their own. Managers may
Every decision will involve different stakeholders and
want to pay more attention to an investor who owns 65
will consider their objectives and their relative power. Do
per cent of the company compared with one who owns
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1 per cent. A key supplier of a business’ major component are very powerful (for example, major investors); managers
will have more influence than the supplier of a component will need to keep this group happy. By comparison,
that can be bought in thousands of different stores. So,
the more well-organised a stakeholder group is, the more
stakeholders in quadrant A are not very interested and are
not powerful (for example, your milk delivery service or
1.5
managers need that particular stakeholder, and the more local newsagent); you do not need to worry much about
that managers like or agree with the stakeholders and their this group.
objectives, the more likely the stakeholders are to influence
a manager’s decision. How conflict might arise from
The role of different stakeholders can be shown using a stakeholders having different aims
stakeholder map, as in Figure 1.19.
and objectives
1.5.2 The relative importance and influence of stakeholders on business activities

Level of interest
One of the issues when dealing with stakeholders is that
Low High their aims might conflict; it might not be possible to please
all of the groups all of the time. For example:
» Investors may push for lower costs to increase their
A B profits and rewards and this may lead to fewer or lower
Low Minimal Keep
effort informed pay increases for employees.
» In order to meet customer demands for cheaper
Power
products, the business may relocate to cheaper

C D production facilities overseas, thus upsetting the local
High Keep Key community.
satisfied players
» In order to meet government demands for more
environmentally friendly operations processes, the
▲ Figure 1.19 A stakeholder map and how a business may business may change its production system, leading to
view different stakeholders higher costs and higher prices for customers.
Groups in quadrant D are likely to influence decisions a lot. A business may have to juggle different demands and
They are interested in what is going on in the business and compromise on occasion.
CASE STUDY
Foxconn and Amazon
The Foxconn Technology Group manufactures technology Foxconn’s working conditions did not improve, and instead
products for well-known multinational companies such deteriorated.’
as Apple and Amazon. The company has been criticised
CLW also reported that Foxconn’s wages, which were
for reducing wages and not operating according to local
already very low, had been cut by a further 16 per cent.
labour laws. In response, Foxconn dismissed two senior
This, the pressure group reported, had led to such low
managers at one of its factories where work is carried out
rates of pay that the company experienced significant
to fulfil orders from Amazon.
labour shortages. These labour shortages resulted in the
Foxconn has received a lot of criticism in the past for its poor company recruiting very young employees, a number of
working conditions. Amazon and Foxconn have previously whom had to work overtime.
attracted attention for allegations of poor treatment of
Source: www.digitalcommerce360.com/2019/08/09/amazon-is-
Chinese workers. The pressure group China Labor Watch under-fire-for-factory-hiring-practices-
(CLW) published allegations in 2018 that Foxconn had and-treatment-of-workers
forced employees to engage in long – and illegal – periods
of overtime working. In response the company announced Questions
that it had taken disciplinary action against the managers 1 Explain two reasons why some of Foxconn’s
responsible for mistreating employees. stakeholders might not have approved of the actions
‘Amazon and Foxconn responded that they would make that the company has taken. [6]
improvements to the factory’s working conditions,’ CLW 2 Evaluate whether Foxconn has done the right thing
stated. ‘However, CLW’s 2019 investigation found that by taking these actions. [12]
How changing business objectives a greater emphasis on environmental issues may lead
to more concern for society as a whole and future
might affect stakeholders generations, in addition to a focus on recycling, reusing
As the objectives of a business change, this may well and less waste and pollution. A focus on better quality
affect the way it treats its stakeholders. For example, might lead to better treatment of suppliers. On the other
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hand, greater pressure for profits may mean managers It is very difficult for managers to take decisions to satisfy
start to cut back on training, career development and wage all stakeholders simultaneously, especially at a time of
1.5 increases in order to reduce costs; they might also bargain
hard to push down suppliers’ prices.
change when major strategic decisions may be forced upon
them. It may be that the best they can do is to satisfy as
many stakeholders as possible.
TEST YOUR LEARNING

1 a Define the term ‘stakeholder’. [2] A change of approach

b Explain one reason why the Malaysian government Multan Textiles Ltd has had a change of heart. Its new
might be a stakeholder of a Malaysian retailer. [3] management team has decided to implement a range
2 Explain one way in which businesses and employees of policies intended to meet the needs of all of its
have responsibilities to one another. [3] stakeholders, rather than solely its shareholders. The
3 Explain two possible responsibilities that a business adoption of policies based on the stakeholder concept
that manufactures chemicals might have to its local has significant implications for all of the company’s
community. [6] stakeholders.
4 a Explain one responsibility that a business may The company has agreed to raise its employees’ wages
have to its suppliers. [3] over the next few years, at a rate in excess of the current
b Explain one likely reaction of a retailer’s rate of inflation, and to improve working conditions. It
stakeholders to a decision to close 10 per cent of also has offered its suppliers more favourable credit
its shops to increase profitability. [3] terms to encourage a long-term relationship. It is also
5 a Explain one responsibility of the Indian reviewing its manufacturing processes to minimise the
government to its businesses. [3] impact of the chemicals on its employees and the local
b Explain one way in which the adoption of an community.
objective of growth might affect an airline’s
The company has a long tradition of manufacturing textiles
customers. [3]
in the region and a good reputation. It is profitable, although
6 a Define the term ‘social responsibility’. [2] its shareholders have expressed some dissatisfaction at
b Explain one reason why a business might wish declining profit levels over the last few years.
to be accountable to its bank. [3]
7 Explain two reasons why a large manufacturer might Questions
experience difficulty in meeting the objectives of its 1 Define the terms:
shareholders and its customers simultaneously. [6]
a ‘shareholder’ [2]
8 a Explain one reason why a business might wish
b ‘stakeholder concept’. [2]
to be accountable to its employees. [3]
2 Analyse one benefit to Multan Textiles Ltd of
b Explain one way in which a retailer could be
implementing policies based on the stakeholder
accountable to its employees. [3]
concept. [4]
9 Define the term ‘internal stakeholder’. [2]
3 Evaluate the case for and against Multan Textiles
10 Explain the possible effect of a hotel’s decision Ltd retaining its original approach based on the
to increase its prices significantly on two of its shareholder concept. [12]
stakeholder groups. [6]
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AS LEVEL
2.1 Human resource management
2.1.1 Purpose and roles of human resource management

Chapter overview
★ the purpose and roles of human resource management (HRM)
★ why and how businesses prepare workforce plans and the importance of labour turnover
★ how businesses recruit employees, including the process and key documents
★ how businesses select employees
★ the nature and use of employment contracts
★ the ways in which businesses make employees redundant and dismiss them
★ issues affecting staff morale and welfare
★ the purpose, methods and importance of training and developing employees
★ key elements of management and workforce relations.
are committed to the firm and who do not seek to leave. Such
What is human resource management? employees should be aware of the goals of the organisation and
Human resource management (HRM) comprises the understand how they can contribute towards the attainment of
acquisition, training, motivation and reward of human organisational targets, such as growth in market share.
resources within the business.
Under this scenario, a business should incur lower
Over recent years, the influence of Japanese management recruitment costs and enjoy higher levels of productivity
techniques, and their evident success in managing and a reduction in faulty products. It may attract top-class
people, has encouraged the adoption of human resource applicants to vacancies because of its reputation as a caring
management by companies across the globe. and enlightened employer. All of these factors should make
the organisation more competitive and better able to cope
GLOSSARY TERM with the rigours of operating in international markets.
Human resource management (HRM) is the process However, in reality the case for HRM is not so clear-cut. Many
of making the most efficient use of an organisation’s businesses in the UK differ in their interpretation of HRM.
employees. Some see it as a confirmation of the value of employees who
have to be developed to meet the needs of the organisation.
Others take a ‘harder’ attitude, viewing employees as simply
2.1.1 Purpose and roles of human another resource to be used as effectively as possible. The
resource management latter approach has a much more short-term focus and may
help a business to meet objectives, such as becoming the
Human resource management can help businesses to lowest-cost producer in the market.
generate a significant competitive advantage over rivals The fact that different interpretations of the policy exist make it
and to achieve organisational objectives, such as growth more difficult to assess its contribution to achieving objectives
and increased profitability. Many companies use HRM to and overall competitiveness. We will look at these two
enhance organisational performance. approaches to HRM more fully in Chapter 7.4 later in this book.
If implemented fully and operated properly, HRM recognises
the individual rather than producing personnel policies for the The role of HRM in meeting
whole workforce. All the elements of HRM (such as recruitment
and selection, training and development, redundancy and organisational objectives
dismissal) are geared to fulfilling the needs of the individual We saw in Chapter 1.4 that an organisational or business
as well as those of the organisation. All aspects of the HRM objective is a target that is normally specific in terms of what
‘package’ should be co-ordinated to ensure coherence and to the target is, how it is measured and the time by which it must
assist the attainment of strategic targets. be completed. A business might set itself targets such as:
If an organisation is successful in operating its HRM policy,
» achieving a certain growth rate in terms of sales (for
example, 10 per cent per year)
one outcome could be motivated and creative employees who
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» becoming the lowest-cost producer in a market, enabling rewarding employees are, it is argued, best done by
it to charge low prices managers and colleagues close to the employee in
2.1 » attaining social objectives, including protecting the
natural environment or maintaining employment levels
question. Empowered teams can play a role in recruiting
employees and identifying training needs. This approach
in low-income communities. to HRM embodies a philosophy entirely in harmony with
modern management techniques such as delayering and
Two key arguments exist which mean that the use of HRM teamworking. This approach to HRM can help a business
within businesses is vital to meet organisational objectives. to meet challenges through possessing workforces which
1 The nature of the workforce has changed over recent are more efficient and responsive to customers’ needs
years. Greater use of part-time and peripheral workers, than those of competitors.
for example, has encouraged human resource managers
AS LEVEL 2.1 Human resource management
to view people as a resource to be deployed as GLOSSARY TERMS

effectively as possible. Simultaneously, the existence of
Delayering is a reduction in the number of levels of
a better-educated workforce, along with the expectation
hierarchy within an organisational structure.
that workers should carry out more complex tasks and
duties, has led managers to view employees as valuable Teamworking is the process of breaking down production
assets to be developed to make the organisation more into large units and using groups of employees to
competitive and able to outperform rivals. complete these tasks.
2 Changes in organisational structure have led to many A workforce (or human resource) plan assesses the
managers taking on responsibility for managing people current workforce and actions necessary to meet the
within the organisation. Techniques such as delayering business’ future labour needs.
and the development of empowered teams have been an Labour turnover is the percentage of a business’
integral part of the implementation of human resource workforce that leaves a business over a given period of
management. Acquiring, developing, motivating and time (usually one year).
CASE STUDY
The First State Bank
In 2020, the First State Bank announced that it was to The automation of the HR function offers other benefits
introduce a human resource management package to to senior managers. The new HR system gives managers
improve the productivity of its 44 000 employees. This instant access to all employees’ qualifications,
programme is intended to develop employees’ skills and experience, performance appraisals and positions held.
to ensure suitable candidates are available for future This will help the Bank’s managers to manage the talent
promotions. available more effectively and will ease the process of
planning its future workforces.
The Bank will use technology to automate many of
the functions of its HR department, including paying Questions
employees, booking holidays and repayment of some
1 Explain two reasons why HRM might be an
expenses. Senior managers at the Bank estimate that this
important issue within the First State Bank. [6]
will save approximately 5000 employee days of work each
2 Evaluate whether the advantages of the
month, resulting in a substantial cost reduction for the
introduction of new technology into the Bank’s HR
publicly owned Bank.
department will outweigh the disadvantages. [12]
2.1.2 Workforce planning Workforce plans plays an important role in making

businesses competitive and enabling them to meet their
organisational objectives. For example:
The reasons for and role of a » They help businesses to deal with changes (such as the
workforce plan impact of new technology or changes in consumers’
tastes) by ensuring that they have the right employees
Before a business recruits, selects or trains employees, it
in terms of numbers, work locations and skills.
must establish future labour needs. This is not simply a
matter of recruiting sufficient employees. Those recruited
» Workforce plans help businesses to prepare for changes
in the workforce, such as the introduction of new
must have the right skills and experience to help the
production-line machinery or a significant proportion of
organisation achieve its corporate objectives. Managers
employees leaving through retirement.
will draw up a workforce plan or human resource plan
to detail the number and type of workers the business Workforce plans are designed to help businesses to prepare
needs to recruit, as well as the location where they will be for changes in their environments and not simply to respond
employed. to them.
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Businesses require a range of information when developing and their ability to achieve organisational objectives. This
human resource plans: suggests that most businesses face a higher labour turnover
» They need to research to provide sales forecasts for the
next year or two. This will help identify the quantity and
than desired or that they face unexpected recruitment
costs. If the rate of labour turnover continues to rise in
2.1
type of labour required. the UK, this may result in businesses incurring significant
» Data will be needed to show the number of employees additional costs to recruit and train new employees. They
likely to be leaving the labour force in general (labour may also face additional wage costs if they have to increase
turnover). Information will also be required on potential pay to reduce the level of labour turnover.
entrants to the labour force. However, it may be that a business suffers a rate of labour
» If wages are expected to rise then businesses may turnover that is too low. For example, in creative industries
reduce their demand for labour and seek to make greater
2.1.2 Workforce planning

such as marketing, it is often helpful for a business to
use of technology. have a stable and steady rate of turnover. This can help to
» The plan will reflect any anticipated changes in the develop ideas for new products and more effective ways of
output of the workforce due to changes in productivity working.
or the length of the working week.
» Technological developments will impact on planning the The implications of different labour turnover rates depend
workforce. Developments in this field may reduce the on the industry in which the business operates and the type
need for unskilled employees while creating employment of labour in question. For example, a seasonal business that
for those with technical skills. hires a high proportion of unskilled employees may not be
concerned by high rates of labour turnover. It can recruit
during the off-season and its expenditure on training
Labour turnover is likely to be low. The same would not be true of an
number of staff leaving during the year organisation that employs highly skilled employees who are
turnover = × 100 difficult to replace. A hospital might be an example of this
average number of staff
type of organisation.
This ratio measures the proportion of a workforce leaving
their employment at a business over some period of time,
usually one year. Low wages and inadequate training leading CASE STUDY
to poor morale among employees may cause high levels of
labour turnover. Another cause is ineffective recruitment Labour turnover and restaurants in the
procedures, resulting in the appointment of inappropriate
staff. Other reasons include redundancy and retirement.
USA
Hotels and restaurants across the world face very
high rates of labour turnover. Restaurants in the USA
HANDLING DATA experienced rates of nearly 75 per cent in 2018, meaning
that around three-quarters of business employees are
Last year, 45 employees at Kenya Fuels Ltd left leaving each year. The equivalent figure for 2010 was
the company. The company had an average of 900 57 per cent.
employees during the year. The company’s HR manager
had forecast that the company’s labour turnover figure The restaurant industry is the US economy’s largest
would be 4 per cent. employer of teenagers, as one-third of all working
1 Calculate the labour turnover figure for this company. teenagers in the USA are employed in a restaurant. The
2 How many employees would have left if the HR industry also employs a high proportion of students,
manager’s forecast had been accurate? who may only work part of the year and tend to leave
employment once they finish studying. This helps
to reduce costs and to allow restaurants to charge
Some level of labour turnover is inevitable. Managers seek competitive prices for meals.
some labour turnover to bring new ideas into a business,
Restaurant guests also develop a comfort level with an
but not so much as to impose excessive recruitment costs.
employee with whom they regularly interact. Appointing
A survey in the UK in 2017 by the Chartered Institute of new employees can affect regular operations which are
Personnel and Development (CIPD) revealed that labour vital to the smooth running of any restaurant, especially in
turnover in the UK was 16.5 per cent and that it has risen the kitchen. Having skilled and experienced staff is vital in
steadily for some years. Businesses attempt to manage the American restaurant industry, where competitiveness
labour turnover to achieve a balance between the costs of is based heavily upon employee performance.
recruitment and the potential for disruption to production
on the one hand, and bringing new employees with Questions
enthusiasm and ideas into the business on the other. 1 Explain two reasons why labour turnover rates
of ‘nearly 75 per cent’ might cause problems for
The implications of different rates of labour managers in restaurants in the USA. [6]
2 Evaluate the possible actions the managers of
turnover restaurants in the USA might take to reduce rates
Surveys in the UK have shown that labour turnover for most of labour turnover. [12]
businesses surveyed has a negative impact on performance
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2.1.3 Recruitment and selection recruitment difficulties. The key reason cited was a lack of
suitable candidates. Recruiting is expensive. The average
2.1 The process of recruitment recruitment cost of filling a vacancy in the UK in 2020 was
£3000 and took nearly 28 days, during which output and
The process of workforce planning, in which a business sales may have been lost. However, many managers would
analyses its expected future labour needs and compares this argue that these figures are less costly than appointing the
to its current workforce, may identify the need for recruiting wrong employee and perhaps having to repeat the process.
new employees. Alternatively, the need for recruitment
may arise because an existing employee opts to leave. The Two very important documents used in the process of
recruitment process is summarised in Figure 2.1. recruitment are job descriptions and person (or job)
specifications.
Use HR plan to decide

number and type of employees needed
GLOSSARY TERMS
Recruitment and selection is the process of filling an
Prepare: organisation’s job vacancies by appointing new staff.
1 Job adverts Job descriptions list the duties and responsibilities
2 Job descriptions associated with a particular job.
3 Person specifications
Person (or job) specifications outline the skills,
knowledge and experience necessary to fill a given
position successfully.
An employment contract is a legal agreement between
Advertise outside the Advertise inside the an employer and an employee setting forth the terms and
business (external recruitment) business (internal recruitment) conditions of the employment arrangement.
Job descriptions
Once managers know the type and number of employees
Receive job applications required, job descriptions can be prepared. These relate
to the position rather than the person. Typically, job
descriptions might contain the following information:
Prepare shortlist for selection, » the title of the post
matching applications and person » employment conditions
specifications » some idea of tasks and duties
» the key aims and responsibilities of the job
» where the job fits into the organisation.
Select employees using interviews, etc.
A job description is likely to form the basis of the
employment contract, which we consider below. It also
▲ Figure 2.1 The process of recruitment and selection
offers other important information to employers and
Source: CIPD Resources and Talent Planning Survey employees.
» It helps employers by allowing them to consider exactly
Recruitment is likely to be a more important activity in a what should make up the job and how this job relates
business that is expanding or one which is developing new to others within the organisation. It can also be used
products or entering new markets. In such cases, the business to judge performance of an employee at some point
may require a substantial number of new employees and these following their appointment. Employees can be set
may come from inside the business (existing employees) but targets based on the information included in the job
are more likely to be recruited from outside it. description. During an interview, the job description
might form the basis for the interviewer’s questions.
STUDY TIP » It provides potential employees with essential
It is easy to get bogged down in the detail of recruitment information to help them to decide whether or not to
and selection procedures. While such knowledge is apply for a job. For example, the descriptions of tasks
fundamental, it is vital to think about how successful and duties will help them to decide whether they would
different approaches to recruitment and selection might enjoy the role.
be in helping the business to achieve its organisational
objectives. Person specifications
Person or job specifications set out the qualifications
and qualities required in an employee. They relate to the
In 2018, more than 70 per cent of businesses taking employee, whereas job descriptions relate to the job. They
part in a UK survey said that they were experiencing include:
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» educational and professional qualifications required together employers and potential candidates. Businesses
» character and personality needed may use employment agencies to recruit highly specialist
» skills and experience wanted. employees or those with skills that are scarce. Although
this is a costly method of recruitment, agencies often have
2.1
Candidates’ applications should be compared against the skills and contacts that many businesses do not possess.
person specification and those applicants with the ‘best fit’
should be invited to interview or other selection procedure.
This document, therefore, plays a vital role in helping an
Online recruitment
organisation decide which of the applicants for a post Online recruitment allows businesses and other
should progress to the next stage of selection. organisations to use their websites to recruit potential
employees cheaply and from any part of the world.
2.1.3 Recruitment and selection

Methods of recruitment This method of recruitment can increase the number of
applicants and the quality of employees who are eventually
Once managers have prepared job descriptions and person employed. Online advertising can reach much larger
specifications, a decision has to be made as to how to recruit audiences, increasing the number of applicants. Equally,
the necessary employees. A number of options are available. this form of advertising can be targeted, as relevant
groups help to improve the quality of applicants. Websites
Job advertisements operated by both businesses and governments bring
The start of recruitment is often drawing up an advert together those seeking work and businesses intending
for the vacant position. This advert could be placed in to recruit. Examples include the privately owned Rozee
newspapers, magazines or on the internet. The advert website (www.rozee.pk) in Pakistan and the New Zealand
needs to be targeted so as to attract suitable applicants government’s jobs website (www.jobs.govt.nz).
while dissuading unsuitable candidates from applying.
For example, if an international airline such as Pakistan
International Airlines was recruiting a senior manager, it CASE STUDY
may advertise the vacancy globally. In contrast, a retailer
seeking to advertise a vacancy for a shop assistant would Job advertisement
be more likely to advertise the job in a local newspaper.
In part, the choice of where to advertise a job will also be
determined by cost; generally, businesses are willing to
spend more heavily on recruiting senior employees.
An effective job advertisement should contain sufficient BUILDING A BETTER WORLD
information to attract and engage potential employees OSEEC provides a platform for social, economic and environmental
but not too much so as to discourage them from applying. communication and collaboration, with the aim of creating and supporting
policies that increase development in these sectors, enriching quality of life for
Figure 2.2 contains a checklist of possible information to people across the globe. Our platform enables global organisations, charities
include in a job advertisement. and governments to share information, co-ordinate resources and collaborate
efforts to tackle shared social, economic and environmental problems.
Director – Environment Directorate
Job title www.oseec.org/ed
A Berlin-based position with a competitive salary and benefits
Location of job The Environment Directorate (ED) oversees global communication on
environmental objectives, including design, collaboration and implementation
Brief description of business, its products and markets of multinational policies to combine economic efficiency with sustainable
environmental practice. The ED also provides information, analysis and
Outline of job role advice to support emerging and transition economies currently engaged in
development, promoting inclusivity and environmental sustainability.
Any special features of the job such as part-time or This position provides intellectual and strategic leadership in the areas of
biodiversity and biosafety, natural resource management, climate change and
flexible hours environmental indicators, resource efficiency and waste reduction, and
sustainable environmental practice. This position is responsible for ensuring
Some indication of qualifications and experience that current and future policies fully reflect the aims of OSEEC in this
required Directorate and for providing effective support for OSEEC members.
The successful candidate will have significant knowledge and experience in
Salary or salary guide the aforementioned policy areas, with attestable powers of analysis,
communication, planning and organisation. They will be expected to
Other reward details such as a company car promote the intrinsic value of OSEEC in bringing together world partners
to multiple audiences, obtaining wide-reaching media coverage.
Explanation of how to apply and the recruitment This position requires fluency in either English or German and a partial
process knowledge of, or willingness to learn, the other. Full details of the position can
be found at www.oseec.org/careers/vacancies (ref. 93752). Applications
Contact details for the business must be submitted online by 23 March 2020.
▲ Figure 2.2 A checklist for writing job advertisements ▲ Figure 2.3 An example job advertisement
Employment agencies Question

Employment agencies provide employers with details 1 Evaluate whether or not this is an effective job
of suitable applicants for posts they may have vacant. advert. [12]
Agencies usually charge considerable fees for bringing
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Other methods of recruitment Internal and external recruitment
Firms headhunt employees who are currently working for
2.1 other organisations in order to offer them employment.
Firms may recruit internally through promotion or
redeployment of existing employees. Internal recruitment
Those employees who are headhunted are usually either offers a number of benefits:
senior managers or people with specialist skills, perhaps in » Candidates will have experience of the business and its
short supply. Specialist executive recruitment agencies exist culture and will be familiar with the firm’s procedures.
which can target precisely the right type of candidates, but » Internal candidates may not require induction training.
they normally charge high fees. » Internal recruitment provides employees with
Governments operate a number of training schemes to opportunities for promotion.
improve the skills and knowledge of the workforce. In the » It avoids the need for expensive external advertising.
USA, the Department of Labor’s Employment and Training » Selection may be easier as more is known about the
Administration funds job-training programmes to improve candidates.
the employment prospects of adults, youths and workers However, internal candidates are drawn from a limited pool
who have lost their jobs. Its training is designed to boost of employees and the skills and experience of this group of
workers’ employability and earnings. This provides a source people may be insufficient to meet the business’ needs. This
of employees for American businesses that are seeking to limitation is more likely in the case of smaller businesses and
recruit workers. with senior appointments or for rapidly growing businesses.
CASE STUDY
IHG uses online recruitment in Dubai
The InterContinental Hotels Group (IHG) is about to open IHG has used online recruitment to enable it to recruit
a new hotel in Dubai. Many of the guests at this new employees from any part of the world. This could
hotel will be from countries other than the United Arab provide the company’s managers with a large number
Emirates (UAE), as Dubai is a major tourist destination of applicants from which to choose. One requirement
and its airport is a hub for flights from a large number from any selected applicants will be to record a video
of countries. The Indigo Dubai Downtown has launched a describing the place in which they live.
recruitment campaign to attract employees with a range
Source: Adapted from www.hoteliermiddleeast.com/
of skills and experience. The intention is to appoint people business/115326-hotel-indigo-dubai-downtown-launches-
in a range of roles within the hotel including finance, recruitment-campaign
reception, cleaning, as well as bar and restaurant staff.
Questions
The company has a reputation for providing
accommodation within a relaxed setting. It has designed 1 Explain two reasons why some potential applicants
a number of eye-catching adverts intended to attract may not apply for jobs using the IHG’s website. [6]
candidates with the skills and personalities that match its 2 Evaluate the case for and against companies based
needs. in the UAE relying increasingly on their websites to
recruit new employees. [12]
Managers may be keen to have a wider choice of candidates investing more resources and time in the recruitment and
and may seek to recruit externally. This can result in selection process.
applications from higher-quality candidates, especially if
▼ Table 2.1 Methods of selection used by a sample of UK
recruitment is through national media or nationally based businesses in 2015 and 2017
recruitment agencies. External recruits may bring fresh
ideas and enthusiasm into the business. This can be a vital 2015 2017
factor in an organisation with a low level of labour turnover. Method of selection
survey (%) survey (%)
However, external recruitment is likely to be very expensive. Competency-based interviews 77 78
It also carries a greater risk as candidates are not known to Interview following contents 83 74
the business. of CV/application form
Online tests 24 23
GLOSSARY TERM
Personality/attitude 36 35
A business culture is the attitudes, values and beliefs that
questionnaires
normally exist within an organisation.
Assessment centres 38 39
Group exercises (e.g. role-
Selection playing)
27 24
A number of selection techniques exist. Because of the high
costs resulting from recruiting the wrong people, firms are Source: Resourcing and Talent Planning Survey, 2017 (CIPD)
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and provide potential employers with a further indication
Question of the applicant’s suitability for the post. References are
1 Evaluate whether the data in Table 2.1 suggests that
UK businesses are attempting to minimise costs of
not always accurate. For instance, an employer may give an
employee an undeservedly good reference if they want to
2.1
selection. [12] get rid of them.
Testing
Methods of selection Testing as part of the selection process can take a variety
of forms. Psychometric tests are very common; these can
Curriculum vitae, résumés and application take two forms. An aptitude test provides candidates with
2.1.3 Recruitment and selection

forms opportunities to demonstrate their skills and abilities
Curriculum vitae (CVs) take various forms but are all designed in relation to the job. For example, an aptitude test
to record key information about potential employees, such as for a sales role might involve the candidate making a
their education, professional qualifications and experience in sales presentation. Personality tests examine the likely
previous employment. This is designed to help managers to behaviour of potential employees and how they might
match employees to person specifications which detail the respond to certain situations in the workplace. They
requirements of the job. Thus, they can form an important involve numerical and written questions and can help to
element of the early stages of the selection process. assess how well the applicant might fit in with existing
employees.
Résumés are very similar. A résumé normally summarises
the applicant’s relevant job experience, education and
training. The résumé is usually sent to employers with a
Assessment centres
covering letter which may contain additional information. Managers are aware of the high costs of poor selection
decisions and this has led to the heavy use of assessment
Some businesses supply application forms for prospective centres. Many managers believe that this is a more
employees to complete. These are normally used in place of reliable method of selection. In such centres, a number
CVs and résumés. They offer the advantage that businesses of candidates are subjected to a variety of selection
can ensure that all applicants have the chance to supply the techniques over a period of between two and four days.
information that is required to make the selection decision. These might include some or all of the following:
Also, because the application forms are in a standard » simulations of circumstances that might occur within
format, it can be easier to compare candidates’ applications. the job
CVs, résumés and application forms all tend to be used » a variety of interviews
early in the selection process, and they can be a useful » group exercises, such as role-plays involving a number of
means of screening candidates and deciding which to the candidates and assessment centre staff
invite to interview or other method of selection. They are » tests of candidates’ personalities.
particularly valuable if a business receives a large number of
applications for a position. Employment contracts
An employment contract is a legal agreement between
Interviews an employer and an employee, setting forth the terms
These remain a popular form of selection technique and and conditions of the employment arrangement. It is a
are the most common in the UK, as shown in Table 2.1. legally binding agreement designed to protect the rights
Interviews can involve one or two interviewers or even of employers and employees. In the UK, the Employment
a panel. Candidates can be asked a series of questions Rights Act requires employers hiring workers for more
designed to test their knowledge of, and suitability for, the than a month to issue an employment contract. A contract
job. Some interviews (sometimes called competency-based does not have to be issued immediately upon an employee
interviews) may require candidates to undertake specific starting work, but its conditions are in force from the
job-related tasks to assess their skills. time an employee commences employment. Employees’
contracts may be verbal, implied (for example, through
They are relatively cheap and allow the two-way exchange previous practice) or written, though the latter is more
of information, but are unreliable as a method of selection. common and preferable in many ways.
Some people perform well at interview, but that does not
necessarily mean they will perform well at work. The laws relating to employment contracts vary between
countries. Here we refer to those that apply within the
References UK. An employment contract in the UK should contain the
following information:
Many employers ask candidates to supply references at some
1 the employee’s and employer’s names
stage in the recruitment and selection process. These are
2 date when employment began
written by former employers or by other people in a position
3 the scale (and rate) at which the employee will be paid
of authority who may know the candidate well. They will set
and the frequency of payment
out the candidate’s strengths and possibly their weaknesses
4 the employee’s usual hours of work
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5 the employee’s entitlement to holidays – how many days shall examine each of these situations in turn and explain
and whether they can only be taken at certain times of the difference between the two.
2.1 the year
6 rules relating to absences due to sickness or injury, GLOSSARY TERMS
including sick-pay conditions
A dismissal occurs when an employer terminates the
7 the employee’s right to a pension (if any) and employer’s
employee’s contract.
and employee’s contributions
8 the notice from either side to terminate the employment Redundancies take place when an employee is dismissed
because a job no longer exists.
contract. This states the period of time that must elapse
between the employee stating their intention to leave
the job and doing so. Similarly, it may record the time
period to be given to employees before making them Redundancy

redundant or dismissing them Redundancy is a legal reason for an employer to dismiss an
9 the job title and a summary of duties employee, but it can only occur if a job no longer exists.
10 the location or locations of the work Redundancies can take place for a variety of reasons, including:
11 details of any trade union agreements relating to the job » A business closes down and all its employees are made
12 disciplinary procedures – this sets out the rules redundant.
establishing standards of conduct at work and how the » The jobs of some employees are replaced by new
employer may respond to any breach of these rules technology.
13 grievance procedures – this will state how an employee » A business moves some of its operations overseas and
can make a complaint against other staff or their some jobs are lost as a consequence.
treatment at work.
An employment contract may include implied terms which are Voluntary and involuntary redundancies
not directly stated. Examples of implied terms include: Voluntary redundancy occurs when an employer, wishing
» employees not stealing from employers to make redundancies, invites employees to apply for
» employers providing a safe and healthy working redundancy in return for a financial compensation
environment package. This is often the first choice for a business
» employers meeting legal requirements, such as giving a wishing to make redundancies. This form of redundancy can
minimum of a certain number of days of paid holidays help to maintain the morale of a workforce at what can
» employees should have essential qualities and be a very difficult time for a business. Offering voluntary
qualifications to carry out the job; for example, lorry redundancies means that employees choose to leave. Some
drivers should have a relevant category of driving licence. employees, for example, those near to retirement or those
If either the employer or the employee suffers financial loss who might find it easy to obtain alternative employment,
because the other party has breached the contract, they might find the offer of financial compensation very
can claim compensation in a court of law. For example, attractive.
an employee who leaves before the end of a fixed-term By contrast, involuntary (or compulsory) redundancy is
contract and thereby causes disruption to the employer may where employees are selected for redundancy. They have
be sued for damages. In many cases in the UK, an employee no choice in the matter. This is likely to occur when a
may take an employer to an employment tribunal to settle a large number of employees are to be made redundant
certain range of disputes relating to employment. and insufficient people are willing to take voluntary
redundancy. Involuntary redundancies often damage the
Employment tribunals morale and performance of the workforce. We shall see in
Employment tribunals in the UK hear claims about matters the next chapter that job security is an important factor
to do with employment. These may include unfair dismissal, affecting motivation at work. Customers may also be less
redundancy payments and discrimination. Employment willing to purchase products from businesses that are using
tribunals are similar to law courts, but they are less formal. involuntary redundancies.
No one in an employment tribunal wears a wig or gown. The law requires that use of involuntary redundancy must
Almost all hearings are open to the public, and evidence is follow set procedures. These are explained below.
given under oath or affirmation.
Procedures for redundancy
2.1.4 Redundancy and dismissal If a business in the UK intends to make 20 or more
employees redundant, it is obliged to consult with any
It is only possible for an employer to legally terminate relevant trade union or other employee organisation at
the employment of a worker for specific reasons and least 30 days before any redundancies occur. The employer
having followed certain procedures. It may be that the must also consult with individual employees. If 100 or more
employer takes disciplinary action against an employee; employees are to be made redundant, consultations must
this may result in the employee being dismissed. Similarly, take place at least 90 days before the process of making
employment may be ended as a result of redundancy. We people redundant can commence.
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Part of this consultation may involve agreeing a procedure If, despite these measures, employees have to be made
by which those employees who are to be made redundant redundant, there must be clear and agreed criteria for
are to be selected. It is likely to be beneficial to involve
employees and their representatives in making such
selecting them. The criteria for redundancy could be based
upon employees’ skills and experience (that is, the business
2.1
decisions. Businesses commonly seek to reduce the number would retain the most skilled and experienced) or on
of employees who have to be made redundant by: absence and disciplinary performance (those with the best
» asking for volunteers for redundancy records keeping their jobs). Employees who are selected for
» banning any overtime to maximise the number of jobs redundancy must be given between one and twelve weeks’
that are retained notice of their impending redundancy, depending on how
» not replacing employees who leave for other reasons. long they have been employed by the business.
2.1.4 Redundancy and dismissal

CASE STUDY
Airline makes redundancies
Philippine Airlines (PA) announced that it has cut 300 causing the cancellation of flights to mainland China,
jobs as a result of continued financial losses. The Hong Kong and Macau.
airline said that this will help the company to reduce its
As part of its statement on the redundancies, the airline
costs, adding that it was offering voluntary redundancy
said that it would be acquiring new aircraft and launching
packages to long-serving employees. Those who accept
new routes between Cebu and Los Angeles, as well as
will receive benefits including flight pass privileges and
routes to Perth, Pagadian, Kota Kinabalu and Manado.
career counselling assistance. The company’s workforce
currently totals 6087 employees. Source: Adapted from www.ch-aviation.com/portal/news/86974
Other cost-reducing initiatives include: Questions
● increasing revenues from flights and other products
1 Explain two reasons why Philippine Airlines might
● a vigorous cost-management approach
prefer to use voluntary redundancies, rather than
● investment in digital technology.
involuntary redundancies, to achieve the desired
The announcement was made after Philippine Airlines reduction in its workforce. [6]
posted its biggest ever loss ($208 million) in 2019. The 2 Evaluate the case for and against Philippine Airlines
company blamed these losses on high levels of interest making 300 employees redundant. [12]
payments on debts and on unexpected global crises,
Redundancy pay Apart from redundancy, there are a number of reasons why
employees may be dismissed legally in the UK. The reasons
Employees in the UK who have been continuously employed
for ‘fair’ dismissal include:
by the business for two years and who are made redundant
due to the closure of the business or reduced need for
» when employees are unable to do their jobs properly,
perhaps because they do not have the necessary skills or
employees are entitled to compensation in the form
qualifications to be competent
of redundancy payments. The calculation for statutory
redundancy pay is:
» as a result of persistent or long-term illness (but not
because of a person’s disability)
» half a week’s pay for each full year of service where the
employee is aged under 22
» for ‘gross misconduct’ – theft or violence towards
colleagues or customers may be considered gross
» one week’s pay for each full year of service where the
misconduct
employee is aged between 22 and 41
» one and a half week’s pay for each full year of service » a ‘substantial reason’ such as not agreeing to reasonable
changes in employment terms or if an employee is given
where the employee is 41 or over.
a prison sentence.
The maximum number of years that can be taken into account
Employees should receive an explanation in writing of the
in calculating redundancy pay is 20 years. Some employers
reason for their dismissal within 14 days of it happening.
may choose to pay higher levels of redundancy pay.
Employees may also be entitled to receive up to 12 weeks’
Many employers will have a set of redundancy guidelines with notice of dismissal, depending upon how long they have
which they will comply to ensure that they do not break any been employed by the business.
employment laws relating to the process of redundancy.
If employees in the UK are dismissed for other reasons,
this can be classed as ‘unfair dismissal’. Dismissals are
Dismissal classed as ‘automatically unfair’ if the reason for dismissal
Dismissal takes place when an employer terminates an is connected with an employee exercising rights relating to
employee’s employment contract. We saw above that factors such as the following:
redundancy is one reason for dismissal. Thus, dismissal is a
more general term than redundancy, which is a specific form
of dismissal.
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» pregnancy: including all reasons relating to maternity Employee morale is the level of satisfaction, as well as the
» family reasons: including parental leave, paternity leave overall sense of well-being, of a business’ employees. An
2.1 (birth and adoption), adoption leave or time off to care
for dependants, such as children who are ill
employee who is satisfied and content at work usually tends to
co-operate with colleagues and managers and to perform well.
» trade union membership: including being a member of a
union and union recognition. GLOSSARY TERMS
Employee welfare is a broad term covering a wide range
STUDY TIP of facilities that are essential for the well-being of a
business’ employees.
Do make sure that you distinguish between redundancy
and dismissal. Redundancy is just one of the reasons Employee morale is the satisfaction felt by employees
why a business can dismiss employees fairly and legally. within the workplace.
Dismissal is a more general term. Work–life balance refers to the obligations placed on
employees by employers that determine the amount of
time that employees spend on work-related activities.
2.1.5 Morale and welfare

At its most basic, every employer is required by law to HRM, welfare and employee morale
provide essential amenities such as toilets, sinks and clean Human resource management can play a central role
drinking water for employees. Most employees also hope to in developing and improving the morale and welfare
find additional facilities, such as a cloakroom and a clean of employees. Recruiting people with the intention of
and hygienic seating area for workers to use during meal developing their skills and improving their performance
breaks. There should be facilities nearby for heating food or throughout a long-term relationship is at the heart of
water for hot drinks. what is called ‘soft’ human resource management. Such
an approach to HRM may well seek to develop the skills of
A ‘good’ employer who is concerned about employee employees and to encourage them to work with the business
welfare may also consider other issues besides the physical for long periods of time. Using this ‘soft’ approach to HRM
working environment. For example, such employers will seek also offers benefits to the business of providing good
to develop their employees as fully as possible to improve facilities for employees.
their performance at work.
CASE STUDY
Working at Google
Here’s a taste of what Google offer their employees:
● On-site physicians and nurses, convenient medical
services, and comprehensive health care coverage help
keep you healthy and happy. (Varies by location.)
● Googlers and their families have travel insurance and
emergency assistance, even on personal vacations.
● New parents get time off and some extra spending money
to help them welcome their new bundle of joy.
● We’ll reimburse you for classes or degree courses
that help you with what you do. Google is committed to
continuous learning among its employees.
● Googlers get legal advice at no cost and, in the USA, also ▲ Figure 2.4 More time with your baby (image for
get common legal services at a generous group discount. illustration purposes only)
Source: www.google.com
Questions
1 Explain two reasons why Google’s employees might
benefit from the company’s commitment to continuous
learning. [6]
2 Evaluate the benefits Google might receive from
treating its employees in this way. [12]
▲ Figure 2.5 Travel without worries (image for

illustration purposes only)
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Work–life balance is a topic of increasing importance for Some governments have become concerned about the
employers as well as employees. The term work–life balance possible adverse implications for the health of employees
refers to the time an employee spends on work-related
duties compared with time spent on non-work activities.
and for rates of labour productivity of excessive working
hours. The European Union has implemented a working
2.1
Non-work activities include leisure interests and time spent time directive intended to limit working hours to a
with family and friends. maximum of 48 per week, although exceptions can be
made.
CASE STUDY
2.1.5 Morale and welfare

International working hours
Despite concerns about the work–life balance of many It also reported that Foxconn failed to follow laws
employees, average working hours in many countries concerning its permanent staff, including claims that
have declined since 2012, as shown in Table 2.2 (below). employees were not permitted to resign during peak
Many countries have laws to restrict the number of hours season, needed to provide three days’ notice if they
people may work, though these are not always enforced. wished to quit during their probationary period, and
For example, China has legislation imposing a 44-hour needed permission to not work overtime.
maximum normal working week with overtime payments
Source: www.theregister.com/2019/09/09/
for hours beyond this. However, surveys suggest that this foxconns_apple_11_ factory_clw_report/
limit is ignored by many employers.
Foxconn is a major company in China which manufactures Questions
large numbers of mobile phones for Apple and other 1 Explain two reasons why many governments have
businesses. A report released in September 2019, by passed laws to impose limits on the number of
China Labor Watch, alleged that Foxconn did not always hours employees may work each week. [6]
follow Chinese labour laws. This investigation found that 2 Evaluate the case for and against Foxconn
its Apple 11 factory ‘routinely’ and ‘repeatedly’ ignored requiring its employees to work very long hours
laws that were put in place to regulate the employment of each week. [12]
temporary workers.
Research has shown that long working hours can damage Many employers are concerned about long working
the health of employees, endanger their safety at work and hours and their impact on the work–life balance of the
increase levels of stress. A few countries have long average people who work for them. Long working hours can
working weeks. In Columbia, the average working week is harm the performance of employees, which may have a
47.7 hours, reportedly the longest in the world. However, significant impact on the performance of the business
long working weeks do not always lead to high levels of itself.
productivity.
Some major businesses have implemented policies designed
▼ Table 2.2 Weekly working hours in a selection of OECD to relieve the pressure on employees and to help them to
countries, 2012 and 2019 achieve a sensible balance between work and non-work
activities. The Colgate-Palmolive company is an American
Country 2012 2019 multinational manufacturer of consumer products such
Australia 33.2 32.9 as soaps and detergents. It has acquired a reputation
Chile 39.0 36.8 for employment practices that set realistic expectations
for employees, and it encourages the development of
Mexico 42.8 41.1 time-management skills. Colgate-Palmolive also offers
Spain 32.4 32.4 its employees the chance to work flexible hours and to
Turkey 35.7 35.2* telecommute. It provides nearby back-up childcare facilities
to assist parents who work at home. As a result, Colgate-
Average of OECD members 33.9 33.2
Palmolive has a low rate of labour turnover, which offers it a
range of benefits.
* 2018 data
Source: OECD data,
https://data.oecd.org/emp/hours-worked.htm
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The impact of diversity and equality in » harassment
» victimisation.
2.1 the workplace
Although the terms ‘diversity’ and ‘equality’ are frequently
The Act identifies a number of ‘protected characteristics’.
These are:
used together, and sometimes interchangeably, they have » age
different meanings. » disability
Diversity, in a workplace context, refers to recognising the » gender reassignment
differences between individual employees and also the » marriage and civil partnership
differences that may exist between different groups of » pregnancy and maternity
employees. Businesses that operate diversity policies will » race
treat people as individuals and will value the benefits that » religion or belief
diverse individuals and groups in a workplace may offer to a » gender
business. Employee diversity could be based upon gender, race » sexual orientation.
and ethnicity, disability, religion, sexuality, class and age. Operating an effective policy for equality offers benefits
In contrast, policies related to equality are intended to to businesses. Drawing on all people within the local
create a fairer society where all employees can contribute community when recruiting offers the best opportunity to
and fulfil their potential. One key aspect of this is to operate employ the most talented employees, which will enhance
policies that allow all employees the opportunity to reach the performance of the business. Similarly, promoting the
senior positions in a business, irrespective of their age, most able employee, regardless of personal characteristics,
gender, ethnicity or sexual orientation. This is considered secures the greatest level of talent for the business. Any
necessary as many groups, such as women and minority other approach is likely to harm the business.
ethnic groups, are under-represented in senior positions The elements of a policy designed to promote diversity can
in businesses. This can mean that the skills and abilities also bring benefit to the business. A diverse workforce may
of such employees are wasted. By including such groups, allow the business to understand the needs of a market
businesses can become more competitive and successful. which may comprise diverse consumers. This will assist
A number of governments have enacted employment the organisation in meeting the needs of its consumers
legislation to ensure that businesses design and implement more effectively. A business that acquires a reputation for
policies to encourage diversity and to promote equality. operating an effective diversity and equality policy may
For example, the UK government passed the Equalities become an attractive employer to potential employees.
Act in 2010. This offered protection to employees on the This process is called employer branding and can
grounds of: help businesses to attract highly talented and skilled
» direct and indirect discrimination employees, whatever their personal characteristics.
CASE STUDY
Equality and diversity at the University of Cambridge
The University of Cambridge, in the UK, is one of the best- aims to help staff understand the main principles of equality
known universities in the world. It was founded in 1209. and diversity, their impacts on the University and how members
In 2020, it had over 11 000 staff and 23 000 students from of staff and students can access support and other resources.
countries throughout the world.
The module, which can be accessed on a variety of platforms,
The University of Cambridge is committed in its pursuit including tablets and laptops, is Cambridge-specific and
of academic excellence to equality of opportunity and to a takes about 30 minutes to complete.
proactive and inclusive approach to equality, which supports
Source: www.equality.admin.cam.ac.uk
and encourages all under-represented groups, promotes an
inclusive culture, and values diversity. Questions
The commitment applies to all protected groups and is 1 Explain two ways in which training might assist
underpinned by the University’s Equal Opportunities Policy Cambridge University to implement its equality and
and Combined Equality Scheme (CES). It is managed by the diversity policy. [6]
University’s Equality & Diversity Committee. 2 Evaluate the extent to which the benefits of the
The University’s Equality & Diversity essential online University of Cambridge’s equality and diversity
training module: policy outweigh its costs. [12]
Firms take positive decisions on welfare and training are important. Other writers on motivational theory would
because they have the potential to improve the morale and argue that providing training and allowing employees to
motivation of employees. We shall see in Chapter 2.2 that develop themselves and to fulfil their potential are powerful
there are different views on what motivates employees. motivators.
Some writers on motivation argue that physical faculties
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products. Both factors can help businesses to reduce their
GLOSSARY TERMS costs.
Diversity, in an employment context, refers to recognising
the differences between individual employees and also the
Development is a broader term than training and refers to 2.1
differences that may exist between groups of employees. a wider range of activities intended to improve employee
performance at work. It includes attendance on courses
Equality is the circumstance in which all people are equal,
studied at colleges and universities, performance tracking
particularly in relation to rights and opportunities in the
and improvement, coaching and mentoring, as well as
workplace.
Training is a process whereby an individual acquires job-
training.
related skills and knowledge.
Types of training
2.1.6 Training and development

Development refers to activities designed to increase
employees’ skills, education, knowledge and abilities in Almost all employees receive training at some point during
the workplace. their working lives and this training comes in different
forms.
Induction training
2.1.6 Training and development Employees may receive training when commencing a new
Training and development can help employees to improve job. This is known as induction training and is intended to
their performance at work. Employees who are offered introduce an employee to the business. Induction training
opportunities for training and development are often more may provide employees with information on the following:
motivated. In the next chapter we will look at some of » important policies such as health and safety, and
the motivational theories that explain this relationship. disciplinary procedures
Businesses that offer good-quality training and » the layout of the factory or office
development often have very loyal workforces, and it » their new colleagues
can help to develop a reputation as a ‘good’ employer. » the basic duties of the job.
Improvements in the performance of a business’ labour
Induction training enables a new recruit to become more
force can assist the organisation in achieving its
productive quickly. It can prevent costly errors resulting
objectives. Training and other development activities
from employee ignorance and can make a new employee feel
can result in higher levels of productivity or fewer faulty
welcome, thereby reducing labour turnover.
CASE STUDY
Center Parcs
apartments and lodges. Each village offers an extensive
range of sports and leisure activities, plus numerous
restaurants, bars and retail outlets and an Aqua Sana
Spa facility. Woodland, water and a natural healthy
environment are the essential elements of a Center Parcs
break.
The company employs about 9500 people and values its
staff. It has the following statement on its UK website:
... we encourage our employees to develop their skills
and reward them when they are successful. Our training
and development programme offers our employees the
opportunity to develop their technical and professional skills
as well as their leadership potential, from entry level through
to managers.
▲ Figure 2.6 Center Parcs is a business that offers its
employees regular opportunities for training. Source: www.centerparcs.co.uk/company-information/our-
responsibilities/our-people.html
Center Parcs opened its first UK village at Sherwood
Forest in July 1987, offering short-break holidays at any Questions
time of year. Since then it has expanded its operations and 1 Explain two possible reasons why Center Parcs
currently operates six villages across the UK and Ireland. might have such a clear and highly prominent
statement on its website. [6]
Each UK holiday village is set in a forest environment,
2 Evaluate the benefits of effective systems of
typically 400 acres (162 hectares) in size, and provides
training to Center Parcs, which is expanding. [12]
high-quality accommodation in fully equipped villas,
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Off-the-job training The impact of training and development
This involves training outside the workplace, at a college,
2.1 university or some other training agency. Off-the-job
Some businesses, for example, Center Parcs, invest heavily
in training and development, often regarding it as a core
training can take the form of a range of activities in element of their human resource management. Some
which job-related skills and knowledge are acquired. These managers value it highly because they believe it improves
activities can include external courses such as lectures and employee attitude, motivation and performance. Others
seminars, self-study or open learning. are less eager to spend money in this way, taking the view
that ‘if they cannot do the job already, why are we paying
On-the-job training them?’ Managers may be especially suspicious of off-the-job
This form of training does not require the employee to leave training, which can be very expensive.
the workplace. They learn from experienced employees Training and development activities offer benefits and
through observation and work shadowing. The trainee may drawbacks to businesses. These activities can be expensive
work through instruction manuals or receive guidance from and disruptive but can improve employee performance. The
senior employees. possible impact, in terms of benefits and drawbacks, is
summarised in Table 2.3.
▼ Table 2.3 The impact of training and development
Drawbacks Benefits
• Training and development activities use up valuable resources • It can improve employee performance, and hence the
that could be utilised elsewhere in the organisation. competitive position of the business, by developing new
• Attendance at training and development activities may mean skills and knowledge.
that employees are unavailable to the organisation for a period • Training and development should improve employee
of time. Production may suffer as a consequence. morale and productivity.
• Employees, once trained, may leave for other, possibly better- • Training and development are core components of HRM
paid jobs. and assist organisations in having the right workforce to
• The beneficial effects of these activities may vary because achieve strategic objectives.
some managers might seek to avoid training and developing • A reputation for training and developing employees
their staff as it can lessen the degree of control they have over will assist businesses in attracting and retaining high-
their subordinates. quality, creative and productive employees.
The impact of training and development of employees is

potentially greater if the market in which the firm operates
GLOSSARY TERMS
is subject to fierce competition. For example, firms may Delegation means passing authority down the
operate extensive development activities in an attempt organisational hierarchy. This is only genuine if the
to improve rates of creativity and/or productivity to gain manager relinquishes some control to the subordinate.
an advantage over competitors. Businesses manufacturing Intrapreneurship occurs when individuals within
motor vehicles have tended to invest more heavily in organisations are being entrepreneurial – taking risks and
such activities over recent years for these reasons. When generating new ideas.
products are similar, price is often a very important
factor influencing consumers’ buying decisions. In such
circumstances, minimising costs (and prices) is vital. A key Employee development to encourage
part of this is making sure that labour is as productive as
possible. intrapreneurship, multi-skilling and
An emphasis on training and development may have an flexibility
impact on the management style used in the business.
Managers who engage in large-scale development and Intrapreneurship
training activities will be more likely to value techniques
such as delegation and teamworking. Partly, this is a We saw in Chapter 1.1 that entrepreneurs are individuals
question of philosophy: democratic and communicative who take risks to develop business ideas and start their own
managers are more likely to value employees and therefore businesses. Some larger organisations attempt to encourage
will aim to develop them as much as possible. However, entrepreneurial approaches among their employees to
there are practical reasons why training and development improve the organisation’s performance. This is termed
will be needed in these circumstances. Businesses cannot intrapreneurship. Such organisations encourage individuals
expect to benefit from granting employees greater to develop ideas for new products or ways of producing
authority without preparing them for such roles. goods and services within their own departments or
sections of the business. In effect, employees are supported
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to behave as entrepreneurs within a large business. One subsequent problem-solving are central to success as an
well-known example of successful intrapreneurship is intrapreneur. These skills may need to be supported by
Spencer Silver, who developed the Post-It note while
working at 3M, an American multinational company. He was
relevant technical skills such as engineering or, as in the
case of Spencer Silver, those of a chemist.
2.1
a chemist who developed the glue used in Post-It notes. » Senior employees The learning and development
His innovative type of glue was strong enough to hold activities are not limited just to employees engaged in
papers together, but easily pulled apart without tearing the intrapreneurial activities. It is important that managers
documents. It could also be used repeatedly. and leaders also have the intrapreneurial spirit and
that this exists throughout the organisation. They
Employees cannot simply be expected to become
should encourage risk-taking, innovative activities and
intrapreneurs overnight. A range of learning and
ensure sufficient resources (human and non-human) are
2.1.6 Training and development

development activities are required to prepare employees to
provided. They may require training and development to
fulfil the role of an intrapreneur successfully.
fulfil such roles effectively.
» Personal skills Intrapreneurs need many of the
strengths associated with entrepreneurs. They should The need for learning and development activities in an
be creative, confident and pursue their ideas with intrapreneurial organisation will be continuous as markets,
persistence. They should be good at solving problems products, technology and consumer needs change over time.
and willing to take calculated risks. Thus, they need In addition, labour turnover will mean that new employees
to be able to analyse risk to avoid making damaging are recruited who lack the necessary skills to operate
decisions. Ongoing training and development activities as effective intrapreneurs. Learning and development
can help to develop and improve such knowledge and activities will be needed throughout the careers of
skills. intrapreneurs.
» Technical skills Successful intrapreneurs must be
Simply recruiting some very talented individuals and
able to analyse markets, organisations and consumer
hoping this will be sufficient to promote intrapreneurship
behaviour to uncover problems. These may take
within the organisation will not be enough. Businesses
the form of unfulfilled or unrecognised needs or
need to develop a learning and development plan to build
production bottlenecks. Intrapreneurs then apply a
innovation throughout the organisation.
range of skills to solve these ‘problems’. Developing
the knowledge and skills to undertake this analysis and
CASE STUDY
Facebook
Facebook has over 2 billion users worldwide and nearly WhatsApp in 2014. The company’s range now
45 000 employees. It is expanding and recently recruited includes:
800 employees in the UK. It is an important company in ● Instagram
the global technology industry. ● WhatsApp
● Messenger
The company describes itself as constantly solving
● Augmented Reality
problems. It hires people with different backgrounds and
● Virtual Reality
viewpoints to help it make better products. The company
● Facebook Connectivity.
supports its employees to become bold and confident and
to seek to solve the problems they care most about. Its Questions
employees work together in small teams to develop new
1 Explain two reasons why Facebook encourages its
products quickly. The company offers high-quality training
employees to be intrapreneurs. [6]
and operates its own university.
2 Evaluate the extent to which training and
Over time, Facebook has extended its product range, development at Facebook is essential to encourage
sometimes by buying other businesses; for example, intrapreneurship among its workforce. [12]
Multi-skilling and flexibility A company with multi-skilled employees has the potential
to have a flexible workforce. This enables managers to use
Multi-skilled workers have the skills to perform roles in more
workers where needed to match the business’ needs. This
than one area of a business’ activities. For example, in a
flexibility assists businesses in:
manufacturing business, multi-skilled workers may receive
training in all aspects of constructing the product, as well
» meeting unexpected increases in demand for their
products
as the ability to perform inspections to ensure products are
of suitable quality. Having multi-skilled employees allows a
» covering for employees who are absent
business to switch workers to where they are needed over time.
» dealing with crises, such as delays in production.
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Labour flexibility arising from multi-skilling allows the business
owner to maintain production levels under circumstances that GLOSSARY TERMS
2.1 would otherwise leave workers idle and reduce profits. Multi-skilling exists when employees have the skills to
carry out several roles within an organisation.
Training and development play critical roles in creating a
A trade union is an organisation of workers established
multi-skilled workforce and the flexibility that arises from
to protect and improve the economic position and working
this. Without enhanced skills and knowledge, employees
conditions of its members.
will be unable to carry out a variety of roles. Training and
development activities will be required on a long-term basis Collective bargaining is negotiation between employers
in industries where the skills required change and develop and representatives of employees, normally trade union
over time. officials.
2.1.7 Management and workforce The benefits of co-operation between

relations management and the workforce
Co-operation between management and the workforce can One way of considering how co-operation between
reduce the number of disputes that may occur between the management and the workforce benefits both parties is to
two sides. Disputes can result in strikes (where workers consider the costs that may arise from any sort of dispute
withdraw their labour) or other measures, such as banning (see Table 2.4).
overtime working.
▼ Table 2.4 The costs of industrial disputes
Employers Employees
• The business may lose revenue from selling its products if the dispute • Employees may lose pay if the industrial dispute
results in industrial action, such as a strike, and production is halted. takes the form of a strike.
• The business may lose future sales if its customers believe that it is • The dispute may weaken the employer’s finances,
an unreliable supplier. putting employees’ job security at risk.
• The business’ relationship with its employees may be damaged in the • A financially weakened employer may not be able
long term, with negative implications for morale and productivity. or willing to pay for training and development for
• The business may be regarded as a more risky investment and may employees, denying them the chance to improve and
encounter more difficulty in raising finance, or it may be expected update their skills and knowledge.
to pay higher interest rates for loans • The employer may respond to the threat of, or actual,
• The business’ image may be damaged if it is involved in a dispute with industrial action by replacing people with technology
its employees and this may result in the loss of some of its customers. in the production process or by moving overseas.
The benefits to employers production, adding to a business’ reliability as a supplier

as its production is not interrupted, and can enhance
Employers benefit in a range of ways from co-operation
labour productivity (thereby lowering labour costs), as
with employees.
workers are motivated by what they regard as fair pay
» Helping to develop a strong employer brand Employers
and working conditions.
who avoid disputes with employees and who have effective
mechanisms to resolve any disputes quickly will be viewed
more favourably by potential employees. This will assist The benefits to employees
them in attracting more able and productive employees. Equally there are a number of advantages to employees from
» Enhancing employee morale Having a workforce with the maintenance of good relations with their employers.
high morale is a valuable asset for any business. Poor » Financial benefits Employees avoid loss of pay during
employer relations are likely to lead to employees periods of industrial disputes if good relations are
believing they are not valued and will reduce their sense maintained. However, because the employer may also
of well-being and morale. Such factors can damage be financially stronger as a result of avoiding wasteful
employee performance severely. disputes, there is a greater possibility of future
» Improving the business’ corporate image Avoiding improvements in pay and conditions.
disputes or settling them quickly helps a business to » Job security An employer is less likely to consider
develop or maintain a reputation as a fair and reasonable replacing employees with technology or moving overseas
employer. This can have positive effects on a range of to locations where industrial action rarely or never occurs.
stakeholders, including customers and investors. » The possibility of greater participation in decision-
» Strengthening competitiveness Good employer– making Involving employees in decision-making is one
employee relations can be a powerful competitive way of helping to maintain good relations, but it is also
weapon. They can reduce costs by eliminating lost a possible benefit to employees from doing their part
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in maintaining a positive relationship. Where amicable by full-time union employees (called organisers or officers).
relationships exist, employers may be more willing The region is made up of a number of branches (more
to offer opportunities for employee involvement in
decision-making.
than 6000 in the case of Unite) and each branch has an
elected shop steward. The shop steward communicates with
2.1
employers on behalf of the union’s members and reports
The value of co-operation between employers and
back to members regarding management decisions. The
employees is probably greatest where the costs of industrial
union head office has administrative, statistical and legal
disputes are most significant. This might be where the
staff, as well as the senior officials of the union. Other
business is in a weak competitive or financial position, and
trade unions operate similar structures.
it is vulnerable to losing its customers to rivals or at risk of
financial failure. Similarly, industrial disputes might be risky Most trade unions across the world have similar objectives.
2.1.7 Management and workforce relations

for employees in areas of high unemployment and for those These focus on improving the economic position of their
who are relatively unskilled. If a prolonged dispute results members by fulfilling the following objectives.
in a loss of jobs, they may experience difficulty in finding » Maximising pay Trade unions engage in collective
alternative employment. bargaining to provide their members with the highest
possible rates of pay.
The impact on employers and » Achieving safe and secure working conditions Unions
often provide training for safety representatives who
employees of trade union involvement can advise employers on health and safety issues.
Creating a workplace in which there is a focus on health
in the workplace and well-being can be an important factor in creating
Trade unions employee engagement.
Trade union membership has declined in many countries » Attaining job security Arguably this is the most
around the world. Figure 2.10 shows that the percentage important objective of a modern trade union, and it is
of national workforces belonging to a trade union varies one that is difficult to fulfil in the light of pressures
significantly. OECD – the Organisation for Economic resulting from globalisation and the increasing use of
Co-operation and Development – has 32 member countries. technology in the workplace.
In 1985, average trade union membership in OECD » Participating in and influencing decisions in the
countries was 30 per cent. By 2019, that had fallen to just workplace Trade unions may achieve this through
16 per cent. collective bargaining or through having representatives
on any employer–employee committees. Trade unions
may play a role in decisions ranging from a change in
Iceland 90.4 fringe benefits, such as free lunches, to the closure of
Sweden 66.1
Belgium 54.2 one or more parts of the business.
Italy 34.3
Canada 25.9
Ireland 24.2
Collective bargaining
United Kingdom 23.2 Collective bargaining between employers and trade unions
Japan 17.1 usually covers issues such as wages and salaries, holidays,
Germany 16.7
Australia 13.7 the length of the working week and employee pensions.
Mexico 12.0 Because the negotiation is collective, any agreement
South Korea 10.5 that is reached applies to all those represented by the
United States 10.1
Turkey 8.6
trade union. The rules for collective bargaining are usually
France 7.9 agreed between the trade unions and each individual firm.
Trade unions are in a better position to negotiate than
Source: Forbes, https://bit.ly/3n5cncW individuals as they have better collective negotiating skills.
▲ Figure 2.7 Trade union membership as a percentage of Furthermore, the threat of taking industrial action (such as
the total workforce in a selection of countries strikes) gives them increased power in negotiations, helping
them to achieve higher rates of pay.
Most OECD countries have seen a decline in trade union
membership. The only ones that have seen increases since
1985 are Iceland, Belgium, Spain and Italy. Iceland remains STUDY TIP
the most unionised country in the OECD, with 90.4 per cent Do not assume that trade unions do not offer any benefits
of its workers being members of a trade union. to employers. The case study below outlines some of
Trade unions are normally organised on a regional basis. the benefits that they can offer and you should be able to
For example, in the UK, Unite operates in ten regions argue the positive and negative impact of trade unions on
throughout the UK and Eire and is the UK’s largest employers.
trade union. Each region has a regional office staffed
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CASE STUDY
2.1
Airbus and European works councils
European Union laws relating to European works councils company operates factories in the UK, Germany, France
affect any organisation with at least 1000 employees, of and Spain. In 2020, it announced plans to consult its
which least 150 employees are located in two or more European works council over plans to cut 2362 jobs in
member states of the EU. European works councils (which its factories. The jobs are under threat due to reduced
operate on behalf of employees) bring together employee levels of demand for its aircraft. The company said it
representatives in a multinational company from across wanted to manage the implications of the job losses for its
Europe. The works councils inform and consult employees workforce ‘in a responsible manner’. The company said
on the group’s activities and future prospects. European it hoped to consult on opportunities for those employees
works councils help trade union members to respond to who are affected. The matters to be discussed include
the decisions that employers take on a global basis. transferring affected employees to work in other locations
A European works council is made up of at least one within the company.
elected employee from each country in which the Questions
multinational operates, along with representatives from
senior management. They normally meet annually and 1 Explain two reasons why Airbus might prefer to
discuss issues affecting employees throughout the transfer employees in Europe rather than make them
organisation. These include health and safety, merger redundant. [6]
proposals, the closure of plants and the implementation 2 Evaluate whether or not Airbus’ employees benefit
of new working practices, such as teamworking. overall from the existence of the company’s European
works council. [12]
Airbus, the multinational plane manufacturer, has its
headquarters in Toulouse in Southern France. The
Employees can receive significant benefits from being non-unionised workplace. This wage differential is known
represented by trade unions. In the UK in 2018, those as the trade union premium. This can increase the business’
employees who were represented by trade unions earned costs of production. As a consequence, profits may be lower
approximately 7.9 per cent more than people carrying out or prices may have to be higher, reducing the business’
similar work who were not members of a trade union. competitiveness. This can be a serious disadvantage in an
industry where competition is based on low prices, such as
Trade unions bring other benefits for employees. For
the airline industry. Despite this, employers can also benefit
example, they can play a major part in monitoring health
from the existence of trade unions for the following reasons:
and safety issues to protect the workforce. This can help to
» They act as a communications link between management
provide a more secure working environment and reduce the
and employees and can reduce the chance of industrial
number of accidents.
action occurring.
It may appear that trade unions only offer disadvantages » Professional negotiation on behalf of a large number of
to employers. They are able to use collective bargaining employees can save time and lessen the likelihood of
to negotiate higher wages than would be paid in a disputes occurring.
TEST YOUR LEARNING

b Explain one method of selection. [3]
6 a Explain one difference between internal and
1 a Define the term ‘human resource management’. [2] external recruitment. [3]
b Explain one activity that forms part of human b Define the term ‘job description’. [2]
resource management. [3]
7 a State three items that might be included in an
2 Explain two possible benefits to a business of an employment contract. [3]
effective system of human resource management. [6]
b Define the term ‘person specification’. [2]
3 a Define the term ‘workforce plan’. [2]
8 Explain one benefit a business might receive from
b Explain one factor that might influence the preparing and using a person specification. [3]
workforce plan of an international retailer. [3]
9 a Explain one difference between redundancy and
4 a Explain one possible effect of a high level of dismissal. [3]
labour turnover in a business. [3]
b Explain one reason why an employee may be
b A business has 9500 employees. During the year, made redundant. [3]
190 leave its employment. Calculate its rate of
10 Explain two reasons why businesses invest in
labour turnover. [3]
training and development despite the high costs. [6]
5 a Explain one difference between recruitment
and selection. [3]
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Data response question Cannell Ltd’s managing director believes strongly in
The company behind the soaps and shampoos in

the importance of training and development, including
induction training. He has proposed doubling the 2.1
hotel bathrooms company’s expenditure on training. Employees work
in teams and the company updates its production-line
Cannell Ltd manufactures soaps, shampoos and other
technology whenever it can afford to do so. The company
complimentary toiletries that are available in hotel
has never had to use redundancy to manage its workforce.
bathrooms. The company operates two factories with
acombined workforce of 380, and labour costs are Questions
47 percent of its total costs. The company is relatively
small and, selling throughout Europe, faces intense 1 Define the terms:
2.1.7 Management and workforce relations

price competition from larger rivals. Recently the a ‘induction training’ [2]
company has had to reduce its prices to retain some b ‘redundancy’. [2]
major customers. Profitability has declined in recent 2 Analyse one reason why Cannell Ltd should be
years – last year it fell by 14.5 per cent. The company concerned about its rate of labour turnover. [4]
has a highly skilled workforce, although its labour 3 Evaluate whether or not the managing director is
turnover figure rose to 23.4 per cent last year from correct to argue that the company should double its
14.9 per cent the previous year. spending on training and development. [12]
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2.2
AS LEVEL
Motivation
AS LEVEL 2.2 Motivation
Chapter overview
★ the nature and importance of motivation as a management and leadership tool
★ the needs of employees while at work
★ some of the theories of motivation that can be applied in the workplace
★ the practical methods of motivation used by businesses, both financial and non-financial.
2.2.1 Motivation as a tool for Thus, well-motivated workforces offer managers and
leaders the means to achieve a range of common business
management and leadership objectives, including those below.
» Growth High levels of labour productivity and low
There are two ways we can think about motivation at work labour turnover will support businesses in increasing
and what causes it: the volume of sales by providing increased output
» Motivation can be the will to work due to enjoyment of cost-effectively.
the work itself. This implies that motivation comes from » Higher profits Having well-motivated and very
within an individual employee. productive employees assists businesses in producing
» An alternative view is that it is the will or desire to products more cheaply per unit. This is an important
achieve a given target or goal that is the result of means of increasing profits.
external factors, such as the promise of a reward, or to
avoid the threat of punishment.
GLOSSARY TERMS
The first of these views assumes that motivation lies within Motivation describes the factors that arouse, maintain and
the individual employee and the second assumes that it is channel behaviour towards a goal.
the result of some external factor. People in the workplace
Absenteeism describes a situation in which an employee
have differing views on the sources of motivation. A survey
is absent from work without a good reason.
revealed that nearly 90 per cent of employers believe that
money is the main motivator, while employees rank pay Human needs can be defined as the elements required for
fourth, behind an interesting job, security and achievement. survival and good mental and physical health.
This distinction is an important one, and you should
remember it when considering theories of motivation and
how, in practice, leaders and managers can motivate other 2.2.2 Human needs
people.
Fundamental human needs are relatively few and finite.
Whatever causes it, motivation is an important factor They are likely to be similar – or the same – for all countries
for all businesses. Having a well-motivated workforce is and cultures and to change little over time. A list of human
vital to assist all businesses in achieving their objectives. needs is likely to include the following:
Organisations whose workforces possess high levels of » physical needs. For example, having enough income to
motivation tend to show the following characteristics: meet essential needs e.g. food, drink and shelter
» a low level of absenteeism by employees at all levels » safety needs e.g. job security, contract of employment,
within the business reduced uncertainty, health and safety policies, and
» relatively few employees deciding to leave the good working conditions
organisation, giving a low level of labour turnover » social needs e.g. team or group working, good
» good relations between managers and other employees communication and involvement
» high levels of labour productivity from the workforce. » esteem needs e.g. recognition, status, responsibility,
A business that enjoys the benefits of a highly motivated respect and feedback on performance
workforce is also likely to have a productive workforce. Low » self-actualisation needs e.g. fulfilment of potential,
production costs offer firms two opportunities: challenging work, sense of achievement and
» to sell their products more cheaply development of new skills.
» to maintain price levels and enjoy greater profits.
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CASE STUDY
2.2
Al Rashed International Shipping Company
The Kuwait-based Al Rashed International Shipping on the quality of its staff. The company aims to have an
Company trades in international markets and has effective workforce and has carefully thought-through
benefited from high rates of recent sales growth and is systems of recruitment and selection, as well as
planning further growth. The company depends on highly training. The company has strict policies to avoid any
motivated staff to achieve its ambitious expansion plans. discrimination and encourages teamworking.
The company was established in 1911 and is currently Training is organised by each department within the
2.2.2 Human needs

a major player in shipping markets in the Persian business. Training focuses heavily on communication and
Gulf. It supplies a range of services including ocean customer service. The company responds quickly and
freight, international air freight and land transport both positively to any customer complaints.
domestically and internationally.
Source: https://al-rashedgroup.com/handbook/
In its vision statement, the company says that it is
‘committed to consistently deliver extraordinary value to Questions
our customers and stakeholders through the building of 1 Explain two ways in which having highly motivated
passionate, empowered teams [of employees]’. employees might offer advantages to the
shareholders of the Al Rashed International Shipping
Ravi Varrier is Al Rashed’s chief executive officer (CEO).
Company. [6]
He has worked for the company for more than 30 years
2 Evaluate the benefits that you think this company might
and believes that the company’s success has been based
gain from having a well-motivated workforce. [12]
How human needs may or may not be » Creation Many working environments offer opportunities
for creativity and some may require this as an integral
satisfied at work part of employment. Others may offer few opportunities.
Employment does offer the possibility of satisfying some, Working in advertising or architecture requires creativity
but possibly not all, of these human needs. The following but this can also be an important part of manual work,
needs could be met through employment, but this may not such as constructing houses. Creativity can take other
always be the case. forms, including developing teams and building brands.
» Subsistence Employment can provide an income » Freedom Working in an organisation does offer
sufficient to allow people to have shelter, food and surprising numbers of opportunities for freedom. In
clothes so that their lives are not threatened by the lack a democratically managed business, managers may
of these basic items. However, this need is only met empower employees. This gives them control over their
if employees have an employment contract that offers working lives and a high degree of freedom not only to
them regular and sufficient hours of work to meet their take decisions but to decide which decisions to take.
basic needs. It is important to remember that the extent to which
» Protection Work can satisfy this need in a number this need may be met at work depends on the way that
of ways. A permanent employment contract may the business is managed. Some managers may opt to
provide the security of knowing that the income from retain control and offer little freedom to more junior
employment will be received for the foreseeable future. employees.
Some forms of employment also provide health care Some other human needs may also be met through working.
and pensions to give employees an income in old age. For example, many businesses provide leisure facilities
However, many forms of employment do not offer much for their employees, and it is not unusual for people to
in the way of protection. Some employees have no engage in leisure activities with their colleagues from
guaranteed hours of work and no pensions. work. However, this may not be the case for people such as
» Participation This can be achieved through working farmers or lorry drivers who often work alone.
in teams, from teams of shop assistants through to
membership of the board of directors of a large public
company. Participation can also take the form of
responsibilities within an organisation.
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CASE STUDY
2.2
Working at Google
Though Google has grown a lot since it opened in 1998, we ● Googlers sharing cubes, yurts and huddle rooms – and
still maintain a small-company feel. very few single offices
● laptops everywhere – standard issue for mobile
At lunchtime, almost everyone eats in the office café, sitting
coding, emails on the go and note-taking
at whatever table has an opening and enjoying conversations
● foosball, pool tables, volleyball courts, assorted video
with Googlers from different teams. Our commitment to
games, pianos, ping-pong tables and gyms that offer
innovation depends on everyone being comfortable with

yoga and dance classes
sharing ideas and opinions. Every employee is a hands-on
● grassroots employee groups for all interests, such as
contributor and everyone wears several hats. Because we
meditation, film, wine-tasting and salsa-dancing
believe that each Googler is an equally important part of our
● healthy lunches and dinners for all staff at a variety of
success, no one hesitates to pose questions directly to Larry
cafés
or Sergey in our weekly all-hands (‘TGIF’) meetings – or
● staff-rooms packed with a variety of snacks and drinks
throw a volleyball across the net at a corporate officer.
to keep Googlers going.
Our corporate headquarters, fondly nicknamed the Source: Adapted from www.google.co.uk
Googleplex, are located in Mountain View, California, USA.
While our offices are not identical, they tend to share Questions
some essential elements. Here are a few things that you
1 Explain two ways in which the human needs of
might see in a Google workspace:
participation and creation may be met by working
● bicycles or scooters for efficient travel between
at Google. [6]
meetings, dogs, lava lamps, massage chairs, large
2 Evaluate the extent to which human needs are met
inflatable balls
by working at Google. [12]
2.2.3 Motivation theories examine the process of motivation and are concerned with
‘how’ motivation occurs. Vroom studied motivation from a
Many different views exist on motivation, and they differ process perspective.
because it is not clear why people work. Is it to gain money,
to enjoy social interaction with other humans, or to fulfil GLOSSARY TERMS
personal needs such as achievement and recognition? Or is Schools of thought are individuals and groups who hold
it a combination of some or all of these? similar views on a particular matter – in this case on what
Motivation theories can be classified broadly into two motivates employees.
different perspectives: content theories and process Piece-rate is a system whereby employees are paid
theories. Content theories consider ‘what’ motivates people according to the quantity of a product they produce.
and are concerned with individual needs and goals. Taylor, Division of labour is the breaking down of production
Mayo, Maslow, Herzberg and McClelland studied motivation into a series of small tasks, carried out repetitively by
from a content perspective. In contrast, process theories relatively unskilled employees.
▼ Table 2.5 Schools of thought for content theories of motivation
School of thought Key writers Essential ideas

Scientific school Frederick Winslow Taylor Motivation is an external factor achieved through money. Employees
(1856–1917) should be closely supervised and paid piece-rate. Time and motion
studies determine efficient means of production and workers are
trained and told how to operate.
Human relations school Elton Mayo This brought sociological theory into management and accepted
(1880–1949) that employees could be motivated by meeting their social needs.
More attention was given to the social dimension of work (e.g.
communication, working as groups and consultation between
managers and employees).
The neo-human Abraham Maslow (1908–70), This school highlighted the importance of fulfilling psychological
relations school of Frederick Herzberg (1923– needs to improve employee performance. Motivation, according
management 2000) and David McClelland to Maslow and Herzberg, depended upon designing jobs to fulfil
(1917–1998) psychological needs.
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Content theories of motivation lines in factories and do not have any management or
supervisory role. His systems forced them to work hard
The content theories of motivation can be divided into
three schools of thought. These are set out in Table 2.5.
and, by raising productivity levels, placed the jobs of the
less efficient workers under threat. Taylor’s approach raised
2.2
efficiency and productivity, so businesses did not need as
The school of scientific management many employees. His ideas resulted in strikes and other
Motivating workers became an important issue as the size forms of industrial action by dissatisfied workers.
of businesses increased in the late-nineteenth century.
Managers developed the division of labour to its fullest 1 Study the work process to
extent in an attempt to increase efficiency and improve determine the most efficient
production methods
2.2.3 Motivation theories

competitiveness. The introduction of mass-production
methods, along with the use of division of labour, increased
the numbers of people working in factories. At the same
time, their tasks became monotonous.
2 Observe and time the best
Against this background, managers began to investigate workers in these methods
ways of increasing employee motivation to improve
competitiveness and employee satisfaction. Frederick
Winslow Taylor was the most notable of these early writers
on motivation and became known as ‘the father of scientific
management’. 3 Train the remaining workers
to the same standard
Taylor’s theories were based on a simple interpretation
of human behaviour, that people were motivated solely
by money – his term was ‘rational man’. He combined this
principle with a simple interpretation of the role of the
manager: to operate the business with maximum 4 Implement differential pay
efficiency. rates and close supervision
to increase productivity
The key elements of Taylorism
» The starting point of Taylor’s approach was work study. ▲ Figure 2.8 The essential features of Taylorism
He measured and analysed the tasks necessary to
complete the production process. He used a stopwatch Taylor’s legacy
to measure how long various activities took and sought It is easy to dismiss Taylor and his ideas. His entire
the most efficient methods of completing tasks. He philosophy was based on the belief that employees were
encouraged the use of the division of labour, breaking motivated only by money. He ignored any social dimension
down production into small tasks. of employment and made employees work very hard for what
» From this he identified the most efficient employees and was a meagre wage. His ideas resulted in workers endlessly
the approaches they adopted. Using these as a basis, he completing monotonous tasks. There was considerable
then detailed ‘normal’ times in which duties should be hostility towards his ideas and opposition from politicians
completed and assessed individual performance against and the business community.
these norms. However, Taylor made a significant and enduring
» Employees were provided with the equipment necessary contribution to the management of business organisations.
to carry out their tasks. This principle extended to He established management as a scientific subject worthy
giving stokers (men shovelling coal) a shovel of a of research and study. His approach was adopted by many
size appropriate to their physique to maximise their premier figures in the business community in the early
efficiency. They were also given elementary training and decades of the twentieth century, including Henry Ford.
clear instructions on their duties. His techniques encouraged the use of mass production and
» Because, according to Taylor, employees were only the conveyor-belt system. Furthermore, his work provided a
motivated by money, the final stage of the system was starting point for a later and more people-centred approach
to design and implement a piece-rate pay system. Under to management.
a piece-rate system, employees are paid according to
the amount they produce. Taylor, however, developed
differential piece-rate systems to encourage efficiency STUDY TIP
among employees. Avoid considering Taylor simply in negative terms.
» Taylor also believed in close supervision of the workforce Certainly, many of his ideas would not be acceptable in
to ensure that they continued to make the maximum modern businesses, but others (for example, simple
effort possible, motivated by pay. piece-rate pay and work study) have endured. A balanced
assessment of Taylor should take into account the lasting
Taylor’s views were unpopular with shop-floor employees. elements of his approach, as well as the shortcomings.
Shop-floor employees are those who work on production
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CASE STUDY
2.2
Salary packages important for Indian employees
A survey carried out by TJinsite, research division of Employees in most industries in India rate salaries
TimesJobs.com, revealed that 77 per cent of employees as important – there was minimal variation between
in India judge salaries to be more important than the different industries. Respondents said that factors such
location of the job. However, the respondents rated as job titles, location and status are significant, but an
salary and job status to be of equal importance, although attractive salary is always a critical factor in persuading
financial rewards are considered important by most employees to apply for jobs.
people taking part in the survey.

Questions
The importance of pay varies between older and younger
1 Explain two reasons why salaries are an important
employees. Younger employees consider pay to be more
element for younger people in choosing jobs. [6]
important, while older workers tend to rate job status
2 Evaluate other possible situations in which
more highly.
salary might be considered very important by
employees. [12]
The human relations school The implications of the ‘Hawthorne effect’

A fundamental weakness of the scientific school was that Following the publication of Mayo’s findings, managers
it ignored the social needs of employees. This, and the gradually became more aware of the importance of meeting
obvious unpopularity of the ideas of Taylor, led to the the social needs of individuals at work. Social environments
development of the human relations school. This school at work and informal working groups were recognised
of thought concentrated on the sociological aspects of as having positive influences upon productivity. The
work, and its foremost member was an Australian-born acceptance of Mayo’s views led to a number of developments
psychologist, Elton Mayo (1880–1949). Initially, Mayo was in businesses during the 1940s and 1950s, many of which
one of Taylor’s disciples, believing in the importance of remain today.
scientific management to business efficiency. » Personnel departments were established to ensure that
employees’ social needs were met at work wherever
The Hawthorne effect possible.
Mayo’s views altered as a result of research he conducted » Employees were provided with a range of sporting and
at the Western Electric Company in Chicago. The research social facilities to foster the development of informal
was to examine the effects of changes in lighting on the groups among employees.
productivity of workers at the company’s Hawthorne plant. » Works outings and trips became a familiar part of an
Previous experiments on lighting and productivity had employee’s year (for example, multinational retailer
produced unexpected results. Researchers had anticipated Marks and Spencer organises short-break weekends for
that improving lighting would increase productivity because its employees).
giving workers better working conditions would allow them » Managers gave more attention to teams and
to work harder and earn more money. They were astonished teamworking.
when productivity increased not only in the group who
were given improved lighting but also among a group whose Mayo’s recognition of the importance of teamworking is
lighting had not changed. perhaps his most enduring testimony. Many firms have
organised their workforce into teams; for example, the
It became apparent that the employees were responding Japanese electronics manufacturer, Toshiba.
to the level of attention they were receiving as part of the
investigations and because they were working together as Mayo’s work took management forward in general and
a group. This became known as the ‘Hawthorne effect’. As motivation in particular. He moved the focus onto the needs of
a result of this and similar experiments, Mayo stressed the employees, rather than just on the needs of the organisation.
importance of ‘social man’ within the workplace.
From these experiments, Mayo concluded that motivation STUDY TIP
was dependent upon: Don’t just think of Mayo in terms of communicating
» the type of job being carried out and the type of with bosses, and his emphasis on social and sporting
supervision given to the employee facilities. This is only part of his work. He advocated
» group relationships, group morale and the sense of the benefits to employers and employees of working
worth experienced by individuals. in teams: this aspect of his work is an important issue
within many businesses today.
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The neo-human relations school employee; managers merely need the key to unlock the
motivational force.
This could also be called the new human relations school.
Abraham Maslow, Frederick Herzberg and David McClelland By focusing on the psychological needs of employees, 2.2
are key members of this particular school and began to put Maslow, Herzberg and McClelland encouraged managers to
forward their views in the 1950s. The neo-human relations treat their employees as individuals, with different needs
school considered the psychological aspects of employment and aspirations. Their work emphasised that, because
and argued that motivation lies within each individual people are different, the techniques required to motivate
individuals will also differ.
CASE STUDY

Motivating accountancy graduates
Respondents to an internet survey have judged training ● The reputation of the business was judged most
and development of skills to be more important than important by 12 per cent and 8 per cent identified the
salary, according to a survey by accountants Ernst and business’ culture as the vital factor.
Young. Most of the 1051 respondents were accountancy
graduates with additional experience in the industry. The Questions
key elements of the survey were: 1 Explain two ways in which employees may be
● Approximately 44 per cent rated training as the most motivated by pay. [6]
important factor attracting them to a job. 2 Evaluate whether the results of this survey show
● A mere 18 per cent of respondents placed salary and that pay as a motivator is outdated and irrelevant for
benefits as the most important factor. today’s employees. [12]
Maslow’s hierarchy of needs

In 1954, Maslow published his ‘hierarchy of needs’,
setting out the various needs that, he argued, everyone
GLOSSARY TERM
attempted to meet through working. Maslow presented his The hierarchy of needs is a theory that employees have
hierarchy of needs as a triangle with basic needs shown at successive requirements that can be fulfilled through work.
the bottom and his so-called higher needs towards the top
(see Figure 2.9).
5 Self-
actualisation
e.g. fulfilling
potential
Higher
4 Esteem needs needs
e.g. recognition
and achievement
3 Social needs
e.g. relationships with fellow employees
2 Security needs
e.g. employment contract, safe working conditions
Basic
needs
1 Physiological needs
e.g. food, drink, shelter
▲ Figure 2.9 Maslow’s hierarchy of needs
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Abraham Maslow established five levels of human needs was satisfied (see Table 2.6). So once an employee’s basic
that can be satisfied through work. Maslow’s argument was needs had been met, perhaps through a system of fair pay,
2.2 a relatively simple one. Employees, he argued, have a series
of needs they seek to fulfil at work. These are in a hierarchy
they could be motivated further by the offer of secure
and continuing employment. Similarly, a worker whose
– once a lower level need is satisfied, individuals strive to social needs were met through employment could next
satisfy needs further up the hierarchy. be motivated by the opportunity to satisfy self-esteem
needs. This could be achieved by taking responsibility for
The key point of Maslow’s argument was that a business
a major project, offering the chance of achievement and
could motivate its employees by offering them the
recognition.
chance to fulfil a higher level of need once a lower one
▼ Table 2.6 An explanation of Maslow’s hierarchy of needs
Maslow’s level of need Examples Means of satisfying needs

Food, water, shelter, clothing Through pay and a warm and dry working
1 Physiological needs
environment
A safe and secure working environment for Implementing a proper health and safety
2 Security needs employees policy, providing employees with employment
contracts
Contact and friendships with other employees Social and sporting facilities, opportunities to
3 Social needs
work in groups
Achievement, recognition and self-respect Delegating authority to junior employees,
4 Esteem needs
offering promotion opportunities
To fulfil one’s potential completely Providing opportunities to take new
5 Self-actualisation
responsibilities and to develop new skills
Maslow’s theory was attractive to managers from the Frederick Herzberg’s two-factor theory
outset. It offered a more individualistic approach to Herzberg’s two-factor theory was the result of a study
motivating employees, recognising that not all people are designed to test the view that people face two major sets
the same. Managers had long realised that what motivated of influences at work. Herzberg’s resulting theory was based
one person would not necessarily motivate another. on the results to questions asked of 200 accountants and
Maslow’s theory offered an explanation and an alternative engineers in the USA.
approach for managers.
Herzberg’s motivators – these satisfiers relate to the job itself and can create positive motivation
Personal Potential
achievement Recognition to satisfy
Interest in
the work Responsibility
itself Growth and
MOST LEAST
advancement
IMPORTANT IMPORTANT
Relationship
with fellow
workers
Working Salary
Company conditions
Supervision Potential
policy and
to dissatisfy
administration
Herzberg’s hygiene factors – these relate to the job environment and have the potential to dissatisfy
▲ Figure 2.10 Herzberg’s hygiene and motivational factors
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The first part of Herzberg’s motivation theory is related to The second finding of Herzberg’s research established those
the environment of the job. He identified a range of factors factors with the ability to motivate – the motivators. These
that shaped the environment in which people work; he
called these influences hygiene or maintenance factors.
factors relate to the job itself and can be used to positively
motivate employees. He identified the following factors as
2.2
These factors are all around the job but are not a part of motivators:
the job itself. Herzberg’s research identified a number of » personal achievement of goals and targets
hygiene factors, including the following: » recognition for achievement
» company policy and administration » interest in the work itself
» supervision of employees » responsibility for greater and more complex duties
» working conditions » personal growth and advancement.
» salary

Herzberg believed that these approaches (hygiene and
» relationship with fellow workers (at the same level).
motivation) must be used simultaneously. Employees
Herzberg’s crucial finding was that hygiene factors do should be managed so they have a minimum of
not lead to motivation, but without them employees may dissatisfaction. They should get achievement, recognition
become dissatisfied. So, according to Herzberg, an employee for achievement, take interest in their work and be given
cannot be motivated by pay, but they might be dissatisfied responsibility to allow them to grow and develop within
by inadequate financial rewards. Hygiene factors were so their work.
named because Herzberg believed attention to them would
prevent hygiene problems. It is important to note that GLOSSARY TERMS
Herzberg’s research classified pay as a hygiene factor and,
Hygiene factors (also called maintenance factors)
therefore, as unable to motivate.
are a group of influences that may result in employee
dissatisfaction at work.
Motivators are a series of factors, such as promotion, that
may have positive influences on employee performance at
work.
CASE STUDY
Frederick Herzberg
Frederick Herzberg was born in Massachusetts in the Herzberg gained a PhD in Psychology at the University
USA in 1923. He attended City College, New York, before of Pittsburg and began to turn his attention to business
enlisting in the army. During his military service, he management. He became Professor of Management at
witnessed the survivors at Dachau concentration camp. Case Western Reserve University, where he established
the Department of Mental Health. In 1972 he joined the
University of Utah’s College of Business.
Herzberg developed a reputation as one of the most
influential thinkers on people at work and employee
motivation. He combined his deep knowledge of employee
psychology with a series of practical experiments in
the workplace. His book Work and the Nature of Man
(1966) was voted one of the ten most important books on
management theory and practice in the twentieth century.
He died in January 2000.
Questions
1 Using examples, explain two differences between
Herzberg’s motivators and hygiene factors. [6]
2 Evaluate the possible reasons why a book on
employee motivation was voted one the twentieth
century’s most important management books. [12]
▲ Figure 2.11 Frederick Herzberg
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▼ Table 2.7 Herzberg and Maslow compared
2.2 Motivation factors (higher needs)

Maslow
• Self-actualisation needs
Herzberg
• Achievement
• Esteem needs (higher needs) • Recognition
• Responsibility
• Interest in work
• Personal growth
Maintenance factors (lower needs) • Social needs • Company policy and administration
• Security needs • Supervision
• Physiological needs (mainly lower • Working conditions

needs) • Relationship with fellow workers
Both Maslow’s and Herzberg’s theories have the major » each employee’s behaviour in terms of what motivates
advantage in that they were not simply theoretical them
writings – practical implications for management were » how they manage and motivate other employees.
within the theories. Both authors encouraged managers to
utilise their employees’ abilities by giving them challenging The need for achievement
tasks. People who have a high need for achievement (n-ach) aim
for excellence. This means that they are likely to avoid
Weaknesses do exist within these theories, of course. low-risk situations as they derive little satisfaction from
Herzberg’s assertion that pay cannot be used to motivate meeting targets that are not challenging. Equally, they tend
might be true of many employees in wealthy, developed to avoid high-risk situations as they fear not achieving.
economies. However, this may not be the case with workers Therefore, this type of person aims to attain realistic but
in poorer, developing countries. Equally, Maslow’s theory is challenging goals – ideally those in which they have a 50
based upon a hierarchy and the assumption that individuals per cent chance of success. This type of employee has a
move from one level to the next. His work has been strong need for feedback on achievement and progress, and
criticised on the grounds that people do not move through they have a need for a sense of accomplishment.
these needs in the same order. It also assumes that, once
a need is fulfilled, it loses its power to motivate. This may The need for authority and power
not be the case, especially with the higher needs. A need for power (n-pow) can fall into one of two
categories:
STUDY TIP » a need for personal power and to direct or control other
employees – this is a need which may be considered
Many answers to questions on motivation receive low undesirable
grades because students do not apply their knowledge
» a need for institutional power – this is a need to
to the scenario in the question. Ensure that you do not
organise other employees to attain the organisation’s
simply explain relevant theories – you must apply them to
objectives.
the scenario.
Managers and leaders with a need for institutional power
are likely to contribute more to a business enterprise than
David McClelland’s theory of needs someone whose need for power is a personal one. The
The American writer David McClelland was also a part of employee with a need for authority and power wants to
the neo-human relations school of thought. He is perhaps have an effect on an organisation and to have some degree
best known for his work on achievement motivation. In of control. They may also want to have more status within
his acquired needs theory, McClelland argued that an the organisation.
individual’s motivation depends upon their needs and that
these needs are determined by the individual’s experience. The need for affiliation
McClelland identified three types of motivational need: Employees who have a need for affiliation (n-aff) generally
» achievement motivation (n-ach) seek harmonious relationships with other people in the
» authority/power motivation (n-pow) organisation. They need to feel accepted and are motivated
» affiliation motivation (n-affil). to work with other people. This type of employee works
well as a member of a team and enjoys social interaction.
McClelland believed that these three needs exist, to Employees who are motivated by the need for affiliation
differing extents, in all employees, irrespective of their role often work successfully and effectively in marketing, sales
or status within the business. McClelland’s work emphasised and customer service.
that the combination of these three needs determines:
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CASE STUDY
2.2
Motivating generation Y employees
The Moresby Bank Ltd is based in Papua New Guinea and Latifa Pini argued that generation Y employees perform
provides a range of banking services. It is relatively small most effectively if given challenging work, rewards
with only 2850 employees. Despite this it experiences related to performance and direct instructions. ‘Give them
problems with its labour turnover rates, particularly challenging work, and if they achieve something, then
among junior employees. In 2020, the Bank suffered an recognise them for that achievement. It does not have to
average labour turnover rate of 23 per cent, while the be a financial reward but something that will make them

figure for junior employees reached 34 per cent. feel proud to be part of the team and organisation,’ Pini
concluded.
The Bank’s executive vice-president for HR management,
Latifa Pini, commented: ‘This bank is very serious about Questions
management of our generation Y employees (those born
1 Explain two differences between the need for
after about 1983) since they are certainly going to be our
power and the need for achievement in McClelland’s
future senior managers. If we don’t understand them then it
theory. [6]
will be difficult to make the bank as successful as it might be.’
2 Evaluate the extent to which McClelland’s
She continued to argue that generation Y employees dislike explanation of the differing behaviour of the older
being forced or ordered to do something, while employees and younger employees at Moresby Bank Ltd is the
born between 1946 and 1964 (called baby boomers) prefer only valid one. [12]
to be in control and want others to follow them.
The implications of McClelland’s work Victor Vroom’s expectancy theory

McClelland’s work has clear implications for leaders and This theory, developed by Vroom in the early 1960s, argues
managers. The principle is that employees with different that motivation depends on employees’ expectations of
needs require different roles and tasks if they are to be the results of their efforts. If employees know what they
motivated effectively. want from an outcome and believe they can achieve that
» An employee with a high need for achievement Such particular outcome, they will be motivated. In brief, Vroom’s
employees should be given tasks which are demanding theory argues that the behaviour of individuals is such as to
but which can be reasonably expected to be achieved. maximise pleasure and to minimise pain in whatever form it
Such employees require regular feedback, especially of a may occur. Vroom’s model consists of three major elements,
positive nature. as illustrated in Figure 2.12.
» An employee with a high need for authority and
power This type of employee is most likely to flourish
and perform well when controlling others. For a junior Expectancy
Expectancy
employee this could be a supervisory role, while more leads to
senior employees may fulfil this need by managing large
teams of employees.
Performance
» An employee with a high need for affiliation Working Instrumentality
as part of a team, especially a co-operative one, is likely leads to
to allow employees to meet their needs for affiliation.
Equally, this type of employee is likely to perform best Outcome
(reward)
when interacting with other employees, and they should be Valence
provided with opportunities to do this whenever possible.
Personal
Process theories of motivation objectives
Process theories of motivation look at what people are
▲ Figure 2.12 Victor Vroom’s expectancy theory
thinking about when they decide whether or not to put effort
into a particular activity. Examples of such theories include » Expectancy This refers to the confidence that
expectancy and equity theories. They try to capture the employees may have in their ability to complete a
process that employees go through when making choices with particular activity or task to an acceptable standard.
goals in mind. Unlike the other theories of motivation we Demotivation will result if an employee believes that
have considered, they see the individual as an active decision- they are not capable of completing the task in question
maker, rather than trying (in the case of the neo-human satisfactorily.
relations school) to meet certain needs. Process theories » Instrumentality This is the belief of employees that
emphasise the actual process (or method) of motivation. the completion of a particular activity will lead to a
There are a number of process theories of motivation, but desired outcome. In a situation of high instrumentality,
we shall just consider the one developed by Victor Vroom. the employee has confidence that specific activities
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will result in the achievement of a valued reward. suggest that monetary methods of motivation are of limited
Instrumentality will be greater if employees recognise value, pay remains a major incentive.
2.2 a clear link between actions and rewards and have
confidence that they will receive the promised rewards
▼ Table 2.8 Opinions on the motivational powers of pay
for achieving their targets. Writer Opinions on the motivational power of pay
» Valence This represents the strength of a person’s
Frederick Taylor Taylor saw pay as the primary motivating
desire to achieve a specific outcome. Valence is
factor for all workers. He referred to
positive if a person prefers the outcome to not
workers as ‘economic animals’ and
achieving it. If the person is indifferent to the
supported the use of piece-rate.
outcome then the valence will be zero. High values
of valence mean that an outcome is highly attractive Abraham He saw pay as a reward which permitted
to employees and has great potential to motivate. In Maslow employees to meet the lower needs on
such circumstances, managers can use the possibility their hierarchy.
of attaining this outcome as a means of motivation. Frederick Herzberg saw pay as a hygiene factor
For example, a salesperson may find the prospect of a Herzberg and a possible cause of dissatisfaction.
monetary bonus for achieving an agreed sales target In a few circumstances pay might be a
very desirable. The salesperson must have confidence motivator if, for example, it is used as a
in their ability to achieve the number of sales recognition for merit.
necessary to receive the bonus.
Time-based pay
2.2.4 Motivation methods in Some employees receive payments based on the number
of hours that they work each week or month. Their income
practice is based on an hourly rate of pay. Thus an employee may
be paid $11 an hour. If the employee works 36 hours in a
The theories in practical situations particular week, they will receive gross pay amounting to
Reading the various theories of motivation, it can $396 ($11 × 36 hours).
appear that there are a number of straightforward
This payment system has the advantages of being simple
methods of motivating employees. However, in practice
to understand and transparent. Many countries across
this is not necessarily the case. Managers may lack
the world have minimum-wage laws based on specific
the resources or knowledge to be able to apply these
hourly rates of pay which can be increased over time to
theories in the workplace. For example, a business
compensate for inflation.
may not have sufficient financial resources to be
able to increase pay or offer promotions as a means However, time-based pay can result in employees becoming
of motivating workers. Furthermore, workforces are clock-watchers and not being prepared to carry out any
increasingly likely to contain diverse employees who may duties outside the hours for which they are paid.
be motivated by different factors. This can make the
task of improving levels of motivation more difficult for Salaries and wages
a manager in a modern business. Most employees receive their payment in the form of
Energage (a research and consulting firm based in salaries or wages. Salaries are expressed in annual terms
Philadelphia) has conducted research into employee (for example, a production manager might be paid a salary
motivation in the USA. It surveyed more than 20 million of $30 000 per year) and are normally paid monthly. Salaried
employees working for 60 000 businesses between 2004 employees are not normally required to work a set number
and 2020. Across all sectors and populations within the of hours per week, though their employment contract may
USA, appreciation of employees’ efforts is ranked among state a minimum number of hours.
the most important drivers of motivation, according to this On the other hand, wages are usually paid weekly and
survey. Appreciation can take many forms, such as financial employees are required to be at work for a specified
rewards or praise, and is part of many of the theories we number of hours. Employees on wages are normally paid a
have studied. This research suggests that in the workplace, higher rate (known as overtime) for any additional hours
elements of many of the theories we have covered can be worked.
very effective in increasing levels of motivation. It also
suggests that there are relatively simple ways to improve
employee motivation. Piece-rate
Under this pay system, employees are paid according to the
quantity they produce – a form of payment by results. Thus,
Financial motivators an employee on a production line might receive an agreed
Managers and organisations use a variety of pay systems in amount for each unit of production they manufacture.
an attempt to improve the performance of their workforce. Piece-rate is common in a number of industries including
Despite attention given to the views of Herzberg, which textiles, electronics and agriculture.
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Piece-rate offers businesses a number of advantages
and disadvantages. The introduction of piece-rate pay GLOSSARY TERMS
can increase the productivity levels achieved by many
employees within a business. This can effectively reduce
Performance-related pay (PRP) exists where some
part of an employee’s pay is linked to the achievement of
2.2
the business’ labour costs for each unit of output that is targets at work. These targets might include sales figures
produced. However, this rise in productivity may be at the or achieving certain grades in an annual appraisal.
expense of quality and customer complaints may increase. Variable pay is a reward for working that is based on
A business using piece-rate may lose customers as a employee performance or results judged against some
consequence of its introduction, especially if quality is an targets.
important factor in customers’ buying decisions.
2.2.4 Motivation methods in practice

Bonuses and commission Performance-related pay
Bonuses are additions to pay that are linked to individual Performance-related pay (or PRP) has become more
or team performance measured against targets or objective widely used over recent years and has developed
criteria. Employers introduce bonus payments to reward along with employee appraisal systems. PRP is only
individuals for doing well. By definition, a bonus payment is paid to those employees who meet or exceed some
an extra and not part of basic pay. Bonuses can be paid to agreed targets. Under PRP, employees are paid for their
employees in different industries and at different levels in contribution to the organisation, rather than their
an organisation. Some examples are: status within it.
» profit-related bonus, for example, to a manager in a Businesses of all sizes throughout the world have introduced
retail organisation PRP. It is widely used in Hong Kong and Japan, with Nissan
» performance bonus payments to senior managers or as a prime example. Despite criticisms, PRP remains popular,
directors or investment bankers and many employees support linking some element of pay
» bonus payments for reaching production targets in to performance. However, there have been criticisms of the
manufacturing. huge rewards paid to some senior managers and directors of
Commission, like piece-rate, is the payment for the quantity moderately successful companies.
(or value) that is produced by an individual employee. In Criticisms of PRP
some industries, such as telesales, an employee’s entire A number of other criticisms of performance-related pay
income may be made up of commission, although it may have been put forward:
have to meet any conditions imposed by minimum-pay » Many employees perceive PRP as fundamentally unfair.
laws. Employees can be paid a percentage of the value of This is particularly true of those working in the services
any products they sell as commission. This form of payment sector, where individual employee performance is
has similar advantages and disadvantages to piece-rate. difficult to measure.
However, in many countries it has become less common. One » Employees fear that they might be discriminated against
explanation for this may be that its disadvantages outweigh because they do not get on with the manager who makes
its advantages. a decision on their performance. This can result in their
performance worsening, not improving.
Profit sharing » A majority of businesses operating PRP systems
Profit sharing is a reward system under which employees do not put sufficient funds into the scheme.
receive some part of the business’ profits. This is a type Typically, the operation of a PRP scheme adds 3–4 per
of performance-related pay (see opposite) but not one cent to a business’ wage bill. This only allows employees
which discriminates between the performances of individual to enjoy relatively small performance awards, which may
employees. Such payments, which may vary according to the be inadequate to change employee performance.
employee’s seniority within the organisation, are separate
Developments in PRP
from, and additional to, regular earnings.
Increasing numbers of businesses are implementing a
Profits are paid to employees in the form of cash or system known as variable pay. Some managers argue
company shares. Profit-sharing schemes can improve an that a business’ performance often depends upon the
employee’s loyalty to the business by breaking down the achievements of the few.
‘us and them’ attitude. Under profit-sharing schemes, a
Variable pay is really a development of PRP. It is similar
greater level of profit is regarded as being of benefit to all
in that it rewards employee performance, but there are
employees, not just to senior managers. Employees may be
differences. PRP operates according to a formula used
more willing to accept changes designed to improve the
throughout the company. Variable pay is far more flexible
business’ profitability.
and the potential rewards for star employees are greater.
The danger with profit-sharing schemes is that they can If the business performs well, employees benefit under
provide rewards that are too small to represent a worthwhile variable pay, but they can suffer financial penalties in a less
payment for employees. On the other hand, if they are too successful period.
generous, the business may lack sufficient funds for capital
investment.
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Some managers remain unconvinced of the value of PRP, no Fringe benefits
matter how sophisticated the scheme. The widespread use
Fringe benefits (sometimes referred to as perks) are those
2.2 of PRP may, in part, be an attempt by managers to keep pay
rates down for the majority of employees. PRP, or variable
extras that an employee receives as part of their reward
package. Examples include:
pay, treats employees as individuals, limiting the ability of
» a company car (or a mileage allowance for an employee’s
trade unions to bargain collectively.
own car)
Targets set. These are
» private health insurance
agreed between employee » employers’ contributions to pension schemes
and line manager. May take » discounts for company products.
the form of sales targets,
level of customer Firms tend to use fringe benefits to encourage employee
satisfaction, etc.
loyalty and to reduce the number of employees leaving the
firm. A danger of the widespread use of fringe benefits is
that costs can increase quickly, reducing profitability.
Pay decision made. Those Evidence collected on STUDY TIP

meeting all performance employee performance Remember that PRP remains a highly topical and
targets fully might receive through, for example,
5% extra. Least effective observation of employee controversial issue. While there are a number of
performers may receive 0%. at work. arguments in favour of it, a central weakness remains.
This can be explained in terms of the theory we covered
earlier. Writers such as Maslow and Herzberg argued that
▲ Figure 2.13 The operation of a typical performance- money has limited power to motivate employees. PRP, no
related pay system matter how it is implemented, has more in common with
Frederick Taylor’s views of motivating employees.
CASE STUDY
Profit-sharing at Ford
Ford is one of the world’s best-known manufacturers of Employees at GM will be paid $8000 and employees at the
cars and other vehicles. In 2019, the company’s profits were lorry manufacturer FCA will receive $7280.
just $47 million, a very heavy fall compared with 2018.
Tim Stone, Ford’s chief financial officer, expressed
The company said that the decline was due to a range of
optimism about the company’s prospects for 2020, while
operational reasons including unexpected costs associated
acknowledging that ‘results were not OK in 2019’.
with the launch of Explorer, a new model of car.
Source: https://eu.freep.com/story/money/cars/ford/2020/02/04/
The fall in profits led to a reduction in the company’s ford-profit-sharing-2020-checks-bonus/4644019002/
profit-sharing payments to its employees. The company
revealed that these would be 13 per cent lower: $6600 Questions
per employee, compared to $7600 in the previous year. 1 Explain two reasons why Ford might expect its profit-
Ford does not pay profit shares to all of its hourly paid sharing scheme to improve the performance of its
employees. workforce. [6]
Some other vehicle manufacturers will pay their 2 Evaluate the possible problems Ford faces in
employees larger sums as profit-sharing bonuses. operating its profit-sharing scheme. [12]
GLOSSARY TERMS
Fringe benefits (or perks) are those extras an employee Job enlargement is giving employees more duties of a
receives as part of their reward package. similar level of complexity. Also called horizontal loading.
Job redesign means changing the group of tasks or duties Job rotation is the regular switching of employees between
which make up a specific job. tasks of a similar degree of complexity.
Job enrichment occurs when employees’ jobs are Empowerment is a series of actions designed to give
redesigned to provide them with more challenging and employees greater control over their working lives.
complex tasks. Also called vertical loading.
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Non-financial motivators an advantage from having an employee able to carry out a
wider range of duties, possibly reducing its labour costs.
Many non-monetary methods of motivation tend to focus
upon the design of employees’ jobs. Employees can be Job rotation is a particular type of job enlargement. Under 2.2
motivated by asking them to do a job that is challenging this system employees switch regularly from one duty to
and interesting. A good job should have at least a number another. Thus, a supermarket may require employees to
of the features listed below. spend one week on the checkout, one week stacking shelves
» Employees carry out duties that result in a definite end and one week dealing with customer enquiries. Job rotation
product. may reduce the level of monotony, but it does not increase
» Clear and challenging goals give employees something to the challenge of the job.
aim at. Goals should be demanding but not unattainable.

» Employees should be able to identify easily their
contributions to the organisation.
Job enrichment
» Jobs should be designed so that employees are involved Increasing the
in planning their own schedules of work, choosing their complexity of
Complexity of tasks
work methods and coping with problems as they arise. tasks carried out
by an employee
The main methods of non-monetary motivation attempt to or a group of
incorporate some of these features into the working lives of employees
employees.
Job enlargement
Increasing the number of tasks
Job redesign of a similar level of complexity
Employers can change the design of employees’ jobs to
encompass more or different duties, or duties that are more Extent of tasks
challenging. Job enrichment occurs when employees’ jobs
▲ Figure 2.14 Job redesign: job enrichment and job
are redesigned to provide them with more challenging and
enlargement
complex tasks. This process, also called vertical loading, is
designed to use all employees’ abilities. The intention is to
enrich the employee’s experience of work. Employee empowerment
Empowerment involves redesigning employees’ jobs
Frederick Herzberg was a strong supporter of job to allow them greater control over their working lives.
enrichment. He believed that enrichment provided Empowerment gives employees the opportunity to decide
employees with motivators that increased the satisfaction how to carry out their duties and how to organise their
they might get from working. Job enrichment normally work.
involves a number of elements:
» redesigning jobs so as to increase not just the range of Empowerment can make work more interesting as it offers
tasks but the complexity of them opportunities to meet a number of individual needs.
» giving employees greater responsibility for managing Empowered workers can propose and implement new
themselves methods of working as they bring a new perspective to
» offering employees the authority to identify and solve decision-making. They may spend a part of their working
problems relating to their work lives considering the problems they face and proposing
» providing employees with the training and skills essential solutions.
to allow them to carry out their enriched jobs effectively. Empowerment would receive the approval of Maslow and
Job enrichment involves a high degree of skill on the part Herzberg. It provides motivators, as well as offering
of the managers overseeing it. They must ensure that they employees the opportunity to fulfil higher needs.
do not ask employees to carry out duties of which they are Employees require training if they are to be empowered.
not capable. They are unlikely to have the skills necessary to schedule
Job enlargement does not increase the complexity of tasks tasks, solve problems, recruit new employees and introduce
carried out by an employee; instead it increases the number new working practices. It takes time to implement
of similar duties. It is also termed horizontal loading. empowerment and teething problems are common.
A number of firms operating a policy of job enlargement
simply require employees to carry out a number of similar Teamworking
tasks. Thus, a receptionist might be asked to carry out a Teamworking exists when an organisation breaks down its
number of duties in addition to dealing with telephone and production processes into large units instead of relying
personal enquiries from customers. The receptionist may upon the use of the division of labour. Teams are then given
also be asked to maintain records of petty cash and update responsibility for completing the large units of work. Team
customer records, for example. members carry out a variety of duties including planning,
Job enlargement offers benefits to the employee in that problem-solving and target-setting. A number of different
carrying out a range of duties, rather than a single one team types operate within businesses:
repeatedly, may stimulate their interest. The business gains
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» Production teams Many production lines have been businesses recognise the motivational and other benefits
organised into distinct elements called ‘cells’. Each of of involving employees in decision-making within an
2.2 these cells is staffed by teams whose members are multi-
skilled. They monitor product quality and ensure that
organisation. We consider employee participation more fully
below.
production targets are met.
» Quality circle teams These are small teams designed to GLOSSARY TERMS
propose solutions to existing problems and to suggest Job design is the process of grouping together individual
improvements in production methods. The teams contain tasks to form complete jobs.
members drawn from all levels within the organisation. Employee participation is the involvement of employees in
» Management teams Increasingly, managers see the process of decision-making within a business.
themselves as complementary teams, establishing

the organisation’s objectives and overseeing their
achievement. Promotion and status
There has been a major trend in businesses towards Promoting an employee to a more senior position within
teamworking over recent years. Teamworking is a major part the business is likely to prove motivational. Organisations
of the so-called Japanese approach to production and its that offer clear paths for promotion are likely to have more
benefits have been extolled by major companies, such as motivated employees, as promotion brings a number of
Honda. benefits including financial rewards, more opportunities for
Teamworking offers employees the opportunity to meet taking responsibility, and recognition. Employees in such
their social needs, as identified by Maslow; Herzberg organisations will be more able to identify a career path and
identified relationships with fellow workers as a hygiene would be expected to be more motivated and committed to
factor and McClelland noted that some employees have a achieving advancement.
high need for affiliation. However, much of the motivational Herzberg recognised that many employees needed
force arising from teamworking comes with the change opportunities for advancement. McClelland identified a
in job design that usually accompanies it. Teamworking group of employees with high needs for authority and
requires jobs to be redesigned, offering employees the power. Both writers acknowledged that having clearly
chance to fulfil some of the higher needs identified by defined routes for progression up the organisational
Maslow, such as esteem needs. Similarly, teamworking offers structure can be an effective means of meeting these needs
some of the motivators; for example, achievement. and can motivate employees and improve their performance
at work.
Training and development If employees believe that their employer offers no prospects
Some businesses invest heavily in training and development, for advancement, they may seek alternative employment.
often regarding it as a core element of managing their This can reduce a business’ retention rates and increase its
workforces successfully. Managers value training because costs, including those for recruitment and training.
they believe it improves employee motivation and
performance. They believe that training helps to motivate Businesses can gain a competitive advantage by
employees because they feel valued by the business and this establishing and publicising clear promotion paths for
fulfils what Maslow would have called their esteem needs. employees. This approach can assist managers in attracting
the most talented employees and in developing a strong
However, training has drawbacks as a technique of employer brand.
motivation. It can be very expensive, especially if it takes
place away from the workplace, and it may not be the most Similarly, granting someone higher status within an
cost-effective method of motivating employees. A further organisation, perhaps through giving them their own office
danger is that employees may leave once they have acquired or parking space, may motivate them by fulfilling their need
new skills and higher levels of motivation, attracted by for self-esteem. However, some businesses have opted for a
higher pay elsewhere. policy of single status in recent years. Single status means
that businesses end discrimination between different grades
Employees may receive induction training when starting of employees within the organisation, by providing the
a new job. This type of training is intended to introduce same facilities and benefits for all.
a new employee to their job and working environment.
Induction training can give employees confidence in their
ability to do a job from the outset and this confidence may
Methods of employee participation
boost their motivation and performance in the workplace. As we have seen, employee participation is the involvement
of employees in the process of decision-making within
a business. Trade unions can be opposed to the use of
Employee participation employee participation because techniques such as quality
Employee participation is the involvement of employees circles can replace unions in the workplace. Employee
in the process of decision-making within a business, participation can take numerous forms, including:
possibly through the appointment of worker directors. Many
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» Quality circles These are groups of workers who meet » Employee shareholders Firms across the world operate
regularly to identify methods of improving all aspects schemes whereby their employees can buy shares in the
of the quality of their work. Quality circles normally
involve four to ten employees, drawn from all levels
company, often at discounted rates. Because employee
shareholders have a financial interest in the business’
2.2
within the organisation, and focus on supplying performance, it may be that their motivation levels
imaginative ideas. and performance will improve as a consequence. If the
» Works councils Managers and employees meet within business performs well, its share prices should increase,
works councils to discuss issues such as working giving financial benefits to the employee.
conditions, pay and training. They are popular in many » Autonomous work groups These are teams of employees
countries, especially Germany. Employee representatives who are given a high level of control over their working

on works councils are normally elected by the workforce lives – in effect, another form of empowerment. Some
and works council representatives may also be appointed such groups elect their own leaders and can appoint new
to a company’s board of directors. staff, as well as having considerable authority over what
tasks to complete and in what sequence.
Elton MAYO Abraham MASLOW Frederick HERZBERG

emphasised the importance of argued that businesses should offer identified factors (which he called
social contact and human employees the opportunity to fulfil ‘motivators’) which are central in
interaction in motivation their ‘higher needs’ such as status improving employee performance
and recognition at work
encouraged use of Maslow’s theory the use of autonomous work

teamworking in business supports the use of groups generate ‘motivators’
quality circles for those involved
EMPLOYEE
PARTICIPATION
▲ Figure 2.15 Employee participation and motivational theory
CASE STUDY
Primark in Bangladesh
Primark is one of Europe’s largest retailers of clothes and led to a number of administrative changes, including
operates more than 230 shops. The company has a well- transparent pay rates and accurate and detailed pay slips.
publicised commitment to improve working conditions in
Primark has also supported the creation and publication
its suppliers’ factories in Bangladesh. It has established
of a range of posters setting out workers’ rights. The
committees to allow employees to participate in decision-
whole scheme is designed to ensure that workers are
making in a number of its factories, allowing employees to
empowered, educated and effective communicators
make proposals to improve their working conditions. The
dedicated to improving working conditions in one of the
programme covered factories in Dhaka, Savar Gazipur
world’s poorer economies.
and Narayanganj. In preparation, Primark provided
training to 500 managers in the factories and more than Questions
1000 employees to ensure they had the necessary skills
1 Explain two difficulties that Primark might face in
to implement decisions to enhance working conditions in
establishing its worker-participation committees. [6]
diverse environments.
2 Evaluate whether or not Herzberg’s theories of
Equipped with new skills, including those related to motivation offer the best explanation of the benefits
bargaining, the factory workers have reduced working that Primark might receive from setting up worker-
hours and increased holiday entitlements, while participation committees. [12]
increasing hourly pay rates. The negotiations have also
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TEST YOUR LEARNING
2.2
1 a Define the term ‘motivation’. [2]
A traditional business
b Explain one characteristic of a highly
motivated workforce. [3] Gibble Ltd is a long-established manufacturer of luxury
2 Explain one way in which a business may benefit pens. It is a traditional business with a clear hierarchy and
from having a highly motivated workforce. [3] many long-serving managers. Its products are recognised
as being of the highest quality and it charges premium
3 a Identify two human needs.
[2]
prices for them. Its most expensive pen sells for $1250.
b Explain two key elements of FW Taylor’s
theory of motivation. [6] Despite the company’s profits reaching record levels, its
4 Explain one difference between Frederick managers are seeking ways to improve the performance
Herzberg’s motivators and his hygiene factors. [3] of its workforce. Some managers believe that pay
5 a Define the term ‘process theory of motivation’. [2] is the best way to improve motivation and employee
performance. Others would prefer more employee
b Explain one difference between the need for
participation allowing greater use of teams and
achievement and the need for affiliation. [3]
techniques, such as empowerment and job enrichment.
6 a Explain one difference between piece-rate
pay and hourly pay. [3] Questions
b Explain one possible benefit to a business of
1 Define the terms:
profit-sharing. [3]
a ‘empowerment’ [2]
7 Explain two features that an employer should include
b ‘job enrichment’. [2]
in the design of a job if it is to motivate employees. [6]
2 Analyse one way in which Gibble Ltd might use
8 a Explain one difference between job enrichment
monetary methods of motivation to improve the
and job enlargement. [3]
performance of its workforce. [4]
b Define the term ‘job design’. [2]
3 Evaluate whether it is inevitable that Gibble Ltd
9 Explain two different types of teams that may be
will use non-financial methods to motivate its
used within a business. [6]
workforce. [12]
10 a Define the term ‘employee participation’. [2]
b Explain two techniques that businesses may
use to encourage employee participation. [6]
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2.3
AS LEVEL
Management
2.3.1 Management and managers

Chapter overview
★ the functions of management
★ the role of managers using the theories of Fayol and Mintzberg
★ the contribution of managers to business performance
★ a range of management styles
★ McGregor’s theory X and theory Y managers.
2.3.1 Management and managers STUDY TIP

Do make sure that you distinguish between management
What is management? and leadership in your answers and avoid using these
Describing management is a complex task, and there have two terms interchangeably. If the question is about
been a number of attempts by writers to classify what management, make sure that is what you write about!
managers do within an organisation. For example:
» Henri Fayol, writing in the early twentieth century, set
out the functions of management. The functions of management
» In contrast, Henry Mintzberg identified ten roles carried The theorist Mary Parker Follett believed that management
out by managers. was ‘the art of getting things done through other people’.
We will consider both of these classifications in more detail From Fayol onwards, various writers over the years have
in this chapter. argued that this involves different functions. However,
those set out in Figure 2.16 would be considered the key
Many business writers draw a distinction between a leader functions that are carried out by most managers.
and a manager. A manager is someone who gets things
done. Managers tend to focus on the present and the short
pany objectives
term and are responsible for implementing the decisions Com
of others. They manage but they also follow. Their role, in
many ways, is to maintain things the way they are.
Leaders, by comparison, are people who are followed, who
have a vision of the future and a clear sense of where they
Di
ng
are taking the business. A leader decides what needs to

re
ni
ct
an
be done and is prepared to shake things up to get it done.

in
Pl
According to a significant writer in this area, John Adair, The

‘leadership is the process of motivating others to act in Manager
particular ways’. We look at leadership in much more detail
g
O
in Chapter 7.3.
llin
rg
an
ro
nt
isi
Co
ng
GLOSSARY TERM
Leadership includes the functions of ruling, guiding and
inspiring other people within an organisation in pursuit of
agreed objectives. Com s
p a n y o bje cti v e
Management is planning, organising, directing and
controlling all or part of a business enterprise.
▲ Figure 2.16 The functions of management
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All businesses operate in different ways and may require » planning
managers to undertake varying tasks and duties. However, » organising
2.3 these various management duties and tasks can be
categorised into four basic functions – the functions of
» directing
» controlling.
management. The four principal functions of management are:
CASE STUDY
Saudi Arabian company wins airport car park contract
AS LEVEL 2.3 Management
Sharjah Airport is one of the busiest in the United Arab also plans to offer drivers parking at Sharjah Airport new,
Emirates. In the past, the managers at Sharjah Airport and more convenient, methods of paying parking charges.
Authority have managed parking by passengers and staff.
Source: www.moodiedavittreport.com/national-parking-company-
However, it was decided recently that another company mawgif-wins-15-year-sharjah-airport-parking-contract/
should be employed to take on this role. The contract was
won by Mawgif, a business based in Saudi Arabia. Questions
Mawgif has promised to use technology to support its 1 Explain two functions of the managers at Sharjah
management of parking at the airport in the hope of Airport Authority. [6]
improving the travel experience of passengers passing 2 Evaluate which of the functions of management will
through Sharjah Airport. It has significant experience in be most important if Mawgif’s managers are to
this area as it already operates parking in more than ten respond effectively to winning this contract. [12]
cities and has operations in Saudi Arabia and Jordan. It
Planning Organising
Planning is the first of the functions of management and Management must assemble the resources that they need
involves looking to the future. It is the foundation upon to carry out the actions set out in the plan. Through the
which the other three functions of management should process of getting organised, management will determine
be based. Planning requires management to evaluate the internal organisational structure, establish and
where the company is currently and where it would like to maintain relationships, as well as allocate necessary
be in the future. This allows managers to take decisions resources.
so that the company moves forward in an organised and
Global demand for palm oil is rising quickly. Worldwide
coherent manner to give managers something against which
production of palm oil has been climbing steadily for
to judge their decisions. Planning may involve a variety of
five decades. Between 1995 and 2015, annual production
tasks, including:
quadrupled, from 15.2 million tonnes to 62.6 million tonnes.
» establishing objectives or targets for the business
By 2050, it is expected to quadruple again, reaching 240
» gathering together forecasts of key data, such as costs
million tonnes. Plantations have been established in Africa
and revenues
and South America. In order to organise this expansion, the
» drawing up plans for functional areas within the
managers will need a range of resources:
business such as finance, human resources or
» land for palm oil plantations and oil mills
marketing – these plans should fit together to help the
» labour to plant the trees, build the mills and, eventually,
business achieve its objectives
harvest the fruit of the trees and process it
» estimating the likely resource needs for any proposed
» capital to finance the plan.
plans.
The companies may also need to restructure their workforce
The planning process is continual because external factors
to operate plantations in Africa and South America to
(such as licences to operate telecommunications services
ensure that their planned operations run efficiently. A well-
in many countries, for example) change all the time. These
managed business will use minimal resources to achieve its
changes may cause a company to adjust its course of action
objectives. (The palm-oil industry has a high environmental
to ensure that it achieves its objectives.
impact which companies must also take into account – see
Planning helps managers to reduce the chance of projects pages 233 and 257.)
failing in the future. A plan can highlight problems and
encourage managers to develop solutions. It can help to Directing
make sure that managers have the resources they need. A
The third function of management is directing. Through
plan can also be extended to help managers to overcome
directing, management is able to influence and oversee the
emergencies or crises – these are called contingency plans.
behaviour of the staff in achieving the company’s goals, as
For example, a company might draw up a contingency plan
well as assisting them by providing the necessary resources.
to cover the consequences if a bid made to operate mobile
Directing employees effectively entails motivation and
phone services is unsuccessful.
communication.
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» Motivation is the willingness to achieve a target or
goal. Employees that are highly motivated generally Question
perform better, which assists businesses in achieving
objectives. For this reason, managers tend to put a lot of
1 Evaluate why it might be necessary for palm-oil
producers to report on their social performance in
2.3
focus on motivating their employees. For example, they Africa to ensure that their activities are controlled
provide financial-incentive programmes to encourage effectively. [12]
employees and may also grant them authority to take
decisions to help improve motivation and performance.
» Communication is the exchange of information between Henri Fayol’s theories of management
one or more people. Effective communication can take Henri Fayol (1841–1925) was a French mining engineer. He

a number of forms. It may simply be praise or clear developed a theory of business administration and published
guidance; alternatively, it could be detailed instructions. his ideas in his book, Industrial and General Administration,
Whatever form it takes it can help to achieve high levels originally published in France in 1916. Fayol created his
of productivity and encourages employees to use their theory at roughly the same time as Frederick Winslow Taylor
initiative as well as to solve problems. developed his ideas about scientific management.
As a director in a mining company, Henry Fayol established
Controlling what he thought were the fourteen key principles of
Controlling involves setting standards using the company’s management. His work set out how managers should
objectives and then evaluating and reporting performance. organise and interact with employees. He also identified
Once management has done both of these things, it should five primary functions of management which supported his
compare the two to determine any necessary corrective fourteen principles.
or preventive action. Managers can report on business
performance in a number of ways: Fayol was one of the earliest writers on management theory
» Financial reports Many companies publish details and remains a very strong influence on management theory
of their financial performance each year. This gives and practice.
interested parties information on their sales, revenues
and profits. In many countries there is a legal Fayol’s fourteen principles
requirement for companies to report on profits or losses 1 Division of work Output can be increased if employees
to assist governments in assessing whether the correct are specialised in different areas of production. This
amount of tax has been paid. occurs because employees become increasingly skilled
» Employee performance Such reports may provide and productive.
information on productivity (the quantity produced per 2 Authority Fayol believed that managers need authority
employee per week, for example), levels of absenteeism to give orders to subordinates. However, it is important
or training costs. For many service businesses, these can to remember that responsibility comes with authority.
be vital measures of performance. 3 Discipline This refers to obedience and is a core value in
» Social performance Managers can measure a business’ an effective organisation.
performance in terms of behaving ethically, minimising 4 Unity of command This means that an individual
pollution and creating jobs. employee should receive orders from one manager and
Palm-oil producers may need information on each of the that the employee is answerable to that manager.
above areas to assess whether their planned expansion 5 Unity of direction In a well-co-ordinated organisation,
of palm-oil production in countries throughout the teams with the same objective should be working under
world is progressing according to their plans. The the direction of one manager and following a single
control process is a constant task for managers. Through plan.
the process of control, a manager is able to identify 6 Subordination of individual interests to the general
potential problems and take the necessary decisions to interest The interests of any one employee or group
overcome them. of employees (including managers) should not be more
important than the interests of the organisation as a whole.
7 Remuneration Employee satisfaction occurs when all
employees are paid fairly. This covers financial and non-
financial rewards.
8 Centralisation This refers to how close employees are to
the decision-making process. It is important to achieve
a balance between senior managers (at the centre)
and more junior employees being involved in decision-
making.
9 Scalar chain Employees must know where they are in
the organisation’s structure. They should know who is
their manager and those people over whom they have
▲ Figure 2.17 A newly established palm-oil plantation authority.
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10 Order Employees must have the right resources to carry Interpersonal management
out their jobs effectively. In addition, the workplace
This category entails managing through other people.
2.3 should be clean, tidy and safe.
11 Equity Fayol believed that managers should be kind and
» Figureheads represent their colleagues. They carry out
social, ceremonial and legal responsibilities and are
treat all employees fairly at all times.
expected to be a source of inspiration. Figureheads are
12 Stability of tenure of personnel Managers should aim
considered to have authority.
to have the right staff in the right place and to minimise
» Leaders create and maintain an effective working
the rate of labour turnover within the business.
environment and motivate and develop more junior
13 Initiative Employees should be given the necessary
employees. In this role, employees manage the
freedom to be creative and to develop new ideas. This
performance and responsibilities of everyone in their
helps to encourage employees to be engaged and
team.
motivated.
» Liaisons must communicate with internal and external
14 Esprit de corps Organisations should strive to promote
contacts. They need to network effectively to gather
team spirit and unity and create good morale within the
information.
workplace.
Fayol’s fourteen principles may have been written more than Informational management
one hundred years ago, but many of these principles are The roles in this category involve processing information.
now adopted by almost all managers, although they were » Monitors search for internal and external information
considered revolutionary when first published. relevant to the business, looking for relevant changes in
the environment. Monitors also look after their teams in
Fayol’s functions of management terms of performance and welfare.
Fayol set out five functions of management. These are: » Disseminators pass on valuable information to others in
» planning » co-ordinating the organisation. This is a central communication role.
» organising » controlling. » A spokesperson represents and speaks for their
» commanding organisation. In this role, they are responsible for
transmitting information about their organisation and
You will see that Fayol’s functions of management are very
its goals to the people outside it.
similar to the generic managers’ roles described earlier (on pages
84–85). Analysing the functions and principles of management
gives some insight into what managers have to do to be Decisional management
effective and efficient. Some management writers have argued This category of management role uses information to take
that when Fayol’s writing on good management was accepted, decisions.
productivity and living standards in America increased. However, » Entrepreneurs plan and initiate change as a manager
this may have been the result of other factors too. within a business organisation.
» Disturbance handlers deal with the unexpected and
Mintzberg’s roles of management also with crises. Managers should take control in such
circumstances and attempt to solve disputes.
Henry Mintzberg is Professor of Management Studies at
» Resource allocators take decisions on the most
McGill University in Montreal, Canada, and a renowned
effective use of an organisation’s resources including
author on management. One of his most famous pieces
finance, staff and capital equipment.
of writing, in 1990, set out the ten roles performed by
» Negotiators engage in important negotiations within
managers within businesses. He argued that management is
and outside the business.
not about functions but about what managers do.
Mintzberg reached a number of conclusions from his studies.
Mintzberg argued that managers performed ten roles and
» Senior managers are very busy and have heavy
that these fall into three categories, as shown in Table 2.9.
workloads! There is little free time and trying to get
▼ Table 2.9 Mintzberg’s management roles and categories away from work is difficult.
» The work is fragmented; managers are moving from
Role Category one task to another. They need to focus on what really
1 Figurehead matters and what really makes a difference (80 per cent
2 Leader Interpersonal management of results usually come from 20 per cent of the effort, so
3 Liaison they try to work out what that 20 per cent is).
4 Monitor » Managers focus on short-term, immediate problems. They
5 Disseminator Informational management are often firefighting, dealing with the problem in front
6 Spokesperson of them; this pushes them away from long-term planning
and thinking.
7 Entrepreneur Decisional management
8 Disturbance handler
9 Resource allocator This category of management role
10 Negotiator uses information to take decisions.
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CASE STUDY
2.3
SF Airlines plans to enlarge fleet
SF Airlines is based in Shenzen, China, and was founded in to operate flights from China to any point in the USA. In
December 2009. It provides a service transporting cargo response to this, the airline will introduce flights from
and has transported around 2.5 million tonnes of cargo to Hangzhou to New York three times each week.
destinations in central and south-east Asia and Europe. It
Source: www.ch-aviation.com/portal/news/85299-chinas-
only commenced flights between Frankfurt (Germany) and sf-airlines-fleet-to-top-60-aircraft-in-2020
Wuxi (China) in September 2019.

Each week, SF Airlines operates an average of 959 Questions
flights to 65 airports. The airline plans to double its 1 Explain two reasons why planning will be an important
fleet to 118 aircraft and to expand its network of routes function for SF Airlines’ managers in the future. [6]
to 70 destinations during 2020. SF Airlines has also 2 This expansion represents a major challenge for SF
expanded its fleet of aircraft by 16 per cent during 2019 Airlines’ managers. Evaluate which of Mintzberg’s
and now operates 58 planes. In December 2019, it was roles would be most important in the management
given approval by the US Department for Transportation of the company’s growth. [12]
» Verbal contact is preferred to written as, with the latter, » Allowing subordinates to work to their full potential
lots of information is received but it takes longer to get Managers who can recognise and respond appropriately
a response. Managers seldom get out and about; walking to the needs and abilities of their workforce are more
around is useful because it makes you visible and more likely to achieve success. Some employees will flourish
aware of the issues within the business. if managers relax control and empower employees
» Managers actually control little of what they do day to to make decisions and take greater control of their
day – things happen to them! working lives. In other situations, managers may need
to use more authority. If managers achieve the right
Mintzberg’s work on management roles was based on
balance between the use of authority and freedom for
observing senior managers, and this is both a weakness
employees, the workforce, and hence the organisation, is
and a strength of his theory. He did analyse what managers
likely to perform better.
really do, but he did not consider the working lives of
» Making good-quality decisions Managers tend to make
middle or junior managers, so, in this respect, his analysis
a lot of decisions. Some of these can have significant
may be considered incomplete.
implications for the performance of the business.
Effective managers will use their experience and skills,
The contribution of managers to as well as data, to make good-quality decisions. Modern
business performance managers frequently have access to enormous amounts
of data on, for example, market trends and consumer
Managers play a critical role in business activities and can behaviour. This can be used to support and inform
have a significant influence on their performance. There are decision-making and can help to reduce the risk in major
many elements of the work of managers which can impact decisions, such as that taken by Volkswagen above.
on the performance of the business. We will consider some
of these below (these are also summarised in Figure 2.18).
Use workforce and other
» Setting suitable objectives Managers play an important resources as efficiently Increased sales
role in setting objectives and monitoring the actions as possible and profits
taken to achieve these. Setting objectives which are
appropriate and achievable is an important part of
business success. If they are too challenging, employees Set
Achieve
may be demotivated by failure; if too easy to achieve, objectives
challenging
on time,
the business may underperform. Effective managers but
enhancing
also monitor the progress of the business towards achievable
business’
its objectives, ensuring, for example, that sufficient objectives
performance
resources are available to employees. Managers at
Volkswagen, the German car manufacturer, plan to
Protecting and/or
switch production from cars powered by internal Take informed decisions
increasing market
combustion engines to those with electric motors. By using experience and data
share
2028, Volkswagen will sell 70 different electric vehicles
and the company will be carbon-neutral by 2050. Its ▲ Figure 2.18 Some ways in which managers can contribute
future success will depend on how effective managers to business performance
are in guiding the business to achieve these objectives.
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Styles of management a range of management styles depending upon the extent
to which managers take decisions or whether subordinates
2.3 There have been many studies looking at styles of
management and evaluating the extent to which they have
contribute significantly to decision-making.
been successful. There is no simple answer to which style is A key factor in differentiating between these styles is
most effective, as it depends on the circumstances. Here, communication. At the autocratic end of the spectrum,
we will consider a range of styles of management. communication is likely to be downward only as the manager
‘instructs’ their subordinates as to their duties. Paternalistic
One classification of styles is to consider the extent management is a ‘softer’ version of this, as we shall see.
to which managers ‘tell’ or ‘listen to’ their staff. Using Democratic management is more likely to result in two-way
this approach, managers have been classified as being communication, as consultation and ‘selling’ of the final
autocratic, paternalistic, democratic or laissez-faire idea take place. Laissez-faire management may result in
(literally meaning ‘leave alone’). However, there are many relatively little communication, as the problem or task may
more different styles of management that can be identified be outlined with subordinates having considerable freedom
using this approach. The Tannenbaum and Schmidt thereafter.
continuum, shown in Figure 2.19, emphasises that there is
Manager-centred management Subordinate-centred management
Use of authority by the manager Area of freedom for subordinates
Manager makes Manager sells Manager Manager Manager presents Manager defines Manager pemits
decision and decision to presents presents problem, gets limits and asks group to function
announces it subordinates i.e. ideas and invites tentative decision suggestions and group to make independently
convinces them questions subject to change makes decision decision within defined
limits
Range of behaviour
▲ Figure 2.19 The Tannenbaum and Schmidt continuum
» one-way communication (downward)

GLOSSARY TERMS » minimal delegation or decentralisation
Autocratic management exists when managers keep » close supervision of employees.
control of information and make major decisions alone.
Sometimes known as authoritarian management.
Martha Stewart, an American entrepreneur, built up a vast
global business venture including publishing, television
Paternalistic management is a style in which managers broadcasting and online commerce, despite (or perhaps
take decisions in what they believe are the best interests
because of) her reputation as an autocratic manager.
of their subordinates.
Under this style, the manager determines objectives,
Democratic management occurs when information is allocates tasks and expects obedience from subordinates.
shared and team members participate in decision-making. In these circumstances, employees become very dependent
Sometimes known as participative management. upon their managers, as they do not have the necessary
Laissez-faire management takes place when managers information (or confidence) to act on their own initiative.
allow subordinates freedom to make their own decisions.
Organisations managed in an authoritarian style can face
difficulties. People avoid making decisions, so that matters to
Autocratic management be decided are either passed up for the decisions to be made
at a higher level or decisions are made by committees – as it
This is also sometimes termed authoritarian management.
is more difficult to dismiss all the members of a committee
It refers to a management or leadership style which assumes
for jointly making a wrong decision. Senior management
that information and decision-making are best kept at the
tends to be overworked and staff turnover tends to be high.
top of the organisation. It is also characterised by:
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This style of management becomes more difficult to operate subordinates having no freedom of action. More benevolent
successfully as an organisation grows. autocratic leadership will allow for the possibility of some
As with all of these management classifications, the
discussion or persuasion. This implies that limited two-way
communication may occur.
2.3
term ‘autocratic manager’ covers a spectrum of actual
styles. Extreme autocratic management will result in
▼ Table 2.10 Autocratic management – circumstances in which it may be applicable
Appropriate Inappropriate
• When a rapid decision is needed – perhaps in an emergency • When taking highly complex decisions requiring diverse

• When it is important that the same message is given out knowledge and skills
by everyone in the organisation – maybe as part of crisis • When leading a talented, self-motivated and creative group
management of employees
• When managers are responsible for a large number of • In circumstances in which junior managers are expected to
(possibly unskilled) subordinates develop a full range of managerial skills
Paternalistic management » the manager acts upon advice and explains the reasons
for decisions
Paternalistic management is broadly autocratic, but this
type of manager takes into account the interests of the
» subordinates have some control over their own working
lives.
workforce when making decisions. Paternalistic managers
consult with junior employees over decisions and may The successful operation of this style requires excellent
take some notice of the views expressed by subordinates. communication skills on the part of the manager and the
However, paternalistic managers retain control over most ability to generate effective two-way communication. A
decision-making and only delegate minor decisions (and considerable amount of management time may be spent on
little freedom) to subordinates. communicating in one form or another. This approach helps
to develop the skills of subordinates and generally results in
A paternalistic manager regards their staff as an extended
a more satisfied workforce.
family. Businesses using this style of management consider
it important to meet the social and leisure needs of their Democratically led groups usually have low dependency on
staff. This approach was common in the UK in the past, and their manager, offer constructive ideas and suggestions
Cadbury’s (a manufacturer of chocolate and similar products) and derive great satisfaction from their employment.
was a well-known example. As a consequence, such groups have high levels of self-
motivation and may require relatively little supervision.
Paternalistic managers often develop very loyal subordinates
because subordinates feel protected and cared for. It is There is evidence of a trend towards more democratic styles
not unusual for paternalistically managed businesses to of management, though this depends on many factors,
have a low rate of labour turnover. This can help to reduce including the size of a business and its culture. The trend
recruitment costs and improve competitiveness. towards democratic management has a number of possible
causes:
However, paternalistic managers do not encourage their
employees to use their creative and imaginative skills, nor
» Management theory has developed and provided
substantial evidence that people are more likely to
do they encourage the use of initiative. This can mean that
be motivated (and productive) through the use of a
the business does not make the most effective use of the
democratic management style.
human resources that it has available.
» Management has become more complex. Globalisation
means that businesses are larger and more complicated
Democratic management organisations, and the environment in which they
Democratic management (sometimes called participative operate is dynamic and subject to rapid change.
management) entails operating a business according to Individuals are more likely to need the support that
decisions agreed by the majority. Decisions may be agreed democratic management provides to succeed in these
formally through a voting system, but they are more circumstances.
likely to be the result of informal discussions. Typically,
democratic management encourages some or all of the STUDY TIP
following:
Do learn the glossary terms in this chapter (and the other
» the manager delegates a great deal and encourages chapters as well!), as understanding the terms that may
decentralisation be used in questions is essential and you may be asked to
» the manager and subordinates discuss issues and provide definitions.
employee participation is actively encouraged
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CASE STUDY
2.3
Steve Jobs
Steve Jobs was an unconventional manager. His Some analysts do not consider Jobs to have been the
management style was not the stuff of textbooks – he best manager of people. There are times when clear
wasn’t known for his democratic style or consensus- and decisive management is essential and a strength,
building approach. Jobs founded the American technology especially in times of crisis. However, it may be that
company Apple with school friend Steve Wozniak in 1976, Jobs should have delegated more and listened more, as
and was effectively fired from it in 1985. However, he subordinates often have great ideas.
returned to the company in 1997 and achieved greatness.

Despite the criticisms of Jobs as a manager, he is
Under his control, the market value of Apple’s shares
considered to have been an excellent communicator and
increased from about $5 billion in 2000 to $351 billion in
he was the public face of Apple for many years. He was
2011, when ill-health forced his retirement. It remains one
also passionate about his work. He loved finding gaps in
of the most valuable companies globally; he also created
the market and developing products that people really
one of the world’s most valuable brands.
wanted. Jobs’ legacy lives on in Apple.
Sir Richard Branson, the founder of the Virgin Group of
companies, was a fan of Steve Jobs. He has described Jobs Questions
as an autocratic manager with a ‘meticulous eye’ for detail. 1 Explain two differences between autocratic and
Branson considered Jobs to be someone who wanted to democratic management styles. [6]
work with people who were like-minded and who would 2 Evaluate whether being passionate about your
follow his instructions. Jobs was not thought to be a good business and a good communicator is more important
delegator and tried to become involved in too many aspects than the management style that is used. [12]
of the business. He was very demanding as a manager,
expecting a great deal from the people who worked for him.
Laissez-faire management style in the expectation of bringing out the best in their
subordinates.
This approach is sometimes described as ‘mild anarchy’.
Under this approach, the manager has a minimal input into Laissez-faire management may be successful in the
the operation of the business. Employees take the majority following circumstances:
of the decisions with little reference to the manager. As a » The manager is one among a number of equals in terms
consequence, the organisation can lack a sense of direction of experience and qualifications.
as well as co-ordination and planning. » The workforce is self-motivated and understands the role
of the manager.
A laissez-faire style of management may occur because
of the personal shortcomings of the manager or a lack
» The workforce understands and agrees with the
organisation’s objectives.
of the essential skills needed to carry out the manager’s
role successfully. Alternatively, it may be a conscious and Laissez-faire management tends to result in highly
brave policy decision to give staff the maximum scope for independent employees who are willing to voice their
showing their capabilities. It may be an appropriate style to opinions. Staff may be satisfied or dissatisfied with this
adopt in certain circumstances. For example, the manager style of management, depending on their skills, the
of a highly creative team may deliberately adopt this complexity of the tasks to be completed and their own
personality.
▼ Table 2.11 The key features of a selection of management styles
Autocratic Paternalistic Democratic Laissez-faire

Description Keeps information and Dictatorial, but Entails managing a Manager has a
decision-making among decisions are intended business on the basis peripheral role, leaving
the senior managers to be in the best of decisions agreed by staff to manage the
interests of the the majority business
employees
Decision-making Sets objectives and Manager explains Encourages Manager evades duties
allocates tasks. decisions and ensures participation and unco-ordinated
Manager retains control social and leisure needs and makes use of delegation occurs
throughout are met delegation
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Autocratic Paternalistic Democratic Laissez-faire
Communication
One-way
communication
Mainly downwards,
though feedback will
Extensive, two-
way. Encourages
Communication is
mainly between people
2.3
downwards from take place contributions from at the same level in the
manager to subordinate subordinates organisation, though
little occurs
Uses Useful when quick Can appear democratic, When complex Can encourage
decisions are required but is really ‘soft’ decisions are made production of highly
autocracy requiring a range of creative work by

specialist skills subordinates
Advantages Decisions and direction Can engender loyalty, Commitment to May bring the best out
of business will be and frequently enjoys business, satisfaction of highly professional
consistent. May project low labour turnover due and quality of work may or creative groups
image of confident, to emphasis on social all improve
well-managed business needs
Disadvantages Lack of information, An autocratic style Slow decision-making Staff are likely to
so subordinates are can result in groups and need for consensus lack focus and sense
highly dependent on becoming highly may avoid taking ‘best’ of direction. Much
managers; supervision dependent. They may decisions dissatisfaction among
needed become dissatisfied subordinates is common
with manager
Thus, a poor performance by a group of workers may be

Style versatility the result of a work environment lacking stimulation and
Building on the contention that there is not a single perfect challenge for employees. The behaviour of employees,
style of management, it is possible to argue that the best argued McGregor, is often the result of the way they are
managers are those who adopt a style suitable to the treated.
circumstances. Thus, the most talented managers might
be the most versatile, able to call on one or more of the McGregor did not believe in the views expressed by Theory
styles we have discussed in order to assess the demands of X managers. He set the theory only to disprove it as part of
the situation. Therefore, a versatile manager might adopt his support for the views expressed by Theory Y managers.
a democratic approach when reaching a decision on a A Theory Y manager is more likely to be one who believes
proposed marketing campaign with a small group of writers the following to be true:
and artists but they may demonstrate a more autocratic » Workers seek satisfaction from employment and not just
style when dealing with a crisis. a pay cheque.
» Workers possess knowledge, creativity and imagination.
Douglas McGregor’s Theory X and » Workers willingly commit themselves to organisational
objectives.
Theory Y » Poor performance by employees is due to repetitive and
Douglas McGregor was an American social psychologist monotonous work or poor management.
who researched into leadership and management in large » Employees wish to contribute to decision-making.
companies. His writing developed understanding of how
Theory X is derived from the work of FW Taylor and the
the attitude of a manager might shape their behaviour. His
scientific school of management, who contended that
book, The Human Side of Enterprise, was published in 1960
workers were ‘economic animals’ motivated solely by
and has received much acclaim, particularly his celebrated
money. Theory X managers seek to get the best from their
comparison of two types of manager as set out in Theory X
employees by use of techniques such as piece-rate pay and
and Theory Y. McGregor’s theories were based on research he
close supervision.
had conducted into the attitudes of managers towards their
employees. Alternatively, Theory Y stems clearly from Mayo’s human
relations approach and Maslow’s work on human needs
His research revealed that many managers assumed their
(see pages 70–72 on motivation). It focuses on meeting
workers were motivated solely by money and had no real
the social and psychological needs of individuals within
desire to work. McGregor referred to this type of manager
the workplace. McGregor’s work is, however, a theory of
as Theory X. He also discovered an alternative, and less
management and not one of motivation.
common, type of manager, which he termed a Theory Y
manager. Such managers, according to McGregor, believed If managers adopt a Theory Y style, the implications can be
workers sought more than financial gain from employment. significant for a business. These might include:
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» greater delegation within the organisation, allowing those » considering the organisation’s structure and approaches,
further down the hierarchy to have greater authority such as thinking about delayering.
2.3 » training for managers to encourage delegation and to
improve two-way communication
Businesses moving towards a Theory Y approach to
management require planning, the support of managers and
» reviewing the business’ culture to discourage managers
shop-floor workers, and considerable training for all the
from retaining what they might see as their ‘authority’
employees involved.
TEST YOUR LEARNING


1 a Define the term ‘authority’. [2] A growing business
b Explain one function of management. [3] Gadfly is a small, private limited company that designs
2 Explain two ways in which good communication and manufactures bicycles. It competes with a number of
might help a manager to carry out the functions large multinationals and its unusual designs have proved
involved in their job. [6] popular. The business is growing quickly (sales are rising
3 a Explain one reason why organising is an by an average of 19 per cent each year) and it now has two
important function of management. [3] factories, each with its own manager who is responsible
b Explain one way in which managers can report for production at their site. A major extension to one of the
on business performance. [3] factories is expected next year. The number of employees
4 Explain one reason why most managers normally is rising rapidly and last year reached 397, most of whom
focus on short-term problems. [3] are relatively unskilled.
5 a Explain one difference between autocratic and The business was established by Ali ten years ago and he
laissez-faire styles of management. [3] hopes that it will continue to grow quickly. Ali is a natural
b Explain one advantage of the use of democratic autocrat and likes to take all of the decisions using little
management. [3] delegation. He is a good communicator, has 30 years’
6 a Explain Henri Fayol’s fourth management experience as an entrepreneur and also understands the
principle: unity of command. [3] bicycle manufacturing industry.
b Explain one other management principle The business is changing as it grows. The company is
identified by Fayol. [3] having to produce a larger range of bicycles, and it needs
7 Explain one reason why managers who allow more skilled employees to design new products and to
employees to work to their full abilities may help to sell the bicycles in new markets – the company made its
improve a business’ performance. [3] first sales in Australia and Argentina earlier this year. Ali
8 a Explain one difference between McGregor’s is beginning to wonder whether his management style is
Theory X and Theory Y managers. [3] suitable for this changing company.
b Explain one way in which FW Taylor’s theory of
motivation might have influenced McGregor’s Questions
Theory X management style. [3] 1 Define the terms:
a ‘delegation’ [2]
b ‘management’. [2]
2 Analyse one reason why planning is an important
part of the managers’ role at Gadfly. [4]
3 Evaluate whether Ali’s use of an autocratic
management style is suitable in these
circumstances. [12]
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3 Marketing
AS LEVEL
3.1 The nature of marketing
3.1.1 Role of marketing and its relationship with other business activities
Chapter overview
★ the role of marketing and its relationship with other business activities
★ marketing objectives
★ the factors influencing supply and demand, and how supply and demand interact
★ the features of different markets
★ market share and market growth
★ the difference between consumer and industrial markets
★ the differences between B2C and B2B marketing
★ the difference between mass and niche markets
★ different methods of market segmentation
★ the costs and benefits of customer-relationship marketing.
3.1.1 Role of marketing and its GLOSSARY TERM

relationship with other business Marketing is the process of identifying, anticipating and
satisfying the needs of customers in a mutually beneficial
activities exchange process.
All organisations need customers. The purpose of all
businesses is to understand and provide the goods and
services that customers want. Indeed, according to Peter
The importance of marketing
Drucker, a very influential management writer, there is Effective marketing occurs when a firm fully understands
only one valid purpose for a business, which is ‘to create a the requirements of its customers and is able to meet
customer’. these needs successfully. The marketing function helps the
organisation to provide a product that the customer wants,
Marketing is the function of the business that is is affordable, is perceived as good value and that leaves
responsible for understanding customer needs and the customer and the organisation itself satisfied with the
developing the right products, setting the right price and transaction. Marketing is an ongoing process because:
promoting and distributing products in the right way. » customers’ needs change over time (for example, the
Marketing provides the link between the customer and the developing interest in health issues has increased
production function of the business. Marketing ensures that demand for health clubs and reduced demand for high-
what is being provided is actually wanted and needed (that fat foods)
is, it is something of value), communicates this and makes » the business environment can change (for example, with
the product available to customers. new laws, changes in technology, the economic climate
or the 2020 Coronavirus (COVID-19) pandemic)
Operations » competitors enter the market with their own offerings,
and so businesses must respond to this
» a firm’s own strengths change and develop.
Human Effective marketing will, therefore, change over time to
Finance ensure there remains a good match between customers’
resources
needs and the business’ own strengths. Effective marketing
will lead to high levels of customer satisfaction, which
means that customers:
Marketing » are more likely to come back and buy more
» are more likely to tell their friends to try the products
▲ Figure 3.1 Integrated business functions; for the » may be more willing to try new products by the business
business to succeed, the activities of the different » may become loyal to the product and less likely to
business functions must be integrated effectively switch to competitors.
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CASE STUDY
3.1
Hugh Davidson
Offensive marketing can be defined as: ‘An openly ● it is important to develop value for money that is better
competitive marketing strategy involving one company than your competitors’, not just the same
exposing and attacking the weaker points of another ● it is important to use resources efficiently – that is, you
company in order to take market share directly away from must think about how much you spend on marketing
the competition.’ and measure the returns from different types of
spending
AS LEVEL 3.1 The nature of marketing
Hugh Davidson is a marketing writer who has advised

● the aim is not just to do well but to achieve profits that
many large companies around the world. One of his books
are above average – the mark of a truly successful
is called Offensive Marketing. According to Davidson,
business.
‘Offensive marketing involves every employee in building
superior customer value very efficiently for above average Questions
profits.’ This is an interesting definition of marketing in
1 Explain one feature of offensive marketing. [3]
that it highlights that:
2 Evaluate the possible benefits of an offensive-
● everyone is involved in marketing, because everyone
marketing approach. [12]
affects the quality of the service and the customer’s
impression of the product
Defining marketing firm. The more effective the marketing, the better the value
provided for customers and the greater the rewards the
A formal definition of marketing should include the features
business should be able to make.
below.
» It is an exchange process – that is, it is two-way. The
business offers the customer a good or service and in Marketing and other business functions
return receives something, usually payment. The purpose of marketing is to ensure that the organisation
» It is mutually beneficial because both sides should gain meets the customers’ needs in the present and in the
from the exchange. Customers should be satisfied with future. Marketing is therefore a dynamic process. To be
the product and firms should make a profit (assuming effective it must work with the other functions of the
that the firm is a profit-making organisation). Firms are business to influence:
unlikely to give away products for nothing. » what is produced, that is, the precise nature of the
» It aims to identify and anticipate customer needs. firm’s offerings (for example, in terms of design, features
Entrepreneurs need to understand their customers to and quality)
know what to offer them. However, it is not always » how many are produced – marketing must estimate
enough just to identify customers’ needs: in fact, likely sales, which in turn will influence the quantity of
sometimes the customers may not know themselves goods and services the business must be able to provide
what their needs and wants are. In some markets, such » the range of products offered (for example, how
as fashion and film, firms have to anticipate what extensive the menu should be in a restaurant; how many
customers will want in the future. They have to predict different models should be displayed in a store)
trends even before most customers know what these » the price at which products are sold – this therefore
trends will be. determines how much can be spent on materials and the
» It aims to delight customers. Nowadays satisfying transformation process if a profit is to be made.
customers may not be enough, as many other firms are
also doing this. It’s much better to delight the customer, Marketing will discuss and negotiate with:
so that they are more than satisfied and more likely to » operations over how much can be produced, what
buy from you. benefits can be offered and what the costs will be
» finance over the amount that can be spent on
The purpose of marketing is to match the abilities and developing, launching and promoting the product or
strengths of the business to the needs of the market. service
Marketing involves a whole range of activities, including » human resources over the number and skills of staff
finding out what customers want, developing new products, required.
packaging and promoting the products, and setting
the price. All these activities are aimed at developing There may be, for example, occasions when the business
and providing goods and services which will satisfy the does not have the money, skills or capacity to develop a
customer (so they will buy them), and make a profit for the product.
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CASE STUDY
Amazon
3.1
When Amazon.com was launched in 1995, it set out ‘to Amazon’s approach is supported by its highly developed
be the Earth’s most customer-centric company, where systems that collect and analyse data, enabling Amazon to
customers can find and discover anything they might want understand customer needs and behaviours. The founder
to buy online … and this will be available at the lowest of Amazon, Jeff Bezos, says that the most important thing
price.’ Being customer-centric means the company is to ‘focus obsessively on the customer’.
starts with what the consumer wants and then works
Questions
3.1.2 Demand and supply

backwards. This goal still drives Amazon, although it
is now worldwide not just in the US and has millions of 1 Analyse one benefit of being a customer-centric
sellers, consumers and content creators (for example, company. [4]
selling their own books). Each of these groups has 2 Analyse one way that Amazon’s focus on providing
different needs, and Amazon always works to meet these products at a low price might affect one of the other
needs by innovating new solutions to make things easier, business functions. [4]
faster, better, and to be more cost-effective. 3 Analyse one way that the needs of consumers and
sellers might differ. [4]
Marketing objectives and corporate

objectives Marketing strategy Marketing objectives
= where are we
= how to get there
Marketing objectives are the targets set for the marketing heading for?
function. Typically, these include:
» Sales targets These might be set in terms of sales volume
or value. Specific targets may be set for the business as a
whole and also for specific products or particular regions. ▲ Figure 3.3 Marketing objectives and strategy
» Market share Increasing sales may not in themselves be
particularly impressive if the market as a whole is growing GLOSSARY TERMS
fast and competitors’ sales are increasing faster than A marketing objective is a marketing target for the
yours. This is why a business may set targets in terms of business, setting out what it wants to achieve and when.
the share of the market. Market share measures the sales A corporate objective is a target set for the business as a
of one product or business as a percentage of the total whole.
sales in the market. A business may set a target such as
A marketing strategy is a marketing plan to achieve the
its sales being 5 per cent of the market in the next year.
marketing objective.
» Brand awareness A business may want to increase people’s
awareness of its brand relative to the competition.
The marketing objectives will be linked to the overall
objectives of the business – the corporate objective.
STUDY TIP
For example, if the business has a target of growth, Remember that marketing is not just about making
the marketing department may have to increase sales. customers happy. The business also needs to meet its
If the corporate target is to boost the profits of the objectives, so think about issues such as the costs of any
marketing action compared to its likely returns. Also,
business, the marketing team might focus on sales of
bear in mind what the business can actually deliver given
the most profitable products and place less emphasis on
its capacity, employees and other resources.
others that sell but are not necessarily as profitable.
Corporate Marketing
objective objective 3.1.2 Demand and supply
(e.g. increase (e.g. increase
profits by 5% market share to A market is made up of buyers and sellers. The sellers
next year) 12% next year) supply the product and the buyers demand it. If markets
are allowed to work without government intervention, and
▲ Figure 3.2 Corporate and marketing objectives if they are competitive with many different sellers, then
the quantity produced and the price in the market will be
STUDY TIP determined by the forces of supply and demand. This can be
An objective should be quantifiable and include a time
shown in a graph.
element. For example, ‘to increase market share to 3 per A supply curve shows how much producers are willing and
cent by 2025’. able to supply at each and every price, with all other factors
constant. It is usually upward-sloping because as the price
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increases, producers are more willing and able to supply Look at Figure 3.5a. If the price was originally at P1 then, at
more. They are more willing because of the higher price, and this price, the quantity supplied is greater than the quantity
3.1 they are more able because the higher price means they can
produce more even if their costs are slightly higher.
demanded – because the price is high, producers want to
sell more than customers want to buy. This leads to excess
supply, or a surplus. In a free market with no intervention,
The supply of a product will depend on:
the price will fall. As it does, the quantity demanded
» the number of firms producing. With more firms
increases, the quantity supplied falls until P0 is reached.
producing, the supply in the industry should increase
P0Q0 is the equilibrium price and quantity; at this price the
» the time period. Over time, more firms can move into
quantity demanded and supplied is equal and there is no
this market if it is attractive, which could increase supply
incentive to change.
» technology. Technological developments will increase
the quantity supplied If the price was P2 then at this low price the quantity
» costs. If a business can reduce its costs (for example, demanded is greater than the quantity supplied and
by using cheaper supplies or being more efficient in its there is excess demand. This is known as a shortage. In
operations) this means it can produce more at each price a free market, the price will increase; this increases the
and supply can increase. quantity supplied and reduces the quantity demanded until
equilibrium at P0Q0 is reached.
A demand curve shows how much customers are willing and
able to buy at each and every price with all other factors Price
unchanged. It is downward-sloping because as the price falls,
customers can afford to buy more with the same income. Supply
The demand for a product will depend on factors such as: P1
» the income of buyers, as this will affect how much they
can afford
» the price of rivals’ products. If these are cheaper, this is
likely to reduce demand for your product
P0
» the price of complementary products (for example, if
you buy a printer and print cartridges together, these
are complementary products). If a complement is
cheaper, customers might buy more of it and more of
the associated product as well P2
» marketing activities. Effective marketing by a business Demand
should help increase demand for the product.
Q0 Quantity
Promotional ▲ Figure 3.5a

activities
Changes in demand conditions
Competitors A demand curve shows the quantity of a product demanded
(substitutes) Population at each and every price, with all other things unchanged.
The demand curve can shift if, at each price, the quantity
demanded changes. This may be because of:
Influences » a change in consumer incomes
on » a change in the price of rivals’ products
demand
» a change in the price of complementary products
» a change in customers’ tastes and social values
Price Complements » a change in the marketing activities of the business.
A change in price leads to a movement along a demand
curve. A change in one of these other factors changes the
quantity demanded at each and every price and shifts the
Income demand curve.
Changes in supply conditions

▲ Figure 3.4 Influences on demand A supply curve shows the quantity that businesses are
willing and able to supply at each price, with all other
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factors unchanged. The supply curve will shift if, at each Price Supply S2
price, there is a change in the quantity supplied. This may
be because of:
» an improvement in technology. This might increase the
Supply S1 3.1
quantity supplied at each price
» a reduction in costs. Again this would allow a business P4
to supply more at a given price
» government subsidies or taxes on producers. P0
A change in price leads to a movement along a supply curve.

