Notes

AS-LEVEL BUSINESS (2023-2025)
Prepared by: Sikander Ayub
TMUC
QUEENSBURY
CAMPUS
AS-LEVEL BUSINESS (9609)

For syllabus 2023-2025
PREPARED BY: Sikander Ayub
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Contents
How to write an essay? .......................................................................................................................... 3
Chapter 1: Enterprise ............................................................................................................................. 6
Chapter 2: Business Structure .............................................................................................................. 14
Chapter 3: Size of Business .................................................................................................................. 22
Chapter 4: Business Objectives ............................................................................................................ 32
Chapter 5: Stakeholders in a Business ................................................................................................. 43
Chapter 6: Human Resource Management ......................................................................................... 49
Chapter 7: Management and Leadership ............................................................................................ 60
Chapter 8: Motivation .......................................................................................................................... 66
Chapter 10: What is marketing? .......................................................................................................... 78
Chapter 11: Market Research .............................................................................................................. 87
Chapter 12: Marketing Mix – Product and Price ................................................................................. 96
Chapter 13: The Marketing Mix – Promotion and Place ................................................................... 112
Chapter 14: The Nature of Operations .............................................................................................. 124
Chapter 15: Operations Planning ....................................................................................................... 128
Chapter 16: Inventory Management ................................................................................................. 133
Chapter 17: Capacity Utilisation ........................................................................................................ 139
Chapter 18: Business Finance ............................................................................................................ 144
Chapter 19: Forecasting and Managing Cashflows ........................................................................... 155
Chapter 20: Costs................................................................................................................................ 162
Chapter 21: Budgets ........................................................................................................................... 174
Specimen Papers for 2023-2025 AS Syllabus..................................................................................... 180
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How to write an essay?

There are various command words which an examiner uses to tell you the exact requirement of what is required
in a question. These command words are usually the very first word of the question. Your answer structure will
solely depend on these command words. It is always advisable to first make a mental or written note of what
you are going to write before attempting any question. Questions with more than 6 marks shall be well thought
and divided in paragraphs. Following are some command words which are mostly used.
Essay Term Definition

Break an issue into its constituent parts. Look in depth at each part using supporting arguments and
Analyse
evidence for and against as well as how these interrelate to one another.
Weigh up to what extent something is true. Persuade the reader of your argument by citing relevant
Assess research but also remember to point out any flaws and counter-arguments as well. Conclude by stating
clearly how far you are in agreement with the original proposition.
Literally make something clearer and, where appropriate, simplify it. This could involve, for example,
Clarify
explaining in simpler terms a complex process or theory, or the relationship between two variables.
Comment Pick out the main points on a subject and give your opinion, reinforcing your point of view using logic
upon and reference to relevant evidence, including any wider reading you have done.
Identify the similarities and differences between two or more phenomena. Say if any of the shared
Compare similarities or differences are more important than others. ‘Compare’ and ‘contrast’ will often feature
together in an essay question.
Say what you think and have observed about something. Back up your comments using appropriate
Consider evidence from external sources, or your own experience. Include any views which are contrary to your
own and how they relate to what you originally thought.
Similar to compare but concentrate on the dissimilarities between two or more phenomena, or what
Contrast
sets them apart. Point out any differences which are particularly significant.
Give your verdict as to what extent a statement or findings within a piece of research are true, or to
Critically what extent you agree with them. Provide evidence taken from a wide range of sources which both
Evaluate agree with and contradict an argument. Come to a final conclusion, basing your decision on what you
judge to be the most important factors and justify how you have made your choice
To give in precise terms the meaning of something. Bring to attention any problems posed with the
Define
definition and different interpretations that may exist
Demonstrate Show how, with examples to illustrate.
Describe Provide a detailed explanation as to how and why something happens.
Essentially this is a written debate where you are using your skill at reasoning, backed up by carefully
Discuss selected evidence to make a case for and against an argument, or point out the advantages and
disadvantages of a given context. Remember to arrive at a conclusion.
Elaborate To give in more detail, provide more information on.
Evaluate See the explanation for ‘critically evaluate’.
Look in close detail and establish the key facts and important issues surrounding a topic. This should
Examine be a critical evaluation and you should try and offer reasons as to why the facts and issues you have
identified are the most important, as well as explain the different ways they could be construed.
Clarify a topic by giving a detailed account as to how and why it occurs, or what is meant by the use of
this term in a particular context. Your writing should have clarity so that complex procedures or
Explain
sequences of events can be understood, defining key terms where appropriate, and be substantiated
with relevant research.
Adopt a questioning approach and consider a variety of different viewpoints. Where possible reconcile
Explore
opposing views by presenting a final line of argument.
Give an Means give a detailed description of something. Not to be confused with ‘account for’ which asks you
account of not only what, but why something happened.
Identify Determine what the key points to be addressed are and implications thereof.
A similar instruction to ‘explain’ whereby you are asked to show the workings of something, making
Illustrate
use of definite examples and statistics if appropriate to add weight to your explanation.
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Demonstrate your understanding of an issue or topic. This can be the use of particular terminology by
Interpret an author, or what the findings from a piece of research suggest to you. In the latter instance, comment
on any significant patterns and causal relationships.
Make a case by providing a body of evidence to support your ideas and points of view. In order to
Justify present a balanced argument, consider opinions which may run contrary to your own before stating
your conclusion.
Convey the main points placing emphasis on global structures and interrelationships rather than
Outline
minute detail.
Review Look thoroughly into a subject. This should be a critical assessment and not merely descriptive.
Present, in a logical order, and with reference to relevant evidence the stages and combination of
Show How
factors that give rise to something.
To specify in clear terms the key aspects pertaining to a topic without being overly descriptive. Refer
State
to evidence and examples where appropriate.
Give a condensed version drawing out the main facts and omit superfluous information. Brief or general
Summarise
examples will normally suffice for this kind of answer.
Evokes a similar response to questions containing 'How far...'. This type of question calls for a thorough
To what
assessment of the evidence in presenting your argument. Explore alternative explanations where they
extent
exist.
Students often ask how much they should write for a particular number of marks. It is entirely up to the student
to write as much as they want but whatever they may write shall be relevant, accurate, to the point, not
excessive and clearly understandable.
It is advisable to start the essay questions with definitions which can be included in the introductory paragraph.
Gradually you make up the whole body of the answer where you discuss or evaluate what has been asked.
Examples must be given where necessary or possible and irrelevant detail shall be avoided to save time.
Conclusions always make an answer complete and attractive. Conclusions show the ability to summarize what
has been discussed in the answer. Remember not to just summarize your answer in conclusion but also give
your final verdict which matters the most. The examiner wants to know what have you concluded after writing
some detail.
Avoid using direct voice in essays. Always use passive voice. The use of words such as “I”, “We”, “Us” is not
recommended. Your sentences shall not be too long so divide them by punctuation or just start a new line.
Always write essay in paragraph format. This way you can divide your answer and can make sections. You can
also control how much you are writing whether less or excess.
Examples of Questions:
1. Discuss whether workers employed in banking are likely to earn more than workers employed in
agriculture. [8 marks]
Up to 6 marks for why they might earn more e.g.:

Up to 3 marks for: some bank workers are skilled workers [1] these are in low supply [1] high demand [1].
Up to 3 marks for bank workers may be difficult to replace [1] may be very productive [1] and so have inelastic demand [1].
Up to 2 marks for: bank workers may need high qualifications/better trained [1] and so have inelastic supply [1].
Up to 2 marks for bank workers may be in a professional organisation/trade union [1] and this will give them more bargaining
power [1].
Up to 6 marks for why they might not earn more e.g.:

Up to 4 marks for: some workers in banking are low skilled [1] e.g. cleaners whilst some workers in agriculture are high skilled
[1] so supply of some bank workers may be higher than some agricultural workers [1] and demand may be lower [1].
Up to 3 marks for: some agricultural workers are very experienced [1] pay tends to rise over time [1] due to promotion [1].
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Up to 2 marks for: agricultural workers in a rich country may earn more than workers in banking in a poor country [1] earnings
vary between countries [1].
Up to 2 marks for agricultural workers in some countries may be more likely to be in a union/labour organisation (1) and so
may have more bargaining power (1).
Maximum of 4 marks for a list-like approach.
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Chapter 1: Enterprise
Introduction:
The first chapter of this book refers to the introduction of business and the economic environment in which it
operates. Business activity does not take place in isolation from what is going on around it. The very structure
and health of the economy will have a great impact on how successful business activity is.
Why do we do business?
In defining the term business first, one can say that it is any organization that uses resources to meet the needs
of customers by providing a product or service that they demand. Products which we see in shelves of super
markets undergo a lengthy process of selection, production and distribution before reaching in our homes.
Business add value to products right from the extraction of raw materials from the earth till its final finishing
process. This is what business activity is (adding value). Without business activity, we would be forced to remain
self-sufficient.
What do businesses do?
Before starting any business, an entrepreneur must identify what consumers desire to buy. The entrepreneur
can do this by doing market research. Once that is done, they find the right resources to produce that good or
service, design the processes of production and distribution. Calculate its costs and revenues and eventually sell
it in the market to make profit (which is the ultimate motive of any business). The desires of consumers can be
divided into two parts mentioned as under:
- Consumer Goods:
These are physical and tangible goods sold to the general public. They include cars, clothes, furniture, electronic
equipment and food items etc.
- Consumer Services:
These are non-tangible products sold to general public. They include services like insurance, banking, hotel rooms,
travel agencies and etc.
Businesses need a set of resources to make a product. They are generally referred to as factors of production in
conjunction.
 Land: It includes all the natural resources (renewable and non-renewable) used to make goods and services.
Examples include timber, coal, oil fields, rivers, real estate and etc.
 Labour: Every business needs labour. These are human resources (skilled and non-skilled) that make up a
workforce.
 Capital: These are the man-made resources used in production such as machines, robots, assembly lines and
computer equipment. It is also referred to as the finance needed to set up a business and pay for its daily
expenditures.
 Enterprise: These are the risk-takers who first took the risk of setting up the business with the motive to earn profit.
They are the ones who assemble everything and provide a start to any business. They combine all other factors of
production into a workable single unit.
The idea of Creating and Adding Value:
The idea of creating value or adding value refers to the situation when a business starts to add value to the
raw materials it has bought to make a good or service. A business can add value by assembling things, refining
things, cutting, polishing, adding, designing and etc. In other words, it is the difference between the costs of
bought in materials and the price the finished goods are sold for. If a customer is prepared to pay a price that
is greater than cost of materials used to produce a good or service, then the business has been successful in
adding value.
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It must be noted that added value is not same as profit because the costs of labour, rents, insurance premiums
and interest rates are yet to be paid by the business. After they have been paid, the surplus can be referred to
as profit.
For any business to successfully create value, it must be consumer focused. If consumers are buying goods at a
greater value than what they originally were, the business is said to have successfully created added value.
The concept of opportunity cost:
So far we have established a sound reason of what the fundamental problem of any business is and why it exists
(limited resources and unlimited needs/wants). It is a general perception in fact, a reality that our wants expand
as we grow old. Starting a family in future will need a bigger house and may be another car or children might
ask for desirable gadgets such as tablets, gaming consoles or expensive jewellery items.
Therefore, it can be established that humans cannot decide upon a time when all of their needs and wants will
be completely and finally satisfied. Our wants are continuously expanding and changing. This leads to scarcity
and ultimately we are forced to make a CHOICE.
Given limited resources and unlimited wants we have to decide or choose which wants to satisfy. The true cost
of any choice we make between different alternatives is expressed as opportunity cost. In other words, it is the
cost of next best alternative forgone or sacrificed.
Dynamic Business Environment:
Due to globalisation, the business environment is ever changing and hence, it has become dynamic meaning
multiple factors of sources will force businesses to make changes to itself to welcome more and more
consumers. This also means that risk factor is rising which can make the original business plan outdated or
unworkable. Therefore, a business plan must be prepared to face following changes in business environment
such as:
- New competitors entering the market

- Legal changes brought by the government such as safety regulations, minimum wage laws or limit on
how much consumers can buy e.g. cigarettes
- Economic changes such as inflation or unemployment
- Technological changes such as advance products or materials that make existing products quickly
outdated
Reasons for business failure:
As discussed earlier, many start-ups often fail during the first year of its operation. Few of the reasons why
business often fail are discussed below.
1. Failure to understand your market and customers: It is highly important to understand your competitive
market space and customers’ buying habits. These will define the whole business strategy from the
start. Considering questions like who the customer is and how much they spend can be vital towards a
business’s success.
2. Opening a business in an industry that is not profitable: It is important to select an industry where you
can achieve desired levels of growth to maintain a sustained level of profit over the years. Business
environment is dynamic and is continuously changing owing to changes in economic situation, law and
order, government policies and international market behaviour. New competitors might come in or
technological changes might make your product completely obsolete.
3. Inadequate financing or lack of capital: Working capital is term mainly used to define the liquidity status
of a business. It means how much cash reserves a business holds to pay of its daily expenses. A suitable
level of working capital is highly important for smooth running of business operations. This way, a
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business can hold inventories level, offer customers time to pay off later, buy raw materials to cater for
unpredictable demand or to pay creditors on time. Cash is king so a business must have sufficient levels
of it otherwise borrowing money and paying it back can be troublesome.
4. Lack of record keeping: It has been observed in local businesses that they operate without any proper
accounting record. Record keeping is necessary to pay off wages, to know when to order new inventory,
to know when creditors are overdue, to know when to get money back from debtors, to know about
actual sales made and etc. Computer software are now available in market which are easy to use and
business must make use of them.
5. Poor management skills: Having skill or knowledge about work is not all sufficient. When it comes to
management, many brilliant entrepreneurs fail because they have no idea how to lead a team. New
entrepreneurs are advised to take leadership courses so that they can understand hidden dynamics (HR
management, work place ethics, and employee employer relationship) of the business.
6. No customer strategy: A business is advised to remain in touch with their customers in order to get
continuous feedback. Social media networks such as Facebook, Pinterest and Twitter have made real-
time interaction with customers very convenient. Recent studies about social media marketing suggest
that business are more successful if they maintain a close contact with customers through social media.
Local, National and International Businesses:
In the past 10 years, advancement in telecommunication and transportation links have greatly triggered the
trend of many multinational businesses operating all around the globe. The path from being a small scale
business to becoming a substantial and wealth pounding multinational business can be understood by explaining
the terms of local, national and international business.
Local business operates in a small and dwell-defined part of the country. Expansion is not their objective as its
nature may not suit it or simply is not one of the primary objectives. Examples may include a boutique, local
book shop and a local school.
National business is one step ahead of local. They have branches spread around the country but have no plans
to carry their operations in other countries. Examples may include national mobile network providers,
supermarket chains and banks.
International businesses operate at the highest scale of operations whereby they have setup production plants
or distribution links in other countries. They are also referred to as Multi-National businesses. Examples can
include car assembly plants, international banks, and food chains.
The issue of international businesses has been on the upfront because sometimes the movement of capital
(human and financial) is considerable and it can favourably or adversely affect the financial position of a country.
By trading together, countries can build up improved political and social links and this can help to resolve
differences between them. Trading internationally can also have drawbacks so they must be considered
seriously by a government. These drawbacks may be:
 There may be loss of output and jobs from those domestic that cannot compete effectively with
imported goods.
 There may be a decline, due to imports, in domestic industries that produce very important strategic
goods for example coal or foodstuff.
 Manufacturing the good in which a country has comparative advantage may take a lot of time. All the
investment to one major industry will require retraining of labour and social and political reforms will
be needed.
 Major problem arises for newly established businesses because they will find it difficult to compete
against already well settled imported goods. Infant industries will not grow.
 Dumping by industry’s major producer may eliminate the whole industry of a country because they
dump goods at a very lost cost which cannot be matched by local producers.
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 There will be loss of foreign exchange if there is Balance of Payment deficit for many years. More money
will flow out of the country than what is coming in. Local currency will devalue at a faster rate.
Multinational Businesses:
By definition, this is a business organization that has its headquarters in one country but with operating branches
and assembly plants in other countries. The credit of emergence of multinational business primarily goes to
increased trend of globalization. Some multinationals even have their revenues exceeding GDP of some
developing countries. Their sheer size and power can influence government decisions and economic activity in
a country.
Advantages of becoming a Multinational:
1. Firstly being a multinational will enable the business to completely avoid trade protection measures
because now they produce as a local industry.
2. The MNC gains access to all the natural and man-made resources offered by the host country.
3. The business will now be closer to its main markets. This will reap several advantages such as lower
transportation costs, easy availability or raw materials, viewed as a local company and better market
information about consumer taste.
4. Lower costs of production can be achieved if located in a developing country. Cost reductions may come
in the shape of lower rents, lower labour rates and availability of government grants. Government
grants are specifically available for multinationals because they invest in technology and employ a large
number of people who are provided with skills.
Disadvantages of becoming a Multinational:
1. Initial setting up costs may be very high.