A change in one of these other factors changes the quantity
3.1.2 Demand and supply

demanded at each and every price and shifts the supply curve.
The effect on equilibrium of a decrease Demand
in demand
Q4 Q0 Quantity
If demand conditions change and there is a decrease, the
quantity demanded at each price will shift demand inwards. ▲ Figure 3.5c
This is shown in Figure 3.5b as the demand curve moves to D2. ▼ Table 3.1 Effects of shifts in supply and demand
At the old price there is now excess supply and this leads to
a fall in the price. As the price decreases, this decreases the Change Equilibrium Equilibrium
quantity businesses will supply and increases the quantity price quantity
demanded until a new equilibrium is reached. The equilibrium
Increase in demand Increases Increases
is now P3Q3; less demand leads to lower prices and output.
Decrease in demand Decreases Decreases
Price
Increase in supply Decreases Increases
Supply Decrease in supply Increases Decreases
P0 HANDLING DATA
1 Draw a diagram of supply and demand for cars for
P3 a given year, showing the equilibrium price and
quantity.
2 Now show an increase in demand. What happens to
D1 the equilibrium price and quantity?
Demand D2
CASE STUDY
Q3 Q0 Quantity
Supply and demand
▲ Figure 3.5b The Pacifica Super Penthouse apartment is located on
the top two floors of New Zealand’s tallest residential
The effect on equilibrium of a decrease building. It is for sale at a price of $40 million. This
makes it the most expensive single-family home in New
in supply Zealand. The building is not yet completed, and so buyers
If there is less supply in a market, perhaps because of a bad have the option to design the penthouse themselves or
crop, the supply curve would move to S2 and equilibrium would leave the interior design to the tower’s developers. The
be at P4Q4 – as shown in Figure 3.5c. Less supply in the market developer’s plans include a conservatory, an open-plan
means that at the original price there is excess demand (that area, a luxury kitchen and dining area, and a wine cellar.
is, a shortage) and this leads to higher prices. As the price The top floor (the 54th) includes a spa and sauna, five
guest bedrooms and a master bedroom.
rises, there is a decrease in the quantity demanded and a rise
in the quantity supplied until the new equilibrium is reached. Questions
This has a higher price and lower output.
1 Analyse one factor that might influence the supply of
The effects of shifts in supply and demand on the apartments in the development. [4]
equilibrium price and quantity are shown in Table 3.1. 2 Evaluate how an increase in demand for apartments
might affect the equilibrium price and quantity in
the short and long term. [12]
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3.1.3 Markets level of competition then firms need to be market-oriented
to survive; if they are not, rivals will meet customer needs
3.1 Consumer and industrial markets more effectively and reduce their sales. Any entrepreneur
wanting to succeed should make sure there is demand for
There are different types of markets. In consumer markets, their product. This will usually be done via market research
the customer buys the product and it is consumed. For to try to identify the likely level of sales.
example, you buy food, music and clothes and then use
(consume) these. If a business is selling products direct to the By comparison, a product-oriented (or product-led) business
consumers who will consume them, this will involve business- focuses more on what it can produce and hopes that this
to-consumer marketing, often abbreviated as B2C. will fit with customer requirements. This is a very risky
approach because the firm may produce something the
These consumer items will have had to be produced and that customer does not want. If an entrepreneur assumes that
will have involved machinery, transport and technology. because they like the idea, everyone else will also like
When you are selling products to be used in the production it, this is being product-oriented. Not everyone thinks or
process for other products (for example, a production line or behaves in the same way, so entrepreneurs must check that
raw materials), this is known as a producer (or an industrial) there is demand before starting out.
market. When one business is marketing its products to
another business to buy, this is known as business-to- Although being product-oriented is less likely to succeed
business marketing, or B2B. than being market-oriented, it can work if the customer has
limited choice; for example, in some countries, governments
▼ Table 3.2 Industrial and consumer markets only allow a few firms to produce particular products and
so customers have to buy what is available. If it is lucky,
Industrial Consumer the business may produce a product that people want, or in
markets markets some cases people invent products that customers did not
Number of buyers Relatively small Large know they wanted until the product arrived. However, over
Nature of buyer Professional Individuals time, as customers find alternatives, product-oriented firms
are likely to suffer.
Local, national and international markets

Some products, such as oil, are sold on worldwide markets. CASE STUDY
There are international producers and the products are
demanded all over the world. Other products tend to Amazon
be more national; this means they are sold mainly or Founded: Incorporated July 1994.
exclusively in the domestic country, such as a chain of
clothes stores. Others may be traded only in the local area, Mission: To be Earth’s most customer-centric company
where people can find and discover anything they want
such as a local taxi business or hairdresser. The markets
to buy online.
in which a firm operates affect the likely sales, the nature
of the competition and the complexity of the marketing Headquarters: Seattle, Washington, USA.
challenge. Websites: Amazon serves its consumers through its
▼ Table 3.3 Examples of local, national and international retail websites. It operates websites in the USA, the UK,
markets Germany, Japan, France, Canada, China, Italy and Spain.
Selection: Amazon and more than 2 million third-party
Type of market Possible examples
sellers offer millions of unique, new, refurbished and
Local Taxis, hairdressers, local food markets used items in categories such as:
National National energy, national rail, national ● Books ● Kids & Baby
water ● Movies ● Grocery
● Music ● Health & Beauty
International Tobacco products, mobile phones, ● Video Games ● Clothing, Shoes &
pharmaceuticals ● Electronics & Jewellery
Computers ● Health & Beauty
● Home & Garden ● Sports & Outdoors
Customer (market) orientation versus ● Tools ● Automotive &
product orientation ● Toys Industrial.
A customer-oriented (or market-led) business is one that Questions

bases its decisions on customers’ needs. It continually 1 Define the term ‘customer-centric business’. [2]
monitors its environment to find out what customers 2 Visit the Amazon website (www.amazon.com).
want, what competitors are offering and what changes Evaluate the ways in which Amazon tries to be the
are occurring in the market. By being market-oriented, a world’s most customer-centric business. [12]
firm should be able to ensure that the product or service
it provides matches its customers’ needs. If there is a high
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Measuring market share and growth be easy to compare this with other firms’ sales accurately;
market share data is therefore most likely to be accurate
Markets will differ in nature. For example, this could be in
terms of:
when looking backwards. 3.1
» Market size The size of a market can be measured in
terms of the volume of sales or the value of sales. For STUDY TIP
example, there may be 20 000 products sold (volume) or In some cases you may be asked to calculate the market
$100 000 sold (value). If the volume of sales increases, the share as shown above. In other cases you may be asked
value will also usually increase, but this depends on what to calculate the size of the market given the market
is happening to the price. If the price falls, it is possible share. For example:
that more units are sold but the value of sales declines. Product A has sales of $20 000; this represents a market
3.1.3 Markets
» The number of competitors Some markets have many share of 40 per cent.
thousands of competitors – just think of how many We now calculate 1 per cent of the market. If $20 000 =
hairdressers and cafés there are. In other markets there 40 per cent of the market, we can divide by 40 to get
are relatively few providers – how many electricity or 1 per cent.
train companies are there, for example?
$20 000
» Market growth Some markets do not change in size 1 per cent market share = = $500
very much, while others grow fast and some shrink. 40
The growth of a market is measured by the percentage Total sales in the whole market (which is 100 per cent)
change in its size over a given period. Generally, will equal $500 × 100 = $50 000.
businesses will prefer fast-growing markets because they
can all sell more. If the market is static then one firm
can only sell more at the expense of another; this can Market growth measures the rate at which the market as a
lead to aggressive, competitive behaviour. whole is growing over a given time period. If, for example,
the growth rate is 2 per cent this year, it means that the
GLOSSARY TERMS market is 2 per cent bigger than one year before. The
Business-to-consumer marketing (B2C) occurs when one growth may be measured in terms of the growth in sales
business is marketing its products to the final consumers. volume or value. Its equation is:
Business-to-business marketing (B2B) occurs when one this year’s market sales – last
business is marketing its products to other businesses. year’s market sales
market growth = × 100
The market size is the total number of items sold (this is last year’s market sales
measuring volume) or the total value of sales.
Market growth measures the rate at which the market as
For example, if the market sales last year were $200 000 and
a whole is growing over a given time period. are now $220 000, then:
$220 000 – $200 000
market growth = × 100 = 10%
Market share is measured by the sales of a business (or a $200 000
particular product) relative to the total market sales. Its
equation is: If the growth rate is positive, it means the market is getting
bigger. If the growth rate is negative, it means the market
sales of a business (or product) has become smaller.
market share = × 100
total market sales Similarly, data on market growth is difficult to estimate at
For example, if product A sells $40 000 and the total market any given moment because of the problems in gathering
sales are $160 000, the market share of product A is: data from all outlets and all producers. Again, it is most
likely to be accurate when looking backwards.
$40 000
× 100 = 25% A further problem with calculating market share and market
$160 000
growth is actually defining the market in which a business
Measuring market share is not always easy. This is because operates. What is the market for your local bus company? Is
the data you have on the sales in general may not be easy it bus transport in your area? But how large do you define
to collect; competitors, for example, may not want to the area being considered? Or is it bus transport in the
share information. It will certainly take time and, at best, whole country? Or is it all forms of transport in your area?
estimates of the market are likely to be a year or so out of It is not always easy to clearly define the market a business
date. While you will know your sales this month, it may not operates within.
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CASE STUDY
3.1
Ford
The data below was produced by Ford, the automobile manufacturer, in its 2019 annual report.
▼ Table 3.4 Ford retail sales, industry volume and market share, 2018
Retail sales Industry volume Market share

(in millions of units) (in millions of units) (%)
United States 2.5 17.7 14.1

Canada 0.3 2.0 14.7
Mexico 0.1 1.5 4.8
North America 2.9 21.5 13.4
Brazil 0.2 2.6 9.2
Argentina 0.1 0.8 12.1
South America 0.4 4.5 8.3
United Kingdom 0.4 2.8 13.7
Germany 0.3 3.8 7.9
EU21 1.4 19.6 7.2
Russia 0.1 1.8 2.9
Turkey 0.1 0.6 10.9
Europe 1.5 20.9 7.2
Middle East and Africa 0.1 3.8 3.0
China 0.8 26.2 2.9
Australia 0.1 1.2 6.0
India 0.1 4.4 2.2
ASEAN 0.1 1.7 6.6
Asia Pacific 1.1 43.5 2.5
Global N/A 94.2 6.3
Total company 6.0 N/A N/A
Source: https://annualreport.ford.com/Y2019/default.aspx
Questions
1 Calculate the proportion of Ford’s sales in 2018 that were made in North America compared to the total
company sales. [2]
2 Calculate the total size of the market for vehicles in North America in 2018. [3]
STUDY TIP
In some cases you may be asked to calculate growth. In 20
other cases you may be asked to calculate the sales given
× $500 000 = $100 000
100
a certain growth rate. For example:
This means the new sales are $500 000 + $100 000 =
A market had sales of $500 000. This grows by 20 per cent. $600 000.
What are the sales now?
To calculate this you must work out 20 per cent of
$500 000 and add it to the original sales. To calculate 20
per cent you use:
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Implications of changes in market share Classification of products and how
and growth marketing might differ for different 3.1
A change in market share means that a business’ sales types of goods and services
account for a greater proportion of the total sales in the
There are many different types of products and these can be
market in the given period. If the market remains the
classified as:
same size or is growing then an increasing market share
means higher sales. However, if the market is declining, » Consumer products, which are items bought by the final
user. These can be subdivided into:
the market share could be increasing even if sales are
– Convenience items These are usually relatively
falling.
cheap items and distribution is the key to marketing
3.1.4 Consumer and industrial marketing

When considering market share, it is important to bear in here; for example, newspapers and milk. Customers
mind the total market size. A small percentage of the global will not spend much time searching for them in
confectionery market is still a lot of sales! different stores; they pick up what is convenient
The growth of a market shows the rate at which sales are in the nearest shop. This means producers have to
increasing. In general, businesses might prefer faster get them distributed in many different places and
growth to slower growth because it creates more sales displayed in a way that attracts attention. This
opportunities. However, it is again important to bear in is important because some convenience items are
mind the size of the sales involved. A 1 per cent growth bought on impulse (for example, chewing gum) when
in the market for laptops is still a large number of sales they are seen in the store.
because the market is so big, whereas a 10 per cent growth – Shopping items These are products such as clothes
of a very small local market might only mean additional or electrical goods which are more expensive than
sales of a few thousand. In well-established, bigger markets convenience items. When customers go to buy them,
growth may be slow but the numbers involved can still they shop around, comparing prices and features;
be huge. they may go and look several times before actually
buying. Customers may go to a retail area where
they can quickly move from one store to another to
HANDLING DATA compare. The producer has to clearly demonstrate
value for money; for example, by stressing a unique
1 A business sells $20 000 in a market worth $800 000. selling point (USP) to show why its product is
Calculate its market share. better than the competition’s.
2 A business has a market share of 8 per cent in a – Specialist products are products that customers
market worth $400 000. Calculate its sales. have probably thought about for a long time and
3 A market was worth $300 000 and increases in size for which they are willing to travel to find the right
to $360 000. Calculate the market growth rate. item; for example, Rolex watches or Ferrari cars.
4 If a market was worth $500 000 but grows by 2 per Specialist products may be distributed to relatively
cent, calculate the size of the market now. few locations, but the nature of the outlet is very
important to the overall brand image. These products
are probably not very price-sensitive because people
want them for their status and their uniqueness.
3.1.4 Consumer and industrial » Industrial products These are products which are
marketing bought by businesses to use in their production process
to produce the consumer goods. They include:
– Installations These are big items of expenditure,
STUDY TIP such as production lines and new office space.
Buyers will take a lot of care over the precise
It is very important when answering marketing questions to
features of the item, especially any technical
think about the specific market the business operates in. It
features, because it is a major item of spending.
is important to adapt your understanding for the particular
– Materials These are materials used in the production
market. Selling bars of chocolate may require heavy
advertising, while selling aeroplanes may require a very
process. There may be several possible suppliers, so
experienced sales team. Attractive packaging may help sell buyers will shop around. The quality, reliability and
perfume, but it is less significant for selling tractors! flexibility of supply will be very important when
buying these products.
– Supplies These are basic items such as paper and
light bulbs; there will be many suppliers and the
GLOSSARY TERM buyer will look for good prices.
A unique selling point (USP) is something about your
product which is perceived by your customers as unique.
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Types of fewer mistakes? At a lower cost? To win sales, it will be
products important to convince the customer of the business case
3.1 for it. The person buying it will need to justify it to their
managers and investors.
Consumer Industrial
Industrial buyers are usually professionals, and therefore
will be very interested in the technical specifications of
what is being offered and a whole range of issues such as
Convenience Installations the payment terms, delivery times and your reliability as a
supplier.
Often business-to-business marketing will involve a sales
Shopping Materials
force approaching the business customers to explain
the benefits of what they have to offer. The sales team
will usually require specialist technical knowledge and
Specialist Supplies
an understanding of how their product helps the other
business.
▲ Figure 3.6 Types of product
Business-to-consumer businesses are dealing with larger
numbers of potential buyers. These buyers will not be
Business-to-business marketing versus professional buyers (it’s not their full-time job!) and they
may be more interested in the brand, the image of the
business-to-consumer marketing product and the emotional benefits they get from buying
When one business is targeting other businesses, it it. In B2C marketing, more use is likely to be made of
will tend to be dealing with relatively small numbers advertising and other promotional techniques to reach a
of customers. These customers will want to understand wider audience.
how buying this product will help them in what they
do – will it enable them to do their work faster? With
▼ Table 3.5 Classification of products
Industrial products Consumer products

Buyers Professionals Amateurs!
Number of buyers • Relatively few May be millions if a mass-market product
• Selling to businesses
May focus on • Technical specifications and how it helps their business • Benefits in terms of consumption
do better • May be more influenced, for example, by
• When the product can be supplied and in what quantities look or design or packaging
• What the payment terms are
Promotion Often uses sales force to approach customers May be advertising for mass-market product
» By focusing on a small segment of the market, this may

3.1.5 Mass marketing and niche not be perceived as a threat by larger, established firms.
marketing If a start-up is perceived as a real threat, the established
firms may cut prices or try to influence stores to get
Niche marketing occurs when a firm targets a specific them to stop distributing the product.
market segment – that is, a particular group of similar
customer needs and wants. For example, Aston Martin However, there are dangers associated with niche
targets the luxury sports car market and Umbro targets marketing:
the football market. By focusing on a niche, a firm can » The total number of customers is likely to be quite
understand the specific requirements of its customers and low and therefore, if anyone changes their mind
ensure its offering meets these needs precisely. A business and switches to a different product, this can have a
can tailor its marketing approach and avoid wasting time significant effect on the total demand.
and money on activities that are not relevant. » If the product does prove to be successful then larger
businesses may be attracted by this success and enter
Niche marketing is quite common for small businesses. This the market. Small businesses may struggle to match the
is because: power and resources of larger firms and so may lose their
» It focuses on just one segment of the market and therefore share of the market.
the resources required may be relatively small. This makes
it affordable and feasible for a start-up business.
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By comparison, a mass marketing approach targets the needed to generate the necessary demand to make mass
majority of the market. This usually involves high volumes production viable. However, over time, a niche product may
of production and much higher capacity levels than niche
marketing. This may make it unrealistic for a start-up
become more mainstream and therefore niche products may
be moved into the mass market.
3.1
business, especially given the high levels of promotion
▼ Table 3.6 Advantages and disadvantages of niche and mass marketing
Niche marketing Mass marketing

Advantages Disadvantages Advantages Disadvantages
3.1.6 Market segmentation

• Small market segment so marketing Small market so • Large-scale production enables lower Products not adjusted
activities can be very targeted overall returns unit costs; this enables lower prices, for differences in
• Small segment of market so larger not that high in making the product accessible for customer needs; specific
firms may not be interested absolute terms customers but at the same time still groups may be targeted
• Can often charge high price for a profitable for the business more effectively by niche
specialised, targeted product which • Large target market means the total producers
helps cover cost of provision sales and profit in absolute terms
may be high
There are various ways in which a market may be

GLOSSARY TERMS segmented, including:
Niche marketing occurs when a business focuses on a » Geographic segmentation This type of segmentation
particular (usually small) segment of the market. focuses on aspects of consumers such as the location of
A market segment exists when there is a group of clearly customers or the climate in different regions. Cars sold
identifiable customer needs and wants. to Africa, for example, will have to withstand high levels
Mass marketing occurs when a business targets the of heat; cars sold to Scandinavia will need to cope with
majority of the market. the cold. Cars targeted at people living in cities may
be relatively small so it is easy to get around and park;
people living in the countryside may want more rugged
vehicles to cope with the terrain.
STUDY TIP » Demographic segmentation This type of segmentation
When studying this topic, you should be aware of the focuses on aspects of consumers such as age, gender,
benefits and problems of a niche-marketing approach. income, occupation, marital status and stage in the
You should also appreciate the importance of family life cycle. In the toys market, for example, the
understanding and monitoring customers’ needs. type of toys 3 year-olds will play with is very different
To make your business more effective, you have to from those wanted by 13 year-olds. When you are single,
understand exactly what your customers want and you may be looking for a city centre, 1-bedroom flat;
provide them with excellent value for money. when you are married with children you may want a
3-bedroomed house with a garden, near a good school
and out of the city.
» Psychographic segmentation This type of segmentation
3.1.6 Market segmentation focuses on aspects of consumers such as personality,
Within any market, different segments may exist. For example, lifestyle, values, social class and attitudes. Are you
within the market for newspapers there are some readers who someone who likes belonging to a group? Are you
are most interested in sport, others who want financial news, someone who is very ambitious? Do you want material
and others who want celebrity gossip. Different newspapers things? Do you care how products have been made and
have been developed to target these different groups. their impact on the environment? These factors might all
influence the way a product is promoted and the actual
Within the chocolate market, the demand can be segmented design of the product. Some holidays may be designed
into groups such as: for adventurous, outgoing types. Others might target
» snacking – you buy the chocolate and eat it there and customers wanting a package holiday in Spain. Your
then (for example, a Mars bar) job and earnings are likely to influence a whole host
» sharing – you buy the chocolate and take it home to of lifestyle factors: the newspaper you read, where you
share with others (for example, Cadbury’s Heroes) shop, where you go on holiday, the interests you have
» gift – you buy the chocolate to give to others (for and what you wear.
example, Thornton’s chocolates).
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STUDY TIP
3.1 Geographic Although targeting specific segments may seem
appealing from a marketing perspective, it may make
production more complex as it requires different models
to be produced. Managers must balance the desire to
meet the specific needs of customers with the costs and
challenges this may generate.
Types of
market
3.1.7 Customer-relationship
segmentation
Demographic Psychographic
marketing
Aims of CRM
Customer-relationship marketing (CRM) involves gathering
▲ Figure 3.7 Types of market segmentation and analysing data about customers. The aim of CRM is
to understand customers’ behaviour and take appropriate
For a market segment to appeal to a business, it must be: actions to move them towards a purchase and repeat
» measurable, so you can identify it exists and measure purchases. A business will interrogate its data on customers
its size to decide on the likely earnings to understand where in the buying process they are and to
» accessible, so you have the resources to offer what identify actions to make them buy and to retain them.
would be required and be able to get your products to
the customers Customer retention is very important to businesses. It
» profitable, so you can meet customer needs and your is a measure of customer loyalty and can be measured by
own needs at the same time. the proportion of customers who continue to buy from the
business over a period of time. If a business sells a product
to a customer who does not return to buy again then, to keep
Advantages and disadvantages of sales going, it has to keep finding new customers. This can
market segmentation be expensive and time-consuming. Ideally, a business will
develop a relationship with a customer and generate ongoing
By segmenting a market effectively, managers can identify
sales. For example, an online retailer might want to develop
which segments they want to target. By understanding the
a relationship so that it becomes the ‘go-to’ place for a
requirements of a particular segment, they can develop
customer to buy from; they become loyal to the business. This
the marketing activities to meet these needs more closely.
loyalty and repeat purchases of a range of products provided
Hopefully, this should increase sales and boost brand loyalty.
by a business can be built up in various ways, such as:
Effective segmentation should lead to effective marketing,
with businesses providing exactly the right product in the » by analysing customers’ buying patterns and making
right place at the right time and price. However, the more recommendations of what else they may want to buy
a market is segmented, the more variations there are to the » analysing customer behaviour to understand what
product and its marketing – imagine producing a different incentives to offer customers to gain their loyalty and
cleaner for the sink, oven, shower, toilet, floor, door handles, repeat purchases.
carpets, work surfaces, windows, walls, and so on. Each
one may meet a very specific need, but co-ordinating and Costs and benefits of CRM
providing such a range of products may be expensive. If
possible, it would be easier and cheaper to produce an all- By holding on to customers and generating repeat
in-one cleaner to cover at least some of these functions. The purchases, the business hopes to generate more revenue
firm may well get cheaper inputs if it buys in bulk and can from its customers while keeping its marketing costs low.
spread one set of marketing costs over more units. The benefits of CRM are that it can lead to more sales from
the existing customer base at relatively low cost. The costs
Businesses may therefore have to trade off the appeal
of CRM are the investment required in data systems to
of segmenting and meeting specific groups of needs
gather tools and staff skills in order to analyse information
more precisely with the benefits and cost advantages of
on customer enquiries and buying patterns.
producing a limited range of products on a larger scale.
GLOSSARY TERMS
Customer-relationship marketing (CRM) involves gathering Customer retention measures the proportion of customers
and analysing data about customers to understand their who continue to buy from the business over a period of time.
behaviours and take appropriate actions to move them
towards a purchase.
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TEST YOUR LEARNING
10 a Define the term ‘customer-relationship
3.1
marketing (CRM)’. [2]
1 Define the term ‘marketing objectives’. [2] b Explain one possible benefit to a business of
2 a Define the term ‘market segmentation’. [2] customer-relationship marketing. [3]
b Explain one benefit of segmenting a market. [3]
3 a Explain one factor that influences the supply of Data response question
goods or services in a market. [3] The fluctuating price of oil
3.1.7 Customer-relationship marketing

b Explain one factor that might increase demand
In 2020, US oil prices became negative for the first time in
for a product. [3]
history. This was due to the greatest fall in demand in
4 a Define the term ‘niche market’. [2] 25 years. The result was a surplus of oil and a fall in the
b Explain one possible benefit of operating in a price of oil to almost –$40. This meant producers were
niche rather than a mass market. [3] paying buyers to take the oil off them, so they didn’t have
5 a Define the term ‘market share’. [2] to pay for storage costs and because they had no more
b Explain one possible benefit to a business of storage capacity.
having a high market share. [3]
The fall in demand was due to the negative growth of most
6 a Define the term ‘market growth’. [2] economies during the ‘lockdown’ that was necessary amid
b Explain one possible benefit to a business of the Coronavirus (COVID-19) pandemic. Supply continued
selling in a fast-growing market. [3] to increase even as demand collapsed, and this is likely to
7 Explain one difference between a consumer cause a fall in petrol prices.
market and an industrial market. [3]
8 a Define the term ‘business-to-consumer Questions
product’. [2] 1 Define the terms:
b Explain one possible difference between a ‘market’ [2]
marketing a business-to-consumer product b ‘surplus’. [2]
and a business-to-business product. [3]
2 Analyse one way in which a fall in the price of oil
9 a Define the term ‘customer orientation’. [2] might affect businesses. [4]
b Explain one possible benefit of being customer- 3 Evaluate the factors that might affect the price of oil. [12]
oriented rather than product-oriented. [3]
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3 Marketing
AS LEVEL
3.2 Market research

AS LEVEL 3.2 Market research
Chapter overview
★ the purposes of market research
★ the main features of a market: size, growth, competitors
★ aspects of customer and consumer characteristics, profiles, wants and needs
★ the difference between primary and secondary research
★ the reliability of data
★ the meaning and value of sampling
★ analysis of quantitative and qualitative data.
3.2.1 Purposes of market research For example, if the sales of a competitor are $40 000 and
the total market sales are $160 000, its market share is:
Market research involves the gathering and analysis of data
that is relevant to your marketing. The purpose of market $40 000
market share of a business = × 100 = 25%
research is to understand more about the customers of a $160 000
business and the main features of the market as a whole to help
the business make better marketing decisions. For example, a A business will be interested in the relative size of these
business might want to use marketing research to identify the competitors because this might reflect their strength
main features of a market, such as: and the threat they might create. In some markets there
» the size of the market. This can be measured in terms may be relatively few competitors – usually this is true in
of the number of dollars spent in it (the value of the the banking and telecommunications industry. In other
market) or the number of items purchased (the volume of industries there may be many competitors; for example, this
the market) is usually the case with hairdressers and cafés.
» the growth of a market. This measures the rate at which
the market has increased (or potentially decreased) in Market research will also allow a business to identify how it
size. The growth in a market is measured by: is positioned relative to its competitors; for example, is it
regarded as better value for money? Is it seen as a premium
change in market size product or more basic than its rivals? This might affect
market growth = × 100
original market size some of the marketing actions the business then takes.

For example, if the market size is $200 000 and it As well as understanding the market as a whole, managers
changes to $220 000, the growth is: can also use market research to identify different aspects
of customers and consumers, such as their characteristics,
($220 000 − $200 000) profiles, wants and needs. A customer is someone who
market growth = × 100 = 10%
$200 000 purchases and pays for a product or service. A consumer
is the person who ultimately uses the product or service.
Usually the growth of a market will be measured over If you buy and drink a cup of coffee, you are the customer
a year; for example, 10 per cent growth this year. If a and consumer. If your parents buy you a present for your
market is growing fast, this means that demand is there birthday, they are the customer and you are the consumer.
and may create more opportunities for sales to increase Businesses need to consider both their customers and
» competitors. Research will give the business an insight consumers when deciding on how best to market their
into how many competitors there are in a market and products.
what their sales are. A business can identify its own
market share and the market share of its competitors. Characteristics of consumers and customers might include
The market share of a business is measured by its sales aspects such as their age, gender, income, where they are
as a percentage of total sales. located and their lifestyle. This might allow the business
to identify patterns within its customers and adjust its
sales by the business marketing accordingly. A customer profile is an outline
market share of a business = × 100
total market sales of the customer base of the business – it outlines the
characteristics of the customers.
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Customer and consumer needs refer to what people must » identify features of the customers and consumers in
have to survive, such as water and food. Customer wants the market. This means identifying customer needs
refer to what people desire but are not essential, such as a
particular type or brand of food. Market research can identify
and wants, and the profiles of different customer
segments.
3.2
the fundamental need to buy the product (for example,
because customers are thirsty or hungry) and customer wants Having undertaken this analysis, businesses can use their
(which shows which product they would like to buy). Having market research findings to:
identified customers’ need, a business will aim to make them » assess the alternative options open to the business to
want its products as opposed to those of a competitor. meet customer needs
» assess the effectiveness of different marketing actions.
Market research provides a manager with information which
3.2.2 Primary research and secondary research

is important for effective decision-making. Imagine you
are wandering around a house at midnight and none of the GLOSSARY TERMS
lights are working. You stumble, move slowly and make
Market research is the process of gathering, analysing
mistakes getting around. Market research can provide the
and producing data relevant to the marketing process.
lighting in the room that enables you to move quickly,
Primary market research gathers data for the first time
efficiently and effectively, to get to where you want. Market for a specific purpose.
research can provide the light you need in order to view the
whole situation.
By undertaking market research, managers should have
a better idea of what people want and how they behave. STUDY TIP
This should mean that the firm can meet their needs more Simply gathering data for the sake of it does not make
effectively and avoid wasteful marketing activities. Imagine much sense, so managers need to be clear about why it
that you are considering launching a new product. If you is being gathered, how accurate it has to be, what time
can find out who your target market is, what they like, there is to gather it in, what the best way of gathering it is
what they read, where they shop, what they watch and and what costs are involved.
listen to, then your marketing can be much more effective.
For example, there is no point in spending money on a
big Saturday afternoon television campaign if your target
audience is out watching a sports match.
3.2.2 Primary research and
Market research may be undertaken before the business is secondary research
set up in order to decide whether or not it is viable. It can
also be undertaken once the business is up and running to Primary market research
decide what to do next; for example, whether to change the In some cases, you may have to gather new data for a
price of a product or launch a new brand. specific purpose. This is called primary market research.
For example, you may want to discover what people in your
local area think of your specific idea, whether they are
Assesses the
Identifies effectiveness likely to use your particular service or what they think of
market of different your business name. This sort of information will not exist
opportunities marketing already, so you will need to undertake new research.
actions
Market
research
Primary research can be tailored precisely to your own
needs, but it can be quite expensive and time-consuming
compared with using information already collected. The
danger is that because of cost constraints, or because you
are inexperienced, you only ask a relatively small number of
people or a specific group that does not really represent the
Assesses the
alternative
population as a whole. This means that your results may be
options open to biased and misleading. If you ask your friends, for example,
the business to they may tell you it is a great idea even if it isn’t, because
meet customer
needs they do not want to upset you!
If you are going to undertake primary research, you need to
▲ Figure 3.8 Uses of market research make sure that you:
» don’t lead people into giving you the answer you want
Typically, market research is used to: (for example, ‘Why do you think my idea is so good?’ is a
» identify features of a market such as its size, leading question)
the segments that exist, its growth and what » ask a representative group of people (that is, that you
competitors exist hope will represent your target group)
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» ask enough people for the findings to be significant (one Surveys may give you an idea of what people think of your
person’s opinion may not necessarily reflect the views of idea and help you decide whether or not to go ahead
3.2 the population as a whole). » by asking a small group of people what they think
(a focus group)
Primary data can be gathered: » by test marketing. Sometimes a business may try a
» by observation. For example, you may watch what is product in a test market, such as a particular region, for
happening in the stores of your possible competitors a while to see how it sells. If this goes well it might be
or count how many people walk by a potential location rolled out to other areas; if sales are poor, changes could
for your shop on a typical day to calculate the be made to the product or the way it is promoted to see
‘footfall’. In high-street retailing, the footfall is an what happens then.
important indicator of the likely number of customers.
The more people that walk past, the more customers GLOSSARY TERMS
you may get
» through surveys. You may have been stopped in the A focus group is a small number of people gathered
street and asked your opinion about something. This is together to talk about a particular issue in open
a face-to-face survey and is one way of finding out what discussion.
people think. Firms also use telephone, mail or online Secondary market research uses data that already exists.
surveys to find out the views of potential customers.
CASE STUDY
Africa
Africa is one of the biggest emerging markets in the and customer or supplier loyalty, and will secure a strong
world. This rapidly expanding, competitive environment position in this growing market.
creates a growing need for market research. Consumers
are the lifeblood of companies, but do companies actually Effective market research methods in
possess sufficient knowledge about their consumers? Are
developing countries
their customers (perfectly) satisfied with their products/
services? What are their opinions and wishes? How could More than 500 million Africans use a mobile phone
their loyalty be improved? These are important questions and the market is growing fast each year. Mobiles
for organisations and investors operating in Africa. Africa have penetrated to even those villages that have no
represents a major market opportunity with a growing electricity and no landlines. The rapid and accelerating
population, a growing middle class and relatively fast penetration of mobile phones through all levels of
economic growth. society in developing countries means that it is possible
to communicate with the basic survivors and emerging
The potential middle classes. This underlines the massive potential
to use mobile phones in order to reach and interact with
Africa will be the fastest-growing economy in the world in
huge groups of people across the continent. The explosive
the next five years. For example, Uganda has an economic
growth of Africa’s mobile communications industry offers
growth of 6.41 per cent per year, yet only 1 per cent of the
a vast potential to interact with people on a personal level.
total global market research budget is invested in Africa.
The basic survivors (people living on or below one dollar Market research is conducted by inviting people to
a day) is a huge group in African countries (in Uganda, participate in surveys and rewarding them with incentives
for example, this group is 65 per cent of the population). such as mobile phone credits. The mobile phone is
Given the fact that Africa is the fastest-growing economy particularly well-suited to market research as it is cost-
in the world, the basic survivors move towards a regular effective, reliable and enables clients to obtain results
middle class, with comparable incomes and Western virtually in real time. Furthermore, it allows consumers
consumer behaviour. This means there is a huge potential to participate in surveys when and where it suits them.
for doing business, but there is still an unused investment These advantages have a positive impact on response
opportunity in African countries. rates, data quality and validity of results.
Companies that find new ways to overcome constraints Source: www.mckinsey.com
and tap opportunities can gain insights, market share
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3.2
1 2 3 4 5
Basic Survivors Working Families Rising Strivers Cosmopolitan The Affluent
Professionals
Basic Survivors are the Working Families are Rising Strivers are Cosmopolitan The Affluent of Africa
largest consumer the second largest emerging from the Professionals are have a disproportionately
group in Africa and are consumer group. They first two segments, typically located in high purchasing power,
characteristically low focus their spending having built their urban areas. They are and are considered
income consumers. on their children’s purchasing power busy with work but wealthy regardless of
They tend to live in needs and they value through access to often have active where they travel
3.2.2 Primary research and secondary research

urban slum areas or stability and routine credit or other social lives. As a result, across the globe. This
rural areas and make in their lives. resources. They value these consumers group is extremely
day-to-day decisions upward mobility and value pragmatic small and very fickle.
based on basic needs. buy based on products but are also
convenience, quality, brand conscious and
or even more influenced by the
‘expressive’ factors. media.
▲ Figure 3.9 Five key sub-Saharan African consumer segments
Questions
1 Analyse one benefit of using the mobile phone to 2 Evaluate the potential benefits of using market
undertake market research. [4] research for businesses targeting Africa. [12]
general information on the economy, the market and on

Secondary market research competitors.
Given that the amount of money you have available to
spend when starting up a business is likely to be limited, While secondary data is usually quite quick to get hold of,
you will probably have to carry out most of your market it is not always in the right format for your needs, or up to
research yourself rather than using specialist companies date. The research may have been done in the previous year,
to do it for you. The cheapest and quickest way of doing when what you want is this year’s figure. It may organise
this is to see what information about the market already sales data according to the sales per country, when what
exists. What data has been collected and published? A you need is data focusing on a particular city. Nevertheless,
tremendous amount of information is available on the secondary research is usually a good starting point. Once
internet, in libraries and in newspapers, as well as from you have looked at secondary sources, you can identify what
other sources. Using data that already exists is called else you need to know and what information needs to be
secondary market research. It is particularly useful for gathered for the first time.
CASE STUDY
Coca-Cola
Sparkling soft drinks
NARTD 4.3%
Hot beverages
Packaged food 4.0%
$1.6 Juice, dairy

trillion and plant Household products 3.5%
0 1% 2% 3% 4% 5%
Note: NARTD = non-alcoholic ready to drink. Industry growth
RTD tea/coffee Hydration for NARTD excludes white milk and bulk water
Energy ▲ Figure 3.11 Industry retail-value growth

NRTD cold
Note: RTD = ready to drink; NRTD = not ready to drink
▲ Figure 3.10 Hot and cold beverages industry retail value
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According to Coca-Cola, there are significant long-term 3.2.3 Sampling
3.2 growth opportunities both for the soft-drinks industry
and for Coca-Cola. Coca-Cola has a 20 per cent market The need for and limitations of
share of cold non-alcoholic beverages, with a very small
market share in hot non-alcoholic beverages. sampling
If you decide to undertake a survey, the total number
In the developing and emerging world, only about 30 per
of people you are interested in is known as your ‘target
cent of beverage consumption is commercialised, and
population’. For example, if you have an idea for a website
Coca-Cola’s market share within these regions is about
half of what it is in the developed world. The developing
dedicated to your favourite football team, your target
and emerging world represents 80 per cent of the population would be all the fans of the club around the
world’s population; over 6 billion people. world. In most cases it will not be possible to interview all of
the people in your target group. It may be too expensive or
Therefore, Coca-Cola believes there is compelling would simply take too long to talk to everyone. Imagine your
long-term growth potential across the world through website was aimed at the fans of a big club like Manchester
growing the overall industry and continuing to gain United FC or FC Barcelona. There are hundreds of thousands
share. of fans all over the world. Even if you managed to identify
▼ Table 3.7 Hot and cold beverages: developed and them somehow, the cost and time involved in trying to talk
developing/emerging markets to them would make it unrealistic, especially if you are a new
business and therefore likely to have limited funds.
Developed Developing and
markets emerging Instead of interviewing everyone in the target population,
(% sales markets (% sales the business might decide to take a sample. A sample is a
volume) volume) group of people that is intended to represent the overall
population. By interviewing, say, 500 fans you would hope
Non-commercial 30 69 to get an impression of what all the others think.
Alcohol 11 3
Obviously, the results will not be 100 per cent reliable,
Hot beverages 12 11 because you have not asked everyone in the population –
Cold beverages 47 17 you have only asked some of them. This means that you
cannot be totally confident of the results. So it is important
Population 1.5 billion 6.1 billion to choose a sample that is big enough to be representative
of the whole market. The findings from a sample that is too
Source: https://coca-cola.com
small may not be very reliable.
Question
1 Evaluate the significance of the data in the case STUDY TIP
study, in Figures 3.10 and 3.11, and in Table 3.7, for
When deciding on the size and type of sample, you need
Coca-Cola’s marketing. [12]
to think about issues such as the time available, the costs
and how accurate the data needs to be.
HANDLING DATA
Sampling methods
1 Following market research, Nick estimates the There are three main ways of selecting a sample:
market as a whole is worth $1 500 000. He believes » Random sample With a random sample, all the
his company can achieve a market share of 50 per members of the target population have an equal chance
cent. What would his sales value be? of selection. If you wanted a random sample of 30
2 Nick also thinks the market will grow by 5 per cent students at your school, you could take a list of names
next year, but he can retain the same market share. of all the students and then pick 30 names at random.
What would his sales value be then? You would then have to find them to interview. This
approach has the advantage that anyone could be
▼ Table 3.8 Primary and secondary research asked. However, it can be quite time-consuming,
because once the names have been selected you then
Primary Secondary have to go and find those people. If they were not in
• New data • Existing data school on that day, you would have to wait until they
• Specific to your needs • Gathered for another were, slowing up the whole process.
• May take longer to gather purpose » Stratified sample A stratified sample is based on
• May be expensive • May be relatively quick
particular proportions (such as 60 per cent males, 40
• May be relatively cheap
per cent females; or 20 per cent aged 16–35 and 80 per
cent aged over 35). This type of sample is used when
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the target population has particular characteristics that Qualitative research is based on the opinions, values and
you want reflected in your sample. You reproduce the beliefs of people. It is usually undertaken using a small
characteristics of the target population and randomly
sample within each category.
focus group or in-depth one-to-one interviews. This type
of market research aims to understand why customers
3.2
» Quota sample With a quota sample, the research sets behave in certain ways, or to find out what people think of
proportions (for example, male/female or different a product or what they would do in a particular situation.
age groups) which may or may not reflect the target Qualitative research examines why customers do what they
population. People who meet these characteristics are do. For example, a focus group might be used to discuss
found as quickly and easily as possible, which means consumers’ views of a brand to understand their shopping
that a quota is not a random sample. For example, habits. This often helps marketing managers understand
if you want to interview 12 students (5 male and 7 what customers think of their product compared to another,
3.2.4 Market research data

female) you simply approach people and see if they and can be a starting point in the research process. Focus
match these criteria and work with the first five male groups may highlight particular issues or give a reaction
students and first seven female students who agree to to a business idea that can be examined in more detail.
take part. Given that qualitative research involves small groups, it
A quota sample is easier and quicker to complete than means that the findings are not statistically reliable; this
a random sample (as you do not need to know all the is why more extensive research is often used as a follow
members of the population), but it is not random up. Qualitative research can be quite expensive and slow to
because members of the population do not have an equal organise because it is so important to get the right group of
chance of selection. To find 30 students, for example, people to talk to.
you might simply find one class and ask them. This could
Quantitative market research is based on relatively large
lead to very biased results because they would all be a
samples and is therefore more statistically valid. This sort
similar age and/or may all study the same subject. With
of research is often used to show what has happened in
a random sample you would expect a range of ages and
a market, and its findings can be expressed in numerical
interests, which might provide a better insight into the
terms (for example, sales of brand X have increased by 45
school as a whole.
per cent; 12 million people watched a particular television
Types of sample programme last week; the market for soft drinks is worth
more than $4 billion). Quantitative market research is used
to answer questions such as: how many units might be
sold? When are items most likely to sell? Where? What has
happened? Quantitative research is usually gathered via
Random Stratified Quota surveys such as telephone, face-to-face or email.
▲ Figure 3.12 Types of sample
Analysing market research results
When analysing the market research results a business needs
Choosing a sampling method to consider:
The choice of sampling method will depend on factors such as: » Can the results be trusted to be relatively accurate? In
» the time available. If time is limited, a quota is likely to other words, is the research valid?
be used because it is relatively quick to do » Would the research give the same results if it were
» your knowledge of the target population. To select repeated? In other words, is the research reliable?
people randomly you must have details of the target
population. If you were selecting from a list of
cardholders or club members this would be feasible. GLOSSARY TERMS
However, if you were interested in potential buyers of A sample is a group of people selected to represent the
your product, you would not necessarily know who they population as a whole.
were and so could not select from this group randomly The validity of market research refers to how accurate
» the extent to which the target population has clearly the findings of market research are.
differentiated groups of buyers. If the buyers can be The reliability of market research refers to the extent to
differentiated clearly (for example, 70 per cent male, which the same results would be received if the research
30 per cent female) then you would want to use a was conducted again.
stratified sample.
3.2.4 Market research data The accuracy may depend on factors such as how the
information was gathered, what the sample size was and
how accurate you want the findings to be. Researchers often
Quantitative and qualitative market express their findings in terms of confidence levels based
research on a statistical analysis of the data. For example, they
Quantitative and qualitative market research are two might say they were 95 per cent confident that sales would
different approaches to market research.
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be between $20 million and $26 million in two years’ time When examining line graphs, you may want to consider the
but only 68 per cent confident they would be between $23 trend and how much sales fluctuate around this trend, as this
3.2 and $25 million. The more precise you want the estimate to
be, the less confident the researchers are likely to be. The
will affect how much capacity is required and is being used.
Do check the axes when looking at data. Figure 3.15 and
confidence level of market research findings relates to how
Figure 3.16 show the same sales figures but, by changing the
reliable the data is.
y-axis, the sales look as if they are rising more sharply in the
second figure.
Interpreting marketing data
Marketing data may be presented in many forms, often Sales ($)
tables, charts and graphs. For example, a pie chart may be 120
used to illustrate market share:

100
Sales (%)
80
Product E: 1, 4% 60
Product D: 2, 8%
40
20
0
Product C: 4, 2017 2018 2019 2020 2021 2022 2023 2024
16%
Product A: ▲ Figure 3.15 Line graph – shallow y-axis
13, 52%
Product B: 5,
20% Sales ($m)
110
100
90
Product A Product B Product C Product D Product E
80
▲ Figure 3.13 Example of a pie chart
70
In this pie chart we can see the sales of each product and
what proportion of the total market sales this represents 60
(that is, its market share). 50
2017 2018 2019 2020 2021 2022 2023 2024
Sales data over time is often shown using a line graph:
▲ Figure 3.16 Line graph – steep y-axis
Sales ($m)
60 Data may also be presented using a bar chart; for example,
the sales of a business in different regions or the sales of
50 competitors.
40
Sales ($’000s)
30 45
40
20
35
10 30
25
0 20
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
15
▲ Figure 3.14 Example of a line graph 10
In Figure 3.14, we can see there is an upward trend in sales. 5
Sometimes marketing managers want to plot the underlying 0
Competitor A Competitor B Competitor C Competitor D
trend to ‘smooth out’ the data. They do this using moving
averages (this is explained in Chapter 8.1). We have assumed ▲ Figure 3.17 Example of a bar chart
this data was produced in 2022. The sales from 2023
onwards are, therefore, forecasts; this is often shown with a Some data may also be in the form of tables. For example,
dotted line. Table 3.9 shows forecasted sales volume and sales value
data for a product.
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▼ Table 3.9 Example of a table showing index values » The sales value in 2022 is 5 per cent more than 2021.
» The sales value in 2023 is 10 per cent more than 2021.
Year
Index of sales
volume (units)
Index of sales
value ($)
»
»
The sales value in 2025 is 15 per cent less than 2021.
The sales value in 2026 is 10 per cent more than 2021.
3.2
2021 100 100
Notice that in this example the sales volume by 2026 is 10
2022 102 105 per cent less than in 2021 and yet the sales value is 10 per
2023 105 110 cent more; this must be because the price of the product
has increased.
2024 110 120
2025 95 115 Using marketing data
3.2.4 Market research data

2026 90 110 When examining any marketing research data, in whatever
form it is produced:
Tables often show data as index numbers. An index number » check the source. Has this been produced internally or
shows percentage changes relative to a starting or base point. by a specialist market research agency, for example? You
In the table above, the base is 2021 and changes in sales will want to take a view on the reliability of the data
volumes and values are shown compared to that. For example: » check the dates. How recent is the data? Markets can
» The sales volume in 2022 is 2 per cent more than 2021. change quickly so be wary of old data. At the same time,
» The sales volume in 2023 is 5 per cent more than 2021. if you are considering forecasts, you need to find out
» The sales volume in 2025 is 5 per cent less than 2021. how it is gathered and how reliable it is likely to be
» The sales volume in 2026 is 10 per cent less than 2021. » check the units. Be sure to check whether you are
measuring in thousands or millions of dollars, for
Notice we can easily see the change in the sales volume;
example. Also check the labelling of the axes – are you
we do not know what the actual level of sales is, only the
measuring sales or profits, for example?
percentage change. Similarly with sales value:
CASE STUDY
Esports
2000
1790
1750
1500
Revenue in US$ millions
1250
1096
1000
865
750 655
493
500
325
250 194
130
0
2012 2014 2015 2016 2017 2018 2019 2022
▲ Figure 3.18 Esports market revenue worldwide, 2012–2022
Esports, or competitive video gaming, has existed for Source: www.mckinsey.com/industries/technology-

over 20 years. Sponsors like Intel and Red Bull have been media-and-telecommunications/our-insights/the-keys-
hosting events for more than 10 years. However, in the to-esports-marketing-dont-get-ganked
last couple of years there has been a significant increase
Questions
in interest in esports by major brands. Companies such as
Coca-Cola and Mercedes have brought spending on their 1 Calculate the percentage growth in esports market
esports sponsorship into their main marketing budget. revenue between 2012 and 2018. [3]
2 Explain one factor that might determine the demand
One of the appeals of esports is the reach it has with for esports. [3]
young men and the high levels of engagement. In the USA, 3 Evaluate the appeal of sponsoring an esports event
in 2020, it is estimated that there were 21 million esports to a business. [12]
fans; 83 per cent were male and 84 per cent under the
age of 35. It is now the third most-popular spectator sport
for young men.
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TEST YOUR LEARNING
3.2 growth in the luxury market is driven by generation Z and
Short answer questions millennial consumers*. Generation Z consumers are more
1 a Define the term ‘market research’. [2] willing to shop in a physical store – although they also
b Explain one reason for undertaking market expect an online presence. They prefer heavily logoed
research. [3] products and are not especially brand loyal. Younger
2 a Define the term ‘secondary market research’. [2] consumers are highly socially and environmentally aware.
b Explain one advantage of secondary research Concern about sustainability and a brand’s social or
compared to primary research. [3] political stance is a key factor in their purchasing decision
3 a Define the term ‘primary market research’. [2] process.

b Explain one advantage of primary research Findings from market research about the luxury market
compared to secondary research. [3] include:
4 Define the term ‘sample’. [2] ● market growth has varied by region. China has
5 Explain one reason why a business may use continued to have very fast growth and is attractive
sampling when undertaking market research. [3] to businesses due to its market size. There are more
6 Explain one feature of effective market research. [3] buyers in China due to fewer restrictions on importing
7 Explain one source of information for secondary products, more restrictions on buying abroad and
market research. [3] more tax-free shops. Spending across the rest of Asia
has been strong in recent years, with Hong Kong,
8 Explain one limitation of sampling. [3]
Macau and Japan benefiting from travelling Chinese
9 Explain one factor that might influence how much is consumers due to the relative strengthening of the
spent on market research. [3] Chinese yuan and strong local consumption in Korea.
10 Explain one reason why spending more on market Sales in the Middle East have remained relatively flat
research may not lead to higher sales. [3] due to low oil prices and lower government spending
Data response question in the economy
● online sales of luxury brands have been rising fast,
Burberry and luxury brands especially in Asia
Consumers around the globe have high expectations of ● in luxury accessories, the handbag category has done
luxury brands. They widely research products before especially well recently
purchasing and expect exceptional service in-store. The ● growth in shoes has been highest in the trainers
strong interest in forward-looking fashions and innovative segment
products is partly driven by the younger customers now
● growth estimates for the luxury market over the next
entering the luxury market.
five years remain in line with 2019 estimates, ranging
Consumers are increasingly using luxury products from 3 per cent to 5 per cent per year.
to say something about themselves, to express their
* Generation Z refers to people born between 1997 and
individuality, their own style or point of view. This means
the early 2010s. Millennials are people born between
luxury products increasingly have to be fashionable and
1981 and 1996.
are often sold in limited-edition ranges. The fastest-
growing segments of the luxury market are young Questions
consumers and Chinese consumers, and they expect to
buy an increasing number of products they would describe 1 Define the terms:
as ‘fashionable’. a ‘market size’ [2]
b ‘market growth’. [2]
The market for clothing and accessories is increasingly
2 Analyse one way in which Burberry might research
polarising between the mass market and luxury products.
the market for its new products. [4]
Consumers are increasingly preferring products that are
positioned either at the highest or the lowest end of the 3 Evaluate how market research can help the
market rather than mid-market. A huge amount of the success of Burberry’s new products. [12]
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3 Marketing
AS LEVEL
3.3 The marketing mix
3.3.1 Elements of the marketing mix

Chapter overview
★ the elements of the marketing mix (the four Ps)
★ the importance of the product in the marketing mix
★ product portfolio analysis
★ pricing methods
★ promotion methods
★ place (channels of distribution).
A customer is influenced by many factors when deciding or enhancing the combination of elements that affect the
whether or not to purchase a product. The combination of customer’s buying decision.
these factors is known as the marketing mix. By developing
an effective marketing mix, a business can meet the needs
of its customers successfully. In this chapter we examine
the different elements of the marketing mix. Place
Price
(distribution)
GLOSSARY TERM
The marketing mix is the combination of elements that
influence a customer’s decision on whether or not to buy The marketing
a product. mix
3.3.1 Elements of the marketing Product Promotion
mix
The marketing mix comprises all the elements associated
with a product that affect whether or not the customer
decides to buy it. A broad range of factors may affect ▲ Figure 3.19 The marketing mix is commonly described as
customers’ purchasing decisions. the four Ps
Consider why a customer might choose to shop in one The marketing mix is often simplified and is commonly
supermarket rather than another. The list below contains a described as ‘the four Ps’. This approach identifies four
number of factors affecting this decision. elements in the mix (all beginning with the letter ‘P’):
» How far away is it? » Price How much are customers charged for the product
» How easy is it to park? and what are the terms of payment? For example, can
» What is the range of products like? you put a deposit down and pay in instalments? How
» Are the prices competitive? does this price compare with that of rivals?
» What facilities are there (for example, a coffee shop)? » Product This includes the many different aspects of a
» Are the staff friendly and helpful? product such as its design, quality, reliability, features
» What services are provided (such as carrying shopping to and functions. For example, you may buy something
customers’ cars)? principally because of its style (for example, Bang &
» Does the supermarket offer a loyalty card? Olufsen, Apple), its features, its reliability and durability
(for example, JCB, Caterpillar) or the brand (for example,
There are clearly many factors that influence a consumer’s DKNY, Gucci).
decision to choose one business rather than another, » Place This refers to the way the product is distributed.
and these are all part of the marketing mix. An effective Is the product sold direct to the customer or through
marketing mix offers the customer the right mix of benefits retail outlets? Can you buy online, or do you have to
at the right price. Improving the mix will involve changing travel some distance to get to a shop where it is sold?
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» Promotion This is the way the firm communicates Intangible aspects of the product refer to aspects that
information about the product to the customer. For cannot be touched but can still be important to customers,
3.3 example, it may use advertising or a sales force to highlight
its strengths. The promotion of a product will affect the
such as the brand and its key values. It also includes
aspects of the product such as a guarantee, after-sales
image that customers have of it and their awareness and servicing or additional technical support which come with
understanding of the benefits of the product. the purchase. Some people stick with their phone service
or energy company because they trust them to fix things
However, the marketing mix can be extended to also feature quickly if ever there is a problem. Some businesses buy
other factors, such as a further three Ps: their photocopiers or computers from companies that can
» People A well-trained, well-informed, polite staff can maintain them effectively.
influence people to buy from one shop rather than another.
AS LEVEL 3.3 The marketing mix
Customer service is an important marketing weapon.

» Physical environment This includes factors such as the GLOSSARY TERMS
layout, decor and parking, and can be an important influence The products of a business refer to what it offers to sell
on which restaurant, pub or store a person chooses. to its customers. These may be goods, which are tangible
» Process The ease of ordering and paying can influence items, or services, which are intangible.
a purchase. Many supermarkets have introduced self- The tangible attributes of a product refer to its physical
scanning to reduce queues and attract customers. aspects, such as how it looks and feels.
The intangible aspects of a product refer to aspects that
cannot be touched but can still be important to customers,
3.3.2 Products such as the brand and its key values.
Product differentiation occurs when the benefits of
The difference between goods and your product are perceived as clearly different from
services competitors’ products.
Products refer to goods which are tangible products;
services are intangible. Businesses will keep reviewing
their products to ensure they are relevant and continue The importance of product development
to meet customer needs. When reviewing their products, Developing new products is essential to most businesses.
businesses will consider the core benefit that the product This is because:
provides. For example, a soft drink satisfies thirst, a washing » customers’ tastes change and so a business must change
machine provides clean clothes and an aircraft moves people what it offers as well; for example, customers generally
and cargo from A to B. Businesses have to be aware of new want less sugar in their food products than in the past
substitutes coming along – with more social communication » competitors will constantly be developing their
systems such as Zoom, Skype and FaceTime, people may not offerings, so a business needs to innovate to keep up
need to travel as much. With more emailing there may be and remain competitive
reduced need for letter-writing paper. The ways of providing a » developments in technology will create new
core benefit can change and businesses must be aware of this opportunities for products (and indeed can create whole
and prepare accordingly. new markets) which businesses will want to make use of
» new laws and regulations change what can be produced;
Tangible and intangible attributes of for example, diesel cars may be banned in the future.
products Of course, some products seem to have been around for

many years – such as Kellogg’s Cornflakes – but even
The tangible attributes of products refer to the physical here there will be some developments relating to the
aspects of a product. In the case of a washing machine, for ingredients, recipe, packaging, size of the boxes and
example, the business would consider what size, features, communications about the benefits of the product. At the
capacity and types of wash were needed and what energy same time Kellogg’s will be developing other products to
usage it had. The features customers require would vary – in meet emerging customer needs.
the case of a washing machine, some people live in tower
blocks and use industrial-size washing machines in the
basement areas. In other cities people have apartments Product differentiation and unique
with smaller washing machines inside. In some countries selling point
people have a utility room with lots of space, and the
One possible approach of marketing is to differentiate the
washing machine is a ‘top loader’ where people put the
products that the business sells relative to its competitors.
washing in from the top. In other regions the workspace
Product differentiation occurs when the benefits of your
on the top is needed and so washing machines are ‘front
product are perceived as clearly different from competitors’
loaders’. Products must be developed according to how
products. Your product may be perceived as easier, safer,
people are likely to use them. These attributes of a product
better designed or trendier, for example. This differentiation
include the specifications, features and design of the
can be achieved by having a unique selling point (USP); this
product.
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is something about your product which is perceived by your such as the size of the paper or whether to switch to colour,
customers as unique. For example, you might be selling the are far less frequent).
only water from Lake X or the best performing car according
to a recent survey. By promoting its USP, a business can 2 The introduction (launch) stage
3.3
differentiate its offering and may be able to charge more or This is the stage at which the product or service is launched
offer better value for money. and put on sale. Many product ideas will never actually
reach this stage. They are abandoned after prototypes have
3.3.3 Product portfolio analysis been produced and tested. In the launch phase, promotion
costs will be relatively high to make potential customers
aware of the product, therefore a loss is still likely to be
Product life cycle
3.3.3 Product portfolio analysis

made. Producers may also struggle to get firms to stock
The product life cycle traces the stages of a product over their products or customers to try their service at this
its life. The typical path for a product can be divided into stage if the business is new, with no proven track record.
five stages, as in Figure 3.20. Buyers may be reluctant to risk switching to or trialling a
new product, particularly if there are heavy costs involved
in doing so. For example, if there is a penalty payment
Sales
for switching from one credit card, mortgage company,

electricity company or gas company to another, customers
are more likely to remain with their existing providers.
3 The growth stage

If the product becomes known and accepted by customers,
Launch sales should grow. At this stage, it should be slightly easier
to get distributors to stock the products, as they will be
Time more confident of sales and therefore willing to stock
Research them. The firm should begin to make profits at this stage,
and Introduction Growth Maturity Decline as revenues begin to outweigh costs. For example, sales
development of teeth-whitening formulas, smoothies, men’s cosmetics
▲ Figure 3.20 The product life cycle and laser eye-surgery are at their growth stage in several
countries. At this stage, you need to make sure you can meet
the demand and manage the growth process. You may be
GLOSSARY TERMS taking on more staff, buying more equipment and expanding
your premises; if this is happening rapidly it can be difficult
Product portfolio analysis occurs when a business
examines the position of all of its products in terms of
to keep control. Making sure you can meet deadlines and
their relative market share and market growth. maintaining quality can be major problems at this time.
The product life cycle shows the stages of a product over Of course, some products never reach the growth stage:
its lifetime. they are launched but are never successful and sales fail to
take off.
1 The research and development stage 4 The maturity and saturation stage
During this stage, the basic idea for the product is At this point in a product’s life, the growth of sales slows
developed and tested. Mock-ups of a design may be made, down. The product may have been in the market for some
models of a product may be produced or a new recipe may time and competitors may have launched similar products.
be taste-tested. This stage can be expensive for a firm Products such as washing machines and televisions are
and no revenue is being generated during this period. This currently in their maturity stage. The maturity stage can
is a time of high risk because the product may never be last for years in some cases. There is no rapid expansion and
developed successfully and the investment at this stage managers must consider what to do next with the product;
may not be recovered. For example, it took James Dyson 15 for example, should funds be invested to try to boost sales
years and more than 5000 prototypes of the Dyson vacuum or should the product be scrapped?
cleaner before he got it right, highlighting the time and
money that can be used up in the development phase. 5 Decline
The length of the research and development process Eventually, the sales of any product are likely to fall. The
will vary from product to product. In the case of new business may find it more difficult to get the product
pharmaceuticals, it can take 12–15 years to develop and test distributed at this stage and may be forced to cut the price
products before they can be launched, whereas developing to maintain sales. For example, you will have seen reduced-
a new design for a greetings card is likely to take months price CDs or books in the bargain areas of shops: the price has
rather than years. Some products, such as newspapers, are been reduced to try to increase sales. Products such as board
modified on a daily basis (although significant changes, games, road atlases and bow ties are in their decline stages.
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then adjust the marketing mix accordingly. For example,
STUDY TIP promotion may be used to announce the launch of a product
3.3 Remember that the shape of the product life cycle will
vary from one product to the next. In some cases, a
in the introduction phase but to stress the differences
with competitors in the maturity phase. The price may
product may sell well for relatively few weeks or months be high initially if the product has some unique features
and then fade; for example, a successful film. Other but may have to be reduced in later stages as competitors
products may sell well for years, such as a popular book. enter the market. Distribution may be difficult to get at
Products may be at different stages in different regions. first when a product is new, but it may be easier over time
when it has begun to prove itself. The business should
be able to improve the firm’s performance by recognising
Using the product life cycle or anticipating where the product is in its life cycle and
Managers may use the product life cycle model to identify adapting the marketing mix accordingly.
which stage a product is in at any given moment and
CASE STUDY
Dyson
Dyson is a technology company that is well-known for the company did not think it could sell enough to be
its product innovations, such as its vacuum cleaners and profitable.
hairdryers. In 2016, it started to develop prototypes of
The intention had been to produce the car in Singapore,
electric cars but, in 2019, Dyson announced it was going
although £200 million was invested in research and
to end this project. The company said it had developed
development and test-track facilities within the UK.
a fantastic car but it was not commercially viable to
produce it. The project employed 523 people, 500 of whom were in
UK, and Sir James Dyson said they had achieved a great
Dyson had intended to invest more than £2 billion
deal, even if the car was not going to go into production.
in developing a radical and different type of electric
vehicle. It was never intended for the mass market but, The company said that work on developing the
even given the premium price Dyson expected to charge, battery technology could be transferred to its other
projects.
Source: Charlie Box/Dyson

▲ Figure 3.21 Dyson patent diagram from 2019
Questions
1 Analyse one factor that influences the design of a 2 Evaluate whether Dyson was right to invest in
vacuum cleaner. [4] developing an electric car. [12]
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Extending sales in the product by consumers as a product to use when dandruff was
already present. The company tried to change this
life cycle
Effect of
perception to get people to use it all year round to
prevent dandruff, as well as cure it
3.3
extension strategy » reducing the price. As products approach the maturity
stage, firms often cut the price to maintain sales. The
success of this depends on how sensitive demand is to
changes in price
» adapting the product. Look around a supermarket
Sales
and you will see endless examples of ‘new, improved’

products or products with added X, extra Y or less Z!

These are all ways of trying to keep the consumer
interested in the product
» introducing promotional offers. Another technique often
Time used by firms to try to prevent sales from falling is to
▲ Figure 3.22 Extension strategies have competitions or offers to boost their sales
» changing the image of the product. Products may be
A firm may try to prevent the sales of a product going into repackaged to make them appear more modern and
decline by using extension strategies. Methods to do this attractive to consumers.
might include:
» increasing the usage of the product on any given GLOSSARY TERM
occasion. For example, shampoo products often advise
An extension strategy occurs when marketing activities
you to wash once, then rinse your hair and wash again,
are changed to prevent sales from falling.
thereby doubling the usage rate
» encouraging the use of the product on more occasions.
For example, Head & Shoulders shampoo was seen
CASE STUDY
Command and conquer
Command and conquer is a computer game in which there More than 30 updated computer games were launched in
is a war between the Global Defence Initiative and a 2020. Final Fantasy vii Remake is a remake of a PlayStation
terrorist group called the Brotherhood of Nod. Command game from 1997. It sold 3.5 million copies in three
and conquer was originally a video game in 1995, when days when it was released in April 2020. Re-releasing
it was first released on compact discs. Players could games appeals to those who remember them from their
compete against others using what was then an emerging childhood. It is also cheaper than developing a new game
technology – the internet. It sold around 3 million copies. from scratch, which can cost $100 million.
In 2020, a new, improved version came out. This was Questions
similar to the original in many ways but had better graphics.
1 Analyse one factor that affects the promotional mix of
Revamping products is common in the music industry where
a new computer game. [4]
music will be remixed, remastered or brought out as a
2 Evaluate whether computer games companies are
special edition or part of a compilation. Film studies produce
right to relaunch past games. [12]
the director’s cut or an edition with ‘extras’ or ‘outtakes’.
▼ Table 3.10 Examples of how marketing decisions may change at different stages of the product life cycle
Introduction Growth Maturity Decline
Price May be low to introduce May be able to increase May hold May cut to boost sales
with demand
Distribution May be limited as stores May increase to gain May hold May focus on best-
unsure whether to stock access to the market performing outlets
Promotion May focus on awareness May try to increase May highlight differences May try to reinforce
awareness with competitors who may existence and benefits
have entered of the product
Product May be limited number May widen range with May stop developing new May focus on best
of models/varieties demand models/varieties performers
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CASE STUDY
3.3
Segway
▲ Figure 3.23 Segway products

The Segway Personal Transporter (PT) was a self- price tag of around $5000 was too high for many
balancing electric scooter that was launched in 2001 customers. The initial difficulties customers often had
by Dean Kamen, its American inventor. ‘Our inspiration balancing also caused problems. The number of high-
for the name “Segway” came from the word segue, profile accidents – including the death of the company’s
which is defined as “to transition smoothly from one owner in 2010 when he drove a Segway off a cliff by
state to another”. Segway transforms a person into an mistake – did not help the Segway’s image. Furthermore,
empowered pedestrian, allowing him/her to go farther, some governments declared that the Segway could not be
move more quickly and carry more.’ The Segway had a used in any public place. It was too fast to be used on the
self-righting technology. If you leant forward, a collection pavement but not safe enough to be used on the road.
of microprocessors and a set of sophisticated tilt sensors
In June 2020, the company announced that it would stop
and gyroscopic sensors adjusted so you maintained your
production of the Segway PT. The company continues to
balance. The Segway could travel up to 12 miles an hour
produce other products and the Segway only accounted
(19 km/h).
for about 1.5 per cent of the company’s revenue by this
In 2015, Segway joined with Ninebot, a privately held stage.
Chinese company. The combined company focuses on
Source: https://uk-en.segway.com/about-the-brand
the research and development, design, manufacturing,
distribution and sales of short-distance transportation Questions
products. According to Segway, more and more people
1 Analyse one reason why the company may have
are using Segway-Ninebot products as an eco-friendly
stopped production of the Segway PT. [4]
alternative for many of the short journeys that are
2 Evaluate the ways in which the marketing of a
typically made by car.’
Segway product might change as it moves from
Unfortunately, the transportation revolution that inventor the introduction to the growth phase of the product
Dean Kamen had envisioned when he launched the life cycle. [12]
Segway PT never really took off. The Segway’s original
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of portfolio analysis was developed by the management
HANDLING DATA consultancy Boston Consulting Group and is known as the
Over five years the sales of a product are as shown in

Boston Matrix. This model analyses the position of a firm’s
products in terms of their market share and the growth of
3.3
Table 3.11. the markets they operate in.
▼ Table 3.11 Sales of a product over five years
GLOSSARY TERMS
Year Sales
Product portfolio analysis (PPA) examines the market
1 $100 000 position of a firm’s products.
2 $150 000

The Boston Matrix is a method of product portfolio
3 $200 000 analysis that examines the products of a business in terms
of their market share and the market growth.
4 $220 000
5 $225 000
1 What stage of the product life cycle do you think the Types of product in the Boston Matrix
sales are in? Explain your answer. Each circle in the Boston Matrix represents one particular
product or service. The size of the circle illustrates the
turnover of the product; the bigger the circle, the higher
The value of the product life cycle model the turnover. The firm’s products can be classified according
The product life cycle model is valuable because it highlights to their market share and the growth of the market in which
the fact that marketing activities have to be adjusted at they operate.
different stages in the development of a product.
Stars Question marks
However, it is important to remember that the product life
High
cycle is just a model and its shape will vary considerably
between products. In the case of a new single release by
Market growth (%)
a band, for example, the life span may be just a matter of

weeks, whereas Marmite was launched in the early twentieth
century and is still in its maturity phase. Toys often have
short life cycles but some of them, such as Barbie dolls, Cash cows Dogs
have been around for many years. So marketing decisions
in relation to the product life cycle are not clear-cut; some
products in decline have had to be taken off the market
because they cannot be made viable while others, such as Low
the drink Tango, have been rebranded and brought back to
great success.
High Market share Low
Often, it will only be clear in retrospect what stage a
▲ Figure 3.24 The Boston Matrix
product was in; what appears to be a slight dip may turn
out to be the decline of a product, or what appears to be a
» Cash cows are products that have a high market share
decline may only be a slight dip: it only becomes clear later
but are selling in a slow-growing market. In some cases,
on. Unfortunately, businesses have to make decisions as
this type of product will be the market leader in a mature
they go. They do not have the luxury of waiting to see what
market. Although the market may not be growing very
would have happened if they had not acted.
fast, this may be because it has grown in the past,
Another limitation of the product life cycle model is that it leaving little room for further expansion. For example,
traces the sales of one product over time. Most businesses the market for washing machines in the UK is quite big
have several products and therefore it is important to look but is not actually growing very fast; given the size of the
at their overall position. market, a brand with a high market share will have sales
worth millions of pounds. By comparison, the market for
Product portfolio analysis electric cars and organic food is still relatively small but
has potential for fast growth. A cash cow already has a
Most firms have more than one product; some have large market share, so much of the promotional work will
hundreds. For example, at the time of writing, Unilever have been done already. The product is likely to have a
owns a huge number of brands, including Ben & Jerry’s, Cif, good distribution system and people will be aware that
Domestos, Lipton, Magnum, Marmite, Omo, Surf, Timotei the product exists. The firm is used to producing the
and Walls, to name but a few. The range of products and product in relatively large volumes and so the cost per
services a firm has is known as its product portfolio. As part unit should be fairly low. As a result, this type of product
of its planning process, a business will examine the position is likely to bring in high levels of cash for the firm. This
of these products in their markets. This is known as product can be used to finance other products.
portfolio analysis (PPA). One of the most famous models
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» Question marks (or ‘problem children’). These are » If a business has too many dogs, it may have insufficient
products that have a small market share of a fast-growing new products to keep it going in the future. As a result,
3.3 market. These products may go on to be very successful
but, equally, they may fail. They are quite vulnerable
it may want to invest in new products.
» If a business has lots of cash cows, it is generating
and their future is uncertain (hence the name). There relatively high levels of cash but, again, needs to
is a high degree of risk associated with these products, think about the future: cash cows tend to be dominant
because you cannot be sure they will succeed. They products in markets that have already grown. A business
need protecting by the firm and they require extensive may want and need to be involved in newer markets as
marketing. Most new products are question marks well, and it should therefore look to develop some star
because their future is so uncertain, although there are products.
» If a firm has too many question marks, it may be quite
exceptions when a product takes off quickly.

» Stars These products enjoy a large share of a market that vulnerable, as question marks need protective marketing
is growing rapidly. They are highly successful products to maintain and grow their position in the market, and
for the business; however, they are usually expensive in this may drain a firm’s resources.
terms of marketing. Money must be spent to ensure they
With an appropriate mix of products, the cash cows can be
retain their position in a growing market. For example,
used to finance the development of question marks and
they may need to be promoted heavily to maintain
turn them into stars. This way the firm uses money from
customer awareness and to increase distribution in the
established markets to enter new markets and so protects
market.
its future. Portfolio analysis, therefore, provides a good
» Dogs These products have a low market share and are
basis for effective marketing planning:
selling in a slow-growing market. A firm may want to
» Dog products may be sold off or production and sales
get rid of these products unless it thinks it can improve
halted.
its sales. However, dogs can sometimes be revived.
» Star products may be invested in to maintain their
Lucozade used to be seen as a drink to help sick people
position.
get better, until it was very successfully repositioned as
» Cash cows may be ‘milked’ to provide funds.
a sports and energy drink.
» Question marks may be protected.
The impact of product portfolio analysis on Stars Question marks
marketing decisions
High
Market growth
The Boston Matrix provides a snapshot of the position of

all of a firm’s products at a particular moment in time,
whereas the product life cycle focuses on just one product. Cash cows Dogs
This enables managers to see whether or not they have a
Low
balanced portfolio – that is, an appropriate mix of products.

It can help a business to be more effective by providing an
overview so that the manager can take appropriate actions. High Low
Relative market share
For example:
▲ Figure 3.25 The Boston Matrix (2)
CASE STUDY
Coca-Cola
The Coca-Cola Company is a beverage company. It underperforming (which it calls ‘zombies’), it eliminates
has over 500 brands which are sold in more than 200 them to make room for newer products.
countries and territories. Its portfolio of products come
Just over half of Coca-Cola’s revenue is now from sparkling
in the following categories: soft drinks; water, enhanced
soft drinks, with tea and coffee and juice, dairy and plant
water, and sports drinks; juice, dairy, and plant-based
drinks making up about another 20 per cent each, and the
beverages; tea and coffee; and energy drinks. In addition,
remaining sales being from hydration drinks.
the company owns four of the world’s top five non-
alcoholic sparkling soft drink brands: Coca-Cola, Diet Source: https://investors.coca-colacompany.com/strategy/
Coke, Fanta and Sprite. growth-strategy
The company believes its success arises from its ability Questions
to connect with consumers by providing them with a 1 Analyse one reason why Coca-Cola sells products in
wide variety of beverage choices to meet their desires, different product categories. [4]
needs and lifestyle choices. The company constantly 2 Evaluate how product portfolio analysis is useful to
reviews its portfolio and when it has products that are Coca-Cola. [12]
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CASE STUDY
3.3
Crocs
Crocs, Inc. is a world-famous shoes manufacturer. The its footwear. It aims to keep its designs simple and
company was established in Colorado, USA, producing light.
simple, comfortable boat shoes. Nowadays, Crocs
The original Crocs products sold very well, but then
footwear can be found all over the world and there are
entered the maturity stage of the product life cycle. At this
over 120 different styles. Crocs are distinctive for their
stage the managers used the original Crocs as cash cows
bright colours and their comfort. The company describes
3.3.4 Pricing methods

to finance the development of new styles for different
its products as the ‘most delightfully comfortable shoes in
types of occasion.
the world’. It claims that comfort leads to happiness and
this makes the world a better place! The footwear is made Source: https://careers.crocs.com/about-us
of very soft, light and flexible material which makes them
easy to wear. The shoes are made using the company’s Questions
own resin, called Croslite. 1 Analyse one feature of Crocs’ products that you
would use when promoting the product. [4]
Since the business started in 2002, over 600 million
2 Evaluate whether the Crocs brand can last for
pairs of Croc shoes have been sold in over 90 countries.
another 30 years. [12]
The company has over 4000 employees worldwide. Croc
says that it designs everything for the people who wear
The price will, therefore, often play a significant role in

STUDY TIP the purchasing decision. However, the relative importance
You need to be able to discuss the value of the product of price is likely to vary according to the product and
life cycle model and product portfolio analysis. How the particular circumstances. For example, if two petrol
can these models be used in marketing? What are their garages opposite each other are charging different prices
limitations? You also need to make sure you can apply for petrol, we are likely to choose the cheaper one. We are
them. Can you tell from sales which stage of the life unlikely to be loyal to a particular brand of petrol. When
cycle a product is in? Can you identify a cash cow or dog buying a wedding ring, however, we do not always go for
product? the cheapest! Similarly, when buying clothes and shoes we
To make their businesses more effective, business may be willing to pay more for an item if we think the brand
managers need to monitor and develop suitable product justifies this.
portfolios. They must also adapt their marketing at
Even if you wanted to choose the cheapest price, it can
different stages of the product life cycle. You need to be
able to make recommendations, such as how to extend
be difficult to compare prices directly – look at how
the life cycle of a product or how to improve the portfolio complicated the price structure is for mobile phones or
of a business’ products. electricity. The structure of special rates, different tariffs
and different options can make it difficult for customers to
know which is actually the best deal.
3.3.4 Pricing methods Cost of

The price of a product can have a major influence on its Type of product producing a
appeal and whether or not customers think it is good unit
value for money. In this section, we examine the factors Factors
influencing the price of a product and different pricing influencing
strategies. Getting the price right is an important element price
of effective marketing, because it will determine whether
Demand for
customers believe they are receiving value for money. Competitors
a product
How price affects purchasing decisions ▲ Figure 3.26 Factors influencing price
The price of a product plays an important part in our
decision about whether or not to buy it. If the price is too Factors determining the price of a product
high, we simply cannot afford the product even if we want
The price of a product will depend on the following range of
it! Even if we can afford it, we may decide it is not value for
factors.
money if the price seems too high compared to the benefits
the product offers.
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» The type of product Demand for some products is more successful ‘reassuringly expensive’ campaign in the UK,
sensitive to price than others. When you are looking stressing that you pay more for high-quality lager. The
3.3 to buy a new microwave, for example, you are likely to
look online or go to a shop that stocks several models.
price was said to reflect the quality. There are now many
websites offering price comparisons; this makes demand
You may even go to a couple of different outlets to more sensitive to price as customers are looking around
compare what they offer. This type of product is called more.
a ‘shopping good’ because you shop around to find a » Pricing points Some businesses aim to have a given
good deal. These products are very sensitive to price range of products at particular pricing points in the
differences so prices need to be competitive. market (for example, the top or bottom end of the
Other products are known as speciality items. These market) depending on the brand image and other
elements of the marketing mix. Some businesses produce
include high-performance cars and luxury watches.

Customers are likely to be willing to travel some distance several different brands, priced at different levels.
to find these items and are heavily influenced by their For example, a business may produce several different
design and branding factors. These products are less watches (often under different brand names); some in
sensitive to price changes because they are unique. This an exclusive range, some for the mass market and some
may lead to higher prices. discounted items.
» The cost of producing a unit Although in the short term » The objectives of the business The price charged by a
a firm may sell an item at a loss to get it established in firm will be influenced by its objectives. If a firm has a
a market, in the long term a product will nearly always particular profit target, this will influence the price that
have to generate a profit. This means the price has to be is set per unit. If it wants to achieve $10 000 profit and
greater than the cost per unit. Some organisations (such expects to sell 20 000 units, it must make $0.50 profit
as museums and hospitals) are non-profit making and so per unit, if this is possible. If, however, it is aiming for a
do not necessarily have to cover their costs. However, high market share (at least in the short term) it may be
most firms in the private sector have to make a long- willing to sell at a lower price if this will help to boost
term profit to survive. The price therefore cannot fall sales.
below the unit cost for too long. » The stage in the product life cycle The price of a
» The ability of customers to pay If the economy is doing product is likely to be changed at different stages in the
well and customers have high income levels, a firm may product life cycle. For example, when the product is in
be able to increase prices. If, however, incomes are the maturity stage, the price may need to be reduced to
falling, customers may be more sensitive to the price avoid losing sales to competitors.
and look for a better deal (or wait before purchasing); » The rest of the marketing mix The price a firm charges
this may delay any price increases by firms. also depends on the other elements of the marketing
» The demand for a product The level of interest in and mix. A heavily branded consumer product (such as Nike
demand for a product will also affect the price that trainers or Coca-Cola) will be expensive compared to a
firms can charge. Holiday companies will often increase product which does not have a well-known brand, for
their prices in the school holidays, when they know lots example. An exclusive four-star restaurant will charge
of families will want to go away. The holiday companies more than a fast-food store. A designer boutique will
lower prices when demand is lower during term time. charge more than Primark. Typically, the price will be
» The sensitivity of demand to price changes The higher if the product:
sensitivity of demand to price is measured by the – has a unique selling point
price elasticity of demand (which we will examine in – is perceived as being exclusive
Chapter 8.1). Demand for some products is very sensitive – is in high demand
to the price, as people shop around for the best deal. – is sold through exclusive outlets.
Other items may not be so sensitive; for example, There are therefore many factors that can influence the
if it is an exclusive item. price of a product, and setting the price is a complex
» Competitors The price that a business sets for its decision. If managers understand these influences, they can
product must take account of competitors’ prices. If market their products more effectively by setting the right
competitors are offering a similar product or service price for the market conditions. Managers can judge, for
and it is easy to switch from one to the other, firms example, whether a price cut makes sense, given the market
are likely to set similar prices to each other. This is why conditions.
businesses will often stress the particular benefits of
what they are offering, so they can justify a higher Of course, a price is not fixed forever and there are a
price. If customers believe a product provides better number of times when a firm might reconsider the price
value for money, they may still buy it even if it is more it is charging for a product. In the following sections, we
expensive. Stella Artois beer, for example, ran a very consider different pricing strategies and approaches.
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CASE STUDY
3.3
Vertu
Vertu‘s aim was simple: to create something When you owned a Vertu you could also get access
extraordinary. Its main products were luxury mobile to a concierge service. This means you had your own
phones. These began at a price of around $10 000. The private butler online. This service was available for
company said that its products brought together great customers 24 hours a day, every day of the year,
craftsmanship, outstanding performance and exceptional and helped customers organise their lives and gain
customer services. access to the most exclusive events and places. For
3.3.4 Pricing methods

example, the concierge service could help customers
Every Vertu phone was handmade by a single craftsman
get tickets to watch large-scale sports events around
at the company’s small factory at Church Crookham,
the world, meet globally famous chefs at Michelin-star
England. This is not like any other phone – Vertu used
restaurants or travel to private islands.
materials such as ruby, sapphire and titanium. Each
material used was selected not just for the fact that Questions
it looks good, but also for its exceptional strength.
1 State one group that would be a target market for
Customers could have phones made to order so that the
Vertu. Explain your answer. [3]
design reflects their personal choices.
2 Evaluate the factors that would have influenced the
price set for the Vertu phone. [12]
been carried out, a firm may want to generate high

GLOSSARY TERMS levels of demand to spread the costs over many units.
Competitive pricing is when companies set their prices at A low entry price might help do this. Price penetration
the same level as, or slightly below, their rivals. is also beneficial if the market is price sensitive (price
Penetration pricing is a pricing strategy aimed at gaining elastic), in that a lower price will generate significantly
market share via a low entry price. higher sales and increase revenue.
Price skimming occurs when a high initial price is set for a » Price skimming This strategy uses a high price to enter
product and this is reduced over time. a market. Even though the price is high, some people
Price discrimination occurs when different prices are may still be eager to try a new product. Once sales from
charged for the same product. this group of people have been exhausted, the price can
be dropped to attract a new group of customers. When
this group is exhausted, the price can be cut again. A
price skimming strategy is appropriate if the firm can
Pricing methods for new products protect its idea or invention so that competitors cannot
When a product is first launched into a market, a firm has enter with a cheaper version in the early stages. Price
to decide what price to charge. It has a number of options: skimming makes sense if the market is not particularly
» Competitive pricing Some firms set their price at the price sensitive (that is, it is price inelastic), so that a
same level as their competitors or deliberately undercut price cut would generate a relatively smaller increase in
their rivals. Richer Sounds, a hi-fi, home cinema and TV sales. This strategy is often used with new technology;
specialist, guarantees to charge lower prices than rivals. for example, the latest computer or computer accessory
Esso operates a ‘pricewatch’ to monitor competitors’ enters the market with a high price, which then falls
prices. Several retailers offer to refund the difference if quite rapidly a year or so later.
you can find the same product cheaper in another local » Price discrimination This occurs when different prices
store. Competitive pricing is common when consumers are charged for the same product. You will sometimes
can easily make a direct comparison between different find that demand conditions for the same product can
products. The rise in internet usage has made it easier vary and the price changes as a result. For example,
for customers to compare prices between firms; this puts demand for public transport around 8 a.m. is very heavy,
more pressure on firms to be competitive. as people want to get to work for 9 a.m. Similarly,
» Penetration pricing This strategy uses a low price to demand is busy between 5 p.m. and 6 p.m., as people
enter the market and gain market share. This makes want to get home. Demand is less heavy at other times
sense if there are cost advantages from producing on a of day. If a business can identify different demand
large scale. For example, in some markets a high level of conditions, it may want to change the price in the
investment is required to set up, such as when investing different markets. The demand for transport before
in premises and equipment. Once this investment has 9 a.m. and between 5 p.m and 6 p.m. is likely to be price
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inelastic: it is not sensitive to price because people have too low customers may worry about the consultant’s
to get to and from work. At these times, a transport competency. Other examples of psychological
3.3 business may increase price to increase revenue. At
other times of day, demand may be more price elastic
pricing are:
– charging, say, $49.99 rather than $50. In the
(that is, sensitive to price) because there is not the customer’s mind, this makes the price ‘$40
same pressure on people to travel; they can always delay something’ rather than ‘$50 something’ and therefore
their journey or not go at all. To raise revenue at these more attractive.
times, the business may decrease price. The result is – putting ‘was’ and ‘now’ or ‘sale’ to suggest this is
that customers pay different prices for the same journey a bargain. For example, ‘was $20, now $15’ may be
at different times of day. more appealing than just stating ‘$15’.
Price discrimination may occur when firms charge
different prices: Penetration

– at different times of day; for example, taxi fares may pricing
be higher after midnight
– to different age groups; for example, lower fares on Psychological Price
the bus for children and pensioners pricing skimming
– to different customer groups; for example, discounts
for members. Pricing
» Dynamic pricing occurs when prices are changed at Cost-based strategies Price
different times to reflect demand conditions. Airlines pricing discrimination
may change prices according to when you book, utility
companies may change rates according to demand
Dynamic Competitive
for their services during a day, theatres, cinemas and pricing pricing
sports stadia may change the ticket prices depending on
when you are looking. Dynamic pricing is much easier ▲ Figure 3.27 Pricing strategies
with online ordering, where the business can track
in real time the availability of places or products and
measure levels of demand by the number of searches and GLOSSARY TERMS
enquiries, and then adjust the price accordingly. For the Dynamic pricing occurs when different prices are changed
business, it means it does not have to estimate demand at different times to reflect demand conditions.
in advance and set what it hopes is the right price – it
Cost-based pricing occurs when a business considers the
can adjust continually, increasing it if demand looks costs of an item and adds on an amount or a percentage to
high and reducing it if demand is low. This should allow ensure it makes a profit.
the business to control demand more effectively and
Psychological pricing takes account of the psychological
ensure, for example, that its planes, hotels and sports
effect of a price on customers.
arenas are full. The business should be able to maximise
revenue (increasing prices if demand is high to ration The promotional mix refers to the combination of
the products available rather than turning people away) ways in which the business communicates about its
and make full use of the capacity available. From a products.
customer’s perspective, it means be prepared to discover
you paid a very different price from the person in the
seat next to you! STUDY TIP
» Cost-based pricing occurs when a business considers You need to understand the many different factors that
the costs of an item and adds on an amount or a can influence the price of a product and the different
percentage to ensure it makes a profit. A shop may pricing strategies and tactics used by businesses. You
buy in a product at $10 and add on $2 to sell at $12. need to be able to discuss the factors that determine the
The advantage of this approach is its simplicity and right price in any situation.
it means the business is certain it makes a profit,
assuming the item sells. However, the disadvantage is
that it is ignoring demand. It may be that there is such By understanding these pricing methods, managers can
demand that this product could sell for $20 at that decide on the best price to set when launching a new
moment. product. To make a business more effective, it needs
» Psychological pricing takes account of the to select a price that makes customers feel they are
psychological effect of a price on customers. For receiving excellent value for money. The price must be
example, a high price for consultancy work might reviewed and changed as market conditions and external
suggest that the person is an expert; if the price is factors change.
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CASE STUDY
3.3
IKEA
IKEA is a furniture and home-furnishings business. It space. It also avoids the assembly costs as consumers
seeks ‘to create a better everyday life for people ... by do this for themselves
offering a wide range of well-designed, functional home- ● stocks many of its products in a warehouse space.
furnishing products at prices so low that as many people Customers find their products and take them to the
as possible will be able to afford them.’ tills themselves; this saves on staff costs.
Source: www.ikea.com/ms/en_JP/about_ikea/the_ikea_way/
3.3.5 Promotion methods

IKEA is, therefore, committed to high-quality design at
low prices. To achieve this it: our_business_idea/index.html
● designs and manufactures the products itself
● manages its supply chain to be as efficient as possible Questions
● locates its stores away from town centres to benefit 1 Analyse one reason why IKEA is able to keep its
from low rents prices low. [4]
● stores many of the products ‘flat-packed’ (that is, not 2 Evaluate the importance of price as a factor in the
assembled) which enables it to store more in any given success of IKEA. [12]

In marketing, promotion refers to the ways in which
businesses communicate about their products. Advertising
A business will want to communicate the benefits of its

products to its customers. It has to let them know the
Sales promotion Personal selling
product exists, what it does and why they should buy it. In
this section, we examine the importance of the promotional
mix in marketing. This is the combination of activities used
to communicate about and promote the business and its
products. Managing the way that a business communicates
with its customers about its products is vital to its success. Public relations Merchandising
What is promotion and what are its

objectives?
The promotion of a product involves communicating about Direct mail Branding
it to existing or potential customers. The purposes of
promotion include:
» informing customers (for example, telling them about
modifications to the product, promotional offers or new
releases) ▲ Figure 3.28 The promotional mix
» persuading them (for example, highlighting your
product’s benefits compared with competitors’ products) The elements of the promotional mix include the
» reassuring buyers they did the right thing by buying the following.
product in the first place. Advertising promotion
The objectives of promotion are likely to be: Advertising is a paid-for means of communication which
» to increase sales of a business is part of the promotional mix. Advertising is often used
» to increase the market share of a product as a long-term strategy to build brand loyalty. There
» to position the product relative to competitors in the are, of course, many different media available in terms
minds of customers. of advertising, such as newspapers, radio, television and
billboards. Increasingly, nowadays, there are also online
advertising media available.
The promotional mix
Managers must determine the most appropriate media
The promotional mix refers to the combination of ways in
to use. This depends on the resources available, the
which a business can communicate with its customers. The
target group and their lifestyles, the likely sales (which
choice of promotional mix influences the effectiveness of
influences how much can be spent) and the nature of the
the way in which the business is communicating; this, in
product. Mass-market products such as cars may be able
turn, influences the effectiveness of the firm’s marketing.
to justify television advertising, for example, whereas a
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local decorator may advertise in shop windows or a local often takes place through a sales force. If a product is
magazine. The difficulty with advertising is that many sold in low volumes, is technical and complex and needs
3.3 consumers are bombarded by different adverts, and so
getting a message through to your target group that they
to be explained to customers, then a sales force is likely
to be an effective promotional method. The sales team
actually pay attention to can be difficult. With the growth can be absolutely essential in some markets. For example,
of digital television and radio, as well as the internet, the manufacturers must work to achieve sales through the
volume of messages aimed at consumers is increasing all retailers; the manufacturing companies’ sales teams compete
the time and this can reduce the effectiveness of some very aggressively to get their products displayed in the best
advertising. Advertisers therefore have to think carefully way to get their promotions highlighted in the stores.
about what messages to deliver, what media to use and
when to advertise. Direct promotion
This promotion involves communications delivered directly

Effective advertising will be measured by considering the to the consumer without any intervening media. Examples
outcomes achieved (for example, more sales or greater of direct promotion are house-to-house selling, such as
awareness of the product) in relation to the costs of the Avon or Tupperware sales, direct mailings and emailings,
campaign. and telemarketing (which is where a sales team telephone
customers). With increasingly sophisticated database
Sales promotions
information, these can be carefully targeted – although this
Sales promotions are attempts to boost sales using
is not always the case. Some direct promotion is associated
techniques such as promotional offers, competitions and
with ‘junk mail’, which means it is not very well targeted.
price cuts. Offers can include 10 per cent extra free and
Businesses do need to be careful where they get their
‘buy one, get one free’ (called ‘BOGOF’). Sales promotions
mailing lists from and ensure they are not breaking any data
may be used as a means of boosting sales in the short
protection laws by accessing a list. Databases have to meet
term. When undertaking a promotional campaign, a firm
data protection requirements (for example, customers must
must consider:
have access to the information held on them) and be kept
» What will it cost?
up to date to be useful.
» What will it do to the brand image?
» To what extent will the offer be effective? For example, Direct promotion can be relatively cost-effective and
the type of offer you would give as a sportswear the response rate can be measured relatively easily. For
company is different from a wine or perfume business example, what proportion of visits or telephone calls lead
» What is the likely impact on sales? to action by the customer? What proportion of people who
receive an email respond to it?
Personal selling
Personal selling is based on face-to-face contact with
customers. This may be used by manufacturers to get STUDY TIP
distributors to take their products, or in industrial markets Don’t confuse the promotional mix with the marketing
and the service sector, where the producer often deals mix. Read the question carefully and make sure you are
directly with the customer. Financial services such as focused on the right ‘mix’!
pensions, insurance and mortgages are often sold in this
way. Similarly, the sale of products such as photocopiers
CASE STUDY
South Africa
According to the market research company Nielsen, South of the total sales of consumer goods that are bought
African shoppers are obsessed with sales promotions. frequently were sold at a discounted price. There were
According to a report by Nielsen, called The Price of also more sales promotions. The danger for producers
Promoting, 75 per cent of South African shoppers know is that consumers are becoming used to looking for
the prices of their regular grocery items and notice when deals. This will reduce the profit margins of producers
those prices change. This makes South Africa one of the and retailers, as 22 per cent of shoppers say that they
most price-sensitive countries in the world. regularly switch stores according to where the best
promotions are (an increase from 16 per cent in 2017).
In South Africa, consumers face significant financial
constraints, especially with the rising price of petrol, Question
taxes and energy bills. This means that customers are
1 Evaluate the importance of sales promotions as
searching for special offers. The use of promotions
part of the promotional mix in South Africa. [12]
can attract customers in the short term but it can also
damage the value of a brand. In 2018, around 30 per cent
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Brands may form an important part of a promotional
CASE STUDY campaign. Businesses may promote the brand because it
brings with it all the associated values. When a new Apple
iPhone is promoted, we expect a super design, a fantastic
3.3
Swatch
look to the product and some new technology, because
Swatch Group is an international group active in the that’s what we associate with Apple. A well-established
design, manufacture and sale of finished watches,
brand brings with it immediately a collection of messages
jewellery, watch movements and components. The
that feed into any communication. A Tesla product will
Swatch Group owns a number of watch brands. These
be innovative, a Gucci product will be luxurious, and a
brands target different groups and have different price
points.
Volvo product will be safe. Promotional campaigns can use
the brand as a selling point in itself (think about strong

Questions brands such as the University of Cambridge or Harvard
1 Define the term ‘segmentation’. [2] University) that immediately conveys something about the
2 Evaluate the possible reasons why a firm such as product.
Swatch operates with different brand names. [12] At the same time, promotional campaigns will help build the
brand. The promotions will convey key messages about the
personality of the brand – is it fun? Quirky? Global? Young?
The role of branding The design and messaging of advertisements, of digital
In some markets, branding is very important. By building campaigns and all other forms of promotion can shape the
a brand, businesses hope to make customers more loyal. brand and customers’ attitudes towards it. Imagine you are
This may allow them to charge more for items, by making about to buy a laptop or tablet – will you look at Apple?
the demand price inelastic. It may also make it easier to Microsoft? Lenovo? HP? Google Chrome? Without even
introduce new products under the same brand name, as thinking about price or technical specifications, you will
customers may feel reassured and be more willing to try have a reaction to each of those brand names; this reaction
them. If customers recognise a brand, they can associate could be due to past experience, but it will also be shaped
with all of its values and this in itself can provide a by the promotional campaigns of the business. At times,
benefit – people may feel more secure driving a Volvo than promotional campaigns will specifically aim to change your
other brands of car, more fashionable using an Apple Mac perception of a brand. Burberry, for example, was originally
than other computers, and smarter wearing Prada than other positioned as quite an exclusive brand, but it then became
fashion labels. Increasingly, some people want to identify one very wide range of products, which some say damaged
with a brand and the lifestyle that is associated with it. its appeal; in recent years it has been trying to re-establish
this link with premium fashion design. Amazon has been
Brand loyalty is very important because it is easier and
criticised for the terms and conditions of employees in its
cheaper for a business to sell more to an existing customer
warehouses, and it has responded to this by promoting
than it is to generate a new customer. However, a brand has
the work of those people working in the warehouses and
to be protected and managers have to be careful that it does
inviting people to visit. Promotion may, therefore, be used
not become associated with the wrong things. For example,
to build, reposition or protect a brand.
in 2010, Toyota had to recall millions of cars due to a brake
problem which damaged the company’s reputation for quality.
CASE STUDY
Sir Richard Branson and the Virgin brand
it was clear he had a real flair for publicity. He originally
set up the Virgin brand as a mail-order record company,
then subsequently opened a physical store in Oxford
Street, London. In 1972, he founded the Virgin Records
music label and recorded what came to be a best-selling
record, Tubular Bells by Mike Oldfield, in 1973. In the
punk rock era, Virgin Records signed the Sex Pistols,
even though other record labels wouldn’t go near them.
This proved to be a marketing success. Over the years,
Virgin accumulated many other stars, including Genesis,
Peter Gabriel, Simple Minds and The Rolling Stones. This
▲ Figure 3.29 Sir Richard Branson gave Virgin a major international presence in the music
industry. Virgin has also diversified into air and rail travel,
Sir Richard Branson was born in 1950 and educated at mobile phones, finance, weddings, wines, retail, drinks,
Stowe School, in the UK. He went into business aged 16, hotels and gymnasiums. It now has around 200 companies
publishing Student magazine. As a young entrepreneur, in over 30 countries, employing more than 25 000 people.
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One of Sir Richard’s strengths has been his ability to get vehicles that are designed to give private individuals the
3.3 free publicity for the business. He has had his picture
taken in a wedding dress, as well as with Pamela
opportunity to see the Earth from space. It will operate
a regular schedule of space flights from the company’s
Anderson, Diana, Princess of Wales, and Nelson Mandela. base at New Mexico’s Spaceport America, the world’s first
In 1985, Sir Richard attempted to beat the record for the purpose-built commercial spaceport.
fastest crossing of the Atlantic by boat, but his vessel hit
driftwood and sank only 100 miles (160 km) from home. Questions
In 2004, he achieved the fastest crossing of the English 1 Explain one key feature of the Virgin brand. [3]
Channel by amphibious vehicle, marking the twentieth 2 Evaluate other products that you think the Virgin
anniversary of the Virgin Atlantic brand. brand could extend to. [12]
Sir Richard’s latest venture is space travel. Virgin Galactic

is a commercial spaceline. It operates modern space
CASE STUDY
Biggest global brands
▼ Table 3.12 Biggest ten global brands
Ranking Company Change in brand value (%) Brand value ($m) 2019
1 Apple +9 234 241
2 Google +8 167 713
3 Amazon +242 125 263
4 Microsoft +17 108 847
5 Coca-Cola –4 63 365
6 Samsung +2 61 098
7 Toyota +5 56 246
8 Mercedes +5 50 832
9 McDonald’s +4 45 362
10 Disney +11 44 352
Source: www.interbrand.com/best-brands/best-global-brands/2019/ranking/
Questions
1 Choose one of the brands in Table 3.12 and explain one element of its brand values (that is, what does
the brand stand for?). [3]
2 Evaluate the benefits to a business of having a strong brand. [12]
The role of packaging However, packaging can also play a role in the promotion
Packaging may be needed to: of the product. Packaging helps communicate about the
» protect the product; for example, while being product. The packaging can:
transported (think of an egg box!) » reinforce the positioning and branding. Think about
» preserve the product; for example, tinned food perfumes; the bottle itself and the box it is in often reflect
» keep the product secure; for example, razor blades a premium product. The shape, the design and the colours
are high-value items and are vulnerable to being of the packaging will send messages about the product
stolen from stores. The packaging of these products » reinforce a promotional campaign; for example, if a
is sometimes bigger than it needs to be to make them promotional offer is on where there is 10 per cent extra
visible in-store free, this can be shown on the packaging.
» provide information to customers; for example, At the same time, the promotional campaign can focus
information on the ingredients. on features such as new sizes, resealable containers, new
shapes of containers or new recyclable materials.
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CASE STUDY
A recent packaging development at L’Oréal is Lip Magnet.
3.3
L’Oréal
L’Oréal’s packaging innovation team designed an
According to L’Oréal, the cosmetic business, packaging applicator capable of applying the right amount of product
is a ‘make or break’ factor in the beauty experience. It on the lips with comfort, precision and creating the
has a huge influence on the commercial success of a sensation of a weightless film. The transparent bottle with
product, affecting the reviews of beauty bloggers and the thick walls highlights the product shade.
responses of their millions of followers.
Questions

1 Analyse one factor that might influence the packaging
of a cosmetic product. [4]
2 Evaluate the importance of packaging in the marketing
mix of cosmetic products. [12]
Source: L’Oréal (UK) Limited

▲ Figure 3.30 L’Oréal packaging
Digital promotion on what they are searching for or what they have been
The fastest growing element of the promotional mix looking at. Adverts can adjust depending on whether this
in recent years has been digital promotion. Digital is a person’s first visit to a website or whether they have
promotion involves promoting a brand, product or been there before. If a business understands its customer
service on digital channels such as search engines, social profile well and targets them effectively, and if it monitors
media, email and mobile apps. Many businesses in recent the actions taken by customers and adapts what it does
years have reduced their spend on printed materials and accordingly, then digital promotion can be very effective
increased their digital spend. and low-cost.
Businesses use social media such as Facebook, Twitter and However, businesses do need to monitor their spending
Instagram to develop their brand image and to communicate and make sure it is targeted. Paying for millions of click-
with their target market. They also use paid-for online throughs by customers who like the online advert but have
advertising such as Google AdWords to target potential no intention of buying the product can waste money. The
customers, or they might pay social influencers such as effectiveness of digital promotion is also limited to those
Kim Kardashian West to endorse their products – this will who are online; it will not reach those who are offline.
enable a business to bring its product to the attention of all
the followers of the influencer. Businesses also encourage GLOSSARY TERMS
customers to leave reviews online, as this can help to gain Digital promotion involves promoting a brand, product or
customers’ confidence in the product. service on digital channels such as search engines, social
Digital promotion can be very cost-effective. You can media, email and mobile apps.
target customers very carefully based on factors such as The click-through rate (CTR) measures the number
their location, age and interests. A business can also track of visits to a website as a percentage of the number
exactly what actions customers take – for example, they can of impressions of a digital advert. For example, a
measure the click-through rate (CTR) from an advert to a CTR of 20 per cent means 20 per cent of the times an
website; they can also track exactly the movements of the advert is viewed, someone clicks on it to find out more
consumer coming to the firm’s website to measure whether information.
it leads to a sale. Adverts can be shown to users depending
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CASE STUDY
3.3
Dwayne ‘The Rock’ Johnson
In 2020, Dwayne ‘The Rock’ Johnson was listed as the before tax. His films include Fast and Furious and
highest-paid sponsor for an Instagram post. It was Jumanji. Johnson also has a partnership with the US
claimed that Johnson charged over $1 million per post sports brand Under Armour and holds a stake in the
last year. Previously, Kylie Jenner was listed as the Norwegian bottled-water brand Voss.
highest-paid. She has 182 million Instagram followers;
Source: www.bbc.co.uk/news/business-53261043
Johnson has 187 million. It was estimated that footballer
Cristiano Ronaldo was worth $889 000 per post, and Kim Questions
Kardashian West could charge $858 000. The rankings of
1 Analyse one factor that influences the amount
social-media sponsors were produced by Hopper HQ and
someone can charge to sponsor a social-media post.
were estimates, as the precise amounts paid are highly
[4]
protected.
2 Evaluate the importance of social media in affecting
According to Forbes, Johnson was the highest-paid consumers’ buying decisions. [12]
actor in the world, earning nearly $90 million in 2019
CASE STUDY
Facebook versus Twitter
▼ Table 3.13 Facebook versus Twitter – selected metrics
Facebook Twitter
Market capitalisation ($bn) 655.7 27.4
3 June 2020
Revenues ($bn) 70.7 3.5
2019
Net profit ($bn) 18.5 1.5
2019
Employees (’000) 48.3 4.9*
Q1 2020
Daily active users (bn) 1.7 0.2
Q1 2020
* Q4 2019
Source: The Economist
Questions
1 Analyse one factor that might determine how much a social-media business can charge other businesses to
advertise on it. [4]
2 Evaluate the importance of social media in the marketing mix of businesses. [12]
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CASE STUDY
3.3
Digital marketing
Recent market research shows: ● 54 per cent of consumers say fashion is the top category
● Only 17 per cent of consumers have been influenced where social media has influenced their purchases, while
to buy a product or service following an endorsement 45 per cent of consumers say the same for technology.
from an influencer or celebrity.
● On the other hand, 32 per cent of consumers are Questions
influenced to buy a product or service following a 1 Analyse one possible objective of a social-media

positive review on social media. campaign. [4]
● 8 in 10 consumers have undertaken at least one or 2 Evaluate the importance of social media for
more financial activities via a digital channel in the businesses wanting to promote their products. [12]
past year.
Each of the different methods of promotion has its own

advantages and disadvantages, as shown in Table 3.14.
For example, personal selling is obviously quite
labour-intensive, and therefore expensive, but the firm gets
immediate feedback from its customers.
▼ Table 3.14 A comparison of promotional methods
Method of promotion Advantages Disadvantages

Advertising • Wide coverage • Can be expensive; for example, TV advertising
• Control of the message
• Can be used to build brand loyalty
Direct promotion • Relatively cheap • May not get read
Sales promotions • Can entertain and interest the consumer • Often short-term effects
• Can encourage brand switching
Personal selling • Two-way communication • Can be expensive
• Can answer customer enquiries • Can only reach a limited number of customers
Digital promotion • Can be very targeted • Need to target effectively
• Can track actions taken online • Will not reach those who are not online
• Can use influencers to attract new customers
CASE STUDY
Red Bull
Red Bull is an ‘energy drink’ that originated in Thailand ● The company heavily invests in brand-building, including
and is sold to combat mental and physical fatigue. The promoting the slogan ‘Red Bull gives you wings’.
marketing of the product has been highly successful and ● Red Bull sponsors many extreme sports events
includes a number of unusual promotional methods. including cliff diving, BMX and skiing. Red Bull also
For example: sponsors the Red Bull Flugtag (‘flight day’ in German),
● Selected students (students are a key market) are a competition where entrants launch themselves off a
given free cases of Red Bull if they throw a party; 30-foot (9-metre) ramp in homemade ‘flying machines’
others are given a car with a model Red Bull on the into a body of water.
top to drive around and be noticed by others. This ● In recent years, mainstream advertising such as
is known as ‘viral marketing’. It relies on a few key television has also been used.
trendsetters spreading the word about a product
and leading to others wanting to be associated Questions
with it. 1 Analyse one reason why a business might choose
● Sales teams identify key bars and clubs and promote to sponsor an event. [4]
heavily via merchandise, such as branded coolers 2 Evaluate other types of events you think it would
and point-of-purchase (or POP) displays. make sense for Red Bull to sponsor. Explain your
selection. [12]
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Choosing the right promotional mix GLOSSARY TERMS
3.3 Businesses use a combination of promotional methods to
communicate to potential customers about their products.
The marketing expenditure budget is the amount of
money a business allocates to spend on marketing
The composition of the promotional mix depends on activities such as promotion.
numerous factors: The distribution channel describes how the ownership of
» Nature of the product Consumer-durable products, a product moves from the producer to the customer.
such as televisions and washing machines, are likely to
be advertised to the final customer. Firms usually use a
sales team to deal with wholesalers and retailers but use To make its promotion more effective, a business might
advertising to get customers to demand the product in alter the total amount spent on it or review the promotional
the stores. By raising awareness of the brand, customers mix. As customers’ habits change, the mix might need to
will recognise it when they go to buy a product. be altered as well (for example, switching to more internet
Similarly, companies producing shampoos and household advertising).
cleaners often advertise on television. By comparison,
sales of heavy construction equipment are usually made
direct to the customer and rely on the sales force. There 3.3.6 Place (channels of
are relatively few customers in this case, the product is
expensive and sold in low volumes, and there are many
distribution)
technical details that need to be explained. A sales force The distribution of a good or service refers to the way
is likely to be much more effective than, say, an advert in which the ownership of it passes from the producer to
in a brochure. the consumer. In some cases, the product goes directly
» Marketing expenditure budget Inevitably, the budget to the end customer from the producer (business-to-
acts as a constraint on all firms’ promotional activities consumer marketing, see page 102). For example, Dell
because it limits the amount of money available to Computers supplies some of its customers direct, without
spend in this area. Faced with a small marketing budget, intermediaries, as does Avon Products. Services such as
for example, a firm cannot even consider television insurance, health care and education tend to be provided
advertising and may have to rely on local newspaper directly to the end customers.
advertising instead.
In other cases, producers use intermediaries. Most producers
» Available options Technological developments are of electrical goods, such as Sony and Phillips, have
creating new possibilities, such as internet advertising
intermediaries between the producer and the final seller.
and text advertising. Legal changes also influence
These intermediaries include:
what is possible; for instance, what products can be
» retailers (such as Walmart), which are the final stage
advertised and how they can promote themselves. For
in the distribution chain. Many goods are sold through
example, there are strong restrictions on the promotion
retailers rather than direct to the customer
of alcohol and tobacco.
» wholesalers. These buy products in bulk from producers
Improvements in the promotional mix may: and sell them on to retailers, who then sell direct to
» reduce costs, as cheaper ways of communicating are the final consumer. Retailers use wholesalers because
adopted they offer a range of products and it is easier dealing
» boost sales, as better ways of communicating are used directly with them than with many different individual
to communicate more effectively and to more people. manufacturers.
The different distribution channels can be described in
STUDY TIP terms of the number of levels involved in the process (see
You need to be able to understand the different Figure 3.31).
messages a business might be trying to communicate
to different groups, such as investors and consumers. Zero-level channel: no intermediaries
You also need to understand the different elements of Producer Consumer
the promotional mix and how these will be changed for
different products and different situations. Think about One-level channel: one intermediary
whether some methods are more appropriate than
Manufacturer Retailer Consumer
others for specific products. Do not assume advertising
is always the answer – there are many other ways of
communicating that may be more effective for some Two-level channel: two intermediaries
products. Manufacturer Wholesaler Retailer Consumer
▲ Figure 3.31 Distribution channels
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» In a zero-level channel, the good or service passes The objectives of distribution
directly from producer to consumer without any
intermediaries. For example, dentists, accountants and
plumbers have zero-level channels.
The management of distribution will focus on ensuring the
right products reach the right customers at the right time 3.3
and at the right cost. It will aim to ensure the distribution
» A one-level channel has one intermediary. For example, process:
a retailer buys the product from the manufacturer and
» gets the products where customers need them; for
sells it to the consumer.
example, in the right shops and outlets
» A two-level channel has two intermediaries. For » makes sure the products reach where they need to be in
example, a wholesaler buys the product from the
good time and are undamaged
manufacturer and sells it on to retailers, who sell to the
» provides good value for money.
3.3.6 Place (channels of distribution)

final customers.
The distribution strategy will vary considerably from Choosing a distribution channel
product to product. In the case of milk, newspapers and
The choice of distribution channel will depend on factors
chewing gum, for example, the aim is usually to generate
such as:
as wide a distribution as possible. These types of goods are
» Access to markets If the target number of customers
called convenience items because consumers are not willing
is relatively small (for example, you are targeting
to travel far to buy them – they need them to be easily
a few large companies), then it may be possible to
accessible. In order to get to as broad a market as possible,
distribute directly. If, however, you have a mass-market
several intermediaries may be used.
consumer product, it is not realistic to try to distribute
With products such as personal computers, vacuum cleaners, individually to all your customers – you will want to
microwaves, and so on, consumers usually want to compare use intermediaries to help get your products to the
the features and prices of different brands. Manufacturers market. Heinz could not distribute its baked beans to
of these products need to get them distributed to certain every individual household in the UK; it has to sell via
stores where customers expect to go to find them. These wholesalers and retailers.
shopping goods do not need to be distributed to as many » The desired degree of control If a producer sells its
outlets as convenience items, but the firm may have to products to other intermediaries then it hands over
fight hard to get intermediaries to stock them. Although control of the way they are marketed. The new owner
with the growth of online shopping manufacturers do sell can change the price, the way it is described relative to
directly to customers, many sales are still through retailers, its competitors and where it is displayed in the market.
including online retailers such as Amazon. Concern over the impact of such decisions on the brand
may mean that a producer decides to sell directly or only
More exclusive (or speciality) products such as Rolex,
via its own outlets.
Porsche, Bang & Olufsen and Bose have even fewer outlets,
but the nature of these outlets is very important. They
» Costs It may be cheaper to sell a product direct to
the customer. If the product goes through various
must reinforce the nature of the brand, and so a great deal
intermediaries, all of whom add on their own profit
of time is spent ensuring they are well maintained and
margin, the final price will probably be higher than if
suitably exclusive. In some cases, the manufacturer owns
the business sold direct to a customer.
the outlet to ensure it presents its products in a way that is
appropriate to the brand. Companies such as Amazon.com, Direct Line and
lastminute.com have turned the distribution of their
Products that are sold to other businesses (business-to-
services into a major competitive weapon. By distributing
business marketing, see page 102) rather than the final
directly to the customer, they have cut their own costs
consumer are called industrial goods (rather than consumer
(enabling them to offer better value) and provide a more
goods). These tend to be distributed directly. This might
convenient service for customers. You can now order your
include machinery, office equipment and specialised
weekly shopping, buy your books, check your bank account
computer software.
and book your holiday from home. The internet allows many
One growing trend in business is for products to be bought firms (even very small firms) to deal directly with their
directly from the producer. Distribution is increasingly customers on a global basis.
zero-level. Customers can access their products online and
Choosing the right distribution channel is an important (and
buy direct from retailers or even direct from the producer.
often under-estimated) part of the marketing mix. It can
Distribution at this point is then either direct to the
have a big impact on the success of the business in terms of
customer or via a pick-up point; if customers are using ‘click
factors such as:
and collect’, for example, they order the product online and
collect it later in-store.
» market coverage
» costs
» control over the way the product is promoted and
marketed in-store.
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Digital distribution Other examples of digital distribution are e-books and
computer games. The Coronavirus (COVID-19) pandemic
3.3 One of the growth areas of business is digital distribution,
when customers access products directly online. When Netflix
in 2020 forced many businesses to increase their online
provision; this is speeding up digital distribution in sectors
began, it physically distributed films on CD to customers’ such as education and health care.
homes. The films were posted out and posted back. It now
produces content which is digitally distributed online. This Digital distribution is cheap and enables products to be
has transformed the entertainment industry. available to customers whenever they wish, wherever
they wish, through a variety of devices. However, digital
Music is another example of an industry which has been distribution will not be appropriate for markets where
revolutionised by digital distribution. Many years ago, music customers want a physical product such as clothing.
companies produced physical records and distributed these

physically to stores. Now, via providers such as Spotify,
customers can consume music digitally.
CASE STUDY
E-commerce sales in Asia
In billion USD 90%
1462 83%
1286 77%
1188 74% 74%
1077
957
832
707
2017 2018 2019f 2020f 2021f 2022f 2023f
Note: f = forecast data
Bangkok Central North North-east South
▲ Figure 3.33 Percentage of adults owning mobile

17%
phones in Thailand
35% E-commerce is a very fast-growing industry in Thailand.

According to the Ministry of Digital Economy and Society,
16% Thai e-commerce has grown the fastest of all economies
that are part of the Association of Southeast Asian Nations
(which is a group of countries that trade together) at 14–18
per cent a year.
11%
21% With a national income of $602 billion, Thailand is
the second-largest economy and the second-largest
business-to-consumer e-commerce market in Southeast
Asia (Indonesia is the largest).
The e-commerce market in Thailand is worth $3.5
By segment (2018)
billion. This is expected to reach $13 billion by 2025,
given the higher level of demand for Thai products.
Fashion Food and beverage, and Demand is especially high for electronics, but behind
Home and personal care this there are high levels of interest in fashion, jewellery,
Electronic and media Furniture and appliances watches, health and beauty products, and car parts.
Toys, hobbies and DIY
▲ Figure 3.32 E-commerce sales in Asia
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One reason for the growth of e-commerce is the engage in online shopping twice a month, and 90 per cent
high number of internet users. Nearly 60 per cent of
households have the internet in Thailand; this is one of the
plan to shop online in the future.
Unsurprisingly, Thailand is an appealing target for
3.3
highest rates in Southeast Asia. foreign investment, due to its market size and growing
In 2008 there were 16.1 million internet users; by 2018 e-commerce potential. Already Chinese internet giants
this had increased to approximately 45 million. There are like Alibaba and JD.com have invested there.
also currently 124.8 million mobile subscribers, 44 million
Source: www.thailand-business-news.com/tech/ecommerce/75276-
LINE messenger users and 52 million Facebook users. thailand-ecommerce-market-shooting-for-success.html
In Thailand, 52 per cent of online transactions are made
Questions

on mobile devices, making the country a regional leader
in mobile commerce. (Thailand is second only to South 1 Analyse one reason why e-commerce is growing
Korea, at 58 per cent.) The Thailand Marketing Research fast in Thailand. [4]
Society reported that 71 per cent of smartphone users 2 Evaluate the benefits of e-commerce to
producers. [12]
» The aroma in the store is likely to be fresh bread (many

Getting the right distribution outlet now have bakeries on-site, but even if they do not, they
Of course, the nature of the distribution outlet itself can can create the smell of fresh bread); this tends to create
have an impact on the buying experience. The layout of positive, warm feelings within us.
the stores, the decor, the availability of staff and changing » You will usually enter on the left-hand side of a store
rooms, and the in-store displays all leave an impression because we tend to like walking in and turning right.
and influence the customer’s view of a product. This is » The basic items such as bread and milk will usually be
particularly important for speciality items such as luxury at the back of the store, so that you have to pass many
cars, jewellery or sophisticated technology. Visit a Mercedes other items to find them and hopefully buy other things
dealership, a Gucci outlet or an Apple store and you along the way.
immediately get a sense of the brand values. » Key items on promotion will be placed in display bins at
the end of aisles so you see them when you turn, or by
If producers of such products are selling through stores
the tills; these are to prompt impulse-buying.
(theirs or anyone else’s), the store design and the way their
» Complementary items such as soft drinks and crisps will
products are displayed is very important. IKEA, the Swedish
usually be placed near each other, as buying one may
furniture retailer, is renowned for its highly effective store
prompt buying the other.
design. Its stores are very large and are placed out of town.
This makes it cheaper for the company to offer a large Store designers have become very aware of the effects that
number of parking spaces. The stores are relatively easy the decor and layout can have on customers, and they have
to get to for car drivers, which is important because the therefore become much more sophisticated in their designs.
items bought are often big and bulky. Once customers get The physical environment is an element of the marketing
there, the stores are designed in such a way that customers mix, because it can have an important effect on where we
have to walk through all the displays to get to the tills – choose to shop and how we behave as shoppers while we are
you cannot ‘nip in’ and buy one thing. This may mean that there.
customers buy more than they had planned.
In supermarkets, all kinds of techniques are used to make GLOSSARY TERM
you buy more: The distribution outlet is where the product is actually
» The width of the aisles and the music being played sold; for example, the shop.
affects the speed that you walk around the store.
» You will usually be greeted by the fresh-fruit displays
when you walk in; this creates an impression in your
mind that all their products are fresh.
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CASE STUDY
3.3
Hotel Chocolat
When Angus Thirlwell and Peter Harris opened the very
first Hotel Chocolat shop in north London in 2004, ‘it
was the start of a revolution in British chocolate’. The
two entrepreneurs were determined ‘to make chocolate
exciting again’. Hotel Chocolat now has 103 shops
along with cafés and restaurants, three boutiques in
Copenhagen and a hotel on its cocoa plantation in the

Caribbean.
Thirlwell and Harris started an online chocolate business,
investing £5000 each, but found greater success with
a conventional high-street presence. The stores were
carefully designed to reflect the premium chocolate sold
there. The company chose dark-walnut wood interiors and
porcelain tiles. It used long counters like a hotel reception
desk, and made the stores spacious so that people could
wander around, like in a hotel lobby. Whereas fast delivery
was the sales pitch of the internet website, quality was the
selling point of the stores.
The company prides itself on doing things differently.
It says that right from the beginning it ignored what it
was told. When it began and was told to make the shells of
its Easter eggs as thin as possible, it did the opposite and
made them incredibly thick! When it was told it must make
chocolate bars with bite-sized pieces, it decided on giant
slabs! ▲ Figure 3.34
The company is unusual in that it grows its own cocoa. Questions
This is grown on its Rabot Estate plantation in Saint
1 Analyse one factor that Hotel Chocolat might take
Lucia. Unlike most chocolate, Hotel Chocolat focuses on
into account when deciding a location for a
more cocoa and less sugar. Often, 40–50 per cent of its
new store. [4]
ingredients are cocoa; much more than is typical in the
2 Evaluate the possible reasons why Hotel Chocolat
industry.
was more successful when it opened stores than
Source: https://us.hotelchocolat.com/our-story when it was just operating online. [12]
CASE STUDY
L’Oréal and distribution
L’Oréal produces beauty products, hair products and fragrances. It uses seven distribution channels, shown in
Figure 3.35.
7 distribution
channels
Department
Pharmacies and Hair salons Branded retail Mass retail Travel retail E-commerce
stores and
medispas
perfumeries
▲ Figure 3.35 L’Oréal distribution channels
Questions
1 Analyse one factor L’Oréal will consider when choosing a distribution channel. [4]
2 Evaluate the advantages and disadvantages of the different channels of distribution used by L’Oréal. [12]
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consumers that, with advances in technology, can be
STUDY TIP processed quickly and cheaply, allowing very targeted
You need to think about the factors that influence a
company’s choice of distribution channel and its outlets,
marketing actions. When developing a promotional
campaign online, a business can set criteria which
3.3
and the effect this has on its costs and the quality of again allow very focused marketing. Google adverts,
service it provides. for example, can run in a given region for selected
search terms. Facebook ads can target people in a
particular age range with particular interests, hobbies
A business may improve its effectiveness by reviewing its or lifestyles. Collecting the right data, analysing and
distribution, as this may influence its market coverage, the using it effectively can enable very focused marketing.
level of service provided and its costs. Many people under- » Price The internet allows prices to be changed according

estimate the importance of distribution, but it is often to when people order (for example, how far in advance
vital to the success of a product. You will only sell chewing of an event), what time of day they order, whether they
gum or newspapers if they are widely distributed and well have visited the site before, whether they have bought
displayed, for example. from you before. The ability to adjust the price based
on many factors so that there is no ‘one’ price is known
The internet and marketing as dynamic pricing. Businesses such as airlines and
The growth of the internet is an important external change online retailers such as Amazon use dynamic pricing very
which has, of course, had a big impact on marketing effectively.
activities. For example, businesses can now: » Promotion Businesses can promote their products online
» trade globally 24 hours a day, seven days a week, and target who their adverts reach depending on, for
relatively easily example, where you are searching from and which terms
» use very targeted marketing; for example, using Google you are using to search. Businesses can get others to
AdWords so that your advert only shows when some key help promote their products through viral marketing,
words are used where their own campaign is forwarded via social media
» monitor consumer behaviour very accurately; for (such as Twitter and Facebook) by individuals to their
example, tracking how visitors to the website move friends. Methods of promotion such as blogs and Twitter
around the site are cheap ways of communicating.
» charge different prices depending on where people are » Distribution Businesses can now sell direct to
searching from and when they search. This is known the customer online rather than selling through
as dynamic pricing (see page 126) and is used a lot by intermediaries. By selling directly through e-commerce,
airlines and hotels. The price you are offered depends on a business may need fewer physical stores. This is known
when you enquire and what the demand is at that stage; as ‘clicks rather than bricks’.
if there are still lots of vacancies, the prices tend to be » Product Some products can now be downloaded rather
lower than having to be physically produced; for example,
» use direct distribution from the producer to the consumer music and e-books.
without the need for wholesalers and retailers. It also » People Interestingly, people are not necessarily removed
enables electronic distribution (for example, of music from marketing due to the internet. In fact, many
and books) without a physical product being distributed businesses now promote in their websites the ability to
(for example, to e-readers and MP3 players). talk to a customer service representative at any time.
The impact of the internet on market research and the The internet can interest you in an item and the sales
marketing mix includes: representative can help you with enquiries or to make
» Data The internet allows businesses to gather and your choice.
analyse data on consumers far more than was ever » Process The internet can make the buying process more
possible in the past. For example, if you go on the convenient in that you can search more widely than in a
website of a business, it can track what you look main shopping street.
at, for how long and what action you then take. It » Physical evidence The design of a store may be less
can monitor whether this is the first time you have significant with the internet, but the design of the
visited and how you reached the site – for example, website becomes the key. The appearance, the ease of
was it through a direct search or via an online advert? finding information and navigating the site affect the
Was it through your laptop or your mobile phone? customer experience.
This all provides extraordinary amounts of data on
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CASE STUDY
3.3
E-books
Book publishers generated almost $26 billion in revenue Questions
in 2019 in the USA. Of this, total print sales were $22.6
1 Analyse one factor that might affect sales of
billion and e-books took $2.04 billion, according to the
e-books. [4]
Association of American Publishers’ annual report (2019).
2 Evaluate the threat that e-books pose for printed
Those figures include fiction, trade and educational books.
books. [12]
Despite the disruption of digital media in other industries

(such as news publishing and music distribution), it seems
that people still favour printed books. In part, it is the
physical object. Cover designs, for example, can make a
book appealing and something people want to own and
have in their homes. Physical books act as a reminder of
what you have read, they show others what you have read
and they decorate your home.
Popular print genres include nature, cookery and
children’s books while crime, romantic and thriller
readers prefer to engage with novels via e-readers, says
Nielsen Book International.
In the UK, 63 per cent of physical book purchases are
made by people aged under 44, while 52 per cent of
e-books are purchased by those over 45, according to
Nielsen. ▲ Figure 3.36
TEST YOUR LEARNING

6 a Define the term ‘price discrimination’. [2]
b Explain one benefit of price discrimination to a
1 Define the term ‘marketing mix’. [2] business. [3]
2 a Define the term ‘product life cycle’. [2] 7 a Define the term ‘brand’. [2]
b Explain one way in which the marketing mix b Explain one way in which developments in digital
might change at different stages of the product promotion help businesses. [3]
life cycle. [3]
8 a Explain one possible objective of promotions. [3]
3 a Define the term ‘extension strategy’. [2]
b Explain one way sales promotions can benefit a
b Explain one extension strategy with an example.[3] business. [3]
4 a Define the term ‘price penetration’. [2] 9 a Define the term ‘distribution outlet’. [2]
b Explain one condition necessary for price b Explain one benefit to a producer of a short
penetration to be effective. [3] channel of distribution. [3]
5 a Define the term ‘price skimming’. [2] 10 a Define the term ‘USP’. [2]
b Explain one condition in the market for price b Explain one benefit to a business of having
skimming to be effective. [3] a USP. [3]
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Data response question opening at midnight to sell the first copies. Fan-generated
Harry Potter
content, helped by the growth of the internet, has been an
important part of the Harry Potter success story. 3.3
Harry Potter is a character who features in a series of Fan sites such as www.the-leaky-cauldron.org and
seven children’s books by JK Rowling. The story is mostly www.mugglenet.com help promote products and
set at Hogwarts School of Witchcraft and Wizardry, and merchandise.
focuses on Harry Potter’s fight against the evil wizard
One of the most remarkable aspects of Harry Potter’s
Lord Voldemort, who killed Harry’s parents as part of his
success is its appeal to adults, apparently reminded of
plan to take over the wizarding world.
classics of their own childhoods. Bloomsbury quickly
The first novel, Harry Potter and the Philosopher’s Stone, was acknowledged the purchasing power of these ‘kidults’ by

published in 1997. Since its launch, the books have gained issuing the Potter series as ‘adult hardbacks’, with covers
immense popularity and commercial success worldwide, redesigned using photographs rather than drawings.
also leading to films, video games and various merchandise –
Following the original seven books and eight film
from ‘Quidditch’ chess sets to ‘HufflePuff’ wall hangings,
adaptations, there are now four Wizarding World of Harry
‘Goblet of Fire’ candle holders to ‘Hedwig’ pillowcases.
Potter theme parks (two in Florida, one in Hollywood and
Altogether, the books have sold well over 500 million one in Osaka in Japan). The Warner Bros Studio Tour, The
copies, have been translated into more than 63 languages Making of Harry Potter, has had more than 8 million visitors
and reach readers via a variety of distribution channels. since it opened outside London in March 2012. Rowling,
The success of the novels has made the author the who began writing the books as a single mother living on
highest-earning novelist in literary history. government benefits, has become hugely wealthy. In 2020,
her fortune was valued at £650 million.
Although the author did not have any age group in mind
when she wrote the books, the publisher initially focused Harry Potter even has its own spin-off prequel series, the
on the market segment of young children, aged 9–11. five-star film Fantastic Beasts and Where to Find Them.
Rowling, whose first name is Joanne, was asked to use
her initials rather than her first name because it was Questions
thought that young boys would not be interested in reading 1 Define the meaning of the following terms:
a book written by a woman. a ‘market segment’ [2]
Word-of-mouth reviews, especially among young males, b ‘distribution channel’. [2]
have been an important part of the books’ success. 2 Analyse one way in which the marketing mix has been
Rowling’s publishers were able to build on this buzz by the used to maintain sales of Harry Potter products. [4]
rapid, successive releases of the first four books, which 3 If no more Harry Potter books are written, evaluate
maintained interest in the brand. the extent to which this means that sales of Harry
The launch of a new Harry Potter book was a great event, with Potter must inevitably decline. [12]
long queues forming outside bookshops and some stores
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AS LEVEL
4.1 The nature of operations

AS LEVEL 4.1 The nature of operations
Chapter overview
★ the factors of production: land, labour, capital and enterprise
★ inputs, outputs and the transformational process
★ how operations adds value
★ the meaning of effectiveness, efficiency, productivity and sustainability
★ capital-intensive and labour-intensive operations
★ the advantages and disadvantages of different operations methods: job, batch, flow and mass customisation.
4.1.1 The transformational sure the rooms are ready, the kitchens meet health and
safety requirements, the televisions, kettles and trouser
process presses in the rooms work, the towels are washed and dried
The process of transforming inputs into outputs is the and there is enough food to feed the guests. If you are
responsibility of operations managers. They are there to running a tyre and exhaust centre, operations management
make sure that the process occurs in the way that the involves making sure you have enough spare parts (held as
business wants and that particular operations targets are inventory) so that you can fix a customer’s car quickly and
met. For example, operations managers may be concerned safely, the equipment you have is suitable and working,
with achieving a particular level of quality and ensuring and you can generate the bill accurately. If you are running
that costs are not too high. a clothes shop, it involves making sure you have the right
number and mix of clothes on display, the store layout is
The effectiveness of a business depends a great deal on the appropriate, the queues are not too long and there is a
quality and cost of the operations process. If managers can security system to prevent theft.
improve the operations of the business, they can make it
more efficient, increase the volume of output and improve GLOSSARY TERMS
quality. The marketing function identifies the opportunities
The output of a business is the total amount produced in a
within a market; the operations function then delivers
given time period.
this as effectively and efficiently as possible. Effective
operations means the business is doing the right thing – Inventory refers to the stocks held in a business, such as
that is, it is meeting its operational targets. The business materials and semi-finished goods.
produces these products in the right quantities and with Operations management oversees the planning, co-
the right specifications. Efficient operations means the ordination and control of the transformation process,
business is doing what it does at a low cost – that is, it is turning resources (inputs) into outputs.
producing and delivering its products in a cost-efficient
manner. Effective operations should lead to more sales There are many different forms of transformation. These
and profits. Poor operations leads to mistakes being made, include:
which can result in having to replace items, recall products » changing the characteristics of materials, information or
or even pay damages. customers. For example, manufacturers take components
Operations involves producing physical goods such as cars, and build something new with them. Beauty salons,
but also providing services, such as schools and hospitals, hairdressers and cosmetic surgeons take people and
which are intangible. These create particular issues: with improve their appearance (we hope!). Doctors, dentists,
physical products, managers will consider how much physiotherapists, psychiatrists and teachers all help us
inventory (or stock) to hold whereas with services, it is not to improve some aspect of ourselves. Accountants take
possible to hold inventory and so managers have to deal our receipts and turn them into a set of accounts to
with queues if demand is high. show investors or government tax inspectors.
» changing the location of materials and information.
The precise nature of operations will, therefore, vary Federal Express and Cathay Pacific simply move items
from business to business. If you are running a hotel, or people around. Google helps you find something that
for example, operations management involves making is already there – it helps you to access information.
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An estate agent gives you information on houses that » Capital This refers to capital goods such as equipment
you might be interested in. This service saves time and machinery. These are vitally important in sectors
and money for the seller and helps the buyer sell the
property more quickly.
such as online businesses, where the technology is at
the centre of the business, or car production, where
4.1
» changing the ownership of materials. Wholesalers buy production-line technology determines output, quality
in bulk from a number of producers. Retailers then buy and flexibility.
from wholesalers because it is easier to deal with them » Enterprise This refers to the ability of employees to
than with every single producer: it reduces the number come up with new ideas, to find solutions to problems
of transactions and makes the process simpler. and be creative. This determines what other resources
When designing its transformation process, a business must are used and what the business offers. Enterprise is
4.1.1 The transformational process

consider questions such as: very important in sectors such as advertising and
» What level of output will be provided? Is the business consultancy.
aiming to produce hundreds, thousands or millions of Operations managers must decide on the right combination
units? How many customers does the business expect of resources for the transformation process given the
to have? desired targets and constraints, such as budgets. This will
» What quality of service will be provided? How many depend on factors such as the nature of the process, as well
people will be served in the shop? Will the business as the cost and availability of different resources.
deliver its products to people’s homes? What will its
policy be if people want to return items?
» How will the business provide the service? Will it provide
The stages of the transformation
it online or via shops? Will it use high staffing levels or process
invest in more equipment? The operations process involves all the different stages,
» What aspects of the process will the business undertake including:
for itself and what elements will be outsourced to » producing the initial idea (for example, in a research
or bought in from other providers? The business may laboratory) to developing prototypes and testing these
decide to manage the shop itself but get cleaners in to check the product works and is safe to launch
to tidy up, employ accountants to do the finances and » designing the best method of production to be efficient
use specialists to design the decor. It may produce a and to hit volume and quality targets
range of clothes but simply do the design work itself » deciding on the levels of inventory which should be held
and get someone else to produce them, like Benetton; to keep production going and just in case anything goes
alternatively, it may design and manufacture the wrong
products itself, like Zara and IKEA. All these decisions » ensuring production goes according to plan
will have an impact on the costs, flexibility and the » delivering to the next stage in the process, such as a
complexity of running the business. retailer
The transformation process of a business is ongoing and » if necessary, handling the recall of products if there are
dynamic. If the output produced is not acceptable or needs faults.
to be improved, the business will have to change the inputs
and/or the way it produces. It will then monitor the results STUDY TIP
and, if necessary, change again. Change may also be due to Remember that operations management can affect the
external factors; for example, increasing concern about the volume of production, the costs and the quality of the
environment has influenced what is produced and how. product. Operational decisions will be linked to the other
functions; for example, to sales, the overall finances of
Using factors of production the business, and the skills and number of employees
Operations will involve the management of its factors of required.
production, such as:
» Land This will include location decisions and finding Operations management involves all the stages of the
the right base for a business, while considering issues transformation process and therefore is directly involved
such as the cost and ease of access to supplies. In in the process of adding value. The more efficient the
some operations processes, such as farming, managing operations process, for example, the fewer resources are
the land is a key part of the transformation process. used up for the output produced and so more value can be
On the other hand, choosing the right site is essential added. Similarly, the better quality the product and the
to a retail operation. Being close to transport links is more effectively that it meets customer needs, the more
essential to exporters. likely sales are to increase and the more the customer
» Labour This refers to the number and the skills of people may be willing to pay for the product, which increases the
you employ; for example, in sectors such as sport, music value added.
and computer programming, the skills of employees are
absolutely critical.
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Marketing is responsible for identifying the needs of The operations of a business will, therefore, affect the value
customers; this department must work with operations to added because it will affect factors such as:
4.1 find the best way of fulfilling these needs while at the
same time meeting the business objectives. For example,
» the amount of resources used and how they are used,
affecting cost of production. The more efficient the
marketing will identify the key benefits customers want operations are, the less waste there is and the lower the
and the prices they are willing to pay; operations must then cost per unit should be.
see if it can meet these targets at an appropriate cost. If » the quality of production and factors such as speed of
operations can deliver the right combination of products at delivery, which will affect how much customers will pay
the right time and quality, and do this efficiently, it will be and how many sales are made.
adding value to the business. Effective operations provides
something customers want and are able to pay for at a cost
that is profitable for the business.
CASE STUDY
Mondelēz International
Mondelēz International is a snacks business that sells its materials, labour and finished goods to meet
products all over the world. Its product portfolio includes production and meet customer demands are in place
chocolate, biscuits, gum and candy. These include world- l developing new production methods and processes
famous brands worth billions of dollars such as Cadbury, l ensuring the quality of products
Oreo, belVita, Milka and Trident. l acquiring, installing and maintaining capital
equipment and ensuring this remains functional.
Part of the success of the business is due to the
effectiveness and efficiency of its operations. According Operations jobs include production operators, who are
to the company, the manufacturing process at Mondelēz in charge of the production lines, and plant managers,
International includes: who have overall responsibility for their area and who are
l safety and environmental measures. These measures constantly seeking to improve the production process.
are to ensure that the business meets global, national
and local safety, security and environmental standards Questions
and regulations 1 Explain one way that operations management
l planning and scheduling production, and ensuring that can add value for Mondelēz International. [3]
the correct supplies of raw materials and packaging 2 Evaluate the importance of effective operations
management to Mondelēz International. [12]
4.1.2 Efficiency, effectiveness, The importance of productivity in

productivity and sustainability operations
One measure of efficiency is productivity. This measures
The importance of efficiency and the output produced given the inputs used up. Productivity
effectiveness in operations is very important to businesses because managers will want
to get the most from the resources that they have. Greater
The operations manager will want the operations process productivity increases efficiency because:
to be both effective and efficient. An operations process is » the more output produced from a given input, the lower
effective if it achieves its set target; for example, it the unit cost
produces the target of 200 units a day. The process is » the less input needed for a given level of output, the
efficient if it does not waste resources and if it minimises lower the unit cost.
costs given the quantity and quality required.
That is, greater productivity leads to higher efficiency.
A production process may be effective but inefficient if it
is producing the target but at a high cost. Equally, it may Labour productivity specifically measures the output per
be efficient at what it does but ineffective if it is producing worker. The equation to calculate this is:
the wrong thing or the wrong quantity. total output
labour productivity =
number of employees

STUDY TIP
Effectiveness focuses on what you do.
Labour productivity measures the output of a business in
relation to the number of employees. For example, if 10
Efficiency focuses on how you do it. people produce 50 units in total each week, their productivity
is 5 units each. The higher the labour productivity, the more
is produced per person per time period.
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Productivity is a crucial concept in operations management related to improving the productivity of its resources.
because it can have a significant effect on the cost of Imagine a juice drinks business where employees are
producing a unit. The higher the productivity, the more
units each worker is making and, if wages are unchanged,
squeezing the fruit by hand; if they bought a juicer,
productivity would increase so that more customers could
4.1
the labour cost per unit will be cheaper. As a result, be served or fewer staff might be required.
managers are constantly seeking ways of improving labour
productivity because this means the firm can either make GLOSSARY TERM
more profit per unit, can reduce the price to become Productivity measures the output per hour, per person or
more competitive or can produce more. Improving the per machine.
effectiveness of the business may therefore be directly
4.1.2 Efficiency, effectiveness, productivity and sustainability

HANDLING DATA
Copy and complete Table 4.1. Assume that employees are paid $200 each per week.
▼ Table 4.1 Calculating labour productivity
Number of Weekly wage Output Productivity Labour cost per unit

employees bill ($) (number of units) (output/number (weekly wage
of workers) bill/number of units)
100 $20 000 1 000 10 $20
100 ? 2 000 ? ?
50 ? 1 000 ? ?
? ? 2 000 40 ?
be able to make more output than colleagues who are

How can productivity be increased? using outdated equipment. As the UK’s Department
Increasing of Business and Skills says when commenting on the
Investment in the number low productivity in the UK compared with many other
equipment of hours countries: ‘A worker can be 100 per cent efficient with a
and worked
Training shovel but it won’t count if his international counterpart
technology
is equipped with a JCB!’
Changing the
» Changing the way that work is done If the way in
Ways to Motivating which a product is made is changed, this can affect
way the
increase employees
work is done
productivity
the speed and the effectiveness of the production
process. Many firms have implemented teamworking
▲ Figure 4.1 Ways to increase labour productivity
in recent years, resulting in improved productivity
levels. If activities in the process can be combined and
Labour productivity may be increased by using a variety of undertaken simultaneously rather than in sequence,
techniques. this speeds up production and enables higher
» Increasing the number of hours worked If employees productivity.
work more hours or more days each week, this could » Motivating employees If employees can be motivated
increase their output. However, this is not necessarily a (perhaps by offering more rewards or by giving people
long-term means of increasing employees’ productivity more responsibility – see Chapter 2.2) effort and
because they are likely to get tired and stressed, and may productivity may increase.
therefore become less productive in the long term. Also, At any moment, managers will have to consider which of
there is a limit to how many extra hours can be worked. the above options are available given the firm’s resources,
» Training This is a very important way of increasing and which will work best when it comes to boosting
productivity. Training can increase employees’ output by productivity. In one business the issue might be motivation;
helping them to gain more skills and to learn new and in another it might be a lack of modern equipment. If
better ways of doing things. managers can boost productivity, they will be improving the
» Investment in equipment and technology If employees performance of the business.
have modern and more efficient machinery, they should
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CASE STUDY
4.1
Finance Against Warehouse Receipts
so the returns the farmers gain are low. To help improve
the situation, the Standard Chartered Bank has helped
develop various financing schemes to enable farmers to
get the finance they need. One of these is called Finance
Against Warehouse Receipts. Under this scheme, farmers
use their crops as collateral; the corn, soya or wheat act
as the security for the loan.

For example, through this scheme, Standard Chartered
has been able to finance farmers’ borrowing to buy
fertilisers. The use of these fertilisers has boosted
average crop yields to over a tonne per hectare – a
significant increase in productivity. The programme has
been so effective that it has helped the country move
from importing maize to producing bumper harvests and
▲ Figure 4.2 Nyiombo Investments Ltd is now able to becoming an exporter.
meet more than 60 per cent of Zambia’s fertiliser
demand. Questions
It is often very difficult for farmers in Africa to get loans in 1 Explain one way you could measure the productivity
order to buy essential materials such as seeds, fertilisers of a farm. [3]
and pesticides. This is because they lack assets to act as 2 Evaluate the ways in which farmers might improve
collateral and so many banks are not willing to take the the productivity of their farms. [12]
risk. Without these resources, farming is inefficient and
CASE STUDY
Assembly lines
The Model T Ford was produced between 1908 and 1927.
During that time, Henry Ford introduced assembly line
techniques which dramatically increased productivity.
Each car moved along a line with parts being added to it;
individual workers specialised in a particular aspect of
production. As a result, producing a car took 93 minutes
instead of 12 hours and this brought down unit costs so
much that the price could fall from $890 to $240. The
ability to produce a reliable car at a relatively low price
made this a tremendous success; so much so that, at its
peak, the Model T accounted for 50 per cent of all cars in
the USA and 10 per cent of all the cars in the world.
Questions
1 Analyse one reason why unit costs usually decrease
when productivity increases. [4]
▲ Figure 4.3 One of the first assembly lines was for the
2 Evaluate the possible implications of introducing
Model T.
assembly line techniques. [12]
Employee resistance to higher » they do not want to work longer or harder

» they do not want to learn new skills
productivity » they fear that higher productivity levels may lead to job
While managers might be eager to increase productivity, losses
employees may resist such efforts, because: » they feel it is unfair that they are producing more unless
they receive higher rewards.
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The implications for a business of the greater interest in
STUDY TIP sustainability are:
Remember that employees may not welcome efforts to
increase productivity. Also, increasing productivity may
» the need to reconsider what is produced. For example, in
the car industry there has been a very significant increase
4.1
lead to a fall in quality if production is rushed. in the demand for electric vehicles in recent years rather
than diesel or petrol; this is because electric vehicles
are less harmful to the environment. National and local
The importance of sustainability in governments in many countries are introducing legislation
to force the switch to electric vehicles
operations » the need to reconsider how products are produced. For
Customers are increasingly interested not only in what a example, can renewable sources of energy be used? Can
4.1.2 Efficiency, effectiveness, productivity and sustainability

business produces but also how it produces it. For example, waste be reduced and can fewer resources be used in the
customers may want to know where supplies come from and process?
how employees are treated. They may also want to know » the need to reconsider the packaging used. A great
how sustainable the operations process is. deal of packaging in the past has been non-recyclable.
Sustainable operations are operations that meet the Plastic packaging has come under particular attack
present needs of the business and, indeed, society without because of the levels of plastic found in the sea and the
compromising on the ability to meet future needs – they do impact of this on sealife.
not use up resources that could be used in the future. For Being sustainable will:
example, if energy is sourced from non-renewable sources, such » involve change. This will need planning and will involve
as coal-fired generators, this is a non-sustainable source – the training and getting employees to understand the need
coal is being used up. If, however, the energy a business uses for change
comes from wind power, the wind cannot be used up (it is » involve costs for new equipment.
renewable). Sustainability also involves considering the impact
of the operations of a business on the environment – does it However, the benefits are:
pollute? Does it create emissions? Does it generate waste? » These actions are good for the environment and
therefore good for society as a whole.
Customers and society as a whole are much more aware » These actions may attract customers, employees and
of climate change issues and of the relationship between investors who are looking for businesses who behave in
businesses and the environment. This awareness is because this way.
we have more information on the damage that has been » These actions may avoid negative comment in the media.
done to the environment and there is a greater appreciation » These actions may be necessary by law or may be in
that the need for change is becoming urgent. Becoming advance of future mandatory changes so the firm does
more sustainable therefore involves: not have to be reactive.
» using more resources that are not used up by consuming
them, such as recycled materials GLOSSARY TERM
» using fewer resources generally Sustainable activities are those that meet the needs of the
» recycling and reusing resources more business or of society without compromising on the ability
» reducing the negative impact of a business’ activities on to meet future needs.
the environment.
CASE STUDY
Coca-Cola
Coca-Cola, the world-famous drinks company, says that l to use at least 50 per cent recycled material in its
its purpose is clear: to ‘refresh the world’ and ‘make a packaging by 2030
difference’. It says it does this by creating loved brands l to collect and recycle a bottle or can for each one that
and ensuring these are produced sustainably. The it sells by 2030.
company says it aims to make a difference in people’s
Coca-Cola is aiming to make packaging part of a circular
lives, communities and the planet as a whole by doing
economy, with a focus on the collection of 100 per cent of
business in the right way.
its products and an increase in the recycling it does. Its
In 2018, Coca-Cola launched its approach to sustainability, goal is to create what is called a ‘closed-loop system’ in
called World Without Waste, with what it said was a which old bottles and cans can become new bottles and
simple, focused purpose: to make the world’s packaging cans.
waste problem a thing of the past. World Without Waste
has three fundamental goals: Questions
l to make 100 per cent of its packaging recyclable, 1 Define the term ‘sustainable operations’. [2]
globally, by 2025 2 Evaluate the importance of sustainability to the
success of Coca-Cola. [12]
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In the case of labour-intensive processes, many of the costs
CASE STUDY are variable, whereas in capital-intensive processes, costs
4.1 How often do you include sustainable
How often do you include sustainable packaging in your
are mainly fixed.
purchasing decision? Global top 10 countries in 2019 (%) ▼ Table 4.2 Advantages and disadvantages of labour- and
packaging in your purchasing decision? capital-intensive processes
Always 10 10 7 9 Advantages Disadvantages

Labour- Production may be May take time to train
20 23 24 intensive flexible to customer staff with necessary
Usually 25
processes needs skills
Less expensive to Product may vary in

set up than buying consistency and quality
45 43 equipment
46
Sometimes 47 Employees can use Volumes produced may
skills and initiative be low
to be creative
Capital- Can produce high Can be expensive to
25 27
Never 17 21 intensive volumes set up
processes Output can be High fixed costs
Millennials Gen Xers Baby Average standardised and increasing break-even
boomers consistent output
Source: McKinsey & Company May be able to Can be difficult to
▲ Figure 4.4 Sustainable packaging – influence on produce continuously customise products to
purchasing decisions (%) individual customer
needs
Question
1 Evaluate the significance of the above data for ▼ Table 4.3 Capital-intensive versus labour-intensive
businesses. [12] processes
Capital-intensive processes Labour-intensive processes

4.1.3 Capital-intensive and Expensive to set up Lower set-up costs
labour-intensive operations Can produce high volumes May involve lower output
levels
A capital-intensive process is one that involves a relatively
Can achieve lower average May be relatively expensive
high proportion of machinery and equipment relative
costs if volume is high for high volumes as high
to other resources. Imagine a bottling process using a
amounts of labour are needed
production line and producing millions of bottles a day.
Other examples of capital-intensive processes are car May be relatively inflexible Can be quite flexible
manufacturing, oil refining and airlines. A capital-intensive
process can produce high quantities of a standardised
product at a relatively low unit cost (as the costs are spread GLOSSARY TERMS
over so many units). However, a capital intensive process: Capital-intensive production means there is a high
» can be expensive to set up with investment in proportion of capital (for example, machinery) used
technology relative to other factors of production.
» can be relatively inflexible in terms of producing Labour-intensive production means there is a relatively
different versions of the product (although technology high proportion of labour (employees) used relative to
means that flexibility is now improving) other factors of production.
» is expensive per unit if only a few items are produced.
A labour-intensive process uses a relatively high proportion
of people (such as full-time, part-time and temporary STUDY TIP
staff) compared to other resources; for example, a design Whether a process should be capital or labour intensive
business, hotels, or a fruit-picking business. will depend on factors such as the importance of a
Using a high proportion of labour can enable the business personal service, the finance available for investment and
to be very flexible and produce a wide range of personalised the volume of output required.
services. However, it may limit the volume of products that
can be produced.
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4.1.4 Operations methods: job, photographer or architect. Each item is unique for each
customer, which means that production is very flexible.
batch, flow, mass customisation It tends to require a wide range of skills because of the 4.1
range of jobs that may be done. It also requires good
project management skills because each order is unique
and will have different planning requirements. As a
Job result, job production tends to be quite expensive.
process
» Batch production This occurs when items move together
from one stage of a process to another. For example,
when producing bread you bake one batch at a time.
This approach is cheaper per unit than job production
4.1.4 Operations methods: job, batch, flow, mass customisation

because you are producing products in groups. At the
same time, you have some flexibility to change the
Different
Mass
types Batch recipe or approach from one batch to another.
customisation
process
of operation process » Flow production This involves large-scale production
processes using production-line technology. It is capable of huge
volumes (for example, of cans of beans or bottles of
water) but produces relatively standardised products.
Products ‘flow’ from one stage to another. It is relatively
expensive to set up to buy the production equipment
and is not especially flexible in terms of producing
Flow a variety of products. However, if the volume of
process
production is high, the set-up costs can be spread over
many units, meaning the unit costs will be relatively
low. Mass production suits mass markets where demand
▲ Figure 4.5 Different types of operation processes is stable and high.
There are different types of operation methods. Some of » Mass customisation This is a relatively new
these are: development made possible by technological advances.
» Job production This involves one-off production. This type of process is on a large scale but, whereas
Imagine the work of a portrait artist, wedding mass production usually lacks flexibility, this
technology enables a variety of models to be produced
CASE STUDY
Coca-Cola and COVID-19
In 2020, Coca-Cola opened the world’s fastest bottling Globally, Coca-Cola experienced significant changes in
production line in Chengdu, Sichuan province. This was consumer buying patterns in 2020, with significant falls in
part of the United States-based Coca-Cola’s efforts to the buying of drinks through distribution channels known
increase its manufacturing capacity and investment in as ‘away-from-home channels’, such as shops.
China.
To expand its range of products, Coca-Cola has recently
The new plant is able to produce 120 000 cans every hour, combined forces with the Chinese dairy business China
while the current industry average ranges between 66 000 Mengniu Dairy Co. This joint venture will produce
cans and 90 000 cans every hour. This equates to 260 000 and sell chilled milk, which is expected to have a real
metric tons of products every year, worth around 1.3 potential for growth in China. Coca-Cola is also offering
billion yuan ($183 million). This is also Coca-Cola’s only a new range of ready-to-drink coffee products in China
automatic production line that is able to produce a variety under the Costa brand, to further benefit from the
of different packaging specifications simultaneously. country’s rising ready-to-drink market. Costa Coffee
entered the Chinese market in 2006 and now has over
Coca-Cola’s first production plant in China was built
500 stores there.
in 1999 in Chengdu. This more recent investment was
part of the company’s attempts to increase work and Questions
resume production after the 2020 Coronavirus (COVID-19)
1 Explain one way in which the Coronavirus
pandemic. This involved investing in equipment renewal
(COVID-19) pandemic affected Coca-Cola’s sales. [3]
and technical transformation, and upgrading facilities.
2 Evaluate the benefits of this new production line
for Coca-Cola. [12]
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on the same production line. VW, for example, uses Problems of changing from one method
the same basic car platform for many of its cars. Mass
4.1 customisation generally involves heavy investment in
technology.
of production to another
Changing from job to batch to mass production will depend
on the nature of demand. Mass production requires high
▼ Table 4.4 Operations processes
volumes and therefore is not appropriate for job production,
Type of production Features where each item is unique. Batch production enables
relatively high outputs and some flexibility (for example,
Job One-off, unique, tailor-made items printing batches of different magazine titles) but is not
Batch Items move as a group from one appropriate if a customer wants something unique.
stage of the process to another

Moving from job to batch to mass production will require
Flow Items move continuously from one investment in capital equipment. It will enable higher
stage of the production process to volumes (assuming the demand is there) but there will be
another less flexibility in terms of tailoring the product to customer
Mass customisation Large-scale production with the needs.
flexibility to produce a number of
different models
TEST YOUR LEARNING

1 a Define the term ‘operations management’. [2] The Singaporean economy
b Explain one way in which effective operations Singapore has a highly developed and successful free-
management can increase the profits of a market economy. The economy depends heavily on exports,
business. [3] particularly of electronics, petroleum products, chemicals,
2 Define the terms ‘effectiveness’ and ‘efficiency’. [4] medical and optical devices, pharmaceuticals, and on
3 a Define the term ‘labour productivity’. [2] Singapore’s vibrant transportation, business, and financial
b Explain one way of increasing productivity. [3] services sectors.
4 a If output is 300 units and the number of In the last ten years, the economy of Singapore has grown
employees is 20, calculate the labour by an average of 5 per cent a year. The country’s productivity
productivity. [2] has also grown over the same period by about 1 per cent a
b Explain one reason why a business might year, which matches that of other developed economies. The
want higher productivity. [3] majority of the population in Singapore has benefited from
5 Explain one reason why employees may resist a growth in earnings and a rise in their standard of living.
attempts to increase labour productivity. [3]
Even so, productivity gains have been slower than in
6 a Define the term ‘sustainable operations the past due to more reliance on people for growth;
process’. [2] for example, in the service sector. The government of
b Explain one reason why sustainability is Singapore is eager to improve productivity and sees
important to a business. [3] this as a key driver of economic growth. It is focusing
7 a Define the term ‘labour-intensive’. [2] on ways of improving productivity through a number of
b Explain one benefit of a labour-intensive programmes and schemes. Singapore has attracted
production process compared to a major investments in advanced manufacturing,
capital-intensive production process. [3] pharmaceuticals, and medical technology production.
8 Explain one reason why a business may adopt a Source: www.forbes.com/places/singapore/?sh=5268e7dcc959
capital-intensive production process rather than
a labour-intensive production process. [3] Questions
9 a Define the term ‘job production’. [2] 1 Define the terms:
b Explain one benefit of batch production a ‘productivity’ [2]
compared with job production. [3]
b ‘economic growth’. [2]
10 a Define the term ‘flow production’. [2]
2 Analyse one reason why an increase in productivity
b Explain one benefit of mass customisation to a can help businesses and the economy to grow. [4]
business. [3]
3 Evaluate the ways in which the Singaporean
government could help businesses to improve
their productivity. [12]
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AS LEVEL
4.2 Inventory management
4.2.1 Managing inventory

Chapter overview
★ how to manage inventory
★ how to interpret inventory charts
★ the importance of supply chain management
★ just in time (JIT) versus just in case (JIC) inventory management.
4.2.1 Managing inventory The costs and benefits of holding

Purpose of inventory inventory
The benefits of holding inventory are that you have
The term ‘inventory’ refers to products that the business
products ready if you need them, and if there are any delays
owns but will use up during the operations process.
or breakdowns in the process you can continue to operate.
Inventory was previously also called stock.
This means sales can continue and the business generates
Types of revenue. However, holding inventory can lead to:
inventory » costs of storage – for example, the costs of a warehouse
facility
» opportunity cost – because the money invested in
inventories could be used elsewhere to earn money.
Money in inventory is therefore ‘tied up’ and not
Work in Finished General generating more returns
Raw materials
progress goods supplies » security costs – to protect the materials from damage
or theft
▲ Figure 4.6 Different types of inventory » the risk of the inventory depreciating, that is, becoming
Types of inventory include: out of date – this may be because the inventory goes off
» raw materials – these are items used in the production (in the case of food) or becomes unpopular (in the case
process of fashion items) and so is wasted.
» work in progress (semi-finished goods) – these are items
where some work has been done on them but they are Buffer inventory, reorder level and
not complete
» finished products – these are goods that are ready to be lead time
sent to the customer » Buffer inventory is the minimum amount of inventory a
» general supplies – these are items that are used to keep business wants to hold just in case of problems.
the business going, such as supplies of cleaning materials. » The lead time is how long it takes from ordering the
supplies from a supplier to them arriving at the business.
These inventories are held: » The reorder level is the amount of inventory left at
» to enable production to take place and so that orders which a business needs to place an order so that the
can be met new inventories arrive before the business goes below
» just in case anything goes wrong. For example, you its buffer level.
may want to hold excess materials in case there is a » The reorder quantity is the amount ordered each time.
problem with deliveries from the supplier; you may want
to hold inventories of semi-finished items in case there
is a breakdown in part of the system; you may want to Inventory (stock) control charts
hold finished goods in case there is a rush order from a Inventory control charts can highlight how much inventory
customer. is being used up, how much to reorder and when.
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In Figure 4.7, the business uses up 200 units a week at a
constant rate. It wants to always hold 100 units as a buffer Inventory 900
4.2
(units)
inventory just in case. The lead time is one week. This 800
means the business needs to reorder at 300 units. As the
supplies are being made and delivered (which takes one 700
week) another 200 units will be used up, which means that
600
when the order arrives, the business is down to its buffer of
100. The reorder quantity in this case is 800 units a month 500
(given that the business expects to use up 200 units for
400
each of the four weeks). Figure 4.7 assumes that the usage
rate of the inventory is constant each week.
AS LEVEL 4.2 Inventory management
300 Reorder level
Inventory 900 200

(units)
800 100 Buffer inventory
700
0
600 1 2 3 4 5 6 7 8 9 10 11 12 Time
(weeks)
500
Run out of inventory
400
▲ Figure 4.9 Effects of failing to reorder
300 Reorder level
200
Inventory (stock) control
100 Buffer inventory
The decision on how much inventory to hold is a trade-
0 off between the costs of holding the inventory and the
1 2 3 4 5 6 7 8 9 10111213141516 problems that might occur if inventory is not held.
Time
(weeks)
The minimum amount of inventory that a firm wants to hold
▲ Figure 4.7 Inventory control chart at any time is known as the buffer inventory (or the safety
inventory). If the level of inventory falls below the buffer
In Figure 4.8, we see a situation where the inventory starts level, there may be a risk of running out; this could either
to be used up at a faster rate after week 8 and the business halt production or mean that customers have to be turned
therefore runs out of inventory before new supplies arrive. away because no finished goods are available. Several factors
This is known as an ‘inventory out’. influence the level of buffer inventory a business holds:
» the rate at which inventory is generally used up. The
Inventory 900 faster inventory is used up, the more the firm will have
(units)
800 to hold at any moment
» the warehousing space available. The smaller the space
700
the firm has for storage, the lower the level of inventory
600 » the nature of the product. If the product is fragile or
500 likely to depreciate, the firm will not want too much
inventory in case it breaks or loses value rapidly
400
» the reliability of suppliers. The more reliable suppliers
300 Reorder level are, the fewer buffer inventories the firm needs to hold,
200 because it knows it can get more as and when required
» the suppliers’ lead time. The lead time is the time it
100 Buffer inventory
takes for products to arrive from when they are ordered.
0 If the lead time is two days, for example, this means
1 2 3 4 5 6 7 8 9 10111213141516
Time
that it takes two days for supplies to arrive once you
(weeks) have ordered them. The shorter the lead time, the
Run out of inventory
smaller the amount of inventories a firm needs to hold.
▲ Figure 4.8 Example of a business running out of If, however, the lead time is long, the firm will need to
inventory hold more inventory to last while it waits for a delivery.
In Figure 4.9, the supplies do not arrive – perhaps due Effective inventory management involves making sure that
to a problem at the supplier because inventory was not the business does not have too much or too little inventory.
re-ordered – leading again to an inventory out.
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Supply chain management
HANDLING DATA Businesses will have suppliers. These suppliers will often
have suppliers, and these businesses may also have their 4.2
own suppliers. There is therefore a chain of suppliers from
800 the raw materials through to the finished product. The
700 supply chain refers to all the different stages involved
in making, distributing and selling a good or service,
600
Inventory (units)
beginning with the material through to the production of

500 parts, through to the distribution and sale of the product.
400
4.2.1 Managing inventory

Think of the food in a McDonald’s restaurant. Farmers will
300 Reorder level have raised animals that are sent to abbatoirs, and the
200 meat is then sent to processing facilities before being
100 distributed to the restaurants. Farmers will also grow
other foodstuffs, such as lettuce, which will be sent to the
0
1 2 3 4 5 6 7 8 9
McDonald’s outlets. Wheat will have been grown and this
Time (weeks)
will be sent to grain mills and then to a factory to produce
buns. The range of ingredients used in McDonald’s foods
▲ Figure 4.10 Inventory control chart will be created through a complex set of relationships with
suppliers. Supply chain management involves managing
1 What is the reorder quantity in the inventory chart the flow of goods and services, and includes all the
above? different processes that transform raw materials into final
2 What is the lead time? products. Effective supply chain management means that
3 How many units are used up each week? these interrelationships between suppliers are managed
well. This can lead to:
» lower costs, because the process is more efficient
» fewer mistakes being made
CASE STUDY » greater co-ordination of what is delivered, when and in
what order
COVID-19 and retailers » better-quality supplies
The Coronavirus (COVID-19) pandemic of 2020 created » less time between orders and delivery.
major problems for retailers. In many countries, Effective supply chain management can therefore help
retailers of non-essential products were forced to shut provide a business with a competitive advantage. Equally,
down for extended periods. For clothes retailers, this poor supply chain management can cause delays, increase
meant that they had inventory that would be seen as out costs and lead to poor quality.
of fashion. Inditex, the world’s biggest fashion retailer,
announced that it was writing off over $300 million Businesses will want to consider their responsibilities in
worth of inventory. This means the company reduced its relation to their suppliers. For example, to what extent do
valuation of what the inventory was worth. they want to know how their suppliers produce? Businesses
Some retailers responded to the virus by cutting prices
are increasingly being questioned about all aspects of their
to try and sell their existing inventory. H&M of Sweden supply chain, such as the ingredients in their products,
cut prices by up to 70 per cent. Other retailers cancelled the source of their supplies, the working conditions and
orders of inventory as they did not think the customer treatment of their employees. Businesses must consider
demand would be there. the processes they want to have in place to manage these
aspects of their supply chain. Many businesses now have
Once lockdown was over and people came out to start a code of conduct of their suppliers to ensure that these
shopping, retailers then faced the problem of not having organisations meet the standards of the business selling the
enough inventory that customers wanted to buy. final product. Greater media coverage has made businesses
Questions think more, not just about how they behave but also about
how their suppliers behave.
1 Explain one reason why clothes retailers hold
inventory. [3]
2 Evaluate the factors that influence how much GLOSSARY TERMS
inventory clothes retailers should hold. [12] The supply chain refers to all the different stages involved
in making, distributing and selling a good or service,
beginning with the material through to the production of
parts, through to the distribution and sale of the product.
Supply chain management involves managing the flow of
goods and services, and includes the different processes
that transform raw materials into final products.
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CASE STUDY
4.2
COVID-19 and supply chains
In recent years, there have been major worldwide shocks pharmaceuticals. The closure of factories, ports and
which have threatened the global supply chains of many airports affected companies across the world and has
businesses. For example, there have been the September also contributed to contracting trade.
11 terrorist attacks in 2001; the SARS virus of 2002; the
One reason that many businesses were affected so badly
financial crisis of 2008 and the trade wars between the
is because they had no plan if their supply chain was
USA and China in 2019 and 2020. All of these changes have
seriously disrupted. They had built a chain of efficient,
damaged global trade, and the use of global supply chains

low-cost suppliers but their plans did not allow for
after the global financial crisis has grown more slowly
unexpected interruptions. Since the pandemic began,
relative to world income than in the decade before.
many businesses have started to look at bringing supply
It is possible that the consequences of the Coronavirus closer to home. However, this often involves higher costs
(COVID-19) pandemic in 2020 will deal an even bigger and does not make use of the specialisms which certain
blow to supply chains than these other events. The regions around the world have developed.
World Trade Organization estimated that global trade
would fall by up to 32 per cent in 2020. China’s Hubei Questions
province, where the Coronavirus outbreak began, is 1 Explain two factors that influence whether a
a manufacturing hub which produces components business chooses local suppliers. [6]
for many industries such as cars, electronics and 2 Evaluate how supply chain management can
affect the competitiveness of a business. [12]
CASE STUDY
The clothing supply chain
A recent UK parliamentary report, Fixing fashion: clothing supplement their basic earnings towards a level where
consumption and sustainability, stated the following: they can support themselves and their families. Precarious
employment conditions are rife, with temporary contracts,
Garment production is one of the world’s biggest and most
agency work and subcontracting the norm. Violations of
labour-intensive manufacturing industries, with estimates
the right to freedom of association are commonplace,
of those directly employed ranging from 25 million to 60
unionisation rates are extremely low and collective
million people. Since the 1980s, many leading Western fashion
bargaining is rare.’
retailers have been sourcing their clothes from countries
with low labour costs and poor environmental governance. A 2016 report into Corporate Leadership on Modern Slavery
This shift in production has been facilitated by a 90 per cent found that of 71 leading retailers in the UK, 77 per cent
fall in shipping costs between the late 1950s and 2015, as believed there was a likelihood of modern slavery occurring
shipping containers revolutionised trade in goods. Most of the at some stage in their supply chains.
garments sold in the UK are produced in Asian countries. This
Poor working conditions in fashion supply chains hit the
fashion model means that consumers in the UK ‘are getting
headlines on 24 April 2013, when the Rana Plaza building
pleasure and enjoyment from fashion, and that is coming
in Bangladesh collapsed. The building housed five garment
at a cost to workers and the environment in exterritorial,
factories where 1138 people died and another 2500 were
overseas production routes, as well as agriculture.’ Poor pay
injured, making it one the largest industrial disasters in
and conditions are standard in global garment supply chains
history. The victims were mostly young women.
according to evidence submitted by the global trade union,
IndustriALL. It stated that: Source: https://publications.parliament.uk/pa/cm201719/
cmselect/cmenvaud/1952/report-files/195205.htm ©
‘Workers work long hours, often far beyond legal limits, for Parliamentary Copyright
poverty wages and in conditions that breach Occupational
Health and Safety (OHS) standards. The wages of most Questions
garment workers are no higher than the level of the minimum 1 Analyse one reason why most garments sold in the
wage in their country, which in many cases is well below West are produced by suppliers in Asia. [4]
the level of subsistence. Excessive working hours are a 2 Evaluate the ethics involved in the management of
continuing and entrenched problem. Production peaks the clothing supply chain. [12]
are managed by relying on excessive overtime. Workers
are compelled to work extremely long hours in order to
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4.2.2 Just in time extremely expensive because production is halted
completely.
One approach to inventory control is known as ‘just in
case’ (JIC). This is the traditional approach in which
» Switching to JIT can lead to an increase in costs because
of the extra reordering. Because parts are ordered much
4.2
businesses hold inventory just in case there are problems more frequently, the firm may lose bulk discounts and
with suppliers or just in case there is an increase in will also have more administration costs.
demand. By holding excess inventory, businesses can
keep producing and selling even if suppliers cannot
deliver and even if demand suddenly spikes. However, the GLOSSARY TERM
disadvantage of JIC is that inventory has to be stored, Lean production is an approach that continually
maintained and protected, and this costs money. seeks to reduce any form of wastage in the production
4.2.2 Just in time

process.
A different approach to inventory control is known as ‘just
in time’ (JIT). Just-in-time production occurs when firms
produce products to order. Instead of producing as much
as they can and building up inventories, firms only produce STUDY TIP
when they know they can actually sell the items. Similarly, The right level of inventory to hold will depend on factors
components and supplies are only bought in by a firm as such as how well it can be stored, the costs to store it,
and when they are needed. the reorder time, the expected level of demand and the
business’ operations strategy.
The aim of just-in-time production is to reduce a firm’s
inventory levels by as much as possible. In an ideal world
there would be no inventories at all; supplies would arrive Using just in time
and be used to produce items that are sold immediately to
the final customer. The advantages of this system are: Running a just-in-time system is complex and places many
» A just-in-time approach should provide a firm with demands on a business. It requires:
tremendous flexibility; firms produce what is required, » Excellent relationships with suppliers Businesses
when it is required. In the past, firms have tended to need to be able to rely on suppliers to deliver goods
try to estimate what demand would be and produce this at precisely the right time. They cannot afford delays
amount in advance of actual sales. This system works as as this halts production. Also, the goods must be of
long as demand has been estimated correctly. perfect quality as the manufacturer has no inventories
» JIT production should reduce costs. With no inventories, to replace faulty supplies. A firm must be able to trust
the firm does not have to pay for warehousing or its suppliers completely.
security. The firm also avoids the opportunity cost of » Reliable employees Because the business does not have
having money tied up in inventories. many (if any) inventories at any stage of the process,
» JIT production should help minimise wastage. If goods the firm cannot cope with stoppages. If strikes occur, for
are produced and left to accumulate as inventories, example, the whole production process stops. A business
they are likely to get damaged, to depreciate, to go out cannot supply customers using inventories as none exist.
of fashion or to be stolen. JIT avoids these issues. This JIT relies upon maintaining a good relationship between
means that JIT is part of a lean approach to business. employers and employees.
Lean production seeks to minimise the waste of » A flexible workforce To ensure that production can
any resource, such as time and materials, to make a respond to demand, a firm needs a flexible labour
business more efficient. force. This means that if someone is ill, another
employee must be able to cover for them, or that if
Although the just-in-time process has many advantages, demand is high in one area of the business, people
there are several potential problems or disadvantages: can be moved to that area to help out. Firms using
» The system relies on suppliers providing parts and JIT expect employees to be ready to work anywhere,
components at exactly the time they are needed. If this anytime. People must change to meet the demand for
type of flexible and reliable supplier cannot be found, different products because JIT is focused entirely on
the system breaks down. matching supply to customer orders.
» JIT can cause problems if the suppliers fail to deliver on
time. The manufacturer has no buffer inventory and so Introducing just-in-time production involves:
cannot produce. For example, the earthquake in Japan in » investment in machinery which is flexible and can be
2011 was a disaster for those directly affected by it. It changed from producing one type of item to another
also caused enormous problems for businesses operating without much delay
a JIT process and reliant on supplies from Japan. With a » training employees so that they have several skills and
delay in supplies, they struggled to produce. The closure can do a variety of jobs (multi-skilling)
of suppliers due to the Coronavirus (COVID-19) pandemic » negotiation with employees so that their contracts are
in 2020 had similar disastrous effects for those reliant on flexible and allow them to move from one job to another
their products. » building relationships with suppliers who can produce
» The JIT system also means that the firm is vulnerable just in time as well.
to action taken by employees. Any stoppage can be
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CASE STUDY
4.2
Toyota
of the Centre for Automotive Industry Research at Cardiff
Business School, Cardiff University, explained that the
problem arose because they relied on parts coming in
from Japan.
Toyota uses a just-in-time supply system, which allows
very little slack in the system. Once supply is interrupted,

it does not take long for other factories to be affected.
Experts have been recommending for years that
manufacturers diversify their supply base. After
all, recent history is full of examples of widespread
supply chain disruptions and their consequences for
manufacturers who were reliant on too few sources
– from the terrorist attacks on 11 September 2001 to
Hurricane Katrina in 2005 and the cloud of volcanic ash
▲ Figure 4.11 The earthquake and tsunami in Japan from Iceland that shut down Europe’s skies in 2010.
(2011) caused problems for companies using JIT
systems. Questions
In April 2011, the Japanese car maker, Toyota, had 1 Analyse one way in which lean-production techniques
to temporarily halt production at its UK engine- might benefit Toyota. [4]
manufacturing plant on Deeside, Flintshire, and five other 2 Evaluate whether Toyota should stop using lean-
of its factories across Europe. The stoppage came after production techniques given the risks of disruption
Japan was hit by an earthquake and tsunami. A director to supply. [12]
TEST YOUR LEARNING

1 Define the term ‘opportunity cost’. [2] Zara
2 Explain one reason why a business might hold The international retailer, Zara, is famous for its ‘fast
inventory. [3] fashion’. It produces relatively small quantities of any one
3 Explain one cost of holding inventory. [3] design and quickly changes the designs to ensure it stays
4 Explain one factor that influences the amount of up to date with fashion. Store managers monitor designs
buffer inventory held by a business. [3] in other stores and sales patterns, and send orders each
5 a Define the term ‘lead time’. [2] week directly to the company’s own factories. Unlike many
b Explain one factor that might influence the lead other retailers, Zara has not subcontracted production,
time of a supplier. [3] and produces in Europe rather than Asia to ensure it
6 Explain one reason why supply chain management keeps control of quality and can respond quickly. It has its
is important to a business. [3] own team of 200 designers able to imitate any new best-
selling designs that hit the fashion world. It designs more
7 Define the term ‘just-in-time production’. [2]
than 12 000 items a year. It can design and get an item in
8 Explain one reason why a business might use its stores in weeks, whereas its competitors take months.
just-in-time production rather than just-in-case Its approach is very much just in time; it produces in
production. [3] response to demand rather than ahead of it.
9 Explain one possible problem of adopting just-in-
time production. [3] Questions
10 Explain one factor that influences the right level of 1 Define the term ‘inventory’. [2]
inventory for a business to hold. [3]
2 Analyse one possible advantage to Zara of holding
relatively little inventory. [4]
3 Evaluate the issues involved if a retailer wishes to
adopt a fast-fashion approach. [12]
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AS LEVEL
4.3 Capacity utilisation and

outsourcing
4.3.1 Significance and measurement of capacity utilisation

Chapter overview
★ the meaning and measurement of capacity
★ the significance and measurement of capacity utilisation
★ the impact on a business of operating under or over maximum capacity
★ the impact on a business of outsourcing.
In this chapter, we examine issues relating to the maximum For example:

output a firm can a produce, which is known as capacity. a Existing output is 300 units a week, maximum output is
A business will not want to have capacity sitting idle but 500 units a week.
at the same time won’t want to have too little capacity, Capacity utilisation = (300 ÷ 500) × 100 = 60 per cent
so getting the capacity right is an important aspect of b Existing output is 400 units a week, maximum output is
operations planning. 500 units a week.
Capacity utilisation = (400 ÷ 500) × 100 = 80 per cent
4.3.1 Significance and Imagine a concert where the stadium is completely

sold out, with 30 000 in the audience; this means that
measurement of capacity capacity utilisation is 100 per cent, which is good for the
utilisation promoter of the event. But what if you have a theatre that
is half-full? This means that its capacity utilisation is only
The capacity of a business is the maximum amount it can 50 per cent.
produce given its existing resources, and it depends on the
number and quality of its factors of production. What is the GLOSSARY TERMS
amount and what is the standard of equipment available?
Capacity measures the maximum amount of output a
How many staff does the business have and how well trained
firm can produce at a given moment with its existing
are they? How efficient is its transformation process?
resources.
Over time, the capacity can be increased with more Factors of production are inputs into the transformational
investment, but at any one moment there will be a process of business, such as land, labour, capital and
maximum number of orders that a business can cope with. enterprise.
The capacity of a bus company can be measured by how Capacity utilisation measures the existing output relative
many passengers it can carry. The capacity of a restaurant to the maximum possible output.
is how many meals it can serve. The capacity of a school is
how many students it can accept. The capacity of a plane is
how many passengers it can take.
HANDLING DATA
Capacity utilisation measures the existing output relative
to the maximum. It can be calculated using the following 1 If capacity is 800 units and present output is 200
equation: units, calculate the level of capacity utilisation.
per cent capacity = existing output over a 2 If capacity utilisation is 20 per cent and capacity is
given time period 3000 units, calculate the present level of output.
× 100 3 If capacity utilisation is 20 per cent and present
maximum possible output output is 4000 units, calculate the capacity.
over a given time period
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CASE STUDY
4.3
Suzuki
In 2020, Suzuki, the motor vehicle producer, announced that According to the Automotive Association of Myanmar,
it intended to increase its capacity in Myanmar. The company sales of new cars in 2019 were 21 916, an increase
invested in a new production line for four-wheeled vehicles of 25 per cent from 2018. Suzuki holds 60 per cent of
at its plant in south-eastern Yangon to handle tasks such Myanmar’s market.
as the painting of car bodies. Suzuki has two factories in
Toyota plans to begin operating its first factory in the
the country.
country in the near future. Chinese manufacturers are
AS LEVEL 4.3 Capacity utilisation and outsourcing
The investment is estimated to be roughly 12 billion yen also due to enter Myanmar to benefit from growing
($108.91 million) and it will increase the factory’s floor demand. The opportunity for Chinese manufacturers has
space tenfold to 42 000 square metres, from the current increased with improved quality and less concern from
4000. younger buyers about the brand.
The factory had previously been importing painted Questions
car bodies from other countries, including India, and
1 Explain one factor that determines the capacity of
assembling the vehicles in Myanmar. With growth
Suzuki. [3]
expected in Myanmar’s new car market, Suzuki has
2 Evaluate the reasons why Suzuki expanded capacity
decided to set up a production system that could supply
at its Myanmar factory. [12]
demand quickly. As a result, the factory’s production
capacity should increase to 40 000 vehicles per year from
a previous 10 000.
there are major cost advantages of having higher capacity

STUDY TIP utilisation. A business with low capacity utilisation not only
Remember that the capacity of a business will affect the wastes resources but has high unit costs. This will reduce
sales it is trying to achieve and, therefore, its human profit margins if the price stays the same. If the firm tries to
resource planning and financial position. There is little increase the price to cover the higher unit costs, it may find
point generating more demand if there is not the capacity, that sales fall and the situation becomes even worse.
unless the business is willing to let others produce for it
and/or have queues and waiting lists. Improving the position of the business may therefore
involve increasing the capacity utilisation, either by
boosting demand (which may be through marketing
The impact of operating under capacity activities) or reducing the capacity of the business if some
If capacity utilisation is low, it means that the existing of it is no longer needed.
output is relatively low compared to what could be
produced. This is inefficient because resources are not being Methods of improving capacity
fully utilised. The business could be producing more and,
assuming the demand was there, earning more revenue and
utilisation
profit. The train could have more passengers, the health Your capacity is under-utilised (that is, capacity utilisation
club could have more members, the sandwich business could is low) if demand is not matching the level of output you
be making more sandwiches. A business will, therefore, are able to provide. For example, you have a cinema that
usually want a high level of capacity utilisation. can take 400 people but there are only 80 watching the
film (this is 20 per cent capacity utilisation); you have a
Higher levels of capacity utilisation are desirable because café with 40 tables but only 4 are occupied at the moment
they spread the fixed costs of a business over more units. (this is 10 per cent capacity utilisation). Capacity under-
The fixed costs of a business are those costs that do not utilisation therefore occurs when demand is too low. In this
change with output; for example, the rent on a building or situation the business may:
the interest payments on a loan. As output expands, these » do nothing If this is seen as a temporary issue, the
fixed costs can be divided by more units. For example, if business may accept under-utilisation for a short time
fixed costs are $10 million and 1 unit is produced, the fixed (for example, when a World Cup football match is on
cost per unit is $10 million; if 10 million units are produced, television, the number of high-street shoppers falls;
the fixed cost per unit is $1. Higher capacity utilisation capacity utilisation in restaurants is usually lower during
therefore helps reduce unit costs and, therefore, increase the week compared to the weekend)
profit margins. Imagine you were renting a market stall for » renew its marketing activities to boost demand For
$500 and you sold 250 items. Each item would have to earn example, changes in the promotional strategy may be
$2 simply to cover the rental costs. If you sold 1000 items, made: new offers, increased efforts by the sales team or
each one would only have to earn 50 cents to cover the fixed more advertising may help increase sales
costs – this is because as your output increases, the fixed
cost per unit falls. This is very significant because it means
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» reduce the level of capacity If, over time, demand customers may switch to another business where they
is lower than capacity, the business may rationalise. can buy the products they want.
Rationalisation means the business may reduce its
capacity levels. For example, you may reduce the
» increasing prices Higher prices can be used to reduce
demand. This can increase profit margins, but the
4.3
number of staff you have, you may sell off some of your business will need to set the price at the right level to
production equipment if it is not needed, or you may sell avoid ending up with demand becoming too low.
off some land if this is not required. Of course, changing If demand looks as if it is going to remain high, a business
capacity levels may be easier in some businesses than may look to invest to increase its capacity over time. For
others. If you run a taxi or delivery business, you could example, a business may build new production facilities if it
reduce the number of vehicles you operate fairly easily. thinks the demand will justify this investment financially.
4.3.1 Significance and measurement of capacity utilisation

However, if you run a cinema, it is not easy to split the
cinema in half to reduce the capacity. If you have a café, Capacity shortage
you cannot easily sell off a quarter of it. In general, it If demand is too high for the firm’s capacity, there is a
is easier to reduce the labour input by making people capacity shortage; for example, there are more people
redundant or asking them to go part-time. Reducing the wanting tickets for a gig than there are places, there are
land and capital inputs can be more difficult queues outside the nightclub, or there is a waiting list for a
» subcontract for other firms If you do have excess product. In this situation a business may:
capacity, you may offer your resources to other firms » do nothing You may think that the fact that the
and produce on their behalf. This is subcontracting. product is in short supply relative to demand adds to its
Some shops may rent out part of their space to other appeal. Some clubs might want to build on the image
businesses, for example. A food business may offer to that they are difficult to get into. Morgan sports cars
produce for someone else and put the other firm’s brand used a waiting list of several years but simply saw this
name on the products. as evidence of the appeal of their cars – they did not
want to increase their output. You may also think that
GLOSSARY TERMS the excess demand is temporary and so not want to
Capacity under-utilisation occurs when a business is make any major changes, given that it may not last (for
producing less than the maximum amount it can produce, example, it may be the latest fashion trend to wear a
given its existing resources. certain brand of sunglasses or t-shirt, or it may just be a
particularly busy day or night). In this situation people
Rationalisation occurs when a business reduces the scale
of its operations and reduces its capacity level.
will simply have to wait. A business may start a waiting
list or limit the number any one person can buy
Subcontracting occurs when one business employs » expand capacity If you believe demand is likely to
another business to undertake some of the work.
remain high then you may increase capacity. This will
require investment (for example, you may need more
people, more equipment and bigger premises) but
High levels of demand relative to may well be worthwhile due to the extra sales you
can generate
capacity » outsource If you cannot meet all the demand yourself,
If demand is high, a business may be operating close to you may use other producers to produce for you. This
100 per cent capacity utilisation. This may be possible in increases the amount you can supply but you need to
the short run, but it may put pressure on resources if the be careful that quality does not suffer and, because
business is operating at full capacity for a sustained period the outsourcing suppliers will want to make a profit,
of time. Employees may feel under pressure and become your own profits may be less on the units they make
tired. There may not be time for day-to-day maintenance compared to you making them yourself. Alternatively, a
and repair of equipment, increasing the risk of breakdown business may outsource some of its non-core activities
or failure. A business may, therefore, wish to operate below so that it can focus on the essential elements of the
100 per cent capacity utilisation over a period. business. For example, in a school the governors may
If demand is above the normal capacity of a business, decide to outsource activities such as the catering, the
managers may respond in various ways. In the short term, maintenance and the security so that they can focus
they may try to increase the capacity by opening longer on teaching and learning. This may enable managers
and asking employees to work more hours than usual. to concentrate on what they do best and make use of
Another response might be to subcontract output to other the skills and experience of specialists in other areas.
producers. This brings risks because the original business Caterers that supply to many schools, for example, may
is no longer directly responsible for the quality. It is also have economies of scale that make it cheaper to use
expensive because the subcontractor will want to make a them than to try to do it yourself
profit. However, using a subcontractor can allow a business » increase the price If demand is too high relative to
to continue to meet its customers’ orders and may maintain supply, a business may increase the price to bring
goodwill. Other responses to high demand include: demand down to the ‘right’ level. This is what happens
» starting a waiting list This can increase the sense in many markets. If demand for a particular company’s
of exclusivity, which may suit premium brands, but shares increases, there is only a certain number available
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and so the holders of these can increase the price. If you » to increase its capacity.
have a house in an area that becomes very desirable then,
4.3 given the higher levels of demand compared to supply,
you can increase the price. The price can therefore act as
However, when outsourcing, a business should consider:
» the impact on costs The provider will want to take a
a rationing mechanism to reduce the demand, and at the profit and therefore the business needs to make sure
same time it can increase the profit margin per item. that outsourcing is better value than doing it itself.
Sometimes a business may outsource initially but, as the
scale of the activity grows, it may be worth taking the
4.3.2 Outsourcing activity back in-house
» the impact on quality The quality of work from a
Outsourcing occurs when the business uses other producers specialist provider may be better than the business
AS LEVEL 4.3 Capacity utilisation and outsourcing
to undertake some of its operations. A business may could produce itself, but the business needs to be
outsource some aspects of its operations which it does sure. The business is not directly in control of what is
not regard as critical to what it does and/or where it may happening and therefore must ensure that specifications
benefit from the expertise and scale of others. A business and expectations are clear and that there are systems in
might outsource its catering and security, for example. place to monitor quality
Similarly, it may outsource its customer enquiry helplines to » reliability of delivery The outsourcing supplier must be
specialist call centres. There may be times when a business able to deliver reliably, on time, so that the rest of the
does outsource key parts of its process to help expand its business’ operations are not held up
capacity and ability to deal with customer orders. » the response of the existing workforce By
Outsourcing may enable a business: outsourcing, a business is moving production away
» to use the specialist services of another business An from the business itself. This may lead to a loss of
outsourcing supplier may be using specialist equipment jobs. For example, if a business decided to outsource
which it is not cost-effective for the business to invest in its design and marketing activities, this would reduce
for itself, given the scale of this particular operation. A the need for these jobs internally. This may meet with
school is likely to outsource the printing of its prospectus, resistance.
because it prints relatively low volumes and it would not
be cost-effective to have its own printing presses GLOSSARY TERM
» to benefit from lower costs by using a business that Outsourcing occurs when the business uses other
specialises in an activity (such as customer credit producers to undertake some of its operations.
checks) rather than trying to learn how to do it itself
TEST YOUR LEARNING

5 Explain one way in which a business might improve
Short answer questions its capacity utilisation. [3]
1 Explain one factor that might influence the capacity 6 Explain one way in which a business might respond
of a business. [3] to a capacity shortage. [3]
2 Define the term ‘capacity utilisation’. [2] 7 Define the term ‘outsourcing’. [2]
3 a If present output of a business is 400 units and 8 a Explain one benefit to a business of outsourcing. [3]
capacity is 1200 units, calculate its capacity
b Explain one disadvantage to a business of
utilisation. [2]
outsourcing. [3]
b If capacity utilisation is 80 per cent and output is
9 If a business produces 200 units and its capacity
400 units, calculate the capacity of the business. [2]
utilisation is 70 per cent, calculate its capacity. [3]
4 a Define the term ‘undercapacity’. [2]
10 Explain one reason why higher capacity utilisation
b Explain one problem for a business of operating is likely to lead to lower unit costs. [3]
under capacity. [3]
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Data response question Airport, near Jakarta, received 112 million passengers
Air travel in Indonesia

in 2018 – far above its intended capacity of 70 million.
In December 2019, a third runway was opened to ease 4.3
Indonesia has seen a rapid rise in its number of air congestion; there are plans to build a new airport to
passengers, from 30 million in 2009 to over 115 million serve Jakarta in the near future. Other improvements
in 2018. This growth has been due to the growth of the are planned around the country, including Kualanamu
middle classes and the appeal of low-price airlines. International Airport which serves Medan. A new airport
Indonesia has also increased in popularity as a holiday is planned in Bali to help reduce congestion in the existing
destination for international tourists; there were over 10 Ngurah Rai Airport in Denpasar. Although a site has been
million international arrivals in 2018. As a result of this proposed on the island, Bali’s popularity as a tourist
4.3.2 Outsourcing
expansion, there are a number of plans to expand the destination has put it under significant environmental
capacity of the airports. Although airports and airlines pressure, with issues around water availability and safe
were massively under capacity in early 2020, demand sewage disposal.
grew fast once travel started up again.
Questions
Given the rise in air travel in recent years, many domestic
and international airports have been operating over 1 Define the term ‘capacity’. [2]
capacity. The government has highlighted the need for 2 Analyse one reason why the Indonesian government
more infrastructure as a priority. Major improvement wants to increase airport capacity. [4]
works are planned for existing airports with further plans 3 Evaluate the factors the Indonesian government
for new ones to be built. Soekarno-Hatta International should consider before deciding whether to
expand airport capacity. [12]
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AS LEVEL
5.1 Business finance

AS LEVEL 5.1 Business finance
Chapter overview
★ the reasons why businesses need capital – for example, for survival or growth
★ why businesses need short-term and long-term finance
★ the distinction between cash and profits
★ shortages of finance and business failure
★ working capital, trade receivables and trade payables, capital and revenue expenditure.
5.1.1 The need for business Any start-up business is likely to require finance to fund
its market research and also for promotion to establish
finance its brand and identity among potential customers. It
can prove difficult for some start-up businesses to raise
Businesses need finance for a variety of reasons; sufficient finance and this is an important reason why
for example, to purchase assets such as supplies of some business ideas never become reality.
raw materials and machinery. There are three major
circumstances in which a business needs to raise finance. Businesses also need cash to allow them to start
trading. Cash is required to pay the bills that arrive
1 When it is first started regularly, such as for supplies of raw materials or
This is referred to as ‘start up’ finance or capital, for for services such as telephone and water. A newly-
obvious reasons. The amount of finance raised by a established business may not receive any payment from
business that is starting up is likely to be relatively its customers for a period of time and it is important
small. An entrepreneur establishing a new business is that the new business has sufficient funds to settle its
unlikely to have access to large amounts of finance, and debts. We will cover cash in more detail in Chapter 5.3.
banks and investors may be unwilling to invest in an
untried enterprise.
GLOSSARY TERMS
Start-up finance or capital may be used to purchase the
An asset is any item owned by a business that can
assets that a business needs to begin trading. In the case
generate an income for the enterprise.
of a manufacturing business, this may be to buy a lease,
allowing the business to use a factory for an agreed Capital is the money invested into a business either by its
period of time. Start-up finance may also be required owners or by organisations such as banks.
to buy machinery and vehicles. Start-up businesses Non-current assets are assets that a business expects to
supplying services may purchase slightly different hold for one year or more. Examples include property and
non-current assets such as leases on shops or offices. vehicles.
CASE STUDY
Creating a STORM of interest
The STORM Creative Events Agency was established and uses its contacts in the media throughout Asia to
by Keyis Ng. It is a fashion, lifestyle, events and public gain extensive coverage of its innovative events.
relations firm. Keyis Ng has had a huge impact on the
Singaporean and regional fashion scene. Questions
The 24-year-old entrepreneur founded his company with 1 Explain two reasons why an entrepreneur starting
a start-up capital of just $15 000. The company organises a new business would need to raise finance. [6]
product launches, private parties, fashion shows and 2 Evaluate the reasons why Keyis Ng was able to start
awards ceremonies to promote brands and business the STORM Creative Events Agency with so little
ideas. It is good at gaining press coverage for its events start-up finance. [12]
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2 When it grows materials can also create a need for short-term finance.
Many businesses seek to grow, and for some it is an Short-term finance of this kind is usually repayable within
important objective, as we saw in Chapter 1.4. When it
is growing, a business will need finance for a number of
a one-year period. 5.1
Sometimes businesses need to purchase major non-current
reasons:
assets, such as land and buildings, or they may decide to
– To buy additional non-current assets For example,
expand or to take over other businesses. To do this they
in 2019, Amazon (an online retailer) announced that
will require long-term finance which will be repaid over
it was expanding its online grocery service, Amazon
a period of time longer than one year and, often, much
Fresh, in India and promised delivery within a few
longer.
hours of an order being placed. This new service will
be available to customers in some parts of Bengaluru Table 5.1 classifies a range of sources of finance according to
5.1.1 The need for business finance

and it will be extended to other cities later. In order whether they are short- or long-term.
to provide this service, the company would have
needed to finance the purchase of a range of non-
current assets, such as additional chilled cabinets
GLOSSARY TERMS
to store perishable food and vehicles to deliver the Short-term sources of finance are needed for a limited
groceries. period of time, normally less than one year.
– To hire and pay for new staff In Amazon’s case, Long-term sources of finance are those that are needed
this means hiring and training delivery drivers for its over a longer period of time, usually over a year.
grocery service. As Amazon Fresh is to be extended
throughout India, this could require a large amount
of finance. ▼ Table 5.1 Classifying sources of finance
– To buy additional supplies of groceries Amazon
Internal sources of External sources of
hopes to sell its groceries to a large number of
finance finance
customers and to provide rapid delivery. This will
require it to hold at least some inventories (stocks) of Short-term • Working capital • Overdrafts
groceries. Finance will be required to purchase these. sources of • Retained profits
3 To survive finance
Sometimes businesses need finance to survive. The Long-term • Retained profits • Bank loans
ability of businesses to survive is often under threat in sources of • Sale of assets • Venture capital
two situations: finance • Sale and • Mortgages
– When first established One-third of new businesses leaseback • Debentures
in the USA did not survive their first two years of • Share capital
trading. A new business may not survive for a variety • New partners
of reasons, including a lack of customers or higher • Government grants
costs than forecast. If the new business can raise and loans
finance during this critical early period, it is much • Crowdfunding
more likely to survive. • Microfinance
– When facing a crisis Crises can take many forms,
but they normally involve a loss of income from sales
or higher than expected costs, or both. If a business The difference between cash
can raise finance during a crisis, it is more likely and profits
to be able to pay its debts on time and to survive.
It was for this reason that governments across the Profit is the surplus of sales revenue over total costs, if
world took steps to increase the finance available to any exists, over a trading period. Just because a business
businesses during the Coronavirus (COVID-19) crisis is profitable, it does not mean that it will hold large sums
in 2020. of cash or even have enough cash. There are a number of
reasons why this situation might arise:
» Firstly, the business might sell large amounts of goods
Short- and long-term sources or services at profitable prices by offering customers
of finance 60 or 90 days to pay for their purchases. This will mean
that the business has to find cash to buy supplies
A business may need short-term finance to pay its bills
and pay employees several months before the cash
and to keep its suppliers happy. This is an important part
from the sale of the product flows into the business.
of the management of cash flow. Managing cash flow
This problem can be worsened if the business pays its
can be difficult if a firm’s customers are late in making
suppliers promptly.
payments for goods and services they have purchased or if
» Alternatively, a business such as a jeweller might hold
sales are unexpectedly low. In either case the firm is likely
large amounts of (expensive) inventory for customers
to be short of funds needed to purchase raw materials,
to view before making a choice. This will result in large
pay wages and salaries, and it will need short-term finance
amounts of cash being tied up in the form of inventories
to continue trading. Sudden increases in the costs of raw
and not available to the business for other purposes.
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» A business may have paid for non-current assets and Thus, a profitable business may find itself short of cash
used large sums of cash to do so. These assets may and possibly unable to settle its bills as they fall due. This
5.1 support the business over many years, and they will lead
to future inflows of cash. However, the outflow of cash
could lead to the firm becoming insolvent and having to
cease trading. A cash crisis is a major reason why many
would be at the start and may place pressure on a firm’s businesses fail.
finances.
Periods of cash shortage
Cash
flows Cash inflows
Cash outflows
0
At end of the
Time
Income trading period
and costs income exceeds Income
costs = profit
Income
Costs
Income
Costs Costs
0
Time
End of trading
periods
▲ Figure 5.1 Profit and cash
STUDY TIP Business failure

Do spend time mastering the distinction between cash A lack of finance is a common cause of business failure.
and profits, as it is very important for the managers of A business fails when it is unable to pay its debts and
businesses. If you are asked about cash flow, try to avoid is unable to continue trading. This is called insolvency.
drifting into arguments about profit and vice versa. A business is judged to be insolvent when its debts (or
liabilities) exceed its ability to pay them. In the UK, and
many other countries, it is illegal for an insolvent business
In the long term, however, a business has to make a profit to continue trading. The process followed by businesses
to satisfy its owners. They have invested funds into the declared insolvent differs between companies and other
business, quite possibly by purchasing shares, and expect to types of business as illustrated in Figure 5.2.
see a return on their investment. This is only possible if the
business makes a profit in the longer term. A business may
survive for some time without making profits if its owners GLOSSARY TERMS
are prepared to be patient, but cash has to be managed Insolvency exists when a business’ debts (or liabilities)
carefully in the short term to ensure that bills can be paid exceed the assets available to pay them.
on time and that the business survives. Liabilities refers to the money owed by a business to
individuals, suppliers, banks and others.
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Unincorporated It is usual for an administrator to be appointed with
businesses (e.g. sole the responsibility of protecting shareholders’ interests.
traders, partnerships)
Bankruptcy Administrators attempt to keep the business trading,
though they may have to sell some assets to do so.
5.1
If the administrator is not able to keep the business
A Creditors
business is receive trading by renegotiating and settling its debts, the
judged some company will face liquidation.
insolvent payments
Working capital
Liquidation Essential, to pay for day-to-day expenses and
Incorporated
keep the business operating
5.1.1 The need for business finance

businesses
(e.g. companies) Unsuccessful
Administration Continues
=
Successful trading
▲ Figure 5.2 Insolvency, bankruptcy, administration Current assets

and liquidation • Cash in the bank
• Trade and other receivables due to settle
1 Bankruptcy
their accounts soon
A business whose owners are not legally separate from • Inventories – raw materials and components
the business itself is known as an unincorporated
business. The owners of these businesses do not have
the protection of limited liability as discussed in less
Chapter 1.2. If an unincorporated business in the UK is
unable to settle its debts, it will be declared bankrupt Current liabilities
by a court of law. The assets owned by the bankrupt (Debts payable in the short term)
business will be sold; this can include the private • Debts repayable to the bank, e.g. overdraft
possessions of the business’ owners, such as property • Trade and other payables who expect to be
and savings. The money raised from this sale will be paid in the near future
shared between the individuals and organisations who • Tax due to authorities
are owed money (known as the creditors). It is unlikely
that the creditors will receive all the money that ▲ Figure 5.3 Working capital
they are owed as the business will not have assets of
sufficient value to cover all its liabilities. GLOSSARY TERMS
2 Administration and liquidation
Bankruptcy occurs when an individual, a sole trader or a
A company (that is, an incorporated business) that is partnership is judged unable to pay its debts by a court of
judged to be insolvent will often have its assets sold to law.
settle its liabilities. These assets will not include the
Liquidation is the dissolution of a company by selling its
private possessions of the business’ owners (normally
assets to settle its liabilities.
shareholders). The process of selling assets for cash is
called liquidation. The process of liquidation takes two Administration is a process available to a company to
forms: protect itself while it attempts to pay its debts and to
– Compulsory liquidation. This occurs when a escape insolvency.
creditor seeks an order from a court of law to have
the business’ assets sold as it has not received
payment of a debt. In such circumstances the court STUDY TIP
will appoint a receiver. A receiver is a business that In some circumstances, current liabilities might be
specialises in taking control of an insolvent company greater than current assets. In this case, working capital
and making arrangements for creditors to be paid. will be negative (and may be called net current liabilities).
A receiver may be able to keep the business going As a negative figure it is often shown in brackets.
if its finances are not too weak. However, it is very
common for receivers to close the business down and
to sell all its assets.
– Voluntary liquidation. This is when the owners of HANDLING DATA
the company decide to enter liquidation. This might
be because they recognise the weakness of the Last year Darwin Hotels Limited had current assets
business’ financial position. It can also occur when amounting to the value of $25.0 million and current
the owners of a company want to retire and are liabilities totalling $19.9 million.
unable to sell the business as a growing concern. 1 Calculate its working capital for last year.
2 This year its current assets fell by 5 per cent while
Some companies may decide to enter administration.
its current liabilities rose by $1.1 million. Calculate
By entering administration, a company receives legal
its working capital for this year.
protection from the threat of immediate liquidation.
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5.1.2 Working capital CASE STUDY
5.1 Working capital measures the amount of money available
to a business to pay its day-to-day expenses, such as bills Melaka Limited raises $9.3 million
for fuel and raw materials, wages and business rates. Much
attention is given to the capital firms choose to invest in for working capital
non-current assets, but of equal importance to the success Melaka Limited has sold $9.3 million of its shares to
of a business is the capital set aside to finance regular raise finance to ensure that it has sufficient working
transactions. capital to fund its future plans. It sold 46.5 million
new shares to raise the finance it required and the
Working capital is what remains of a business’ liquid assets company’s directors said they were ‘delighted’ with the
once it has settled all its immediate debts (see Figure 5.3). support of the shareholders in buying the shares.
It is possible to calculate the working capital of a business Melaka Limited operates in the oil and gas industry
from its statement of financial position by using the and is seeking to expand quickly and provide energy to
following formula: the rapidly growing Asian economies. This involves the
working capital = current assets – current liabilities discovery and extraction of oil and gas from different
locations including the Timor Sea and the Gulf of
A statement of financial position records a business’ Thailand.
assets and liabilities. We look at statements of financial
In June 2020, the company announced losses of $5.7
position (also known as balance sheets) in detail in
million for the financial year compared to profits of
Chapter 10.1. $14.2 million for the previous financial year.
Working capital is important to all businesses. It has been
described as the ‘lifeblood’ of a successful enterprise. Question
If any business is unable to pay its bills promptly, then 1 Explain two reasons why Melaka Limited might
it may be forced to close down as a consequence of have needed large amounts of working capital. [6]
insolvency.
However, working capital can also be a source of finance
for a business. If a business manages its working capital
Managing trade receivables and
effectively it may have a strong working capital position. To trade payables
do this, it may need to: By managing trade payables and trade receivables carefully,
» make sure that its trade receivables (the money that it is businesses can reduce the chances of running out of cash and
owed from customers and any other groups) are received improve their working capital position. As we saw earlier, a
on time shortage of cash is a major cause of insolvency.
» ensure that it does not hold too high inventory (or
stock) levels as this can tie up large amounts of cash for Most businesses are granted time to pay for products by
a business their suppliers. For example, an airline might buy a large
» pay its own debts (trade payables) as late as possible quantity of aviation fuel for $5 million from an oil company.
so that as much cash as possible is held in the business This fuel might be delivered in March, but payment may not
at any given time. be expected until June. This means that the oil company is
giving the airline credit (called trade credit) for three months.
If a business’ current assets exceed its current liabilities The $5 million will be a trade payable for the airline as it is
on a regular basis, this provides the business with a money that it owes for goods it already has but for which
potential source of finance. However, this source of finance payment is outstanding. This is a financial advantage for the
is only available on a short-term basis. airline as it is, in effect, a $5 million loan for three months
on which no interest is charged. It is also an example of a
GLOSSARY TERMS trade payable – a short-term debt which has yet to be paid.
Working capital is the cash a business has for its In contrast, many businesses also give their customers
day-to-day spending. time to pay for the goods and services that they buy.
Current assets are items owned by a business that can be A coffee producer may sell large quantities of coffee to
readily turned into cash. Examples include cash, money customers such as shops and cafés. The coffee producer
owed by customers (trade receivables) and inventories may, for example, allow a large supermarket trade credit for
(stocks). two months when it places an order for coffee worth $2.5
Trade payables is the amount of money owed by a million. This is a valuable order and the coffee producer will
business to its suppliers for goods and services that have want to keep the supermarket as a customer. This means
been received but which have not been paid for. that the supermarket does not have to pay the $2.5 million
Trade receivables is the amount owed by a business’ for the coffee it has bought until two months after it
customers for products that have been supplied but for arrives in its warehouses. From the coffee producer’s point
which payment has not yet been made. of view this is a trade receivable, as it is a debt for goods
supplied which has not yet been received.
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Businesses can improve their working capital position by part of its trading activities. Spending on employees’ wages
managing trade receivables and trade payables carefully. is an example of revenue expenditure. Revenue expenditure
There are several actions a business can take:
» It can delay its trade payables (or negotiate more trade
is shown on a business’ income statement as it is part of a
business’ trading costs or expenses. The differences between
5.1
payables) if possible. This will mean that it will hold revenue expenditure and capital expenditure are summarised
cash within the business for longer, giving it a higher in Table 5.2.
sum of cash within the business.
▼ Table 5.2 Revenue and capital expenditure
» It can require that its trade receivables are paid by its
customers within a shorter time period. This will bring
Revenue expenditure Capital expenditure
quicker inflows of cash, again helping its trade balance.
» Many businesses will seek to carry out both of the Explanation This is spending on This is spending on
5.1.2 Working capital

actions above, as each has a positive effect on their assets that are used non-current assets
holdings of cash. up in a relatively that will be used by
short period of time. the business for a long
We will look at trade payables and trade receivables in more
period of time.
detail in Chapter 10.2.
Examples Spending on fuel, Expenditure to purchase
Revenue expenditure and capital components and raw property, vehicles and
materials. production equipment.
expenditure
Possible Revenue expenditure This type of spending
We have seen that businesses need to raise capital to start effects on is essential to has no immediate
up and to expand. Once a business has raised funds to profits production but, if not effect on profits.
finance its start-up costs, the business can start trading. controlled, can have However, capital
If it takes a decision to expand, the business will require an immediate and expenditure is essential
additional finance, in excess of that received from sales, to damaging effect on a if a firm is to generate
finance the purchase of additional non-current assets and business’ profits. long-term profits.
other items.
If the start-up or the expansion is successful, the new or
newly expanded business will earn revenue from its sales.
GLOSSARY TERMS
This will be used to buy more labour services and raw Revenue expenditure refers to the purchase of items such
materials to enable it to continue trading. as fuel and raw materials that will be used up within a
short space of time.
The expenditure carried out by a business can be divided
Capital expenditure is the spending by a business on non-
into two categories: revenue expenditure and capital current assets such as premises, production equipment
expenditure. Capital expenditure is on items that may and vehicles.
be used many times, mainly non-current assets. A new
A statement of financial position is a financial statement
computer system is an example of capital expenditure.
that records the assets (possessions) and liabilities
Expenditure on items required to start up or to expand a
(debts) of a business on a particular day at the end of an
business can be classified as capital expenditure. These will
accounting period. It was previously called a balance sheet.
be shown on a business’ statement of financial position as
they include the purchase of non-current assets. An income statement is a financial statement showing a
business’ sales revenue over a trading period and all the
Revenue expenditure is on the goods and services needed by relevant costs incurred to generate that revenue.
a business that will be used up in the short term as a normal
CASE STUDY
Vardhman Textiles
Vardhman Textiles, one of India’s largest textile
manufacturers, plans to increase its capital expenditure by
142 per cent in 2021–22 to finance the purchase of the new
property and machinery needed for its planned expansion.
The company expects to spend Rs. 7.5 billion compared to
Rs. 3.5 billion in 2018–19.
The company manufactures fibre, yarn, sewing thread and
fabrics, and forecasts significant rises in its revenue from
sales and consequently rises in its profits.
Vardhman’s recently released Annual Report judged
that yarn exports would be affected due to a slowdown
▲ Figure 5.4 A selection of textiles in demand owing to the Coronavirus (COVID-19) crisis
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in 2020. However, it expects a revival in global demand Questions
5.1 and significant growth in yarn sales in 2021. The Report
expects cotton prices to be relatively unchanged in 2021–
1 Define the terms:
a ‘revenue expenditure’ [2]
22 following a 6.1 per cent fall in cotton prices in 2019–20.
b ‘capital expenditure’. [2]
At the same time, the prices paid by buyers of yarn have
2 Evaluate the view that this capital expenditure will
risen by 32 per cent to Rs. 210 per kilogram.
increase the profits earned by Vardhman Textiles. [12]
TEST YOUR LEARNING

HW has:
l ordered increasing amounts of supplies needed to
1 Explain one circumstance in which a business may manufacture its machinery and has some overdue
need to raise finance. [3] bills
2 Explain one difference between short-term and l offered trade credit to its customers allowing them 90
long-term sources of finance. [3] days to pay for deliveries
3 Explain one difference between cash and profits. [3] l not been able to persuade its own suppliers to offer it
4 a Define the term ‘bankruptcy’. [2] more than 30 days’ trade credit for its purchases.
b Explain one circumstance in which a business
HW has recently supplied a major customer with
would be judged to be insolvent. [3]
machinery valued at $14.6 million – easily its largest-ever
5 Explain one difference between compulsory
order. The company is waiting for payment, which is due in
liquidation and voluntary liquidation. [3]
45 days.
6 Analyse one circumstance in which administration
might enable a company to avoid liquidation. [4] The company’s financial position is mixed: it is profitable
7 a Define the term ‘working capital’. [2] but short of cash. Its products are well-designed, reliable
and it is able to charge high prices. The company’s
b Explain one reason why working capital
managers are very successful at keeping costs low.
is important to all businesses. [3]
However, it has an urgent need for short-term finance and
8 Explain one difference between trade payables
this is worsening.
and trade receivables. [3]
9 Explain two ways in which a business might manage Last month HW faced a financial crisis and was unable to pay
its trade receivables and trade payables effectively. [6] its suppliers. It feared that it might be forced into liquidation.
10 Explain one difference between revenue expenditure However, it was advised to go into administration. The
and capital expenditure. [3] administrator was able to renegotiate the later repayment of
some of its debts and the company survived.
Data response question Questions
HW Limited is growing very quickly 1 a Define the term ‘liquidation’. [2]
HW is a private company that manufactures machinery for b Explain one reason why HW had ‘an urgent need
export to businesses across the world. The company has for short-term finance’. [3]
grown quickly recently and has been keen to attract new 2 Analyse one reason why HW is profitable but suffers
customers. It expects to continue its fast growth in sales from cash-flow problems. [4]
and needs to place a very large order with its suppliers for
3 Evaluate whether or not it was a good decision for
parts and components.
HW to enter administration. [12]
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AS LEVEL
5.2 Sources of finance
5.2.1 Business ownership and sources of finance

Chapter overview
★ business ownership and sources of finance
★ internal and external sources of finance
★ the factors that affect the choice of sources of finance
★ how businesses select their sources of finance.
5.2.1 Business ownership and sources of finance for use. In contrast, a limited company
has a greater range of sources of finance that it can use,
sources of finance including the sale of shares. In the UK, only public limited
companies can benefit from being able to raise capital
The form of ownership (or legal structure) is a major by selling shares on the London Stock Exchange, but all
influence on the sources of finance that are available to companies can sell their shares to individuals, with certain
a business. We looked at the different types of business limitations.
ownership in Chapter 1.2.
Table 5.3 sets out the major sources of finance available
Start-up businesses, many of which may be sole traders or to each of the major legal structures and offers some
partnerships, normally have a relatively limited range of consideration of factors that decision-makers in each case
sources of finance to draw upon as they represent a greater may take into account. We shall consider these sources of
risk to potential investors and have few, if any, internal finance in more detail in the following section.
▼ Table 5.3 The legal structure of a business, possible sources of finance and key issues
Legal form of business Possible sources of finance Key issues for consideration
Sole trader or proprietor Owner’s savings, banks, suppliers, • Difficulty in providing security for those
government grants and loans lending funds to ensure repayment (known as
collateral)
• Loss of control by owner
• Businesses must provide evidence that they
have potential to develop
• Financial history of business/owner
Partnership Partners’ savings, banks, suppliers, • Problems of introducing new partner
government grants and loans • Lack of collateral
• Potential expense of raising large sums of
money
• Should it form a limited company?
Private limited company (ltd) Dependent upon the size of the private • Disagreement among existing shareholders
limited company: suppliers, banks, • Difficulty finding suitable shareholders
government grants and loans, venture • Loss of control by existing shareholders
capital institutions, private share issues • Lack of collateral for those lending funds
• Element of risk in a loan
Public limited company (plc) Suppliers, banks, government grants and • State of economy and stock market
loans, venture capital institutions, public • Ability to move to an area receiving
share issues via the stock exchange government aid
• Recent financial performance
• Reputation of company and senior managers
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5.2.2 Internal and external and are not paid to owners. It is common for businesses to
use these retained earnings as sources of finance. By using
5.2 sources of finance retained earnings for reinvesting, a business avoids paying
interest on a loan and this can avoid heavy interest charges
We saw in the previous chapter that businesses need finance if a large loan is required. Furthermore, using this source of
for a range of reasons. There are a number of sources from finance may avoid the need for a company to sell further
which they can raise finance. These can be split into two shares, enabling existing shareholders to retain control if
categories: they continue to hold a majority of the shares.
» internal sources of finance from within the business
» external sources of finance from outside the business. But using retained earnings can have substantial
opportunity costs – that is, the business may lose out from
AS LEVEL 5.2 Sources of finance
GLOSSARY TERMS not using these funds in another way. Reinvesting retained
earnings may not be popular with shareholders who could
An internal source of finance is one that exists within the
receive higher dividends if retained earnings were reduced.
business.
Alternatively, the business may lose out on interest it may
An external source of finance is an injection of funds have received if it had held the money in an interest-paying
into the business from individuals, other businesses or bank account.
financial institutions.
Trade credit is a period of time offered by suppliers of This method of finance is only available to firms making a
goods and services before payment is to be made. profit over a period of time. Even then, the profits may not
be sufficient to purchase expensive non-current assets.
Internal sources of finance Sale of unwanted assets

The major internal sources of finance are owners’ Firms can raise cash by selling assets that they no longer
investments, retained earnings, sale of unwanted assets, sale require – normally these are non-current assets. The sale
and leaseback of non-current assets and working capital. of some assets can raise large amounts of finance for
businesses. Thus, a business might have land, buildings
Owners’ investments or other assets that are not required and they may decide
One source of finance is for the owners of the business to to sell to raise capital. In 2019, Murphy Oil Company, an
provide the funds from their own resources. This may involve American multinational, sold some assets it owned in
the use of savings. Alternatively, the owners of a business Malaysia, including oilfields, for $2.13 billion. Murphy Oil
may take out a personal loan using their house (or other Company was raising money to invest in shale oilfields in
assets) as security and invest this money into their business. America which were expected to be highly profitable.
They may also persuade friends and family to invest in their Raising finance in this way offers a key benefit in that the
business, perhaps in return for part-ownership. business is not committed to a stream of future interest
Owners investing in their own business can be helpful in payments, nor might its shareholders suffer dilution of
persuading others to invest. Banks and other financial control. However, the business would normally lose access
institutions will often want to see evidence that business to the assets it has sold.
owners are willing to risk some of their personal capital
in the enterprise before agreeing to make a loan or other Sale and leaseback of non-current assets
investment. If the owners are not willing to risk investment But what if the non-current assets will continue to be
in their own business, it will be more difficult to raise required by the business? A popular technique of raising
finance from other sources. funds in recent years has been sale and leaseback. Under
this arrangement firms sell valuable assets and lease them
Retained earnings back again. This means that they have the capital from the
Earnings from previous years are a major source of finance, sale of the assets as well as the continuing use of these
particularly for smaller businesses. A company’s retained assets, so that their business is not disrupted. The major
earnings are those profits from previous years that have not drawback is that the business now has to pay for the use of
been paid to shareholders as dividends. For other types of assets which previously were freely available. This may have
business, they are the profits that remain in the business a negative impact on long-term profits.
CASE STUDY
Ted Baker Plc in a sale and leaseback deal
The British fashion clothing retailer, Ted Baker Plc, has the property known as the ‘ugly brown’ building. This will
sold its headquarters in King’s Cross, London, in a sale and allow the company to reduce the amount of debt that it has
leaseback deal. The company, which sells clothing in stores and the interest payments due on it.
in ten countries, has received a reported £78.75 million for
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In 2020, Ted Baker Plc also announced that it was cutting 102 many of its shops due to the 2020 Coronavirus (COVID-19)
jobs and removing 58 vacant posts as part of a strategy to
cut its costs. The retailer expects to save £12 million over the
pandemic. Although it continues to sell its products
online, its managers estimate that sales have fallen by 68 5.2
next two financial years as a result of these staff reductions. per cent as a result of the store closures.
Ted Baker’s financial performance has been poor in Questions
recent months. Ted Baker recorded a loss from trading of
1 Explain two reasons why Ted Baker might have
£23 million over the six months to August 2019, compared
wanted to reduce its amount of debt. [6]
to a profit of £24.5 million in the same period in 2018. The
2 Evaluate whether or not a sale and leaseback deal
company’s share price has fallen from around 500 pence
was a good method for Ted Baker to raise finance
in October 2019 to just over 100 pence in April 2020.
5.2.2 Internal and external sources of finance

at this time. [12]
Along with many other retailers, the company has
suffered a heavy fall in sales when it was forced to close
levels, chasing customers for payment (other organisations

STUDY TIP that owe the business money) more urgently and delaying
Do take care to distinguish between the sale of unwanted payment to suppliers can raise cash generated from a firm’s
assets and sale and leaseback arrangements. The latter working capital.
may be appropriate as a source of the finance if the
assets are important to a business’ continued trading. Firms might seek to improve terms they are offered for
If the assets are surplus to requirements, a simple sale trade credit. Many suppliers grant their customers an
may be the best option. interest-free period of grace in which to pay for goods
and services they have received. From the customers’
point of view, this is a useful form of finance that helps
Working capital fund working capital at the expense of the seller’s cash
As we saw in the previous chapter, working capital is flow. The typical credit period offered to customers is 30
the cash required by a business to pay for its day-to-day days. If a business can extend this period to, say, 60 days,
operations. Working capital is needed to pay for items it is equivalent to an interest-free loan lasting for two
such as fuel, raw materials and wages. Reducing inventory months. It may be, however, that suppliers are less willing
Sale of
Owners’ Retained Sale and Working
unwanted
investment earnings leaseback capital
assets
Internal
Government Sources
grants of
finance Share capital
Crowdfunding
Debentures
Microfinance
External
Trade credit New partners
Debt factoring
Venture capital
Mortgages
Bank overdrafts
Bank loans
Leasing and
hire purchase
▲ Figure 5.5 Internal and external sources of finance
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to offer discounts on selling prices if they grant generous agreed figure. They are also simple to arrange – established
trade credit terms. Although the receipt of trade credit is business customers can often arrange or increase the limit
5.2 a means of improving a company’s working capital, it is
technically an external source of finance.
of an overdraft without completing any forms.
However, overdrafts can be quite expensive, with interest
being charged at between 4 and 6 per cent over the bank’s
External sources of finance normal lending rate on a daily basis. This is not a problem
When individuals, other businesses or organisations such unless a business seeks to borrow on overdraft over a long
as banks or governments provide capital to a business, this period of time. In these circumstances, it might be better
is termed external sources of finance. Businesses are more for a business to convert its overdraft to a longer-term
likely to use external sources of finance when: method of finance. A further drawback of using overdrafts
» a large sum of finance is required (as they will find it as a source of finance is that banks can demand immediate
more difficult to raise such sums internally) repayment, although this is rare.
» the level of risk associated with the business is low,
making it easier to persuade outsiders to invest or lend Trade credit
money This is another form of short-term finance which is
» the company’s profit levels are relatively low, reducing normally available for periods of 1–3 months. Trade credit
the possibility of the use of retained profits. is the period of time given by suppliers before payment
The following are some of the main external sources of for goods and services is due. Trade credit is really an
finance. interest-free loan offered by suppliers, usually for periods
of 30–90 days. This can be invaluable for any business that
Share capital is short of cash, and the absence of interest charges makes
it more attractive than an overdraft.
This is a very common form of finance for both start-up
capital and also for additional capital in a later stage of the
business’ life. Firms raise capital by selling, quite literally, Leasing and hire purchase
a share in their business to investors. A share is simply a These are similar forms of finance in many ways, but they
certificate giving the holder ownership of part (or a share) have one important distinction. Hire purchase is a means
of a company. Owning shares is sometimes called having of buying goods whereby a buyer pays through a series of
equity in a company. By selling large numbers of shares, instalments, often paid monthly. In most cases, the goods do
companies can raise significant sums of capital. Issuing not belong to the purchasing business until the final payment
shares can be very expensive as it normally involves hiring is made. This operates similarly to a loan in that the business
the services of specialist financial experts, which means it effectively has the finance to buy the goods and pays the
is only appropriate for raising very large sums of capital. cost back over time. Goods purchased on hire purchase may
be more expensive than if the business was able to pay cash.
Share capital is available to both private limited companies and
public limited companies. However, in the UK, it is much easier Leasing also involves paying for non-current assets, such
for public limited companies to sell shares for two reasons: as vehicles and machinery, over a period of time. However,
» They can sell shares on the stock exchange. This is an in this case the business never owns the assets; it is really
efficient international market which brings together renting them for a specific time period. It does, however,
buyers and sellers of shares and sets share prices. avoid the need for businesses to find large sums of capital
» Unlike private limited companies, public companies do not to finance the purchase of expensive non-current assets.
need the permission of other shareholders to sell shares.
Equally, existing shareholders can sell their shares freely. Bank loans
Both these factors make it easier to buy and sell shares in Bank loans are relatively straightforward to arrange if the
public limited companies and encourage shareholders to buy business that is seeking the credit has a satisfactory financial
shares in the first place. history. The bank gives the business an agreed amount of
money and the business makes repayments over an agreed
There are a number of benefits from selling of shares or period of time. The amount repaid includes the amount
equity as a source of finance. Although a company will of capital borrowed, plus interest. If the bank lending the
be expected to pay an annual return to shareholders capital considers the loan in any way risky then it is likely
(dividends), the level of this payment is not fixed and in to charge a higher rate of interest. Small businesses, in
an unprofitable year it may be possible for the company to particular, suffer from this effect. Normally banks charge
avoid making any payment. about 2 per cent over their base rate of interest for bank
loans. Interest rates can be fixed or variable. A fixed rate
Bank overdrafts means that the interest rate charged will not change over the
A bank overdraft is perhaps the best-known method of period of the loan; however, a variable rate may change.
short-term finance. It is a service offered by banks allowing Banks will often require security for their loans and this will
a business to borrow up to an agreed limit for as long as it usually be in the form of property. Such security is often
wishes. Overdrafts are a very flexible form of finance as the termed ‘collateral’. If the business defaults on the loan by
amounts borrowed can vary as long as they are within an not making repayments, the bank can sell the property or
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other assets held as collateral in order to recoup the money collateral for the loan. These loans can be for long periods
that was lent. In this way, the bank lowers the degree of of time – often up to 50 years. Mortgages can have fixed or
risk it incurs in making loans to businesses. variable rates of interest and are particularly suitable when
a business wishes to raise large sums of money.
5.2
GLOSSARY TERMS Some businesses may choose to remortgage their premises
A bank loan is an amount of money provided to a business to raise capital. A remortgage either increases the existing
for a stated purpose in return for a payment in the form of mortgage or establishes a mortgage where one did not exist
interest charges. before. This source of finance is particularly popular with
Venture capital is funds (in the form of a mix of share and small businesses.
loan capital) that is advanced to businesses which are

thought to be relatively high-risk. Debentures
Debt factoring takes place when banks provide up to 80 Debentures are a special type of long-term loan to be repaid
per cent of the value of a business’ debts immediately to at some future date, normally within 15 years of the loan
provide an instant inflow of cash. being agreed. The rate of interest paid on debentures is
fixed. In some circumstances, debentures may not have
a repayment date, representing a permanent loan to the
Mortgages business; this is an irredeemable debenture. Debentures are
Mortgages are long-term loans granted by financial normally secured by using the business’ non-current assets
institutions solely for the purchase of land and buildings. as collateral. They are another form of loan capital. Holders
The land or building in question is used as security or of debentures do not have voting rights in the business.
CASE STUDY
Even banks need to raise capital
India’s third-largest private-sector bank raised Rs 125 000 customers, shareholders and investors consistently and
million ($1.76 billion) by selling shares in September 2019. on a sustainable basis’.
Axis Bank said that its share issue was oversubscribed
Raising this capital from an external source of finance will
(meaning that the demand for shares was greater than the
help Axis Bank to achieve its growth strategy.
number for sale). The share price was Rs 629 each.
Source: www.vccircle.com/axis-bank-raises-1-76-bn-via-
Shares of Axis Bank were trading 1.3 per cent higher at share-sale-to-gic-others-bain-capital-sits-out
Rs 703.70 on the Indian Stock Exchange following the share
sale. The shares were sold to several large-scale foreign Questions
investors as well as to insurance companies. 1 Explain one difference between external and
Amitabh Chaudhry, Axis Bank’s chief executive officer internal sources of finance. [3]
said ‘We will strive to ensure that we continue our 2 Evaluate the case for and against Axis Bank
growth journey and keep delivering the best value to our raising finance by selling shares. [12]
Venture capital sources of finance. However, a significant drawback is that

providers of venture capital will not advance huge amounts
Venture capital is an important source of finance for
to businesses. It is unusual for venture capitalists to lend in
small to medium-sized businesses which are considered to
excess of $850 000 in a single deal.
be risky and therefore in some danger of failing. Venture
capital is normally a mix of loan and share capital. Financial Debt factoring
institutions (for example, merchant banks) provide venture Debt factoring is a service offered by banks and other
capital, and wealthy individuals (who are known as ‘business financial institutions. If businesses have sent out bills (also
angels’) are another source. termed invoices) that have not yet been paid, they can ‘sell’
Organisations and individuals providing venture capital these bills to gain cash immediately. Selling or factoring
frequently wish to have some control over the organisation debts in this way provides up to 80 per cent of the value of
to which they are providing finance. The business’ owners an invoice as an immediate cash advance. A further payment
may need to sell some shares in their company (generally is made once the financial institution receives the payment
a minority stake) to the person or organisation providing of the invoice. It is usual for the financial institution to
the venture capital. Providers of venture capital may seek retain approximately 5 per cent of the value of the invoice
a non-executive director role in the business in which they to cover its costs of collecting the debts. However, in some
are investing. Venture capital investors not only provide circumstances, no payment may be required and, in others
capital but also experience, contacts and advice when cases, a flat fee may be charged rather than a percentage
required, which distinguishes venture capital from other payment. The process is summarised in Figure 5.6.
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Business
5.2 5. Factor pays

business remainder 3. Factor initially
of debt when pays business 2. Business ‘sells’
collected from approximately debts to factor.
customer; charges 80% of value
1. Business fees of of debts.
supplies customer approximately 5%.
with goods
and services. Organisation providing
factoring services
Financial
4. Customer pays organisations
factor full value of such as banks
debts when due. provide debt
factoring
services
Customer
▲ Figure 5.6 The process of debt factoring
Many small firms believe that to lose up to 5 per cent of Microfinance

their earnings makes factoring uneconomic – this can
Microfinance is a term that describes the provision of
eliminate much of their profit on the sale of their products.
financial services for poor and low-income clients. Although
Their customers are also likely to be aware that the debts
much publicity has been given to the granting of small
have been factored, which may cause them to worry about
loans, microfinance includes other basic financial services
the business’ ability to manage its short-term finance. They
such as savings, the transfer of money and insurance for
may seek other suppliers if they believe the business is
those on low and very low incomes. An important element
financially unstable. However, debt factoring does offer a
of microfinance is that it supports the transfer of money
number of benefits:
from people earning reasonable incomes to poorer relatives
» The immediate cash provided by the factor means that and friends in different countries. Without the services
the firm is likely to have lower overdraft requirements
provided through microfinance, this might not be possible.
and will pay less interest.
» Factoring means businesses receive the cash from their Improving access to such services allows those on low
sales more quickly. incomes to fund activities which will create incomes, build
assets and protect against risks. Microfinance is regarded
Debt factoring has become more popular for businesses
by many as a way of reducing poverty among low-income
in some countries. This is particularly true for small and
citizens across the globe. Microfinance can entail a transfer
medium-sized businesses, as overdrafts have become more
of money from high-income to lower-income countries. The
difficult to arrange.
case study below illustrates its workings and benefits.
CASE STUDY
Lendwithcare
Lendwithcare ‘fights poverty and injustice in 87 countries María requested a loan in order to purchase new furniture
around the world to help the world’s poorest people find and accessories for the parlour. Hopefully, this will make their
routes out of poverty’. As part of its poverty-fighting business more attractive and bring in more customers. María
work, Lendwithcare provides microfinance services. would also like to purchase extra inventories, specifically
Large numbers of relatively wealthy individuals in creams, soaps and lotions, as many of their customers are
high-income countries provide small amounts of women who ask for facials and make-up. María is seeking a
funds to Lendwithcare. These are subsequently lent to loan of about $2000 and plans to repay it over one year.
entrepreneurs in low-income countries and repaid over a Source: https://platform.buildily.com/lend-with-care;
period of time. The loans normally help the entrepreneurs www.lendwithcare.org
to establish or expand their businesses.
Questions
Lendwithcare is seeking to organise microfinance for
María del Carmen Jimenez’s business plan. María 1 Explain two reasons why banks in Ecuador might
is 28 and a single mother with one child, and lives in be unwilling to lend María $2000. [6]
Cariamanga in Ecuador. María is a primary school 2 Evaluate the arguments for and against lending
teacher. She has had the position for the last six years. María a small sum of money. [12]
Additionally, she runs a beauty parlour with her sister. Her
sister works at the parlour full-time while María joins her
each day after finishing teaching at school.
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Crowdfunding A number of entrepreneurs have set up internet-based
businesses to meet the needs of savers and small and medium-
Crowdfunding is a source of finance that entails collecting
relatively small amounts of money from a large number of
sized businesses. They have acted as a link between the two
groups, providing information on businesses seeking finance
5.2
supporters (the ‘crowd’). Crowdfunding in a business context
and administering loans provided by the ‘crowds’ of savers.
usually involves members of the ‘crowd’ each lending a small
Each saver may lend a relatively small amount to any business;
sum of money to the business. Occasionally, these small
this limits the effect if the business fails to repay the loan.
sums may be given as donations or represent early payment
for the business’ goods or services. Online businesses (such Crowdfunding is attractive for businesses as it avoids the
as Kickstarter) exist to bring together entrepreneurs and need to deal with local banks, which can be bureaucratic
large numbers of investors offering small sums of capital. and slow to make decisions. Furthermore, even if the banks

The activities of businesses such as Kickstarter have helped agree to grant a loan to a business, they may charge higher
to make crowdfunding a viable and popular source of interest rates than crowdfunders.
finance for businesses, especially small ones.
Crowdfunding has become popular in recent years, especially GLOSSARY TERMS
with small and medium-sized businesses, because banks in Microfinance is the provision of financial services for poor
many countries have been unwilling to lend following the and low-income clients.
financial crisis of 2009–10. Equally, savers with spare cash Crowdfunding is a source of finance that entails collecting
have received very low interest rates and these have often relatively small amounts of money from a large number of
been lower than the rate of inflation, meaning that savings supporters (the ‘crowd’).
are losing value over time. Consequently, savers have sought
other ways to generate income from their savings.
CASE STUDY
Crowdfunding: a different source of finance
George Christakos owns and manages a restaurant Using crowdfunding as a source of revenue, the
in Nova Scotia, Canada. Facing the normal difficulties restaurant raised $23 000 from 115 contributors, 80 per
in raising capital, he decided to use his business’ cent of whom lived close to the restaurant. Crowdfunding
customers as a source of finance. He wanted to enlarge campaigns can take many different forms. Some involve
the restaurant that he co-owned with his father, Leo, in donations while others, such as Mr Christakos’ effort,
the town of Halifax. George’s first choice as a source of involve the pre-purchase of goods or services. In any
finance, the bank, decided not to lend him any money. event, the goal is to raise capital.
Not dismayed, George and his father decided to use
crowdfunding to raise the finance they needed. Questions
1 Analyse two reasons why a loan from the bank
Mr Christakos’ crowdfunding effort was unique, but
might have been George Christakos’ first choice
entirely suitable for his business, and comprised three
of a source of finance. [8]
options for his customers. For investing $50, a customer
2 Evaluate the major advantages and disadvantages
was rewarded with lunch for two and two t-shirts. The
to a small business of using crowdfunding as a
option of a four-course dinner for two for investing $100
source of finance. [12]
proved to be the most popular. For customers with larger
sums to invest, George offered two dinners a year for the
rest of the restaurant’s life.
Government grants businesses in buying new premises or improving existing

properties. An estimated 4500 grants and financial
There are various grants and subsidised loans available to
programmes are available to UK organisations, amounting to
businesses from the UK government and other agencies
a potential total value of £50 billion. Many other countries
within the UK. The government offers grants and loans
offer similar schemes.
to support business expansion, to provide funding for
researching and developing new products, and to assist
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Government grants will usually only cover a proportion The rate of interest
of the total costs of a start-up or an expansion. There is
The rate of interest charged by organisations granting loans
5.2 also likely to be a great deal of competition from other
businesses for government grants and there is usually a
can be a significant influence, especially if the loan is a
large one. The interest rate charged will depend on the level
fixed amount of money available under most grant schemes.
of risk that the loan represents to the lender and the time
However, the major advantage of government grants is that
period of the loan. A short-term loan to a high-risk business
entrepreneurs and businesses do not have to repay them as
might be charged at a high rate of interest.
long as they meet any conditions under which the grant was
given.
CASE STUDY
GLOSSARY TERM
A government grant is a sum of money given to

entrepreneurs or businesses for a specific purpose.
Pakistan’s cement industry faces high
borrowing costs
Paying interest on loans has become a major cost for
Pakistan’s cement industry, given that interest rates
HANDLING DATA have steadily risen to around 13 per cent at the start
of 2020. Companies in the cement industry are paying
A government provided a grant of 15 per cent of the high interest rates on long-term borrowing. This has
start-up cost of a new business under one of its led to calls for a reduction in interest rates amid fears
schemes. The amount of the grant was $375 000. How that the high costs of financing loans might hit the level
much was the start-up cost of the new business? of profits made by firms in Pakistan’s cement industry.
Some of the firms are considering issuing shares as an
New partners alternative means of raising the finance that they need.
This is an option for small and medium-sized enterprises. The industry’s financial position has been weakened
A partnership (whether it has limited liability or not) can further by poor levels of demand in Pakistan for
take on a new partner who will invest into the enterprise concrete products and by a sharp decline in the level of
in return for becoming a partner and owning a share of the exports to India. Sales of cement products have been
business. Similarly, a private limited company can decide flat in most countries, with the exception of China.
to sell more shares, as long as the existing shareholders
support the decision. In return for the ownership of a share Questions
of the business, the new partner(s) or shareholder(s) will 1 Explain one benefit that Pakistani cement
provide an injection of capital. producers might receive from selling shares to
raise finance. [3]
Table 5.1 on page 163 classifies the sources of finance we 2 Evaluate the reasons why high interest rates
have discussed according to whether they are short- or have been such a burden for businesses in the
long-term, internal or external sources. You will note that cement industry in Pakistan. [12]
retained profits can be classified as short- or long-term
finance, as a business can opt to use this type of finance
over any timescale. The costs of selling shares
For a public limited company, a share issue can be an
attractive option. However, this can be an expensive
5.2.3 Factors affecting sources of method of raising capital, as it entails considerable
finance administration and promotion and, on occasions, a form of
insurance to provide the funds if the sale is not successful.
The managers of a business that is deciding on a source When shares are first sold by a company, it has to use the
(or sources) of finance will be influenced by a number of services of other expert organisations to organise the sale.
factors, including the following. It is common for companies to use merchant banks for this
purpose.
Cost of the source of finance Public limited companies sometimes use rights issues to
For most businesses that are raising capital, the cost of sell new shares. A rights issue involves selling additional
alternative sources might be an important factor in making shares to existing shareholders in proportion to the number
a decision as to the best source of finance. The costs of shares already owned. For example, existing shareholders
incurred by firms raising capital can take a number of forms. may be offered the opportunity to buy one new share for
each eight already held. Because of the relatively low cost
of issuing shares in this way, it is usual for them to be sold
at a slight discount to encourage sales.
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Certain forms of finance are only available if the person or
STUDY TIP organisation investing gains a say in how the business is
Do not confuse the sale of new shares and second-hand
ones. Firms sell newly issued shares directly to the
managed. This is perhaps most obvious in the sale of shares.
If a private or public company makes a succession of share
5.2
shareholders. In contrast, second-hand shares are sold issues, it may be that the number of new shares issued is
mainly through the stock exchange. When second-hand greater than the number of ‘original’ shares. In this case,
shares are sold on the stock exchange, it is not a source the new shareholders may gain control of the company.
of finance for the company whose shares are sold – it However, it may be possible for the company to issue shares
is merely a means of the shareholder recovering the that do not carry full voting rights. This can allow the
investment by selling the shares to another person or original shareholders to retain control though, of course,
organisation. it makes the issue of new shares much less attractive to
5.2.3 Factors affecting sources of finance

potential shareholders.
Opportunity cost Smaller businesses that do not trade as companies can

also lose some degree of control if they opt to use certain
A decision to use a particular source of finance may have a sources of finance. For example, venture capitalists may only
cost in terms of what has to be given up as a consequence agree to provide finance to what may be a risky business if
of the decision. For example, a decision to use sale and a part of their investment is in the form of shares and they
leaseback as a source of finance may appear to be a low- have a say in the management of the business.
cost option. However, this source of finance will commit
the company to paying each month or year for the asset
that has been sold. Similarly, using retained profits for The uses to which finance is put
reinvestment into the company involves an opportunity Some sources of finance are particularly suitable in certain
cost which can be measured in terms of the reduction situations. For example, a business that is seeking to raise
in the amount of profits available to pay dividends to finance to purchase property and has to rely on loan finance
shareholders. Finally, receiving trade credit from a supplier will probably consider taking out a mortgage. As we saw
may be an attractive short-term source of finance, but it earlier, a mortgage is a long-term loan (and can be available
carries a possible opportunity cost in that the supplier at relatively low rates of interest) and the combination of
may charge a higher selling price because it is, in effect, these two factors makes it an ideal source of finance to
providing an interest-free, short-term loan. purchase property, which can be very expensive.
For many businesses, accessing sources of finance at the If the finance is being raised to fund a risky start-up, then
lowest possible cost is the most important factor. an entrepreneur may experience difficulties in finding
investors willing to put capital into the business. In this
Flexibility situation, a venture capitalist may be the best choice as this
source of finance specialises in investing in relatively high-
Some sources of finance are highly flexible and can be risk enterprises and may also provide support and guidance
adapted to meet a business’ precise needs. The most to novice entrepreneurs.
obvious example is an overdraft. This source of finance
allows a business to overspend its current account or not Finally, if the finance is needed to fund additional working
according to its needs (but subject to an overall limit). capital, perhaps because a business is expanding, then an
Thus, a business can use its overdraft only when necessary overdraft or perhaps trade credit may be selected as the
and can avoid any interest charges at times when its funding will only be required for a short period of time
finances are stronger. This flexibility has a cost, however: until the business achieves a higher level of sales and an
overdrafts are an expensive source of finance. increased inflow of revenue. This additional revenue can
repay the overdraft or settle the outstanding trade credit.
Although government grants are appealing to many
businesses because they do not normally have to be repaid,
they can be an inflexible form of finance. Many grants are The level of existing debt
only available with strict conditions attached. Many UK If a business has substantial amounts of existing loans,
government grants are only made if the business creates banks may be unwilling to agree to increasing the amount
new jobs or at least maintains employment levels. Because of debt. Banks may judge that further loans will represent a
of this, grants may not be a suitable source of finance in risk to them as the interest payments may be considerable,
circumstances where labour is relatively expensive and the especially if interest rates rise. In such circumstances,
newly acquired finance could be used to introduce labour- a business may be forced to seek alternative sources of
saving technology. finance, such as selling an asset (and possibly leasing it
back) or selling shares if the business is a company. As a
The need to retain control rule of thumb, if a business has borrowed more than half
the total capital that it has raised, banks may judge further
Some sources of finance may result in the original owners loans to be too risky.
of the business losing some, or even complete control of it.
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5.2.4 Selecting the source of persuade suppliers to offer increased trade credit, which
can fund short-term needs for finance. Equally, such a
5.2 finance reputation will assist a business in negotiating loans,
possibly at favourable rates of interest, or in persuading
The preceding section has highlighted that a business will shareholders to purchase the company’s shares.
choose its sources of finance based on a number of factors, » The business’ legal structure This will play a role in
including cost, flexibility and the need to retain control. making the decision on the appropriateness of sources of
When making judgements on the most appropriate source of finance. Thus, only companies will be able to elect to use
finance, managers must take into account a range of factors share capital as a source to fund start-ups or expansions.
relating to the business’ internal position and the business » The business environment The environment in which
environment in which it is trading. the business is trading will also shape the decision.
» The business’ financial situation Is it profitable? If If sales in a market are growing, the business may be
so, it may be able to use retained profits as a source of better able to finance the repayments on a loan as its
finance or at least be able to provide evidence to banks revenues should increase in the future. On the other
and other trade payables (creditors) that it can repay hand, if interest rates are high (making loan capital a
loans. Alternatively, it may have assets that it can sell relatively expensive source of finance), businesses may
and lease back, or simply sell. seek alternative sources.
» The business’ reputation A reputation as a reliable
and popular business may also enable its managers to
CASE STUDY
Venture capital in China very scarce in 2020
At the time of writing, China is facing a lack of venture 50
capital for its start-up businesses. The situation is not 45
simply affecting start-ups, as established businesses that
40
are seeking to grow are also starved of venture capital.
35
There was a fall of over 65 per cent in investment in start-
30
US$ billion
ups by venture capitalists in China and Hong Kong (called

Greater China) in the first three months of 2020 compared 25
to the same period in 2019. This increased the difficulties 20
in raising capital experienced by many businesses through
15
Greater China in a period which has become known as the
‘capital winter’. Figure 5.8 shows the dramatic decline in 10
venture capital as a source of finance in 2020 as compared 5
to previous years.
0
2018 2018 2018 2018 2019 2019 2019 2019 2020
Questions
(1) (2) (3) (4) (1) (2) (3) (4) (1)
1 Analyse two circumstances in which a business Year (quarter)
might choose to use venture capital as its primary
▲ Figure 5.7 Venture capital provided in Greater China,
source of finance. [8]
quarterly 2018–20
2 Evaluate the other sources of finance that an
entrepreneur starting a business in China in 2020 Source: https://edition.cnn.com/2020/03/26/tech/china-startup-
might choose to use. [12] funding-coronavirus/index.html
As you can see, a business will take a range of factors into

STUDY TIP account when selecting the best source (or sources) of
If a question asks you to suggest and justify a source finance to use. There is no single best source – it always
of finance for a given situation, do not always select a depends on the circumstances.
single source. It is very common for businesses to use
several sources of finance to fund a project, especially
if a large sum of capital has to be raised. It may also be
easier to justify the use of a mix of sources, as it reduces
the impact of the disadvantages of any single source of
finance.
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TEST YOUR LEARNING
5.2
1 a Explain one source of finance that is available Sunshine Tours looks to expand
to a sole trader. [3] Sunshine Tours Plc is a London-based company that sells
b Define the terms ‘leasing’ and ‘hire purchase’. [4] its shares on the London Stock Exchange. It sells holidays
2 a Define the terms ‘loan capital’ and ‘share capital’. [4] to European and American tourists. All of its holidays
b Define the term ‘sale and leaseback’. [2] are based on the island of Mauritius. The company
has suffered a decline in sales due to falling incomes
5.2.4 Selecting the source of finance

3 Explain one advantage and one disadvantage of
using debt factoring as a source of finance. [6] in Europe and America, and its profits have steadily
4 Define the term ‘microfinance’. [2] declined, reaching just £48 million in 2019. However,
5 Using an example, explain one difference between sales are forecast to rise over the next three years at an
short-term and long-term sources of finance. [3] accelerating rate.
6 a Define the term ‘venture capital’. [2] The company’s directors wish to expand the business. The
b Explain one advantage to a business of using company already has large long-term debts, although it
venture capital as a source of finance. [3] has repaid 30 per cent of these since 2017. Its business
7 a Define the term ‘government grant’. [2] plan for 2021–24 sets out details of capital expenditure
b Explain one reason why it is easier for a public totalling £150 million, although the sources of finance to
limited company to raise finance by selling be used have yet to be decided.
shares than it is for a private limited company. [3] The company’s shares have been performing well, despite
8 Explain one reason why a partnership may its recent dip in profits, and it has maintained impressive
experience difficulties in raising large sums of dividend payments to its shareholders. One of the
finance. [3] directors believes that the company should raise all the
9 a Define the terms ‘overdraft’ and ‘bank loan’. [4] capital it needs by selling shares. Another argues for the
b Explain one disadvantage to a business of using use of debentures as interest rates are low in the UK.
an overdraft as a source of finance. [3]
Questions
10 Explain one advantage and one disadvantage to
companies of raising capital by selling shares. [6] 1 Define the terms:
a ‘capital expenditure’ [2]
b ‘debenture’. [2]
2 Analyse two factors that the directors of Sunshine
Tours Plc may take into account when deciding which
sources of finance to use to raise the £150 million it
needs. [8]
3 Evaluate whether or not Sunshine Tours Plc
should sell shares as the only means of raising
the capital it needs. [12]
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AS LEVEL
5.3 Forecasting and managing

cash flows
AS LEVEL 5.3 Forecasting and managing cash flows
Chapter overview
★ the meaning and purpose of cash-flow forecasts
★ the interpretation and amendment of simple cash-flow forecasts
★ the methods that businesses can use to improve their cash flow.
5.3.1 Cash-flow forecasts should be included in the plan at the time they take
place. A simplified cash-flow forecast is illustrated in
Figure 5.8, which introduces opening and closing cash
The meaning and purpose of cash-flow balances. These are the sums of cash held by a business
forecasts at the start and end of a trading period.
Businesses need to manage their cash carefully to ensure
they have sufficient to pay their bills as they become due NOVEMBER
for payment. This means that businesses need to manage Closing cash
balance:
cash flows to ensure that cash can flow into the business in + $35 000
time to be available to make payments – that is, in time to
meet cash outflows.
Cash flow is the movement of cash into and out of a
DECEMBER
business over a period of time. A potentially profitable Opening cash
enterprise can fail because of poor management of cash balance:
flow. Businesses are especially vulnerable to cash-flow + $35 000
difficulties in their first months and years of trading
and during periods of major expansion. It is for this
reason that many financial institutions demand evidence DECEMBER
that entrepreneurs and managers have planned the DECEMBER
DECEMBER Take away
Add total cash
management of cash for a new or expanding enterprise inflow of:
Net cash flow total cash
before granting a loan. of ($20 000) outflow of:
$120 000
$140 000
GLOSSARY TERMS
Cash is a business’ most liquid asset – it is notes and coins
DECEMBER
as well as funds held in the business’ bank accounts. Closing cash
A cash-flow forecast is a document that records a balance:
business’ anticipated inflows and outflows of cash over + $15 000
some future period, frequently one year.
The structure of a cash-flow forecast JANUARY

Opening cash
Most businesses construct cash-flow forecasts. These balance:
are predictions of a business’ inflows and outflows of + $15 000
cash. Although cash-flow forecasts differ from one
another, they usually have three sections and are
normally calculated monthly. An essential part of cash-
flow forecasting is that inflows and outflows of cash ▲ Figure 5.8 Opening and closing cash balances
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January February March » Steve expects his business to have an opening cash
Cash sales balance of $2000 at the start of June.
1 Cash in Credit sales
Total inflow
» Steve anticipates his cash sales to rise steadily for
each of the four months (from $5750 to $9215) as his
5.3
Raw materials business becomes better known. However, he has already
Wages received an order to supply books to a local college. The
2 Cash out
Other costs order was for $10 000. He expects payment in September,
Total outflow but will buy the books in June, at the same time as he
3 Net
Net monthly
purchases his initial inventories.
monthly
cash flow » Each month, Steve orders books from his suppliers to
cash flow
5.3.1 Cash-flow forecasts

replace those he has sold.
4 Opening Opening balance » He has to pay his own wages and those of a part-time
and closing
Closing balance assistant. These normally amount to $1500 each month.
balances
» Other costs including his rent, rates, heating and
▲ Figure 5.9 A typical layout for a cash-flow forecast lighting amount to $1500 each month in June and July,
but are higher in August and September.
Figure 5.9 shows a typical layout for a cash-flow forecast.
Although the exact structure can vary, all cash-flow Steve’s cash-flow forecast (shown in Table 5.4 on page 182)
forecasts should contain the following elements. illustrates many of the key principles. An important figure
1 Cash in The first section forecasts the cash inflows for each month is shown in the row entitled ‘Net monthly
into the business, usually on a monthly basis. This cash flow’. This simply records the balance between the
section includes receipts from cash sales and credit inflow and outflow for the month. June is a good example
sales. Credit sales occur when the customer is given of how this operates: in June, Steve had cash inflows from
time to pay (normally 30, 60 or 90 days) and are savings and borrowings of $75 000 and he expected to
recorded in the forecast in the month in which the receive $5750 from book sales. At the same time, he planned
income is received. to spend $94 500 on his initial purchase of books, as well
2 Cash out The cash out (or expenditure) section will as supplying the college’s order, and also on marketing,
state the expected expenditure on the goods and wages and rent. Thus, in June he expected his net cash flow
services. Thus, a typical section might include forecasts (cash inflows less cash outflows) to be –$13 750 ($80 750 –
of expenditure on rent, rates, insurance, wages and $94 500). In cash-flow forecasts, negative figures can be
salaries, fuel, and so on. These are shown for the shown in brackets or with a minus figure in front. Hence, the
month in which the payment is made. At the end of this figure entered for net monthly cash flow in June is ($13 750).
section, the total expected outflow of cash over the There are two main reasons why businesses might forecast
time period in question would be stated. their cash flows:
3 Net monthly cash flow The net monthly cash flow is 1 To support applications for loans Almost all new
calculated by subtracting the total outflow of cash from enterprises require loans to enable them to become
the total inflow. established, and established businesses may need them
4 Opening and closing balances The final section of during periods of expansion. Banks and other financial
the forecast has the opening balance and the closing institutions are far more likely to lend money to a
balance. The opening balance is the business’ cash business that has evidence of financial planning. It is
position at the start of each month. This will, of course, reassuring for the bank that the business’ managers
be the same figure as at the end of the previous month. understand the importance of cash and have planned
The net monthly cash flow is added to the opening carefully to avoid cash-flow crises. Cash-flow planning
balance figure. The resulting figure is the closing cash gives the bank more confidence that the entrepreneur
balance for the month. It is also the opening balance for or managers will be able to make the repayments of the
the following month. loan as and when they are due.
2 To help avoid unexpected cash-flow crises One-
Cash-flow forecasts – a case study fifth of newly established businesses fail within two
Steve Marshall is buying a bookshop. He knows that he needs years of starting trading. A high proportion of these
to forecast his cash flow to help him to identify times when fail because of cash-flow difficulties. Similarly, many
he might experience cash-flow problems. Knowing when he is large and established businesses encounter cash-
likely to be short of cash gives him the chance to arrange an flow problems which can result in the closure of the
overdraft or short-term loan. His bank is unlikely to advance business, as in the case of De La Rue, the British
him a loan unless he constructs a cash-flow forecast. printer discussed in the case study on the following
page. Planning can help avoid such difficulties. Cash-
Steve has made the following forecasts about his business for flow planning can help to ensure that businesses do
the first four months of trading from June until September: not suffer from periods when they are short of cash
» Steve has raised $75 000 from a bank loan and his and unable to pay their debts. By forecasting cash
savings to buy the lease on a property and to purchase flows, a business can identify times at which it may
books. He also intends that this money will be used to not have enough cash available. This allows it to make
pay his start-up marketing costs. the necessary arrangements to overcome this problem.
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▼ Table 5.4 Steve Marshall’s cash-flow forecast
5.3 June July August September

Cash in
Savings and borrowings 75 000 0 0
Cash sales 5 750 7 500 8 475 9 215
Credit sales 0 0 0 10 000
Total cash inflow 80 750 7 500 8 475 19 215
Cash out
Purchase of lease on shop 30 000 0 0 0
Purchase of books 59 000 4 500 5 000 6 100
Wages 1 500 1 500 1 500 1 500
Marketing costs 2 500 1 500 975 400
Other costs, e.g. rent 1 500 1 500 1 605 1 630
Total cash outflow 94 500 9 000 9 080 9 630
Net monthly cash flow –13 750 –1500 –605 9 585
Opening balance 2 000 –11 750 –13 250 –13 855
Closing balance –11 750 –13 250 –13 855 –4270
CASE STUDY
Banknote printer runs short of cash
In the United States of America, printing money and cash inflows. In 2018, the UK government decided to use
minting coins is the job of the Bureau of Engraving and another supplier for its new blue passports following the
Printing, part of a government department. But in the country’s decision to leave the European Union. In the
United Kingdom, banknotes and passports are printed by following year, the Venezuelan central bank defaulted on
a private company, De La Rue. It is an irony that De La Rue a payment, resulting in De La Rue losing £18 million in
is running low on cash. income.
De La Rue is one of the world’s major suppliers of Questions
passports and banknotes. It is thought to be the largest
1 Analyse two reasons why cash-flow forecasting is
commercial printer in the world. The company’s cash-
an important activity for De La Rue. [8]
flow problems have occurred despite the company earing
2 Evaluate the reasons why a company that earns
£564.8 million in revenues and recording an annual profit
profits of £31.5 million in a year might run out
of £31.5 million in 2019.
of cash. [12]
De La Rue’s survival has been put in doubt by two pieces
of bad news in two years which will reduce its expected
HANDLING DATA
Use the information in the De La Rue case study to
calculate the percentage of De La Rue’s revenue that
was profit in 2019.
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Interpreting and amending cash-flow 2 Outflows differ from the forecast It is common for a
business to experience higher outflows than forecast or
forecasts for outflows to take place earlier than expected. 5.3
Interpreting cash flows For example, Steve Marshall’s cash-flow forecast (Table 5.4)
Interpreting a cash-flow forecast simply means reading may have under-estimated the bookshop’s cash sales in June.
the forecast and taking note of what it reveals. Managers The actual figure may have been $6750. This would result in a
will look at cash-flow forecasts in detail and will look number of changes to Steve’s cash-flow forecast for June:
for periods when the business is expected to be short » the business’ total cash inflow being $81 750 in June
of cash. This will be shown when closing balance figures » the business’ net monthly cash flow becoming –$12 750
are negative. A negative figure for a closing balance tells » the business’ closing balance becoming –$10 750.

managers that, in that period, the business’ cash outflows The key figure here for Steve Marshall is the closing balance
have been sufficiently high to use up more than the cash figure. This is still a negative figure, but a small one. As a
that is available. It also tells managers that cash outflows result, Steve may need a smaller overdraft from his bank to
are taking place before sufficient inflows have occurred. ensure that he has sufficient cash to pay the bookshop’s
If managers can identify cash-flow problems before they costs in July.
occur, through the use of cash-flow forecasts, they are able to Cash outflow figures may also be different from the
take remedial actions to prevent the problem occurring. They forecast, requiring amendments to be made. The handling
might, for example, arrange an overdraft with the bank to data feature below gives an example of this.
ensure they have enough cash available to pay bills on time.
The case study of Steve’s bookshop also illustrates how the HANDLING DATA
construction and interpretation of a cash-flow forecast can
be of value to managers. Steve’s business will be short of cash Use the information from Table 5.4 to answer the
during June, July, August and, to a lesser extent, September. following questions.
The closing balances for these months indicate that he will 1 What would the closing balance have been in
require a maximum of $13 855 of additional cash in a month September if marketing costs in September were
to enable him to pay his rent, wages, and so on. Knowing this $2150?
in advance means that Steve can take steps to avoid a cash 2 What would have been the opening balance for
crisis, possibly by agreeing an overdraft with his bank. October?
Although the use of cash-flow forecasts can help businesses
to plan and manage their finances, the process does involve Methods of improving cash flow
a degree of uncertainty. Managers cannot be certain about
Trying to prepare accurate cash-flow forecasts is only part
the accuracy of their forecasts of inflows, especially if they
of the solution. Businesses have to decide how they are
are engaging in a new venture, such as launching a new
going to improve their cash position – if they identify
product or entering a new market. Most businesses will
a future problem with their cash position. A number of
base their forecasts of cash inflows on the results of market
techniques can be used to improve a cash flow:
research. However, this may not be accurate if the managers
» Reducing costs If a business is able to reduce its
carry out insufficient primary research or rely on out-of-
costs of production, this will lead to a reduction in the
date or inappropriate secondary research data. This is more
amount of cash flowing out of the enterprise and will
of a risk for companies entering markets where less current
strengthen its cash-flow position. This reduction in costs
data is available.
can be achieved in a number of ways. A manufacturing
Forecasting cash outflows accurately can also be difficult. business may seek lower-cost resources to reduce its cash
Unexpected changes in the price of resources can result in outflows. For example, a furniture manufacturer may opt
forecasts proving to be very inaccurate. For example, between to use timber from non-sustainable sources because it is
the start of January and the middle of March 2020, the price cheaper. A business supplying services may seek to reduce
of a barrel of West Texas oil fell from over $63 to around wages by cutting hourly rates or reducing the number of
$27, a decrease of 57.1 per cent. Forecasting cash outflows employees. Such actions may result in undesirable side
accurately can be challenging for businesses that use large effects even if the business’ cash-flow position improves.
quantities of products which have volatile prices, such as oil. Using lower quality resources may reduce the quality of a
product and lead to a business having to reduce its prices,
Amending cash-flow forecasts which may damage cash inflows. Moving away from the
use of environmentally friendly (and more expensive)
Changes in a business’ circumstances can have a substantial
resources or cutting wages and/or employment levels
effect on a business’ cash-flow forecast and it may have to
may attract adverse publicity. The outcome may be a
be amended as a consequence. A cash-flow forecast may
fall in sales, which could reduce cash inflows. However,
need amending for two broad reasons:
it is possible that a business may opt to use techniques
1 Inflows differ from the forecast This will be a concern
such as recycling to reduce the costs of acquiring raw
if they are lower than forecast, perhaps because sales
materials. This can have a positive effect on the business’
are lower than was expected or because payments are
image if it is perceived to be environmentally friendly and
received later than anticipated.
may result in rising sales.
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» Improving the management of trade receivables and 5.6 on page 174 illustrates the stages involved in debt
trade payables Most firms receive some trade credit factoring. This technique offers the advantage of providing
5.3 from their suppliers; this is known as trade payables. This
means they may be given 30, 60 or 90 days to pay for
a significant and immediate inflow of cash, but it can
damage the business’ profitability. It is likely that a debt
supplies. If a business can persuade suppliers who have factor will charge a fee equivalent to approximately 5 per
previously been reluctant to offer trade credit to do so, cent of the total value of the debts and this will reduce the
it will increase its trade payables figure and improve its business’ profits on the transaction by the same percentage.
cash-flow position. Remember that cash-flow management
is a matter of timing; delaying payments always helps.
Another important move might be to extend existing
HANDLING DATA
trade credit agreements from, say, 30 to 60 days. It may Inara Industries has invoices to the value of $770 000
not, however, be possible for a small or newly established which it wishes to use for debt factoring. The factoring
business to negotiate favourable credit terms if it does company has offered 80 per cent of the value of the
not have a suitable financial history. A business may also invoices immediately and a further 15 per cent when
offer customers less favourable terms for trade credit. they are paid by the customer in three months’ time.
This means it reduces its trade receivables. This may 1 How much will Inara Industries receive from the
require all customers to pay for products within 30 days, factoring company immediately?
whereas in the past trade credit was for 60 days. Good 2 How much will Inara Industries receive from the
control of trade receivables and trade payables can mean factoring company in total?
earlier inflows of cash and fewer bad debts. If a business
is not actively chasing up customers to ensure that they Arranged short-term borrowing
pay, and pay on time, cash-flow problems may be the
result. Firms can improve their cash-flow position by The majority of businesses have agreed an overdraft
managing these inflows and outflows more effectively. with their bankers. Overdrafts can be expensive but
reasonably economical because a business only borrows
when necessary. A short-term bank loan will also provide
Using sources of finance to strengthen an inflow of cash, but it may be more costly in terms of
a cash position interest charges.
We saw in the previous chapter that a business may raise
finance through a number of sources of finance. Some Sale and leaseback
of these sources can be particularly useful in helping to This method of improving cash flow entails a business
overcome a period of cash shortage. selling a major asset – for example, a building – and then
leasing it from the new owner. This provides a significant
Debt factoring inflow of cash into the business, improving the immediate
cash position, but commits the firm to regular payments to
We saw in the previous chapter that a business can receive
lease the asset, which may weaken its future cash position
cash earlier by ‘selling’ its debts to a debt factor. Figure
and its profitability.
CASE STUDY
Otago Communications suffers cash problems
Otago Communications (OC) is one of New Zealand’s OC has suffered from well-publicised cash-flow
leading manufacturers of telecommunications equipment. problems, particularly in recent months – its cash
It supplies large quantities of equipment to multinational position weakened by NZ$680 million over three
companies throughout the world, offering generous trade consecutive months alone. A spokesperson for OC said:
credit terms. Its profits have been steady in recent years, ‘We have enough cash resources to do what we need. But
though disappointingly low. Last month it announced its to cut costs and save cash we are looking at all possible
intention to sell one of its best-known factories to raise options with no stones being left unturned. One of those is
NZ$75 million of urgently needed cash. The company’s the possibility of selling one of our factories.’
factory is located in a stylish glass and steel building in
Dunedin, on New Zealand’s southern island. OC moved into Questions
the building in 2001 and enlarged it in 2007; it is currently 1 Analyse two other ways in which OC could have
the workplace for 1880 of the company’s employees. improved its cash-flow position. [8]
2 Evaluate whether the advantages of OC’s
The company intends to sell and lease back the building
planned sale and leaseback deal outweigh its
as it is vital to its operations. Analysts estimate that it will
disadvantages. [12]
raise NZ$200–300 million, which would provide a crucial
cash inflow for the business.
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Leasing outflow of cash from the business and helps it to retain
a larger holding of cash. As with leasing, this technique
Using leasing, a business simply leases (or rents) non-
current assets (such as vehicles and computers) rather than
can strengthen a business’ short-term cash position
substantially due to the high cost of non-current assets.
5.3
buying them. This conserves precious reserves of cash and
The purchaser only becomes the owner of the asset once
can have quite a significant impact on a business’ short-
the final payment is made. Hire purchase may be used to
term cash position, as non-current assets can be very costly.
finance the acquisition of relatively expensive assets such
However, as with several of these techniques, it does require
as vehicles and can therefore have a considerable impact on
businesses to make a steady outflow of cash over time.
the business’ cash-flow position.
Hire purchase
Choosing a method of improving

We saw in the previous chapter that hire purchase is a
means of obtaining credit for the purchase of a non-current cash flow
asset. The business purchasing the asset pays a percentage There is no single best method of improving a business’
of the purchase price as a deposit and the remainder in cash flow. All the methods we discussed have their
instalments over a lengthy period of time. This slows the advantages and disadvantages, as summarised in Table 5.5.
▼ Table 5.5 The advantages and disadvantages of selected methods of improving a business’ cash flow
Method Advantages Disadvantages

Improved management • Can be a ‘free’ method of improvement • Reducing trade credit offered may result in a
of trade receivables and • Can be implemented relatively quickly loss of customers
payables • Available to most businesses • May not be available to new businesses or
those without a reputation as reliable payers
Debt factoring • Can generate large and immediate inflows of • Can reduce the amount of profit on each sale
cash (by up to 5 per cent)
• Available to businesses with little power to • May not be viable for businesses making very
negotiate favourable trade credit terms small profits (such as start-ups)
Short-term borrowing • Can be available to the business immediately • Businesses with weak cash positions may be
• May be highly flexible (as in the case of an unable to negotiate short-term loans
overdraft) • Can be a relatively expensive option as
interest rates may be high
Sale and leaseback • Avoids the need for any interest payments • Only a business with saleable assets can
• Retains the use of the asset for the business engage in this method
and can raise large sums of finance • This may reduce the business’ long-term
profits by increasing expenditure
Leasing • Avoids the need for large cash purchases on • The business is committed to regular, smaller
assets that may decline in value outflows
• Can allow businesses to use the most up-to- • The company does not own the assets that
date assets are used
Reduction in costs • Can boost the business’ profitability as well • May compromise quality of products if
as strengthening its cash-flow position cheaper resources are used
• May improve the business’ image if it involves • Businesses may have to lower prices if quality
techniques such as recycling is reduced
Hire purchase • Can delay cash outflows by a considerable • This is an expensive method of buying non-
time period current assets and may reduce profitability
• May be used to finance the purchase of • The business does not own the asset until the
relatively expensive non-current assets, final payment is made
having a significant impact on a business’
cash-flow position
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TEST YOUR LEARNING
5.3 8 a Define the term ‘trade payables’. [2]
b Explain one method a business might employ to
1 a Define the term ‘cash flow’. [2] improve its cash-flow position. [3]
b Explain one reason why a business might 9 Explain one advantage and one disadvantage of the
forecast its cash flow. [3] use of debt factoring as a method of improving a
2 Explain one reason why a profitable business may business’ cash-flow position. [6]
be short of cash. [3] 10 Explain two reasons why a small business suffering
3 Explain one reason why newly established
from cash-flow problems might prefer to arrange a

businesses are vulnerable to cash-flow problems. [3] short-term loan rather than rely on an overdraft. [6]
4 a Explain one difference between net monthly
cash flow and an opening balance. [3] Data response question
b A business has a closing balance of $10 000 at Mugunga Mines Ltd
the end of October and has experienced a net
monthly cash flow of $44 500. Calculate its The rising price of copper in world markets has resulted
opening balance in November. [2] in the opening of new copper mines in Uganda. In the past,
these might not have been considered profitable, however,
5 a Define the term ‘cash-flow forecast’. [2]
the price of copper might continue to fluctuate in the future.
b Explain one benefit to managers of preparing a
cash-flow forecast. [3] Mugunga Mines Ltd (MM) is one company that reopened
6 A business has the following cash-flow data for July: a small mine last year. It is a well-established company
– an opening balance of $130 250 with valuable non-current assets and a good record for
being profitable. Opening the new mine necessitated a
– cash inflows of $675 750
large investment ($3.5 million) in mining equipment and
– cash outflows of $754 500. preparatory work before mining could commence.
a Calculate its net cash flow for July. [2]
b Calculate its opening balance for August. [2] The company’s customers have been given at least 60
days’ trade credit before paying for the copper they
7 A business has forecast the following cash-flow
purchase and the size of their orders has risen quickly.
data for February:
The company had some cash-flow difficulties in the first
– cash inflows of $115 000 year of operating the new copper mine. It has prepared
– cash outflows of $140 115. a quarterly cash-flow forecast for the second year of
a Calculate the business’ net cash flow for the month. [2] trading for the copper mine, as shown in Table 5.6 below.
b Its actual cash inflows were 10 per cent higher One manager commented that the cash-flow forecast
than expected. Recalculate its net cash flow. [3] showed an improving cash position.
▼ Table 5.6 A cash-flow forecast for MM’s copper mine for Year 2
Quarter 1 Quarter 2 Quarter 3 Quarter 4

$000s $000s $000s $000s
Cash in
Credit sales 875.5 923.0 998.7 1,075.4
Total cash inflow 875.5 923.0 998.7 1,075.4
Cash out
Transport and distribution costs 313.6 322.6 366.3 387.7
Wages and salaries 500.5 501.2 502.5 503.1
Other costs 100.8 102.1 107.8 108.7
Total cash outflow 914.9 925.9 976.6 999.5
Net monthly cash flow (39.4) (2.9) 22.1 75.9
Opening balance (125.5) (164.9) (167.8) (145.7)
Closing balance (164.9) (167.8) (145.7)
Questions 2 Analyse one reason why Mugunga Mines Ltd’s cash

position is described by one manager as ‘improving’
1 a Define the term ‘trade credit’. [2] over the year. [4]
b Calculate the company’s closing balance for 3 Evaluate whether debt factoring is the best way for
quarter 4. [3] the company to deal with any future cash-flow
difficulties. [12]
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AS LEVEL
5.4 Costs
5.4.1 Cost information

Chapter overview
★ why businesses need accurate information on costs
★ the types of costs businesses have to pay
★ the full and contribution approaches to costing, including their uses and limitations
★ how cost information can be used for decision-making, including setting prices, to monitor and improve business
performance, to calculate profits and for special order decisions
★ the calculation and interpretation of break-even output
★ the uses and limitations of break-even analysis.
5.4.1 Cost information GLOSSARY TERMS

What is a cost? It is simply an expense paid by a business Costs are expenses that a business has to pay to engage in
as part of its trading. Some of the expenses or costs firms its trading activities.
have to pay include payments for raw materials, fuel and Revenue is the income a business receives from selling its
components, as well as wages and salaries. goods or services.
In contrast, revenues are a business’ income or earnings

over a period of time. Total revenues are the sum of a
business’ earnings from the sale of all its products. Total The need for accurate cost information
revenue is calculated by multiplying the selling price of a Calculating costs accurately can help managers to make
product by the number of products sold. a number of important decisions. By combining cost
information with expected revenues, managers can calculate
revenue = quantity sold × average selling price whether or not a business (or an element within it) is likely
Costs and revenues are vital data for most businesses. to make a profit or a loss. From this information, a range of
By comparing the total costs for a business over a period other decisions may follow, including:
of time with the revenue that it earns, it is possible to » whether or not to start up a new business
calculate whether the business has made a profit or a loss. » whether to go ahead with a planned expansion
An important formula for almost every business is: » whether to take on a particular order from a customer,
which may be unusual in some way
profit (or loss) = total revenue − total costs » whether there is a need to reduce waste
» whether to engage in some activity, such as increasing
Average Number
Variable Fixed
security to prevent loss or wastage.
selling × of units +
price per costs costs
sold Without precise information on costs, managers cannot
unit
make decisions that are likely to prove beneficial to a
gives gives
business. For example, a business may be considering a
TOTAL REVENUE minus TOTAL COSTS decision to enter a new market and its market research
may indicate the likely returns from this expansion.
A critical element of the decision, though, will be to
gives
calculate the costs of doing so, enabling the business’
1 Profit if TR > TC
2 Loss if TR < TC managers to forecast the likely profitability of this
3 Break-even if TR = TC decision. Calculating the costs of this decision with a
high degree of accuracy is not always easy, as we shall
▲ Figure 5.10 Costs, revenues and profits/losses
see later in this section.
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Types of costs Variable costs
In contrast to fixed costs, variable costs alter directly
5.4 Fixed costs
Fixed costs do not change when a business alters its level of
with the level of a firm’s output. This means that a firm
increasing its output is likely to have to pay higher variable
output. For example, a business’ rent will not vary if there costs, whereas one reducing its output could expect
is an increase or decrease in the level of production. Other variable costs to fall. Expenditure on fuel, raw materials
examples of fixed costs include management salaries and and components are all examples of variable costs.
interest payments made by the business.
XYZ Computers Ltd in Figure 5.12 faces variable costs of
Figure 5.11 relates to XYZ Computers Ltd, a business that $500 for each computer it manufactures; this is necessary
produces computers. You can see that whether the factory to pay for various items including the electronics, case
AS LEVEL 5.4 Costs
produces 10 000 or 60 000 computers each year, the fixed and monitor. Thus, to produce 20 000 computers means the
costs faced by the business will remain the same at company faces variable costs of $10 million (20 000 × $500);
$5 million. to manufacture 50 000 results in variable costs of $25
million (50 000 × $500).
Fixed costs ($m)
Variable costs ($m)

7
50
6
Fixed
5 40
costs
Variable
4 costs
30
3 25
2 20
1
10
0 10 20 30 40 50 60 70
Output of computers per annum (000s) 0 10 20 30 40 50 60 70
▲ Figure 5.11 Fixed costs Output of computers per annum (000s)
The reason that these costs do not alter is that the business ▲ Figure 5.12 Variable costs
simply uses its existing facilities fully at times when it It is usual to illustrate variable costs as a straight line,
is receiving more orders. For example, in the run-up to as in Figure 5.12. This suggests that expenditure on items
warm summer weather, a manufacturer of sunglasses might such as fuel, labour, raw materials and components rises
increase its output, thereby using its existing production steadily along with output. Variable costs are drawn this
facilities more fully. The firm’s rent, rates and other fixed way for simplicity. In the real world, the line may gradually
costs will be unchanged. Similarly, as winter approaches, flatten out as businesses frequently negotiate lower prices
sales and production of sunglasses are likely to fall, per unit when placing large orders. This means that XYZ
meaning some production facilities might be unused, but Computers Ltd may be able to purchase components more
fixed costs will remain the same. cheaply, meaning that the variable costs associated with a
production level of 50 000 computers might be $22.5 million.
This means that the variable cost of each computer has
fallen from $500 to $450.
CASE STUDY
High fixed costs in Mauritius
Manufacturers of cement in Mauritius sold around 700 000 Until 2011, the government of Mauritius controlled the
metric tonnes of the product in 2019. The island has a price of cement as it was concerned that prices might be
large number of construction projects, including the too high and prevent development. A major cause of this
sports centre in Côte d’Or and the Metro Express, all of was a lack of competitiveness in the industry. High fixed
which lead to a large demand for cement. costs of production meant that it was difficult for new
businesses to raise enough capital to enter the industry
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and compete effectively with established producers. Questions
As a consequence, the industry comprised two major
suppliers.
1 Analyse two reaons why a business entering an
industry may want to keep its variable costs as low
5.4
The degree of competition in the Mauritian cement as possible. [8]
industry has been reduced rather than increased. The two 2 Evaluate the reasons why high fixed costs may have
firms that existed in 2011 – Lafarge and Holcim – merged led to the cement industry in Mauritius having just
in 2015 to form a single company: LafargeHolcim Ltd. one supplier after 2015. [12]
The Honshu Motor Company

Total costs
5.4.2 Approaches to costing

This manufacturer of motor cars may incur direct and indirect
The calculation of total costs assumes that all the costs faced costs as set out below.
by a business are either fixed or variable. This means total Direct costs Indirect costs
costs can be calculated simply using the following formula: • direct materials such as sheet • indirect labour costs, for
steel and engine parts example management salaries
• direct labour, for example and wages paid to security staff
total costs = total fixed costs + total variable costs • other indirect costs such as
wages paid to employees on
production line administration and distribution
Total costs of production are an important piece of
information for a business. Managers can use this direct costs + indirect costs = total costs of production
information in taking decisions on levels of output and ▲ Figure 5.13 Direct and indirect costs of production
prices to be charged. For example, firms that have very high
levels of fixed costs, perhaps due to needing expensive
equipment, will seek to produce large quantities of output.
This reduces the effect of fixed costs on the selling price by The differences between full and
spreading them over a large quantity of sales.
One point to note is that a business’ total costs when
contribution costing
output is zero are only fixed costs, as without any A problem faced by businesses when attempting to calculate
production there cannot be any variable costs. costs accurately is allocating or dividing up indirect costs
between different elements of the business. This can be a
particular problem for large businesses that produce a range
Direct and indirect costs of products.
An alternative way of classifying the costs encountered by
a business is to divide them into direct and indirect costs. One reason why it is difficult to calculate the total costs
Direct costs can be related to the production of a particular of producing a single unit of output is that indirect costs
product and vary directly with the level of output. Examples can be allocated in different ways and this can result in
include the costs of raw materials and fuel. different cost figures. As a consequence, managers may take
decisions that are incorrect.
Indirect costs are overheads that cannot be allocated easily
to the production of a particular product and relate to the When a business produces a number of products using
business as a whole. Indirect costs include the costs of a single office or factory, it is difficult to calculate the
marketing and administration. Indirect costs are generally total cost of producing a single unit of output of any of its
recognised as difficult to control. Unless managers are products accurately. The problem it faces is how to allocate
vigilant, these costs can increase rapidly and reduce a indirect costs such as marketing and administration. There
business’ profits. are two approaches that can be taken.
Indirect costs are also called ‘overheads’ and are Full costing
always fixed costs. Direct costs tend to vary with the One method of deciding upon costs is full costing, which is
level of production and are normally (but not always) used by many businesses. This is also known as ‘absorption
variable costs. costing’ and normally categorises costs as direct and
indirect. This approach to costing involves charging all the
GLOSSARY TERMS costs of a particular enterprise to a unit of output. Thus,
Direct costs can be related to the production of a
all the costs associated with the production of a particular
particular product and vary directly with the level of product are ‘absorbed’ by it. This approach may require
output. managers to allocate indirect costs to all the business’
different products.
Indirect costs are overheads that cannot be allocated to
the production of a particular product and relate to the Full costing can allocate (or divide up) indirect costs
business as a whole. between different products produced by a business using
Full costing allocates all the costs of production for the a range of criteria, such as the percentage of total indirect
whole business. Therefore, these costs are absorbed costs used in the production of each product.
into each output unit. This is also known as absorption
costing.
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Total cost of Total direct Allocated share
operating a division within a business. We explore this in
producing a = + the case study on Palm Foods.
costs of indirect costs
5.4 particular
product The allocation of indirect costs in this way is unlikely to be
entirely accurate. This has significant implications because,
by changing the way that these costs are allocated, the
Divided by Total cost of
number of units = a single unit profitability of different areas of a business can be affected.
of output of output For example, in the Palm Foods case study, if the company’s
accountants had decided to allocate indirect costs on the
▲ Figure 5.14 Key relationships for full (absorption) basis of the number of employees in each division, then the
costing indirect costs allocated to the division producing meat
AS LEVEL 5.4 Costs
30
meals would have been: × $6 000 000 = $2 250 000. This
Contribution costing 80
is $150 000 below the method actually used and would have
The concept of contribution is an important one and is boosted the profits of this division by a similar amount,
used in calculating break-even output, as we shall see later assuming nothing else changes.
in this section. The use of contribution is based on clearly
classifying costs as fixed or variable. Contribution can be
calculated by use of the formula below:
HANDLING DATA
contribution = sales revenue – variable costs The accountants in the Palm Foods case study might
have decided to use the number of employees working
Contribution has two potential uses. Firstly, it is used to in each of the company’s divisions as the basis for
pay the fixed costs incurred by a business. Any contribution allocating its indirect costs.
remaining after this transaction is profit for the business.
Calculate how the total indirect costs would have
profit = contribution – fixed costs been allocated between the fish and vegetarian meals
It is possible to consider contribution in two broad ways: divisions if this method had been used.
either in relation to a single unit of output or in relation to
the entire output of a particular product or business. So, as we have seen, if a business makes two or more
When contribution is calculated for the sale of a single products, or operates multiple divisions or brands, full
product, we refer to it as contribution per unit. It is costing entails allocating (or absorbing) indirect costs as
calculated by using the formula: accurately as possible to the different parts of the business’
operations. If, for example, a business just produced two
variable costs of products, it could allocate its indirect costs taking into
contribution selling price of one –
per unit = unit of output producing that account the type of overhead:
unit » Indirect costs such as rent or property taxes could be
allocated or apportioned according to relative floor
space taken up by the production of the two products.
GLOSSARY TERMS So, if product A takes up 60 per cent of the floor
Contribution can be defined as the difference between
space, then 60 per cent of these fixed costs should be
sales revenue and variable costs of production. apportioned to product A.
» Indirect costs such as wage costs associated with
Break-even is the level of production or output at which a
management and administrative staff could be allocated
business’ sales or total revenue is exactly equal to its total
according to the number of people employed in the
costs of production.
production of each product.
Profits are the amount by which revenue exceeds total
costs, although there are several different measures of As many businesses produce more than a single product,
profit. especially large-scale businesses, this approach to costing
is widely used. It is also recognised by many governments
as the accepted method to use in preparing financial
The full-costing method statements. This trend is also increasing as markets become
The full-costing approach normally divides costs into more global in nature and businesses have to extend their
direct costs and indirect costs. To calculate the total cost product ranges to meet the diverse needs of customers
of producing a single unit it is necessary to include all across the world. Nevertheless, when a business produces
costs, both direct and indirect. This can be a tricky process a range of products (as we can see in the Rajasthan
if it is to provide accurate costing figures. The problem Electronics Ltd case study) it requires managers to make
centres on allocating indirect costs or overheads in a way difficult decisions to allocate indirect costs.
that represents the true costs of producing a product or
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CASE STUDY
5.4
Palm Foods allocates its indirect costs
Palm Foods manufactures a range of ready-to-eat The company’s managers want to know the cost of
meals aimed at high-income consumers. The company’s production for its three divisions to help with their
products can be divided into three divisions: decision-making. They use the full-costing approach to do
l Meat meals: these contain a range of foods based this. The company’s total indirect costs for 2019–20 were
mainly on chicken and lamb. $6 million.
l Fish meals: this is a smaller part of the company’s
The company’s accounts department has calculated some

production and is becoming less popular.
key statistics relating to the three divisions within the
l Vegetarian meals: these are increasingly popular as
company.
meals on their own or as accompaniments to some of
the company’s other products.
▼ Table 5.7 Palm Foods’ key statistics
Accounting item Meat meals Fish meals Vegetarian meals

Sales revenue (%) 50 20 30
Number of employees on each production line 30 25 25
Area of the factory floor used by each division (square metres) 2 000 1 300 1 700
Total direct costs incurred in production (%) 40 30 30
Palm Foods’ accountants have decided to allocate the l Vegetarian meals: 1 700 × $6 000 000 = $2 040 000
company’s indirect costs for 2019–20 according to the 5 000
area of the factory’s floor space used by each of its three Questions
divisions. As a consequence, the indirect costs were 1 Calculate the allocation of indirect costs that would
allocated as shown below: have resulted if the company’s accountants had used
sales revenue as a guide. [6]
l Meat meals: 2 000 × $6 000 000 = $2 400 000
5 000 2 Evaluate the ways in which the company should have
1 300 allocated its indirect costs. [12]
l Fish meals: × $6 000 000 = $1 560 000
5 000
CASE STUDY
Full costing at Rajasthan Electronics
Rajasthan Electronics Ltd manufactures consumer The company’s managers use a policy of full costing
electronics which are sold in Pakistan and other to calculate its costs and profits on its three products,
countries in Asia. The company’s production is divided which are made in the same factory in Faisalabad. The
into three product groups: televisions, microwave company’s indirect costs were $120 million for the year.
cookers and digital radios. The costs associated with the Rajasthan Electronics’ managers decided to allocate the
company’s production over the last financial year are company’s indirect costs on the basis of the percentage
shown in Table 5.8.
▼ Table 5.8 Production costs at Rajasthan Electronics Ltd
Televisions ($m) Microwave cookers ($m) Digital radios ($m) Total ($m)
Revenue from sales 286 145 225 656
Direct materials costs 107 77 78 262
Direct labour costs 97 45 87 229
Total direct costs 204 122 165 491
Allocated indirect costs 52 27 41 120
Total costs 256 149 206 611
Profit 30 (4) 19 45
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of revenue earned by each division. The calculations (with The managers’ decision to allocate indirect costs in this
5.4 some rounding) carried out by the finance department are

shown below:
way resulted in two of its divisions earning profits while
the third, the microwave division, recorded a small loss.
l Allocated indirect costs to televisions: Not all of the company’s managers agreed with this
286 approach to allocating indirect costs, and the managers
$120 million × = $52 million
656 of the microwave division were angry at suggestions that
l Allocated indirect costs to microwaves: production of microwaves should be stopped as they were
145 apparently making a loss rather than a profit.
$120 million × = $27 million
656
Questions
l Allocated indirect costs to digital radios:
AS LEVEL 5.4 Costs
225 1 Analyse two other possible ways that Rajasthan

$120 million × = $41 million Electronics Ltd might have allocated its indirect
656
l Total indirect costs = $120 million costs. [8]
2 Evaluate whether or not Rajasthan Electronics Ltd
should stop producing microwave cookers. [12]
In the case of Rajasthan Electronics Ltd, the use of full unprofitable and decide to discontinue production of this
costing makes it very difficult to judge with any certainty product. This could prove to be a poor decision for two
the precise financial position of the company’s three reasons, as we shall see in the following continuation of the
product ranges. There is a danger that the company’s case study.
senior managers may judge that the microwave division is
CASE STUDY
Further events at Rajasthan Electronics
The managers of the microwave division are concerned l Allocated indirect costs to televisions:
about proposals to end production of their cookers. In $120 million × 0.46 = $55 million
response, they have recalculated the company’s profits
for the past financial year using full costing but using a l Allocated indirect costs to microwaves:
different basis for allocating indirect costs. $120 million × 0.15 = $18 million
The company’s operations managers have recently l Allocated indirect costs to digital radios:
reported that the production of televisions uses 46 per $120 million × 0.39 = $47 million
cent of the factory’s floor space, that digital radios uses
● Total indirect costs = $120 million
39 per cent and microwave cooker production takes place
in 15 per cent of the available factory space. This was This allowed the managers to present a revised set of
used as a basis to recalculate the profits from the three profit figures, as shown in Table 5.9.
product ranges. Their revised calculations (again with
some rounding) are shown on the right:
▼ Table 5.9
Televisions ($m) Microwave cookers ($m) Digital radios ($m) Total ($m)
Revenue from sales 286 145 225 656
Direct materials costs 107 77 78 262
Direct labour costs 97 45 87 229
Total direct costs 204 122 165 491
Allocated indirect costs 55 18 47 120
Total costs 259 140 212 611
Profit 27 5 13 45
This data shows that: Questions

1 The microwave division may be profitable.
1 Analyse two reasons why a large business might use
2 If production of microwaves is discontinued,
full costing. [8]
the business’ fixed costs are unlikely to change
2 Evaluate whether this is a more accurate way of
and will have to be paid by the remaining two
calculating the company’s profits for its three
divisions, which will damage the profitability of the
product ranges than the approach based on the
company.
percentages of revenues earned by the divisions. [12]
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HANDLING DATA
Use the data in the Rajasthan Electronics case studies to 2 Calculate the change in the company’s profits if it
5.4
answer the following questions. managed to reduce its direct materials costs by
1 Calculate the percentage of total costs that are 10 per cent.
represented by direct labour costs.
Uses and limitations of the full-costing method

Full costing has a number of uses as well as limitations.

Some of these are summarised in Table 5.10 below.
▼ Table 5.10 The uses and limitations of full costing
Uses Limitations
• This approach to costing allows a business to take all of • It is difficult to allocate indirect costs accurately – the
its costs into account before making pricing decisions. allocation is often based on proportions of direct costs.
• Using the full costing is very common as this approach is • It can result in bad decisions. Businesses may discontinue
recommended by the International Financial Reporting production of apparently unprofitable divisions,
Standards (IFRS). departments or brands.
• Managers have to give thought as to the most effective • If sales are below what is expected, allocated indirect costs
method of allocating indirect costs, which may result in per unit of production could be higher than forecast, meaning
an accurate approach. that a price that was expected to be profitable may not be.
▼ Table 5.11 Sales revenue, variable costs and contribution

GLOSSARY TERM for a business producing three products
Contribution costing calculates the cost of a product
solely on the basis of variable costs, thus avoiding the Product A ($) Product B ($) Product C ($)
need to allocate fixed costs. Revenue from 175 000 342 750 55 250
sales
Variable 87 150 169 700 14 525
The contribution-costing method labour costs
Contribution costing is sometimes referred to as ‘marginal
Variable 32 000 88 560 12 770
costing’. Contribution costing excludes fixed costs as a
materials costs
central part of the calculation and only allocates variable
costs. This is valuable in a business that has a number of Other variable 25 450 67 425 13 050
products, or several factories or divisions. A product or costs
division that earns sufficient revenue to cover its fixed Total variable 144 600 325 685 40 345
costs is likely to be viewed favourably by the managers costs
of the business. If this is the case then the product will
Contribution 30 400 17 065 14 905
generate a positive contribution and assist in paying fixed
costs or providing profit.
The example in Table 5.11 shows that product A contributes
The contribution-costing approach can be applied to the $30 400 towards paying fixed costs, product B $17 065 and
production and sale of a single unit of output or to the product C $14 905. In total this is $62 370. If we assume that
entire output of a product or products over a given time the fixed costs of the company for this period of time are
period. If a business would incur an additional cost of $39 500, we can calculate the profits that the company has
$100 in producing a single extra unit of output (this is its made.
marginal cost) but would expect to sell that product for
Total contribution: $62 370
$125, then it would make a positive contribution of $25 on
that unit of output. Fixed costs: $39 500
Alternatively, we can consider contribution costing for the Profit: $22 870
entire production of a particular product or products as
If a product makes a positive contribution, as is the case in
shown in Table 5.11.
Table 5.11, then it is worth the business continuing to produce
it. There may even be an argument for continuing to produce
it if it makes a negative contribution, as we shall see later.
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The difference between contribution and profit GLOSSARY TERMS
It is essential to understand that contribution and profit
5.4 are not the same thing. Contribution is the surplus left over
Average costs are the total cost of production divided by
the number of units produced.
from sales revenue (or total revenue) once variable costs
have been paid. Profit is any surplus from sales revenue over Marginal cost is the extra cost resulting from producing
one additional unit of output. In most situations the
a trading period once all costs have been paid.
marginal cost of an additional unit of a product is the
variable cost of its production.
The limitations of contribution costing and when
it might be used
As with full costing, contribution costing has a number of ▼ Table 5.12 Fixed, variable and total costs of producing
AS LEVEL 5.4 Costs
limitations. The main limitations include the following. televisions

» It can be difficult to distinguish between fixed and
Level of production Fixed Variable Total
variable costs accurately. For example, some costs
(million televisions) costs costs costs
have elements of both and are known as semi-variable
per year ($m) ($m) ($m)
costs. One example of a semi-variable cost is landline
telephone costs. The monthly line rental would be a 0 200 0 200
fixed cost, because it remains the same irrespective of 1 200 180 380
the level of business activity. However, the call charges
2 200 360 560
are variable as they are likely to alter directly with a
business’ level of activity. 3 200 481 681
» Fixed costs do not always remain constant when the 4 200 624 824
level of output alters. Some fixed costs tend to be
5 200 760 960
higher as a result of a business increasing its level
of output. For example, promotional costs or website 6 200 880 1 080
maintenance costs may increase in line with production 7 200 990 1 190
levels. This makes the division of costs into fixed and
8 200 1 240 1 440
variable elements less accurate.
» The tax authorities in some countries do not accept the
use of contribution costing. For this reason, its use is Average costs
less common than that of full costing. Average costs are simply total costs at any level of output
Contribution costing is likely to be used in a number of divided by that level of output. They are also called unit
circumstances. It can help managers to decide whether to costs. In Table 5.12, it is possible to calculate average costs
accept an order as it shows the variable costs of producing at each level of output. For example:
products. If a business receives a number of non-standard » At an output of 3 million televisions, the average cost is
orders, it may use contribution costing to determine $681 million ÷ 3 million = $227 per television.
whether or not to accept such orders. We will explore this » At an output of 5 million televisions, the average cost is
more fully in the next section. $960 million ÷ 5 million = $192 per television.
» At an output of 7 million televisions, the average is
Businesses that produce many different products may be more $1190 million ÷ 7 million = $170 per television.
likely to use contribution costing because the difficulties
involved in allocating fixed (or indirect) costs between Average costs tend to fall as a business increases its
many different products can be too great. Any resulting cost production levels because its fixed costs are spread over a
figures may be judged inaccurate and any decisions taken on larger output, and so the amount allocated to each product
the basis of these figures may be incorrect. is smaller as the level of production rises.
5.4.3 Uses of cost information HANDLING DATA

Calculating average, marginal and Use the information in Table 5.12 to answer the
total costs following question.
Managers can calculate a number of costs to assist with At what levels of output would the average cost of
decision-making. Three vital ones are: televisions be:
» average costs a highest b lowest?
» marginal costs
» total costs.
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Marginal costs Manufacturing in the circumstances of scenario B would
allow the company to set lower prices for its bicycles or to
Marginal costs are the extra costs resulting from producing
one additional unit of output. Marginal costs do not
enjoy higher profits – or both. For example, in scenario B it
could reduce its price from more than $150 per bicycle to,
5.4
really take into account fixed costs, as they have to be
say, $100. This would allow it to make a profit of $30 per
paid whatever the level of production of the business.
bicycle and it is likely that sales would rise significantly due
Thus, marginal costs are concerned with variable costs
to the price fall, possibly boosting profits further.
(the direct costs of materials and labour, for example). In
most situations, the marginal cost of an additional unit
of a product is the variable cost of its production. In the GLOSSARY TERMS
example of our television manufacturer in Table 5.12, we Cost-plus pricing is the process of establishing the price
5.4.3 Uses of cost information

know that to produce 4 million televisions would result in of a product by calculating its cost of production and then
a total cost of production of $824 million. If we assume adding an amount which is profit.
that fixed costs are unchanged and that the variable cost Contribution pricing is based on the notion that any price
of producing one more television is $200, the total cost will set that is higher than the variable cost of producing a
rise to $824 000 200 for 4 000 001 televisions. This means product is making a payment towards fixed costs.
that the marginal cost of producing this one additional
television is $200.
Marginal costs and prices (contribution pricing)
Costs and pricing decisions By knowing how much it costs to produce an additional
unit of output, a business can be guided in setting
The costs of production can have a significant influence on
prices or deciding whether to accept orders at specific
a firm’s pricing decisions.
prices. Marginal costs are based on the variable costs of
production. Fixed costs will not be affected by the decision
Average costs and prices (cost-plus pricing) to supply additional units and so it is the contribution from
Cost-plus pricing is the most commonly used method of any sale that is critical. Contribution can be calculated
setting prices. It involves deciding the price of a product using the formula below:
based on the average cost of a single unit of the product.
The average cost is calculated by dividing total production contribution = revenue – variable costs of production
costs by the number of units that are produced. To this The concept of contribution is useful when taking pricing
value is added an amount which is called a mark-up. The decisions. If the manager or owner of a business sets a price
mark-up is, in effect, profit. Average cost plus mark-up is in excess of the variable cost of producing the product,
the price charged. then each sale will make a positive contribution to fixed
For example, if a furniture manufacturer is aware that a costs. If sufficient sales are made, the enterprise will earn a
single table costs $125 to produce and decides to price the profit. This approach to pricing is also called contribution
table at $150, the pricing method is cost-plus. In these pricing.
circumstances the manufacturer can be certain the product For example, the manager of a restaurant may calculate that
will sell at a profit, but may be less sure about the level of the typical variable cost of serving a meal to a customer is
sales. Cost-plus pricing does not take into account the state $12. If the restaurant charges customers an average price
of the market or actions of competitors. of $25 for each meal, then it will make a profit as long as
it attracts enough diners. It is certain that the revenue
Scenario A Scenario B received from each customer will contribute $13 ($25 − $12)
The company produces 1000 The company produces 5000 towards fixed costs.
bicycles during the year. Total bicycles during the year. Total
production costs are $100 000 + production costs are $100 000 + Contribution pricing offers firms flexibility when deciding
($50 × 1000) = $150 000 ($50 × 5000) = $350 000 upon the amount to charge for their products. Businesses
Average cost of producing one Average cost of producing one
bicycle = $150 bicycle = $70 that have well-established products in high demand may
be able to price significantly in excess of the variable cost
▲ Figure 5.15 Average costs and production levels of production. In these circumstances, each sale makes
a major contribution to fixed costs and profits. Fashion
A firm can help to keep costs of production for each clothing is an example of a product where prices are set
individual unit to a minimum by producing on the largest considerably above variable costs. Thus, a business might
possible scale. Consider the two scenarios shown in charge the equivalent of $75 for a t-shirt that costs $10
Figure 5.15 for the London Bicycle Company. This company to manufacture. The contribution of $65 from each sale
has fixed costs of $100 000 and each bicycle has variable is necessary because the business faces high fixed costs,
costs of $50 for materials and labour. spending heavily, for example, on marketing. Furthermore,
products in the fashion industry have very short lives.
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However, contribution pricing has its weaknesses. While » the costs incurred by separate areas of the business
setting a price that generates a positive contribution (divisions or branches, for example) do not differ
5.4 may result in the firm earning a profit, this depends upon
the business in question achieving sufficient sales. This
significantly without good reason
» costs are not increasing unexpectedly and are similar to
is far from certain as this approach to pricing places the forecasts set out in the company’s budgets
relatively little emphasis on the state of the market. Using » the business continues to hit its profits targets.
contribution as a guide for pricing may result in low levels
of sales because competitors’ prices are lower or their We look at budgets in much more detail in Chapter 5.5.
responses may be unpredictable. A business that operates many similar branches or outlets
may compare the costs of its branches and seek to reduce
STUDY TIP
AS LEVEL 5.4 Costs
costs to those achieved by the most efficient performer.

Many students confuse contribution and profit, yet this In this way, the company uses cost data as indicators of
distinction is vital and understanding it is important to best practice and seeks to duplicate this approach in other
gain top-level grades. Profit is revenue less all costs, areas of its business to improve performance and profits.
while contribution is revenue less only variable costs. It may be possible for senior managers to set cost targets
for areas of the business controlled by junior managers and
to reward achievement of these targets. In this way, large
Using costs to monitor and improve organisations are more able to control costs and improve
profits.
business performance
Managers of all businesses constantly monitor costs to
ensure that:
CASE STUDY
Starbucks expands in the Indian market
The American coffee retail chain, Starbucks, opened its now has 157 outlets in ten Indian cities including Mumbai,
first coffee shop in India in 2012. Understandably, the Hyderabad, Chennai and Bengaluru.
market of 1200 million people was very attractive to the
Starbucks will continue to need to set its prices lower
company, as incomes and a taste for coffee among Indians
than in the United States if it is to increase its sales
increased. However, selling in India required the company
further in India. Starbucks’ expansion plan in India
to change its approach in some ways. Starbucks, famous
includes offering customers more vegetarian food options
for its caramel macchiato and espresso, offered smaller
and adding new food items.
and cheaper beverages to attract coffee drinkers in India.
In 2019, Starbucks opened more than 30 outlets in India, the Questions
largest number of new store openings since 2012. However, 1 Analyse one reason why selling its products at
Café Coffee Day is still India’s largest coffee shop chain. lower prices in India might not necessarily reduce
Starbucks’ revenue. [4]
In 2018, Starbucks also announced its plan to open outlets
2 Evaluate the reasons why the costs of operating a
in the western state of Gujarat, where it opened five
coffee shop in Gujarat might be different from those
stores in the cities of Surat and Ahmedabad. Starbucks
in a state in the USA. [12]
However, for a large-scale global business, such as information, managers can take decisions to improve the
Starbucks in the case study, it may be difficult to compare business’ performance and, especially, its profitability. For
performance in different countries in this way because of example:
huge differences in costs. Thus, monitoring and comparison » It may be able to reduce its costs following such an
of costs in this way is likely to be more effective if it takes analysis. If it is placing increasingly large orders with its
place in a single country or within countries with similar suppliers, it may be able to negotiate larger discounts
costs for resources such as labour. for bulk orders. Alternatively, if it is not using all of
its supplies, it may reduce the size of its orders and its
Equally a trend of falling costs may provide an indication
costs. This is vital if the supplies are perishable.
that profitable opportunities exist. For example, in 2019,
» Labour is a major cost for many businesses and
the rental costs of retail properties in Hong Kong fell by
especially those operating in the service sector.
over 10 per cent compared with the previous year. This
Monitoring labour costs is important to maximise
cost information might assist a retail business to make a
profits. For example, if a business hires too much labour
profitable decision on expansion.
and that labour is not fully employed then the business
Thus, budgets can be used to monitor how well costs are is incurring costs that are not matched by revenue.
controlled, but also to assist the business’ managers in Profitability will be damaged as a consequence.
improving the business’ performance. By using the cost
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A business’ managers may look at cost data over a period of ▼ Table 5.13 Sales revenue, total costs and profits from
time. Changes in the figures may reveal underlying problems producing televisions
that can be corrected to improve the business’ profits. We
can consider a few examples of using cost data in this way. Level of production Sales Total Profits 5.4
» Rising labour costs within a business when output is not (million televisions) revenue costs or losses
increasing could show that employees are working less per year ($m) ($m) ($m)
efficiently. This could be caused by a range of factors, 0 0 200 (200)
including a lack of training or poorly motivated employees.
1 300 380 (80)
Once the cause of the rising labour costs has been
identified, managers can take appropriate remedial action. 2 600 560 40
» Rising costs of raw materials over time could indicate
5.4.3 Uses of cost information

3 900 681 219
that there are high levels of waste or that suppliers have
4 1 080 824 256
increased costs significantly. In either case, the cost
information could alert managers to a problem which 5 1 250 960 290
needs attention to improve profits. In 2020, Hasbro, the 6 1 320 1 080 240
American toy manufacturer, said it would be seeking to
7 1 420 1 190 230
manufacture more of its toys outside China due to the
rising costs of producing in China. 8 1 600 1 440 160
» A business’ fixed costs may increase more rapidly than
might be expected over time. Managers responsible for
controlling these costs may take action in response. HANDLING DATA
Use the information in Table 5.13 to answer the
Using cost information to calculate following questions.
profits 1 Assume the television manufacturer could always
sell its televisions at $300 per television, no matter
Profits are the amount by which revenue exceeds total
what its level of output. At what level of output would
costs, although there are several different measures of
it make the highest profit?
profit. Figure 5.10 on page 187 illustrated that comparing 2 Why is profit highest at this level of output?
the total costs for a business with the revenue that it earns
over a period of time shows whether a business has made a
profit or a loss. The key formula for profit is: Contribution costing and special-order
profit (or loss) = total revenue − total costs decisions
At the end of a trading period, the managers of a business One of the key advantages of using contribution costing is
can calculate the business’ profits using its cost and that it can help managers to make what are called special-
revenue information. So, if a business generated sales order decisions.
revenue totalling $256.4 million during the financial year
and incurred total costs amounting to $208.9 million, it GLOSSARY TERM
could calculate its profits as follows:
Special-order decisions occur when a business’
profit = $256.4 million – $208.9 million = $47.5 million managers have to decide whether or not to accept unusual
customer orders.
In Table 5.12 on page 194 we considered the fixed, variable
and total costs of producing televisions. Table 5.13 shows
how this cost data can be used to calculate whether or Special-order decisions
not the business producing televisions makes a profit. Businesses sometimes have to make decisions on whether
Furthermore, it can be used to calculate the expected profit to accept orders that are not on their normal terms. For
at different levels of output and to decide which might be example, a firm might receive a large order for its products
most profitable. However, this is only possible when the at a price significantly lower than it usually receives.
company has the relevant revenue information as well. In this Alternatively, a business might receive an order which offers
case, we assume that to sell higher quantities of televisions, a price above the usual but which requires special features
the company has to sell its products at lower prices. This is or a very early delivery date, meaning the supplier is likely
why its revenue does not rise steadily with output. This cost to incur additional costs in fulfilling the order.
information, when added to information about sales revenue
(or total revenue), allows managers to calculate profits. Firms faced with the dilemma of whether to accept this
type of order are facing special-order decisions. In these
The information in Table 5.13 suggests that the television circumstances, the concept of contribution can be applied
manufacturer would make the highest profits if it produced to assist the business in reaching a decision on whether or
(and sold) 5 million televisions per year. Of course, it not to accept the order.
is important to understand that this is forecast data
and might not be completely accurate. However, it is an
important aid to a business’ decision-making.
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CASE STUDY
5.4
Margaret Roberts Woollens
are very popular with tourists and sell for high prices,
particularly during the summer season. The cost of wool
and the wages paid to knitters means that the average
variable cost of producing a single woollen garment is
$30. To the surprise of the managing director of the firm,
a large order is received from a national clothes retailer.
AS LEVEL 5.4 Costs
The retailer requires 5000 sweaters and other garments,

but is only willing to pay Margaret Roberts Ltd $32 per
item. Should Margaret Roberts Ltd accept the order?
Contribution is the key to making this decision. The firm
would earn a positive contribution on each sale. Each
woollen item sold would incur variables costs of $30, but
would earn revenue of $32. Thus each sale would create
$2 of contribution. Therefore, meeting the order would
earn the business an additional $10 000 in contribution.
This might mean profits would rise (or losses would fall)
by $10 000.
Questions
1 Analyse two reasons why accepting this order may
not increase the level of profits earned by Margaret
Roberts Ltd. [8]
▲ Figure 5.16 One unit on which contribution costing 2 Evaluate the non-financial factors the managers at
could be applied Margaret Roberts Ltd might consider before deciding
Margaret Roberts Ltd manufactures woollen sweaters whether or not to accept this order. [12]
for local shops at a standard price of $40. The sweaters
Prices lower than normal will not simply resell the product to other firms at the
usual selling price, thereby making a quick profit at the
It is not unusual for a firm to receive an order for a large
expense of the manufacturer.
quantity of its products at a price below that normally
charged. Consider the case study above.
» A business may accept a lower price than normal, even if
it doesn’t produce a positive contribution, if it believes
A number of factors need to be taken into account when that it will result in more sales at higher prices in the
taking special-order decisions such as this. future.
» Will additional fixed costs result from accepting the
order? In the circumstances above, Margaret Roberts Ltd
may have to hire additional factory space, increasing STUDY TIP
its overheads, meaning that additional contribution is When responding to questions on special-order decisions
required to meet these costs before extra profits are (or costing decisions generally) it is important to consider
earned. Thus, if the firm has to pay an extra $10 000 non-financial factors as well as financial ones. Read the
in rent, then profits will be unchanged as a result of case study or stimulus material carefully to ensure you
accepting the order. Therefore, having sufficient spare pick up on any non-financial factors that may have been
capacity is an important prerequisite of accepting such included as clues.
an order.
» Might the order lead to higher variable costs? Accepting
a large order might mean that workers are paid overtime, Prices higher than normal
pushing up variable costs. Workers at Margaret Roberts It may appear a stroke of good fortune for a business
Ltd might be paid higher hourly rates, meaning that the to receive an order at a price above that usually levied.
variable cost of producing a single item rises to $35. However, if the order requires products to have a
In these circumstances the order would not be worth specification higher than normal or to be delivered at short
accepting. notice, it is likely that the supplier will face higher costs.
» Before making a special-order decision (at a price below This may make the order unprofitable.
the norm), a business needs to ensure that the customer
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Once again, contribution is the key to the decision. If the Contribution and break-even
selling price exceeds the variable costs and no additional
fixed costs are incurred, the order would be worthwhile
and would result in increased profits. Therefore, if
Contribution is an important part of break-even analysis. We
saw earlier that contribution can be defined as the difference 5.4
Margaret Roberts Ltd had an order for a new style of between sales revenue and variable costs of production.
sweater which needed more expensive wool than normal Contribution is calculated using the following formula:
and had to be completed within six weeks, the firm would contribution = revenue − variable costs
need to:
» calculate the extra variable costs associated with the Contribution can be used to pay the fixed costs incurred
order – overtime pay for workers and more expensive by a firm. Once these have been met fully, contribution
materials, for example provides a business with its profits.
5.4.4 Break-even analysis

» consider whether it had sufficient spare capacity to
Revenue from sales
meet the order – avoiding additional fixed costs
» decide whether accepting the order would generate
less
extra contribution and profits.
Variable costs
Qualitative factors
Qualitative factors are often important in such decisions. gives
Accepting an order such as that received by Margaret
Roberts Ltd may offer long-term benefits. The customer Contribution
may return with further orders and it may help to increase
brand awareness in new markets. It may help the business contribution is
used to pay
concerned to achieve its corporate aims, especially if these
are growth or increasing market share. Fixed costs
On the other hand, the consideration of qualitative factors once fixed costs are
may result in a decision not to supply a special order. paid, contribution
provides
It may be regarded as too risky. For example, managers
may believe that allowing their products to be sold in
large quantities at lower prices could damage its brand Profits
image. It may, for example, make the product appear less
exclusive and make it difficult to charge higher prices
in other markets. Sales and profit margins may fall as a ▲ Figure 5.17 Contribution is the difference between sales
consequence. revenue and variable costs of production. Profit is the
surplus of sales revenue over all costs
5.4.4 Break-even analysis Calculating break-even output

The manager of a business wishing to calculate the break-
What is break-even analysis and why is even point or level of output will require the following
information:
it important? » the selling price of the product
Break-even output is that level of output or production at » the variable cost of producing a single unit of the product
which a business’ sales generate just enough revenue to » the fixed costs associated with the product (remember,
cover all its costs of production. At the break-even level fixed costs do not change as the level of production
of output, a business makes neither a loss nor a profit. alters).
A business’ managers may use break-even analysis for a
This information is used within the following formula:
number of reasons:
» to help decide whether a business idea will be profitable
and whether it is viable break-even fixed costs
=
» to help decide the level of output and sales necessary to output selling price per unit − variable
generate a profit cost per unit
» to support an application by a business for a loan from a
bank or other financial institution This formula can be rewritten given that contribution is the
» to assess the impact of changes in the level of result of taking away variable cost per unit from the selling
production on the profitability of the business price of a product:
» to assess the effects of different prices and levels break-even fixed costs
of costs on the potential profitability of the business =
output contribution per unit
» to judge whether launching a new product or entering
a new market will be profitable given expected sales We will use the scenario set out in the following case study
forecasts. to illustrate the construction and interpretation of break-
even charts.
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CASE STUDY
5.4 Using break-even analysis
Sarah Feng is planning to expand her restaurant chain furnished buildings. Sarah plans to call her restaurant
and to open a new restaurant in New York, specialising ‘The River Palace’.
in Cantonese food. She has a lot of experience in the
Sarah needs a loan to open The River Palace. She has
industry, as she already operates 12 restaurants in Sydney
already looked at a building which would accommodate
and Kuala Lumpur. Her new restaurant will maintain her
up to 30 diners. She produced the figures set out in
reputation for serving high-quality food in beautifully
Table 5.14.
AS LEVEL 5.4 Costs
▼ Table 5.14 Sarah’s analysis for The River Palace
Type of cost or revenue Amount

Average selling price per meal at The River Palace $60
Variable costs per meal – ingredients, fuel, wages $35
Monthly fixed costs of the new restaurant – lease for the property, rent and rates $10 000
Using this information, Sarah was able to calculate how So, Sarah knows that, if her plan for The River Palace
many meals she will need to sell (or how many diners she is to break even, she will need to attract at least 400
has to attract) in her restaurant if the project is to break customers each month. If she attracts more than 400
even. customers, the project will make a profit. Sarah plans to
open The River Palace on 25 evenings each month and
break-even fixed costs would, therefore, break even if she had an average of 16
=
output contribution per unit customers each night in the new restaurant.
Sarah knows her fixed costs will be $10 000 each month Questions
and this figure is entered into the top of the formula. To fill 1 If Sarah increases her prices to an average of $70
in the bottom, Sarah has to take away the variable cost of per meal, calculate the level of her new break-even
producing a meal from the price the customer pays for a output. [6]
meal. The contribution earned from each meal in Sarah’s 2 Evaluate whether or not Sarah’s planned price
new restaurant is $25 ($60 − $35). Thus: increase would be a good idea. [12]
$10 000
monthly break-even output = = 400 diners
$25
While this calculation gives Sarah a quick guide to the each. So, the highest revenue she could possibly receive
number of customers her restaurant will need to break even, is $45 000 ($60 × 750). Her vertical scale should have a
it tells her little more about the level of profit or loss The maximum value of $45 000.
River Palace might make. A break-even chart is one way to
Sarah’s break-even chart shows the monthly fixed costs she
work out the level of profits the business will generate if
will have to pay: $10 000. This is illustrated in Figure 5.19.
her forecast is proved to be correct.
Variable costs are also illustrated. As variable costs
Break-even charts are expenditure on items such as components and raw
materials, these costs will rise along with output. If Sarah
Sarah knows that The River Palace can seat a maximum of has an increasing number of people dining at The River
30 customers per night and that she normally opens for 25 Palace, she will need to buy more food and her wage bill
evenings each month. This means that her maximum number will also rise.
of customers each month is 750 (30 customers × 25 nights).
When Sarah constructs her break-even chart, her horizontal Variable costs always start at zero. The highest variable
axis will run from zero to 750 customers. cost Sarah could encounter is to provide 750 meals, each
having a variable cost of $35. The highest variable cost
The vertical scale on a break-even chart records costs and would therefore be $26 250 ($35 × 750). This maximum
revenues. Normally revenues are the highest figure. At most, figure is connected by a straight line to the origin as
Sarah could attract 750 customers paying an average of $60 shown in Figure 5.18.
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The maximum value on this axis is worked out Finally, the break-even chart shows the revenue The River
by multiplying the maximum output by the Palace will earn. Sarah has already calculated that an
45
5.4
average selling price (i.e. $60 x 750 = $45 000).
average customer spends $60 on a meal in her restaurant.
40 Once again, there are two extreme situations.
» If The River Palace does not have any customers, it will
35 not have any revenue. Thus the revenue line begins at
Costs and revenues ($000)
30 Variable
the origin.
costs » If the restaurant is full, Sarah expects each of the
25 750 customers to pay $60 on average. If The River
Palace attracts this level of custom, it will earn
$45 000 ($60 × 750).

20
15 Figure 5.20 shows the break-even chart with the revenue

Fixed costs = $10 000 line included. To make the chart easier to read, the variable
10 costs line has been left out in this case.
The
origin The maximum figure on this axis is simply
5 the maximum level of output. The new Revenue
restaurant can seat 750 diners each month 45
0 100 200 300 400 500 600 700 750
40
Monthly output (customers)
Break-even occurs Total costs =
▲ Figure 5.18 Fixed and variable costs on a break-even chart 35

where total costs and fixed costs +
revenue are equal variable costs
30
Total costs are simply the sum of fixed and variable costs.
» If The River Palace has no customers in a month, it will 25
not incur any variable costs. At zero output, total costs
are the same as fixed costs. In Sarah’s case, this will 20
mean a total costs figure of $10 000 per month. 15 Fixed costs
» At the other extreme, The River Palace might be full, = $10 000
with 750 customers each month. Sarah will add together 10
fixed costs (still $10 000, of course) and variable costs at Break-even output
full capacity (750 customers’ meals each having variable 5 confirming the earlier
costs of $35), equal to $26 250. Thus, total costs for calculation
0
the restaurant in these circumstances will be $36 250 100 200 300 400 500 600 700 750
($10 000 + $26 250). Monthly output (customers)
The line connecting these two points represents total costs. ▲ Figure 5.20 The complete break-even chart
This line should be parallel to the variable costs line and is
shown in Figure 5.19. The break-even chart tells Sarah that she needs 400
customers each month if The River Palace is to break
even. This confirms the calculation we carried out
45 earlier. However, a break-even chart provides much more
Total costs = fixed information. Sarah can use it to read off the level of profit
40 costs + variable costs or loss her new restaurant will make according to the
This total costs line will be
parallel to variable costs – number of customers it attracts.
35 the difference between the
two lines is fixed costs If the River Palace attracts fewer than 400 customers
30 Variable each month, it will record a loss. The amount of the loss is
costs
shown on the graph by the vertical distance between the
25
total cost line and the revenue line at the relevant level of
20 output. Similarly, if the restaurant attracts more than 400
customers in a month, it will generate a profit that month.
15
Fixed costs
Here the profit is shown by the vertical distance between
= $10 000 the revenue line and the total cost line.
10
Figure 5.21 shows the level of loss and profit made by The
5 The origin – all variable River Palace if it attracts 200 customers and 600 customers
cost curves begin here per month.
0
100 200 300 400 500 600 700 750
Monthly output (customers)
▲ Figure 5.19 Including total costs on a break-even chart
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Revenue
45
5.4 Revenue earned from

600 customers = $36 000
40
Total costs
35
Profit = $5 000
AS LEVEL 5.4 Costs
30 Total cost of supplying

600 customers = $31 000
Costs and reveunes ($000)
25
Total cost of supplying
200 customers = $17 000 Break-even
point
20
Loss = $5 000
The margin
15 of safety
10
Revenue earned
from 200 customers
= $12 000
5
Break-even
output
0 100 200 300 400 500 600 700 750
Loss-making Profit-making Monthly output

range of output range of output (Number of customers)
▲ Figure 5.21 Showing profits and losses on a break-even chart
CASE STUDY
Nigerian films fail to break even
The film industry in Nigeria is experiencing some good make a lot of one-off noise, but people don’t remember them
times. Much of this is due to the efforts of Kunle Afolayan, in six months’ time,’ he says. ‘That isn’t the kind of legacy I
a 46-year-old director. Kunle has produced a series of want to leave.’ Most of his films have been financed through
films since 2005 which have impressed knowledgeable a combination of his own earnings, bank loans and individual
film critics and have received highly favourable reviews in investors, though he has now attracted funding from further
the New York Times. afield, receiving a Ford Foundation grant to make Citation.
Despite this international acclaim, it remains difficult to The Ford Foundation was established by the Ford motor car
generate profits from making films in Nigeria. His new manufacturing company.
film, Citation, about a scandal at Nigerian and Ghanian
Source: https://econ.st/32pt6A6
universities which came to light in 2018, began filming in
2020. Kunle predicts that it will ‘beat records’. The film Questions
is still showing and earning revenues, but some analysts 1 Explain two actions that Kunle Afolayan might take
believe it is unlikely to break even. to help make his latest film profitable. [6]
2 Evaluate why investors might choose to invest in a
Yet box-office receipts are not Kunle’s main concern.
film which is not expected to make a profit. [12]
‘Nigerian films that are driven by commercial interests alone
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HANDLING DATA The uses and limitations of break-even
Mike plans to open a business providing people with

analysis
Most financial techniques have uses and limitations, and
5.4
help to learn how to use computers and the internet. break-even analysis is no exception. The uses of break-even
Mike thinks his fixed costs will be $21 000 per year
analysis include the following:
and the variable costs of serving each customer will
» It is a simple technique, allowing most entrepreneurs to
be $100. His average price per customer will be $240.
use it without the need for expensive training. Because
He expects to have 200 customers in his first year of
trading.
of this, it is particularly suitable for newly established
1 If his figures are correct, will he break even in his and small businesses.
» It is a technique that can be completed quickly,

first year of trading?
2 Calculate his expected profit or loss during his first providing immediate results.
year of trading. » It can be of value in supporting a business’ application
to a bank for a loan.
» By using break-even charts, a business can forecast the
The margin of safety effect of varying numbers of customers on its costs,
A break-even chart can be used to show the margin of revenues and profits.
safety, although this can also be calculated. The margin » Break-even analysis can be used to analyse the
of safety measures the quantity by which a firm’s current implications of changing prices and costs on the
level of sales exceeds the level of output necessary to enterprise’s likely profitability.
break even. However, break-even analysis has a number of limitations:
The following formula expresses the margin of safety as a » It assumes that all products are sold. For example,
number of units of output. Sarah might assume that she will attract 600 customers
each month. She will order the necessary food and hire
margin of safety = current level of sales − break-even output sufficient staff. However, if only 500 turn up, she will
In our previous example of The River Palace restaurant, if not make the profit indicated for 600 customers on the
it is successful and attracts 600 customers each month, the break-even chart.
margin of safety will be 200 customers (600 customers – » It is a simplification of the real world. Businesses do not
400 customers). This means that, in these circumstances, sell all their products at a single price and calculating
the restaurant could lose 200 customers each month before an average is unlikely to provide accurate data. The
it reached break-even output and began to make a loss. technique is also difficult to use when a business sells a
This is shown in Figure 5.21 (page 202) for an output of 600 number of different products.
customers per month. » Costs do not rise steadily as the technique suggests. As
we have seen, variable costs can rise less quickly than
There is an alternative method of calculation which output because of the benefits of buying in bulk.
expresses the margin of safety as a percentage of current » Any break-even analysis will only be as accurate as the
sales. The formula to use for this is: data on which it is based. If costs or selling prices are
margin of current level of sales − break-even output incorrect, then the forecasts will be wrong.
safety = × 100
Break-even analysis offers some support to businesses,
current level of sales
and especially to start-up enterprises or those seeking to
Using this formula for our example we would get: expand by launching new products and/or entering new
markets. However, it is only a guideline and its value should
600 − 400
margin of safety = × 100 = 33.3% not be overstated. Perhaps, most importantly, entrepreneurs
600 and managers should bear in mind that the value of the
This tells us that the restaurant could lose just over 33 technique depends on the use of reliable data for costs,
per cent of its sales before it found itself in a break-even prices and expected sales.
position.
GLOSSARY TERM
The margin of safety measures the quantity by which a
firm’s current level of sales exceeds the level of output
necessary to break even.
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TEST YOUR LEARNING
5.4 10 a Define the term ‘margin of safety’. [2]
b Calculate the margin of safety if a business has
1 Define the terms: sales of 10 000 units per year and its break-even
a ‘costs’ [2] output is 6500 units. [2]
b ‘revenues’. [2]
2 a Explain one difference between average costs Data response question
and marginal costs. [3] The new hotel
AS LEVEL 5.4 Costs
b Explain one reason why average costs might

Santa Rosa Hotels has just opened its latest hotel in
fall as a business increases its level of output. [3]
Huaraz, close to the Parque Nacional Huascarán in Peru.
3 a Define the term ‘full costing’. [2] The area is a popular tourist destination and the numbers
b Explain one way in which a large manufacturing visiting are rising quickly. There are many other hotels in
business might allocate its overheads between the the area and the new hotel is not expected to be full at any
different products that it supplies. [3] time during its first year of operation.
4 Explain one reason why it might be difficult for the
manufacturer in question 3b to allocate its overheads The hotel’s manager is keen to make the new business
accurately. [3] profitable and plans that every guest at the hotel will
make a contribution to fixed costs. They are concerned
5 Explain one reason why a business might refuse an
about their pricing decisions, as labour and other costs
order for its products at a price that is higher than
are expected to rise significantly over the next year or two.
normal. [3]
6 Explain one reason why a business might decide to Santa Rosa Hotels has not been a very profitable company
accept an order for its products at a price of $300 per since 2019 and its shareholders are keen to see an
unit when its normal selling price is $400 per unit. [3] improvement in this area over the next year or two.
7 Explain one way in which a business might calculate
the marginal cost of a single unit of output. [3]
Questions
8 Explain one reason why contribution costing avoids 1 Define the terms:
the need to allocate overheads. [3] a ‘contribution’ [2]
9 a Define the term ‘break-even output’. [2] b ‘fixed costs’. [2]
b A business sells its products for an average price 2 Analyse one reason why it is important for the
of $40, has fixed costs of $100 000 and contribution company to calculate its costs accurately. [4]
per unit of $15. Calculate the level of output 3 Evaluate the case for and against the decision to use
required to break even. [2] cost-plus pricing. [12]
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AS LEVEL
5.5 Budgets
5.5.1 The meaning and purpose of budgets

Chapter overview
★ the meaning and purpose of budgets and the benefits and drawbacks of their use
★ the meaning, calculation and interpretation of variances.
5.5.1 The meaning and purpose of and other items which are essential for the process of
production. Research is necessary to prepare accurate
budgets expenditure budgets. For example, an independent
forecast in 2019 revealed that wages in countries in
What are budgets? Asia are expected to rise by between 2.3 per cent and
12 per cent during the next financial year – this would
Budgets are financial plans. Firms plan their earnings and
be important data for Asian firms with large workforces.
expenditures using budgets. Budgets are usually drawn
The production budget will also contain forecasts for
up on a monthly basis, over the period of a financial year.
expenditure on overheads and a cash budget as well.
There are a number of types of budgets:
» Sales revenue or income budgets These set out » Profit budgets This type of budget forecasts a
business’ total revenue and total costs and shows
the business’ expected sales revenue from selling its
whether it is expected to make a profit or loss over
products. Important information here includes the
a future trading period. The Coronavirus (COVID-19)
expected level of sales and the likely selling price of
pandemic of 2020 led to numerous businesses revising
the product. A start-up business may have relatively low
their profit budgets following forecasts of substantial
revenue budgets during its first few months of trading. It
falls in revenue from sales.
is likely that the sales revenue budgets will be increased
as the business becomes better known. In contrast, an
established business may have a large and loyal customer STUDY TIP
base and substantial inflows of revenue from a range of Remember that budgets are forecast data and may
different products or brands, for different regions, or be incorrect. You should read any case study material
from a number of subsidiary companies. carefully to see if there is any evidence about its likely
» Production or expenditure budgets Businesses need accuracy and use this to help to develop your answers.
to plan their expenditure on labour, raw materials, fuel
CASE STUDY
Hotels in Singapore
Hotels in Singapore enjoy one of the highest rates of ● Many businesses have decided to reduce their
occupancy in the world. Data from the Singapore Tourism travel and accommodation budgets. Fewer business
Board shows that 93.8 per cent of its hotel rooms were travellers are forecast to stay in hotels in Singapore.
occupied in July 2019. This represents a small increase These changes have already affected the financial
from the summer of 2018, when the rate was 92.5 per cent. performance of hotels in Singapore. In the autumn of 2019,
Forecasters are expecting Singapore’s hotel occupancy Singapore Hotels Ltd reported that the average earnings
rate to decline in the future. They have identified three from its rooms was $240. Since the summer of 2019, the
reasons for this forecast: average earning figure had fallen from just over $249.
● Hotels in Singapore are projected to lose customers to Questions
competitors located in Hong Kong, which is expected
1 Analyse two reaons why the changes forecast in the case
to become a more popular location for business
study might have a significant impact on the sales revenue
conferences, boosting demand for hotels.
budgets of the hotel division of Singapore Hotels Ltd. [8]
● A number of new hotels are due to open in Singapore
2 Evaluate why it might be difficult for hotel companies
during 2020, including the Singapore New Edition. This
in Singapore to forecast future sales revenues
will increase the number of hotel rooms available.
accurately at this time. [12]
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There is the risk, of course, that the information in budgets concerned that its product range is not selling well, it
may not prove to be accurate. For example, sales revenue may increase its budgets in the areas of market research,
5.5 budgets may be incorrect if there is an unexpected slump in
sales due to, say, a change in consumers’ tastes and fashions,
research and development or advertising.
» Budgets can be used to motivate employees. Employees
or the entry of a new competitor into a specific market. can gain satisfaction from being given responsibility
for a budget. Often large businesses use what is known
The benefits and drawbacks of budgets as ‘delegated budgets’ whereby control of budgets
is given to individuals and teams at all levels within
As with most techniques of financial control, there are
the organisation. They may also gain satisfaction
benefits and drawbacks to the use of budgets.
from keeping within a budget. As a result, their level
of motivation and their performance may improve,
AS LEVEL 5.5 Budgets
The benefits of budgets benefiting the firm as a whole. In Chapter 2.2 we

» Production or expenditure budgets allow managers considered motivation in more detail.
to ensure that a business does not overspend. Senior » Sales revenue budgets can also be used as targets
managers receive their own budgets and can allocate for employees, possibly as part of the appraisal
these between the various parts of the department process. Employees may be motivated to improve their
or area for which they are responsible. Figure 5.22 performance by the existence of targets in the forms of
illustrates this process. As long as each individual sales revenue budgets.
budget holder makes sure that they do not spend » Information on expenditure budgets allows senior
more than the agreed figure, the business’ overall managers to examine those areas of a business that
expenditure should remain under control. Modern manage costs effectively. The most successful areas
technology makes the control and monitoring of such or divisions can become models for other parts of the
budgets easier. business.
» Budgets allow senior managers to direct extra funds into
important areas of the business. Thus, if a business is
Board of Directors
(advised by Director
of Finance) plans
revenue and spending
for financial year
Production Human Resources
Decides budget of $3m

for marketing – Director
of Marketing controls
budget
Public relations – Advertising – Staff salaries and

$¾m for $½m to pay for a expenses – $1¾m for sales
sponsorship and series of advertising and marketing salaries,
events campaigns commission and expenses
These budgets will be controlled by relevant managers. They may be

further divided into, for example, a budget for expenses for the sales force.
▲ Figure 5.22 An example of using budgets within a company
The drawbacks of budgets in their ability to control finances. The cost of the
training could be substantial, depending on the skills
» If a business intends that a significant proportion of its
of the workforce. Furthermore, there could be teething
employees should manage budgets (known as delegating
problems as employees adjust to the new roles and
budgets) then training will be required. Some people will
responsibilities.
not welcome the extra responsibility or feel confident
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» Allocating budgets fairly and in the best interests of the » Budgets normally relate to the current financial year
business is difficult. Some managers may be skilled at only and are short-term in nature. Therefore, managers
negotiating large budgets for the areas for which they
are responsible. This might be at the expense of more
might take decisions in order to keep within the current
budget which is not in the longer-term interest of the
5.5
worthy areas. Thus, for example, a manager responsible business. For example, a decision to reduce the size
for the sales force in existing markets may receive a of a workforce for budgetary reasons might result in
large budget allocation, while insufficient funds are competitors gaining more of the market over the next
given to developing new markets. few years.
CASE STUDY
5.5.1 The meaning and purpose of budgets

Alibaba
The Alibaba Group was founded in 1999 by 18 people led Alibaba owns and operates a wide variety of different
by Jack Ma, a former English teacher from Hangzhou, businesses throughout the world. For example, in 2018,
China. Its founders started the company to support small Daraz, a Pakistani online store, was bought by the Alibaba
businesses, to help small enterprises to compete more Group, making the South Asian e-commerce platform an
effectively in China and globally. Initially the company important part of Alibaba’s global operations.
created online marketplaces enabling buyers and sellers
The Alibaba Group aims to grow quickly. It has set itself
to meet and buy and sell products. By 2019, the company
some important targets to ensure its continued growth.
had grown very rapidly and employed 102 000 people,
Three important targets are:
earned revenues totalling $56.15 billion and profits
l to have 2 billion global customers by 2036
amounting to just under $12 billion.
l to create a further 100 million jobs
By 2020, Alibaba provided a wide range of services. Its l to support over 100 million profitable businesses on
websites provide: its websites.
● sales services for businesses and consumers
l services for electronic payments Questions
l search engines for shopping 1 Analyse two reasons why budgeting would be
l cloud computing services. important to Alibaba while it is growing quickly. [8]
2 ‘It is impossible for Alibaba to draw up accurate
budgets.’ Evaluate this view. [12]
allocate funds to the same use each year. Managers may

Different approaches to budgeting find it difficult to acquire large sums for new and more
Incremental budgets risky activities. This may result in lower profits in the
Incremental budgets are a very simple approach to long term.
budgeting. In an incremental budget, figures from the
previous budget are used as a basis for the new budget.
According to circumstances, a small percentage change may
GLOSSARY TERMS
be made to the previous figures to allow for alterations in Incremental budgeting is a process where budget figures
costs or expected revenues. are minor changes from the preceding period’s budgeted
or actual data.
Incremental budgets work well in a stable business A flexible budget is a budget that is designed to change
environment, where changes are relatively small and along with the sales volume or production levels.
normally predictable. This approach to budgets is more
common in less competitive or less changeable markets
where profits are relatively stable. However, the use of Flexible budgeting
incremental budgets can have a number of shortcomings. Flexible budgets (or flex budgets) avoid some of the
» It can encourage overspending by managers Managers problems that are associated with the use of variances
may be encouraged to add a percentage to costs each within normal budgets. A common problem with the use
year rather then looking at ways to reduce costs when of variances is that some of the variances may be due to
using incremental budgeting. external factors, such as a significant fall in sales due to
» Managers may ‘massage’ the data Some managers may an economy moving unexpectedly into a period of falling
forecast little growth in sales revenue but substantial incomes. In such circumstances, it can be difficult to
increases in costs when drawing up incremental budgets. identify how much of a difference between a forecast
This would lead to them having favourable variances and an actual budget is due to external factors and how
which could suggest the area has been managed much to poor management within the business. The use
efficiently. of flexible budgeting removes at least some of the effects
» It does not encourage risk-taking One of the main of the external factors, allowing managers to analyse
criticisms of incremental budgeting is that it tends to underlying issues.
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In the example in Table 5.15, the managers would be means that, in this case, direct costs will be divided by
able to see that sales were much lower than expected, at 750 000 and multiplied by 600 000 to reflect the change in
5.5 $600 000 rather than $750 000. The flexed budget adjusts
other budget figures in the light of this change. This
sales revenue.
▼ Table 5.15 An example of a flexible budget
Normal budgets ($000s) Flexible budgets ($000s)

Budget Actual Budget Flexed budget Actual
Sales revenue 750 600 750 600 600
Overheads 200 204 200 200 204

Labour 180 162 180 144 162
Materials 220 201 220 176 201
Other costs 60 53 60 48 53
Total costs 660 620 660 568 620
PROFIT 90 (20) 90 32 (20)
Therefore, although costs fell as a result of the large drop in However, the process has a number of drawbacks too:
sales, they didn’t fall as much as may have been expected » Zero budgeting is effective for setting production (or
given the substantial reduction in output. Once the budget expenditure) budgets, but it has little relevance to sales
has been flexed, it is simple to see that all categories of budgets. To set a zero budget for sales revenue would be
costs recorded adverse variances and that they overspent ridiculous.
in the context of the falling level of production. Contrast » Budgets might be allocated according to the negotiating
this with the original budget – the favourable variances skills of managers rather than the genuine needs of their
for direct costs such as labour and materials may have areas or departments.
suggested that the budget holders managed these costs
effectively. GLOSSARY TERMS
A budget holder is responsible for the use and
HANDLING DATA management of a particular budget.
Zero budgets exist when budgets are automatically set
1 Look at the information in Table 5.15. If the flexed at zero and budget holders have to argue their case to
budget for sales revenue was $700 000, calculate the receive any funds.
flexed budgets for labour and materials.
The uses of budgets

Zero budgeting Measuring performance
Gathering information can be time-consuming even if
For many businesses, the figures in the profit budget will
budgets are based heavily on the previous year’s figures.
have an important influence on decision-making within
An alternative approach used by a number of firms is zero
the business. Comparing the actual profit figure with the
budgeting. Using this system, each expenditure budget
budgeted figure for the trading period can be a useful
is set at zero at the start of the budget setting process.
measure of a business’ performance.
Managers responsible for the areas covered by the budget
(HR managers, for example) have to bid for budget and to A business’ managers will also use budgeted and actual
justify the money they request. data to assess the performance of elements of the business
as well as its performance overall. We saw earlier (in
Using zero budgets can help firms in a number of ways:
Table 5.15) that the use of flexible budgets can strip out
» It avoids budgets creeping up each year as one year’s
the effects of changes in the market and overall sales.
budget is based on the figures from the previous year,
The resulting budgetary data can be used to judge the
plus a little to allow for inflation. In this way, it can
effectiveness of, for example, the control of costs in
assist a firm to control costs.
different areas of the business. Those managers who return
» It helps firms adjust their spending as the relative
favourable variances on expenditure budgets may be judged
importance of areas within the firm changes. For example,
more effective.
the purchase of an automated switchboard might mean
that the budget for this area can be reduced. This money A business’ budgets may also highlight the relative
can be used effectively elsewhere in the business. performance of a business’ divisions or sectors. Many
multinational businesses operate in different regions of
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the world. Coca-Cola, the American multinational soft research they undertook. Similarly, managers will respond
drinks company, produces and sells its products throughout to expenditure budgets that show significant variances –
the world. It separates its activities into five geographic
divisions: North America, Africa, Asia, Latin America,
adverse or favourable. 5.5
Businesses use budgets to assess the viability of new
Europe and other. The performance of these areas against
projects, such as launching a new product or relocating to
the budgets that have been drawn up will assist the
a new region or country. In this case, the research process
company’s managers in judging the performance of these
involved in preparing the necessary budgets is helpful and
five divisions.
the final budget figures are likely to have a major influence
Budgeted data alone can be used as a measure of on a final decision by senior managers.
performance. It may be that a business’ budgeted profits
5.5.2 Variances
are low or declining when compared to previous financial
years. This may lead the business’ managers to take 5.5.2 Variances
decisions to improve the financial performance of the Once a business has planned its sales revenue and
business in advance of the year’s trading. This may entail expenditure, it is essential to monitor the accuracy of
changing prices and reducing costs in the short term. In these financial plans by comparing the budget figures
the longer term, management teams may consider entering with the actual figures resulting from the business’
new markets and developing new products as a means of trading. Budgets can also provide a wealth of information
improving financial performance. to help managers take decisions on how to improve the
performance of the business.
Allocating resources » Analysing budgeted and actual expenditure This
The provision of detailed budgets on expected sales can provides information on how successful the business
reveal much about the forecast performance of individual is at controlling its costs. As a business grows, it is
areas or divisions within a large business. This information possible to judge the ability of different parts to manage
can help managers to make decisions on which areas of the its expenditure against given targets. If one area of a
business are likely to perform well and those that may not. business is regularly overspending its budgets, managers
Using this information, managers can make decisions on may take action to reduce expenditure and, by so doing,
how to allocate financial, human and other resources most increase profitability. Relevant actions might include
effectively. We saw in the previous section that Coca-Cola addressing issues such as poor motivation, quality
operates five divisions in different regions of the world. problems or not using capacity fully. Of course, if a
The company’s managers may allocate more resources to business or part of a business fails to meet expenditure
those divisions that perform most successfully when actual budgets regularly, it may be because the budgets are too
performance is judged against budgeted data. low to be achievable.
» Analysing sales revenue A business that fails to
It is not unusual for businesses to have budgets of many meet its sales revenue budgets for one or more of its
millions, or even billions, of dollars – this would certainly products may need to consider why this is occurring.
be the case for Coca-Cola. In such circumstances, it is Prices may be too high when compared with those
impossible for a single person, or even a group of people, of competitors, the business may not be advertising
to effectively monitor these budgets to ensure costs are sufficiently or not targeting the correct market
controlled and planned revenues are earned. A system segments, or the quality and/or design of the product
of budgets allows a large number of people within the may be inadequate. Good managers will use the
organisation to take a share of responsibility for managing information from analysing budgets to make decisions
finances. This process was illustrated in Figure 5.22 to improve the business’ sales performance.
(page 206). In this way, budgets provide an effective means » Analysing profits budgets Profits below budget are
of allocating resources. likely to be a cause of concern for most businesses.
These can be caused by excess expenditure or by revenue
Controlling and monitoring a business falling short of expectations or a combination of these
Budgets are an effective way of ensuring that a business factors. This scenario may prompt managers to examine
does not spend more than it should. As long as every means of cutting expenditure as well as boosting sales
employee ensures that they do not spend in excess of their revenue.
budget, costs should not get out of control. Equally, if
those involved in sales meet their targets then the business Adverse and favourable variances
should earn its planned level of profit. This should help the
business to achieve its objectives. A variance occurs when an actual figure for sales revenue,
expenditure or profits differs from the budgeted figure.
Managers may also take decisions based on the actual data Actual sales revenue or expenditure figures may be higher
in budgets through the calculation of variances. If, for or lower than budgets. Variances are categorised as adverse
example, sales budgets show substantial adverse variances, or favourable. These two categories of variance are shown in
managers may question the quality of their products or their Table 5.16 on page 210.
approach to pricing, as well as the accuracy of the market
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▼ Table 5.16 The two categories of variance $840 000. However, the actual figure was $790 000. In this
case the variance (or difference) is $50 000. It is an adverse
5.5 Favourable variances
A favourable variance
Adverse variances
An adverse variance occurs
variance because it will result in the business’ profits being
lower than forecast or its loss larger than forecast. In
exists when the difference when the difference between contrast, the business’ fuel costs are only $70 000, which is
between the actual and the figures in the budget and $5000 less than the budgeted figure. In this case, this is a
budgeted figures will result the actual figures will lead to favourable variance because this will result in the business’
in the business enjoying the firm’s profits being lower profits being larger than forecast (or a smaller loss than
higher profits than shown in than planned. budgeted).
the budget. ▼ Table 5.17 Calculating variances
Examples of favourable Examples of adverse

variances include: variances include: Revenue/ Budget Actual Variance
• actual wages less than • sales revenue below the cost figure ($) figure ($)
budgeted wages budgeted figure Sales 840 000 790 000 $50 000 (adverse)
• budgeted sales revenue • actual raw material costs revenue
lower than actual sales exceed the figure planned
Fuel costs 75 000 70 000 $5000 (favourable)
revenue in the budget
• expenditure on fuel is less • overheads turn out to be Raw 245 000 265 000 $20 000 (adverse)
than the budgeted figure. higher than in the budget. material
costs
Possible causes of favourable Possible causes of adverse
variances: variances: Labour 115 000 112 000 $3000 (favourable)
• wage rises lower than • competitors introduce new costs
expected products, winning extra
• economic boom leads to sales
higher than expected sales • government increases HANDLING DATA
• rising value of currency business taxes by
1 Look at the information in Table 5.15 (page 208).
makes imported raw unexpected amount
Calculate the actual sales revenue required under
materials cheaper. • fuel prices increase as
the ‘normal budget’ to result in a favourable
price of oil rises.
variance of $79 000.
The process of calculating a variance is simple, as shown

by Table 5.17. It simply involves a comparison between Calculating variances can give a business advance notice
the budgeted figure and the actual figure. In Table 5.17, that its financial plans are inaccurate. This can be carried
the business had forecast that its sales revenue would be out each month and will show before the end of the financial
Seek new markets

Cut prices at home or overseas Product range
if consumer demand
update or extend as
is sensitive to price
appropriate
changes (price elastic)
Improve company Adverse sales

image revenue Increase advertising
PR donations to sales revenue less than and/or promotions
charities planned
Cut wages or increase

Adverse production Reduce waste
labour productivity
(cost) variances use fewer raw materials
increase amount
expenditure higher and produce fewer
produced per worker
than planned faulty goods
per hour
Seek cheaper raw

materials
purchase from
overseas or in bulk
▲ Figure 5.23 Responding to adverse variances

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year that the firm’s finances are not as planned. This Other factors leading to adverse and
allows the business to take action to reduce expenditure or
increase revenue at an early stage. Figure 5.23 summarises
the range of actions that businesses may take in response
favourable variances
It may be that variances are not the result of unexpected
5.5
to adverse variances. developments and changes in the markets in which
Firms may also need to respond to favourable variances. businesses operate. Poor forecasting techniques can also
Production costs which are lower than planned may be result in unexpected revenues and expenditures, and
regarded as beneficial. But sales revenue that is greater therefore variances.
than anticipated might be caused by the firm selling Managers may make insufficient use of market research to
more products than planned. In these circumstances, the forecast sales revenue. This can lead to adverse or favourable
5.5.2 Variances
business might not have sufficient supplies to meet future revenue variances. It may also result in inaccurate budgets
customer requirements. This could result in the loss of long- for expenditure, as the managers will not have forecast
established customers and should be avoided. correctly the amount of labour and other resources that
There are internal connections in budgets which are the business needs to satisfy customers’ needs. Inaccurate
important to understand. For example, if a business budgets are also the result of inexperience on the part
experiences a rise in output and sales revenue above of managers, and variances will be more common when a
expectations, it will affect expenditure. If a product business is new to a market and has no financial records on
becomes unexpectedly popular and sales rise, the which to base forecasts.
business may have to purchase more raw materials and
hire additional labour. This is likely to result in adverse STUDY TIP
expenditure variances. Similarly, sales below those set out
Questions asking you to analyse variances are common in
in the budget may lead to favourable variances for costs, as
Business exams. It is important for you to identify those
expenditure falls since less is produced. We considered this
areas in which major differences between planned and
in the section on flexible budgets on page 207.
actual expenditure or revenue have occurred. This will
help to give a focus to your answer. It is also very likely
that you will be asked to suggest possible causes (or
cures) for the variances.
CASE STUDY
BMW’s new factory in Mexico
In 2019, the German car manufacturer, BMW, opened a
new car factory in Mexico, approximately 400 km north
of the capital city, at San Luis Potosí. The new factory
uses ports on both the west and east coasts of Mexico for
transporting components and to export finished vehicles.
The company has invested more than US$1 billion in
the new production location. The plant, which already
employs 2500 people, has a high proportion of Mexican
employees who have been trained in BMW’s approach to
production.
The factory at San Luis Potosí will build BMW’s most
successful model series: the BMW 3 Series Sedan.
This popular car has set the standard for performance,
efficiency and design, and the company expects high sales
of the new model. The new model does, however, face ▲ Figure 5.24 Use of robots on BMW’s production line
intense competition from the Audi 4 and Mercedes C class means that fewer workers are used.
and others.
In its new factory, robots and employees work directly Questions
alongside one another, making effective use of the 1 Analyse one possible factor that might result in the
strengths of each. Production began in April 2019, with the new factory recording adverse variances. [4]
plant producing 240 cars per day by October. In 2020, the 2 ‘The “intense competition” that the BMW 3 series
factory‘s production had risen to 580 cars per day, moving will face is the most important reason for BMW
towards its annual production capacity of 175 000 units. drawing up budgets for the new factory.’ Evaluate
this view. [12]
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CASE STUDY
5.5
ADL acts on budgets
ADL is a television company in Argentina which produces The company’s managers have just been reviewing
and broadcasts a range of programmes and operates its financial performance, including analysing its
three satellite channels. It is particularly noted for performance against budgets. Some of the data they
producing documentaries and popular drama series. considered is shown in Table 5.18 below.
The market for making and broadcasting television
One of ADL’s managers said she believed that this
programmes is growing rapidly in Argentina and other
budgetary data provided the best possible measure of
Spanish-speaking countries, although rates of growth

ADL’s performance.
vary widely over time. Last year’s growth in sales was 11.5
per cent, while the year before it was just 2.9 per cent.
▼ Table 5.18 ADL’s budget data
Budget ($m) Actual ($m) Variance

Sales revenue 3 347.8 3 999.4
Labour costs 1 552.2 1 840.3 288.1 A

Materials costs 205.7 201.6 4.1 F
Other costs 630.1 916.6 286.5 A
Overheads 597.0 602.4 5.4 A
Total costs 2 985.0 3 560.9
Profit/(loss) 362.8 438.5
Questions
1 Calculate the variances for the company’s total sales 2 One manager believed that ‘this budgetary data
revenue, total costs and profits, stating whether each provided the best possible measure of ADL’s
is adverse or favourable. [6] performance’. Evaluate this view. [12]
TEST YOUR LEARNING

6 a Define the term ‘variance analysis’. [2]
b Explain one reason why it is important for
1 Define the terms: managers to monitor budgets once they have
a ‘sales revenue budget’ [2] been set. [3]
b ‘expenditure budget’. [2] 7 A business has the following budgetary data:
2 a Explain one reason why setting budgets may
▼ Table 5.19
lead to an improvement in the motivation of
employees. [3]
Budget ($m) Actual ($m)
b Budgets are short-term in nature. Explain one
reason why this might be a problem for a Sales revenue 254.75 295.10
business. [3] Total costs 222.86 256.84
3 a Explain one reason why it might be difficult for
a business to forecast its sales accurately. [3] Calculate its profit variance and identify whether it is
b Explain one way in which a change in the economy adverse or favourable. [4]
may make a business’ budgets inaccurate. [3] 8 Explain one difference between adverse and
4 a Define the term ‘flexible budget’. [2] favourable variances. [3]
b Explain one reason why a business might decide 9 a Explain one factor that may lead to a business
to use a flexible-budgeting system. [3] having adverse variances on its profits. [3]
5 a Define the term ‘zero budgets’. [2] b Define the term ‘incremental budgeting’. [2]
b Explain one reason why a business might decide 10 Explain one way in which budgets might help a
to use a zero-budgeting system. [3] large multinational company to manage its finances
efficiently. [3]
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Data response question ▼ Table 5.20 Nadal Ltd, Ronda Café – budget figures for
Nadal Ltd
first three months of trading
5.5
Nadal Ltd’s cafés sell budget-priced drinks such as coffee Budget ($) Actual ($)
and tea, as well as tapas and light meals. The company Sales revenue 11 500 10 990
has succeeded despite, or maybe because of, the weak
economic position in Spain. The company’s brand name Indirect costs 4 250 4 300
is associated with low prices and value for money. The Direct costs 6 890 6 900
company plans to expand using finance raised mainly
Profits 360 (210)
through loans.
5.5.2 Variances
Last year, Nadal Ltd opened its 59th café in Ronda, Questions
southern Spain. This is its first café in this part of Spain
and the company has only conducted secondary market 1 Analyse two problems that Nadal Ltd faced in
research. The new manager in Ronda has no experience setting its budgets for the new café. [8]
of cafés or financial planning, but they are experienced 2 a Calculate the profit variance for the first three
in retail and in managing people. Despite this, sales have months of trading for the Ronda café. [3]
risen steadily, if slowly, and customer feedback is positive. b Evaluate whether the benefits of drawing
up budgets outweigh the drawbacks to
Nadal Ltd. [12]
3 ‘The managers at Nadal Ltd should be pleased with
the performance of its café in Ronda.’ Evaluate this
view. [12]
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A LEVEL
6.1.1

External influences on business
activity: Political and legal
A LEVEL 6.1.1 External influences on business activity: Political and legal
Chapter overview
★ the cases for and against nationalisation and privatisation
★ how the government might use the law to control a range of business behaviour
★ the effects of changes in political and legal factors on businesses and their decisions.
Businesses cannot ignore changes in their environment and

The business environment any single business is not sufficiently large or powerful to
Businesses do not operate in isolation and are subject to have any significant influence on this external environment.
a range of external influences. This external environment This means that all businesses have to make appropriate
is subject to constant change and these changes can mean responses to changes in their external environment
different things to different businesses. For example, a to ensure that they remain competitive and, for many
change in the economic environment might lead to a fall enterprises, as profitable as possible.
in consumers’ incomes. This could cause a large reduction
in sales for a business selling luxury products such as The factors which make up the external environment for
jewellery but have little impact on a retailer selling businesses differ. A small business that grows vegetables
basic foods. and fruit for sale in a local market is likely to be subject
to different external forces compared to a multinational
company that sells consumer electronics globally. Despite
Politi this, the elements making up the external environment for
ntal cal
nme and
vir
o leg businesses can be classified as shown in Figure 6.1.
En al
We shall consider each of these elements of the business
FORCES
environment over the next three chapters. In particular,
we will consider the impact of changes in these elements
and how such changes might affect decisions taken by
l
ona
Econ
businesses.
Internati
omic
Responses to forces for

change by entrepreneurs,
directors, managers and
The political environment
other stakeholders A range of political decisions can help to determine
the business environment. For example, governments
Co m
throughout the world take decisions on the extent to

h ic
ra p
which they will become involved directly in the production

pe
ti t o
og
of goods and services. In some European countries,

m
rs
FOR CHANGE
government-owned businesses supply a range of products
de
d
an
su d
pp l an including water and electricity. The government in the USA
lie ci a
rs So tends to rely on privately owned organisations to supply
Technological most products to consumers.
▲ Figure 6.1 The external environment within which

businesses operate
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6.1.1.1 The advantages and The advantages of privatisation
» Increased efficiency This is a key argument for
disadvantages of privatisation governments implementing a policy of privatisation and 6.1.1
The issue of privatisation is a central part of the debate was used to justify its use in the UK from 1980 onwards.
about the extent to which the government should intervene Managers in government-owned businesses do not
in the economy. Over time, governments in diverse normally share in profits and may be set targets other
economies such as Argentina, Malaysia, New Zealand and than making profits. In a privatised business, managers
the UK have implemented policies to reduce the state’s role are responsible to shareholders who expect to receive a
in the economy, to allow markets and businesses to operate share of profits. Managers also often receive a share of
with the maximum degree of freedom. In part, this has been profits. These factors encourage managers to cut costs
6.1.1.1 The advantages and disadvantages of privatisation

achieved through the policy of privatisation whereby state- and increase efficiency. There is some evidence that
owned enterprises are sold to the private sector. businesses do operate more efficiently once privatised.
» Operational independence Managers in state-
In some countries, privatisation has been accompanied owned businesses often have to meet targets set by
by the reduction in government subsidies and grants to governments. Such targets might include maintaining
industry and by legislation limiting the state’s role in employment levels, rather than producing as efficiently
business matters. This approach to managing the business as possible with whatever size workforce is optimal.
environment is described as laissez-faire (where the Being free of any government targets, privatised
government intervenes as little as possible) and puts faith businesses can become more competitive and may, in
in a greater degree of self-regulation by businesses. the longer term, be more profitable.
Nationalisation is a policy which has the opposite effect » Higher levels of investment and innovation
to that of privatisation, as shown in Figure 6.2. There are Governments are often unable to afford to invest
recent signs that some governments are pursuing policies, enough to ensure a business remains competitive.
including nationalisation, which involve a greater degree They may have other priorities, such as investing in
of state control over business. This has been driven health care services, which are important if they want
by a number of factors, including the perceived weak to be re-elected. Privatising a business may mean that
performances of privatised businesses in some economic its new owners are more willing and able to invest in
sectors. The Coronavirus (COVID-19) crisis of 2020 has also establishing production methods and in developing new
resulted in some governments being forced to take a greater products which make the business more competitive.
degree of control over economic activity. At the time of This can secure its long-term future.
writing, it remains to be seen to what extent this will be a
permanent state of affairs. The disadvantages of privatisation
» Some industries are not suited to competition The
Can be achieved through Can be achieved through nature of some industries means that it can be most
a policy of privatisation a policy of nationalisation efficient to have just a single producer – this is termed
a ‘natural monopoly’. For example, it makes sense to
have a single firm supplying tap-water to households
A more laissez-faire
in a particular area. If this single business is privately
approach to managing the owned, it would lack competition and may charge high
business environment prices and offer poor services, as customers would have
no choice. Privatising such businesses would be unlikely
Lesser Extent of the state’s role in the economy Greater
to offer benefits to consumers or to promote efficiency.
▲ Figure 6.2 Nationalisation and privatisation » The need to protect consumers Some industries, such
as health care and education, are not well-suited to
We shall consider privatisation first. There are, not private ownership. The risk in privatising businesses
surprisingly, advantages and disadvantages to privatising in these types of industries is that private businesses
businesses. The main advantages and disadvantages of might prioritise profits over, for example, patient care
privatisation are set out below. in a hospital. Many countries in the world operate public
health services for these reasons.
GLOSSARY TERMS » Short-termism There is a risk that the managers of some
Privatisation is the process of transferring organisations privatised businesses may focus on short-term profits to
from state ownership to being owned and controlled by satisfy shareholders through rising share prices and high
individuals and other businesses in the private sector. dividend payments. However, this might be achieved at
Nationalisation is the transfer of a privately owned the expense of investing in projects which would provide
organisation to the control of the state. long-term profits, ensuring the viability of the business
Innovation is the development of new ideas into new over many years and its ability to provide employment
products or new methods of producing products. and pay taxes to the government.
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An assessment of privatisation » Levels of long-term investment There is some
controversy over whether state or private ownership
6.1.1 Privatisation will not always be successful. Firstly, it depends
on the industry. Some industries such as airlines and
results in higher long-term levels of investment.
However, there is a school of thought that governments
telecommunications have enjoyed much increased levels of are more likely to provide the long-term investment
efficiency and profits following privatisation. It has proved needed to create important services for the public, such
less effective in industries such as public transport and as railways and electricity supply networks. Governments
health care, where the profit motive is not so important. across the world have provided the investment necessary
Privatisation has generally been more successful in creating to create high-speed railways.
efficient and fair industries when regulators have been
established. Regulators can ensure that competition is fair The disadvantages of nationalisation
and that dominant firms do not exploit their market power » Political interference Opponents of nationalisation
at the expense of competitors and customers. In particular, argue that governments are subject to political pressures
it is important that governments avoid privatisation where and take decisions that please voters rather than making
it would create a private monopoly (a single supplier of a sound business sense. Some governments have pursued
particular product) as the lack of competition may result in policies which have led to nationalised businesses hiring
high prices and poor products. too many workers. This has boosted employment (often
in poor regions) but has resulted in high costs and
6.1.1.2 The advantages and uncompetitive enterprises. Subsequently, governments
are often unwilling to make redundancies for fear of the
disadvantages of nationalisation bad publicity that will result.
» Inefficiency This is perhaps the major criticism
Nationalisation occurs when the state takes control of of nationalised businesses. The managers of some
privately owned enterprises. It is not surprising that there nationalised businesses are not expected to meet
are also advantages and disadvantages associated with a targets that would be common in privately owned
policy of nationalisation. enterprises. Nationalised businesses are also sometimes
shielded from the full force of competition from overseas
The advantages of nationalisation businesses. These factors can remove the incentive
for managers to produce up-to-date and desirable
» Businesses can operate in the public interest Privately
products at the lowest possible cost, thereby offering
owned businesses normally operate with a profit
the greatest value to consumers. It is this perceived
motive – though there are exceptions. Nationalising
weakness that has prompted many calls for privatisation.
a business means that the government can set its
» Reduced competition Nationalisation can discourage
objectives. These objectives can be in the interests of
competition. Governments that privatise industries
society as a whole and not just based on making the
frequently reduce the regulations governing that
maximum possible profits for the owners of the private
industry at the same time. This encourages more
business. The East Coast Main Line is a major railway
businesses to enter that industry. The outcome is often
route between London and Edinburgh in the UK. This
more choice and lower prices than would be the case
route was privatised in 1997 but returned to state
with a nationalised business.
control in 2008, when the private company operating
it suffered financial difficulties. It was managed
successfully by the state until 2015, when it was once GLOSSARY TERM
again privatised before being taken into state control Regulation is the enforcement of principles or rules that
once more, as the second private company operating result from the passing of a law or series of laws.
it faced financial problems. This shows that there are
circumstances in which it is challenging for a private
company to make sufficient profits while operating a An assessment of nationalisation
business in the public interest. As with privatisation, it is not possible to say that
» The treatment of employees There is some evidence nationalised businesses will perform better (or worse) than
to suggest that employees are more likely to be their privately owned equivalents. Inevitably, it depends
exploited within a privatised business. Governments on the circumstances. However, it is possible to say that
often privatise businesses to cut the costs of the advantages of a nationalised business are more likely to
operating them. So, for example, many government outweigh its disadvantages in the following circumstances:
buildings in the UK are cleaned by employees » where high-quality managers are appointed and clear
belonging to private companies. Private cleaning targets are set
companies win contracts for cleaning by offering » where the central government does not try to manage
to provide such services at very low costs. The pay, the business
conditions and job security for cleaners and other » where sufficient investment is available for short- and
employees in state-run businesses tend to be better long-term investment needs
than in their privatised equivalents. » where the interests of all stakeholders are considered
and not simply the need to generate profits.
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▼ Table 6.1 A comparison of privatisation and nationalisation
Management
Privatisation
Transferred by the state to be managed by
Nationalisation
Owned and managed by the state instead of
6.1.1
the private sector the private sector
Examples In 2015, the Australian government sold NSW Ferguson Marine Engineering, a shipbuilding
Electricity to the private sector for more company, was nationalised by the Scottish
than $16 billion. Government in 2019.
Key benefits • Increased efficiency • Better treatment of employees
• Operational independence • Operate in public interest
6.1.1.3 How a government might use the law to control business activity
• Higher levels of investment and • The state can provide a reliable source of
innovation long-term investment
Key drawbacks • Some industries not suited to competition • Political interference
• The need to protect consumers • Inefficiency
• Short-termism • Reduced competition
Circumstances in which more • Industries open to global competition, • Natural monopolies such as water supply
likely to be successful such as airlines or telecommunications • Non-profit services such as health care
• Industries requiring a high degree of
innovation
STUDY TIP
Laws relating to employment practices,
Do think about the cases for nationalisation and working conditions and pay
privatisation in different situations. You should appreciate These laws govern the relations between workers, employers
that there is not a simple answer to the question of which and trade unions. The UK government has a range of laws
is best. Thinking about the circumstances in which each which it uses to control the ways in which people are
is best will deepen your understanding and improve your employed in the UK. Governments can use laws to control a
ability to develop arguments and make judgements on range of issues related to employment, including:
this issue. » employment practices
» conditions of work
» wage levels.
6.1.1.3 How a government might Some examples of the employment laws in the UK are shown
use the law to control business in Figure 6.3.
activity Working
The Minimum
time
The law is a framework of rules governing the way in which regulations
Wage Act
societies operate. Laws are sometimes called legislation.
Working
These rules apply to businesses as well as individuals. The conditions
Pay
legal framework influences businesses in a number of ways, Laws relating to
affecting almost all areas of business activity. Marketing, Health and employment practices, The National
production, employment, relationships with customers and Safety at working conditions Living Wage
competitors, and even decisions on location are examples of Work Act and pay
areas of business activity that can be influenced by laws.
Collective Employment Individual
STUDY TIP labour law practices labour law
You do not need to know about specific laws, but you
would benefit from some knowledge of the major laws Employment The Equality
Relations Act
in your country relating to the aspects of business
Act
behaviour covered below. You should also consider the
effects they have on local businesses. This chapter will ▲ Figure 6.3 Employment legislation
use examples of laws in operation in the UK to illustrate
the explanations.
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Employment practices Employers and employees are likely to negotiate on a
variety of matters. These negotiations may include items
Employment practices refers to the way in which businesses
6.1.1 treat their employees from hiring until the end of their
such as working conditions and other workplace rules, pay,
hours of work, holidays, sick leave, retirement benefits
relationship with the business. Most countries have a range
and health care benefits. Some examples of these laws
of laws covering issues relating to individual employees and
in the UK, as well as a later one granting more powers to
groups of employees within the workplace.
trade unions, are described below.
Laws relating to individual employees are frequently » Employment Act 1980 Under this Act employers were
designed to ensure that all employees are treated fairly and no longer obliged to negotiate with unions – many
equally. In recent years, there has been a focus in many unions were derecognised as a consequence.
countries on avoiding discrimination against particular » Trade Union Act 1984 This legislation made a secret
groups of employees. The UK passed a key piece of anti- ballot of employees a legal requirement before unions
discrimination legislation in 2010, as outlined below. could take any industrial action against employers, such
» The Equalities Act 2010 This Act replaced a number as strikes.
of earlier anti-discrimination laws in the UK (such » Trade Union Reform and Employment Rights Act 1993
as the Disability Discrimination Act) to simplify Unions were required to give employers a minimum
legislation in this area. The Act relates to nine protected of seven days’ notice before taking official industrial
characteristics which cannot be used as a reason to treat action. It also abolished minimum pay rates, although
people differently or unlawfully. Each person in the UK is laws establishing minimum wage rates were introduced
protected by this Act, as everybody has one or more of by a different government in 1999.
these characteristics. The protected characteristics are: » Employment Relations Act 1999 Under this Act, a
– age trade union with a membership exceeding 50 per cent
– disability of the employees in any particular business can demand
– gender reassignment union recognition and the right to introduce collective
– marriage and civil partnership bargaining.
– pregnancy and maternity
Laws relating to employment practices can quickly become
– race
outdated, as business practices and operations change.
– religion or belief
Governments in countries throughout the world are under
– sex
pressure to ensure that laws relating to all aspects of
– sexual orientation.
employment are up-to-date and fit for purpose.
This Act makes unfair treatment unlawful in the
workplace, in education and when supplying goods and One matter which is receiving a lot of attention in
services. many countries across the globe is that of the insecure
employment of workers in the so-called gig economy. A
Employees in many countries are protected against unfair
‘gig’ is a term used to describe a single piece of work, such
dismissal. Unfair dismissal is the termination of a worker’s
as delivering a meal or transporting a passenger in a taxi.
employment contract without a legal reason. In the UK,
At the core of the gig economy are app-based platforms
legislation relating to unfair dismissal only relates to
that allocate work in small quantities – making deliveries,
workers once they have been in a particular job for one
driving passengers or cleaning homes. People working
year or more. There are a limited number of reasons why an
in the gig economy are not classified as employees,
employee might be dismissed:
but contractors. As a consequence, they do not receive
» where a job no longer exists – this is redundancy
guaranteed hours of work or amounts of pay. However,
» gross misconduct – examples of this include theft from
from the point of view of companies operating in the gig
the employer or behaving violently at work
economy, using workers in this way can be an effective
» failing to carry out duties in a ‘satisfactory manner’
means of controlling labour costs. The case study below
» another substantial reason – for example, the ending of
looks at the response of law-makers in the American state
a temporary contract.
of California to the gig economy.
All other reasons for dismissal are considered unfair.
Employees who think they have been unfairly dismissed can
claim compensation by taking their case to an industrial GLOSSARY TERM
tribunal. The gig economy is a labour market in which short-term
contracts or freelance work are common, as opposed to
There are also laws that govern relationships between permanent jobs.
employers and groups of employees. This is often referred
to as collective labour law. This group of laws applies
to the operation of industrial relations and collective
bargaining as well as the activities of trade unions.
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CASE STUDY
6.1.1
New laws affect the USA’s gig economy
The government in California (one of the USA’s most Examples of occupations in the gig economy include taxi
prosperous states) has passed a new law that makes it drivers, food-delivery workers, construction workers
mandatory for contract (or gig) workers to be treated by and those employed in nail salons. It was predicted that
companies as employees. The intention is to improve job the new law would affect at least 1 million workers in
security and working conditions of employees in the state’s California.
gig economy. Uber’s use of contractors has enabled the
But the new law threatens the business models (and
company to operate taxi services in cities across the world.
possibly the futures) of gig economy companies like
The legislation came into effect at the start of 2020 and Uber and Lyft, which employ large numbers of people as
states that, if a company directs a worker in the way they contractors to reduce costs and increase profitability. The
perform their tasks or includes their work as part of law has received a lot of criticism from some businesses
their regular business, they must class that worker as an for potentially reducing employment levels and the growth
employee instead of a contractor. of businesses.
The new law may have an effect on other states. Trade Questions
unions and other employee groups are calling for similar
1 Analyse one possible way in which the managers
legislation in New York, Washington State and Oregon.
of a Californian business in the gig economy might
Many people working in the gig economy have been respond to this new law. [4]
classified as contractors without access to benefits 2 Evaluate the case for and against the passing of
including minimum wage rates, sick pay and holiday pay. this new law in California. [12]
We will explore the gig economy and other new employment ▼ Table 6.2 The legal requirements for paid holidays in a
practices further in Chapter 7.4. selection of countries
Country Legal entitlement Notes