2. Communication links with headquarters will be delayed as there is time-zone gap and information may
not reach correctly.
3. Language barrier and cultural barriers can become a barrier in efficient setup of the new branch.
4. Some governments of developing nations may put operating restrictions on MNCs such as minimum
wage or higher taxes.
5. Matching the skill level of employees in the home country with that of the new location will take time
and training.
6. The host country may not be technologically advance as per the home country.
Potential Benefits of MNC for Host Country:
1. The total GDP of the economy will increase which will raise income level of all residents. This will lead
to improvement in living standards.
2. A well-established MNC helps in improving managerial skills as it brings its well tested expertise to the
host country. Managers are well trained who then if shift to another business can implement those
expertise for collective good.
3. Governments of host country earn substantial tax revenues from these MNCs. Government then uses
these revenues for injections in the local economy.
4. As already discussed before, the advent of MNC encourages the local industry to match their level. They
will also be investing in advanced capital and machinery.
5. Unemployment level may come down as MNCs employ a great number of people.
6. Foreign exchange can improve as imports which were happening before the MNC will reduce.
Potential Threats of MNC for Host Country:
1. MNCs are famous for their scale of operations. As they operate on an extensive scale to achieve
economies of scale, they deplete the natural resources on an increasing scale as well. Many
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governments speak against the depletion caused by these MNCs but their power and position within
the host country enable them to make their way avoiding these restrictions.
2. MNCs send a good portion of profits back to their home country. Only the remaining portion of profit
is reinvested back in host country.
3. There have been increasing amount of reports stating that MNCs exploit human capital by paying them
minimum of wages and taking a full day’s work. Foxconn, which manufactures iPhones is repeatedly
under the radar of such incidents.
4. MNCs operating in under-developed countries may cause deforestation at large scale for factories
construction. They may also create noise and air pollution because of their commercial activities.
5. Infant industries are eventually driven out of the competition due to their inferior equipment and
limited finance.
Role of Entrepreneurs and Intrapreneurs:
A new business idea might have the best available land and labour and will be well financed, but without the
enthusiasm and creativity of an entrepreneur or intrapreneur, it will most certainly fail.
Role of entrepreneur:
- Have an idea for new business

- Create a business plan
- Invest their own savings and capital (risk-taker)
- Accept the responsibility of managing the business
- Accept the possible risks of failure
Role of Intrapreneur:
‘Intrapreneur’ is the term given to people who have the same qualities as entrepreneurs and are encouraged to
demonstrate the same skills as entrepreneurs within an existing business. There are three key differences
between an entrepreneur and an intrapreneur.
In order for intrapreneurship to take place and to continue in a business, it must continuously invest in in
innovation and advancement so that it can keep its dynamic employees and managers who are hungry to grow,
be creative and prove their mettle. Hence, an enterprise must have a structure whereby it can support
intrapreneurship which can give initiative to existing employees to take risks and create new business
opportunities. The benefits of intrapreneurship to existing businesses include:
• Injecting creativity and innovation into the business – developing new products to increase sales or creating
exciting ways of selling existing products.
• Developing new ways of doing business – creativity in solving problems such as low efficiency can be more
successful than continuing to use the old ways.
• Driving innovation and change within the business – generating excitement within the business about a new
opportunity makes change more acceptable.
• Creating a competitive advantage – by developing more innovative products.
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• Encouraging original thinkers and innovators to stay in the business – this is summed up by the expression:
‘You don’t have to leave our company to become an entrepreneur!’
Characteristics of a successful Entrepreneur:
New business ventures started by risk-taking entrepreneurs can be inspired by a new idea or may be a new way
of offering an existing good in the market. An example can be of food vending trucks recently introduced in
Lahore and Karachi but which are well established in the US.
For any business to be successful, following characteristics shall be possessed by the entrepreneur:
- Innovation: It would mean devising a new product in the market particularly for a niche market. May
be innovation can be derived by delivering an old product/service but in a new way (see food truck
example above). However, for a true innovation, the idea has to be original and shall not be easily
copied.
- Commitment and self-motivation: Both these factors are prime especially when a business is taking
initial steps. It requires additional hours of work, energy and patience.
- Multi-skilled: An entrepreneur will have to make the product, promote it, sell it and then keep financial
records of buying and selling. All these tasks require multiple levels of skills and abilities.
- Leadership skills: There is an evident difference between a boss and a leader. A leader is the one who
works WITH the team. A boss is a person who just directs the work to his subordinates.
- Self-confidence and ability to bounce back: It is very likely that a new business venture will fail due to
unforeseen circumstances or due to new entry in business dynamics. A true entrepreneur must keep
steady level of patience and belief that if not today then later on their idea will work. Apple was a huge
failure as well.
- Risk-taking: It is often said that where there is high risk there is always a higher return. Same principle
applies here in business. A business owner must take risks which no other entrepreneur is willing to
take. Only then there will room for growth. Remember, there is always room at the top.
Challenges in business environment:
Following are few of the challenges often faced by all types of businesses.
1. Identifying successful business opportunities:

Regarded as the most important is identifying a suitable business model. This is where everything starts
and leaps forward. Individual ideas are usually inspired by individual thinking and basic environment
that entrepreneur is involved in. Identifying a market need does half of the work towards success. The
remaining success comes with planning, implementation and proper business strategy. Whatever the
business model may be, it is highly important that that idea (product) is being demanded in the market.
Only then sales will be possible. There are real-life instances whereby market needs were not catered
for but the product was so well thought that it struck the consumers immediately. Examples include
first generation iPod and iPad, GoPro cameras, Tesla Model X and S, Wireless phone chargers,
Facebook, Online Poker, Uber, Hybrid Cars and etc.
It is important to note that majority of new business ideas comes from extensive research and
knowledge or market dynamics.
2. Finance (Capital):
Once a business idea is established with all the workings, plans, aims and objectives, the next task is to
raise the finance or capital to set-up the business operations. This is where most people fail. We might
have numerous business ideas every day but we eventually give them up when we ask ourselves the
question “where will the money come from?”
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Obtaining finance becomes difficult because no person has enough savings or inheritance. People might
not know about micro-financing opportunities offered by banks, religious reasons, banks may not trust
you because you are a new player, your business plan might not be attractive or may seem too risky by
investors (those who invest money in order to gain profit).
3. Determining a suitable location:

With the idea and finance part done, an entrepreneur now has to decide where to establish his business
so that it may take a physical shape. Popular or famous commercial spaces might have a higher rent so
the fixed costs (those costs which do not change with the level of output) will be higher as well. Less
popular or suburban spaces might have lower levels or rent but they might not be able to cover a
substantial number of customers.
Therefore, a business shall locate in a place which shows promising market potential with a good
number of customers (a bakery in a residential area), the place shall be famous or prestigious if your
product is high end (Louis Vuitton at Champs Elysees avenue in Paris), not very farm from family, shall
be close to other related businesses (a car showroom located near to market of car mechanics or a
chemical factory located near to river or waste canal).
The problem of location is completely eradicated when businesses decide to sell online (first opted by
H&M, Zara, BestBuy, Wal-Mart and etc.). This way, the entrepreneur may avoid the costs of buying or
renting the premises.
4. Competition:
New businesses always face problem with existing sellers in the market who are well established. A
unique product may not face this problem but a common product will (a new soap brand let’s say unless
your soap offers something very unique). New businesses can overcome competition by offering good
customer service, discounts, build customer trust and offer unique services (often seen in beauty
salons). For a moment, consider how many fizzy drinks brands have been successfully able to compete
in Pakistani market?
5. Building a customer base:

Building a sound customer base defines the long-term success of your business. In the past 10 years,
Lahore city saw a surge in restaurant businesses with new entrees in food like French cuisine, Italian,
burgers and now Japanese is getting famous as well. However, these business weren’t able to survive
for long just because they failed to retain their customer base. Either they lost customers to new
restaurants which offered more variety in food or offered cheaper yet high quality or customers just
became fed up of eating French cuisine. A business can overcome this by offering services to suit
individual needs, introducing new products, advertise, provide after-sale services and etc.
Role of enterprise in a country’s economic development:
Following are few benefits that economy enjoys because of enterprises:
- Employment creation: New businesses employee factors of production, primarily labour which will
eventually result in fall in unemployment levels in the economy. They will help to create jobs and
enhance the skills of labour force.
- Economic Growth: Any increase in output of goods or services from a start-up business will increase the
Gross Domestic Product (GDP = the total value of goods and services produce within the geographical
boundaries of a country in a year) of the country. This will lead to economic growth which means the
economy is growing in both size and value. Successful businesses will pay out taxes to government and
governments can use this revenue to fund other projects.
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- Exports: Most business start-ups offer products that meet the needs of local markets. Some
will expand their operations to the export market in other countries. This will increase the
value of a nation’s exports and improve its international competitiveness.
- Innovation and technological change: Any new business brings innovation in one way or the other and
it adds dynamism to an economy. For instance, in 1990s in India, most of the start-ups were IT related.
Now, most of the world’s leading IT companies are owned by Indians and they generate billions of
dollars of revenue putting India in the front line of technological race alongside USA and China.
- Increased Social Cohesion and Social responsibility: As small businesses create employment, people feel
more involved in the economy and more socially representable. It leads to harmony in society and less
conflicts. Moreover, many business act socially responsible by giving back to the society. They do this
by reducing the waste, organizing public events and being environmentally friendly.
- Personal development: Starting and managing a successful business can aid in the development of
useful skills and help an individual towards self-actualisation – a real sense of personal achievement.
The Business Plan:
A business plan is a document that is prepared by the entrepreneur and it will be used to attract bankers, venture
capitalists or potential shareholders to invest money in the business. The plan will include following elements:
 Executive summary − an overview of the new business and its strategies.

 Description of the business opportunity − details of the entrepreneur’s skills and experience; nature of
 The product; the target market at which the product is aimed
 Marketing and sales strategy − details of why the entrepreneur thinks customers will buy the product
and how the business will sell to them.
 Management team and personnel – details of the entrepreneur’s skills and experience and the people
they intend to recruit.
 Operations − premises to be used, production facilities, IT systems.
 Financial forecasts − the future projections of sales, profit and cash flow for at least one year ahead.
Benefits of Business Plan:
 It will be used to obtain finance from banks for new start-up.

 Investors will scrutinize the plan in detail and see whether it is worthwhile to invest in the business.
 The plan will guide the owner to rethink its strategies and possible strengths and weaknesses of the
business itself.
 It will be used as a guiding tool for managers especially in the early years of business which are the most
difficult.
Limitations of Business Plan:
 The plan is just a guidance tool and will not guarantee success.
 The plan can create a false sense of certainty in the minds of owners and they can become care-free.
 The plan is based upon forecasts and predictions and with changing business environment, the plan can
become outdated or completely irrelevant.
 The plan has to be backed-up by detailed market research which is expensive to conduct for start-ups.
 The plan might make owners inflexible and not allow them to make necessary changes to the plan when
external economic factors change.
13
Chapter 2: Business Structure

Introduction:
This chapter relates to detailed study about various types of business structures that exist in real world. They
vary in size, revenue generated, production scale, legal entity and other important features that we shall study
in detail.
The three sectors of an economy:
Any economy of the world operates under the sphere of four major economic sectors. The division of the
economy in these three spheres define the business dynamics of a country, its employment and occupational
distribution, its development level and kind of output produced. They are recognised as:
- Primary Sector: This is where most of the raw material of the industry comes from. Mainly related to
extraction of natural resources such as agricultural goods, oil, fishing industry, timber, mining, minerals
and etc. Most developing or under-developed economies operate in this sector.
- Secondary Sector: Often referred as the industrial sector where processing of raw materials take place.
It is the manufacturing sector where goods are actually produced. Examples include steel industry,
construction industry, electronics industry, textile industry and etc.
- Tertiary Sector: Most developed economies are heavily dependent upon their tertiary sector which
involves the provision of services such as banking, insurance, transport, technology, retailing and
education. UK is considered as one of the most heavily tertiarized economy because it leads in
education, health and financial services sector.
- Quaternary Sector: This sector of the economy is only seen in highly developed economies such as
Germany, France, Belgium, USA, UK and Canada where most of the research and development takes
place. It involves research in medicine, manufacturing methods, product development, computer
equipment and energy. This is the most highly paid sector in the economy as well.
Public and Private Sectors:
Any industry in a country will be either owned/operated by private sector or by public sector. In terms of their
motive and nature, both sectors differ a lot.
Private sectors include businesses that are owned and operated by individuals or groups in the local public. The
main motive of any private organization will be to earn profit. Competition thrives in private sector therefore it
is very efficient and offers more choice.
Public sector include all organizations that are owned and operated by the government. The work public here
means government (working for the general public). The main motive is collective welfare of people. There is no
competition in public sector from within so they are usually inefficient and cannot offer more choice.
For a minute, consider that you have to send an expensive parcel which shall be delivered next morning. Which
business will you go to? TCS or Pakistan Post? What is your choice and why?
There are certain organizations (or strategic industries) that are too big or risky to be given to private sector.
These usually include health, education, defence, police, law and energy. Private sector might abuse these
industries resulting in expensive provision. However, there are cases where public sector organizations
especially in telecommunication sector which have been sold off to private companies (PTCL). The transfer of
ownership from public sector to private sector is called as Privatization. The opposite of this is called as
Nationalization (Silk industry in Pakistan).
The existence of public sector is highly important in an economy because the need for the provision of Public
goods. These are those goods that cannot be charged for (due to non-excludability and non-rivalrous nature).
14
Non-excludable means that people who do not pay for the good can still use it. Non-rivalrous means the
consumption of that good by one person will not reduce the consumption for another person.
Industrialization & Change in Business Activity:
It refers to increased mechanization in the economy and it directly affects the secondary sector. There is an
increasing number of developing countries which are now heavily industrialized and they are responsible for
majority of the production of the world. Developed economies have major proportion of economic activity going
on in tertiary and quaternary sector. However, industrialization is not always advantageous.
Benefits:
- GDP increases and this raises the average income of people living in the country. Eventually, standards
of living will improve.
- Increase in local output means there will be less need for imports. Exports may also rise if product
quality is good.
- More jobs will be created due to increasing number of factories and other businesses.
- Tax revenue collected by the government will rise as firms will be earning more profit.
Problems:
- Factories usually locate to urban areas. This will lead to mass movement of people from rural to urban
areas resulting in congestion.
- To produce more, the industries may need more raw materials which will be imported. This will result
in higher import bill.
- Mechanization may also lead to unemployment as machines will be doing most of the work.
In developed economies such as UK and France, the rate of industrialization has decreased (deindustrialization)
over the past decade. In UK more than 70% of the employment level is filled by tertiary sector and 80% in France
is related to Tertiary sector. The reasons for increase in deindustrialization include:
- Rise in incomes have led people to spend more on services (such as tourism. Hotels business, sports
and financial services). The spending on physical is rising but its rate of increase is slower as compared
to that of services.
- Newly industrialised economies are much more competitive as compared to those industries in
developed economies. NICs produce the same goods much cheaper and are able to match the quality
once produced by developed countries. Therefore, the imports of developed countries are increasing.
Consequences of deindustrialisation
The consequences of the decline in the relative importance of the primary and secondary sectors and the
increase in relative importance of the tertiary and quaternary sectors include:
- Job losses in agriculture, mining and manufacturing industries.
- Movement of people towards towns and cities.
- Job opportunities in service industries – tertiary and quaternary sectors.
- Increased need for retraining programmes to allow workers to find employment in service industries.
Economic Systems:
1. Command Economic System:

This is the economic system in which resource allocation is done by the government alone and there is
no role or existence of private sector. Only public sector is there and essential goods and services will
be provided.
15
2. Free market system:

This is the economic system in which resource allocation is done by the forces of demand and supply
and the price mechanism prevails. There is no role or existence of public sector.
3. Mixed economic system: This is the mixture of command and free market system. Government provides
public and certain merit goods while the private sector provides other goods and services at a price
decided by the price mechanism.
Legal Structure of Firms:

SOLE PRIVATE PUBLIC
PARTNERSHIP COOPERATIVE PUBLIC CORPORATION
TRADER LIMITED LIMITED
Profit
Profit Profit Welfare of its Provision of essential
MOTIVE maximizati Profit maximization
maximization maximization members goods/services
on
Sole trader Ordinary partners Directors
Directors and Parliament→Ministers
CONTROL itself controls control the and Managers only
Managers →Directors→Managers
the business business Managers
2-50 2 to unlimited Only members are
OWNERSHIP Single Owner 2-20 partners Government owns it
partners shareholders shareholders
Personal
savings, loan Retained profits, Shares,
Shares, debentures, Shares, retained
FINANCE OR from friends loan from banks retained Retained profits, grants from
retained profits, profits, loan from
CAPITAL or banks, and friends, profits, loan government
loan from banks banks
retained personal savings from banks
profits
Unlimited
liability means General or
owner has to Ordinary Partners:
Limited
LIABILITY sell even his unlimited liability. Limited liability Limited liability Limited liability
liability
personal Sleeping Partners:
things to cover limited liability
losses
Yes. The
business
No. The Yes. The business
and owners Yes. The business
SEPARATE owner and No. The partners and owners are Yes. The business and owners
are and owners are
LEGAL business is and business is considered as are considered as separate of
considered considered as
IDENTITY considered as considered as one separate of each each other
as separate separate of each other
one other
of each
other.
Yes. Shares
No shares can No shares can be Yes. Shares can be Yes. Shares can be
SHARES can be Yes. Shares can be issued
be issued issued issues issued
issued
DEBENTURES No debentures No debentures Yes Yes Yes Yes
VOTING 1 share=1 Ordinary
No concept No concept 1 member=1 vote No concept
POWER vote shareholders
Ordinary Partners
Retail and Producer
TYPES No types & Sleeping No types No types No types
cooperatives
Partners
DIVORCE Shareholder
Shareholders and
BETWEEN s are
directors are
OWNERSHIP No No usually Less divorce No
different so more
AND directors so
divorce
CONTROL less divorce
Accounts
are only
Accounts are
published
SECRECY OF Accounts are Accounts are not published and Accounts are only Accounts are showed to
to
ACCOUNTS not published published showed to public to showed to members government
shareholder
attract investor
s, govt and
banks
16
SIZE OF As business is
Slightly larger Larger than High Economies of
FIRM/ECONO small, little Larger than PLC due to ample
economies of scale partnership scale due to Smaller than PLC
MIES OF economies of funds from govt
than sole trader ECOS investments
SCALE scale
Efficient Efficient
Efficient because Efficient because
because because Not efficient because Not efficient because motive
EFFICIENCY motive is to earn motive is to earn
motive is to motive is to motive is welfare is welfare
profit profit
earn profit earn profit
Most quick Slower than Slower because of
DECISION Slower than sole Slow because of lack Slow because of govt politics
decision partnership different
PROCESS trader of profit motive and structure
making s departments
Owner’s
Formal Very formal and Bureaucratic style
MANAGEMEN choice of Partners’ choice of Formal but less than
managemen organized management with govt
T management management style PLC
t system management system pressure
style
Income tax
Only income plus Income tax plus Receives tax cuts No taxes because it is a govt
TAXES Only income tax
tax corporation corporation tax from govt run organization
tax
The scale is
May have
not large The scale is not Can have Very common and very large
DISECONOMIE DIS-ECOS
enough to large enough to significant DIS- Less than PLC as the scale of business is
S OF SCALE but less
have DIS- have DIS-ECOS ECOS huge
than PLC
ECOS
Textile
Barber,
Restaurant, Rice firm,
EXAMPLES Mobile shop, NESTLE, APPLE Utility Stores WAPDA, GEPCO, PIA
Mill, Estate Shop Master
Grocers
Group PVT
Important Concepts:
Capital: It is the money invested in the business by the entrepreneur. It is of two types; a) Fixed Capital b).
Working Capital
Fixed Capital: It is the money spent when buying long life assets such as building premises, fixtures, computer
equipment, cars machinery etc.
Working Capital: It is the money spent on daily expenses of the business such as bills, repairs, wages,
transport etc.
Share Capital: Money raised by issuance of shares/stocks is called Share Capital.
Unlimited Liability: It means that the owner of the business may have to sacrifice all his/her assets in order to
pay for liabilities and bills of the business. The owner can be taken to court for legal proceedings so that lenders
can get their money back.
Limited Liability: It means the owner of the business especially in the case of sleeping partners in Partnerships
and Limited Companies are not required to sacrifice all of their personal belongings in order to pay loans or
business bills. Only the money they have invested in the business will be lost. Meaning, they have a limited
liability.
Separate Legal Entity: It means the owner of the business and his business are considered as one single unit
under the law. If one fails, the other has failed as well. Sole traders are partnerships are not separate legal entity.
General Partners: These are those partners in a Partnership who share unlimited liability and can lose
everything if business goes bankrupt.
Sleeping Partners: These are those partners in a Partnership who are not directly involved in the management
of the business and have just invested their money for the sake of profits. They have limited liability and will
lose only the amount which they have invested in the case of business bankruptcy.
Stocks/Shares: These are certificates which represent ownership in a business. People buy shares of a company
to earn Dividends.
Shareholders: These are those people who have bought stocks/shares of a limited company. Ordinary
Shareholders are owners of a company.
17
Dividends: These are the profits which a company pays to its shareholders. The more shares a person has, the
more dividends he will get.
Board of Directors: These are the main owners of the company who control all the operations. They make all
the decisions as they have valuable financial and managerial skills. They are selected by the shareholders of the
company.
Controlling Interest: Whoever owns more than 50% of any business, he or she has a controlling interest in that
business. They have the most power in decision making of the business and can throw out managers, directors,
shareholders, employees etc.
Stock Exchange: It is the place where all companies declare themselves as public limited companies and sell
their shares to public to raise capital.
Public Listing: Any company can be listed in the stock exchange so that it can become open to general public
and public can buy shares.
Flotation: Whenever a public limited company issues new shares, it is called flotation.
Multinational: It is a type of business organization who has its head-office in its home country but it operates
in many other countries on a large scale. Their worth is sometimes more than billion dollars and employee
thousands of workers worldwide.
Privatization: It is the transfer of public sector organizations to private sector to improve efficiency and
increase competition e.g. PTCL
Nationalization: It is the transfer of private sector organizations to public sector. It is done to protect failing
industries.
18
Advantages and Disadvantages of Private Limited
Advantages and Disadvantages of Public Limited Companies
Legal formalities in setting up a company:
It is necessary for any new company to meet certain requirements set up by the government. These
requirements protect the investors, owners and creditors in different ways.
19
1. Memorandum of Association:
This is an official document that entails the name of the company, its head office’s address, declared
maximum share capital for which the company seeks authorization, assets and aims and objectives of
the business.
2. Articles of Association:
This document entails the hierarchy of the business which means the authority levels, directors’
names, their roles, meetings criteria, board selection criteria, internal matters and etc.
When these documents are completed and submitted to the relevant government organizations (Inland
Revenue, chamber of commerce and industry and lawyers), the registrar of the companies will declare the
company as incorporated and be allowed to trade.
Other forms of business organizations:
1. Franchises:
It is legal contract between two firms where the franchisee will take up another business’s name
(franchisor) and brand for a prescribed period of time.
Franchising is simply a method for expanding a business and distributing goods and services through a
licensing relationship. In franchising, franchisors (a person or company that grants the license to a third
party for the conducting of a business under their marks) not only specify the products and services
that will be offered by the franchisees (a person or company who is granted the license to do business
under the trademark and trade name by the franchisor), but also provide them with an operating
system, brand and support.
Advantages of Franchise Disadvantages of Franchise
There are fewer chances of a new business A share of the profits or revenue has to be paid
failing because it is using an established brand to the franchiser each year.
name and product.
Advice and training are offered by the The initial franchise licence fee can be
franchiser. expensive.
The franchiser pays for national advertising. Local promotions may still have to be paid for
by the franchisee.
Supplies are obtained from established and The franchisee cannot choose which supplies or
quality-checked suppliers. suppliers to use.
The franchiser agrees not to open another Strict rules over pricing and layout of the outlet
branch in the local area. reduce the franchisee’s control over their own
business.
2. Joint Ventures:
A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources
for the purpose of accomplishing a specific task. This task can be a new project or any other business
activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs
associated with it. However, the venture is its own entity, separate and apart from the participants'
other business interests.
3. Holding company:
A holding company is a special type of business that doesn’t do anything by itself. Instead, it owns
investments, such as stocks, bonds, gold silver, real estate, art, patents, copyrights, licenses, private
businesses or companies, or virtually anything of value. The term holding company comes from the fact
that the business has one job: to “hold” their investments. Examples include General Electric, Bank of
America, Barclays PLC, Goldman Sachs, Morgan Stanley, Nishat, Engro Pakistan and etc.
20
Social Enterprises: These are normal businesses but with a different aim of representing the society by making
itself a part of it. They make money in socially responsible and ethically acceptable ways and uses most of its
profit to benefit the society. They live by the three main rules (triple bottom line):
1. Economic: make profit to reinvest back into business and provide some return to owners.
2. Social: provide jobs or support for local, often disadvantaged communities.
3. Environmental: to protect the environment and to manage the business in an environmentally sustainable
way.
21
Chapter 3: Size of Business

Introduction:
Chapter two of the course gave us a detailed outline of various forms of legal structures that exist in the world
ranging from Sole trader to Joint Ventures companies with a variety of business structures between them. All of
these legal structures varied in terms of aims and objectives, liability, labour involved, risk factor, ownership and
control, issuance of shares or not and etc.
This chapter solely relates to the size of any business, how we can measure it and what that size represents. It
must be noted that comparison of size of a sole trader who starts business with a small amount of capital cannot
be truly compared with that of Joint Venture or a Public Limited Company. However, the measure of size will
help us in understanding how big or valuable are the internal matters or the operations of the business.
Governments also use the size of a business to identify those business that might need financial or technical
assistant to grow.
There are several methods through which size of a business can be measured. One method may regard a
business as big but the other methods can regard it as small. Several methods and discussed below. It must be
noted that all these methods must be considered in conjunction when deciding whether a business is big or
small.
Different measures of size:
1. Number of employees:
It is often regarded as one of the simplest and quickest method to measure size of a business. People
often say the more employees a business has, the bigger it will be. However, many technical or hand-
crafted businesses such as carpet manufacturers, advanced assembly lines making car engines
(Mercedes AMG division) and chemical manufacturing plant might use very few employees and more
machines but still produce highly valuable products. Where does the measure of number of employees
will stand then?
2. Revenue:
Revenue is the money coming into the business by selling of goods and services in the market. It is
calculated as number of units sold multiplied by per unit market price. It is a type of measure that is
advised to be used when comparing size of firms in the same industry such as a soda manufacturer with
a juice manufacturer or a hair dresser with a hair dresser. Comparing firms working in different
dimensions will not make any sense because one might be producing high quality products and can
enjoy substantial revenues and the other might be providing domestic services (house cleaners) and
enjoying average revenues (but big enough for their own needs).
The measure of revenue is further used to calculate market share which is discussed as under.
3. Market share:
Market share is calculated as: Total Sales of Business A X 100
Total sales of the industry
This measure signifies how much sales a particular business has made in comparison to the total sales
made by the industry in a given period of time. Assume the sales of Shezan fruit juice with that of total
sales of juices in Pakistan. The larger the market share of a business, the more the probability of its size
being considered as big in that particular industry. However, market share is a relative measure which
means the total market share of the industry might be small as compared to other types of industries.
So carefulness is required in comparison.
4. Capital employed:
Capital employed is value of all the assets (fixed and current) minus the current liabilities. Basically, it
is the investment made by a business to make it functional. Therefore, it can be called shareholders’
funds or equity capital.
22
Example:
Harvester Business group has started a new restaurant business with fixed assets (building, kitchen
equipment, tables, cutlery and etc.) worth of $200,000 and has current assets which includes cash, bank
and debtors worth of $120,000. It has few creditors’ worth of $80,000 and owing expenses worth of
$10,000. Calculate the capital employed by Harvester Business group.
Generally, the larger the business enterprise, the greater the value of capital needed for long-term
investment. However, different firms have different scale of capital needs such as a laundry business
capital requirements will be minimal as compared to a steel manufacturer capital needs.
5. Market capitalization:
This measure is only capable for public limited companies who have their shares quoted on the stock
exchange. It is calculated by the formula:
Market Capitalization = share price X number of shares issued
This formula signifies that how much a company’s capital is worth in the market. For instance, the latest
figures (May 2022) of Tesla Motors Inc. shows its market capitalization at $815.45bn with per share
price at $787.11.
This measure is prone to errors in comparison because of changes in share prices every day (sometimes
after every 6 hours). Therefore, it is not a fixed measure to identify the size of a business.
Why profit is not a good measure of size of a business?