Working conditions
to paid holiday
The term ‘working conditions’ refers to a range of factors per year
affecting an employee’s experiences at work, including
hours of work and paid holidays, as well as their safety and China 16–26 days Precise figure depends
security in the workplace. on length of employment
with the enterprise
Many countries have laws relating to working hours. The
USA – No federal or state laws
European Union (EU) operates its Working Time Regulations,
on paid holidays
which were introduced in 1998. This European Union
legislation set a limit of 48 hours on the number of hours Singapore 18–25 days Precise figure depends
that employees could be required to work each week. on length of employment
Employees can opt to work longer hours if they wish, but with the enterprise
employers cannot insist that they do so without inserting Iran 53 days This includes 27 days of
an appropriate clause in their employment contract. The paid public holidays
regulations also gave employees an entitlement to four
weeks’ paid annual leave. Although the UK has left the Laws relating to health and safety in the workplace
European Union, these laws will remain in place until and are an important element of the conditions of work for
unless new ones are passed. all employees, especially those working in potentially
It is increasingly common for employees to have an dangerous industries, such as mining. The International
entitlement to a period of paid holiday each year. These Labour Organisation (ILO) reports that there are more than
legal rights are also part of the Working Time Regulations 2.78 million deaths per year in workplaces throughout the
mentioned above. This law applies to most employees who world. Additionally, there are some 374 million non-fatal
are paid at their normal rate. The amount of paid holiday set work-related injuries each year resulting in more than 4 days
out in employment legislation varies considerably between of absences from work. The human cost of this is vast and
non-EU countries. Table 6.2 offers some examples. the economic burden of poor health and safety practices is
estimated at 3.94 per cent of global gross domestic product
(GDP) each year. In this case, GDP measures the total value
of output produced by the world’s economy over a year.
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Health and safety legislation has been enacted to » providing protection against dangerous substances.
discourage dangerous practices by businesses and to
6.1.1 protect the workforce. The legislation in the UK is designed
to prevent accidents in the workplace and has developed
Businesses are required to protect the health and safety of
their employees ‘as far as it is reasonably practicable’. This
steadily over the last 30 years. The main Act in the UK means that the business concerned must have provided
is the Health and Safety Act of 1974. This is an example protection appropriate to the risks. Thus, a chemical
of delegated legislation, whereby parliament gives manufacturer would be expected to provide considerable
responsibility to government departments to update the protection for its employees. The Act also requires employees
scope of the legislation as necessary. This process avoids to follow all health and safety procedures and to take care of
any particular aspect of legislation taking up too much of their own and others’ safety. In the UK, the Health and Safety
parliament’s time. Executive (HSE) oversees the operation of the Act and carries
out inspections of businesses’ premises. The HSE also carries

The Health and Safety at Work Act gives employers a out investigations following any serious workplace accident.
legal obligation ‘to ensure that they safeguard all their
employees’ health, safety and welfare at work’. The Act Wage levels
covers a range of business activities, including:
» the installation and maintenance of safety equipment Pay rates are another area relating to employment in which
and clothing a high proportion of countries have passed laws. Many
» the maintenance of workplace temperatures countries have minimum wage laws, which set out wage
» giving employees sufficient breaks during the rates below which businesses must not pay. The use of
working day minimum wage laws is illustrated in Figure 6.4 below.
100%
73% 91%
97%
89%
Note: The ILO has 187 members, meaning few countries are not members.
Source: International Labour Organisation; Minimum wage setting in Europe and beyond –
the ILO perspective, 18 September 2019, David Mosler
▲ Figure 6.4 The proportion of ILO members in different regions of the world that operate minimum wage legislation
Minimum wage rates can vary within countries. Some are » separate minimum wage rates for those aged 16–17,
not the same throughout the different regions of a country. 18–20 and 21–24
In the USA, some states (for example, Alabama and South » all part-time and temporary workers must be paid the
Carolina) do not have any minimum wage laws and the rates minimum wage.
can vary significantly in other states. In 2020, the minimum
In April 2016, this legislation was supplemented by
hourly wage rate in Wyoming was $5.15 compared to $13 per
the introduction of the national living wage in the UK.
hour in California. Other countries have passed minimum
This applies to employees aged 25 and over and pays a
wage laws which impose different minimum rates for different
significantly higher rate than the minimum wage. In 2020,
occupations. For example, India has a large number of
the rate was set at £8.72 per hour. UK minimum and national
different minimum wage rates for some selected occupations.
living wage rates are raised each year to ensure that these
The UK’s National Minimum Wage Act came into force on wages at least keep up with the current rate of inflation.
1 April 1999. The key features of this legislation are:
In November 2020, the University of Massachusetts
» a general hourly minimum wage rate for workers aged
Amherst, the National Bureau of Economic Research and
over 24
the IZA Institute of Labor Economics carried out research
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into the effects of minimum wages. Their conclusions were There is a considerable quantity of marketing legislation in
that even the UK’s relatively high minimum wage rates the UK. The Acts listed below represent a few highlights.
had little negative impact on employment rates, while
substantially increasing the pay and living standards of
» The Consumer Rights Act 2015 replaced three major
pieces of marketing legislation in the UK. This Act was
6.1.1
low-paid employees. introduced to modernise the law in this area, making it
simpler and stronger. The Consumer Rights Act states
that all products (including, for the first time, digital
Laws relating to marketing products as well as physical products) must be of
satisfactory quality, fit for purpose and as described.
behaviour All products must meet the following standards:
The law covers the marketing activities of businesses in – Products must be of satisfactory quality. Goods
most countries. Approximately 80 per cent of countries shouldn’t be faulty or damaged when purchased.
have passed laws to protect consumers from the marketing – Products should be fit for the purpose they are
activities of businesses. The scope of these laws varies supplied for and offer the consumer the benefits
and there is a general criticism that they are not updated promised.
sufficiently to reflect changes in marketing behaviour, – The goods supplied must match any description
such as the use of the internet. The UK has a series of laws given to consumers, or any models or samples shown
designed to safeguard consumers against: to consumers.
» businesses charging excessively high prices or rates of » The Consumer Credit Act 1974 This Act lays down
interest that consumer credit can only be given by licensed
» unfair trading practices; for example, selling quantities organisations. It also sets out the terms under which
less than those advertised credit may be given.
» unsafe products, such as children’s toys with sharp
objects or toxic paint It is also necessary to protect the public from improper use
» having insufficient information on which to take of the power of advertising. It involves a combination of
purchasing decisions. legal controls and self-regulation.
» The Trade Descriptions Act 1968 This Act makes
Since 2014, the Competition and Markets Authority (CMA) misleading descriptions of goods and services an offence.
has overseen legislation relating to marketing activities » The Advertising Standards Authority This body
in the UK. It seeks to improve the position of consumers supervises the operation of this code of practice. It
by giving them information to allow them to make better is an independent body; its members are not in the
choices when purchasing goods and services. It also advertising industry. The ASA protects the public and
protects consumers by prosecuting businesses that offend deals with their complaints.
against marketing legislation and by negotiating voluntary
codes of practice with producers of goods and services.
CASE STUDY
Queensland to ban ‘junk food’ adverts
The government of the Australian state of Queensland Jane Martin is the executive manager of the Obesity Policy
has banned junk food advertising at government-owned Coalition, a group pressing the Australian government
locations in a bid to eliminate poor diets and obesity to take action against obesity. Ms Martin approved this
among children. The state’s Health Minister, Steven Miles, decision by the government of Queensland, noting that
said the unhealthy marketing activities would be stopped young people are particularly susceptible to junk food
throughout the state. The advertising sites affected will advertising.
include bus stops and train stations.
The governments of other Australian states are
‘Junk food advertisers target kids, we know that, and considering passing similar laws to control marketing
obesity in childhood is a leading indicator of obesity in activities.
adulthood,’ Mr Miles said. ‘This is about doing what we can
Source: www.abc.net.au/news/2019-04-21/junk-food-ads-
to protect our kids from the kind of marketing that leads binned-queensland-government-crackdown/11034284
them to make unhealthy choices.’
‘Obesity is a real challenge for our community, for our Questions
hospitals and the health services, but also for the 1 Analyse two ways in which laws can constrain the
individuals who are suffering – this is really just a decision activities of fast-food businesses. [8]
about the government leading by example and saying that 2 Evaluate the extent to which laws of this type
we will use our spaces to advertise healthier options,’ benefit the stakeholders of fast-food restaurants
he said. in Queensland. [12]
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Laws relating to competition The scope of
UK and EU
6.1.1 Competition law is intended to protect businesses and

consumers from the effects of anti-competitive practices.
competition law
Most governments believe that free and fair competition in

markets brings many benefits. The UK government set out
the importance of competition to its economy in 2001: Abuse of a Other
Cartel activity dominant anti-competitive
Vigorous competition between firms is the lifeblood of strong market position practices
and effective markets. Competition helps consumers get a
good deal. It encourages firms to innovate by reducing slack, ▲ Figure 6.5 The extent of competition law
putting downward pressure on costs and providing incentives

for the efficient organisation of production. As such, GLOSSARY TERMS
competition is a central driver for productivity growth in the
A cartel exists when two or more businesses collude to
economy, and hence the UK’s international competitiveness.
control prices and/or output, thereby limiting competition
Source: UK Department of Trade and Industry and increasing profits.
Businesses operating in the UK are subject to UK and, at the A merger is the combining of two or more firms into a
time of writing, to EU competition law, although this may single business, following an agreement by the firms’
change after 31 December 2020. The major competition laws management teams and shareholders.
in the UK are: A takeover occurs when one company acquires complete
» the Competition Act 1998 control of another by purchasing more than 50 per cent of
» the Enterprise Act 2002 its share capital.
» the Enterprise and Regulatory Reform Act 2013.
Competition law in the UK operates in three main areas: Mergers and takeovers
1 Cartel activity Cartels involve two or more businesses
Takeovers and mergers have the potential to provide
working together to limit the extent of competition
businesses with a high degree of market power, as they
that exists in a market; they are considered to be a
create larger enterprises. They can also lead to a reduction
serious form of anti-competitive practice. Cartels are
in the degree of competition within a market. The
agreements between businesses not to compete with
competition authorities in the UK are required to assess
each other, for example, on price, discount levels,
whether a merger or takeover should be prohibited on the
credit terms or in respect of particular customers or in
basis of whether it can be expected to lead to ‘a substantial
particular areas. The outcome is that consumers will
lessening of competition’. In the UK, the primary
be disadvantaged, primarily because they will have to
responsibility for the regulation of mergers and takeovers
pay a higher price (agreed by the cartel) than would
lies with the Competition and Markets Authority (CMA).
otherwise be the case. In addition, the economy will
Mergers will be assessed by the CMA if:
be damaged by a lack of competitiveness among its
» the business being taken over exceeds a given size (a
businesses.
sales revenue exceeding £70 million), or
2 Abuse of a dominant market position The law defines
» the newly merged business would control 25 per cent or
a dominant market position as ‘a position of economic
more of its market.
strength enjoyed by an undertaking which enables it to
prevent effective competition being maintained in the
relevant market by affording it the power to behave to Key UK competition laws
an appreciable extent independently of its competitors, The legal framework for the UK’s competition policy
customers and ultimately of its consumers.’ Such markets is provided by the Competition Act 1998, the Enterprise Act
can be national or local, as well as the whole of the EU. 2002 and the Enterprise and Regulatory Reform Act 2013.
Abuse of such a position can take a number of forms, » The Competition Act 1998 prohibits cartels and
including: abuses of dominant market position. It also outlaws
– imposing unfair purchase or selling prices or other concerted practice; for example, when businesses
unfair trading conditions agree to divide up a market and not to compete in each
– limiting production, markets or technical other’s ‘part’ of the market. The penalties for breaching
development to the prejudice of consumers this Act can be severe. Businesses may be fined up to
– imposing unfair and inconsistent terms on different 10 per cent of their worldwide sales revenue if they
trading partners. enter into an anti-competitive agreement or abuse a
3 Other anti-competitive practices These could include dominant market position.
agreements with suppliers not to sell below certain » The Enterprise Act 2002 amended earlier laws and
prices, limiting production to drive up prices, agreeing strengthened the power of the UK authorities to deal
not to sell to a competitor’s customers, etc. This also with anti-competitive practices and market dominance.
includes mergers and takeovers which may be harmful This Act has a number of important provisions:
to the competitive process in markets. – It places a clear focus on the impact of the business’
activities on the degree of competition. Practices
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are judged as to whether they create a ‘substantial means that businesses may be sued for damages by
lessening of competition’ rather than whether they third parties that have been harmed by their anti-
are ‘in the public interest’.
– It imposes tougher penalties on those involved in
competitive actions.
– The assessment of mergers is influenced less by
6.1.1
cartels by criminalising their activities. Directors or politicians and is more independent.
other people involved may be fined or sent to prison » The Enterprise and Regulatory Reform Act 2013 The
for up to five years if involved in cartel activity. main provisions of this Act, relating to competition, are
Company directors may also be disqualified from as follows:
being a director for up to 15 years. – It created the CMA, bringing together the
– It empowers consumer organisations to make Competition Commission and the competition work of
complaints (known as ‘supercomplaints’) to the the Office of Fair Trading. Thus, a single organisation
CMA about markets that are not working well for is responsible for competition policy.
consumers. For example, in 2018, this legislation was – It makes it quicker and simpler for businesses,
used to make a complaint about businesses charging especially small and medium-sized enterprises,
loyal customers higher prices than new customers for to make legal challenges to anti-competitive
the same products. behaviour.
– There are greater opportunities for victims of – It also makes it easier for consumers and small
anti-competitive behaviour to gain compensation. businesses who have suffered loss due to anti-
Consumer bodies will be able to make claims on competitive behaviour to obtain redress.
behalf of individuals who have suffered. This
CASE STUDY
US authorities approve T-Mobile and Sprint merger
The competition authorities in the United States have When T-Mobile and Sprint announced their merger plan,
approved a merger between two of the country’s biggest they claimed that their combined assets would make them
mobile telephone service providers: T-Mobile and Sprint. a stronger competitor to the other two companies in the
The new business will be valued at $26.5 billion. On market: AT&T and Verizon. T-Mobile and Sprint said they
the face of it, this deal reduces the number of mobile would be able to reduce prices for consumers and more
telephone providers in the USA from four to three. quickly offer the new 5G service across America. These
claims have faced harsh criticism from consumer groups
The deal was finally approved after the two companies
and some experts.
agreed to sell some of their assets to another company. The
deal includes agreement that Dish, a satellite dish supplier, Questions
will buy Boost Mobile, Virgin Mobile, Sprint’s prepaid
1 Analyse one reason why reducing the number of
business, and ‘certain’ other assets currently owned by the
companies selling products in a particular market
two companies. This will position Dish as the fourth major
might be harmful to consumers. [4]
US mobile telephone provider, replacing the one that will be
2 The American competition authorities ruled in favour
lost once T-Mobile and Sprint merge. The two companies
of the merger. Evaluate whether or not this is a good
will be required to provide at least 20 000 cell sites and
outcome. [12]
hundreds of retail locations to Dish, and it will also get
unrestricted access to T-Mobile’s network for seven years
as it works to build a mobile network of its own.
» the size, layout and external appearance of buildings

The law and business location decisions » proposed means of access and impact on the
Many countries have legal systems which control where neighbourhood
businesses can locate. It is not unusual for businesses » availability of infrastructure, such as roads and
to be located in particular areas – often alongside other electricity supply
businesses. So, many towns and cities create industrial » how the proposed use of the development relates to the
estates where business can locate. Retailers may be limited rest of the neighbourhood.
to certain streets – often where other shops already
operate. Many countries, including the United States, make Another factor influencing business location which
it illegal to locate businesses outside designated zones. has a legal dimension is the use of special economic
zones. These are areas within individual countries where
Businesses that want to build new premises may need to business and trade laws are different from the rest of
apply for permission from the authorities. Applications for the country. They are designed to attract businesses to
new premises are decided in line with national and local locate there. Governments pass laws to allow businesses
policies. Points for consideration include: locating in these areas a range of benefits such as tax
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holidays, financial support, and fewer laws and regulations
relating to employment and international trade. Often
6.1.1.4 The impact of changes
6.1.1 these special economic zones are sited in poor regions in political and legal factors
of the country. By 2018, 147 economies operated special
economic zones including China, India, Bangladesh, Saudi on businesses and business
Arabia, the Philippines, South Korea and the UAE. decisions
Changes in political and legal factors frequently lead to
Laws and particular goods and services more intervention in business matters. For many businesses,
Governments use laws to control the production, sale this can be a disadvantage as such interventions can result
and consumption of a range of goods and services. Legal in increased costs of production, as businesses in most
controls may be applied to particular products for a number nations are legally obliged to employ a number of non-
of reasons: productive employees. For example, health and safety laws
» The production and consumption of these products may may require the appointment of safety officers. In addition,
result in damage to the natural environment. other costs of production may increase as businesses
» The goods and services may be harmful to consumers have to pay minimum wage rates and locate in what may
and they may also be addictive. be costly places. Similarly, the requirement (under the
» Their consumption may have adverse effects on others or Equalities Act in the UK) to make ‘reasonable’ alterations
on society generally. to the working environment to enable the employment of
Globally there are many products that are subject to legal people with disabilities adds to production costs.
constraints; we shall consider a small selection. Some of the Changes in laws relating to employment practices,
more common ones include: marketing behaviour or competition, or decisions to raise
» tobacco minimum wage rates, may all have negative effects on
» alcohol businesses. Such changes can be critical if they increase
» medicines costs of production and the business concerned operates in
» gambling a globalised market with very price-conscious customers.
» vehicles with diesel and petrol engines. If rival businesses operating in other countries do not face
Governments tend to take a range of steps to control similar increases in costs of production, they will operate
businesses that produce and sell these products, as well as with a competitive advantage. Such changes may result in
consumers who use them. some businesses losing sales, market share and profits.
» Taxation Governments may impose heavy taxes on the However, there can be positive consequences for businesses
sale of products, such as tobacco and alcohol. This is from political and legal changes. Changes in employment and
intended to discourage consumption, though it also acts other laws can help to motivate the workforce and improve
as an important source of revenue for many governments. the performance of the workforce. For example, employees
Tobacco taxes in many countries form more than 50 per who work in a safe and secure physical environment will be
cent of the selling price of the products. more contented and probably more productive. Employers
» Limiting sales Governments may control the sale of will also avoid the costs, delays and bad publicity caused
products directly to a lesser or greater degree. The use by accidents at work or employee complaints about poor
of vehicles with petrol and diesel engines is restricted conditions. Furthermore, freedom from arbitrary dismissal
in many cities including Singapore, London, Milan and may encourage a more co-operative and productive
Stockholm. Equally, there are commonly age limits workforce, enhancing the performance of the business.
on those who can buy and consume certain products,
such as gambling and tobacco. It is thought that such The effects of legal and political changes may be greater
products can be particularly harmful to younger people. for small firms that have fewer resources and are less able
In some countries (for example, Canada), strong alcohol to keep up with changes in employment and other laws,
can only be purchased from a relatively small number of and may not be able to afford to respond in the appropriate
licensed shops. manner. Larger firms are more likely to employ specialists
» Outright bans on production and consumption and are more likely to be prepared for, and able to finance,
The sale of alcohol is banned in a number of Muslim change. They may also be able to afford employment
countries and some states in India. All forms of lawyers to advise them on avoiding some of the effects of a
gambling are illegal in Cambodia and Qatar. new piece of legislation.
» Restricting sale to ensure safe consumption
Many countries control the sale of products, such as STUDY TIP
medicines, to ensure that consumers use them safely.
Do think about political and legal changes in a balanced
The intention is for consumers to receive the health
way. The effects on businesses do not always have to be
benefits with minimal risks. In most countries, only
negative, as we have seen. Also think in a structured way
specified shops and other outlets with suitably qualified about how businesses might respond to such changes.
staff are allowed to sell certain medicines. Considering the likely effects on, and responses of, each
functional area of a business may be helpful.
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CASE STUDY
6.1.1
Vietnam increases its minimum wage rates
The Vietnamese government increases its minimum According to a survey released by an employment
wage rates each January in line with the cost of living. A website, salaries in Vietnam are rising faster than other
new minimum wage rate for workers, which will result in Asian countries but still remain low – and lower than
an increase in monthly pay of up to 300 000 Vietnamese in countries such as China. Vietnam’s minimum wage
dong, equivalent to approximately US$14, was introduced increase of 5.7 per cent is higher than last year’s figure of
in January 2020. This represented an increase of 5.3 per cent, but lower than that in 2018 and 2017.
6.1.1.4 The impact of changes in political and legal factors on businesses and business decisions
approximately 5.7 per cent in the country’s minimum
Vietnam has been considered a low-cost location for
wage rates.
multinational businesses and is a popular location for many
The country has different minimum wage rates in four well-known multinationals. Samsung, Bosch, Panasonic
regions, determined by the level of economic development and General Electric all have operations in the country.
in each region. Zone 1 covers urban Hanoi and Ho Chi
Minh City. Zone 2 covers rural Hanoi and Ho Chi Minh Questions
City, as well as Can Tho, Da Nang and Hai Phong. Zone 1 Analyse two possible effects of this change in minimum
3 includes provincial cities and the districts of Bac Ninh, wage rates on businesses located in Vietnam. [8]
Bac Giang, Hai Duong and Vinh Phuc. Zone 4 comprises 2 Evaluate the best way for businesses in Vietnam to
the rest of the country. respond to this change in minimum wage rates. [12]
contemplating a merger or takeover. Conversely, changes

Business responses to the effects in laws relating to conditions of work, including health
of changes in the political and legal and safety, might result in the purchase of new assets to
meet changed legal requirements.
environment » Changes in prices and target markets Rising costs
Most businesses will take decisions necessary to offset the may force some businesses to pass these onto
effects of the change in their political or legal environment consumers in the form of higher prices, if market
as far as possible. If the changes are judged favourable, conditions allow. Other businesses may decide to
businesses will consider how to take advantage of the new target other market segments which may be willing to
circumstances. Business decisions could take a number of pay higher prices.
forms, which include the following. » Decisions to cut production and/or develop new
» Changes in production methods Legal and political products Political and legal changes can lead to
changes may lead to decisions whereby businesses businesses deciding to stop producing certain
use fewer employees in the production process and products and to supply other products. Legal changes
replace them with capital equipment. Some businesses, in many countries have led to tobacco sales falling
particularly footloose multinationals that can move significantly. Some tobacco manufacturers have
location easily, may decide to close production facilities responded by closing factories, while others have
and produce elsewhere. switched production to vaping products.
» Selling or buying assets Businesses may take the
decision to sell part of their operations if they need to
meet the requirements of competition authorities when
TEST YOUR LEARNING

b Explain one reason why laws relating to
employment practice need to be updated
1 Define the terms: regularly. [3]
a ‘privatisation’ [2] 5 Explain one way in which minimum wage rates
b ‘nationalisation’. [2] might vary within a single country. [3]
2 a Explain one advantage of privatisation. [3] 6 a Explain one way in which laws relating to
b Explain one reason why some industries may not marketing behaviour might affect businesses. [3]
be suited to privatisation. [3] b Explain one type of business activity that
3 a Explain one advantage of nationalisation. [3] competition law is designed to prevent. [3]
b Explain one reason why nationalised industries 7 Explain one action that a government might take
may be less efficient than those in the private to control the production, sale and consumption of
sector. [3] particular goods and services. [3]
4 a Define the term ‘trade union’. [2]
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8 Explain one reason why political and legal changes One director of MD said that the effects of the changes to
6.1.1 might reduce the competitiveness of a business.

9 Explain one reason why the existence of laws to
[3] laws on working conditions would damage the company’s
future performance.
control employment practices may be beneficial to The new government has also taken a decision to
businesses. [3] nationalise one of MD’s most important suppliers of
10 Explain one way in which a business might respond components which is sited close to its factory. This was
to a change in the law which increases its costs of an unexpected change and MD’s directors are concerned
production significantly. [3] about the impact it may have on its operations.
Data response question Questions

MD vehicles 1 Analyse one possible effect on MD of the government’s

MD is a multinational company that manufactures vehicles decision to nationalise one of its major local suppliers. [4]
and has factories in several countries. The company’s 2 Evaluate the decisions that the company might take
workforce is becoming less productive over time and in response to the changes in the laws relating to
profit margins are falling as a result. The market for cars working conditions. [12]
is increasingly price competitive, although MD is a brand 3 One director said that ‘the effects of the changes to
that is highly valued by customers and demand for its cars laws on working conditions would damage the
is not strongly sensitive to price. company’s future performance.’ Evaluate this view.[12]
A new government has been elected in one of the Essay question
countries where MD produces over 30 per cent of its cars
1 Evaluate whether or not new laws designed to
in a very large factory. This government has announced
promote competition are in the interest of all the
changes to laws governing working conditions which will
stakeholders of a business. [20]
come into force in one year’s time. These include:
● an increase in the number of days of paid holiday from
15 to 20
● an extension of health and safety laws.
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A LEVEL
6.1.2

External influences on business
activity: Economic
6.1.2 External influences on business activity: Economic

Chapter overview
★ how governments assist businesses and promote enterprise
★ the ways in which governments constrain business activity
★ government macroeconomic objectives
★ the effects of macroeconomic objectives and economic performance on business activity
★ the government’s economic policies – fiscal, monetary and supply side policies – and their impact on businesses.
Every business is affected to some degree by the national economic stability in its management of the economy by
(or global) economy in which it operates. An economy is an avoiding, whenever possible, sudden and dramatic changes
immensely complex thing. It comprises millions of buyers in the performance of the economy.
(or consumers) and hundreds of thousands of businesses
A country’s economic environment is made up of two main
all making decisions to spend, hire labour, use certain
elements:
machinery, produce more or less, lend money or borrow it to
» The factors which reflect the performance of that
produce goods and services.
economy as well as other economies; for example, how
This is then complicated further by the actions of fast prices are rising (inflation) and the number of
governments that intervene in the working of the people who do not have a job (unemployment).
economy in order to achieve their social and economic » The actions taken by governments to achieve the desired
objectives. Most governments aim to manage economies economic performance.
so as to maximise the standard of living of the country’s
The factors which make up the economic environment are
inhabitants, while pursuing other goals such as protecting
summarised in Figure 6.6.
the environment. The UK government aims to achieve
Government policies affecting

the economy
Policies to support Exchange- Policies to

Fiscal Monetary Supply-side
businesses and rate avoid market
policies policies policies
promote enterprise policies failure
Businesses
in the
economy
The exchange Economic

Inflation Unemployment
rate growth
Elements of economic
performance affecting
the economy
▲ Figure 6.6 Influences on the economic environment
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6.1.2.1 How governments might How governments help businesses
6.1.2 help businesses and encourage There are a number of ways in which governments may
provide help to businesses throughout the economy.
enterprise
Governments benefit from having a strong economy. It Developing an effective infrastructure
provides employment for the country’s inhabitants and a An economy’s infrastructure is essential for its businesses
source of taxation for the government. The government to be able to operate. Without effective systems of
is able to use the tax revenues it receives to pursue transport, communications and energy supply, businesses
its objectives, such as providing education and health would not be able to engage in production and supply goods
A LEVEL 6.1.2 External influences on business activity: Economic
services. For these reasons, all governments intervene and services. Infrastructure can also help to determine
in the economy to help businesses and to encourage the competitiveness of a country’s businesses. If energy,
enterprise. transport and communications are provided efficiently and
relatively cheaply, it can help to reduce the operating costs
of businesses and sharpen their price competitiveness.
GLOSSARY TERMS
Enterprise is the skill needed to make new ideas work. Some governments recognise the importance of up-to-date
infrastructure to economic success and invest relatively
Infrastructure refers to the physical and organisational
heavily. Figure 6.7 shows the relative amounts invested in
factors necessary to allow both society and an economy
to operate effectively; for example, transport and
infrastructure in a selection of countries between 2008 and
communication networks. 2017. Governments may invest directly or use a mixture of
state and private investment to develop their infrastructures.
A joint venture occurs when businesses collaborate on a
In recent years, there have been more projects, of greater
project (or projects) but do not formally join together all of
scale and complexity than ever before, being proposed and
their activities.
progressed. High-profile examples include a new bridge
linking Hong Kong to Macau and Zhuhai, Thailand’s Eastern
Economic Corridor, Australia’s Inland Rail project and the
Dubai Solar Park (this is the world’s largest single-site solar
installation, to which more than US$4.3 billion of private
investment has been committed).
2.0
1.8
Infrastructure investment (% GDP)
1.6
Australia
1.4
1.2
India Turkey
1.0
Japan UK
0.8
0.6 Germany
0.4 USA
0.2
0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Year
Note: This data relates to transport infrastructure investment only. GDP is a measure of the value of a nation’s output.
Source: OECD; https://data.oecd.org/transport/infrastructure-investment.htm
▲ Figure 6.7 Infrastructure investment in a selection of countries, 2008–17, as a percentage of GDP
HANDLING DATA
Look at the data presented in Figure 6.7 and answer the 2 In 2016, Germany’s investment in its infrastructure,
following questions. measured in billions of euros, was higher than in 2015.
1 The graph shows infrastructure investment as a Explain how this happened, given that the graph in
percentage of GDP. Why might the USA’s investment in Figure 6.7 shows a decline between 2015 and 2016.
transport infrastructure have been higher in 2017 than
that of Turkey?
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The UK has taken some important decisions on its » Recruitment and training It is common for governments
infrastructure. It has not invested as heavily as some to operate systems designed to match unemployed
other countries in its infrastructure over the past 30 years,
although investment has risen since 2009. Partly as a
workers to potential jobs. In this way, they can help
to reduce the costs to businesses of finding suitable
6.1.2
response to this, the government prepared its infrastructure new employees. In the UK, the government operates
spending plan for the period to 2033. Job Centre Plus to bring employers with vacancies
The National Infrastructure Plan details about £375 billion of and unemployed workers together. A new government
investment in energy, transport, communications and water website named Universal Jobmatch has been introduced,
projects by 2033. The insurance industry also plans to spend allowing unemployed workers to search for employment;
£25 billion by 2020 using customers’ payments in pension employers can upload and manage their own vacancies
6.1.2.1 How governments might help businesses and encourage enterprise

and other funds to finance this investment. Examples of the while searching for prospective employees. Similarly,
UK’s programme of investment in infrastructure include the governments can support businesses by providing training
Crossrail Project in London, the development of a new nuclear or helping businesses to provide their own training. The
power station at Wylfa, North Wales, and, controversially, the Indian government funds programmes providing training
building of a high-speed rail line, known as HS2, to connect and has also established the National Skill Development
London to Birmingham and, later, Manchester and Leeds. Corporation (NSDC) as a public–private sector partnership
to stimulate investment in training.
How businesses benefit from investment in » Helping businesses to raise finance Governments may
infrastructure provide loans and grants directly to businesses, usually
Infrastructure projects create significant opportunities for to invest in new equipment, buildings or other facilities.
businesses as well as providing better facilities (such as They may also guarantee loans provided by banks. This
road and rail transport for them to use). There are obvious makes banks more willing to lend to what might be
opportunities for firms in the construction industry to high-risk businesses, as the government guarantees
benefit from expenditure on building new roads, bridges the repayment of the loan should the business default
and power stations. These can result in strategic decisions on payment. We look at how the UK government helps
to expand production or to engage in joint ventures with businesses financially in more detail below.
competitors to deliver on large infrastructure projects such » Supporting businesses trading overseas It is common
as the Crossrail Project in London. for governments to support businesses that are
exporting goods and services overseas. In the UK, the
Other businesses in a wide range of industries are also likely government supports businesses that are exporting, or
to benefit from orders associated with improving the UK’s planning to do so, through the work of the Department
infrastructure. For example, the Crossrail Project has resulted for International Trade. This department helps
in Bombardier (a Canadian multinational engineering company) businesses to acquire the skills and contacts necessary
supplying an order for 65 new trains for the Crossrail railway. for exporting and provides advice about exporting
This order created 760 new jobs to build the trains and 80 jobs to particular countries. It also offers help in winning
to maintain them once they are operational. Bombardier has contracts overseas, on using technology to facilitate
a contract to build 60 per cent of the new trains that will be exporting and by organising trade shows and exhibitions
needed in the UK as it improves its infrastructure. to showcase UK businesses and exports.
Providing advice to businesses
The provision of advice to companies can be a relatively Government policies to encourage
inexpensive means of supporting businesses and helping
them to become more competitive. Governments can offer enterprise
advice in a number of areas, including: Governments generally seek to establish an enterprise-
» raising capital and managing finance friendly business environment, which will encourage people
» managing employees effectively; for example, offering and organisations to develop their ideas as well as to
guidance on recruiting, training and keeping employees establish and expand their businesses. Governments pursue
» trading overseas – governments may offer advice on how policies to promote enterprise for many reasons: enterprise
to sell products in specific overseas markets creates jobs, increases the taxes paid to the government
» developing new products and processes of production. and, of course, today’s new enterprises can become
Many governments operate websites which offer a range tomorrow’s multinational businesses.
of advice and contacts for those starting new businesses Establishing or expanding a business can be a risky process
and managing existing ones. For example, the USA federal for those involved: entrepreneurs may give up safe, well-
government operates a small business hub which provides a paid jobs and owner-managers may mortgage homes to
wide range of advice for the country’s small businesses. borrow money to expand businesses. It can go wrong,
but the aim of much government support is to promote
Providing services for businesses enterprise and to reduce the degree of risk.
Governments can support business activities in other ways Decisions and actions by governments and their agencies
apart from offering advice. encourage and promote the development of enterprise and
innovation. The UK encourages enterprise in a number of
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ways, both financial and non-financial. These have changed » The New Enterprise Allowance This is available to the
significantly in recent years as the importance of enterprise long-term unemployed who want to start their own
6.1.2 to the government has increased. business. It is in two parts: a weekly allowance totalling
£1274 over 26 weeks and access to a loan of up to £2500.
Financial support for enterprise » Start-up loans This scheme provides loans to businesses
The British Business Bank is a government-owned of up to £25 000, with the average being £7200. There is
business development bank. It manages all UK government a fixed interest rate of 6 per cent and repayment can be
programmes that help smaller businesses to gain access made over any period between 1 and 5 years.
to finance. It was established in 2012 to help make sure » Enterprise Finance Guarantee (EFG) EFG is a loan
finance markets for small and medium-sized businesses work guarantee scheme. It allows banks and other lenders to
effectively. It does not lend directly to businesses, but it offer small businesses which lack security or a proven
will work alongside private-sector partners. It will pull in track record a normal commercial loan. Lenders can use
more private-sector funding to maximise its impact. At the EFG to help businesses arrange loans and overdrafts.
end of the 2018–19 financial year, the bank had lent £6.6 Loans can be guaranteed from £1000 to £1.2 million.
billion to 89 000 businesses. Its lending activities increased Small and medium-sized businesses with annual sales
by 27 per cent in that year. revenue below £41 million can get EFG-backed loans.
Between its launch in 2009 and 2018, EFG has supported
Some of the national schemes of financial support for the provision of over 29 000 business loans to a value of
enterprise (specifically smaller businesses) overseen by over £3.2 billion.
the British Business Bank are shown below, but these are
supplemented by a variety of regional and local policies.
CASE STUDY
Malaysia urged to make social enterprise scheme simpler
Social enterprises are businesses which have clear social In many Asian countries, such as Malaysia, incomes
objectives, such as helping those on very low incomes have risen but governments have continued to struggle
or protecting the environment. A scheme in Malaysia with poverty in towns and cities, unequal educational
designed to help this type of business will increase growth opportunities and environmental issues. This has led a
rates in this sector. However, Malaysian entrepreneurs number of countries (Thailand and Vietnam, for example)
have argued that the government must offer greater to pass laws intended to encourage and support social
incentives and fewer regulations. enterprises. Some critics of these laws think that too
many regulations will limit the growth in numbers of
Twenty-two diverse social enterprises have received
social enterprises.
accreditation recently for this scheme. The scheme
gives social enterprises tax deductions as well as the Source: www.reuters.com/article/us-malaysia-socialenterprise-
opportunity to apply for grants. scheme/cut-the-paperwork-malaysia-urged-to-make-
social-enterprise-scheme-simpler-idUSKBN1ZT19A
However, some entrepreneurs state that registration
is not easy to manage. ‘The documentation process is Questions
very data-intensive. Aspiring or new social enterprises 1 Analyse two ways in which the Malaysian government
will find it difficult so there must be an easier process,’ might encourage the creation of more social
said Kuhan Pathy, co-founder of Masala Wheels, a enterprises. [8]
social enterprise that supports disadvantaged young 2 Evaluate the view that any government intervention
people. into a market will lead to significant long-term
constraints on some businesses. [12]
Non-financial support for enterprise One element of the BIS’ work has been to develop ‘growth
hubs’ across the UK. Since May 2016, the UK has 39
The UK government provides a range of support, advice
growth hubs across the country. They are communication
and inspiration for entrepreneurs establishing and growing
networks bringing together local and national, public- and
their businesses. A focal point of government support for
private-sector partners – such as Chambers of Commerce,
enterprise is its website ‘Business is Great’.
universities and banks – co-ordinating local business
The Department for Business, Innovation and Skills (BIS) support and connecting businesses to the right help for
is the key UK government department concerned with their needs. Businesses that have been in contact with a
developing and providing enterprise support. It works with growth hub are growing faster than other businesses in
businesses, financial institutions and other government terms of sales revenue (9 per cent compared to 2.5 per
departments to help UK businesses start up, grow and cent on average) and employment (8 per cent compared to
succeed. 0.1 per cent).
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Other aspects of BIS’ work to provide a more ‘enterprise- necessary to develop new products and processes. The
friendly’ environment in the UK include: government established UK Research and Innovation
» Reducing the number of regulations which constrain
business activity. The government operates a policy of
in 2018. This new organisation operates across the
whole of the UK with a combined budget of more than
6.1.2
removing two regulations for each new one created. £6 billion.
» BIS works with the tax authorities in the UK (HM » The government offers a range of schemes to help
Revenue and Customs) to offer support to new and small entrepreneurs and businesses to develop new products
businesses by reducing the tax they pay on any profits and processes. These include help to develop the ideas
and also the cost of employing people. (in terms of expertise, advice and funding) as well as
» Supporting innovation through helping researchers, support on how to protect ideas (known as intellectual
developers, innovators and businesses, together with property or IP).
6.1.2.1 How governments might help businesses and encourage enterprise

universities, to bring together the skills and technology
CASE STUDY
The Four Anjels bakery
In 2010, four entrepreneurs established Four Anjels It is possible to judge that the support the Four Anjels
bakery in Gloucestershire, England. It operates with received was effective: by 2020 the bakery was operating
the vision of employing ‘passionate bakers to make 24 hours a day, five days each week.
hand-made products’. Initially the bakery had just five
employees but has since grown to have 40 staff and major
customers including Caffè Nero.
After six years of successful operation, the business’
owners realised that changes would be required in order
to continue their planned development and growth. Project
manager Phil Stevens said: ‘We knew that we needed
to relocate to new premises, but we also saw that we
were entering a period of significant change. We needed
guidance to manage the change efficiently and further
business support around the issues that would naturally
come from a period of change and rapid growth.’
The team consulted a range of different business advisors
and consultancy services, but could not find the kind of
support they needed. Phil was sceptical of the advice they
received, feeling it was not considering fully the needs of ▲ Figure 6.8
their specific business. Source: www.thegrowthhub.biz/the-buzz/
‘When we made contact with the growth hub and were news/case-study-four-anjels
introduced to our business guide, Sarah Gregg, we knew
Questions
from the very first meeting that we had found the right
partner. She took the time to really get to grips with our 1 Analyse two reasons why the support provided by
business and requirements, and then showed us how the Gloucestershire growth hub was an important
growth hub could provide us with effective support.’ element in expanding Four Anjels. [8]
2 ‘Non-financial help is more important than financial
The four entrepreneurs attended a number of growth hub support to establish an enterprise-friendly business
events. Meeting a financial advice panel ‘provided a valuable environment.’ Evaluate this view. [12]
focus and delivered real results’ according to Sarah Gregg.
The UK government also seeks to encourage enterprise and The effects of enterprise policies
to develop the relevant skills in young people. It:
The impact of these policies to encourage enterprise and
» recruits young business owners to volunteer as innovation is greatest among smaller organisations. It has
enterprise champions to talk to young people about
a substantial impact on strategic decisions made by the
establishing and running their own enterprises
owners of such businesses by influencing decisions on
» works directly with schools and colleges to encourage whether to start an enterprise or to expand it. However,
the use of schemes. For example, it promotes
these policies also stimulate innovation in organisations
the ‘Enterprise Village’ to help schools to set up
of all sizes. In many ways, this could affect functional
businesses.
decision-making significantly as managers seek to expand
operations, hire additional employees to produce innovative
products and plan marketing campaigns to promote them.
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6.1.2.2 How governments might the United Arab Emirates investigated the behaviour
of a Pakistani bank to determine whether or not it had
6.1.2 constrain business activity breached the country’s financial laws.
» Regulation of privatised monopolies to protect
In the previous chapter, we considered a range of laws consumers and other businesses We saw in
which might constrain the activities of businesses. For Chapter 6.1.1 that privatisation brings advantages
example, many governments have passed laws constraining and disadvantages. Regulations are used to protect
the production, sale and consumption of certain products consumers, especially when state-owned monopolies
such as alcohol, tobacco and gambling. Laws that affect have been privatised. In the late-twentieth century,
businesses are supplemented by regulations in many the UK privatised many state-owned monopolies that
countries. Regulations are used to set out how businesses supplied products including water, electricity and
should respond to laws. gas during the 1980s and 1990s. This meant that
The most common forms of regulation are government these monopolies became private companies and the
regulation and self-regulation. Government regulation is government established regulators (Ofwat, Ofgem and
a natural extension of legislation, in that it defines and Ofcom, for example) to ensure that the companies did
controls some of the ways that a business or individual can not abuse their market positions. The role of these
operate in order to follow the law. A very straightforward regulators is to act to ensure that consumers’ interests
example is food packaging in Canada, which must, at the and those of other businesses are protected and that
very least, be packaged with both English and French these natural monopolies do not charge excessive prices
wording. and make excessive profits.
» Self-regulation In some industries, governments have
The use of regulation permitted self-regulation to operate, usually through
a code of conduct which all businesses within the
Regulation can relate to a variety of business activities, industry agree to abide by. The government reserves
including pricing and their impact on the environment. the right to impose legal controls if a code of conduct
There are a number of aspects of regulation that affect is judged to be ineffective. Such self-regulation can
business activity in the UK and shape the economic be overseen to ensure that firms in industries subject
environment in which all firms operate. These include: to legal controls operate properly and as intended. For
» Regulation with the aim of creating free and fair example, the Indian government has proposed using
competition between businesses Regulation can self-regulation to control the content that is available
relate to any industry or business in the UK that is on the internet throughout the country. India already
not operating in the best interests of consumers. The uses self-regulation to limit the activities of the print
focus of most regulation is to protect the consumer and broadcast media.
by ensuring that there is sufficient competition
within specific industries and to eliminate any trading
activities that are not in the interests of consumers. Other ways in which governments
Such activities may include businesses limiting the might constrain business activity
range and variety of products available to consumers.
Governments can intervene in markets to constrain the
Regulators can take a number of actions to protect the
activities of businesses in other ways apart from imposing
interest of consumers, such as controlling prices, taxing
regulations.
profits that are judged to be ‘excessive’, and allowing
» By subsidising production of good and services When
new entrants to an industry to have access to the
a government offers a business or an industry a subsidy,
facilities of existing producers.
it effectively pays a part of the costs of production. This
Regulations constraining business activity operate in
encourages a greater increase in output of that product
every country. In 2020, Chinese regulators investigated
as it becomes more profitable to produce it. However,
Luckin Coffee Inc for uncompetitive activities; at the
this can have negative effects on those businesses
same time, regulators in America were investigating
that supply goods and services which compete with
whether Apple’s credit card infringed some of the
the subsidised products. In a number of countries,
country’s rules.
governments offer subsidies to kerosene producers.
» Regulation of certain high-profile industries such as
These affect the competitiveness of businesses
banking Some industries in the UK and elsewhere are
supplying gas or solar power and may result in some
regulated particularly closely because of their potential
failing or not growing as they might have done without
to act against the interests of consumers or their ability
the subsidies to their competitors.
to damage the economy. Banking and financial services
» Providing information on products Many consumers
are examples of such industries.
are unable to make informed and good-quality
Governments in a number of countries have passed
buying decisions on health and education products.
new laws constraining the activities of banks and
Governments intervene in a range of markets through
other businesses supplying financial services such as
the use of advertising to give consumers relevant
insurance. These new laws have led to regulations which
information to help them make better buying decisions.
are imposed and monitored by relevant authorities,
Such advertising may impact negatively on industries
often central banks. In 2020, the banking regulator in
such as those supplying alcohol, tobacco and gambling.
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» Implementing a range of economic policies We shall Governments tend to control external costs in three
see later in this chapter that governments can intervene main ways. They can impose indirect taxes (that is, a
in markets by implementing a range of policies, such
as altering interest rates or changing the level of
tax that adds to the selling price of a product) with the
aim of raising the costs of production to account for
6.1.2
expenditure on goods and services supplied by privately the external costs paid by other groups in society. This
owned businesses. should lead to higher prices and lower profit margins,
discouraging production and consumption of the
products. Alternatively, governments can levy fines on
6.1.2.3 How governments deal businesses that damage the environment and thereby
with market failure impose costs on others. Finally, a government may pass
laws to ban processes and products that cause external
6.1.2.3 How governments deal with market failure

One reason for governments to intervene in the operation of costs.
a market is market failure. 3 Consumers and producers possess insufficient
information about products Some consumers may have
When a market operates correctly, it responds to the signals
too little information about the benefits of buying
given by prices and increases or reduces the resources
products, such as health and education services. As a
used by businesses in the market to supply more or less of
result, they may buy too little of them and there will be
the product. Over time, global oil prices have risen from
an inadequate supply of these products – this is a form
$30 per barrel in 2016 to more than $60 per barrel at the
of market failure. Governments frequently intervene
start of 2020. The price has risen because consumers of
in these markets to encourage consumers to buy these
oil (individuals and businesses) have demanded more of
types of products, either by subsidising them or by
the product. In response to the signal of rising prices,
supplying the products themselves and providing them
oil companies have sourced new supplies of oil and have
without charges. This form of market failure is likely to
increased production.
result in undersupply, as too few resources are allocated
The failure of markets to work properly can come about for to producing goods and services in these markets.
a number of reasons. Most governments have taken steps to However, it can also result in the over-consumption of
attempt to limit the extent of each type of market failure. some products (drugs, for example) if consumers are
1 Monopolies and cartels The existence of monopolies unaware of the dangers they pose.
and cartels might mean producers have too much power, To overcome this type of market failure, governments
resulting in insufficient output and high prices. As a frequently provide information about the benefits or
consequence, consumers may receive too little of certain drawbacks of products. For example, in many countries
products, resulting in a lower standard of living. there have been health information programmes to
Governments frequently pass laws to encourage advise smokers of the danger to health of consuming
competition and to restrict a wide range of anti- tobacco. Many such programmes have been successful
competitive activities. Such laws prohibit the abuse and there has been a sharp decline in tobacco
of monopoly power (for example, by raising prices consumption in many countries.
excessively to boost profit margins) and the operation of 4 Poaching of skilled labour If a business invests
cartels. Such laws protect consumers from the adverse heavily in training its workforce to provide job-
effects of monopoly power. Offending firms are normally related skills, it can expect a consequent increase
fined, sometimes very heavily. in productivity as a reward for devoting resources
2 Damage to the environment Producers that pollute the to training. However, one possible outcome is that
environment are not paying the full costs of production. highly skilled employees become attractive to rival
For example, they might discharge toxic waste into a businesses, who are able to offer them higher wages as
river rather than paying for it to be taken away and they have not paid the training costs. Such poaching of
treated. These costs are imposed on someone else. It is labour can result in too few resources being allocated
often governments (and therefore taxpayers) that have to training for fear of poaching. Thus, the market fails.
to pay to clean up the pollution. This means that part of Overcoming the poaching of labour is difficult for
the costs of production are paid by a third party. Costs any government. If it has sufficient funds available,
passed on in this way are called external costs, and they it may provide some training itself and can offer tax
can result in severe environmental damage and problems benefits to businesses that engage in staff training.
for future generations. This type of market failure However, such approaches can be very costly to have any
creates oversupply of certain products as producers significant effect.
(and ultimately consumers) do not pay the full cost
of production. Some industries (for example, palm oil GLOSSARY TERM
producers) have received criticism for the environmental
Market failure occurs when a market does not work
damage arising from the deforestation that has properly and resources are not allocated correctly.
accompanied huge increases in the supply of this type
of oil.
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the rate of economic growth result in the business cycle,
STUDY TIP which we consider later in this section. If the rate of
6.1.2 Market failure is a strong argument for government
intervention in the economy and can provide a powerful
economic growth is negative (that is, if the economy is
getting smaller) for six consecutive months, then it is said
line of analysis when responding to questions on the to be in recession.
merits (or otherwise) of state involvement in the business
Economic growth is normally judged through the changes in
environment.
the level of gross domestic product (GDP), which measures
the value of a nation’s output of goods and services. In
February 2020, the GDP of the UK was £2 264 855 million.
6.1.2.4 Macroeconomic objectives The population of the UK is approximately 66 million,
giving a GDP per head (or per capita) equal to £34 316.

of governments and their impact Governments seek to increase this figure over time, as it
on business activity represents a rise in the country’s standard of living.
Every government in the world operates with a number Most countries’ economies experience economic growth over
of macroeconomic objectives. The key macroeconomic a period of time, though, in the short term, economies may
objectives for the UK are as follows. stagnate or even decline in size. Figure 6.9 illustrates the
» Sustainable economic growth This means that the quarterly economic growth rates for the UK from 2010
value of the economy’s entire production of goods and until 2020.
services should increase over time. However, this should Governments usually aim to maintain steady and sustained
be at a rate which is sustainable – this means that it can economic growth over a period of time. However, this is a
be maintained over time while minimising the damage to difficult target to achieve, as the operation of the business
the environment. cycle tends to create the fluctuations apparent in Figure
» A steady and low rate of inflation The UK 6.9. Governments use counter-cyclical policies (including
government’s inflation target at the time of writing control via interest rates and taxation levels) to attempt
is 2.0 per cent, meaning that it aims to have prices to eliminate the more extreme fluctuations. High rates of
rising in the UK at this rate annually. This is a major economic growth are not desirable, as they tend to result in
economic objective which the Bank of England pursues slumps whereby economic growth may become negative.
on behalf of the government.
» Low levels of unemployment It is not possible to Governments can stimulate growth as a consequence
eliminate all unemployment in an economy. The UK of their economic policies. Short-term growth can be
government (along with many others) wants to achieve encouraged by cuts in interest rates and taxation which
a level of employment whereby those who are able and fuel borrowing and spending, leading to greater output
willing to work have a job. and, hence, economic growth. The danger is, however,
that firms and individuals purchase products from
These macroeconomic objectives have implications for overseas, promoting growth in foreign economies. Supply-
businesses, as they influence the economic environment side policies may be put in place to achieve sustained
in which all businesses operate. In the following sections, economic growth. This type of policy involves increasing
we will look at each of the government’s main economic the productive capability of the economy by improving
objectives in more detail, along with the impact they can the skills of the workforce, encouraging more people into
have on business activity. employment and promoting competition within markets to
increase output and GDP.
Economic growth
Economic growth is an increase in the value of goods and
services produced by a nation’s economy. Fluctuations in
GLOSSARY TERMS
Macroeconomics is the study of the behaviour of a whole Unemployment is the number of people who are seeking a
economy and the factors that can influence it. job but are unable to secure one.
Microeconomics is the study of smaller parts of an A recession is characterised by falling levels of demand and
economy, such as the behaviour and decision-making of declining levels of output and employment over at least a
businesses and individual consumers. six-month period.
Economic growth is an increase in the value of goods and A slump takes place when production is at its lowest,
services produced by a nation’s economy over a period of unemployment is high and there are many business
time. failures.
Inflation is a sustained rise in the general price level and a Supply-side policies are a range of measures designed to
corresponding fall in the value of money. improve the free operation of markets and, therefore, the
total amount that is produced (or supplied) by an economy.
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3
2.5
6.1.2
GDP
1.5
6.1.2.4 Macroeconomic objectives of governments and their impact on business activity

1
2010 2012 2014 2016 2018 2020
Year
Source: Trading Economics (Office for National Statistics)
▲ Figure 6.9 Economic growth rates in the UK, 2010–20
CASE STUDY
UK’s economic growth slows
The UK’s Office for National Statistics (ONS) has stated However, economists said the underlying momentum
that growth in gross domestic product (GDP) was flat of the economy slowed over the year as a whole.
overall in the last quarter of 2019, as consumer spending Manufacturing output fell sharply in the fourth quarter,
was low over the Christmas shopping period and owing to weaker levels of production in the car industry,
manufacturing output fell sharply. effectively finishing 2019 in recession after three
The growth rate slowed in the third quarter of 2019, consecutive quarters in contraction.
although annual growth did increase slightly to 1.4 per The ONS said quarterly GDP growth had been declining
cent in 2019, just above the 2018 economic growth rate of during 2019, continuing the slowing that has been
1.3 per cent. experienced over the previous five years.
However, the ONS reported that the economy grew by Questions
0.3 per cent in December from the previous month,
1 Analyse one reason why economic growth is an
faster than expected, and suggesting that the decline in
important macroeconomic objective for most
economic growth might be short-lived. Surveys show
governments. [4]
that the service sector – which accounts for about 80
2 ‘The economic data provided in the case study
per cent of the economy and includes hotels, shops and
represents bad news for all UK businesses.’ Evaluate
restaurants – also recovered to show the strongest
this view. [12]
growth since mid-2018.
The case for economic growth is not clear-cut. Growth brings disadvantages as well as advantages for businesses. These
arguments are summarised in Table 6.3.
▼ Table 6.3 The benefits and drawbacks of economic growth for businesses
The benefits The drawbacks

• High rates of economic growth provide the government • Not all regions within an economy benefit equally during
with increased tax revenues permitting greater periods of economic growth. For example, firms selling in
expenditure on health, education and transport, prosperous regions of a country are likely to enjoy increased
benefiting all businesses and encouraging further growth. sales, while those in less prosperous regions may only see a
• Growth provides opportunities for all in society. marginal increase in revenues.
Individuals benefit from greater chances of promotion; • Growth may result in shortages of labour and other materials.
high levels of consumer spending encourage enterprise. This may result in higher wages and prices, fuelling inflation
Businesses small and large may thrive in a growing and creating uncertainty among the business community.
environment. • Growth places individuals and businesses under pressure.
• Businesses generally enjoy higher sales and increased Workloads increase and decisions may be rushed. In these
profits. Expansion is likely for firms selling income circumstances, it may prove impossible to maintain the quality
elastic products such as cars and foreign holidays. of management and businesses may lose co-ordination and a
Growth creates new markets for products. clear sense of direction.
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Economic growth and the business cycle pressure during booms. Skilled workers may become
scarce and firms competing for workers may offer higher
All countries suffer fluctuations in the level of GDP and
6.1.2 business activity within their economies. At times spending,
wages. Simultaneously, as the economy approaches
maximum production, shortages and bottlenecks will
output and employment all rise; during other periods, the
occur as insufficient raw materials and components
opposite is true. The value of a country’s output over a
exist to meet demand. Inevitably this will result in their
period of time is measured by a nation’s gross domestic
prices rising. The combination of rising wages and rising
product – this figure is dependent upon the level of
prices of raw materials and components will create
economic activity. A rising level of economic activity will
inflation. It is the existence of inflation that usually
be reflected in a higher level of GDP.
leads to the end of a boom.
» A recession occurs when incomes and output start to
GLOSSARY TERM fall. Technically a recession exists once GDP has fallen
The level of economic activity refers to the amount of for two successive three-month periods – that is, for six
spending and production in an economy. Governments months. Falling sales will begin to eat into businesses’
generally aim to have smooth increases in the level of profits. In circumstances such as this, governments in
economic activity over time. the UK and elsewhere have tended to lower interest rates
in an attempt to stimulate demand and sales. Despite
The business cycle describes the regular fluctuations the falling interest rates, falling profits are likely to
in economic activity (and GDP) occurring over time in result in plans to invest in new factories and offices
economies. Figure 6.10 illustrates a typical business cycle. being delayed or abandoned. The level of production in
the economy as a whole may stagnate or even fall. The
Trade cycles generally have four stages:
amount of spare capacity within the economy will rise.
» Recovery or upswing as the economy recovers from Some businesses will fail and the level of bankruptcies is
a slump; production and employment both begin to
likely to rise.
increase. Consumers will generally spend more in these
» A slump often, but not always, follows a recession.
circumstances as they are more confident in the security
In some circumstances, an economy may enter the
of their employment. Initially, businesses may respond
upswing stage of the business cycle without moving
cautiously to signs of increasing consumer confidence.
through a slump period. Governments may take action
No major decisions are required to meet rising demand
to encourage this by, for example, increasing their
while spare capacity exists – firms simply begin to utilise
own spending or lowering interest rates. A slump sees
idle factories, offices and other assets. As business
production at its lowest, with high unemployment, and
confidence increases, firms may take the decision to
increasing numbers of firms will fail.
invest in further non-current assets (factories, machinery
and vehicles, for example). Employees experience less Figure 6.10 illustrates a smooth and regular trade cycle in
difficulty in finding jobs and wages may begin to rise. operation. In reality, the change in gross domestic product
» A boom follows with high levels of production and is likely to be irregular, as economic cycles of different
expenditure by firms, consumers and the government. duration and intensity operate simultaneously. The business
Booms are normally characterised by prosperity and cycle is a major influence on the performance of businesses.
confidence in the business community. Investment in As the economy moves from one stage of the cycle to
non-current assets is likely to increase at such times. another, businesses can expect to see substantial changes
However, many sectors of the economy will experience in their trading conditions.
Gross domestic product
r time
Boom GDP ove
Trend of
Recovery or
upswing
Recession
or downswing
Slump
0
Time
▲ Figure 6.10 The stages of the business cycle
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The impact of economic growth and the
business cycle
Table 6.4 identifies some actions that different businesses 6.1.2
might take in response to the business cycle. However, not
all businesses are equally affected by the changing trading
conditions, as summarised in Table 6.5.
▼ Table 6.4 The trade cycle and business actions
Stage of business cycle Key features Likely reactions by business

Recovery or upswing • Increasing consumer expenditure • Opportunity to charge higher prices
• Existing spare capacity used • Rising numbers of business start-ups
• Production rises • Businesses take decisions to invest in non-current
• Business confidence strengthens assets
• Investment increases • Businesses operate nearer to (or at) full capacity
Boom • Rate of inflation increases • Firms face increasing pressure to increase prices
• Bottlenecks in supply of materials and • Businesses seek alternative methods to increase
components output
• Some firms unable to satisfy demand • Wage rises offered to retain or attract skilled
• Profits probably high – but hit by rising labour
costs • Managers plan for falling levels of demand
Recession • Government reduces interest rates • Firms seek new markets for products – possibly
• Firms reduce production as demand falls overseas
• Spare capacity rises • Some products may be stockpiled
• Business confidence declines and • Workers laid off – or asked to work short-time
investment is cut • Financially insecure firms may become bankrupt
• Profits fall or insolvent
Slump • Increasing number of bankruptcies and • Firms offer basic products at low prices
insolvencies • Businesses may close factories to reduce capacity
• Government lowers interest rates further • Large-scale redundancies may occur
• High levels of unemployment • Marketing concentrates on low prices and easy
• Low levels of business confidence and payment deals
consumer spending
▼ Table 6.5 Products affected and unaffected by the business cycle
Firms supplying these products may be significantly Firms supplying these products are unlikely to be affected
affected by the business cycle to a great extent by the business cycle – in fact demand
may rise for some of these products in a recession/slump
• Leisure air travel • Fuel, including petrol, gas and electricity
• Sports and leisure goods • Cigarettes and tobacco
• Jewellery • Water and sewage services
• Household furniture • Unbranded basic foods
• Cars
A number of businesses may find that demand for their products such as televisions and laptops, and construction
products is relatively unaffected as the business cycle materials such as bricks and windows.
moves through its stages and the rate of economic growth
Businesses selling basic foodstuffs might have to take little
alters. Producers and retailers of basic foodstuffs, public
or no action to survive a recession; in fact, demand for their
transport and water services may notice little change
products might increase as consumers switch from more
in demand for their products. This is because these are
expensive alternatives. At the other extreme, businesses
essential items consumers continue to purchase even when
supplying materials to the construction industry could
their incomes are falling – demand for them is not sensitive
be hard hit, as firms delay or abandon plans to extend
to changes in income.
factories and build new offices. Their position might be
Demand for other categories of products is more sensitive made worse by a fall in demand for new houses, as hard-up
to changes in income levels and therefore the stages of the consumers abandon schemes to move home.
business cycle. Examples include foreign holidays, electrical
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CASE STUDY
6.1.2
Pakistan misses economic growth target
government should take action to support the country’s
economy to achieve sustained economic growth. In its
report, the SBP pointed out that the output of Pakistan’s
larger manufacturing businesses fell by nearly 6 per
cent in comparison with the previous year. The industries
affected by this decline included construction and vehicle
manufacturing. In view of this, the report suggested that

Pakistan could not be expected to achieve its GDP growth
target of 4 per cent. The central bank has previously
predicted a growth rate of around 3.5 per cent for
Pakistan’s economy; other economists fear it might be as
low as 2.4 per cent. The country’s growth rate would need
to be around 7 per cent to maintain living standards for its
rapidly-growing population.
▲ Figure 6.11 The State Bank of Pakistan Questions
Pakistan’s central bank has estimated that the rate of 1 Analyse two effects on businesses in Pakistan of the
economic growth in the country for the financial year country’s rapid growth in population. [8]
2019–20 will not reach the 4 per cent target that was set. 2 ‘The expected fall in the economic growth rate will
have differing impacts on the country’s businesses.’
The State Bank of Pakistan (SBP) has analysed Pakistan’s
Evaluate this view. [12]
economic performance and recommended that the
Short-term responses may be all that are required if

HANDLING DATA governments are successful in eradicating the more extreme
effects of the business cycle.
Assume that Pakistan’s average annual population
growth is 1.75 per cent. Given that the country had 219
million inhabitants in 2019, what will be the revised Inflation
forecast for 2025? Inflation can be defined as a persistent rise in the price
level and the associated fall in the value of money. For
Economic growth and the business cycle are permanent many businesses, a low rate of inflation is not a problem.
features of the economic environment for firms. The effects As long as wages are rising at about the same rate or
of changes in the business cycle vary from industry to higher, a low constant rate of price increase simply serves
industry. Firms selling goods whose demand is sensitive to to help maintain demand. Inflation only becomes a major
changes in income (known as income elastic goods), such problem for businesses when it is high, rising rapidly or
as designer clothes and foreign holidays, may find that (worst of all) is doing both together.
sales rise in a boom and fall during recession. Conversely,
businesses selling staple products, such as foodstuffs, Inflation in the UK, and in many industrialised nations
where demand is not income elastic may be relatively throughout the world, has been at historically low rates
unaffected by the business cycle. over the last 15 years or so. The UK’s rate of inflation
was 0.7 per cent (as measured by the CPI – see below) in
It is possible to argue that the business cycle will only September 2020, and is forecast to remain around 2 per cent
provoke short-term responses in many firms, because its until 2023.
effects are relatively short-lived. Booms and slumps do not
last forever and businesses can take actions to see them How is inflation measured?
through difficult trading periods. During boom periods, The UK government measures the rate of inflation by use of
managers may increase prices to restrict demand and the Consumer Price Index (CPI). The CPI was introduced in
increase profitability; they may subcontract work to other December 2003 and measures the average monthly change
firms or seek supplies from overseas. Equally, in conditions in the prices of goods and services purchased by households
of recession or slump, lay-offs may occur or short-time in the UK. The government will use this to set targets for
working may take place while overseas markets are targeted inflation in the future. The CPI is calculated using more
to increase sales. Well-managed firms will predict the onset than 700 separate goods and services for which price
of a boom or slump and take appropriate action in advance. changes are measured throughout the country.
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The causes of inflation » Wage rises If trade unions and employees are successful
There are a number of factors that may cause inflation. in negotiating pay increases significantly above the
Economists tend to classify the causes of inflation as rate of inflation, then further price rises might be the
result. This becomes more likely if productivity is not
6.1.2
demand-pull or cost-push factors. The cause of inflation
can be an important factor for businesses as it provides increasing, allowing businesses to offset some of the
some indication of likely future government policies to increased wage costs against additional production.
control inflation. However, labour market conditions can influence the
rate of wage increases and, therefore, inflation. For
example, wages in Spain fell by about 20 per cent
Demand-pull inflation between July 2011 and January 2014 as jobs were scarce
Demand-pull inflation occurs when the demand for the

and the rate of unemployment rose above 20 per cent.
country’s goods and services exceeds its ability to supply This contributed to the country’s very low inflation rate.
these products. As a consequence, prices rise generally as » Imported inflation One of the hidden causes of
a means of restricting demand to the available supply. The inflation is rises in import prices. The UK and Belgium
underlying cause of this might be the government allowing are susceptible to this type of inflation as they are
firms and businesses to have too much money to spend, ‘open’ economies, importing large quantities of raw
perhaps as a consequence of cutting taxes or lowering materials, components and finished goods. Import
interest rates. prices rise when the exchange rate is falling and more
of the domestic currency is required to purchase a given
Cost-push inflation
amount of a foreign currency. Although exporters might
Cost-push inflation occurs when firms face increasing costs complain about rising exchange rates, they do help to
due to factors such as rising wages or increasing costs of control inflation.
raw materials and components. This type of inflation can
arise from a number of sources.
GLOSSARY TERMS
The Consumer Price Index (CPI) measures the rate of Cost-push inflation happens when firms face increasing
inflation based on the changes in prices of a basket of goods costs due to rising wages or increasing costs of raw
and services. materials and components.
Demand-pull inflation occurs when the demand for the
country’s goods and services exceeds its ability to supply
these products.
4
CPI
–2
2010 2012 2014 2016 2018 2020
Year
Source: https://tradingeconomics.com/united-kingdom/inflation-cpi
▲ Figure 6.12 Inflation in the UK 2010–20
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CASE STUDY
6.1.2
Comparing the rates of inflation in Uruguay and Indonesia
The annual inflation rate in Uruguay increased to 10.86 per Indonesia’s annual inflation rate declined to 2.67 per cent
cent in April 2020 from 8.32 per cent in the previous in April 2020, the lowest since March 2019 and below
month. It was the highest inflation rate since June 2016, as market expectations of 2.77 per cent. Prices rose more
prices rose further for food and non-alcoholic products, slowly for housing and utilities, food, drinks, and food and
and housing. Uruguay’s exports declined by 40 per cent restaurant services. On a monthly basis, consumer prices
between April 2019 and March 2020. rose 0.08 per cent in April, the least since October 2019.
10
8
CPI
2
2010 2012 2014 2016 2018 2020
Year
Source: https://tradingeconomics.com/uruguay/inflation-cpi
▲ Figure 6.13 Inflation in Uruguay 2010–20
10
8
CPI
2
2010 2012 2014 2016 2018 2020
Year
Source: https://tradingeconomics.com/indonesia/inflation-cpi
▲ Figure 6.14 Inflation in Indonesia 2010–20
Questions
1 Analyse one likely effect of Uruguay’s high rate of 2 ‘Indonesian businesses have operated in a better
inflation on its businesses. [4] macroeconomic environment than those in
Uruguay.’ Evaluate this view. [12]
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The impact of inflation on business Types of unemployment
Inflation can have a number of effects on businesses. People can be unemployed for a number of reasons.
» Many businesses may suffer falling sales in a period Governments find it useful to distinguish between the 6.1.2
of inflation. Consumers might be expected to spend various types of unemployment, as each type requires
more during inflationary periods, as they would not a different remedy. Although many different types of
wish to hold an asset that is falling in value. However, unemployment exist, we shall focus on three main types.
research shows that people save more (perhaps due to
uncertainty) and sales for many businesses fall. 1 Structural unemployment
» It can be difficult to maintain competitiveness (and Economies continually change: some industries die and
especially international competitiveness) during bouts others emerge to replace them. Structural unemployment

of inflation. Rising wages and raw material costs may occurs due to fundamental changes in the economy whereby
force firms to raise prices or accept lower profit margins. some industries reach the end of their lives. Structural
Firms operating in countries with lower rates of inflation unemployment occurs for a number of reasons:
may gain the edge in terms of price competitiveness – the adoption of new methods of production
under such circumstances. – significant and permanent changes in demand
– increasing competition from overseas
Inflation can offer some benefits to businesses, however. – rising income levels, meaning demand for some
Some analysts suggest that low and stable rates of products declines.
inflation may be beneficial. A steady rise in profits can
create favourable expectations and encourage investment But structural change in the economy also offers
by businesses. Inflation can also encourage long-term opportunities to businesses. Rising incomes and
borrowing and investment by businesses, as the value of technological developments have led to the development
their repayments (in real terms) declines over time. of the mobile phone industry. This industry employs a large
number of people in manufacturing the product, supplying
networks and in retail outlets.
Unemployment
Unemployment remains an important issue in most Structural unemployment is a difficult problem for
countries. It is important because it represents a waste of governments to solve. Because large numbers of employees
resources if labour is unused: if all available workers were may no longer have the skills that employers require,
used, the country concerned would be able to produce more training is an important part of any solution. Other
and its citizens would enjoy a higher standard of living. The approaches include encouraging foreign producers to
social effects of high and prolonged rates of unemployment establish themselves in the country to provide employment
can be devastating – poor health and crime are just two for those with skills not needed by domestic businesses.
factors associated with unemployment and poverty. The UK has been particularly successful in attracting motor-
vehicle producers from across the world.
GLOSSARY TERM
Structural unemployment occurs due to fundamental
changes in the economy whereby some industries reach
the end of their lives.
8
Unemployment rate
3
2010 2012 2014 2016 2018 2020
Year
Note: The unemployment rate is the percentage of the workforce who do not have a job but are looking for one.
Source: https://tradingeconomics.com/united-kingdom/unemployment-rate
▲ Figure 6.15 UK unemployment
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Competition
from overseas STUDY TIP
6.1.2 New methods
of production
Changing patterns
of demand
It is important to relate the impact of unemployment (or
changes in other economic factors) to the precise type
of business under consideration. Some businesses rely
heavily on labour as a key element of production – this is
Causes more likely to be true of businesses that supply services.
Structural
unemployment Hence, a change in the level of unemployment will have a
Effects greater impact on this type of business.
Certain skills no New opportunities The impact on businesses of changing

longer needed
Localised unemployment levels
unemployment Rises in unemployment can have serious implications for
▲ Figure 6.16 Causes and effects of structural businesses, though the precise impact and likely responses
unemployment of firms will depend upon their circumstances and the type
of unemployment.
2 Cyclical unemployment Cyclical unemployment might result in businesses suffering
Cyclical unemployment arises from the operation of the
from falling sales. In the short term, firms may be able to
business cycle – a topic we considered in detail earlier in
add any surplus production to inventories. Alternatively,
this chapter. The boom stage of a business cycle will see
businesses may seek new markets, perhaps by selling
this type of unemployment minimised as firms increase
overseas. Not all businesses will be equally affected
their production levels. At this stage of the business cycle,
by changes in unemployment levels. Businesses selling
those who have been unemployed for some time (and with
essential products may be relatively unaffected by cyclical
relatively few skills) may find work.
unemployment, while suppliers of luxury products could
At the other extreme, much of the unemployment suffer substantial reductions in sales.
experienced during a slump will be cyclical. The effects
Structural unemployment can have a significant effect
of cyclical unemployment can be considerable as
on businesses because it is frequently highly localised
unemployment increases substantially in the move into
and often very persistent. For example, high levels of
recession. Some businesses seek to protect themselves
unemployment suffered by former coal-mining communities
against cyclical unemployment by the introduction of
would have considerable implications for most businesses
profit-related pay. Such schemes allow pay to fall during
in the locality. Unemployment brought about by the
a recession along with profits, reducing the need to make
decline of an industry also has an impact upon associated
workers redundant.
industries. For example, falling production in the UK’s
3 Frictional unemployment shipbuilding industry contributed to the decline in the
People moving between jobs cause frictional country’s steel industry.
unemployment. If a person leaves one job, they may not If there is a need to reduce output then rationalisation
be able to move into a new position immediately. While and redundancy might follow and factories and offices
they are searching for new employment, they are classified may be closed. Research and development plans may be
as frictionally unemployed. The government providing abandoned or postponed as firms seek to reduce their
improved information on job vacancies available may reduce costs to match their (reduced) revenues. A predicted fall in
the level of frictional unemployment. A healthy economy the level of demand may encourage the firm to diversify,
will have some amount of frictional unemployment as possibly into foreign markets. Businesses may consider
people move between jobs. mergers with other firms to help reduce costs or to
broaden product ranges.
GLOSSARY TERMS
Periods of low unemployment cause different problems
Cyclical unemployment is caused by the operation of the for businesses and provoke different responses. Falling
business cycle, rising in slumps and falling in booms. unemployment and accompanying skill shortages create
Frictional unemployment exists because people may problems that take time to solve. Businesses look to the
be temporarily out of work between leaving one job and government to assist through the provision of state training
starting another. schemes and the development of relevant vocational courses
Inventories are the raw materials and other items in schools and colleges. In the UK, governments have
necessary for production to take place. They also include attempted to support industry in these ways.
finished products that have not yet been sold.
Migration is the movement of people between countries or
regions with the intention of settling in the new location.
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However, businesses can take action. » Businesses may invest in training schemes to develop
» Skill shortages encourage the development of capital- the required skills in their employees. This may entail
intensive methods of production in manufacturing and
service industries. Using technology to replace labour
giving relatively junior or unskilled employees additional
skills to enable them to carry out a wider range of
6.1.2
can boost productivity, thereby enhancing international activities. This can be a risky approach, however, as
competitiveness. unscrupulous competitors may poach skilled employees
» Businesses may relocate to take advantage of more once training is completed.
plentiful and cheaper sources of skilled labour. However,
in the case of the UK, this may require location outside The skills shortage creates difficulties for many businesses
Europe as most of the EU is experiencing similar skill and opportunities for others. Recruitment agencies and
shortages. firms providing training for other businesses may enjoy

increasing demands for their services during a period of
skill shortages.
CASE STUDY
Global migration
20% and over
10–19%
5–9%
1–4%
<1%
No data
Source: United Nations Report on International Migration, 2019 (page 13)
▲ Figure 6.17 International migrants as a percentage of the total population, 2019
Migration is the movement of people between different in countries such as the UK and Australia. They can
countries. Over the last 20 years, many European and assist in overcoming skill shortages and reduce the
North American countries have experienced significant expenditure that firms must make on training. In addition,
inflows of migrants from parts of the Middle East, Africa the increased supply of people into the labour market may
and Asia. According to the UN, ‘in 2019, more than half help to prevent wages from rising. This is especially likely
of all international migrants worldwide lived in Europe if migrants are willing to work for lower wage rates.
and Northern America, with roughly 82 million residing
Source: United Nations Report on International Migration 2019
in Europe and nearly 59 million in Northern America’. (page 6), www.un.org/en/development/desa/
Although some people have left countries in Europe and population/migration/publications/migrationreport/
America, the inflows have generally been much larger, docs/InternationalMigration2019_Report.pdf
creating a positive net inflow of migrants. Figure 6.17
shows the percentage of the population that are migrants Questions
in most countries. 1 Analyse two benefits that Australian businesses
The impact of migration depends upon a number of might receive from a net inflow of migrants. [8]
factors and not just the size of the net migration flow. 2 Evaluate whether a net inflow of migrants affects
If migrants possess suitable skills and are primarily of the competitiveness of businesses in the receiving
working age, they offer substantial benefits to businesses nation. [12]
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The economic environment and growth. These plans may include increasing innovation as
part of the development of new products, entering new
6.1.2 business strategy
A business’ strategy is simply the long-term plans through
markets or pursuing a policy of takeovers and mergers.
Figure 6.18 summarises some of the major economic
which it seeks to attain its corporate objectives – that variables that might impact upon businesses’ strategic
is, the objectives of the whole business. For example, a planning and decision-making. The diagram also emphasises
business may have growth as a major corporate objective the interrelationships that exist between the elements that
and will develop plans to achieve the desired rate of make up the economic environment for businesses.
Unemployment State of labour market

Business cycle
• Type (e.g. frictional) • Skill surpluses
• Boom
Unemployment • Location • Skill shortages
• Slump
varies according • Skills in surplus • Migration flows
to stage of the
business cycle
Business strategy
e.g.
• Growth
Inflationary pressures • Rationalisation
more likely in a boom • Market dominance
• Diversification
• Technological
leadership
Inflation and Close links

Inflation interest rates between
Exchange rates
tend to rise and Interest rates interest and
• Rate of price increase exchange rates • Level and trend
fall together • Levels, relative to
• Trend in price change other nations • Affect all firms
• Rate relative to that but especially those
• Trend: rising/falling
in other countries trading overseas
▲ Figure 6.18 Business strategy and the economic environment
6.1.2.5–7 Government 1 Monetary policy Using this policy, the government (or
the central bank, such as the Bank of England, acting
macroeconomic policies and their on its behalf) manipulates the amount of money and/
or interest rates within the economy in order to achieve
impact on businesses the desired level of economic activity.
Governments operate a number of different policies with the 2 Exchange rate policy This is often regarded as a part
aim of providing the best possible economic environment of monetary policy and involves the manipulation of
for businesses. This entails adjusting the level of activity the value of a country’s currency. This can affect the
in the economy to avoid the excesses of booms and slumps. economy by changing the prices of exports and imports
The government’s economic policies can be divided into the and, thereby, the price competitiveness of the country’s
following categories: businesses.
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3 Fiscal policy This refers to the government’s use Monetary policy
of taxation and public expenditure to manage the
economy. By adjusting the levels of taxation and
government expenditure, the government can alter the
This type of economic policy involves adjusting the amount
of money in circulation and, hence, the level of spending 6.1.2
level of activity within the economy. and economic activity. Monetary policy can make use of one
4 Supply-side policies These are designed to improve or more of the following:
the free operation of markets and, therefore, the total » adjusting interest rates
amount that is produced (or supplied) by the economy. » controlling the money supply
Privatisation is one type of supply-side policy, along » manipulating the exchange rate (which we will consider
with limiting trade union power and providing training separately).
for unemployed workers.
6.1.2.5–7 Government macroeconomic policies and their impact on businesses

Although at times all three techniques have been used, more
recently governments have tended to rely upon altering
GLOSSARY TERMS interest rates to manage the economy. Since 1997, in the
Monetary policy is controlling the amount of money and/ UK, the Monetary Policy Committee of the Bank of England
or interest rates within the economy in order to achieve has had responsibility for setting interest rates. Giving this
the desired level of economic activity. power to central banks is common in other countries, too.
For example, the Reserve Bank of India performs a similar
Exchange rate policy is the deliberate adjustment of the
value of a country’s currency to achieve desired changes in
role. In the UK, the Monetary Policy Committee sets interest
the prices of imports and exports. rates monthly with the aim of achieving the government’s
target for inflation while attaining long-term growth in the
Fiscal policy is the use of taxation and public expenditure
economy. Table 6.6 highlights the aims that may lie behind
to manage the level of activity in an economy.
authorities altering interest rates and, importantly, the
implications for individuals and businesses.
▼ Table 6.6 Changes in interest rates – objectives, impact and business decisions
Rising interest rates Falling interest rates

The likely objectives of increasing interest rates include: Reductions in interest rates may be introduced with the
• reducing the level of consumer spending following objectives in mind:
• limiting inflationary pressure in the economy • reducing levels of unemployment
• slowing the level of economic growth (as measured by GDP) • stimulating the level of production in the economy
• avoiding increasing imports creating a deficit on the • promoting exports sales by reducing the exchange value of
balance of payments. the currency
(In general, higher interest rates will assist in dampening • increasing rates of economic growth in the economy.
down an economic boom.) (Reducing interest rates can assist an economy in recovering
from a slump.)
The likely impact on businesses of increasing interest rates The impact on businesses of falling interest rates include:
include: • Demand and sales are likely to increase, especially for
• Many businesses may experience falling sales as consumers products bought on credit.
increase savings. • Production is likely to be stimulated, increasing
• Demand for products purchased on credit may decline employment.
significantly. • Export sales of price-sensitive products may increase while
• The cost of borrowing, whether short- or long-term, is likely imports become less competitive.
to increase for businesses, possibly cutting profit margins. • Businesses may undertake increased investment, promoting
• Increased value of the currency increases the prices of growth in industries such as construction.
exports while reducing import prices.
Examples of how businesses’ decisions may be affected by Examples of how businesses’ decisions may be affected by
increasing interest rates include: falling interest rates include:
• Businesses may cancel or defer investment plans as they • Businesses may decide to increase investment in new
may be too costly with higher interest rates. factories and new products as borrowing is cheap and
• Firms reduce levels of inventories as they seek to cut consumer spending may be forecast to rise.
borrowing costs. • Firms may invest in advertising campaigns to attract new
• New marketing campaigns might be introduced, possibly customers at a time of cheap borrowing.
based on low prices, to attract consumers. • Businesses may offer attractive ‘buy now, pay later’ deals to
• Some businesses may seek to borrow money from overseas if attract customers as they can afford to increase borrowing
interest rates are significantly lower in foreign countries. to finance this.
• Some businesses may seek to use cheap finance to finance
takeovers of rivals or suppliers.
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Broadly speaking, rises in interest rates depress the level of Not all businesses are affected equally. We can identify
economic activity and reductions promote an expansion of several categories of businesses that are particularly
6.1.2 economic activity. susceptible to changes in interest rates:
» Small firms are often affected greatly by changes in
Interest rates are the price of borrowed money. Although
interest rates, as they have smaller financial reserves
the Bank of England sets the base rate, many other interest
and a relatively greater need for borrowing. The Bank of
rates operate in the UK. The precise rate of interest charged
England estimates that every 1 per cent rise in interest
on a loan depends on several factors, including the time
rates costs the UK’s 1.5 million small firms an extra
period of the loan and the degree of risk attached to it.
£200 million in interest rate payments. Significant rises
In the UK, expenditure is particularly sensitive to changes in interest rates can lead to substantial increases in
in interest rates. One prime reason for this is mortgage bankruptcies or insolvencies among small firms.
interest payments. Millions of UK consumers have mortgages, » Even larger firms with high levels of borrowing can be
which are large loans taken out to purchase houses. A rise in affected by alterations in interest rates. For example,
interest rates increases the payments made on mortgages, a rise in rates can lead to a hefty increase in interest
leaving less money available for other types of expenditure. payments, forcing firms to reduce costs elsewhere or to
Similarly, a cut in rates reduces mortgage payments, freeing pass on the extra expenses in the form of higher prices
money for other forms of expenditure. – if this is possible. Alternatively, a cut in interest rates
offers a substantial reduction in expenses to such firms,
The impact on businesses and their improving their competitiveness.
» Firms trading overseas are affected by alterations in
decisions of changes in interest rates interest rates. Rising interest rates tend to lead to an
The impact of rising interest rates will depend upon the increase in the country’s exchange rate. This occurs
size of the change as well as the initial rate. A small because individuals and businesses overseas purchase,
increase at a relatively high level of rates will have little say, rupees to invest in Indian financial institutions to
impact, while a larger increase from a low base rate will benefit from higher interest rates. Rising demand for a
have a significant impact, prompting businesses to take currency tends to increase its price – or its exchange
significant decisions. rate. A fall in interest rates would have the opposite
effect.
CASE STUDY
Consumer debt worries in Russia
The monetary authorities in Russia have been concerned income already used to repay existing debts. If banks do
by a sharp increase in unsecured borrowing by the make any ‘risky’ unsecured loans, they will be required to
country’s consumers. Any borrowing that is unsecured hold increased reserves to cope with any consumers who
is not guaranteed by collateral such as property or other do not repay their debts.
saleable assets. Credit cards and some bank loans
Forecasts by the Russian Central Bank suggest that growth
are examples of unsecured borrowing. In 2019, around
rate of consumer borrowing will decline in the last three
5 million Russians were using more than 50 per cent of
months of 2019 to about 10 per cent, from 22 per cent in 2018.
their incomes to repay unsecured loans. Any financial
institution offering new loans of more than 10 000 roubles Questions
($154) will be subject to the new rules.
1 Evaluate whether or not the effects of a continued
Before being able to offer unsecured loans, banks rise in unsecured borrowing will be entirely bad for
in Russia will be required to assess the extent of a businesses in Russia. [12]
consumer’s previous borrowing and the proportion of
However, it is not only the direct effects of altering interest of unemployment, inflation and growth existing in the
rates that affect businesses. The use of interest rate economy. Changes in interest rates also change business
policy by the authorities can have a profound impact upon managers’ expectations of these key economic variables,
the general economic environment in which businesses affecting their day-to-day and strategic decisions.
operate. The Reserve Bank of India changes interest rates
Table 6.7 illustrates the relationship that exists between
to assist the Indian government in achieving its economic
the level of interest rates and key economic variables such
objectives. This means that altering rates affects the level
as economic growth and unemployment.
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▼ Table 6.7 Interest rates and other economic variables
Other economic variables

Unemployment
Rising interest rates
Unemployment increases as levels of
Falling interest rates
Unemployment decreases as the level of
6.1.2
production decline economic activity rises
Inflation Falling demand and output reduces Increasing output and spending causes
inflationary pressure prices to rise, fuelling inflation
Economic growth Will slow as businesses cut output and Is stimulated by cheaper loans and rising
investment business investment

Exchange rates Exchange value of currency is likely to rise Exchange value of currency generally falls
Quantitative easing (QE) interest rates. For example, a period of very low interest
rates (as is the case in North America and much of
Since March 2009, interest rates in the UK have been held at
Europe at the time of writing) may encourage decisions
very low levels by the Bank of England. In March 2020, the
on investment as any funds needed will be relatively
rate was cut to 0.1 per cent, the lowest figure ever, as part
cheap, making it likely the profits on a project will
of the government’s response to the Coronavirus (COVID-19)
be higher.
crisis. Many other countries have very low rates of interest
at the time of writing. Rates in Hungary, Hong Kong, South
» Prices Reductions in interest rates may give a business
more flexibility to raise prices as consumers will be more
Korea, the USA and New Zealand are all below 1 per cent.
able to afford loans to buy products. A rise in rates
Such low interest rates limit the flexibility of authorities might put pressure on businesses to reduce prices for
responsible for monetary policy. There is no real possibility some products – especially those (such as cars) normally
to lower rates further to expand production and to help bought using loans.
the economy achieve higher rates of economic growth. » Product development Falling interest rates might
When interest rates can go no lower, a central bank’s only encourage businesses to invest in developing new
monetary policy option is to pump money into the economy products as the cost of doing so may be reduced.
directly. That is quantitative easing (QE). Alternatively, rising rates may persuade businesses to
adapt existing products to reduce production costs and
The way the central bank does this is by buying assets –
boost price competitiveness.
usually financial assets, such as government and corporate
bonds – using money it has simply created. The institutions
» Cutting costs Rising rates may provoke bouts of cost-
cutting as businesses seek to reduce the debts on which
selling those assets (either commercial banks or other
they have to pay interest. This can lead to decisions
financial businesses such as insurance companies) will then
affecting many parts of a business including the sale
have ‘new’ money in their accounts, which then boosts the
of assets, reductions in the size of the workforce and
money supply. The hope is that this money is subsequently
ceasing production of less successful products.
used to purchase goods and services and to boost output
and growth. In 2020, the UK government announced a new
programme of quantitative easing with a total value of GLOSSARY TERMS
£200 billion to help to stimulate the economy as part of its Debt is an amount of money that has been borrowed by a
response to the Coronavirus crisis. Quantitative easing has business but not yet repaid.
also been used by central banks in Japan, Sweden, the USA An exchange rate is the price of one currency expressed
and Brazil. in terms of another. For example, the US dollar might be
worth 0.78 euros.
Business decisions and changes in
monetary policy Exchange rates
Businesses can be affected significantly by changes in An exchange rate is simply the price of one currency
monetary policy, both the use of quantitative easing and expressed in terms of another. Thus, at a particular time,
changes in interest rates. Such changes may prompt a range the Chinese yuan may be worth 3500 Vietnamese dong or
of decisions by businesses, depending on the scale and 4.9 Thai baht.
expected duration of any changes in monetary policy. We
consider a small sample below. London is one of the premier international centres
» Borrowing Changes in interest rates directly affect the for buying and selling foreign currencies – each day
cost of borrowing; quantitative easing can affect them transactions total billions of pounds. Exchange rates
indirectly. Businesses will be likely to adjust the amount between most currencies vary regularly according to the
they borrow and invest in the light of changes in balance of supply and demand for each individual currency.
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The effects of exchange rate changes
Exchange rates can change significantly over time. A rise in HANDLING DATA
6.1.2 the value of a currency is an appreciation; a decline in its
In May 2020, an American company exported cars
value is termed a depreciation.
to Uruguay at an average price of $32 000 per car.
In October 2018, the American dollar exchanged for 32.49 Assuming no other changes, how much would an
Uruguayan pesos ($U). By May 2020, the exchange rate was average car sell for in Uruguay?
$1 = $U44.21. This meant that the value of the Uruguayan
peso had depreciated by just over 36 per cent over the Changes in the value of currencies affect the prices of
period. Alternatively, the value of the American dollar had exports and imports, as shown in Table 6.8.
increased (or appreciated) by the same amount.
▼ Table 6.8 The effects of changes in the value of the Uruguayan peso
The exchange rate of Uruguayan Prices of Uruguayan exports overseas Prices of imported goods in Uruguay
pesos (in foreign currencies) (in pesos)
Appreciates (rises) Increase Fall
Depreciates (falls) Fall Increase
Using the information in Table 6.8, we can see that the fall » If firms agree deals priced in foreign currencies, they
in the value of the Uruguayan peso against the American may receive more or less revenue from a particular
dollar between October 2018 and May 2020 would have had transaction than expected if the exchange rate alters in
the following effects (assuming no other changes): the intervening period. Thus, a deal to sell clothes to
» Prices of Uruguayan exports to the United States of France may give Bangladeshi manufacturers less revenue
America (for example, wool from its Corriedale sheep) than anticipated if the contract is agreed in terms of
would have fallen by approximately 36 per cent. Sales euros and the Bangladeshi taka then rises in value
would be likely to rise as a consequence, and Uruguayan against the euro. In these circumstances, the quantity of
exporters would receive the same amount in pesos per euros stated in the contract will convert into a smaller
kilogram of wool. number of taka, causing a shortfall for the exporter.
» American products (for example, software for computers) » Changing exchange rates can affect prices and sales
imported by Uruguay would have been up to 36 per cent in overseas markets, even if the exporter avoids direct
more expensive. However, the price the Americans received exchange risk by insisting on payment in domestic
in dollars would not have changed. It is likely, however, currency. For example, a London-based clothes
that because prices were higher in Uruguay, American designer may sell clothes overseas but stipulate that
companies would sell smaller quantities of their products. they are paid in pounds sterling. A rise in the value of
the pound may mean that foreign retailers are forced
Small changes in the exchange rates of most countries occur
to increase the prices of the clothes to maintain profit
all the time as demand for the currency and supplies of it
margins. As a consequence, sales may be lower than
alter. A series of slight rises and falls over a period of time
expected, giving the London-based design company
is not necessarily a major problem for industry. Of more
less revenue than forecast.
concern is a sustained rise or fall in the exchange rate,
» Competitors may respond in unexpected ways to exchange
or a sudden and substantial change in the exchange rate.
rate changes. Foreign firms may reduce prices to offset
Governments often seek to control fluctuations in exchange
the effects of an exchange rate change, putting rivals
rates (as we shall see later this chapter), as exchange rate
under pressure to do the same or lose market share.
changes can create uncertainty for a number of reasons.
▼ Table 6.9 Changes in exchange rates
How might Zimbabwean firms respond to a How might Zimbabwean firms respond to a
rising value of the Zimbabwean dollar? falling value of the Zimbabwean dollar?
Exporters • Allow prices to rise in foreign markets reducing • Exporters could allow prices to fall in overseas
probable sales. Remember, exporters receive markets as a result of the exchange rate change.
the same price in dollars for each overseas sale They will receive the same amount in dollars from
but will sell less in this situation. each sale but should achieve higher sales.
• Leave prices unchanged in overseas markets. • Increase their prices to maintain price levels
Sales should be unchanged but the exporter in terms of the foreign currency. Sales should
will receive fewer dollars from each sale. remain constant (depending on competitors’
Neither of these options is attractive to actions) and revenue should rise in dollars as
exporters – a rising exchange rate is bad news. a result.
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How might Zimbabwean firms respond to a How might Zimbabwean firms respond to a
rising value of the Zimbabwean dollar? falling value of the Zimbabwean dollar?
Domestic producers • Reduce prices to compete with cheaper • Enjoy increased sales as a result of rising prices 6.1.2
imports. of competitors’ imported products, assuming
• Enjoy the benefits of cheaper imports of foreign businesses do not hold prices down.
materials and components. • Increase prices (to some extent) to enjoy
• Emphasise other elements in the marketing increased revenues from each sale.
mix; for example, the quality of the product. • Beware the increased cost of imported raw
materials and components.

particular, Toyota has argued strongly for the UK to adopt
STUDY TIP the euro to eliminate exchange rate risk.
Remember that products are not sold on the basis of
price alone. When considering the likely consequences An alternative approach is to require suppliers to price
of a change in exchange rates, it is important to note that their products in a different currency – this is usually
factors such as quality, reputation, after-sales service the currency in which it sells its products. As a result,
and meeting delivery dates are important influences on fluctuations in the exchange rate will have less impact on
buyers’ decisions. a business as it pays suppliers in the same currency that it
receives from its customers.
Exchange rate policy
GLOSSARY TERMS Exchange rate policy is normally implemented by the
A currency appreciates when its value rises against authorities responsible for a country’s monetary policy.
another currency or currencies. Many economists believe that exchange rate policy is a
A currency depreciates when its value declines against part of monetary policy. Exchange rate policy involves the
another currency or currencies. country’s authorities affecting the value of its currency
against those of other countries. This can be done in
several ways:
The impact of changes in exchange rates on » changing the country’s interest rates, as we saw earlier
businesses » buying or selling large quantities of a currency on the
Fluctuations in exchange rates create a great deal of foreign exchange market to alter its value
uncertainty for businesses trading internationally. When » not allowing the currency to have a ‘free’ value
exchange rates are volatile, businesses become uncertain determined by the forces of supply and demand but
about earnings from overseas trade. This adds to the risk imposing a fixed exchange rate. The government can
businesses incur as part of their trading activities. decide at any time to change its fixed exchange rate,
though this approach does bring other problems.
Firms like to operate in a relatively risk-free environment
and to reduce uncertainty. The undesirable consequences of
exchange rate changes can be reduced through the use of The impact of exchange rate policy
techniques such as forward foreign currency markets. This Exchange rate policies have an effect on businesses because
sets a guaranteed exchange rate at some future date (when changes affect the prices of imports and exports. We saw
transactions are completed), meaning that the amount earlier that a fall in the exchange rate makes a country’s
received from overseas trading is more certain. However, exports cheaper overseas, while making imports from
fixing an exchange rate in this way does not guarantee a foreign countries more expensive. In effect, a fall in the
particular level of sales. Furthermore, the bank arranging exchange rate can increase the price competitiveness of a
this service may require a fee. business. Its products can be sold more cheaply overseas
and products sold in its ‘home’ market by foreign producers
Exchange rate changes are more of a problem in will become more expensive. The opposite is true, of course,
markets where fierce price competition occurs. In these for a rise in the exchange rate, which will increase the price
circumstances, demand is more likely to be price elastic of exports from the country concerned while simultaneously
and businesses are under pressure to respond quickly to any making imports cheaper.
change in exchange rates.
The impact of exchange rate policies on businesses may
Businesses may respond to the pressures of exchange vary according to a number of factors, including:
rate changes by seeking to create productive capacity in » how important price is in consumers’ buying decisions.
overseas markets to avoid the effects of changing currency Demand for some products is highly sensitive to price
values. A number of foreign motor manufacturers located in changes; for example, some foods and fuels. Businesses
the UK have revealed that they are considering relocating in operating in price-sensitive markets will be strongly
the euro zone in Europe to avoid the difficulties imposed by affected by exchange rate policy
fluctuations in the value of the pound against the euro. In » the extent to which the business is engaged in overseas
trade. Some businesses buy raw materials, components
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or finished goods from overseas, others sell products expenditure and the amount raised in taxation in any given
overseas, and some do both. Businesses that engage year. In the UK, the fiscal year runs from 6 April to 5 April
6.1.2 heavily in importing and exporting will be more exposed
to changes in exchange rate policy.
the following year; in many other countries it runs from
1 January to 31 December.
The balance between taxation and government expenditure
Business decisions and changes in the UK is determined annually when the Chancellor of the
in exchange rate policy Exchequer announces the annual budget. The government
can operate two broad types of fiscal policy:
Businesses may not respond to changes in exchange rates,
1 Expansionary fiscal policy This entails cutting taxation
especially if they are relatively minor or not expected to be
and/or increasing government expenditure on items
long-term. However, businesses do have a number of ways
such as health, education, social services, defence and

in which they can respond to exchange rate changes when
transport. The effect will be to increase the amount the
necessary.
government borrows to fund its expenditure (known as
» Lower prices This can be effective in offsetting the the public sector net cash requirement or PSNCR) or to
price advantages that overseas competitors might have
reduce the surplus held in the government’s coffers at
following a change in exchange rates due to policy
the end of the fiscal year.
changes. However, one consequence is likely to be a fall
2 Contractionary fiscal policy This is brought about by
in profit margins, unless the business can reduce its
reducing government expenditure or increasing taxation,
costs of production.
or by both policies simultaneously. The effect is to cut
» Adjust quality or the product itself The business may the government’s borrowing or to reduce the deficit on
reduce the quality of its products, possibly by using
its budget for the fiscal year.
cheaper raw materials, or its size if it is a food product,
for example. Figure 6.19 summarises the operation of fiscal policy. Fiscal
» Produce overseas Some multinational businesses can policy can help to stabilise the economy (avoiding the worst
switch production to factories overseas to avoid the effects of the business cycle) through the operation of the
effects of adverse changes in exchange rate policy. This ‘automatic stabilisers’. For example, lower unemployment
is not an option for most businesses. when the level of economic activity is high means temporarily
lower social security spending and higher income tax
Fiscal policy receipts. Higher company profits generate higher tax receipts,
Fiscal policy is the use of government expenditure and and higher spending by consumers yields higher receipts
taxation as a means of controlling the level of activity from indirect taxes. These factors together will have a
within the economy. In particular, a government’s fiscal contractionary effect, dampening an economic boom.
policy is the relationship between the level of government
Results in:
Achieved by:
Expansionary fiscal policy: Increased output and spending,
Cutting rates of taxation
To increase the level less unemployment but
and/or increasing
of economic activity possible increase in inflationary
government expenditure
pressure and more imports
Fiscal policy
Results in:
Achieved by:
Contractionary fiscal policy: Lowered output, spending and
Increasing rates of taxation
To reduce the level of employment; may curb
and/or cutting government
economic activity inflationary pressure and
expenditure
spending on imports
▲ Figure 6.19 The operation of fiscal policy
The impact of fiscal policy on businesses Although the overall effect may be predicted, the
implications for individual businesses will vary according
Tax and expenditure policies can have immediate effects on
to the type of product supplied. Firms supplying luxury
the level of economic activity, although the precise effects
goods (long-haul foreign holidays, for example) might be
will depend upon the types of tax altered and the nature of
significantly affected by a change in income tax rates,
government expenditure.
especially for those earning higher incomes, while those
» Direct taxes These are taxes on income and profits
selling basic foodstuffs may be relatively unaffected.
and, in the UK, include income tax and corporation
tax (levied on company profits). Direct taxes take a
» Indirect taxes VAT (value added tax) is the major tax on
spending in the UK and other EU countries. It and other
larger amount from individuals earning high salaries
taxes on spending are classified as indirect. Changes in
and companies announcing handsome profits. The
this type of taxation can have a rapid effect on the level
government can forecast with some accuracy the effects
of economic activity, although its effects are difficult
arising from an increase (or reduction) in income tax.
to predict. An increase in VAT or other indirect taxes
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will lower consumer spending, reducing demand for items will have a rapid impact, as they are received by
goods and services and, eventually, lowering the level relatively poor members of society who will most likely
of economic activity. For example, Japan increased its
main indirect tax rate from 8 to 10 per cent in October
spend any increase or cut back, if necessary, almost
immediately. An increase in transfer payments often
6.1.2
2019 and this has had a significant impact on consumer results in substantial increases in demand for basic
spending. However, the extent of the fall in demand goods such as food, public transport and gas.
will depend upon the price elasticity of demand for the 2 The infrastructure Governments improve the
goods in question. Consumers will continue to purchase infrastructure through their spending on housing, roads
essentials such as fuel and food, although demand and flood protection. Investment in these areas can
for products associated with home improvements, for increase the level of economic activity by boosting
example, may decline. An important side effect of demand for the services of construction firms while

increasing indirect taxes is that it is inflationary. reducing costs for other firms. A new road, for example,
might cut a business’ transport costs. This, however, is
Government expenditure is the other half of fiscal policy.
a much slower method of altering the level of economic
Governments may alter expenditure in two broad categories:
activity. In 2020, the Chinese government announced that
1 Transfer payments This is expenditure on
it was planning a number of new infrastructure projects
unemployment benefit, pensions and other social
to help to increase the economy’s economic growth rates.
security payments. Changes in expenditure on these
Path of GDP without

Economic activity declines as govt. policies
Level of economic
economy moves into recession,
activity rising rapidly
production rises less quickly GDP following
threatening inflation and
or declines. Unemployment increasing implementation of
increased imports
govt. counter-
cyclical policies
GDP
Govt. policies head off worst

excess of a boom. Slackening
of growth in GDP achieved by
increasing interest rates or increasing Deep slump avoided by policies
taxation, cutting govt. expenditure such as cutting interest rates,
reducing rates of taxation or
increasing govt. expenditure
0
Time
▲ Figure 6.20 Government economic policies at work
to below those in other countries, it may lead to some

GLOSSARY TERMS businesses relocating to that country, particularly those
Direct taxes are taxes on income and wealth; for example, businesses that do not incur huge costs in moving
income tax, corporation tax and inheritance tax. location. One reason why Google has established a
Indirect taxes are taxes on spending; for example, value significant part of its operations in Ireland is the low
added tax (VAT). rate of Irish business taxes. Equally, improvements to a
country’s infrastructure may reduce costs of production,
making it a more attractive location.
Business decisions and changes in fiscal » Production decisions Businesses may adjust their
policy production levels according to the level of taxation and
government spending. Reductions in taxes and increases
Fiscal policy changes can have considerable effects on in government spending can lead to increased demand
business decisions because they can remain in place for long for products. Businesses will need to adjust output
periods of time. A decision by a government to increase accordingly and this may require decisions to increase
indirect taxes or to increase investment in infrastructure productive capacity. The UK government is committed
is likely to continue to have an impact on businesses for to spending heavily on infrastructure over the next few
some time. years and construction businesses will increase their
Changes in fiscal policy may affect a number of decisions capacity accordingly.
taken by businesses, many of them strategic. We consider » Human resource decisions Governments levy a range
some examples below. of taxes on employment. In the UK, businesses have
» Location decisions Changes in rates of taxation and to pay a tax called national insurance for each person
government spending (for example, on infrastructure) employed. Changes in these taxes can affect the cost of
can influence decisions on where some businesses using labour and may lead to decisions to use more or
locate. If a government reduces its taxes on businesses less labour in the production process.
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Supply-side policies » Other supply-side measures Governments have tried to
make other resources more freely available by removing
6.1.2 Supply-side policies are a range of measures intended to
improve the operation of free markets and the amount that
controls on the operation of markets that provide
capital and land. The negotiating of the free movement
is produced by the economy. They can take a number of
of capital throughout the EU has been a major factor in
forms.
increasing the funds available to EU enterprises.
» Labour market measures In recent years, many
governments have implemented policies intended to
allow labour markets to operate more effectively. The The impact of supply-side measures on
UK government has been a strong advocate of allowing businesses and their decisions
labour markets to operate more freely and flexibly.
The effects of supply-side measures on businesses are

For example, by reducing the power of trade unions,
varied and depend on the precise nature of the policy.
businesses were enabled to implement policies to
Labour market measures have the potential to increase the
allow them to use labour more flexibly and efficiently.
number of potential employees and to allow businesses
Employees were able to carry out a range of duties,
to use them more flexibly. Privatisation gives businesses
rather than limited roles, to avoid demarcation disputes.
the opportunity to enter markets that were previously
Disputes and confrontations became less common as a
controlled by the state, or to buy shares in or attempt
consequence of a series of laws.
takeovers and mergers with businesses that were previously
Other policies have been implemented to encourage
state-owned. Other changes allow businesses greater
the effective operation of labour markets. Unemployed
freedom in moving capital and other resources across
people have been encouraged back into the labour force
national frontiers to where they are needed.
through the provision of training programmes designed
to equip them with employable skills, by limiting These effects have significant implications for business
the availability of unemployment benefit to those in managers and owners. They may opt to make decisions, such
genuine need, and by cutting income tax rates on low as expansion, if more labour is available and it is possible
earners to encourage people into the labour force. to use it more flexibly to suit the precise needs of the
» Privatisation As we saw in Chapter 6.1.1, this is the business. Expansion overseas may become more possible
process of transferring organisations from the state if controls on capital and other resources are eased.
to the ownership and control of individuals and other For example, many businesses located in the European
businesses. Privatisation can offer opportunities for Union have expanded into other countries within the EU.
privately owned businesses to trade in markets which Privatisation has given opportunities to businesses to take
were previously government controlled. There may also decisions to enter new markets. For example, in the UK,
be opportunities to purchase state-owned businesses. most water is supplied by private companies. Previously
they would not have been able to operate in this market.
CASE STUDY
China’s economy showing signs of recovery
After initially concentrating on responding to the trouble filling factory floors until early March as workers
domestic Coronavirus (COVID-19) epidemic, the Chinese in (severely) virus-hit
government has switched its attention to boosting the regions such as Hubei and Henan were barred from
performance of its economy, which was badly affected by travelling.’
the virus.
The Chinese government has provided extensive financial
In 2020, China’s National Bureau of Statistics (NBS) support to small businesses. The Global Times of China
released some positive data showing that the country’s said that this support amounted to billions of dollars.
economy is beginning to recover from the worst effects of
Source: www.thestar.com.my/business/business-news/2020/
Coronavirus. All but 4 per cent of the country’s medium- 04/04/china-showing-signs-of-economic-recovery
and large-scale businesses have resumed production and
orders for components and other supplies have increased. Questions
Approximately 80 per cent of employees have returned 1 Analyse two likely effects of rising consumer
to work as the country has ended much of its lockdown. confidence and spending on businesses in China. [8]
Simultaneously, demand for goods and services has risen 2 Evaluate how the Chinese authorities might use
as consumer spending has increased. economic policies to ensure that the economy
A report on labour in China by Caixin Global said that continues to grow steadily over the next few years. [12]
‘Many companies in labour-intensive industries had
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▼ Table 6.10 A summary of methods of government intervention
How governments’ economic policies help businesses

Method of intervention Expected effects
6.1.2
Reductions in the rate of interest Businesses may invest more in new production facilities as the cost of
borrowing is reduced, and consumers may increase spending as loans are
cheaper and saving is less worthwhile due to lower interest rates. The
level of economic activity should rise.
Cuts in direct and indirect taxes May encourage higher levels of production as it becomes more profitable,
and consumers may also increase spending as their net pay (after tax)

rises or as the price of goods falls. Once again, the level of economic
activity should increase.
Increases in government spending (e.g. on Lower-income consumers in receipt of rising benefits are likely to increase
infrastructure or welfare benefits) spending on a range of basic products (as saving of such rises in benefits
occurs rarely). Businesses in construction and engineering sectors may
receive orders from government for infrastructure projects, directly
increasing output. Government’s expenditure on infrastructure is also
likely to increase pay of many associated workers, increasing spending and
therefore production. These effects will increase the level of economic
activity.
Helping unemployed back into work through These supply-side actions should increase the level of economic activity
policies such as training and improving information by increasing the number of people who are in employment and have the
on job vacancies right skills to carry out a job efficiently. This can enable businesses to
increase production and to do so in a cost-effective manner because they
employ suitably skilled workers.
How governments’ economic policies constrain business activity
Method of intervention Expected effects
Increases in the rate of interest By making borrowing more expensive, this is likely to dissuade businesses
and consumers from borrowing for investment or to buy expensive
products such as homes, cars and electrical products. It may also
encourage saving, reducing consumption and investment further.
Increases in direct and indirect taxes This reduces the take-home pay of employees and/or increases the prices
of products. Either of these effects will reduce consumers’ spending
on goods and services and reduce the level of economic activity.
Simultaneously, businesses may have reduced profits available to invest
(and to encourage future investment).
Reductions in government expenditure Reductions in transfer payments, such as pensions, directly affect the
ability of less well-off consumers to purchase goods and services. At the
same time, the government may reduce orders placed with a range of
domestic businesses. The effects of both types of cuts will be to reduce
economic activity.
Implementing health advice policies Economists call products such as tobacco and alcohol ‘demerit’ goods
(e.g. on the dangers of tobacco or alcohol) because they can be harmful and many consumers are unaware of this. As
a consequence, consumers are discouraged from consuming them through
advertising and other policies. This can (and does) result in reduced sales,
leading to lower levels of production and decreased levels of economic
activity.
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TEST YOUR LEARNING
6.1.2 6 Explain two ways in which a government’s anti-
inflationary policy may affect small businesses. [6]
1 a Define the term ‘enterprise’. [2] 7 a Explain one difference between cyclical and
b Explain one way in which a government might structural unemployment. [3]
intervene to help businesses. [3] b Define the term ‘exchange rate’. [2]
2 a Explain one economic objective for a government. 8 a Explain one reason why exchange rate changes
[3] can create uncertainty for businesses. [3]
b Explain one reason why businesses may benefit
b Define the term ‘unemployment’. [2]

from a steady rate of economic growth. [3]
9 Using examples, explain one difference between
3 a Define the term ‘market failure’. [2] fiscal and supply-side policies. [3]
b Explain one way in which market failure may 10 Explain two ways in which a rise in interest rates
affect businesses. [3] might affect an exporter located in India. [6]
4 a Define the term ‘recession’. [2]
b Explain one consequence for a car manufacturer Data response question
of the economy experiencing a period during
The UK’s economic performance
which it doesn’t grow. [3]
5 a Define the term ‘inflation’. [2] Since 2014, the performance of the UK’s economy has
been relatively weak, and there have been signs of
b Explain one effect of inflation on a major
further weakness as its rate of economic growth has
retailer. [3]
fallen steadily. Some key data for the economy is shown
in Table 6.11.
▼ Table 6.11 Selected macroeconomic data for the UK, 2014–19
Year 2014 2015 2016 2017 2018 2019

GDP growth (%) 2.6 2.4 1.9 1.9 1.4 1.4
Inflation rate (CPI, %) 0.5 0.2 1.6 3.0 2.1 1.3
Unemployment rate (%) 5.7 5.1 4.7 4.4 4.0 3.8
Exchange rate ($ per £) 1.54 1.47 1.23 1.35 1.27 1.31
The performance of the UK’s economy over this period 2 Evaluate the effects of the changes in the exchange
has varied between regions. London and the south-east rate over the period 2014–19 on UK exporting
of England have been less affected by slowing growth businesses. [12]
rates. Some businesses have performed well despite 3 ‘The data in Table 6.11 suggests that UK businesses
the difficult economic conditions. For example, Jaguar would have been uncompetitive between 2014 and
Land Rover Automotive performed strongly over most of 2019.’ Evaluate this view. [12]
this period, principally due to its buoyant export sales.
In contrast, some of the UK’s retailers have struggled Essay questions
despite high levels of employment in the UK. 1 Evaluate the extent to which government policies
aimed at reducing inflation cause rapidly expanding
Questions
businesses more difficulties than inflation itself. [20]
1 Analyse one possible consequence of the falling 2 ‘All businesses in a country benefit from a sustained
rate of unemployment for the UK’s businesses. [4] fall in a country’s exchange rate.’ Evaluate the
extent to which this statement is true for a country
of your choice. [20]
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A LEVEL
6.1.3–7

External influences on
business activity: Other
6.1.3 Social and demographic

Chapter overview
★ social and demographic factors affecting businesses
★ technological change and businesses
★ how competitors and suppliers impact on businesses
★ international and environmental factors affecting businesses.
In the previous chapter we saw how the economic 4 Competitors and suppliers The actions of competitors
environment can affect business behaviour. However, can act as a major constraint on business activities.
economic influences are not the only force shaping the For example, businesses can be under pressure to
external environment in which businesses trade. We can deliver new products or to sell at highly competitive
identify at least six other factors that contribute to the prices. In contrast, many businesses, and especially
business environment: manufacturers, rely upon suppliers to deliver raw
1 Social factors Businesses are subject to pressures materials and components promptly and reliably.
from groups in society and social change. Pressure 5 International factors Trading links with other nations
groups in several countries are currently calling on a are important for many businesses. Countries across
number of large businesses, mainly multinationals, to the world have reached trade agreements and advances
pay a ‘fair’ amount of tax on their profits. This may in technology have facilitated trade across national
lead to businesses altering their practices to record frontiers. Multinational companies have played a greater
more profits in the countries in which they operate role in economies, although their relationships with
and therefore to pay a greater amount of tax on national governments have not always been entirely
profits. Simultaneously, social changes are occurring. harmonious.
One example is the increasing number of one-person 6 Environmental factors Managing businesses to minimise
households as more people opt to live alone. The the adverse impact on the environment attracts an
number of one-person households worldwide is forecast enormous amount of attention from the media and
to rise by 30 per cent between 2016 and 2030. This the general public. At the same time, consumers and
change has implications for housebuilders and suppliers businesses have become more aware of the impact
of foodstuffs, both of whom may need to supply larger of their activities on the environment. Businesses
volumes of smaller-sized products. have responded to these concerns by using audits to
2 Demographic changes This refers to changes in the monitor the effects of their activities and seeking more
population structure and size. Such changes can have sustainable approaches to production.
profound implications for businesses. For example,
the population of China is ageing quickly. By 2050, GLOSSARY TERM
approximately 26 per cent of China’s population will
Demography is the study of human populations, including
be aged over 65, compared with 11 per cent in 2018. their size, growth rates and movements.
This change will reduce the quantity of labour available
to China’s enormous manufacturing sector, as well as
creating a significant change in the types of products
that are purchased. The movement of people, for
example, from the countryside to cities is also a notable Businesses are a part of society and are affected by social
change in many countries. changes; equally, businesses’ actions impact upon society.
3 Technological factors Changes in technology are taking Social factors that affect businesses include migration and
place at an increasing rate and can have an enormous new patterns of demand created by changes such as ageing
impact on businesses. For example, the development populations. At the same time, the actions of businesses,
of the internet and online retailing has forced many such as their activities damaging the environment, also
retailers to make significant alterations to their business affect society.
models.
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6.1.3.1 Corporate social responsibility ▼ Table 6.12 Stakeholders’ interests
6.1.3–7 Corporate social responsibility is a business philosophy Stakeholder Possible nature of stakeholder’s interest
that emphasises that firms should behave as good group
citizens. They should not merely operate within the law Shareholders • Expectation of regular dividends
but should consider the effects of their activities on • Rising share prices
society as a whole. Thus, a socially responsible business • Preferential treatment as customers; for
attempts to fulfil the duties that it has towards its example, lower prices
employees, customers and other interested parties.
Collectively, these individuals and groups are termed a Employees • Steady and regular income
business’ stakeholders. • Healthy and safe working conditions
A LEVEL 6.1.3–7 External influences on business activity: Other
• Job security
Stakeholders include shareholders, employees, customers, • Promotion and higher incomes
suppliers, pressure groups and the local community. The
Customers • Certain and reliable supply of goods
interest that stakeholders have in a business will vary
• Stable prices
according to the nature of the group.
• Safe products
• After-sales service and technical support
Local Suppliers • Frequent and regular orders
communities • A sole-supplier agreement
Residents, other • Fair prices
businesses,
Customers
local councils Suppliers Government • Prompt payment of correct taxes to
Providing raw agencies HRMC (the organisation responsible for
Final consumers, materials,
wholesalers, components, collecting some taxes in the UK)
pressure groups services, etc. • Ensuring the businesses operate according
to local laws
The
business Local • Steady employment
communities • Minimal pollution and noise
Employees Government • Provision of facilities (for example,
Individuals, trade agencies scholarships, arts centres or reclaimed
unions, works tax authorities, areas) for the local community
councils local councils
Shareholders
Individuals, Some businesses willingly accept these responsibilities,
institutional partly because their managers want to do so and partly
investors because they fear a negative public image. It can be
argued that socially responsible behaviour can pay off for
businesses in the long term, but it may entail additional
▲ Figure 6.21 Examples of a business’ stakeholders short-term expenditure.
STUDY TIP GLOSSARY TERMS

Corporate social responsibilities are the duties a
Figure 6.21 shows the primary stakeholders for
business has towards employees, customers, society and
businesses, although others exist. When writing about
the environment.
stakeholders, it is important to develop answers fully.
This is impossible if you attempt to cover too many A pressure group is a group of people with common
stakeholder groups – just concentrate on the two or three interests who organise to influence public opinion and the
that are most relevant. decisions of businesses and governments.
Dividends are money that is paid out of profits to the
company’s shareholders. It is a reward to the owners of
Meeting social responsibilities has many implications for the business.
businesses:
» taking into account the impact of their activities on the
local community – protecting employment and avoiding The impact of corporate social responsibility
noise pollution, for instance The nature of a business’ social responsibility will vary
» producing in a way that avoids pollution or the reckless according to the nature of the business. A petrochemicals
use of finite resources company is more likely to be concerned with polluting the
» treating employees fairly and not simply meeting the environment than a bank. On the other hand, in an age
demands of employment legislation of rapid developments in information technology, banks
» considering the likely sources of supplies (and whether may see their corporate social responsibility to be the
they are sustainable) and the ways in which suppliers maintenance of employment. We can identify a number of
meet their social responsibilities. key elements of corporate social responsibility beyond the
responsibilities a business has to its shareholders.
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» Responsibilities to consumers The consumer has Issues associated with corporate social
become a force to be reckoned with over recent decades responsibility
and this has been reflected in the development of
consumerism. Increasingly, consumers have been better
There are a range of issues relating to corporate social 6.1.3–7
responsibility that modern managers have to take into
informed about products and services and prepared
account. We can consider a variety of actions and decisions
to complain when businesses let them down. The rise
that managers might – or might not – take if their business
of consumerism has meant that businesses have been
is to be judged as socially responsible. Taking the positive
required to behave more responsibly by looking after
approaches outlined below would assist most businesses in
the interests of the consumer. Offering high-quality
meeting their social responsibilities.
customer service, supplying high-quality products that
» Engaging in sustainable production Many

are well-designed and durable at fair and reasonable
manufacturers have considerable potential to cause
prices should create satisfaction and, quite possibly,
damage to the environment. Using sustainable
generate repeat business.
production processes (sometimes at considerable
» Responsibilities to employees Businesses have a
cost) can reduce or eliminate many forms of pollution.
variety of responsibilities to their employees that are
Malaysia, the world’s second largest producer of palm
not a legal requirement. For example, firms should
oil, has pledged to conserve a minimum of 50 per cent
provide their employees with training to develop
of its total land area as preserved forests. In 2010, 58
their skills as fully as possible and make sure that the
per cent of Malaysian land remained as forest. For many
rights of employees in developing countries (where
businesses, the impact of their sources of supply can be
employment legislation may not exist) are protected
considerable. Using sustainable sources for resources
fully. This may mean paying higher wages and incurring
means that future generations will have access to the
additional employment costs.
same materials. Body Shop International’s refusal to use
» Responsibilities to the local community Firms can
any materials that are unsustainable or any components
benefit from the goodwill of the local community. They
that have been tested on animals reflects a sense of
can encourage this by meeting their responsibilities
responsibility to many relatively poor communities in
to this particular stakeholder group. This may entail
developing countries and to animals.
providing secure employment, using local suppliers
whenever possible and ensuring that the business’
» Putting employees before profits Maintaining
employment, even when the level of sales is not
operation and possible expansion does not damage the
sufficient to justify this, is an important means of
local environment.
fulfilling corporate social responsibilities, as is the
» Responsibilities to suppliers Businesses can promote
continuation of unprofitable factories to avoid creating
good relations with suppliers by paying promptly, placing
high levels of localised unemployment. These types of
regular orders and offering long-term contracts for
policies are only really possible in the short term, unless
supply. These are not legal requirements and might result
the business in question is earning handsome profits
in higher prices for materials and components but may
elsewhere.
also assist suppliers to meet their own responsibilities –
for example, in the maintenance of employment.
» Supporting local communities This is an important
way of fulfilling social responsibilities which can
Over recent years, businesses have become much more provide the public with a clear perception of the ‘caring’
aware of the expectations of stakeholder groups. In the side of modern businesses. The US Bankcorp is one of
past, managers were expected to operate businesses largely the largest banks in the USA and provides banking,
in the interest of the shareholders. A growing awareness investment, mortgage and payment services to millions
of business activities by consumers and other stakeholder of individuals and businesses. In 2019, it gave $13
groups has complicated the task of the management million to workforce development programmes across the
team. Businesses are also subject to the attentions of country that provided education critical to long-term
pressure groups pursuing a particular interest. For instance, economic success. This is part of the bank’s commitment
Greenpeace campaigns to protect the environment and its to supporting the communities in which it trades.
activities have significant implications for businesses. For » Social auditing Carrying out social audits is not a new
example, it is acting against uncontrolled deforestation idea – businesses in the Netherlands used this idea as
in Indonesia and Malaysia which is creating palm-oil long ago as 1966. Social auditing assesses the impact
plantations. Today’s managers have to attempt to meet the of a business’ activities on society as a whole. It is
conflicting demands of a number of stakeholder groups. not simply a measure of financial performance. Many
successful businesses recognise that they will only
GLOSSARY TERMS prosper in the long term if they satisfy the needs of all
their stakeholders – and are seen to be doing so.
Sustainable production occurs when the supply of a
In 2019, over 90 per cent of the world’s largest
product does not impose costs on future generations by,
for example, depleting non-renewable resources.
companies engaged in some form of social auditing.
High-profile examples include Bosch, Walt Disney, BMW,
Social auditing is carrying out independent investigations
IKEA and Lenovo. Social audits normally have several
into the impact of a business’ activities upon society in
elements. Businesses start the process by designing and
general.
implementing policies, setting out how they will manage
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the impact of their businesses on society as a whole. Social audits can be a valuable exercise for firms to
This may include issues such as: conduct. They may identify antisocial (or potentially
6.1.3–7 – using sustainable sources of raw materials
– ensuring that suppliers trade ethically, avoiding, for
antisocial) behaviour before problems arise. This
helps to promote the corporate image of the business
example, the use of child labour as a caring and responsible organisation. However,
– operating a thorough health and safety policy above conducting an audit of this kind is not a guarantee that
legal requirements, thereby protecting the well-being a firm is socially responsible. Managers must ensure
of employees that social policies are carried out effectively at all
– engaging in a continuous process of environmental levels within the organisation and that employees
management, monitoring the effects of production are committed to them. Sufficient resources must be
on the natural environment devoted to ensuring that the business remains socially
– trading ethically and attempting to take account of responsible, and problems identified in social audits
the moral dimension in decision-making. should be resolved speedily. The danger of a less active
The next stage of social auditing is that an independent approach is that social audits publicise weaknesses
body monitors the effectiveness of these policies and the and firms are seen not to respond, with damaging
impact on society generally. Finally, once the social audit consequences for their corporate image.
is complete, businesses review their policies in the light
Businesses can engage in activities which are generally
of the information from auditors. In most cases the social
regarded as being harmful to society in general. We consider
audit is published in a process known as social reporting.
three examples of ways in which businesses might behave
that are not considered socially responsible.
Suporting Putting
Social
local employees
Sustainable 1 Paying incentives for the award of contracts Some
auditing production businesses have been accused of paying bribes to other
communities before profits
organisations to win contracts to supply products. This
is unethical and means that markets do not operate
Actions having a positive efficiently. Without the payment of bribes, it would
effect on society be expected that the supplier offering the best value
for money would be awarded a contract. In a fair
competition, businesses would consider the cost and
Corporate social the quality of the product to make a decision on which
responsibility supplier to use. Payments by suppliers to win contracts
means that this no longer applies. Such actions can
result in companies keeping inaccurate records of their
Actions having a negative financial affairs, governments receiving lower tax
effect on society receipts and consumers buying products which are not
the best that might be available to them under truly
Paying incentives Using certain Presenting the free competition. Unfortunately, there have been a
to win contracts accounting practices business or its number of examples of large businesses engaging in
products inaccurately
paying bribes to win contracts. We look at one high-
▲ Figure 6.22 CSR and positive and negative actions profile example in the case study below.
CASE STUDY
Airbus fined for paying bribes to win contracts
Airbus is a European company that manufactures aircraft. Airbus admitted that it had used agents to pay bribes
In 2020, it was fined £3 billion for paying large bribes in to win contracts for supplying aircraft. Prosecutors in
20 countries to ensure it received contracts to supply France had investigated possible cases of bribery in other
aircraft. The investigation into Airbus’ corruption took four countries including China and Japan.
years and involved enquiries in a number of countries,
including the UK and France. This fine was the largest Questions
ever imposed on a company for corruption. 1 Analyse one reason why paying bribes in this way
is not in the interest of society in general. [4]
The judge at the court in London said that the company’s
2 Evaluate whether paying the £3 billion fine or the
offences were ‘grave’ and that the use of bribes was
loss to Airbus’ reputation will have the biggest
clearly a major problem within Airbus. The court was told
impact on the company. [12]
that in the four years after 2011, Airbus had paid bribes
in Malaysia, Sri Lanka, Indonesia, Taiwan and Ghana.
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2 Accounting practices A business’ accounts are a
financial record of its trading activities over a period GLOSSARY TERMS
of time. They are supposed to be a ‘true and fair’ record
of what has happened and give an accurate picture of
Window dressing is the preparation of financial
documents in order to present a company’s performance
6.1.3–7
the business’ financial position. This has not always in the best possible light.
been the case, and businesses have engaged in a range Social accounting (also known as corporate social
of accounting practices to present their financial responsibility reporting) is the process of communicating
performance in a more favourable light. Some are illegal, the social and environmental effects of a business’
while others are not illegal but are not ethical. operations to its stakeholders.
Some practices, such as hiding the level of the business’
debts, are illegal. In 2001, the managers at Enron, an

American commodities and energy company, hid huge 6.1.3.2 Why businesses need to consider
debts that the company owed. When this was revealed,
the company collapsed. Shareholders and investors lost
the needs of the community
over $74 billion and thousands of employees lost their It is easy to argue that by meeting the needs of the
jobs. In 2008, Lehman Brothers (a bank) also hid the communities in which they operate, businesses are likely
extent of its debts, prompting the business to collapse to reduce profitability. Providing workers with ongoing
when this became public. training, investing in facilities for the local community,
Other accounting practices may be legal and are trading with suppliers who do not use cheap child labour
often called window dressing as businesses attempt and only engaging in non-polluting production techniques
to make their financial performance look as positive to protect communities will all increase costs. The outcome
as possible. These include borrowing short-term at a for the business will be lower profits and reduced levels of
vital point to make the business’ cash position look competitiveness. However, this is a relatively simple view
favourable or valuing certain assets (such as brands) at and there are more subtle arguments in favour of businesses
what might be considered excessive levels to increase fulfilling their obligations to the community.
the company’s value. Finally, some businesses may » To project a positive public image Some businesses
bring forward sales to an earlier trading period to have a high profile with regard to issues of social
increase profitability during that period. responsibility. For example, many people see oil
3 Presenting the business or its products inaccurately companies such as Shell and ExxonMobil as having
It is natural that a business will present itself and its enormous potential to pollute. The directors of these
products in the best way possible. After all, it wants to companies have recognised this and regard socially
achieve the highest levels of sales possible. Businesses responsible behaviour as an important competitive
may use terms in their advertising which may not be weapon. As an example, Shell supports education and
entirely clear. For example, following concerns about produces much valuable material for use in schools and
the impact of plastic on the global environment, many colleges. In particular, the company gives information
businesses claim to sell products with packaging that on environmental matters. Clearly, both Shell and
is biodegradable. However, this can be meaningless ExxonMobil hope that being seen to be socially
as most materials do biodegrade over time, although responsible will improve their sales.
some plastics can take hundreds of years to do so. In The actions of all businesses are more open to scrutiny
September 2015, the authorities in the USA discovered nowadays than in the past, making it increasingly
that many Volkswagen cars being sold in America had important to manage their public image. At the same
a ‘defeat device’ – or software – in diesel engines that time, consumers have become more concerned about
could detect when they were being tested, changing the impact of businesses on their communities. Recent
the performance accordingly to improve results. A research in the USA has revealed that over 65 per cent
number of stakeholder groups can be affected by these of consumers will be less likely to buy products from
actions. For example, in the case of Volkswagen’s ‘cheat’ businesses that damage the environment or do not care
technology, consumers buying the company’s products for their employees and local communities. Businesses
did not receive the product they believed they were are also subject to the attentions of pressure groups
buying. People throughout the USA and other countries pursuing a particular interest. For example, Greenpeace
could also be subject to higher levels of air pollution as campaigns to protect the environment and Amnesty
a consequence as well. International seeks to protect human rights. Both
pressure groups operate globally, and the actions
A growing proportion of businesses are engaging in of pressure groups such as these can highlight any
corporate social responsibility reporting or social behaviour by businesses which harms the communities
accounting. As a result, a ‘successful’ business might not in which they operate. Pressure groups can generate
be the most profitable but the one of most value to all adverse publicity with the potential to damage sales. As
sections of the society within which it operates. companies become larger, they often operate globally
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and managing these huge enterprises becomes more It may be that looking after the interests of everyone in the
difficult. Many multinational companies operate global community by engaging in socially responsible behaviour
6.1.3–7 supply chains in which it is very difficult to monitor the
activities of all suppliers. Pressure groups will publicise
might reduce profits in the short term, but over a longer
timescale the marketing advantages may dominate and
any actions by suppliers which are harmful, such as the profits could increase.
use of unsafe factories, and the impact can be quite
damaging for any businesses linked to these suppliers. 6.1.3.3 Demographic changes
Demographic change covers any change in the population,
including average (or median) age, life expectancy, family
structures and migration between countries. Demographic
change can be analysed at global, national or local levels.
Global demographic changes

Population growth and size
One notable change in the global population is that it
is growing quickly, particularly since 1950. In 2019, it
was 7.7 billion and is forecast to reach nearly 11 billion
people by 2100. However, the rate of growth of the world’s
population is forecast to slow significantly by the end of
the current century, when the rate of change is expected
to be around zero. The actual and forecast changes are
▲ Figure 6.23 Pressure groups seeking to protect human shown in Figure 6.24.
rights have publicised the terrible effects of a factory
fire in India in 2020. The fire killed seven people in a HANDLING DATA
factory which supplies denim to major clothing suppliers
throughout the world. 1 Use the information in Figure 6.24 to calculate the
percentage change in global population between:
» To reduce costs of production Sometimes, behaving
a 1950 and 1987
in a socially responsible manner by considering the
b 1987 and 2019
needs of the community may reduce production
c 2019 and 2050 (forecast).
costs. Treating employees with respect, providing 2 The increase in the size of the population is similar
good training and paying above the going rate may in each of these periods. Explain why the percentage
improve motivation and performance and reduce labour figure falls over time.
turnover. For businesses where labour represents a high
proportion of total costs (banking and insurance, for
example), this could represent an important saving. The growth in the global population will not be evenly
Furthermore, building a reputation as a ‘good’ employer spread throughout the world. Some continents, such as
may help the business to attract the most talented Africa, are forecast to have very rapid population growth,
employees, which can assist in improving levels of whereas the population of Europe is forecast to decline.
creativity and productivity. A survey of companies in More than half of global population growth between now
the USA ranked Microsoft as the country’s top employer. and 2050 is expected to occur in Africa. Africa has the
The company scored highly for paying employees well, highest rate of population growth among major areas.
investing to provide facilities in local communities and The population of sub-Saharan Africa is projected to double
in protecting the environment. This can give businesses by 2050.
in technology industries an important competitive
On the other hand, the populations of 55 countries or areas
advantage.
in the world are expected to decrease by 2050, of which
» To create product differentiation In markets 26 may see a reduction of at least 10 per cent. Several
where little product differentiation occurs, adopting
countries are expected to see their populations decline
a position where the business is seen to care for the
by more than 15 per cent by 2050, including Bosnia and
community may improve sales and profits. This can
Herzegovina, Bulgaria, Croatia, Hungary, Japan, Latvia,
be important in making a business stand out from its
Lithuania, Republic of Moldova, Romania, Serbia, and
rivals. It can help to maintain customer loyalty and to
Ukraine. Figure 6.25 summarises the differences in forecast
attract new customers. It can also enable a business
population growth for the world’s continents.
to charge higher prices than some competitors who
may not possess the same public image. In the UK, the
Co-operative Bank is notable in the banking sector in
promoting its ethical and socially responsible views.
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2.1% 10.9 billion
Annual growth rate of the world population in 1968 in 2100
World population 6.1.3–7

9.7 billion
in 2050
7.7 billion
in 2019

1.08%
in 2019
5 billion
in 1987
2.5 billion
0.04% was the average in 1950
2 billion
population growth rate
in 1928
between 10 000BCE
1 billion
and 1700
in 1803
600 million
in 1700
0.1%
1700 1750 1800 1850 1900 1950 2000 2019 2050 2100
Projection
Source: Our World in Data (author Max Roser); https://ourworldindata.org/future-population-growth

▲ Figure 6.24 World population growth 1700–2100
+26% 37–41
North –4% North 40–46
America Europe +20% Europe 29–40
Asia America
Asia
+115% 19–25
+27% Africa 27–41 Africa
Latin and Latin and
South South
America
+48%
America
32–37
Oceania Oceania
Source: UN Source: UN
▲ Figure 6.25 Changes in population 2013–50 ▲ Figure 6.26 Rises in median population age, 2013–50
The average age of the global population countries. Figure 6.26 summarises how the average age of
The global population is ageing, which is reflected in the population will rise in different parts of the world.
higher average age for the populations of most countries.
Nearly every nation in the world is experiencing growth in
Migration
Research into migration by the International Organisation
both the number and proportion of older persons in their
for Migration has produced some startling statistics:
populations. By 2050, about 16 per cent of the global
population will be aged over 65, compared to 9 per cent
» In 2017, approximately 272 million people were
international migrants, or 3.6 per cent of the world
in 2019. In 2050, one in four persons living in Europe and
population, and approximately 750 million were internal
North America could be aged 65 or over. In 2018, for the
migrants.
first time in history, persons aged 65 or older outnumbered
children under five years of age globally. The number of
» About 51 per cent of international migrants reside in
10 countries. The most popular destination country
persons aged 80 years or over is projected to increase by
is the United States (where 49.8 million foreign-born
198 per cent, from 143 million in 2019 to 426 million in 2050.
people officially resided in 2017), followed by Germany
There are two major causes of the ageing global population. (12.2 million), Saudi Arabia (12.2 million), the Russian
Fewer people are being born and people are living longer. Federation (11.7 million), the United Kingdom (8.8
The result is fewer younger people and more older people million), the United Arab Emirates (8.3 million), Canada
driving up the average age of the population in almost all and France (7.9 million each), Australia (7.0 million) and
Spain (5.9 million).
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» The top five countries by size of their diasporas (number » rising average ages
of international migrants living abroad) in 2019 were » large migrant flows.
6.1.3–7 India (17.5 million), Mexico (11.8 million), China (10.7
million), the Russian Federation (10.5 million), Syria (8.2
However, other factors vary between different countries. In
terms of population growth, many countries in Africa have
million) and Bangladesh (7.8 million).
forecast much higher rates of population growth, while some
» Europe has a relatively high proportion of international
European countries are anticipating falling populations.
migrants in its population – over 10 per cent on
average. Countries in northern and western Europe have Population flows within nations
the highest shares, with some cities having very high There are large-scale population movements taking place in
proportions. For example, in 2018, 36 per cent of the many countries. One of the most prominent of these is the
population of London were born overseas. movement of people from rural areas to towns and cities.
Figure 6.27 gives some indication of the size, sources This is a process called urbanisation. It has taken place on
and destinations of flows of international migrants. Many a large scale in developing countries, where workers move
migrants move from countries with relatively low incomes from the countryside to seek better-paid employment in the
to those with higher average incomes. increasing number of factories that are operating in urban
areas. China’s urban population rose from 45 to 60 per cent
of its total population between 2007 and 2019. The Economist
National demographic changes forecasts that the country’s cities will eventually be home
We saw above that there are two changes in population to approximately 1 billion people – about 70 per cent of the
which are common to most nations. These are: country’s population.
Source: SAGE Publications
▲ Figure 6.27 Flow of migrants between the world’s countries and regions, 2010–15
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But urbanisation is not limited to emerging economies » The global trend towards urbanisation means that many
such as that of China. Most countries in the world have cities and large towns have experienced increasing
experienced this phenomenon. In 2019, for example, 83 per
cent of people in the USA lived in urban areas. Table 6.13
populations.
» The attractiveness of a particular locality within a
6.1.3–7
shows the rates of urbanisation for a selection of countries country depends on a range of factors including wage
in 2000 and 2018. levels, availability of jobs and the cost of housing.
» Some rural areas (for example, prosperous seaside towns)
GLOSSARY TERM can attract people who have retired.
Urbanisation is the movement of people from the In the UK, places with coastlines such as Dorset, Devon and
countryside to live in cities. Cornwall attract people of retirement age from elsewhere

in the UK. London’s population is growing, like many other
▼ Table 6.13 Urbanisation rates for a selection of countries, cities. It is a very popular home for people aged 20–29, but
2000 and 2018 every other age group in London declined in number between
2014 and 2017. The places in the north of England that saw
Country Population living in urban areas (%) the largest increases in population were rural areas.
2000 2018
Japan 79 92 STUDY TIP
Argentina 89 92 The information about local changes relates mainly to
Netherlands 77 91 the UK. You should investigate the population changes in
your country and consider how businesses may respond
UK 79 83 to this.
Portugal 54 65
Nepal 13 20
6.1.3.4 The impact of social and
Indonesia 42 55
demographic change
Source: World Bank data, https://data.worldbank.org/
indicator/SP.URB.TOTL?locations=US
The impact of corporate social responsibility
We have already seen that consumers throughout the world
are better informed about the activities of businesses
HANDLING DATA with respect to the environment and their stakeholders.
Developments in technology, and notably the rising use of
In 2000, the population of Japan was 127 million and, by social media to report behaviour by firms that is deemed
2018, it had fallen slightly to 126 million. Use the data in unacceptable, have had a significant impact on corporate
Table 6.13 to calculate how many additional Japanese decision-making. Bad news about a company can be shared
people were living in urban areas in 2018 compared to and re-shared thousands of times, reaching many potential
2000. consumers. Companies have to be aware of this and aim to
avoid being the subject of bad news.
The other important factor in national population changes Businesses have to care about being socially responsible
is the impact of global migration flows on national because their customers do. A number of studies have
populations. Figure 6.27 shows that there have been shown that a business’ CSR policies increasingly influence
significant flows from lower-income countries to those with consumers’ spending decisions. For example, a survey by
higher average incomes. This has resulted, for example, in Landor Associates, the branding company, found that 77 per
substantial flows from countries in Africa and south Asia cent of consumers say it is important for businesses to be
to countries in North America and Europe. Many of these socially responsible.
migrants are young males. Between 1990 and 2019, most
of the increase in the number of international migrants Being judged to be a socially responsible business can
occurred in high-income countries (98 million), whereas the help organisations to attract the best employees and
middle-income and low-income countries only added about to build a strong employer brand. In a global workforce
20 million to their migrant population (17 million and 3 study by Towers Perrin, the professional services firm, CSR
million, respectively). was identified as the third most important influence on
employee engagement. And it is likely to become more
important: a survey by the accountancy firm, Deloitte,
Local demographic changes
revealed that among employees aged 18–26, a business’
These can vary from country to country but a few trends degree of social responsibility is an important influence on
may be observed: their decision to work there.
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Acting in a socially responsible manner can also help » Choosing suppliers is an increasingly important issue for
businesses to access new markets, and this can be very firms which are keen to confirm that their raw materials
6.1.3–7 attractive at a time when globalisation is increasing
competitive pressures. CK Prahalad (who was a well-known
and components come from socially responsible firms.
Many firms operate a code of conduct for suppliers,
business author and Professor of Corporate Strategy at including the American restaurant chain McDonald’s.
the University of Michigan) made a case for the fastest This fast-food company operates a code of conduct
growing new markets and entrepreneurial opportunities prohibiting suppliers from using child labour and
being found among the billions of poor people ‘at the insisting upon basic health and safety standards. The
bottom of the [financial] pyramid’. Thus, companies that company has a contractual right to inspect suppliers’
can incorporate socially responsible behaviour within their premises to ensure their code of conduct is implemented.
strategic decision-making may be able to gain access to » Supporting the local community is an important way
these markets and benefit over time from their growth. of fulfilling social responsibilities. It can provide the
Business decisions and social responsibility public with a clear perception of the ‘caring’ side of
modern businesses. During the Coronavirus (COVID-19)
Businesses can take a variety of decisions and actions, crisis in 2020, Adobe, the American software company,
allowing them to meet their responsibilities to their supported education at home by allowing students,
stakeholders in general. schools, colleges and universities free access to its
» For manufacturing businesses, the impact of their desktop apps online. Visa, the American multinational
sources of supply can be considerable. Using sustainable financial services company known for its credit
sources for resources means that future generations and debit cards, has built partnerships with local
will have access to the same materials. The French governments and non-profit enterprises around
multinational company, Danone, manufactures a range of the world with the aim of increasing the degree of
food products. It has made sustainability a priority and financial inclusion of the world’s poorest people. Visa’s
is pursuing a range of policies to achieve this priority; integration of CSR into its strategic decision-making
for example, reducing its CO2 emissions. is offering poorer people in developing countries new
» Many manufacturers have considerable potential to means to pay and receive money, as well as to save. It
damage the environment. Taking decisions to alter also helped to increase the company’s revenues, which
production processes (sometimes at considerable cost) rose by over 17 per cent in 2019 compared with 2018.
can reduce or eliminate many forms of pollution. In » More than half of the best-known companies in the
2020, Avantium, a Dutch biotechnology company, UK (those making up the FTSE 100) are members
announced a pioneering project that hopes to make of Business in the Community. This organisation
plastics from plant sugars rather than fossil fuels. The exists to assist member companies in ‘continually
project has the backing of Coca-Cola, which hopes to improving, measuring and reporting the impact that
secure the future of its bottled products by tackling the their business has on their environment, workplace,
environmental damage caused by plastic pollution and marketplace and community’.
dependence on fossil fuels.
CASE STUDY
Global Reporting Initiative
Global Reporting Initiative (GRI) has pioneered and GRI has its headquarters in Amsterdam in the Netherlands.
developed a comprehensive Sustainability Reporting This acts as a hub, co-ordinating the activity of GRI’s many
Framework that is widely used around the world. The network partners. GRI has regional offices in Australia,
Framework enables all businesses to measure and report Brazil, China, India and the USA. Its global network
their economic, environmental, social and governance includes more than 600 supporters as well as 30 000 people
performance, thus enabling businesses to be more representing different businesses and industries.
transparent. This transparency and accountability builds
stakeholders’ trust in organisations and can lead to many Questions
other benefits. Thousands of businesses of all sizes and in 1 Analyse two differences between an oil company’s
many different industries use GRI’s Framework in order economic performance and its social performance. [8]
to understand and communicate their performances to 2 Evaluate the benefits businesses might receive
stakeholders. from using GRI’s standard format to report their
performance to stakeholders. [12]
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population over the long term, even if the more modest
GLOSSARY TERMS demographic forecasts are correct.
Strategic decision-making relates to choices made by
senior managers over the long-term plans of the business.
However, if income per head remains low, or even declines, 6.1.3–7
the impact on demand may diminish considerably. The
Accountability is the extent to which an individual or group
population of Nigeria is expected to increase from 200
is held responsible for a decision or policy.
million currently to 900 million by 2100. If incomes rise,
this would be a highly attractive market for many businesses
The impact of demographic change and as it will have a larger population than the USA. It would
also comprise many younger consumers who might buy the
business decisions products of fashion clothing and technology companies at

The implications of demographic change and population a time when demand in some countries with declining and
movements are potentially immense but also difficult to ageing populations may be stalling. Businesses may need
predict as population forecasts can vary widely. The picture to make strategic decisions about entering new markets
is further complicated by a lack of certainty about likely to take advantage of these opportunities. These may be
income levels in some countries which experience rapid profitable in the longer term but could involve a high
population growth. Demand for a wide range of goods and degree of risk. Other firms will find these opportunities
services could increase rapidly along with the size of the attractive and they could prove highly competitive.
CASE STUDY
Demographic change and the UK leisure industry
In 2013, Visit England commissioned Trajectory, a leading
insight and futures consultancy, to report on forecast
changes in the external environment for businesses in the
leisure and tourism industry over the period 2013–23.
The information below is part of its report.
▼ Table 6.14 A summary of population and social change trends
Type of demographic change Possible implications

Ageing society As life expectancy increases, there will be increasing numbers of older people in society.
Vertical family (where several Driven by both rising life expectancy and lower fertility rates, the shape of the family is
generations of the same changing.
family live in one household)
Baby boom Over the past 15 years, a sustained rise in the birth rate has caused a mini baby boom.
Untraditional families New types of family are emerging, including step families, same-sex parents and older
parents.
Changing ethnic profile There is a rising number of both BAME and foreign-born people, whose tourism habits need
to be understood.
Squeezed middle generation Amid rises in the number of younger and older people, the number aged 35–49 is falling.
Multi-speed demography For different regions and local authorities, the speed and nature of these changes will vary.
Key implications for the leisure industry ● Black and minority ethnic (BAME) and immigrant
populations’ tourism habits are currently poorly
● Families are changing in size, shape and composition, and
understood, but are an increasingly large part of the
are far removed from the traditional ‘nuclear’ family –
market.
tourism businesses need to be flexible and responsive.
● A baby boom and an ageing population will see an Source: www.visitengland.com/sites/default/files/
emphasis on the intergenerational family holiday. visit_england_report_print_tcm30-39493.pdf
● Grandparents will be younger than ever before, and
retiring baby boomers will prioritise their leisure time. Questions
● A sharp rise in the number of over-80s will see a 1 Analyse two possible decisions that a UK hotel chain
generation keen to go on holiday but potentially reluctant might take in response to the opportunities provided
(or unable) to travel far. by the forecast demographic changes for the UK. [8]
● The ‘squeezed middle generation’ (those aged 35–49 2 ‘Forecast global demographic changes offer more
in 2020) will be lacking free time and willing to treat opportunities than threats for UK businesses.’
themselves. Evaluate this view. [12]
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The ageing populations of Europe and Japan will provide migrants to the cities which may not be well catered for
increasing opportunities for a range of businesses supplying by existing businesses. It is, of course, easier to gain a
6.1.3–7 products, such as health care and leisure products. However,
the scale of these opportunities can be difficult to predict
customer base in a market that is growing.
over the longer term. The Office for Budget Responsibility

(OBR) has predicted that health care spending in the UK
could range from 7.8 to 16.6 per cent of GDP in 2061,
compared with 7.1 per cent in 2018–19. At the same time,
the UK will have a larger number of young people due to a
rise in its birth rate since the 1990s.
Businesses will have opportunities in the form of the

development of new markets (for some ethnic groups), as
well as the expansion of existing ones, such as those for
the young and very elderly. The latter may prove attractive
as it may involve functional and less risky decisions as
businesses seek to increase sales in growing markets in
which they already operate.
HR managers will also be able to use the innovative
▲ Figure 6.28 Masdar City in Abu Dhabi in the United
potential of diverse workforces towards achieving business
Arab Emirates will incorporate the latest technology in
goals. Recent research has identified a strong correlation
construction, energy supply and transportation. It will be
between those businesses that employ diverse workforces completed by 2025 and will be home to 50 000 people and
and the level of the businesses’ performance. Drawing on 1500 clean technology businesses
the changing composition of populations, as is occurring in
the UK, can enhance a business’ competitiveness. The most The threats to businesses of demographic change and
innovative companies are already using increasingly diverse population movements can take the form of increased
workforces in terms of gender, ethnicity, age and values. competition, possibly from overseas businesses, attracted
For many other businesses, opportunities and threats by the growing market. Competition may force up the
will coexist. Changes in the structure and location of price of resources such as land and property, pushing up
population, caused by age changes, urbanisation and the operating costs of businesses in urban areas. Rents for
migration, will create new or expand existing market offices in major cities are rising quickly; rents for office
segments or niches. Enterprises which can respond quickly space in New York are approximately four times those in
or which are proactive may be able to exploit new markets, rural areas of the USA. Businesses in urban areas may face
especially with the use of appropriate technology. The squeezed profit margins as a consequence, unless they can
threats of competitors growing at their expense will be take decisions to locate in less costly areas.
greater for businesses that do not recognise that this
element of their external environment is changing rapidly.
6.1.4 Technological
Urbanisation throws up a range of issues for businesses.
In the twenty-first century, the rate of technological
Opportunities exist in providing many different goods and
progress is increasingly rapid. The last few years have seen
services to markets that are growing quickly. The consumers
a number of technological advances that have significant
of these goods may be individuals, other businesses and
implications for businesses. The internet has probably been
governments. This high level of investment is likely to be
the biggest single technological factor leading to change
replicated in urban areas across the world, as governments
in business behaviour, but other sources of technological
seek to provide transport and communication facilities
change, such as biotechnology, are also having and will
to allow cities to flourish. Companies that can provide
continue to have substantial effects on businesses and
technological solutions to problems (such as providing
their decisions. Technological change impacts on many
large amounts of cost-efficient, renewable-energy, high-
areas of a business and requires managers to make decisions
technology, low-carbon transport) will benefit from the
in response. Some possible impacts and responses are
process of urbanisation. Urbanisation can also provide
summarised in Table 6.15.
opportunities for new businesses to supply the needs of
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▼ Table 6.15 Examples of the impact of technological change on business functions and some possible responses
Area of business Examples of impacts

Creation of new markets
Some possible responses
Development of new products to meet demand in new markets
6.1.3–7
Marketing New means of communicating with Businesses adopt new methods of marketing communications
customers and distributing products
New methods of internal Location decisions may change. New technology may be
communication used to create more efficient communication with other
stakeholders, such as suppliers
6.1.4 Technological
Operations management Different ways to design and Using new technology to seek competitive edge when
produce products developing new products or processes. Some smaller
businesses may seek to operate in niche markets or engage in
merger or takeover activity
Different methods of May result in more homeworking or closer supervision of
communication employees to improve productivity
Human resources
New methods of production Adjustments to workforce to reflect changing methods and
maintain competitiveness
patterns in, and influences on, buyer behaviour. This can

6.1.4.1 The impact of technological then inform the development of new goods and services.
change The beauty industry was one of the first industries to
Marketing decisions use the power of large-scale data gathering and analytics
Technological advances have created new markets for new in order to better understand and respond to customers’
products and new ways to sell them. needs. Companies like Alibaba’s Tmall Innovation Group in
China have access to data gathered from more than 4 billion
New markets and new products customers to draw from when developing new, innovative
New technology can open up new markets for businesses. In products that appeal to their customer bases.
1990, mobile telephones were unheard of by most people. Using technology in the products themselves, rather than
In 2019 alone, 1.37 billion smartphones were sold globally in the production process, also offers great advantages to
by manufacturers. Companies such as Samsung, Apple, businesses. Firms possessing a technological lead over rival
Huawei and Xiaomi have grown as a consequence of the producers are frequently able to charge a high price for
developments in this field of communications technology. their products – at least until the competition catches up.
Markets for voice-controlled devices, such as Amazon’s This technique of price skimming is likely to boost profits.
Alexa speaker, have been created as a consequence of Possessing a technological edge may attract new customers
technological advances. A forecast by Juniper Research to a business. Apple sets very high prices for the latest
estimates that there will be 8 billion voice-controlled models of its smartphones, while older models are sold at
devices globally by 2023. Today, there are multibillion-dollar lower prices once they are no longer considered to be the
markets selling products such as smart televisions and very latest technology. The high profits generated from
tablets to billions of consumers globally. this approach to pricing helps the company to finance the
Businesses can use new technology to help them to development of further new products.
develop new products. This is particularly the case for
manufacturing businesses. The increasing use of technology GLOSSARY TERM
across every aspect of manufacturing – from R&D (research Big data refers to large and complex sets of data.
and development) and design, through manufacturing to These have been difficult to analyse in the past, but
distribution – has seen the volume of data rise extremely improvements in technology are making the use of big
rapidly. Advances in software are helping manufacturers to data more feasible.
gain insights into important aspects of their businesses,
including market trends, consumer behaviour and causes
of inefficient production. Businesses are able to analyse New ways of promoting and selling products
big data to learn more about their customers and use One of the world’s largest businesses, the Microsoft
this in designing new products which meet customers’ Corporation, has played a central role in developing
needs as fully as possible. Big data is a large, diverse set new technological products, particularly computers and
of information that grows at an ever-increasing rate. It software. Microsoft has benefited from technology in
often comes from multiple sources, such as social media, terms of being able to develop new products but also from
questionnaires and from monitoring consumer buying using technology to promote and market its products.
patterns. It is often presented in different formats. New Technological advances have allowed the company to
software enables businesses to analyse big data to identify produce new products, such as its software and gaming
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equipment (for example, the Xbox), as well as providing a Decisions by businesses to use technology to distribute
means to promote and sell its products online as consumers products offers substantial cost advantages. Thus, Apple
6.1.3–7 can download the company’s software at any time. does not have to pay to distribute its products, nor does
it have to pay retailers commission on each sale. This
It also has used technology as a basis for product
increases the company’s profit margin and increases its
development and to encourage consumer loyalty. Microsoft’s
flexibility in pricing decisions. The company also receives
Office product (a package containing Word, Excel, etc.) is
marketing benefits in that it can easily collect large
designed to be used with its Windows operating system
amounts of data about its customers and their preferences,
but is also highly compatible with the company’s internet
enabling it to target its future marketing effectively.
browser (Edge). Technology has offered the company the
opportunity to develop and sell a suite of products, rather Technological change has enabled businesses to promote
than a single one. products in new ways and to target particular audiences
more effectively. For example, social media provides a
Businesses increasingly rely entirely on technology to
major opportunity for businesses when it comes to product
distribute their products. Apple is famous for producing
marketing. It can be a quick and easy way to communicate
innovative technological products, but the company also
information on new products to a large group and that
uses technology to distribute its products. Its iTunes
group can be targeted carefully. Social media is flexible:
store allows purchasers to download music, music videos,
it can be used for a product launch, public statement or
television shows, applications, iPod games, audio books,
a networking event to engage customers. It also allows
various podcasts, feature-length films and movie rentals.
businesses to use influencers (often celebrities with a
It is also used to download applications for the iPhone.
large online following) to persuade potential customers
Technological change has changed the way that many
to buy particular products. Finally, increasing numbers
companies market their products and this has disrupted
of businesses are using chatbots powered by artificial
the activities of many established businesses. One example
intelligence (AI). These are attempts to recreate humans
is television broadcasting. In China, Tencent streams
using technology, and they can be used to engage with
videos, allowing its customers to watch a wide range of
potential customers to promote brands and particular
programmes at any time. By 2019, the company had over
products.
90 million customers and, along with other video-streaming
companies, posed a major threat to traditional television
broadcasters. These developments have put pressure on GLOSSARY TERM
existing broadcasters to change their business models Artificial intelligence and machine learning are similar
and many have developed their own video-streaming concepts and refer to technology that can think and act
(or on-demand) services. like humans.
CASE STUDY
Google’s AI-powered chatbot
Chatbots have been used by businesses for several years, commercial uses. It is expected to be used to replace
but until now their use has been limited to a few simple some humans in engaging in conversations with
functions, such as voicing certain sections of a business’ customers and to improve the learning of foreign
website. languages.
Google believes that it has made a significant Questions
development with a chatbot called Meena, which has
1 Analyse two ways in which a business might use
the ability to engage in conversations which nearly
Google’s Meena to increase its competitiveness. [8]
match those provided by employees. Meena is a very
2 ‘The most important way in which technological
complex piece of software which is ‘trained’ using
change will influence marketing is through enabling
social-media conversations. Google says that Meena
businesses to base decisions on a better understanding
has the ability to engage in sensible and specific
of their customers.’ Evaluate this view. [12]
conversations and, therefore, has many potential
Operations management decisions communicate simply, cheaply and (most importantly) quickly
across the globe. Developments such as video conferencing
New methods of communication have allowed employees in a business to see and talk with
Technological advances also affect the ways in which one another while at different locations. Software products
businesses operate. Communications within businesses such as Zoom and Microsoft Teams allow up to 500 people
have been transformed by technology. Businesses can to participate in meetings simultaneously. This offers
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considerable benefits in terms of use of time and reduction previously carried out by people. The most dramatic aspect
of costs to multinational businesses or even those operating of this has been use of computer-controlled technology
more than a single site one country. on the production line. This is now an integral part of
lean production. Its use allows businesses to control the
6.1.3–7
Extranets and virtual private networks (VPNs) are methods
production line to supply variants on a standard product
by which businesses can enable specified employees and
to meet the precise demands of consumers. For example,
other stakeholders to communicate through secure computer
Vauxhall’s car factory at Ellesmere Port in the UK uses
links. These have created better communications between
computer-aided manufacturing systems to produce different
businesses, helping to improve efficiency. Companies
colours and styles of cars in succession in response to
like Walmart, the giant American retailer, share sales
customers’ orders. This is part of the company’s just-in-time
data through private links with suppliers such as Procter
(JIT) or ‘pull’ manufacturing system.
6.1.4 Technological
& Gamble, to enable production and deliveries to match
demand in the stores. Walmart estimates that this improved
its inventory control enormously when introduced and saves
$2 billion in costs each year.
Advances in communication technology also offer
businesses opportunities to reduce costs of production.
Following the lockdowns in many countries due to the
Coronavirus (COVID-19) crisis in 2020, a range of businesses
recognised that large numbers of employees could work
from home for at least part of the working week. Advances
in communication, such as the business communication
platform provided by Slack Technologies, a multinational
software company, allow companies to maintain efficiency
with a high proportion of employees working from home.
Unsurprisingly, technology companies such as Twitter and
LinkedIn are leading this trend, though managers in many
businesses will see this as a way to cut costs in providing ▲ Figure 6.29 Computer-aided manufacturing (CAM)
systems being used to spray-paint car bodies
office space for employees.
The use of computer-aided design and computer-aided
New methods of production manufacture (CAD and CAM respectively) has assisted
New technology offers a range of benefits to businesses and in improving productivity levels in many manufacturing
consumers. This can be vital in an increasingly competitive industries, helping to keep costs down and enhance
global market in which businesses seek to take decisions productivity. Because of this, their use has spread to many
to improve their market position by offering high-quality industries, including food processing and the manufacture
products at the lowest prices possible. A significant of pottery. Technology on the production line often involves
advantage of technological change to businesses is that the use of robots, as shown in Figure 6.29. But the latest
it allows the development of new methods of production, wave of robots adds to what a human employee can achieve.
resulting in lower costs. This permits the firm to enjoy Cobots (collaborative robots) are programmable through
higher profits on each sale. Using ever-more sophisticated assisted movement. They ‘learn’ by first being moved
technology in developing, planning and producing products manually and then copying the movement moving forward.
is one way of achieving lower costs. These robots are considered collaborative because they can
The process of manufacturing in many industries has been work alongside humans.
transformed by automation, whereby machines do jobs
CAPP
Computer-aided process planning
– identifies the most efficient ways in which
to manufacture products.
CAD
Computer-aided design
– this allows designers to produce
new products and components
using 3D models displayed on CAM
computer screens. CAD makes it Computer-aided manufacture
easy to develop and redraw designs. – computers are used to operate robots and
other machines on the production line.
Linking CAD and CAM allows new designs
to be accommodated quickly into the
production process. CAM can also be used
to order raw materials and components
▲ Figure 6.30 Computer-aided design, computer-aided manufacture and computer-aided process planning
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Other businesses have virtually removed humans from the Technology can also allow managers to track employees
production process. In June 2018, the Chinese e-commerce at work using employee ‘wearables’. This can help to train
6.1.3–7 giant JD.com unveiled a fully automated storage and
shipping facility in Shanghai. Its factory has 20 industrial
workers but can also be used to monitor performance,
although some employees may consider it too intrusive.
robots that can pick, pack and transfer packages with no As an example, employees working in some warehouses
human presence or oversight. Without robots, it would take are required to wear a wristband that not only tracks their
as many as 500 workers to fully staff this 40 000-square- locations as they ‘pick’ items to be dispatched but can also
foot warehouse – instead, the factory requires only five ‘read’ their hand movements, buzzing or emitting a pulse to
technicians to service the machines and keep them working. alert them if they are selecting the wrong item.
This approach to production is termed a ‘lights-out factory’
Employees’ reactions to decisions based around
as the robots can operate in the dark.
technological change can be diverse. The reaction will

Technology is not only used in production processes in the depend partly on the likely effect of the technological
manufacturing sector but is also widely used by businesses change on the workforce and partly on the understanding
that supply services. For example, companies such as Aviva and attitudes of the workforce about the change, along with
supply insurance policies using the internet. Policyholders the way it is communicated to them and implemented. For
enter their requirements onto the company’s website some employees, it may represent an opportunity. They may
and complete their personal details. Aviva’s technology have a chance to acquire new skills, to make their jobs more
computes the price and deducts the appropriate sum from secure and enjoy higher wages or salaries. The new working
the customer’s credit card before downloading the policy to practices may offer great benefits. Technology can allow
the customer’s computer. The whole production process is employees greater control over their working lives, leading
based on technology. to increased responsibility and possibility of achievement.
This can result in greater motivation. Others may fear
Human relations technological change as it increases job insecurity. This
is likely to be true of those with few skills who carry out
Humans within businesses are always affected by tasks that may be easily automated. Fear of unemployment
technological change. This is particularly true when new may lead to industrial action as workers seek to protect
technology is introduced into the production process. their jobs. In such circumstances, the introduction of new
Such change may simply lead to some minor changes in technology may be awkward and expensive. Redundancy
the duties of employees. On the other hand, technological payments may be expensive and corporate images may
developments can result in enormous changes for a suffer.
business’ workforce. For some it may be redundancy, as
humans are replaced by technology as part of the process New, technology-based products can create jobs and
of automation. Many banks have made workers redundant unemployment at the same time. For example, the AI-
owing to advances in technology with, for example, online powered chatbots we discussed earlier will inevitably cause
banking replacing high-street branches. Other employees a loss of jobs for employees, such as those working in call
may be required to undertake duties dramatically different centres. Simultaneously, employment has been created in
from those with which they are familiar as a result of the industries developing, manufacturing and maintaining the
increasing use of technology in the banking sector. chatbots.
Technological change can also impact in other ways; for The reaction of employees to technological change may
example, by giving companies access to highly skilled depend upon the culture of the business. Businesses
employees for specific tasks. Some workers with very operating with a traditional culture, placing great emphasis
specialised skills (for example, in science) may be located on bureaucracy and convention, may experience difficulties
across the globe. Developments in computer software in adapting to technological change. The existence of a
enable businesses to gain access to such staff. Computer task culture may make the process less difficult. It may be
platforms such as Kaggle and Science Exchange allow most appropriate where the managers of businesses that are
businesses access to employees with specialised skills affected by technological change develop a culture that is
on a short-term basis for a particular project. This allows responsive to change and where employees’ attitudes are to
managers to make decisions not to employ such people embrace change rather than to resist it.
permanently, offering advantages such as a wider pool of
labour and lower labour costs.
CASE STUDY
Google’s culture
For its employees, Google feels like a small business, take advantage of opportunities to talk with colleagues
even though this is not the case. Despite its recent growth, from different departments. Conversations may be about
the company encourages this impression by providing work and highly technical or about someone’s pet – which
facilities such as its café, where most employees eat and can be brought to work.
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As its website states: to Bangalore. Dozens of languages are spoken by Google
Google’s emphasis on innovation and commitment to cost
containment means each employee is a hands-on contributor.
staffers, from Turkish to Telugu. When not at work, Googlers
pursue interests from cross-country cycling to wine-tasting, 6.1.3–7
from flying to frisbee. As Google expands its development
There’s little in the way of corporate hierarchy and everyone
team, it continues to look for those who share an obsessive
wears several hats. The international webmaster who creates
commitment to creating search perfection and having a great
Google’s holiday logos spent a week translating the entire site
time doing it.
into Korean. The chief operations engineer is also a licensed
neurosurgeon. Because everyone realises they are an equally Source: http://mooglemb.com/threads/googlecache/
important part of Google’s success, no one hesitates to skate 64.233.187.104/corporate/culture.html
over a corporate officer during roller hockey. Questions
6.1.5 Competitors and suppliers

Google’s hiring policy is aggressively non-discriminatory 1 Analyse two reasons why some employees in
and favours ability over experience. The result is a staff manufacturing businesses may fear technological
that reflects the global audience the search engine serves. change. [8]
Google has offices around the globe and Google engineering 2 ‘Google’s culture assists the business in embracing
centres are recruiting local talent in locations from Zurich technological change.’ Evaluate this view. [12]
Threats and technological change following the introduction of state-of-the-art technology

Technological change can be threatening as well as onto production lines. Workers will take time to adapt
providing opportunities for businesses. The impact of to what is required of them and the technology may not
technological change has been profound on one of the UK’s behave as expected. This may result in lower levels of
most familiar organisations: Royal Mail. In recent years, the productivity and lead to higher production costs.
company has seen its volume of business fall by between 5
and 7 per cent per annum as the average number of letters
posted has declined each year. The major reason for this
change is increasing competition from digital delivery of Competitors and suppliers are important stakeholders for
information. Royal Mail expects the volume of items it businesses. In Chapter 6.1.2, we looked at how market
handles to continue to decline, but at slower rates, over structures and the power of buyers and suppliers can affect
the next few years. The company has estimated that the businesses. Here we will consider how competitors and
decline in its volume of business will continue to reduce its suppliers can affect businesses and their decisions.
operating profit and share price. Competitors frequently play a significant role in determining
The threats of rapid changes from technology are the success of a business. Competitors may influence
considerable. Firms in high-technology markets will face businesses in many ways. The entry of a new competitor
demands to research new products and to implement into a market can pose problems for existing businesses,
more efficient methods of production. However, as we who may lose market share and profits as a consequence.
have seen, pressures exist in most industries to improve Equally, they can provide a stimulus for product or market
technology used in products and processes to maintain development and may enhance the business’ efficiency.
competitiveness. New technology, in whatever form, They can influence a business’ marketing mix; for example,
can be a major drain on an organisation’s financial the prices at which it sells its products. This is illustrated
resources. Installing new technology on the production by some businesses engaging in competitive pricing, as we
line or developing new products with more sophisticated discussed on page 125.
technology will involve a heavy capital outlay and possibly As we shall see, managing suppliers effectively can help
disrupted production. Thus, a business may lose sales businesses to face the challenges posed by competitors.
revenue at the time its expenditure rises significantly. However, the process of managing suppliers has become
Some firms may experience difficulty in raising the funds more difficult as supply chains have become more complex.
necessary to purchase new technology. Many businesses operate global supply chains, developing
Businesses operating in markets experiencing rapidly relationships with other firms from numerous countries.
changing technology can be left behind or find it too Businesses are also increasingly associated with the actions
expensive to keep up with other producers. Small firms can of their suppliers, and their reputations can be damaged by
be particularly vulnerable even if they are well-managed. suppliers being judged to have behaved unethically. Several
This is one factor leading to mergers and takeovers in multinational clothing manufacturers have been criticised
markets supplying high-technology products or where there for using suppliers who have been accused of paying very
are rapid changes in technology. low wages and using child labour on production lines. Such
allegations can be very damaging to sales figures.
New production methods do not always work effectively
from the start. Some teething problems are inevitable
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6.1.5.1 The impact of competitors and However, businesses seeking to enter a market will seek
to avoid these barriers to entry. One way in which this
6.1.3–7 suppliers
Businesses will want to try to make the competitive
can be achieved is through disruptive innovation. This
form of innovation creates a new market by disrupting
environment more favourable. This means they may take an existing one and often avoiding barriers to entry in
decisions such as those outlined below. consequence. Technological change has enabled much
disruptive innovation to take place. Airbnb is a classic
Imposing and avoiding barriers to entry example of disruptive innovation that combines business-
model innovation and technology to avoid potential
Barriers to entry make it more costly for other businesses barriers to entry in the hotel industry. It provides an
to enter the market and help to remove or avoid competitive online marketplace that brings together people with
threats. For example, a business may spend very heavily on accommodation and travellers seeking somewhere to stay.
promoting its products so that any entrant would face high At the outset, Airbnb focused on matching travellers who
costs in raising customer awareness of its products. Equally, were looking for a cheap alternative to staying in a hotel
an established business may introduce substantial price but, as the business grew, it expanded into providing
cuts on its products to make it more difficult for a rival to higher-priced accommodation as well. It now lists over
compete. Most businesses protect new ideas and products 5 million places for people to stay and offers more
that they have developed to prevent competitors using accommodation than any hotel chain. It has avoided the
them. Protecting intellectual property (IP) though the use fixed costs (such as buying or renting suitable properties)
of patent, registered design and copyright laws is important that form a barrier to entry into the hotel industry.
in many industries, such as computing and software.
CASE STUDY
Netflix
Netflix started out as a DVD-by-mail rental business. By but it was too late. Netflix was growing very rapidly and,
launching an online subscription-based movie-streaming despite Blockbuster’s brand and resources, Blockbuster
service, it utilised new technology and a new business unable to dislodge Netflix from its now firmly established
model to disrupt the existing market. Today, its online market position.
platforms are used by over 180 million people in more
10
than 190 countries.
9 2004: Blockbuster
launches online $8 billion
In the 1990s, Blockbuster dominated the video rental 8
industry and was expanding rapidly, with over 9000 on-demand, drops
7
late fees 2007: Blockbuster
stores worldwide and nearly 85 000 employees. After the
US$ billion
6
launches total access
turn of the century, however, Blockbuster began to lose 5 DVD by mail
significant revenue to Netflix, which targeted market 4
segments that had been left unexplored by Blockbuster. 3
Initially, Netflix’s movie-subscription service via mail 2007: Netflix
2 launches
didn’t appeal to Blockbuster’s mainstream customers, 1 streaming
but was very attractive to new customers who had 0
Bankrupt
adapted well to online shopping. 2002 2004 2006 2008 2010 2012 2014 2016
However, Netflix did not reach the mainstream until after it Blockbuster revenue Netflix revenue
separated from its DVD mail service and changed to online
streaming. Instead of having to visit a store to rent (and ▲ Figure 6.31 Revenues for Netflix and Blockbuster,
then return) a movie, customers could access a huge range 2002–16
of entertainment without having to get off their sofas, for a
fixed monthly subscription fee. When Netflix switched to its
Questions
subscription-based business model, Blockbuster was still 1 Analyse one barrier to entry that made it difficult for
the market leader, earning billions of dollars. Netflix to compete with Blockbuster at first. [4]
2 Evaluate how Blockbuster might have responded
As Netflix gradually began to win customers with its more successfully to the entry of Netflix into its
flexible and accessible online-streaming service, market. [12]
Blockbuster launched rival online services in response –
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GLOSSARY TERMS Managing suppliers
Businesses seek to manage their suppliers so as to enhance
A barrier to entry is something that makes entering a
market more difficult for businesses, such as the need for
their competitive position. Some businesses seek to have 6.1.3–7
specialist skills. power over their suppliers. This can strengthen the business’
own financial and competitive position. Businesses tend
A patent provides legal protection for a new invention.
to have power over suppliers if they are larger and if
Disruptive innovation is innovation that establishes a alternative sources of supply exist.
new market by disrupting an existing market or creates a
new market segment, sometimes replacing established Having power over a supplier offers a number of benefits to
market-leading businesses and products. a business:
» The business has more control over price, meaning it can

demand a low price, helping it to increase sales.
Responding to competitors or the impact of » It may not have to pay quickly for the items (so it can
substitute products hold the money and have a stronger cash-flow position).
» Suppliers may be more willing to supply slightly different
If a business has few competitors, customers will face more
products or meet earlier deadlines without making
difficulty in finding alternatives to those products sold by
additional charges.
that business. The management team of a business may seek
to lessen the impact of an emerging competitor by either It may be that a business seeks a different relationship with
merging with the business or by taking it over. The latter a supplier. This might be one in which they work closely
option is favoured by large businesses that are threatened by together, seeking a long-term relationship. Suppliers can
smaller innovative enterprises. However, this is an approach offer businesses specialist advice and can be sources of
that may need to be taken before the new business poses too innovation, helping to develop new competitive products.
much of a threat, as in the case of Blockbuster and Netflix. For example, at the time of writing, many customers in
Bigbasket is India’s largest online grocery store. In 2020, it the UK are complaining about the use of plastic packing
bought a smaller rival, Daily Ninja, that sells groceries to by retailers. Packaging suppliers may be able to work with
those buying basics daily – a different market segment. This customers to develop effective and environmentally-friendly
action effectively neutralised the threat posed by the new forms of packaging.
arrival and provided a boost to Bigbasket. Developing a long-term relationship with suppliers can offer
It is common for businesses to face established competitors. a range of potential benefits to a business:
As we saw in Chapter 6.1.1, most countries have laws to » Lower costs Selecting the most efficient suppliers helps
encourage free and fair competition and to avoid any to minimise the costs of components, raw materials and
collusion between businesses in the same industry. Many services. Using a small number of suppliers may also
businesses respond to competitors by taking actions assist in maintaining consistent quality and avoiding
such as: costs associated with faulty items. This can give
» seeking to move themselves into a different market businesses greater freedom in pricing decisions, as they
position by, for example, selling to a different market can reduce prices while maintaining acceptable profit
segment or differentiating their products from those margins.
sold by rivals. Some airlines compete with rivals by » Collaboration Good relationships with suppliers can
operating low-cost models, enabling them to offer very promote effective two-way communication, as both
low fares to customers parties can offer ideas on how to improve production
» targeting new markets, possibly overseas. In the UK, a systems to their mutual benefit. Suppliers might, for
number of the major supermarkets, such as Tesco, faced example, offer suggestions on how technology could
strong competition and little growth in UK markets. be used to make a supply system more responsive and
Some targeted overseas markets in response. Tesco efficient.
operated a chain of stores in California. Others decided » Innovation Suppliers can stimulate innovation in
to enter different markets within the UK; for example, products and production processes by offering the
Sainsbury’s established a bank. benefits of their expertise in specific areas. In 2020, the
American car manufacturer, General Motors, recognised
Often competitors will produce products which are very
the contribution of many of its suppliers to the success
good substitutes for those sold by an established business.
of its business by presenting them with awards. Its
Dealing with substitute products may involve short-term
suppliers had been strongly innovative, helping it to
decisions such as price reductions. This is more likely to be
develop improved seating and safety technology in its
successful if price is an important element of the buying
vehicles. Research in the vehicle manufacturing industry
decision. An alternative approach is to produce a new
in the USA suggests that businesses which develop
product to compete with the new substitute. If these are
long-term relationships with suppliers have the fastest
very similar, they may be called ‘me too’ products, though
product development processes and improve product
these are rarely as successful as the product they emulate.
quality consistently.
Other management teams may take a longer-term approach
and invest in researching and developing new products with
which to provide competition.
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6.1.6 International » Engaging in international trade can increase and
stabilise a business’ sales over time. Trading overseas
6.1.3–7 All businesses operate in an international environment to
some extent. Even small businesses that only sell in local
assists businesses to extend the life cycles of their
products. For example, many London-based fashion
markets may buy supplies from overseas or face foreign houses are selling products in the southern hemisphere,
competition. Therefore, international trade and trading targeting Australia, New Zealand and South Africa
links form an important part of the external environment in particular. Many items of fashion clothing have
for businesses. notoriously short life cycles and this is one way of
extending a summer season for fashion clothes, boosting
6.1.6.1 The importance and impact of sales and profits. Equally, in a period of low economic
growth, such as that experienced by most European

international trading links countries at the time of writing, overseas markets such
International trading links are important for businesses in as those in Asia can be highly lucrative and rescue
economies throughout the world for a number of reasons: flagging sales.
» They provide supplies of raw materials and components » Exposure to international competition can encourage
for businesses at highly competitive prices. This enables domestic businesses to improve their efficiency to
importers to be price competitive in turn, as costs are increase the chances of survival. It may also result
lowered below what they would have been without in businesses adopting modern and more productive
international trade. methods of production to enhance competitiveness.
» They open up markets for the goods and services that
they produce. This can assist businesses in increasing The importance of international trading links does vary
sales and profitability. The case study below shows between countries and can be judged through trade
how the Australian mining industry (and the Australian openness – that is, an economy’s exports and imports
economy generally) has benefited from its export links expressed as a percentage of its GDP. Figure 6.32 shows the
with China. Trading links also allow businesses to enter trade openness data for most of the world.
new markets, benefiting from economies of scale.
No data 0% 20% 40% 75% 100% 150% >350%
Source: Feenstra, Robert C., Robert Inklaar and Marcel P. Timmer (2015), ‘The Next Generation of the Penn World Table’
American Economic Review, 105(10), 3150–3182, available for download at www.ggdc.net/pwt
▲ Figure 6.32 Trade openness
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CASE STUDY
6.1.3–7
Australia’s continuing mining boom
● In 2018–19, 242 000 people were employed in mining
compared to 90 000 in 2002 – that is about 2 per cent of
the Australian workforce.
● Iron ore prices doubled between 2009 and 2019.
● Investment in mine projects or infrastructure in
Western Australia was higher than in any other region
6.1.6 International
in the world in 2019.
% %
30 30
China
20 20
▲ Figure 6.33 An open mine in Australia
Japan
The extraordinary economic growth rates achieved by
China since the early 1990s have been a major influence USA EU
on the Australian economy, and especially on its mining 10 10
industry, much of which is located in Western Australia
and the Northern Territory. As China’s rate of economic
South Korea India
growth has regularly been around 7–8 per cent per year 0 0
since 2011, its demand for Australian resources soared 01/02 05/06 09/10 13/14 17/18
to supply the roads, infrastructure and the products it
exports throughout the world. Australian exports to China ▲ Figure 6.34 Australian exports by destination
rose in value from $5 billion in 2002–03 to approximately (percentage share), 2001–18
$117 billion in 2018–19. Source: www.rba.gov.au/publications/bulletin/2019/jun/
spillovers-to-australia-from-the-chinese-economy.html
There were a number of other significant changes
resulting from increased exports of primary resources to Questions
China between 2002 and 2019:
1 Analyse one possible problem that businesses
● Weekly household incomes in Western Australia and
in China may face as a result of the high rates of
the Northern Territory, where mining is an important
economic growth in the country. [4]
industry, have risen more quickly than in the rest of
2 ‘All the stakeholders of Chinese manufacturing
Australia.
businesses have benefited from the increasing
levels of trade with Australia.’ Evaluate this view. [12]
» They allow overseas competition access to a business’

GLOSSARY TERM domestic market. This competition can be very fierce.
Trade openness is a measure of the extent to which an » The market price for products may fall as a result of
economy engages in trade. It is usually calculated using global trade.
the value of the economy’s exports and imports expressed
as a percentage of its GDP. Businesses may take a variety of decisions in response to
the existence of international trading links. We will consider
International trading links are therefore important to a sample of these below.
businesses for a variety of reasons. They have a significant » Decisions on suppliers and products The existence of
impact on businesses, both positive and negative. Benefits international trading links may offer businesses a wider
include: choice of suppliers, particularly if the raw materials,
» They provide new markets and potential for growth in components or products supplied are not perishable or
sales. bulky. Many clothing retailers, for example, choose to
» They provide sources of supply for raw materials, buy their clothing from producers located in countries
components, labour and capital. with low wage costs, such as Bangladesh and Vietnam.
This type of trade is made significantly easier due to
However, international links can pose risks for businesses the use of technology in international trade, as we shall
as well:
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see later. Using low-cost suppliers overseas can boost a the European Union) was a key driver behind their plans
business’ profit margins. for overseas growth, according to the findings. Equally,
6.1.3–7 Some resources may only be available from overseas
and unless there are effective trading links with the
many Asian companies have taken decisions to move
a part of their operations within the European Union,
appropriate countries, it may not be possible to produce because this offers the chance to trade freely within
certain products. For example, rare earths are 17 elements 27 countries without barriers. So Toyota, for example,
such as cerium and yttrium that have magnetic and the Japanese car manufacturer, has factories in various
conductive properties. They are used in manufacturing a countries within the EU, including France and Portugal.
wide range of consumer products, from iPhones to electric » Decisions on mergers, takeovers and joint ventures
car motors, rechargeable batteries, satellites and lasers. Close trading links between countries can also encourage
However, there are few viable sources of supply in the businesses to work together. This might be formally as
world for these products. China has substantial supplies the consequence of a merger or a takeover. Alternatively,
of rare earths, but a dispute between it and the USA businesses may simply agree to work together on one or
may mean that American manufacturers struggle to buy more projects as part of a joint venture. International
supplies of rare earths. This may force manufacturers to trading links are normally an important element of such
seek alternative supplies or to design these elements out deals to allow components, supplies and other resources
of their products, if possible. to move freely and efficiently between the countries
» Market-positioning decisions International trading links involved in the project.
may allow a business to reposition itself in the market.
Access to cheaper sources of supply could, for example, 6.1.6.2 The impact of international trade
enable the business to seek to increase its market share
by positioning itself as a low-cost producer. Alternatively, agreements on businesses
it may achieve this through relocating part or all of its When two or more countries enter into a trade agreement,
operations overseas to reduce its production costs. they agree to lower or remove any trade barriers that may
» Expansion and location decisions Businesses may exist between them. These may be in the form of tariffs
consider the state of existing trading links between (taxes on imports) or quotas (limits on the volume of
countries as part of a plan to expand into overseas imports). They may also agree to some degree of integration
markets. Deteriorating international trading links can between their rules on international trade.
also fuel major decisions. Research by Velocity Global in International trade agreements are common and many
2019 showed that 90 per cent of senior decision-makers countries have multiple agreements, as shown in Figure 6.35.
at UK technology firms were seeking to expand overseas. Trade agreements can be classified according to the number
Almost half of those businesses (43 per cent) said that the of partners or by level of integration of trade policies.
uncertainty caused by Brexit (the UK’s decision to leave
42
11–31
6–10
1–5
Not applicable/
no trade agreements
Source: The World Trade Organization/Statista

▲ Figure 6.35 The countries with the most trade agreements in 2019
» Bilateral and multilateral trade agreements A bilateral and textile exports and imports between the USA and
trade agreement is simply one that exists between two Australia. A multilateral trade agreement exists between
countries. It may cover all industries or just a number of more than two countries. The Asia-Pacific Economic Co-
specified ones. The USA and Australia have a bilateral operation Group is an agreement between 21 countries
trade agreement which was signed in 2004. This trade bordering the Pacific Ocean to implement policies to
agreement removed tariffs on a range of agricultural encourage free trade.
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» The level of integration on international trade
policies An international trade agreement might just
GLOSSARY TERMS
create free trade between the nations concerned. Free
trade agreements simply remove barriers to trade, such
The internet of things (IoT) refers to the billions of
physical devices throughout the world that are connected
6.1.3–7
as tariffs and quotas. However, some international trade to the internet and collecting and sharing data.
agreements may go further and involve some level of A blockchain is a digital database containing information
integration on tariffs to be imposed. A customs union (such as records of financial transactions) that is tamper-
not only creates a free trade area but also member proof.
countries agree to impose common tariffs on imports
from external countries. The European Union (EU) is an
Artificial intelligence and machine learning
6.1.6 International
example of a customs union.
Artificial intelligence (AI) and machine learning can
Such agreements can have a number of effects on
be used to optimise trade shipping routes and manage
businesses. They can facilitate trade between businesses
vessel and truck traffic at ports. This can reduce the time
that are located within the countries that reach the
taken to transport goods from one country to another,
agreement. For example, agricultural businesses in both
thereby reducing costs and encouraging greater volumes
Australia and the USA have benefited from the removal
of international trade. One company in India is using AI
of tariffs on their exports to each other. As a result,
to reduce the costs of transporting products in lorries
agricultural business in both countries have the opportunity
across long distances to ports. The company’s system uses
to sell within larger markets. This may enable them to
algorithms to predict precisely when lorries will arrive and
take decisions to increase production and to benefit from
leave particular locations, allowing teams of drivers to be
economies of scale, increasing their competitiveness.
constantly employed. AI is thus helping to cut down travel
However, the downside is that agricultural and textile firms
time by more than half, by eliminating the need for rest
in both countries have been subject to tougher competition.
breaks which a single driver would require.
Some businesses may fail as a consequence or be forced to
merge or seek other markets as a result. Additional cost savings can be made by automating
warehousing and container loading and unloading. AI
International trade agreements can create new markets for
algorithms combined with advanced robotics cut storage
businesses. Many multinational businesses consider the
costs and allow products to be received by the customer
European Union a very attractive market. This is because it
more quickly.
comprises over 500 million relatively high-income consumers
across 27 countries. This can affect the location decisions Machine learning can stimulate international trade in
of businesses. Many firms have created productive capacity a number of ways, including the provision of instant
within the EU to avoid its common external tariff. In 2017, translations. E-commerce search queries from potential
there were nearly 3000 large multinational companies (such buyers overseas can be instantly translated from one
as Ford or Sony) with some operations within the EU. Many language to another and immediate responses offered.
of these companies have taken decisions to make major
investments into the EU. In 2018, investment into the EU The internet of things
totalled €301 billion. The internet of things (IoT) relates to the fact that many
billions of devices are connected to the internet nowadays,
6.1.6.3 The role of technology in and they are capable of collecting information and sharing
it. Due to the rapidly falling price of computer microchips
international trade and the widespread availability of wireless networks, it has
Technological advances are transforming international become possible to link nearly anything (from a tiny pill to
trade by making processes more efficient. The newest a lorry) to the IoT.
wave of technologies has been driven by innovations in
telecommunications, computing and the development of global IoT technology can reduce the number of items lost in
information networks. The twenty-first century will most likely transit, as they can be tracked continuously. It can also
be noted for the falling cost of trading information. Thanks to optimise the transporting of products, reducing transport
fibre-optic cables, satellites and digital technology, the cost costs. An average shipping container has only 20 per cent
of overseas telecommunications is approaching zero. of its capacity used. Research has shown that tracking each
container using IoT technologies could improve container
In this section, we will look at four technological utilisation by 10 to 25 per cent and reduce annual spending
innovations: on containers by nearly $13 billion by 2025. Lowering the
» artificial intelligence and machine learning costs by using technology in these ways is likely to create
» the internet of things (IoT) larger volumes of international trade.
» 3-D printing
» blockchain technology.
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3-D printing large network of users. Blockchains create a continuously
growing list of records, which are combined in ‘blocks’
Three-dimensional (3-D) printing is a manufacturing process
6.1.3–7 that creates a physical object from a digital design. The
that are then ‘chained’ to each other – hence the term
‘blockchain’. Once added to a blockchain, information is
process works by using a printer to lay down thin layers of
time-stamped and cannot be modified, so that attempted
material in the form of liquid or powdered plastic, metal
changes can easily be detected, and transactions are
or cement, and then fusing the layers together. Boeing,
recorded and shared.
the American aircraft manufacturer, is using 3-D-printed
titanium parts in the construction of its 787 Dreamliner In addition to making movement of goods across
airliners. national frontiers more efficient, reliable and secure,
blockchains are changing the ways in which international
It is possible that 3-D printing has the potential to have
trade is financed. For example, blockchain is being used

the greatest impact on international trade of any current
to simplify the time-consuming and costly process of
technological development. It might make improvements
obtaining a Letter of Credit, a payment mechanism used in
in the cost and efficiency of transporting goods irrelevant.
international trade.
Instead of producing products in one country and
transporting them to many others, it may become possible AI and
to set up ‘printing centres’ in various countries near to The internet Blockchain
machine 3-D printing
of things (IoT) technology
large numbers of customers. Only local transport would learning
be required, cutting costs significantly. 3-D printing also
allows some complex products to be produced in one
piece, thus lowering the number of production steps and Lowering costs Making international
production costs. of international trade simpler and
trade more secure
There are differing views on the impact of 3-D printing on
global trade, as it is too slow to support mass production
currently. However, the more optimistic studies forecast Potential to
that once high-speed 3-D printing is mass-adopted and increase volume of
cheap enough, global trade may decrease by as much as 25 international trade
per cent, since 3-D printing reduces the need for imports. ▲ Figure 6.36 Technology and international trade
For these technologies to have the maximum possible
Blockchain technology
impact on international trade, it will be important for
A blockchain is a digital database containing information governments to reach agreements on a range of issues,
(such as records of financial transactions) that is tamper- including taxation and licensing the use of the technology.
proof. It can be simultaneously used and shared within a
CASE STUDY
Maersk’s ‘reefers’
Back in 2012, in response to increasing competition, the handling of off-power periods and wrong temperature set
Danish shipping company Maersk formed a joint venture points. The system can also be used to detect faults, allowing
with Ericsson, a Swedish multinational telecommunications for quicker repair and cutting down on the need for manual
company, to develop a real-time remote container equipment inspections. Maersk’s end goal now is to use big
management (RCM) system across its fleet of ‘reefers’, or data for predictive maintenance to prevent faults.
refrigerated containers.
Source: The World Trade Organization – ‘The Future of World
Close to 300 000 reefers have been equipped with RCMs that Trade: How Digital Technologies are Transforming
transmit reefer performance data 24 hours a day, seven days Global Commerce; www.wto.org/english/
a week, on key issues such as temperature, power supply and res_e/publications_e/wtr18_3_e.pdf
location to Maersk’s private data cloud, where they can be
Questions
analysed in real time at the company’s headquarters.
1 Analyse two ways in which the use of this technology
The system, which has been operational since mid-2015, might affect Maersk’s profits from transporting
allows Maersk to track and monitor container performance products internationally. [8]
at any point. According to Maersk, prior to the introduction 2 ‘Advances in technology will inevitably lead to
of the RCM system, close to 60 per cent of cargo losses greater volumes of international trade.’ Evaluate
stemmed from malfunctioning reefer units, poor supplier this view. [12]
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6.1.6.4 Multinational businesses The advantages of multinationals to host
countries
A multinational corporation (MNC) is a business
organisation which has its headquarters in one country but » Economic growth and employment Multinationals bring
foreign investment to countries that are not their home
6.1.3–7
has operations in a range of different countries. There are
numerous examples of such organisations: car manufacturers base. If they choose to expand by building production
like Ford, Toyota, Honda and Volkswagen, oil companies like facilities, they will be bringing investment into the
Shell, BP and ExxonMobil, and technology companies like country or cutting unemployment as well as helping the
Huawei, Google, Microsoft and Ericsson. sales figures of local businesses which supply them with
goods and services. The effects of the investment might
Multinational companies operate a global strategy, be seen as essential for helping a country escape from
6.1.6 International
making strategic decisions in terms of resources, poverty or vital in promoting economic development
facilities and markets available throughout the world. within the country.
Many businesses trade as multinationals to exploit the » Skills, production techniques and improvements in
cheap labour and other resources available in developing the quality of the workforce It can be argued that
countries. Furthermore, by selling in global markets, multinationals bring with them new ideas and new
multinationals can reap the advantage of economies of techniques that can help to improve the quality of
scale. The trend in many markets is towards fewer, larger production and help boost the quality of human capital
producers. The global car manufacturing industry is an in the host country. Many will not only look to employ
example of this, with many mergers and takeovers in local labour but also provide them with training and new
recent years. skills to help them improve productivity and efficiency.
Multinational businesses, by their very nature, tend to be » Availability of quality goods and services in the host
large or very large organisations. Research has revealed country In some cases, a multinational’s production
that approximately 82 000 businesses in the world can in a particular country may be primarily aimed at the
be classified as multinationals. The largest 100 of these export market. However, in other cases, much of the
companies account for about 40 per cent of international multinational’s production may be aimed at consumers
trade. Their size means they often have considerable in the country in which the products are produced.
power and influence and, as a result, have come in for In the case of many Japanese car manufacturers, the
some criticism of their actions. Events such as the tax investment made into UK production has enabled them
avoidance scandal in the UK and other European countries to get a foothold in the European Union and to avoid
(covered in the case study below) have attracted much tariff barriers; Brexit may lead to them reconsidering this
criticism and, sometimes, an assumption that MNCs are decision. Consumers in the UK have had access to high-
always a ‘bad’ thing. quality vehicles at cheaper prices, and the competition
this has created has also led to improvements in working
practices, prices and quality in other related industries.
Why do companies want to become » Improvements in infrastructure In addition to the
multinationals? investment in a country in production or distribution
For many companies, the following might be some or all of facilities, a company might also invest in additional
the reasons to expand into different countries: infrastructure facilities like road, rail, port and
» Reduce transport and distribution costs by producing communications networks. This can provide benefits for
nearer to markets Some multinationals seek to expand the whole country in that it creates employment as well
to Asian countries, as sales are growing relatively rapidly as providing improved facilities for local businesses.
for many products in that part of the world.
» To be able to sell in new markets by locating in them The disadvantages of multinationals
This can help a business such as Lenovo or Walmart to If a country plays host to a multinational company, it may
develop a recognised brand. pay one or more of the costs below.
» Secure supplies of raw materials or markets There may » The effect on employment may be minor If the
be controls on exporting certain raw materials so, by multinational uses skilled employees, many jobs might
locating in the country concerned, businesses can avoid go to skilled workers from other countries rather than
such regulations. to domestic workers. Alternatively, a multinational
» There may be cost advantages, most often in terms company may operate capital-intensive systems of
of low labour costs Many companies have created production, using little labour from the domestic
production facilities in countries with low labour costs. country. This would mean that the effect on employment
For example, Coca-Cola established production facilities may be minimal and the wages paid to these workers
in Vietnam as early as 1993 to take advantage of low may not stay in the host country.
production costs. » Some MNCs may be footloose This means that they
might locate in a country to gain advantages in
terms of lower rates of taxation or lax regulations on
The case for and against multinationals environmental protection. However, the multinational
The activities of multinational companies have attracted may relocate elsewhere if regulations are tightened or
a lot of attention in the media over recent years and have tax rates are increased. As a result, there might not be a
provoked strong reactions among stakeholder groups. long-term benefit to the country.
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» Pollution and environmental damage Some countries their overall tax bill by setting up offices in countries with
may have less rigorous regulatory authorities that fail low tax rates and claiming their profits are earned there.
6.1.3–7 to monitor the environmental impact of multinationals’
activities effectively. This can cause long-term
For example, each dollar of profits reported in the USA
or Germany will be taxed at a rate of around 30 per cent,
problems. In 2020, there was a leakage of styrene gas whereas profits reported in Bermuda will be taxed at 0 per
at the LG Chem factory in Andhra Pradesh in India. At cent. New research by the University of California suggests
least 13 people were killed and over 1000 hospitalised. that 40 per cent of multinational profits are shifted to
This led to people being evacuated from the area and tax havens and that 10 per cent of the world’s largest
complaints of lack of government regulation. multinational firms are responsible for 98 per cent of this
» Profits leaving the host country Profits might go back activity. The result is that governments throughout the
world lose $200 billion in tax revenue. At the same time,
to the headquarters of the multinational rather than

being reinvested within the host country. This may multinationals rely on public services such as transport and
lead to lower rates of employment and GDP in the host energy links, which are often paid for by the taxes of other
country than might have been expected. organisations and individuals.
A pressure group, Tax Watch UK, has estimated that five
6.1.6.5 Relationships between major multinational companies – Apple, Cisco, Facebook,
Google and Microsoft – made profits estimated at $30
multinationals and governments billion from trading in the UK between 2012 and 2017. Most
Multinationals are very powerful. The revenue of Walmart, of these profits were transferred to other low-tax countries,
the American multinational retailer, gives it a bigger budget resulting in taxes of just $933 million or a tax rate of about
than most governments have. With financial power comes 3 per cent.
influence. As multinationals have become larger and more
powerful, a number of aspects of their relationships with Governments have struggled to reach agreements on how
governments have become more critical and complex. to tax multinational companies fairly. There has been
Multinationals are no longer just a source of taxation for tension between governments over a key question: if a
governments. multinational from one country invests or sells its products
in another, in which nation should it pay taxes on its
Tax issues profits? This matter is not yet resolved. In the meantime,
Many governments have problems in ensuring that hugely countries such as France and the UK are threatening to
profitable multinational companies, such as Amazon and impose their own taxes on the profits of multinational
Google, pay appropriate levels of taxation on these profits. companies unless an international agreement is reached.
Many such companies are very successful in minimising
CASE STUDY
Multinationals under spotlight for tax avoidance
One of the UK government’s most important committees ‘Global companies with huge operations in the UK
has called for multinational companies that make a large generating significant amounts of income are getting
proportion of their sales in the UK, but pay little tax there, away with paying little or no corporation (profits) tax
to pay a fair and reasonable amount of tax on profits. This here,’ said a member of the PAC. ‘This is outrageous, and
follows demands from politicians in other European and an insult to British businesses and individuals who pay
Asian countries for measures to tackle corporate tax their fair share.’
avoidance. A number of multinational businesses, including
Source: www.reuters.com/article/britain-tax-bigbusiness-
Coca-Cola, Google, Amazon and IKEA, have been strongly idUSL5E8MU9DT20121203?edition-redirect=uk
criticised for operating policies to reduce declared profits
to avoid paying taxes on these profits. Coca-Cola has Questions
been criticised by the authorities in Vietnam and has been 1 Analyse two reasons why multinational companies
investigated by tax authorities. In 2020, it was prosecuted such as Coca-Cola are often able to make higher
and forced to pay $35.4 million in tax arrears and fines. profit margins than those which operate in a single
The UK government’s Public Accounts Committee country. [8]
(PAC) believes the government create rules limiting 2 Evaluate the possible consequences for the UK or
activities that reduce companies’ tax bills, and should Vietnam if multinationals such as Google and Coca-
also collaborate with other countries to minimise profit- Cola are forced to pay higher rates of taxation. [12]
shifting globally.
However, the relationship between governments and the EU authorities concluded that Nike (a multinational
multinationals over tax is complex. Some countries are sportswear manufacturer) had paid too little tax in
encouraging multinationals to locate there for tax purposes the Netherlands. This was a result of a deal between
by offering low rates of tax on profits. Some countries offer the government and the company, which benefited the
‘sweetheart’ deals to particular multinationals. In 2019, Netherlands but not the rest of the EU.
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Governments taking part-ownership of some atmosphere. These emissions are produced predominantly
multinationals by the consumption of fossil fuels (for example, the
Some governments have recognised that multinationals
have the ability to generate enormous revenues and have
burning of petrol or diesel in engines, and by the plastic-
manufacturing process), much of which is the result of
6.1.3–7
taken significant shareholdings in those companies in business activity. As greenhouse gas (principally carbon
recent years. Governments across the world owned almost dioxide) emissions increase, the so-called greenhouse effect
25 per cent of the Fortune Global 500 (the world’s largest increases, which causes global temperatures to rise and
500 companies measured by revenue earned) in 2019. By climate conditions to alter drastically.
investing in state-owned enterprises beyond their borders, Other environmental problems include the pollution of
governments earn a share of profits and gain some influence rivers and land and the dumping of waste, some of which is
6.1.7 Environmental
over the economies of other countries. This can be an toxic and harmful to wildlife and humans alike.
important way of generating funds to replace the ‘lost’ tax
revenues. Businesses contribute in many ways to the creation of
environmental damage, such as:
As an example, Russia is able to wield influence in countries » the emission of gases through production processes
in eastern Europe as its giant energy company, Gazprom, has » pollution caused by transporting raw materials and
built a gas pipeline to supply these states. China controls products, particularly using road vehicles which
over 1000 multinational companies, including Sinopec and emit noxious gases and create congestion and noise. Air
ICBC China. Countries like France and Germany are also pollution is a major cause of death and is estimated to
prominent owners of multinational companies. be responsible for 5 million deaths globally each year
Governments as customers of multinationals » pollution of the sea by businesses using it as a ‘free’
Most governments are becoming more dependent on the dumping ground. The North Sea between the UK and
goods and services that are supplied by multinationals. Europe is one of the most polluted stretches of water in
Governments are seeking to supply services digitally the world
wherever possible and have become more reliant on » destruction of natural environments as a result of
multinational companies to enable them to do this. For activities such as logging (cutting down trees for
example, Huawei, a Chinese technology company, supplies commercial purposes, as in the Indonesian forests) and
technology for the telecommunication systems used in many the building of homes on greenfield sites (that is, land
countries. that has not been previously built on).
India is a good example of a country where products Figure 6.37 illustrates that emissions of carbon dioxide
provided by multinational companies will be increasingly by all countries have continued to rise in recent years.
demanded by the government. Government spending in Emissions of carbon dioxide from some countries are
India on IT services reached $7.7 billion in 2020 and is growing more slowly. However, emissions in some regions
forecast to grow by 7–8 per cent per year for several years. with large numbers of developing economies (for example,
Multinational companies can expect to win a number Asia) have risen more sharply since 1999. Despite engaging
of contracts to help the Indian government to provide in activities that damage the environment, there is evidence
healthcare and education and collect taxes using digital that some businesses and some regions are improving some
platforms. aspects of their environmental performance.
40
Lighter band shows
6.1.7 Environmental 30
margin of error
CO2 (gigatonnes)
The media take a great interest in business activities in

relation to the environment. When firms are found to be
20
guilty of some act of pollution, adverse publicity is likely to
follow. Society expects higher standards of environmental
performance than in the past and, thus, environmental 10
factors are an increasingly important influence on business
behaviour. 0
1959 1979 1999 2019
6.1.7.1 The influence of physical Source: Global Carbon Project/CICERO

▲ Figure 6.37 Global emissions of carbon dioxide 1959–2019
environmental issues
There are many potential causes of damage to the There is a considerable body of evidence, as shown in Figure
environment. The major environmental concern identified 6.38, to show that world temperatures are rising. Although
by most governments is global warming. This is the rise in global warming is a controversial topic, many scientists
global temperatures which, although it occurs naturally over argue that businesses throughout the world are a major
the course of millennia, is accelerated by the release of a contributor to this trend. This development is linked to the
mixture of gases (called greenhouse gases) into the Earth’s rise in emissions of carbon dioxide shown in Figure 6.37.
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1 that firms pay all the costs associated with the production
Global temperature anomaly (°C)

0.8 of a product, governments can avoid market failure, which
6.1.3–7 0.6 we discussed in Chapter 6.1.2. Market failure could occur as
a result of pollution because suppliers may not be charged
0.4
the full costs of production and oversupply might result, as
0.2
profits are high. Most governments take actions to avoid
0 businesses causing environmental damage and imposing
−0.2 costs on others.
−0.4
−0.6 How environmental issues might influence
−0.8 business behaviour

1860 1880 1900 1920 1940 1960 1980 2000 2020
The need to alter business practice to take account of
Source: Berkely Earth environmental issues has implications for most aspects of
▲ Figure 6.38 Evidence of rising average global business activity.
temperatures 1850–2019 » Production Firms face pressure to redesign products
to use less packaging and materials and to make
How businesses contribute to environmental these materials biodegradable or recyclable. These
requirements affect all types of businesses. For
issues example, housebuilders are under great pressure to
Businesses are acutely aware of their private costs (the costs build on brownfield sites (land previously used for
of production they have to pay themselves), such as expenses building, often in cities and towns) and to protect the
for raw materials and wages. These are easy to calculate countryside by minimising the use of greenfield sites.
and form part of the assessment of profitability. However, Strict controls on production techniques are intended
environmental pressure groups and others have pressed for to minimise pollution.
businesses to acknowledge the costs they create for other » Purchasing Businesses are encouraged to seek sources
groups in society – the external costs of production. of supply that are sustainable and do not damage the
Noise, congestion, air and water pollution all impose costs environment, or to use recycled materials. For example,
on other individuals and groups in society. A firm extracting the paper industry uses a great deal of recycled
gravel from a quarry may create a number of external costs. materials, and it includes this as part of its promotion.
These could include congestion and deterioration of local » Marketing Businesses use their ‘green credentials’
roads caused by its lorries. This would impose costs in as an important component of their marketing
terms of delay and noise pollution on local residents. The strategy. Adverts will make reference to environmental
destruction of land caused by the quarrying could create an protection and even projects to improve the
eyesore for people living nearby and may reduce the value of environment. Packaging will confirm the company’s
their properties. Dust may be discharged into the atmosphere. concern to avoid pollution, especially that caused by
However, the quarrying firm will not automatically pay for single-use plastic. This is particularly important to
these costs. It requires government action to ensure that it firms that are seen to have great potential to pollute,
pays these external costs as well as its internal ones. including oil companies such as BP and Sinopec. It is
also important to those businesses who use this aspect
of their operations as a USP – Body Shop International
Total cost is an example of the latter. The case study on Unilever
of production on page 285 shows the importance some managers
place on an environmentally-friendly (or sustainable)
business model.
» Human resources New processes and procedures in
Private or External manufacturing make some jobs and skills obsolete,
internal costs costs creating a need for redundancies or retraining.
Environmental management has resulted in many
e.g. Fuel costs, e.g. Air pollution, businesses needing employees with new skills, requiring
wages and rising sea levels, a retraining programme or recruitment. Environmental
salaries Governments acidified water managers seek to minimise the effects of the business’
attempt to activities on the environment and to ensure that the
ensure businesses
firm meets new legislative requirements as they emerge.
pay all costs
of production Businesses may also seek to hire employees skilled in
resource management and with the ability to influence
▲ Figure 6.39 Internal and external costs of production corporate decisions to ensure the development of
Thus, the total costs of production equal internal or private management strategies designed for the most efficient
costs plus external costs borne by third parties. By ensuring use of scarce natural resources.
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The implications of environmental protection are profound, German car manufacturer, BMW, for example, promotes
especially for the so-called polluting sector (for example, itself as a manufacturer of cars that are almost entirely
chemicals, oil extraction and refining). They require a
corporate response from senior managers within a business.
recyclable. This could prove attractive to environmentally
aware consumers.
6.1.3–7
But, as with many external influences, the environment
provides opportunities for businesses as well as constraints. 6.1.7.2 The use of environmental audits
New markets have been created for businesses supplying Many businesses conduct environmental audits to assess
training in environmental management. Firms also offer the impact that their operations may have on the physical
to supply environmental control equipment to adapt environment. This type of auditing began in the USA
production processes so that they minimise the possibility in the 1970s and has spread globally. It is particularly
6.1.7 Environmental
of environmental harm. Equally, a market exists for testing common in businesses that operate in industries with the
equipment to monitor emissions or the toxicity of waste potential for environmental damage, such as airlines and car
products. Finally, businesses can use environmental policies manufacturing. An environmental audit may cover a range
as a means of obtaining a competitive advantage. The of a business’ activities:
Environmental impacts
Recycling
Atmosphere (chemicals
and GHGs such as CO2)
Emissions reduction
Energy, Business operations Products

Users
resources
Waste,
Resource end-of-life products
Streamlining of
recycling, reuse
energy and
material Promoting the
procurement three Rs
(reduce, reuse
Final disposal and recycle)
Hydrosphere
(chemical substances) (waste)
Emissions reduction Emissions reduction

Source: Toshiba Group’s Environmental Report, 2019
▲ Figure 6.40 The factors influencing the standards used in Toshiba Group’s environmental audit, 2019
» its emissions of gases such as carbon dioxide The performance of the business in each of the areas of
» the business’ use of energy, water and other resources, its activity will normally be judged against targets set by
and their environmental impact – generally businesses the business itself and any relevant regulatory standards
set themselves targets of using fewer resources imposed by environmental legislation. Figure 6.40 shows
» how much waste the business creates and how it the aspects of its operations that would be used to develop
disposes of it standards for Toshiba Group’s environmental audit. The
» the impact of its use of transport on the environment Toshiba Group is a Japanese multinational company that
» how the business’ operations impact on biodiversity – manufactures a range of electronic products.
this could be vital, for example, for businesses
producing or using herbicides to control weeds in crops GLOSSARY TERM
» the supply chain used. If a business’ suppliers do not
An environmental audit is an independent assessment
operate in an environmentally friendly manner, it can of a business’ activities to judge the extent to which it is
have a substantial effect on the business’ environmental complying with relevant laws and its own policies.
performance. The supply chain can determine over half
of the organisation’s impact on the environment.
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A business might take an environmental audit for a number » Customers Some customers, and especially those that
of reasons: are businesses, will look closely at the environmental
6.1.3–7 » to ensure it meets any necessary legal requirements
» to protect or improve its corporate image
audits of businesses from which they buy products.
Some will seek to deal only with businesses that protect
» in response to concerns about the environmental impact the environment; others will not wish to be associated
of its operations, including previous accidents that have with a business that might receive bad publicity as a
damaged the environment result of damaging the environment. Most customers
» to help with a decision on whether or not to invest in new will be interested in product safety and disposal of the
assets, such as a new factory or production equipment. products once they are no longer useful.
Environmental audits are normally conducted by » Employees Employees of a business, or their trade
independent organisations that specialise in this type of unions, may monitor the business’ audit to check on their
work. Prior to the audit, the standards against which the safety in the workplace. Much of the information in an
audit is to be conducted will be discussed and agreed. environmental audit is of relevance to this stakeholder
Once the audit is complete, the auditing organisation will group, including emissions of gases, the effects of
submit a report detailing its findings against the relevant reported chemical spills and training on health hazards.
standards. If the audit reveals weaknesses, the business » Suppliers The information in an environmental audit is
will take any necessary steps to improve its environmental important to suppliers. It sets out the environmental
performance. Table 6.16 shows part of the results of the standards to which the business expects to operate
Toshiba Group’s audit in 2019, identifying good and non- within its supply chain. It also shows the recent
conforming aspects within different areas of its operations. performance of suppliers, enabling them to judge and, if
necessary, improve their own performance.
▼ Table 6.16 Adapted from part of the outcome of Toshiba
Group’s environmental audit, 2019
6.1.7.3 The impact of sustainability on
Items to be Number of non- Number of
confirmed conforming items good examples
business and business decisions
Sustainability can be considered to have three elements:
Environmental 15 9
economic, social, and environmental (also known as
policies and systems
the three Ps: profit, people, and planet). The aim of a
Legal compliance and 9 4 sustainable business approach is to meet the current needs
risk management without destroying the chances of future generations
Business processes 9 2 meeting their needs. Sustainability may involve using
minimal resources in production, possibly by recycling,
Products and services 4 8 allowing employees to work from home to reduce time spent
Information 1 13 commuting, and not using resources that cause pollution,
disclosure and such as oil or gas.
communication
For a business to be sustainable, it must focus on long-term
Supply chain 4 0 strategies for making a positive impact on the environment
management and on society. Sustainability is about considering business
decisions in terms of years, or even decades, and considering
Source: www.toshiba.co.jp/env/en/management/audit.htm many more factors than just short-term financial benefits.
The information in an environmental audit can be used Consumer awareness of the importance of sustainability
by the business itself as well as by a number of its has increased as high-profile campaigns (such as the
stakeholders. one about plastic waste) highlight the issues. According
» The business The managers within the business will to a report in 2018, 81 per cent of respondents of a
use audits for a variety of purposes. A primary use is to global survey felt strongly that companies should help to
identify aspects of the business’ operations which may improve the environment. Approximately 85 per cent of
not meet the company’s own standards or any relevant respondents born between 1981 and 1996 stressed the
regulations. Once any non-conforming aspects have importance of businesses protecting the environment.
been identified, suitable corrective action can be taken. These consumers are projected to be spending $150
In Toshiba’s case in 2019, in Table 6.16, the company billion on sustainable goods by 2021, which sends a clear
may need to address a number of issues within its supply message. Further research, however, shows that many
chain. The business may also use this to help to present businesses have been slow to respond to consumers’ desire
an environmentally friendly image to help it increase for sustainable business models. In 2018, only 27 per cent
sales and market share. The Toshiba Group publishes a of businesses surveyed included sustainability in their
huge amount of information about its environmental business strategy.
performance. The company uses this as a competitive
weapon to enhance its status in consumers’ eyes.
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CASE STUDY
6.1.3–7
Unilever says sustainability is key to business model
Unilever is a multinational manufacturer of consumer Unilever annually reports progress against its targets
products. It makes a number of well-known and popular in its Sustainable Living Report – an audit of its social
brands such as Persil, Dove and PG Tips. The company responsibility activities. Some of its successes include:
puts corporate social responsibility at the heart of its ● more efficient use of energy and water in its factories
operations through its Unilever Sustainable Living Plan ● offering health and hygiene programmes to 1.3 billion
or USLP. It has moved to using sustainable resources to people
6.1.7 Environmental
reduce its environmental footprint. ● no longer sending any waste to landfill sites and reducing
waste resulting from consumption of its products
‘We want to help create a world where everyone can live
● using only renewable electricity throughout the company
well within the natural limits of the planet. By using our
and halving gas emissions from manufacturing
resources as a business to address issues such as health
● lowering the quantities of sugar in beverages and
and hygiene, gender equality, climate change and plastic
meeting high nutrition standards for foods that are
packaging waste, we are delivering short-term and long-
manufactured
term benefits for our shareholders and society.’
● employing a workforce in which women have more
Rebecca Marmot, Chief Sustainability Officer, believes that opportunities and are in 51 per cent of management
the USLP has brought many benefits. ‘Unilever’s Sustainable roles.
Living Brands – which include brands like Dove and Source: www.unilever.com/news/press-releases/2020/unilever-
Hellmann’s – have consistently outperformed the average celebrates-10-years-of-the-sustainable-living-plan.html
growth rate of other products since 2014. We have avoided
over €1 billion in costs, by improving water and energy Questions
efficiency in our factories, and using less material and 1 Unilever’s USLP has reduced the business’ costs of
producing less waste. The USLP has also become a decisive production by €1 billion. Analyse two ways in which
factor in helping Unilever to attract the best talent, and this might have occurred. [8]
has been instrumental in forging strong partnerships with 2 Evaluate how Unilever’s shareholders might react
NGOs, government organisations and other businesses.’ to the company’s USLP. [12]
Businesses can take a range of decisions to make their organisation support the move. This may require training
operations more sustainable. We shall consider a few of and a shift in the business’ culture. For example, it
these below. may require managers to develop a more innovative
» Reduce waste Some businesses produce large amounts culture to encourage employees to develop new ideas
of waste directly or indirectly. Reusing resources such as and approaches to making the business’ operations
water can cut waste during production, as can making sustainable.
products and packaging recyclable. Some analysts argue » Marketing decisions As we saw earlier, changes in
that selling products that are not recyclable will become consumers’ opinions are driving businesses to make the
increasingly difficult in the future. Equally, compostable changes necessary to make the organisation sustainable.
packaging is becoming an essential for many consumers. It is therefore vital for businesses to promote their
» Energy usage This is another high-profile element ‘green credentials’ once they are in place. This can be
of sustainable production. Using fossil fuels creates an important element of maintaining competitiveness.
carbon emissions, which contributes to the rise in This is a major reason for the Toshiba Group incurring
global warming. Many businesses are switching to considerable costs in environmental audits and reporting
using renewable forms of energy for all aspects of its findings. Many companies use their sustainable
their operations, including the use of electric cars. policies in their promotional activities.
Consumers increasingly expect and respond positively » Investment decisions Businesses are increasingly
to such initiatives. Businesses in the energy industry recognising the advantages of investing in ‘clean’
are also under pressure to adapt their products to make technology to allow their operations to become more
them sustainable. For example, BP, one of the world’s sustainable. Others are making enormous strategic
largest oil companies, is committed to developing clean decisions to supply products which do not damage the
and renewable sources of energy over time. environment. Volkswagen, the German car manufacturer,
» Change business cultures Senior managers must has decided to stop producing cars with petrol or diesel
take strategic, long-term decisions to make the engines and has switched production to electric cars. It
business more sustainable. However, this is unlikely believes this investment will generate good returns in
to be successful unless people at all levels within the the long term.
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TEST YOUR LEARNING
6.1.3–7 is rising. By responding quickly and efficiently to such
Short answer questions changes, Muirvale Housebuilders, one of the UK’s smaller
1 Explain one implication of an environmental change housebuilding companies, has increased its profits
for businesses. [3] steadily, although its profits declined last year. It trades
2 a Define the term ‘corporate social responsibility’.[2] in a market that is dominated by large companies such
b Explain one implication for businesses of meeting as Taylor Wimpey. Muirvale’s prices are 5 per cent higher
their corporate social responsibilities. [3] than the market average.
3 Explain two reasons why a small retailer competing
Muirvale’s corporate plan sets out:

with much larger rivals might decide to meet its
– its intention to build a greater variety of properties
corporate social responsibilities as fully as possible.[6]
than most of its competitors, including large, small
4 a Define the term ‘pressure group’. [2] and retirement properties
b Explain one way in which a manufacturer might – its commitment to meet its customers’ needs as fully
meet its responsibilities to the local community. [3] as possible, including after-sales service
5 a Explain one important trend over recent years – its aim to enhance its reputation for quality products.
in the population of a country with which you are
familiar. [3] Part of the company’s strategy is its use of corporate
b Explain one impact this trend in population may social reporting, of which it was an early adopter. It uses
have had on local businesses. [3] sustainable materials and builds on more expensive
brownfield (previously developed) sites whenever it can. It
6 a Explain one marketing decision that a business
wishes to present itself as a socially aware business and,
may take in response to technological change. [3]
in particular, aims to be environmentally friendly as far as
b Explain one reason why employees may welcome
possible. It uses the results of its corporate social report
technological change. [3]
extensively in its marketing.
7 a Explain one barrier to entry that an entrant to an
industry may face. [3] Muirvale’s market research has shown that, possibly
b Explain one way in which a business’ decisions owing to tougher economic conditions in the UK, demand
may be influenced by the structure of the market for most types of housing in the UK has become more
in which it operates. [3] price elastic. The research has also revealed a high level
of awareness of Muirvale’s socially responsible behaviour.
8 a Define the term ‘trade openness’. [2]
b Explain one way in which international trading Questions
links might pose a threat to a business. [3]
1 Analyse two demographic changes that may have
9 Explain one difference between a bilateral and a influenced Muirvale Housebuilders’ corporate
multilateral trade agreement. [3] plans. [8]
10 a Explain how one area of business activity might 2 Evaluate how the existence of larger competitors
be affected by environmental factors. [3] might influence Muirvale Housebuilders’ decisions. [12]
b Explain one difference between internal and 3 ‘Muirvale Housebuilders should continue to produce
external costs of production. [3] its corporate social report.’ Evaluate this view. [12]
Data response question Essay question
Muirvale Housebuilders 1 ‘Concern about possible damage to the environment
The structure of the UK’s population is changing quickly, is the most important factor affecting the external
especially flows of migration and age patterns. At the environment, particularly for large businesses.’
same time, the number of single-person households Evaluate the extent to which this statement is true.[20]
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A LEVEL
6.2.1
Developing business strategy
6.2.1.2 Strategic management

Chapter overview
★ business strategy
★ strategic management
★ approaches to developing business strategy.
6.2.1.1 Business strategy 6.2.1.2 Strategic management

A business strategy is the long-term plan of a business Strategic management is the process of developing and
that is developed to help it achieve its objectives. For implementing a strategy.
example, to achieve growth, a business may decide to
target emerging economies, such as Brazil and China, as its It has three stages: analysis, choice and implementation.
strategy. A strategic decision: » Strategic analysis involves an assessment of the current
» is long-term – often strategies are planned to last for position of the business and its environment, plus a
several years forecast of the opportunities and threats which might
» involves high levels of resources, such as finance emerge in the future. A business will want to assess how
» is high risk, due to the resources involved. There is also good or bad its own internal activities are; for example,
a risk that the overall plan could be wrong (no matter how efficient is it? How much capacity does it have?
how well-implemented) How strong is its brand? How well trained are its staff?
» is difficult to reverse. If resources have been committed, What is its financial position? It will also want to assess
it will not be easy to reallocate them. the business environment; for example, how intense is
the level of competition? What is the economic climate
Strategic decisions will be made by senior managers within like? What technological changes are occurring in the
the organisation. They are difficult decisions to make, not industry? By analysing the internal and external aspects
just because so much is at stake but also because they are of the business, managers can identify the strengths
not decisions that are taken very often. A new strategy is and weaknesses of the business and the opportunities
likely to be unique to the business and the situation it is in, and dangers it faces. Some of the tools managers use
and therefore these are challenging decisions to make. to analyse their business, such as SWOT analysis, are
The purpose of the strategy is to identity clearly how the examined below.
business is going to achieve its objectives. The strategy may » Strategic choice occurs when managers decide on the
set out which markets it is going to compete in, what its strategy they want to pursue based on their analysis.
product range will be and where the product will fit in the These decisions may focus on what customers the
market relative to competitors. Having a clear plan makes it business wants to cater for; for example, should it
easier for everyone in the business to operate: it will help concentrate on its existing customers or aim at a
managers to decide on priorities and where to allocate time new group? Which products should it offer – should it
and funds. The strategy will help co-ordinate the actions of focus on existing products or develop new ones? Some
everyone in the organisation, as they can consider how their businesses choose to concentrate on gaining more
actions contribute to the overall plan. market share with their existing products in existing
markets; others may choose a different strategy, such
The strategy is put into effect through a series of shorter- as developing new products for new customers. The
term actions, known as tactics. For example, if the strategy different strategic choices open to a business are
was to expand overseas, the business would need to decide analysed later using models such as the Ansoff Matrix.
which foreign market to enter first, which products to offer » Strategic implementation. Choosing a strategy may
and whether to enter an alliance with a local business. be quite a complex decision but, to make sure it is
successful, it has to be implemented effectively. This is
GLOSSARY TERM often a challenge. Successful implementation involves
Strategic management is the process of developing and planning what has to be done when, by whom, to
implementing a strategy. what standard and using what resources. Successful
implementation involves making sure the right things
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happen at the right time in the right way. It involves than expected or not working. This requires effective
co-ordinating and managing resources and trying leadership and includes plans for how the business will
6.2.1 to prevent things from overrunning, costing more respond if something goes wrong.
Strategic analysis Strategic choice Strategic implementation
▲ Figure 6.41 Strategic-management process

A LEVEL 6.2.1 Developing business strategy
plan is still appropriate. With the growth of online business,

The need for strategic management does it need to have high-street stores any more? With the
To develop a strategy a business will want to: opening up of more markets overseas, should it set up in
» set out its objectives Russia? With more skilled staff, should it broaden the range
» analyse the business environment to determine the best of services it offers? Strategic management therefore means
way of meeting these objectives the business needs to review and analyse its position before
» analyse the internal functions of the business. planning what to do next. It should ensure the business
The ‘right’ plan will depend on what needs to be achieved, strategy is appropriate for the conditions of the moment
the current situation of the business and the world around and prepare itself effectively for the future.
it. As circumstances change, so should the strategy. A Once a strategy is agreed, it then has to be put into practice.
business needs to be constantly reviewing what it is doing The implementation of the strategy is as important as the
because of changes inside and outside of the business. strategy itself – there is no point having a good plan and then
New products, new staff, new competitors, new laws, for carrying it out badly. Equally, there is no point implementing a
example, mean a business has to review whether its existing strategy effectively if it is actually the wrong plan!
CASE STUDY
Disney
In February 2020, Bob Iger gave up his role as the Chief It relies heavily on its film studios, even more now that it
Executive of Disney. At that time, Disney was extremely has acquired Lucasfilm (which owns Star Wars) and Fox.
successful. Its film division was highly profitable, with This increased its consumer product sales (for example,
seven of the ten biggest hits of 2019. It had just launched of light sabres and Iron Man toys) until the virus hit and
its streaming service, Disney+, to challenge Netflix. It had cinemas and shops closed.
also completed a $69 billion acquisition of 21st Century
Disney has also diversified into theme parks and leisure
Fox. During Bob Iger’s 14 years in charge, Disney’s share
facilities. In 2020, it owned six theme parks and four
price had increased in value fivefold. However, by May
cruise ships as well as an island in the Bahamas. These
2020, profits were 91 per cent lower than the year before,
have all been closed because of the outbreak of the virus.
due to the impact of the Coronavirus (COVID-19) global
pandemic. Questions
Coronavirus has had a major impact on Disney and 1 Analyse two reasons why Disney’s share price had
other entertainment businesses. Cinemas are shut, increased under Bob Iger. [8]
advertising is down, filming is disrupted and there are 2 Evaluate the reasons why Disney’s strategy
no live sports to show on television. However, Disney has appears to have gone wrong. [12]
been hit especially hard given the nature of its portfolio.
Business strategy and competitive do effectively and efficiently?) and whether it fits the external
environment (a major push for growth at a time of recession
advantage may be difficult, for example, whereas a move into products
The strategy of a business will determine the markets in for older people may work if the population is ageing).
which it competes, what goods and services it offers and
Effective strategic management understands the internal
how it wants to position itself relative to competitors. Will
and external environment and, from this, develops a
it focus just on Europe? Will it concentrate just on hair care
strategy that is possible for the business to achieve and
products? Will it aim to be a premium brand or a discount
that provides it with an advantage over rivals. Every
business?
business will be seeking to find a strategy (such as cost-
The success of a strategy depends on whether it fits with the cutting or differentiating) that will provide it with a
strengths of the business (that is, can it do what it sets out to competitive advantage over its rivals.
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The first stage in strategic management is to analyse large quantities of oil to be heated. The Acti-Fry made
the existing situation to identify the strategic choices healthier French fries with only one tablespoon of oil. This
available. transformed the market for French-fry makers. 6.2.1
Another example of a blue ocean strategy is Cirque du Soleil.
STUDY TIP This is a Canadian entertainment business which began in
Never underestimate the importance of getting the right
the 1980s, set up by a group of people who had a vision
strategy. If you are trying to develop your print publishing of what they wanted a modern circus to be. They didn’t
business while everyone else goes online, you may be want light-hearted entertainment for children. They wanted
doomed. If you invest in heavy, petrol-consuming cars a much more sophisticated experience with some of the
while the world becomes more concerned about the world’s best performers. Children were still in the audience,
6.2.1.3 Approaches to developing business strategy

environment, you will struggle. Getting the strategy but the high prices meant that what was offered had to
right is the key to success, which means you need to amaze adults. Cirque du Soleil did not attempt to be another
understand the strengths of a business and the external circus with clowns and performing animals – its blue ocean
environment when analysing a case study. strategy reinvented the market.
Scenario planning
6.2.1.3 Approaches to developing This is another technique to help managers plan ahead.
business strategy In this approach, managers try to imagine three or four
possible scenarios that might develop in the future in their
Blue ocean planning industry. Scenario planning does not assume the future
This occurs when a business combines a strategy of will be like the past; it asks managers and experts to think
differentiation and low costs to create a new space in the of what the world might look like in the future. This could
market and new demand. This approach seeks to create and be very different from the past (as we saw with the rapid
capture uncontested market space, which thereby makes the collapse of financial markets in 2007 and 2008 across the
competition irrelevant. The blue ocean view is that you can world). This technique has been used widely by Shell, where
redefine industries and markets. managers work with experts to create possible visions of
what the world might look like in the future. For example,
In their book, Blue Ocean Strategy, Chan Kim and Renée one scenario might include a stable political position in
Mauborgne introduced the terms ‘red ocean’ and ‘blue the Middle East, high levels of oil production and a low oil
ocean’. Red oceans are all the industries in existence price. Another might focus on high levels of intervention by
today – this represents the known market space. In red the government to reduce car usage, leading to high taxes
oceans, the industry boundaries are defined and accepted, and low levels of demand. Managers then work on how these
and the competitive rules of the game are known. In this scenarios might affect their business and the implications
situation, companies try to outperform their rivals to grab a for their strategy. Peter Schwartz, who was head of Shell’s
greater share of existing demand. As the market space gets scenario planning team in the 1980s, describes scenarios as
more crowded, profits and growth are reduced. Products ‘stories that can help us recognise and adapt to changing
become commodities, leading to aggressive, ‘bloody’ aspects of our present environment. They form a method for
competition. This where the term ‘red’ comes from. By articulating the different pathways that might exist for you
comparison, blue oceans represent all the industries not in tomorrow, and finding your appropriate movements down
existence today – the unknown market space, where there is each of those possible paths.’
no competition. In blue oceans, demand is created instead
of being fought for. This creates opportunities for growth GLOSSARY TERMS
that are both profitable and rapid.
PEST analysis is a way of analysing the external
▼ Table 6.17 Red and blue ocean strategies macroenvironment of business.
The macroenvironment refers to factors largely outside
Red ocean strategy involves: Blue ocean strategy
the control of the business, such as the economy and
involves:
legal changes. A business cannot easily influence these on
• Competing in the existing • Creating an uncontested its own.
market space market space
• Attempting to fight and • Aiming to make the
beat the competition competition irrelevant PEST analysis
• Fighting for existing demand • Creating new demand
• Focusing on differentiation
PEST analysis is a way of analysing the external
or low cost
macroenvironment of business. The macroenvironment
refers to external factors that are beyond the control
An example of blue ocean thinking led to the change made of the business itself. PEST analysis examines Political,
by the French Groupe SEB. SEB moved out of the highly Economic, Social and Technological factors. It can also be
competitive market for conventional French-fry makers known as PESTEL analysis, referring to Political, Economic,
by creating a fry maker that operated without needing Social, Technological, Environmental and Legal factors.
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Managers attempt to identify the relevant factors in their The results of a PEST analysis will vary from business to
environment and, again, rank them according to their business. For some, the economic growth of a country will
6.2.1 relative importance for the business.
» Political factors include legal issues, trade agreements
be vitally important; for others, what the government is
doing may be more significant. Furthermore, if a business
and changes in government policy. operates in many different countries or has different
» Economic factors include the interest rates, inflation, business divisions, it may need to undertake a number of
economic growth and exchange rates. PEST analyses. These need to be reviewed regularly as the
» Social factors include demographic factors and social external environment changes.
trends.
» Technological factors involve changes in technology.
CASE STUDY
Africa’s expanding market
Source: McKinsey & Company

▲ Figure 6.42 The size of Africa
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The physical size of the African continent is often Africa already has many big companies (over 400
underestimated. Figure 6.42 helps put it in perspective.
Africa covers 11 million square miles. According to the
with a revenue of over $1 billion) and a tremendous
entrepreneurial spirit. Many entrepreneurs have 6.2.1
management consultant, McKinsey, many managers set up specifically to meet unmet demand in Africa.
underestimate the size of African markets and For example, Jumia is one of the continent’s leading
overestimate the challenges they will face. This leaves e-commerce businesses. M-Kopa sells solar power kits
Africa as a real opportunity for many businesses. to over 600 000 rural households. Roha is an investment
company which supports manufacturing businesses; a
There are, of course, challenges such as economic and
recent investment by Roha is an $80 million glass-bottle
political volatility and some infrastructure limitations
plant near Addis Ababa. The plant has the capacity to
in a number of countries. However, Africa has 1.2 billion

produce 200 million bottles a year.
potential customers and this number is expected to
double by 2050 (at a time when world population growth Africa is not a continent to ignore.
is generally slowing). Africa will soon be the fastest-
Questions
urbanising region in the world. Africa already has as many
cities with over 1 million inhabitants as North America 1 Analyse two reasons why Africa might be a good
does, and more than 80 per cent of its population growth region of the world for businesses to target. [8]
over the next two decades will occur in cities. The income 2 Evaluate the usefulness of PEST analysis when
per capita of Africa’s cities is more than double the assessing Africa as a potential market. [20]
continental average, making them attractive markets for
many businesses. Consumer spending in Africa was over
$1.4 trillion more than India’s in 2019.
them in order of their significance – what is the biggest and

SWOT analysis most damaging threat, for example?
A SWOT analysis considers the internal and external
environments of a business. The process of undertaking a SWOT analysis involves
discussion and, in itself, is useful to get managers sharing
‘S’ and ‘W’ stand for strengths and weaknesses. These ideas and perspectives. SWOT analysis is the basis for
are internal features of a business at the present time. strategic planning.
Strengths may include:
» a high level of cash funds Developing the outcome of a SWOT analysis into
» a strong brand name
» a good distribution network strategic objectives
» highly skilled staff. Once a SWOT analysis has been undertaken, managers should
Weaknesses might include: have a clearer view of what the business is good at, what
» high borrowing its weaknesses are, what it could be doing and what it
» a lack of new products being developed. must protect itself against. From this, they can develop a
strategy (or series of strategies) which may seek to:
‘O’ and ‘T’ stand for opportunities and threats. They refer to » build on their strengths to exploit their opportunities;
external events that might happen in the future. Threats are for example, use the brand to launch more products
events that might damage the business and opportunities » reduce or remove their weaknesses; for example, reduce
might benefit the business. Opportunities might include: borrowing
» entering new markets overseas » protect themselves against threats; for example, taking
» an alliance with a competitor to develop new technology over a competitor who is threatening to take more
» going online. market share.
Threats might include: A SWOT analysis is not a one-off exercise. Given that the
» legislation that would increase wage costs internal and external environment is constantly changing,
» new competitors entering the market it should be continually reviewed and strategies adjusted
» takeover by a competitor. accordingly. For example, a strategy of growth may be
Managers will try to identify the relevant strengths, appropriate in a booming economy, but in a recession it may
weaknesses, opportunities and threats. They will then rank be necessary to focus on survival.
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CASE STUDY
6.2.1
Colgate
Colgate describes itself as a caring, innovative growth ● number 2 position worldwide in liquid fabric
company that is reimagining the future for people, their conditioners, and hand dishwashing
pets and our planet. The company says it keeps a tight ● number 1 market share in vet clinics in the USA.
focus on four product categories: oral care, pet nutrition,
Colgate is the brand most recommended by the
home care and personal care. Its brands include Colgate,
dental profession worldwide, and it also has a strong
Palmolive, Ajax, Sanex and Hills Pet Food. These
recommendation by vets worldwide.
brands have strong market positions. For example, the

company has: The company’s strategy is to drive organic sales growth.
● number 1 position worldwide in the liquid hand soap This, it says, will be achieved by:
market ● accelerating growth through product innovation and
● number 2 position worldwide in bar soaps and liquid building on existing brands
body cleansing market ● innovating to gain share in high-growth market
● number 1 position worldwide in manual segments
toothbrushes ● expanding in new distribution channels
● number 2 position worldwide in mouthwash ● maximising growth online
● number 1 position in worldwide market share in ● investing to gain greater market penetration in
markets where it competes growing populations.
50
40.6
40 Colgate 41.1
30
20
13.7 Competitor 1 15.5
Competitor 2 12.6
10 13.2
12.9 Competitor 3 7.5
0
‘01 ‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 ‘16 ‘17 ‘18 ‘19
Year to date
Source: Colgate-Palmolive Company
▲ Figure 6.43 Colgate’s market share of the worldwide toothpaste market
61.6%
Questions
41.3%
1 Analyse two reasons why Colgate keeps focused
37.1%
on just four product categories. [8]
2 Evaluate the ways in which Colgate’s strengths
might influence its strategy. [12]
Dove Coca-Cola Colgate
▲ Figure 6.44 Proportion of households buying Colgate
products
CASE STUDY
Increasing environmental awareness
Greater environmental awareness among citizens and achieve a low-carbon economy expressed by the Paris
governments led to the signing of the Paris Agreement Agreement means that businesses will need to change
in December 2015. This was an agreement among many what they produce and how they produce it. For example,
governments to take action on climate change and which we are starting to see a significant move away from diesel
naturally has implications for business. The desire to vehicles and towards electric ones.
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Increasing environmental awareness also means there Questions
is pressure from investors for more information on how
businesses are producing. For example, the Climate
1 Analyse two actions governments might take to
achieve a low-carbon economy. [8]
6.2.1
Action 100+ is an initiative by 256 investors. These 2 Evaluate the impact of climate change on business
investors have trillions of dollars in their funds and strategy. [20]
will only invest in businesses which have high levels of
disclosure about their impact on climate change.
CASE STUDY

Lego
Lego’s mission is to bring LEGO® play to more children Innovating retail
around the world. Lego says that:
Digitalisation and the rise of e-commerce are reshaping
When children play, they learn. They learn lifelong skills like the toy retail market, as shoppers look for new
problem-solving, communication and collaboration, which experiences from different sources – powerful brand
are more critical than ever. A study by the World Economic experiences in physical stores and ease and value for
Forum estimates that, given the pace of change, 65 per cent money online. To adapt to these changes, Lego is investing
of kindergarten children will hold jobs that have not yet been its retail ecosystem, for example, by upgrading its
invented. The only way that children can be prepared is to LEGO.com e-commerce site and opening nearly 150
give them skills that can be applied whatever their job turns branded stores, including flagship stores in Amsterdam
out to be. and Beijing.
Play is an effective way to develop these skills from a young Expanding into new markets
age, and LEGO® play is especially powerful as it offers
Lego’s annual report points out that, ‘by 2032, 90 per cent
children endless possibilities. Just six two-by-four LEGO®
of the world’s 2 billion children will live outside Europe and
bricks can make 915 million different combinations. Our
North America, with more than three-quarters living in
strategic priorities are designed to deliver long-term,
eastern Asia’. Perhaps not surprisingly, Lego is increasing
sustainable growth and, importantly, bring the power of
investment in these growth markets. For example,
LEGO® play to even more children around the world in order
Lego plans to have over 200 stores in around 40 cities in
to inspire and develop builders of tomorrow for generations
China in the near future. It has also continued to build its
to come.
e-commerce presence on popular platforms, such as Tmall
Sustainable growth and JD, and extend its partnership with Tencent to provide
The company’s designers strive for creativity and unique digital content and games. The company was also
innovation. Each year, around 60 per cent of the pleased with the success of its new product range, which
company’s products are new. The company is also was designed to celebrate Chinese New Year. This showed
creating completely new approaches to play, such as Lego that there is strong consumer demand for culturally
LEGO® Hidden Side, which combines augmented reality relevant products.
and building. It has also built LEGO® play into a range of Source: Lego Annual Report 2020, https://issuu.com/
digital experiences such as digital games, apps and voice- arturocreative/docs/lego_memoria_ final
based intelligent home assistants. Developing ‘fluid play’
– the combination of digital and physical play – will be a Questions
priority for Lego now and in the future. 1 Analyse two factors influencing Lego’s strategy. [8]
2 Evaluate the opportunity that digital technology
creates for Lego. [12]
STUDY TIP
The key to PEST and SWOT analysis is to prioritise the
key issues in the external and internal environments.
Managers can list their business’ strengths and
weaknesses and the opportunities and threats in the
environment, but the key is identifying which are the most
important ones and, therefore, being able to know where to
concentrate their thinking.
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The role of business vision/mission mission is to be ‘the leading global pharmaceutical company’
then a strategy that involves retrenchment to focus on just
6.2.1 statements and objectives in strategic the domestic market would not be acceptable. The mission
sets out the overall guidelines within which strategies
analysis must fit. It sets the scope of the business’ activities, for
Whatever strategies are developed, these must fit with the example, in terms of where it wants to compete, which
overall mission statement or vision of the business. If the product markets it wants to be involved in and the relative
mission is to be ‘the world’s greatest airline’ then a strategy focus on different stakeholder groups.
that takes the business into soft drinks would not fit; if the
CASE STUDY
Environmental profit and loss statements
The way customers have been buying clothes is, in many and investors can assess the impact of its activities.
cases, extremely environmentally unfriendly. On average, The ‘Environmental Profit and Loss Account’ (or EP&L)
people are buying 60 per cent more items of clothing today developed by Kering (the owner of brands such as Gucci
than they did 15 years ago but they only keep them for half and Balenciaga) is one way of doing this. This approach
as long. So we are buying more new clothes and using provides a methodology to measure a company’s
them less than we used to. This is bad for the environment environmental impact in a way that can be compared
because production of textiles has a greater effect on between businesses. It takes into account carbon
climate change than international aviation and shipping emissions, air pollution, water use, water pollution, waste
combined, as a recent UK parliamentary report highlights. generation and any land adaptation needed to produce
the product. All of these are costed and included in the
However, consumers may change their habits and
company’s environmental profit and loss.
are expected to ask more questions about how their
clothes are made in the future. Generation Z (those born Questions
between 1995 and 2010) are especially interested in the
1 Analyse two benefits to businesses of producing
environmental impact of the clothes they buy so, to target
environmental profit and loss statements. [8]
these customers, producers need to look at what they do.
2 Evaluate the importance to a business of taking
One way in which brands may respond is to calculate the account of environmental issues when developing
environmental costs of producing goods and express its strategy. [12]
these in monetary terms so the business, its customers
The role of Boston Matrix analysis

A business may use the Boston Matrix, which we covered For example:
on pages 122–123, as part of the data gathered for a SWOT » Dogs (low growth, low market share). Should the
analysis. The Boston Matrix highlights the position of business sell off these products or stop producing them?
different products in their market and the growth of the Or, if it invests heavily, is there a chance of reviving
market as a whole. Undertaking this analysis enables a them successfully?
business to take a view of what its strategy should be next. » Cash cows (high market share, low market growth). Can
the business milk these (that is, take as much cash as it
Stars Question marks can from them) to finance investments elsewhere?
» Question marks (or problem children; low market share,
High
fast market growth). Should the business invest in these

Market growth (%)
to build them up?

» Stars (high market share and growth). Should the
business invest to protect and grow these?
Cash cows Dogs
The business will also take an overview of its portfolio. If it is
too reliant on cash cows, for example, it may need investment
into new products for the future. If it has too many question
marks, for example, this is quite high risk in the short term.
Low
For very large firms the Boston Matrix is used not just for
High Market share Low products but for the whole business. If a company owns
many other companies then it may analyse the relative
▲ Figure 6.45 The Boston Matrix strength of these using the matrix and decide which ones to
sell, invest in and milk.
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Porter’s Five Forces analysis » Legal restrictions If the existing provider has a patent,
this means you cannot imitate the invention without
Businesses will also want to analyse the markets in which
they operate. A common tool used for this is Porter’s Five
permission (and usually paying a licensing fee). 6.2.1
Forces analysis. This examines five different forces which High barriers to entry mean that the firms already in the
determine the likely profitability of an industry. The market are ‘safe’ from competition, at least for a while.
immediate business environment that contains these forces This means that the competitive pressure is reduced and
is known as the microenvironment (or the competitive this may affect the quality of the service. On the other
environment). It includes groups that the business is likely hand, if entering a market is very simple then it is highly
to interact with regularly. These groups exert forces on the competitive, forcing better service. For example, setting
business, namely: up a sandwich shop is not particularly expensive or

» rivalry difficult, and so there is enormous pressure in terms of the
» entry threat prices charged and quality of food and service provided.
» buyer/supplier power There are always shops closing and opening and new
» substitute threat. forms of food emerging because of the very high level of
competition. This is good for customers but not so good for
An understanding of the existing forces will determine the
the entrepreneurs, who have to remain very responsive to
profits that can be generated, but it will also highlight how
market requirements to survive.
a business might want to change its strategy to make the
forces more favourable. These forces are examined in more If there are very few barriers to entry, this is likely
detail below. to reduce the profits being earned by the established
businesses in an industry. If high profits are being
made by existing firms, more businesses will enter
GLOSSARY TERM
and the profits will have to be shared out among more
The microenvironment (or the competitive environment) organisations. If, however, there are high barriers to entry
refers to groups or individuals that businesses regularly then existing firms can make high profits without others
interact with, such as suppliers, distributors and
entering to take them away.
competitors.
Buyer/supplier power
Rivalry The competitive environment in a market also depends on
This refers to the number of firms in the market and their the power of buyers and suppliers. All businesses are part
relative size. If there are many firms of a similar size then of a supply chain and are reliant on other businesses or
the potential profits of the market have to be shared individuals that they buy from or sell to. If you are reliant
between them, reducing the likely profits of any one on a few key suppliers then they are likely to be able to
business. However, if the market is dominated by, say, two charge you more, and the level of service they have to
firms then their profits are likely to be relatively high. provide may not be that high because you need them so
much. They are likely to be able to increase their profits at
your expense – you pay them more so your profits fall and
Entry threat theirs increase.
The way a business behaves will not only be affected by the
existing number of competitors in the market but will also
Raw materials
depend on how likely it is that other firms will enter the
market in the future. This in turn depends on the existence
of barriers to entry, which are factors that make it difficult Supplier
to enter a market, such as:
» Entry costs Heavy investment may be required to set up Manufacturing
the business because of specialist equipment or facilities
needed. You can imagine that setting up a chemical Distribution
plant or car manufacturing premises could require quite
large sums of money. This will automatically make it Customer
difficult for some entrepreneurs to enter the market.
By comparison, setting up an online business might be
Consumer
relatively cheap.
» Brand loyalty If the established firms have a high level ▲ Figure 6.46 A supply chain
of brand loyalty then it will be more difficult for others
to enter the market, because of the problems in gaining The power of suppliers depends on:
sufficient market share to break even. Loyalty to Nike » their number and how similar their products are. If it
sportswear and Twinings tea, for example, make entry is easy for you to switch suppliers then their power is
into these markets quite tough. lessened
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» their size and the extent to which they depend on Substitute threat
you. If the suppliers are small and rely on you then you This refers to the ease with which a buyer can switch to
6.2.1 have power over them. If you represent only a small
percentage of their business then they have more power,
an alternative type of product that performs the same
function. If you are charging high prices for aluminium
because they are more likely to reject your requests if cans, could buyers switch easily to plastic bottles? If
they choose. the price of air flights is high, can buyers switch to sea
Similarly, buyer power affects what happens in a market. If ferry and trains to get to their destinations? The greater
buyers have a lot of power, they may be able to push the the substitute threat, the more buyers can move away;
price down and insist that the product is amended to meet therefore, the prices that existing firms will be able to
their requirements. If buyers are powerful, you are likely charge will be lower, as will their profits.
to receive a lower price, reducing your profits. A buyer will ▼ Table 6.18 Porter’s five forces summary
have power if:
» there are relatively few buyers, so that the business Five forces Effect
relies on them heavily. For example, if a company makes Rivalry Low rivalry means there is little competition
very specialised technical equipment, there will be a and this enables higher profits.
limited set of customers, so the business will need to
retain those customers. On the other hand, the loss of Barriers to High barriers protect existing firms and
one customer at a nightclub may not be that significant entry enable higher profits.
» they have many potential alternative suppliers, so they Buyer power Low buyer power means established firms can
can switch away from a business relatively easily if they charge more and earn higher profits.
need to. This puts the business in a weaker bargaining
Supplier Low supplier power enables established
position. If you are the only firm that can produce a
power firms to push down the price of supplies,
particularly complex piece of equipment then you have a
increasing profits.
lot of bargaining power; if you are one of many possible
suppliers of paperclips, you are not in such a strong Substitute Low substitute threat means customers cannot
position. threat easily switch away, enabling higher profits.
CASE STUDY
Aerospace and defence
The global aerospace and defence industry, perhaps of its suppliers (for example, one that makes smaller
more than any other industry, involves huge numbers components such as nuts and bolts, or springs and
of parts to produce the finished product. A fighter jet levers). The deals tend to be larger than $200 million, but
engine, for example, has thousands of complex individual smaller than $500 million. They are often paid for in cash.
parts, which means there are thousands and thousands In addition to having the right skills, suppliers must also
of specialist parts suppliers. Each and every one of them be sufficiently large and capable to respond to the big
is contributing to the manufacture of planes, missiles or players’ requirements. Having suffered delays to major
engines that are sold for billions of dollars. programmes, such as the Airbus A380 and the Boeing 737,
as a result of difficulties in dealing with suppliers, both
The aeroplane makers like Airbus and Boeing, the engine
are eager to deal with fewer suppliers of everything, from
makers such as GE and Rolls-Royce, and the defence
seats and curtains to in-flight entertainment equipment
firms including Raytheon and Northrop Grumman, are
and avionics.
huge and powerful organisations. Each of them has
trading relationships with a vast number of suppliers, who Questions
in turn rely both on the big players and on each other. 1 Analyse the effect of two of Porter’s five forces
The industry often experiences mergers and takeovers. on the likely profits of aeroplane manufacturers. [8]
For example, in the commercial aviation market, most 2 Evaluate the effect of the power balance between
deals tend to involve a supplier (such as a company defence manufacturers and governments on the
making the landing gear for an aeroplane) buying one profits being earned in the industry. [12]
» few competitors and substitutes, so that customers

Actions to change the competitive could not easily find alternatives
environment » low supplier power, so that they have power over
Businesses try to make the competitive environment more suppliers. This might mean that they can demand a low
favourable. This means that to increase their own chances of price and do not have to pay quickly for the items (and
success they would want: so can hold on to the money and earn interest in the
» a high barrier to entry, so that other businesses will not bank for longer)
enter the market – this would remove a competitive threat
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» low buyer power, so that buyers are dependent on their Hamel and Prahalad argued that if an organisation is not
products. This should make demand more price inelastic, good at something, it should consider outsourcing it to
and so they may be able to charge more for their
products.
others that have competencies in these areas. Businesses
should concentrate on what they are good at and build on
6.2.1
this. For example, a business might make smartphones but
Businesses will want to change the five forces to make the its actual competence is in its assembly skills, which could
industry more favourable. For example, they might: be adapted to other products.
» join together in an industry association to have more
buying power over suppliers Hamel saw strategic planning not as a series of logical
» buy competitors’ companies to reduce the degree of steps but as moments of dramatic change. He said that
competition in the market ‘Strategic innovation will be the main source of competitive

» develop USPs to reduce the ability of customers to find advantage in the future.’ He believed great strategies come
substitutes. from challenging the existing situation.
Businesses need to think about their purpose, seek out
STUDY TIP ideas from the fringes and, in particular, embrace the
You need to be able to decide on the relative strength of democratising power of the internet. They need to think of
the five forces in a given industry and the impact of this on their competencies and build their strategies based on this.
the profitability of businesses. You should also consider
how businesses might react to influence the forces and The Ansoff Matrix
make them more favourable. Make sure you are clear
The Ansoff Matrix was developed by Igor Ansoff (1918–2002).
about the difference between substitute threat and
It examines strategies in terms of the products offered
rivalry, as these are often confused. A business producing
and the markets a business competes in. It highlights four
the same type of product is a rival. A business producing
something that consumers might switch to is a substitute.
possible strategies open to businesses, as in Figure 6.47.
Products
Existing New
Core competencies framework
Working with CK Prahalad, Gary Hamel, an American
management consultant, developed the concept of core New product
Existing Market penetration
development
competencies in relation to strategic management in
Markets
1990. ‘Core competencies are the collective learning in

the organisation, especially how to co-ordinate diverse
production skills and integrate multiple streams of
technologies.’ In summary, core competencies are the New Market development Diversification
things that an organisation does extremely well, and an
organisation’s strategy should be based on these things.
Prahalad and Hamel identified three factors in their
framework to identify the core competences of a business. ▲ Figure 6.47 The Ansoff Matrix
Core competences should: » Market penetration This strategy occurs when a firm
1 provide access to a wide variety of markets A business tries to sell more of its existing products to its existing
may be particularly good at new product development customers. To achieve more sales, the firm may adjust
and could extend into many different product elements of its marketing mix. For example, it may
categories. Or it may be good at developing technology increase its spending on advertising or cut its prices.
to link people who want to offer a service to those This is a relatively low-risk strategy because managers
who want to use that service, such as house rental, car are familiar with the products and markets. It may be
rental, bike rental or food delivery possible to implement actions to boost sales in existing
2 deliver a significant customer benefit Businesses need markets in the short term.
to consider what it is that makes customers choose one » New product development This strategy focuses on
business over another – is it the ability of the producer developing new products and offering these to existing
to produce the same product more consistently than clients. Firms operating in the soap, shampoo and
other? Or more quickly? Or better designed? laundry detergent markets, for example, are continually
3 be difficult for competitors to copy There is little developing new brands for their customers. This strategy
point having a competence that others can provide is risky in the sense that many new products often fail.
as well. This is because it means the business won’t Only one in ten new products launched survives the
stand out. A core competence should be something first two years, so all the investment in developing the
that requires a particular technology, location, culture product can be lost. On the other hand, managers should
or system that others struggle to imitate. For example, have a relatively good understanding of the market and
a business may have patented technology that others their customers’ buying processes, and so they may feel
cannot use without permission.
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confident (often wrongly) that their offering will be because it is now operating in two different markets. If
successful despite the high failure rate of others. sales decline in one market, demand may be sustained or
6.2.1 » Market development This strategy occurs when a
firm offers its existing products to a new market. For
even increase in another one.
Diversification is risky in the sense that managers
example, it may try to sell its products overseas or it are operating in an unfamiliar zone. Imagine that
may try to target new segments of its existing market. your senior managers at school decided to move the
Many sportswear companies have successfully marketed organisation into clothes retailing as well. Of course,
their products as fashion items, for example. Chewing- it is possible they could run a business like this very
gum companies have offered their product as an aid to well, but it would be completely different from running
giving up smoking, as something which helps prevent a school, and they are likely to have real problems
tooth decay and as a breath freshener; the product, adjusting to the different circumstances. On the other
therefore, has been offered to many new segments. hand, by operating in different markets, managers
This strategy involves quite a high level of risk, because are spreading the risks of demand falling; if demand
managers will not know the market well and will have to falls in one market, sales in the other market may
work hard to understand the segments within the market continue to sustain the business. Market penetration,
and the buying process. by comparison, is safe in that managers are operating
» Diversification This strategy involves offering new within their comfort zones; your school managers are
products to new markets. For example, a chocolate still running the school but trying to make it bigger.
company may decide to diversify into the soft drinks The managers know about education, they know the
market. This is a high-risk strategy because the firm may suppliers they want to work with, the competitor schools
have only a very limited understanding of the production and market conditions. The danger is that the business
and marketing requirements of the new sector. If it is is dependent on one market alone, which can make it
successful, however, it actually reduces the firm’s risk vulnerable.
CASE STUDY
Primark
In June 2020, as the number of cases of Coronavirus Primark’s new US stores will be in New Jersey and Florida,
(COVID-19) fell in most countries, Primark, the low-price increasing its total number of US stores to 11. In France,
clothes retailer, announced it was going ahead with Primark will open stores in the Belle Epine and Plaisir
plans to open five new stores in the USA, France and shopping centres in Paris. The company will also open its
Poland. This market development strategy was despite first new store in Warsaw, Poland. Primark has announced
(or possibly because of) economic uncertainty over further stores will be opened in Malaga and Lisbon.
Coronavirus. Many other retailers announced closures Primark suffered particularly badly in the lockdown due to
and redundancies, and Primark revealed it had had a the virus because it had no online shopping site.
75 per cent fall in sales in the three months before this
announcement. Questions
1 Analyse two factors Primark might consider when
Once Primark started to reopen its stores in June, it
choosing a country in which to expand. [8]
experienced high sales of childrenswear, leisure clothes
2 Evaluate the advantages and disadvantages of a
and nightwear. Summer clothes such as shorts and
market-development strategy for Primark. [20]
t-shirts were also in high demand. Sales of travel-related
clothes were down.
STUDY TIP
Choosing where to compete (markets), what to compete should follow logically. You start with the strategy and
with (products) and how to compete (positioning) are the the mix follows from this.
key strategic decisions. Once these decisions are made, Remember that when answering a question on strategy, you
the tactical decisions (that is, the marketing mix) are don’t usually have to go through all the different options. For
more straightforward – if you know what to offer, whom example, you may need to select which strategy works best
to offer it to and what you are trying to achieve, the mix for the business and possibly compare it with another.
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CASE STUDY
6.2.1
Mars corporate fact sheet
● Mars was founded in 1911, when Frank C Mars started
making and selling buttercream sweets in Tacoma,
Washington, USA.
● Wrigley was founded in 1891, when William Wrigley
Jr arrived in Chicago with $32 in his pocket and the
ambition to start a business of his own.

● Mars’ first blockbuster product was Milky Way,
invented by Frank and his son Forrest in 1923.
● In 1893, the Wrigley Company introduced Juicy Fruit
and Wrigley’s Spearmint gums, with Doublemint
making its debut in 1914.
● Mars established the Waltham Centre for Pet Nutrition
in 1965 in the UK.
▲ Figure 6.48 A selection of Mars chocolate Mars brands

● Chocolate: M&M’s, 3 Musketeers, Combos, Dove,
Mars, Incorporated, is a family-owned company, with six Galaxy, Twix, Snickers, Mars, Milky Way, Kudos,
industry-leading business units: chocolate, petcare, food, Maltesers, Celebrations
drinks, symbioscience and, most recently, Wrigley gum ● Petcare: Pedigree, Whiskas, Cesar, My Dog, Sheba,
and sugar (after it joined with Wrigley). Headquartered Royal Canin, Kitekat, Frolic, Chappi, Winergy, Trill,
in McLean, Virginia, Mars operates in more than 79 Waltham, Aquarian, Banfield
countries. It is a recognised leader in confections with ● Food: Uncle Ben’s, Dolmio, Suzi Wan, Masterfoods,
a wide range of product offerings including gum, mints, Seeds of Change, Ebly
hard and chewy sweets, lollipops and chocolate. Mars has ● Drinks: Flavia, Klix
approximately 65 000 associates worldwide and $28 billion ● Mars: Symbioscience focuses on innovative solutions
in annual revenue. that change the way we care for ourselves and the
The combination of Mars and Wrigley in 2008 brought natural world, for example, Mars Plantcare-Seramis,
together two strong, international businesses and created Mars Sustainable Solutions
one of the world’s leading confectionery companies. ● Wrigley gum and sugar: Starburst, Skittles, Lucas,
The portfolio spans a variety of categories such as Tunes, Lockets, Kenman, Skwinkles, Rondo, Juicy
confectionery items, main meals, side dishes, beverages, Fruit, Orbit, Altoids, Life Savers, Eclipse, Extra, Hubba
snack foods, frozen snacks, organic foods, pet foods, and Bubba, Doublemint, Spearmint, Pim Pom, Sugus.
now also includes Wrigley’s vast portfolio of gum brands
and sugar items. Questions
1 Analyse two possible benefits of Mars being a family
Fast facts company. [8]
● It is one of the world’s largest family-owned 2 Evaluate whether Mars’ strategy of operating in
companies. several different regional and product markets is a
● It has more than 317 sites worldwide, including 150 good one. [20]
manufacturing facilities.
● Its products are sold in more than 180 countries.
STUDY TIP Force Field Analysis

Remember that while choosing the right strategy is When making a strategic choice there will be forces
critical, the business must also be able to deliver it. If pushing for change. These could be falling profits, a new
you choose a low-cost strategy, can the business actually management team or a falling share price. At the same time,
get its costs down? Does it have a more efficient way of there will be resistance to change such as unwillingness
providing the service than others? Does it have better by employees or financial constraints. This idea of forces
relations with suppliers? Is it avoiding some costs by for change and restraining forces was put forward by Kurt
missing out some stages (for example, direct selling)? Lewin, a social psychologist, in his Force Field Analysis
You cannot sustain low prices unless you somehow model.
have lower costs, so make sure this is feasible for the
business. Similarly, if you offer a differentiated product,
how is it differentiated? What value have you actually
created? Is this sustainable or can it be imitated easily?
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Driving forces
(positive forces for change)
Restraining forces
(obstacles to change)
Using the decision-tree model
A decision tree sets out the options to managers. Given the
6.2.1 problem facing them, managers will identify possible courses
of action.
In Figure 6.50, the square highlights that a decision has to
Present
State be made. The lines coming out from this are the different
or options; in this case there are three, including doing
Desired nothing. Managers have to estimate the different outcomes
State
from each course of action; this is shown on the lines
coming from the circle.
Expected
outcome
success
▲ Figure 6.49 Lewin’s Force Field Analysis model $1m
Modify existing product 0.8
At any moment, the forces for and against strategic change ($0.2m) failure
will be balanced, which is why the business is pursuing its 0.2
($0.3m)
existing strategy. For strategic change to occur, there must
success
be an increase in the forces pushing for change (perhaps $4m
Enter new market 0.6
if there is a takeover and the new owners insist on it) or
a decrease in the forces preventing change (for example, ($1m) failure
($2m)
a training programme gives staff the necessary skills). 0.4
Managers must identify the forces for and against change
and try to increase the forces for and decrease the forces Do nothing
($0.5m)
against if they want change to occur.
▲ Figure 6.50 A decision tree
Imagine a situation in which managers want to introduce
new technology. To bring about change, managers must For each of these possible outcomes:
try to increase the pressure for it. For example, they might » The result is measured in financial terms so the
stress to employees: outcomes can be compared.
» the dangers of holding on to old technology (for example, » The probability of each outcome is estimated. The
loss of competitiveness and the possible loss of jobs) probabilities of all the outcomes must add up to 1
» the benefits of new technology (in terms of boosting (or 100 per cent) – this means there is a 100 per cent
competitiveness) chance that something will happen.
» the threats from competitors who are already using this
technology. In Figure 6.50, three options are identified:
a Modify the existing product This is expected to cost
Alternatively, managers might focus on reducing the $0.2 million. The likelihood of success is 0.8, so the
resistance to change and perhaps: managers are 80 per cent confident of success perhaps
» educate employees on the benefits of the change because it is modifying a product they know well. The
» offer incentives to those willing to change result of success would be $1 million. The probability of
» threaten or intimidate those who resist failure is 0.2 (20 per cent). (Note: Only two outcomes
» guarantee jobs to reduce this insecurity are given and one of these must happen, so the
» offer training to those who need to re-skill. probability of success or failure must add up to 1.)
b Enter a new market This is more expensive. The
Decision trees cost is estimated to be $1 million. The probability
In order to make the right decisions, managers may of success is estimated at 0.6 and is expected to
use different approaches to help them organise their generate returns of $4 million. The probability of
information and think through the various problems. These failure is estimated at 0.4 and this is expected to lead
include decision-tree analysis. Decision-tree analysis tries to losses of $2 million.
to estimate the possible outcomes of different courses of c Do nothing This is expected to lead to losses of
action and work out the likelihood of these occurring. A $0.5 million.
decision tree is a mathematical model which can be used Faced with a choice between these options, a manager
by managers to help them make the right decision. By will consider the likely outcomes, the probability of these
combining possible outcomes with the probability of them outcomes and the initial investment.
happening, managers can compare the likely financial
consequences of different decisions. Using the data on the outcome, the manager can calculate
what is known as the expected monetary value (EMV) of
The value of the technique will, of course, depend on each decision. This is the average return expected from a
managers’ ability to accurately estimate the options and decision, taking account of the different financial outcomes
their likelihood, but it does stress the key issues of risk and their probability. It shows what you would expect to
and rewards.
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gain (or lose) on average if you made this decision many outcomes might be more complicated, but the same
times. The EMV is calculated by multiplying the probability principles apply.
of each outcome by its financial value and adding these
together; it is a weighted average of the outcomes.
Expected
outcome
6.2.1
very successful
$0.5m
For example: 0.4
a Modify the existing product There is a 0.8 chance of Training successful $0.3m
$1 million (that is, this is fairly likely) but there is a 0.2 ($0.1m) 0.4
chance of losing $0.3 million. If this decision was taken fails ($0.1m)
many times, the EMV would be: 0.2

EMV = (0.8 × $1m) + (0.2 × –$0.3m) very successful
$3m
= $0.8m –$0.06m = $0.74m Introduce 0.5
new technology successful
If this decision were repeated many times then 80 per ($0.5m) 0.2
$1m
cent of the time you would gain $1 million and 20 per
fails ($1m)
cent of the time you would lose $0.3 million; on average, 0.3
the reward would be $0.794 million.
b Enter a new market There is a 0.6 chance of gaining
$4 million and a 0.4 chance of losing $2 million, so:
Do nothing
EMV = (0.6 × $4m) + (0.4 × $2m) ($0.2m)
= $2.4m –$0.8m = $1.6m ▲ Figure 6.51 A decision tree
If this decision were repeated many times then 60 per
cent of the time you would gain $4 million and 40 per Calculations
cent of the time you would lose $2 million; on average a Training
the reward would be $1.6 million.
EMV = (0.4 × $0.5m) + (0.4 × $0.3m) + (0.2 × –$0.1m)
Using the EMV, the managers can compare this with the = $0.2m + $0.12m – $0.02m = $0.3m
initial costs and estimate the likely overall return.
a Modify the existing product The expected gain is Net gain = EMV – initial cost = $0.3m – $0.1m = $0.2m
$0.794 million. Given an initial cost of $0.2 million, b New technology
this leads to an expected net gain of $0.594 million.
b Enter the new market The expected gain is $1.6 million. EMV = (0.5 × $3m) + (0.2 × $1m) + (0.3 × –$1m)
Given an initial cost of $1 million, this leads to a new = $1.5m + $0.2m – $0.3m = $1.4m
gain of $0.6 million. Net gain = $1.4m – $0.5m = $0.9m
c Do nothing This is expected to lead to a loss of
$0.5 million. c Do nothing Expected loss = $0.2 million.
Based on this analysis, the manager would select the Based on this, the managers would choose new technology
option of entering a new market because it has the highest because it has the highest net gain of $0.9 million.
expected net gains. In reality, the number of possible
CASE STUDY
EMV
Expected
outcome
Questions
success $2m 1 Calculate the missing values in the decision tree in
New advertising 0.8 Figure 6.52. [2]
($1m) failure 2 Calculate the EMVs for the following options on the
($0.1m)
? decision tree:
success a new advertising [3]
$6m b new product [3]
New product 0.5
($2m) c do nothing. [1]
failure
($4m) 3 Decide which option should be chosen. [6]
?
Do nothing
($0.2m)
▲ Figure 6.52 A decision tree
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» The outcomes are assessed in financial terms, but some
HANDLING DATA outcomes may not be easy to value; for example, the
6.2.1 If the probability of winning $10 000 is 40 per cent and
potential impact on a brand image of a poor product or
the social impact of a decision.
the probability of winning $20 000 is 60 per cent, what » The trees do not take account of what might or might
is the EMV of this decision? What if the probability of not fit with the ethics of the business. A decision may
winning $10 000 was 25 per cent and the probability of be profitable but unacceptable to the business; for
winning $20 000 was 75 per cent? example, it may be profitable to launch a new brand of
cigarette in a country, but a company may not want to
associate with this type of product.
STUDY TIP » The EMV is calculated as a weighted average – it shows
Remember that managers can take action to try to what would happen on average if the decision was
increase the probability of success and reduce the made many times. However, decision trees are most
probability of failure. In the case of a new product launch, likely to be used for big strategic decisions that will
greater investment in market research or greater only happen once; in this case the EMV is of limited
expenditure on promotion may help, for example. value because you will actually receive only one of the
outcomes, not an average of them. The implications of
this are shown below.
The usefulness of decision trees
Decision trees are very useful because:
» They make managers think about the different options. STUDY TIP
This discussion can create new solutions which may not Remember to check where the data has come from and
have been thought of if they had not gone through this how likely it is the decision-makers will have been able
process. to estimate the probability and the financial value of
» It makes them consider the possible outcomes, both outcomes effectively. Some outcomes will be difficult to
good and bad. This may make them realise some of the estimate in financial terms.
difficulties or attractions they might not have realised
without thinking it through in this structured way.
» It makes them quantify the possible outcomes. They Implementing a strategy
have to discuss and research to find out how likely an Developing a strategy is not enough to be successful. A
outcome is and what it would lead to financially. This, business must implement the strategy effectively. This
again, can be very revealing. involves:
» It means that they make a decision based on logic rather » clear communication of what needs to be done when, by
than emotions. If needs be, this can be demonstrated to whom and why
others to explain why a decision was made and help to » effective leadership to inspire and motivate employees
gain support. towards making sure the strategy is successful
However, businesses need to treat decision trees with some
» effective management to monitor what is happening
and to take actions if anything is delayed or not on
caution because:
target. The business needs clear, measurable targets and
» The value of a decision tree will depend on the options
effective systems to measure and control activities
included. If managers fail to think of a good solution,
the decision made will be relatively poor.
» sufficient resources for all the tasks that need
implementing.
» The values for the probabilities are estimates and
therefore may not be accurate – particularly if the Even if a strategy is implemented effectively, managers
decision has not been made before. Also, managers may must keep reviewing their business environment to ensure it
suffer bias and over-estimate the possibility of success if is the right strategy. As circumstances change, it may well
they like the idea of a project. be that the strategy needs to change too.
TEST YOUR LEARNING

1 Define the term ‘business strategy’. [2] 5 Define the term ‘blue ocean strategy’. [2]
2 a Define the term ‘strategic management’. [2] 6 Define the term ‘PEST analysis’. [2]
b Explain one possible benefit of strategic 7 Explain two of the five forces in Porter’s model. [6]
management. [3] 8 Define the term ‘core competencies’. [2]
3 a What is meant by ‘S’ and ‘W’ in ‘SWOT analysis’? [2] 9 Explain two types of strategy in the Ansoff Matrix. [6]
b Give an example of each. [2] 10 Explain one reason why decision trees can help
4 a What is meant by ‘O’ and ‘T’ in ‘SWOT analysis’? [2] lead to better decisions. [3]
b Give an example of each. [2]
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Data response question and partnerships – with VW, Rivian and Mahindra –
Ford
that are increasing Ford’s leadership in electric and
autonomous vehicles, and creating new business models 6.2.1
Ford, the vehicle producer, has a plan which it calls for profitable growth in emerging and emerged markets.
Creating Tomorrow Together. It says that to move this
In the fast-changing world of vehicles, Ford says that
plan forward requires tough decisions. For example,
its founding mission of ‘advancing human progress by
the company has had to reduce the size of its workforce,
providing freedom of movement’ is as vital, if not more
reduce the number of layers of management to flatten the
so, than it has ever been. According to Ford, it has always
structure and generally try to reduce bureaucracy.
built great vehicles that allow people to move freely and
Other actions taken by Ford have included investment now, with a more intelligent world, it can do more to

in Europe and South America to build on the company’s support human progress than ever before.
strengths in these regions, while trying to support regions
Ford’s aim is to design smart vehicles for a smart
that perform less well. In China, for example, Ford has
world. In doing so, it says it has the opportunity to
been developing a local leadership team and has localised
create significant value for all of its stakeholders, while
the first of five products – its Lincoln Corsair.
designing and building a better transportation system that
Ford says it needs to develop a targeted vehicle product will improve life for everyone.
portfolio for its different markets. This includes a new
Source: Ford Annual Report 2019, https://annualreport.
F-150 and electric Mustang Mach-E, as well as relatively ford.com/Y2019/default.aspx
new vehicles such as the Ranger, Explorer, Police
Interceptor, Escape, Super Duty and the Lincoln Aviator Questions
and Corsair in North America; the Ford Puma and two-ton
1 Explain two factors in Ford’s external environment
Transit in Europe; and the Territory, the first-ever fully
which might determine its strategy. [6]
Ford electric vehicle in China.
2 Analyse two factors in Ford’s internal environment
Ford appreciates that the vehicle industry is in the middle which might determine its strategy. [8]
of profound change, unlike anything it has seen in the 3 With reference to Porter’s five forces, analyse the
115-year history of its business. It says that the forces effect of two of the five forces on the profits of the car
driving this disruption are rapidly advancing technology industry. [8]
that is leading to increasingly intelligent vehicles and a 4 Using the Ansoff Matrix, evaluate the possible
deep need for a smarter transportation system – one that strategies that Ford could adopt in the future. [12]
is cleaner, safer and less congested. It is the pairing of
5 Evaluate the benefits of strategic management to
the two that will revolutionise the industry, and Ford says
Ford. [20]
it wants to be there leading the change. This will include
offering a range of compelling propulsion choices for its Essay questions
customers that are high-performing and good for the
planet by reducing CO2 emissions. 1 Evaluate the extent to which buyer power determines
the profits made by businesses in the food-retailing
Ford also wants to bring new levels of intelligence and industry. [20]
much greater computing power to help make navigation, 2 Evaluate the importance of strategic management
music and connecting its vehicles to smartphones, and for the success of a multinational business. [20]
also to the smarter world, faster and easier. Its cars will
3 Evaluate the usefulness of decision trees to
be connected to the cloud, to combine conversational
managers when making strategic decisions. [20]
voice recognition with the power of internet search, so
4 ‘Diversification is the best strategy for a business
drivers and passengers always have access to the latest
with an objective of rapid growth.’ Evaluate the
information, from the closest restaurant to the nearest
extent to which you agree with this view. [20]
electric-vehicle charging station.
Ford is also working with Argo AI to develop self-driving
vehicles. The company has made strategic agreements
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A LEVEL
6.2.2

Corporate planning
and implementation
A LEVEL 6.2.2 Corporate planning and implementation
Chapter overview
★ corporate planning
★ corporate culture
★ transformational leadership
★ strategic change
★ contingency planning and crisis management.
6.2.2.1 Corporate planning In the same way that people can differ and their attitudes
can vary enormously, so the culture of businesses can be
A corporate plan sets out where the business wants to tremendously different. For example, organisations may be:
go and how it intends to get there. It sets out what its » Entrepreneurial In these organisations you are
objectives are. The plan shows the detail of what needs highly valued if you try something, even if it does
to be done to get where the business wants to be. Each not necessarily work. The fact you had an idea and
department will produce its own plan linked to the overall tried to make it work is regarded as worthwhile and
plan for the business. commendable. This type of organisation may value
people who ‘think outside the box’, try new approaches
Having a plan clarifies for everyone what they are supposed
and show initiative.
to be doing and what success looks like, and it enables them
» Bureaucratic This type of business may want people
to prioritise resources and measure success.
who stick to the rules and who do not make decisions
for themselves. In some organisations, you may not
6.2.2.2 Corporate culture want people to start making up their own rules. At
the tax office, for example, you would want all the
The strategy of a business will be influenced by its culture. tax forms processed in the same way. The risks of
This will affect whether it is a risk-taker, whether it seeks letting people use their initiative could be too high in
short-term rewards or is willing to plan long term, whether some organisations or some parts of organisations; for
it cares about its stakeholders and even whether it seeks to example, you may want nursing staff to concentrate on
go beyond its existing borders. In this section we discuss administering the treatment doctors have prescribed
the meaning and importance of culture. and not diagnosing people or making decisions on the
medication for themselves.
What is corporate culture? » Customer-focused Some organisations clearly value
The culture of a business (corporate culture), can be their customers (most would, we hope, but in reality not
described as the values, attitudes and beliefs of the all do!). This means getting it right for the customer,
people working for it. It describes ‘the way we do things who is regarded as important – staff are expected
around here’ (Ouchi 1981). Hoftstede (1991) describes it as to put themselves out to make sure the customer’s
‘the collective programming of the mind’, which perhaps expectations are met. Employees are not expected
highlights how individuals’ own values may change as they to find reasons why things cannot be done. While a
become accustomed to the established ways of doing things customer-focused approach seems sensible and certainly
when they join a business. advisable in competitive markets, some businesses have
been much more inward-looking and have focused on
In reality, there is no one culture in a business – different what they could do and what they wanted to do rather
departments, different levels within the business, different than what customers wanted. British Airways had a
groups of employees may all have their own way of doing terrible reputation in the 1970s, because it placed too
things. Nevertheless, there may be some key areas where much emphasis on flying planes and not enough on
people generally agree and this can therefore help to define the customer experience. Money was being invested in
the ‘overall culture’ of a business. engines, landing gear and pilots’ uniforms but not in
improving the in-flight entertainment or the cleanliness
of the planes. A big push to refocus on customer needs
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led to a change in approach (which culminated in the the other extreme are high-risk organisations, where
rebranding of the business as the ‘world’s favourite decisions are made without enough thought about the
airline’), training all staff to place the customer first.
More recently, McDonald’s has been accused of being
resources and the dangers involved. In 2008, the global
banking system underwent major shocks due in part to
6.2.2
too inward-looking and not appreciating the change high-risk lending – bank managers had taken undue risks
in the market demand towards wanting healthier food. in their attempts to increase their lending and this had
Similarly, the major American car manufacturers, such as damaged them in the long term when borrowers could
General Motors and Ford, spent too long producing big, not repay.
oil-guzzling cars and did not appreciate that customers » Short term, long term Some businesses are very
wanted more fuel-efficient, smaller vehicles that were focused on the short term (perhaps because of pressure
being provided by producers such as Toyota. from investors for dividends); this means they may
6.2.2.2 Corporate culture

» Conservative (or not!) In these businesses there is a be reluctant to invest in new product development or
tendency to avoid risks. Relatively safe decisions are training. Others look more towards the long term (for
taken and before any new ideas are accepted there example, they might plan 15 years ahead for the next
is extensive (possibly overly extensive) research. At revolution in the internet).
CASE STUDY
Johnson & Johnson
The mission statement of Johnson & Johnson highlights for those qualified. We must provide competent management,
the importance of the customer to the business. This and their actions must be just and ethical.
set of beliefs has been proved on many occasions when
We are responsible to the communities in which we live and
employees have worked hard to make sure that customer
work, and to the world community as well. We must be good
service is outstanding and that customers are treated
citizens – support good works and charities and bear our
properly.
fair share of taxes. We must encourage civic improvements
Our credo and better health and education. We must maintain in good
order the property we are privileged to use, protecting the
We believe our first responsibility is to the doctors, nurses
environment and natural resources.
and patients, to mothers and fathers and all others who use
our products and services. In meeting their needs everything Our final responsibility is to our stockholders. Business
we do must be of high quality. We must constantly strive to must make a sound profit. We must experiment with new
reduce our costs in order to maintain reasonable prices. ideas. Research must be carried on, innovative programmes
Customers’ orders must be serviced promptly and accurately. developed and mistakes paid for. New equipment must
Our suppliers and distributors must have an opportunity to be purchased, new facilities provided and new products
make a fair profit. launched. Reserves must be created to provide for adverse
times. When we operate according to these principles, the
We are responsible to our employees, the men and women
stockholders should realise a fair return.
who work with us throughout the world. Everyone must
be considered as an individual. We must respect their Source: www.jnj.com/credo
dignity and recognise their merit. They must have a sense
of security in their jobs. Compensation must be fair and Questions
adequate, and working conditions clean, orderly and safe. 1 Analyse two benefits of outstanding customer service
We must be mindful of ways to help our employees fulfil to Johnson & Johnson. [8]
their family responsibilities. Employees must feel free to 2 Evaluate the impact ‘Our credo’ might have on the
make suggestions and complaints. There must be equal performance of Johnson & Johnson. [12]
opportunity for employment, development and advancement
GLOSSARY TERMS Types of culture

A corporate plan sets out where the business wants to go There are many ways of analysing the culture of a business,
and how it intends to get there. although, given that every business will be unique, all these
Corporate culture refers to the values, attitudes and can do is describe in broad strokes some of the key features
beliefs of a business’ employees; it refers to ‘how we do of an approach. One model is that of Charles Handy (1993),
things around here’. which outlines four types of culture:
» Power culture This type of culture is most common in
relatively small, owner-run businesses. There is one
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dominant person (or a few key people) who makes all the overlap (for example, university lecturers designing their
major decisions and all employees refer to them if they own courses independent of each other and the students
6.2.2 want to know what to do. The ‘boss’ is in charge of all
the operations of the business and its success depends
finding that elements of these courses overlap).
Unfortunately, sometimes the individuals will resist if a
very much on them. This can be very positive because it more centralised approach is needed, because they are
can lead to decisive leadership, quick decision-making used to their independence.
and a consistent approach. However, if the business
starts to grow, the person or people at the centre The importance of corporate culture
may become overloaded and unable to cope with the
The culture of a business or a part of a business matters
number of decisions that need to be made. This can
because it determines how employees will behave in any
bring decision-making to a halt as employees wait to
given situation. This can work in an organisation’s favour.

get a response. It also encourages employees to become
Companies such as Google have a culture that recognises
reliant on the boss and not learn how to make decisions
and rewards creative talent and technological skills. Bright
for themselves.
computer programmers will go far in this organisation
» Role culture This is very common in businesses as
regardless of their age and, to some extent, regardless of
they grow and tend to adopt a more formal structure
their formal qualifications; if they can do it and prove they
and culture. The importance of someone begins to be
can do it, they will probably be promoted. This encourages
defined by their position in the hierarchy and their
ideas and new thinking which helps keep Google ahead of
job title. This type of culture relies quite heavily on
its rivals. A culture of accuracy and attention to detail, by
rules and procedures. To do well you need to follow the
comparison, may ensure your firm of accountants does not
systems that are in place and do what is expected of
make any mistakes.
you, rather than using your initiative to define your
own job boundaries. Communication is via established On the other hand, a culture can limit a firm’s success.
channels of communication rather than through, say, In some retail organisations, the customer seems an
informal conversation. This leads to very predictable unwelcome visitor! Customers are not truly valued and
outcomes in terms of performance. Senior managers employees do not make the effort to provide good customer
know what is going to happen because employees do service. This will lose the business money over time. In
what they have been told to do. This has the value of other organisations, the unwillingness to take risks may
certainty. However, the danger is that the organisation mean market opportunities are missed. For example,
is inflexible to change and is not prepared for imagine that a retailer’s culture was one of unquestioning
unexpected challenges. agreement with the chief executive’s decisions; this would
» Task culture This is relatively common in businesses mean that when the wrong products were ordered and the
such as design agencies or management consultancies, wrong approach to displays was chosen, no one would dare
where the value of an individual to a project depends to speak up. The culture did not encourage a questioning
on their expertise rather than any formal title. In this approach, which meant that even though staff may have
approach, teams are formed for particular projects and seen the iceberg ahead, they would not shout out the
individuals brought into these as and when they can dangers because they simply followed the course the
contribute. Your value depends on what you can add captain set for them.
to the team rather than your age or how long you have
The importance of culture in terms of the success (or failure)
been working there. This approach can bring together
of a strategy should not be underestimated. Is the business
expert teams to help solve different problems; however,
full of ideas, encouraging initiative, stressing the value of
co-ordinating this approach can be difficult.
working hard and working effectively? Are new projects met
» Person culture This is not very common, but it occurs in
with open arms? Do individuals take care to get it right and
an organisation or part of an organisation where there
show commitment to a project? All these issues depend on
are groups of well-qualified individuals who respect
the culture of a business. It determines what people do,
each other’s skills and knowledge. This may occur in
how they work together, how much effort they make, what
a university or a doctors’ practice, for example. Each
they strive for and, basically, determines how the business
individual is fairly self-reliant and can make decisions
‘ticks’. Whatever strategies you bring in, whatever ideas you
for themselves. They collaborate with each other and
have, the culture of the business will influence whether
share their expertise and skills when needed, but they
they are implemented, how they are implemented and the
operate independently. This works well if the business
level of commitment to them by employees.
can function with relatively independent units, but the
danger is that the approach lacks consistency and may
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CASE STUDY
6.2.2
The five principles of Mars
Quality How is it possible to maintain our principles, offering
superior value for money and sharing our success? Our
The consumer is our boss, quality is our work and value for
strength lies in our efficiency, the ability to organise all
money is our goal.
our assets – physical, financial and human – for maximum
Our company is dedicated to the highest quality in all the productivity. In this way, our products and services are made
work we do. Quality is the uncompromising standard for our and delivered with the highest quality, at the least possible
6.2.2.3 Transformational leadership

actions, and it flows from our passion and our pride in being cost, with the lowest consumption of resources; similarly, we
part of the Mars community. Quality work, which results from seek to manage all our business operations with the most
our personal efforts, is the first ingredient of quality brands efficient processes for decision-making.
and the source of our reputation for high standards.
Freedom
Responsibility We need freedom to shape our future; we need profit to
As individuals, we demand total responsibility from ourselves; remain free.
as associates, we support the responsibilities of others.
Mars is one of the world’s largest privately owned
Mutuality corporations. This private ownership is a deliberate choice.
Many other companies began as Mars did, but as they
A mutual benefit is a shared benefit; a shared benefit will
grew larger and required new sources of funds, they sold
endure.
stocks or incurred restrictive debt to fuel their business.
We believe that the standard by which our business To extend their growth, they exchanged a portion of their
relationships should be measured is the degree to which freedom. We believe growth and prosperity can be achieved
mutual benefits are created. These benefits can take many another way.
different forms, and need not be strictly financial in nature. Source: www.mars.com/about/five-principles
Likewise, while we must try to achieve the most competitive
terms, the actions of Mars should never be at the expense, Questions
economic or otherwise, of others with whom we work. 1 Analyse two factors that might influence the culture of
Mars. [8]
Efficiency
2 Evaluate the ways in which the culture of Mars might
We use resources to the full, waste nothing and do only what affect the behaviour of employees and its business
we can do best. performance. [12]
» Idealised influence (II) This means that the leader

GLOSSARY TERM acts as a role model and wins the respect of their team.
Transformational leadership exists when leaders identify They encourage a shared vision so the team sets out to
what changes are needed, create a vision and inspire achieve the overall objectives of the business.
employees to carry through the changes. » Intellectual stimulation (IS) These leaders encourage
others to innovate and to form new ideas for the
organisation and themselves. They push others to
6.2.2.3 Transformational challenge their own beliefs and values, as well as
those of the company, in the belief that this leads to
leadership innovation.
Transformational leadership is a style of leadership that » Inspirational motivation (IM) Transformational leaders
was described by James Burns in his book Leadership and work to increase team morale through motivational
later developed by Bernard Bass. It is an approach in which techniques and acting as inspiration for their followers.
leaders work with others to agree what needs to be changed They set high expectations to individual followers and
and develop the appropriate steps to be taken. However, motivate them to gain their commitment to a shared
it sets out to transform the rest of the team so that they organisational or team belief.
become leaders themselves. This can be a powerful way » Individualised consideration (IC) Transformational
of bringing about change because those involved are the leaders create a diverse and supportive environment,
leaders of it. where individual differences are respected and
celebrated. They will know each of their followers
Bass identified four elements that make up a individually, and listen to any concerns or needs that
transformational leader, known as the ‘four Is’. These are: their team members may have.
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These four elements create an open, communicative and Perceived personal risk
diverse culture; this is intended to empower the team. Low from change High
6.2.2 Transformational leaders are often described as mentors

and role models. They lead by example and create an
High
environment where innovative thinking is aligned with

the values, beliefs and objectives of the organisation. Moderate to
This gives ownership of the change to the people who are High readiness indeterminate
for change readiness for
closely involved in it.
Level of satisfaction with

change
existing situation
Idealised
influence (II)
Moderate to
indeterminate Low readiness
readiness for for change
change
Inspirational Transformational Intellectual
motivation (IM) leadership stimulation (IS)
Low
▲ Figure 6.54 Employee readiness for change

Change may not happen because there is resistance to it.
Also, it may be that the business lacks the resources to
Individualised
bring it about. We may know that we need to update our
consideration (IC) database systems, improve our websites or refurbish our
stores, but we may lack the resources to do so. Often, the
▲ Figure 6.53 Bass’ model of Transformational leadership very time when change is needed (when a business is doing
badly) is when a business is short of resources to bring it
about. The lack of resources may involve a lack of:
6.2.2.4 Leading and managing » money; for example, a business may not have the cash or
strategic change access to credit to invest
» skills; for example, a business may not have the talents,
Given that change is going to occur both internally and experience and abilities within its organisation to
externally, managers must consider the best way(s) of manage a change or bring about change effectively. This
managing it. Resistance to change may come in many forms, may be due to the recruitment policy, a lack of training
such as: and/or a new situation arising which requires new skills
» a lack of effort to learn the necessary new skills or a it does not have
general lack of co-operation » time; you should never underestimate time as a resource.
» a demand for more pay
» a refusal to use the new systems There may be many changes managers want to bring about,
» a demand for extended discussion to slow down the but they may be so busy firefighting (see Mintzberg’s
process of change. analysis of what managers do on pages 86–87) that they
cannot implement all the changes they would like to.
Figure 6.54 highlights the different states that employees
might be in when managers are introducing change. This model Another problem that can occur is that managers simply
by Zeira and Avedisian highlights that openness and readiness do not recognise that change is needed. They may be too
for change will depend on how dissatisfied employees are with inward-looking and not appreciate that their market has
the present situation and the extent to which they think they changed. A manager like this is a reactive rather than a
will suffer from the change. The more dissatisfied they are and proactive manager.
the less they think they will personally suffer as a result of it,
the more open they will be to change. STUDY TIP
Remember that the best way to bring about change will
depend on what the change is, how much those involved
understand the need for it, the degree of resistance to it
and the time and resources available.
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Developing a change culture
CASE STUDY Changing culture can be important but difficult. Businesses
will want to have a culture that is open to change and 6.2.2
Huawei be willing to embrace a new strategy and implement it
Huawei was founded in 1987. It is one of the world’s fully. According to Kotter and Schlesinger (1979), the main
largest providers of information and communications reasons why people resist change are:
technology (ICT) infrastructure and smart devices, » self-interest – they do not want the effort of change or
such as smartphones. Huawei says it is ‘committed to are better off as they are (for example, their status or
bringing digital to every person, home and organisation importance might be lower after the change)
for a fully connected world’. Huawei has over 194 000 » misunderstanding and lack of trust – they do not
6.2.2.4 Leading and managing strategic change

employees operating in more than 170 countries and understand why change is necessary and/or are
regions. It has more than 3 billion customers around the suspicious about why the change is happening
world. » they prefer the status quo – they would rather keep
Huawei is a private company which is completely things as they are because they feel comfortable with it
owned by its employees. Through the Union of Huawei » they do not think the new idea will work – they think
Investment & Holding Co., Ltd, the company has there are flaws in it and therefore it would be wrong to
a shareholding scheme which is only available to pursue it.
Huawei employees. No government agency or outside
organisation holds shares in Huawei.
To change the culture of an organisation, you need
to change what people value and what they believe is
Huawei says that it exists to serve its customers. It says important. This can happen, but it often takes time.
the company’s common values are ‘staying customer- Imagine you were someone who does not like sport, who
centric and creating value for customers’. sees no point in taking part in it if you do not like it,
Source: www.huawei.com/uk/corporate-information and who likes the freedom your sixth form gives you to
choose whether to participate. If the school headteacher
Questions suddenly decides that your views on the importance of
1 Analyse one reason why being customer-centric sports at school are wrong and that from now on it will
might face resistance from employees. [4] be compulsory, you would probably argue about this. It
2 Evaluate the ways Huawei might develop a is possible that over time you could be convinced that
strategy to avoid resistance from employees. [12] compulsory sport at school would help your academic
performance or help you feel better in yourself, but simply
being told that this is true would not necessarily work. You
Developing a strategy to manage would want to see some evidence or try it out for a while
to see for yourself, or be talked through the arguments for
change and against until you were convinced and agreed with the
Managers will need to consider the right strategy to manage arguments being made. Unfortunately, businesses do not
change in any given situation. This will depend on factors always have time to go through this process with every
such as: member of staff. Sometimes culture needs to be changed
» the potential level of resistance faster than a process of education and discussion allows;
» the extent to which the reason for change is understood sometimes leaders may think it is better to push on and let
» the resources and time available. people see the benefits rather than spend the time trying
In some cases, the focus may be on informing staff. In to convince them in advance.
other cases, persuading employees of the need for change To achieve change quickly, managers may:
or the benefits of change is more significant. On some » offer incentives for those who agree to the changes
occasions, the strategy may need to concentrate on forcing and start adopting them (higher marks for those who
it through. participate in sport); this is a ‘carrot’ approach
» punish those who do not adopt the changes (lower marks
Techniques to implement and manage for those who do not participate in sport); this is the
‘stick’ approach.
change successfully
Neither the carrot nor the stick approach will in itself
Change is most likely to be successful if:
change people’s attitudes. They are simply changing
» those affected by the change are involved in bringing it
behaviour. They do not change what you believe, simply
about (rather than having it imposed on them)
what you do. This means people will not be very committed
» those involved in the change feel they have an
to the changes. However, in the long term, if the changes
opportunity to air their views
are proved to be beneficial, people may change their
» the benefits of the change are made clear to those
attitudes as well.
involved
» individuals feel able to cope with the change; they feel Other approaches include:
they have the resources and skills to deal with it » educating people about the benefits of change
» the people involved agree with the reasons for the change. » reassuring people about the change, to reduce fears
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» providing resources to enable people to prepare and » a major computer virus attacking the database
train for change » an epidemic causing illness among staff.
6.2.2 » focusing on key people to get their support; once they
are won over, others will follow.
Contingency plans might include:
» using two suppliers for the same part or component
Why can change go wrong? in case there are problems with one of them; this can
Kotter (1990) studied more than 100 companies going safeguard supply
through change and identified the following most common » paying a fee to be able to use computer facilities or
errors made by managers who were trying to bring about office space elsewhere in case of flooding, earthquake or
change: a terrorist attack
1 Too much complacency It is common to think problems » training employees in several tasks so they can take
can be dealt with later. Managers need to create a sense over from others if there are major absences, illnesses or
of urgency when introducing change. strikes
2 Failing to build a substantial coalition This means that » ensuring new products are in development so that if
forces opposing change often undermine the changes there is a problem with existing products, they can be
that managers are trying to bring in. Managers need replaced.
to build a coalition to gain support and help push the However, you cannot afford to have a contingency plan
change through. for every event (such as alien invasion or being hit by a
3 Underestimating the need for a clear vision Without meteorite). Managers must therefore decide exactly which
a clear vision of where you are headed, you may end up events are worth preparing for and how many resources
with a series of initiatives that are rather disconnected. to put into contingency planning. Should the firm have
4 Permitting roadblocks against the vision This means back-up plans in case there are problems with suppliers?
allowing things to get in the way and delay change. Should it have a plan for what to do if there is a safety
Managers need to empower people to clear such obstacles. problem with one of its products? What about planning
5 Not planning or achieving short-term wins It is for a situation where a competitor makes a takeover bid?
important to sustain momentum. Managers need to Decisions must be based on the likely risk and damage of
secure short-term wins to show they can succeed. any event.
6 Declaring victory too soon Managers need to keep
moving. A contingency plan should provide a sense of direction and
7 Not anchoring changes in corporate culture Managers enable each element of the business to see how it should
need to anchor change and make sure it is part of the contribute. It should help managers set their priorities and
culture; for example, by rewarding those who have allocate their resources.
helped bring it about.
CASE STUDY
Change may not come
about because of:
Honda
In 2020, Honda, which produces motorcycles, cars,
generators and lawn mowers, had to deal with a
cyber-attack that affected its worldwide operations.
The attack impacted on the company’s ability to access
Resistance A lack of Ignorance that its computer servers, use email and internal systems.
to change resources change is needed Honda said that one of its internal servers was attacked
externally.
▲ Figure 6.55 Unsuccessful change
Work at Honda’s UK factory was stopped, and other
6.2.2.5 Contingency planning and operations in North America, Turkey, Italy and Japan
were suspended.
crisis management Cyber-security experts said it was probably a
Businesses operate in uncertain and risky environments. ransomware attack, whereby hackers could have
Managers are always making decisions about the future and, encrypted data or prevented Honda from accessing some
inevitably, are not sure of exactly what the future will be of its IT systems.
like. This makes planning even more important – planning Honda employs nearly 220 000 people globally across
for a situation that is expected but also reviewing the plan over 400 group affiliate companies.
regularly to assess where the business is compared with
where it is expected to be. Managers must then decide what Questions
to do next to get back on track, if necessary. One type of 1 Analyse two ways in which a cyber-attack might
planning is known as contingency planning. This occurs affect Honda. [8]
when a firm prepares for unlikely events, such as: 2 Evaluate the possible benefits of contingency
» a fire planning to Honda. [12]
» the bankruptcy or insolvency of a major customer
» the closure of an important supplier
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The greater the likelihood of an event and the greater the
potential damage if it does occur, the more likely a firm is GLOSSARY TERM
to plan for it. Food manufacturers, for example, are likely to
plan for a situation where their products are contaminated
Contingency planning involves preparing for unexpected
events.
6.2.2
and they have to recall them. An airline will plan for the
event of a crash. An oil transportation business will prepare
for a spillage. The impact of a crisis
When a disaster does occur, such as a fault in a product or
The need for contingency planning highlights the dynamic a fire at a factory, this can cause panic. It is hoped that
nature of business and the need to be prepared for the the firm will have a contingency plan which it can put into
unexpected. Obviously, a firm cannot prepare for every
6.2.2.5 Contingency planning and crisis management

action but, even so, this is likely to be a stressful time. It
emergency, but it is worth highlighting the biggest risks is easy to rush into a decision at times like these because
and preparing for these. Firms must continually examine of the pressure to do something and be seen to be doing
their own operations and their environment to check that something – this can lead to rushed and inappropriate
they are prepared for possible changes in the future; in this decision-making. On the other hand, if you delay too
way managers will be proactive (anticipating and preparing long, the crisis may get worse. As well as sorting out the
for change) rather than reactive (having to react to crises crisis itself, the firm may have to handle the press. When
as they develop). managing a crisis, it is important to:
Of course, this does not mean that companies that have » identify the ‘facts’ as soon as possible. What is the
contingency plans are safe from disaster. Unfortunately, scale of the problem? How many people are likely to be
managers often do not or cannot foresee what events affected?
will occur. In 2008, for example, there was a major global » establish good communication systems. Managers must
financial crisis that few had predicted. This led to a problem make sure that everyone is ‘online’ and reacting in the
gaining credit and lower customer spending, which damaged same way. If, for example, different managers are giving
many businesses, very few of which would have had any the press different information following a scare about
form of plan for this scenario. In 2020, the Coronavirus the safety of the product, this will create the impression
(COVID-19) pandemic adversely affected national and global they are not in control and the public may lose faith
economies, as countries were forced to close their borders » have the authority and resources to make decisions
and go into full lockdown to prevent spreading the virus. quickly, rather than having to consult endless committees.
TEST YOUR LEARNING

Lenovo began with a small team of 11 engineers over 30
Short answer questions years ago, in China. Now it is made up of a diverse team
1 a Define the term ‘corporate plan’. [2] of innovators in more than 180 markets. Lenovo says that
b Explain two benefits to a business of having a these innovators are ‘constantly reimagining technology to
corporate plan. [6] make the world more interesting’ and to solve some of the
2 Define the term ‘corporate culture’. [2] global challenges we face. Lenovo says it is ‘dedicated to
3 Explain one way in which culture affects decision- transforming its customers’ experience with technology’.
making. [3] Lenovo’s strategy has been described by analysts as one
4 Define the term ‘task culture’. [2] of ‘protect and attack’; it is both defensive and offensive
5 Define the term ‘innovative culture’. [2] at the same time. Defensively, Lenovo is aiming to build
6 Explain one link between corporate culture and on its success in China, where it is the top seller of PCs.
strategic management. [3] To do this, it aims to build its links with distributors and
7 Define the term ‘transformational leadership’. [2] retailers as well as increasing its direct, online sales.
8 Explain two elements of effective strategic change. [6] Lenovo also aims to build relationships with large-scale
buyers, such as governments and educational institutions.
9 a Define the term ‘contingency planning’. [2]
This involves Lenovo sales representatives working
b Explain one benefit of contingency planning. [3] closely with these partners.
10 Define the term ‘crisis management’. [2]
Lenovo has a strong position within China thanks to
Data response question an extensive distribution network, many of whom are
exclusive distributors, meaning they cannot sell other
Lenovo firms’ products. Lenovo is also a Chinese business;
At Lenovo, innovation isn’t just what we do, it’s part of our this may mean it has closer links with the culture of
DNA. It doesn’t just make us who we are, it flows through the country than some others and this may give it an
everything we do – from the smartphone in your pocket and advantage in that market. An example of this was the
light bulbs in your smart home to the servers in your data ‘wedding computer’ that Lenovo produced. This was a
centre. And beyond. low-price computer in the colour red (which denotes
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luck in China) and which had the Chinese symbol for Historically, Lenovo has focused on PCs but is now looking
6.2.2 ‘happiness’ on it. This was extremely popular in rural

China as a gift at weddings.
to what it calls the ‘PC+ world’, in which the PC links
a network of interconnected devices such as tablets,
smartphones and smart TVs.
The ‘attack’ part of Lenovo’s strategy is to become much
bigger overseas. This international expansion can provide Source: www.lenovo.com/gb/en/about/whoweare
long-term profits but often involves initial losses as the
business tries to establish itself. Operating overseas Questions
is also difficult because consumers around the world 1 Analyse two benefits to Lenovo of investing in
can have very different consumer preferences, and innovation. [8]
the competition and regulatory framework can differ 2 Evaluate the extent to which Lenovo’s ‘protect and
significantly. To maximise its impact overseas, Lenovo attack’ strategy seems to be a good one. [20]
has made various acquisitions to use local expertise. For
example, in 2014 it bought Motorola Mobility because of Essay questions
this company’s strength in North and Latin America. In 1 Evaluate the extent to which it is easy to change the
2017, Lenovo purchased 51 per cent of Fujitsu’s PC division culture of a struggling business. [20]
because of its strength in Japan.
2 Evaluate the importance of culture in determining
Lenovo is not only expanding geographically, it is also the success of a multi-site business. [20]
investing heavily in innovation to develop new products.
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A LEVEL
7.1 Organisational structure
7.1.1 Relationship between business objectives and structure

Chapter overview
★ how organisational structure can support business objectives
★ different organisational structures
★ delegation and accountability
★ control, authority and trust
★ centralisation and decentralisation
★ line and staff employees.
7.1.1 Relationship between CHIEF EXECUTIVE,

MANAGING DIRECTOR
BOARD OF DIRECTORS –
business objectives and structure

responsibility for
AND OTHER DIRECTORS establishing strategy
e.g. Director of Finance, and the business’s
Director of Marketing overall direction
What is an organisational structure? MANAGERS
The organisational structure, which may be shown in an Take responsibility for MIDDLE MANAGERS –
organisation chart, sets out: achieving short- and traditionally have
long-term targets, responsibility for a function,
» the routes by which communication passes through the
Authority may be delegated

e.g. sales managers, e.g. market research
business production managers,
» who has authority (and power) and responsibility training managers
Accountability
within the organisation SUPERVISORS/TEAM

» the roles and titles of individuals within the LEADERS
organisation Given authority for
overseeing operations
» the people to whom individual employees are (market research,
accountable and those for whom they are responsible. production quality, for
example) on a
Figure 7.1 illustrates a simplified organisational chart for a day-to-day basis
large business.
SHOP-FLOOR WORKERS
The organisation’s structure plays a vital part in shaping the These could be
production teams,
success of the business. This determines the ways in which sales representatives,
its work activities are organised and how responsibility and clerks involved in finance,
authority are allocated. The structure of an organisation training, quality control
and advertising
affects how employees (from the most junior to the
very senior) carry out their responsibilities and use their Communication can pass up and
authority, how they co-ordinate and work alongside others, down the organisation, as well as
horizontally, e.g communication
and the extent to which the business achieves its goals and between managers
objectives.
▲ Figure 7.1 A simplified organisational chart
GLOSSARY TERMS
An organisational structure is the way in which a business
The case for flexible organisational
is arranged to carry out its activities. structures
Authority is the power to control situations or the A flexible organisational structure is one in which workers can
decisions and actions of others. easily adapt to their customers’ needs, efficiently complete
Responsibility is the duty to complete a task and to be their work and make decisions as and when necessary.
accountable for one’s actions.
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Management writer, Peter Drucker, was a strong advocate A flexible organisational structure is likely to possess a
of flexible organisational structures. A common mistake number of important characteristics:
7.1 by managers, Drucker argued, is that they tend to become
obsessed by organising the business’ structure just one
» It will be continually changing and evolving to meet
changing needs. Employees at all levels will be used to
way. At various times, decentralisation has been the key change and will be likely to respond positively to it.
element of a successful structure; later, close control and » It will focus strongly on the needs of its customers. This
command of employees was considered essential. ‘There is may mean that, for example, employees may work in
no such thing as the one right organisation,’ Drucker wrote. teams which can be disbanded and new ones formed to
‘There are only organisations, each of which has distinct meet customers’ changing demands.
strengths, distinct limitations, and specific applications. It » The organisation may make use of consultants and
has become clear that organisation is not an absolute. It is temporary and part-time employees to supply specialist
A LEVEL 7.1 Organisational structure
a tool for making people productive in working together. As skills or to manage peaks and troughs in demand for its
such, a given organisational structure fits certain tasks in products.
certain conditions and at certain times.’
CASE STUDY
The structure of HSBC
HSBC is one of the world’s largest banking and financial Banking, Global Banking and Markets, Retail Banking
services organisations. Its global businesses serve more and Wealth Management, and Global Private Banking.
than 40 million customers in 64 countries and territories. However, it has also created a ‘global network of locally
In 2019, it had over 235 000 employees. However, HSBC incorporated subsidiary companies’ that oversee of the
has announced that it plans to cut its global workforce by bank’s operations at a country and regional level. Its
up to 35 000 people by 2023, as part of a move to restore simplified organisational structure is shown in Figure 7.2,
profitability. while Table 7.1 shows some of HSBC’s largest and
best-known subsidiaries and their primary areas of
HSBC operates within four business groups as part
operation.
of a matrix organisational structure: Commercial
HSBC
Holdings Plc
UK
Holding company
HSBC Latin HSBC
American 99% HSBC Overseas HSBC Bank HSBC 99% HSBC HSBC Bank 94% HSBC Intermediate holding
Holdings (UK) Mexico SA Holdings (UK) Canada Bank Plc France Egypt SAE Holdings BV company
Limited Limited Operating company
UK
HSBC North HSBC
HSBC Bank 80% The Saudi 40%
America Trinkaus &
Brazil SA British Bank
Holdings Inc Burkhardt AG
Germany
HSBC The Hongkong
HSBC HSBC Bank HSBC Asia HSBC Bank
HSBC Bank Investments 70% HSBC Bank and Shanghai
Finance Middle East Holdings (China) Co
Chile (North Malta Plc Banking
Corporation Limited (UK) Limited Ltd
America) Inc Corporation Ltd
USA HK
HSBC Bank HSBC HSBC Bank HSBC Bank
HSBC
(Panama) Securities (Vietnam) (Taiwan)
Bank AS
SA (USA) Inc Limited Ltd
Turkey
HSBC HSBC Bank HSBC Private HSBC HSBC HSBC Bank
99% HSBC HSBC Bank Banking
Latin America Argentina Private Bank Australia Malaysia
USA Inc USA, NA# Holdings
BV SA (Suisse) Limited Berhad
(Suisse) SA
HSBC Bank PT Bank
98%
Bermuda Ekonomi
Limited Raharja Tbk
62% Indonesia
Hang Seng
Hang Seng
Bank (China)
Bank Limited
Ltd
HK
Middle
Latin America North America Europe East Asia-Pacific
Source: HSBC
▲ Figure 7.2 The simplified organisational structure for HSBC
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▼ Table 7.1 Some of HSBC’s major subsidiaries The HSBC brand is recognised worldwide. HSBC operates
Subsidiary Primary area of operation

under a single brand name and logo all over the world.
The bank’s latest advertising campaign is underpinned by 7.1
Hong Kong, with an the phrase ‘Together we thrive’, reflecting its long-term
The Hongkong and Shanghai commitment to helping customers succeed throughout
extensive network
Banking Corporation Limited the world.
throughout Asia-Pacific
Hang Seng Bank Limited Hong Kong Source: www.hsbc.com/investors/investing-in-hsbc/
group-structure
HSBC Bank Plc United Kingdom
HSBC France France Questions
7.1.1 Relationship between business objectives and structure

HSBC Bank USA N.A. United States of America 1 Analyse one key issue in designing an effective
organisational structure for a multinational business
Grupo Financiero HSBC, S.A. employing 235 000 people. [4]
Mexico
de C.V. 2 Evaluate whether the advantages to HSBC of
organising itself in this way are greater than the
disadvantages. [12]
GLOSSARY TERM Organisational structures should

A matrix organisational structure uses teams of facilitate growth and development
employees with suitable skills drawn from across the An organisational structure should allow and assist a
normal departments to respond to the business’ needs. business to increase its scale and to change in other ways
to enable it to meet its corporate objectives. The structure
Organisational structures should used when a business seeks to grow and develop should
allow the organisation to adapt, to produce new products or
reflect businesses’ needs to operate in different markets.
The organisational structure adopted by a business will
As a business grows, its chain of command from those at
depend upon the type and size of the business, and it will
the top of the organisation to those at the bottom is likely
be designed to meet the needs of the business as fully as
to lengthen. This may require a structure that is flatter,
possible. A number of key factors will be taken into account
with fewer layers of authority between senior and junior
by the business’ managers when designing (or redesigning)
employees. This will make communication easier and more
an organisation’s structure:
reliable, ensuring that decisions are more likely to be
» The business’ size As the business grows, it is more
understood and acted upon and that senior managers can
difficult for managers to control growing numbers of
readily gather information from below. If a structure has too
employees. Thus, in order to manage their workloads
many layers of authority, decisions may be slower and the
efficiently, they will devise a structure that gives
organisation may become less competitive as it becomes
more authority to those lower in the organisational
slower to respond to changes in the market and other
structure.
external changes.
» The type of product supplied by the business A
business that supplies a range of diverse products Organisational structures are subject to factors that require
may organise itself traditionally into divisions. For them to adapt if the business is to remain successful. Changes
example, Hard Rock Café operates in this way. It in technology, changes in competitors’ behaviour, changes
originally started as a restaurant business, established in government policies and changes in tastes and fashions
by Peter Morton and Isaac Tigrett, but later expanded can all act as a catalyst for a change in an organisation’s
into hotels and casinos. Key areas of the business, structure. For example, a new competitor entering a market
such as casinos, have some degree of independence, might result in an increase in price competitiveness,
while still operating within the overall structure of the necessitating existing firms to cut costs. Reducing the size
organisation. of the workforce and adapting its structure to contain fewer
» The business’ objectives Businesses that are seeking layers of authority may be one way to achieve this. However,
growth may organise themselves so as to minimise costs if a structure is too rigid, this may not be possible.
and, hence, selling prices. This may encourage the use
of organisational structures which pass considerable
authority to relatively junior employees to minimise STUDY TIP
management costs. This may also motivate junior You should assess the strengths and weaknesses of any
employees and improve productivity. organisational structure by using all the information
available to you and considering the extent to which
the structure assists the business in achieving its
organisational objectives.
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Organisational structures should Managing
7.1 encourage intrapreneurship Director (1)
We saw earlier in this book that entrepreneurs are people Directors (3)
who have business ideas and a willingness to take the
risk necessary to start their own businesses to develop Total = 121 Managers (9)
them. The managers of some large organisations seek to employees
capture and use the spirit of entrepreneurship, and the
design of the organisation’s structure is one way to do 27 supervisors
this. Intrapreneurs are expected to take responsibility for
turning an idea into a profitable product through taking 81 shop-floor

workers
necessary risks and innovating. Shutterstock, a business
that supplies photos for commercial purposes, holds a
hackathon lasting 24 hours once a year to let employees ▲ Figure 7.4 A ‘narrow’ or ‘tall’ organisational structure
pursue their own ideas. A hackathon is an event during Traditionally, UK businesses have tended to use ‘narrow’ or
which employees develop new technologically-based ideas ‘tall’ organisational structures as they have grown. However,
at an accelerated pace. attracted by the prospect of faster and more effective
To foster intrapreneurship within a large organisation, it communication, and influenced by the structures used by
is important to use empowerment to help employees to the some of the world’s most efficient companies, many
be creative and innovative. In terms of the organisational businesses have either adopted or moved towards flatter
structure, this means that it must be designed to allow organisational structures. Drawbacks exist in making such
employees freedom to take their own decisions. This a move. The process of flattening structures (which is
may require limited control and supervision by managers called delayering) has led to businesses operating with
to encourage employees to have the confidence and significantly wider spans of control.
opportunity to develop ideas. This may exist in a structure in
which managers are responsible for relatively large numbers Chains of command
of self-motivated employees. Furthermore, employees will be The organisational structure shows the business’ chain of
given (or delegated) authority to take a range of decisions command. This is the way that authority is organised within
and have authority over the resources that are necessary the business and shows who has control over which other
for intrapreneurs to operate successfully. An organisational people in the enterprise. It also reveals how communication
structure which allows managers to have trust in their flows through the organisation and how many layers that
employees’ ability and motivation to develop successful new messages must pass through to move from the top to the
products is essential to promote intrapreneurship. bottom of the organisation – or vice versa.
7.1.2 Types of structure GLOSSARY TERMS

Intrapreneurship takes place when individuals come up
Key features of formal organisational with new ideas within their division, department, team or
business unit and follow them through.
structures Empowerment is a series of actions designed to give
Levels of hierarchy employees greater control over their working lives.
A fundamental element of any organisational structure is the Levels (or layers) of hierarchy refer to the number of
number of levels or layers of hierarchy. Organisations with layers of authority within an organisation. That is, the
a large number of layers or levels are referred to as ‘narrow’ number of layers that exist between the chief executive
or sometimes ‘tall’. That is, there is a substantial number of and a shop-floor employee.
people between the person at the top of the organisation Delayering is a reduction in the levels of hierarchy within
and those at the bottom. In contrast, ‘flat’ organisational an organisational structure.
structures have fewer layers of authority. Figures 7.3 and 7.4 The chain of command is the line of communication and
illustrate both flat and tall types of structure. authority existing within a business. Thus, a shop-floor
worker reports to a supervisor, who is responsible to a
departmental manager, and so on.
Managing
Director (1)
Total = 111
Once businesses have adopted a narrow organisational
employees Managers or structure, they have long chains of command from those
team leaders (10) at the top of the organisation to those at the bottom.
Businesses with many layers of hierarchy frequently
100 shop-floor experience communication problems, as messages moving
workers
up and down the organisation pass through many people
and may be distorted or not passed on. Some business
▲ Figure 7.3 A ‘flat’ organisational structure writers have estimated that each extra level of hierarchy in
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the structure reduces the effectiveness of communication the employees for whom they are responsible. As the span
within the organisation by approximately 25 per cent. of control widens, the subordinate is likely to be able to
Spans of control
operate with a greater degree of independence. This is
because it is impossible for an individual to monitor closely
7.1
the work of a large number of subordinates. A traditional
A span of control is the number of people who report
view is that the span of control should not exceed six if
directly to a manager. Spans of control and levels of
close supervision is to be maintained. However, where
hierarchy have a relationship. An organisation with a wide
subordinates are carrying out similar duties, a span of
span of control will have relatively few levels of hierarchy –
control of 10 or even 12 is not unusual. It is normal for a
the ‘flat’ organisation in Figure 7.3 (page 316). Conversely,
span of control to be narrower at the top of an organisation.
‘narrow’ organisations have many layers of hierarchy but a
This is because senior employees have more complex
7.1.2 Types of structure

narrow span of control. Figures 7.3 and 7.4 illustrate a broad
and diverse duties and are, therefore, more difficult to
and a narrow span of control for two organisations that have
supervise. Figure 7.5 shows that Manager A has a span of
a similar number of employees.
control of two, while Supervisors B and C have spans of
A narrow span of control allows team leaders, supervisors control of 5 and 4 respectively.
and managers to keep close control over the activities of
Manager A
Supervisor B Supervisor C
Worker Worker Worker Worker Worker Worker Worker Worker Worker

D E F G H I J K L
▲ Figure 7.5 Spans of control
Responsibility and authority Centralisation and decentralisation

Responsibility means that someone is expected to complete Centralisation and decentralisation are opposites. A
a task or series of actions, and that they are answerable centralised organisation is one where the majority of
for the results of their actions and any decisions they have decisions are taken by senior managers at the top (or
taken. In business, a manager is still responsible even when centre) of the business. Centralisation can provide rapid
they ask someone else to carry out some tasks. Authority decision-making, as few people are likely to be consulted. It
gives managers and other employees within a business the should also ensure that the business pursues the objectives
power or right to exercise control and to make judgements. set by senior managers.
Decentralisation gives greater authority to empower
Delegation and accountability
employees lower down the organisational structure.
One key strategy an entrepreneur might adopt is to delegate This may mean granting greater authority to employees
authority as the organisation increases in scale. Giving in branches, departments or divisions of the business.
people more authority is likely to lead to wider spans of Decentralisation may also entail relocating jobs and
control. Wider spans of control can operate effectively if functions (such as managing budgets) to other parts of the
junior employees have been delegated authority to take organisation. Decentralisation may result in quicker and
decisions. This reduces the workload on their manager more effective decisions taken by employees with a good
or team leader; this person does not have to monitor all understanding of the customers’ needs. It may also result
subordinates so closely, freeing time for other duties. in more motivated employees who relish greater authority.
The extent to which an organisation adopts delegation as However, it does rely upon good communication and a clear
a key element in its organisational structure depends upon focus on organisational objectives.
the managers’ views of control. Some managers like to
retain as much control of decision-making as possible, and GLOSSARY TERMS
only delegate when the pressure of their workload makes A span of control is the number of subordinates directly
this essential. responsible to a manager.
However, it is important that an employee understands how Centralised organisations are ones in which managers
much authority has been given to them through delegation hold the greatest decision-making power.
and therefore understands what they are responsible for. Decentralised organisations give greater decision-making
Frederick Herzberg, when developing his two-factor theory power to employees further down the organisational
of motivation, argued that clear accountability is the basis structure.
for providing achievement as a motivator.
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Informal organisational structures organisation. A flat hierarchical structure may also make
greater use of delegation, as managers at all levels have to
7.1 This type of structure exists where the organisation does
not have an obvious structure. This is common in the case
deal with wider spans of control. Close management may prove
impossible if a manager has a large number of subordinates
of professionals (doctors and lawyers, for example) where reporting to them and delegation can become a necessity.
they operate as a team. The professionals normally receive
administrative support from others within the organisation. Communication in formal organisations is principally
downwards and uses established routes, moving down from
This form of organisational structure allows highly trained senior to junior employees. Employees are aware of lines
and motivated employees to organise their working lives of command and communication and the position of their
and to take decisions with a high degree of independence. department or unit within the organisation. All employees
However, it is less appropriate for many businesses as it appreciate the possibilities for promotion that exist in the
lacks co-ordination and control by senior managers. business. Furthermore, as the business becomes larger,
decision-making can become slower as communication
Three types of organisational has to pass through many layers within the organisation.
Simultaneously, co-ordinating the business’ attempts to
structures achieve its objectives becomes difficult. Senior managers
Businesses can adopt different organisational structures become more remote and may take decisions that are not
according to a number of factors, including the size of the appropriate to local situations or to the needs of particular
organisation, the environment in which it operates and the groups of customers.
personal preferences of the owners and senior managers.
We will discuss the factors influencing the choice of ▼ Table 7.2 The advantages and disadvantages of
organisational structure in detail in the next section of this traditional hierarchical structures
chapter.
Advantages Disadvantages
• Authority and • Organisation can be slow to
Hierarchical structures
responsibility are clearly respond to customer needs.
Hierarchical organisational structures share decision- established. • Communication, and
making throughout the business and give all employees • The promotion path is especially horizontal
a clearly defined role, as well as establishing their clearly signposted. communication, may be poor.
relationship with other employees in the business. In • Flat structures may • Senior managers may
a hierarchical organisational structure, all employees offer junior employees become remote from junior
(apart from the most senior director or manager) are interesting jobs with employees and customers.
subordinate to someone else. It is common for this type delegated authority. • Managers can become
of organisational structure to be based upon departments overworked if the span of
and, because of the dependence upon agreed procedures, control is too wide.
it can be bureaucratic.
Chief Executive Functional structures

Many hierarchical structures (such as that shown in
Directors Figure 7.6) are based around functions within the
business. This means that the hierarchy is based upon
Managers departments such as marketing, human resources and
the other internal functions that are a part of most
Junior Managers businesses. Figure 7.7 illustrates this.
This type of functional structure allows specialists to
Supervisors operate (for example, in marketing and finance) within
Shop-floor Staff
their area of expertise. They can generate new and very
innovative ideas, but other areas of the business may be
unaware of such developments.
▲ Figure 7.6 A hierarchical structure
The disadvantages of this structure can become more
If this type of structure is ‘narrow’, it normally has a number
apparent as the organisation grows in size. Departments
of features:
may bid for resources in an attempt to increase their size
» The organisation will be centralised, with the most and prestige within the business, rather than because this
important decisions taken by senior managers.
will benefit the organisation.
» Hierarchy is important and senior managers expect to be
treated with respect. Organisational structures based on geography
» Tradition is important and change is often implemented and products
slowly. This type of organisational structure can be seen operating
Alternatively, as we saw earlier, it may be a ‘flat’ organisational in businesses throughout the world in slightly different
structure which may result in a more decentralised ways. Some businesses organise their structures around
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Chief
Executive
7.1
Finance Human Resource Production Sales and Marketing Senior
Director Director Director Director Management
7.1.2 Types of structure

Finance Human Resource Production Sales and Marketing Middle
Managers Managers Managers Managers Managers
Trainee Accountants, Personnel and Supervisors and Marketing Officers Junior Managers and
Accounts Clerks, etc. Training Staff Production Workforce and Sales Force Shop-floor Employees
▲ Figure 7.7 A functional organisational structure
geographical regions, possibly based on countries or An alternative approach is to structure the organisation
even continents. Figure 7.2 on page 314 shows how the according to the products or brands that it produces. This
multinational bank HSBC structures its organisation based allows the employees to focus on the needs of customers
on geographical regions – at least to some extent. for a specific product, rather than what might be a diverse
range of products.
CASE STUDY
The BBC
The British Broadcasting Corporation (BBC) is the ● news and current affairs
largest television and radio broadcaster in the world. It ● design and engineering, including new technologies
is a public sector organisation owned by the state and ● finance, human resources, strategy, security and
operates under a Royal Charter. Its main task is to provide property
impartial television, radio and online services to the UK. ● BBC nations and regions.
It also operates an international broadcasting service,
In addition, the BBC also operates BBC Studios and BBC
BBC World Service, which broadcasts in more than 40
World News. BBC Studios is a wholly owned subsidiary
languages and reaches over 200 million people each
which sells BBC and other UK television programmes
week. In 2019, the BBC had 22 401 employees.
overseas.
The work of the BBC is overseen by a Trust which sets the
The BBC’s headquarters was previously at Broadcasting
corporation’s objectives and makes sure that the BBC’s
House in London. In 2011, it started the process of moving
senior managers meet high standards of performance. It
some of its operations to Salford, near Manchester, in the
also monitors the output of the BBC against the expectations
north of England, and by 2020 it had 3200 staff working
of its audiences by holding a detailed review every five years.
there.
The Executive is responsible for the operational
management of the BBC and for fulfilling the objectives Questions
set by the Trust. The Executive comprises the Director- 1 The BBC Trust sets its objectives and the Executive is
General of the BBC and other senior figures, including responsible for its operational management to achieve
those responsible for television, radio, news and current these objectives. Analyse one possible implication of
affairs, and digital services. this division of roles. [4]
2 Analyse two problems the BBC may have faced in
Alongside the Executive, the BBC has the following
moving a significant proportion of its operations to
operational areas:
Salford, more than 200 miles (320 km) away from
● television
London. [8]
● radio and education
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Functional organisational structures have similar advantages around the supply of these products. This is the case with
and disadvantages to hierarchical structures. In addition, the BBC, where its different divisions look after music, news
7.1 they can generate high levels of motivation and loyalty
to departments or divisions. However, this focus on
and future media, including its online services. Employees
may need different skills to operate in these separate
departments or divisions can become harmful if decisions divisions to meet customers’ needs effectively. Organising
are taken without reference to other elements of the the business into smaller specialist divisions can improve
business or its overall objectives. the quality and speed of decision-making as well as the
quality of the product itself.
Some businesses, such as HSBC, opt to base their
organisational structures on geographical regions because
the products that consumers demand vary considerably in Matrix structures
different countries. By organising itself in this way, the This type of organisational structure is task-orientated
Bank is able to meet the needs of its 60 million customers and based on the use of teams. It is intended to overcome
more fully. Indeed, it promotes its services by emphasising many of the problems associated with the traditional or
that it operates in many different markets with customers hierarchical structure. It is a combination of a vertical
who have different needs. chain of command, operated through departments or units,
and horizontal projects of product teams. A typical matrix
Other businesses produce highly differentiated products
structure is illustrated in Figure 7.8.
that require different production methods. As a
consequence, they base their organisational structures
Chief Executive
Production Marketing Human Resources Finance
Project A Manager Production Staff Marketing Staff HR Staff Finance Staff
Project B Manager Production Staff Marketing Staff HR Staff Finance Staff
Project C Manager Production Staff Marketing Staff HR Staff Finance Staff
Project D Manager Production Staff Marketing Staff HR Staff Finance Staff
▲ Figure 7.8 A typical matrix structure

Businesses using matrix structures put together teams of of being drawn from various areas in the business. This
individuals with the specialist skills necessary to complete is because they are pursuing a clearly defined objective,
a particular project. Each individual within the project providing team members with a sense of purpose and
team brings a particular skill and carries appropriate responsibility.
responsibilities. The aim is to allow all individuals to use
Matrix structures bring problems with them. Employees can
their talents effectively, irrespective of their position within
find it difficult having two managers (project managers
the organisation. So, a project manager looking to develop a
and departmental managers) because of divided loyalties.
new product may be able to call on IT and design skills from
They can be uncertain about which parts of their work to
relatively junior employees elsewhere in the organisation.
prioritise and conflict can result. Matrix structures have a
Matrix structures focus on the task in hand – launching reputation for being expensive to operate: administrative
a new product, opening new retail outlets, closing down and secretarial staff can be costly when used in support of a
factories or entering overseas markets for the first time. number of projects.
Project groups often have strong senses of identity in spite
▼ Table 7.3 The advantages and disadvantages of a matrix structure
• Focuses on tasks necessary for business success • Employees can have divided responsibilities
• Encourages organisations to be flexible and responsive to • Conflict can occur between project and departmental
customers’ needs managers, reducing performance of organisation
• Motivates and develops employees by providing varied and • Heavy expenditure on support staff may be required
challenging tasks
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How and why organisational structures change recruitment of shop-floor employees may mean that the
new managers’ spans of control become too wide to be
with growth
In a very small organisation, an entrepreneur or manager
operated effectively. This, in turn, might require the
appointment of more managers, which may ultimately
7.1
may be able to make all the necessary decisions and carry require the introduction of an additional level of hierarchy
out many managerial tasks. They may not necessarily have if the original owner’s span of control and workload become
the experience or knowledge to do this as effectively as unmanageable.
possible, but lack of finance may preclude the employment New divisions or departments
of specialists. Another structural consequence of growth may be that,
However, as an organisation grows this may become more as a business moves into new markets or starts to supply
7.1.3 Delegation and accountability

difficult – it becomes impossible for the entrepreneur to new products, it establishes separate areas within the
take all decisions. Because of this, the structure adopted by organisation to manage this. This can be necessary for two
the organisation might need to be adjusted as it develops. reasons:
1 The development means that the organisation is too
Increasing levels of hierarchy large to manage as a single entity. Better-quality
The most obvious change is that the organisation will decisions and a tighter focus on meeting customer
introduce more levels of hierarchy to avoid managers needs may be achieved with a separate division.
having too heavy workloads. A small business may initially 2 The new development may require the provision of very
be owned and managed by a single person, but growth distinct products, requiring employees with different
may mean that the owner has to recruit two managers skills and distinctive operational procedures. This may
to take control of some of the business’ functions. These be carried out most effectively within a separate part of
managers may report to the owner, creating an additional the organisation.
level of hierarchy. Further growth and consequent
CASE STUDY
China’s banks need to review organisational structures

The Chinese economy is entering a period of change. This ● Finally, the banks should adapt their organisational
has significant implications for the country’s banks, many structures. Changes in types of customers and
of which operate throughout the entire country, with some the need for new and innovative products will call
also operating branches overseas. The banks have been for different organisational structures. The new
left facing three major challenges: organisational structures will require close co-
● Business analysts believe that China’s banks should seek operation and co-ordination among different divisions
to increase their dealings with small- and medium-sized and groups of employees.
enterprises, as well as with retailers. This is important
as large enterprises use more non-bank finance. Questions
● Secondly, the banks must develop more new and 1 Analyse two issues that China’s banks may face if
innovative products to win new customers and to meet they implement a change in organisational structure. [8]
their changing demands. 2 Evaluate the best type of organisational structure
for China’s banks. [12]
Organisational structure and delayering

As an organisation reduces the number of levels of hierarchy
7.1.3 Delegation and accountability
through the process of delayering, it becomes a flatter We saw earlier in this chapter that delegation is the passing
organisational structure. This may be necessary because the down of authority through the organisation. In contrast,
business is becoming less responsive to its customers, or accountability refers to the fact that responsibility remains
because it needs to reduce the number of managers to lower with the manager or other person who has delegated
costs and enhance its competitiveness. authority. For example, a junior employee who is delegated
responsibility to carry out specific tasks or to make certain
A flatter organisational structure will entail fewer levels of decisions will be held accountable by the relevant manager
hierarchy and wider spans of control. It does not necessarily if they perform poorly. This accountability can take several
mean that the organisation will adopt a different structure. forms within a business:
A business with a functional structure may not change its » The poorly performing employee may not receive a bonus
type of structure as it removes layers, it may simply operate or other financial reward that is associated with the
with fewer levels. delegated task.
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» If the employee is considered not to have the necessary training to acquire the essential skills to carry out
skills to perform delegated tasks that are a central part their new tasks. Trust must exist between manager and
7.1 of their employment, this may lead to the business
offering further training.
subordinate. The manager must trust the employee to
carry out the delegated tasks effectively and be willing
» Alternatively, if the employee is deemed to be to give up control of the tasks that are delegated.
incompetent in carrying out delegated tasks, this may On the other hand, the subordinate must trust that
form the basis of a case for dismissal. the manager will not interfere in the delegated tasks
without good reason, and that they will support the
The key point here is that delegation passes down the subordinate’s decisions and actions.
organisational structure, while accountability flows upwards » The manager may need to implement means to support
from subordinates to managers. subordinates carrying out delegated tasks. This is
essential if the tasks are very complex or if the employee

The process of accountability is new to having greater authority and a different
Delegation is likely to be an effective element of the way role within the business. The support may be regular
an organisation structures itself and operates if a number meetings or an ongoing programme of training.
of conditions are met. There are a number of stages in the
process of delegation: The impact of delegation on a business
» The process of delegation should commence with Delegation affects all aspects of a business and not just its
planning and preparation. Thus, both the junior and workforce. Through the use of delegation, a business may
senior employees need to understand the objectives of change its operational methods, using employees in teams
delegating authority. In 2019, Starbucks continued its and allowing them greater authority to take decisions.
programme of expansion in India by opening five new Delegation can impact on a business’ marketing function.
coffee shops in Surat and Ahmedabad. The company It can be used to provoke increased levels of innovation
will have delegated authority to its senior managers in and greater responsiveness to the needs of a business’
the country and, in turn, the senior managers will have customers. Implementing delegation may be costly initially
granted authority to branch managers to operate the but, over time, it can improve employee motivation and
branches successfully. This will have entailed careful productivity, helping to reduce unit costs of production.
preparation and the recruitment and selection of If delegation is used effectively, it may increase the
suitable employees. competitiveness of a business through the creation of
» Both parties to delegation may require training to more innovative products, a more settled and productive
provide them with the necessary skills to be a successful workforce and, in the longer term, an improved financial
part of an organisation that makes effective use of performance.
delegation. Managers may require training to help them
select the best people to delegate to and to support The use of delegation can bring benefits and drawbacks to a
employees through the process. Employees may require business, as summarised in Table 7.4.
▼ Table 7.4 The advantages and disadvantages of delegation
• Delegation can improve the motivation levels of junior • The costs of training. Delegation may require a business to
employees. This can improve labour productivity and spend heavily upon training employees to ensure they have
reduce rates of labour turnover. the necessary skills.
• Delegation can speed up and improve the quality of decision- • It may be inappropriate in some organisations where
making. Decisions may be taken by employees who are close leadership styles are authoritarian and managers may
to customers and have a better understanding of their needs, be unwilling (or lack the skills) to pass control to junior
and they do not have to refer decisions to managers. employees.
• Delegation can reduce the workloads of senior and middle • Delegation is not a suitable strategy to adopt to manage
managers, allowing them to focus on key tasks and to a crisis. Such situations would require rapid decisions by
improve their performance. experienced senior managers.
• Delegation improves the skills of junior employees and
prepares them for more senior roles in the organisation.
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Delegation and motivation 7.1.4 Control, authority and trust
We saw in Table 7.4 that delegation can have very positive
effects on the motivation levels of junior employees. If The relationship between spans of 7.1
subordinates are delegated authority to manage interesting
and challenging duties, it can enhance motivation.
control and levels of hierarchy
» Maslow would argue that delegation allows employees to Two fundamental features of an organisation’s structure are
fulfil self-esteem needs by being involved in decision- span of control and levels of hierarchy. These two factors
making and having the trust of managers, which is a are interrelated: an organisation that reduces its levels of
form of recognition. hierarchy is likely to widen the spans of control of many
» Similarly, Frederick Herzberg believed that delegation of its employees. Increasing the number of levels with
7.1.4 Control, authority and trust

acts as a motivator. His research revealed that personal approximately the same number of employees will narrow
achievement, recognition and interest in the work itself spans of control.
are three of the most important means of motivation. If Earlier in this chapter we looked at the distinction between
subordinates are delegated challenging and interesting tall and flat organisational structures. Table 7.5 explores
tasks, Herzberg’s theory suggests that this could have a this relationship and its implications further.
highly positive effect on motivation.
▼ Table 7.5 Spans of control, levels of hierarchy and narrow and flat organisational structures
Balance between spans Associated leadership Other comments Examples

and levels style
• Managers can retain control of
This is more likely to
Tall organisational decision-making.
be authoritarian, with
structures with many • Employees may be relatively unskilled More likely to be used in
managers having a Theory
levels of hierarchy and and less prepared to take decisions. relatively small businesses
X view (see page 91) of
narrow spans of control • Motivation may depend upon financial
employees.
incentives.
• Employees are more likely to be skilled,
Flat organisational Leaders may use democratic possibly multi-skilled. This structure may be used
structures with few methods based upon a • Motivation will be linked to job design. by large businesses and
levels of hierarchy and Theory Y view (see pages • The business may engage in delayering especially those operating
wide spans of control 91–92) of employees. and/or may make use of self-managed multinationally.
teams.
Delayering has been a common feature of changes in Despite these advantages, the process of widening spans
organisational structures of many businesses in recent of control by removing layers of hierarchy can lead to
years. Delayering reduces the number of levels of hierarchy disadvantages. Job losses are an integral part of delayering
but widens spans of control. It is common for businesses to and this can threaten the security needs of all employees
remove whole layers of management (and especially middle within the business, damaging motivation levels and
managers). The process of delayering offers a number of employees’ performance. Further issues are knowledge
advantages to businesses: management and succession planning. A danger in
» It can result in substantial reductions in wage costs, delayering is the loss of knowledge that is essential to the
which may be important for a business that operates in a organisation from the dismissal of the next generation of
price-competitive market or one that aims to increase its senior managers. An organisation that is delayering needs
profitability. Middle managers are frequently highly paid to handle these issues openly and sensitively.
and so removing them results in a substantial saving on
wage costs.
» By removing layers of hierarchy, delayering can GLOSSARY TERMS
shorten the chain of command, improving the flow of Labour productivity measures the relationship between
communication within the business and making it more the amount of labour used in production and the quantity
responsive to the changing needs of its customers. of outputs of goods or services.
» Delayering (rather like delegation) results in junior
Knowledge management is the process of identifying,
employees having greater authority. This may enhance
maintaining and effectively using an organisation’s
motivation as jobs will have to be redesigned and may resources of knowledge.
become more diverse, challenging and interesting.
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CASE STUDY
7.1
Google
Google has been reported to have nearly 60 staff for every offices and cafes are designed to encourage interactions
manager, and it makes extensive use of small project between Googlers within and across teams, and to spark
teams. It also releases staff for about 20 per cent of conversation about work as well as play.
their time for their own self-directed innovation projects.
Google’s approach to organising its employees is
The company continues to produce innovative online
successful and it is a highly profitable business.
services and functions, including services which have
revolutionised online commerce. Source: www.google.com

We strive to maintain the open culture often associated with Questions
start-ups, in which everyone is a hands-on contributor and
1 Analyse two problems that Google might encounter
feels comfortable sharing ideas and opinions. In our weekly
from allowing its employees to work unsupervised
all-hands (‘TGIF’) meetings – not to mention over email or in
for 20 per cent of their time. [8]
the cafe – Googlers ask questions directly to Larry, Sergey
2 Evaluate the possible reasons why Google operates
and other execs about any number of company issues. Our
a flat organisational structure. [12]
Theory X view (see page 91) of employees. Managers are