Many people think profit is the ultimate bottom line for measuring success and size of any business.
The more profit a firm earns, the bigger it will be. This is not always and surely the case. Consider an
example of a firm which produces matchsticks and you can get them at Rs.2 from a local shop. How
much profit you think that firm will be making when it sells a matchstick for just Rs.2? Does this example
confuse you? It should because profit for all the firms will differ in terms of how much they sell and
how much is their profit margin.
In terms of calculating profits, it involves too many variables such as nature of product being sold,
number of units sold in comparison to how many you produced (Bugatti Chiron vs Toyota Prius),
23
expenses involved and etc. Software companies usually employee few people to work in a 4 room office
building but they may enjoy millions of dollars’ worth of profits every year.
The factor of profit shall only be considered in conjunction with all the above factors measuring size of
business. Only then it can give a meaningful and clearer distinction of whether a business is big or small.
The significance of small and micro businesses:
The definition of a small business can depend according to the expanse of economy they are operating in.
countries and their respective economies attach different definitions to small and micro businesses.
Typically, these are those businesses that do not employ more than 50 employees and have annual sales
turnover (revenue) of $1mn to $5mn. The amount of capital employed can also vary depending upon businesses
to business.
These firms are building blocks of any economy and they employ major chunk of the working population. Some
of these firms grow to become large multi-national companies. Governments of many countries have realised
the importance of small and micro businesses and how much money they help to circulate in the economy.
Importance of small businesses:
a) Major employer: A major proportion of the job market is supplied by small businesses. They help poorer
families to grow and improve their life style by giving them some level of income.
b) Variety of businesses: Many of the small enterprises are owned by enthusiastic entrepreneurs who
have innovative ideas and newer approach to businesses. They create variety of competitive products
which ultimately benefits the consumer by having more choice in goods and services. Examples may
include designers, restaurants, craft industries and etc.
c) Offer tough competition: Small companies give tough competition to large companies who provide
same products but at a much expensive rates. Examples include local parcel services as compared to
renowned brands such as TCS, DHL and Leopards. In Europe in recent years, small firms such as Ryanair
and EasyJet have provided low cost air travel to inter-Europe destinations resulting in tough
competition for Air France, Air Italia, Lufthansa and British Airways.
d) Specialist Businesses: This factor is specially related to technical industries where the existence of small
firms have proven marginally beneficial for the whole industry. Many of the machine repairs and spare
parts supply is controlled by micro businesses in major manufacturing cities of Punjab such as Sialkot,
Gujrat, Faisalabad and Gujranwala. These micro-businesses specialize in provision of special machine
spare parts and their repairs. Large firms are not able to compete with these firms because they cannot
be flexible. Small firms have plenty of room to redesign their methods and provide unique specialist
services.
e) Potential to become MNC: Many giant multi-national companies and brands around the world were
once garage businesses or were started at a very small scale. Typical examples include KFC, Virgin
Media, Apple and Heinz Tomato Ketchup.
f) Cost-effective: Small firms have smaller operations and fewer number of staff at disposal. They may
enjoy lower average costs as compared to large firms. Goods and services provided by small firms are
cheap and ultimate benefit is to the consumer. For instance, Tony & Guy vs your local hair dresser.
How governments support small businesses:
a) Reduced corporation tax: Tax given to the government by businesses is called corporation tax and it is
usually a fixed annual rate applied on the profit earned. Governments support small businesses by
allowing them to pay a small amount of corporation tax so that they have ample profits to reinvest back
into the business for growth and development.
24
b) Loan guarantee scheme: It is a scheme (an agreement) whereby government acts as a guarantor on
behalf of the small business to pay back loan taken from bank in case the business fails. Banks can easily
lend money to small business because it removes the element of risk.
c) Advisory Services: Government being the policy maker is the best consultant. They help small
businesses by providing them with valuable information regarding upcoming policies and business
opportunities. A local chamber of commerce and industry does just that.
d) Help in Business Strategy: Governments of many countries have set up training centres and workshops
in poverty ridden areas primarily to support or establish small businesses there and stimulate the flow
of income. Governments help the business by providing specialist training of product development,
marketing strategy, HR management, availability of finance, acquiring of premises to start operations
and many more.
Advantages and Disadvantages of Small Businesses:
Advantages:
i. Due to a smaller scale, a single or few owners can manage the business so there is no need to hire
professional managers who take high salaries.
ii. As they are small and their operations are not centralized or at a massive scale, they are able to be
flexible according to ever changing consumer demands. This is the key advantage because large scale
business are not that quick to change their production techniques.
iii. They are more able to provide specialists services to consumers such as personalised selling and
products.
iv. Staff feels more involved in work practices and their feedback is heard by the owners. They do not feel
alienated from job.
v. Setting up is easy and does not require extensive capital.
vi. Government assist small business due to their potential in generating employment and income.
Disadvantages:
i. Banks may not be willing to give loan because of greater risk of failure. Even if they do the rate of
interest will be higher than usual.
ii. Excessive burden on the owners (if single or two) to manage all important operational activities. Some
departments may be ignored.
iii. Usually focus on the production of one type pf product so they cannot diversify and distribute their
risks.
iv. Cannot experience economies of scale because they cannot produce at a large scale to lower down
their average costs.
Advantages and Disadvantages of Large Businesses:
Advantages:
i. They can afford to employ specialist managers and consultants because their scale of operations enable
them to have sufficient level of profits
ii. They can achieve economies of scale whereby they reduce average cost by producing more number of
units. They are able to spread the cost of production over many number of outputs.
iii. They may be price setters and other firms follow their lead.
iv. Acquiring finance is not difficult as they are able to give collateral to banks in exchange of loans.
v. They produce more than one variety of products so they can diversify their risks. If one product fails,
the other can still earn profits.
vi. Large firms are leader in research and development because they have the finance to invest in it.
25
Disadvantages:
i. Many large businesses are spread out in various locations and regions. Managing them can be difficult
and might need to create individual policies to manage each location. There can be communicational gaps
between departments or between head-offices and other regional offices.
ii. They have the tendency to become over-efficient leading to diseconomies of scale whereby average
costs tend to go up after a certain level of production. The firm will then have to reinvest in newer
technologies or increase the scale of production entirely to add additional capacity.
iii. Employees may feel alienated from work as their feedback might be taken in consideration. This leads
to demotivation and staff turnover.
iv. May often suffer from a divorce between ownership and control that can lead to conflicting objectives.
Family Businesses:
Family-owned companies are characterised as organisations in which the shareholders belong to the same
family and participate substantially in the management, direction, and operation of the company.
In such companies, the voting majority is in the hands of the controlling family, including the founder(s) who
intend to pass the business on to their descendants. Usually in such organisations, one or more families linked
by kinship, close affinity, or solid alliances hold a sufficiently large share of capital to enable them to make
business decisions.
Extract from Express Tribune (18th September 2013):
Family-owned business (FOBs) is the oldest and most common model of organisation. The economic importance of such
institutions is often underestimated. It was not earlier than the 21st century that economists, academics and government
policy makers started realising the potential of this segment and today, it has been recognised as a prime source of wealth
creation and employment in the global economic landscape. According to an analysis by Boston Consulting Group, FOBs
account for more than 30% of all companies with sales in excess of USD 1 billion. Another research estimates that 40% of
the Fortune 500 are family controlled. Samsung, Ford, Walmart, Toyota and Tata Group are just a small list of names
making big impacts in the global market, whereas National Foods, House of Habibs, Bestway group (owner of UBL, Wells
Pharmacy UK, Bestway Cement and Retail and wholesale outlets in the UK) are some of the examples of Pakistani family-
owned business which are growing worldwide. According to new research by Barclays Bank, family-owned small
businesses in Britain are among the fastest growing of all enterprises in the country, and will contribute more than £200
billion a year to the UK economy by 2018. Currently, it has more than two million family-owned businesses and that first
generation companies are growing sales at a rate of 22% a year, generated revenues of £540 billion in 2013 and that this
figure is set to hit £661 billion by 2018.
For many people, family-owned businesses symbolise bad governance, micro-management and use of
company assets to bolster personal life styles. However, if managed properly, such businesses have the
potential to grow into fast-growing corporate entities while retaining their concentrated shareholding
patterns.
Strengths of Family Businesses:
i. Commitment:
The family owners feel emotionally attached to the business so they show genuine commitment
and dedication to the work so that it can be successfully passed on to next generations.
ii. Reliability and pride:

Family business are very sensitive to their products because the name of family is attached to it.
They take pride in what they produce and they strive to increase the quality of the goods.
iii. Passing on the skills and knowledge:

The foremost priority of any family business is to carry forward the legacy. They do this by passing
on the skills and knowledge to younger generations who are involved in the business from a young
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age. This increase the level of commitment and understating of business practices that are special
to that family business.
Weaknesses of Family Business:
i. The problem of succession: Many family businesses fail when authorities are passes on to younger
generations and when deciding who takes which task. This can happen because of lack of skills of
splitting between families.
ii. Informality: Due to the nature of family business, there are no clear roles and objectives given to family
members. This leads to vague aims and objectives. In the long-run, this leads to inefficiencies and
conflicts.
iii. Traditional: Often there is a conflict of approach between younger generations and the real founders
of the business. Younger owners may split up leave the business and follow their aims elsewhere.
Moreover, family businesses tend to keep primitive practices in the heart of their culture to keep
things the traditional way.
Why some businesses want to grow?
- In order to enjoy higher profits

- Growth will allow a higher market profile hence more market share can be earned. With greater market
share, the business will gain more bargaining power over suppliers and buyers.
- A large business is most likely to achieve economies of scale.
- Large businesses most likely to gain government contracts.
- There will be reduced risk of takeover from another business.
The concept of internal growth and external growth:
Internal growth is also known as organic growth and it happens naturally within the business such as a retail
business is opening more shops around the city. This growth is much slower than external growth and involves
less risks.
External Growth:
External growth is business expansion achieved by means of merging with or taking over another business from
either the same industry or a different industry. This is often referred to as ‘integration’ and is also considered
as the fastest method of expansion.
The table below details out 4 types of integration along with their advantages, disadvantages and potential
impact on shareholders.
1. Horizontal Integration:
It is the integration between firms in the same industry and at the same stage of production. For
instance a coal extractor merges with a coal extractor. Another definition can be, horizontal
integration is the process of a company increasing production of goods or services at the same part of
the supply chain.
Examples of horizontal integration include an oil company's acquisition of additional oil refineries or an
automobile manufacturer's acquisition of a light truck manufacturer. There have been many public
horizontal integrations. For example, the acquisition of Porsche SE by Volkswagen AG, fully completed
in 2012, was a horizontal integration. Volkswagen, as of April 2012, owned 49.9% of the Porsche car
company, and agreed to purchase the remaining 50.1% in July of 2012. The deal was for a total amount
of $5.6 billion, or 4.46 billion euros.
Advantages:
- eliminates one competitor
- possible economies of scale
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- increased power over suppliers as now has more market impact

- can do rationalization as to put all effort on a more profitable site while developing the lesser one
Disadvantages:
- Rationalization may bring bad publicity and the ignored site may call for a strike
- If the outcome of merger is large market share then the business may be scrutinized over monopoly
allegations.
Impact on Stakeholders:
- Consumers now have less choice.
- Workers may lose job security as a result of rationalisation.
2. Vertical Forward Integration:

In this, a business merges with another business from the same industry but on an upper stage of
production. For example a dairy farm merges with cheese producer. Another definition can be, forward
integration is a business strategy that involves a form of vertical integration whereby business
activities are expanded to include control of the direct distribution or supply of a company's products.
For example, the company Intel supplies Dell with intermediate goods - its processors - that are placed
within Dell's hardware. If Intel wanted to move forward in the supply chain, it could conduct a merger or
acquisition of Del in order to own the manufacturing portion of the industry.
Advantages:
- Business may find a stronger retail position in a market in case a manufacturer integrates with a
retailer.
- Business is now able to control its promotions and pricing.
Disadvantages:
- Consumers may suspect uncompetitive activity and react negatively.

- Lack of experience in this sector of the industry which means a successful manufacturer does not
necessarily make a good retailer.
- Workers may have greater job security because the business has secure outlets.
- There may be more varied career opportunities.
- Consumers may resent lack of competition in retail outlet because of the withdrawal of competitor
products.
3. Vertical Backward Integration:

In this, a business merges with another business from the same industry but on a lower stage of
production. For example a shoe maker merges with a leather maker. Another definition could be,
backward integration is a form of vertical integration that involves the purchase of, or merger with,
suppliers up the supply chain. Companies pursue backward integration when it is expected to result in
improved efficiency and cost savings. For example, this type of integration might cut transportation
costs, improve profit margins and make the firm more competitive.
A general example of backward integration is when a bakery business moves up the supply chain to
purchase a wheat processor and/or a wheat farm. In this scenario, a retail supplier is purchasing one of
its manufacturers.
Advantages:
- Gives control over quality, price and delivery times of supplies.
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- Encourages joint research and development into improved quality of supplies of components.
- Business may now control supplies of materials to competitors.
Disadvantages:
- May lack experience of managing a supplying company. A successful steel producer will not
necessarily make a good manager of a coal mine.
- Supplying business may become complacent due to having a guaranteed customer.
- Possibility of greater career opportunities for workers.
- Consumers may obtain improved quality and much more innovative products.
- Control over supplies to competitors may limit competition and choice for consumers.
4. Conglomerate:
In this, a business merges with a totally different business in another industry. For instance, a telecom
provider merges with a supermarket. Another definition could be, a conglomerate is a corporation that
is made up of a number of different, seemingly unrelated businesses. In a conglomerate, one company
owns a controlling stake in a number of smaller companies, which conduct business separately. Each of
a conglomerate's subsidiary businesses runs independently of the other business divisions, but the
subsidiaries' management reports to senior management at the parent company.
Warren Buffet’s Berkshire Hathaway, a conglomerate that has successfully managed companies
involved in everything from plane manufacturing to real estate, is widely respected. Berkshire
Hathaway owns majority stake in over fifty companies, and had minority holdings in companies ranging
from Wal-Mart to car manufacturers, yet only has an office of 24 people. Buffet’s approach to
management of companies in Berkshire Hathaway’s owns is to manage capital allocation and allow
companies near total discretion when it comes to managing the operations of their own business.
Advantages:
- Diversifies the business away from its original industry and markets.
- This should spread risk and may take business into a faster growing market.
- A conglomerate can allocate capital for one of their companies if external capital markets aren’t
offering as kind terms the company wants.
Disadvantages:
- Layers of management add to the overhead of their businesses, and depending on how wide-
ranging a conglomerates interests are, management’s attention can be drawn thin.
- The financial health of a conglomerate is difficult to discern by investors, analysts, and regulators
because the numbers are usually announced in a group, making it hard to discern the performance
of any individual company held by a conglomerate.
- Lack of management experience in the acquired business sector.
- Greater career opportunities for workers.
- More job security because risks are spread across more than one industry.
Integration and Synergy:
A merger is an agreement by shareholders and managers of two common businesses to bring both firms
together under a common board of directors with shareholders in both business owning shares in the newly
merged business.
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On the other hand, a Takeover is when a company buys more than 50% of the shares of another company to
gain the controlling stake in it. This is also referred to as ‘acquisition’.
In practice, many mergers and takeover fail to gain true synergy. Synergy can be defined as a situation in which
the two businesses integrated perform well than when they were apart. Synergy also means harmony and
uniformity in the operations of the two businesses.
The reason why obtaining synergy is difficult can be:
 The integrated firm is too big to manage and control which leads to diseconomy of scale.
 The research facilities which are now available after integration may be of a little mutual benefit
especially if the integration is regarded as a conglomerate.
 The business and management culture may differ greatly. One company may support
environmental legislations and is inclined towards following CSR while the other may not.
Joint Ventures and Strategic Alliance:
Joint ventures and Strategic Alliance are the distinct two forms of external growth that do not involve complete
integration or changes of ownership. We have already discussed Joint Ventures in AS syllabus. As a recap its
definition is as follows:
Joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the
purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint
venture (JV), each of the participants is responsible for profits, losses and costs associated with it. However, the
venture is its own entity, separate and apart from the participants' other business interests.
Strategic alliances are agreements between firms in which each agrees to commit resources to achieve an agreed
set of objectives. It is less involved and less permanent than a JV. These alliances help a company to develop a
more effective process to gain several marketing or managerial objectives. It is not necessary for a strategic
alliance to be formed with similar industries. There are varied examples of strategic alliances such as:
 Spotify and Uber have partnered to provide stereo control to Uber customers. Not every Spotify
consumer uses Uber, nor does every Uber rider have a Spotify account. The strategic alliance allows
each company to pursue prospects from the other’s existing customer base, all while continuing to
promote both products. In both cases, it gives the company a leg up over its competition.
 Over the years, Starbucks has become synonymous with coffee. Like it or hate it, you instantly recognize
the name. With a Starbucks location in most (if not all) Barnes & Noble bookstores, customers have
twice the reason to shop there. Coffee break, and browse the latest bestsellers shelf all in one stop.
 Audi and Bang & Olufsen has started a strategic alliance whereby the high end luxury cars by Audi are
fitted with B&O sound systems which gives the car extra luxury feel. This alliance has helped Audi to
design the interior of their cars in a way which provides the best sound experience to the driver. To
B&O, it has provided with an opportunity to stay with the competition which was rapidly dominated by
Burmester (Mercedes) and Harman Kardon (BMW).
Theoretically, strategic alliances can be made with a variety of stakeholders such as:
 With a university  finance provided by the business to allow new specialist training courses that will
increase the supply of suitable staff for firm.
 With a supplier  to join forces in order to design and produce components and materials that will be
used in a new range of products. This may help to reduce the total development time for getting the
new products to market.
 With a competitor  to reduce risks of entering a market that neither firm currently operates in.
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Problems resulting from rapid growth:
Many businesses want to keep up with the pace of the market they are operating in. A market is formed by
many factors and different categories of businesses (small and large) so its growth is rapidly increasing. To match
this, a rapidly growing business will take up many projects or invest heavily in technology to stay with the market.
It must be noted that this move by a business to achieve rapid growth is not without its problems. See table
below for problems of Rapid Growth:
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Chapter 4: Business Objectives