The difference between authority more likely to be willing to trust employees if:
and responsibility » the business’ culture and leadership style encourage
Managers frequently delegate authority to more junior trust and delegation
employees. This gives them power in relation to an agreed » employees are skilled and prepared to exercise greater
set of circumstances. For example, Pakistan International authority
Airlines may delegate authority to one of its pilots to take » they have received training on effective delegation.
decisions on a particular flight. However, despite this If these factors are present, trust is more likely. If managers
decision, overall responsibility for this flight remains with are unable or unwilling to trust subordinates, they will
the senior managers at the Airline. Thus, if problems arise, retain control.
the senior managers are responsible for the well-being of
the plane and all its passengers. Even if the pilot makes an
error, responsibility will still lie with the senior managers, 7.1.5 Centralisation and
possibly because they gave authority to someone without
all the necessary skills. Therefore, while it is possible to
decentralisation
delegate authority, the responsibility remains with the We looked at centralisation and decentralisation on
delegator (or senior employee). page 317. In recent years, many businesses have
decentralised because it brings benefits to many
stakeholders.
STUDY TIP
» Decentralisation provides junior employees with the
Do not say in your answers that managers delegate opportunity to fulfil needs such as achievement and
responsibility – this would reveal incomplete recognition through working. This should improve
understanding. Managers can only delegate authority –
motivation and reduce the business’ costs by, for
responsibility remains with them.
example, reducing the rate of labour turnover.
» Decentralisation is doubly beneficial to managers. It
reduces the workload on senior managers, allowing
Possible conflicts between control them to focus on strategic (rather than operational)
and trust issues. At the same time, it offers junior managers an
opportunity to develop their skills in preparation for a
To be effective, delegation has to be based upon more senior position.
trust. The manager has to be willing to cede control to » Customers may benefit by having more decisions
employees and to trust them to take the right decisions on made locally which can encourage the business to
the business’ behalf. Giving trust has to be accompanied meet their needs more fully. Many junior employees
by a reduction in control. Delegation is ineffective if in the organisation may have better understanding
managers are continually looking over subordinates’ of customers’ needs and operational matters, and
shoulders. Such close supervision will not allow the junior delegation may allow them to use their skills and
employees to use their authority independently and is not understanding to good effect.
an efficient use of the manager’s time.
However, some businesses remain centralised. This might
For some managers, it can be difficult to give up control be because the senior managers like to remain in control of
and to trust subordinates, especially if they have a the business and to take the major decisions. The decision
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to centralise may reflect the preferred style of management
of the business’ senior managers and their desire to retain aken by junior
ions t emp
ecis
authority. This may occur when employees are relatively
low-skilled and its managers are experienced decision- M
an
y d
lops j
Deve unior
loy
ee
s 7.1
makers. In addition, if a business makes all its buying employees
decisions centrally, it is likely to benefit from purchasing H
elp loca
economies of scale, allowing the possibility of shareholders
s t l cu
o m sto
CENTRALISATION
receiving increased benefits. In such circumstances, an
eet mers
organisation is likely to perform more effectively if power Senior
need
managers are
remains at the centre of the organisation. Senior
s of
managers experienced
Most decisions
7.1.6 Line and staff

want to decision-
taken by senior makers
retain managers
STUDY TIP control Purchasing
economies
n
i m t iv a ti o
Do not assume that decentralisation is preferable. of scale
ve s
pro
Whether a business should decentralise or not will
Mo
Many employees
are low skilled
always depend upon its circumstances.
Red
u c es w o rk lo a d of
s enio r
m anager
GLOSSARY TERMS
Line managers have authority over specified people within DE C E N N
T R A LIS A TIO
the organisation.
Staff managers have responsibility for support functions
within the business, such as information technology ▲ Figure 7.9 Centralisation and decentralisation
systems.
CASE STUDY
IOHK
Many millions of people in the world do not have access Tamara Haasan, chief of staff at IOHK, believes the way
to financial services such as bank accounts. IOHK has the company works offers many benefits. ‘A remote,
disrupted markets, for example, by creating software distributed business operating system encourages people
which makes financial services more widely available. Its to share information, communicate daily, find information,
customers include governments and other businesses. track goals, deliverables and still have fun and form
The company is decentralised and uses small teams to personal connections in a seamless and sustainable way.’
carry out individual projects.
However, IOHK also depends on more conventional
The company is not unusual in that it uses blockchain approaches to managing its employees, including
technology in its software development. More unique is its manuals for induction and other training. It is determined
use of the concepts underpinning blockchain technology to have a collaborative workforce and not one that
to organise and manage its business. IOHK’s business comprises many isolated employees.
model is based around decentralisation. It has 250
Sources: www.verdict.co.uk/decentralised
employees living and working in 20 different countries and -working-blockchain-iohk/
no headquarters. Employees work from locations and to
schedules that suit their individual needs. The company’s Questions
business model depends on technology. Its ‘distributed 1 Analyse one reason why IOHK is dependent on
business operating system’ enables employees to be technology to allow its decentralised structure to
highly productive. The company says that this technology operate efficiently. [4]
enables it to equal, and even exceed, productivity levels 2 Evaluate the case for IOHK using decentralisation
achieved by most businesses. in this way. [12]
7.1.6 Line and staff accountable for carrying out certain duties. Line managers
operate with the aim of assisting the business in meeting
Line managers normally hold departmental responsibilities its corporate objectives.
(including managing people and other resources) and derive
Staff managers are often appointed as the organisation
their title from fulfilling a role in the line of command from
grows in size and are used to relieve senior managers of
the top to the bottom of the hierarchy. They have the power
some time-consuming duties. Examples of staff managers
and authority to direct the actions of subordinates who are
include IT and HR managers. Staff managers only indirectly
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contribute towards achieving corporate objectives. responsibility of senior managers within the business to
Instead, a staff manager is responsible for making sure all make decisions to clarify and publicise responsibilities.
7.1 the supports are in place so that the line staff are hired,
trained, equipped and supported while they carry out the Is there a ‘best’ structure for
actual operations.
organisations?
It is easy to criticise traditional hierarchical structures as
Causes of conflict between line and being old-fashioned, costly and having little relevance to
staff managers modern businesses. This is not always the case. We can list
The authority of staff managers is different from that of line scenarios and circumstances in which such a structure would
managers. While the line manager focuses on generating be appropriate and effective. Similar arguments can be put
revenue, the staff manager often has to engage in expenditure forward for matrix or functional structures.
to support further operations. This can lead to tensions in the We do, however, tend to think of an organisation as
workplace, especially when there is no clear understanding of operating a single structure. It may be that large businesses,
the difference in the authority of the positions. in fact, operate more than a single structure, reflecting
Line managers do not always welcome the appointment of the different needs of various areas of the organisation.
specialist staff managers. Line managers might feel that Therefore, a large firm may organise itself as follows.
their position and status is threatened and may believe » Its research and development division may operate
staff managers only understand a part of the complexities on an informal basis to make the most effective use
of their jobs. When staff managers take decisions relating of talented and highly skilled scientists. This division
to their specialist areas (for example, developing and would simply make sure that the scientific team received
implementing recruitment policies), line managers may sufficient administrative support from clerical staff.
not consider that they meet the needs of their particular » Its administration may be based on a traditional
division or department and may oppose their use. structure in the expectation of achieving a continually
high standard of work and benefiting from a consistent
Staff managers may sometimes feel that their opinions are approach to this aspect of business.
not taken into account in corporate decisions. For example, » Its sales and marketing teams may be organised on
when appointing a new member of staff, the relevant line a matrix structure and have clear targets and tasks
manager may have the final say, but a specialist HR staff to achieve. These could be in the form of developing
manager may have a valuable contribution to make to the existing markets, breaking into new markets or
selection process, and they may be unhappy if they are not conducting market research.
allowed to play a part in the decision.
It may be that these differing structures could be found
Conflict is more likely in organisations where there is not a within a single organisation. Dangers exist in this approach,
clear and well-understood division between the authority as the organisation could become difficult to co-ordinate,
of line managers with responsibility for operations and that and some divisions may begin to pursue objectives different
of staff managers. If these authorities overlap, it is the from those of the overall business.
TEST YOUR LEARNING

b Explain one advantage to a large multinational
Short answer questions business of engaging in delegation. [3]
1 Define the term ‘organisational structure’. [2] 7 a Define the term ‘authority’. [2]
2 Explain two factors that might influence a b Explain one reason why authority may be
business’ managers when designing its delegated but responsibility may not. [3]
organisational structure. [6]
8 a Explain one reason why trust is an important
3 a Define the term ‘level of hierarchy’. [2] element of delegation. [3]
b Explain one reason why communication may be b Explain one reason why a policy of delegation
more difficult in a narrow hierarchy. [3] might be difficult to implement within a business
4 Explain one advantage and one disadvantage to a that operates an authoritarian leadership style. [3]
business of operating a functional organisational 9 a Explain one reason why a business may choose
structure. [6] to operate a decentralised organisational
5 a Define the term ‘matrix organisational structure. [3]
structure’. [2] b Explain one benefit to a large multi-site business
b Explain one disadvantage to a business of implementing a policy of decentralisation. [3]
of operating a matrix organisational structure. [3] 10 a Define the terms ‘line managers’ and ‘staff
6 a Define the terms ‘delegation’ and managers’. [4]
‘accountability’. [4] b Explain one reason why conflict may occur
between line and staff managers. [3]
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Data response question become more empowered. He is considering increasing
Nayudu Software Ltd

the training budget (which was overspent in 2020) but
considers maintaining profit margins a priority. 7.1
Janardan Nayudu’s software company is growing quickly. Questions
It designs, installs and maintains software for a range of
companies throughout India and Asia. All of its software 1 Analyse two possible implications for Nayudu
solutions are individually designed to meet its customers’ Software Ltd of a ‘significant increase in its typical
precise needs. It has excellent relationships with its span of control’. [8]
customers (most of which are large businesses) due 2 a Calculate the increase in the number of
to the consistent quality of its work. It has a reputation employees between 2019 and 2020. [2]
7.1.6 Line and staff

for improving on and developing the work of some of its b Calculate Nayudu Software Ltd’s average span
competitors and for having highly skilled employees. of control in 2020. [2]
c Evaluate whether training is the most important
Growth has led to a need to change the company’s
factor for the company in preparing to empower
organisational structure: it increased its workforce by
its workforce. [12]
24 per cent in 2020 (to 496) compared with 2019. Many
employees were attracted by pay rates that were 9 per 3 ‘The company should move to a matrix structure
cent above the industry average. Despite this, labour as Janardan Nayudu proposes.’ Evaluate this view. [12]
turnover remained at 12 per cent.
Essay questions
In 2020, the company employed 31 managers and these 1 Evaluate the extent to which delayering will assist
changes together led to a significant increase in its a business in achieving its corporate objectives. [20]
typical span of control. As a consequence, authority has
2 ‘A matrix organisational structure is always likely
been delegated to all employees, including those newly
to be more efficient than a functional organisational
appointed. Some managers are unhappy with this change.
structure.’ Evaluate the extent to which this
Janardan Nayudu wishes the business to move to a matrix statement is true. [20]
organisational structure. This will allow the employees to
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A LEVEL
7.2 Business communication

A LEVEL 7.2 Business communication
Chapter overview
★ the purposes and methods of communication
★ the channels of communication used by businesses
★ barriers to communication
★ the role of management in facilitating communication.
7.2.1 Purposes of communication THE SENDER

(initiates the
MESSAGE
(the information
communication) that is transmitted)
STUDY TIP
Before reading this chapter, it is worthwhile revisiting
AS Level Section 2 on leadership, organisational
structures and motivation. This will provide you with MEDIUM
a good foundation for studying communications. (how the message
is passed on,
FEEDBACK e.g. email)
(was the message
What is communication? received and
understood?)
Communication involves the transfer of information. This
transfer can take place between people, or between people
and organisations, or between different organisations. A
transmission mechanism is simply the method by which one RECEIVER
(the audience at
person communicates with another. Letters and email are whom the message
examples of methods of communication. Communication is targeted)
involves a number of elements, as shown in Figure 7.10.
▲ Figure 7.10 The process of communication
CASE STUDY
Cathay Pacific
International Airport and operates 155 aircraft. The airline
employs nearly 34 000 people (including its subsidiaries)
and has a well-designed website. Along with its
subsidiaries, it carried more than 35 million passengers
during 2019.
The company engages in communication for many
different reasons, including marketing purposes. Over
recent years, it has made greater use of electronic
communication, both internally and externally.
Questions
▲ Figure 7.11 A Cathay Pacific aeroplane 1 Analyse two reasons why electronic communication
Cathay Pacific is the international airline of Hong Kong. may be important to Cathay Pacific. [8]
It operates scheduled passenger and cargo services to 2 ‘Marketing is the most important reason for Cathay
79 destinations in 46 countries. It has four wholly owned Pacific to engage in communication.’ Evaluate
subsidiary airlines. Cathay Pacific is based at Hong Kong this view. [12]
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Advertising provides an example of business communication. Operational reasons
» The sender is the company that commences the process This forms a significant reason for communication within
of communication.
» The message is the information that the business wishes
and outside the business. Internal communication will take 7.2
place continually to ensure that operations are organised
to send to its audience. In the case of Cathay Pacific,
efficiently. For example, meetings may be held to discuss
an advertisement may be transferring information about
how to respond to a large order or complaints from
the quality of the airline’s services.
customers. Alternatively, communication will be necessary
» The medium is the way in which the message is with suppliers to order raw materials or components and to
communicated. Cathay Pacific might use newspapers and
arrange delivery.
magazines to transmit its advertising message.
» The audience is the target group at whom Cathay Communications may also be essential if the business faces
7.2.1 Purposes of communication

Pacific might aim its message. This group would be a crisis. It may be necessary to communicate urgently with
fairly broad, including any potential airline passengers affected stakeholders, such as employees and customers,
on any of its routes. and to make public statements intended to reassure all
» Feedback, in Cathay Pacific’s case, could take the stakeholders. In 2019, Boeing, the American multinational
form of the company asking customers where they aircraft manufacturer, faced such a crisis when two of its
heard about the airline when making a booking. Cathay 737 Max planes crashed, killing 346 passengers and crew.
Pacific could also ask about the effectiveness of its The BBC reported that the company was criticised by an
advert to assess whether to use similar approaches in international panel, including representatives from the
the future. Federal Aviation Administration (FAA), as well as officials
from NASA and nine other countries, for ‘confusing’
communications following the crashes. This was very
GLOSSARY TERMS damaging for the company and emphasises the importance
Communication is the exchange of information between of effective communication in such circumstances.
people.
Feedback is a response to communication that may Managing the workforce
confirm receipt and comprehension.
Effective communication is essential to create and
Effective communication occurs when information is maintain a productive workforce. This category of
passed on to other people or groups and feedback is
communication would include that essential to the process
received, confirming that the communication has been
of recruitment and selection, which we considered at length
understood.
in Chapter 2.1. Negotiation with trade unions or other
An annual report is a comprehensive account of a employee representatives over pay and working conditions,
company’s activities during the trading year that has just as well as appraisal interviews, are further examples of this
finished. category of communication.
Financial communication
When is business communication Information on a business’ financial performance is vital
essential? to effective decision-making at all levels within the
Businesses communicate with their stakeholders in a variety organisation. Junior managers will require budgets to
of ways and for a variety of purposes. There are numerous enable them to control expenditure and to act as targets for
circumstances in which is it essential for businesses to engage revenue. More senior managers might look at data relating
in communication, and we consider some of these below. to cash flow and profitability produced by the business’
finance department. This type of communication will also
take place externally when businesses send invoices to
Marketing purposes customers or pay those sent by suppliers.
Businesses need to communicate with potential and actual
customers to research their needs through primary market
Legally required communication
research. In many industries, this creates an ongoing
need for two-way communication. Businesses also inform Most businesses are obliged to communicate with external
their customers of the products that they are selling parties to provide key information. In the UK, businesses
through a variety of promotional activities, and they may have to engage in two-way communications with Her
use public relations events to present the business in a Majesty’s Revenue and Customs (HMRC) to establish any
positive light to its stakeholders, including local residents liability to pay taxes and then to pay those taxes. Public
and government. This category of communication will companies have to publish an annual report and accounts
also include routine items, such as arranging delivery of containing specified information on financial and other
products to customers and negotiating prices. aspects of the business’ performance over the previous
financial year.
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This communication can be internal, that is with other For example, a business providing details of job vacancies
individuals or groups within the business. Thus, an email on its website as part of the process of external recruitment
7.2 sent from the director of human resources to team leaders
concerning overtime rates would be an example of internal
would be communicating externally.
Figure 7.12 summarises the key internal and external reasons
communication. External communication takes place
for communication and emphasises that it is a two-way
between a business and other organisations or individuals.
process.
COMMUNICATIONS
INTERNAL EXTERNAL
exchange of information with
external individuals and firms
exchange of information
within an organisation
FORMAL INFORMAL information generated information needed
emails verbal communication

letters non-verbal communication
job specifications gossip/grapevine
Customers Local residents Government bodies Government bodies Customers Suppliers

cost and availability pollution, profit and laws and orders, prices and
of goods and employment loss data, regulations, statistics market delivery
services opportunities tax returns on industry research data dates
▲ Figure 7.12 A summary of communication
» Interviews These are a formal method of communication

7.2.2 Methods of communication that may be used to appoint new staff or to deal with
There are a number of standard methods of communication disciplinary or grievance issues. This method encourages
that are used by businesses. detailed discussions, though they can only involve a
relatively small number of people.
Spoken communication
» Telephone communication This is widely used in Written communication
business to transmit simple messages quickly and This is more appropriate when detailed information needs
effectively. It allows contact with individuals and offers to be exchanged. It can be slow, though modern technology
immediate feedback, but it does not offer a written (for example, texts and emails) can speed up the process.
record of discussions or allow callers to view each other’s » Reports are widely used to transmit information by
body language. businesses. They can relate to important issues, such as
» Meetings These occur in a variety of forms, including board an investigation into the establishment of a new nuclear
and shareholder meetings or meetings with customers power station, or smaller topics, such as reasons for low
and suppliers. Less formal meetings such as quality circles sales of a new product. They are also used to inform on
and social events are also forums in which information the financial performance of companies.
is exchanged. Meetings can allow in-depth discussion » Business letters are an external form of communication
and testing of ideas, as well as providing a record of used, for example, to make contact with politicians
communication. However, they are time-consuming and about factors affecting the business or to arrange other
expensive, especially for multinational businesses. forms of communication, such as meetings. The use of
» Presentations These are frequently used in businesses; letters is declining, however, as they are replaced by
for example, internally to transmit information on electronic forms of communication.
new projects and ideas, and externally to attract new » Memoranda are extensively used internally to exchange
customers. Detailed information (especially relating to information concisely and rapidly on a wide range of
sales and products) can be exchanged using this method topics, though in many businesses they have been
and the record of a presentation can be sent to any replaced by emails.
interested parties.
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Electronic communication and provide after-sales service. A rapidly increasing
volume of business is conducted via the internet in most
Developments in technology have transformed the way in
which businesses communicate and are continuing to do so.
countries throughout the world.
» Social networking media These include well-known
7.2
» Electronic mail (email) This method of communication websites such as Facebook, Instagram, WeChat, Sina
allows computers to speak to one another throughout Weibo and Twitter. Many businesses operate Facebook
the world at very low cost. Messages are stored on pages to communicate with customers and other
servers and can be accessed by the recipient through stakeholders, to respond to enquiries and to project a
the use of a password. This is particularly useful for positive corporate image, and the capability and uses of
quick international communication across different time social networking media continue to evolve. Businesses
zones, as messages can be stored until the recipient is can also promote events, offer discounts and draw
7.2.2 Methods of communication

available. attention to sales using social media. Recruiters and
» Websites These play a central role in communication for salespeople often seek key contacts through social-
most businesses, even relatively small ones. They offer media websites.
a chance to communicate with stakeholder groups to
publicise products, collect research data, achieve sales
CASE STUDY
Golden Screen Cinemas’ Facebook page
Golden Screen Cinemas is Malaysia’s largest cinema followers and the pages have trailers for movies that it is
chain. The company operates 34 cinemas with 366 showing or will show soon.
screens. Its largest cinema is in Mid Valley Megamall and
has 21 screens and 2763 seats. Golden Screen faces tough Questions
competition from TGV Cinemas, which has 32 cinemas 1 Analyse one possible reason for Golden Screen
throughout Malaysia. Cinemas having a Facebook page. [4]
2 Evaluate whether or not Golden Screen Cinemas
Golden Screen Cinemas makes effective use of its
should rely solely on electronic communication
Facebook pages to communicate with its customers. This
for its marketing in the future. [12]
can be seen at https://www.facebook.com/GSCinemas.
At the time of writing, the company has 1.89 million
» Text messages These are used by businesses to need for employees to travel to meetings. This form
communicate with customers, mainly for marketing of communication was used widely during the 2020
purposes. Research shows that 99 per cent of texts are Coronavirus (COVID-19) pandemic, and many businesses
opened, making them an effective medium. are expected to continue to make extensive use of this
» Web chats and chatbots Live web chat is operated technology to replace face-to-face meetings in the
by a human. Customers type their queries, and a future.
customer support agent responds by manually typing » Instant messaging tools Software such as Slack has
their answers. Live web chat is a popular way to deliver become important for business communication. This
customer support; in fact, you can argue that some software is ideal for letting workers share quick thoughts
demographics prefer website chat to other channels, or even hold digital meetings in and out of the office.
such as voice or email. Web chat has its challenges Most such tools also include facilities for sharing files.
though, particularly as its scope is limited by the
number of employees a business can use in this way. Visual communication
Chatbots provide a similar service to customers but are
Visual communication uses images to transmit information
operated by computers using artificial intelligence. This
to audiences. Methods of visual communication that are
offers businesses the possibility of dealing with many
used by businesses include posters, displays, webpages and
customers simultaneously.
photographic communication. Some businesses use symbols
» Intranets These are electronic, computer-based
to represent their products and image: Nike’s tick is one
communication networks, similar in nature to the
example.
internet but used internally by individual businesses.
They are ideally suited to large businesses, especially Visual communication can be used as an effective method
those with a number of locations. They can provide an of communicating a simple message or as a reminder of
email service as well as access to information of interest information previously communicated. It may be effective
to large numbers of employees. and is more likely to be used in certain industries, such
» Video conferencing This allows people to communicate as fashion clothing. Recent research suggests that people
face-to-face while in different locations, nationally retain and recall information that is presented visually more
or internationally. Software such as Zoom and Alibaba fully than that which is presented orally. However, it does
DingTalk are popular as they can facilitate meetings have a significant drawback in that it is often one-way and
of up to 100 people. It saves time and avoids the may not offer the opportunity for feedback.
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% taken into account by managers when assessing the strengths
100 and weaknesses of any method of communication.
7.2 80
» Costs of communication Businesses will take into
account the cost of any method of communication when
60 deciding whether or not to use it. Most businesses
40 attempt to control costs tightly to maximise profits
and returns to owners such as shareholders. Costs of
20
communication can include the purchase of relevant
0 technology and associated training costs. Attendance
Oral Visual Visual + Oral at meetings involves opportunity costs for employees
involved as they are not carrying out other duties.
Source: Jerome Bruner, as cited by Paul Martin Lester in

‘Syntactic Theory of Visual Communication’
▲ Figure 7.13 Percentage of oral and visual information STUDY TIP
retained When weighing up the strengths and weaknesses of
methods of communication, do not just analyse costs
incurred. Do consider the potential costs to businesses of
Strengths and weaknesses of different poor or incomplete communication.
methods of communication
Owners and managers of businesses will select which » Speed of communication In many situations, businesses
method of communication to use on the basis of the relative require communication to be rapid as well as accurate.
strengths and weaknesses of the various methods. A number Electronic communication has made this objective easier
of factors will determine any choice made, such as cost and to achieve through use of telephones (landlines or
speed of communication. The factors which are of greatest mobiles), email, live chat and video conferencing. Speed
importance will depend on the circumstances. A business may be vital to meet the urgent needs of a customer, to
that is experiencing cash-flow difficulties may consider costs advise of problems with a product or to communicate
closely, while for a news media organisation speed may be decisions to employees. Figure 7.14 assesses a selection
most important. We will consider three factors which will be of methods of communication in terms of speed and cost.
MORE
EXPENSIVE video conferencing
television
live chat
chatbots
interviews
phone calls
cost of
communication
gossip
email
the cost/speed
trade-off
letters
memos
CHEAPER
SLOWER speed of FASTER

communication
▲ Figure 7.14 The speed and cost of a selection of methods of communication
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» Target audience Some communication within businesses larger numbers of people are used, especially if they are
may simply involve an exchange of information between in different locations. For example, if the chief executive
two people at the same location. In such circumstances,
a number of methods may be used including email,
of a multinational business wishes to communicate with
several thousand employees in many countries about the
7.2
telephone or a face-to-face discussion. The problem of implications of the company’s new strategy, email may
selecting the best method becomes more complex when be the chosen method as it is low-cost and quick.
CASE STUDY
Khosa Law Chambers
7.2.2 Methods of communication

Khosa Law Chambers has operated in Lahore for more Minister Benazir Bhutto and numerous other senior
than 40 years. The law firm has represented clients in politicians and business leaders.
a wide variety of cases, some of which have attracted
The company has a network of affiliates in major cities
attention from national and international media.
around the world – for example, London and Toronto.
A number of the company’s cases have been important in
legal terms, with long-term implications. The legal practice Questions
is broad-ranging and handles cases in human rights, 1 Analyse one reason why effective communication is
banking, immigration, corporate, real estate and crime. particularly important to Khosa Law Chambers. [4]
2 Evaluate the most important influences on
The Chambers has represented some of the most
Khosa Law Chambers’ choice of methods of
important people in Pakistan, including the former Prime
communication. [12]
▼ Table 7.6 Summary of the strengths and weaknesses of a selection of methods of communication.
Method Advantages Disadvantages

Email • Fast and cheap • Can result in too much communication
• Can be used for mass communications • Can contain viruses
• Can be personalised
Telephone • Very cheap • No visual elements
• Allows instantaneous feedback • No physical record of the communication
Meetings • Can include visual elements • Can be very expensive
• Encourage interactions and immediate feedback • Time-consuming if travel is involved
• Remote meetings can involve people from • Remote meetings can have technical problems
different locations cheaply
Business letters • Provides a physical record of communication • Can be costly, especially when written in bulk
• Suitable for formal circumstances, such as job • Slow, as dependent on speed of mail delivery
appointments
Social media • Can be targeted at particular audiences • May be expensive in terms of staff time
• Offers visual elements and opportunities for • Mistakes in this form of communication are made
feedback public
Text messages • Cheap to deliver • Only suitable for simple short messages
• Can be used for mass communications • More difficult to include visual elements
Live chat • Can deal with customers’ individual issues • Can be costly in terms of staff needed
• Feedback can be provided • May give inconsistent messages
Chatbots • Provide consistent message • May not be suitable to respond to unusual queries
• Can be used by businesses on a large scale • Quality of communication may vary if
programming is poor
years ago, for example, few businesses would have used

The strengths and weaknesses of using chatbots to communicate with customers. Technology
technology in communication has significant strengths and weaknesses when used by
We saw earlier that technology is increasingly offering businesses as the basis of a method of communication, as
businesses new ways in which to communicate. Just a few shown in Table 7.7 (page 334).
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▼ Table 7.7 Strengths and weaknesses of using technology in communication
7.2 Strengths
• It provides cheap and quick methods of communication
Weaknesses
• Some employees may be resistant to the new technology
and can transfer complex and highly technical information and make ineffective use of it.
effectively. It is of particular value to companies that operate • New technology can be expensive to install and may require
internationally or those that sell to target groups which use substantial training of employees, incurring further costs.
electronic media as the major means of communication. • High-technology communication systems can generate
• It avoids the need for endless pieces of paper, as businesses enormous amounts of communication that may not improve
strive towards paperless administrative systems. the efficiency of the organisation. Technology does not
• It allows automatic generation of communications; for necessarily encourage selective communication.

example, reordering of inventories and invoicing of customers.
7.2.3 Channels of communication Communication may be one-way, either moving up,

down or across the organisational structure with no
Communication channels refer to the way information flows feedback. Communication can be two-way, moving up and
within an organisation and with other organisations. down the organisational structure, perhaps as a part of
discussion between managers and team leaders over the
How communication works within a development of a new product. This entails those at higher
and lower levels in the organisational structure initiating
business communication. In contrast, vertical communication
Communication can take place in many different ways takes place either up or down the organisational structure.
within a business. Some communication is interpersonal Figure 7.15 shows an example of a company’s chief executive
(just between two people); for example, an appraisal communicating with those lower down the organisational
interview. Individuals may also communicate with groups – structure; for example, over relocation plans. Finally,
a manager may brief a sales team prior to the launch of a horizontal communication may occur between employees
new product, for example. Communication also takes place at the same level in the organisation, possibly a planning
between groups within businesses; for example, between a meeting between the company’s managers.
management team and trade union representatives.
Chief Executive
Board of Directors
Two-way Vertical
communication communication
between Managers from Chief
managers Horizontal communications Executive
and team between managers to shop-
leaders at a floor
meeting Team leaders employees
Shop-floor employees
▲ Figure 7.15 Communication flows through an organisational structure
GLOSSARY TERMS Problems with different channels of

One-way communication takes place when information is communication
passed within a single direction in the organisation with no
Each of the channels of communication we discussed in the
feedback taking place.
previous section has associated problems.
Two-way communication exists when information is » One-way communication One-way communication
passed up the organisational structure as well as down it, means that no feedback will be received. Feedback can
or outside the organisation and back in again. be important when communicating within or outside
Vertical communication is the exchange of information the business. If a manager simply issues instructions to
between individuals or groups who are at different levels subordinates without offering opportunities for them to
within the organisation; for example, between managers respond, then the quality of decision-making may suffer.
and shop-floor employees. Subordinates may have valuable insights into decisions,
Horizontal communication involves individuals or taken from a different perspective, which may help
groups at the same level of hierarchy within the business managers avoid making costly errors. Having a different
exchanging information; for example, a meeting of a perspective on decisions can improve a business’
company’s board of directors. performance. It is for this reason that many businesses
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operate quality circles which provide employees from Many large businesses operate in several locations around
all levels of the organisation opportunities to offer the world. This means they have employees from different
suggestions and ideas.
» Two-way communication Two-way communication can
cultures using diverse languages and working in different
time zones. All three of these factors can inhibit effective
7.2
contribute to a manager being subject to too much communication.
information. The use of electronic information brings
some disadvantages in this respect and some managers GLOSSARY TERM
can receive hundreds of emails every day. This makes
Teleworking is working from home, or remotely, while
it very difficult for managers to respond and to select
using technology to communicate with employers and
those messages which are most important. Two- colleagues.
way communication can also delay decision-making,
7.2.4 Barriers to communication

especially if a large number of people are involved in the
decisions. This may not, for example, assist a business in
providing a speedy response to an emergency. Too much reliance on IT systems
» Vertical communication This channel of communication Some businesses have recognised the imperfections in their
may prove ineffective if employees do not pass on communications systems. However, many have relied upon
information to their subordinates or superiors. Equally, IT to overcome these problems and have created further
they may provide information which is incomplete, problems. If IT is to be effective, it requires that employees
inaccurate or both. This type of problem is more likely be trained and that systems suit their precise needs. Simply
to arise in organisations which have a tall organisational throwing IT at the problem creates more, rather than better,
structure with many levels of hierarchy and relatively communications.
narrow spans of control. Digital Platypus is a UK-based marketing agency business
» Horizontal communication Some horizontal which organises fundraising campaigns for charities.
communication may be informal and may not It attempts to prevent technology being a barrier to
support decisions that have been made through communication by banning internal emails. Any employees
vertical communication channels. This can result who flout this ban have to make a £5 donation to charity!
in a less clear focus on organisational objectives
and may require further vertical communication to
correct it. For example, managers at a particular Inappropriate management and
level in the organisation may be critical of a major leadership styles
decision. They may discuss it among themselves
Some managers use leadership styles that discourage
rather than responding up the hierarchy to the
effective two-way communication within the business.
decision-makers. This could slow decision-making
Some individuals prefer to operate an autocratic leadership
and damage organisational efficiency. It can also be
style (which we discuss in the next chapter) and a
time-consuming if decisions made through horizontal
traditional organisational structure. This only encourages
communication have to be approved subsequently by
downward communication, resulting in a lack of information
senior managers – and through vertical communication.
at different levels in the organisational structure.
This may slow decision-making and harm a business’
competitiveness. Equally, some managers may encourage working practices
that keep managers and shop-floor employees apart (such as
having separate facilities) and this may discourage effective
7.2.4 Barriers to communication communication, some of which may be informal.
There are a number of factors which can prevent
information flowing through an organisation and to relevant STUDY TIP
stakeholders outside it. The importance of communication to a business cannot
be underestimated. When dealing with case studies, it
Changes in business practices is often an important argument to say that a business’
The increasing need for information (and thus performance can be improved in many ways through
communication) has been further increased by improvements in communication.
developments such as empowerment, decentralisation and
the widespread use of just-in-time techniques. Extending
the roles and authority of employees creates a greater need Merger and takeover activity
for new channels and methods of communication. In view Mergers and takeovers usually create larger and more
of this, it is perhaps not surprising that many businesses complex businesses. Mergers and takeovers are popular
have been unable to keep up! The use of consultants and methods of achieving high rates of growth, but when they
contract workers and the rise in teleworking have increased fail, it is often due partly to poor communication. This
the diversity of communication required. Through the might be due to a lack of information in the pre-merger or
involvement of so many groups, communication has become takeover stage, as well as during the co-ordination that
more difficult to carry out efficiently. is essential afterwards. This can create communication
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problems and the process itself can pose similar difficulties. Lack of understanding by managers
The merger in 2012 between the Ghana Water Company
7.2 Ltd and Ghana Urban Water Ltd was eased because it
was relatively small-scale and because of the similarities
A principal cause of poor communication is that managers
do not recognise that there is a problem. Symptoms of
between the two businesses. The chief executive of the poor communication (such as poor industrial relations and
newly merged business was able to lead meetings of low levels of motivation) may be thought to have other
employees discussing the implications of the change. causes. Because senior managers have access to all the
information they require and can communicate easily with
Two multinational car manufacturers, Nissan and Renault, all in the organisation, they may be unaware that others in
have worked together in an alliance for some time, the business do not receive information that is essential to
producing engines and other components that could be used their jobs.
in cars sold by both companies. However, the two companies

decided not to go ahead with a full merger in 2020 due, in The use of jargon or technical terms
part, to poor communication between the two businesses.
Potential barriers to communication included different These are specialist terms used by people in particular
languages, business and social cultures, and working in industries which may be used when communicating
different time zones. with non-specialists. This is possible in a wide range of
industries and not just in technology companies.
CASE STUDY
The email problem
Manuel Gomes is the chief executive of Rapid Games Ltd, of control,’ he says. ‘I have to pick the emails that are
a software company. The company operates nine offices relevant to me very carefully as I get copied in to so many
in cities across Europe, having just merged with a rival messages sent by employees within the company. My
business. It has ambitious plans to open offices in Asia major worry is that I might miss a vital email message –
next year as part of its continued expansion. The company one that contains the most important information that I
has experienced a significant level of labour turnover will need to know all year.’
recently and has appointed a large number of new
managers since Manuel’s appointment. Questions
1 Analyse one barrier to communication, other than
Manuel has only been in his job since the merger five
the use of technology, that may exist at Rapid
months ago and is already experiencing communication
Games Ltd. [4]
problems. He currently has 7000 emails in his inbox – and
2 Evaluate the actions that Rapid Games Ltd might
the number has grown steadily. He says that he receives
take to prevent its use of technology becoming a
about 150 emails each day. ‘I fear my inbox is getting out
barrier to the company’s communications. [12]
business. Information exchanged in a company meeting

Overcoming barriers to communication is a formal communication channel, as is the company’s
The first stage in overcoming barriers to communication is annual report.
for managers to identify the particular barrier or barriers » Informal communication takes place outside the formal
that exist. This analysis allows them to apply appropriate structures within a business. Gossip between groups
solutions to overcome the difficulties. Table 7.8 lists of employees during a break from work is an obvious
some major barriers to communication and suggests some example. Informal communication can be rapid but
approaches to overcome each of these. inaccurate, and it is important for businesses to ensure
that important matters are communicated promptly
7.2.5 Role of management in using formal methods, such as meetings, to avoid wildly
inaccurate information being transmitted.
facilitating communication
In most organisations, formal and informal communications GLOSSARY TERMS
take place. Formal communication is the exchange of information
» Formal communication uses official channels to and ideas within and outside a business using official
transmit information on behalf of an organisation, channels, such as annual general meetings.
such as its goals or policies. This information often Informal communication is the exchange of information
follows a chain of command, flowing from managers to and ideas using unofficial channels, such as at social
subordinates throughout the organisation. It may also events.
flow from the organisation to stakeholders outside the
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▼ Table 7.8 Possible methods to overcome a selection of barriers to communication
Barrier to communication
Changes in business practice
Possible means of overcoming it
Planning and training are important here. Planning will help to identify any communication
7.2
issues that may arise as, for example, the result of delegating authority to a significant
proportion of the workforce. Once identified, training can provide the knowledge and skills
that the employees will require.
Too much reliance on IT systems In some senses, this is another change in business practice and therefore planning and
training can dovetail to provide an analysis of the problem and solutions to it. However,
it may also require an understanding on the part of managers at all levels that more
7.2.5 Role of management in facilitating communication

communication is not necessarily better communication. Using technology selectively and
with a clear focus is most likely to improve communication.
Inappropriate management and Managers and leaders may use autocratic styles leading to, for example, much one-
leadership styles way communication. In some circumstances, this might result in poor communication,
for example, as in a situation where subordinates are skilled and experienced and have
important information to communicate. Adopting a leadership style more suited to the
circumstances may be an appropriate measure here.
Merger and takeover activity Frequent and regular communication can help all employees and the business’ stakeholders
to understand the changes that are taking place and their implications. Encouraging
employees to be proactive in raising issues and providing a consistent message can help to
limit lack of knowledge and misunderstandings.
Lack of understanding by Managers should receive training in communication as it is a central part of their work.
managers This should focus on the barriers that are most likely to exist in their internal and external
communications and how to avoid these.
Use of jargon or technical terms Communications training to ensure employees consider the audience for communication
and select language appropriately will help. Some larger businesses may have employees
monitoring the use of language in formal communications.
» Gaining immediate feedback It may be difficult to obtain

The role of informal communication the views of employees to a significant decision using
within a business formal channels of communication. This may take time
Informal communication moves freely within the and employees may be guarded in what they say. Managers
organisation and is not bound by pre-defined channels could use informal communication to gain a reaction to
and communication routes. Informal communication in a major decision from different perspectives within the
the workplace is often called the ‘grapevine’ and generally organisation, possibly even before it is announced using
begins with employees through social relations. Informal formal channels. This might help to improve the quality of
communication tends to increase during times of change decision-making within the business.
within businesses, such as during a takeover or merger. » Job satisfaction The use of informal communication can
Informal communication can also be fuelled by a lack of help to increase the level of job satisfaction enjoyed by
formal communication. This occurs because employees a business’ employees. Expressing ideas and frustrations
speculate about what might happen in the absence of hard to colleagues without any concerns about their reactions
information. Research suggests that between 75 per cent can help employees to manage the stresses and strains
and 90 per cent of information transmitted through informal of working life. For this reason, many businesses provide
communication is accurate. It also shows that informal facilities (such as social areas) which facilitate informal
communication has little long-term effect on organisations. communication.
The advantages of informal communication The disadvantages of informal communication

» Improving working relationships Informal » Inaccurate information Employees may transmit
communication plays a vital role in developing inaccurate information through informal channels.
relationships throughout an organisation. It might This can occur because there are no controls on this
create better understanding between the members of a channel of communication and no penalty for passing
team, improving productivity as a result. A harmonious on false or distorted information. Managers may have
relationship between management and labour also to devote time and other resources to correcting any
benefits businesses. Management can use informal misunderstandings or issues arising from the use of
communication channels to know the attitudes and informal channels of communication.
opinions of the workforce. This can help to reduce » Contradicting formal communication A business
misunderstanding between workers and management, may experience a situation in which information sent
and will improve their relationships. through formal channels is contradicted by that passed
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through informal ones. This can create difficulties for Good communication can have a positive impact upon
the business, as decision-making may slow and levels employee motivation and performance. Praise and
7.2 of motivation and productivity may be damaged if
employees believe that they are not being given the full
recognition are widely seen as motivators, but they rely on
communication. Communication can also give employees
story through formal channels. important feedback about their performance and help to
improve it in the future. In this respect, appraisal systems
Informal communication is more likely to be widespread
(and especially developmental appraisal systems) have been
within organisations that have ineffective formal channels
of considerable value.
of communications. Although some degree of informal
communication is welcome and advantageous for most
businesses, it should supplement and enhance formal Suppliers
channels and not replace them. Efficient and profitable

production requires supplies
to arrive promptly,
Communication and business efficiency especially under
JIT systems.
Effective communication is an essential element of business
success. A survey by the Institute of Management and
UMIST in the UK stressed the importance of good-quality
communications within businesses. The survey reported that Business
good communication could assist employees of all types Employees
Customers managers
within a business and enhance its efficiency. Good
Effective Effective
communications
» Good communication makes it easier to implement communication communication
with employees
change – an important issue in a business environment, allows businesses allows managers
(praise, listening
to discover and to take good
which is subject to rapid and continual change. fulfil customers’ quality decisions
to ideas) can
improve the
Businesses that manage change successfully tend to be needs – increasing on the basis of the
performance
more efficient and competitive. sales and profits. best information
of the workforce.
available.
» It encourages and develops commitment to the business
from employees at all levels within the organisation,
increasing levels of motivation and rates of labour
productivity. General public
» Effective communication helps to ensure that the Being aware of social change
business is co-ordinated and that all employees and presenting the business
favourably assists in recruiting
pursue the same corporate objectives. As a result, the quality staff and
business is more likely to be successful in achieving its achieving profitable
objectives. sales.
The role of a manager in a modern organisation is ▲ Figure 7.16 The benefits of effective communication with
to communicate with everyone – shareholders, the stakeholders
media, customers and suppliers. The measure of today’s
manager is how well they communicate, and good-quality
communication by managers with the business’ stakeholders
STUDY TIP
offers many benefits. When answering questions on the importance of effective
communication, avoid the temptation to try to develop
Successful decision-making requires that managers have too many arguments. Select the best two or three and
access to as much relevant information as possible. The key develop these as fully as possible.
management roles of planning, prioritising, co-ordinating
and controlling depend upon access to information. This
indicates the importance of good communication to Communication is the cornerstone of co-ordination. In large
businesses. businesses, it is easy for different departments or parts of
the organisation to pursue differing objectives. Regular
For example, modern techniques such as just-in-
and effective communication can help to ensure that all
time production place great emphasis on effective
employees remain closely focused on agreed corporate
communication systems. If supplies of components or
objectives and that the business operates efficiently.
raw materials are not available when required, businesses
are likely to incur substantial (and unnecessary) costs,
as well as being unable to provide high-quality customer
service. Similarly, techniques such as Kaizen (which
aims at continuous improvement and is discussed in
Chapter 9.3) rely heavily upon effective, two-way internal
communication.
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CASE STUDY
7.2
Black Fern Media Limited
Black Fern Media Limited (BFM Ltd) is a media company BFM publishes 15 daily and more than 75 non-daily
located in New Zealand and Australia. The company is newspapers across Australia and New Zealand. It is a
partly owned by an Italian company. BFM has interests leading publisher in New Zealand, with The New Zealand
in several different markets including publishing Journal shaping public opinion in the country. In Australia,
newspapers, online publishing, radio broadcasting and it offers popular and entertaining publications in some of
advertising in New Zealand and Australia. It uses teams Australia’s most wealthy regions.
7.2.5 Role of management in facilitating communication

throughout its organisation to collect and publish news
The company has market-leading online sites, such as
and other information for broadcasting and publishing.
BFM News Online, and a strong audience connection with
The teams work together to provide the highest quality
its radio and news-branded web and mobile sites. BFM
service possible. The company relies heavily on
continues to expand its digital businesses.
communications technology (such as video conferencing)
to keep its costs low. Questions
In New Zealand, BFM operates seven radio networks 1 Analyse two reasons why effective communication
broadcasting news, popular music and classical music. might improve the efficiency of BFM Ltd. [8]
In Australia, BFM’s major radio networks bring together 2 Evaluate the most important reasons why effective
audiences in Sydney, Melbourne, Brisbane and Adelaide. It communication is essential to BFM Ltd. [12]
also operates a nightclub in Sydney.
in technology when facing communication problems.

Methods to improve communication By evaluating communication needs before taking
Good-quality communication is essential for successful any action, a business increases the probability of
management. Globalisation is resulting in businesses implementing an effective solution. A survey in the
becoming larger and more diverse, meaning that, to operate UK revealed that nearly 50 per cent of voicemail
successfully, good communication is even more important systems were switched off within a year of installation,
than ever. To adapt to the changing demands of the global indicating that many managers do not spend time
marketplace, a business can take a number of actions to evaluating the position before taking decisions to invest
improve its communication. in new technology.
» Train employees in communication skills Modern » Recognise that cultural and linguistic differences
business communication is a complicated activity, often exist These are common within a large multinational
requiring competence in a range of activities: listening, and can inhibit effective communication. Honeywell,
speaking, writing and reading skills, to say nothing of the computer manufacturer, operates in 11 countries,
technological skills. To carry out all these activities employs 114 000 people and encourages its employees to
satisfactorily, employees will require training at regular be sensitive to cultural differences when communicating.
intervals – it is not a one-off action. In spite of this, The company stresses that it is important to respect
training in communication skills is a priority with a and value cultural differences, to be aware of prejudice,
relatively small number of businesses and is often cut and to ensure that employees have the full picture when
during less prosperous periods. communicating before making judgements. Multicultural
» Avoid the danger of generating too much information communication is set to become a common feature
Modern technology has substantially increased the in the lives of more employees as business becomes
risk of this occurring, and many firms simply invest increasingly global.
TEST YOUR LEARNING

3 a Define the term ‘communication channel’. [2]
b Using examples, explain one difference between
1 a Define the term ‘communication’. [2] vertical and horizontal communication. [3]
b Explain one difference between the message and 4 Explain one advantage and one disadvantage of using
the medium in the process of communication. [3] written communication within a large multinational
2 a Explain one reason why businesses company. [6]
communicate. [3] 5 Explain two factors that the owner of a newly
b Explain one reason why feedback is an important established business might consider when deciding
element of successful communication. [3] on the best way to communicate with actual and
potential customers. [6]
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6 Explain one reason why a small business may decide of temporary and seasonal employees attend too. Little
7.2 not to make extensive use of technological methods of

communication. [3]
use is made of electronic methods of communication,
such as computers or mobile phones; the company has
7 a Explain one reason why agreeing to a merger not made a decision on whether to create a website. The
may result in communication difficulties for both wider management team has developed a good personal
businesses involved. [3] relationship with the buyers of their fruit, but sales and
b Explain one other barrier to communication. [3] profits have fallen slowly in recent years. Competitors
8 a Explain one reason why it is important for are promoting themselves and selling directly overseas,
businesses to communicate effectively with responding to a changing market and increased overseas
suppliers. [3] sales.
b Explain one reason why good communication The farm’s workforce is dissatisfied with the leadership
can help to improve the motivation of a business’ style and the use of spoken instructions. This year its
workforce. [3] productivity declined by 5 per cent to 8550 litres of fruit
9 Explain one difference between formal and informal juice per employee. At the same time, the rate of labour
communication. [3] turnover of full-time employees rose to 25 per cent. Most
10 a Define the term ‘effective communication’. [2] employees believe internal and external communication
b Explain one action that the managers of a is poor.
business with six restaurants may use to improve Questions
communication. [3]
1 Analyse one strength and one weakness of
Data response question Casa Rosa’s reliance on spoken communication. [8]
2 a Calculate the labour productivity for Casa
Casa Rosa Rosa’s employees for last year. [4]
Chile has a long history of producing fruit juice. In recent b Evaluate whether or not Casa Rosa should
years, the industry has grown rapidly and much of its invest in technology to improve communication.[12]
output is exported to countries throughout the world. 3 Evaluate the extent to which the leadership
Casa Rosa has an 80-hectare site in Atacama, a popular style is the major factor determining the
fruit-growing region. quality of communication at Casa Rosa. [12]
The farm’s owner uses an autocratic leadership style,
insisting that all 24 current employees assemble for an Essay question
unpopular 30-minute briefing each morning, where the 1 Evaluate the extent to which technology can help
instructions for the day are issued. The large numbers large businesses improve their communication. [20]
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A LEVEL
7.3 Leadership
7.3.1 Leadership
Chapter overview
★ the purpose of leadership and what roles a leader might have
★ the qualities of a good leader and the different leadership styles that exist
★ the nature of emotional intelligence and Goleman’s four competencies.
» The leader will play a key role in determining the

7.3.1 Leadership structure of the organisation (hierarchies and spans of
We saw in Chapter 2.3 that a manager is someone who control). They will determine lines of communication and
gets things done. Leaders, by comparison, are people who control, and they will be instrumental in shaping the
are followed, who have a vision of the future and a clear culture of the business.
sense of where they are taking the business. According to a » Leaders may become role models for individuals within
significant writer in this area, John Adair, ‘Leadership is the the organisation and may choose to build alliances of
process of motivating others to act in particular ways.’ senior individuals to protect their position.
The nature of leadership has changed over recent years
The purpose of leadership for a number of reasons. Rapid advances in information
Leaders provide the vision that takes a business forward. technology have meant that leaders have far more
They take the difficult decisions and can inspire or push information available to them to make decisions. This
through difficult changes. Leadership may not always be in can help them make better-informed decisions, but it can
the hands of one person – the leaders may be a team – but also mean that they have too much data and experience
the direction needs to come from somewhere. Particularly difficulty in selecting the key elements.
in a crisis, people look to a leader for guidance and to show Leaders may have been specifically recruited to change
them what to do; this is often why, when an organisation is the way a business operates and may face resistance from
in trouble, a new leader is brought in. employees who fear they will be worse off following the
The ability of great leaders in sport, in business, in politics changes. Employees may try to block or disrupt the change.
and in all aspects of life to achieve great things is inspiring. A leader’s ability to implement change may depend upon
Just think of someone like Nelson Mandela, who helped the amount of support received from others within the
bring about the end of the division between black and white organisation. It will also depend upon factors such as:
people in South Africa and made this a peaceful process by » the resources available to implement change. In some
leading through example. cases, the leader may lack resources, making change
difficult if, for example, funds are not available for
It can be argued that leaders have a range of duties relating training or recruitment
to all aspects of the business’ operations. The tasks of » the extent to which employees understand the need for
leaders may include: change
» Deciding objectives for the organisation Leaders have » the support from other senior managers.
to establish a sense of direction for the organisation
and establish objectives to move the organisation The challenge faced by leaders has been increased by
towards its overall aims. In 2020, Amir Paracha was developments such as the trend for many markets to
appointed as chief executive officer (CEO) of Unilever become global. This has meant that many firms now operate
Pakistan Limited. He has experience of improving in a larger and far more competitive environment. Decisions
the performance of a business’ sales and marketing in such circumstances have become more complex and
functions, and he is likely to set objectives in this area managers are now often required to attempt to organise
as well as others for the company. production in a number of countries, facing a variety of
» Providing expertise and setting standards for the languages, customs and cultures. Production difficulties are
organisation The leader is likely to be required to show compounded by differing demands from customers across
enthusiasm in difficult times and to take a major role in the globe.
solving problems as they arise.
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if they are subsequently elected by shareholders. The role
STUDY TIP of directors is largely strategic; they set and oversee the
7.3 If asked to discuss the importance of leadership in a case
study, do look for evidence in the case study itself that
achievement of long-term goals for the business.
Directors can be executive, non-executive or independent.
you can use to support your arguments. For example, the
Executive directors are employed by the company in a senior
business may trade in a very changeable market, which a
capacity, possibly with responsibility for a part or function
leader can do little about.
of the business, such as marketing. Non-executive and
independent directors perform similar roles, although the
latter may not own shares in the company. These types of
Leadership roles in business directors are not employed by the company and are usually
A LEVEL 7.3 Leadership
An entrepreneur who is designing a structure for a new appointed because they have a particular knowledge or
organisation, or amending an existing one, is likely to skill. They also may protect the interests of the company’s
consider a number of roles for employees as part of the shareholders, employees, customers and other stakeholders
process. if decisions are not taken with their interests in mind.
Directors exist within relatively small, privately owned
Directors companies but are likely to fulfil broader roles than in larger
Directors are found as part of the workforce of a company – companies because smaller companies employ fewer people.
either private or public. Directors are proposed by the
chief executive officer of a company and take up the role
CASE STUDY
Trina Solar appoints non-executive director
Trina Solar Ltd is a manufacturer of solar photovoltaic company, and acts as an adviser to Bridgepoint, a British
(PV) products and one of the leaders in this particular private equity company. Henry is a graduate of the
market. The company has announced the appointment of University of Hong Kong, holding a degree in electrical
Henry Chow as a non-executive or independent director. engineering.
Henry has held a number of posts as a director in the Asia Questions
Pacific region. He worked for IBM, serving as general
1 Henry Chow has been a manager and a director at
manager and subsequently as chairman of the IBM
IBM. Analyse one significant difference between
Greater China Group. Henry was also a member of IBM’s
these two roles. [4]
Worldwide Management Council and IBM’s Strategy Team.
2 Evaluate the key benefits that you think Trina
These groups advise IBM on its strategy and help it to
Solar Ltd will gain as a result of Henry Chow’s
respond to a changing world environment.
appointment. [12]
Henry already holds a number of senior roles. He is a
non-executive director on the board of AMD, an American
Managers managers to take decisions on day-to-day issues, such as

staffing or tactics to meet deadlines. Supervisors also act
Managers carry out a range of duties. These are often
as a line of communication between managers and shop-
categorised as planning, organising, motivating and
floor workers.
controlling. Managers normally have authority over a
number of junior employees and plan and monitor short- and
medium-term strategies for the business. We looked at the Worker representatives
role of managers in more detail in Chapter 2.3. Employee representatives may be chosen by their fellow
employees or appointed by management. Their roles can
In a small business, the owner may carry out the duties of
vary but most:
manager and director, looking after all the planning for the
» receive information from and give information to
business as well as organising and controlling day-to-day
management teams; for example, about pay and
activities. This is one reason why many entrepreneurs are
conditions or major decisions to be taken by the
very busy people!
company, such as an expansion
» pass on information to all employees within the
Supervisors workforce, often through meetings
Supervisors represent a link between managers and the » are consulted by management teams over certain
business’ shop-floor workers. They are the first rung of workplace matters that are likely to have a significant
management and are in regular contact with shop-floor impact on employees, such as the introduction of new
workers. Supervisors are delegated some authority by technology into a business.
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Worker representatives are frequently involved in issues contribute to decision-making. The modern leader has to
concerning pay. They may take part in negotiations over take into account their views and to broaden the ownership
future pay rates for the workforce of a business and,
recently, in some countries, have played a role in limiting
of decision-making. Indeed, given the complexity of many
modern organisations, the leader relies upon support from
7.3
the pay received by senior managers within businesses. others in the management team.
Furthermore, the increasing pace of change means that
The qualities of a good leader today’s leaders have to be dynamic and flexible and able to
The business environment in which leaders operate has respond effectively to changing environments. In particular,
changed over recent years. Many subordinates will not leaders of businesses providing technical products or services
just accept being given instructions; junior and middle might experience and have to respond to rapid change.
7.3.2 Theories of leadership

managers are often well-trained and expect to be able to
CASE STUDY
What to look for in a top CEO
Four leading Ghanaian managers have offered advice on Michael Ikpoki stressed the importance of a sense
what makes a good leader and how to lead a successful of responsibility and that generating high returns for
business. Prince Kofi Amoabeng, chief executive shareholders was an essential element of success. He
officer (CEO) of UT Bank, Jude Bucknor of Bucknor and added that successful leaders make the most effective
Associates, Dr Kofi Amoah of Progeny Ventures and use of their workforces and develop talent in others.
Michael Ikpoki, CEO of MTN, each spoke to an audience of
Dr Kofi Amoah concluded that having a sense of humour
Ghana’s business leaders and received acclaim for their
and control over the workplace are central qualities in a
presentations.
successful leader in business.
The four speakers made up the panel at the fifth MTN
Source: www.ghanamma.com/2012/06/29/
Business World Executive Breakfast addressing the top-ceos-inspire-others/
question ‘Being an effective leader in business’. The
speakers emphasised the importance of having vision and Questions
being passionate about business matters. 1 Analyse one way in which the leader of a large
Jude Bucknor said, ‘It is essential for a good leader to multinational company can help to make the business
have a vision that spells out clearly where you want to go successful. [4]
and how you will get there.’ He argued that innovation is 2 Evaluate the possible reasons why these experienced
also important and that leaders have to be able to think and successful CEOs have different views on the
creatively. qualities needed for a successful leader. [12]
So, has the general view of a good leader changed over recent years?
▼ Table 7.9 Traditional and modern views of good leaders
The traditional view of a ‘good’ leader The modern view of a ‘good’ leader
• A strong, decisive character • Charismatic, with a flair for public relations
• An ‘expert’ in the relevant field of business • Possessing principles; for example, taking ethical decisions
• An autocrat (to a significant degree) • Excellent communicator, and a good listener
• Focus on profits and financial success • Welcoming advice and support from specialists
• Good communicator, but most comfortable with downward • Flexible and able to flourish in a changing environment
communication
» Power and influence theory Where do leaders get their

7.3.2 Theories of leadership power?
Over the years, many theories have been presented » Transformational theory How do the most successful
concerning leadership. Views have altered, and this has been leaders carry out their roles?
reflected in the changing approaches to leadership adopted
by businesses. We shall consider five different groups of Trait theory
leadership theories:
Many writers have argued that all leaders should have
» Trait theory What characteristics should a good leader
a number of traits or characteristics, though there is
possess?
some disagreement as to the precise nature of these
» Behavioural theory What does an effective leader do?
traits. However, the consensus is that certain personality
» Contingency theory How do the circumstances affect
traits differentiate a good leader from other people.
the success of a leader?
Trait theories have developed from the concept of the
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charismatic leader – Nelson Mandela or Barack Obama, for Contingency theory
example. Examples such as these have led to trait theory
7.3 being termed ‘great person theory’. Supporters of the idea
of the charismatic leader contend that such individuals
The contingency theory of leadership states that a leader’s
effectiveness depends (or is contingent) on whether or not
have identifiable characteristics that set them apart from their leadership style matches the situation. This means
ordinary mortals. Some traits commonly mentioned by that a leader may be effective in one set of circumstances,
writers include: but not in another. Contingency theories identify several
» being informed and knowledgeable factors that can determine the circumstances faced by a
» having the ability to think creatively and innovatively leader, including:
» possessing inner motivation and the desire to achieve » the nature of the subordinates who are being led
» having the ability to act quickly and decisively » the tasks facing the employees
» projecting an air of authority. » the business’ objectives.

One of the reasons for the decline in popularity of trait Fred Fielder (who was a business and management
theories is that successful leaders have been found to psychologist at the University of Washington) developed
exhibit different characteristics from each other. one of the best-known contingency theories of leadership
in 1967. Fielder argued that a leader’s style cannot easily be
adapted and, therefore, that the effectiveness of a leader
Behavioural theories depends on there being a match between the style and
These theories focus on how a leader behaves, trying circumstances. Fielder believed that there is no best style
to identify the right way of leading rather than what a of leadership because its effectiveness depends on the
leader is like as a person. There have been many studies situation in which the leader is working. He argued that, to
looking at styles of leadership and considering which are identify an effective leader for a specific situation, it was
successful. important to consider both the leader’s personality and the
One classification of styles considers the extent to which demands of the situation. Fielder categorised a person’s
leaders ‘tell’ or ‘listen to’ their staff. Kurt Lewin developed leadership style by examining the traits of employees which
a framework for categorising the behaviour of leaders. He that leader would and would not want to work with. This
identified three types of leaders: revealed which of the two following factors most strongly
» autocratic leaders take decisions without consulting described their leadership style:
their subordinates » Task-orientated Such leaders perform well in situations
» democratic leaders invite opinions from subordinates where it is vital to complete a particular job, and they
before taking any decisions can build teams to achieve this.
» laissez-faire leaders allow subordinates to take » People-orientated These leaders are good at building
decisions without interfering. relationships with people and in maintaining harmonious
working relationships.
However, there are many more different styles of leadership
that can be identified using this approach. The Tannenbaum The demands of the situation can be judged to be
and Schmidt continuum (shown in Figure 2.19 on page 88) favourable or unfavourable by considering three factors:
emphasises that there is a range of leadership behaviour 1 Relationships between the leader and subordinate
depending upon the extent to which leaders take decisions members This is the extent to which the other
or whether subordinates contribute significantly to members trust and have confidence in the leader and
decision-making. shows their willingness to be guided by the leader.
Higher levels of trust and confidence give a more
A key factor in differentiating between behavioural favourable situation.
leadership styles is communication. At the autocratic end of 2 Task structure The extent to which the tasks facing the
the spectrum, communication is likely to be downward only group are structured, with clear goals and instructions
as the leader or manager ‘instructs’ their subordinates as to on completion. More structured tasks represent more
their duties. Democratic leadership is more likely to result in favourable situations.
two-way communication, as consultation and ‘selling’ of the 3 The leader’s position power The power the leader has
final idea take place. Laissez-faire leadership may result in to direct the subordinate group is based on their place
relatively little communication, as the problem or task may in the organisation and ability to reward and punish.
be outlined with subordinates having considerable freedom The more power the leader has, the more favourable the
thereafter. position.
The behaviour of leaders affects their performance in the Fielder’s research found that a task-orientated leader
role. However, research has shown that different types of will be more effective when the situation is favourable.
leadership behaviour may be optimal at different times. In this situation the task is structured, the leader has
Therefore, the most talented leaders may be those that good relationships with subordinates and has power.
adjust their style to match the situation. For example, All subordinates need here is a leader that can offer
a leader might adopt a ‘tell’ style if subordinates lacked direction. Equally, task-orientated leaders will be more
job-related skills and experience and were less able to effective than relationship-orientated leaders when the
contribute effectively to decision-making. situation is unfavourable. In this case, subordinates need
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a leader that can provide task structure and direction. As » Reward power Some leaders derive power from being
relationships between leaders and other members are poor, able to offer rewards to their employees. These rewards
a relationship-orientated leader will have little impact. can take a variety of forms, though many are financial
in nature. They include pay rises and promotions,
7.3
Fielder argued that a relationship-orientated leader will
perform more effectively in a moderately favourable participating in interesting projects or receiving
situation. As the leader will be liked to some extent by training. Although this is one of the more common forms
the group, have some power and the task will have some of power used by leaders, it has limitations. Leaders may
structure, the ability to develop good relationships will be run out of rewards – there are only so many promotions
important in completing the task successfully. they can offer and the company’s budget is unlikely to
extend to endless pay rises. In some circumstances, the
Fielder’s conclusion was that the most effective way to
7.3.2 Theories of leadership

rewards on offer may not be attractive to all employees.
manage a given situation is to change the leader to match For this form of power to be effective, the rewards must
the situational factors (leader–member relations, task be available and desirable.
structure and the leader’s power) or to change the situation » Coercive power Coercive power uses the threat of force
to suit the leader. to gain compliance from others. Using this form of
Other writers have developed contingency theories of power, a leader controls subordinates by threatening, or
leadership. However, Fielder and other contingency implementing, some form of sanction. This might, for
theorists all argue that, no matter how skilled and example, be a refusal to grant a promotion or a bonus.
experienced the leader is, there will always be situations Coercive power is often not an effective source of power
that they will find challenging to handle. Therefore, for a leader. Coercive leaders frequently get low levels of
contingency leadership theorists believe that a leader’s performance from their subordinates, who simply seek to
success depends on the leader’s skills matching the do enough to stay out of trouble.
situation and not adapting to it. » Legitimate power Legitimate power comes from a
person being appointed to, or selected for, a position
of authority. In some senses, this is the power that is
GLOSSARY TERM associated with a job title; the CEO of a company has
The contingency theory of leadership considers the power partly because of the role that they hold. The
context of leadership and the impact of the situation on the higher the position in the hierarchy, the greater the
leader’s success. potential the employee has to use legitimate power.
However, legitimate power can be unpredictable and
temporary. If a leader loses their job title and position,
Power and influence theories legitimate power can instantly disappear, because
Power and influence theories of leadership examine the people were influenced by the position held rather than
different ways that leaders use power and influence to by the person.
achieve results, and the leadership styles that are developed » Informational power Possessing and controlling
as a consequence. Leadership and power are closely related: information that is needed by others can be a source
a person who is a leader is also likely to have the most of power for leaders. The types of information that
power to make decisions. However, power does not just can generate power include knowledge of a business’
depend on the leader; it depends also on how the leader is financial performance, who is to lose their jobs during an
perceived by others. economic downturn or details of a takeover bid for the
business. This form of power is becoming more widely
A well-known theory of power and influence is French and
used in many businesses. Leaders have access to much
Raven’s five forms of power.
more information nowadays as a result of the availability
to collect and analyse big data. This form of power arises
French and Raven’s five forms of power not only from having access to the information but also
In a study in 1958, two social psychologists, John French from being able to manipulate or withhold it.
and Bertram Raven divided power into five distinct and » Expert power This form of power derives from a person’s
separate forms. The five types of power they identified knowledge and/or experience. Employees will frequently
were coercive, reward, legitimate, referent and expert. In respond positively to someone that they respect for
1965, Raven identified informational power as a sixth form their capacity to carry out a role effectively. James
of power. Table 7.10 summarises the forms of power and Dyson, the founder and owner of Dyson Ltd (a British
divides them into two categories. electronics company) might use this form of power
▼ Table 7.10 French and Raven’s forms of power because of his scientific experience and expertise – as
well as legitimate power from his role as the owner. This
Positional power Personal power form of power is more durable than many other forms. It
will remain so long as a leader is perceived to retain this
• Reward power • Expert power
expertise. For some leaders, such as James Dyson, it may
• Coercive power • Referent power
be used throughout their careers.
• Legitimate power
» Referent power This form of power arises from a leader’s
• Informational power
personality, image, charisma or presence. Leaders with
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referent power have the ability to influence followers, » Show confidence and optimism about the vision and how
but this is dependent entirely on the followers’ it will be achieved.
7.3 perceptions of their leader. Within many businesses,
this form of power has become increasingly important
» Achieve the vision through implementing a series of
small, achievable steps.
as the organisation has adopted more collaborative
styles of working, with greater use of delegation and
empowerment. As with expert power, this form of power 7.3.3 Emotional intelligence/
is likely to last so long as the leader is judged to retain
those personal characteristics that enable them to
emotional quotient
influence others. Daniel Goleman defined emotional intelligence as the
‘capacity for recognising our own feelings and those of
In the past, many leaders in many organisations relied

others, for motivating ourselves, and for managing emotions
mainly upon positional power to give them influence over
well in ourselves and in our relationships’. Emotional
subordinates. However, this has changed in recent years.
intelligence (or emotional quotient, EQ) is a relatively new
The move of many businesses towards flatter organisational
managerial model, which received much attention following
structures and greater questioning of authority has resulted
the publication of Goleman’s book, Emotional Intelligence, in
in personal power becoming more important and more
1995. The EQ concept argues that IQ (intelligence quotient,
widely used.
a conventional measure of a person’s intelligence) is too
narrow as a measure of potential performance of employees,
Transformational theory including managers and leaders.
Transformational leadership occurs when leaders perform
The EQ model emphasises that there are areas of emotional
their roles so effectively that they gain the trust, respect,
intelligence that determine how well employees will
appreciation and loyalty of the people who follow them.
perform. A high-performing employee needs more than
We have also explored transformational leadership in the
a high IQ (the normal measure of intelligence) because
context of corporate planning and strategic implementation
this ignores vital elements of a person’s character and
in Chapter 6.2.2.
behavioural patterns. Some employees may be brilliant and
The transformational style of leadership changes (that have a very high IQ, but they may lack personal skills and
is, transforms) people’s behaviour. It was originally not get on well with other people. Research indicates that
devised by sociologist James Downton Jr, and developed people with a high IQ are not automatically good performers
further by political scientist James MacGregor Burns, who in the workplace.
popularised it in his 1978 book, Leadership. He defined
When researchers measured employee performance against
transformational leadership as a process where ‘leaders and
IQ, they discovered that:
their followers raise one another to higher levels of morality
» low IQ predicts low performance
and motivation’. The work by Burns was then further
» high IQ produces varying levels of performance, from
developed by Bernard M Bass, who studied the underlying
very low to very high.
psychological attributes that make a transformational leader
and identified a number of key features. Transformational The same results were found when the research included the
leaders: professional skills that employees possessed. That means
» set clear and consistent goals that an employee with a high IQ (and professional skills)
» encourage others can be a very high performer, but they may equally be a
» lead through influence and charisma very low one. Thus IQ and professional skills in themselves
» are models of integrity and fairness do not predict high performance. They are necessary for
» inspire others to rise to challenges employees to perform well, but they are not enough on
» encourage people to look beyond their self-interest their own.
towards the greater good of the organisation.
An important step in this area was to test for employee
Bass described transformational leadership in terms competencies and not just intelligence and professional
of what he termed the ‘four Is’. These described how a skills. Research compared groups of high and average
transformational leader can provide idealised influence, performers to find the competencies that made the
intellectual stimulation, inspirational motivation and difference.
individualised consideration. These were explained in
more detail on page 307. GLOSSARY TERM
Transformational leadership can be viewed as a process with Emotional intelligence is the capacity for recognising our
a number of stages: own feelings and those of others, for motivating ourselves,
» Work with employees to create an attractive vision. and for managing emotions well in ourselves and in our
relationships.
» Combine the vision and a strategy to achieve it.
» Develop the vision into smaller elements and actions to
be completed.
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Goleman’s emotional intelligence Emotional intelligence and business
competencies
Goleman’s work evolved to produce a model of 18 personal
Emotional competencies have particular relevance for
leaders and managers. Leaders have to be able to motivate 7.3
and inspire others, establish good relationships and manage
competencies grouped into four clusters as summarised in conflicts between subordinate employees. They also have
Table 7.11. His research tested these competencies against to influence the ways other employees behave and be good
employee performance and this showed that possession communicators (including listening!). A leader’s role is to
of these competencies did coincide with high levels of motivate others to do their jobs effectively. Managers have
employee performance in the workplace. Although there to work within a team, be able to develop others (as part
have been a number of studies on the importance and of delegation), be able to initiate change and also be able
7.3.3 Emotional intelligence/emotional quotient

impact of emotional intelligence competencies, Goleman’s to manage conflict. To carry out these roles successfully,
work was carried out specifically within businesses. leaders and managers have to possess emotional
▼ Table 7.11 Goleman’s four competencies of emotional competencies.
intelligence
Research shows that exceptional leaders and managers
Self-awareness Social awareness possess a range of emotional competencies – both personal
and social. Such competencies, it is argued, are the
1 Emotional self-awareness 10 Empathy
major factor determining the performance of leaders and
2 Accurate self-assessment 11 Organisational awareness
managers. Emotional competencies can be learnt and may
3 Self-confidence 12 Service orientation
develop over time. Therefore, training in this area can play
Self-management Relationship management an important part in developing all of an organisation’s
(social skills) human resources.
4 Emotional self-control 13 Developing others Thus, emotional intelligence is increasingly relevant to
5 Transparency 14 Inspirational leadership the development of organisations and employees, because
6 Adaptability 15 Being a catalyst for change the EQ principles provide a new way to understand and
7 Achievement orientation 16 Having influence assess people’s behaviour, leadership styles, attitudes,
8 Initiative 17 Conflict management interpersonal skills and, most importantly, their potential
9 Optimism 18 Teamwork and performance.
collaboration
Source: Adapted from Transgrowth at www.transgrowth.com
EQ is responsible for
58% of your job
performance
$29 000
People with high EQ
make $29 000 more
annually than their
low EQ counterparts
90% of top
performers have high EQ
Source: Talent Smart

▲ Figure 7.17 The importance and benefits of emotional intelligence
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TEST YOUR LEARNING
7.3 Laporte Ltd was founded by Rahim in 2004 and he retains
Short answer questions control of the business. He has a clear vision for the
1 a Explain one difference between a leader and a business and is an effective communicator – including
manager. [3] being a good listener. Rahim dominates the senior
b Explain one purpose of leadership. [3] management team that takes strategic decisions and likes
2 Explain two factors that determine the ability of a to control important decisions, but he is known to care
leader to implement change. [6] deeply for the well-being of the company’s employees. He
3 a Explain one leadership role in business. also has a reputation for becoming involved in some day-
[3]
b Explain two qualities of a good leader. [6] to-day decisions, usually to the irritation of more junior
managers.
4 Explain one difference between trait and behavioural
theories of leadership. [3] Laporte Ltd is experiencing change. It is entering new
5 Explain one difference between autocratic and markets in China and Japan and launching several new
laissez-faire styles of leadership. [3] clothing ranges to attract new customers. The firm will
6 Explain one advantage of the use of democratic need a new factory to meet the expected increase in
leadership. [3] demand. This will be built close to its existing facilities
7 Define the term ‘contingency theory of leadership’. [2] and will more than double its productive capacity.
8 a Define the term ‘transformational leadership’. [2] Rahim is under pressure from shareholders to increase
b Explain one feature of a transformational leader.[3] the company’s profits and dividends, and he is beginning
9 Define the term ‘emotional intelligence’. [2] to wonder whether his leadership style is suitable in these
10 Explain one reason why emotional competency can circumstances.
help a leader to be effective. [3]
Questions
Data response question 1 Analyse two reasons why Rahim’s leadership might
be important to Laporte Ltd’s stakeholders over
Changing times the next few years. [8]
Laporte Ltd is a small sports clothing manufacturer that 2 Evaluate the extent to which Rahim’s leadership
competes in markets with much larger, multinational style is suitable in these circumstances. [12]
manufacturers such as Nike. Laporte Ltd’s clothes are
Essay question
popular as they are unusual designs and much more
long-lasting than other clothing that is available. This has 1 Evaluate the importance of emotional intelligence
enabled Laporte Ltd to achieve rapid growth over the last in determining whether or not a person is likely to
five years and an increase in its market share, though this be a successful leader. [20]
remains small.
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A LEVEL
7.4 Human resource management

strategy
7.4.1 Approaches to human resource management

Chapter overview
★ different approaches to human resource management
★ flexible-working contracts
★ the ways in which employee performance is measured
★ the causes and consequences of poor employee performance
★ how to improve employee performance
★ management by objectives
★ technology and human resource management.
7.4.1 Approaches to human psychological techniques of motivation are essential

elements of HR strategies. Organisations that adopt
resource management these techniques and structures would naturally move
towards adopting some type of HR strategy.
A human resource strategy is the medium- to long-term
plan that is implemented to achieve the business’ human However, the adoption of HR strategies by businesses in
resource (HR) objectives. It is a central element of a many developed countries is not as sweeping and as clear-
business’ approach to human resource management (HRM). cut as some might suggest. Surveys have indicated that
A number of factors have persuaded UK businesses to many companies have opted to select only the elements
implement HR strategies. of the HRM package that fit in with their philosophies,
» A principal argument is that Japanese businesses have management style and corporate objectives. For example,
had apparent success in managing people using this a firm might choose to implement rigorous selection and
approach, and they have been seen to gain significant appraisal methods but ignore other aspects, particularly
competitive advantage from managing a human resource developing employees through training. This means that
that produces high-quality products at minimum cost. there is not a single HR strategy or approach to HRM.
It is HRM that is credited with achieving this match Different firms have interpreted HRM in different ways.
between employee behaviour and organisational » Hard HR strategies Some firms operate ‘hard’ HR
objectives. policies, treating employees as a resource to be used
» Changes in organisational structure have led to many optimally. Such firms regard employees as yet another
managers taking on responsibility for managing people resource to be deployed as efficiently as possible in
within the organisation. Techniques such as delayering pursuit of strategic targets. Employees are obtained as
and the development of empowered teams have been an cheaply as possible, controlled and then disposed of
integral part of the implementation of HR strategies. when necessary.
Acquiring, developing, motivating and rewarding » Soft HR strategies Other firms use HR systems that
employees are, it is argued, best done by managers and can be regarded as ‘soft’. This approach is based on the
colleagues close to the employees in question. notion that employees are perhaps the most valuable
» The increasing popularity of psychological approaches asset a business has and they should be developed to
to motivation has encouraged the adoption of HR maximise their value to the organisation. This makes a
strategies which demand styles of working that meet long-term approach essential. Employees are seen as a
the social and psychological needs of employees. resource to be valued and developed over time and in
The adoption of flatter organisational structures and response to changing market conditions.
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▼ Table 7.12 Hard and soft approaches to HRM
7.4 ‘Hard’ HRM ‘Soft’ HRM

Philosophy Regards employees as a resource like any other Sees employees as different from, and more
available to the business important than, any other resource available to
managers
Timescale Sees HRM as a short-term policy; employees Takes a long-term view of using the workforce
hired and fired as necessary as efficiently as possible to achieve long-term
corporate objectives
A LEVEL 7.4 Human resource management strategy
Key features • Employees paid as little as possible • Managers consult with employees
• Employees only have limited control over • Managers give control over working lives
working life to employees through delayering and
• Communication mainly downward in direction empowerment
• Leaders tend towards Theory X view of • Leaders tend towards Theory Y view of workforce
workforce • Emphasis on training and developing employees
• Employees recruited externally to fulfil the • Employees promoted from within, reflecting
business’ needs, giving short-term solutions long-term desire to develop workforce
• Judgemental appraisal • Developmental appraisal
Associated leadership Leaders operating this style of HRM are more Leaders implementing this style of HRM are more
style likely to be at the autocratic end of the likely to be democratic in nature.
leadership spectrum.
Motivational Probably the main motivator is pay, with limited Motivation through delegation and empowerment.
techniques used use of techniques such as delegation and Heavy use of techniques designed to give
teamwork. employees more authority.
CASE STUDY
Appointing an HR manager
HR Manager – global manufacturer, Guangdong Candidate profile
province Candidates will be expected to bring significant
Location: Shenzen, China knowledge of HR management within a multi-site
manufacturing environment.
Salary: Over $125 000 per annum ● Ability to communicate effectively in Chinese and
A global manufacturer is seeking to appoint an HR English
manager with responsibility for a workforce of 900 ● Evidence of implementing major changes to working
employees. practices across organisations
● Experience of developing effective relationships with
The organisation core stakeholders
The company manufactures a range of products for ● Education to tertiary level, supported by relevant
use in the automotive industry. Its sales have increased professional qualifications
rapidly since 2015 and further growth is forecast. The ● A track record of successful management in a
company’s mission is to be innovative and to support its manufacturing context
customers in developing new products and maintaining ● Varied experience of management, including the use of
competitiveness. full range of hard and soft HR strategies.
The role Questions

The person appointed will be located in Shenzen but will 1 Analyse two differences between hard and soft HR
have responsibilities at other factories in Guangdong strategies. [8]
province. They will be expected to provide strong 2 ‘It is impossible to use hard and soft HR strategies
leadership to improve workforce performance to help to within a single business with any success.’ Evaluate
the meet the company’s HR and corporate objectives. this view. [12]
The role involves managing staff within a manufacturing

context and also introducing significant organisational
change.
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Hard HR strategies » It can help a business to build a reputation for being
a ‘good’ employer. Good employers seek to offer
A hard HR strategy offers a number of advantages to a
business:
their employees diverse and interesting jobs and
the opportunity to develop their skills. The pay and
7.4
» It makes it easier for businesses to adapt the size and
conditions on offer are attractive and the employer
composition of their workforces to match the needs
ensures that employees receive regular training to
of their customers. Thus, a business using this type of
improve their skills and enhance promotion prospects.
strategy will be prepared to hire and dismiss workers
Being regarded as a good employer allows businesses
as necessary, without the need to maintain the size of
to attract higher-quality candidates, which in turn
its workforce during a downturn in sales. This allows
improves the quality of the workforce and the overall
a business to cope more effectively when trading in
7.4.1 Approaches to human resource management

performance of the business. A recent survey showed
markets that suffer from regular fluctuations in levels of
that working for a respected employer was one of the
demand.
most important factors to jobseekers when applying for
» It can result in lower costs, especially in the short term.
employment. This can make a soft HR strategy attractive
Adopting a hard approach to employees may mean that
to employers in Asia, as the region is suffering from
a business only uses employees with minimal skill levels
a severe shortage of employees with technical and
and relies on the use of technology and a small number
professional skills. Attracting and retaining highly
of highly skilled core employees to meet the needs of
skilled employees is vital for the future of many
its customers. This means that the business may be
businesses in the region.
able to reduce expenditure on its workforce by paying
low wage rates (perhaps minimum wage) and to avoid
» It can improve knowledge management within a
business. This means that the business is more likely
heavy and regular expenditure on employee training.
to possess a workforce with the knowledge and
Such a strategy, if successful, may boost profits to the
skills essential for the business to continue trading
satisfaction of shareholders.
effectively. This comes about because this approach
» It allows managers to retain control over the workforce
usually results in a lower level of labour turnover
and to direct operations as they wish. Under such an
and therefore employees develop long-term working
approach, employees will be told what their duties
relationships with businesses, allowing them to bring
are, with relatively little opportunity for discussion on
experience to bear in decision-making.
how to complete a job and limited input in terms of
suggestions on how to improve the production process.
» It may also develop a more creative workforce.
Employees will be given more opportunities to
This approach can assist a business in maintaining its
contribute to decision-making and to provide
focus on its corporate objectives.
suggestions and ideas on improving the operation of the
However, the hard approach to HR can also bring about a business. This can motivate the employees (by meeting
number of disadvantages: what Maslow identified as an individual’s higher needs)
» The level of labour turnover might be very high. This and also provide an organisation with some excellent
can impose a number of costs on the business. First, it ideas, without incurring the costs of hiring consultants.
has to recruit replacement employees. This can be costly Because these ideas are generated by people with
in terms of advertising and using managers to select various perspectives on the organisation, they can be
the new staff from the applicants. Secondly, even if different and creative.
the jobs are relatively unskilled, some training is likely
Of course, this type of human resource strategy does have
to be required, which may involve further expenditure.
its drawbacks:
Finally, new employees are likely to be less productive
during the initial period of their employment, which will
» It can be very expensive, especially in the short term.
The costs of training employees can be significant,
detract from the overall levels of productivity achieved
particularly if they are given off-the-job training. These
within the business.
costs could be wasted to some degree if the employee
» Employees may be demotivated by this approach to
leaves soon after completing the training, possibly as
employment. The failure of managers to develop a long-
a consequence of being ‘poached’ by an unscrupulous
term relationship with employees will mean that it is
rival – this is an example of market failure. Higher rates
unlikely that what Herzberg identified as motivators will
of pay and good working conditions can also add to an
be present in the job to any great extent. For example,
employer’s costs.
the chance to take responsibility for projects and
opportunities for promotion will be limited. This approach
» It can be difficult and expensive to alter the workforce
in response to a change in market conditions. The soft
relies heavily on pay as a motivator and ignores the
HR strategy is likely to rely heavily on full-time and
potential of social and psychological factors to motivate
permanent employees, and thus the business might have
employees and improve their performance at work.
surplus capacity if demand falls and little potential to
increase output if demand rises.
Soft HR strategies
The approach to HR strategy used will obviously depend
A soft HR strategy offers a number of advantages to a
upon the type of business concerned. It may be that
business, although in many cases these are the opposite of
businesses employing less-skilled employees may opt to use
those discussed above.
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a harder approach, as the costs of losing employees may be
less and the potential for increasing responsibility within STUDY TIP
7.4 the organisation is less obvious. On the other hand, a more
skilled workforce might be more suited to a softer approach
When dealing with questions on the advantages and
disadvantages of the two types of HR strategy, it is
to make the most effective use of their talents and to essential to consider the nature of the business and its
minimise the risk of highly trained, skilled and productive workforce. This may enable you to justify the use of a
employees leaving the organisation. particular approach, either hard or soft.
CASE STUDY
Skill shortages in Singapore

Active Global Caregivers (AGC) looks after mainly network in the southern Asian region and has presented
elderly patients in their own homes in a number of Asian the prospect of working in Singapore as favourably as
countries. Its charges are relatively low. possible. Despite these initiatives, it can still take a
considerable period of time to recruit new employees and
Singapore is experiencing an ageing population. Nearly
the company is under pressure to provide training to its
1 million of its citizens are forecast to be over 65 by
existing workers.
2030 and about a third are expected to need eldercare.
Its current population is just under 6 million. While Questions
the demand for care in Singapore is rising, the country
1 Analyse two problems that AGC may have faced
is suffering from a shortage of skilled health-care
as a result of encountering significant skill
employees.
shortages in Singapore not long after the business
AGC is aware of the difficulty of recruiting skilled health- was established. [8]
care workers given increased demand from other 2 ‘The skill shortages will encourage companies
nearby countries. It has had to devise ways to attract the providing care for the elderly in Asia to adopt
employees that it requires. AGC has created a recruitment soft HR strategies.’ Evaluate this view. [12]
7.4.2 Flexible workforces Using temporary workers

Temporary workers are employed for a limited period
Businesses across the world use fewer full-time employees than
of time – often to meet a business’ need for additional
was the case in the early 2000s. Such employees are relatively
staff during busy periods or to provide specialist skills
expensive as the firm incurs all the costs of employment, such
which are only needed rarely. The need to maintain
as making pension contributions and providing training. Those
competitiveness by matching the size of the workforce
full-time employees who are hired tend to be highly skilled and
to expected sales is one factor causing an increase in
perform central roles within an organisation.
the proportion of temporary workers in the workforce in
Businesses have opted for workforces containing increasing the UK and other countries. Temporary workers are often
numbers of part-time and temporary employees, as well as employed in businesses that normally trade for only part of
those who work at home or for hours which can vary each the year. Examples include staff employed at theme parks
week. Labour forces with high proportions of these types of and many people in the tourist industry, including skiing
employees are called flexible workforces. instructors.
Having a flexible workforce can provide a business with a
competitive advantage. If a workforce is flexible, it can be GLOSSARY TERMS
adjusted to meet the business’ needs. When the business Flexible workforces exist when businesses place less
faces high levels of demand and sales, it can call on more reliance upon permanent full-time employees and make
workers to enable it to increase production. When times greater use of other forms of employment such as part-
are quiet and sales are low, it does not incur unnecessary time, temporary and zero-hours contracts.
costs by employing idle workers. A simple example exists in Temporary workers have employment contracts that only
retailing. Many shops have more customers at the weekends. exist for a specific period of time – perhaps six months.
To ensure they can serve all these customers promptly, they Part-time staff work less than a full-time week; for
employ part-time employees to supplement full-time workers example, 20 hours each week.
at the weekends. Job-sharing is a flexible form of working, in which two
people work part-time to complete the work of one full-
Types of flexible workforces time employee.
There are a number of ways in which businesses can create
flexible workforces. Some of the main ones are discussed in
this section.
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The number (and proportion) of workers on temporary and 2018, though this hid significant changes in levels of
contracts varies significantly within the 37 countries of the temporary workers and changes in their importance within
Organisation for Economic Co-operation and Development
(OECD). This is shown in Table 7.13, which compares the
the workforce. There have been significant rises in Turkey
and Sweden and falls in Colombia and South Korea. In most
7.4
data in a selection of countries for 2008 and 2018. The countries, a much higher proportion of young people (aged
average proportion of employees on temporary contracts 18–24) tend to be on temporary contracts.
across the OECD countries remained stable between 2008
▼ Table 7.13 Comparative data on percentages of employees working part-time and on temporary contracts in 2008 and
2018, in selected countries
7.4.2 Flexible workforces

Percentage of workforce on temporary contracts Percentage of workforce on part-time contracts
Country
2008 2018 2008 2018
Canada 11.9 12.6 18.6 18.7
Chile 31.2* 28.6 9.1 20.7
Colombia 28.5 27.0 15.1 15.5
Japan 8.4 N/A 19.6 24.0
Korea (South) 22.4 19.4 N/A N/A
Portugal 21.1 22.0 11.9 10.5
Sweden 13.4 14.8 23.6 21.9
Turkey 11.1 13.1 8.5 9.9
UK 4.8 4.2 25.3 26.0
OECD average 11.3 11.3 18.7 21.3
* 2010 data
Source: Organisation for Economic Co-operation and Development (OECD); http://stats.oecd.org
Part-time working
Part-time staff only work for a portion of the standard Per
lw
iphera orkers
working week. Many employees work for two or three emp
o ry or sel
ra
f-e
e,t m
days each week. Sometimes two people share a full- im
pl
-t
time job, each working for a part of the normal working
oy
art
Core workers
ed
•p
week. This is called job-sharing. In contrast, a full- • full-time employees

time employee works for the entire working week. In • highly skilled and
trained
many countries, a full working week is between 35 and • important roles
45 hours. • job security
on ry
•
The percentage of employees who work part-time has ly

h ir e ssa
d w hen nece
risen steadily across most OECD countries, with Chile,
Japan and Turkey recording notable increases. Developing
countries such as Argentina exhibit the same trend.
In 2008, 32.4 per cent of those employed in Argentina
▲ Figure 7.18 The organisation of a firm with a flexible
worked part-time; by 2018 the equivalent figure was 37.8 workforce
per cent.
The business’ core workers would be highly qualified and
Core and peripheral workers trained, would be motivated and would be in permanent
full-time employment with security of employment. In
One way in which a flexible workforce can be organised contrast, the peripheral workers would only be hired when
is as part of a ‘flexible firm’. This idea was developed by necessary. They may be low-skilled or have highly specialised
John Atkinson and The Institute of Manpower Studies. skills that are not required all the time. An example of the
They explained that flexible workforces comprise a core latter category could be experts on environmental pollution.
workforce and a peripheral workforce, as illustrated in This would allow the business to respond to fluctuations in
Figure 7.18. demand without incurring the ongoing costs of employing
all its workers on a permanent basis. The peripheral workers
could be employed part-time or by using temporary contracts.
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Annualised hours contracts childcare reasons. From 2014, this right was extended to
all employees in the UK with at least 26 weeks’ continuous
Employees working in this way are expected to work, say, an
7.4 average of 38 hours each week, but they can be employed
service.
to work longer hours during busy weeks, with an equivalent Homeworking avoids the need for employees to spend
reduction in working hours during quieter periods. It is time and money travelling to and from work. It can also
common for this type of contract to be used for employees save costs for an employer, who doesn’t have to provide
working in agriculture and horticulture. an office or other workplace for the employee. Advances
in information technology have made homeworking
more practical for many people. Employees are able to
Zero-hours contracts communicate effectively using software packages such as
These are given to people who are employed by the business Zoom, Microsoft Teams and Slack. We considered this fully in
but only work and receive pay when both the business and Chapter 7.2.
employee agree to do so. Some types of work that might use
zero-hours contracts include: Shift-working
» providing catering services at events
Shift-working is an employment practice that is designed
» cleaning in offices, factories and other commercial
to allow businesses to carry on their core activities for 24
premises
hours a day. It is very common in industries such as health
» caring for elderly or unwell people
care, where patients can require services at all times of the
» delivery driving.
day. In the USA, it is estimated that approximately 15 per
Under UK law, an employee on a zero-hours contract has cent of employees are involved in working shifts.
the same rights as a standard employee, including minimum
wage and holiday pay. But the supply of work is very much
in the hands of the employer. Employees do not have a
guarantee of receiving any hours in a given week or month
and shifts can be cancelled with very little notice, leading
to financial insecurity for employees working on these
contracts.
Zero-hours contracts are widely used in the UK and are
increasing in popularity among employers. In 2019, 896 000
people were employed on this type of contract in the UK,
compared to just 190 000 in 2011. The use of zero-hours
contracts in the UK has caused a lot of controversy, in part
because the lack of guaranteed hours increases employees’
financial insecurity. This may be why they are less widely
used in many other countries.
▲ Figure 7.19 Shift-working is essential in some industries
Flexitime such as health care. It does, however, impose strains
Flexitime exists when a business allows its employees on employees who regularly switch between different
to work flexible hours. A flexitime system is designed to shifts.
offer employees more freedom to start and finish work Working shifts can mean that businesses are able to use
at times that suit their family responsibilities and travel expensive assets such as factories and machinery as fully
arrangements. Most businesses using this system agree core as possible. The fixed costs of these assets can be spread
working hours during which all employees must be at work. over a greater volume of production, helping to reduce
An employee has to work the agreed core hours but has the unit costs. Providers of services may also be able to gain a
flexibility to fit in the remainder of their hours to suit their competitive advantage by offering services 24 hours a day.
circumstances. Most businesses allowing employees to work Some supermarkets are open all day and night nowadays.
flexitime also permit them to vary the number of hours each
week, so long as, over time, they have worked the total
Job-sharing
number of agreed hours.
We saw earlier that two people can share a full-time job,
each working for a part of the normal working week.
Homeworking This can offer businesses benefits if the people have
Homeworking avoids the need for employees to travel complementary skills, and they may be able to work more
to work. Instead, they carry out their duties where they effectively than a single person. However, communication
live. Different countries have different approaches to problems can exist as the people job-sharing do not
homeworking. In some, the right to work from home is normally work together.
provided by law; in others it is entirely up to an employer–
employee agreement. Since 2003, working parents in the
UK have been entitled to request flexible working for
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reduces labour costs, as they are only employed when
GLOSSARY TERMS required and the employer does not have to pay some
Annualised hours operate when an employer states the
number of hours employees must work over a whole year.
associated costs, such as holiday pay and pension costs, as
the worker is not classified as an employee. However, the
7.4
Weekly working hours can be varied to suit the employer’s idea that gig workers are independent freelancers and not
circumstances. employees is being challenged in some countries.
A zero-hours contract exists when an employer does not Workers do not always benefit under the gig system of
have to offer the employee any fixed hours of work and the employment. Their income is insecure as they are not
employee does not have to accept the hours offered. guaranteed specific hours of work or levels of income.
Flexitime is a way of working which allows employees Working in a gig role can also disrupt the individual’s

to fit their working hours around their individual work–life balance and patterns of sleep. This form of
circumstances. flexible employment can mean that workers have to make
Shift-working is an employment practice in which themselves available for any gigs irrespective of the time
different groups of workers are employed at the same and other necessities such as family commitments.
place of work but at different times of the day to ensure
continuous production.
The advantages and disadvantages of
Compressed working hours is an employment practice in
which an employee normally works full-time but in fewer flexible-working contracts
than the normal number of days per week. The advantages and disadvantages of flexible-working
contracts can be considered from the point of view of both
the business and its employees. There are diverse flexible-
Compressed working hours working practices and all of the benefits do not apply to
Compressed working hours is a flexible-working each.
arrangement under which employees are allowed to
compress their regular normal working week into fewer The advantages of flexible-working contracts
days. For example, someone working a five-day working Businesses can benefit from the use of flexible-working
week could ask to work only Monday–Thursday but start contracts in a number of ways. It can assist in recruitment,
their day earlier and finish later in order to make up their as being able to work flexibly is attractive to many
total number of hours. Under this system, employees can employees. Acquiring a reputation for providing flexible-
take time off for personal reasons and make up the time by working possibilities, whether in terms of hours or location,
working longer hours at other times of the week. can help to make a business an attractive employer and to
Compressed hours can be very attractive for employees, build an employer brand. This also helps a business to retain
although employers may not always have key employees its most experienced and skilled employees.
available at critical times, unless the system is very well- The International Workplace Group (IWG) reported in
managed. 2019 that UK, USA, Australian and Indian businesses are
particularly likely to use flexibility to attract and retain top
The gig economy workers in an increasingly competitive talent market. In
One matter which is receiving a lot of attention in Poland, a staggering 92 per cent report they are using this
many countries across the globe is that of the insecure strategy.
employment of workers in the ‘gig economy’. The gig
Some forms of flexible working can assist businesses
economy is based on flexible, temporary or freelance jobs,
in becoming and remaining competitive. Some forms of
often involving connecting with clients or customers
flexible contracts, such as zero-hours contracts and the
through an online platform. People working in the gig
use of gig workers, help to keep labour costs to a minimum
economy are not classified as employees but as contractors.
as many non-wage payments, such as holiday pay, may be
As a consequence, they do not receive guaranteed hours of
avoided. This helps to enhance price competitiveness and to
work or amounts of pay.
enable the business to provide goods and services flexibly
Many well-known businesses operate in the gig economy to meet the demands of their customers. Both factors can
and employ people on flexible contracts as a means of boost sales and market shares.
providing price-competitive products. Uber, FedEx and
A further benefit to businesses from the use of some forms
Deliveroo are all part of the gig economy. The Chartered
of flexible employment contract is that it assists them in
Institute for Professional Development estimates that
matching supply to demand. Businesses that commonly
1.3 million people in the UK are employed within the gig
experience expected fluctuations in demand (such as
economy. America has a more developed gig economy, with
tourism) or in the need for labour (agriculture) can use
estimates showing that around 30 per cent of the working
temporary contracts or annualised hours to overcome the
population is already working in some form of gig role.
problems associated with a fluctuating need for labour
From the point of view of a business, operating in the gig over time. This avoids labour shortages and a potential
economy and using workers in this way can be an effective loss of customers or idle labour and higher costs of
means of controlling labour costs. Employing gig workers production.
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Flexible contracts can also allow businesses to hire
specialised labour without incurring training costs. They can 85% of respondents confirm that productivity has increased
7.4 hire the people they need as contractors or on temporary

contracts and receive as many benefits as possible with
in their business as a result of greater flexibility.
minimal expenditure. Keeping labour costs low in this way OVER 4/5 of respondents confirm that, when faced with
helps businesses to control overall costs and to be price- two similar employment offers, they would turn down
competitive. the one that didn’t offer flexible working.
Finally, there are significant advantages in terms of

motivation and labour productivity from the use of some OVER HALF of employees globally are working outside of
forms of flexible-employment contracts. Allowing employees their main office headquarters for at least 2.5 days a week.
to work flexitime, compressed annual hours or homeworking

can improve motivation and levels of productivity. A
survey conducted by the IWG in 2019 revealed the extent 65% of businesses say flexible working helps to reduce
of employee support for at least some forms of flexible investment in property and to manage risk.
contracts. Figure 7.20 shows a summary of some key findings.
Employees can also benefit from working on flexible 65% of respondents believe that businesses that tailor the
contracts. It can make the job more attractive if they can work environment to the work function of staff are more
productive.
benefit from arrangements such as compressed hours to,
for example, pursue further education or qualifications to
enhance career prospects. Forms of flexible working, such Source: IWG Global Workspace Survey, 2019
as part-time contracts, homeworking and flexitime, enable ▲ Figure 7.20 Some benefits of flexible working
employees to fit their other commitments (for example,
childcare) around their working lives. These approaches to Homeworking offers savings in time and money to
working support employees in managing their work–life employees by enabling them to work from home for at
balance and can increase their loyalty to businesses. least part of the working week. This avoids the need to
commute to work, which can be very costly. It can also give
The use of gig working and zero-hours contracts also employees more freedom in terms of choosing where to
supports employees who may only wish to work for limited live. Being located close to the place of work is no longer
and irregular hours. Using this form of contract, employees so important. Cheaper housing may be available in other
are able to work for just the times that suit them. This form locations.
of contract could be popular with students, for example.
▼ Table 7.14 A summary of the advantages and disadvantages of flexible-working contracts for businesses and employees
For businesses For employees

Advantages • Manage fluctuations in demand effectively • Can help to manage work–life balance
• Lower cost of employing people with specialist • Supports employees in meeting other
skills commitments, such as child care
• Reduction in training and other non-wage labour • Reductions in expenditure on travel to work
costs • Suitable for those only available to work at
• Increased competitiveness certain times
Disadvantages • Communication may be less effective • Insecure employment and uncertain earnings
• Some types of contract may lead to higher levels • Communication can be an issue
of labour turnover • Some forms of flexible contract may result in
• Some flexible contracts can damage employee social isolation
motivation and performance • May damage career progression
CASE STUDY
Uber and flexible contracts
Uber is an American multinational company that provides began to sell its shares to the general public as it ‘went
ride-sharing (taxi) services as well as food-delivery public’ in its initial public offering (IPO).
services. It has grown rapidly over recent years but is
Uber drivers from seven American cities stopped work to
not yet profitable, despite receiving revenues of over $14
take part in the protest, while there was a demonstration
billion in 2019. Some of Uber’s drivers in the USA withdrew
by drivers in front of the company’s headquarters in
their labour for 12 hours in protest against poor working
San Francisco. The protests became international
conditions and low wages. At the same time, the company
when the company’s drivers in several cities in the UK
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also expressed their dissatisfaction with their working ● more transparency in Uber’s decision-making
conditions.
Shona Clarkson, an organiser with the Gig Workers
● the opportunity for employees to participate in
company decisions. 7.4
Rising, felt drivers were not being treated fairly. ‘Uber’s Uber argues that its drivers are not employees and, thus,
much-anticipated IPO will put millions into the pockets are not entitled to typical employee benefits such as
of executives, but the drivers who are the core of the holiday pay. Instead, the company contends that they are
service of the company will get nothing. Uber is paying contractors.
drivers poverty wages and continues to slash wages while
Source: www.theguardian.com/technology/
executives make millions.’ 2019/apr/24/uber-drivers-strike-ipo

In the USA, drivers working for Uber may only earn an
average of $8.55 per hour before tax is deducted. In Questions
comparison, the minimum wage in California is $11 per 1 Analyse one advantage and one disadvantage to
hour. The drivers in San Francisco have called for four Uber’s employees of working for the company. [8]
major changes: 2 Evaluate the extent to which Uber looks after the
● higher pay rates interests of all of its stakeholders. [12]
● better working benefits, such as holiday pay and
greater job security
The disadvantages of flexible-working contracts pay for essential items, such as accommodation. In turn,
this brings disadvantages to businesses. Employees on these
Flexible working can result in relatively poor
contracts may be poorly motivated as their employment is
communication between employees and the business
insecure and productivity may suffer as a result. Businesses
and this can be a disadvantage for both groups.
can suffer from very high rates of labour turnover in these
Businesses may find that employees job-sharing on
circumstances. Research shows that fast-food chains in
temporary contracts or working from home are less
the USA have labour turnover rates of 130–150 per cent,
able to communicate effectively, as there is little or no
meaning that the average employee stays with the business
opportunity for face-to-face communication. Technology,
for less than one year. Businesses with high rates of labour
in the form of video conferencing and messaging, can
turnover can have high recruitment and training costs.
help with this. However, some businesses are concerned
This can be less of an issue in industries such as fast-food
that electronic communications may not be entirely secure
retailing, where many employees are relatively low-skilled
and this may pose a risk when exchanging confidential
and limited training is required.
information.
A minority of employees may feel that the use of flexible
Some forms of flexible contracts are less popular among
employment contracts can damage their chances of career
certain groups of employees. In particular, zero-hours
progression. Homeworking and part-time contracts may
contracts and gig working have received much criticism for
mean that an employee is not regularly in the workplace and
failing to provide a regular and certain income. A lack of a
may be less visible when opportunities for promotion arise.
guaranteed income can make it difficult for employees to
CASE STUDY
Zero-hours contracts
Industrial action became more common in the UK in 2019, the use of zero-hours contracts. In the same month,
as employees became less willing to accept existing employees from several branches of the fast-food retailer,
pay and working conditions. Data collected by EMW, a McDonald’s, did the same in several locations in the UK.
commercial law firm, showed that UK workers engaged in McDonald’s had previously offered employees working
96 strikes over the year compared with 66 in the previous on zero-hours contracts the opportunity to transfer
year. to contracts under which hours of work were fixed. It
reported that 80 per cent of its employees declined the
EMW identified that one cause of the 45 per cent rise in
offer.
the number of strikes in the UK was dissatisfaction with
zero-hours contracts. The UK’s official statistics agency, Questions
the Office of National Statistics (ONS), has produced
1 Analyse one possible implication of being on a zero-
data showing that between 2012 and 2018, just over a
hours contract for an employee at McDonald’s. [4]
quarter of new jobs in the UK were offered on zero-hours
2 ‘McDonald’s should expand its use of zero-hours
contracts. These contracts are unpopular as they do not
contracts to its restaurants in other countries.’
guarantee employees a set number of working hours.
In November 2019, cleaners and security staff at
University College, London, took industrial action against
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7.4.3 Measurement, causes and business but not so high as to impose excessive recruitment
costs. Estimates suggest that the average rate of labour
7.4 consequences of poor employee turnover in the USA in 2019 was 19 per cent. In contrast, in
the UK, the average labour turnover rate is approximately
performance 15 per cent, with varying rates for different sectors. For
example, privately owned businesses tend to have a slightly
Methods of measuring employee higher rate, while organisations in the public sector (schools
performance and colleges, for example) have marginally lower rates.
Before managers decide on changes to the workforce Managers attempt to manage labour turnover to achieve
as a result of recruitment or training, it is important a balance between bringing new employees with
to assess the performance of the existing workforce. A enthusiasm and ideas into the business against the costs
number of measures are available to businesses to assess of recruitment. Research by the Chartered Institute for
the performance of their employees. Armed with this Professional Development (CIPD) in the UK suggests that
knowledge, managers are then in a better position to most businesses face a higher labour turnover than desired
implement appropriate changes to improve the performance and that this results in unexpected recruitment costs.
of the workforce and the business overall.
HANDLING DATA
Labour productivity
Serendipity Ltd manufactures electrical components.
output per period
labour productivity = Its managers recorded the following data over the most
number of employees at work
recent financial year:
This is perhaps the most fundamental indicator of the ● Average number of employees = 750
performance of a group of employees and has implications ● Output of components (000s) = 2250
for a business’ costs and, hence, the prices that it can ● Number of employees leaving the business = 50.
charge. Productive workers produce larger quantities of The company’s managers also calculated that its
output per worker per time period and this is a measure that productivity figure has fallen by 15 per cent since the
is relatively easy to calculate. year before.
Labour productivity depends upon factors such as the 1 Calculate Serendipity Ltd’s productivity and labour
extent and quality of capital equipment available to the turnover figures for the most recent financial year.
2 Calculate Serendipity Ltd’s productivity figure for
workforce, as well as its skills and degree of motivation.
the year before this.
Thus, it is possible for managers to take a range of actions
with the intention of improving labour productivity figures.
Research indicates that, overall, labour productivity in the UK Absenteeism
increases by about 2 per cent per annum. This improvement
in efficiency reduces the labour costs involved in producing number of staff absent (on one day)
absenteeism = × 100
a typical unit of output. Improvements in labour productivity total number of staff
allow businesses to enjoy increased profit margins or to Absenteeism occurs for a variety of reasons, including
reduce prices (while maintaining profit margins), hopefully industrial accidents and illness. The term is frequently used
leading to increased sales. Businesses can increase their to describe a situation where an employee is absent from
competitiveness in terms of costs and prices if they can work frequently and without good reason. Thus, it is used
increase productivity at a higher rate than that of rival as a measure of the morale and motivation of a workforce.
businesses. High levels of absenteeism can dramatically increase a
business’ costs.
Labour turnover
number of staff leaving during the year STUDY TIP
turnover = × 100
average number of satff Being able to interpret and comment on the results of
measures of employee performance in relation to the
This ratio measures the proportion of a workforce leaving business in question is important. For example, rates
their employment at a business over some period of time, of labour turnover could be critical in industries where
usually one year. Low wages and inadequate training, employees are highly skilled and expensive to train.
leading to poor morale among employees, may cause high
levels of labour turnover. Another cause is ineffective
recruitment procedures, resulting in the appointment of
inappropriate staff. Other reasons include redundancy and GLOSSARY TERM
retirement. Absenteeism occurs when an employee is not present at
their place of work.
Some level of labour turnover is inevitable. Managers seek
some level of labour turnover to bring new ideas into a
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Health and safety workforce. Absence due to accidents and injuries in the
workplace increases the labour costs incurred by a firm and
health and
number of working days lost per
annum for H & S reasons
can lead to adverse publicity. 7.4
safety = × 100 Managers need to measure employee performance to assess
total number of possible working days
the efficiency (and competitiveness) of the workforce. In
This measures the safety of the working environment. A service firms (where labour costs are a high proportion of
dangerous working environment not only lowers employee total costs), this can be a particularly important factor.
morale but may also damage the performance of the Measures of employee performance also help to assess
whether a workforce is fully motivated.
7.4.3 Measurement, causes and consequences of poor employee performance

CASE STUDY
Labour productivity in Pakistan
Pakistan has a long-standing problem with its low rates around 1 per cent. In many other Asian countries, labour
of labour productivity. Labour productivity per worker in productivity has been growing at over 5 per cent per
the country grew 1.4 per cent annually between 2000 and annum in recent years.
2017, as opposed to 3.9 per cent in Bangladesh, 5.8 per
Rates of labour productivity are dependent on the use of
cent in India and 8.5 per cent in China.
capital equipment and technology as well as the skills and
The Nobel Prize winning economist Paul Krugman had motivation of the workforce.
little doubt about the importance of labour productivity.
He noted that ‘productivity isn’t everything, but in the long Questions
run it is almost everything.’ 1 Analyse one possible implication for a business’
competitiveness if its workforce has negative labour
In the 1980s, labour productivity in Pakistan grew at
productivity rates over a period of several years. [4]
4.2 per cent per annum. By the 1990s, this had sharply
2 ‘The use of more technology in the workplace is the
declined to 1.8 per cent, falling further to 1.4 per cent
best way for Pakistani businesses to improve their
during 2000–17. Since 2007, it has been growing at
labour productivity figures.’ Evaluate this view. [12]
thinking about work and that their job affects their personal
The causes and consequences of poor commitments (26 per cent).
employee performance The report also uncovers evidence of high levels of work
There are a number of factors which can result in poor intensity which, like a poor work–life balance, is known to be
employee performance at work. a cause of stress. Nearly a quarter of people say they often
or always feel exhausted in their jobs (22 per cent), or under
Poorly designed jobs excessive pressure (22 per cent).
Employees may perform poorly because the job they Source: CIPD, UK Working Lives Survey 2019; www.cipd.co.uk/
are required to do has been designed poorly. It may be about/media/press/poor-work-life-balance
monotonous, involving a limited range of duties which are
repeated regularly. It may be too stressful, too demanding Leadership and management styles
or too time-consuming, meaning that employees have
insufficient leisure time. All of these factors can result in Employees may perform poorly at work because they are
employees performing their work poorly. managed badly. Managers and leaders may opt to use styles
which are inappropriate to the skills and experience of
The CIPD researched the working lives of over 5000 the workforce and the circumstances. Some managers, for
employees in the UK in 2019. A summary of its key findings example, may exercise a high degree of control over highly
is given below. qualified and skilled employees, while expecting them to
The UK Working Lives Survey is an annual assessment of job be creative and productive. In these circumstances, the
quality across seven different categories including pay and workforce would respond more positively to a management
benefits, contracts and employment terms, and voice and style which was more democratic in approach. Similarly,
representation. some employees may require guidance and support and
might not respond effectively to a management style which
Poor work–life balance was identified as a particular problem, allows them considerable freedom at work. This might lead
with many people admitting their job caused disruption to to poor employee performance at work.
family life and made it hard for them to switch off in their
downtime. Three in five (60 per cent) say they work longer A leader or manager may be a poor communicator and this
hours than they want and one in four (24 per cent) say they can impact adversely on employee performance. Employees
overwork by ten or more hours a week. A quarter (24 per cent) may not be set clear targets or given helpful feedback on
admit it’s difficult to relax in their own time because they are performance which would help them to improve.
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Demotivation (such as the ability to lead) or the experience required.
Because of this, they may not be able to carry out the
Frederick Herzberg identified a number of factors which had
7.4 the potential to demotivate employees. If employees believe
duties and tasks of the job effectively.
that their wages or salaries are too low, if they have a poor
relationship with fellow workers, or if working conditions are The consequences of poor employee
unsafe or unpleasant, they are likely to be demotivated. A
demotivated worker will be likely to perform poorly and may
performance
leave the business when the opportunity arises. A business with poorly performing employees is likely to be
at a competitive disadvantage. Its unit costs of production
may be higher than those of its rivals, meaning that it
Insufficient resources
may not be able to compete in terms of price. This can be

Employees may perform poorly because they do not have a significant disadvantage if the business’ customers base
the necessary skills to carry out their duties efficiently. The their buying decisions on price or if competitors sell very
business may not invest in providing employees with the similar products.
training necessary to allow them to work efficiently. This
is likely to be a more important factor in industries such In some sectors, poor employee performance may result in
as medicine and technology, which are subject to ongoing a business becoming less innovative. This could reduce its
changes. ability to develop new products to meet changing consumer
needs or to reflect advances in technology. This could be
Employees may also perform poorly because they have highly damaging for businesses such as Apple or Lenovo,
insufficient or unreliable physical resources to be which rely on maintaining customer loyalty by continuously
productive. For example, an employee may have low levels producing market-leading products.
of productivity if their production-line equipment is
outdated or unreliable. If a business has ineffective recruitment and training
systems, it may acquire a reputation as a poor employer.
Many employees and ex-employees make comments about
Ineffective systems of recruitment and their employers online, and it is easy for people considering
selection applying for a job with a business to conduct some simple
Businesses might simply appoint the wrong employee to a research. This may make it more difficult for the business to
position. This employee might be the wrong person as they attract the most skilled and productive employees. In turn,
do not possess the necessary skills, personal characteristics this could damage its long-term performance.
Causes of poor Measures of employee Consequences of poor

employee performance performance employee performance
Poorly designed jobs

Competitive
disadvantage
Inappropriate leadership Labour productivity
and management styles
Lower levels of
Labour turnover innovation
Demotivation
Reputation as a
Absenteeism poor employer
Insufficient resources
Health and safety Higher recruitment
and training costs
Ineffective recruitment
and selection
▲ Figure 7.21 The causes, measurement and consequences of poor employee performance
7.4.4 Strategies for improving Training

employee performance Businesses can invest in training to provide job-related
skills the employees require to carry out their work
There are a number of approaches a business can take more effectively. Training can also improve a workforce’s
to improve the performance of its employees. A logical performance in terms of health and safety by alerting
approach to improving poor employee performance is to employees to dangers in the workplace and encouraging the
consider the causes and to implement policies intended to use of safe working practices.
address this.
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pay. Team pay is a method of linking the pay of employees
to the level of performance that they have achieved in a
team. Team pay means that all members of a team receive
some sort of financial incentive when a goal or target
7.4
is reached. The goals might be financial, sales-related
or expressed in terms of quality. Team pay might be a
supplement to basic pay or it might represent the entirety
of an employee’s pay.
Team pay is a very attractive technique, as more businesses
adopt flatter organisational structures and make more use
7.4.4 Strategies for improving employee performance

of delegation. Modern businesses using these approaches
to organising their employees require a workforce that can
be flexible in its ability to deliver improvements in quality,
profitability and customer service.
▲ Figure 7.22 On-the-job training Team pay aims to reinforce behaviour that leads to effective
Training can also improve employee performance if teamwork. Being a part of a successful team can be very
managers and leaders receive training to help them to satisfying and may discourage absenteeism, as individuals
handle subordinates more sensitively and effectively. may be unofficially accountable to other team members and
not want to let them down.
However, training can be costly and there is always
the risk that employees may leave the business for ▼ Table 7.15 Team pay versus individual pay
alternative, higher-paid employment once they possess
these employable skills. Training to improve employee Team pay Individual merit pay
performance is more likely to be effective when employees • Rewards teamwork and • Creates internal competition
are highly skilled or when improved employee performance co-operation • Encourages withholding of
can provide a distinct USP. • Encourages information- information
sharing and • Individuals try to improve
Motivation communication work systems – with less
A highly motivated workforce is likely to be highly • Encourages group to chance of changes being
productive with low levels of labour turnover and improve work systems implemented, as may not be
absenteeism. In Chapter 2.2, we considered a number of • Increases flexibility and widely supported
ways in which businesses may improve the motivation of ability to respond to • Decreases flexibility
their workforces. This may require businesses to redesign changing needs • Incorporated into base
jobs to make them more attractive and fulfilling, perhaps • May be incorporated into salary
by empowering employees and/or offering the opportunity base pay • No focus on wider
to work in teams. Well-designed jobs can help to reduce • Focus on wider organisation
labour turnover and absenteeism by allowing employees to organisation
fulfil Maslow’s higher needs (such as self-esteem) at work. Source: M Thompson, Team-working and Pay (1995) Institute
Herzberg argued that personal achievement, recognition and of Employment Studies
responsibility were key motivators. By creating jobs that
allow employees to have responsibility, to achieve goals
and to receive recognition, it is possible for businesses to Employer branding
satisfy larger numbers of employees and discourage them Employer branding can be defined as creating a perception
from leaving the business. of the business as a really good place in which to work
in the minds of current employees, as well as other
STUDY TIP stakeholders such as customers and shareholders. A survey
of 895 businesses in the UK by the CIPD revealed that 69
Don’t forget the materials that you studied at AS Level.
per cent of businesses consider that they have an employer
Your studies of motivation will help you to understand
much of the material we cover in this chapter.
brand, and that this is particularly important to smaller
businesses with fewer than 250 employees. Having a good
employer brand helps to persuade employees to stay with
Pay systems a business and can be an important factor in retaining the
services of skilled and potentially footloose employees.
Businesses can use pay systems, such as piece-rate or
performance-related pay, which reward employees according
to the amount produced or for the attainment of specified Flexible-employment contracts
targets. This approach can be effective in improving We saw earlier in this chapter that there are a variety of
productivity, especially in manufacturing organisations. ways in which businesses can employ people more flexibly.
This can bring together some of the other benefits, such as
A newer approach to pay, which is intended to improve
improving motivation and enhancing a business’ reputation
the performance of teams within the organisation, is team
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as an employer. In particular, the use of flexitime, Thus, in our example in Figure 7.23, a business has a
homeworking and job-sharing can offer real benefits mission statement that sets the organisation the overall
7.4 to employees. The use of such contracts can improve
motivation and reduce labour turnover. Both factors can
target of becoming the ‘premier supplier of bottled water
in Europe’. The business’ corporate objectives contribute
be expected to improve employee performance in the to this mission – one might be to increase sales in Europe
workplace. by a certain percentage each year. A business comprises
functions such as marketing, finance and production.
Management by objectives These functions should contribute to the achievement of
corporate objectives by doing their bit. Thus, marketing
Peter Drucker spent many years researching major
should increase sales, raise production output and so on.
companies, such as General Electric and DuPont in
Finally, the departments, teams and individuals at the
the United States. In 1954, he published The Practice

bottom of the hierarchy should all make their co-ordinated
of Management, one part of which was his theory of
contribution to the attainment of the objectives of the
‘management by objectives’ (MBO). This theory stated the
functional area of the business in which they work.
central role of objectives in business management.
An important element of the operation of MBO is the review
Implementing MBO of the extent to which targets have been met and the
development of new goals, targets and objectives in light of
According to Drucker’s theory of management by objectives,
this experience.
to implement MBO managers should:
» identify and agree targets for achievement with subordinates
» negotiate the support that will be required to achieve The usefulness of MBO
these targets The usefulness of MBO in any given situation depends on
» evaluate over time the extent to which these objectives the balance of its advantages and disadvantages. MBO
are met. offers a number of advantages to businesses:
» MBO can improve communication within the organisation
The objectives set at each level should be co-ordinated to
as the target-setting and evaluation process takes place.
ensure that the business achieves its corporate objectives.
It can give managers a fuller appreciation of the duties
Each member of staff should make a contribution, no matter
and problems faced by their subordinates.
how small, towards the whole business achieving its overall
» Employees may be motivated by having a clear
objectives.
understanding of what they are trying to achieve and
e.g. 'To become
how it helps the business achieve its overall goals. MBO
the premier Mission has the potential to improve employee performance.
supplier of bottled statement » MBO can highlight training needs for managers and
water in Europe'
subordinates, improving their performance and
productivity.
e.g. to increase Corporate objectives,
sales in Europe by once achieved, allow » The attainments of goals can help all employees to fulfil
5% in each of the the business to fulfil some of the higher needs identified by Maslow.
next 5 years its mission statement
Drucker recognised at the outset that MBO had a number of
potential drawbacks:
Objectives stated in greater detail
e.g. (marketing Business functions

function) to achieve pursue objectives » Some employees may find the setting of targets
a 10 per cent share to assist the
business in threatening. Employees at different levels within
of the bottled water
markets in Italy and achieving its the organisation have varying perceptions of issues,
Spain within 5 years corporate objectives problems and their solutions. The manager might set
targets that the subordinate considers unachievable.
e.g. (market Attaining » All employees within the organisation must be
research) to develop departmental committed to the technique if it is to succeed and
a plan to research objectives
customers' views on contributes to the benefit the business.
bottled water in Italy business achieving its » Setting targets for highly specialised employees can
and Spain corporate objectives be difficult and tends to remove the focus from the
mainstream corporate objectives.
e.g. to design Individuals and » Modern businesses operate in a business environment
questionnaires teams negotiate that is changing rapidly; for example, as a result of the
as part of targets which assist
market research departments in globalisation of markets. Objectives can quickly become
campaign achieving their goals out of date if, for example, a technological development
by a multinational competitor means that products are
▲ Figure 7.23 Management by objectives obsolete.
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7.4.5 Roles of IT and AI in human a business many thousands of dollars, and technology has
the potential to reduce the costs and time taken when
resource management appointing new employees. Social media has been used as 7.4
an integral part of recruitment for many years, with websites
Types of technology and HRM such as LinkedIn playing a key role in bringing together
There are five main trends in technology that are influencing those looking for work and employers with job vacancies.
the ways in which HR operates within a business: However, more recent technological advances have helped
» Data analytics The use of artificial-intelligence (AI) to make the recruitment process faster and more cost-
technology to interrogate data stored on cloud-based effective. Technology can be used to scan and analyse
databases has transformed the amount of information applicants’ CVs and application forms and select the most
7.4.5 Roles of IT and AI in human resource management

available to HR specialists. desirable candidates. AI enables HR teams to evaluate
» Cloud computing This is the core of most technological large numbers of job applications quickly and efficiently.
HR systems. It stores vast amounts of data and Some businesses are now also using AI in the form of
its accessibility can encourage employees to work chatbots to conduct interviews with candidates. There is
collaboratively. some evidence that AI can outperform humans in judging
» Mobile technology The use of mobile technology through the hard skills that are essential to complete a job, such
smartphones and other devices increases and improves as relevant job-related knowledge. This allows human HR
communication between HR and other employees. specialists to focus on assessing candidates’ soft skills,
» Social media This technology is still widely used for such as their ability to fit in with the existing team and
recruitment and selection, and it is used increasingly as an business culture. It is likely that this combination of AI and
inexpensive means for communication and team-building. HR specialists will improve the recruitment and selection
» The internet of things (IoT) This works with AI and process.
the cloud to gather data from employee wearables and
other devices. Phenom People is a business that provides AI software in
the USA to help businesses make good-quality recruitment
Social The internet Cloud Big data Mobile and selection decisions. The company operates a ‘talent
media of things computing and analytics technology experience management’ platform as an all-in-one solution
to recruitment issues. Phenom People claims to have over
300 companies as clients, including Microsoft.
Managing the performance of employees

Traditionally, the performance of employees was managed
through regular appraisal meetings, during which
Technologically past achievements were evaluated and targets set for
based HR the future. Technological developments have created
performance-management software which tracks the
performance of employees continuously and can update
▲ Figure 7.24 Developments in technology and HRM targets and provide employees with feedback on their
performance at any time. The software also allows other
employees to contribute to the assessment of an individual
How technological advances affect HRM employee’s performance as a central part of the process.
Recruitment and selection Figure 7.25 summarises the operation of performance-
management software.
The process of recruitment and selection is a costly exercise
for most businesses. Recruiting a senior manager can cost
Colleagues and
Personal goals, Employee records Manager and
managers give Software accumulates
projects and tasks when tasks and employee have
constructive criticism and summarises
which work towards goals are regular catch-up
to employee, employee performance,
the organisation’s completed so that discussions, either
recognising strengths which can be used
objectives are put manager can track in person or
and areas for in a formal appraisal
into the system progress electronically
improvement
▲ Figure 7.25 The operation of performance-management software

One feature of managing employee performance is the use is engaged at any time. Some businesses use wearable
of wearables by the business’ workforce. Employee wearables technologies to provide augmented instruction; for
are clothing that incorporate some computing and software example, to check that employees are selecting the correct
technologies. Wearable technology in the workplace can items from the shelves in a warehouse. This technology
be used to monitor an employee’s productivity by checking can also identify if an employee is engaged in a hazardous
on their location and the activities in which the person activity and intervene, if necessary.
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Communication between HR and other information without interrupting work patterns. This can
assist in engaging and enthusing employees and improving
employees
7.4 Advances in communication technology have made it easier
performance at work.
for those responsible for HRM to communicate and work
with employees across the organisation. Many organisations
Creating a more diverse workforce
have moved away from using emails, as inboxes become too Research throughout the world indicates that more diverse
crowded and the level of engagement of employees with workforces (in terms of both gender and ethnicity) generate
this form of communication is often poor. higher levels of productivity and profitability. In part,
this may be because consumers in many countries value
New forms of technology have helped to improve businesses that employ diverse workforces. HR managers
communication and stimulate employee engagement with can use technology to monitor recruitment practices for
HR initiatives. Nowadays, many companies use different diversity. They can also use technology to analyse HR data
online methods to exchange files and messages such as to identify any salary gaps between employees of different
Skype, Slack and Basecamp. Some HR managers use social gender or ethnicity, and they therefore help to promote a
intranets and computer-based newsfeeds to transmit positive culture within the business.
CASE STUDY
FTD Ltd
FTD Ltd is a clothing retailer with 112 shops located will improve the performance of its workforce. They are
throughout the UK. It also sells online. It has enjoyed rising considering the following proposal:
profitability, employing nearly 2000 people in its stores ● replacing many online customer advisors with chatbots
and in three very large warehouses, from which clothing is ● using employee wearables to monitor the performance
distributed to its shops and its customers. Many employees of employees, especially in its warehouses
are on zero-hours contracts and those who turn down ● recruiting and selecting employees using only
work are rarely offered any further employment. Its pay information technology and artificial intelligence to
rates are below average for the industry. analyse applications and conduct interviews.
The company’s workforce is not well-motivated and The company’s directors have very different views on the
labour turnover is high. Employees complain of poor likely success of this proposal.
working conditions, limited training and many only stay
a few months. They say they have little communication Questions
with managers – apart from receiving instructions – and 1 Analyse two ways in which FTD Ltd might improve
are frequently disciplined for minor errors or lateness. the productivity rates of its employees. [8]
Last year, the company’s labour turnover rate was 105 per 2 Evaluate the case for and against the company’s
cent, the highest ever. Productivity has also declined and proposal to make greater use of information
last year was estimated to have fallen by 3.5 per cent. technology and artificial intelligence in managing
its workforce. [12]
The company’s managers have investigated increasing the
use of technology in its operations in the belief that this
with a precise focus. It allows payrolls and other HR records

Technology is changing the role of HR to be updated quickly and to be accessible to all authorised
within a business people within the business.
Developments in technology have allowed HR managers to This simplification of the many administrative tasks
spend less time on basic administrative tasks. Technology through the use of technology has given more time for HR
has allowed databases to replace physical files and enabled managers to devote to strategic matters. This means that
much more time-effective searches and analyses to take HR managers can focus on long-term people issues, such
place. Storing information in cloud systems means that as ensuring the business matches human resources to the
much more data (including big data) is available for business’ needs, and that it develops values and cultures
analysis. This can be conducted rapidly and efficiently. It in the workforce that support the achievement of the
also allows HR specialists to produce reports speedily and organisation’s corporate objectives.
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TEST YOUR LEARNING
7.4
1 Explain two differences between a ‘hard’ and a Punjab Sugar Mills Ltd
‘soft’ human resource strategy. [6] Punjab Sugar Mills has enjoyed a substantial rise in sales
2 a Define the term ‘flexible workforce’. [2] over the last four years, although sales have fluctuated
b Explain one advantage to a business of using at times. It trades in a highly competitive global market
temporary employment contracts. [3] in which profit margins have declined steadily. The
3 Explain one difference between annualised-hours, level of production at the factory tends to fluctuate in a
7.4.5 Roles of IT and AI in human resource management

compressed-hours and zero-hours employment predictable way throughout the year as sugar harvests
contracts. [3] are completed in different parts of the world.
4 a Define the term ‘flexitime’. [2] The company’s workforce has grown rapidly too, although
b Define the term ‘job-sharing’. [2] some HR managers support the introduction of more
5 Explain one reason why some businesses benefit technology to replace people. The process of producing
from operating within the gig economy. [3] sugar is suited to the use of technology, and this could
6 a Explain one advantage of the use of flexible- help the company to achieve its overall aim of increasing
employment contracts. [3] its profitability. However, Punjab Sugar Mills Ltd has
b Explain one disadvantage of the use of flexible- decided to invest heavily in training its employees at
employment contracts. [3] all levels during the last 18 months rather than buying
7 a Define the term ‘labour productivity’. [2] technology, preferring to use labour-intensive production
b Woodland Mines Ltd recruited 250 people last methods. The factory operates for 18 hours a day, 5 days
year and 200 employees left. Its average each week.
number of employees during the year was 6000. The company’s chief executive values his workforce and
Calculate its rate of labour turnover. [3] considers good employer–employee relations essential
8 a Explain one reason why absenteeism may be a if the business is to succeed in the future. However, some
problem for a business. [3] employees believe that communication is poor within the
b Explain one method a business might use to business, despite the company’s democratic management
improve the performance of its employees. [3] style. Employees complain that they do not always get a
9 a Define the term ‘management by objectives’. [2] chance to voice their opinions.
b Explain one advantage to a business of the The management team have been studying some key data
use of management by objectives. [3] for the company, shown in Table 7.16.
10 Explain one way in which technological advances
The price of sugar cane has fluctuated on world markets,
might affect the way a business recruits and selects
leading to significant fluctuations in the company’s costs.
employees. [3]
However, growing demand in Indian markets and in other
Asian countries, with rising incomes, has boosted sales
revenue.
▼ Table 7.16
Last year One year ago Two years ago Three years ago
Sales ($’000s) 4 785.6 4 387.4 4 401.9 4 011.2
Sugar production (metric tonnes) 9 570 8 335 8 282 8 337
Profit margin (%) 9.22 10.43 9.14 7.95
Employee numbers 2 512 2 401 2 456 2 339
Labour turnover (%) 7.3 7.1 11.2 7.4
Questions
1 Analyse one way in which the use of flexible 3 Evaluate the possible actions that Punjab Sugar Mills
workforces might enable Punjab Sugar Mills Ltd’s Ltd’s managers might take to improve further the
managers to reduce the company’s labour costs. [4] performance of the company’s workforce. [12]
2 a Calculate the company’s productivity figures for
last year and two years ago. [4] Essay question
b Evaluate the strengths and weaknesses of the 1 ‘Labour productivity is always the most important
performance of Punjab Sugar Mills Ltd’s measure of employee performance.’ Evaluate the
workforce over the last four years. [12] extent to which this statement is true. [20]
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8 Marketing
A LEVEL
8.1 Marketing analysis

A LEVEL 8.1 Marketing analysis
Chapter overview
★ the elasticity of demand: price, income and promotional
★ new product development
★ research and development (R&D)
★ sales forecasting.
8.1.1 Elasticity Price elasticity of demand

There are several types of elasticity, but one of the most
Market analysis important to businesses is the price elasticity of demand.
Market analysis examines the conditions of a market. This This measures the sensitivity of demand to a change in
includes the size of a market and the factors that influence price, with all other factors unchanged. A business can
demand. A key aspect of market analysis is to consider how change its price but, before it does so, it will want to know
sensitive demand is to changes in different factors. the possible impact on the demand for its products.
Every business is interested in what affects demand for its
products and services. What is it that makes its sales go up, Why does the price elasticity of demand matter?
or down? Will sales alter if the business changes the price By calculating the price elasticity of demand, a business
or if consumers’ incomes change? What is the strength of can identify how changes in price may affect the quantity
the relationship between, for example, price and sales? If of its sales and, therefore, revenue. This is important for its
the price is cut by 10 per cent, will sales go up by 5 per marketing planning. If, for example, a business is planning
cent, or will they go up by 50 per cent? Similarly, if average a price cut, it will want to estimate how much sales are
consumer income levels rise by 5 per cent, what impact will likely to increase. This allows the business to ensure it has
this have on demand for the firm’s products? sufficient inventory or capacity to meet demand. It may
also have implications in terms of employing people. For
The relationship between changes in demand and changes example, the firm may need to hire extra people or get
in factors, such as price and income, is measured by staff to work overtime to meet orders. The business will
the elasticity of demand. Effective marketing involves also want to calculate whether the price cut is worthwhile
an understanding of what influences demand and how financially. Will the price cut lead to higher profits or not?
sensitive demand is to different factors. This requires an An understanding of price elasticity should, therefore, lead
understanding of the concept of elasticity. If the change to better pricing decisions.
in quantity demanded is greater than the change in the
variable, with all other factors unchanged, this is known as
elastic. If the change in quantity demanded is less than the Calculating the price elasticity of demand
change in the variable, with all other factors unchanged, The price elasticity of demand measures the percentage
this is known as inelastic. change in quantity demanded following a price change,
when all other factors remain the same.
We now consider some of the key variables that can
affect demand – namely, price, income and promotional price elasticity percentage change in quantity demanded
=
expenditure – and consider the elasticity of demand in of demand percentage change in price
relation to these.
GLOSSARY TERMS
Market analysis examines the conditions of a market.
The price elasticity of demand measures the sensitivity
of demand to a change in price, with all other factors
unchanged.
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Demand is said to be price elastic if the value of the Demand is said to be price inelastic if the value of the
price elasticity of demand (that is, the size of the number, price elasticity (that is, the size of the number, ignoring
ignoring whether it is a positive or negative number) is
greater than 1 – that is, a given percentage change in price
whether it is positive or negative) is less than 1 – if
a change in price leads to smaller change in quantity
8.1
brings about a greater change in quantity demanded. For demanded. For example, a price cut of 10 per cent, leading
example, if demand rises by 20 per cent when the price is to an increase in demand of only 5 per cent, will have a
cut by 10 per cent, the price elasticity of demand will equal price elasticity of demand of
+20
= −2 +5
= −0.5
−10 −10
8.1.1 Elasticity
The value of 2 shows that for every 1 per cent change in The negative sign shows that as price goes down, quantity
price, the quantity demanded changes by 2 per cent – demanded rises – that is, they move in opposite directions.
that is, by twice as much. The negative sign simply shows The 0.5 (which is less than 1) shows that every 1 per cent
that the price and quantity demanded move in different change in price leads to a 0.5 per cent change in quantity
directions. If price goes down, quantity demanded rises, demanded. This means that demand is not very sensitive to
and if price rises, quantity demanded falls. price changes – that is, demand is price inelastic.
Demand is price elastic. Quantity demanded Demand is price inelastic.

The quantity demanded increases The quantity demanded
changes more than changes less than
the price. the price.
+10%
Quantity demanded
increases
+0.5%
–1% Price cut –1% Price cut
▲ Figure 8.1 Price elastic and price inelastic demand
What determines the value of the price

HANDLING DATA elasticity of demand?
1 The price elasticity of demand is –0.8. Is this price
elastic or inelastic? What happens to sales if the Availability of
price increases by 20 per cent? similar products
2 The price elasticity of demand is –3. Is this price
elastic or inelastic? What happens to sales if the Type of product Time
price increases by 20 per cent?
Factors influencing price

elasticity of demand
GLOSSARY TERMS
A price elastic demand means that the impact of a change
in price leads to a larger change in the quantity demanded
(in percentages), with all other factors unchanged. Demand for a brand
Proportion of income
versus demand for a
spent on a product
A price inelastic demand means that the impact of a product
change in price leads to a smaller change in the quantity
demanded (in percentages), with all other factors ▲ Figure 8.2 Factors influencing the price elasticity of
unchanged. demand
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The price elasticity of demand will be affected by a number than demand for petrol in general, as it is fairly easy
of factors, such as: to switch to another petrol company. Demand for a
8.1 » The availability of similar products If a consumer can
switch easily from one product to another, its demand
particular brand is therefore likely to be more price
elastic than demand for the whole product category.
is likely to be quite sensitive to price changes (that is,
demand will be price elastic). When buying an energy-
saving light bulb, for example, most customers do
Price elasticity of demand, total
not care what brand they buy – faced with two types, revenue and profits
they are likely to buy the cheaper one. Demand would
A price cut and price elastic demand
therefore be price elastic. Many businesses attempt to
differentiate their products so that consumers do not If demand for a product is price elastic, a business can
switch to competitors’ offerings (that is, the firms try to increase its revenue by lowering the price. Although it earns
make demand for their products price inelastic). Coca- less for each item, its overall revenue increases because it is
Cola, for example, has worked hard to distinguish its selling so many more products.
products from other cola drinks. Coca-Cola hopes that Imagine that a firm sells 10 000 units at $5; its total
relatively few consumers will switch brands, even if its revenue is 5 × 10 000 = $50 000. If the price is cut to $4
price is higher. Successful branding should, therefore, and sales jump to 15 000, the new total revenue will be $4 ×
reduce the price elasticity of demand and make demand 15 000 = $60 000. A 20 per cent price cut increases sales by
price inelastic. 50 per cent and revenue increases.
» Time In the short term, customers are often loyal to
their existing provider (for example, their credit card Whether this increase in revenue also means an increase
company, their bank or their insurance company). in profit depends on what happens to the costs when the
This may be because they can’t be bothered to look firm produces and sells more. If, for example, a business
for alternatives or because they think that changing has to increase capacity, it may incur significant additional
isn’t worth it in the short term as conditions might expenses and so, although it is earning more, profits may
change again and so any advantage a competitor has fall. On the other hand, if revenue increases more than
may be temporary. However, over time, if customers costs, profits will rise.
feel they are getting a bad deal, this will act as
an incentive to switch. They also have more time GLOSSARY TERM
to explore their options. This means demand will
The total revenue is the income generated from sales. It is
become more price sensitive (that is, more price
also known as turnover or sales.
elastic) over time.
» The type of product When buying convenience
products, such as milk, purchasers tend to go to the A price cut and price inelastic demand
nearest shop. Consumers do not spend much money
on each item and are not too concerned about price. If demand for a product is price inelastic, the revenue will
Demand for this type of product is likely to be price fall when the price is cut. This is because the increase in
inelastic. In comparison, shopping for goods such as sales is not big enough to compensate for the fact that each
clothes is likely to be much more sensitive to price item is selling for less.
(that is, more price elastic). This is because customers Imagine that a firm sells 10 000 units at $5; its total
spend time comparing their options. revenue is 5 × 10 000 = $50 000. If the price is cut to $4 and
» The proportion of income spent on the product sales increase to 11 000, the new total revenue will be $4 ×
If you spend only a small proportion of your income 11 000 = $44 000. A 20 per cent price cut increases sales by
on a product, you may not be very sensitive to price only 10 per cent and revenue falls.
changes, because they will have a limited impact
on your spending. However, if you spend a high In this situation, when demand is price inelastic, the
proportion of your income on something (such as business could earn more by putting the price up.
housing) then a given percentage change will have a Although it would lose some customers, the fact that it
more noticeable effect and demand is likely to be more is charging more per unit means its overall income will
price sensitive. increase.
» Demand for the brand versus demand for the product Imagine that a firm sells 10 000 units at $5; its total
Demand for petrol is likely to be very price inelastic – revenue is 5 × 10 000 = $50 000. If the price is increased
most consumers would find it difficult or inconvenient to $6 and sales fall to 9000, the new total revenue will be
to do without their cars. However, demand for one $6 × 9000 = $54 000. A 20 per cent price increase cuts sales
company’s petrol is likely to be more price elastic by only 10 per cent and revenue increases.
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▼ Table 8.1 Summary of price elasticity and revenue
Price elastic demand

Price decrease
Revenue increases
Price increase
Revenue decreases
8.1
Price inelastic demand Revenue decreases Revenue increases
CASE STUDY
Price elasticity of demand
8.1.1 Elasticity
▼ Table 8.2 Price elasticity of demand
Goods Estimated price elasticity of demand

Inelastic Salt –0.10
Matches –0.10
Toothpicks –0.10
Coffee –0.25
Tobacco products, short-run –0.45
Legal services, short-run –0.40
Taxi, short-run –0.60
Cars, long-run –0.20
Approximately a value of 1 Films –0.90
(that is, % change in quantity Housing, owner-occupied, long-run –1.20
demanded = % change in price)
Private education –1.10
Elastic Restaurant meals –2.30
Foreign travel, long-run –4.00
Airline travel, long-run –2.40
Fresh green peas –2.80
Cars, short-run –1.20 to –1.50
Sources: Bohi (1981); Cheng, and Capps Jr (1988); Gwartney, and Stroup (1997); Houthakker, and Taylor (1970);
US Department of Agriculture
Questions
1 Define the terms:
a ‘price elastic demand’ [2]
b ‘price inelastic demand’. [2]
2 Evaluate the significance of the findings in Table 8.2 for marketing managers. [12]
STUDY TIP
Students’ understanding of elasticity is often imprecise and so when someone has actually grasped the concept accurately,
it stands out from the other scripts! It is worth learning elasticity carefully.
Think about your wording – a price inelastic demand means that the relative change in the quantity demanded is less than
the change in price. It does not mean that there is no change at all. Remember that elasticity measures change in the
quantity demanded relative to changes in other variables.
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CASE STUDY
8.1
Elasticity of air-travel demand
The price elasticity of air-travel demand varies according the greater opportunity for substitution on short-haul
to the coverage and location of the market in which prices routes (for example, travellers can switch to rail or car in
are changed, as well as the importance of the air-travel response to air-travel price increases).
price within the overall cost of travel.
Questions
The estimate for the price elasticity of demand for a
1 Analyse two reasons why demand for short-haul
particular route was found to be −1.4 on average, whereas

flights was more price elastic than demand for long-
the price elasticity of demand for flights from any airport
haul flights. [8]
in one country to another was −0.8.
2 Evaluate the significance of the findings above for
Air-travel price elasticities on short-haul routes were the pricing of flights on a particular route. [12]
higher than on long-haul routes. This largely reflects
In both the above cases, demand increased when income

HANDLING DATA increased. These are called ‘normal products’ and have a
positive income elasticity of demand. If demand falls as
1 The price elasticity of demand is −0.2. The price is income rises, the product is known as an ‘inferior’ product.
$200 and sales are 500 units. The price increases by This leads to a negative income elasticity of demand.
10 per cent.
a What is the effect on sales?
For example, if the quantity demanded falls by 2 per cent
b What was the original total revenue? when income rises by 6 per cent, then:
c What is the new total revenue? –2%
2 The price elasticity of demand is −2.5. The price is income elasticity of demand = = –0.33
+6%
$200 and sales are 500 units. The price increases by
10 per cent. Products such as basic own-brand items may be perceived as
a What is the effect on sales? inferior products; with higher levels of income, customers
b What was the original total revenue? switch to other items that are perceived as better.
c What is the new total revenue?
▼ Table 8.3 Summary of income elasticity of demand
Another common measure of elasticity is the income Income elasticity Meaning

elasticity of demand; this is analysed below. of demand
Positive Normal product. Demand increases with
Income elasticity of demand an increase in income. Demand falls
when income falls.
The amount that demand changes in relation to changes in
income, all other factors unchanged, can be measured by Negative Inferior product. Demand decreases
the income elasticity of demand. with an increase in income. Demand
increases when income falls.
income elasticity percentage change in quantity demanded
= Value greater Elastic. The percentage change in
of demand percentage change in income
than 1 quantity demanded is greater than the
For example, if demand increases by 20 per cent when percentage change in income.
income rises by 10 per cent, then: Value less than 1 Inelastic. The percentage change in
+20 quantity demanded is smaller than the
income elasticity = = +2 percentage change in income.
+10
Luxury product Has positive income elasticity with a
This product is income elastic because the demand has
value greater than 1.
changed by more than the percentage change in income.
These are ‘luxury’ products, such as health clubs. Necessity product Has positive income elasticity with a
value less than 1.
Alternatively, if demand increases by 5 per cent when
income rises by 10 per cent, then: Managers will monitor income elasticity because it will
+5 influence what they produce, sell and where they target.
income elasticity = = +0.5
+10 For example, if an economy is booming, retailers may decide
to hold more luxury products. If an economy is declining,
This product is income inelastic because the demand has managers might decide to focus on producing inferior
changed by less than the percentage change in income. products, or if their products are luxury, they might target
other markets where incomes are growing fast.
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Limitations of the concept of the
HANDLING DATA
1 If demand rises by 5 per cent when income rises by
elasticity of demand
It is important to remember that the value of price elasticity
8.1
20 per cent, what is the income elasticity of demand? of demand at any moment is an estimate – you will never
2 If demand rises by 15 per cent when income rises by know exactly how sensitive demand is to any given variable
5 per cent, what is the income elasticity of demand? until you actually change that variable and see what happens.
3 If demand falls by 4 per cent when income rises by Therefore, a specific value of elasticity of demand needs to
8 per cent, what is the income elasticity of demand? be treated with some caution. This is especially true because
4 If the income elasticity of demand is +1.8, what is the markets keep changing and this will affect the value of any
impact on demand of an increase in income from
8.1.2 Product development

elasticity of demand. New products, changes in consumer
$20 000 to $22 000?
tastes, developments in distribution and competitors’
5 If the income elasticity of demand is –0.2 and sales
marketing campaigns will all affect the demand for a product.
are 5000 units, what is the effect of a 4 per cent
increase in income?
This can make it difficult to know exactly what caused a
change in sales following the change in one variable. Was
it the change in the variable? Or was it government policies
Promotional elasticity of demand or consumer confidence? For example, while it may appear
The promotional elasticity of demand shows the sensitivity that a price cut of 1 per cent increased sales by 2 per cent,
of demand in relation to changes in promotional suggesting a price elasticity of −2, in reality the sales may
expenditure, all other factors unchanged: have gone up for completely different reasons.
percentage change in quantity Having said this, with experience, by asking experts or by
demanded analysing the results from a test-market, managers are likely
promotional elasticity to have some idea of approximately how sensitive demand
=
of demand percentage change in promotional is to a variable and may feel confident to base decisions
expenditure on this. Even if they do not know the exact value, an
A positive result would show a positive correlation between understanding of whether demand is elastic or inelastic is
promotional expenditure and the quantity demanded. useful when it comes to making decisions.
The bigger the figure, the stronger the relationship. For
example, a result of +0.1 means a 1 per cent increase in GLOSSARY TERM
promotional spending increases sales by 0.1 per cent; a Research and development (R&D) is the generation and
value of +3 means a 1 per cent increase in promotional application of scientific knowledge to create a product or
spending increases quantity demanded by 3 per cent. develop a new production process which can increase the
firm’s productive efficiency.
Managers will be interested in the promotional elasticity
of demand because it will influence their spending in this
area. If, for example, the promotional elasticity of demand
for a product is +4, this means demand is very sensitive to 8.1.2 Product development
changes in promotional spending and managers may want to A common strategy in marketing is to focus on new product
allocate more resources to promotion. If, on the other hand, development. New products may be the result of a need to
the promotional elasticity of demand is +0.001, this means adapt to changing customer tastes or may be due to new
that demand is not very sensitive to changes in spending. technology. Some businesses focus developing their product
In this case, managers may focus on other areas, such as range on their market-research findings. Others are led more
developing the design of the product, rather than investing by their own research and development (R&D) and the
in promotional spending. innovations that come from this. In some cases, the basic
Of course, within the overall heading of promotion there are product is developed without the business knowing what
different ways of promoting a product (such as advertising) to do with it. Dr Spencer Silver developed the technology
compared to sales promotions (such as competitions). for an adhesive that could stick paper to things but would
Managers may want to measure the sensitivity of demand also enable the paper to be removed easily. However, it took
to different forms of promotion in order to identify which several years before he realised the potential of this product
forms are the most effective. in the form of Post-It notes.
New product development will be critical for some
STUDY TIP businesses. In the pharmaceutical industry, businesses are
Remember to be precise when using the concept of very dependent on a relatively small number of patented
elasticity of demand in your answers. Is it the price medicines. Developing new products to take over when the
elasticity or the income elasticity you are referring to, patents on existing ones end is a vital part of business
for example? Remember that when demand is income planning. Some companies base their strategies on new
inelastic, this does not mean that demand never changes product development. 3M aims for over 25 per cent of its
at all; it simply means that the change in demand is revenue to come from products that have been launched in
smaller than the change in income. the last 5 years. 3M invests over 5 per cent of revenue into
research development.
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The importance of new product development can be seen well as spending on testing and launching new products.
in the Ansoff Matrix (as discussed in Section 6 – see pages The failure rate of new products is relatively high and,
8.1 297–298). Developing new products involves investment
in research and development to produce new products, as
therefore, new product development involves a high
degree of risk.
The new product development process

The stages of new product development are shown in Figure 8.3 below.
Product and
Idea Concept Business Test Launch of the
process
generation testing analysis marketing product
development
▲ Figure 8.3 Stages in the development of a new product like that’). This means the business will want to build an
innovative culture. Amazon, for example, stresses that it
» Stage 1 involves generating the initial idea and is important to try out new things, even if some fail. 3M
considering whether it is feasible for the business. encourages innovation by ensuring that money is set aside
For example, can the business produce it? Is there a in budgets for people to try out new ideas.
sense that there is demand? At this stage, ideas may
be rejected because the business does not have the Externally, many new ideas are registered at the Intellectual
necessary resources. Property Office; firms may search the patent office records
» Stage 2 involves testing the concept further; this is and, if they find a product or process they would like to use,
likely to involve market research to identify what is they can pay a fee to the owner of the patent for the right
actually required by the market – for example, in terms to use their technology. Alternatively, a firm might buy a
of features. At this stage, ideas may be rejected because franchise to produce under another firm’s name; in return
the demand does not actually exist. for this right the firm pays a fee and/or a percentage of its
» Stage 3 involves analysing the business case for the turnover.
product and assessing its possible returns. At this stage, A firm’s customers can also be a valuable external source
an idea may be rejected because it is not financially of new ideas. You will notice that many companies have a
viable. customer phone line or a comments book to gain feedback
» Stage 4 involves development of the product idea and from their consumers on their service and to discover more
also the process involved in producing it. At this stage, about what customers really want. Innocent Drinks, for
the actual production may prove more difficult or more example, has a ‘banana phone’ which customers can ring
expensive than initially imagined and the project may be with their ideas.
dropped.
» Stage 5 involves test marketing. This occurs when the
product is sold in a limited region or in limited numbers The importance of research and
to assess customers’ reaction to it. If demand proves development
disappointing, a project may be dropped. Research and development (R&D) is part of the innovation
» Stage 6 involves the launch of the product. Even at this process. It refers to the generation and application of
stage, problems can occur in getting the product to scientific knowledge to create a product or develop a new
market or positioning it effectively. Many new products production process. For example, it may involve a team
are withdrawn not long after being introduced. of employees at a confectionery company researching a
In some cases, such as new medicines, the process of new new flavour or a new variety of sweet and then trying
product development can cost billions of dollars and take out different versions until they have one they (and the
many years because of all the testing required and the many customers) are happy with. Or it may involve another team
regulations the products have to meet. in the business focusing on new ways of producing the
confectionery.
Ideas for new products Research and development may be focused on an idea that
Firms may generate the ideas for new products internally employees have or it may be the result of market research
or externally. Internally, ideas may simply come through which has identified a market need. The effects of the
discussion, employees’ suggestion schemes, brainstorming Coronavirus (COVID-19) pandemic in 2020 highlighted the
activities or the firm’s own research department, if it has urgent need for a vaccine, which led to massive investment
one. However, generating good ideas for new products by many pharmaceutical companies.
regularly requires a culture in which innovation is valued. Investing in research and development can be risky because
This means people will be encouraged to question, to many research projects do not lead to successful products.
challenge and to improve the existing way of doing things There are many stages in developing a new product and
(rather than adopting an attitude of ‘it’s always been done there is no guarantee that an idea will go through to
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the next stage. Even if a product is launched, it may not the external environment may be different from what was
succeed. For example, the marketing activities may be expected or competitors may respond aggressively.
ineffective, customers’ needs and wants may have changed, 8.1
CASE STUDY
The leading investors in research and development
8.1.2 Product development

In US$ billion
Amazon 22.6
Alphabet 16.2
Volkswagen 15.8
Samsung 15.3
Intel Co. 13.1
Microsoft 12.3
Apple 11.6
Roche 10.8
Johnson & Johnson 10.6
Merck 10.2
Toyota 10
Novartis 8.5
Ford 8
Source: Statista.com
▲ Figure 8.4 R&D spending
Questions
1 Analyse one way in which expenditure on research and development can benefit a business. [4]
2 Evaluate the possible factors that determine the amount that a business invests in research and development. [12]
CASE STUDY
Kellogg’s
Kellogg’s, the US breakfast cereal and snack-maker, has Concern about the role of food companies in contributing
said it will not change its marketing strategy to children to obesity increased with a landmark lawsuit against
despite concerns about obesity. Its managers said that the McDonald’s by New York teenagers, who claimed the
obesity issue centred around calorie intake and exercise, fast-food company played down the health effects of eating
not ‘bad food’. Kellogg’s plans to launch its Kashi brand Chicken McNuggets. Kraft Foods has focused attention on
of wholegrain cereals in the UK and will soon introduce a the issue by voluntarily pledging to stop marketing in schools,
new version of All Bran to Japan. stop advertising to children under six and shifting food
promotions to the 6–11 year-old towards healthier items.
The development illustrates how US food companies are
responding to increased concern about the contribution Asked whether Kellogg’s would be changing its promotional
of some processed foods to obesity and the marketing of strategy in the wake of Kraft’s move, the company’s
these products to children by highlighting efforts to develop chief executive said, ‘We don’t move based on what the
healthier products. competition does.’
The company’s chief financial officer said, ‘The whole Both Kellogg’s and its main rival in the breakfast cereals
issue with obesity is really calories in, calories out. There market, General Mills, have in the past year stepped up the
aren’t any bad foods, it’s all about balance.’
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introduction of cereals containing whole grains, including those kinds of problems are really much more significant
8.1 those aimed at children. The chief executive said, ‘Kids have
been eating our products for decades. Offering options
and if we can put a dent in that, that would be very positive.’
Source: www.warc.com/newsandopinion/news/cadbury-kelloggs-
for what kids may want and what their mothers may want on-defensive-over-child-obesity/17177
them to eat is certainly a thing we’re interested in doing.’
The vice-president in charge of marketing said, ‘We think Questions
advertising cereal to kids is a very good thing to do and we’d 1 Analyse two reasons why product development may
like to do it more. Twenty-five per cent of kids walk out of be important to Kellogg’s. [8]
the door in the morning having eaten nothing. We think that 2 Evaluate the usefulness of the concept of elasticity
of demand to Kellogg’s. [20]
CASE STUDY
Akio Morita
Akio Morita was the founder of Sony. After serving in the
Japanese navy, he set up a small electronics company,
Tokyo Telecommunications Engineering, with his friend
Masaru Ibuka. Ibuka was an engineering genius who
invented many of the technical advances behind the brand
Morita created.
The company became very successful in the 1950s when
it produced a small transistor radio. The transistor was
invented in America, but Morita bought a licence from Bell
Laboratories to produce it in Japan. By the end of the decade,
Morita was exporting from Japan to the USA and Europe.
In 1958, he changed the company’s name. After weeks of
searching he found the name sonus, which is Latin for ‘sound’.
He changed this to Sony because ‘sony boys’ is Japanese
for ‘whizz kids’. In 1961, Sony became the first Japanese
company to be listed on the New York stock exchange. ▲ Figure 8.5 An original Sony transistor radio
With significant investment in R&D, Sony had further In 1998, the Sony Walkman was declared the number
successes with televisions and videotape recorders. one consumer brand in America. Morita’s famous view of
Morita developed the Sony Walkman which, at the time, globalisation was ‘think globally, act locally’. This means
was a groundbreaking product. This product (which that Sony used R&D to develop products that could be
changed the way we listened to music) was launched with used globally but could also be adapted to local tastes. By
almost no market research and against the views of many adapting what it did, Sony managed to be regarded as an
within the business. American brand within America and a Japanese brand in
Japan.
‘The public does not know what is possible. We do,’ said
Morita. Interestingly, Apple’s Steve Jobs had the same Source: www.economist.com/news/2008/11/07/akio-morita
message many years later. ‘The visionaries have the Questions
ability to look beyond where we are now to develop what
customers want, whether or not they know it.’ Morita’s 1 Analyse two benefits of R&D to Sony. [8]
focus was on R&D, not market research. 2 Evaluate the risks to Sony of developing products
without market research. Justify your answer. [12]
source of income to some organisations. If one firm suspects

Protecting ideas for new products another of illegally producing a patented product or using its
If a firm manages to develop new products and new processes patented technology, it can sue the offender. However, this
successfully, it will naturally want to protect these from can be costly and time-consuming. To protect a product or
being copied or imitated by competitors. If an innovation is process worldwide, a firm must register the patent in different
genuinely new, a firm may protect it by taking out a patent. countries; this can also be an expensive and slow process.
In the UK, under the 1988 Copyright, Designs and Patents Act,
the holder of a patent has the right to be the sole user of a By comparison, the work of artists, writers and musicians
process or manufacturer of a product for 20 years after it is is automatically protected by copyright. Copyrights do not
registered. have to be registered, although, once again, it is up to the
copyright holder to sue offenders. Designs and logos can be
The owner of a patent may sell the right to produce the protected by registering a trademark.
product or use a process to others. This can be a valuable
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CASE STUDY
8.1
L’Oréal
With the opening up of the emerging markets, L’Oréal’s
mission is broadening in response to the vast diversity of
populations. The whole company is focused on this new
horizon: teams enriched by their cultural diversity, a portfolio
of international brands present in the different distribution
8.1.3 Sales forecasting

channels, and research that is capable of grasping the
world’s complexity. The exploration of new scientific and
technological territories is being enriched by this global
dimension. Knowledge of different cultures and rituals
worldwide enables the laboratories to anticipate and invent
the products of the future.
L’Oréal:
● has 36 global brands
● operates in 150 countries
● has more than 88 000 employees
● registered 497 patents in 2019.
▲ Figure 8.6 A selection of L’Oréal products
Source: L’Oréal Annual Report 2010, www.loreal-finance.com/
For more than a century L’Oréal has been pushing back system/files/2019-09/LOREAL-2010-AR-volume1DEF.pdf
the boundaries of science to invent beauty and meet the
aspirations of millions of women and men. Its vocation is Questions
universal: to offer everyone, all over the world, the best of 1 Analyse two reasons why L’Oréal might want to
cosmetics in terms of quality, efficacy and safety, to give target emerging markets. [8]
everyone access to beauty by offering products in harmony 2 Evaluate the importance of innovation to the
with their needs, culture and expectations. success of L’Oréal. Justify your answer. [12]
CASE STUDY
Research and development spending
▼ Table 8.4 Top five countries in terms of number of Questions
patents
1 Analyse two benefits to a business of having a patent. [8]
Rank Country Total number of patents (2019) 2 Evaluate the possible reasons why the number of
patents varies so much from country to country. [12]
1 USA 198 766
2 Japan 57 465
3 South Korea 24 743
4 China 22 294
5 Germany 18 701
Source: https://statnano.com/report/s135
» the staffing required

8.1.3 Sales forecasting » the likely cash flow
Sales forecasts are estimates of the level of sales of » the return on investment.
a business in the future. The sales forecast is a very
important part of the planning of a business. The sales GLOSSARY TERM
forecast will affect:
A sales forecast is an estimate of the volume or value of a
» the expected level of revenue firm’s sales in the future.
» the capacity and production levels required
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All the different functions of the business will, therefore, ▼ Table 8.5 Monthly sales
be interested in what the sales forecast is because it will
8.1 affect their decisions. At the same time, the sales forecast
must be made in conjunction with the other functions; for
Month
January
Sales $m
5
example, the level of sales that is possible will depend on
capacity and the levels of staffing available. February 12
March 30
Methods of forecasting sales April 15
Managers are naturally interested in how markets will May 10
develop in the future, as well as their present situation.
It is important, therefore, for firms to look ahead when June 35

undertaking marketing. Marketing managers will be eager July 30
to forecast what sales in the market are going to be in the
August 16
future. From this they can estimate the likely sales of their
own products and produce their sales forecasts. September 50
A firm’s sales forecast sets out targets for overall sales and October 70
for particular products and services. It is a key element of November 30
a marketing plan and influences decisions throughout the December 22
organisation. To understand market trends, managers might
use one or more of the following methods of analysing
trends. Monthly sales ($m)
80
Calculating moving averages 70

If you look at the sales data in Table 8.5 and plot the figures 60
on a chart, you will see that the sales are quite erratic from 50
one month to the next, as shown in Figure 8.7. In October,
for example, sales are relatively high, whereas in August they 40
are lower. However, although the sales change from month to 30
month, the overall trend is clearly upwards. 20
One way of plotting the underlying trend is to calculate 10
the moving average. This looks at several periods at a
0
time and averages out the data. By doing this, the effect
y
ry
st
ch
ril
ay
ne
ly
er
r
be
be
be
ar
of particularly high or low figures is reduced because an Ju
gu
ua
Ap
ob
M
ar
Ju
nu
em
m
br
Au
ct
ve
ce
Ja
average has been taken.

Fe
pt
O
No
De
Se
A type of common moving average is known as a four-period ▲ Figure 8.7 Monthly sales
moving average. This could be four days, weeks, months or
years. To calculate this, the first step is to find the average Again, the set of four months can keep moving down and
for each ‘set’ of four periods; in this case, each set of four the average sales per month calculated. This is shown in
months. Table 8.6.
For example: However, you can see there is a problem in terms of plotting
these figures. The average figure lies between a month. To
For January to April, total sales are: overcome this problem, the average of these averages is
$5m + $12m + $30m + $15m = $62 million calculated, allowing a figure to be plotted lining up with
a month (or in other cases it might line up with a year or
So the average sales for those four months is: quarter). This is called ‘centring’.
$62m
= $15.5 million
4
Now move down a month and consider February to May.
Total sales are:
$12m + $30m + $15m + $10m = $67 million
This means the average sales per month are:
$67m
= $16.75 million
4
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▼ Table 8.6 Four-month moving average sales ▼ Table 8.7 Four-month centred moving average
Month Sales ($m) 4-month average

Month Sales ($m)
4-month
average
4-month centred
moving average
8.1
January 5
January 5
15.5
February 12
February 12
16.75
March 30

March 30
22.5
15.5
April 15
April 15 16.125
22.5
16.75
May 10
May 10 19.625
22.75
22.5
June 35
June 35 22.5
32.75
22.5
July 30
July 30 22.625
41.5
22.75
August 16
August 16 27.75
41.5
32.75
September 50
September 50 37.125
41.5
41.5
October 70
October 70 41.5
41.5
41.5
November 30
November 30 42.25
43
43
December 22
December 22
In this case, we take the first two moving averages and
average them. So, the average of moving averages = ($15.5 m This can now be plotted on a graph, as Figure 8.8 shows.
+ $16.75m) ÷ 2 = £16.125 million, and this can be plotted
between these results; for example, February is $16.125 Monthly sales ($m)
80
million. Then we take the next two results, $16.75m and
$22.5m, and average these. ($16.75m + $22.5m) ÷ 2 = 70
£19.625 million. The midpoint of these two results lies in 60
March. This process is continued for all the moving averages
50
to produce the four-month centred moving average, as in
Table 8.7. 40
We can see that the four-month centred moving average 30

shows the underlying trend of the data. It ‘smooths out’ 20
some of the particularly high or low figures because it takes 10
an average of four months. It shows the upward underlying
trend of the sales figures. 0
ry
ry
ch
ril
ay
ne
ly
pt st
ve r
De ber
r
be
be
Ju
u
a
ua
Ap
ob
M
ar
To recap the method:

Ju
nu
g
em
m
br
Au
ct
ce
Ja
» Find the total for the given set – that is, four months.
Fe
O
No
Se
» Find the moving average for this set – that is, four- Sales ($m) 4-month centred moving average
month moving average. ▲ Figure 8.8 Four-month centred moving average
» Centre your findings by adding two results and averaging
them.
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Extrapolation Extrapolated figures must therefore be treated with caution
– their reliability depends entirely on the extent to which
To estimate the future sales in a market, managers may
8.1 look back to identify trends that have occurred (using,
the future will imitate the past. Obviously, firms can learn
from past trends – in the UK, for example, retail sales are
for example, moving averages) and then, based on these,
likely to increase in the run-up to Christmas, holidays in
predict forwards. This is known as extrapolation. A holiday
Spain are more likely to be popular in the summer, central
company experiencing a fall in the number of enquiries in
heating is likely to be used more when the weather is
a particular month compared with past years may change
colder, and so on – but they must also look out for future
its sales forecast downwards. This technique is useful,
changes in the market conditions. Rapid developments in
provided the trends identified in the past continue into the
technology, for example, can lead to major changes in terms
future. If, in fact, there has been a major shift in buying
of what we produce and how business is conducted, and
patterns (for example, the timing of buying has changed

this may make extrapolation more risky. Sales of netbook
or the economy has unexpectedly entered a recession),
computers looked to be soaring upwards until tablets such
extrapolation could be misleading.
as the iPad were launched.
GLOSSARY TERMS
Extrapolation involves identifying the underlying trend
in past data and projecting this trend forwards. In Figure
8.8, for example, the underlying trend in sales figures is
Sales
clearly upwards. If we assume this trend will continue, we

Extrapolated trend can project it forward and estimate future sales.
Trend
Correlation occurs when there are apparent links between
variables; for example, promotional spending and sales.
Present Future
Time Correlation
▲ Figure 8.9 An extrapolated trend Rather than using extrapolation, future market sales
Extrapolation is thus only likely to be effective if market may be estimated using correlation. Correlation occurs
conditions continue to develop in the future as they have when there appears to be a link between two factors. This
in the past – that is, extrapolation only works if past trends process attempts to identify whether there is any link (or
actually continue. The problem is that many markets are very correlation) between different variables and the level of
dynamic and change rapidly. The market for cameras, for sales. For example, a firm might discover a correlation
example, has seen rapid change in the last 20 years with the between its sales and the level of income in an economy –
arrival of digital cameras. In this situation, extrapolation with higher income, consumer sales might increase.
may be very misleading – examining the past may provide Correlation analysis examines data to see if any relationship
little indication of what is going to happen in the future. appears to exist between different variables. This is
Sales can drop suddenly, regardless of what has happened in important for marketing managers because, if they can
the past, perhaps due to a recession, competitors launching identify the key factors that determine demand for their
a new product or a problem with production. The impact goods, and they can estimate what is happening to these
of the Coronavirus (COVID-19) pandemic on the sales of factors (for example, estimate income growth), they can
businesses all over the world is an example of how suddenly estimate total market sales and then their likely sales.
and dramatically change can happen. Examples of different types of correlation are shown in
Figures 8.10 and 8.11.
Price
Sales
Advertising Sales
▲ Figure 8.10 Positive correlation between advertising and ▲ Figure 8.11 Negative correlation between price and sales
sales
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» In Figure 8.10, a ‘positive correlation’ means that there is a link between the two but this does not mean that
is a direct link between the variables. An increase in drinking coffee actually makes you smoke or vice versa. It
advertising, for example, might lead to an increase in
sales and vice versa. The sales of a product might be
is important, therefore, to treat correlation figures with
some caution. Just because sales figures and the amount of
8.1
positively correlated with income levels and the number money spent on advertising expenditure are both increasing
of customers in the market. does not necessarily mean that the advertising is boosting
» In Figure 8.11, a ‘negative correlation’ means that the sales. In many cases, firms feel that the high sales mean
two factors are inversely related. An increase in price, they can spend more on advertising; that is, sales may
for example, is likely to lead to a fall in sales, so price determine advertising spending rather than vice versa.
and demand have a negative correlation. Alternatively, the increase in sales could be coincidental – it
could be caused by factors other than advertising.

It is important to note that correlation analysis simply
identifies an apparent link between the two factors; it However, the more times the correlation appears to exist
does not show cause and effect. For example, there is (for example, if the firm has regularly advertised and at the
often a strong link between coffee drinkers and smokers; same time sales have regularly increased), the more likely it
people who smoke often drink a lot of coffee as well. There is that managers will believe that a link does occur.
CASE STUDY
NHS bed crises
Health-service managers in the UK try to avoid bed crises We can predict almost the day when large numbers of
by using weather reports to forecast when people will fall patients will seek treatment.’
ill. The Meteorological Office has set up a unit using new
More patients die in Britain from weather-related illnesses
technology to give doctors up to two weeks’ notice of how
than almost any other country in Western Europe. For every
many patients are likely to develop bronchitis, heart attacks
one degree fall in temperature, 1.37 per cent more people
and strokes. The service, which claims to be the world’s
die. This is much higher than in other countries because
first, allows hospitals and surgeries to prepare for increases
the British are often less well-prepared – they do not dress
in demand using warnings generated by a supercomputer.
warmly against the cold, their houses are less well-heated
In the past, the UK’s National Health Service (NHS) or insulated, and they take less exercise.
has been caught out by sudden changes in the number
of patients suffering respiratory and cardiovascular Questions
diseases. Meteorological Office experts say the timing 1 Analyse two reasons why the NHS analyses weather
was due almost entirely to changes in temperature and patterns. [8]
climatic conditions. According to a spokesperson, ‘there is 2 Evaluate other factors that are likely to influence
a very close link between weather conditions and illness. demand for health-care services. [12]
Types of research might include test-marketing (trying out

STUDY TIP the product in a given area) or surveys. A test-market is a
In many of the cases you are likely to face, a business will representative selection of consumers which the firm uses
be making a major decision. In this type of situation, large to try out a new product. Having seen the results in the
sums of money may be at stake and the future of the test-market, the firm can estimate how the product might
business may be at risk. It is possible but very unlikely sell elsewhere and produce a sales forecast. By using a
that in this situation a decision will be made without some test-market, the firm can see customers’ reactions before
market analysis. You may question the way the analysis committing to a full-scale launch. If necessary, changes
has been undertaken, but some information is likely to be can still be made before the product is widely available.
better than none. Many film companies, for example, show their films to a test
audience before they go on general release, to assess the
public’s reaction.
Other ways of estimating future sales The disadvantage of using test-marketing is that
Using market research competitors have an opportunity to see what you are
planning to launch. This gives them time to develop a
Market research can be used to try to identify likely future
similar product and race you to launch first on a wide
trends, rather than assuming they will be similar to the
scale. A test-market may also give misleading results.
past. The value of this research depends on whether it is
This might be because the test-market chosen is not
primary or secondary and the quality of the information.
representative or because competitors’ actions lead to
If a small sample is used, for example, the forecast is less
misleading results. For example, rivals might increase their
likely to be accurate than if a larger sample had been used.
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promotional activities in the test-market to reduce a firm’s market is great or if the firm is facing a new scenario and
sales and lead it to believe that the new product will not does not have past data to build on.
8.1 do well.
A qualitative approach to sales forecasting may be based
on a ‘hunch’. Managers may make an educated guess of
Qualitative sales forecasting what sales will be given their experience. Alternatively
Managers could use their own experience or hire industry qualitative sales forecasts may use the Delphi technique. In
experts for their opinion of what is most likely to happen. the Delphi technique, managers assemble a group of experts
This approach to forecasting is known as qualitative sales who are all asked individually for their views. These views
forecasting. It is not based on statistically valid data, but are analysed and key areas extracted. These findings are
it is linked more to personal judgements and feelings. This circulated again to the experts for feedback and may be
qualitative approach is common if the rate of change in the circulated several times, incorporating the feedback each
time until a consensus is reached.
CASE STUDY
The flawed market research of new Coke
In 1985, the chairman of Coca-Cola announced, ‘the best
has been made even better’. After 99 years, the Coca-Cola
Company decided to abandon its original formula and
replace it with a sweeter version, named ‘New Coke’. Just
three months later, the company admitted it had made a
mistake and brought back the old version under the name
‘Coca-Cola Classic’!
Despite $4 million of research, the company had clearly
made a huge mistake. The background to Coca-Cola’s
decision to launch a new product was much slower
growth in its sales in the 1970s, especially compared
with Pepsi. Pepsi was also outperforming Coca-Cola in
taste-tests. The relatively poor performance was even
more disappointing, given that Coca-Cola was spending
an estimated $100 million more than Pepsi on advertising. ▲ Figure 8.12 A poster from the 1985 Coca-Cola relaunch
The taste-testing of the new recipe for Coca-Cola involved
that is, that if they chose a new flavour, the old one would
191 000 people in more than 13 cities. In all, 55 per cent of
be withdrawn. Also, the symbolic value of Coca-Cola may
people favoured New Coke over the old formula.
have been overlooked.
However, once the launch was announced, the company
was amazed by the negative response; at one point calls Questions
were coming in at a rate of 5000 a day. People were most 1 Analyse two ways in which Coca-Cola may have
annoyed by the fact that Coca-Cola dared to change the researched the market. [8]
formula of one of the USA’s greatest assets. 2 Coca-Cola did extensive (and expensive) market
research and yet still made a mistake. Evaluate whether
What went wrong? Possibly one problem was that when
this means that market research is a waste of time. [20]
undertaking the testing, customers did not know that
choosing one cola would mean the other was removed –
The method of forecasting used by a firm will depend on and consider the timing of the cash outflows to provide
the nature of the product and the market situation. these products. The cash-flow forecast will be produced
as a result of these considerations.
Sales forecasts and business decisions » Operations planning The expected level of sales will
influence the production schedule and, therefore, all
Sales forecasts will influence:
aspects of operations, such as the ordering of supplies,
» The expected profit figures for the business This will
inventory levels and distribution scheduling. The sales
be important to investors and if the business is putting
forecast must be produced in conjunction with the
together a business plan to raise funds. Managers will
operations team. If the expected level of sales is higher
usually present to investors or would-be investors their
than the firm’s capacity, for example, the business must
profit expectations for the coming years, and these will
decide whether to reduce the sales it makes, expand its
be based on their sales forecasts. This is why forecasts
capacity or subcontract.
and the assumptions on which they are based are looked
at very closely. The sales forecast will also affect the
» Human-resource decisions The level of sales for
different products potentially in different markets and
cash-flow forecast. Finance managers will consider the
parts of the world will affect HR requirements. High
level and timing of sales, look at the likely credit period
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levels of demand for one particular product may require » Marketing decisions If the sales forecasts are
staff to be retrained or moved from one part of the disappointing, it may be that the marketing team need
business to another to meet this level of sales. If the
forecasts are disappointing, the HR team may need to
to review their activities to see if there is anything they
can do to improve them. The business will continue to
8.1
stop recruiting or even make redundancies. The impact review the actual sales figures against the forecast and
of the Coronavirus (COVID-19) pandemic in 2020 meant take action where needed.
that many businesses had to review their sales forecasts
downwards and, as a result, make staff redundant.
CASE STUDY

BP
$150 In 2020, BP announced that it was forecasting lower oil
prices for decades to come. Prices had fallen as demand
$125 for energy reduced with the Coronavirus (COVID-19)
pandemic, but BP believed that the pressure from
$100 government to cut carbon emissions would mean that
oil prices would stay low. Given the impact of its sales
$75 revenue forecasts, BP said it would have to become
a leaner, more agile and lower-cost organisation.
$50 The company has announced it will cut 10 000 jobs.
$38.41
$25 Questions
1 Analyse two reasons why oil prices might be low. [8]
$0 2 Evaluate the value of sales forecasting to BP. [20]
2000 2004 2008 2012 2016 2020
▲ Figure 8.13 Brent crude oil prices
scenarios. This may help to ensure they are much better

STUDY TIP prepared for change than if they did not forecast at all.
Remember how important a sales forecast is. If you do Also, even though a forecast may not be exactly accurate,
not have any sense of the scale of the possible sales, how it may give an indication of the direction in which sales are
can you plan how much to spend, how much to produce,
moving and some sense of the magnitude of future sales,
and how many people to employ?
which can help a firm’s planning. Ultimately, it may not
matter much whether sales are 2 000 002 units or 2 000 020
units, but it makes a big difference whether they are 2 million
The reliability of sales forecasts or 4 million in terms of staffing, finance and production
Forecasts are most likely to be correct when: levels – that is, provided the forecast is approximately right,
» a trend has been extrapolated and the market conditions it can still be very useful, even if it is not exactly correct.
have continued as before
» a test-market is used and is truly representative of the It is also important to remember that sales forecasts can be
target population updated. A firm does not have to make a forecast and leave
» the forecast is made by experts (such as your own sales it there. As conditions change and new information feeds in,
forces) and they have good insight into the market and the managers can update the forecast and adjust accordingly.
future trends
» the firm is forecasting for the near future (it is usually
easier to estimate what sales will be next week rather
STUDY TIP
than estimating sales in five years’ time). There are many sources of information that may help
with market analysis, such as internal, external, primary
and secondary. Although the temptation may be to gather
The benefits of sales forecasting as much data as possible, this can lead to too much data
Inevitably, a firm’s external and internal conditions are and actually delay action. A challenge to all businesses is
likely to change and this can make it extremely difficult getting good-quality information – the right amount at the
to estimate future sales. It depends, in part, how much right time, telling you the right things. Also, look at how
good-quality data you have gathered and the rate of change the data is gathered; the value of market analysis depends
in the environment. However, the fact that there are on the quality of the information used. If information was
difficulties in forecasting does not necessarily make this a gathered using a small sample or if leading questions were
useless management tool. The simple process of forecasting asked then it may be very misleading.
makes managers think ahead and plan for different
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TEST YOUR LEARNING
8.1 e-commerce and digital marketing, with 50 per cent of its
Short answer questions promotional spend involving online activity.
1 a Define the term ‘price elasticity of demand’. [2]
Previously, in forecasting its sales, L’Oréal used the past
b Explain one implication for a business if the price
to project the future. However, it argues that nowadays
elasticity of demand for its product is −3. [3]
this approach is not relevant. Technology, it claims, makes
2 a Define the term ‘income elasticity of demand’. [2]
forecasting a science. L’Oréal has what it calls a ‘Beauty
b Explain one implication for a business if the income Tech’ programme, which uses data, consumer insights
elasticity of demand for its product is +2. [3]
and machine learning to forecast demand. Its analysis

3 a Explain one implication for a business if its of data enables L’Oréal to ensure the right inventory is
promotional expenditure elasticity is +0.5. [3] in the right place at the right time, automatically. The
b If the promotional elasticity is +0.8, calculate the Beauty Tech Data Platform has been built with Google. It
effect on demand of an increase in promotional compiles all the relevant data and then uses algorithms
spending from $4 million to $5 million. [3] and artificial intelligence to automatically create more
4 Explain one problem of using the concept of elasticity detailed and more reliable sales forecasts.
when making decisions. [3]
The data are linked to marketing, sales, digital,
5 Explain one benefit to a business of investing in new finance and supply chain departments, driving closer
product development. [3] collaboration between these functions. All inputs are
6 Explain one source of ideas for new products. [3] integrated in real time so that the algorithms can forecast
7 a Define the term ‘research and development’. [2] demand in real time. The results are huge: improved
b Explain one way in which research and sales forecast accuracy, improved ability to ensure the
development helps a business. [3] rights products are there at the right time, maintenance of
8 a Explain one way of forecasting sales. [3] correct inventory levels and quicker identification of any
b Explain one reason why it is important for a changes in trends.
business to produce sales forecasts. [3] Source: www.loreal.com/en/group/about-loreal/our-purpose
9 Define the term ‘moving average’. [2]
10 Define the term ‘qualitative sales forecasting’. [2] Questions
1 Is demand for L’Oréal products likely to be price
Data response question elastic or price inelastic? Explain one reason for your
choice. [3]
L’Oréal
2 Is demand for L’Oréal products likely to be income
Our goal is to offer each and every person around the elastic or income inelastic? Explain one reason for
world the best of beauty in terms of quality, efficacy, safety, your choice. [3]
sincerity and responsibility to satisfy all beauty needs and
3 Is demand for L’Oréal products likely to be sensitive
desires in their infinite diversity.
to promotional expenditure? Explain one reason for
L’Oréal has five divisions: fragrances, skin care, make-up, your choice. [3]
hair care and hair colour. L’Oréal’s brands include Garnier, 4 Analyse two ways in which technology is helping
Maybelline, NYX, Stylenanda, Essie, Niely, Lancome, Yves L’Oréal with its sales forecasting. [8]
Saint Laurent, Armani, Biotherm, Urban Decay, Diesel and 5 Evaluate the usefulness of sales forecasting to
Cacharel. L’Oréal. [20]
The company understands the importance of analysing
Essay questions
trends in its markets, such as an ageing population in
most markets, a growth in men’s consumption in its 1 Evaluate the extent to which the concept of elasticity
product areas, and a growth of the middle classes in is useful in marketing planning. [20]
many markets as incomes rise. It is very focused on 2 Evaluate the possible benefits of market analysis
to a business. [20]
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8 Marketing
8.2
A LEVEL
Marketing strategy
8.2.1 Planning the marketing strategy

Chapter overview
★ planning the marketing strategy
★ the contents of a marketing plan
★ the benefits and limitations of marketing planning
★ approaches to marketing strategy
★ strategies for international marketing.
8.2.1 Planning the marketing

strategy Objectives
A marketing plan sets out what a business intends to do

in relation to its marketing activities. The plan is likely
to be based on market research. This research will inform
the marketing decisions to ensure they are logical and
supported by the data. Market research is likely to provide
Marketing Marketing
information on issues such as: mix plan
Resources
» the market size (which may be measured in terms of
sales volume or sales value)
» the likely market growth
» the segments in the market and their size and growth
» the positioning of competitors according to
customers Research
» customers’ views of the brand
» information on the level of sales, through different
distribution channels and trends in distribution (for
example, whether there is a move towards online sales). ▲ Figure 8.14 Elements of a marketing plan
Based on this type of information, the business can develop The marketing plan will set out what has to be done and
its marketing plan. It will then use market research to what resources are needed to do it. Each activity should
assess how the plan is progressing and whether changes have a timeline so that progress can be measured. These
need to be made to the plan. activities will include the marketing mix; for example,
It includes: details of any promotional campaigns running, including
» the marketing objectives such as increasing market details of when they run, how much they cost and who is
share, increasing sales of particular products in monitoring the response.
particular regions, smoothing out sales across the year, A marketing plan should be detailed and specific. It
achieving certain distribution targets (for example, to should have clear targets to be achieved by named people
be available in 1000 outlets by next year) or improving in a given time. This allows progress to be measured and
brand awareness. assessed throughout. If the outcomes are not as intended,
» the marketing strategy; that is, how the objectives will the marketing plan can be amended.
be achieved (for example, by new product development
or targeting new segments) GLOSSARY TERM
» the resources required, such as staff time
The marketing plan sets out the marketing objectives,
» the marketing budget; that is, how much can be spent
strategy, budget and the activities necessary to achieve its
on marketing activities
objectives.
» details of marketing activities, showing what will be
done, by when, who is responsible and how much money
will be spent on each activity.
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The benefits of marketing planning 8.2.2 Approaches to marketing
8.2 By producing a plan, the marketing department is forced to
think carefully about what it has to do. It has to make choices
strategy
between what to spend its money on. It has to debate when The marketing strategy is the long-term marketing plan
is the best time to undertake different activities and how aimed at achieving the marketing objectives. Imagine we
long they are likely to be. This is an important process that want to increase sales by 50 per cent over the next five
can uncover potential problems and possibly highlight new years. How can we do this?
ways of doing things. The marketing plan is vital because: 1 We may decide to boost sales of our existing products. If
» it shows which products need to be available to sell in we do this, we could try to:
what quantities and at what times; this is crucial for the – increase the amount that existing customers buy
A LEVEL 8.2 Marketing strategy
operations department when they purchase (for example, buy more items
» it will influence HR planning in terms of the numbers every time they visit our shops)
and skills of staff needed at particular times – increase the number of customers (for example,
» it will influence the financial forecasts, showing encourage people to switch to our shop)
expected profits and cash flow. – increase the number of times they buy (for example,
more visits to the shop)
Having a marketing plan:
– increase the amount they spend (for example, get
» helps to co-ordinate action between the different them to trade up to premium items).
business functions
2 Or we may decide to develop new products.
» can motivate employees by setting clear targets for
different people so that they can assess their progress There are different ways of achieving an objective. Each
and be measured on what they deliver strategy selected will have different implications in terms
» can enable a proper review to see whether the targets of the precise marketing activities being carried out.
have been achieved and, if not, why not. The strategy adopted will need to fit with the specific
marketing objectives. For example, an increase in market
The limitations of marketing planning share may be achieved through lower prices to penetrate
the market, whereas a repositioning of the brand to become
While marketing planning can bring benefits, it can be more of a premium item might include new branding and
difficult to do and does have limitations. Conditions packaging but not price cuts. A strategy of entering a new
may be changing fast, information you want may not be market may require heavy investment in promotion to raise
available and you may not have the resources you would awareness, whereas a strategy trying to get customers to
like. There will be constraints and there will be uncertainty. switch from a competitor may focus on sales promotions.
Sticking rigidly to a marketing plan can be dangerous if The marketing team will have limited resources and must
circumstances have changed significantly. Events such as allocate these to support a strategy that meets the specific
the Coronavirus (COVID-19) pandemic, for example, will have objectives.
required massive changes in the marketing plans of many
businesses. Also it must be recognised that some plans
may turn out to be wrong. This could be because they were Deciding on a marketing strategy
based on incorrect or incomplete information, because of a Marketing strategies can vary significantly. For example:
lack of skill and experience of the planner or because they » Lobbs is an exclusive shoemaker producing expensive
proved more difficult to implement than imagined. made-to-measure shoes – this is a niche, differentiation
strategy. Clarks competes much more in the mass market.
However, this does not mean that planning should be
» Primark aims at the mass market via low prices. Karen
abandoned; simply that businesses and marketing managers
Millen aims more for the expensive fashion market.
may need to be flexible and adapt the plan if conditions
» The Ford Ka was aimed at the younger driver (perhaps
or objectives change. By having a marketing plan, it is
their first car). The Aston Martin DB7 is aimed at the
possible to assess progress and, if it is different from what
highly successful executive.
is expected, changes can be made. With no plan at all,
people do not know what they are supposed to be doing When deciding on a marketing strategy, there are many
and therefore may either not make decisions (because they issues to consider as well as the marketing objectives. These
don’t know what is the right thing to do) or will make their include being consistent with:
own decisions (which may not be in line with what the » the values of the business For example, the business
business as a whole wants to achieve). may be committed to sustainability and this might
affect what is offered. The business may have outlined
a clear ethical policy which might prevent certain
HANDLING DATA promotional strategies, such as targeting children to get
them to pester their parents to buy them a present.
1 If your sales are $200 000 and your market share is » the resources of the business There is no point
3 per cent, what is the size of the market overall? developing a marketing strategy based around high-
2 If you set a target market share of 5 per cent of the volume sales if the business does not have the capacity
above market, what level of sales would you need
to achieve?
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CASE STUDY
8.2
Barbie
Barbie has been experiencing major competition from ● those who do not buy dolls at all, to try to win new
Bratz dolls in recent years. To boost sales of Barbie, customers.
managers could target different segments:
Each of these would be a different strategy to achieve the
● those who buy Barbie already, to try to get them to buy
same objective of increasing sales.
more
● those who used to buy Barbies but are older now, to Questions
8.2.2 Approaches to marketing strategy

try and get them to return to the dolls (for example,
1 Analyse two benefits to the producer of Barbie of
adult collectors)
identifying different segments in the market. [8]
● those who do not buy Barbies but buy Bratz dolls, to
2 Advise which of the strategies above you would
try to win over these customers
recommend. Justify your answer. [12]
for this. Similarly, there is no merit in a strategy focused A firm’s marketing strategy should aim to exploit its market
on a premium positioning if the business cannot provide opportunities and defend the firm against threats. It should
the level of customer service to support this. naturally build on the firm’s strengths and avoid entering
» the product itself For example, clothes retailing works market segments or offering products where its weaknesses
well online and a more digital distribution might be a will be exposed.
logical strategy. By comparison, hairdressers may promote
more online but won’t be able to distribute digitally.
» market conditions The nature of the market and the Set corporate objectives
markets in which the business competes will determine
what is feasible and what are achievable targets. For Set marketing objectives
example, the sales targets for Coca-Cola will be set in
billions of dollars, whereas a market stall in your village
may be happy with sales in the hundreds of dollars. Analyse your strengths and weaknesses
Market conditions will determine where the business
should compete and which segments it should target.
For example, should the firm compete in a niche market Analyse the external environment
or try to compete head-on with the major players in a
mass market? Should it compete in particular regions, in Produce marketing strategy
the country as a whole or globally?
Implement marketing strategy
The
business Review
▲ Figure 8.16 Forming a marketing strategy

When assessing a marketing strategy, managers should make
sure they are clear about:
Marketing » the characteristics of the target market
The market
strategy
Objectives » the positioning of the business relative to competitors
» the nature of the strategy (is it aiming to justify a
premium price or is it offering a low price?)
» the marketing objectives (how will success be
judged?)
» the risk involved in any strategy relative to the likely
The
product returns
» whether it fits with the business strengths. Could
Primark suddenly move into the premium market, for
▲ Figure 8.15 Factors to consider when developing a example? What about Gucci chewing gum? 7-Eleven
marketing strategy luxury hotels? Virgin old people’s homes?
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A co-ordinated marketing strategy
8.2 The marketing strategy must be linked to planning with the
other functions. It must be co-ordinated with all the other Marketing
areas of the business. For example:
» The expected level of sales must fit with what can be
delivered operationally.
» The positioning in the market must fit with what can
be delivered in terms of the product quality and level of
Finance Operations
service.
» The staff will need the required skills and training to
deliver what is promised.

» The budget must be in line with financial plans to
achieve the desired overall profit targets. The marketing
activities must be affordable. For example, a business
Human resources
with limited funds may not be able to afford a major
promotional campaign.
A lack of co-ordination between the marketing strategy and
the other business functions could mean the resources are ▲ Figure 8.17 Marketing decisions must be co-ordinated
not in place in the right quantities and qualities required to with the other functions of a business
deliver on the strategy.
CASE STUDY
Unilever
Unilever is a large multinational business. Its mission
is ‘to add vitality to life. We meet everyday needs for
nutrition, hygiene, and personal care with brands that
help people feel good, look good and get more out of
life.’
Its marketing strategy is now focused on what it calls
‘power brands’; that is, key brands such as Dove and
OMO that it wants to develop globally. These brand
names will be extended to a wider range of products,
but lesser-known brands have been or are being
sold off. To achieve growth in the future, Unilever is
targeting emerging markets. In these markets, it has
▲ Figure 8.18 Some of Unilever’s power brands
two strategies:
● to get customers to buy products for the first time Questions
● to get customers to trade up.
1 Analyse two possible benefits of a strong brand. [8]
Source: www.unilever.com/news/press-releases/2004/04-02-12- 2 Evaluate the possible reasons why Unilever has decided
Unilever-puts-vitality-at-core-of-new-mission.html to focus its marketing strategy on power brands. [12]
STUDY TIP GLOSSARY TERMS

Remember how important the marketing strategy is. Protectionism occurs when a government protects
The price and the promotional mix are only likely to work domestic producers against foreign competitors.
if you are actually competing in the right market in the Tariffs are taxes placed on foreign goods and services
first place and in the right way. If your strategy is clear being imported into a country.
(for example, you decide you want to be a low-price
Quotas are limits on the number of foreign goods and
competitor) then much of the marketing mix becomes
services that can be imported into a country.
straightforward – you are likely to offer basic products at
a low price with a message of value for money.
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Why change a marketing strategy? » More funds may be needed to enable the strategic
change. This may be to research the options, develop
It may be necessary for a firm to change its marketing
strategy for a number of reasons, such as:
new products or launch them in the market. This can be
difficult if, for example, the reason for the change was
8.2
» It may have changed its marketing objectives Rather
that the business had financial difficulties.
than wanting more sales from a given product range,
managers may now seek to diversify (for example,
to spread risk) or there may be more pressure from IT and AI, and marketing activities
investors to boost profits. Developments in information technology (IT) are enabling
» Market conditions may have changed The slowing down marketing teams to gather and analyse data in much bigger
of the rate of growth in the PC market has led firms like quantities and at much faster speeds. Companies such
8.2.3 Strategies for international marketing

Microsoft to look for new markets to enter, such as cloud as Amazon can track in real time, not just what people
computing. Government regulations to reduce smoking are buying but what they are looking at, how they are
is forcing tobacco companies to look for new markets moving around the website and when they are coming
and, particularly, new products. The decline of the back to look again. This can give businesses a much deeper
traditional film camera market led the UK-based camera understanding of who their customers are, what influences
shop Jessops to reconsider what it offers. Concerns over their purchases and what drives behaviour. Businesses
diet have made McDonald’s think about how to make its can identify trends, build algorithms to anticipate
offerings seem healthier. behaviours and adjust their strategies accordingly.
» Competitors’ actions A head-on attack from other firms Information technology can also link marketing to the
may force an organisation to move into a new segment, other functions more effectively, providing better
or to focus on particular areas of its business where co-ordinated decisions.
it has a competitive advantage. In the UK, the threat
of supermarkets such as Walmart attacking its core Artificial intelligence (AI) is also helping marketing by
business led to Boots, which sold mainly health-care and enabling marketing decisions to be taken automatically.
beauty products, moving more into segments such as AI can interpret data and identify patterns that allow it
photography, optical and dental care. to drive dynamic pricing, adjusting the price according to
» The firm’s own strengths As a firm develops its staff, criteria such as time of day, location of the search and the
technology and product range, it may find that its previous behaviour of the customer. Examples of the use of
strengths create new opportunities and this brings about AI in marketing include:
a change in strategy. » making recommendations to customers on other
» Poor performance If your strategy is working well, you products they might like, based on previous buying and
are likely to keep on with it. If your strategy is failing, search patterns.
you need to rethink. A change in marketing strategy » generating content on social media to match the
may be prompted by the possibility of exploiting an interests of the potential customer
opportunity and/or protecting a business against threats » generating website content according to who is looking
or poor performance. at it (for example, is this the first visit to the site or a
return visit?)
Changing your marketing strategy can be a difficult process. » using chatbots on a website to provide computer-
For example: generated responses to customer enquiries
» If you keep the same brand name and try to move » generating customer-specific content in online advertising
upmarket, it can be difficult to win customers over. For so that the advert you see depends on who you are.
many years, Skoda was trying to reposition itself as a
relatively low-priced but reliable, well-designed brand.
For older buyers who remember quality problems in the 8.2.3 Strategies for international
past and its very basic design, this was quite a shift in
its positioning and buyers took time to be convinced.
marketing
Equally, changes to the strategy can damage the brand Businesses may not just be undertaking marketing activities
and hurt the long-term success of the business. At one in one area or even one country. Companies such as Google,
point, Burberry was growing so fast and using its brand Mercedes and Netflix will be operating in countries all over
on so many products that it started to devalue its image the world. This is made possible due to globalisation.
and the company had to be more selective to maintain a
premium image. Globalisation
» It will involve changes in the other functions. For
In recent years, the amount of international trade involving
example, the operations process may need to change,
businesses buying and selling across borders has increased.
perhaps to achieve higher volumes, fewer defects or
This is because:
faster service. Equally, responsibilities and duties of
staff will change, which can be disruptive and resisted.
» Political agreements have opened up markets by
removing or reducing protectionist measures such as
tariffs (taxes on foreign imports), quotas (limits on
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the numbers of imported goods) and administrative
restrictions that might make it difficult for foreign GLOSSARY TERMS
8.2 businesses to sell or operate in a country. Barriers to
trade still exist – for example, it is difficult for the big
The World Trade Organization is an organisation of
countries aimed at reducing protectionism across the
Western retailers to get permission to open in India – but world.
they have been falling in recent years due to the work of Economic collaboration occurs when countries make
governments and organisations such as the World Trade trade easier between each other.
Organization. Governments realise that trade enables
their businesses and citizens to access new markets
and, thus, stimulates economic growth. The increase in The implications for marketing of increased
trading agreements around the world, which makes trade
easier, is because of economic collaboration. Of course,

globalisation
there are still trade disputes and countries will block Globalisation from a marketing perspective opens up
trade with some other countries, but generally there has enormous opportunities and threats. It creates the
been a move towards greater collaboration. possibility of new markets and, literally, billions of
» Better transport and communications technology has new customers if you can successfully target them. For
made it easier and cheaper to find markets, to move example, there are enormous numbers of people moving
products around the world and to manage businesses in out of poverty and eager to buy consumer products
other countries. in the emerging BRIC economies (Brazil, Russia, India
and China). Other economies to watch because of their
Look at the labels on your clothes to see where they potential for fast growth have been identified as CIVETS
were made, find out where the different components of by some commentators (Cambodia, Indonesia, Vietnam,
your laptop or mobile phone were made, and look at the Egypt, Turkey and South Africa) or the MINT economies
source of items on the shelves at your local shop and you by others (Malaysia, Indonesia, Nigeria and Turkey).
will appreciate how global the world has become. Many However, globalisation also creates the possibility of
businesses buy in products and services from abroad and new competitors from abroad entering your markets. This
sell their products abroad. means you have to be even better at what you do in your
Not only that, but money also flows around the world, own market.
being invested in overseas banks and used to buy foreign
companies. Many famous ‘British’ brands, for example, are
now owned by overseas companies: Jaguar and Tetley Tea
are owned by Tata from India, and Manchester United FC is
owned by the Glazer family from the USA.
CASE STUDY
The NFL
The National Football League (NFL) has experienced
numerous problems in its marketing efforts to globalise
American football. Its attempts began in the 1970s with
some exhibition games played worldwide. In the 1980s,
the NFL created a European League, but this closed
down in 2006 as fans were disappointed by the quality of
the European game compared to the US game. The NFL
then focused on playing more games around the world
in countries such as Mexico and Canada, where they
felt there would be a market. These countries are of a
reasonable size, have a strong interest in sports and a
media interested in sports content. However, while local
events and partnerships had some impact, the biggest
change has been due to technology. Social media and
online opportunities have created new ways for the NFL ▲ Figure 8.19 American football has struggled to become
to distribute its products to a growing market worldwide. popular internationally
Technology has enabled globalised messaging and
communication. Questions
1 Analyse two problems the NFL might have in bringing
its sport to new markets around the globe. [8]
2 Evaluate the ways in which technology has made it
easier for a business to succeed globally. [12]
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CASE STUDY
8.2
Chinese export markets
Table 8.8 shows the top main export markets for Chinese producers in 2019.
▼ Table 8.8 Top main export markets for Chinese producers, 2019
Rank Country Market value ($bn) Percentage of China’s total exports

1 United States 418.6 16.8

2 Hong Kong 279.6 11.2
3 Japan 143.2 5.7
4 South Korea 111 4.4
5 Vietnam 98 3.9
Question
1 Analyse two factors that might make markets attractive for Chinese exporters. [8]
Entering a foreign market does, of course, bring various

International markets problems. Perhaps most importantly, the firm is unlikely
Overseas expansion may be appealing for several reasons: to know the market as well as its domestic market. It will
» The domestic market is saturated Many markets are need to ensure it fully understands market conditions,
mature (for example, the demand for microwaves, fridges including consumer buying behaviour, legal and economic
and televisions in the UK). Companies can only generate factors and the possible response of the competition.
replacement sales rather than many first-time buyers. Given that the market is not known as well, entering an
In emerging economies such as Brazil, Russia, India and overseas market can be seen as risky. This is why many firms
China, the economies are growing much faster, creating entering overseas markets find a local partner to help them
opportunities for a rapid growth in sales. If investors understand the market.
are pushing for fast growth, it may be that this is more
likely to come from abroad.
» The domestic market is subject to increasing STUDY TIP
competition or regulation Further expansion within
a country may be blocked by a government that wants International marketing offers many opportunities in
to prevent monopoly power, for example. Expanding terms of new sales; for example, in China alone there
are more than 1 billion potential customers. However,
overseas may overcome this problem.
understanding the needs of customers, the competition
» The benefits of particular market opportunities
and the nature of the market can be very complex when
overseas For example, China and India have populations
going overseas.
of more than 1 billion that could be targeted.
CASE STUDY
JD Sports
In 2020, JD Sports, the sports retailer which also owns The company said that it was confident that, domestically
Blacks and GO Outdoors, announced high profits despite and internationally, in stores and online, its unique brand
difficult trading conditions. It said that this success was provided a solid foundation for future development.
due to its growth internationally. The sports retailer
JD also operates in France, Portugal, Spain, Austria,
reported total sales growth of 15 per cent in the 48 weeks
Malaysia, Australia and Singapore, and the company is
to 5 January 2020.
eager to continue growing.
JD Sports had opened two stores in Thailand in the second
half of 2019, as well as its first five branches in the USA. Questions
1 Analyse two factors which determine whether JD Sports
JD Sports said its policy not to enter into short-term
is likely to open a store in a particular country. [8]
discounting had helped maintain its profit margins.
2 Evaluate the importance of international expansion to
JD Sports. [12]
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CASE STUDY
8.2
Tesco withdraws from overseas markets
In 2020, Tesco left Poland, selling 300 loss-making stores Holdings. That was followed in March by the sale of
to Netto (a Danish discount supermarket) for £181 million its south-east Asian operations to Thai conglomerate,
on the grounds of ‘market challenges’. It continued to Charoen Pokphand, for $10.6 billion. The deal, which
operate in the Czech Republic, Hungary and Slovakia, included more than 2000 stores, was the biggest in
where it believes there continue to be growth prospects. Thailand’s history.
However, it has struggled in Poland, where consumers
have continued to shop at convenience-led corner shops, Questions

many of which are owned by larger companies and so are 1 Analyse two reasons why Tesco expanded outside of
able to compete on price with supermarkets. the UK. [8]
2 Evaluate the possible reasons for the recent sale of
In February 2020, Tesco also sold its joint venture in China
Tesco stores in some countries. [12]
for £275 million to its state-run partner, China Resources
CASE STUDY
Food and drink in Asia

When Coca-Cola launched the Minute Maid Pulpy in According to Coca-Cola, Minute Maid Pulpy is the best-
Malaysia, the focus of its marketing campaign was on the selling drink in China, Taiwan and Hong Kong. However,
content of orange pulp in the drink. Coca-Cola believe Pepsi Co has also entered the Asian market in recent years
that Malaysian customers enjoy chewing the pulp, so they and currently has several products, including Tropicana
developed this new beverage to suit local tastes. Guo Bin Fen juices and Cao Ben Le drinks, which are
inspired by Chinese medicine.
There is a history of Western food and beverage
businesses adapting their products in an effort to tailor
to local tastes. Some examples are McDonald’s and
Starbucks: McDonald’s offers Corn Cups on their menus
in Asia, and Starbucks offers green tea Frappuccinos to
their customers in China.
Questions
1 Analyse two benefits to Coca-Cola of having many
different brands around the world. [8]
2 Evaluate the advantages and disadvantages of
changing the recipes of products for different
regions. [20]
▲ Figure 8.20 Minute Maid Pulpy
As with entering any market, the marketing department Once options have been identified, the firm must choose
needs to carefully analyse marketing opportunities when which ones to target and then develop an entry plan,
thinking of expanding overseas. This means looking at thinking about when and how it will enter the markets.
factors such as the market size and the potential for For example, will it simply sell to the market or set up and
growth. The analysis will use techniques such as correlation produce locally as well?
and extrapolation, but the firm may need to use local
Understanding overseas markets can be difficult because
expertise to try to understand the market better.
of differences in language, climate, culture and buying
The market analysis should help identify possible markets patterns. There is therefore potentially a high amount of
for the firm’s products, looking at the market conditions and risk involved, so managers must consider the likely rewards
the strengths of the brand and the products themselves. and how much time and effort to spend on market research.
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CASE STUDY
8.2
Exports
The top five export products from Malaysia are: 3 other base-metal goods
1 electrical machinery and equipment 4 cocoa
2 mineral fuels, including oil 5 oil seeds.
3 machinery, including computers
Source: www.worldstopexports.com/malaysias-top-10-exports
4 animal/vegetable fats, oils, waxes
5 optical, technical and medical apparatus. Question

The top five export products from Nigeria are: 1 Analyse two factors that determine which are the top
1 mineral fuels, including oil exported products from a country. [8]
2 ships and boats
The method of entry into international markets If the market overseas looks as if it will prosper long-term, a
firm might take over a foreign partner or invest itself to set
When considering entering international markets,
up its own operations there. These show real commitment
businesses will want to:
and are major strategic decisions involving a high degree of
1 identify which markets they might want to enter This
risk and expenditure. Several UK businesses have found it
will depend on factors such as the potential market size
difficult to succeed abroad because of the real differences
and degree of competition
in approach between regions.
2 select how to enter This will depend on factors such as
the amount of investment and the degree of risk
3 enter the market This focuses on the implementation GLOSSARY TERMS
of the decision of how to enter. It involves bringing A pan-global marketing strategy markets a product the
together the necessary resources and managing the same way in all markets.
entry strategy effectively. A localised strategy adapts the marketing mix for local
conditions.
Identify Select how Enter
markets to enter markets
▲ Figure 8.21 Entering international markets

Pan-global strategy or localisation?
Typically, firms will start trading internationally by
Once the decision has been made to enter an overseas
exporting abroad. This means they will continue to focus
market, a business must consider the extent to which it
on the domestic market but accept orders from abroad.
will adapt its offerings to local conditions. Is it possible
This is a low-risk strategy – it simply involves a firm
to market the product in almost the same way in every
sending its products to other countries. It may at this
country (as Gillette does with its razors), which is known as a
stage do some marketing abroad; for example, advertising
pan-global marketing strategy, or will the marketing
its products or attending promotional events. If sales from
have to be adjusted for each market and be localised? If
abroad continue to grow, the firm might look for an agent
a business pursues a pan-global strategy, this means it is
or representative overseas. This means it has someone
adopting essentially the same marketing mix wherever it
based abroad who knows its firm well and understands
competes. A pan-global marketing strategy has been adopted
local conditions. They will try to generate business for the
by businesses in several markets, such as jeans, soft drinks
firm and may be paid on commission. Again, the risk of
and luxury goods. A Rolex watch, for example, is positioned
this approach is relatively low.
and marketed in a very similar way across the world.
A bigger commitment would be made when the firm finds a
One advantage of a pan-global approach is that it offers
partner and forms a joint venture or alliance. For example,
marketing economies of scale; for example, the business
it might collaborate on projects and share the profits. At
can develop one advertising campaign and one approach to
this stage it is not just someone representing the firm but
packaging worldwide. However, this type of strategy does not
someone who the firm is working with locally to generate more
respond to the requirements of different national markets
sales. For example, a drinks company might have an alliance
and so the business may lose sales to competitors who focus
with a local drinks company to share distribution costs or to
more on local needs. In markets such as food and drink and
gain access to some outlets. It might also franchise, if that
the media, a business may need to adapt significantly to
was appropriate. This would mean it was working with local
local requirements. On the other hand, a more local approach
partners who would understand the political, legal, economic,
may meet customer needs more precisely but may be more
social and technological issues better.
expensive and more complex to manage.
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In reality, most companies will choose a balance between Factors to consider when entering overseas
the pan-global and localised approach. Unilever, for
8.2 example, has built several superbrands, such as Dove. These
are global brands that sell in many different markets. They
markets
When considering entering an overseas market, marketing
have the same name and logo everywhere. However, some managers think about:
adjustments are made in the way the product is promoted » the likely costs to establish the product in the market
to reflect local conditions. Unilever calls itself a ‘multi- and continue promoting
local multinational’. This is reflected in its structure: it » the likely risk (given that they may not be familiar
has brand managers who look after a brand globally and with factors such as the culture, the legal system or
local country managers who look after all related issues in competitive environment, the risk could be relatively
their areas. This approach is also called a ‘think global, act
high)
local’ strategy. Companies try to find economies of scale » the likely competition
where they can by doing things in the same way but, where » the understanding of the market
necessary, adjusting to the local market. McDonald’s has » the time frame
the same basic brand image and approach everywhere, but » the link with the business’ strengths and experience
it adjusts the menu in different countries. Coca-Cola sells » how to enter
its main brands globally but has more than 200 local brands » the likely returns (these could be huge in some markets
that only sell in limited areas. but must be balanced against the risk).
CASE STUDY
Lego
The Danish company, Lego, is one of the world’s biggest CEO Jorgen Vig Knudstorp believes that, while physical
toymakers by sales and has almost tripled its sales play is still important, Lego’s popular video games and
since 2007, despite the financial crisis and the popularity website are allowing the company to connect with children
of digital games. Lego’s sales overtook those of Hasbro in the digital age.
(which makes Transformers, My Little Pony and Play-
The company, which was founded in 1932, used to have
Doh), which was previously number two behind Mattel.
only a small presence in toy markets in North America
Lego’s new line of Friends building sets – developed for
and the UK but has significantly increased sales in the
girls – sold well alongside their established City, Star
USA, which is now its largest market. Lego also aims to
Wars and Ninjago ranges.
expand into Russia, Latin America and Asia to meet the
needs of their emerging middle classes.
Lego is 25-per-cent owned by the Lego Foundation, and
75-per-cent owned by the founder’s family. Jorgen Vig
Knudstorp noted that the company only keeps the cash it
needs in order to operate – the rest goes to the family to
be invested elsewhere. ‘If Lego needs [the cash], it flows
back.’
Lego is currently building a new factory in Hungary
and expanding the capacity of its factory in the Czech
Republic in a bid to move the bulk of its production to
low-cost countries. It plans to shut its packaging plant
at its headquarters in Billund but will be investing in its
moulding and engineering facilities there instead.
Source: www.ft.com/content/adefc266-7c15-11e2-bf52-
00144feabdc0
▲ Figure 8.22 A Lego model of the Star Wars Death Star Questions
1 Analyse two factors that might determine demand for
Lego. [8]
2 Evaluate the factors Lego might consider before
choosing a new market to target. [12]
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TEST YOUR LEARNING
total international revenues. Although many Chinese
8.2
Short answer questions customers value more premium brands, Uniqlo products
1 a Define the term ‘marketing plan’. [2] are used as plain items to go with fashion items. Uniqlo’s
b Explain one benefit to a business of having a cold weather Heattech range has done particularly well in
marketing plan. [3] China. In other warmer Asian markets the Heattech range
2 Explain the importance of one element of a has been in less demand so Uniqlo has focused on other
marketing plan. [3] products.
3 Explain one reason why market research is useful

The chief executive of Uniqlo is a big fan of globalisation
in developing a marketing plan. [3] although he is worried that barriers to trade could limit
4 Explain two factors that should influence a international expansion. Uniqlo buys high volumes of ‘top-
marketing strategy. [6] quality materials at low cost by negotiating directly with
5 Explain one way in which artificial intelligence can materials manufacturers worldwide and placing large-
affect marketing activities. [3] volume orders to achieve the most favourable terms’. It
6 Define the term ‘globalisation’. [2] does not buy in quantities lower than 1 million. Uniqlo
7 Explain one reason for increased globalisation. [3] does not own any factories. It outsources all production
8 Analyse one way in which globalisation provides an to partner factories in China, Vietnam, Bangladesh,
opportunity for businesses. [4] Indonesia and India.
9 Explain two ways a business might enter a foreign Uniqlo is keen to develop its market share in the US.
market. [6] However it recognises that the North American market
10 Explain one factor that might influence a business remains highly competitive with many competitor brands.
on how to enter a foreign market. [3] In the United States, the company says that ‘the climate,
culture and type of products that consumers desire
Data response question differ on the east and west coasts. Even on the west
coast, climatic differences exist. Los Angeles enjoys
Uniqlo warm winters, while San Francisco winters are cold, and
Uniqlo focuses on what it calls ‘classic’ designs. Its vision Seattle’s are even colder. We adjust our product ranges
is to become the world’s number one casual clothing accordingly by offering shorts in Los Angeles even in
brand. Uniqlo believes that everyone can beneﬁt from winter, by increasing our fleece displays in San Francisco,
simple, well-designed clothes. and by focusing on down outerwear in Seattle.’
Whereas Inditex (which owns Zara and Hennes & Mauritz In Europe, Uniqlo has found that customers are very
of Sweden) aims to follow fashion trends, Uniqlo (which conscious of sustainability issues. Therefore, they say,
is the main brand of Fast Retailing) wants to sell designs ‘it is up to us to conduct brand marketing that helps
that are ‘timeless’. consumers understand its corporate aim to create a
Uniqlo’s main growth markets are in Asia with networks of sustainable society’.
shops in countries such as Vietnam, Singapore, Indonesia Source: www.fastretailing.com/eng/group/strategy
and Thailand, but the company has also expanded into
Europe and America. This international expansion has Questions
been important for the growth of the company and its 1 Analyse two ways in which Uniqlo benefits from
success has been reflected in a rising share price. In globalisation. [8]
Japan, its home country, Uniqlo has actually been closing 2 Evaluate the challenges Uniqlo faces when expanding
stores as the population is ageing and shrinking. In 2017, overseas. [12]
Uniqlo’s international revenue overtook its domestic sales
for the first time. By 2019, Uniqlo had 817 stores in Japan Essay questions
and 1370 stores abroad. including 807 in Greater China
1 Evaluate whether the advantages of targeting
(Mainland China, Hong Kong and Taiwan), 188 in South
overseas markets outweigh the disadvantages. [20]
Korea, 231 in Southeast Asia and Oceania, 91 in Europe,
and 62 in North America. 2 Evaluate the extent to which greater globalisation
is good for business. [20]
China is a particularly important market for Uniqlo.
China contributes over 70 per cent of the company’s
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A LEVEL
9.1 Location and scale

A LEVEL 9.1 Location and scale
Chapter overview
★ local, national and international location and relocation decisions
★ the scale of a business
★ offshoring and reshoring
★ globalisation and location
★ internal and external economies and diseconomies of scale.
9.1.1 Location Benefits of the optimal location

The location of a business can affect its costs, its demand, It may not always be possible to get the best (or optimal)
its image and its ability to attract employees to work for location. You may find that a particular site is already taken
it. The location decision is therefore an important decision or is too expensive. However, getting the best or nearly the
that can affect the ability of the business to compete. The best location can have several advantages:
decision of where to locate can also reflect the values of » Lower costs may make the break-even output lower and
the business; for example, if it wants to help employment in reduce the risk of losses if sales are lower than expected.
a particular area. So, location choices should not be taken Lower costs may increase the return on investment and
lightly and will involve decisions at the most senior level. make a project worthwhile.
» Being closer to the customer (and therefore possibly
A location decision can involve high levels of investment getting more customers as a result) may boost sales and
and have a major impact on competitiveness. The right profits. Stores based in the city centre have a higher
location(s) for a business may affect: footfall than those a few streets away.
» the costs of production » Overcoming trade barriers may increase sales (for
» the tax rates paid example, it is difficult to export to some countries
» the availability of employees and the skills available because of barriers to trade). By basing itself inside a
» demand for the products customs union, such as the European Union, a firm may
» the ease of accessing markets be able to sell in a particular country.
» the ease of accessing supplies » It may add to the brand image For example, having
» access to natural resources. your flagship store on Fifth Avenue in New York or
Given the impact on costs and revenues, a location decision Covent Garden in London may be important for the
will involve an assessment of the break-even output and likely status of your business.
financial returns. Location decisions may involve several
different layers of decision-making: first which country, then
which region and, finally, which specific plot of land.
CASE STUDY
Where products come from
If you have ever wondered where products are produced, 4 avocados: Mexico, California, New Zealand, Peru and
here are some examples of the biggest producing South Africa
countries for different products: 5 kiwi fruit: New Zealand
1 pineapple: Costa Rica 6 broccoli: China, India, Spain and Mexico.
2 pistachios: Iran and USA
3 nutmeg: Indonesia, India, the Netherlands and the Question
United Arab Emirates 1 Analyse two factors that influence whether a region
has an advantage in producing a certain product. [8]
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Deciding where to locate measured, such as the expected impact on costs and revenues
(these are quantitative), as well as other factors that are less
The decision on where to locate a business will be based
on a combination of quantitative and qualitative factors.
easy to quantify, such as the attraction of the surroundings
and the quality of life in the area (these are qualitative).
9.1
This means that it is a combination of factors that can be
CASE STUDY
Bangladesh
An increasing quantity of clothes are now being made China’s largest online clothing retailer has already
9.1.1 Location
in Bangladesh and exported to China thanks to the shifted a portion of its shirts and casual trousers orders
low labour costs. This helps businesses based there to Bangladeshi factories. Meanwhile, Western fashion
to continue to generate sales despite a slow-down in brands such as Ocean and H&M are also making clothes
demand from Europe. for Chinese customers in Bangladeshi factories.
In Bangladesh, the average monthly salary for garment However, Bangladesh’s poor infrastructure and political
workers is around $70 to $100, whereas China is instability have been a major concern for the clothing
experiencing increasing demands for higher wages from manufacturers. In addition, there have been violent labour
its employees. In some Chinese factories, for example, protests (during 2019 and 2020) with workers demanding
wages are now around $400–500 a month per worker. better wages and conditions.
Chinese manufacturers say that if they source clothes
from Bangladesh, prices can come down by 10–15 per Questions
cent. Bangladeshi garment exporters say the other 1 Analyse two factors a business might consider when
advantage they enjoy is that more than 90 per cent of deciding whether to produce for itself or subcontract
their products, such as t-shirts, jeans, sweaters and to other businesses. [8]
casual trousers, enjoy duty free access to the Chinese 2 Evaluate the advantages and disadvantages of
market. Bangladesh as a place to produce garments. [20]
CASE STUDY
American Apparel
sweatshirts, underwear and jeans became extremely
popular among the young, cosmopolitan group that
Mr Charney says represents the ‘world-metropolitan
culture’.
From the beginning, Mr Charney put great emphasis on
making his employees happy. Pay is performance-related,
and was far above California’s minimum wage. American
Apparel staff could buy subsidised health insurance for
$8 a week. They were entitled to free English lessons,
subsidised meals and free parking. Their workspace was
properly lit and ventilated.
Anti-sweatshop activists praise Mr Charney as a pioneer
of the fair treatment of garment workers. The benefits he
▲ Figure 9.1 Dov Charney, founder of American Apparel provided were expensive: subsidising health insurance
cost his firm $4–5 million a year; subsidising meals
Dov Charney is the founder and chief executive of American cost another $500 000. Mr Charney said ‘I believe in
Apparel, the largest t-shirt manufacturer in America. capitalism and self-interest. Self-interest can involve
He is widely ‘admired for single-handedly creating one of being generous with others.’ While Gap, another
America’s most successful fashion retailers’, for devising American fashion chain, outsources 83 per cent of its
his company’s provocative approach to advertising, and for production to factories in Asia, all of the 4000 or so
treating employees well. workers involved in American Apparel’s manufacturing
Mr Charney opened his first shop in 2003. By 2015, he process worked in the same factory in downtown Los
had more than 140 stores in 11 countries selling casual Angeles. Mr Charney argued that it gave him control over
clothes for men, women and children. His unbranded, every stage of production, and enabled him to monitor
brightly coloured and moderately priced t-shirts, the fashion market and respond quickly to new trends.
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However, in 2015, American Apparel became bankrupt. The Questions
9.1 company was bought by new investors and relaunched. A
decision was taken to outsource production overseas. The
1 Analyse one reason why American Apparel wanted
to produce in Los Angeles. [4]
company’s slogan is now ‘Ethically Made—Sweatshop Free’, 2 Evaluate the view that American Apparel is wrong
with the majority of its products being made internationally. to outsource. [12]
Most of its apparel is outsourced to factories in Central
America, primarily Honduras and Nicaragua.
Source: www.economist.com/business/2007/01/04/the-hustler
very effective at attracting overseas investment, not

Factors affecting location just because of financial aid, but also because of
Factors affecting a firm’s location include: the general level of local and national government
» Geographic factors; for example, the location of the co-operation in areas such as planning permission.
market. In some cases, such as retailing, it will often Governments often use a combination of push and
be important to be close to the market. A central pull techniques to encourage firms to locate in
high-street location is more likely to attract business particular regions. Incentives such as grants can help
than a site located some distance away from the main to pull firms into an area; refusing permission to build
shopping areas. In other industries, such as telephone in other areas helps to push firms to locate where the
banking, it is not so important to be close to the government wants them to be.
customer. » The nature of the business itself The extent to which a
» The infrastructure of the region The availability of firm has freedom over the location decision depends in
energy sources and transport facilities will affect the part on what it actually does. A self-employed website
ease, speed and cost of production. The importance designer, for example, may be able to work from home.
of such factors will vary between industries; A fast-food restaurant, by comparison, must be located
for example, transport facilities are crucial to a somewhere near its customers, while a mining company
wholesaler but less significant for an online insurance must base its production facilities where the actual
business. minerals are.
» Political factors; for example, political stability. The » Marketing factors; for example, market access. The
political climate can have an impact on the appeal of location of a firm may affect its ability to trade in
a certain area. For example, in 2016, the UK decided particular markets. Firms based outside the European
to leave the European Union. For some businesses, this Union, for example, must pay a tax (a tariff) to sell their
may make the UK less attractive as a location as it is no goods within the EU. Firms located within the EU do not
longer within the Union and, therefore, exports from the have to pay this tax. This may make the EU an attractive
UK may face protectionist measures. Increased rivalry location for businesses that want to export to these
between the USA and China in recent years has led to markets.
trade wars that may deter some producers who want to » Exchange rates If the pound is strong, it is expensive
export to one of these countries from locating in the for UK-based producers to export. On the other hand,
other. it means UK firms have strong purchasing power
» The costs of a particular location relative to other overseas, which may lead some firms to relocate
options; for example, the cost of land itself will overseas when the pound is strong in value in terms
vary from area to area, as will the cost of labour and of other currencies.
services such as electricity. Taxation rates can also vary » Demographic factors; for example, it may depend on the
significantly from country to country. The decision to availability of labour with the right skills in the area.
locate can therefore have a significant impact on a firm’s » Legal factors; for example, businesses may not
profits. be allowed to build in some areas where wildlife is
» The availability of lower-cost locations abroad has protected or, if the process is dangerous (such as
been a major factor for UK firms considering relocating nuclear energy), a firm may not be allowed to set up
to Asia or eastern Europe. Low-wage employees and a near towns.
much lower cost of living often make it very financially » Resources A firm may locate in a particular area
attractive for UK firms to be based overseas. because of the resources it offers. Microsoft located near
» The availability of government grants and Cambridge in the UK because it wanted easy access to
incentives If, for example, a government offers top graduates and research facilities.
low rents or lower taxes to attract firms, this can » Image A perfume company, for example, may benefit
obviously act as an incentive to locate there. In the from being based in Paris or Milan, but it may not gain
last 20 years, for example, development agencies in the same prestige from being located in Scunthorpe in
regions of the UK, such as Wales and Scotland, were the north of England.
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» Quality of life For example, how attractive is the area in
itself? What are the facilities like? What is the standard
Closer to
the market
of living like?
» Ethical issues Some British firms have avoided
9.1
locating in low-wage areas for fear of being criticised
for ‘exploiting’ local staff or taking jobs away from
the UK. In many cases, firms expand in areas where
Overcome
Government
trade they already have established links (and therefore feel
subsidies some responsibility to the community) rather than
barriers
Reasons for take jobs elsewhere. The Body Shop set up one of its
locating
9.1.1 Location
manufacturing operations at Easterhouse in Glasgow,
abroad
Scotland, specifically to bring jobs to a deprived area.
Lower Less
costs regulation
▲ Figure 9.2 Reasons for locating abroad
CASE STUDY
Tesla
In 2019, Elon Musk, the chief executive of Tesla, Car production in Germany has mainly been based outside
announced that the electric-vehicle company would of Berlin. Daimler and Porsche, for example, produce near
set up its first European production plant near Berlin Stuttgart. However, some of the newer mobility ventures,
in Germany. Tesla wanted to create an engineering and such as VW’s ride-hailing business, Moia, are based in Berlin.
design centre there. The site would produce the Model
Tesla is a California-based company. It will now face
3 and Model Y vehicles initially. It is located near the
increasing competition from Volkswagen, a German
city’s proposed new airport. Tesla had already expanded
business, which has made the biggest commitment to
production abroad with a plant near Shanghai.
electrification of any major car maker, as the industry
Musk said that German engineering is outstanding and prepares for increasingly strict EU emissions regulations.
that some of the best cars in the world were built in
Germany. In 2016, Tesla acquired the German company, Questions
Grohmann Engineering, a specialist group for automated 1 Analyse two possible reasons why Tesla chose Berlin
manufacturing. for its first European production facility. [8]
2 Evaluate the importance of location to Tesla. [12]
CASE STUDY
Apple
Around 12–16 million units of Apple classic Airpods Many Apple suppliers, such as the two major iPhone
(approximately 30 per cent of the total global annual builders, Foxconn and Pegatron, and iPad maker Compal
production) are now being mass produced in Vietnam. Electronics, are all expanding production in north
This is part of a shift of production out of China by Apple, Vietnam. Many are helping other tech companies, such as
especially as trade relations between the USA and China Google and Amazon, to diversify production.
worsen. Many other US producers are also seeking to
Part of the motivation to become less reliant on suppliers
diversify their production to locations other than China.
in one country is to reduce risk if anything happens there.
Typically, producers are looking at Vietnam, Thailand,
India and other south-east Asian countries. Questions
Apple is said to have asked suppliers to plan to move 1 Analyse two reasons why Vietnam might be becoming
around 15–30 per cent of its hardware production out of a more attractive location for manufacturing. [8]
China. Inventec, another AirPods assembler, is currently 2 Evaluate the effect of location on the profits of Apple. [20]
building a production plant in Vietnam.
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CASE STUDY
9.1
Disney
In the early 1980s, the heads of Disney were looking for a bedrock were discovered beneath the site, which meant
location in Europe to open a new theme park. The first one construction would be too difficult. Finally, a site in the
outside the USA was Japan, and now Disney was looking rural town of Marne La Vallée was chosen because it was
for another base. close to Paris, and its location was estimated to be no
more than a four-hour drive for 68 million people and no
Disney initially came up with more than 1000 possible
more than a two-hour flight for a further 300 million. The
locations in Europe. By March 1985, the number of

agreement to build was signed in 1986.
possible locations for the park had been reduced to four;
two in France and two in Spain. Both of these countries Questions
saw the potential economic advantages of a Disney theme
1 Analyse two operational issues involved in running
park and were offering financial deals to Disney. A strong
a theme park. [8]
possibility was a site near Toulon in southern France,
2 Evaluate the factors that might influence where
not far from Marseille. The pleasing landscape of that
Disney locates a theme park. [20]
region, as well as its climate, made the location a likely
winner for the European Disney. However, thick layers of
the UK because callers like the accent of people from these

Qualitative factors affecting location areas more than the accents of people from the south-east.
Although firms are likely to examine the potential impact Although this factor may well impact on a firm’s profits, it is
on revenues and costs of selecting a particular site, the difficult to place an absolute value on an accent and so this
decision may also be affected by less measurable factors, also counts as a qualitative factor. Other firms have located
such as whether the location itself appeals to the managers their call centres to India to cut costs despite understanding
or the quality of life in the area. For example, many issues due to the language differences.
Japanese firms have been attracted to the UK because of
the importance of the English language in business. It is
also because English is learnt in Japanese schools – this
Types of location decision
makes it easier for these firms to set up in the UK than in There are, in fact, many types of location decision that
France, for example. managers may have to consider. There is the initial decision
of where to set up the business. In many ways, this is the
The culture of the country and the extent to which you easiest decision in that the managers have no commitments
think you understand its traditions, its ways of working and to existing facilities. On the other hand, it usually occurs
its customers are all very important. According to Rugman at a time when money is tight and the firm will be heavily
(2000), the probability of an American multinational constrained by what it can afford. A key decision at this
opening its first operations outside the USA in Canada time is the desired capacity level – how big must the
or the UK is 70 per cent; these are similar countries and factory be? Or how much office space is needed? Managers
therefore appear to be familiar territories. The probability of may want to be optimistic about the possible growth of the
an American multinational opening its second operation in business; at the same time, they do not want to commit to
Germany or Japan is 2 per cent; these seem less appealing large facilities and then find these are under-utilised.
as the cultures are less familiar.
Once a firm is established, it may have to consider
Once a few firms have set up in a location, this can also act relocating at some point in its development. This occurs
as an incentive for others to locate there, as they may think when a firm wants to move its facilities. This may be
this proves it is safe and that networking (that is, using necessary because the initial reasons for choosing a place
the expertise and experience of others) will be easier. The have now gone (for example, government grants have been
growth of Hollywood as a film centre and Silicon Valley as withdrawn or tax rates have been increased), or perhaps
a centre for computing are in part because the success of because the firm has outgrown its premises.
some firms has drawn in others.
When relocating, a firm may have more experience of the
Other possible qualitative factors which could attract type of facilities it needs than it did when it first chose its
managers to particular areas include the fact that they like location; it may also have greater financial resources than
the region, or they have particular attachments to the place. when it started up. However, relocation brings with it all
Managers might also choose a location because the name of sorts of new problems, including:
the place enhances the product’s image – a fashion house » staff who do not want to move (or the firm does not
in New York sounds more exclusive than a fashion house in want to pay to relocate) – these people may need
Grimsby; an advertising agency in London may have more compensation
appeal than one in Dundee. The reasons a particular location » there could be a period of lost production time during
is chosen are, of course, varied. In the case of call centres, the move
some firms have located in the north-east or north-west of
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» the costs of notifying customers and suppliers, as well competitiveness and profitability of a business. However,
as administrative costs such as changing the firm’s moving production overseas can raise ethical issues. The
literature to include the new addresses. business may be criticised for taking jobs away from the
home country and there may be accusations of exploiting
9.1
A new location may also be part of an expansion process employees abroad. Offshoring may also bring problems
– a firm could be building new production facilities or associated with managing a business based overseas; for
opening up a new outlet, for example. The acquisition example:
of new premises inevitably brings with it issues of » With products having further to travel, there may be a
management structure and control. A new facility will great risk of delays which could delay production.
need to be controlled and the senior managers will need » It may be more difficult to manage operations overseas,
to decide on the best way of structuring the business, for example, due to communication issues if the
9.1.1 Location
such as deciding what new jobs are created, what the businesses operate in different time zones.
reporting relationships will be and how to ensure effective » There may be an exchange rate risk if there is a different
communication. currency in the overseas location. Changes in the
Some location or relocation decisions may be within the exchange rate may reduce the cost advantage of being
local area; some may be within the local region; some may based overseas, and this could introduce an element of
be overseas. financial risk in the operations of the business.
» The further afield you go, the more complex and more » There may be a risk of political change in the overseas
difficult the decision becomes because you have more country, which could remove the advantages of going
possible options. there in the first place. In some cases, overseas
» You may not know the region as well, so it may take governments, for example, have seized assets of foreign-
longer and you may need expert help. owned businesses.
» There may be more factors to consider; for example, These problems with offshoring sometimes cause businesses
when going international, you need to consider different to bring back production from overseas to their home
laws, cultures, political systems and exchange rate country; this is known as ‘reshoring’. This has been a
changes. growing trend in recent years. Reshoring will be considered,
for example, if government policies change (making
Offshoring domestic production more attractive again) or if costs
abroad rise (making production abroad less attractive).
One type of location decision is known as ‘offshoring’. This
occurs when a business moves production out of its own
country to another. For example, a US business might move Globalisation
production to Vietnam. Typically, a business will offshore to Globalisation occurs when countries become more open
make use of the resources elsewhere and, in many cases, to to trade and the movement of money, people, goods and
benefit from lower costs. Differences in wage levels around services across borders. With more globalisation, businesses
the world mean that businesses that are labour-intensive, will look to locate in different places around the world
such as clothes producers, look to locate production in low- and it will be easier for them to do this. Globalisation has
wage economies. Producers may also want to benefit from: increased due to factors such as:
» less strict regulation on issues such as health and » better communications, enabling businesses to operate
safety, environmental protection and employee rights. more easily around the world
Managers may want to take advantage of a country » lower transport costs, making it financially viable to
where it is easier to hire and fire staff and where move products all over the globe
employment costs are lower » fewer trade barriers, making it possible to export and
» government incentives that are used to attract foreign import products more easily.
investment. This might include tax advantages or
Of course, many social, economic and cultural differences
subsidies
still exist between countries and the difficulties of locating
» avoiding protectionist measures if the products are to be
overseas should not be under-estimated, but globalisation
sold within the region
has brought about more openness. This means, for example,
» being closer to the markets where the products are
that it may be easier and more appealing to locate
sold. For example, Jaguar Land Rover Automotive Plc set
production overseas than it was in the past. Countries
up production in China to be closer to this important
often have trading agreements in which standards and
market
regulations are brought together so that, for example,
» a more skilled workforce.
operating anywhere within the European Union is relatively
A business may offshore all of its operations or just straightforward as the same policies apply. Globalisation,
some of them. For example, Dyson, the home appliance therefore, opens up more markets to trade in, to locate in
manufacturer, keeps its research and development and to buy from.
department in the UK, where the business started, but has
Having said this, we certainly are not operating in a world
moved production abroad to Malaysia.
which is one open market, and there will be instances where
Offshoring may be used to benefit from the advantages trade flows are made more difficult. Under President Trump,
that overseas operations can offer. This can increase the for example, the USA pursued a ‘Make America Great Again’
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campaign which introduced many trade barriers with China. made the USA more attractive for some companies that
China responded with its own trade barriers. These policies, had shifted production abroad; a number of US businesses
9.1 combined with lower taxes and fewer business regulations, reshored their production back to the USA as a result.
CASE STUDY
Reshoring
In 2018, foreign direct investment and the number of US ● US government policy, making it more expensive to
companies reshoring was at its highest ever level. The import many products from China
appeal of relocating production back to the USA was due ● a desire to have supplies closer to home, because of
to a combination of factors, such as: growing concerns that global supply chains could be
● a reduction in regulations, making it easier to do disrupted by events around the world.
business in the USA
● tax cuts, making it cheaper to do business and Questions
enabling businesses to keep more of their profits 1 Analyse two factors leading to greater globalisation in
● higher wages and prices in China, meaning it was the world economy. [8]
no longer so attractive on cost grounds 2 Evaluate the impact of greater globalisation on the
location decisions of a business. [20]
» investing in its labour; for example, training the

9.1.2 Scale of operations workforce to increase its productivity or hiring more
employees to provide more ‘people input’
Factors influencing the scale of a » taking over another business or merging with another
business organisation (for more on mergers and takeovers, see
page 222).
When we talk about the scale of production, we are referring
to a firm’s output level; this will depend on its capacity. The As a business grows and changes its scale, it tends to
capacity is the maximum output that an organisation can experience efficiency gains (called economies of scale)
produce at any moment, given its resources. The capacity of up to a certain scale and then inefficiencies (called
a firm at any moment will depend on: diseconomies of scale) after that (see Figure 9.3).
» its capital, such as office space, store space, level of
machinery and equipment
» the existing level of technology
» the number and skills of its employees.
If a business increases its capacity, it is increasing the
scale of its production. Deciding on the correct scale for
Cost per unit
an organisation is a critical decision for its managers. If

the capacity is too low compared with demand, they will
have to turn away orders, possibly losing customers. If the
level is too high compared with demand, they will have idle
resources such as equipment and machinery.
The ‘right’ scale for a business will depend on:
» The expected levels of sales The higher the level of
demand, the greater the desired scale, assuming the 0
demand can be sustained. Economies of scale Diseconomies
» The costs involved in growing Can the business afford Output of scale
to expand? Expansion often involves investing in the
short term and may take months or even years to gain a ▲ Figure 9.3 Economies and diseconomies of scale
return. The organisation may not be able to produce on
the scale it wants because it does not have the money GLOSSARY TERMS
to buy all the resources it needs. Capital is the money invested into a business and is used
» The resources available For example, firms may not be to purchase a range of assets, including machinery and
able to recruit sufficient numbers of staff if the skills inventories.
they want are in short supply. Economies of scale occur when the unit costs fall as the
A firm can increase its scale by: scale of production increases.
» investing in new capital, such as IT systems, equipment Diseconomies of scale occur when unit costs increase as
and technology the scale of production increases.
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Causes of internal economies of scale and so is likely to offer better terms and conditions. The
bargaining power of firms may mean lower unit costs and
Internal economies of scale occur when the cost of
producing a unit (the unit cost) falls as the firm increases
also better cash flow. This approach is what enables a
business such as Walmart to compete so effectively.
9.1
its scale of production (its capacity level). There are several » Marketing economies As the business expands, the cost
types of economy of scale, as Figure 9.4 shows. of a media campaign can be divided over more units of
sales, making bigger campaigns more feasible.
» Managerial economies As businesses grow, they can
Technical afford to employ managers in specialist areas, such as
human resources and a legal department. This is because
the costs can be spread over more output. The use of
9.1.2 Scale of operations

specialists can lead to more effective and more efficient
decision-making.
Marketing Financial
» Financial economies As a business gets bigger and has
more assets, it may be able to borrow money at lower
Types of
internal interest rates. Banks may be more confident that they
economy can take assets if need be and so there is less risk of
of scale not recovering the money; this means they are likely to
charge less.
Businesses that grow also tend to benefit from ‘learning
by doing’. More experience of what to do, how to do it,
Purchasing Managerial what not to do and who to use to do it can make the whole
process more efficient. This efficiency gain should not
be underestimated. If you are trying to start a business,
for example, there is a tremendous amount you simply
▲ Figure 9.4 Internal economies of scale do not know how to do. However, a more experienced
» Technical economies of scale As a firm expands, it businessperson will have made the errors in the past and
may be able to adopt different production techniques will now be getting it right and operating more efficiently.
to reduce the unit cost of production. For example, a Economies of scale can be important because the costs of
business may be able to introduce a production line. This producing a unit can have a significant impact on a firm’s
is expensive in itself, but if it can be used to produce competitiveness. If an organisation can reduce its unit
on a large scale, the costs can be spread over many costs, it can either keep its price the same and benefit from
units, reducing the unit cost. At Mars’ factory in Slough, higher profit margins, or it can pass the cost saving on to the
3 million Mars bars are produced each day. customer by cutting the price. If it chooses the first option,
Another technical economy of scale is known as this may mean higher rewards for the owners or more funds
specialisation. As firms grow bigger, they are able to for investment. If, on the other hand, it cuts the price, it may
employ people to specialise in different areas of the be able to offer better value for money than its competitors.
organisation. Instead of having managers trying to do The ability to lower price and still make a profit may be very
several jobs at once or having to pay specialist companies important in a market with falling demand; this means such
to do the work, they can employ their own staff to firms may be in a better position to survive a recession.
concentrate on particular areas of the business. For
example, they might employ their own accountants or Firms with economies of scale may be able to price
market researchers. By using specialists rather than buying competitors out of the market if they wish. This can act as
in these services from outside firms, the business can make a threat to potential entrants who know they would be less
better decisions and save money. For example, a specialist efficient than the established business at first, because
finance director may be able to find ways of reducing they would be operating on a smaller scale and therefore
the tax burden or organising cheaper sources of finance. may not want to take the risk of a price war. This means
Specialisation also occurs when, as a business grows, it that economies of scale can act as a barrier to entry.
splits the process into a series of separate routine tasks. The extent to which economies of scale exist will vary
Each individual then completes their task and, because between industries. In industries such as energy or
they are focusing on a relatively small task and repeating telecommunications, very heavy investment is required to
it, they become faster at it and more efficient. start operations and these costs can be spread over large
» Purchasing economies As firms get bigger, they need to outputs, meaning economies of scale are important. It is
buy more resources. As a result, they should be able to difficult for small businesses to survive in these industries
negotiate better deals with suppliers and reduce the price because they are very inefficient relative to the bigger
of their components and raw materials. Large firms are firms. In other industries such as hairdressing, the costs are
also more likely to get discounts when buying advertising mainly labour, and growth requires more people. This means
space or dealing with distributors. If a firm can become a economies of scale do not exist to the same extent and
big customer, the supplier will be eager to keep that deal many small businesses exist in this industry as a result.
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CASE STUDY
9.1
Vertical farms in Japan
In Japan there are now ‘farm factories’ producing high The vertical farms can offer a stable supply of crops
volumes of lettuces. Within the factory, robots move lettuce (because they are growing indoors) and because conditions
seedlings onto massive racks where they are grown under are so hygienic that the plants have fewer blemishes. The
LED lights. At full capacity, some of these factories produce producers can also automate the slicing of lettuces, enabling
30 000 lettuces a day. These factories are known as vertical them to supply fast-food outlets with salad-ready lettuce.
farms. Plants are grown indoors in stacked layers, often
Japanese vertical farmers are now looking to expand

without any soil. These vertical farms can be built anywhere
overseas where this process could appeal – particularly in
and produce whatever the weather. The scale of production
countries where water supplies are an issue, such as the
can reduce unit costs, making the business profitable.
United Arab Emirates. The main environmental concern
To generate the returns investors require, a viable about these farms is the source of energy for the LED
vertical farm needs big facilities to gain economies of lights but, wherever possible, this is solar power.
scale, low levels of waste, and high levels of automation
of processes such as seeding and harvesting, that have Question
traditionally been labour-intensive. 1 Evaluate the importance of scale to vertical
farmers. [12]
CASE STUDY
WarnerMedia
WarnerMedia’s aim is to become the world’s leading ● use technology and develop new business models
video-content company. To do this, it says it wants to be to increase the value of its content to consumers and
the preferred choice for the best talent and the best ideas distributors and to drive the growth of the business
in the industry; this will enable it to provide engaging ● increase its presence in the most attractive
and valuable content. WarnerMedia shares this content international markets to take advantage of the growing
with consumers around the world through a range of demand for its content worldwide
technologies. ● ensure it is efficient, to help provide attractive returns
to its shareholders.
It says that in all its decisions it will be financially
disciplined so that it can deliver high financial returns to Questions
its shareholders.
1 Analyse two possible factors which influence the
WarnerMedia’s strategy has four main elements. The strategy adopted by WarnerMedia. [8]
company sets out to: 2 Evaluate the benefits to businesses such as
● use its large scale and its brands to invest in the best WarnerMedia of operating on a large scale. [20]
storytelling in the industry
Causes of internal diseconomies

of scale Communication
Diseconomies of scale occur when a firm expands its
capacity and the cost per unit increases. Diseconomies of
scale are often linked to the problems of managing more
businesses. As organisations grow, they have more products,
operate in more regions and have more staff, and simply
keeping everyone focused and working together can be Types
difficult. of internal
diseconomies
Diseconomies of scale can therefore occur for several of scale
reasons:
» Communication problems With more people involved Motivation
Co-ordination
in the business, it can be difficult to ensure that and control
messages get to the right people at the right time.
Although developments in information technology such
as emails and intranets have helped, it can still be ▲ Figure 9.5 Internal diseconomies of scale
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quite difficult to make sure everyone in a large business » having a mission statement to unify the business and
knows exactly what they are supposed to know, when outline the central purpose
they are supposed to know it. When businesses are in
different parts of the world, there can be differences
» managing by objectives – an approach in which all
employees are set targets tying them to the overall
9.1
in time zones; however, even if people are in the corporate objective
same buildings, where there are hundreds of them it » using appraisals to review individuals’ progress and
can be difficult meeting up. With increased numbers, ensure that they feel involved and as if they are acting
there is great reliance on email rather than face-to- in line with the overall aims of the business
face discussions and this reduces the quality of the » communicating regularly in a variety of ways to ensure
communications. There may be more messages in your people feel informed. This could be via newsletters,
inbox, but this does not mean that communication is

corporate videos, emails or staff meetings.
actually effective.
» Co-ordination and control problems Just as Getting the ‘right’ size of firm is a crucial issue for managers.
communicating properly gets more difficult in a large Firms want to be big enough to have market power and
organisation, so does controlling all the different benefit from economies of scale but not so big that they
activities and making sure everyone is working towards suffer from diseconomies of scale. In industries such as
the same overall goals. As the firm expands and sets brewing and pharmaceuticals, many firms have joined
up new parts of the business, it is easy for different together to benefit from economies of scale. At the same
people to be working in different ways and setting time, other firms have split up into smaller units because of
different objectives. It becomes increasingly difficult the problems of large size. There is, it seems, no ideal size.
to monitor what is going on and to make sure everyone It depends on the particular nature of the business, its own
is working together. Culture differences are likely to culture and communication, and the nature of the industry.
emerge as differences in the values of different parts Unit costs
($)
of the business become apparent. The UK division
will do things differently from the French division,
the operations team see themselves as different from
the marketing team. These differences in approach,
management styles and values can lead to difficulties
in terms of how the different parts of the business work
together, causing inefficiency. These differences can get
worse and lead to resentment due to the communication
problems outlined above.
» Motivation As a firm gets bigger, it can become much
harder to make sure everyone feels like a part of the Output
organisation (again highlighting the importance of Internal economies of scale: Internal diseconomies of scale:
communication). Senior managers are less likely to as output increases, unit as output increases, unit
be able to stay in day-to-day contact with all the costs fall costs rise
employees, and so some people may feel less involved. ▲ Figure 9.6 Internal economies and diseconomies of scale
In a small business, there is often a good team
environment; everyone tends to see everyone else every
day and it is easier to feel they are working towards
STUDY TIP
the same goal. Any problems can be sorted out quickly, Remember to look at the case studies to get an idea of how
face-to-face. As the organisation grows, its employees big the owners or managers want the business to be. Also:
can feel isolated and have less sense of belonging. ● check if the demand is actually there to justify
As a result, they can become demotivated. Think of expansion – there is no point producing more if you
cannot sell
Maslow’s hierarchy of needs (see Section 2.2) and you
● check if it is possible to staff the expansion
can appreciate that social needs and ego needs may be
● check to see if the business has mechanisms in place
neglected due to less personal contact.
(such as budgeting and appraisals) to try to ensure
Diseconomies of scale often occur when mergers that diseconomies of scale do not occur if it grows.
and takeovers take place. Managers often anticipate
economies of scale from sharing resources, synergy and
the power of a large scale. In reality, the difficulties Causes of external economies and
of agreeing on standard policies, cultural clashes,
different priorities and strategies can lead to significant diseconomies of scale
diseconomies which lead to cost disadvantages overall. Internal economies and diseconomies of scale occur when
In practice, most takeovers and mergers lead to worse a business expands the size of its operations. External
financial performance for the combined companies than economies and diseconomies occur when at each and every
they achieved individually. To avoid diseconomies of scale, level of output the unit cost falls (for external economies)
managers use practices such as: or rises (for external diseconomies). This happens due to
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factors outside of the business. External economies of scale Unit costs
($)
may occur because:
9.1 » suppliers have expanded and benefited from internal
economies of scale; as a result their unit costs fall
and this might be passed on to the business they are
supplying
» investment in infrastructure – for example, by the
government – reduces costs such as communication or
transports costs
» the business locates in a particular area which
specialises in this industry. Examples include Hollywood,
which specialises in film production and Silicon valley, Output

Output 1 Output 2
which specialises in technology businesses. It is likely
External economies of scale: at each output, unit costs fall
that a network of suppliers will develop in these areas due to factors external to the business
and many other similar businesses will be drawn to it
▲ Figure 9.7 External economies of scale
because they may be able share resources and facilities.
It is also likely to attract other businesses linked to the Unit costs
industry; for example, businesses linked to research and ($)
development or staff training. By locating in this area, a

business will have access to specialist suppliers and also
employees at a lower cost than if it had to buy them in
from elsewhere. The benefits that occur when businesses
within an industry cluster together are called economies
of agglomeration.
External diseconomies of scale may occur if suppliers have
become too big and experienced internal diseconomies,
which increases their unit costs. They might then increase
prices and so businesses buying from them experience Output 1 Output 2
Output
external diseconomies of scale. External diseconomies of scale: at each output, unit costs rise
due to factors external to the business
▲ Figure 9.8 External diseconomies of scale
TEST YOUR LEARNING

1 Explain one possible ethical issue that might affect Pantaloon Retail India Ltd
a business’ location decision. [3] ‘With more than 1000 stores and 16 million square feet
2 Explain two factors that influence the location of a (1.5 million square metres) of operational space,
business. [6] Pantaloon Retail India Ltd is now close to a point where it
3 Explain one reason why a business might offshore reaps the benefits of economies of scale,’ its founder and
its operations. [3] managing director Kishore Biyani says.
4 Explain one reason why a business might reshore
The company’s aim is to expand its operational retail
its operations. [3]
space to 25–30 million square feet (2.3–2.8 million square
5 Explain one reason why a business might relocate. [3] metres) in the next four years. Its annual revenues are
6 Define the term ‘unit costs’. [2] expected to grow by 30–35 per cent between now and then.
7 a Define the term ‘internal economy of scale’. [2]
Biyani recently said the company was very well-placed in
b Explain one internal economy of scale. [3]
terms of its cost structures. ‘We are eliminating all the
8 Define the term ‘internal diseconomy of scale’. [2] excess costs that are there in the system and becoming
9 Explain one reason why internal economies of scale very, very competitive.’
may help a business succeed. [3]
10 Explain one reason why diseconomies of scale affect The global retailing business is one of low profit margins,
unit costs. [3] with profitability dependent on the efficiency of a company
and its supply chain management, and its operational
scale.
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Retailing in India Questions
India’s large-scale retailing sector is still in its early
growth stage, with the majority of the population relying
1 Define the terms:
a ‘revenue’ [2]
9.1
on millions of small, independent shops for their daily b ‘supply chain’. [2]
groceries.
2 Analyse two possible consequences of limiting
Government restrictions on direct investment by other the extent to which foreign retailers can compete
countries have thus far protected the local industry but in India. [8]
also meant there has been a lack of investment in areas 3 Evaluate the importance of economies of scale in
such as warehousing and cold-storage facilities. helping a retail business to compete. [20]

In the past, foreign retailers have been allowed to own up Essay question
to 51 per cent of businesses which sell products from a
single brand, such as Nike sportswear. Those businesses 1 Evaluate the possible advantages and disadvantages
who sell multiple brands, such as Walmart Stores, have to a business of expanding the scale of its
been prevented from selling directly to consumers in production. [20]
India. However, they are permitted to run cash-and-
carry businesses which supply wholesalers and smaller
businesses and shops.
Source: www.marketwatch.com/story/indias-pantaloon-retail-
taps-economies-of-scale-2011-07-24
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A LEVEL
9.2 Quality management

A LEVEL 9.2 Quality management
Chapter overview
★ the meaning of quality in terms of meeting customer expectations
★ the difference between quality control and quality assurance
★ the impact of quality control and quality assurance
★ the impact of total quality management (TQM) on a business
★ the meaning of benchmarking
★ the importance of benchmarking in quality management.
9.2.1 Quality control and quality sure that the targets are being achieved. By improving the
quality of their products, managers should improve customer
assurance satisfaction which should lead to repeat business.
An important aspect of operations management is
making sure that the goods and services produced are of GLOSSARY TERM
a suitable quality. A quality product is one that meets A quality product is one that meets customer
the specifications that the firm has set out and, in turn, expectations.
meets the customers’ needs and expectations. As famous
management writer Peter Drucker says, ‘Quality in a product
or service is not what the supplier puts in. It is what the Quality targets
customer gets out and is willing to pay for. A product is not The nature of the quality targets that are set will depend on
quality because it is hard to make and costs a lot of money, the type of business.
as manufacturers typically believe. This is incompetence.
Customers pay only for what is of use to them and gives them A hotel might set quality targets involving:
value. Nothing else constitutes quality.’ What is and what is » customer satisfaction levels
not quality therefore depends on the customers’ views. » accurate billing
» speed of response, such as in reception and the
Quality has been defined as ‘fitness for use’ by Juran (1981) restaurant.
and ‘conformance to requirement’ by Crosby (1979). A pad
of paper priced at $1 or a light bulb priced at 75 cents can A manufacturing business might consider the following
both be quality products, provided they do what consumers aspects of quality:
expect them to do. By comparison, a million-dollar house » the proportion of products with defects
or a $400 suit may be poor quality if they do not meet » the amount of waste produced in the process
consumers’ expectations. The fact that these products » the proportion of returned goods.
are expensive does not mean they are necessarily of good A hospital might consider these aspects of quality:
quality. To improve the effectiveness of the business, » the time taken to see patients
managers must make sure that what they are producing » the average length of time spent by patients in hospital
consistently meets customers’ requirements. This in turn » the recovery rates for different types of operation
means that to produce good products, a firm must identify » patient satisfaction rates.
exactly what customers are looking for. The firm must then
specify exactly what the product has to do and make sure These quality targets will not be fixed forever. Once a target
that these specifications are achieved every time. is achieved, managers should look to make it even more
challenging or find another area that needs focusing on, in
To achieve quality, managers must therefore set targets order to improve the business further.
based on customer needs and expectations and then make
Business Set quality target Identify needs Customer
▲ Figure 9.9 Identify needs – set quality target
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Why does quality matter? The effects of poor quality are therefore expensive. Philip
Crosby, a management writer in this area, believes that
Poor quality leads to mistakes that have to be put right or
fixed. Goods may have to be thrown away. Items may be
between 20 and 35 per cent of firms’ revenues can be spent
putting right all the consequences of poor quality. He argues
9.2
returned and have to be replaced. In a worst-case situation, that investing to prevent mistakes occurring is far cheaper
you may even be sued for failing to deliver the products than putting things right later on. Improving quality can
promised. You may also lose customer goodwill and loyalty. improve customer satisfaction and save money.
CASE STUDY
9.2.1 Quality control and quality assurance

L’Oréal
At L’Oréal, the cosmetics business, quality is regarded as is the material described and that it will perform as
essential for success. The company says that its mission is necessary. To allow these further checks, each production
to guarantee that the raw materials it uses and the products plant has a quality department with its own laboratory
it manufactures ‘are of identical quality to what was agreed for performing the necessary tests. No raw materials are
when they were approved, anywhere and at any time’. used until all these checks have been undertaken.
L’Oréal says that ‘the performance, safety and regulatory
Source: https://beautytmr.com/the-incredible-way-we-guarantee-
compliance of our formulas are based on the quality of our the-quality-of-our-products-b7c28270ac22
raw materials’, so it does not allow any variation in quality.
First, the raw materials are checked as soon as they Questions
enter the supply chain using industrial specifications. 1 Explain one way in which L’Oréal ensures the quality
The supplier details the criteria, standards and checking of its supplies. [3]
methods that must be adhered to. Once the raw materials 2 Analyse two reasons why quality is important to
arrive at the production plant, the labels are checked L’Oréal. [8]
on each package, and the raw materials are identified to 3 Evaluate the importance of quality supplies to
ensure that the item received matches the item ordered. L’Oréal. [12]
Further checks may ensure that what is in the delivery
STUDY TIP
Remember that we are referring to quality from the intended to; it does not necessarily mean it is the most
perspective of the operations team. This, therefore, focuses expensive item in the store. Expensive items can be poor
on whether the item is fit for purpose and does what it is quality if they are produced badly.
CASE STUDY
Jaguar Land Rover Automotive
In 2019, the automobile manufacturer, Jaguar Land Rover As example of the quality problems, in 2017 JLR had
(JLR), experienced disappointing financial results in China. to make 13 recalls in China for component defects
Partly this was due to the very competitive market conditions. including engines, instrument panels, airbags and
However, it was also due to poor quality production which batteries. The recalls affected 106 000 vehicles; this was
led to a loss of brand reputation and sales. JLR had several more than 70 per cent of JLR’s sales in China that year.
problems in China with the reliability and dependability of its
In recent years, local dealers have had to offer major
production. At the same time, the overall car market in China
discounts to sell their inventory. The quality problems
was getting smaller – in 2019 the number of new cars sold
have damaged the brand image of Jaguar and Land Rover
fell for the first time in 28 years.
in China, making their products even less attractive to
JLR’s quality problems go back to when the UK luxury local buyers. However, JLR has other challenges ahead.
automaker was still owned by Ford. The problems For example, it needs to produce more electric vehicles to
continued after Tata Motors acquired JLR in 2008. In meet local regulatory requirements. This requires major
2014, JLR started production at a joint venture with Chery investment and changes in production.
Automobile in the east China city of Changshu. Five models
Source: https://europe.autonews.com/automakers/jaguar-land-
that were assembled locally – the Land Rover Evoque and rover-hurt-quality-control-issues-china
Discovery, and the Jaguar XFL, XEL and E-Pace – were all
launched between 2015 and 2017. Producing within China Questions
meant customers could circumvent the 25 per cent tariff 1 Analyse two possible costs of poor quality for JLR. [8]
that Chinese customs placed on imported vehicles. Not 2 Evaluate the likely impact of poor quality on JLR’s
only did JLR produce locally, it also changed its vehicle financial performance. [20]
interiors and exteriors to meet local tastes.
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Quality control employees are told, ‘don’t accept errors, don’t build errors
and don’t pass them on’. This is a very different view from
9.2 The traditional approach to improving the quality of a firm’s
products is to put resources into inspecting the finished
the past, when quality was seen as something undertaken
only by the quality control department.
products to find any faults that exist and remove them.
The logic behind this approach is that, if all the goods Quality assurance requires training so that individuals can
and services with defects can be found, the customer will carry out their tasks effectively. It also involves choosing
only receive perfect products. As a result, quality will be the right suppliers so that they deliver products without
improved. This is known as a quality control system and it any defects – you will not check their products because
relies on the inspection of products. you assume that they are correct. Thus, the responsibility
for any problems caused later will be with the suppliers,
In recent years, many managers have questioned whether which therefore puts pressure on them to get it right
quality control is the best approach. One problem is that (see Figure 9.10).
quality control assumes that defects are inevitable. The
task is to make sure that they are discovered before the Choosing the right suppliers Self-checking by employees
customer receives the product. In effect, this is saying to
some elements of the production team that it is acceptable
for them to make mistakes because the quality control Quality assurance
department will find them later. This may mean that
employees do not take sufficient care in their work.
Employees reject faulty work Training
GLOSSARY TERMS ▲ Figure 9.10 Quality assurance

A quality control process relies on checking products for
faults at the end of the production process. Total quality management (TQM)
A quality assurance process aims to prevent mistakes Total quality management (TQM) is an approach to
throughout the production process, rather than using
quality involving all the employees in the organisation.
resources (such as time and money) to correct them at
This quality assurance system appreciates that everyone
the end.
within the firm contributes to the overall quality of the
Total quality management (TQM) is an approach to quality product or service.
involving all the employees in the organisation, whereby
employees consider not only the expectations of their TQM recognises that all employees are of equal importance,
external customers but also those of their colleagues (or including those on the factory floor, the office staff, the
‘internal customers’), to ensure that all aspects of the cleaners, the maintenance staff and the delivery drivers.
work they produce are high quality. The way in which customers are dealt with when they
make enquiries, the accuracy of invoices sent out and the
reliability of the vans all have an impact on how customers
Quality assurance view the firm. It is not just the people who directly make
or provide the product who matter.
The quality assurance approach puts more emphasis
on preventing mistakes rather than finding them. If the It is very important that all employees think about the
process can be designed in a way that ensures defects do work they do and whether it is of a suitable quality. This
not happen (and in which employees produce correct work means that they need to think of who their customers
every time), inspection at the end of the production process are. These customers may be the people who actually buy
is less important. This approach to quality focuses more the product, but they also include anyone for whom work
on prevention, not just inspection. It stresses the need for is produced.
employees to get it right first time.
Customers are not just external (the people from outside
An important part of this approach is that employees check the business who buy the product); they are also internal.
their own work rather than relying on someone else to Employees need to think of the requirements of all the
check it for them at the end of the process. This is known people they produce work for and ensure they are providing
as self-checking. Under this approach, employees also have exactly what is required. For example, the warehouse staff
the right to reject any work of an unacceptable standard, have to load materials onto the van for delivery, so the
whoever produced it. Previously, employees often accepted delivery drivers are the internal customers of the warehouse
poor-quality items as they did not feel responsible for the staff. Under the TQM approach, everyone has to think about
finished product. Faulty products were simply passed along their customers’ needs: what they want, what standard they
the production line until the quality control department want it to and when they need it by.
found the mistakes at the end. Under a quality assurance
The TQM approach considers that employees should always
system, employees are held responsible for their own work;
aim to improve the quality of what they do. It is tempting
if they find faulty work from other employees, they need to
to assume that what you are doing is ‘good enough’ and,
communicate with colleagues to sort it out or report it.
if profits are reasonable, it is easy to become complacent.
Ensuring that they produce quality work is now seen as Such complacency is dangerous because markets and
a part of everyone’s job. At General Motors, for example, conditions can change incredibly rapidly. To succeed, firms
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must be continually trying to improve what they do to later. Unfortunately, in the rush to put products on the
ensure that they actively delight customers. Under TQM, market, firms are willing to accept products and processes
quality is seen as a dynamic process – it is a journey,
not a destination. If managers are able to improve the
that are only adequate, rather than excellent. This is all part
of a very common approach that is often more expensive in
9.2
quality of the firm’s operations, this should improve its the long term. According to the UK Department of Trade and
competitiveness. Industry, ‘Many senior managers [in the UK] still consider
the design function a necessary evil, a costly and non-
productive unit which often delays the introduction of a
Why might employees resist a TQM approach? new product.’
Some employees may resist the introduction of a TQM
approach. This could be because they see quality as the
9.2.1 Quality control and quality assurance

job of a separate quality control department and do not
STUDY TIP
see why they should check their own work. They may think You need to be aware of the importance of quality and the
it will lead to the redundancies of colleagues in quality difference between quality control and quality assurance.
control if they actually manage to prevent all mistakes You should be able to discuss the benefits of better
quality, the ways this can be achieved and difficulties
and so do not want to do this. They may also be reluctant
achieving it.
to take on additional tasks. If they adopt TQM, they must
first be willing to reject any work that is passed to them To increase its effectiveness, a business may try to
that is not satisfactory; that may involve telling colleagues improve its quality and prevent mistakes occurring. You
and friends to do something again, which can be difficult need to think of the consequences of improving quality
to do on a personal level. Also, they must check their own for the other functions of the business, such as human
resources, marketing and finance.
work before passing it on and may not see why they should
do this. Some employees may also resist a TQM approach
because they:
» don’t see why it is necessary Improving quality
» don’t want to have to undertake additional training Quality is an important element of a firm’s success. Not
» prefer to carry on doing things in the same old way. surprisingly then, managers should always be looking to
Given that TQM involves a change in responsibilities and improve the quality of their goods and services. If managers
duties, managers must make sure they: want the business to improve its quality, they must make it
» explain why it is necessary clear that this is a priority and develop appropriate systems
» provide the necessary training and support so that to make sure that employees are always trying to improve
employees feel capable and reassured quality. Bringing about better quality involves:
» provide appropriate rewards so that employees » defining clearly the needs of your internal and external
feel they are treated fairly for taking on extra customers in order to set appropriate quality targets
responsibilities. » introducing a TQM approach and ensuring that aiming for
zero defects and getting it right first time is seen as an
important element of everyone’s job
Designing the product » ensuring that the resources are available to enable
The process of improving quality begins with a good quality targets to be achieved (for example, sufficient
understanding of what internal and external customers training so staff can check their own work) – this may
want. This involves effective market research and use of cost money at first but will save money in the long term
information. The better the understanding of customers’ » working closely with suppliers to ensure they can meet
needs (including your own staff, your operations your needs quickly and reliably
department), the more likely it is that a firm will produce » ensuring that there is an ongoing programme of target-
something that meets their needs precisely. setting and measuring – once targets are consistently
achieved, more demanding targets can then be set
The aim is to design a product to meet customers’ » ensuring that your reward systems recognise those who
requirements and a means of producing the product that achieve better quality.
enables the business to make an appropriate amount of
profit. The design stage is absolutely critical to the success
of a product and to achieving good quality. Effective Philip Crosby’s four absolutes
planning before production begins means that the firm Philip Crosby’s name is best known for his writings on the
will produce something that customers want and that it is concepts of ‘Do It Right First Time’. He considers traditional
produced in an efficient way. The way the process is laid quality control, the idea of acceptable quality limits (that
out, the equipment used, the level of technology involved is, treating a certain level of defects as acceptable), to
and the way in which it is organised all have a major impact represent failure rather than an assurance of success. In
on the final quality of the goods or services. his view, firms must aim for ‘zero defects’ rather than ‘an
acceptable level of defects’. Of course, having a zero defects
Most companies would benefit from investing more at approach will not prevent people from making mistakes,
the design stage. If the initial design of the product and but it will encourage everyone to improve continuously.
process is wrong, it is very expensive to put things right
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The ultimate goal is to train all the staff and give them the
tools for quality improvement and to help them to prevent GLOSSARY TERM
9.2 mistakes occurring. Benchmarking occurs when one business decides to
measure its performance against the leaders in the field,
Crosby’s four absolutes of quality management are:
learning and, therefore, improving the quality of what it does.
1 Quality is defined as conformance to requirements, not
as ‘goodness’ or ‘elegance’ – that is, quality is defined by
the customers, not by you!
2 The system for causing quality is prevention, not The benchmarking process
appraisal – that is, don’t fix it later, get it right first 1 The firm must plan what it wants to benchmark, which
time. firms it wants to benchmark with, how it is going to
3 The performance standard must be zero defects, not collect the data, which resources to allocate to the
‘that’s close enough’ – that is, don’t accept mistakes. project and who is responsible for the project.
4 The measurement of quality is the price of non- 2 The firm must collect data from the other firm (or firms).
conformance – that is, quality saves you money because This may be through visits to their factories or offices.
it saves you all the costs of fixing the mistakes and 3 The firm must analyse its findings to identify how it
having to rework items. could improve its own process.
4 The firm must adapt its findings so it can implement
the new methods in its own firm, given its own
STUDY TIP
circumstances.
Students often assume that improving quality increases 5 The firm must measure the outcomes to ensure that
costs. Crosby suggests that it can actually save money. benchmarking has led to the desired improvement.
9.2.2 Benchmarking Plan what

to
As part of the drive to improve quality and to meet customer benchmark
requirements more effectively, some business will use a
process called benchmarking. This aims to develop better Collect
processes and systems and this should lead to better quality. Measure data from
outcomes other
Benchmarking occurs when one business measures its business
performance against other organisations. Firms benchmark
against other organisations that are strong in particular
areas. The aim of benchmarking is to learn from the
best firms in the world and discover ways of improving
operations. If you want to know how to manage large Adapt and Analyse
numbers of visitors, talk to Disney; if you want to know implement findings
how to come up with great design, ask Apple; if you want to
move things around reliably, talk to UPS.
▲ Figure 9.11 Benchmarking
Looking for ways to improve corporate performance
internally assumes that a business’ staff knows the best
way of doing something, or they know how to improve it. The benefits of benchmarking
Analysing the actions of other organisations, especially By undertaking benchmarking a firm should be able to:
experts in the relevant business area, means a business is » develop a better understanding of customers and
more likely to find the best solution. This is particularly competitors
true if firms benchmark against the best in the world. » have fewer complaints and more satisfied customers
Benchmarking may be against other firms in the same » reduce waste and improve quality.
industry or even against organisations in a completely
different sector. It highlights the importance of being a Benchmarking can be difficult because some firms will
learning organisation and not being complacent. Firms may naturally be unwilling to share their information. They
use benchmarking to help them improve in areas such as: may want to keep their methods and processes secret and
» the reliability of their products might be reluctant to provide rival businesses with ideas
» their ability to send out the correct bills (also called on how to improve. One way of avoiding this problem is to
invoices) benchmark against firms in different industries.
» their ability to deliver items on time Firms must also be careful about trying to copy another
» the time it takes to produce a product. organisation’s methods exactly. Every organisation has
Organisations undertaking benchmarking are those most its own way of doing things, its own skills and its own
eager to learn and improve and those that are unafraid to circumstances. They may have to adapt the other firm’s
seek outside help. They are focused on quality and meeting methods for their own use.
customer expectations.
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TEST YOUR LEARNING
Quality has been a problem because Tesla has been
9.2
Short answer questions developing the technology at the same time as trying
1 a Define the term ‘quality’. [2] to meet ever growing levels of demand. The company
b Explain one cost of improving quality. [3] has aimed to continue being innovative and develop new
2 a Define the term ‘quality control’. [2] technologies, but it has also had to scale up production
b Explain one method of quality control. [3] very rapidly. Perhaps not surprisingly, this has led to
3 a Define the term ‘quality assurance’. [2] production problems. Car reviews have highlighted
problems such as gaps between the car door panels, the
9.2.2 Benchmarking
b Explain one benefit of quality assurance. [3]
computer screens going blank and doors not opening
4 a Define the term ‘total quality management’. [2] being common with its earlier models. However, the
b Explain one reason why staff may resist total Model Y was rated fourth in its class in consumer reports
quality management. [3] in 2020. The Lexus IS was first with a reliability rating
5 Explain one link between training and quality. [3] of 84 per cent, Tesla took fourth at 59 per cent while the
6 Explain one reason why spending more to improve BMW 3-Series and the Alfa Romeo Giulia had only 20 per
quality might save costs in the long term. [3] cent and 13 per cent respectively.
7 Define the term ‘benchmarking’. [2] Interestingly, despite its quality issues, Tesla remained the
8 Explain one benefit to a business of benchmarking. [3] fourth best-selling luxury maker in the USA with 9.8 per cent
9 Explain two reasons why better quality is becoming market share. The Model Y was expected to be its top seller.
more important to businesses. [6]
10 Explain one reason why a product could be expensive Questions
to buy but be of poor quality. [3] 1 Explain one reason why Tesla might have had quality
issues. [3]
Data response question 2 Analyse two ways in which poor quality might reduce
Tesla Tesla’s profits. [8]
Tesla has been a highly innovative car producer from 3 Evaluate the importance of quality to Tesla. [20]
the very beginning. Its founder, Elon Musk, had a vision
Essay questions
of an electric car that would transform the car industry.
However, from its early days, the company had quality 1 Evaluate the extent to which you think the
problems. This is perhaps not surprising considering the success of total quality management depends on
fact that its technology was leading the world. employees. [20]
2 Evaluate the extent to which improving quality is
While the early Tesla models were criticised for their
expensive. [20]
quality, experts say that its 2020 Model Y marked a shift in
the quality of the build of the car. The 2018 Model 3 Tesla
was said by many to be poor quality even though it looked
good. The Model Y had a much better finish.
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A LEVEL
9.3 Operations strategy

A LEVEL 9.3 Operations strategy
Chapter overview
★ operational decisions and links to other business functions
★ the changing role of information technology (IT) and artificial intelligence (AI) in operations management
★ flexibility of operations
★ innovation in processes and products
★ enterprise resource planning (ERP)
★ lean production including Kaizen, quality circles, simultaneous engineering, cell production, just in time (JIT)
★ operations planning.
9.3.1 Operations decisions

will have identified a market opportunity and then must
liaise with operations to see what is possible:
Operations management controls the transformation process » Can the business produce enough to meet the expected
of the business. It lies at the very heart of a business sales? Or will it need to increase its capacity?
because it produces the goods or services it offers to its » Can the business provide the right level of quality? What
customers. However, operations decisions cannot be made benefits can it provide effectively and efficiently? What
in isolation; they must be integrated with the decisions level of service can be provided?
of the other functions. This is a two-way relationship; for » Can the business sell at the price recommended by
example, the nature of operations might influence the marketing and still make a profit?
human resource requirements but, equally, the skills and
Many decisions will need to be reviewed to find the best
talents of employees might influence what the business can
solution. For example, is it better to find cheaper supplies
produce.
so you can keep costs down, or could you actually push the
selling price up if the quality is better? Could you produce
the item with fewer features without damaging demand
significantly?
Marketing
Operations managers will also want to work closely with the
human resource function. The operations of the business
will influence:
» the number of staff required
» the skills of employees and any training requirements.
Finance Operations
If there are labour shortages, this might have an impact on
how much can be produced; if there is a shortage of certain
skills, it might influence exactly what can be produced.
The finance function will also liaise with operations.
For example, it will be important to assess the costs of
Human resources different operational options to see if the business can earn
a sufficient return. Any proposed investment in technology,
capacity, new equipment or new facilities will need
analysing in terms of the financial implications. Finance
▲ Figure 9.12 The interrelated functions of business may need to be raised internally or externally to pay for
One of the functions that operations must liaise closely any change in operations. Some operational possibilities
with is marketing. The starting point for new products will may not be affordable or generate sufficient returns to go
usually (but not always) come from marketing. Marketing ahead.
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The key to a successful business, therefore, lies in » Computer-aided design (CAD) This enables a business
integrating the various functions so that the limitations to develop models and prototypes on computers rather
and opportunities are clear. If functions operate
independently, they might find out too late that what they
than having to actually build them. This can save
time and money. It also provides more flexibility and
9.3
want and have planned for is not possible. accuracy when it comes to adjusting the design. By
saving and editing ideas, it is easier to update them.
Role of IT and AI in operations » Computer-aided manufacturing (CAM) This can enable
higher levels of accuracy, quality and speed, and it can
management therefore reduce costs.
Developments in information technology (IT) are
Businesses are also able now to benefit from greater use
9.3.1 Operations decisions

occurring at an increasing rate and they are making major
of artificial intelligence (AI). AI occurs when computer
improvements to the operations process. Such developments
systems are developed to undertake cognitive problems
include:
that normally require human intelligence such as learning,
» Better communications such as email, information
problem-solving and pattern recognition. This means that
stored in the cloud and video conferencing. This can
computers make decisions and undertake tasks that were
enable better and faster decisions to be made and can
previously done by humans.
increase productivity. One trend that has really taken off
following the Coronavirus (COVID-19) pandemic in 2020 AI can affect all aspects of operations. For example, AI can
is remote working. IT enables people to work from home be used to monitor systems and predict whether there are
much more easily than in the past. This can save the any likely problems emerging. It can be used to forecast
business money on rent and travel costs. The impact on sales and therefore determine production scheduling. It can
productivity can vary. make decisions to solve operational problems. All of this can
» Faster transfers of information and better sharing of free up people to focus on other tasks.
information with suppliers. This enables the business
IT and AI systems can help a business to integrate all the
to order supplies when needed and to ensure the right
aspects of operations more efficiently. They enable data
quantity and quality are ordered.
to be collected and analysed faster and more efficiently,
» Better links with retailers and better inventory control
and they can improve the use of resources, reduce wastage,
systems reduce the amount of inventory that needs to
increase flexibility and enable better decisions to be made.
be held at any moment.
However, there are investment costs, as well as the costs of
» Better data analysis; for example, calculating the costs
development and training, which need to be considered.
of any operations.
» The use of radio-frequency identification (RFID)
These are tags that can be used to identify and track GLOSSARY TERMS
items within the operations process. An RFID tag Computer-aided design (CAD) involves the use of
consists of a tiny radio transponder, a radio receiver computers to develop, explain and modify a design.
and transmitter. This enables the business to track Computer-aided manufacturing (CAM) is the use
exactly where items are at any moment and to transmit of computer software to control machines in the
information to the next stage of the process. manufacturing process.
CASE STUDY
Amazon
In 2018, Amazon opened a supermarket in Seattle with The AI system needs to identify exactly who people are
no checkout operators or self-service tills. The store to make sure the right people are charged for the right
uses hundreds of cameras mounted on the ceiling and items. It needs to identify what has been put in the basket
electronic sensors to identify each customer and track the and kept and not count anything that has been put back.
items that they select. It needs to be able to identify each product accurately
for billing. This is very sophisticated technology which
When customers enter the store, they swipe their
Amazon has had to develop.
smartphones with the Amazon Go app. Then they are free
to put any of the products on the shelves straight into their Questions
shopping bags. AI sensors track exactly what goes into a
1 Analyse two benefits to customers of Amazon using
customer’s basket and add this to their bill. Purchases are
its AI technology in its stores. [8]
billed automatically to customers’ credit cards when they
2 Evaluate the benefits to Amazon of using its AI
leave the store.
technology in its stores. [12]
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CASE STUDY
9.3
Microsoft
Microsoft, like some other technology companies, pays Microsoft said it was part of an evaluation of its business
news organisations to use their content on its MSN and was nothing to do with the Coronavirus (COVID-19)
website. From July 2020, the MSN homepage stopped pandemic.
featuring news stories produced by journalists. Nearly
30 researchers lost their jobs when Microsoft replaced Question
them with AI software. Responsibility was handed over to 1 Analyse two factors Microsoft would have considered
computers to select and edit news articles from content before adopting AI to choose content for its MSN
that appeared on other sites to put on its homepages. website. [8]
CASE STUDY
L’Oréal
L’Oréal sells to a billion consumers and makes a total of a variety of sources to rethink its production plants, make
approximately 7 billion products every single year. That them more flexible and design them to be producing in
is nearly 20 million products a day. These include hair anticipation of what is happening in the market so that
care and cosmetics. The company has huge amounts of stores have the right products they need at any time.
data available and it says it aims to use this to create even
better products. To do this, it collaborates with IBM, which Question
it describes as one of the world’s finest IT companies. 1 Analyse two benefits to L’Oréal of working with IBM to
Working with IBM, L’Oréal has created a platform called develop Operations 4.0. [8]
Operations 4.0. This analyses the data it collects from
9.3.2 Flexibility and innovation product or service will be delivered? Imagine a new
phone line is being fitted to your house. What is the
lead time before it can be fitted? Is it days or weeks or
The importance of flexibility in months? Can you determine the day and time it will be
operations fitted, for example, or do you have to stay in all day to
allow them access to the house because the company
Targets in operations management include:
cannot give you a set time?
» the quantity of goods and services that have to be
produced and when the output is required, given the
» specification How much can the customer influence the
actual design of the product? Imagine you are buying a
expected sales pattern. Operations will have to consider
new phone – how much choice do you have in terms of
whether it can deliver the right quantity at the desired
specifications? Could you personalise it?
time
» the level of quality expected by customers – that is, Complete flexibility would involve the customer having a
what benefits are they expecting? personalised product that only they have, that is prepared
» the expected costs to enable a profit to be made at the when they want and how they want it. By comparison, there
desired selling price. is a lack of flexibility if the business produces one version
of a product and the customer has to ‘take it or leave it’.
Operations targets also include the flexibility of operations
Examples of flexibility include:
required. For example, should a restaurant provide a set
menu or should customers be able to choose from a range
» made-to-measure shirts and suits
of items? Does a university provide a range of modules that
» design-your-own shoes
can be studied in any combination or does it offer a limited
» choosing the colour, tyres, interior design and other
specifications of a model of car.
number of degrees? Does an airline offer a range of flights
at different times from different locations? Businesses need The more flexible operations can be, the better it is in
to decide how flexible they want to be. Flexibility can occur terms of meeting customers’ needs. Flexible production
in terms of: allows a business to target customers’ requirements more
» the quantities that customers can buy Think of Coca- precisely. However, in reality, there may be constraints
Cola and the number of different sized cans and bottles limiting this flexibility:
it offers » The business may not be able to offer all the desired
» delivery time How much flexibility is there for the features, because it lacks either the necessary skills or
customer to determine the day and time that the technology. The costs of being flexible may be too high;
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switching from producing one product to another can be than they were previously, and they want products that
expensive. Economies of scale will be more difficult to are more niche- and less mass-market. In the holiday
achieve for short production runs of different products.
» The business may not have the capacity to produce in
industry, for example, more people want to choose their
own destination, where they stay and what they do on
9.3
the quantities required and therefore may need to look holiday, so they put together a unique holiday just for
to others to produce some of it (called subcontracting). them.
The business may be busy with another order and so
Technology is also enabling more flexibility in production.
cannot start a new one for some time.
Mass customisations, for example, occur when products
The flexibility offered by a business will depend on how are produced on a large scale but customers have choice
the business wants to position itself in the market and the over certain features, which ‘customises the product’. When
9.3.2 Flexibility and innovation

impact it will have on revenue compared to costs. buying a computer, for example, you may choose the screen
size, the programmes that are pre-installed, the hard drive
The pressure from customers is for more flexibility. With
and so on. For each of these choices, a customer chooses
greater access online to information about their options,
from a limited list but the result is a product that feels
customers are generally in a stronger bargaining position
relatively customised.
CASE STUDY
Awl & Sundry
Awl & Sundry’s company mission is ‘to democratise the successful. He found a group of craftsmen who made
luxury of bespoke footwear’. ‘beautiful, stylish, comfortable and durable’ shoes at
a significantly reduced production cost compared with
The company’s founder, Nikunj, discovered he could not
producers in the USA.
find a smart pair of shoes for a reasonable price. After six
weeks of searching, he could find nothing that combined Source: https://shopconsortium.com/awlandsundry
comfort, style and affordability – the only options forced him
to choose between them. The Awl & Sundry business was Questions
therefore created because of Nikunj’s ‘frustration of not 1 Analyse two factors that might influence the price of
being able to find the perfect pair of shoes at a fair price’. Awl & Sundry’s shoes. [8]
2 Evaluate the importance to Awl & Sundry of the shoes
Nikunj then set out to find a shoemaker able to create
being custom-made. [12]
custom-made shoes for a reasonable price – and he was
Process innovation involves thinking about how you do

Process innovation something, whereas product innovation focuses on what you
Innovation involves developing new ideas. This may be do. Process innovation can occur:
developing new products (called product innovation) » when businesses change current processes involving the
or developing new ways of doing things (called process way they produce or deliver a product; for example, to
innovation). For example, enabling people to order and pay enable ordering online
online is a process innovation – it is making the old way of » when businesses adopt new ways of producing. For
doing things seem slow and cumbersome. example, they may automate a process by replacing
Businesses will be looking for ways of being more efficient people with machines. Several aspects of building cars
and this means looking to save costs. Process innovation can are now undertaken by robots rather than people.
enable a business to improve what it does and save money in
doing so; for example, using technology such as CAD and CAM STUDY TIP
to produce can enable better results, faster and at a lower Remember that innovation can lead to new products but
cost. Just think about how the internet has transformed the also new ways of doing things – think of the way we listen
way we find information – think of the quantity and quality to music, read books and book tickets these days.
of information we now find quickly, and think about the time
saved compared with going to the library and trying to find
a book that someone else may already have borrowed! Think
also of how much easier it is to check in for a flight these GLOSSARY TERMS
days thanks to online check-in; it makes it easier and more Product innovation focuses on developing new products.
convenient for the consumer and can enable the business Process innovation involves developing new ways of doing
to reduce staffing levels and speed up the process at the something.
airport.
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9.3.3 Enterprise resource ERP and business efficiency
9.3 planning By linking together the different functions and different
parts of the supply chain using ERP, the business should be
Enterprise resource planning (ERP) involves the use of more efficient and more flexible. It should also have less
software to integrate the collection and use of information need to hold inventory because items can be ordered and
for managers throughout a business. delivered just in time. A customer may place an order and this
information is immediately transferred to all the departments
ERP is a type of software that is used by businesses to
that need to know about it, such as finance and production.
manage their day-to-day business activities, such as their
Production is now triggered to begin, and this sends out
accounts, their supplies, their projects and their compliance
orders to all the different suppliers for the right quantities of
with regulations and policies. ERP is based on data being

parts to arrive at the right time. This means inventory levels
held centrally and in a common format. ERP brings together
can be low, reducing inventory holding costs.
information that was previously held in different databases,
and helps to collect, store and analyse data across the With better information, managers should know instantly
business. what is available and what it is possible to produce in
the coming weeks; this should make the business more
For example, a car manufacturer buys in many different
responsive to changes and enable better use of the
parts from many different suppliers. Any given part, such as
resources available, including the workforce, thus increasing
brake pads, from a supplier will be uniquely identified in the
capacity utilisation. This can help a business to be more
central database. Information will be stored on how many
efficient and to be more flexible to customer needs. It can
brake pads were ordered and on what date, the product’s
also enable it to provide more accurate information for
specifications, when pads were due to arrive and when they
customers; for example, when estimating delivery times.
actually arrived, what they cost and when they were used.
This data would be essential to many departments within ERP therefore enables real-time data to be available, and
the business. this provides greater visibility and awareness of what
is happening at each stage of the process. It provides
The aim of ERP is to enable decision-makers within the
managers with insight into exactly what is happening ‘live’
business to have the information they need, when they
within the business. With lower costs, prices can also be
need it. It also links the business to outside stakeholders,
more competitive.
such as suppliers. It should provide information in a form
that is reliable, relevant and cost-effective, and it should
enable managers to know what resources are available at STUDY TIP
any moment, thus helping them with planning. Remember that inventory holding costs can include
security, depreciation if inventories go out of date,
GLOSSARY TERM warehousing costs and the opportunity cost of money tied
up in inventory.
Enterprise resource planning (ERP) involves the use of
software to integrate the collection and use of information
for managers throughout a business.
▼ Table 9.1 The impact of ERP
Factor Impact of ERP

Inventory control With better knowledge of demand patterns and existing inventory levels, managers should know
what to reorder and when, thus avoiding having too much inventory or running out.
Costs Better information should avoid over- or under-ordering and improve efficiency, thus reducing costs.
Pricing Lower costs may enable lower prices. Greater awareness of demand patterns may enable more
dynamic pricing.
Capacity utilisation Greater awareness of how resources are being used throughout the business may enable better planning,
ensuring higher capacity utilisation. For example, the business will be better placed to know whether it is
able to accept an order or how it can reorganise production to make it possible to accept an order.
Response to change Better information enables a quicker and more informed response to changes; the business will know
more about what is feasible given the constraints.
Management information ERP provides management with real-time information, which helps with staffing, inventory control
and cash flow.
Workforce flexibility ERP enables managers to track and plan production more accurately. This means employees can be
deployed exactly as and when required to particular tasks. There should be less wasted time for
labour. However, it does require workforce flexibility to enable the number of people to be increased
or decreased easily and for people to move from one task to another as required. This flexibility will
affect employment contracts and require employee training.
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9.3.4 Lean production » Kaizen
» quality circles
Lean production aims to reduce wastage and, thereby,
make a business more efficient. This may be crucial in
» simultaneous engineering
» cell production
9.3
an age of growing competition where there is a need to » just-in-time (JIT) manufacturing
provide excellent value for money. By being more efficient, » waste management.
a business can reduce its prices and maintain its profit
margins, but it might hope to increase sales or keep the Lean production involves focusing on problem areas and
price constant and benefit from higher profit margins. finding the most efficient ways of addressing these. Once the
‘right’ method has been found, staff then need to be trained
With greater globalisation and competition from all over and shown how to do this and then follow this approach. The
9.3.4 Lean production

the world, the pressure is on organisations to become more aim is to develop clear and reliable ways of doing things. At
efficient. They are often facing demands for increased Toyota, for example, every activity is completely specified,
pay and higher input costs, but they cannot easily pass then applied routinely and repetitively. This is because all
these on to their customers so, to maintain profits, there variation from best practice leads to poorer quality, lower
is a pressing need for greater efficiency. Managers are productivity and higher costs.
constantly looking for ways of reducing the cost per unit.
This does not necessarily mean producing more cheaply – a The lean approach includes the ‘five Ss’:
Ferrari car, a Chanel dress and Jimmy Choo shoes are always » Sieketsu The aim is to standardise the approach in every
likely to be expensive to make. However, many managers area so there is a right way of doing things and this is
will want to find the cheapest way of producing at a given applied consistently.
quality level. As we saw earlier, this may be achieved by » Seiso Employees are expected to keep their work area clean.
innovation. It can also be helped by trying to become » Seiton Employees are expected to organise their tools,
leaner in the way that a product is produced. materials and documents so they can find them easily
and quickly.
Lean production aims to reduce all forms of waste in the » Seiri Employees need to have key equipment only and
production process. It is an approach that was developed remove unnecessary tools from their work area.
most fully in Japan. Waste is called ‘muda’ in Japan and » Shitsuke Employees are expected to follow the ways set
lean production aims to drive out all forms of muda. This out to complete a task.
includes the waste of materials, time, energy and human
effort. Lean production streamlines operations so that The lean approach can be applied to any business operation.
costs are reduced and efficiency increased. To achieve this, Some benefits include:
a number of techniques have been developed (mainly in » Banking Think of the processing of cheques and credit card
Japan) aimed at getting things right first time and reducing payments. The more efficient this process is and the less
wastage levels. According to Taiichi Ohno (from Toyota), the time that is wasted along the way, the faster the bank can
seven types of waste include: collect its money and the better the return on investment.
1 Defects These only have to be put right later on » Hospitals Think of the ‘processing’ of patients – how
and cost money or they have to be thrown away or much time this can take and how many resources could
reworked. be wasted. A lean approach can lead to lower costs and
2 Overproduction of goods not demanded by actual faster treatment time, leading to better patient care.
customers If they are not needed, why produce them? » Airlines Think how much money is wasted as aircraft sit
They only have to be reworked or thrown away. on a runway waiting to take off again. If ways could be
3 Inventories awaiting further processing or found to reduce the turnaround time, this could save the
consumption This represents idle money. airlines millions of dollars and allow the airports to earn
4 Unnecessary processing Why add features or extra work millions more in landing fees. Think of when you land
if it is not needed? on a flight – are there ways of getting you off the plane
5 Unnecessary motion of employees This wastes time more quickly? Are the landing crews ready to get on the
and energy. aircraft quickly? Is the plane designed in a way that
6 Unnecessary transport and handling of goods Again, makes cleaning easier and faster?
a waste of resources.
7 Waiting for an earlier stage of the process to deliver STUDY TIP
Waiting time is idle time! Remember that bringing in lean production may not
Lean production therefore aims for: be quick. It may involve new suppliers and new ways of
» zero delays working and training which might be resisted by those
» zero inventories within the business and existing partners.
» zero mistakes
» zero waiting
» zero accidents. GLOSSARY TERM
The techniques involved in lean production include: Lean production aims to reduce wastage and, thereby,
make a business more efficient.
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CASE STUDY
9.3
The Egyptian textiles industry
Egypt has a fully vertically integrated textiles industry. ● breakdowns of machinery and equipment owned by the
The entire production process – from the growing majority of firms, as a result of non-existent suitable
of the cotton to the production of yarns, fabrics investments to carry out replacement and renewal
and ready-made garments – is carried out within operations
the country. The sector is an important part of the ● defective products and customer returns
Egyptian economy and accounts for around 30 per cent ● decreased profit margins
of employment and 15 per cent of exports. However, ● marketplace competition

analysts argue that the industry faces several problems. ● no more space for inventory
These include: ● delays in delivery time.
● high inventory levels, including work-in-progress
(WIP) inventory, incoming and finished goods Question
inventory 1 Evaluate the potential benefits of lean production to
the Egyptian textiles industry. [12]
reduction in costs for one unit, resulting from Kaizen, can

Kaizen lead to significant increases in profit overall because of the
The belief that firms can always do better is known as scale of the sales involved. And if the improvements keep
‘Kaizen’. Kaizen is a Japanese word meaning continuous coming, the profits keep rising!
improvement. The Kaizen approach tries to get employees
to improve what they do in some small way, every day of The Kaizen approach stresses that changes must be
every week of every year. If workers improve the quality of monitored and evaluated to determine the extent of
their work by 1 per cent every single day, the effect over the improvement made. At each stage, there should be
just one year would be enormous. Too often, businesses assessment of what actions have been taken and how
seek dramatic changes instead of small, regular changes. If effective they have been.
you want to improve your grades in your exams, it is unlikely The idea of continuously improving can be seen in the
that there is any one thing you can do that will lead to a work of Edward Deming (see Figure 9.13). Deming was
sudden improvement in your marks. However, if you begin an American who achieved great fame in Japan for his
to change many things over time, your grade is likely to work on quality. Deming advised managers to focus on a
improve gradually. specific area and find the best way of performing, setting
Thus, the Kaizen approach focuses on the idea that appropriate quality targets. Managers would plan what
improvement comes through a series of small changes – needed to be done, then do it, check to see the results and
it is gradual rather than radical. The Chief Executive of then take action – the plan-do-check-act (PDCA) cycle. If
Toyota said that ‘when 70 years of very small improvements the targets were consistently being met, managers could
accumulate, they become a revolution’. The profit margins then increase the level of quality they were trying to
of many businesses are relatively small – they rely on achieve and focus on how to do this. If the existing targets
selling large volumes of products. What may seem like a tiny were not being met, managers should find out why and fix
this before raising the bar.
Plan Do
vement
ous impro
Act Check Continu
▲ Figure 9.13 The Deming cycle
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Quality circles Amazon can deliver within 24 hours. At Yo Sushi, you can
help yourself rather than wait for a server to come to you.
Quality circles occur when employees involved in a
particular part of the operations process meet to identify As customers become eager for ‘instant’ service, the ability 9.3
ways of improving quality. Managers invite employees to to supply items as and when they are wanted may be crucial
become involved in improving the process. The benefit of to a business’ success. The growth of internet shopping, 24-
this approach is that those directly involved in the task are hour telephone banking and home delivery by supermarkets
helping to develop it; they will have the direct experience all reflect a desire for quick, easy access to products. Firms
to make improvements. Employees in a quality circle usually must try to react by reducing the time it takes to develop
meet without senior staff present. They develop their ideas products. Also, with new products being launched more
and then present them to the management team. frequently and with rapidly changing customer tastes,

products do not tend to survive for as long as they did in
However, for quality circles to work effectively, the business the past. More than 80 per cent of new products are likely
must have a culture where employees feel valued and want to fail in the first few years. It may be important, therefore,
to contribute. They must feel listened to and think their to develop products very quickly to keep competitive in the
ideas will be taken into account so that they will volunteer market.
to be involved. Quality circles rely on employees wanting
to improve the business; the ideas build on employees’ To speed up the development of products, businesses have
expertise. adopted simultaneous engineering methods. These involve
getting all the engineers and designers who are concerned
with a project to work on it at the same time. Instead of
STUDY TIP having one person look at a product idea, develop it and
Remember that a quality circle focuses on a specific part then pass it on to the next person or department, time can
of the operations process. It does not focus on issues be saved if everyone is looking at and discussing the work
that cover the whole organisation. However, there may be simultaneously. This process has become easier due to the
many quality circles within a business. increasing use of information technology, which enables
employees to communicate and share information more
easily.
Simultaneous engineering An important element of simultaneous engineering is
With the levels of competition in most markets increasing scheduling activities effectively so that they are undertaken
rapidly, businesses are always looking for new ways of as efficiently as possible. There are various ways to do this,
out-competing their rivals. Many firms have tried to use including using critical-path (or network) analysis, which we
time as a competitive weapon. If an organisation is able will discuss below. This is particularly important in project-
to produce an item in a shorter period of time than its based industries, such as construction, where every project
competitors, or deliver it more rapidly to customers, more may be slightly different and needs very careful co-ordination.
sales may result. Huawei keeps producing new models of its
products, for example, so that by the time the competition GLOSSARY TERM
has copied the features of the last one, it has already Simultaneous engineering occurs when as many activities
moved on to a new version. Domino’s Pizza has competed as possible involved in developing new products are
aggressively in the fast-food market by trying to achieve undertaken at the same time (as opposed to in sequence)
pizza delivery within 30 minutes. Similarly, Dell can to save time.
produce a computer to a customer’s specifications within
weeks. Opticians can produce a pair of glasses in hours.
CASE STUDY
Thyssen Krupp
Thyssen Krupp is an engineering business that provides together with its customers to develop optimal and
products to companies in the vehicle industry, such as integrated production concepts. It develops customer
car manufacturers. The company is a great believer in concepts and provides technical solutions using its
the benefits of simultaneous engineering. It argues that technical know-how and planning expertise.
the goal of simultaneous engineering is significantly
shorter development times and faster market entry, given Question
ever-shorter product life cycles. It says that during the 1 Analyse two benefits of simultaneous engineering to
simultaneous engineering phases, the company works Thyssen Krupp’s customers. [8]
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Cell production than simply undertaking the same task again and again on a
production line – in that system, you probably have no idea
9.3 Cell production is a method of organising production
around teams rather than a traditional production line, and
why your part of the process matters, and there is almost no
skill variety or sense of task significance.
it can lead to less wastage. Instead of producing items on
a production line, the process is divided into a series of
different stages undertaken by teams or cells. Each team is GLOSSARY TERM
given the responsibility for a stage in the process. Cell production occurs when the production process is
divided into stages undertaken by teams.
An advantage of this approach is that teams are responsible
for a complete unit of work. Instead of each individual
working on one simple task and having no real involvement

with the final product, working in cells can give employees Just-in-time production
a sense of team spirit. It can also improve quality because Inventories are goods that have been produced or are in
teams have work for which they have overall responsibility, the process of being produced but which have not yet been
and they can clearly see the results of their efforts. Cell sold. As we saw at AS Level (page 155), just-in-time (JIT)
production can, thereby, be very motivating for employees, production occurs when firms produce products to order.
who feel they have more control over their own work, and Instead of producing as much as they can and building up
the team’s members can organise among themselves when inventories, firms only produce when they know they can
and how items are produced. They can also share their actually sell the items. Similarly, components and supplies
skills and expertise, and they are also likely to feel much are only bought in by a firm as and when they are needed.
greater responsibility for their work, because the next cell The aim of JIT production is to reduce a firm’s inventory
has the right to refuse their work if it is poor quality. Cell levels by as much as possible; in an ideal world there would
production thus involves self-checking by team members. be no inventories at all. Supplies would arrive and be used
to produce items that are sold immediately to the final
Hackman and Oldham (1976) developed a model of job customer.
design which highlighted the key elements of a motivating
job (see Figure 9.14). Running a just-in-time system is complex and places many
demands on a business, as explained below.
Core job dimensions Psychological states Outcomes » Excellent relationships with suppliers Businesses need
to be able to rely on suppliers to deliver goods at precisely
Skill variety the right time. They cannot afford delays as this halts
Meaningfulness High intrinsic
Task identity motivation production. Also, the goods must be perfect quality; the
Task significance of work
High job manufacturer has no inventories to replace faulty supplies.
performance A firm must be able to trust its suppliers completely.
Responsibility High job
Autonomy for outcomes satisfaction
» Reliable employees Because the business does not have
Low many (if any) inventories at any stage of the process,
absenteeism the firm cannot cope with stoppages. If strikes occur, for
Feedback Knowledge of and labour example, the whole production process stops. A business
results turnover
cannot supply customers using inventories as none exist.
▲ Figure 9.14 The key elements of a motivating job JIT relies upon maintaining a good relationship between
employers and employees.
This model stressed the importance of designing jobs in » A flexible workforce To ensure that production can
which individuals had: respond to demand, a firm needs to have a flexible
» skill variety – that is, they use a range of skills labour force. This means that if someone is ill, another
» task significance – that is, they are working on something employee must be able to cover for them, or if demand
that has some significance in terms of the overall is high in one area of the business, people can be
business, rather than just working on a small section and moved to that area to help out. Firms using JIT expect
thereby not appreciating why what they do matters employees to be ready to work anywhere, anytime.
» task identity – that is, the work they do has a sense of People must change to meet the demand for different
completion (for example, handing over a complete unit products because JIT is focused entirely on matching
of work to the next stage of the process) supply to customer orders.
» autonomy – that is, individuals have some independence
to make decisions on how they do the work Introducing JIT production involves:
» feedback – that is, employees receive information on the » investment in machinery which is flexible and can be
quality of their work. changed from producing one type of item to another
without much delay
Cell production helps in most of the areas above and should » training employees so that they have several skills and
therefore create more motivating work. Teams have control can do a variety of jobs (multi-skilling)
over what they do; together they produce a complete unit » negotiation with employees so that their contracts are
of work and they hand it over to the next cell, which will flexible and allow them to move from one job to another
give them feedback, and each member of the cell may » building relationships with suppliers who can produce
undertake a range of tasks. This should be more motivating just in time as well.
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Waste management
Central to lean production is the aim of reducing all forms
of waste. According to the European Union Waste Framework Reduce 9.3
Directive, waste is ‘anything for which we have no use;
which we want to or are required to throw away’.
By reducing wasted time and wasted materials, the Recycle Reuse
operations process becomes faster and more efficient.
However, there may still be waste products that are generated
by the processes of the business and waste management will

seek to manage all aspects of this. It will aim: ▲ Figure 9.15 Principles of waste management
» to reduce the usage of materials and use the minimum How businesses manage their waste and the impact of their
possible waste in the environment is increasingly becoming a focus
» to recycle any materials it can for consumers and governments. There is a growing number
» to reuse any waste wherever possible of regulations affecting how businesses use their resources,
» to minimise any impact of the operations activities on how they produce their products and what happens once
the environment; for example, preventing land their products have been used to limit the waste being
pollution. generated by business.
CASE STUDY
EU regulations to reduce waste
New regulations are about to be introduced in the ● increase the recycled content in products
European Union (EU) to ensure products are designed ● reduce the impact of products on the climate and
so that they last and can be repaired if they go wrong. environment
These regulations will apply to a range of everyday items ● provide incentives when producers keep the ownership
such as mobile phones, textiles, electronics, batteries, of the product or the responsibility for its performance
construction and packaging. The rules will also try throughout its life cycle – similar to car leasing.
to prevent ‘premature obsolescence’; this occurs
when manufacturers deliberately make goods with Questions
a short life cycle so that customers have to buy 1 Analyse two reasons why the EU would want to
a newer model. introduce the regulations outlined in the case study.[8]
2 Evaluate the potential impact on producers if the
The EU also wants to set a food waste reduction target,
regulations outlined in the case study are
stop over-packaging and end microplastic pollution. Other
introduced. [20]
recommendations are to introduce regulations that:
CASE STUDY
Waste and the clothing industry
In a recent UK parliamentary enquiry it was stated that: the customer. When garments are cut out as patterns, for
instance, as much as 15 per cent of the fabric can end up on
… fashion consumption is causing a waste problem in the
the cutting room floor. [...] In 2016, this supply chain waste
UK and other countries. The sector ... still operates on a
for clothing in the UK was estimated at over 800 000 tonnes
linear model of ‘make, use, dispose’. ... around 300 000
compared to just under 700 000 tonnes in 2012. This increase
tonnes of clothing ends up in household bins every year,
is driven primarily by the increase in clothing consumption.
with around 20 per cent of this going to landfill and 80 per
Around 440 000 tonnes of supply chain waste arises during
cent incinerated.
preparation of fibres to make yarn and during garment
Increasing garment lifetimes is one of the most effective production, most notably in China and India. [...] Some
means of reducing their environmental footprint. Extending designers, such as Mark Liu and Phoebe English, are now
the life of clothing by an extra nine months could reduce experimenting with zero-waste pattern-cutting techniques in
carbon, waste and water footprints by around 20–30 per which the garment pieces are designed to fit together like a
cent each. jigsaw so that nothing is wasted when they are cut. Businesses
[in New York State] are required by law to separate and
The waste is not just of finished products.
recycle or repurpose all textile waste including fabric scraps,
Hundreds of thousands of tonnes of fabric are wasted at the clothing, belts, bags and shoes if textiles make up more than
design and production stage before the clothing reaches 10 per cent of their waste during any month.
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Waste also comes in the form of clothes that are France introduced a scheme for clothing in 2007 making
9.3 destroyed without being sold.

In 2018, the British luxury brand Burberry faced a storm of
clothing, linen and footwear companies responsible for the
management of their end-of-life products. The scheme has
nearly trebled clothing collection points ... and collection
criticism when it revealed in its Annual Report for 2017–18
rates have increased by more than 50 per cent.
that ‘the cost of finished goods physically destroyed in the
year was £28.6 million’ ... [The company] had incinerated Source: https://publications.parliament.uk/pa/cm201719/
unsold clothes, accessories and perfume to protect its brand cmselect/cmenvaud/1952/report-files/195207.htm
and prevent unwanted stock from being sold cheaply. ... in © Parliamentary Copyright
September 2018, Burberry pledged to end the practice and
Questions
said it will reuse, repair, donate or recycle all excess stock.
1 Analyse two ways in which clothing producers could

In some countries, producers are being made responsible reduce waste in their industry. [8]
for what happens to the clothing once customers have 2 Evaluate the need for better waste management
finished with it. in the clothing industry. [20]
Summary of the impact of lean production

▼ Table 9.2 Summary of the impact of lean production
Issue Impact of lean production

Inventory levels Reduced
Quality Improved. Lean production requires products to be right first time. It does not build in the idea
that there is buffer inventory in case something goes wrong. This focuses everyone on getting it
right first time and not having errors.
Efficiency • Increased, as savings are made on inventory costs
• Less time wasted
• Less waste of materials
• Less throwing away of out-of-date inventory
Reliance on suppliers Increased. Links with suppliers need to be excellent.
Capacity management Production occurs when demand is there; it does not produce in the hope that demand will occur.
This means production needs to be flexible according to demand and capacity utilisation will
vary. When there is ‘downtime’ (i.e. there is no production) maintenance activities will take place.
Capacity utilisation may be lower under lean production, but what is produced is sold.
Employees’ role Need to be flexible so they are ready to work when needed and in terms of what they do and when.
» The business is also very dependent on employees. If

Limitations of lean production staff strike, for example, the business has no supplies
An operational strategy of introducing lean production is to keep producing. This puts employees in a strong
not necessarily easy, cheap or quick. It requires: bargaining position, which means again that trust is
» a workforce that is willing to take on extra vital. Employees must feel involved and well-looked-
responsibilities, such as getting involved in a Kaizen after.
approach and quality circles. This means employees need
to feel trusted and respected. If this is not the case Businesses that develop an operational strategy around lean
initially, this trust needs to be won production must therefore have excellent relationships with
» investment in the training of staff both suppliers and employees.
» the right suppliers. These must be able to produce to
order and to produce high-quality items that can be used
in the process without having to be checked
9.3.5 Operations planning
» investment in technology; for example, to introduce an The business environment is continually changing. This
ERP system and to link the business more closely with creates new opportunities and threats. To anticipate change
retailers and suppliers. or to react to it, managers need to undertake operations
planning. Operations planning will consider how the
The lean approach can also bring problems:
business will meet its operations targets; for example, how
» For example, if there is a delay or disruption to supplies,
it will produce, what production will be scheduled and how
this will halt production at the business because it
it will achieve its set quality targets. Planning will set out:
has no buffer inventory. The business becomes very
» what needs to be done
reliant on suppliers and this is why a strong working
» how it will be done
relationship and high levels of trust are needed.
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» how progress will be monitored Critical-path or network analysis
» what action will be taken if the plan is not on target
»
»
the resources required for an activity
who is responsible for a given activity.
To achieve productive efficiency, managers will want to
plan projects as effectively as possible to ensure that time 9.3
and resources are not wasted. They do not want to have
Part of operations planning may involve setting up project people and machines sitting idle unnecessarily or materials
teams. These teams may be established to: delivered well before they are required. To help them in the
» develop a new product planning process, managers may use network analysis, also
» research a new market opportunity called critical path analysis (CPA).
» work on a new process. Network analysis is a method of organising the different

Once the task is complete, the project team will be activities involved in a particular process in order to find
disbanded and another one created as and when required. the most efficient means of completing the task. The aim
The membership of a project team will usually depend on is to complete the project in as short a time as possible.
employees’ ability to contribute to the task. People may To do this, a firm will determine the exact order in which
be brought from different areas of the business to work on activities have to be undertaken and identify those which
specific projects. can be undertaken simultaneously to save time. Network
analysis can be used in any type of project that involves
Alternatively, a business may have permanent teams set
several activities – anything from opening a new store, to
up specifically to manage projects, such as developing
planning a new advertising campaign, to organising the
new software or computer games. These teams will
relocation of the firm. The technique was developed for
usually have members from different functions across the
DuPont in 1957 to speed up the building of a new plant. In
business so they can examine a project from different
order to undertake network analysis managers must:
perspectives. These teams will be given different projects
» identify all the different tasks involved in the process
and be expected to develop, test and implement them
» estimate the expected length of time each task will take
effectively.
» determine the order in which the tasks must be
A project usually involves individuals collaborating to completed. For example, in some cases, particular tasks
achieve a particular aim. They are temporary and work cannot be completed until another one has taken place
within a given time and other resource constraints. first (these are known as ‘dependent’ activities). In
Managing a project therefore involves managing a team of other cases, activities can be undertaken simultaneously
people to complete a task on time, to a given standard and (these are known as ‘parallel’ activities, because they
within given budget constraints. It involves: can be undertaken at the same time as each other – ‘in
» good communication skills to communicate to people parallel’).
what is being done and what has to be done by when
» good people skills to pick the right team and to keep the GLOSSARY TERM
team working well together
Network analysis or critical path analysis (CPA) is a
» good planning skills to establish what can be done by method of organising the different activities involved in
when and by whom a particular process in order to find the most efficient
» good management skills to review progress and keep the means of completing the task.
project moving forward.
These skills are especially important given that the project
may be in unfamiliar areas and/or where there is a great Network charts
deal of pressure to get the task completed because it can The next step is to construct a network chart. This is a
be vital to the future of the business (for example, a new diagrammatic representation of all the activities involved
product). They are important to ensure an innovative idea in the project, the order in which they must be undertaken
becomes a reality. and the time each one will take. When drawing a network
diagram, the following features are used:
Why do projects fail? » a circle (called a ‘node’) represents the start and end of
Projects may fail because: an activity
» not enough time is spent on the planning, because of » a straight line represents the activity itself.
pressure or a desire to get on with the work A line showing an activity is labelled in the following way:
» the difficulties and the time and cost involved are » above the line, the name of the activity is given
underestimated, because often these projects have not » below the line, the length of time the activity is
been done before so there is a lack of experience expected to take is shown – this is known as the
» sometimes people want projects to succeed so almost expected duration of the activity.
ignore the potential problems or are too confident they
can overcome them, or there are factors outside their In Figure 9.16, activity B is expected to last ten days and
control, such as changes in the economy or problems activity A is expected to last four days, but activity B can
with suppliers. only be started when activity A is completed (that is why it
only begins once A is complete).
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A B Adding earliest start times and latest
finish times
9.3 4 days 10 days
The next stage in producing a network chart is to show
▲ Figure 9.16 various information that can be calculated from the
In Figure 9.17, activities C and D can only be started after duration of each activity. This information is shown
activity B has been completed. Activity E can only start inside the node and, to do this, we now draw nodes in the
when C and D are finished. following way:
» The left-hand side shows the number of the node; this is
C used simply for reference and is done by numbering the
nodes left to right.
A B 3 E
days » The right-hand side of the node is used to show two
4 10 D 5
days days days other pieces of information, known as the ‘earliest start
1 time’ of the next activity and the ‘latest finish time’ of
day
the activity before.
▲ Figure 9.17
Earliest start time
In Figure 9.18, we have added in some more activities. You The earliest start time (EST) is exactly what it says: it is the
can see that: earliest time a particular activity can begin. This piece of
» activity F can start immediately information is shown in the top-right space of the node at
» activity G can start once activity F is completed the beginning of an activity.
» activity H can start once activities E and G are
As you can see in Figure 9.19, the earliest times have now
completed.
been added. To calculate these figures, you take the EST of
C the activity before and add on the duration of that activity.
A B 3 E H C
4 10 days 5 3 A B 3
days days D days days 0 4 14 17
1 E
0 4 14 17
day 4 10 D 5
1 H
22 25
F G
22 25
6 9 3
days days
F 6 G
▲ Figure 9.18 6 13 9
All this information can be shown in Table 9.3. ▲ Figure 9.19

▼ Table 9.3 Network chart summary The earliest time A can start is day 0 (this is the first
activity in the project); this activity takes 4 days so the
Activity Preceded by Duration (days) earliest time that B can start is day 4. Activity B takes 10
A – 4 days so the earliest that C and D can start is day 14. E can
B A 10 only start when C and D are both finished. C takes longer
than D, so the project must wait for this activity to be
C B 3 completed before moving on; the earliest that E can start is
D B 1 therefore day 17.
E C and D 5 If you have a choice of numbers to add on to calculate
F – 6 the EST, choose the bigger number. The projects cannot
G F 9 continue until all previous dependent activities are
finished, so you must wait for the longest one to be
H E and G 3 completed. Before H can start, for example, it must wait for
both E and G to be completed, which means it cannot start
We now have a whole network diagram. Remember the until day 22.
following rules when constructing a chart:
» The lines showing different activities must never By identifying the ESTs, a firm can see when materials
cross. are likely to be needed. This means that components and
» The lines showing activities should always begin and supplies can be ordered to arrive just in time to be used,
end at the midpoint of the nodes. rather than arriving too early and sitting around, taking up
» The diagram must begin and end with one node. space and costing money, or arriving late and delaying the
» When drawing the activities and nodes, do not put the whole project. Materials and resources for activity E, for
end node on any activity until you are sure what comes example, do not need to be ready until day 17.
next and whether anything else must also be completed Calculating the EST is therefore an important part of
before the following activity takes place. developing a lean approach to a project and ensuring
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people and materials are co-ordinated and ready at exactly delayed at all, the whole project will be late and will not be
the right moment. finished in 25 days.
Latest finish time ▼ Table 9.4 Example of a critical path 9.3
The bottom-right space of a node is used to show the latest
finish time (LFT) of an activity. Again, this shows exactly Activity Preceded by Duration (days)
what it says – the latest an activity can be finished without A – 4
holding up the whole project. B A 10
Activity H must finish on day 25 – the day the whole C B 3
project can be completed. Since activity H takes 3 days, D B 1

it means the activities before must be finished by day 22
if the project is to be completed on time. Activity E must E C and D 5
therefore be completed at the latest by day 22. Since E F – 6
takes 5 days, this means the activities before (C and D) G F 9
must be finished by day 17. Given that C takes 3 days (which
H E and G 3
is the longer activity out of C and D), if this stage is to be
completed by day 17, the stage before must be finished by
By identifying the activities on the critical path, managers
day 14.
can see exactly which activities are the priority in terms of
Rules when calculating ESTs and LFTs making sure they stay on time. The critical path also shows
To calculate the EST of an activity, work left to right and minimum project duration – that is, the shortest time in
add on the duration of the next activity to the previous which a project can be completed.
EST; if there is a choice, choose the biggest number to
add on. GLOSSARY TERMS
To calculate the LFT of an activity, work right to left and Free float time is the length of time an activity can overrun
deduct the duration from the previous LFT; if there is a without delaying the start of the next activity.
choice, choose the largest number to deduct. Total float time is the length of time an activity can
overrun without delaying the completion of the whole
Float time project.
Using the ESTs and the LFTs, it is possible to calculate The critical path refers to activities that have no float time;
the float time of an activity. There are two types of float if they overrun at all, the whole project is delayed.
time: The minimum project duration is the shortest period of
» Free float measures how much an activity can overrun time necessary to complete the project.
without delaying the next activity. To calculate free
float, use the equation:
Dummy activities
free float = earliest start time of the next activity
Sometimes, when constructing network diagrams, the
– the earliest start time of this activity
relationships get so complex that to help you draw them,
– the duration
you need a dummy activity. This is an activity that has no
» Total float measures how much an activity can overrun
time or costs involved, and you include it in the diagram to
without delaying the whole project. To calculate total
help show the relationships between ‘real’ activities – it is
float, use the equation:
simply a device to help you draw the diagram. See Table 9.5
total float time = latest finish time – duration for an example.
– earliest start time
▼ Table 9.5
For example, if activity D has to be finished by day 17,
can start on day 14 and lasts 1 day then the total float is Activity Preceded by Duration (normal time)
17 – 1 – 14 = 2 days. This activity has 2 days’ slack – it could A (None) 3 weeks
overrun by 2 days and the project would still finish on time. B (None) 4
By comparison, if activity B has to be finished by day 14, can
start on day 4 and lasts 10 days, its float is 14 – 10 – 4 = 0. C (None) 5
Here, there is no float – it must be completed on time or D A 8
the whole project will be delayed. B is therefore known E A, B 3
as a ‘critical’ activity because it has no total float. By
F C 5
identifying all of the critical activities, the firm can see
which activities must be finished on time; this is known as
A, B and C have no predecessor. They all start from the first
the critical path.
node (node 1). A can go from node 1 to node 2. B can go
The critical path for the project in Table 9.4 is ABCEH, from node 1 to node 3. C also starts at node 1. D can only
because these activities have no total float time. If they are occur after activity A, so D starts at node 2.
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Now for activity E; the difficulty here is where E should start. the firm can order materials and supplies to arrive
E can only begin after A and B. A ends at node 2 and B ends exactly when they are needed and not before. This saves
9.3 at node 3. But E poses a problem. If we joined A and B up,
going into node 2, so that E could start from here, this would
on storage costs and also the opportunity cost of having
money tied up in inventories. This can improve the firm’s
work for E but would be wrong for D. This is because it would liquidity and free up cash which can be used elsewhere
suggest D needed both A and B to finish before it could start, in the organisation.
which is not correct – it only needs A. The solution is to add » Managers can use network analysis as a control
a dummy activity that runs from node 2 to node 3, as shown mechanism to review progress and assess whether the
in Figure 9.20, then start E at node 3. This shows that E needs project is on target. If there have been delays, the
A and B whereas D only needs A, which is what we want. effects of the ESTs and LFTs can be reworked to see the
effect on the completion of the project.
2
Although some of the estimates of the likely durations may
A D prove to be wrong, and although external factors may cause
Dummy delays, this does not mean that CPA is unnecessary. On the
contrary, by having a network diagram, the effects of any
B E
1 3 5 delays can be calculated relatively easily in terms of the
impact on the final completion date. CPA enables managers
to understand the significance and likely dangers of any
C F delay. Projects may still overrun, but managers should
4 be able to predict if this is going to happen as soon as a
problem emerges (rather than being taken by surprise) and,
▲ Figure 9.20 Network chart with dummy activity if possible, take action to get the project back on track.
CPA as a management tool HANDLING DATA

Network diagrams and CPA are useful management tools in
project management. ▼ Table 9.6
» When undertaking a CPA, managers must consider
exactly what activities are involved in a project. This Activity Preceded by Duration
is a useful exercise because it helps to make sure that A – 3
nothing is forgotten. It also means that managers B A 5
are likely to consult all the different departments
C – 2
and functions involved, and this can help to improve
everyone’s understanding of the issues and get them D B 10
involved in getting the project completed. E C, D 4
» Managers can calculate the earliest time by which the F – 1
project should be completed. This can be important
information for customers (for example, the firm can G F 12
announce a release date) and is important to help plan H E 3
launch arrangements. It can also help the managers I E, G 5
decide whether or not a deadline can be met.
J H, I 3
» Managers can identify the critical activities that must
be completed in time to get the whole project finished 1 Construct a network diagram from the data in
as quickly as possible. This means that they can focus Table 9.6.
on these specific activities and make sure they do not 2 What is the critical path?
overrun. At the same time, the amount of float time on 3 Calculate the total float and free float for each of the
non-critical activities can be calculated. While managers activities in the network.
cannot ignore these activities entirely, it may not matter
so much if they overrun (provided they do not use up
all their float time). It may even be possible to transfer GLOSSARY TERM
labour and other resources from non-critical activities to
Liquidity measures the ability of a business to meet its
critical ones to ensure the latter are completed promptly. short-term debts.
» Managers may be able to produce items or develop
products more quickly than the competition, providing
the business with a possible competitive advantage.
By seeking to reduce the time taken for a project, Limitations of CPA as a management
network analysis is an important element of time-based
management. tool
» Managers can implement JIT ordering. Network analysis Although CPA can help business decision-making, it can
shows the ESTs for each activity. Using this information, have a number of drawbacks and limitations.
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» It relies on the estimates for the expected duration. » All projects must be managed properly if they are to be
If these prove to be inaccurate, the calculations for completed on time. Drawing up a network diagram is
ESTs and LFTs, and so the critical path analysis, may
be wrongly identified. The estimates may be incorrect
only the starting point. Managers must agree on who is
responsible for each stage of the project. They must be
9.3
because some managers may exaggerate how long an given the resources and budget to complete in the time
activity takes to make it easier for them to complete agreed. There must be an effective review system to
within the agreed time. On the other hand, some make sure the project is on schedule and to agree what
managers may be too optimistic, particularly if these action to take if it is not. A network diagram can provide
activities have not been carried out before. A more a valuable focal point for the management system, but
complex version of CPA, called programme evaluation it is up to the managers to make sure that everything

and review technique (PERT), includes a range of is implemented correctly and that each activity is
estimates for the durations of different activities. completed on schedule.
PERT produces a number of network diagrams based
on optimistic, pessimistic and most likely durations of
activities to take account of the fact that estimates STUDY TIP
cannot be completely relied on. Some students argue that because the estimates of the
» If JIT is used for the delivery of materials, the ability durations of activities can be wrong, or because changes
to complete the project on time will depend on the can happen to delay activities, this means that network
reliability of suppliers. If they are late, this will prevent diagrams are useless. In fact, it is because things can go
the next activity starting on time. wrong that these diagrams are so important – because
you have planned out what is expected to happen, this
» CPA simply shows the quickest way to complete a
means that if something does go wrong it is possible to
project; it does not guarantee that this is the right
quickly calculate the effect of this on the project and take
project to be undertaking in the first place. It may be
appropriate action.
that the firm’s resources could be used more effectively
elsewhere.
CASE STUDY
National Programme for IT
An ambitious multibillion pound programme to create a The problem, say analysts, is that the project was too
computerised patient record system across the entire ambitious and the technology kept changing. The result
UK National Health Service (NHS) was scrapped in 2010. was that a lot of money was wasted that could have been
The £12.7 billion ($21.8 billion) National Programme for spent on nurses and improving patient care. The project
IT was ended after years of delays, technical difficulties, has not delivered as targets on dates, functionality,
contractual disputes and rising costs. The UK government usage and levels of benefit have been delayed and
decided it was better to discontinue the programme rather reduced. Providers of NHS care, such as hospitals and GP
than put even more money into it. An announcement was surgeries, will now be told to strike IT deals locally and
expected for months after the National Audit Office cast regionally to get the best programmes they can afford.
serious doubt on the wisdom of ploughing further money
into the scheme. Questions
1 Analyse two reasons why this project was scrapped. [8]
2 Evaluate the possible reasons why this project
went wrong. [12]
whether the firm has or is willing to invest in the necessary

Other issues in CPA resources.
Before a project is started, managers must agree on a
definition of success. They must set out exactly what Managers will also be interested in the utilisation of
they want to achieve, otherwise subordinates may cut resources throughout the project. It may be that certain
corners to get the project done on time. The result may be activities could be undertaken simultaneously but that,
that the project is completed quickly but the quality is poor. as a result, some weeks would require very high levels of
personnel, whereas in other weeks very few people would be
Managers must also agree on what resources and spending needed. If it adopted such an approach, a firm may have to
they are willing to commit to the project. Obviously, the bring in extra staff for the busy weeks and pay its existing
quickest way of completing a project will depend on what staff to do little in the other weeks. Rather than have such
facilities and resources are available and how much the fluctuations in staffing levels, managers may want to shift
firm is willing to invest into getting it completed. With activities around; this may mean that the project takes a
more people, more money and more machines, the project bit longer, but it may nevertheless be more desirable if it
could probably be speeded up. Whether particular activities means that its full-time staff are fully employed each week.
can be conducted simultaneously will often depend on
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CASE STUDY
9.3
China’s Belt and Road Initiative
China’s Belt and Road Initiative is a huge investment Moscow New Silk Road
Rotterdam Maritime Silk Road
project to promote trade. It aims to connect six main
economic corridors, creating transport links in China,
Trieste Samarkand
Mongolia and Russia, Eurasian countries, central
and west Asia, Pakistan, other countries of the Indian Xian
subcontinent and Indochina. China has provided billions
Fuzhou
of dollars for this massive construction project. The Kolkata
investment will significantly improve the infrastructure
in these regions and help markets to develop, with better
Nairobi
transport for supplies and exports. The programme
includes investment in trains, roads and ports. It has been
called China’s New Silk Road (the original, ‘Maritime Silk ▲ Figure 9.21 China’s Belt and Road initiative
Road’ was an ancient trading route across the world).
For example:
Question
● In Uganda, China has built a 50 km (30 mile) road to the 1 Evaluate the benefits of operations planning to the
international airport. businesses involved in China’s Belt and Road
● In Tanzania, China is investing in creating the biggest Initiative. [12]
port on the continent.
● In Europe, Chinese firms have bought 51 per cent of
the port authority of Piraeus, near Athens.
TEST YOUR LEARNING

this production system is to completely eliminate waste.
Short answer questions Toyota sets out to make vehicles ordered by customers in
1 Explain one way in which operations decisions are the quickest and most efficient way, as swiftly as possible.
affected by another business function. [3]
The TPS was established based on two concepts:
2 Explain one reason why operations flexibility can help
a business compete. [3] ● ‘jidoka’ (which translates as ‘automation with a human
touch’). This means that when there is a problem, the
3 Define the term ‘process innovation’. [2]
equipment halts immediately, preventing any further
4 a Define the term ‘enterprise resource planning’. [2]
errors
b Explain one benefit of enterprise resource
● just in time, whereby exactly what is needed (and no
planning to a business. [3]
more) is produced in a continuous flow.
5 Explain two ways in which lean production can
increase the profits of a business. [6] Toyota says that ‘TPS and its approach to cost reduction
6 Explain one way that adopting just-in-time production are the wellsprings of competitive strength and unique
might affect inventory control. [3] advantages for Toyota’. The company believes in making
only ‘what is needed, when it is needed and in the amount
7 a Define the term ‘network diagram’. [2]
needed’. To be able to fulfil a customer order as quickly as
b Explain one benefit of constructing a network
possible, the vehicle must be quickly and efficiently built by
diagram. [3]
following these principles:
8 Define the term ‘dummy activity’. [2]
1 When a vehicle order is received, production instructions
9 Define the term ‘free float’. [2] are issued to the beginning of the vehicle production line
10 a Explain one benefit of using critical path analysis as soon as possible.
as a management tool. [3] 2 The assembly line is stocked with the required number of
b Explain one limitation of using critical path analysis all necessary parts so that any kind of ordered vehicle can
as a management tool. [3] be assembled.
3 The assembly line must replace the parts used by
Data response question retrieving the same number of parts from the parts-
producing process.
Toyota 4 The preceding process must be stocked with small
Toyota is widely recognised as the founder of lean- numbers of all types of parts and produce only the
production techniques. These form the essence of what is numbers of parts that were retrieved by an operator from
known as the Toyota Production System (TPS). The aim of the next process.
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According to Toyota, ‘waste can manifest as excess 2 Explain two factors necessary for just in time to
inventory, extraneous processing steps and defective
products, among other instances. All these waste
succeed at Toyota.
3 Analyse two reasons why quality circles would be
[6]
9.3
elements intertwine with each other to create more useful to Toyota. [8]
waste, eventually impacting the management of the 4 Analyse two ways that enterprise resource planning
corporation itself.’ would benefit Toyota. [8]
Toyota says that, through the philosophies of ‘Daily 5 Toyota produces new models of car every few years.
Improvements’ and ‘Good Thinking, Good Products’, Evaluate the benefits of critical path analysis for
TPS has developed into a world-famous production Toyota when developing a new car. [12]
system. All Toyota production divisions continue to 6 Evaluate the importance of lean production to

make improvements to TPS, day and night, ‘to ensure its Toyota’s success. [20]
continued evolution’.
Essay questions
Source: https://global.toyota/en/company/vision-and-philosophy/
production-system 1 Evaluate the benefits of using critical path
analysis when undertaking a new project to
Questions build a factory. [20]
1 Explain two benefits of just in time for Toyota. [6] 2 Evaluate whether effective project management
is the key to business success nowadays. [20]
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A LEVEL
10.1
Financial statements
A LEVEL 10.1 Financial statements
Chapter overview
★ the meaning, purpose and contents of a statement of profit or loss
★ changes in financial statements and their effects
★ the meaning, purpose and contents of a statement of financial position
★ changes in financial position and the links between the two types of financial statement
★ inventory valuation
★ depreciation.
Public companies in the UK and many other countries are

required to prepare financial statements complying with 10.1.1 Statement of profit or loss
the International Financial Reporting Standards (IFRS).
This encourages a more global approach to the presentation What is profit?
of financial data, making comparisons and analysis more At its simplest, profit is what remains from revenue once
straightforward. Despite this, there are some differences in costs have been deducted. However, in the construction of
the ways that companies choose to present data in financial the statement of profit or loss, three main types of profit
statements, and you may notice some minor variations in are identified:
the examples we look at in this chapter. 1 Gross profit This form of profit is calculated by
deducting cost of sales, such as materials and shop-floor
Businesses produce a range of financial statements that labour (also termed direct costs), from a business’ sales
record their financial performance over a given trading revenue. This gives a broad indication of the financial
period. For many companies around the world, this is a legal performance of the business without taking into account
requirement. We shall look at two financial statements in other costs, such as expenses.
this chapter: 2 Operating profit This is a further refinement of the
» statements of profit or loss (also called income concept of profit and is revenue less cost of sales
statements) and expenses, such as rent and rates. This is a better
» statements of financial position (previously called indication of the performance of a business over a
balance sheets). period of time as it takes into account most costs
incurred by a firm over a trading period.
STUDY TIP 3 Profit for the year This measure of profit takes into
When considering statements of profit or loss and account a business’ income from all of its sources,
statements of financial position, do think about them trading and non-trading, and the full range of costs
from the perspective of a variety of stakeholders. It incurred including taxes on profits and interest
may be natural to consider them from the standpoint of charges. A business’ managers can decide how to
shareholders and suppliers, but think of the conclusions utilise profit for the year, and they may decide to pay
that employees and customers may draw from the same dividends to shareholders or to retain profits within
financial information. the business.
GLOSSARY TERMS
A statement of profit or loss is a financial statement Profit can be defined in a number of ways, but it is
showing a firm’s sales revenue over a trading period and all essentially the surplus of revenues over costs.
the relevant costs generated to earn that revenue. A loss is a situation where a business’ expenditure exceeds
A statement of financial position is a financial statement its revenue over a specific trading period.
recording the assets (possessions) and liabilities (debts) of
a business on a particular day at the end of an accounting
period.
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The contents of a statement of There is no single format for a limited company’s
statement of profit or loss. In the UK, the Companies Act
profit or loss
Figure 10.1 provides an initial guide to the contents of a
of 2006 sets out the minimum amount of information
that must be included, though some modification can
10.1
statement of profit or loss as presented by most companies. be made to ensure a ‘true and fair view’ of the business’
Negative figures are normally shown in brackets on financial performance.
statements. However, this is not always the case, as is The accounts of public limited companies also contain
shown in the extract from Marks & Spencer Plc’s statement notes giving further details of the figures included in
of financial position on page 437. the statement of profit or loss. This depth of information
The statement of profit or loss comprises three main is important to allow shareholders and other interested
10.1.1 Statement of profit or loss

sections: parties to make an accurate assessment of the financial
1 Firstly, gross profit is calculated. This is the difference performance of the business.
between the revenue figure (sometimes called sales
revenue or turnover) and the cost of the goods that BUSINESS’ REVENUE
have been sold. The latter is normally expressed from sales
simply as ‘cost of sales’. This element of the statement minus
of profit or loss is sometimes called the trading
COST OF SALES (such as Cost of sales is often referred to
account.
fuel and raw materials) as ‘direct costs’.
2 Secondly, operating profit is calculated. This is
calculated by deducting the main types of expenses, gives
such as administration and selling costs. Gross profit is a broad measure of
3 The final stage of the statement of profit or loss is to GROSS PROFIT
profit that ignores some costs.
calculate profit for the year. This is arrived at by deducting
minus
the amount of tax payable for the year and any interest
Other examples include expenditure
paid while adding interest received. The profit for the EXPENSES (such as
on security and wages for
year figure shows the net amount that has been earned rent and managers’ salaries)
administrative staff.
for the shareholders. If the figure is negative (that is, gives
all costs and expenses exceed revenues for the year, Operating profit is a fair measure of
as in the case of Rolls-Royce below), this is termed loss OPERATING PROFIT performance as it excludes
for the year. non-trading activities.
making
Public limited companies are required by law to publish allowance for
their accounts. This means that they are available for INTEREST paid and received Companies pay corporation tax
scrutiny not only by the owners (shareholders), potential by the firm, profits on taxation on their profits.
investors and bankers but also by competitors. When
a company draws up its statement of profit or loss for
external publication, it will include as little information as PROFIT FOR THE YEAR
possible. Public limited companies usually supply no more
detail than is required by law. ▲ Figure 10.1 The contents of a statement of profit or loss
CASE STUDY
Rolls-Royce
Rolls-Royce Holdings is one of the UK’s best-known It sells its products throughout the world for commercial
companies and employed 50 000 mainly highly skilled and military use. Rolls-Royce operates joint ventures with
people in 2020. It manufactures engines for aircraft, companies in Germany.
ships and more general business use. It spends heavily
Rolls-Royce Holdings Plc’s statement of profit or loss is
on researching and developing new products and is the
shown in a summarised form in Table 10.1.
world’s second-largest manufacturer of aircraft engines.
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▼ Table 10.1 Rolls-Royce’s summarised statement of profit or loss
10.1 Summarised statement of profit or loss for Rolls-Royce Holdings Plc (years ended 31 December 2018 and
31 December 2019)
2019 (£m) 2018 (£m)
Revenue 16 587 15 729
Cost of sales (15 645) (14 531)
Gross profit 942 1 198
Research & development expenses (770) (768)

Other expenses (1 024) (1 591)
Operating loss (852) (1 161)
Profit from other sources 139 358
Finance income (interest received) 252 271
Finance costs (interest paid) (430) (2 415)
Taxation (420) 554*
Loss for the year (1 311) (2 393)
* Rolls-Royce Holdings Plc received a substantial tax credit in 2018.