Introduction:
Any business whether big or small needs to set clear objectives or targets to work towards. Without any
objectives, it will be meaningless to operate because there is no clearer target that is to be achieved. All the
individuals at their personal level set some objectives and allow themselves a time frame in which they aim to
achieve it. Given these objectives, the individuals then set up tasks, devise methods and make plans so that they
can see their objectives become achievable.
Many sole traders start small so they plan small by having little objectives e.g. survive for the first two years
before thinking of expansion or new product. Limited companies set up attractive objectives so that investors
are interested to invest. The companies mention their objectives in MoA but they lack important detail as to
how the company really plans to achieve these objectives.
For objectives to be fully understood and achievable, they must be delegated from top to bottom through all
levels of management so that everyone works towards the same goals. Otherwise after some time, some
partners or shareholders may disagree with each other causing confusion and disorientation.
What is a good and an effective objective?
The most effective business objectives usually meet the following ‘SMART’ criteria:
S – Specific: The objectives must be specific to a certain business and suit its nature. For instance, a gym has a
specific goal to get additional 25 members by the end of winters.
M – Measurable: Objectives must be quantifiable so that comparisons with previous years or with competitors
can be made. For instance, an airline company wants 25% increase in revenue during holiday season.
A – Achievable: Objectives must be easily achievable in the given time frame to the staff. Otherwise, they will
feel more pressurized and might just give up. An achievable target brings more motivation and speeds up the
process.
R – Realistic and Relevant: Firms shall set objectives which are achievable with the given resources at disposal.
They should be realistic enough to understand and carry out. Additionally, they should be relevant to the
members of staff who are being directed at an objective. For instance, the packaging department will find the
objective of reducing packaging waste by 1/3 within 6 months will find this goal more relevant and realistic than
telling them to improve the quality off goods being packed.
T – Time Specific: Setting up a time frame before any objective helps in planning the individual components of
the overall goal. Objectives will only prove meaningful if they have a time limit attached to them otherwise the
objective of increase in market share by 10% was achieved in how many months or weeks or years will be
meaningless unless there was a set time frame at the beginning.
Hierarchy of Objectives:
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Corporate Aims:
These are the very long term goals that a business hopes to achieve. These goals outline a business’s main
purpose and what it stands for in the long run. These aims then direct all the divisional, departmental and
individual aims of the whole organization.
Many businesses set their corporate aims on various platforms. Some set them on customer basis, some set
them on financial performance basis and some base them on growth basis. All these corporate aims have one
thing in common, that is they are designed to provide guidance to the whole organization and not just the part
of it. Refer to the following example of The Body Shop below.
The Body Shop is a UK based multi-national company that opened its first store in 1976 in Brighton. By 1978
they were expanding to other countries at the rate of 2 shops every month. Its founder, Anita Roddick, sold the
business to L’Oréal Paris for £652 million in 2006. Since the inception of The Body Shop, it had an aim to work
for the betterment of the environment and the community. The company strongly believed in social activism
and to support this claim, the company started many initiatives such as Greenpeace, Save the Whale, Community
Trade, Against Animal Testing, The Body Shop Foundation, Stop Violence at Home, Sustainable Development,
Recycled PET bottles and many more.
Having all these aims and beautiful and effective campaigns to support them, The Body Shop quickly became
one of the world’s leading social enterprise (social, economic and environmental). It developed a very unique
corporate culture of sustainability of the world we live in and all the inhabitants in it as well especially animals
and poorer people who often are exploited by capitalists companies. Its main aim for year 2020 is labelled as
“Enrich not Exploit” and to achieve this aim the company has set 14 smaller objectives of “Enrich our People,
Enrich our Planet and Enrich our Products”. In this aim, it covers all the aspects of social, environmental and
economical dimensions of a business and has a given something to work for in the future.
So what benefits flow from establishing corporate aims?
- Firstly, setting up aims will give a starting point on which all other objectives can be set. These corporate aims come
on the top of Hierarchy of Objectives (in Body Shop’s case it is Enrich Not Exploit is current corporate aim).
- These aims will then set up a typical environment in all departments of the corporation and everyone will work
with a purpose and direction. These aims must be carefully communicated to all the individuals to remove
confusion and ambiguity.
- These aims can then be measureable at a later date to assess how much they have achieved and what is left behind.
In the case of Body Shop’s Enrich Not Exploit aim, they will publish not only internal management reporting but
will also publish annual commitment reports which will be transparent in terms of their business practices and
show their progress towards achieving these aims.
- These aims are also used to set up a framework to develop future business strategies. In the case of body shop, it
had many corporate aims over the years but each aim was directed towards the major aim of community support
and love for the environment. The aims have to exist to provide the workers with some sense of work so that they
can also set individual aims as well.
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[Source: The Body Shop UK, www.thebodyshop.com/en-gb]
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Mission Statements:
It is becoming increasingly common for businesses to express their corporate aims into one single statement.
This statement is referred to as Mission Statement. These statements express the vision of the company in an
attractive, motivating and understandable way.
Following are some mission statements of world’s famous companies:
- IBM  Innovation that matters – for our company and for the world
- Save the Children  To inspire breakthroughs in the way the world treats children and to achieve
immediate and lasting change in their lives.
- San Diego Zoo  The zoo is a conservational, recreational and educational organization dedicated to
the reproduction, protection and exhibition of animals, plants and their habitats.
- Tesla  Tesla’s mission is to accelerate the world’s transition to sustainable energy.
- Google  To organize the world’s information and make it universally accessible and useful.
These mission statements become an active ingredient of a company’s promotional campaigns. Most companies
publish and explain their mission statements in annual accounts and newsletters which they sent to shareholders
and stakeholders around the world. Their websites loudly display the mission statements and also they affiliate
themselves in terms of sponsorships of events which reflect the company’s own nature or purpose. For instance,
Red bull always associates itself to power and energy and you can see their affiliation with all kinds of thrilling
and adventure sports where they display what the brand stands for.
These mission statements driven by the objectives of a company then also help to devise strategies at divisional,
regional and at an individual level. Companies use them to design advertising campaigns, to motivate the
employees, to develop a unique organizational culture and to create moral codes and ethical work practices. As
aims and objectives change over the years so does these mission statements and the corresponding business
strategies.
Benefits of having a mission statement:
- Provide quick information to outsiders about the central vision of the company.
- Can be used as a motivational tool for the employees and they will feel associated to any positive
aspects to it.
- They can direct an employee’s behaviour at work by inspiring their moral behaviour.
- Other businesses know what a particular stands for and this can give a competitive edge.
Drawbacks of mission statement:
- They are often common between two similar businesses and can be copied.
- Sometimes they are too much in detail and loses its purpose. Contrarily, they can be vague and
confusing and do not deliver the true essence of what the business stands for.
- They are often designed to attract or satisfy public pressure groups.
- They cannot be used to measure success of a business or to say whether it is good bad.
Corporate Objectives:
Corporate objectives materialize and are created to remove any confusion and vagueness in aims and mission
statements. These objectives are department or region specific and are delegated to concerned people in detail.
They are often divided in small achievable targets which are easy to understand and carried out. There are some
common corporate objectives found in almost all corporations around the world.
1. Profit maximization
Profit is a reward for taking a risk. Every entrepreneur’s main motivation to take greater risks with his
money and investments to earn profit which he can use for future and current uses. Similarly all the
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stakeholders in a business concern largely with profit because without it, there is no motivation to take
risks.
Profit maximization means to produce at that level where the distance between total revenue and total
cost is the greatest. If a business is making profit but not maximizing it, the owners see it as a missed
opportunity and waste of resources.
Benefits of Profit Maximization as an objective:
- Costs will be reduced to a maximum level so all elements of production will be efficient which includes
workers being careful not to waste ant raw materials, suppliers will be carefully selected to ensure
cheaper raw materials, production line will be made technologically advanced to reduce time in
production and to eliminate any wastages or inefficiencies.
- Competitors can be beaten in terms of profits and their reinvestment. This is will used to regain market
share.
- Profits will be reinvested into business for future growth.
Limitations of Profit Maximization as an objective:

- Many companies focus on short-term profits because they are easier to achieve. This enables
competition to enter in the market who can beat you in the long-run because you didn’t plan for the
long-run.
- Many businesses try to increase level of sales to achieve higher profit. This is okay because more profit
will be coming in but it will put added pressure on sales staff to achieve required sales target.
- Most business analysts assess the performance of a business through return on capital employed
(ROCE) rather than level of profits.
- Some stakeholders might not give highest importance to profit levels but shareholders and owners
might do. There are stakeholders such as the common society which may ask a business to reduce its
water pollution but for the business and its shareholders the use of water is necessary for its production
purposes. Powerful stakeholders may also be able to jeopardize any business by legal formalities.
- In reality, for any business it is difficult to correctly identify a suitable level of profit maximization. This
happens because of price changes, business environment changes and legal changes.
2. Profit Satisficing
This is the opposite of profit maximizing. It states that the business is just making enough profit to keep
the owner happy and not striving hard to earn maximum profit possible. This objective is more common
in small businesses where owners do not want to put in extra hours of work and want to enjoy family
time as well. The objective here is to earn that much profit which gives some level of satisfaction and
the business also gets healthier.
3. Growth
In any business, growth means increase in value or level of output which helps in earning more revenue
and profits. Growth may also mean expansion of operations.
Benefits of growth as an objective:

- Large firms grow at a faster rate so small firms cannot take over and competition remains small or
insignificant.
- A little growth gives more motivation to owners and workers because they see the potential in coming
days.
- Growth leads to economies of scale where more is produced at a lower average cost.
- Growth is one of the factors that attracts new investors to the business.
Limitations of growth as an objective:

- Growth that is too rapid can create managerial issues in terms of labour, finance and production.
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- If sales growth was an objective, then it might come at an expense of lower profit margins because the
business gave too many discounts. Shareholders might not be happy as they will receive lower
dividends.
- Too much growth will lead to diseconomies of scale so a complete expansion of all resources will be
essential.
- Profits which are used to re-invest into the business for other projects will give lower returns to
shareholders.
- Growth which requires diversification may turn the core focus of the company and real aim might get
lost.
4. Increasing market share

Market share means how much of total sales of a particular product belongs to any particular brand or
business. It is calculated by dividing a companies’ sale of a product with the total sales of that product
in the whole market. Many businesses employ a great deal of resources in developing an attractive
marketing mix to increase their market share. Sometimes, the market itself grows at a much larger rate
than the sales rate of the company. In this case, the company will be struggling to keep up.
Benefits of market share as an objective:

- Retailers and wholesalers will be keen on stocking products of that company who has an increasing
market share because increasing market share means customers are demanding more of this
company’s products.
- The business can use this position to dictate terms of profit margin they allow to the retailers and
wholesalers because they are so keen. This results in higher profit margin kept with the business.
- Customers will be confident in buying the products of the market leader because it is at the top. This
leads to more sales and an increasing positive brand image.
- The business may not need to promote the product much heavily now.
5. Survival
Survival means to meet the ends at any possible way. This objective is relative to most small and new
businesses because of higher chances of failure owing to fierce competition. Owners mostly aim to
survive for first couple of years before they increase the scale of operations or introduce any new
product range.
The benefit of this objective is that the business can focus on smaller yet vital details of the business
like product quality, building customer trust and achieve some level of sales. Profits will be carefully
reinvested into the business and the natural efficiency will be main aim to lower down the costs.
Drawbacks may include too much narrow focus on survival that innovation loses its essence. It will
create a more pressurising situation rather than a calmer environment which is much needed for
motivation at work. New products will not be launched and customers might shift to other brands who
were bold enough to take risk despite of being a new business.
6. Corporate Social Responsibility (CSR)

Corporate social responsibility is a company’s initiative to assess and take responsibility for the
company’s effects on environmental and social well-being. This concept states that a company is like
an active citizen of the society and shall not pursue immediate short-term financial benefits at the
severe cost of future utilities. (Also check definition in the book page 43).
This is one of the newest development in business studies and still there is plenty of room for this idea
to grow and take greater shape. Apart from setting up financial objectives, a company must adhere to
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its social and ethical responsibilities because it will be in the company’s interest. The reason being that
due to increased awareness of environmental damage caused by capitalist economies and companies,
many people now disregard waste prone and unethical companies. This leads to adverse publicity.
This notion is now widely supported by many legal regulations put up by many EU countries in which
Sweden leads the way which have recently banned all use of plastic bags entirely. CSR not only includes
ethical considerations in terms of production techniques but also in terms of wages paid to staff, their
working hours, animal testing and their charity contribution.
Having this as one of the main objectives in company will lead to positive publicity and stakeholders
regard the company as “green” or socially responsible. Companies such as Levi’s Strauss, The Body
Shop, Coca-Cola and Nestle have adopted CSR as one of their objectives.
7. Maximising short-term sales revenue

This objectives means increasing the sales revenue (sales price per unit X units sold) to generate
increased flow of cash into the business. It will benefit employees who want to achieve bonus on sales
done but they might need to provide discounts to promote more sales. However, it might lead to over
production due to increased demand and cause temporary diseconomies of scale.
8. Maximizing Shareholder value

Shareholders are investors in public limited companies who have bought shares of the company in
order to receive dividends as a reward for their investment. They are also called as owners because
they have shares in the ownership of the company. Maximizing shareholder value would mean that
they get more dividends. The allocation of dividends is only possible when the company has made
profits. A higher rate of dividend attracts more investors and increase the value of shares they hold so
that they can sell them in stock exchange at a higher premium to earn profit.
The benefit of this objective is that it will create value of shares in the stock exchange market and many
potential investors would be willing to invest in. Companies use this to raise additional finance.
However, this objective to satisfy shareholders might put the interest of other stakeholders at risk and
there will be conflicts between shareholders and stakeholders.
Relationship between mission, objectives, strategy and tactics:
As discussed above as well, corporate aims are designed and comprises of various achievable objectives. These
objectives then direct the business strategies in all concerned departments. These strategies then help in
developing tactics through which the respective strategies will be implemented with success. There is a close
and very relative relationship between these concepts.
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Business strategies are often designed for long-term plans because corporate aims are long-term. Managers
carefully need to understand all the objectives so that they can devise a reasonable business strategy.
For instance, Honda plans to sell 1 million vehicles by the end of 2017. This has become their core aim till 2017
in terms of number of units sold which will give them a certain level of revenue and profit. To achieve this aim,
they will set objectives based on regional level whereby all regional Honda distributors will plan a separate
business strategy to generate a certain level of sales. They will use various marketing tactics and design a
complete marketing strategy. Moreover, the production facility will start to increase its capacity to meet
increased demand for vehicles because promotional campaign will generate demand. Therefore, the setting of
clear and realistic objectives is one of the primary roles of senior management. Before strategy for future action
can be established, objectives are needed.
Stages of Business Decision Making:
There are 7 crucial stages of business decision making which ultimately lead to easier construction of objectives
and aims. These stages are:
- Set Objectives (SMART)

- Asses the problem or situation
- Gather data about the problem and possible solutions
- Consider all open options
- Make the final strategic decision
- Plan and implement the decision
- Review its success against the original objectives. (Refer to figure 4.4 in book page 45)
Why objectives might change over time?
Any business whether big or small cannot continue for a long time with just one aim and objectives. The
objectives might change because the business is exposed to external factors all the time that might force
business to revise their core aims and hence business objectives and respective strategies. The reasons for
change in objectives are:
1. New business usually have ‘survival’ as their main aim at the start. They may quickly come out of that stage and
want to pursue objectives of expansion and profit maximization at later stages in business life.
2. The competitive environment of any business is extremely dynamic and ever changing because the world is moving
at a fast pace. Obtaining finance is becoming easier and new competition can easily beat older businesses by
innovation and technology.
Recession (when the economy collapses) might slow down business activity and survival might become main aim
again which will lead any business to revise its sales strategies and profit ratios.
Moreover, government continuously plays its role in the economy by introducing new regulations and laws. Some
of these laws might favour a firm’s aims and some may force them to dry out.
3. Some short-run objectives complement the long-run objectives. These short-term objectives are temporary so they
can frequently change because success in the long run is one of the crucial aims of any business.
Factors that influence corporate objectives:
As discussed in the chapter so far, corporate objectives differ due to various reasons depending upon size and
nature of the business. Entrepreneurs and managers normally consider the following factors before outlining
their business’s objectives.
a) Corporate Culture:
To any organization, their culture is key to everything. Corporate culture is naturally born in an organization and is
not adopted. It grows from within the business and is unique to every organization. The culture of a business will
include:
- Behaviour and attitude of employees
- Decision-making style
- Leadership style (autocratic, democratic and laissez faire)
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- Organizational structure (hierarchy of control)

- Product type among many more
The culture of the business will define how it does things and what does it stand for. The culture will define how
aggressive or regressive employees are in achieving their objectives.
Abercrombie & Fitch is America’s most popular younger generation clothing brand and it lives by the culture of
modernism and loudness. The brand associates itself with physical fitness and cool looks among youth. Their retail
shops are attractively built to attract youth and they only hire male and female models as sales assistants. The
colour scheme in their clothing is loud and bright. Their marketing campaigns also reflect the business culture of
modernism, youth activism and intimate advertising.
Ralph Lauren, on the other hand is another American clothing brand which produces high end clothing line for
middle aged people who are driven by success and power and keep an extravagant life style. The business also
supports and runs its own charity called as The Ralph Lauren Foundation. The management is driven by the culture
of finesse, diversity and unmatchable quality. The business also aims to be the leader in modern fashion with a
touch to keep its originality and culture.
b) The size and legal form of business:

Smaller businesses like sole traders and medium-sized partnerships focus more on survival and profit satisficing (a
satisfactory level of profit). Their objectives will be determines according to their legal business size. Larger
organizations such as Public Limited companies are run by directors who are professionals and their main aim is
towards increasing their own bonuses and salaries. The larger the growth, the more bonuses they can earn. Hence,
larger businesses will objectify growth and profit maximization at current resources and small business will
objectify survival.
c) Public Sector and Private Sector Business:

Public sector are controlled and owned by the government. Private sector are business that are run and controlled
by private individuals and no government is involved in the decision making process.
Public sector’s main aim and objective is to work for the welfare of people and they do not aim for profit
maximization. Even public sector do charge a fee for let’s say Public Schools but they are there to provide service
for underprivileged where private sector does not pay heed. Public sector base their objectives on the ‘quality of
service’ they provide.
d) Years of operation:
Objectives greatly change according to the life span of the business. A newly formed business will focus on survival
at all costs. Later once the business has established in the market, it can then move towards growth and capturing
new markets.
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Management by Objectives (MBO):
For successful implementation of corporate objectives, they must be translated and broken down into specific
targets for specific divisions, departments and ultimately, the individuals. As discussed earlier that corporate
objectives are for the whole organization therefore, they do not necessarily reflect the objectives of any specific
division of that organization. However, all the divisions will make separate objective that will target the original
aim of the organization.
The divisional objectives differ mainly because:
- Separate sector of market they are operating in

- Different product they are dealing in
- Different country they are dealing in
- Different scope of the business (product development or finance)
Managers ensure that these divisional objectives are co-ordinated between all other divisions of the
organization and they are consistent and worked together. They must also ensure that their respective division
has full set of required resources that will be needed to fulfil the divisional objectives. Once the divisional
objectives have been outlined, they are then streamlined to different departments (departmental objectives)
who then assign smaller tasks to individuals in that department. This whole process is called as management by
objectives.
For MBO to be effective, feedback and recommendations must be taken from key personnel in the organization.
Once the aims and objectives will take shape, the personnel will see their input in those aims and objectives and
will naturally strive hard to see them achieved successfully. This will result in benefits like:
- Employees and managers achieving more

- Employees seeing the overall plan and can make their personal targets
- A feeling of shared responsibility that each workers shall do their part with honesty and accountability
- A better relationship between top managers and low level employees.
Business Ethics and their effect on business objectives and decisions:
The term ethics means a set of moral principles that govern a person’s behaviour while doing a task. In business
terminology, it would mean a business shall following a set of rules and regulations that contain a combination
of moral values of a company’s vision, guidelines and behavioural code towards internal (company itself) and
external aspects (society and environment) of the business.
CSR, which was discussed previously, is the main reason for modern businesses to be more ethically responsible
of their actions. Consumers’ today are also more informative and socially active and they have better knowhow
of environmental and societal damage many businesses do. Consumers now know how to respond and act
against unethical practices so businesses must take caution if they want to taste a moral defeat by the hands of
customers and social pressure groups.
Many business decisions involve some level of moral and ethical dimension to it. Managers must take good care
before making crucial decisions and consider all costs attached to these decisions. Popular ethical and moral
issues include:
- Child labour
- Genetically modified food to cattle to artificially enhance their growth
- Pesticides on crops that contaminate them
- Lower wages in under-developed nations by big corporates and higher salaries to the CEOs.
- False advertising
- Cheaper raw materials to save on costs (Plastic bottles)
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Recently, Apple Inc. faced a bundle of allegations that it uses cheap labour in China for manufacturing its gadgets
and that workers there are working in a miserable conditions. Many pressure groups took this issue to social
media platforms like Facebook where pictures and videos demonstrated the conditions of Apple workers. The
top management of Apple responded to these allegations by immediately checking their production facilities
and lifting contracts from some manufacturers.
Alternatively, Samsung mobile was accused of infringing (copying) the design and electronics patents of Apple
iPhone. This is again an unethical move my Samsung to copy someone else’s work. The US court of Patents and
Copyrights later gave the verdict in the favour of Apple Inc. that Samsung will pay the penalty.
Benefits of establishing and practicing ethical codes:
- Negative word-of-mouth can be avoided if company goes to court for violating ethical codes.
- Loss of customer loyalty and future building of customer base can be avoided if the company follows
ethical codes.
- Ethical business attract ethical customers so businesses get external support and customers base
increases.
- Likeliness of achieving government contracts.
- Skilled, motivated and well-qualified workers want to work for the company.
Drawbacks of establishing and practicing ethical codes:
- Ethical practices can prove costly for example organic supplier will supply raw material to the food
processor at a higher price.
- Paying fair wages will increase labour costs if minimum wage in a country is higher. This will reduce
profitability.
- Competitors might win if they are not following ethical codes.
- True advertising might bring about the ‘real image’ of the company.
- Not taking bribes to secure business contracts can mean failing to secure significant sales.
Communicating Objectives:
Mission statements and annual published reports are often considered as a good method to communicate with
external stakeholders of the business. However, communicating the objectives of the business with internal
stakeholders such as employees is very crucial. If employees are unaware of the objectives than how can the
business expect them to achieve them?
Benefits of effectively communicating objectives with employees:
• Employees and managers have a greater understanding of both individual and company-wide goals.
• Employees understand the overall plan and how their individual goals fit into the company’s business
objectives.
• Employees share responsibility for targets and objectives by interlinking their goals with those of others in the
company.
• Managers stay in touch with employees’ progress more easily, as regular monitoring of employees’ work allows
for praise or training to keep performance and deadlines on track.
Research Task
 Investigate and explain the mission statement and objectives of your favourite brand.
 Examine how useful their mission statement is to groups within the business e.g. managers, workers
and stakeholders.
 Examine the likely importance of the organization’s objectives to its future success.
 Do you think your brand is ethically responsible and is following CSR? Discuss.
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Chapter 5: Stakeholders in a Business

Introduction:
One of the most traditional concept kept by all businesses is the ‘shareholder concept’. This concept states that
the shareholders are the real owners of the company and the directors and managers of the company shall
always strive to increase the shareholder value by earning more profits.
Recently, the shareholder concept has taken a new dimension in which the interests of suppliers, employees
and customers are also taken into consideration. This new dimension is known as the ‘stakeholder concept’
which states that there are many other parties involved and interested in business activity. These parties consist
of governments, local communities, pressure groups, trade unions and environmentalists among many other.
Thus, stakeholders can be defined as people or groups of people who can be affected by and who have interests
in the decisions of a business.
Types of Stakeholders:
There are numerous types of internal and external stakeholders involved with a business:
1. Consumers (who pay the price of our product to buy it)

2. Suppliers (who supply us with raw materials and services)
3. Employees and their families (include basic labour force, managers, guards, electricians etc.)
4. Local Communities (schools, universities, social clubs)
5. Government and agencies (local government and council agencies )
6. Pressure groups (environmentalists, scientists, philosophers, writers, journalists)
7. Lenders (banks, investors, creditors)
Impact of business activities on Stakeholders:
The following table shows the impact of some typical decisions taken by the business and its impact in
stakeholders.
Business Decision Impact on Employees Impact on community Impact on customers

- More job and career - More jobs for local - Better service provided by bigger
opportunities. residents and increased business with more staff
- Disruption during building spending in other local - Larger business could be less
Expansion by building a new head
and more complex lines of businesses persona and therefore offer inferior
office
communication after - Disruption caused by customer service.
expansion. increased traffic and loss of
green fields.
- The lager business may be - If the business expands on - The larger may benefit from
more secure and offer the existing site, local job economies of scale which could
career promotion vacancies and incomes lead to lower prices.
opportunities. might increase. - Reduced competition could have
Takeover of a competing firm
- Rationalisation may occur - Rationalization of the opposite effect (less customer
(horizontal integration)
to cut costs and jobs may duplicate offices or choice might result in higher
be lost factories might lead to prices).
some closures and job
losses.
- Training and promotion - Local business providing - More efficient and flexible
opportunities might be IT services could benefit production methods might improve
offered. from increased orders. quality and offer variety.
Automation of Processes and
- Fewer untrained staff will - Specialist workers may - IT reliability problems could cause
installation of IT equipment
be required and those not be available locally so supply delays.
unable to learn new skills more commuting by staff in
may be made redundant. cars might be necessary.
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Stakeholder – Their roles, rights and responsibilities:
The following table gives an insight on to the roles of various stakeholders which they play in a business
activity, what are their rights that must be fulfilled by the business and what are responsibilities of these
stakeholders towards the business activity.
Stakeholder Roles Rights Responsibilities

- to be honest
- Purchase goods and - To receive goods and
- to pay for the goods and services
services services that meet local
bought when requested
Customers - Provide revenue from sale laws regarding health and
- not to steal
which allows the business safety, design,
- not to make false claims about
to function and expand performance and so on.
poor service or failed items
- To be paid on time as
agreed between the two
parties - to supply goods and services
- Supply goods and services - To be treated fairly by the ordered by the business in the
Suppliers to allow the business to purchasing business e.g. time and condition as laid down by
start production not to have lower prices the purchase contract or
forced on them by much agreement
powerful customer
business
- to be treated within the
minimum limits as - to be honest
- provide manual and other established by national - to meet the conditions and
labour services to the laws e.g. national minimum requirements of the employment
business, in accordance wage contract
Employees with employment contract, - to be treated and paid in - to cooperate with the
to allow goods and services the ways described in the management in all reasonable
to be provided to employment contract requests
customers - to be allowed to join a - to observe the ethical code of
trade union for protection conduct
of their rights
- to be consulted about
- to cooperate with the business,
major changes that might
where reasonable to do so, on
- provide local services and affect the community e.g.
expansion and other plans
infrastructure to the expansion plans, changing
- To meet reasonable requests
Local community business to allow it to methods of production
from business for local purposes
operate, produce and sell - not to disrupt the
such as public transport (e.g. to
within legal limits community lifestyle and
allow staff to get to work) and
living standards by business
waste disposal.
activity
- pass laws that restrain
- to treat businesses equally under
many aspects of business
the law
activity - businesses have the duty
- to prevent unfair competition
- provide law and order to to government to meet all
that could damage business
Government allow legal business activity legal constraints, such as
survival chances
to take place producing only legal goods
- to establish good trading links
- achieve economic stability and to pay taxes on time
with other countries to allow
to encourage business
international trade
activity
- provide finance to the - to be repaid on the
- provide agreed amount of
business in different forms agreed date
Lenders finance on agreed date for the
- To allow them enough time - To be paid the finance
for repayment of loans. agreed time period
charges (interests) on time.
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Responsibilities of business towards Stakeholders and its Impact on the Business Activity:
1. Responsibility to Customers:
A business must fulfil the demands of the customers if it wants to stay in the market for long-run. With
increased trade and globalization, there is increased competition and customers have now choice.
 Deliver best quality goods that are possible to make with existing resources and research.
 Not to offer false claims about the product’s durability, quality and features in advertising.
 Prices shall be reasonable and not exploitable.
 Products shall perform as intended.
 Not to break the law of consumer protection.
 Offer refunds and claims if that is the company’s policy.
 Not to use high-pressure selling tactics that customers end up making unwanted purchase.
Benefits:
- Good publicity by positive word of mouth.

- Repeat purchases and a stronger customer base.
- Customer loyalty
- Better customer feedback
2. Responsibilities to Suppliers:
Suppliers shall be carefully selected in terms of their quality and delivery times of raw materials. A
company’s good will as good as its supplier.
 The purchasing business shall pay the due amount promptly and within prescribed time.
 Place regular orders with the same old supplier so that they are financially supported.
 Offer long-term contracts for security of business deals.
Benefits:
- Supplier will always be willing to supply and can allow extra credit time if good relations are developed.
- Supplier will take caution in sending best quality materials.
- Spread good words about the business.
3. Responsibilities to Employees:
Employees are the back bone of the business and their satisfaction and care of need is essential for
smoother business running and better productivity. To support the employees, many countries have
also passed laws for employee protection.
 Provide training opportunities for their personal growth and skill development.
 Give them job security by signing job contracts.
 If minimum wage is very low, pay them higher wages so that they can meet their essential needs easily.
 Offering good and acceptable working conditions.
 Involve them in decision making so that they do not feel alienated.
Benefits:
- Maintaining a high level of employee loyalty who stay with the business for a long period of time and
contribute in its growth.
- Low labour absenteeism.
- Good word of mouth from existing employees which can attract more qualified and loyal staff from other
businesses.
- Employees can give best suggestion to improve production methods, product quality and efficiency
because they are directly involved in the production.
- Improved motivation among workers.
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4. Responsibilities to Local Community:

Local community which surrounds the businesses plays an important part in business decision making
when it comes to expansion plans. These local communities can include commercial areas, markets,
social clubs, small government organizations, public sector offices, housing societies and many other.
 Keep the adverse environmental impact of business to the minimal level.
 Offer plenty job opportunities for local community to grow financially.
 Offer secure employment so that there is no fear of job losses.
 Support other local businesses for increased community feel.
 Reduce the transportation impact caused by business activity like congestion and pollution.
Benefits:
- Local councils will happily give permissions for expansion.