Source: Rolls-Royce Holdings Plc Annual Report, 2019; www.rolls-royce.com/~/media/Files/R/Rolls-Royce/
documents/annual-report/2019/2019-full-annual-report.pdf
Questions
1 Analyse one reason why Rolls-Royce’s employees may 2 Evaluate whether or not Rolls-Royce’s shareholders
be extremely concerned about the company’s financial would have been pleased with the company’s financial
performance over these two years. [4] performance in 2019. [20]
investment. Some owners want to see the company grow

HANDLING DATA over a number of years and to benefit from owning a share
of a more valuable business.
Suppose that Rolls-Royce Holdings Plc’s cost of sales
As Rolls-Royce Holdings Plc made significant losses in both
had been £15 324 million in 2019. Calculate its gross
2018 and 2019, the company’s management team had to
profit, operating profit and loss for the year, assuming
no other changes.
make a difficult decision about whether to pay dividends
to shareholders using profits from previous years or by
borrowing. The team decided to pay dividends of 11.7 pence
per share in both years.
How might a business use its profits?
One of the most important decisions taken by a business is
how to use its profits, assuming that it makes any. The uses GLOSSARY TERM
of profits can be divided into two categories: Assets are items owned by a business, such as cash in the
» Distributed profits These profits are paid to the owners bank, vehicles and property.
of the business and this will be in the form of dividends
if the business is a company.
» Retained profits (or earnings) This portion of a Factors that can cause amendments in
business’ profits is kept for investment in the business.
Such profits may be used to purchase assets to help statement of profit or loss
the business trade in the future. Examples include 1 Changes in selling prices If a business raises or reduces
machinery, vehicles or properties. its prices, it is almost certain that its sales revenue
will alter as a consequence. A key determinant of the
A key issue in distributing profits is the balance between
effect on sales revenue following a price change is price
the short term and the long term. Distributing a high
elasticity of demand. A business may be more inclined
proportion of profits may keep the business’ owners (most
to raise its prices if it believes demand is price inelastic.
likely shareholders) happy in the short term, but it might
In this situation, sales of a product are not particularly
not be in the interests of those wanting a long term
sensitive to price and thus a price rise may increase
revenue.
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2 Changes in the volume of products sold If a product An example of amending a statement of profit
becomes more or less popular, the amount that is sold
or loss
is likely to alter and so will the business’ sales revenue.
This may well be as a response to a price change, West Kericho Estate is a well-established tea plantation 10.1
although other factors such as changing fashions or in Kenya. It has recently prepared a draft of its statement
the entry of new products onto a market may also of profit or loss for the year, which is shown in Table 10.2
change the quantity of products that a business sells. as the original figures. However, the original figures were
Alternatively, the business may increase sales as a found to contain a number of errors:
consequence of entering a new market or launching a » The company actually sold 12 500 kg of tea.
new product. » The selling price of its tea averaged at $280 per kg over
3 Changes in costs A rise in cost of sales or expenses the year.
10.1.1 Statement of profit or loss

is likely to reduce the profit recorded on a business’ » Its administrative and other expenses were actually
statement of profit or loss, or it is likely to increase $901 500.
its losses. » The interest rates charged on the company’s loans rose,
increasing its interest charges by 20 per cent.
» The company’s directors decided to increase the
STUDY TIP dividends it paid to $175 475.
If the quantity of products sold by a business is adjusted,
These changes are shown in the right-hand column of
then it is likely to have a knock-on effect on the business’
Table 10.2.
costs. It is highly likely that the business’ cost of sales
will alter and some expenses may also change, such as
distribution costs. You must ensure that, when answering
questions on this topic, you alter costs when necessary.
▼ Table 10.2 West Kericho Estate’s original and amended statement of profit or loss
Original figures ($) Amended figures ($)

Revenue (12 400 kg @ $275 per kg) 3 410 000 3 500 000
Cost of sales (12 400 kg @ $160 per kg) (1 984 000) (2 000 000)
Gross profit 1 426 000 1 500 000
Administrative and other expenses (878 000) (901 500)
Operating profit 548 000 598 500
Finance income (interest received) 12 000 12 000
Finance costs (interest paid) (36 000) (43 200)
Profit before tax 524 000 567 300
Taxation (@ 25%) (131 000) (141 825)
Profit for the year 393 000 425 475
Dividends paid (136 000) (175 475)
Retained profits 257 000 250 000
There are a number of key points to note about these unit cost of production was unchanged at $160 per kg,
amendments: the overall cost of sales rises as output has increased.
» The new revenue figure is calculated by multiplying » Gross profit changes if either revenue or cost of sales
the company’s output of tea (in kg) by the average price alters.
per kg. » Finance costs increased by 20 per cent, which has an
» If output changes, then the cost of sales will alter too effect on the profit before tax figure.
because the quantity produced changes. Here, output » Finally, dividends were increased, leaving a slightly
rose from 12 400 kg of tea to 12 500 kg. Even though the smaller figure for retained profits.
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CASE STUDY
10.1
Malé Traders Ltd
Malé Traders Ltd is based in Mauritius and grows sugar. Its estimated statement of profit or loss is shown in Table 10.3.
▼ Table 10.3 Malé Traders Ltd estimated statement of profit or loss
Original figures ($)

Revenue (10 425 tonnes @ $470 per tonne) 4 899 750
Cost of sales (10 425 tonnes @ $290 per tonne) (3 023 250)

Gross profit 1 876 500
Administrative and other expenses (975 450)
Operating profit 901 050
Finance income (interest received) 45 675
Finance costs (interest paid) (102 300)
Profit before tax 844 425
Taxation (corporation tax @ 20%) (168 885)
Profit for the year 675 540
Dividends paid (380 000)
Retained profits 295 540
Malé Traders Ltd has updated the information used for Question
its statement of profit or loss. The cost of its goods sold
1 Analyse whether or not the company retained more
has been changed to $300 per tonne; its administrative
or less profit than shown in its original forecast. Use
expenses were $956 425 and it received $51 200 as
calculations to support your answer. [8]
interest on its bank accounts. The tax rate for profits was
altered to 22 per cent. Finally, its dividends paid were
unchanged.
The impact on a business’ profit or loss The factors which can cause a business’ profits to fall – or
its losses to increase – are the opposite of those listed
of changes in costs and prices above. All these factors are summarised in Figure 10.2.
It is very rare for a business to earn the same profit (or
make the same loss) in two successive years. This is because
the environment in which the business operates is always
changing. New competitors arrive, existing ones cease Rising
trading, governments change taxes on profits, and sales Increases in revenues profits – Reductions in costs
and consumers’ tastes change. All these factors, and many • higher prices or falling • lower cost of sales and/or
others, combine to impact on a business’ statement of profit • increased sales volumes losses expenses
• reduced rates of taxation
or loss.
Falling
Profits generally rise (or losses fall) if: profits –
» selling prices increase and not too many customers buy or rising
elsewhere Reductions in revenues losses Increases in costs
» sales volumes (the quantity sold) increase and prices • lower prices • higher cost of sales
remain stable or even rise • lower sales volumes and/or expenses
» cost of sales and/or expenses decline, or they increase at • increased rates of
a lower percentage rate than revenue taxation
» governments make favourable tax changes, normally ▲ Figure 10.2 A summary of factors affecting a statement
through reducing rates of taxation. of profit or loss
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10.1.2 Statement of financial 1 Non-current assets These are assets owned by a
business that it expects to retain for one year or more.
position Such assets are used regularly by a business and are 10.1
not bought for the purpose of resale. Examples of
A statement of financial position is a financial statement non-current assets include land, property, production
recording the assets (possessions) and liabilities (debts) of equipment and vehicles.
a business on a particular day at the end of an accounting 2 Current assets This category of asset is likely to be
period. It was previously called a balance sheet and many converted into cash before the next statement of
companies, for example Rolls-Royce, still use this term. The financial position is drawn up. Therefore, cash and
statement of financial position only represents a picture inventories (previously called stock) are examples of
of a business’ assets and liabilities at a moment in time – current assets, as they are only retained by the business
10.1.2 Statement of financial position

it is commonly described as a ‘snapshot’ of the financial for a short period of time.
position of an organisation. Because of this, statements
of financial position always carry a date on which the
valuation of assets and assessment of liabilities took Liabilities
place. A consolidated statement of financial position is a A liability is a debt owed by the business to organisations
statement of financial position for a business that includes or individuals. Another way of thinking about a liability is
information from all its divisions. that it shows the sources of capital the business has raised
in order to purchase its assets. As with assets, there are a
number of categories of liabilities:
Key statement of financial position relationships » Current liabilities In many senses, these are the
1 Assets = Liabilities equivalent of current assets. They represent debts owed
This is the fundamental relationship which helps to explain
by the business due for payment within one year or less.
why the statement of financial position ‘always balances’ Examples of such short-term debt are overdrafts and
2 Total assets = Current assets + Non-current assets taxes due for payment. Trade and other payables are
organisations such as suppliers to whom the business
Businesses need to invest in a range of assets if they
are to operate efficiently owes money. These are normally classified as a current
liability because payment is usually due within a short
3 Liabilities = Share capital + Borrowings + Reserves
period of time.
» Non-current liabilities These are debts that a business
▲ Figure 10.3 Key statement of financial position does not expect to repay within the period of one year.
relationships
Mortgages and bank loans repayable over the course
By recording assets and liabilities, the statement of of several years are common examples of this type of
financial position sets out the ways in which the business liability.
has raised its capital and the uses to which this capital » Equity It may seem strange that the money invested
has been put. The statement of financial position provides into the business by its owners (shareholders in the
a great deal of information for those with an interest in a case of a company) is a liability. However, if the
business, and it is the primary financial document published company ceased trading, shareholders would hope for
by businesses. the repayment of their investment. Thus, these funds
(called ‘total equity’ or ‘total shareholders’ equity’) are
Statements of financial position are an essential source liabilities. This element of the statement of financial
of information for a variety of business decisions and for position also includes reserves. These are the company’s
a number of stakeholders. The precise information drawn accumulated, retained profit.
from the statement of financial position will depend upon
the stakeholder and the nature of their enquiry. We shall
consider the users of financial information later in this GLOSSARY TERM
chapter. Equity is the shareholders’ stake in a company. It is the
balance that shareholders would receive if a company sold
Assets its assets and repaid all liabilities.
An asset is simply something that a business owns. Assets
are what a business purchases with its capital. There are
two main categories of assets that appear on the statement Net current assets and net assets
of financial position. The distinction between the two Net current assets are calculated using the following
categories is based upon the time the assets are held within formula:
the business.
net current assets = current assets – current liabilities
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The figure that is calculated is also known as ‘working Some profits paid to owners (Dividends to
capital’. Many firms aim to have current assets which are shareholders if a company)
10.1 twice the level of current liabilities, though businesses

in some industries operate efficiently with lower ratios.
However, if current liabilities are greater than current
assets, then the figure will be in brackets.
Successful trading period
A business’ net assets can be calculated by totalling
the business’ assets and subtracting the business’ total
liabilities. Thus:
Some profits
net assets = (non-current assets + current assets) retained in business

– (non-current liabilities + current liabilities)
This is one way of calculating the value of a business.
Net assets represent what would be left to the owners of Reserves
a business if all its assets were sold and all its liabilities Retained profits
accumulated over time
paid. Net assets are sometimes called ‘net assets employed’.
Figure 10.5 shows how they can be calculated.
Reserves Figure for reserves rises

representing a liability and balancing
Retained profits invested
in assets and hence the
the rise in the value of assets value of assets rises
An important feature of a statement of financial position
is reserves. Reserves are simply profit accumulated during ▲ Figure 10.4 Assets, liabilities and reserves
previous years’ trading and not paid out to the owners of the
business. This accumulated profit is not held in the form of
cash, but it is invested into a range of assets that are useful The format of a statement of financial
to the business and will hopefully generate further profits. position
If a business is successful, purchases more assets and Presenting the data for a statement of financial position
grows, then its value will increase and so will the value of in a vertical format (as in Figure 10.5) is the most common
the assets. It may borrow money to achieve this growth; if format used, and all public companies in the UK are legally
it does, liabilities will grow at the same rate. However, if it obliged to present their statement of financial position
funds its growth out of profits, then the matching liability this way.
will be recorded as reserves, indicating that the owners’
stake in the business has risen in value. Remember that
the owners’ funds in the business are a liability, as they
represent money lent to the organisation.
£m
Assets are listed in order of liquidity – illiquid (difficult to turn into cash) first. Non-current assets 320
Comparing short-term (current) assets and liabilities gives information on the Current assets 165
business’ cash position. If net current assets is positive, the business should be
able to pay its way. Current liabilities (85)
Net current assets are also known as Net current assets 80

working capital.
Non-current liabilities records money borrowed long term by the business. Non-current liabilities (130)
Net assets shows the worth of the business. Net assets 270
Total equity is the money invested by the business’ shareholders. Total equity 270
▲ Figure 10.5 The format of a statement of financial position
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CASE STUDY
10.1
Marks & Spencer Plc
Marks & Spencer Plc is a well-known retailer in the UK. It sells clothing, food and household goods (such as furniture)
through 1463 stores and its website.
▼ Table 10.4 A summarised consolidated statement of financial position for Marks & Spencer Plc
Summarised statement of financial position for Marks & Spencer Plc, 28 March 2020 and 30 March 2019
10.1.2 Statement of financial position

2020 (£m) 2019 (£m)
Non-current assets 8 968.9 7 415.9
Inventories 564.1 700.4
Trade receivables and cash 546.4 552.6
Other current assets 104.5 182.1
Total current assets 1 215.0 1 435.1
Total assets 10 183.9 8 851.0
Trade and other payables 1 426.4 1 424.4
Other current liabilities 423.0 900.5
Total current liabilities 1 849.4 2 324.9
Non-current liabilities 4 626.0 4 056.9
Total liabilities 6 475.4 6 381.8
Net assets 3 708.5 2 469.2
Share capital 1 398.0 823.2
Reserves and retained earnings 2 310.5 1 646.0
Total equity 3 708.5 2 469.2
Note: Unlike many companies, Marks & Spencer does not Questions
use brackets for liabilities figures on its balance sheet.
1 Calculate Marks & Spencer Plc’s net current assets
Source: Marks & Spencer Annual Report 2020; https://corporate. figures for 2019 and 2020. [4]
marksandspencer.com/documents/msar2020/m-and-s_ar20_ 2 Evaluate the value of the information in this statement
financial-statements.pdf of financial position to a bank considering offering
Marks & Spencer a £250 million loan. [12]
value of its non-current assets on the statement of

Amending statements of financial financial position. The compensating amendment could
position take a number of forms:
When amendments are made to a statement of financial • The business’ cash balance may fall by the same
position, there are often knock-on effects because of the figure, leaving the figure for total assets unchanged.
system of double-entry that is used to draw up a statement • The business may arrange a long-term loan to pay for
of financial position. This double-entry system is used the new assets, causing a rise in liabilities to match
because, as we saw in earlier, a statement of financial the increased value of assets.
position must always balance between assets and liabilities. • Similarly, additional shares may be sold, causing an
Therefore, if a change is made to either assets or liabilities, increase in total equity which represents a liability
there has to be a compensating change to ensure that the to the company.
balance is maintained. » The business repays a long-term loan This action will
initially reduce the company’s liabilities on its statement
There is a range of actions a business might take which of financial position. The compensating amendment
would affect its statement of financial position. For could be one of the following:
example: • The business sells additional shares to raise the
» The purchase of non-current assets If a business funds to repay the loan. Thus, the two changes to
purchases non-current assets, such as property or the company’s liabilities will cancel one another out
vehicles, then the initial effect will be to increase the on the statement of financial position.
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• The business sells an asset to generate the finance retained earnings (and therefore total equity) of the
to repay the loan. This would lower the company’s same amount.
10.1 assets by the same amount, as its liabilities are
reduced.
A wide range of other transactions will affect the statement
of financial position, such as the sale of inventories or
» The business reduces the value of some non-current
the use of an overdraft. The compensating amendments
assets on its statement of financial position This
here may be a rise in the amount of cash held in the
is a common action taken by a business and is termed
company’s bank account and a rise in current assets, such
depreciation (we will look at this in more detail later
as inventories, which may have been purchased using the
in this chapter). In this case, the balancing amendment
overdraft facility.
is likely to be a reduction in the figure for reserves and
CASE STUDY
Belem Manufacturing Ltd
▼ Table 10.5 The company’s managers need to incorporate a number of
changes into the figures shown in Table 10.5. These are:
Belem Manufacturing Ltd statement of financial ● The company has taken out an additional loan of $10
position as at 30 November million and has purchased vehicles with this capital.
$m ● Some of the company’s customers (receivables) paid
early – this amounted to $100 million.
Non-current assets 6 977 ● The company’s property has increased in value by
Inventories 1 500 $150 million due to general rises in property prices.
Receivables 1 075 The managers recognise that each of these changes will
need a compensating change to ensure that the statement
Cash 1 000
of financial position still balances.
Total current assets 3 575
Questions
Total assets 10 552
1 Calculate a revised statement of financial position
Current liabilities (4 720) based on these changes and ensure that it still
Net current assets (1 145) balances. [8]
2 Evaluate the extent to which these changes have
Non-current liabilities (1 041)
strengthened the company’s financial position. [12]
Net assets 4 791
Share capital 1 860
Reserves and retained earnings 2 931
Total equity 4 791
The relationship between items in stakeholders with a figure which allows them to judge the
value of the business with some degree of certainty.
the statement of profit or loss and
the statement of financial position The difficulties of valuing inventories
There are a number of ways in which the information in It can be difficult to value inventories accurately for a
a business’ statement of profit or loss is related to that number of reasons:
included in its statement of financial position. These are » Some inventory may lose value because it is perishable.
explored later in this chapter on page 442. For example, foods may lose value as they approach the
end of their saleable life. This may make the valuation of
inventory a more complex task, as inventory of different
10.1.3 Inventory valuation ages may have different values.
Inventories used to be called stock. In recent years, » Inventory may be a fashion product and therefore of less
businesses across the globe have tried to minimise (or more) value as tastes and fashions change.
inventories, recognising that they can be costly to store » When valuing certain inventories, it can be difficult to
and manage and that they have the potential to tie up large define a market price as part of the use of the
amounts of cash. net realisable value (NRV) method, which we will
discuss below. For example, a business selling antique
It is important that a business values its inventories furniture may experience problems in determining an
accurately on its statement of financial position to provide
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accurate figure for some items of furniture, especially 1 Firstly, calculate the total value of all inventories held
those that are unusual. With other products, such as by the business. This is simply the amount the company
works of art, it may be that valuations differ between
different people.
could sell its assets for on the open market. As an
example, take a business that manufactures cans and
10.1
» Valuations can be affected by a range of external bottles for use in the food industry. On the day its
factors. For example, a business’ valuation of its statement of financial position is drawn up, it might
inventories of oil could vary considerably as the global have the following inventories:
oil price alters. In the first six months of 2020 alone, – 2 000 000 cans as inventory that are sold for $0.30
global oil prices varied between a maximum of $63.27 each to other businesses
per barrel and a minimum of $11.57 per barrel. – 500 000 small bottles each with a selling price of
$0.40
10.1.3 Inventory valuation

– 600 000 large bottles which can be sold for $0.60 per
STUDY TIP bottle.
Although there are a number of methods of valuing The total value of the inventory is (2 000 000 × $0.30)
inventory, you only need to know the net realisable value + (500 000 × $0.40) + (600 000 × $0.60) = $600 000 +
(NRV) method. $200 000 + $360 000 = $1 160 000.
HANDLING DATA
GLOSSARY TERMS What would be the total value of the inventory above
Depreciation is the reduction in the value of a non-current if all bottles were valued at $0.50, assuming no other
asset over a period of time changes occur?
The net realisable value (NRV) method is a means of
valuing inventories (or other assets) at the amount that
would be raised by selling them, less any costs involved in 2 Next, the costs incurred in selling each asset the
the sale of the inventories. company possesses must be deducted. This would
include the cost of advertising the goods for sale and
the expenses involved in distributing these products.
Continuing our example, we could assume the cost of
The NRV method of valuing advertising and distributing the cans and bottles is
$85 000.
inventories 3 The final stage entails deducting the costs associated
There are a number of methods of valuing inventories, but with selling the products from the revenue raised from
we shall concentrate on a single one – the net realisable their sale. Thus NRV = $1 160 000 – $85 000 = $1 075 000.
value (NRV) method. This approach values inventories at
their likely selling price after allowing a reasonable amount The NRV method is widely used to value inventories
for the costs associated with either the eventual sale or in businesses throughout the world. The International
the disposal of the asset. It is a commonly used method Financial Reporting Standards’ (IFRS) accounting rules
of valuing inventories so as to ensure that they are not require businesses to value inventory using the NRV method
overvalued or undervalued on a business’ statement of unless the cost of buying the inventories is lower. In other
financial position. words, IFRS rules state that inventories should be valued
at cost or NRV, whichever gives the lower figure. Hence,
There are a number of stages in calculating the value of inventory that is difficult to sell may have a very low value
inventories using the NRV method: in the statement of financial position.
CASE STUDY
Goch Minerals Company
Goch Minerals Company is a mining company which realised by the company for gold rose from $1529 to
operates a number of mines in South America. Its mines $1730 over the same time period. The company valued its
include the Crib Gold Mine in Honduras, the Sao Cisco and inventories using the NRV method.
Sao Porto gold mines in Brazil, a copper mine in Mexico
and recently-opened copper and iron ore mines in Brazil. Questions
Its products are used by a wide range of manufacturing 1 Analyse one reason why inventory valuation is a
businesses. particularly important issue for manufacturing
businesses. [4]
The company announced its trading figures for the third
2 Evaluate why the use of the NRV method of inventory
quarter of 2020, stating that its revenue fell by 9 per cent
valuation might be a good choice for the Goch Minerals
compared with the same trading period during 2019. The
Company. [12]
company mined 50 101 ounces (1420 kg) of gold during
the first half of 2020. The price per ounce (28.3 grams)
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10.1.4 Depreciation business recorded on the statement of financial position
is a relatively accurate indication of the true worth of
10.1 A business may engage in revenue or capital expenditure
as we saw in Chapter 5.1. However, only capital expenditure
the business.
» Depreciation also allows firms to calculate the true
has any relevance to the process of depreciation. cost of production during any financial year. Singapore
Depreciation is the reduction in the value of a non-current Components Ltd would have overstated its costs in 2017
asset over a period of time. Thus, a manufacturer may if it had allocated the entire cost of its new equipment
purchase production-line equipment and reduce its value to that particular financial year. By depreciating the
as shown in Table 10.6. equipment by $20 000 each year for four years, one
quarter of the cost of the equipment is recorded each
▼ Table 10.6 The principle of depreciation
year on Singapore Components Ltd’s of profit or loss.
Singapore Components Ltd This helps to gain an accurate view of the profitability
(or otherwise) of the business over the lifetime of the
Year Value of asset on Amount
equipment.
statement of financial depreciated
position at end of year ($) annually ($)
GLOSSARY TERM
2017 60 000 20 000
Capital expenditure (CAPEX) is the money spent by
2018 40 000 20 000 businesses on physical assets such as property or
2019 20 000 20 000 machinery.
2020 0 20 000
Table 10.6 illustrates the effects of depreciation on the Depreciation: a non-cash expense
statement of financial position and the statement of profit Depreciation is an expense or a cost to a firm that is
or loss of Singapore Components Ltd. The initial cost of recorded on the statement of profit or loss. However,
the production-line equipment in 2017 was $80 000. The depreciation is unusual in that it is a non-cash expense.
company expects that this equipment will last for four years Depreciation does not require a business to make any
and have no resale value. The effect on the accounts is payment. It is recognition of the cost of providing a
shown in the table. The value of the asset falls by $20 000 particular expense normally made at the time the asset was
each year, reflecting its decline in value. The amount of purchased. Depreciation is not a method of providing the
the decline in value (that is, depreciation) is shown as cash necessary to replace the asset at the end of its useful
an expense on Singapore Components Ltd’s statement life.
of profit or loss.
Calculating depreciation: the straight-
HANDLING DATA line method
Recalculate the asset value and amount of annual This is a simple method of depreciation that reduces the
depreciation in Table 10.6, assuming that annual value of a non-current asset by the same amount each year,
depreciation is 20 per cent of the initial cost of the until the asset is of no further use and is sold or scrapped.
equipment. This method of depreciation can be calculated by using the
following formula:
Firms have to depreciate their non-current assets for a annual straight-line cost of machine – residual value
number of reasons: =
depreciation working life in years
» To ensure the business is valued accurately. In the
case of Singapore Components Ltd, it would have been The residual value of a non-current asset is the amount
incorrect to show the value of the production-line received when the asset is no longer required and is sold.
equipment as $80 000 throughout its life. Its resale
value would decline for a number of reasons: Assessing straight-line depreciation
– The equipment would lose value as a result of wear
and tear. Straight-line depreciation offers a number of advantages to
– The production of more modern equipment would the managers and other stakeholders of a business:
mean that the value of this ‘older’ style of equipment » It is very simple to calculate and equally easy to
declines. understand. The value of a non-current asset can be
– Poor or inadequate maintenance of the equipment seen to steadily decline in the business’ statement of
may mean expensive repairs are necessary, further financial position.
reducing the equipment’s value. » It spreads the cost of an asset over its working life,
» Thus, reducing the value of a non-current asset in line which is important if a business is to have an accurate
with the factors above ensures that the value of the view of its financial performance.
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However, this approach to depreciation has a fundamental » Depreciation provides an accurate value of a business’
shortcoming. Its simplicity is its principal weakness. Few assets throughout their lives. This allows for a ‘true and
assets lose their value steadily over a period of time. It is
much more common for an asset to lose value more heavily
fair’ assessment of the overall worth of the business at
any time. Having an accurate figure for the overall value
10.1
in the early years of its life. Thus, the straight-line method of the business is important for stakeholders, such as
may overvalue a non-current asset in the early years of investors and creditors.
its life. This is particularly true of vehicles and other » The amount of annual depreciation affects the overall
technology products. value and profits of a business, as shown in Table 10.7.
Why is depreciation important?
10.1.4 Depreciation
Depreciation is an important matter to businesses for a
number of reasons:
▼ Table 10.7 The effects of depreciation
Too much depreciation Too little depreciation

Effects on statement of financial Non-current assets valued at less than their Non-current assets on the statement of
position true worth, meaning that the true value of financial position will be overvalued,
business is understated giving a false impression of the
company’s worth
Effects on statement of profit or Depreciation expenses overestimated on Low rates of depreciation will reduce the
loss statement of profit or loss, reducing level of expenses incurred by a business. This will
profits result in a business’ profits being higher
than they would otherwise be
Wider effects Business may look unattractive to prospective This may make the company more
investors. Tax liability on profits may attractive to investors, but it will also
be reduced, but tax authorities might increase its tax liability
investigate! Business may record surplus
when asset is finally sold
CASE STUDY
Depreciation at the nightclub
Alan Cork, managing director of Frenzy, a nightclub in depreciation entered as a cost on the statement of profit
Otago, New Zealand, has just authorised the purchase of or loss would also be $5000. This method of depreciation
a new sound system. The new system cost $18 000 and spreads the $15 000 cost of the sound system evenly over
Alan estimates that, in a rapidly changing world, he will the three years of its working life.
need to replace it at the end of three years. The company
supplying the sound system has advised Alan that the Questions
resale value after three years would be $3000. 1 Analyse one reason why this company should
depreciate its assets. [4]
As a result, the value of the new sound system on the
2 Evaluate whether or not the use of depreciation
statement of financial position of South Island Leisure Ltd
would strengthen South Island Leisure Ltd’s financial
(the company that owns the nightclub) would be reduced
position. [12]
by $5000 annually. At the same time, the amount of
The relationship between statements However, many of its figures are affected by transactions
recorded on the statement of profit or loss.
of financial position and statements of » Profit, dividends and retained earnings Any part of
the profit for the year which is not paid to shareholders
profit or loss as dividends is recorded as retained earnings or profits
We have seen that the statement of profit and loss on the statement of financial position.
summarises a business’ revenues and costs over a certain » Short-term borrowing If a business arranges a short-
period of time, and it shows the resulting profit or loss term loan, this will appear on the statement of financial
for that trading period. On the other hand, the statement position as a current liability. Although the loan itself
of financial position gives a snapshot of the business’ will not be shown on the statement of profit and loss,
financial position on a given day. It doesn’t show day-to- the interest payments on the loan will be recorded
day transactions or the current profitability of the business. there and will affect the profit for the year figure.
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» Depreciation We saw above that, as part of the process of Depreciation
depreciation, the value of non-current assets is reduced
10.1 on the statement of financial position and an expense
is recorded on the statement of profit or loss. This link Statement Statement
between the two statements is summarised in Figure 10.6. of of profit
» Inventories The method used to value inventory helps financial or loss
position The amount
to determine a business’ costs of sales and therefore its The value of
profit. The formula used in the statement of profit or by which the
many value
loss is: non-current
of non-current
assets
is reduced assets is
cost of sales = opening inventory
over time reduced

+ inventory purchases and their annually is
– closing inventory current shown as an
values are expense on
The value of closing inventory (that is, at the end of the recorded the income
each year statement.
trading period) depends on how inventory is valued on on the
the statement of financial position. The lower the value of statement
closing inventory, the higher the cost of sales, which results of financial
in lower profit. Conversely, a higher closing inventory position.
valuation results in lower cost of sales and higher profits. ▲ Figure 10.6 Depreciation – a link between the statement
The closing inventory figure will be included in the business’ of financial position and the statement of profit or loss
statement of financial position under current assets.
TEST YOUR LEARNING

6 a Define the term ‘depreciation’. [2]
b A non-current asset that was purchased for
1 a Define the term ‘statement of profit or loss’. [2] $880 000 is expected to have a residual value of
b Explain one effect on a statement of profit or $120 000 after 8 years, when it will be sold. Using
loss of a rise in the average selling price of a the straight-line method of depreciation, calculate
business’ products. [3] the annual depreciation figure for this asset. [3]
2 Explain one likely consequence for a business’ 7 Explain one reason why the straight-line method
gross profits of: of depreciation may result in a non-current asset
a a rise in its cost of sales. [3] having an incorrect value on a business’ statement
b a rise in its expenses. [3] of financial position. [3]
3 a Explain one reason why cost of sales is 8 A business sells a product for which demand is price-
likely to alter along with the level of output of a elastic. Explain one likely effect of a reduction in
business. [3] prices on its operating profits. [3]
b Define the term ‘non-current asset’. [2] 9 a Explain one way in which depreciation links the
4 Explain two reasons why the statement of financial statement of financial position and the statement
position is an important document for a business’ of profit or loss. [3]
stakeholders. [6] b Define the term ‘inventory’. [2]
5 a Explain one way in which a business might use 10 a Define the term ‘net realisable value method of
its profits. [3] valuing inventories’. [2]
b Explain one effect of a rise in the selling prices b Explain one effect that reducing the value of
of a business’ products on its gross profit. [3] inventory on a statement of financial position
might have on a business’ profits. [3]
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Data response question whether to supply the business, invest in its shares, lend
Saddlers – a growing supermarket business

it money or work for the business.
10.1
Saddlers is a large supermarket business, established Questions
more than 100 years ago. The public company has 1750 1 Analyse two reasons why it is important for Saddlers
stores and a fleet of 124 lorries which it uses to deliver to depreciate its assets. [8]
products from its warehouses to its stores. It has started 2 a Calculate the annual straight-line depreciation for
to deliver to individual customers and is purchasing vans the company’s vans, assuming they have a residual
to carry this out. The company pays $27 500 for each van value of $9500. [4]
and depreciates them over six years.
b Evaluate the extent to which Saddlers might face
10.1.4 Depreciation
Saddlers is respected for its extensive range of very fresh problems in valuing its inventory. [12]
fruit and vegetables. Saddlers purchases and stores huge 3 Evaluate whether Saddlers’ statement of financial
amounts of oil products to heat its buildings and fuel its position is more important to its stakeholders than
lorries. The company also sells non-perishable foods its statement of profit or loss. [20]
and has recently expanded into clothing and electrical
products. Essay question
The company’s stakeholders have to take a range of 1 Evaluate the extent to which the use of the straight-
decisions in relation to the business. They make use of line method of depreciation guarantees that a rapidly
its statement of financial position and statement of profit growing company includes accurate figures in its
and loss to allow informed judgements on issues such as statement of profit or loss. [20]
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A LEVEL
10.2
Analysis of published accounts
A LEVEL 10.2 Analysis of published accounts
Chapter overview
★ the calculation and interpretation of liquidity ratios, profitability ratios, financial efficiency ratios, the gearing ratio
and shareholder ratios
★ methods that businesses may use to improve ratio results.
We introduced statements of financial position and interest in the published accounts of a business for a
statements of profit or loss in the previous chapter. variety of reasons. For example, suppliers may want to judge
This chapter examines the use of a range of ratios to the financial position of a business to evaluate whether
analyse published accounts and to help to make informed they should offer the firm credit. Similarly, individuals
judgements of the financial performance of businesses. contemplating buying shares in the business may try
to assess the business’ potential to make profits in the
There are a number of groups that are interested in the
future. Figure 10.7 summarises stakeholder groups and their
financial information provided by businesses, especially
interest in a company’s financial performance.
by public limited companies. Collectively, these groups
can be referred to as stakeholders and they may take an
Accounting information
• statement of
financial position annual report and accounts
• statement of profit
or loss
Internal users External users

• Managers – Is this business achieving organisational objectives? • Suppliers – How much cash does the business have?
– Is it using resources efficiently? – Will it be able to pay its bills?
• Employees – Is the business stable and jobs secure? • Government – What is the tax liability of the business?
– Are they receiving fair pay in the light of the • Competitors – How is the business performing in relation
business’ performance? to other businesses?
• Shareholders – What is the return on their investment?
– How does this compare with alternative investments?
▲ Figure 10.7 Stakeholders and financial information
What is a financial ratio? GLOSSARY TERMS

Ratio analysis allows stakeholders to evaluate a business’
Ratio analysis is a technique for analysing a business’
performance through the investigation of key financial financial performance by comparing one piece of
statements, such as the statement of financial position accounting information with another.
and the statement of profit or loss. The major feature of
Liquidity refers to how easy it is to convert assets into
ratio analysis is that it compares two pieces of financial
cash without these assets losing value.
information. By comparing two pieces of data in this way,
it is possible to make more informed judgements about a
business’ performance.
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Types of ratio 3 Financial efficiency ratios measure the effectiveness
with which an enterprise uses the resources available to
There are a number of ways of classifying financial ratios
(see Table 10.8). One approach is to identify five main
it. These are also termed ‘internal control ratios’.
4 Gearing examines the relationship between internal and
10.2
categories of ratio:
external sources of finance. It is therefore concerned
1 Liquidity ratios, also known as solvency ratios, measure
with the long-term financial position of the company.
the ability of the business to settle its debts in the
5 Investment ratios measure the returns received by
short term.
the owners of the company, allowing comparisons with
2 Profitability ratios assess the amount of gross or
alternative investments. They are sometimes called
other profit made by the business in relation to the
‘shareholders’ ratios’.
business’ turnover or in relation to the assets or capital
10.2.1 Liquidity ratios

available to it.
▼ Table 10.8 Types of financial ratios
Type of ratio Liquidity Profitability Efficiency Gearing Investment

Ratios used • Current ratio • Operating profit • Inventory • Long-term • Dividend per
• Acid test (or margin turnover ratio loans: capital share
quick) ratio • Gross profit • Payable days employed • Dividend yield
margin • Receivable days • Price–earnings
• Return on capital
employed (ROCE)
Purpose of ratios To assess the To provide a To provide evidence To assess the To give investors
ability of the fundamental on how well the extent to which information on the
business to pay its measure of the managers have the business returns on their
immediate debts success of the controlled the is based on investment
business business borrowed money
Interested • Suppliers • Shareholders • Shareholders • Shareholders • Shareholders
stakeholders • Managers • Managers • Managers • Managers • Managers
• Competitors • Employees • Suppliers • Competitors
• Employees • Competitors
Sources of information for ratio analysis

The most obvious sources are the published accounts of
STUDY TIP
the business or businesses concerned. In particular, ratio Do take care to express the results of your ratio
analysis requires access to a business’ statement of financial calculations in the appropriate format. The section below
position and statement of profit or loss. However, although offers you guidance on this.
this might be essential information, it is not all that is
required to conduct an in-depth ratio analysis of a business.
Other possible sources of information include: Expressing ratios
» the financial performance of the business over Ratios are normally expressed in one of four forms, as we
recent years Having an understanding of the trends shall see in the following sections:
of ratios over time can assist in making judgements. 1 as days; for example, a business’ trade receivables may
A profitability ratio might appear fairly low, but be 43 days
if it represents a continuation of a steadily rising 2 as a percentage; for example, ROCE expresses operating
trend then the figure may be more acceptable to profit as a percentage of capital employed by the
stakeholders business
» norms or benchmarks for the industry The results 3 as a multiple; for example, inventories (stocks) may be
of ratio calculations should be judged against what turned over (or sold) five times a year
is normal for the industry. For example, an investor 4 as a ratio; for example, the acid test ratio might have a
might calculate that a company’s debtor day ratio is 35 result of 0.9:1.
days (the number of days, on average, that customers
take to settle their bills). This might be acceptable
for a manufacturing business but not for a fast-food
business These ratios allow managers and other interested parties
» data on the economic environment A decline to monitor a business’ cash position, and they can be
in profitability ratios might appear to reflect an calculated from data that is on the statement of financial
unsuccessful business. However, this might be more position. These ratios are important because even profitable
acceptable in the context of a severe economic businesses can experience problems with liquidity and may
recession, whereby sales and prices have declined. be unable to pay their bills as they fall due. This can, in
severe cases, threaten the business’ survival.
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Liquidity ratios measure the liquid assets held by a firm Using this ratio
(cash and other assets, such as receivables that are easily
For many years, holding current assets twice the value
10.2 convertible into cash). The value of these assets is then
compared with the short-term debts or liabilities the
of current liabilities was recommended. This is no longer
accepted, partly due to the use of computers in inventory
business will have to pay. In this way, stakeholders may
control and the widespread use of just-in-time systems of
evaluate whether the business’ performance may be harmed
production. A more typical figure might now be 1.6:1.
as a result of liquidity problems. Suppliers, as well as
managers, are likely to be interested in a business’ liquidity In spite of this, the ‘normal’ figure for this ratio varies
ratios, as they indicate its ability to pay money that according to the type of business and the state of the
is owed. market. Fast-food outlets, such as McDonald’s, and
banks typically operate with lower ratios, whereas some
GLOSSARY TERM manufacturing firms may have higher ratios.
Liquid assets are items owned by a business which can Firms with high current ratio values (say, 3:1) are not
be easily and quickly converted into cash. Examples necessarily managing their finances effectively. It may be
include shares and government bonds, which can that they are holding too much cash and not investing in
normally be sold quickly. non-current assets to generate income. Alternatively, they
may have large holdings of inventories, some of which
might be obsolete.
Current ratio
This ratio measures the ability of a business to meet its Acid test (or quick) ratio
liabilities or debts over the next year or so. The formula to This ratio measures the very short-term liquidity of a
calculate this ratio is: business. The acid test ratio compares a business’ current
liabilities with its liquid assets (that is, current assets
current ratio = current assets minus inventories). This can provide a more accurate
current liabilities indicator of liquidity than the current ratio, as inventories
can take time to sell. The acid test ratio measures the
The current ratio is expressed in the form of a ratio, for
ability of a firm to pay its bills over a period of two or
example 2:1. This would mean that the firm in question
three months without requiring the sale of inventory. Its
possessed $2 of current assets (cash, trade receivables and
formula is:
inventories) for each $1 of current liability (trade payables,
taxation and proposed dividends, for example). In these liquid assets
circumstances, it is probable that the business would be acid test ratio =
current liabilities
able to meet its current liabilities without needing to sell
non-current assets or raise long-term finance. The acid test ratio is also expressed in the form of a ratio;
for example, 2:1.
CASE STUDY
Chinese steel manufacturers face liquidity problems
With the Coronavirus (COVID-19) outbreak in 2020 severely largely improve from early March,’ said a manager at a
slowing demand and deliveries, China’s steel producers Hebei mill that has reduced its output by 30 per cent.
are running short of storage space and are facing liquidity
Mills also face a liquidity crisis from the sudden fall in
problems as they lack money to pay their workers.
steel sales. China produces vast quantities of steel and
Steel mills have tried to maintain output, targeting sales the steel manufacturers are losing at least $4.25 billion in
to the construction industry from early March. Steel sales revenue each day. The companies are turning to any
inventories peak annually in late winter, but in 2020 they financial means to acquire cash, including selling their
rose significantly higher than normal levels. cargoes of seaborne iron ore before they arrive in China.
Just one week saw a rise of 13 per cent in China’s Source: www.argusmedia.com/en/news/2074167-chinese-
total steel inventories, according to industry data. steel-producers-face-space-money-shortages
Some Shanghai warehouses are at full capacity, while
inventories in Lecong city are sitting at over 700 000 Questions
tonnes, which is beyond its warehouse capacity. 1 Analyse one reason why manufacturers may be
especially vulnerable to liquidity problems. [4]
The growth in inventory is largely due to the reluctance of 2 Evaluate the extent to which it is important whether
the steel mills to reduce their output. However, a survey or not a steel manufacturer holds a high level of
by Argus has shown that some mills have already cut their inventory. [12]
output by 10–50 per cent. ‘We think demand for steel will
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Using this ratio The results of the calculations in Table 10.9 show that
Tiffany & Co. has a very positive liquidity position. Its
Conventionally a ‘normal’ figure for the acid test ratio was
thought to be 1:1, giving a balance of liquid assets and
current ratio is 4.0:1, indicating that it has $4 of current
assets for every $1 of current liabilities it has to pay. This
10.2
current liabilities. However, in recent years many businesses
should enable it to pay these short-term debts as they fall
have operated successfully with acid test figures nearer
due, and it has significant current assets in reserve in case it
to 0.7:1.
encounters unexpected debts. Its current ratio is very high
The value of the acid test ratio considered acceptable will because it holds a large volume of expensive inventory –
vary according to the type of business. Retailers might mainly jewellery – to allow it to meet its customers’ needs
operate with a figure of 0.4:1, because they trade mainly as quickly as possible. Its acid test ratio also looks very
in cash and have close relationships with suppliers. A reassuring to stakeholders. It has $1.46 of liquid assets for

manufacturing business might operate with a ratio nearer to every $1 of current liabilities.
the standard 1:1.
Apple is well known for its consumer electronics and
Firms should not operate over long periods with high especially the iPad. Its liquidity position is also very strong,
acid test ratios, as holding assets in the form of cash is which is perhaps not surprising for a highly successful
not profitable and does not represent an effective use of multinational. One notable feature of its liquidity ratios is
resources. As with the current ratio, the acid test ratio can that the result of its acid test ratio is little different from
be improved by selling non-current assets or agreeing long- that of its current ratio. These results show that Apple
term borrowing. holds very low volumes of inventory. Partly, this is because
it subcontracts its manufacturing operations to other
Interpreting the results of liquidity companies, such as Foxconn.
ratios Finally, Carrefour is a French-owned retailer with stores

in many countries. Its liquidity ratios may appear less
Liquidity ratios are based on figures drawn from the comforting at first. However, it is not uncommon for
statement of financial position relating to a particular retailers to operate with low liquidity ratios. Businesses
moment in time. Because of this, some caution should be such as Carrefour can rely on customers paying promptly
exercised when drawing conclusions from this type of ratio. and mainly in cash. Thus, the company can be confident
The actual figures on the statement of financial position that it will receive a regular inflow of cash into the
may be unrepresentative of the firm’s normal position, business.
due to factors such as window dressing or a sudden and
unexpected change in trading conditions.
▼ Table 10.9 The liquidity ratios for three multinational companies
Company Tiffany & Co. Apple Inc. Carrefour SA

Type of business Retailer of jewellery and other The company designs, develops A French supermarket chain
luxury goods and sells consumer electronics with stores in 18 countries
Date of statement of
31 January 2020 30 September 2019 31 December 2019
financial position
Current assets $3 880 million $162 820 million €18 875 million
Inventories $2 460 million $4 110 million €5 867 million
Current liabilities ($970 million) ($105 720 million) (€23 061 million)
Current ratio 4.0:1 1.54:1 0.82:1
Acid test ratio 1.46:1 1.50:1 0.56:1
$50 000 in cash and $70 000 in current liabilities, the

Methods of improving liquidity current ratio is 1.43:1. This could be improved by using
Firms can improve their current ratio in several ways: some cash to pay the short-term debts. If $40 000 of
» raising more cash through the sale of non-current assets the short-term debts are repaid, the ratio changes
or the negotiation of long-term loans (Note: Raising to $60 000 of current assets and $30 000 of current
more cash through short-term borrowing will increase liabilities, giving a current ratio of 2:1
current liabilities, having little effect on the current » negotiating improvements in trade credit terms with
ratio.) suppliers and customers. If trade receivables pay more
» delaying any capital payments that would require cash quickly and trade payables can be delayed, the business’
payments cash position can be strengthened.
» paying off some current liabilities. For example, if a
business has current assets totalling $100 000, with
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10.2.2 Profitability ratios Using this ratio
A typical ROCE may be expected to be in the range of
10.2 These ratios compare the profits earned by a business with
other key variables such as the level of sales achieved
20–30 per cent, though it varies between industries and
businesses. It is particularly important to compare the
or the capital available to the managers of the business.
results from calculating this ratio with the business’ ROCE in
Profitability ratios are important because they can measure
previous years and also those achieved by competitors.
the effectiveness of managers in using the business’ assets
to generate profits. They are also important to company A business may improve its ROCE by increasing its operating
shareholders as they influence the company’s share price, as profit without raising further capital or by reducing the
well as its ability to pay dividends. These ratios are also a amount of capital employed, perhaps by repaying some non-
key way of comparing the performance of businesses in the current liabilities.
same industry.
The returns here vary enormously. The most eye-catching
figure is that of Rolls-Royce Holdings Plc (see Table 10.10
The return on capital employed (ROCE) on page 449). The company’s financial position has been
ratio severely affected by higher than expected costs associated
with its Trent 1000 turbofan engine. It had to pay costs
This is an important ratio, comparing the operating profit totalling nearly £2 billion over problems related to this
earned with the amount of capital employed by the engine, but it announced that most of the difficulties were
business. The capital employed by the business is measured resolved and that it expected to return to profitability.
by its issued shares, plus its reserves, plus its non-current
liabilities.
Gross profit margin
The importance of this ratio is reflected in the fact that it This ratio compares the gross profit achieved by a business
is also termed ‘the primary efficiency ratio’. The result of with its revenue. Gross profit is earned before expenses
this ratio, which is expressed as a percentage, allows an such as administration and marketing costs are deducted.
assessment to be made of the overall financial performance The ratio calculates the percentage of the selling price
of the business. A fundamental comparison can be made of a product that constitutes gross profit. The answer is
between the prevailing rate of interest and the return on expressed as a percentage.
capital employed (ROCE) generated by a business.
gross profit margin = gross profit × 100
ROCE = operating profit × 100 revenue
capital employed
For example, in 2019 Rolls-Royce’s gross profit was £942
million. This was achieved from a revenue of £16 587
STUDY TIP
million. The company’s gross profit margin is therefore:
ROCE is one of three key ratios used to assess the financial
performance of businesses. The other two are the acid £942 million
test ratio and gearing. Using these three ratios enables a
gross profit margin = × 100 = 5.68%
£16 587 million
company’s short- and long-term liquidity positions to be
examined, as well as being a fundamental measure of its This confirms the result shown in Table 10.10. This gross
profitability. Do think about the ways in which a business profit margin is low, especially if we take into account
may increase its ROCE figure if it is considered to be too that the company has not paid its expenses for selling the
low. This may have implications for all the functional areas products and also its administrative costs. We saw in the
of the business to increase profits and/or to reduce the previous chapter that the company recorded a substantial
amount of capital employed in the business. loss in 2019 (£1311 million).
Using this ratio

GLOSSARY TERMS The figure for gross profit margin varies depending upon the
Capital employed is the total long-term funding used by a type of industry. Firms that turn over their inventory rapidly
business. It is calculated by adding together the business’ and then can trade with relatively few assets may operate
non-current liabilities, its share capital and its reserves. with low gross profit margins. Greengrocers (retailers who
Return on capital employed (ROCE) is an important sell fruit and vegetables) and bakers may fall into this
measure of business efficiency, which expresses category. Firms with slower turnover of inventory and
operating profits as a percentage of the capital employed requiring substantial fixed assets may have a higher figure.
by a business. Housebuilders may fall into this category.
The sales mix can have a major influence on this ratio. A
farmer selling eggs at a 10 per cent gross profit margin and
renting out holiday cottages at a 40 per cent margin could
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improve the business’ overall profit margin (but reduce its same period was $4772 million. The company’s operating
turnover) by discontinuing egg production. profit margin is therefore:
operating profit margin = $4772 million ×100 = 12.20%

10.2
Operating profit margin $39 117 million
(Note that the terms ‘operating profit margin’ and ‘profit
margin’ are synonymous and that either is acceptable to use Using this ratio
when discussing this ratio.) Results of this ratio can vary according to the type of
This ratio calculates the percentage of a product’s selling business, though a higher profit margin is preferable. A
price that is profit from operations, or operating profit comparison of gross profit and operating profit margins can
be informative. A business enjoying a stable gross profit
10.2.2 Profitability ratios

after most costs have been deducted, but before tax is paid
and before any allowance has been made for interest paid margin and a declining operating profit margin may be
and received by the business. Because this ratio includes failing to control expenses effectively. This may be due to
the majority of a business’ costs and expenses, it may be the purchase of costly new premises, for example.
regarded as a better indication of performance than gross
profit margin. Once again, the answer to this ratio is written Interpreting the results of profitability
as a percentage.
ratios
operating profit margin = operating profit × 100 One key issue here is the comparison between gross and
revenue operating profit margins. A comparison of the two margins
As an example of the calculation of this ratio, we can use can inform stakeholders of the management of a business’
Nike, the American manufacturer of sporting equipment and costs. The other important figure is that for ROCE, which is
clothing. The company’s revenue for the trading year ending a fundamental measure of a business’ efficiency.
in May 2019 was $39 117 million; its operating profit for the
▼ Table 10.10 The profitability ratios of three multinational companies
Company Apple Inc. Lenovo Rolls-Royce Holdings Plc

An American company which A Chinese multinational A UK multinational
Type of business designs, develops and sells technology company engineering company
consumer electronics
Date of statement of profit 30 September 2019 31 March 2020 31 December 2019
or loss/currency US$ million US$ million Pound sterling
Revenue $260 174 million $50 716.3 million £16 587 million
Gross profit $98 392 million $8 357.3 million £942 million
Operating profit/(loss) $63 930 million $1 438.6 million (£852 million)
Capital employed $182 300 million $8 870.0 million £1 534 million
ROCE (%) 35.07 16.22 –55.54
Gross profit margin (%) 37.82 16.48 5.68
Operating profit margin (%) 24.57 2.84 –5.14
It may not be a surprise that Apple Inc, the American Rolls-Royce Holdings Plc. We saw earlier that the company
consumer electronics company, is highly profitable. The is experiencing costly problems with one of its engines. The
most noteworthy figure here is Apple’s operating profit outcome is some very poor figures for profitability, notably
margin. This is over 24 per cent, meaning that 24 cents ROCE. Its financial performance is expected to improve in
from each dollar of revenue received by the company the future.
represents profit. This is a measure of the company’s global
success, but it is also necessary if it is to continue to be
a market leader in global consumer electronics. Continued HANDLING DATA
success will require the company to invest consistently in
Use the information in Table 10.10 to answer the
developing new products, and this high level of profit gives
following questions.
it the funds it needs.
1 Assuming no other changes, what level of operating
Lenovo, the Chinese multinational technology company, profit would Lenovo have needed to make in 2020 to
produced a steady figure for its ROCE, though far below record a ROCE figure of 20 per cent?
that achieved by Apple. The company may seek to 2 Given Apple’s 2019 profit figure, what amount of
control its costs more tightly in the future to improve its capital employed would be necessary to result in a
profitability. The most eye-catching figures come from ROCE figure of 40 per cent?
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CASE STUDY
10.2
Profits at McDonald’s
The McDonald’s Corporation is one of the world’s largest ▼ Table 10.11
restaurant chains, with a menu based mainly on burgers.
McDonald’s restaurants offer a substantially uniform $m
menu, although there are geographic variations to suit Revenue 21 076.5
local consumer preferences and tastes. At the start of
2020 it had 38 695 restaurants in 119 countries, of which Cost of sales 9 961.2
36 059 were operated by franchisees and 2636 were Operating profit 8 885.9
operated by the company. The company has raised its
dividend for 43 consecutive years since paying its first
Questions
dividend in 1976. It has a globally recognised and valuable
brand name, as well as a clear focus on consumer needs. 1 Calculate the following for McDonald’s in 2019:
a its gross profit margin [4]
The company’s financial performance for 2019 was above b its operating profit margin. [3]
expectations with sales volumes rising by 5.9 per cent, 2 Evaluate the possible reasons why the McDonald’s
although revenue was relatively unchanged from 2018. Corporation generates such a high operating profit
Table 10.11 below shows some key figures from the margin. [12]
company’s statement of profit or loss for 2019.
Improving profitability 10.2.3 Financial efficiency ratios

It is important to understand the difference between profits This group of ratios measures the effectiveness with
and profitability. A business can improve its profits if it which management controls the internal operation of
reduces its costs or increases its revenues without any the business. They consider the following aspects of the
other changes occurring. However, increasing profitability management of an enterprise:
requires managers to increase the amount of profit » how well inventories are managed
compared to some other measure, such as revenue or capital » the time that the business takes to settle its own debts
employed. Thus, a business might measure its profitability » the efficiency of its control of trade receivables; that is,
by calculating its operating profit margin. how long before customers pay their accounts.
Not all actions intended to increase profits will increase Financial efficiency ratios are important because they
profitability and vice-versa. For example, a decision to measure how effectively a business is managing its assets.
increase prices is likely to increase a business’ profitability, They show the ability of managers to use its assets and
as it will probably result in a higher percentage of the manage its liabilities effectively over the current or latest
selling price of the product being profit. However, if trading period. There are a large number of ratios that fall
demand is price elastic, it may result in a fall in profits. under this heading, but we shall concentrate on just three.
We can identify a number of key ways in which businesses
can increase profitability: The rate of inventory turnover ratio
» Increase prices If a business increases its prices and This ratio measures a company’s success in converting
costs do not rise, or they rise by a smaller percentage inventories into sales. The ratio compares the value of
than price, profit margins are likely to increase. inventories with the sales achieved, valued at cost. This
» Reduce costs Another way to increase profitability is to permits an effective comparison with inventories, which
reduce costs of sales and/or expenses. This can increase can also be valued at cost. If the company makes a profit
the proportion of profits in the selling price of the on each sale, then the faster it sells its inventories, the
product and thereby improve profit margins. greater the profits it earns. This ratio is only of relevance
» Reduce capital employed If a business is able to use to manufacturing businesses, as firms providing services do
fewer resources in production, perhaps by selling any not hold significant quantities of inventories.
spare capacity (factories, offices or equipment), it can
cost of sales
reduce the capital employed by the business. If this inventory turnover ratio =
action does not damage its ability to generate profits average inventories held
then a higher ROCE figure is likely to result. In this form, the results of calculating this ratio are
expressed as a number of times per year. Century and Paper
STUDY TIP Board Mills Ltd is a Pakistani company based in Karachi
It is important to respond to the precise wording of
and Lahore which manufactures a range of paper products.
questions relating to profits and profitability. If a question On 30 June 2019, the company held inventories valued at
asks about profitability, do address this and not profits. 3484 million Pakistani rupees (PKR). During the company’s
Similarly, if a question asks about profits, avoid straying financial year, which ended on that day, the company had
into discussing profitability. achieved sales (at cost) of PKR19 578 million. The company’s
inventories turnover ratio was therefore 5.62 times.
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The inventory turnover formula can be reorganised to Trade receivables turnover days
express the number of days taken on average to sell the
business’ inventories. This ratio is also referred to as trade receivables (or
debtors’) collection period. It calculates the time typically 10.2
taken by a business to collect the money that it is owed by
inventory turnover ratio = inventories × 365
cost of sales customers. This is an important ratio, as granting customers
lengthy periods of credit (that is, periods of time to pay)
Our Century and Paper Board Mills Ltd calculation would may result in a business experiencing liquidity problems.
then become:
The formula uses credit sales, rather than revenue, to
exclude any cash sales the business might make. If a
inventory turnover ratio = 3484 million × 365 = 64.95 days
10.2.3 Financial efficiency ratios

19 578 million company has cash sales, these should be excluded from the
calculation.
Thus, if Century and Paper Board Mills Ltd sells its complete
inventories every 65 days, it will sell its inventories just trade receivables turnover = trade receivables × 365
over 5.6 times during a year. credit sales
Using this ratio GLOSSARY TERMS

The standard figure for this ratio varies hugely according Credit sales are purchases made by a business’
to the type of business. A market trader selling fruit and customers for which payment is delayed, normally by
vegetables might expect to sell his entire inventories every 30–60 days.
two or three days – about 100 times a year. At the other Cash sales are purchases where payment is made at the
extreme, a shop selling antique furniture might only sell its time of the sale.
inventories every six months – or twice a year.
A low figure for inventory turnover could be due to
obsolete inventories. A high figure can indicate an efficient
Using this ratio
business, although selling out of inventories regularly There is no standard figure for this ratio. In general, a
results in customer dissatisfaction. shorter figure is preferred as the business in question
receives the inflow of cash more quickly. However, it can be
an important part of a business’ marketing strategy to offer
STUDY TIP
customers a period of trade credit, of perhaps 30 or 60 days.
Other aspects of a business’ activities can have significant
impacts on the results of ratio calculations. For example, A rise in this ratio may be due to a number of causes. A
if a business uses a JIT system of inventory control, it is period of expansion may mean that a business has to offer
likely to have a much higher level of inventory turnover. improved credit terms to attract new customers, or a ‘buy
now, pay later’ offer may have been introduced.
CASE STUDY
Late payment legislation
The Late Payment of Commercial Debts (Interest) Act Late payments are an important issue for many small
1998 and Late Payment of Commercial Debts Regulations businesses in the UK. About one-quarter of all insolvencies
2002 give businesses in the UK the statutory right to claim in the UK are caused by late payments. In a report in 2016,
interest on late payments from other businesses. The the Federation of Self-Employed and Small Businesses
law was originally introduced in November 1998 but was (FSB) estimated that if all payments were made on time, this
amended by European Union directive in 2002. would have kept 50 000 UK businesses operating. In 2020,
there were further efforts in the UK to strengthen laws
The law allows all businesses, including public sector
protecting businesses from the effects of late payments.
organisations, to claim interest from any other business or
organisation if payment is late. A late payment is defined Questions
as where the agreed credit period given by the supplier
1 Analyse two reasons why customers making late
to the purchaser has expired. If no credit period has been
payments can cause problems for a small business.[8]
specified by the supplier, the Act specifies a default period
2 Evaluate whether a small business might be
of 30 days, after which interest will accumulate.
reluctant to claim interest from a customer which
regularly delays payment. [12]
a business to pay the money it owes to its suppliers and

Trade payables turnover days other trade payables. This is an important ratio, as delaying
This ratio is also referred to as trade payables (or creditors’) payment for as long as possible can help a business to avoid
collection period. It calculates the time typically taken by liquidity problems.
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assess its liquidity position. If the figure for trade payables
trade payables turnover = trade payables × 365 days is lower than the trade receivables days, it is more
credit purchases
10.2 The calculation of this ratio only requires the inclusion of
likely that the business will experience liquidity problems.
This is because, on average, it is paying suppliers and other
purchases of goods and services on credit. Therefore, the trade payables more quickly than it is receiving payment
formula uses credit purchases rather than cost of goods from its customers.
sold, as some supplies may be purchased and payment made
immediately. These cash payments should be excluded from STUDY TIP
the calculation of the trade payables turnover ratio. Trade payables days is not a ratio that you would normally
be asked to calculate alone, but it is important to use
Using this ratio
it alongside trade receivables days as a comparison

It is best to consider this ratio alongside the equivalent between the two, as it gives a useful insight into the extent
trade receivables days ratio result. By comparing trade to which the business is managing its finances efficiently.
payables days and trade receivables days, a business can
CASE STUDY
More on Century and Paper Board Mills Ltd
Some key data from the 2019 Annual Report for Century and Paper Board Mills Ltd is shown in Table 10.12. We have
assumed that all payments and sales are made under credit terms.
▼ Table 10.12 Some financial data for Century and Paper Board Mills Ltd, 2018 and 2019
2019 (PKR million) 2018 (PKR million)

Credit sales 22 241 18 965
Credit purchases (19 578) (16 459)
Receivables 3 149 2 465
Payables (2 528) (2 216)
Source: Century and Paper Board Mills Ltd Annual Report 2019; http://centurypaper.com.pk/admin/
annual_report/Century-Paper-Low-24-Aug-2019-min.pdf
Questions
1 Calculate the company’s trade receivables turnover days and trade payables turnover days in 2018 and in 2019. [8]
2 Evaluate whether Century and Paper Board Mills Ltd managed its payables and receivables more efficiently
in 2018 or in 2019. [20]
is negotiated, this can be a good method of improving

Improving financial efficiency financial efficiency. However, a unilateral decision to delay
Improving the inventory turnover ratio requires a business payment can create a poor relationship with suppliers,
to hold lower levels of inventories or to achieve higher who may suffer their own liquidity problems as a result
sales without increasing levels of inventories. However, it of the delay in payment. Businesses may also be charged
can be too simple just to argue that a lower figure is an interest on delayed payments. If a business’ managers
improvement. As we saw earlier, this is not the case in all could engineer a situation where a business’ trade payables
circumstances. Efficient inventory management requires turnover days figure was higher than its trade receivables
a business to hold the minimum necessary to ensure that turnover figure, then this would represent an improvement,
it can meet its customers’ requirements. An efficient so long as relationships with customers and suppliers were
inventory turnover ratio will vary according to the nature of not harmed.
the business.
The trade receivables ratio may be improved by reducing
the credit period on offer to customers or by insisting on
10.2.4 Gearing ratios
cash payment. A more focused approach is to conduct an Gearing measures the long-term liquidity of a business.
aged receivables’ analysis. This technique ranks a business’ Under some classifications of financial ratios, gearing is
receivables according to the period of credit taken. This included as a liquidity ratio. There are a number of methods
allows managers to concentrate on persuading the slowest of measuring gearing; we shall consider the simplest form
payers to settle their accounts. Trade payables’ turnover of the ratio. This ratio analyses how businesses have raised
days figures can be improved by delaying payment. If this their long-term capital. It measures the proportion of
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the long-term capital used within the business (capital rates. However, this may be considered acceptable in
employed, in other words) that has been raised through a business that is growing quickly and generating high
long-term loans. So, it compares its non-current liabilities
to its capital employed. The result of this calculation is
profits. Furthermore, a business with a low gearing ratio
may be considered too cautious and not expanding as
10.2
expressed as a percentage. quickly as possible.
gearing = non-current liabilities × 100 Using this ratio

capital employed
The key yardstick is whether a business’ long-term
This measure of a business’ performance is important, borrowing is more than 50 per cent of capital employed.
because by raising too high a proportion of capital through Companies with secure cash flows may raise more loan
10.2.5 Investment ratios

long-term borrowing, businesses can become vulnerable to capital because they are confident of being able to meet
increases in interest rates. Shareholders are also unlikely to interest payments. Equally, a business with well-known
be attracted to a company with a high gearing ratio, as their brands may be able to borrow heavily against the value of
returns might be lower because of the high level of interest these brands to increase long-term borrowing. Firms can
payments to which the enterprise is already committed. improve their gearing by repaying long-term loans or by
» As a general guide, a business with a high gearing ratio issuing more ordinary shares.
has more than 50 per cent of its capital in the form of
non-current liabilities. Next Plc, in Table 10.13, is very heavily geared as it is
» A business with a low gearing ratio has less long-term significantly in excess of the 50 per cent standard maximum
borrowing and a gearing figure that is below 50 per cent. figure. The other two companies are less highly geared,
although BP has a figure just above the 50 per cent
Much attention tends to be given to businesses that have benchmark.
high gearing and are vulnerable to increases in interest
▼ Table 10.13 Gearing ratios of some leading international companies
Company Next Plc BP Toyota

Country and industry UK, clothing retailer UK, oil and gas extraction Japan, vehicle manufacture
Date of statement of 25 January 2020 31 December 2019 31 March 2020
financial position/currency £ millions US$ millions US$ millions
Non-current liabilities £2 282 $120 891 $129 171.5
Capital employed £2 723 $221 599 $319 958.2
Gearing (%) 83.80 54.55 40.37
These ratios are important because investors consider the

HANDLING DATA potential returns on their investments before deciding
whether or not to buy a company’s shares. Dividends
Use the information in Table 10.13 to calculate the offer a short-term return on an investment and may be of
following. interest to shareholders seeking a quick return. However,
1 Assume that BP’s non-current liabilities in 2019 other shareholders may seek a long term return on their
were US$99 720 million. What would have been the investment. They may be prepared to forgo high levels of
effect on the company’s gearing ratio? dividends in the short term to allow profits to be invested.
2 What figure for non-current liabilities would have They hope that the business will grow, increasing the price
been necessary in 2020 for Next Plc to have a of shares and providing a capital gain for shareholders.
gearing ratio of 50 per cent?
There are a number of ratios that may be used by
shareholders. However, we shall concentrate on ratios
10.2.5 Investment ratios that compare the dividends received against the capital
investment made by shareholders when purchasing shares.
These are also called shareholders’ ratios or investors’
ratios. The results of this group of ratios are of particular Dividend per share
interest to the shareholders of a company or to anyone
considering purchasing shares in a particular company. This is an important investment ratio and is necessary
to calculate the dividend yield, which we shall consider
Shareholders can receive a return on their purchase of later. It is simply the total dividend declared by a company
shares in two ways: divided by the number of shares the business has issued.
1 through dividends paid from the company’s profits over
the financial year dividend per share = total annual dividends
2 as a result of a rise in the price of the shares, called a number of issued shares
‘capital gain’.
Results of this ratio are expressed as a number of cents or
pence per share, depending on the currency used.
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Assume that a company has issued 1725.69 million shares Dividend yield
and announces dividends totalling £293.77 million.
10.2 The dividend per share (DPS) for the company would be
calculated as follows:
This ratio is really a development of the previous ratio and
provides shareholders with more information. The dividend
yield compares the dividend received on a single share
£293.77 million with the current market price of that share. This provides
DPS = = 17.0 pence per share
1725.69 million shares shareholders with a better guide to a business’ performance,
as it compares the return with the amount that would need
It is normal for dividends to be paid in two parts: an interim to be invested to purchase a share. The result of calculating
dividend halfway through the financial year and a final this ratio is given as a percentage.
dividend at the end of the year.
dividend yield = dividend per share × 100

Using this ratio market price of share
A higher figure is generally preferable to a lower one, as Imagine a shareholder was considering investing in the
this provides the shareholder with a larger return on their company mentioned above, and they noted that the share
investment. However, some shareholders are looking for price on one particular day was 475 pence (or £4.75), and
long-term investments and may prefer to have a lower DPS that the DPS for the company was 17.0 pence. The potential
now in the hope of greater returns in the future and a rising shareholder could calculate the dividend yield as follows:
share price.
It is wise to compare the DPS with that offered by dividend yield = 17.0 × 100 = 3.58%
475
alternative companies. However, it is also important to bear
in mind how much has to be invested to buy each share. A Using this ratio
low DPS may be perfectly acceptable if the company has a
low share price. A higher return will be regarded as preferable by
shareholders seeking a quick return. Longer-term investors
A business can improve this figure by announcing higher might settle for a lower figure, allowing the firm to reinvest
dividends (and therefore reducing the amount of profit profits and offering the possibility of higher profits and
retained within the business). This may prove attractive dividends in the future.
to some shareholders, but it may not be in the long-term
interests of the business, particularly if profits are not Results for this ratio can vary dramatically according to
rising. fluctuations in the company’s share price.
CASE STUDY
Hewing International Plc announces dividends
Hewing International Plc is a mining company that
specialises in precious metals with its headquarters in
Belarus, although its shares are sold on the London Stock
Exchange. The company owns gold and silver mines in
Belarus, Moldova and Kazakhstan. Production output in
2020 consisted of 50 per cent gold, 39 per cent silver and
11 per cent copper.
In June 2020, Hewing International Plc announced a
dividend per share of £0.31 or 31 pence per share. At
the time, the company had 382 million issued shares
and the total dividend payment was £118.42 million; the
company’s share price on the London Stock Exchange
was quoted at 1155 pence. Last year’s dividend yield was
1.95 per cent.
The company has introduced a new dividend policy, paying ▲ Figure 10.8 Hewing International Plc trades in precious
regular dividends, which will represent 30 per cent of the metals
company’s profits for the year.
Questions
Commenting on the board’s decision, Klaudia Darbonova,
CEO of Hewing International, said, ‘Our new dividend 1 Analyse one way in which you think that Hewing
policy demonstrates how important we think it is to give International Plc’s shareholders will respond to this
our shareholders good and sustainable levels of investor announcement. [4]
return.’ 2 Evaluate the factors that might shape the
shareholders’ reactions. [12]
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Dividend cover ratio P/E ratios. However, different industries can have very
different growth prospects, making valid comparisons
The dividend cover ratio shows how easily a business
can pay its dividend from its profits for the year. A high
more difficult. 10.2
dividend cover means that the business can easily afford to
pay the dividend, and a low value means that the business CASE STUDY
might have difficulty paying a dividend.
La Araucania Fruit Producers
dividend cover = profit for the year This company is located near Temuco in Chile. La
annual dividend
Araucania Fruit Producers reported the figures shown
in Table 10.14 in its annual reports in 2018 and 2019.
10.2.5 Investment ratios

This ratio should be considered in the context of the
stability of a company’s profits for the year. A low level ▼ Table 10.14
of dividend cover might be acceptable in a company with
steady profits, but the same level of dividend cover in a 2019 2018
company with volatile profits would indicate that future
Total annual dividends $450 000 $425 000
dividend payments may be at risk.
Number of issued shares 1 875 000 1 850 000
Using this ratio Market price of share $4.86 $5.24
Generally speaking, a ratio of 2 or higher is considered (31 December)
safe (in the sense that the company can well afford the Profit for the year $787 000 $680 000
dividend) but anything below 1.5 is risky. If the ratio is
under 1, the company is using its retained earnings from Questions
a previous year to pay this year’s dividend. This is not a 1 Use relevant investment ratios to compare La
situation that can continue for a long-term period. Araucania Fruit Producers’ financial performance
in 2018 and 2019. [8]
Price–earnings ratio 2 Evaluate whether La Araucania Fruit Producers
was more attractive to potential shareholders
This ratio compares the current market price of a company’s in 2018 or in 2019. [20]
shares to its earnings per share. The price–earnings (or P/E)
ratio is also called the ‘price multiple’, and it is sometimes
referred to as a ‘multiple’ ratio because it shows how
much investors are willing to pay per dollar of earnings. Methods of improving investor return
If a company’s P/E ratio was 16, this would show that an Investor return can take two forms:
investor was willing to pay $16 for $1 of earnings per share. » rising share prices giving a capital gain
An average P/E ratio is approximately 14–15. » increased dividends providing shareholders with a higher
income.
To calculate the P/E ratio, it is first necessary to calculate a
company’s earnings per share (EPS). The EPS is the amount A management team can possibly increase the company’s
of the company’s profits that belong to a single share. The share price by improving its relative performance against
EPS is calculated using the formula below: other businesses in the same industry, although external
factors, such as the general performance of the economy,
earnings per share = profit for the year will also influence share prices. However, if a company’s
total number of issued shares financial performance is strong over a period of time, it is
Once the EPS has been calculated, it is then possible to use likely to have a rising share price.
this information to complete the calculation of the P/E ratio. A number of companies, including Apple and American
Airlines, have engaged in share buy-back schemes. This
price–earnings ratio = current share price simply involves the company buying some of its own shares
earnings per share back from shareholders. Sometimes companies do this to
return excess cash (which is not needed for operations)
Using this ratio to shareholders. This tends to increase the value of the
In most circumstances, a higher P/E indicates that investors company’s remaining shares. It also helps to increase the
are anticipating higher growth in earnings in the future dividend per share for shareholders. Overall, it is likely to
than in companies with a lower P/E ratio. improve the return for the company’s investors.
Comparing the P/E ratio of a chosen company to other Management teams can also take a series of actions to
companies in the same industry is a valuable exercise. improve dividends, most obviously by increasing the
It can also be beneficial to analyse it against companies proportion of profits for the year distributed to shareholders
from other industries or against the company’s previous in the form of dividends.
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TEST YOUR LEARNING
10.2 slowed and interest rates are expected to rise in the near
Short answer questions future. However, the government is confident of attracting
1 a Define the term ‘ratio analysis’. [2] foreign investment into the industry.
b Explain one distinction between financial
The company’s most recent accounts produced some
efficiency ratios and profitability ratios. [3]
interesting ratios, as shown in Table 10.15.
2 a Define the term ‘gearing ratio’. [2]
b Explain two sources of information that might be ▼ Table 10.15 Ratios for Lahore Construction Ltd
important when conducting ratio analysis. [6]
The year
3 Explain one reason why a company may have a low Ratio Last year
figure for the rate of inventory turnover. [3] before last
4 Explain two reasons why return on capital employed Profit for the year ($m) 50.24 71.76
is such an important ratio for stakeholders. [6] Acid test ratio 0.82:1 1.12:1
5 Explain one reason why it is useful to use the trade
Gearing 51% 64%
payables turnover and trade receivables turnover
ratios together when assessing a company’s ROCE 15.2% 14.1%
financial performance. [3] Total annual dividend ($m) 15.7 18.4
6 Pelennor Products is a rapidly growing business Number of issued shares (m) 180.39 176.82
providing IT services. The company’s trade receivables
turnover ratio has increased from 33.2 days to Average share price ($) 2.42 2.20
41.7 days over the past year. Explain one possible Earnings per share (EPS) ($) 0.17 0.14
implication of this for the business. [3]
7 a A company has non-current liabilities totalling The company has faced some criticisms from its
$456 000 and its figure for capital employed is shareholders. It has repaid some of its loans, reducing
$780 500. Calculate its gearing ratio. [2] its non-current liabilities. It is negotiating a $12 million
b Explain one reason why a business might be contract with the Pakistan government to build new roads
concerned if its gearing figure was 75.6 per cent.[3] near to Jacobabad.
8 Explain one reason why the dividend yield ratio might
Questions
provide a good measure of a company’s performance
for a potential shareholder. [3] 1 Analyse two benefits to LC Ltd’s stakeholders of the
9 Explain one reason why a dividend cover ratio of company reducing its gearing ratio. [8]
1.2 might be regarded as worrying by a company’s 2 a Calculate LC Ltd’s dividend cover for the two
shareholders. [3] years. [4]
10 Explain one aspect of a business’ performance that is b Evaluate the extent to which LC Ltd’s
not covered by ratio analysis. [3] shareholders would be satisfied with its
recent performance. [20]
Data response question 3 Evaluate whether or not it is possible to judge
LC Ltd’s future performance from its published
Lahore Construction Ltd (LC Ltd)
accounts. Justify your decision. [20]
Over the last ten years, it is estimated that the
construction industry in Pakistan has contributed Essay question
approximately 2.5 per cent of the country’s GDP. However,
1 Evaluate the extent to which return on capital employed
there are now fears that the industry is stagnating. LC Ltd
is a more valuable ratio for shareholders looking for
builds houses, roads and bridges. It has suffered from
long-term returns than investment ratios such as the
declining sales recently, as its housebuilding activity has
price–earnings ratio. [20]
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A LEVEL
10.3
Investment appraisal
10.3.1 The concept of investment appraisal

Chapter overview
★ the concept of, and need for, investment appraisal
★ the basic methods of investment appraisal: payback and accounting rate of return
★ discounted cash-flow methods of calculating investment appraisal: net present value and internal rate of return
★ quantitative and qualitative factors in investment appraisal
★ comparing methods of investment appraisal.
10.3.1 The concept of investment legal requirements or the expectations of consumers. For
example, one of the world’s largest mining companies,
appraisal Rio Tinto, has started using driverless trucks in its iron
ore mines in Western Australia. These are expensive
This chapter looks at the techniques that businesses can vehicles which improve the productivity of the mines.
use to make major investment decisions. It considers
the reasons why businesses undertake programmes of Investment appraisal is needed because, in each
investment, and it will look at financial and non-financial circumstance, the business’ managers must use an
methods of assessing the worth of alternative investment appropriate financial technique to decide whether the
projects. returns received from an investment are sufficient to justify
the initial capital expenditure.
Investment is an important term within business studies
and often entails managers taking major decisions.
Investment can mean a decision to purchase part or all of GLOSSARY TERMS
another business, perhaps as a result of a takeover bid. Risk is the chance of a misfortune occurring, possibly
However, it is perhaps more common to use the term in resulting in financial loss.
relation to the purchase of a non-current asset or some Investment appraisal is a series of techniques designed to
other major expenditure. What is common is that all such assist businesses in judging the desirability of investing in
actions involve a degree of risk. This must be judged particular schemes.
against the likely return. The final decision will depend
upon managers’ assessment of these two factors.
Businesses take decisions regarding investment in a variety Risk and investment appraisal
of circumstances. Risk is an important factor within investment decision-
» When contemplating introducing new products A making. Risk can be defined as uncertainty that is
business may assess the likely costs and returns from quantifiable or that can be measured. There are two major
investing in one or more new products. types of risk:
» Expansion This may entail evaluating whether or not to » Systematic risk relates to the environment in which
invest in new non-current assets as part of a planned a project will operate. This type of risk could include
programme of growth. Tottenham Hotspur Football a loss of sales and cash inflow due to, say, an adverse
Club in London invested $1 billion in developing a new movement in the exchange rate.
stadium, built in part on its existing ground at White » Specific risk is associated with a particular project; for
Hart Lane. The Club hoped to increase its sales revenue example, launching a product that is entirely new and of
by attracting larger crowds into the new stadium, which which the firm has little experience.
has a capacity of 62 000 spectators.
Techniques of investment appraisal can incorporate an
» Spending Businesses may also use techniques of allowance for risk, perhaps by reducing cash inflows or
investment appraisal before spending on promotional
increasing costs. More sophisticated techniques use the
campaigns, developing new brands or products or
theory of probability to attempt to arrive at more accurate
retraining the workforce.
predictions. In these ways, techniques of investment
» Investing in new technology This may be undertaken to appraisal can assist managers in making more informed and
reduce costs and improve productivity or to meet with
less risky investment decisions.
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Risk should be distinguished from uncertainty. Uncertainty In Table 10.16, the calculation is simple: payback is
is not measurable and cannot be included in numerical achieved at the end of year 3, when the initial investment
10.3 techniques of investment appraisal. An investment project
that appears to have a high degree of uncertainty attached
of $500 000 is recovered from earnings ($100 000 in year 1
plus $200 000 in each of years 2 and 3).
to it may not be undertaken, because the firm in question
Calculations can be a little more complex, however, as
may be unable to assess its likely costs and benefits.
shown in Table 10.17.
▼ Table 10.17 A more complex example of payback
10.3.2 Basic methods
Year Cash outflow $ Cash inflow $
Financial techniques for making
A LEVEL 10.3 Investment appraisal
1 500 000 100 000
investment decisions 2 100 000
A number of techniques are available to managers to assist 3 200 000
them in taking decisions on whether to go ahead with 4 300 000
investments or to help in making a judgement between two
or more possible investment opportunities. This section will
In this case payback is achieved during the fourth year. The
look at three of the most important of these techniques:
formula used to calculate the point during the year at which
payback, the accounting rate of return and discounted
payback is achieved is as follows:
cash flow. These financial techniques are valuable, but they
do depend upon a number of assumptions: number of amount of investment not recovered
» that all costs and revenues can be forecast easily and payback =
full years(+
revenue generated in next year )
accurately for some years into the future
» that key variables (for example, interest rates) will not In Table 10.17, the investment has recovered $400 000 after
change unexpectedly three years. Therefore $100 000 remains to be recovered in
» that the business in question is seeking maximum profits. year 4 before payback point is reached. During year 4, the
investment will generate $300 000. Thus:
There are two major considerations for managers when
deciding whether or not to invest in a non-current asset or
another business: payback = 3 years + 100 000 = 3.3 years, or 3 years 4 months
300 000
1 the total profits earned by the investment over the
foreseeable future An alternative method of calculating the time required
2 how quickly the investment will recover its cost. This to reach payback in the final year is to divide that year’s
occurs when the earnings from the investment exceed inflow of cash by 12 to find out the monthly inflow. From
the cost of the investment. this figure it should be relatively easy to calculate the
The process of assessing these factors is called investment number of months’ inflows that will be needed to cover
appraisal and refers to the process of assessing one or more the outstanding balance of the cost of the investment.
potential investments. In our example, the business required a further $100 000
to achieve payback in year 4 and the total inflow for that
year was $300 000. So, dividing the inflow of $300 000 by
Payback 12 months gives $25 000 per month. As there is $100 000


Payback is a simple technique that measures the time period left to pay, this will take 4 months $100 000 .
required for the earnings from an investment to recoup $25 000
its original cost. Quite simply, it finds out the number Figure 10.9 illustrates the concept of payback in the form of
of years it takes to recover the cost of an investment a graph.
from its earnings. In spite of (or perhaps because of) the
obvious simplicity of the payback technique, it remains
the most common method of investment appraisal used by
businesses, especially small ones.
▼ Table 10.16 A simple example of payback
Year Cash outflow ($) Cash inflow ($)

1 500 000 100 000
2 200 000
3 200 000
4 150 000
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700
Cumulative STUDY TIP
cash inflow
Do not spend too long on investment appraisal
calculations and do not carry out the same calculation
10.3
600
repeatedly. Make sure you show your workings when
Cash answering questions.
500 outflow
($500 000)
Accounting rate of return

Cash flows $000
400
The accounting rate of return (ARR) is a more complex and
10.3.2 Basic methods

meaningful method of investment appraisal. It is also called
300
the ‘average rate of return’. This technique calculates the
percentage rate of return on each possible investment.
200 The resulting percentage figure allows a simple comparison
Payback with other investment opportunities, including investing in
3 years
100 4 months
banks and building societies. It is important to remember,
however, that a commercial investment (such as purchasing
CAD/CAM equipment for a production line) involves a degree
0 of risk. The returns may not be as forecast. Therefore, it is
1 2 3 4 important that such an investment earns significantly more
Years than the rate of interest available in the local bank. If the
▲ Figure 10.9 Payback on a graph percentage return on purchasing the CAD/CAM equipment
was identical to that on a high-interest account in a bank,
Payback has the advantage of being quick and simple and
the latter would represent the better investment, as it
this probably explains its popularity, especially with small
carries little risk.
businesses. However, it does have disadvantages. It ignores
the level of profits that may be ultimately generated by There are two formulae that are used to calculate ARR.
the investment. For profit-maximising businesses, this may It can be calculated as:
represent an important omission. Furthermore, payback
ignores the timing of any receipts before payback is ARR = average profit × 100
achieved. The following example highlights this weakness. average investment
Two investment projects, A and B, each require an An alternative approach is to use the formula below:
investment of $1 million. Their expected earnings are shown
in Table 10.18. ARR = average profit × 100
asset’s initial cost
▼ Table 10.18 Comparing investment returns
Where:
Year Project A cash inflow ($) Project B cash inflow ($) total profit before taxation over the
1 500 000 100 000 asset’s lifetime
average profit =
2 300 000 100 000 useful life of the asset (in years)
3 100 000 300 000
In both cases, average profit is calculated in the same
4 100 000 500 000 way. The difference is in the investment figure used on the
bottom of the formula. It is either:
Both investment projects achieve payback at the end of » the initial investment, or
year 4. However, A is obviously more attractive because it » the average investment, where this is calculated by:
yields greater returns in the early years. Payback does not
take into account the timing of any income received. (initial investment – any residual value at the end of
the investment)
2
HANDLING DATA
Calculate the percentages of total revenue for projects
A and B (in Table 10.18) that are received in the first two
years. What is the significance of this difference?
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CASE STUDY
10.3
Miller Reprographics
Purchasing new IT equipment for Miller Reprographics Questions
is estimated to cost $120 000 and a return of $220 000
1 a Calculate the payback of this investment. [3]
over five years is anticipated. The cash inflows for this
b Calculate the ARR of this investment over the
investment for each of the five years is as follows:
first five years. [4]
● Year 1 – $30 000
2 Analyse two reasons why Miller Reprographics
● Year 2 – $40 000
might prefer to use ARR rather than payback to
● Year 3 – $40 000
judge this investment. [8]
● Year 4 – $50 000
3 Evaluate the factors that Miller Reprographics
● Year 5 – $60 000
might consider when deciding whether or not this
Miller Reprographics may consider this to be an attractive really is an attractive investment. [12]
investment. The company’s profits have declined in recent
years and the management team is keen to ensure that its
profitability improves in the future.
ARR is considered to be more useful than payback because

HANDLING DATA it considers the level of profits earned from an investment,
rather than simply the time taken to recover costs. It also
Use the data in the Miller Reprographics case study to offers easier comparison with returns on other investments,
calculate the total profit the company would have had to notably financial investments in banks and building
earn to generate an ARR of 35 per cent. societies. However, this technique also fails to differentiate
between investments that generate high returns in the early
years and those that offer greater rewards later on.
Income from Cost of Total profit

minus =
investment investment from investment
Total profit from Expected lifespan Average

divided by =
investment of asset in years annual profit
Average Cost of Accounting

divided by × 100% =
annual profit investment rate
of return (ARR)
▲ Figure 10.10 How to calculate accounting rate of return
10.3.3 Discounted cash-flow 1 Risk Having $1000 now is a certainty; receiving the
same amount at some point in the future may not
methods occur. The full $1000 payment may not be made; in
fact, no payment at all may be made. An investment
The technique of discounted cash flow takes into account project may fail to provide the expected returns
what is termed the ‘time value’ of money. The time value of because of a competitor’s actions, because of a
money is based on the principle that money at the present change in tastes and fashions, or as a consequence of
time is worth more than money at some point in the future. technological change.
Thus, according to this principle, $1000 today is of greater 2 Opportunity cost is the best forgone alternative. Even
value than $1000 in one or two years’ time. There are two if no risk existed, the time value of money would still
major reasons why this time value principle exists.
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exist. This is because the money could be placed into Discounting
an interest-bearing account generating a return. Thus,
if we assume that a rate of 5 per cent is available on an
interest-bearing account, $1000 in one year’s time is
Discounting is the process of adjusting the value of money
received at some future date to its present value – that 10.3
worth the same as $953 today. The reason for this is that is, its worth today. Discounting is, in effect, the reverse
by investing $953 at an interest rate of 5 per cent, we of adding interest. Discounting tables are available to
would have $1000 after one year. illustrate the effect of converting future streams of income
to their present values. The rate of interest plays a central
This time–value principle means that the longer the role in discounting, in the same way as it does in predicting
delay before money is received, the lower its value in the future value of savings. Table 10.20 shows the
present-day terms. This is called present value. Table discounting figures and value in present-day terms of $1000
10.3.3 Discounted cash-flow methods

10.19 shows two investments requiring identical outlays. over a period of five years into the future. If the business
Both projects also receive the same cash inflow over a anticipates relatively high interest rates over the period of
four-year period and would generate the same accounting the investment then future earnings are discounted heavily
rate of return (10 per cent). However, the majority of the to provide present values for the investment. Lower rates
cash inflow for project A occurs in year 1, while in project result in discounting having a lesser effect in converting
B this is delayed until year 4. The time–value principle future earnings into present values.
would suggest that project A is preferable to project B. To
show the effect of the time–value principle, we need to GLOSSARY TERMS
calculate the present value of cash inflows and outflows
Discounting is reducing the value of future earnings to
through the use of discounting.
reflect the opportunity cost of an investment.
▼ Table 10.19 Two similar investment projects with Present value is the value of a future stream of income
different time patterns for cash inflows from an investment, converted into its current worth.
Year Investment project Investment project
A ($’000s) B ($’000s) The basic calculation is that the appropriate discounting
0 (now) (500) (500) factor is multiplied by the amount of money to be received
1 400 100 in the future to convert it to its present value. Thus, at a
rate of interest of 10 per cent, the present value of $1000 in
2 100 100 two years’ time is $826 ($1000 × 0.826). The present value
3 100 100 of $1000 received in four years’ time is $683. This figure is
4 100 400 lower because the time interval is greater and the effect of
the time–value principle is more pronounced.
▼ Table 10.20 The process of discounting
Year Discounting factor used to Present value of $1000 Discounting factor used to Present value of
convert to present value at a discount rate of convert to present value $1000 at a discount
assuming 10% of interest 10% ($) assuming 5% rate of interest rate of 5% ($)
0 (now) 1 1 000 1 1 000
1 0.909 909 0.952 952
2 0.826 826 0.907 907
3 0.751 751 0.864 864
4 0.683 683 0.822 822
From this example, we can see that the rate of interest has
a significant effect on the present value of future earnings. Net present value
With a higher rate of interest, there is a greater rate of Discounting expected future cash flows is the basis of
discount. Thus, the present value of $1000 in three years’ calculating net present value (NPV). This method of
time is $751, if the rate of interest is assumed to be 10 per investment appraisal forecasts expected outflows and
cent. However, if the rate of interest is estimated to be 5 inflows of cash and discounts the inflows and outflows. To
per cent, the present value is greater, at $864. calculate NPV, we need to know:
» the initial cost of the investment
The choice of interest rate to be used as the basis for » the chosen rate of discount
discounting is an important decision by a business » any expected inflows and outflows of cash
undertaking investment appraisal. The discounting rate » the duration of the investment project
selected normally reflects the interest rates that are » any remaining or residual value of the project at the
expected for the duration of the project. end of the investment (if the investment is to purchase
production equipment, this may have scrap value once it
is obsolete, for example).
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The outflows of cash are subtracted from the discounted to make a decision. There are a number of criteria that a
inflows to provide a net figure: the NPV. This figure is business may use to make an investment decision:
10.3 important for two reasons:
1 If the NPV figure is negative, the investment is not
1 The rate of interest The accounting rate of return (ARR)
and net present value (NPV) methods produce figures
worth undertaking. This is because the present value that can be compared with the rate of interest. Any
of the stream of earnings is less than the cost of the interest rate chosen for this process will be based on the
investment. A more profitable approach would be interest rate set by the Bank of England (in the UK) or
to invest the capital in an interest-bearing account, other relevant central bank. In essence, the managers of
earning at least the rate of interest that was used for the business will seek a return that will be greater than
discounting. the current and forecast interest rates if the accounting
2 When an enterprise is considering a number of possible rate of return is used or, if they are using NPV, the
investment projects, it can use the NPV figures to rank interest rate that is current should produce a positive
them. The project generating the highest NPV figure NPV.
is the most worthwhile in financial terms. In these However, using the interest rate as a criterion is not
circumstances, a business may select the project (or straightforward. Many investment projects are long-
projects) with the highest NPVs. term, and expenditure and returns may take place over
many years. It is highly unlikely that interest rates will
An example of calculating net present value remain unchanged for this period of time. Therefore,
managers have to decide on a rate or range of rates to
Sailing Monthly is one of New Zealand’s most popular sailing
use in their calculations.
magazines. The owners of the magazine, Bure Publishing,
2 The level of profit We saw in Chapter 10.2 that a series
are investigating the production of an online edition
of ratios can be used to assess the profitability of a
especially designed for tablet computers. The company has
business. One of these, return on capital employed (or
conducted negotiations with two software houses regarding
ROCE), provides a figure that measures operating profits
the development of a website for its new product, e-sailing.
generated against the value of resources available to the
The two software houses offered very different ideas:
business. It is not unusual for a business to set itself
one (proposal A) suggested a basic product allowing Bure
targets in terms of ROCE. Managers may insist that any
Publishing to offer access to the magazine at a bargain
new investment project should generate returns that
price; the other (proposal B) proposed a more sophisticated
will at least match (and hopefully exceed) the business’
product, to a higher technical standard, offering the
overall target for ROCE.
opportunity for premium pricing.
3 Alternative investments It would be unusual for a
The cash flows associated with these proposals over a business to consider only a single investment project.
five-year period are set out in Table 10.21 (page 463). These Most managers contemplating a major investment
show the cost of developing the website and the expected will have other options. These could be very different
revenues, less operating costs for the site each year. Bure investments or simple variants on the first proposal.
Publishing estimates that a 10 per cent discount rate would The business may simply select the project or projects
reflect likely market rates of interest. that perform the best, subject to some minimum criteria
in terms of profits or percentage returns. In such
Bure Publishing would opt for proposal A on the basis
circumstances, opportunity cost is an important concept
of this financial information, as the NPV for proposal A
for managers to bear in mind.
(the cheaper option) is higher than that for proposal B.
The net cash flow for proposal A is also positive, as cash
inflows exceed outflows. Therefore, the investment is STUDY TIP
viable. However, non-financial information may affect this Investment criteria can be useful to you when responding
investment decision. to questions on investment appraisal. When judging
whether or not a business should go ahead with a
10.3.4 Investment appraisal particular investment, it is important to think about what
criteria the business would expect the investment to
decisions meet. The case study may directly state these or they
may be implied. In either case, by relating your answer
Quantitative results and their impact on to the criterion or criteria, you have a basis for making a
investment decisions judgement that you are able to justify.
Once the investment appraisal process has produced an

answer, this needs to be compared with something in order
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▼ Table 10.21 Comparing Bure Publishing’s investment projects using discounted cash flow
Proposal A Proposal B
10.3
Year Annual cash Discounting Present value ($) Annual cash Discounting Present value ($)
flows ($) factors at 10% flows ($) factors at 10%
0 (212 000) 1 (212 000) (451 000) 1 (451 000)
1 46 000 0.909 41 814 89 400 0.909 81 265
2 57 500 0.826 47 495 115 000 0.826 94 990
3 63 250 0.751 47 501 122 500 0.751 91 998
10.3.4 Investment appraisal decisions

4 69 000 0.683 47 127 144 275 0.683 98 540
5 71 000 0.621 44 091 140 000 0.621 86 940
Net present value 16 028 Net present value 2 733
CASE STUDY
Entrepreneur makes a takeover bid for Newcastle United Football Club
Henry Mauriss, an Los Angeles-based television agreement with Newcastle, thus ending Ashley’s
executive, has made a late, £350 million bid to buy 13-year ownership of the club. It is understood that
Newcastle United Football Club (which plays in the UK’s Mauriss believes he could take control of the club as early
Premier League) from the current owner, Mike Ashley. as September. However, there are other uncertainties.
Mauriss is the 56-year-old chief executive of Clear TV who The UK’s Premier League has a £500 million contract for
has made a fortune in the broadcasting industry. This bid overseas broadcast rights with Qatar’s beIN Sport. This
is worth £50 million more than the bid a Saudi Arabian- may be lost if the Saudi deal fails.
led consortium had previously agreed with Newcastle’s
owner. It is Mauriss’ first venture into the ownership of a Questions
sports club. 1 Analyse two benefits of using the NPV approach to
help to decide the financial case for major decisions
In order for Mauriss’ bid to succeed, the Premier League
such as this takeover. [8]
would have to veto the Saudi-led group’s offer (which has
2 Evaluate the difficulties that Henry Mauriss may
been on the table for three months). If this happened, the
have faced in forecasting the financial costs and
bid would also depend on whether the group chose to
returns of the proposed takeover investment. [20]
pursue the issue.
Should the Saudi consortium’s attempted buy-out
fall through, Mauriss would be at liberty to reach an
and no financial records to use as a guide in forecasting

The risks and uncertainties of sales. In December 2012, the global retailer Tesco
investment decisions announced that it was pulling out of the USA, having
It is not a simple matter to assess the degree of risk failed to break into one of the world’s toughest retail
involved in an investment decision from quantitative data. markets. Operating costs proved to be high and sales
Risk is the chance of something adverse or bad happening. figures did not reach expectations. Apparently even one
In the context of investment decisions, there are two broad of the UK’s largest companies did not find it easy to
possibilities: costs may be higher than forecast or sales may forecast its sales accurately.
be lower than expected. » Competitors’ reactions Deciding on a particular
programme of investment may bring a business into
Forecasting future sales can be a very difficult, and often competition with rivals in new ways. Entering a new
expensive, exercise. Market research can be used, but it is market (as in the case of Tesco above), producing new
costly and not always reliable. The difficulties in forecasting products or developing new methods of production may
sales arise from a number of factors: all provoke a response from competitors. This may take
» Timescales It is much harder to forecast sales accurately the form of increasing advertising, cutting prices or
many years into the future. Over a longer timescale, it is bringing out new products. Each of these actions will
more likely that tastes and fashions may change or that impact on the sales associated with the investment
new competitors or new products may enter the market. project. However, not knowing the type or extent of
» New markets If an investment project is based on a reaction in advance makes it very difficult to estimate
business entering a new market (either in geographical its effect on future sales.
or product terms) then the business has less experience
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» Equally, costs may rise above the forecast level, » Corporate objectives Most businesses will only
reducing the returns from the investment, as we saw undertake an investment if they consider that it will
10.3 with Tesco’s unsuccessful expansion into the USA. In
October 2018, the price of oil rose to nearly $75 per
assist in the achievement of corporate objectives. For
example, Rolls-Royce, a company that publicly states its
barrel, reducing the profit margins of many companies, aim to produce high-quality products, may invest heavily
including airlines such as Virgin Atlantic. By May 2020, in training for its staff and in research and development.
oil was priced at $17 a barrel. The volatility of prices for This will assist in the manufacture of world-class
such a fundamentally important product highlights the aeroplane engines and vehicles.
difficulties that firms face when attempting to forecast » Environmental and ethical issues These can be
future costs of production. important influences on investment decisions. Some
firms have a genuine commitment to trading ethically

Qualitative factors and their impact on and to inflicting minimal damage on the environment.
This is a core part of their business philosophy. As a
investment decisions consequence, they would not exploit cheap foreign
The financial aspects of any proposed investment will labour or use non-sustainable resources. Other firms may
clearly have an important influence upon whether a have a weaker commitment to ethical and environmental
business goes ahead with the plan. However, a number of trading but may still avoid some investments for fear of
other issues may affect the decision: damaging publicity.
» Corporate image A firm may reject a potentially » Industrial relations Some potentially profitable
profitable investment project, or choose a less investments may be turned down because they would
profitable alternative, because to do otherwise might result in a substantial loss of jobs. Taking decisions that
reflect badly on the business. Having a positive lead to large-scale redundancies can be costly in terms
corporate image is important in terms of long-term of decreased morale, redundancy payments and harm to
sales and profits, and it may be considered more the business’ corporate image.
important than gaining short-term advantage from
profitable investments. Boeing, the American aircraft STUDY TIP
manufacturer, invested in developing a new aircraft:
It is essential to think about quantitative and qualitative
the 737 Max. The new plane was involved in two
factors when making decisions on investment projects.
crashes, one in 2018 and one in 2019, killing a total of
Most case studies will include some qualitative issues
346 people. In response, many countries grounded for you to weigh up, and a good-quality answer will
the plane, and the company began working on the take these into account in addition to any quantitative
flight-control software that is believed to be the cause information.
of the problem. Many months later – at the time of
writing – the problem remains unresolved. Boeing’s
investment in the 737 Max and other aircraft may prove
less profitable as a consequence.
CASE STUDY
Cargill plans $113-million expansion in the Ivory Coast and Ghana
Global food and agriculture company, Cargill, has budgeted Lionel Soulard, managing director for Cargill West-Africa,
$113 million to expand its cocoa-processing operations at said, ‘Working directly with both governments and other
its sites in Yopougon, Ivory Coast, and Tema, Ghana. The key stakeholders, we are committed to economic growth,
company’s plans for the two sites are as follows: building sustainable local businesses and diversifying
● Yopougon Production capacity will be increased by 50 sources of income for cocoa farming communities.’
per cent as a result of investing $100 million. Cargill will
Source: www.cargill.com/2019/cargill-invests-$113-
employ an additional 85 local people and many jobs will million-in-ivory-coast-and-ghana
be created in other local businesses. More facilities will
be devoted to the production of Gerkens cocoa powders. Questions
● Tema An investment of £13 million will be used to 1 Analyse one reason why Cargill would have used
increase production capacity at this site by 20 per cent. investment appraisal techniques as part of its
Along with these investments, Cargill intends to invest just decision to invest in the Ivory Coast and Ghana. [4]
over $12 million in improving its sustainability and supply 2 ‘Qualitative factors would have influenced
chain traceability programmes in Africa. The company Cargill more strongly than quantitative factors in
anticipates that this investment will provide a safer reaching this decision to invest $113 million.’
environment for those living in the areas surrounding its Evaluate this view. [20]
cocoa farms. It should also improve consumer confidence
by making the supplies it uses more traceable.
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A comparison of investment appraisal investment will be how long it takes to cover the cost of the
investment from additional revenues. Payback is therefore
methods
The method of investment appraisal chosen will depend
valuable for firms who wish to minimise risk. 10.3
Larger firms that have access to more sophisticated
upon the type of firm, the market in which it is trading and financial techniques may use the accounting rate of return
its corporate objectives. A small firm may be more likely to or discounted cash-flow methods. These methods highlight
use payback because managers may be unfamiliar with more the overall profitability of investment projects and may be
complex methods of investment appraisal. Small businesses more appropriate for businesses where profit-maximisation
also often focus on survival, and an important aspect of any is important.
▼ Table 10.22 A comparison of techniques of investment appraisal
10.3.4 Investment appraisal decisions

Method of investment appraisal Benefits Limitations
Payback • Easy to calculate • Ignores timing of payments before
• Simple to understand payback
• Relevant to firms with limited funds who • Excludes income received after payback
want a quick return • Does not calculate profit
Accounting rate of return • Measures the profit achieved on projects • Ignores the timing of the payments
• Allows easy comparison with returns on • Calculates average profits – they may
financial investments (e.g. bank accounts) fluctuate wildly during the project
Discounted cash flow • Makes an allowance for the opportunity • Choosing the discount rate is difficult,
cost of investing especially for long-term projects
• Takes into account cash inflows and • A complex method to calculate and
outflows for the investment’s duration easily misunderstood
Is it worth using techniques of In assessing the value of numerical techniques of

investment appraisal, some thought has to be given to
investment appraisal? the alternative. Without the use of payback and the like,
The results of investment appraisal calculations are only as managers would operate on the basis of hunches and
good as the data on which they are based. Firms experience guesswork. Some managers may have a good instinct for
difficulty in accurately forecasting the cost of many major these matters, whereas others may not. As markets become
projects. It is even more difficult to estimate the likely more complex and global, the need for some technique to
revenues from investment projects, particularly long- appraise investments becomes greater. It is more difficult
term ones. It is perhaps possible to make an allowance to for an individual or a group to have an accurate overview of
represent risk; for example, the possibility of a competitor a large international market comprising many competitors
taking actions that result in sales being lower than forecast. and millions of diverse individuals. Detailed market research
However, uncertainty (which cannot be measured) may make to forecast possible revenues and the use of appropriate
any investment appraisal worthless. techniques of investment appraisal may become even more
important in the future.
TEST YOUR LEARNING

4 a Explain one disadvantage of using payback in the
Short answer questions circumstances in question 3. [3]
1 a Define the term ‘investment’. [2] b Explain how the accounting rate of return is
b Explain one reason why a business might need to calculated. [3]
engage in investment appraisal. [3] 5 Bangar Leisure is considering the purchase of a
2 a Define the term ‘risk’. [2] new boat for cruises in Brunei Bay. The Royal Queen
b Explain one reason why a major retailer may make is available at a cost of $900 000 and would cost
a major investment. [3] $100 000 each year to operate. Over its ten-year life,
3 Thames Radio is contemplating investing in new the cruiser would generate $280 000 in revenue each
broadcasting equipment. The cost of the investment year. Calculate the accounting rate of return on this
is forecast to be £150 000. The expected additional investment. [4]
revenue from being able to broadcast to a larger area 6 a Define the term ‘present value’. [2]
is £40 000 per annum. Calculate the payback period of b Define the term ‘discounting’. [2]
this investment. [4]
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7 Harare Printers is appraising the costs and benefits Although holidaymakers are visiting Sri Lanka in
10.3 of a new piece of machinery. The equipment costs

$300 000 and has a working life of four years. The
increasing numbers, its uncertain political situation has,
at times, deterred some international travellers from
company expects to generate revenue of $120 000 visiting Tangalle. Leisure Group Ltd plans to build its
each year if it purchases the machine. Calculate the large, modern building in an unspoilt bay; this will result
net present value of this project, assuming an interest in the destruction of many trees and other plants.
rate of 10 per cent. [5]
Leisure Group Ltd’s costs are shown in Table 10.23 and
8 a Explain one criterion that a company may use to are based on the use of a construction company based in
make a decision on whether or not to go ahead with the United Arab Emirates.
an investment programme. [3]
b Explain one reason why it can be difficult to ▼ Table 10.23 Leisure Group Ltd’s costs
forecast sales. [3]
Year Investment cost ($) Profit ($)
9 Explain two actions a business may take to manage
the degree of risk involved in an investment decision. [6] Now (year 0) 2 500 000 0
10 Explain two qualitative factors a business may take 1 – 52 000
into account when making an investment decision. [6]
2 – 110 000
Data response question 3 – 150 000
A risky investment? 4 – 200 000
Tangalle is one of Sri Lanka’s most-visited tourist
destinations – its beaches are especially popular. Questions
Leisure Group Ltd operates a number of hotels in 1 Analyse two reasons why Leisure Group Ltd’s
other parts of Asia and is an ethical business which is proposed investment could be considered risky. [8]
committed to good employment conditions and good 2 a Calculate the accounting rate of return on the
wages for all its employees. High potential sales is one proposed hotel for its first four years of trading. [6]
factor influencing Leisure Group Ltd’s investigation into b Evaluate the major qualitative issues relating
building a new hotel in the town – its first one in the to the proposed hotel. [12]
country. This will help to achieve its corporate objective
3 Advise Leisure Group Ltd on whether or not it should
of growth. Leisure Group Ltd is profitable – its most
build the hotel. Justify your decision. [20]
recent ROCE figure was 17 per cent. The popularity of
Tangalle with tourists may also explain a rumour that Essay question
the Intercontinental Hotel Group (the world’s largest
hotel business) is to open a large hotel just outside 1 Many businesses operate in global markets.
the town. Evaluate whether this means that qualitative
factors should play the most important role in all
investment decisions. [20]
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A LEVEL
10.4
Finance and accounting strategy
10.4.1 Using accounting data to enable strategic decision-making

Chapter overview
★ how financial statements are used to develop strategies
★ what is in an annual report and its value to businesses and their stakeholders
★ how businesses judge performance over time and against competitors
★ the impact of accounting data on business strategy
★ the impact of debt and equity decisions, changes in dividend strategy, business growth and other business strategies
on ratio results
★ the limitations of ratio results and published accounts.
10.4.1 Using accounting data The business’ ability to raise finance

If the business is pursuing an expansionary corporate
to enable strategic decision- strategy, it is likely to need to raise funds to finance
making its plans. In Chapter 6.2.1 we considered the possible
approaches managers might take to developing strategies.
Businesses produce a number of financial statements, but A blue ocean strategy or a diversification option under
we are only concerned with two: the statement of profit or Ansoff’s classification may require expenditure on, for
loss and the statement of financial position. We covered example, recruiting and training employees to make the
these two statements in detail in Chapter 10.1. workforce more innovative, or it may require the purchase
Senior managers develop corporate strategies for businesses of new non-current assets to facilitate expansion into new
to enable them to achieve their corporate objectives. They markets.
use multiple sources of information to help them to make The statement of financial position can provide important
good-quality decisions and these sources include financial information to help assess the business’ ability to raise
statements. The contribution of a company’s chief financial funds. This statement paints a picture of the sources of
officer (or CFO, who is responsible for managing the finance used by a business and allows stakeholders to assess
business’ finances) has changed in recent years. Advances whether the business has borrowed an excessive amount
in technology designed to record, manipulate and present of finance. This would make it vulnerable to rising interest
financial data have meant that finance specialists have rates and increase the degree of risk in an expansionary
been able to contribute more to other aspects of the strategy. If the business’ gearing ratio is significantly below
management of a business. The CFO’s role has become the crucial 50 per cent figure, it may be more possible to
less about analysing historical financial data and more finance a corporate strategy using loan capital.
about contributing to the development of new corporate
strategies. The information in key financial statements is The statement of financial position also shows the value or
very important in developing these strategies. worth of a business. A single statement may only provide a
limited amount of information – the value of the business at
a single point in time. However, a series of statements over
GLOSSARY TERM time can indicate the success of a business in achieving
A chief financial officer (CFO) is the senior manager who and sustaining growth. This, of course, may make it more
has overall responsibility for the financial affairs of an possible for the business to raise finance through share
organisation. capital, as a business that has enjoyed steady growth may
be more attractive to potential shareholders. This could be
the case as the business’ previous strategy may be judged
The statement of financial position successful, and a growing business may benefit from a
This statement can provide a considerable amount of rising share price.
information to help directors and managers to develop
corporate strategies.
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The business’ liquidity position substantial borrowing. The company’s liquidity position
will be an important factor in shaping such a decision
We saw earlier that liquidity measures the ability of a
10.4 business to meet its short-term debts. The statement of
as, for example, it shows its ability to make loan
repayments on time.
financial position contains details of the business’ current
assets and liabilities, and the acid test and current ratios
» A business’ liquidity position will also be a factor
influencing the willingness of banks and other
can be calculated to assess the business’ liquidity position.
organisations to make long-term loans to the business.
Liquidity is important in determining a business’ future If the business’ liquidity position is weak, it may be
strategy. This can be valuable to managers developing difficult to raise the necessary loan capital. Equally,
strategies in a number of ways: shareholders may be reluctant to purchase shares and
» It can provide evidence of the business’ ability to this can limit the business’ options for devising new
A LEVEL 10.4 Finance and accounting strategy
finance future capital expenditure. For example, a strategies.

strategy based on developing new products may require
CASE STUDY
Apple’s strategy
Apple is a multinational technology company which uses ▼ Table 10.24 Extracts from Apple’s statement of
product differentiation as its core business strategy. It financial position, 28 March 2020
utilises sleek, simple designs and advanced functionality
to differentiate its products and services. The main Items $m
objective of implementing a differentiation strategy is to Non-current assets 176 647
increase competitive advantage.
Cash and short-term investments 94 051
Apple seeks to exploit its core competencies (such as a
talented and innovative workforce) to achieve long-term Inventories 3 355
competitive advantage. Its strategic targets focus on Other current assets 46 347
business development in areas where its rivals are less Total current assets 143 753
formidable.
Total current liabilities 96 094
Apple has created its competitive advantage by adapting
and developing the features of its products and services. Non-current liabilities 145 881
This strategy also allows Apple to benefit from first- Equity 45 243
mover advantage, in that its innovations are usually
Reserves 33 182
in advance of those developed by rivals. Apple is very
innovative in pursuit of its strategy.
In 2019, Apple’s revenue was $260 174 million and its profit
Apple has simultaneously developed expertise in for the year totalled $55 256 million. These figures were
software, hardware and services. Apple devices and very similar to those achieved in 2018.
software work together and sync with ease. Apple’s
strategy creates discouraging switching costs for its Questions
existing customers if they wish to change to a competitor’s 1 Analyse one reason why Apple’s liquidity position
products, and also provides opportunities to offer loyal might be said to be ‘strong’. [4]
customers new products and services. 2 ‘Apple’s financial position is the primary reason for its
corporate strategy of product differentiation.’ Use the
information in the case study to evaluate this view. [20]
managers with vital information in devising new strategies;

The statement of profit or loss and for example, whether to be more or less aggressive, whether
financial strategies to seek to change strategy or whether to continue with an
A management team can draw on some key information existing strategy.
in the statement of profit or loss to help it to devise a Figures for profits hold more value in devising strategies.
corporate strategy. They may provide some insights into the success of existing
The business’ revenue is an important factor. Alone, this strategies – at least in financial terms. Figures for gross and
figure may be of limited value, but when judged over operating profits provide some evidence of the business’
time – or compared to that of other businesses in the same ability to control costs. A business that is highly successful
industry – it can provide an insight into the business’ in this area (for example, the Irish low-cost airline, Ryanair)
current position within its market. This may provide senior may seek to establish strategies based on cost leadership.
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Profit for year data indicate the resources that are available However, the structure and contents of the annual report
to a business’ management team to implement new should enable shareholders to judge the company’s position
strategies. A company with a rising profit for the year figure
may be able to sustain dividend payments to shareholders
and performance, as well as its corporate strategy. 10.4
There are a number of elements which are commonly
while reinvesting profits into supporting a new (and
included in an annual report. The contents list below relates
possibly) expansionary corporate strategy. Lego, the Danish
to companies in the UK. However, these contents will be
toymaker and retailer, enjoyed a 3 per cent rise in profits
similar in most countries as many companies have (or seek
in 2019 to 8.3 billion Danish Kroner ($1.25 billion). The
to have) shareholders from around the world.
company also announced plans to open a further 150 new
» Highlights This is a summary of the company’s year. It
stores in 2020, 80 of which will be in China.
normally contains information such as the company’s
10.4.1 Using accounting data to enable strategic decision-making

corporate objectives, its strategy and business model
Statement of financial
position and some key performance indicators (KPIs), often for
a five-year period.
» Strategic report This is an important element which
summarises the success of the directors in implementing
the company’s strategy. It should evaluate the company’s
Liquidity Gearing position at the end of the financial year and include
Growth? financial and non-financial KPIs in support of this analysis.
It should report on the risks that the company has faced
Corporate
Innovation?
during the year and how the directors have managed and
strategy responded to such risks. There should be an explanation
of any other factors that have affected the strategic
Diversification?
performance of the business; for example, environmental
Revenues Cost controls Profits or ethical issues. The strategic report should also offer
some analysis of those factors which might be expected to
impact on the company’s future performance.
» Statements or reviews These are written by those
holding key positions in the organisation (chairman,
Statement of profit chief executive, chief financial officer, for example).
or loss
The chairman’s report will normally refer to dividend
payments, the governance of the company and corporate
▲ Figure 10.11 Financial statements and strategy
responsibility. The chief executive will comment on the
business’ performance, its KPIs and the market and wider
GLOSSARY TERM business environment in which the company is trading.
Key performance indicators (KPIs) are measures of how » Directors’ report This contains information about
well a business is meeting its targets, such as revenue or individual directors, their individual responsibilities,
profit per customer. recommendation on the dividends to be paid to
shareholders and their interests. It also includes
information on voting rights of shareholders and the
Annual reports and strategic company’s share capital.
» A report on ethics, sustainability and corporate social
decision-making responsibility This will contain information about
Companies publish their annual report a few months after company policy and actions in the country or countries
the conclusion of the financial year to which it relates. in which the business operates, as well as (possibly) the
Experienced business analysts often joke that annual policy or actions of its suppliers.
reports should be read back-to-front. They point out that » A report of corporate governance This explains who
the financial data is normally included at the back, while the company is managed by, the management structures
the early sections are frequently a marketing exercise in place and how its management complies with relevant
intended to present the company in a very favourable light. laws.
» Directors’ remuneration This records the remuneration
The contents of an annual report can vary according to the
(pay) of all the company’s directors, as well as
country in which the company is based. The main function
a statement of the policy relating to directors’
of an annual report is to explain the company’s performance
remuneration.
over the most recent financial year to shareholders and
» Independent auditor’s report Auditors are specialist
other investors. It should show how the company generates
accountants who inspect company accounts to ensure that
value for its owners in the long term. The organisation
they are accurate and fair. Their report will confirm this.
of the annual report varies between companies, as each
seeks to present its performance as positively as possible.
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» Financial statements These cover a range of financial product plans, and research and development to give
statements including the statement of financial shareholders an insight into the company’s prospects.
10.4 position and the statement of profit or loss, as well
as a five-year financial report and the company’s
Shareholders may use the information within annual
reports to compare a number of companies as potential
accounting policies. The statements also include notes investments.
which can be extremely detailed but often contain very » Customers An annual report can be a means of
important information. sustaining the confidence of customers that the
» Other information This section can provide information company is a suitable supplier for the long term. The
about shareholders, the financial calendar for the financial information can reassure customers that the
forthcoming year and links to further information that is company’s future is secure by showing, for example,
that it has sufficient cash and has not borrowed too
available online.
heavily. Customers will also be concerned about the
The usefulness of annual reports quality of products, research into new products and
that production will not be interrupted. A report by the
Annual reports are a legal requirement for public companies director of operations might be of particular value in
in many countries because they offer benefits to the meeting the needs of customers for this type of
business’ stakeholders as well as to the business itself. information.
The company that produces an annual report can benefit » Suppliers Most companies use a range of suppliers to
in that it offers a marketing opportunity. The company’s provide the goods and services required for production.
management team can use it to publicise some of their Suppliers will be interested in the company’s liquidity
most successful products as well as the company’s plans for position, as this will give useful information on their
the future. This can help it to attract customers, especially ability to pay as well as the expected payment periods.
if it is a B2B company – that is, one that sells to other They may also be interested in new products in planning
businesses. In such cases, the customers are more likely and expected market growth rates, as these have
to read the annual report as they are likely to place large implications for the orders that the company is likely to
orders with the company and have a significant stake in its place with its suppliers.
future. » Employees Many companies seek to build an employer
The annual report can play an important role within brand whereby they are seen as an attractive place to
the business too. It can be an important means of work by existing and potential employees. Employees
communicating targets and plans to important decision- will want to know whether the company is financially
makers within the company. The annual report is likely to secure and whether it is a good employer, offering
set out the company’s future strategy in its early sections, competitive pay rates and opportunities for promotion.
and this can be particularly valuable at a time of change. Reports by key directors, such as the company’s chief
The report can support other means of communicating a executive, can help to present the company as an
change in strategy. exciting and rewarding place to work.
» The media Newspapers, radio and television all report
However, an annual report will be of greater value to on business matters. The annual reports of companies
a business if it is read by key target groups, such as are an important source of information. Although the
shareholders and employees. Making it engaging and trend in revenues and profits may attract the initial
available in different formats (PDFs online as well as headlines, other elements of the report can be used
traditional paper copies) can increase its usefulness. to help to build a strong public image of the company.
The annual report has value to other stakeholders as well: National and international media can help to shape
» Shareholders and other investors It is possible to the views of many key stakeholders worldwide – an
argue that shareholders and other investors (potential increasingly important factor for many companies in
as well as existing) are a prime target for the messages a globalised world. In particular, it may influence the
contained within an annual report. It is a means of company’s ability to attract investment.
keeping shareholders up-to-date with developments The above makes clear that annual reports have considerable
within the business and its markets, as well as in its potential to influence a company’s stakeholders. However,
financial performance. A well-designed and informative the most obvious criticism is that annual reports are often
annual report can help to engage investors and historical documents. They are likely to offer greater value
may assist in attracting investment in the future. if they have a clear focus on the company’s future and
The most obvious limitation of annual reports is are designed to meet the need for information among
that they contain a lot of historical information. To the company’s major stakeholders. Figure 10.12 shows the
overcome this potential weakness, an effective annual benefits that a good-quality annual report may offer.
report should include sections on market conditions,
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Shareholders
The media
Financial and
and other
investors
10.4
market
information on
Gives positive data future prospects
on performance and
prospects as key
influencers
Annual reports
Maintain confidence
• well-designed
10.4.2 Using accounting data and ratio analysis in strategic decision-making

by presenting data on
• informative
liquidity, quality, etc.
• available
• targeted
Employees Employer Customers

branding – it’s
a good place Positive information
to work on likely future orders
Security of payment
Suppliers
▲ Figure 10.12 Annual reports and company stakeholders
10.4.2 Using accounting data its management team may implement strategic operational
decisions to improve this aspect of the business’ financial
and ratio analysis in strategic performance.
decision-making However, the use of time-series financial data can be
unreliable. A business may show consistent improvements
Assessing business performance over in financial performance over a period of time, but this
cannot guarantee that this trend will continue in the future.
time and against competitors Businesses are subject to constant change, both internally
Management teams increasingly use financial data to and in the environment in which they operate. The
support strategic decisions. W Edwards Deming, an retirement of a particularly talented and experienced leader,
American professor and management consultant, recognised the emergence of a new competitor or a sudden crisis, such
the importance of data in decision-making: ‘In God we as that caused by the Coronavirus (COVID-19) pandemic
trust. All others must bring data’ is one of his most famous in 2020, may result in a sudden deterioration in financial
quotes. Financial data can be enriched if it is provided for a performance. Trend analysis can provide some important
period of time and also if competitors’ data is available for data in assessing financial performance, but the future may
comparison. differ markedly from the past.
Using time-series financial data Using data from competitors

We saw earlier that annual reports frequently contain a It is usually insufficient to assess a business’ financial
five-year summary of financial data. In the UK, this is a performance using just financial data relating to that
legal requirement for public companies. It is important to company – even if it is available for a period of time.
judge the performance of a company by considering data Some managers benchmark data from those businesses that
over time to establish whether or not a particular trend is are industry leaders and use this as targets. For example,
emerging. For example, a small fall in revenue or operating some retailers operate with very low levels of liquidity.
profits might not appear particularly significant. However, This can help to reduce borrowing costs as lower levels of
stakeholders may consider it more significant if it is a short-term debt might be required. Benchmarking other
pattern that has been consistent over a number of years. businesses and using these as targets can help to improve
a business’ financial efficiency. In the UK, the Centre for
Similarly, senior managers may use trend analysis to inform
Interfirm Comparisons helps businesses of every kind to
decisions on operations. Therefore, for example, if a
improve their financial performance by providing financial
business’ cash position has steadily weakened over time,
data as a basis for comparison.
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CASE STUDY
10.4
BP’s performance over five years
BP is a multinational oil and gas company, with refining and retailing. In 2019, it had 73 000 employees
headquarters in London. It operates in all areas of the working in locations across the world.
oil and gas industry including exploration, extraction,
Diversity and inclusion

(relates to BP employees) 25 2019 performance
2019
Each year we report on the 25 Both measures increased slightly. As a

percentage of women and 24 global business we are committed to
2018
individuals from countries 24 increasing the diversity of our
other than the UK and the 21 workforce and leadership.
2017
USA among BP’s group leaders. 24
22
2016
23
19
2015
21
Women in group leadership
People from beyond the UK
and USA in group leadership
Greenhouse gas emissions (MtCO2B)

We provide data on greenhouse 2019 46.0 2019 performance
gas (GHG) emissions material to 2018 46.5 Our Scope 1 (direct) equity share
our business on a carbon emissions decreased by 0.5MtCO2B
dioxide-equivalent basis. This 2017 49.4 to 46.0MtCO2B in 2019
particular KPI comprises Scope 2016 50.1 (46.5MtCO2B in 2018).
1 (direct) emissions of CO2 and 2015 49.0
methane.
Return on average capital employed (%)

Return on average capital 2019 8.9 2019 performance
employed gives an indication of The decrease reflects lower profit
2018 11.2
a company’s capital efficiency. due to the impact of lower oil and
2017 5.8 gas prices and weaker refining
2016 2.8 environment.
2015 5.5
Total shareholder return (%)

Total shareholder return (TSR) 5.8 2019 performance
2019 Improvement in TSR reflects increased
represents the change in value of 1.1
a BP shareholding over a calendar dividends in 2019.
(4.6)
2018 0.5
year. It assumes that dividends are
reinvested to purchase additional 20.0
shares at the closing price on the 2017
9.5
ex-dividend date. 29.0
2016
55.5
We are committed to maintaining a (12.8)
progressive and sustainable dividend 2015
(8.3)
policy.
ADS basis (Note: The ADS basis for measuring total shareholder return includes shares available for purchase by American investors.)
Ordinary share basis
▲ Figure 10.13 A selection of BP’s performance data, 2015–2019

Source: BP Annual Report 2019 (pages 34–5), www.bp.com/content/dam/bp/business-sites/
en/global/corporate/pdfs/investors/bp-annual-report-and-form-20f-2019.pdf
Questions
1 Analyse two reasons why BP might have decided to 2 ‘The financial information included in this case study
include non-financial data, such as that shown in would allow a shareholder to make an accurate
Figure 10.13, in its annual report. [8] assessment of BP’s future financial performance.’
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If suitable data is available, it can be a useful help for A management team that is devising a new strategy will be
stakeholders seeking to judge performance. Managers, influenced by the business’ existing financial efficiency.
shareholders and other stakeholders can see if the
company’s revenue has grown as quickly as that of
Poor results on financial efficiency ratios, such as a low
rate of inventory turnover, might encourage new strategies
10.4
competitors or whether the performance of the company’s that in part minimise holdings of inventory. This might,
operating profit differs significantly. for example, be a factor encouraging the development of a
strategy of market penetration.
It can be particularly useful to make comparisons with data
from competitors over a period of time. Figure 10.13 shows
BP’s ROCE data for a five-year period. The company’s ROCE Assessing the business’ ability to finance
figures vary from 2.8 to 11.2 per cent. A shareholder might a new strategy

consider these to be low figures. However, a comparison Many new corporate strategies require major investments.
with the ROCE data for Shell, one of BP’s major rivals, shows Management teams taking decisions on adopting a blue
that BP’s ROCE performance holds up well. Shell’s ROCE ocean strategy or strategy of growth may need to invest
figures fluctuated between 2 and 9 per cent over the same in recruiting new employees or training existing ones, or
period of time. This information enables the stakeholder to they may need to purchase expensive non-current assets
make a more informed judgement. to increase productive capacity. A large investment may
However, there are times when the use of data from be a central element of implementing the new strategy. A
competitors might not be so helpful. Some ratios do range of financial data may be helpful in determining the
a poor job at comparing one company with another. A strategy.
company’s choice of accounting policies used in its financial » ROCE data for the business may be used to set
statements will have an effect on its ratio results. For investment criteria by which the investment element of
example, companies may use different methods of inventory the strategy is determined. It may simply be that any
valuation (and not just the net realisable method) and investment should generate a return at least equal to
any ratios that include inventory will differ from those the business’ average ROCE figure over recent years.
companies that use a different approach to inventory » Liquidity will shape some investment decisions. Poor
valuation. Such ratios include inventory turnover and the levels of liquidity (as measured by the current ratio or
acid test ratio. the acid test ratio) may restrict the business’ ability
to raise finance, as well as its willingness to engage in
long-term borrowing. The business’ financial resources
The impact of accounting data on may force the adoption of a less ambitious (and less
business strategy costly) strategy. Alternatively, it may be decided to
implement the chosen strategy over a longer period of
In the 1980s, relatively little use was made of accounting
time.
data in devising corporate strategies. Many large businesses
have subsequently employed strategic management
» Gearing, recent figures for profit for the year and
dividend decisions will influence the business’ ability
accountants to provide and analyse accounting data about
to raise capital to fund a new strategy. Gearing figures
the business and its competitors to help develop and
which are rising over time and are close to the 50 per
implement corporate strategy.
cent figure may mean the business has limited potential
Accounting data can help a business’ management team to to raise further loan capital. On the other hand, a
develop strategy in three principal ways. business that has generated strong and rising profit for
the year figures without paying too high dividends may
Improving business performance be able to finance more costly strategies.
Strategic decisions such as whether or not to enter a
particular market or to produce a specific new product can Managing risk
be based on an analysis of potential profitability. Financial Risk is the chance of something going wrong. Many new
data used to compile the statement of profit or loss may corporate strategies carry a degree of risk. A business
be interrogated to identify existing markets which offer may develop a strategy of diversification entailing selling
the highest levels of profitability. Financial forecasts new products in new markets. The potential rewards of
would normally be developed as part of a proposed new this strategy may be considerable, but the level of risk
strategy and profitability in terms of profit margins or may also be high. Accounting data can help a business to
ROCE estimated. Strategic choices can be influenced by decide whether this risk is worth taking. It may be that
having a view of which strategies generate profitability the forecast profitability figures are very much higher than
ratios reaching a sufficient level. This might be a stronger existing ones, making it an attractive strategy. A range of
factor for those businesses which have suffered low and/ accounting information, such as that relating to existing
or declining profitability in recent years. For example, liquidity, may help the management team to judge whether
profitability might inform strategic decisions on entering the risk involved in the new strategy is too high.
new markets where higher prices may be charged.
Accounting data may also enable managers to judge whether
the business could survive the failure of the new strategy,
as well as shaping the decision itself. In November 2007,
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Tesco, one of the UK’s largest supermarkets, entered the The impact of changes in dividend
American retailing market. It invested $500 million to open
10.4 182 stores in California and Nevada, aiming for increased
rates of sales growth at a time when revenue growth in
strategy on ratio results
A dividend strategy can be an important factor
the UK was relatively slow. As we saw earlier, the project in persuading investors to buy a company’s shares.
failed and Tesco withdrew from the US market in 2012, Shareholders are attracted to companies that can be relied
having incurred losses totalling an estimated $1.5 billion. upon to pay dividends, particularly if these payments
The company would have used its accounting data to help increase steadily over time.
it to judge whether it could afford a loss of this size before
implementing this strategy. Companies can operate a number of strategies when
deciding what proportion of their profit for the year to
distribute to shareholders in the form of dividends. Three

The impact of debt or equity decisions possible strategies are explained below.
on ratio results » A strategy of increasing payments steadily over time.
This strategy, so long as it can be sustained, will help the
Decisions made by managers in relation to the business’
company to attract shareholders and will make it easier
capital structure can be important in both the short and
(but potentially more costly) to raise capital by issuing
long term. Managers have to take ‘debt or equity decisions’.
shares. Despite the potential cost, a number of high-profile
They may opt to borrow funds, normally long-term, to
companies have adopted this approach. For example, in
finance capital expenditure. This is funding by debt and it
2020, Coca-Cola announced increased dividends – the 57th
means that the business is committed to paying interest
consecutive year in which it had done so!
until the loans are repaid. Alternatively, a company
may sell shares to raise finance. In this context, this is
» Some companies operate a refinement of the above.
They operate a stable growth trajectory in dividend
termed equity. The business does not have to pay interest
payments, seeking to increase it by a set percentage
on equity, but it would be normally expected to pay a
each year. Over the last few years, Apple has increased
proportion of profits as dividends.
its dividends by around 5 per cent per year. This can be
All companies have to take a decision on the capital reassuring to shareholders, but it may be difficult to
structure that they will employ. These decisions may change sustain during less prosperous periods.
over time. In Chapter 10.2 we saw that Next Plc (a UK clothes » Other businesses follow a dividend strategy which is
retailer) had raised £2723 million in capital by 2020. Of this based around short-term financial performance. So,
sum, £2282 million was debt. In contrast, Toyota (a Japanese dividend payments rise at times when profits are high
car manufacturer) had raised $319 958.2 million in capital by and decline when they are low. Many companies will pay
March 2020, of which ‘only’ $129 171.5 million was debt. dividends from retained earnings if they incur a loss
The most obvious impact of debt and equity decisions is on during a financial year.
the business’ gearing ratio. Businesses that borrow larger In the short term, a change in a dividend strategy by
proportions of their capital will have a higher gearing ratio. a company will have an impact on the results of its
Unsurprisingly, in the cases of Next and Toyota above, the investment ratios. A change in strategy which results in the
former had a much higher gearing ratio: business paying higher dividends might have the effects
» Next = 80.80 per cent outlined below. A decision to reduce dividend payments
» Toyota = 40.37 per cent. would be expected to have the opposite effects.
To summarise, the more a business chooses debt over equity » The dividend yield ratio may increase if dividends rise
as a source of capital, the higher its gearing ratio. We saw in Chapter 10.2 that this is calculated by dividing
the dividend per share by the current market price of the
Debt or equity decisions can also affect the results of share. A rise in dividends is likely to increase the dividend
investment ratios, though the outcomes here are less per share and the dividend yield as a consequence.
predictable. The decision to raise more capital through However, the announcement of increased dividends might
equity results in the issue of a larger number of shares. For increase the company’s share price and this could dampen
example, this decision might reduce a company’s earnings the increase in the dividend yield figure.
per share (particularly in the short term) and therefore » The dividend cover figure can fall if dividends increase
affect its price/earnings ratio, depending on the effect on Dividend cover is calculated by dividing profit for the year
the market price of the company’s shares. by the annual dividend payment. If this payment rises,
and profits are unchanged, the dividend cover figure may
STUDY TIP fall, perhaps prompting fears among shareholders that
it is unsustainable. However, it may be that the reason
Don’t forget that, when calculating the gearing ratio
for the rise in the dividend payment is that profits for
following an increase in long-term borrowing, the
the year have risen. The two rising figures may cancel
figures on the top and the bottom of the formula need
one another out, leaving the dividend cover figure
to be altered. Students often forget to add the increased
borrowing onto the capital employed figure, which forms
unchanged.
the bottom half of the formula!
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» Liquidity ratios may decline if companies increase Alternatively, a business may decide to invest in increasing
dividend payments When a company makes a decision its productive capacity to achieve a growth objective.
to pay dividends to its shareholders, this results in a
cash outflow. The company’s holdings of cash (which are
This may entail investing in non-current assets, such as
machinery or property, or taking over a smaller competitor.
10.4
a current asset) may be lowered as a consequence. This In such a situation, the business’ capital employed is likely
means that a decision to increase dividends may reduce to increase. The impact on the business’ ROCE figure would
the company’s liquidity position as measured by the normally be negative in the short term, as sales and profits
current ratio or the acid test ratio. may take time to increase. If operating profit increases
less quickly than the business’ capital employed, then the
Of course, the reason that the company has made the business’ ROCE figure will decline. However, in the longer-
decision to change its dividend strategy may also be term, if the growth strategy is successful, ROCE should

reflected in its ratio results. For example, a company such increase as operating profits rise. In 2019, AstraZeneca, a
as Coco-Cola, which consistently increases its dividend pharmaceutical company, enjoyed rapid rises in sales of its
payments, has managers that are confident in its ability drugs designed to treat cancer. The firm had invested in
to generate profits. It may be that such decisions are developing these products over many years and the impact
accompanied by rising profitability and this will be reflected on its ROCE figure was seen in 2020, when it rose to 31.58
in rising profit margin and ROCE figures. per cent from 24.15 per cent in the previous year.
The impact of business growth on ratio The effects on liquidity ratios

results Growth can weaken a business’ liquidity position, especially
A growing business is one that is expanding in one of if it is a rapid rate of growth. If the business does not
several ways. It may be enjoying higher sales values and/or have access to the long-term finance that it needs, it will
sales volumes, there might have been an increase in the be overtrading. Increased demand can lead to difficulties
productive capacity of the business as shown in increased in financing increased purchases of raw materials and
numbers of employees, or there might have been an increase components. For example, a rapidly-growing business
in the value of the business as measured by its total assets may seek increased periods of trade credit from suppliers,
employed. increasing its trade payables and thus its current liabilities.
Rising current liabilities are likely to result in weaker
Growth can affect the financial ratios of a business. The liquidity ratios, as both the current and acid test ratios
precise effects will depend on the rate of growth and have current liabilities as the denominator in their formulae.
whether it entails increasing productive capacity or using Therefore, a higher figure for current liabilities indicates a
existing capacity more fully. However, we can identify a lower acid test or current ratio figure and a weaker liquidity
number of likely effects on a range of financial ratios. figure.
However, the effect of growth on liquidity ratios does
The impact on profitability ratios depend on the circumstances. If a business’ management
It might be expected that a period of growth would improve team have planned access to sufficient finance or draw on
a business’ profitability ratios. In many cases this might be cash reserves then the impact may be limited and of little
true, especially if the business is using existing capacity consequence to investors. In some industries, growth is
more fully and has not incurred heavy costs in creating the more easily financed. Some retailers may sell products for
growth. In such circumstances, it would be likely for the cash and growth may increase holdings of cash as well as
business’ ROCE to increase as its revenues and profits rise current liabilities, resulting in little impact on liquidity
and its capital employed is left relatively unchanged. ratios.
However, it is important to take into account how the
business’ growth has been achieved as well as its nature. GLOSSARY TERMS
A business may achieve growth through cutting prices to
increase sales volumes and this is likely to be effective if Capital structure refers to the way in which a business
demand is price elastic. However, in these circumstances, has raised the capital it requires to purchase its assets.
profit margins will be likely to fall as a smaller proportion of A dividend strategy refers to a company’s long-term
the selling price will be profit. In 2019, Tesla, the American approach to allocating a proportion of its profits to
electric vehicle manufacturer, cut its prices by up to $2000 shareholders as dividend payments.
per vehicle in an attempt to increase its sales volumes. As Overtrading occurs when a business expands quickly
a consequence, its operating profit margin fell even though without organising the long-term finance that is necessary
its revenue increased. to fund the expansion.
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Financial efficiency ratios Other ratios
May weaken; depends on:
10.4
Impact may vary; depends on:
• nature of the business • extent of any long-term borrowing
• actions of the management • changes in profits and share price
team
Liquidity ratios Profitability ratios

May weaken; depends on: May improve; depends on:
• timescale • pricing decisions
• initial cash position • costs of financing
• quality of financial • timescale

planning
Business
growth – rising
revenues, sales
volumes,
productive
capacity
▲ Figure 10.14 The impact of business growth on all of these ratios will depend on a range of factors, including the degree
of success of the strategy of business growth and the skills and experience of the management team
The effects on financial efficiency ratios The impact of other business strategies
There is a potential for business growth to weaken financial
efficiency ratios, though the impact will depend on on ratio results
the nature of the business and how well it is managed. There is a wide range of strategies available to managers
Businesses may hold greater volumes of inventory in other than business growth. We will consider two diverse
anticipation of rising sales and, if sales do not rise as strategies and the impact they may have on a business’
quickly as expected, the rate of inventory turnover can financial ratios.
decrease. There may also be an adverse movement in the
balance between trade receivables and trade payables. To Cost leadership
increase sales, a business may offer its customers more A business might seek to increase its market share through
favourable trade credit terms. This may, for example, be an a strategy of cost leadership. This strategy could be used
increase of 30 days in the period allowed for payment, or it to achieve market penetration. A central element of this
may involve offering trade credit where none was offered strategy is to minimise costs to allow the business to set
before. This might be essential to win new customers and prices as low as possible, if desired. A cost-leadership
create growth in sales. Such decisions will increase the strategy is more likely to be used in markets where demand
trade receivables turnover figure and may mean that it is price elastic. A number of airlines across the world
exceeds the trade payables figure. This represents a lower operate cost-minimisation strategies.
level of financial efficiency. Cost leadership has the potential to increase a business’
profitability ratios if it chooses not to set prices as low as
The effects on other ratios possible. If costs are a lower proportion of revenue, then
Business growth has the potential to increase a business’ profit margin ratios are likely to be higher than they would
gearing ratio but only if any capital expenditure associated be otherwise. However, on occasions businesses use a
with growth is mainly financed through long-term strategy of cost leadership to reduce prices to allow them to
borrowing. For those businesses that finance growth be the lowest-price supplier in the market. This might result
from retained earnings, the effect could be to lower the in low profit margins. However, if the strategy is successful,
company’s gearing ratio, as its capital employed will high sales volumes can boost the level of profit over time.
increase without any rise in non-current liabilities. Cost leadership encourages financial efficiency, as
The effects on investment ratios are difficult to predict. businesses pursuing this strategy seek to avoid any
It is possible, during the early stages of a period of growth, unnecessary costs. This would include minimising holdings
that a company’s annual dividend might be reduced as of inventory and managing liquidity carefully to avoid the
retained earnings are increased. This could reduce its costs associated with short-term borrowing. This should
dividend yield, depending on what is happening to the lead to a situation where the rate of inventory turnover is
company’s share price, and simultaneously increase its as high as possible, with inventory sold quickly. The trade
dividend cover if profits for the year are maintained. receivables turnover figure would be expected to be below
However, possible changes in profits and market share that of trade payables to protect cash holdings as far as
prices make it difficult to forecast what might happen. possible.
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Diversification servicing debts as well as rising expenditure in areas such
as promotion. The outcome, in the short term at least, could
Igor Ansoff categorised diversification as the riskiest of his
four strategies, as it involves selling new products in new
be lower percentage figures for profit margins and ROCE.
The impact on these ratios in the longer term will depend
10.4
markets. It is risky because the product and the market that
on how successful the new strategy proves.
is targeted are unfamiliar to the business.
A diversification strategy might entail the business in heavy
A strategy of diversification may well weaken the business’
capital expenditure requiring an increase in long-term
profitability ratios, as it is a costly approach. The business
borrowing. In the short term, at least, this might result in
will need to invest in developing new products at the same
an increase in the company’s gearing ratio. In some cases,
time as establishing itself in a new market. A strategy
this could take the gearing figure beyond the 50 per cent
of diversification is likely to lead to significant levels of

benchmark.
investment by the business. This may increase costs of
CASE STUDY
Reach4entertainment
Reach4entertainment Enterprises Plc (R4E) supplies Against the tough backdrop of 2017, a new senior
branding, design and advertising services to businesses management team has set up a strong base for 2019 by
in the theatrical, film and live-entertainment sectors. In reducing expenses and winning new business.
2018, following a period of poor financial performance,
2019 was a year of great advancement, reflecting the continued
the company developed and implemented a strategy of
success of the turnaround strategy and the diversification of
diversification. The information below is taken from the
the company into new areas of live entertainment.
company’s annual reports in 2019 and 2020.
With the shutdown of live venues and events in March 2020,
Covid-19 has had a significant impact on the entire industry.
▼ Table 10.25
2019 2018 2017

Revenue (£’000s) 135 397 76 718 80 211
Operating profit/(loss) (£’000s) 1 934 579 (2 394)
Non-current liabilities (£’000s) 11 225 1 838 2 035
Capital employed (£’000s) 25 901 11 259 11 260
Earnings/(loss) per share (pence) 0.06 0.03 (0.30)
Share price @ 30 June (pence) 102 150 152
On 27 June 2020, the company’s share price was 33 pence. Source: Adapted from R4E Annual Reports 2019 and 2020,
R4E does not currently pay a dividend. www.r4e.com/investor-relations
Questions
1 Calculate the changes in the following ratios for R4E 2 ‘R4E’s diversification strategy has been completely
in 2017 and 2019: successful.’ Use the information in the case study
a ROCE [4] and the results of your ratio calculations to
b gearing. [4] evaluate this statement. [20]
The impact of a diversification strategy on investment making. Both sources of information, however, have
ratios is difficult to predict and will depend on the success significant limitations.
of the strategy, along with the timescale involved. It may
The information presented in financial statements (and
be that profits and dividends are under pressure in the short
used for ratio analysis) may not always represent the
term, but dividends could increase over the longer term,
business’ financial position as accurately as possible. Most
especially if profits rise significantly.
businesses, especially public limited companies, are under
pressure to present their financial performance in the most
The limitations of using published favourable terms possible. There are a number of methods
accounts and ratio analyses by which a company can improve the look of its balance
sheet – these processes are called window dressing. The use
We have spent some time considering the uses of financial of window-dressing techniques can improve the business’
statements and of financial ratios in strategic decision- financial performance, at least in the short term, and
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provide more favourable financial data for analysis. This can place which might mean that conclusions made on the
mean that data in financial statements (and financial ratios basis of this data are out-of-date. New products may
10.4 based upon them) have to be treated with caution. have been launched onto the market or there may have
been a dramatic shift in consumers’ tastes. It is risky to
Financial statements can be window-dressed using a number
assume that the future will look like the past. Financial
of techniques, including:
statements also show what has happened and do not
» Some companies borrow money for a short period of
explain why. Further information may be needed here.
time to improve their cash position just before the date
» Inter-firm comparisons may be unhelpful Most
on which the balance sheet is drawn up. This action may
competitors will be different in one or more ways. They
enhance the company’s apparent ability to pay its short-
may differ in scale, in the segment of the market that
term debts.
is targeted or the objectives of the business. Many
» An alternative method of improving a company’s cash

businesses operate globally nowadays and the market
or liquidity position is through the use of sale and
conditions can vary hugely between different markets.
leaseback. This entails the sale of major non-current
Therefore, differences in performances may be due to
assets and then leasing them back. Many retailers have
variations in market conditions rather than efficiency.
negotiated sale and leaseback deals on their high-street
» The data used to compile financial statements may
properties.
not be entirely reliable In addition to the issue of
» On statements of profit or loss, businesses may bring
window dressing, some information included in these
forward sales to an earlier period and thereby boost
statements may differ due to different accounting
revenue for a particular financial year. This does result,
methods. Differences in approaches to depreciation
however, in a lower figure in the next financial year. This
and inventory valuation can impact on financial
was part of the issue involved in the financial scandal
information.
faced by Tesco in the UK in 2014.
» The corporate objectives of the business Businesses
There is a fine line between presenting accounts as operate with different corporate objectives and this
favourably as possible and misrepresenting the performance may make comparisons invalid. Managers developing a
of the firm, which is illegal. The authorities in many strategy could find it difficult to judge the financial
countries have made several adjustments to accountancy performance of a competitor. It is too simplistic to
procedures in order to restrict the extent of window assume that all businesses pursue profit maximisation.
dressing. However, window dressing offers only short-term Businesses may not do so for a number of reasons. They
advantages to businesses. Any benefit will be offset by a may be more concerned about maintaining a reputation
decline in apparent financial performance in future years. for high-quality products or meeting the needs of
employees as fully as possible. Equally, they may take
There are a number of other limitations to using published
a long-term view of profits and be prepared to sacrifice
accounts and the results of ratio analyses:
short-term gains. A business might, for example, spend
» The information presented in financial statements
heavily on research and development to achieve greater
and used in ratios is historical It relates to a trading
financial rewards in the future.
period that concluded, at best, some months before.
In many fast-moving markets, changes may have taken
CASE STUDY
Intel
Intel is an American multinational company that the company’s figure of 16 per cent from 2015–19. Intel’s
manufactures semiconductor chips. It is the world’s price–earnings ratio is approximately 11.5, below the US
largest chipmaker and has been the market leader since average of 15.8. The company’s shares are now priced at
1992. In 2019, the company earned revenue amounting to a level that should make the company attractive to many
$71.9 billion and profits of $22.0 billion. It has more than potential shareholders.
110 000 employees worldwide.
The company’s latest dividend yield figure is 2.16 per
Intel holds a 16.5 per cent share of the global semiconductor cent. The dividend represents about 28 per cent of the
market and increased its sales in 2019 while the market company’s earnings.
size declined by nearly 12 per cent. While personal
computer sales are slowing, they remain important, and Questions
Intel is expected to maintain its market position. 1 Using the data given, analyse two reasons why an
investor might decide to buy shares in Intel. [8]
Analysts studying Intel have mixed opinions on how it will
2 Evaluate any other information that would be useful
perform in the future. They anticipate average earnings
to an investor who is considering investing in Intel. [20]
per share growth at around 14 per cent up to 2022, below
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Another significant set of limitations of financial » the quality of the workforce and management team
statements and ratio analyses arise from their consideration These are important factors in assessing a business, but
of solely financial data. While this is undeniably important,
other elements of a business should be taken into account
they are not ones that will be revealed directly through
ratio analysis. Indeed, a business that invests heavily
10.4
when evaluating performance, such as: in its human resources may appear to be performing
» the market in which the business is trading A business relatively poorly through the use of ratio analysis
that is operating in a highly competitive market might » the economic environment In general, businesses
experience relatively low profits, reducing the results of might be expected to perform more poorly during
ratios such as ROCE periods of economic recession and to produce weaker
» the position of the firm within the market A market results from ratio analysis. During the period of poor
leader might be expected to provide better returns than

economic performance for many major economies
a small firm struggling to establish itself. However, which started in 2020, it is reasonable to expect the
the small, struggling firm may be investing heavily financial performance of many (but not all) businesses
in developing new products and establishing a brand to decline.
identity. The struggling firm may generate large profits
in the future
TEST YOUR LEARNING

b Explain one implication for the dividend cover
Short answer questions figure if dividends fall. [3]
1 a Define the term ‘strategic decision-making’. [2] 9 Explain two reasons why a strategy of business
b Explain one reason why information about a growth might not improve a business’ profitability
business’ liquidity position might help managers ratios. [6]
to develop corporate strategies. [3] 10 a Define the term ‘window dressing’. [2]
2 Explain one way in which the information in a b Explain one other limitation of using published
business’ statement of financial position might enable accounts and the results of ratio analyses to
its managers to assess its ability to raise finance. [3] assess business performance. [3]
3 a Define the term ‘annual report’. [2]
b Explain one factor that is normally included in Data response question
the strategic report within a company’s annual
Pandang Ltd
report. [3]
4 Explain two reasons why shareholders and other Pandang Ltd manufactures industrial vehicles (for
investors might be considered the primary target example, diggers and trucks) which are exported to many
for information included within a company’s annual countries. The company sells in very competitive markets.
report. [6] These markets are changing quickly as new technology
(allowing the development of self-driving vehicles, for
5 a Define another stakeholder group (apart from
example) is having a significant impact.
shareholders and investors) who will have an
interest in the information in a company’s The company has recently appointed a new CEO, who
annual report and explain one reason why. [3] intends to develop new corporate strategies to expand
b Define the term ‘benchmarking’. [2] its sales by at least 10 per cent each year for five years.
6 Explain one reason why using financial data for one She also wants to extend its product range and enter new
year only might be of limited value when making markets.
strategic decisions. [3] Pandang Ltd has faced difficulties over the last 12 months.
7 a Explain one way in which accounting data may It is attempting to cut the cost of its pension scheme and
help a company’s managers to manage the risk has introduced a less generous scheme which resulted
of a new strategy. [3] in a bitter dispute with its employees. The new scheme is
b Define the term ‘debt’. [2] expected to save the business $600 million annually and
8 a Define the term ‘dividend strategy’. [2] will have pleased the company’s shareholders.
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▼ Table 10.26
10.4 Last year ($m) The year before last ($m)

Statement of profit or loss
Revenue 10 172 9 776
Operating profit 166 219
Profit for the year 99 151
Statement of financial position
Non-current assets 5 404 6 843

Current assets 1 803 1 454
Current liabilities 2 082 2 016
Non-current liabilities 739 1 320
Reserves and equity 4 386 4 961
Questions
1 Analyse two ways in which Pandang Ltd’s managers 3 ‘It is possible to assess Pandang Ltd’s future
might use the information in its statement of financial performance on the basis of the results of its
position to develop its future corporate strategies. [8] financial ratio analysis.’ Evaluate this statement. [20]
2 a Calculate the percentage change in the
company’s revenue between last year and Essay question
the year before last. [3] 1 ‘Profitability ratios are far more important than any
b Evaluate the strengths and weaknesses of Pandang other ratios for managers when developing a new
Ltd’s financial performance last year and the year corporate strategy.’ Evaluate the extent to which
before last using relevant financial ratios. [12] you agree with this statement. [20]
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Index
Index
Page numbers in bold indicate case studies. see also economy; external influences barriers 335–6, 335, 337
absenteeism 66, 358 enterprise 1–15 channels 334–5
accountability 264, 313, 317, 321, 322 and finance 178 effectiveness 338–9, 339
accounting rate of return (ARR) 459–60, 460, objectives 33–40 in management 90–1, 313, 318, 328–40,
465 size of business 27–32 345, 359, 362, 403
achievement needs 74, 75, 75 stakeholders 41–6 methods 330–4, 331, 333, 336–8, 357
acid test ratio 446–7 strategy 287–312 purposes 328–30, 328
adding value 2–3, 143, 144 structure of business 16–26 use of technology 268–9, 331, 332,
administration 165 business objectives see objectives 333–4, 363, 364, 413
adverse variances 209–11, 211–12 business performance 196–7 communities
advertising 51, 128, 134, 221, 232–3, 329, see also financial statements/reports; relationship with business 42, 42, 43,
378, 379 ratio analysis 147, 256, 259–60, 264
advertising standards 221 business plans 13–14, 14 responsibilities to 257, 282
aims of business 288–9, 294 business strategy community co-operatives 24
annual leave 219 choice 287, 297–302 companies 20, 21
annual reports 100, 329, 469–71, 472 competitive advantage 288–9, 296–7 competition
annualised hours contracts 354 economy 244 see also globalisation
Ansoff Matrix 297–8, 371, 477 implementation 287, 302 effect on business 271–3, 272
appraisals 77, 403 marketing 383–92 competitive advantage 153, 260, 283,
appreciation (currency) 248–9 strategic analysis 287, 289–93, 292, 293, 288–9, 352, 401, 426, 468
artificial intelligence (AI) 268, 277, 331, 333, 294–6, 296 and costs 188–9
363, 387, 413, 413, 414 business values see corporate culture; ethical and external factors 241, 249, 266
assessment centres 53 issues gauging extent 106
assets 170, 432, 435–41, 437 business-to-business 102, 135 international 274
authority 313, 317, 323, 324 business-to-consumer 98, 102 and investment 463
autocratic management 88–9, 90–1, 90, 335, legislation and regulation 222–3, 223,
344 CAD/CAM/CAPP 269, 413 232
autonomous work groups 81 capacity 157 effect on marketing 385, 389
average costs 194, 195 capacity shortage 159–60 and pricing 124, 125, 126, 271, 273
average rate of return 459–60, 460, 465 capacity utilisation 157–60, 158, 416, 422 and privatisation 215, 216
capital 2, 143, 162 simultaneous engineering 419
B2B 102, 135 capital employed 448 and strategy 288–9, 295–7
B2C 98, 102 capital expenditure (CAPEX) 167, 167–8, 477 and success 7
backward vertical integration 31 capital structure 474 use of technology 136, 267–8
balance sheets see statements of financial capital-intensive operation 148 and workforce 61, 63, 65, 80, 352, 355,
position cartels 222, 223, 233 360
bank loans 19, 170, 172–3, 177 cash balances 180, 181 Competition Act 1998 222
bank overdrafts 172, 177 cash cows 121, 122, 123 competitive advantage 153, 260, 283, 288–9,
bankruptcy 165 cash crises 164, 183 352, 401, 426, 468
banks 174, 174, 232, 305 cash cycle 34 competitive environment 295–7
Bass model 307–8, 346 cash-flow forecasts 180–3, 182, 380 competitive pricing 124, 125, 126, 271, 273
batch production 149, 150 cash flows 34, 163–4, 183–5, 184 compressed working hours 355, 356
behavioural theories of leadership 344 cash sales 181, 182, 451 compulsory liquidation 165
benchmarking 410, 445, 471 cell production 420 compulsory redundancy 54
big data 267, 364 centralisation 85, 317, 324–5 computer-aided design and manufacture 269,
blockchain technology 277, 278 chains of command 315, 316–17, 323, 336 413
blue ocean planning 289 change conflict, stakeholders 45, 45
bonuses 77 see also demographic change; economy; conglomerate diversification 31
borrowing 246, 247, 401, 436, 453, 474 social change; technology consumer legislation 221
see also loans of objectives 38 consumer markets 98
Boston Matrix 121–2, 294 and organisational structure 315, 321 consumer price index (CPI) 239
brand awareness 95 effect of politics and legislation 225 consumer products 101, 102
brand development 3 product response to 116 consumer protection 223, 232, 233
brand image 396, 398 effect on stakeholders 43 consumers 103–4, 106–7, 257, 296–7
brand loyalty 104–5, 295, 368 transformation process 142–3 contingency planning 310–11, 310
brands and branding 22, 23, 123, 129–30, workforce management 146, 270, 308, contingency theory 344
129, 130, 131–2, 135, 386, 387 309–10 contribution 199
break-even analysis 190, 199–203, 200, 202 change culture 309–10 contribution costing 190, 193–4, 199
break-even charts 200–2 click through rate (CTR) 132 contribution pricing 195, 196
break-even output 190, 199, 200, 201, 202, climate change 281–2, 293 control, in organisations 322–3, 324
203 cloud computing 363, 364 convenience items 135
British Business Bank 230 cobots 269 co-operation 62–3
budgets 38, 205–11, 205, 207, 211–12 codes of conduct 39 co-operatives 24, 24
buffer inventories 151, 152 coercive power 345 copyright 375
bureaucratic organisations 304 collateral 172–3 core competencies frameworks 297
business culture see corporate culture collective bargaining 64 core workers 353
business cycle 236–8, 242 commission 77 Coronavirus pandemic 6, 6, 21, 136, 149, 153,
business development see expansion; growth communication 154, 167–8, 215, 264, 288, 372, 381
business environment annual report role 470
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corporate culture 52, 270, 270–1, 285, 304–7, debts 177 Drucker, P. 93, 313–14, 362, 406
Index
305, 307, 309–10, 309, 418 see also trade payables dummy activities (CPA) 425–6
corporate image 63, 464 decentralisation 317, 324, 325, 325 dynamic pricing 126, 139
corporate objectives 33, 95, 464, 478 decision trees 300
corporate planning 304 decisional management 86 earliest start time 424–5, 427
corporate social responsibility 256–8, 258, decision-making e-commerce 137, 139–40, 140
264 and communication 334–5 economic development 35
correlation analysis 378–9, 379 for/in crises 310–11 economic environment 6, 227, 445, 479
cost-based pricing 126 decision trees 300–2, 300 economic growth 12, 234–8, 235, 238, 247,
cost information 187, 194–9, 196, 198 external factors 265 279
cost leadership 476 use of financial statements 467–71, 468, economic sectors 16–17, 18
cost-push inflation 239 478 economies of scale 400–1, 402, 403–4
costs investments 462–4, 463, 464 economy 445
see also labour costs; production costs impact of legislation 225 effect on business 6, 227, 244, 370, 445,
break-even analysis 199–203, 200, 202 locations 394, 395, 398–9 479
cost information 187, 194–9, 196, 198 in management 63, 89, 90–1, 297–302, business role 5, 12, 29
cost leadership 476 322, 412–13 economic growth 234–8, 235, 238, 247
costing methods 189–94, 191–2 and objectives 33–9 exchange rates 247–50
distribution 136, 279 and operations 143, 412–13 fiscal policy 250–1
and economies of scale 401 and production 118, 119, 120, 122, 341 government intervention 228–33, 230,
of finance 176 ratio analysis 471–8, 472 231, 244–52, 252, 253
of integration 31 and risks 8, 11–12, 473–4 inflation 238–41, 240
inventories 151 and sales forecasts 380–1 monetary policy 244, 245–7, 246
and investment 463–4 and social responsibilities 264, 265 effect on pricing 124
effect of legislation 224 impact on stakeholders 43–4 unemployment 241–3, 247, 253, 270, 279,
and location 396 decision trees 300–2 280
and operations 148, 412 deed of partnership 19–20 effective communication 329
opportunity costs 177 delayering 48, 316, 321, 323 effectiveness 144
outsourcing 160 delegation 61, 317, 321–2, 322–3, 324 efficiency 144–6, 144, 146, 215, 338, 416,
production 65, 195, 224, 233, 260, 269, Delphi technique 380 422, 448–52
282 demand see also lean production
and productivity 145, 146 see also supply and demand elasticity of demand 124, 366–71, 370, 373–4
and profits 124, 433, 450 capacity utilisation 159 electronic communication 328, 331, 331, 333,
reduction 3, 183, 185, 247, 277, 284–5, and flexible workforce 355 335
416 and pricing 124, 366–71, 369, 370, 432, email 331, 335, 335
sale of assets 439 450, 476 emerging markets 109–10, 375, 386, 389
and suppliers 273 demand-pull inflation 239 emotional intelligence 346–7
types 187–9, 188, 189, 401 Deming, Edward 418, 471 employee co-operatives 24
zero budgets 208 democratic management 89, 90–1, 344 employee morale 56–9, 63, 70
costs-plus pricing 195 demographic change 238, 255, 260–6, 265, employee participation 80–1, 81
Covid-19 see coronavirus pandemic 471–8 employee welfare 55–6, 70
CPI 239 demographic segmentation 104 employees
credit sales 451 depreciation 151, 248–9, 438, 440–1, 441, see also labour productivity; motivation of
creditors see trade payables 442 staff; salaries and wages; workforce
crises 163, 164–5, 181–2, 183, 310–11, 329 development of businesses see enterprise; intrapreneurs 10, 61–2, 62, 316
critical path analysis 423–7 expansion; growth; start-ups role in lean production 422
Crosby, P. 406, 407, 409–10 digital distribution methods 136, 139, 140 performance 85, 357–64
crowdfunding 175, 175 digital promotion 132, 132, 133, 134, 387 reliability 420
cultural differences 339, 398 direct costs 189 representatives 342–3
current assets 166, 435, 446 direct distribution 135 responsibilities to 257, 284
current liabilities 435, 436, 446 direct promotion 128, 134 as stakeholders 42, 43, 44, 80–1, 256, 470
current ratio 446, 447 direct taxes 250 employer branding 59, 63, 361, 470
curriculum vitae/résumés 53 directors, roles 342 employment agencies 51
customer loyalty 268, 368 discounted cash-flow 460–2, 465 employment conditions 45
customer-focused organisations 304–5, 387, diseconomies of scale 400, 402–3, 404 employment contracts 50, 53–4
415 dismissal 55–6 flexible working 352–7, 361–2
customer-oriented businesses 95, 98, 99 see also redundancy employment legislation 217–21, 219, 224,
customer-relationship marketing (CRM) 104–5 disruptive innovation 272, 273 225
customer retention 104–5 distributed profits 432 Employment Relations Act 1999 218
customers distribution channels 135–40, 137, 138, 139, employment tribunals 54
characteristics 106–7 140, 268, 279 empowerment 48, 79, 81, 316
focus on 95, 98, 99, 304–5, 387, 415 diversification 34, 298, 299, 477, 477 enterprise
loyalty 268, 368 diversity 58–9, 59, 266 business activities 1–8
and pricing 123 dividend cover ratio 455, 474–5 business plans 13–14
as stakeholders 42, 43, 256, 284, 470 dividend per share ratio 453–4 definition 2, 143
customs unions 277, 394 dividend strategy 474–5 entrepreneurs and intrapreneurs 8–13, 9,
dividend yield ratio 454, 474 62, 86, 130, 162
data analysis 363, 379 dividends 21, 43, 172, 453–5, 454, government support 228–31, 231
see also break-even analysis; financial 474–5 legislation (laws) 222–3
statements/reports; marketing division of labour 85 Enterprise Finance Guarantee (EFG) 230
analysis; ratio analysis divisions 320, 321 enterprise resource planning (ERP) 416
debentures 173 dominant market position 222 entrepreneurial organisations 304
debt factoring 173, 174, 184, 185 double-entry accounting 437 entrepreneurs 8–9, 8, 9, 12, 13, 86, 130, 162
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environmental audits 283 role of communication 329 government 280–1
Index
environmental issues 147, 233, 264, 280, costs 187–204 see also public service sector; regulation
281–4, 282–4, 293, 464 failure of businesses 164–5 economic growth 234–8, 235, 247
environmental profit and loss statements 294 financial statements 430–43, 431–2, exchange rates 247–50
EPS (earnings per share) 455 434, 437, 438, 439, 468 fiscal policy 250–1
Equalities Act 2010 58, 218, 224 investment appraisals 457–66 interventions 228–33, 230, 231, 241,
equality 58–9, 59, 218, 224, 364 need for finance 162–4, 162 242, 244–52, 252, 253
equations objectives 33–4, 35 monetary policy 244, 245–7, 246
capacity utilisation 157 planning 205–11 objectives 234, 235
costs 189, 190, 195, 199, 200, 203 ratio analysis 444–56, 450, 451, 452 relationship with business 12–13, 16, 29,
EMV 301 sources of finance 163, 169–79, 170–1, 256
financial statements 435, 436, 440–1 173–6, 178, 184, 230 rights and responsibilities 42
float time 425 strategic decision-making 467–79, 468, supply-side policies 252
human resource management 358, 359 472, 477, 478 government expenditure 253
investment appraisal 458 for types of business 19, 20, 22, 23 government finance 229, 230
market share/growth 99, 100 working capital 165–7, 166, 167 government grants 175–6, 177, 396
marketing 366, 370, 371, 376 financial efficiency ratios 476 governments, objectives 293
productivity 144, 358 financial motivators 76–7 gross domestic product 234, 235, 235, 236
profits 187, 197 financial objectives 33, 34, 35 gross profit margin 448–9, 450
ratio analysis 446, 448–55 financial ratios see ratio analysis gross profits 430, 431, 468
working capital 166 financial regulation 232 growth
equity 86, 435, 474 financial statements/reports 85 business 23, 30–1, 33–4, 34, 315, 320
esprit de corps 86 annual reports 100, 329, 469–71, 472 economic growth 234–8, 235, 238, 247
ethical issues 35, 39, 85, 271, 394, 397, 399, financial position 435–8, 438–9, 442 expansion 167, 252, 276, 389, 400, 457
464 limitations 477–9 finance for 163, 467
European Union (EU) profit or loss 430–4, 442 and financial ratios 475–6
business size 28 fiscal policy 250–1 markets 99–101, 100, 106, 121, 178, 273,
customs union 277, 394, 399 fixed costs 188, 188–9, 189, 195, 198, 199, 276, 277, 298, 298, 299
regulations 57, 64, 219, 220, 421, 421, 200, 201 in product life cycle 117, 120
451 flat organisational structures 321, 323, 324
exchange rates 247–50, 396 flexibility Handy culture model 305–6
exclusive products 124, 125, 135, 415 budgets 207–8 hard HR strategies 349, 350, 351
expansion 167, 252, 276, 389, 400, 457 employees 42, 62, 155, 252, 352–7, 361, Hawthorne effect 70
expectancy theory 75–6 416, 420 health and safety 220, 224, 284, 359
expected monetary value (EMV) 300, 301, 302 in marketing planning 384 Health and Safety at Work Act 1974 220
expenditure budgets 205, 206, 209 in operations management 149–50, 155, Herzberg, Frederick 72–3, 73, 74, 76, 79, 80,
expert power 345–6 414–15 81, 323, 361
exploitation of workers 216 in organisations 313–14 hierarchical structures 318, 326
exports 229, 248, 389, 391, 391, 392 of pricing 195, 247, 268, 276 see also levels of hierarchy
extension strategies 119 sources of finance 177 hire purchase 172, 185
external economies/diseconomies of scale flexible budgets 207–8 homeworking 354, 356, 357
403–4 flexible workforces 62, 155, 252, 352–7, 361, horizontal communication 334, 335
external growth 30–1 416, 420 horizontal integration 30
external influences 6, 214 flexitime 354, 356 horizontal loading 79
see also competition; economy; technology float time 425 human needs 66–7, 68, 70, 71–2, 71, 74–5, 75
demographic change 238, 255, 260–6, flow production 149 human relations school 70–1
265 focus groups 109 human resource management
legislation (laws) 217–24, 219, 221, 223, Force Field Analysis 299–300 see also leadership; motivation of staff;
225, 225 forecasting training; workforce
on objectives 38 cash flows 180–3, 182 communication 90–1, 313, 318, 328–40,
political environment 214–17, 224, 225 sales 375–81, 379, 380, 381 345, 359, 362, 403
and risks 8, 11–12, 457, 459, 460, 463–4, formal communication 336 employee performance 85, 357–64
473–4 formulas see equations flexibility of workforce 62, 155, 252,
social change 255–60, 264–5 forward vertical integration 31 352–7, 361, 416, 420
external production costs 282 franchises 21–3, 23, 24, 372, 390 investment in 479
external recruitment 52 free float time 425 management of workforce 50, 62–5, 67,
external sources of finance 170, 171, 172–6, free trade agreements 276–7 155, 329
173–6 French and Raven’s 5 forms of power 345–6 planning 48–9, 380–1
external stakeholders 41 fringe benefits 77, 78 processes and strategies 83–90, 349–52
extrapolation 378 full costing 189, 190–3, 191–2 purpose and role 47–8
functional structures 318–20, 319 recruitment and selection 50–4, 352, 360
factors of production (inputs) 1–2, 143, 157 redundancy 54–5, 55, 56–7, 160, 464
failed businesses 7 GDP 234, 235, 235, 236 strategies 349–51, 350
fair dismissal 55 gearing ratios 474, 476, 477 structure of organisation 313–27
family businesses 28–9, 29, 299 geographic segmentation 103–4 impact of technology 48, 266, 270,
favourable variances 210, 212 gig economy 218, 219, 355, 356, 356–7, 357 363–4, 364
Fayol, Henri 85–6 global crises 311 hygiene factors 73
feedback 329, 334, 337 global population 260–1
Fielder, Fred 344 globalisation 224, 339, 341, 362, 375, 385, imports 239, 249, 276, 277
finance and accounting 387–92, 388, 399–400 incentives 396, 398, 399
blockchain technology 278 see also multinational businesses income budgets see sales revenue
budgets 38, 205–12, 205, 207, 211–12 Goleman, Daniel 347 income elasticity of demand 370
cash flow 34, 180–6 goods and services legislation 224
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income statements see statements of profit job production 149, 150 locations for businesses
Index
or loss job redesign 78–9, 80 decision-making 394–9, 394, 395–6,

incremental budgets 207 job rotation 79 397–8
indirect costs 189, 190, 191–2 job satisfaction 56, 79, 89, 206, 337, 361, 420 expansion 276, 279
indirect taxes 250–1 see also motivation of staff globalisation 399–400, 400
induction training 60, 80 job security 63 and legislation 223–4
industrial disputes 63, 69 job-sharing 353, 355, 357 relocation 251
industrial markets 98 job specifications 50–1 long-term finance 163, 453, 468, 477
industrial products 102, 135 job training 60 long-term investment 216
inelasticity of demand 367, 368, 369, 370 joint venture businesses 24–5, 31, 229, 276 long-term planning 305
inflation 238–41, 240, 247 just in case inventory control 155 losses 187, 202, 432–3, 434
informal communication 336 just in time processes 155, 156, 269, 338,
informational management 86 420, 426, 427 macroeconomic policies 244–52, 252
informational power 345 maintenance factors 73
infrastructure 228–9, 251, 279, 396 Kaizen approach 418 management
innovation key performance indicators (KPIs) 469 see also decision-making; human resource
see also products, development; knowledge management 323, 351 management; leadership
technology Kotter’s errors in change 310 business performance 87–8, 473–4
in business environment 8, 29, 215, 230, conflict 326
231, 273, 375 labour 2, 143, 196–7, 233, 251 functions 83–5, 84, 86
and employees 324, 360, 372 see also employees; motivation of staff; roles 86–7, 313, 336–9, 342–3
marketing 374, 375 workforce styles 88–91, 90, 335, 359
in operations 415 labour costs 6, 77, 196, 197, 279, 351, 355, theories 85–7, 91–2
R & D 372–3, 373 357 management by objectives 362, 403
inputs see factors of production see also labour productivity management teams 80
insolvency 164–5 labour markets 252 managers 31, 44–5, 207, 208, 347
instrumentality theory 75–6 labour productivity see also management
intangible aspects of products 116 and business objectives 33 manufacturing see production
integration (growth) 30–1 and costs 196, 197 margin of safety 203
interest rates 28, 176, 176, 178, 245, 246, improving 48, 77, 269, 322, 359, 364 marginal costs 194, 195
247, 253, 462 measurement 144–6, 146, 358 see also contribution costing
intermediary distributors 135 labour turnover 48, 49, 49, 351, 357, 358, 364 market conditions 385, 387
internal finance sources 170–1 labour-intensive production 148 market development 298, 298, 299
internal growth 30 laissez-faire management 90–1, 344 market failure 233
internal recruitment 52 land 2, 143, 173 market forces 5, 6
internal stakeholders 41 latest finish time 424, 425, 427 market growth 99–101, 100, 106, 121, 178,
international businesses 7–8 lead time 151 273, 276, 277, 298, 298, 299
international environment 274–7, 275, leadership market-led businesses 95, 98, 99
279–81, 280 and communication 335 market penetration 297, 298, 473, 476
international markets 98, 387–92, 389, 390, emotional intelligence 346–7 market research
392 flexibility 344 see also marketing analysis
international trade 274–8, 275, 278, 387–92 purpose and roles 83, 86, 341–3, 342, data 108, 111–13, 113–14, 139, 183
internet 139–40, 175, 277, 363, 387 343 purpose 106–7
see also digital promotion; online sales theories and styles 307–10, 323, 343–6, for sales forecasting 379–80
internet of things 277, 363 350, 359 sampling methods 110–11
interpersonal management 86 lean production 155, 156, 417–22, 418, 419 types 106–7, 109–10, 111–12
interviews 53, 330 leasing 172, 185 market segments 103–4, 128–9, 136, 385
intranets 331, 333 legal issues 6, 10, 18–26 market share 34, 95, 99–101, 100, 121–2,
intrapreneurship 10, 61–2, 62, 316 legislation (laws) 58, 217–24, 451 276, 476
inventories 142, 151–6, 153, 156, 413, 416, see also regulation market size 99, 101, 106, 383
452 annual reports 471 marketing 132
valuation 438–9, 439, 442 business locations 223–4 see also market research; marketing
inventory control charts 151–2 competition 222–3, 223 analysis; marketing mix; markets
inventory turnover ratio 450–1, 452, 476 employment conditions 217–21, 219, 224, communication 329
investment appraisal 225 customer relationship marketing 95, 99,
decisions 462–4, 463, 464 goods and services 224 104–5, 144, 470
methods 458–62, 460, 463 marketing 221, 221 definition 94
risk 457–8, 463–4 patents 272 demand and supply 95–7, 95, 99, 158
investment ratios 474–5, 476, 477 level of economic activity 236, 244, 246, objectives 93–5, 383, 384, 387
investments 31, 170, 216, 453–5, 454, 455 250–1, 253 and operations management 412
see also shares levels of hierarchy 316, 317, 321, 323, 335 segmentation 103–4, 128–9, 136, 385
investors 31, 470 liabilities 164–5, 166, 435, 436, 446 strategy 381, 383–92, 385, 389, 390,
involuntary redundancy 54 limited companies 20, 25, 169 392
limited liability 20 and sustainable businesses 282, 283, 285
jargon 336 line managers 325, 326 impact of technology 266–7, 387
JIC 155 liquid assets 166, 446 marketing analysis
JIT 155, 156, 269, 338, 420, 426, 427 liquidation 165 artificial intelligence in 387
job adverts 51, 51, 56–7 liquidity 368, 445–7, 446, 468, 475 data analysis 108, 111–13, 139, 267
job descriptions 50 loans 173, 174, 175, 176, 181, 246, 246, elasticity of demand 366–71, 370
job design 359 437–8 product development 371–5, 373–4, 375
job enlargement 79 see also borrowing sales forecasting 375–81, 379, 380, 381
job enrichment 78, 79 local businesses 7 marketing expenditure budget 134, 135
job performance see employees, performance local markets 98 marketing mix
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components 115–16 nationalisation 16, 17, 215, 215–16, 217 role of leaders 342–3
Index
distribution 135–40, 137, 138, 139, 140, natural monopolies 215 and objectives 313–16
268, 269 negotiators 86 types 314–15, 316–21, 319, 321
pricing see pricing main entry neo-human relations school 71–5 outputs
products 115, 116–23, 118, 119, 120, net assets 436 see also products
122, 123, 125, 384 net current assets 435–6 break-even output 190, 199, 200, 201,
promotion see promotion main entry net monthly cash flow 181, 182 202
marketing plans 383–4 net present value 461–2, 463 capacity utilisation 157–60
marketing strategy net present value (NPV) 461–2 and fixed vs variable costs 188
development 384–7, 385 net realisable value (NRV) 439 outsourcing 159, 160, 395–6
for international markets 387–92, 389, network analysis 423–7 overheads 189, 190, 191–2
390, 392 network charts 423–6 overseas production 250
planning 383–4 New Enterprise Allowance 230 overseas trade 236, 237, 246, 249, 274–7,
markets niche marketing 29, 103 279–81
barriers to entry 272, 273, 295, 394, 396, non-current assets 172, 185, 435, 437, 438 see also international markets
463 non-current liabilities 435, 436, 453 overtrading 475
failure 233 non-financial motivators 78–80 owner investment 170
growth 99–101, 100, 106, 121, 178, 273, NPV 461–2, 463 ownership of businesses 18–26, 27, 44, 169,
276, 277, 298, 298, 299 NRV 439 171
international 274, 275, 277, 389
position in 479 objectives packaging 131, 131–2, 147, 147, 148
types 98, 101–3, 104–5 and decision-making 33–9 paid holidays 219
Maslow’s hierarchy of needs 71–2, 74, 76, 81, ethical 39 pan-global strategies 391–2
323, 361 government 216, 234, 235 partnerships 19–20, 169, 176
mass customisation 149–50 growth 34 part-time workers 353, 357
mass marketing 103 management 288–9, 294, 315, 341, 362, patents 272, 273, 295, 372, 374, 375
matrix organisational structure 314–15, 315, 403 paternalistic management 89, 90–1
320, 321 and marketing 93–5, 124, 136, 383, 384, pay systems 361
Mayo, Elton 70–1, 81 387 see also salaries and wages
McClelland, David 74–5, 75 organisations 313–16 payback technique 458–9, 465
McGregor, Douglas 91–2 social 35, 36, 37 P/E ratio 455, 474
mergers 30, 31, 222, 270, 273, 276, 335–6 and stakeholders 42, 45–6 penetration pricing 125, 126
merit goods 17 trade unions 64 people-orientated leaders 345
microfinance 174, 174 offensive marketing 94 performance related pay (PRP) 77–8, 361
migration 243, 244, 261–2, 263 offshoring 399 peripheral workers 353
minimum project duration 425 off-the-job training 60 person culture 306
minimum wage 220, 224, 225 on-the-job training 60 person specifications 50–1
Mintzberg, Henry 86–7 one-level channels 135 personal selling 128, 134
mission statements 294, 403 one-way communication 334–5 PERT 427
Modern Slavery 154 online recruitment 51, 52 PEST analysis 289–90, 291
monetary policy 244, 245–7, 246 online sales 136 see also external influences
monitoring performance 196–7, 208–9 on-the-job training 59 piece-rate 69, 76–7, 361
monopolies 215, 232, 233 operating profit margin 449, 450 placement of product 115
mortgages 173 operating profits 430, 431, 468 see also distribution channels
motivating jobs 420 operations management 33–40 planning
motivation of staff capacity and outsourcing 157–61 business plans 13–14
role of communication 338 capital-intensive/ labour-intensive 148 business strategy 287–302
delegation and delayering 322, 323 communication 329 corporate planning 304–11
demotivation 360 critical path analysis 423–7 financial 205–11
and flexible working 356, 357 decision-making 412–13 human resource management 48–9, 380–1
in Herzberg theory 73 effectiveness and sustainability 144–6, marketing strategy 383–4
human needs 66–8, 68, 70, 71, 75 144, 146, 147, 148 operations management 380–1, 422–7,
job satisfaction 56, 79, 89, 206, 337, 361, flexibility and innovation 149–50, 155, 428
420 324, 414–15 workforce 48–9, 84, 87
in large organisations 403 inventories 151–6, 153, 156 plcs see public limited companies
and legislation 224 lean production 417–22 political environment 214–17, 224, 225, 396
methods 70, 71, 75, 76–81, 78, 81, 350, location and scale 394–405 pollution 233, 264, 280, 282
351 methods 149–50, 149 population see demographic change
and objectives 38–9, 66, 362 planning 380–1, 422–7, 428 Porter’s Five Forces analysis 295–6, 296
and productivity 145, 146, 384 quality management 406–11 power culture 306
theories 68–76, 73, 75 impact of technology 266, 267–70, 413, power needs 74, 75
motivators 59, 72, 73, 351, 361 413–14, 416 power theories of leadership 345–6
moving averages 376–7 transformation process 1–3, 8, 142–4 present value 461–2
multinational businesses 8, 209, 277, 278–81, opportunity costs 5, 6, 151, 177, 426, 460–1 pressure groups 256
314–15, 339, 391–2, 447 organic growth 30 price cuts 119, 153, 272, 273, 366, 368
multi-skilled workers 62 organisational structure price discrimination 125–6
see also management price elasticity of demand 366–70, 369, 370,
narrow organisational structures 316, 321 accountability 322 432, 450, 476
narrow spans of control 335 authority 323, 324 price inelasticity of demand 367, 368, 369
National Infrastructure Plan 229 communication in 334–5 price skimming 125, 126, 267
national living wage 220 control 322–3, 324 price-earnings (P/E) ratio 455, 474
national markets 98 delegation 321–2, 322–3 pricing
National Minimum Wage Act 1999 220 divisions 326 see also marketing mix
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and costs of production 195 promotion (marketing) risk averse cultures 306
Index
cuts in price 119, 153, 272, 273, 366, 368 advertising 116, 128, 134 risks/risk-taking 8, 11–12, 473–4
and demand 96, 124, 159, 366–70, 369, branding 129–30, 129, 130 investments 457, 459, 460, 463–4
370, 432, 450, 476 digital promotion 132, 133, 134 robots 269, 270
dynamic 126, 139 direct promotion 128, 134 ROCE 448, 449, 462, 473, 477, 478
impact of ERP 416 and elasticity of demand 371 role culture 306
and financial rates 247, 248, 249, 250 packaging 131, 131–2
impact of legislation 225 personal selling 128, 134 salaries and wages 70, 71, 76, 220–1, 225,
in marketing mix 123–6, 124, 127 promotional mix 118, 119, 134–5 239, 361
methods and factors 123–6 sales promotions 128, 128–9, 134, 134 see also labour costs
pricing points 115 promotional elasticity of demand 371 sale and leaseback 170, 170–1, 177, 184
and profits 124, 195, 368, 434, 449, 450 promotional mix 119, 127, 134 sales
and sales 196, 378, 379 promotional offers 119 cash sales 181, 182, 451
pricing points 124 PRP 77–8, 361 decline 117
primary market research 107–109 psychographic segmentation 104 and exchange rates 248
primary sector businesses 2, 16 psychological pricing 126 extending in product life-cycle 119
private limited companies (ltd) 20, 25, 169 psychometric tests 53 forecasting 375–81, 379, 380, 381
private sector 16, 17, 18, 33–4 public limited companies (plcs) 20, 26, 169, effect of inflation 241
privatisation 16, 17, 215–16, 217, 252 172, 176, 430, 431 international trade 274
process innovation 415 public service sector 1, 5, 16–17, 34–5, 215 and market share 100, 101
producer markets 98 sales forecasting 375–81, 379, 380, 381
product design 408 qualitative research 111 sales promotions 128, 128–9, 134, 134
product development 371–5, 373–4, 375, 419 qualitative sales forecasting 380 sales revenue 182, 205, 205, 206, 209, 432
product differentiation 116, 260, 320 quality 421–2 sales targets 95
product innovation 415, 415 quality assurance 406, 408 sales teams 128
product life cycle 117–21, 120, 124 quality circle teams 79, 80, 81, 418 sales techniques 138, 138
product-oriented businesses 98 quality control 404, 406 sampling methods 110–11
product portfolio analysis 117–22, 122, 123 quality management 404–11, 407, 422 scale of business 401–4
production 79, 225, 251, 257, 269, 341, 400, quality of products 160, 250 scenario planning 289
415, 418, 419 quality targets 406 scientific school 68, 69–70
see also production costs; products quantitative easing 247 seasonal businesses 49
production budgets 205, 206, 209 quantitative research 111 secondary market research 109–10
production costs 65, 195, 224, 233, 260, 269, quaternary sector businesses 16 secondary sector businesses 16
282 quota sampling 111 security costs 151
see also fixed costs; labour costs R & D 117, 118, 371, 372–3, 373, 374, 375 selection for jobs 52–3
production teams 79 random sampling 110 self-regulation 232
productivity see labour productivity ratio analysis 444–56 share buy-back schemes 455
products for decision-making 471–8, 472 share capital 172, 173, 176, 176
see also production; production costs financial efficiency ratios 450–2, 451, shareholder concept 44
characteristics 116 452 shareholders 478
development 116, 267, 268, 297–8, 409, gearing ratios 452–3 annual reports 470
477 investment ratios 453–5, 455 company control 20, 43, 177
environmentally friendly 282 liquidity ratios 445–7, 446 employees 80–1
and exchange rates 249 profitability ratios 445, 448–50, 450 investment ratios 453–5
effect of interest rates 247 rationalisation 159 as stakeholders 42, 256
effect of legislation 225 recessions 234, 236 shares 20, 21, 176, 455, 474
life cycle 117–21 recruitment 48, 50–2, 52, 52, 56–7, 229, 355, see also investments
in marketing mix 115, 116–23, 118, 119, 360, 363 shift-work 354
120, 122, 123, 384 redundancy 54–5, 55, 160, 464 shopping goods 124
use of network analysis 426 references for jobs 53 short-term finance 163
organisational structure 315 regulation (EU) 57, 64, 219, 220, 421, 451 short-termism 215, 305
types 101–2, 116 regulation (UK) 10, 216, 231, 232, 389 simultaneous engineering 419, 419
profit budgets 205, 208 relationship-orientated leaders 344, 345 size of businesses 27–32, 28, 30, 315
profit for the year 430, 431, 442, 469 reliability of research 112 slumps 234, 236
profit sharing 77 relocation 398–9, 400 small businesses 27–9, 28, 29, 103, 224, 246,
profitability ratios 475, 477 renewable energy 147 270, 401
profits reorder levels 151, 152 see also limited companies; partnerships;
budgets 205, 209 reports see annual reports; financial sole traders
and contribution 199 statements/reports SMART objectives 39
and costs 167–8, 193, 195, 196–7, 202, research and development 117, 118, 371, social accounting 259
434 372–3, 373, 374, 375 social auditing 257–8
difference from cash 163, 164 reserves 435 social change, effect on business 6, 255–60,
gross profits 430, 431, 448–9 reshoring 399–400, 400 264–5
maximisation 33 responsibility 313, 317, 324 social enterprises 25, 25, 35, 36, 230
and pricing 124, 195, 368, 434, 449, 450 résumés 53 social influences on business
and privatisation 215 retail co-operatives 24 competitors and suppliers 271–3, 272
profitability ratios 475, 477 retailers 135 demographic change 255, 260–6, 265
and revenue 187 retained earnings 170, 177, 432, 442 environmental issues 281–4
and sales forecasts 380 return on capital employed (ROCE) 448, 449, international environment 274–7, 275,
as source of finance 170, 172 462, 473, 477, 478 279–81, 280
programme evaluation and review technique revenue expenditure 167 social change 6, 255–60, 264–5
427 revenues 167–8, 187, 468 sustainability 284–5, 284–5
project management 423–7, 427 rights issues (shares) 176 technology 266–71, 268, 277–8, 278
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social media 132, 133, 331, 331, 333, 363 tariffs 276, 277 unity of command/direction 85
Index
social objectives 35, 37 task culture 306 unlimited liability 19, 20
social responsibilities 35–6, 256–60 task-orientated leaders 344–5 urbanisation 263, 266
soft HR strategies 349, 350, 351, 352 taxation 231, 233, 250–1, 253, 280, 280, 329 see also demographic change
sole traders 18–19, 169 Taylor, Frederick and Taylorism 69–70, 76 USP 102
sources of finance 163, 169–79, 170–1, team pay 361 utilities 34
173–6, 178, 184, 230 teamworking 70, 79–80, 145, 320, 361, 420,
spans of control 316, 321, 323, 335 423 valence 76
special economic zones 223–4 technology validity of research 112
speciality products 52, 124, 125, 135, 415 effect on business 6, 266–71, 268, value chain 4, 5
special-order decisions 197–9, 198 270–1, 272 variable costs 188–9, 193–4, 198, 199, 200,
specific risk 457 effect on competition 272 201
staff development 59–62 investment in 145, 285, 457 variable pay 77
staff managers 325–6 effect on leaders 341 variances 209–12, 211–12
staffing see employees; labour; motivation of in management 331, 332, 333–4, 363–4, venture capital 173, 177, 178
staff; workforce 413, 413–14, 416 vertical communication 334, 335
stakeholders 31, 41–6, 42, 44, 45, 256, 445 in marketing 387, 388 vertical integration 31
start-ups 7, 10–11, 11, 19, 162, 177, 203, 230 effect on trade 277–8, 278 vertical loading 78–9
statements of financial position 167, 435–8, temporary workers 352–3 visual communication 331–2
437, 438–9, 438, 441, 442, 467–8, 468 tertiary sector businesses 16 voluntary liquidation 165
statements of profit or loss 430–4, 431–2, test marketing 109, 379–80, 380 voluntary redundancy 54, 55
434, 441, 442, 468–9 Theory X and Theory Y 91–2, 323, 324 Vroom, Victor 75–6
stock control 152 time-based pay 76
see also inventories time-series data 471, 472 wages see salaries and wages
straight-line depreciation 440–1 time value of money 460–1 waste management 421, 421–2
strategic alliances 31 total float time 425 wholesalers 135
strategic decision-making 264, 464, 467–79 total quality management (TQM) 408 window dressing 477–8
strategic management total revenue 368 work–life balance 57
aims and objectives 288–9, 288, 294 trade agreements 276–7, 399 worker representatives 342–3
analysis 289–93, 292, 293, 294–6, 296 trade barriers 272, 273, 295, 394, 399–400 workforce
of change 307–10 trade credit 166, 171, 172, 177, 184, 185, 447 see also employees; labour productivity;
choice of strategy 287, 297–302 trade cycle 236, 237 motivation of staff; salaries and
competitive environment 296–7 Trade Descriptions Act 1968 221 wages
implementation 302 trade openness 274, 275 benefits of multinationals 279
planning 289 trade payables 166–7, 184, 185, 447, 452, 476 communication 337
strategy 287, 297–302 trade payables turnover days 451–2, 452 contracts 53–4, 352–7, 361–2
stratified sampling 111 trade receivables 166–7, 184, 185, 447, 452, diversity 364
structure of businesses 16–17, 18–26 476 flexibility 62, 155, 252, 352–7, 361, 416,
subcontracting 159 trade receivables turnover days 451, 452, 452 420
subsidies 232 trade unions 63–4 health and safety 220, 224, 284, 359
success in business 7, 8 legislation 218 investment in 479
suppliers trademarks 375 legislation 217–21, 219, 224, 225
and economies of scale 401, 402, 403, training 59–62 management 50, 62–5, 67, 155, 329
404 communication skills 339 morale and welfare 56–9, 155, 351, 358
and integration 31 for delegation 322 planning 48–9, 84, 87
and lean production 155, 420, 422 government services 229 in project management 423, 427
management of 257, 273 to improve performance 60, 145, 360–1 recruitment selection and redundancy
outsourcing to 160 job training 52, 59, 60 50–6, 55, 56–7, 160, 282, 360, 464
as stakeholders 42, 43, 44, 256, 470 and motivation 79, 80 response to change 146, 270, 270–1, 308,
trade credit 166, 171, 172, 177, 452 trait theory 343–4 309–10
supply and demand 95–7, 97, 159, 355 transfer payments 251 training see training main entry
see also demand transformation process 1–3, 3, 6, 8, 142–4 turnover 48, 49, 49, 351, 357, 358
supply chains 153, 154, 271, 275, 279, 282, transformational leadership 307–8, 346 workforce relations 62–5, 67
284, 295–6 trend analysis 471 working capital 166–7, 166, 171, 436
supply-side policies 234, 252 trends, and extrapolation 378 working conditions 81, 219–20
survival 34 triple bottom line 36 working from home 354, 356, 357
sustainability 147, 147, 148, 257, 264, 284–5, turnover working hours 57–8, 145, 154
284–5 inventory 450–2, 452 work-life balance 57–8
SWOT analysis 291 labour 48, 49, 49, 351, 357, 358 works councils 80
systematic risk 457 two-factor theory 72–3, 73, 74, 76, 323 written communication 330
two-level channels 135
tactics 37, 287 two-way communication 334, 335 zero budgeting 208
takeovers 30, 31, 222, 270, 273, 276, 335–6 zero defects approach 409, 410
tall organisational structures 316, 323, 335 unemployment 241–3, 247, 253, 270, 279, 280 zero-hours contracts 354, 356, 357, 357, 364
tangible attributes 116 unfair dismissal 55–6, 218 zero-level channels 135, 136
Tannenbaum and Schmidt continuum 88 unique selling point (USP) 102
targets 33, 38 unit costs of production 401
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Practice and apply what you have studied and

Save time marking and get support for delivering

9781398308114.indb 1 05/03/21 11:06 AM

9781398308114.indb 2 05/03/21 11:06 AM

1 Business and its environment

2 Human resource management

9781398308114.indb 3 05/03/21 11:06 AM

3.1.5 Mass marketing and niche marketing 102

5 Finance and accounting

9781398308114.indb 4 05/03/21 11:06 AM

7 Human resource management

9781398308114.indb 5 05/03/21 11:06 AM

8.2.1 Planning the marketing strategy 383

10 Finance and accounting

9781398308114.indb 6 05/03/21 11:06 AM

The syllabus (9609)

The Cambridge International AS & A Level Business syllabus Handling data

9781398308114.indb 7 05/03/21 11:06 AM

Context based on text and numerical data. Each question is split

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1.1.1 The nature of business activity

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9781398308114.indb 2 05/03/21 11:06 AM

1.1.1 The nature of business activity

9781398308114.indb 3 05/03/21 11:06 AM

how different firms create value. What can businesses do

9781398308114.indb 4 05/03/21 11:06 AM

1.1.1 The nature of business activity

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» Technological issues For example, changes in the Economic Social

examined in the rest of this book. Even if a business does

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1.1.1 The nature of business activity

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and the possibilities of combining them in a particular

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1.1.2 The role of entrepreneurs and intrapreneurs

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Location Starting a business rank Starting a business score 1.1

1.1.2 The role of entrepreneurs and intrapreneurs

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STUDY TIP The role of business enterprise in the

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1.1.3 Business plans

» a financial section which would include a cash-flow

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TEST YOUR LEARNING

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1.1.3 Business plans

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1.2 Business structure

to support small businesses. [3]

3 a Define the term ‘corporate responsibility’. [2]