- Local communities can ignore some adverse effects caused by the business provided it is giving much
more to the society in return such as sponsored public events, public parks, and hospitals or play grounds.
- More chances of local contracts being granted that will immensely help business to grow.
5. Responsibilities to Government:
Nearly every business is governed and regulated by laws implemented by the government. These
regulations are in place to ensure safety for all including customers, producers, suppliers and pressure
groups. Governments encourage businesses to grow because it will stimulate the economy and help
alleviate poverty at national scale putting less pressure on the government.
 Businesses shall pay taxes on time.
 Public limited companies shall provide all the final accounts.
 Provide necessary statistical data to the government for its analysis purposes of GDP growth.
 Try to seek export markets rather than increasing imports because exports appreciates the currency and
Balance of Payments will improve.
Benefits:
- Governments will permit the business to go ahead with expansion plans.

- Likeliness of business receiving long-term government contracts which will ensure continuous stream of
revenues.
- Subsidies will be provided by the government which can be used to reduce costs and increase profit
margin.
- Licences of sensitive products such as pesticides, arms, energy sector and food items can be granted to
those businesses that adhere to government rules and regulations.
- Government might invest.
Corporate Social Responsibility Evaluation:
The concept of CSR is relevant here because the chapter deals with the roles and rights of stakeholders. CSR in
its true essence also states that apart from the business itself, it shall work towards betterment of the society
and act as a citizen.
However, there is a mixture of thoughts concerning with if CSR shall be made an integral part of the business.
One school of thought supports the integration of CSR into business activities. The supporters say that CSR can:
- Help to achieve the triple bottom line approach in which economic, social and environmental aspects of
business activities are analysed in conjunction and improved.
- Help to target the best minds from the job market whereby newer graduates seek to apply to those firms
that are CSR pro-active.
- Help to generate a unique form of brand loyalty among customers by applying a set of unique ethical
values in its operations and products. In return, the businesses get public support and social
contributions.
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- Help to avoid severe scrutiny by pressure groups in terms of workers’ safety, product ingredients and
waste management.
- Help to attract better and environmentally friendly suppliers who also want to associate with CSR. This
helps to reduce down the waste by all means and in all sectors of production.
Critics of CSR think otherwise. They are of the view that CSR drives away the focus of a firm from efficiently using
its resources and putting effort in an immeasurable and useless task. By spending money on CSR projects, it is
suggested that businesses have less to invest for expansion and less to pay out to owners, who took the risk to
originally invest in them. The critics say that CSR:
- Is used as a public stunt to make unverified claims to attract customers and satisfy the stakeholders. In
reality, the business operations are found to be exploiting these claims.
- Implementation can be very expensive and might reduce profits. Hiring/buying newer machinery or
buying good quality raw material might prove to be expensive.
- Is a relatively newer term and not many consumers really care about ethical aspects of the businesses as
long as they are getting what they ask for.
If businesses think rationally and economically, they are more likely to follow CSR objectives as long as they do
not hinder the shareholder objectives. However, over the last decade the businesses community of the world
has seen exponential rise in awareness of ethical consumerism which can be linked to CSR. Consumers are
becoming more and more aware of the environmental and social implications of their day-to-day consumption
decisions and in some cases make purchasing decisions related to their environmental and ethical concerns.
Over a long period of time, the marketing, public relations and employee motivation benefits of CSR policies
might pay for themselves and generate higher profits.
Conflicts arising from different Stakeholder objectives:
Many business objectives complement each other and are acceptable to a broad range of stakeholders. For
example, an objective for a business start-up of achieving survival would be supported by nearly all the
stakeholders. It is in no-one’s interest for a business to fail. However, once a business becomes better
established and larger, then potential conflicts begin to arise. Consider these two examples in a little detail:
Business expansion versus higher short-term profit:
An objective of increasing the size and scale of a business might be supported by managers, employees, suppliers
and the local community – largely for the extra jobs and sales that expansion would bring.
However, an expansion is often associated with increased costs in the short-term (e.g. extra marketing spending,
new locations opened, more production capacity added). This might result in lower overall profits in the short-
term, which may cause conflict with the business shareholders or owners. In the longer-term, however, most
business owners would be pleased to support an expansion if it increases the overall value of the business.
Job losses versus keeping jobs:
This has been a big issue for many businesses during the economic downturn in 2008-2010. In order to reduce
costs and conserve cash, business managers have often made redundancies amongst the workforce or
introduced other measures like short-time working to reduce wage costs. This will have been supported by
business owners and managers. However, it creates a potential conflict with stakeholders such as employees
(who are directly affected), the local community (affected by local job losses) and suppliers (who suffer from a
reduction in business). Here are some other potential causes of conflicts between stakeholders:
• “Short-term” thinking by managers may discourage important long-term investment in the business
• New developments in the business such as a major product launch or new factory may require extra finance to be raised,
47
which reduces the control of existing investors

• Investing in new machinery to achieve better efficiency may result in job losses
• Extending products into mass markets may result in lower quality standards
Clearly, the senior management must establish its priorities in these situations. They must try to prioritize which
are the most important stakeholders and what will be the cost attached in meeting the needs of stakeholders.
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Chapter 6: Human Resource Management

Introduction:
Human Resource Management is the outcome of motivational theories which we discussed in previous chapter.
Many theorists such as Maslow, Herzberg and Mayo pondered upon the need of employee management in an
effective way so that they are motivated and give benefit to the organization. Many managers take good care
of their assigned resources such as machinery, land, raw materials and offices. Managers tend to ignore the
most important resource which a company employs and that is the human capital.
To cater this issue, Human Resource Management departments have been made an integral part of business
strategies so that best form of human resource is kept within the business or existing workers can be trained in
the best way.
Human resource management can be defined as the strategic approach to the effective management of an
organizations’ workers so that they help the business gain a competitive advantage. The HRM aims to recruit
capable, flexible and committed people, managing their performance and developing their key skills to the
benefit of the organization.
Purpose and Role:
Traditional personnel departments that used to exist in many organizations had a limited scope related to the
workforce. These personnel departments were only responsible for recruitment, training, discipline and welfare
of staff. They tended to be:
- Bureaucratic (rigid) in their approach which led to inflexibility towards employees’ issues.
- focused on recruitment and ignored training and development
- Controlled all of the human resource themselves without allowing any control to other departments’
managers.
- Not represented at AGMs and non-participating in strategic management teams when crucial decisions
were made.
As compared to this, HRM department has a much broader scope and purpose. It focuses on:
 Planning the workforce needs of the business that how much staff is required
 Recruiting and selecting appropriate staff for the right jobs
 Appraising (evaluating), training and developing staff
 Preparing contracts of employment for all staff for job security and job description.
 Involving all managers in the development of their staff for uniformity in human resource
 Improving staff morale and welfare to trigger motivation through guidance and advice
 Developing appropriate payment systems with employee’s input
 Measuring and monitoring staff performance by evaluating their targets and goals
Planning the workforce needs of the business – strategic workforce planning:
Workforce planning is defined as analyzing and forecasting the workers and the skills of those workers that will
be required by the organization to achieve its objectives. It’s important to calculate the future staffing needs of
the business. Failure to do this can lead to too few or too many staff with the wrong skills. HR must work in close
coordination with the corporate plan of the business so that employees do not deviate from the main targets.
HRM department must also coordinate with other departments and ask them about their staffing needs.
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Steps in workforce planning
There are three steps in workforce planning.
1. Workforce audit
A check on the skills and qualifications of all existing workers/managers. This helps the HRM
department to find out any deficiency in staff and makes planning for future staff easier. For existing
staff, any deficiencies can be worked upon to improve on performance and quantity of employees
needed.
2. The number of staff required in the future (depends on)

Forecast demand for the firm’s product- Influenced by market and external conditions such as seasonal
factors (season-in or season-out), competitors’ actions, trends in consumers’ tastes and etc.
The productivity levels of staff- If productivity is forecasted to increase then fewer staff will be needed
because more is being produced from fewer inputs.
Objectives of the business- Expansion plans? Increase customer service levels? New products range?
Automation or labor-intensive work?
Changes in the law regarding workers’ rights- Government passes laws that establish a shorter
maximum working week and minimum wage level. Working weeks directly affect the availability of
labour hours in a week. Minimum wage levels directly affects the profitability of the business so in order
to decrease costs, less staff may be wanted in future plans.
The labor turnover and absenteeism rate- the higher the rate at which staff leaves the business
(turnover), the greater will be the firms need to recruit replacement staff which proves very costly and
time consuming. The higher the absenteeism, the greater will be the firms’ needs for higher staffing
levels to fill up the gaps.
3. The skills of the staff required

Pace of technological change- Newer production methods are introduced all over the world every now
and then. This requires constant need for the staff and labour to be trained and well equipped with
latest knowledge about machines and computer equipment. The universal application of IT has meant
that traditional typists are now rarely required- skilled IT operators are more in demand now.
The need for flexible or multi skilled staff- Businesses try to avoid excessive specialization because it
discourages an overall skill level and focuses on just one or a couple of aspects of job. Most businesses
need to recruit staff or train them with more than one skill that can be applied in a variety of ways. This
gives them more adaptability to changing market conditions.
Recruiting and selecting staff:
Recruitment is a process of:
 Identifying the need for a new employee

 Defining the job to be filled
 The type of person needed to fill it
 Attracting suitable candidates for the job.
After the process of recruitment is finished and the company has a list of suitable employees to hire, the process
if selection begins. Selection is a process of:
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 Interviewing the short-listed candidates

 Written tests such as IQ and EQ
The process of recruitment and selection is often considered in conjunction and they are necessary when the
organization is looking forward to expand which obviously requires more human resource and when employees
leave the company and need urgent replacement. The process of recruitment and selection is a lengthy one and
involves several crucial steps which are discussed below:
Methods of recruitment and selection:
 Drawing up a job description

A job description is a detailed list of the key features about the job. All important tasks and
responsibilities are stated in it. Its advantage will be that right people will apply for the job. It includes:
- Job title
- Details of the tasks to be performed
- Responsibilities involved
- Place in the hierarchical structure
- working conditions
- How the job will be assessed and performance measured
 Drawing up a person specification

This is an internal task of the HR department in which they make a benchmark personality for the
vacancy. This ‘person profile’ will ease the selection process by eliminating applicants who do not match
or come closer to the benchmark.
 Preparing a job advertisement

Job advertisements can be given in newspapers, relevant magazines (e.g. a chef’s job posted in food
magazine), TV, social media platforms, job centres or career websites (www.rozee.pk). These job
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advertisements must include job description. In case of internal recruitment, jobs can be displayed on
main business halls or meeting points. Online applications are much more popular due to lesser paper
work (see book page number 161 for benefits of internal and external recruitment).
 Shortlisting
Once job advertisements have been published and applications have been received, the process of
selection starts. Shortlisting means to select a few among many who fulfil the person specification and
job description criteria. The method of shortlisting involves intelligence and emotional tests and
candidates who pass them are called for interviews.
 Interviewing
Interviews are the most common and effective form of selection. It is a face-to-face question and
answer session with top management including the HR manager and possibly a psychologist (if a higher
post vacancy). Businesses situations are put forward where candidates’ answers give an idea to the
selectors about their intelligence level and confidence level. Their physical appearance is checked and
their life achievements are discussed.
Other forms of selection methods include CV (curriculum vitae), references from previous employers,
application forms given by company and assessment centres (job centres).
Internal and External Recruitment:
If the selected candidate already works for the organisation, this is referred to as internal recruitment. External
recruitment is when the successful applicant does not currently work for the business. Internal recruitment and
external recruitment have different advantages.
Employment contracts:
The employment contract is a legally binding document between the employer and employee that sets out all
terms and conditions related to the job. The contents of these contracts must be ethically fair and according to
the government regulations. A typical contract will contain following features:
- Employee’s responsibilities
- Nature of contract; permanent job or temporary
- Amount of working hours and respective wage or salary packages
- Payment dates and payment methods
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- leave schedules including holidays and penalties

- Perks to be given and under what conditions
- Job leaving notice (which is usually 2 months) from both sides.
These employment contracts are a form of protection for employees and employers. They eliminate
the chances of unfair dismissal, poor worker performance, legal complications in case of court hearings
against workplace harassments and they offer job security on top of everything.
Labour turnover:
Labour turnover is calculated as:
Number of employees leaving in 1 year X 100

Average number of people employed
It is the rate at which employees leave the company. Labour turnover is most common in low unemployment
areas because of availability of better jobs there. Costs related to labour turnover can be troublesome for the
company has new recruits will take time to understand the dynamics (culture, ethics, methods, hierarchy) of the
business. Companies that have a high labour turnover usually show signs of discontent among workers who have
low morale or it can indicate wrong recruitment by the HR department at the beginning.
Training and development of labour:
In business terminology, it involves educating the workers regarding tasks to be performed in order to increase
their skills, process and product knowledge and efficiency. No matter whether the recruitment was internal or
external, employees at new posts are always trained for better performance. Training further gives confidence
to the worker.
There are different types of training:
1. Induction training:
Induction is a process whereby all the new selected recruits are invited to a meeting where they are
given a complete guideline about the company’s introduction, work ethics, company policies, and
security measures, responsibilities towards work and staff members, singing-in and signing-out
procedures, premises and work floor guidelines, product knowledge, breaking the ice sessions,
emergency safety guidelines and few video tutorials. These help the recruits to understand the job
descriptions before they formally start the job.
2. On-the-job training:
This is a training which is given inside the business premises or on the work floor alongside other
workers who are not new. These trainings are conducted by departmental managers or line managers
who carry out tasks in front of the new recruits and delegate smaller tasks to them. This training is
cheaper as compared to off-the-job training.
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3. Off-the-job training:
This is a training given outside the work premises in which specialist training institutes train the new
recruits. These training centres can be set up by the firm itself or by computer manufacturers who
introduce new machines and software. These trainings can be expensive and paid by the employer in
most cases.
Evaluation of training:
Training has always proven to be advantageous for the firm and for the personal growth of the workers. No
doubt it is expensive but the long-term benefits of this surpasses the short-term costs. Employees may find
better paid jobs if they are well trained. They can perform the work well with less time. However, workers may
leave a job for a better paid one after getting training from a particular firm over few years. This is called as
poaching and it is considered one of the major drawbacks of training.
Generally speaking, training will bring collective benefit for the organization because untrained staff will be less
productive and cannot bring innovation and improvement at workplace. They will be demotivated and accidents
are workplace can occur. The notion of staff training and development is also supported by Maslow’s hierarchy
of needs and Herzberg’s two factor theory because training can give a sense of achievement when the task is
done well. This brings motivation in employees.
Employee appraisal:
It is the process of assessing the effectiveness of an employee against pre-set objectives. In this, the HR
department develops a career plan for its workers which ultimately becomes an individual’s aim of working in
an organization. This career plan is in line with firm’s aims and objectives.
On the basis of this career plan, the HR department analysis and measures the performance of its workers with
the benchmark values and figures. The system of appraisal shall be continuous and employees shall be well
informed on the methods and criteria that they will be appraised upon. At the end of the year, the HR
departments and the functional department will give appraisal reports to the employees for their feedback and
opinions.
The concept of appraisal and development are key features of Herzberg’s theory as well.
Dismissal vs Redundancy:
In both concepts, an employee(s) has to leave the job. Dismissal means that an employee is being sacked (fired)
from the job after violation of terms and condition of the employment contract.
Dismissal is a serious for both; the employer and employee. The employee’s financial reward is withdrawn on
immediate basis and he/she also loses social circle which was developed when he/she was part of the company.
Whenever a company dismisses an employee, it must make sure that it was in accordance to rules and
regulations of the employment contract and code of conduct at work. Unfair dismissal may lead to legal
formalities against the firm if the employee sacks the company on valid grounds with proofs.
Dismissal can happen and will be legal when following situations happen repeatedly:
 Inability to do the job even after sufficient training and guidance

 Continuous negative attitude at work which has also affected performance of other employees
 Violating the health and safety procedures which can jeopardize the safety of workers
 Deliberately damaging business premises.
 Harassment and bullying of other employees
 Portraying false image of the company outside
 Leakages sensitive information such as raw materials and ingredients
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There are certain instances when the dismissal can be regarded as unfair. These include:
 Pregnancy
 Discrimination on the basis of skin colour, gender, religion or nationality.
 Being a member of trade unions
 A non-relevant criminal record which will not directly affect the worker’s performance or the safety of
other employees. If the conviction was central to the job specification such as an accountant convicted
of fraudulent handling of accounts, then he/she may be dismissed if the employer comes to know about
this.
Employees are often involved in certain misconducts at the workplace. The employer shall never be too quick
to dismiss an employee. There should be several warnings (verbal and written) so that the employee can know
what it might lead to if he/she does not stop. However, several misconducts such as sexual harassments, stealing
or frauds can lead to immediate dismissal without any notice or warnings.
Unfair dismissal can prove very costly to the employer if they are proven guilty in the employment tribunal. In
such cases, the employer will be asked to pay heavy sums of money to the employee in compensation for his/her
lost job and social status and emotional damage. The employer will obviously not take them back nor does the
law says so because it will not just work the same old way. That’s why they are asked to pay the penalties in
terms of money and restoration of pride of the worker.
Redundancy:
It is the downsizing of the workforce when their skills or services are no longer required and they become
unnecessary for the firm. It is important to note that redundancies don’t happen because of employee’s violation
of code of conduct. Redundancies can happen due to reasons such as:
- Fall in demand for the firm’s product leading to smaller scale of production.
- Automation of production space.
- Newer technology that replaces workers with machines or computers.
- To save costs to remain competitive otherwise the whole firm can shut down due to losses.
Redundancies can prove very damaging for the employees. In USA during the great recession of 2008, thousands
of workers were made redundant due to prolonged and unavoidable losses to the financial sector. Redundancies
at large scale can invite pressure groups and other stakeholders to portray negative image of the firm. In most
real life instances, experienced and old workers with many years of services are not made redundant.
Employee morale and welfare:
Motivated workers are bound to outperform those who are disengaged and less efficient. It is because morale
of motivated workers is high and they do not miss the workdays which can cost the employer thousands of
dollars in lost productivity.
Developing and maintaining good morale in the workplace starts with the step of workforce planning. Right
people must be placed at the right jobs with proper training. It is the morale of the employees which will decide
how long they plan to stay in the organization. Much of the mood of the organization depends on the mood of
the manager. There are certain ways by which a manager can keep the morale of his employees high and make
them feel that he and the company are concerned for their welfare.
1. Understand the role they are given through proper training, development and appraisal. By this
employees will feel connected to the organization.
2. Manager can keep morale high with his own example by keeping a good and reachable character.
3. Organization’s culture shall be standardized and employee friendly. Senior managers must ensure that
their subordinates are look upon with care.
4. Consultation of employees is necessary before making crucial decisions.
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5. Managers shall visit workers’ rest areas to see if it is clean and meet the hygiene standards.
6. Acknowledgement and encouragement of staff when a target is met.
7. Respect all team member and show care by responding to their problems and concerns.
Overall, if senior management works towards welfare and morale of its workforce it will definitely
create loyalty among workers who will stay for long-term with the organization.
Work-life balance:
Work-life balance means an employee is able to give required time to the work as well as spend enough time
with family or to pursue other interests. For the welfare of the workforce, a work-life balance must prevail and
HR department must understand its value.
In recent years the pressure on the general working population to increase productivity has increased primarily
due to following reasons:
- Consumer expectation of availability of goods 24/7.

- Matching business needs with the way employees work.
- Increased globalization which has pushed competition at all levels.
Last year, Apple was a target of many trade unions and pressure groups who accused the company’s Chinese
production facility of making the labourers work extra hours way beyond the standard working hours. This led
to poor health and increased stress levels and also some severe legal complications.
With increased awareness of labour laws and activeness of human rights organizations, many HR departments
have introduced several methods which can allow employees to take control of their working lives and take time
for leisure with family and friends.
- Flexible working hours especially for students.

- Teleworking which is when employees work from home. Mostly related with IT related jobs.
- Job sharing whereby two workers can share the working hours. Though, both workers will receive equal
share of the total pay.
- Sabbatical (time-off) leave in the case of maternity periods, illness, domestic issues such as divorce.
Employees may not get pay during this leave but they are guaranteed the job after the leave period
expires and they re-join.
Policies for diversity and equality:
Diversity: Diversity policy means that an organization has an intention to employ a mixed workforce which
involves hiring employees from all sorts of religious, racial and national and gender backgrounds. In an
organization, people come and work from all walks of life so natural differences in terms of conscience, culture,
work ethics and language are bound to materialize. These differences shall be accepted by an organization
because diversity also brings useful variation in the workforce. Many mature and developed organizations put
immense value to diversification in the workforce during induction trainings of new employees.
One benefit of workplace diversification is that it increases the workforce base from which an organization can
select workers from. They are most likely to hire the best from a bigger base. Workers from different
backgrounds will approach problems in a rather untraditional but still a quicker and more effective way. Workers
who have a different mother tongue will help the firm to sell its products in international markets.
Equality: Equality policy is a practice in which everyone in an organization is treated fairly and is given equal
chance of growth and personal development so that an employee can reach his/her full potential. These equality
policies are mentioned in the job descriptions and also in the employment contract. The countries in EU have
strict laws that govern equality issues and they promote equality by not basing their recruitment and dismissal
decisions on a worker’s race, sexuality, gender, age, religion or nationality.
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Advantages of promoting equality at workplace includes creating an ideal environment which boosts employee
morale. Companies that support equality get good brand image and reputation and they will receive applicants
who are top talents.
Employee development to encourage Intrapreneurship:
Many business such as notable accountancy firms including Deloitte, KPMG and PwC offer their employees
discounted MBA programmes alongside their jobs to enhance their skills and intrapreneurship abilities. Most
employees can demonstrate intrapreneurship if they are:
• Encouraged to be independent thinkers and creative.

• Given opportunities to mix and work with other skilled employees from different departments.
• Empowered with the authority and resources they need to introduce innovations.
• Assured that some failure is expected and acceptable. Removing the ‘don’t fail’ ethos is important -
Intrapreneurs are meant to take risks and some of their ideas will not work!
• Encouraged to start with small ideas and innovations – before moving on to the bigger issues.
Conflict between Management and Workforce:
In any business, there are likely to be conflicts between workers and managers. Managers would want to keep
costs down especially wage costs because they make a significant proportion of the total costs. Workers on the
other hand would try to work lesser hours but with a higher demand for wage rate. Clearly, there is a conflict
between objectives of both parties.
These conflicts are inevitable but can be resolved or their effect can be minimised. In very broad terms, there
are three approaches that may be adopted by management and labour to deal with conflict situations. Much
will depend on the culture and legal structure of the country the company operates in as well as the culture of
the business itself.
Collective Bargaining:
Collective bargaining can be defined as the collective negotiation of the wages and work conditions by trade
unions with national employers for the whole industry. This is likely to result in mutual benefit of both parties.
In case collective bargaining fails, it can halt the whole industrial process. The recent example can be of strike
action by oil tankers association of Pakistan who did not comply with government safety rules as they were
perceived as unrealistic and expensive.
Evaluation: It is observed that collective bargaining is done at a larger scale whereby major employers and
stronger trade unions sit together and talk. Therefore, national agreements may not always be equally beneficial
for smaller businesses.
If negotiations in collective bargaining prove useless, this may give a negative vibe among investors who then
may not be very interested in investing anymore in that particular sector.
Trade Unions and their Role in HRM:
By definition, trade union is an organization of working people with the objective of improving the pay and
working conditions of their members and providing them with support and legal services. Companies around
the world are continuously trying to reduce their costs of production and in this effort, they mainly focus in
keeping a low number of labour units. The application of technology into business activities has also lead to mass
redundancies leaving workers without work and job security. Trade unions, therefore, help workers to get
employers agree on level terms regarding many important aspects with respect to employees. Reasons for a
worker joining trade union can be:
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 Unions put pressure on employers that all legal requirements of the job are met such as health and
safety standards, minimum wage rates and proper training to use heavy machinery.
 In case of unfair dismissal or poor conditions of work, a workers can get full support from union to take
employers to court for legal action.
 Through collective bargaining, whereby unions negotiates on behalf of all workers in an industry, the
union is in a much stronger position to get on with its terms. Therefore, union is a sort of ‘power through
solidarity’ and that is the reason it forms the basis of union’s strength.
 Unions perform industrial actions which are far more effective and consequential rather than an individual
going on a strike.
Union Recognition and Collective Bargaining:
In some countries, it is not a legal requirement for businesses to recognize trade unions for collective bargaining
and they rather prefer to negotiate with individual on their own terms. Despite of this, many countries have
made laws that make it necessary for businesses to recognize unions because it can give them several benefits
such as:
 Employers would be able to negotiate with one officer from the union rather than listening to
individuals one after the other. This method also removes any misunderstanding that one employee
may have got a better salary deal than the other.
 Union recognition by business may also help in establishing two-way communication channel in a more
official way which will be naturally taken more seriously.
 Unions can impose discipline on members who plan to take hasty industrial action that could disrupt a
business.
 Responsible unionism give employers more trust on their workers and they can discuss issues more
freely with them. This often leads to increased productivity levels and in turn, rising profit levels.
Employees/Trade Unions and Employers – What action can they take?
Trade Unions:
Unions can use a number of tactics to encourage employers to accept their demands. These are:
i. Negotiations: Formal meetings whereby senior representatives from both parties get involve.
ii. Go Slow: It is a form of industrial action in which workers keep working but at the minimum pace
as demanded by their contract of employment.
iii. Work to Rule: In this, employees refuse to undertake any type of work outside their employment
contract such as overtime.
iv. Strike Action: This is the most extreme form of action in which employees totally withdraw their
labour for a period of time. Production halts immediately and the business can shut down.
v. Overtime bans: Workers refuse to work more than the contracted number of hours each week.
During busy periods, this action can delay production and business will face unhappy customers.
Employers:
Methods employers can use to influence an industrial dispute include:
i. Negotiations: If face to face meetings fail to reach an agreement then (arbitration) mediation may
be required.
ii. Public relations: Media channels can be used to achieve public support for employer’s position in
the dispute. Unions can be pressurized.
iii. Threats of redundancies: This may work if the union’s position is weak. If the union is strong then
it can portray employer as a bully leading to poor publicity.
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iv. Changes of Contract: If employees are taking advantage of their employment contracts to work to
rule or ban overtime then new contracts could be issued after expiry of old ones which insist on
higher work rates or some overtime working.
v. Closure: Closure is the last resort for the employer which will definitely end all forms of contracts
with the employees. Usually businesses decide to close down if the demands of the unions are
proving to be loss making for the business and therefore, continuation is not possible.
vi. Lock-outs: Short-term closure of the business or factory to prevent employees from working, and
being paid. Some workers who are not keen on losing pay for long periods may put pressure on
their union leaders to agree to a reasonable settlement of the dispute.
Evaluation of Employer Power vs Union Power:
Employers will find themselves more powerful when:
 Unemployment rate is high. Workers will find it difficult to get jobs.

 If actions by employer such as lock-out of closure can have immediate and serious consequences on
workers standard of living.
 There is public support for employer as unions’ demand are unrealistic.
 Profits are low and threats of closure are taken seriously.
 The employer is thinking to completely relocate to a much cheaper location within the country or in
another country.
Unions will find themselves more powerful when:
 The number of workers belonging to the union are a lot.

 When there is mutual understanding between workers and unions on industrial actions such as strikes.
 When the business is operating on full capacity and can afford to pay higher wages because productivity
is high.
 Unions know that industrial actions will cause employer serious trouble especially during season-in.
 Inflation is high and wage rates do not match the increment in inflation.
 Labour costs are a low proportion of total costs.
 There is public support for the union especially if the business is notorious monopoly.
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Chapter 7: Management and Leadership

Introduction:
In textual terms, the precise definition of management cannot be truly defined majorly because of variation in
nature of the businesses, variation in aims and objectives, nature of product, leadership styles, industrial sector
and scale of operations. However, by looking at the operations of any business we can simply say whether it is
well managed or poorly managed. If a business is achieving its aims and objectives, we can assume that it is well
managed. If the employees are happy, we can say the business is well managed. If the firm is making profits, we
can say it is well managed.
On the contrary, a poorly managed business will have signs like lack of motivation among office and production
staff, less innovation, customer dissatisfaction and employee turnover.
This chapter will contain all the relevant information about the functions of management, leadership styles and
emotional quotient and intelligence.
Management and Managers:
A manager is an individual with set of managerial skills that help him/her to get things done. A good manager
must; know how to delegate tasks to his subordinates, set aims and objectives, manage the resources and
motivate the members of staff. Every manager has a set of unique styles with the help of which they are able to
motivate their subordinates to carry out certain tasks. The system by which the manager is able to delegate
tasks and make the business progress is referred to as management.
Fayol’s Functions of Management & Mintzberg Managerial Roles:
The following functions of management presented by Henri Fayol outline the major role for any manager in a
business. The manager must ensure that these functions are being carried out according to the business plan.
a) Setting objectives and planning:

For any manager, it is the first and foremost role to devise aims and objectives of the business. These aims and
objectives must be future oriented and based upon strategic aims and objectives. Once set, these strategic goals
must be translated to the lower management so that all levels are working in uniformity towards a shared goal.
b) Organising resources to meet objectives:

As for every business, the resources are limited and have costs attached to their use. These resources not only
include raw materials but human resource as well. The workforce must be made accountable to their work and
tasks shall be carefully delegated to them in accordance to individual skills and abilities. Moreover, departments
shall be interlinked in decision making processes which will not only create harmony in operations but
responsibility among department as well.
c) Directing and motivating staff:

Perhaps the most crucial function of management is delegating work to the staff which creates motivation. A
motivated staff show care and love the product they build. The management must show them the way that guides
them towards organisational goals and must work to develop staff capabilities by delegating them work which is
challenging but doable.
d) Coordinating activities:
Large scale companies such as multinationals has a very different set of managerial dynamics. The organization is
divided into regions, departments, divisions and products they manufacture. Coordination among all these sectors
of a single organization is top priority of managers. By coordination means uniformity in goals, uniformity in
problem approach and solutions and agreement between divisions regarding research and product development.
This avoids duplication of tasks among the wide expanse of the company’s operations and saving of precious
resources of human and natural resources.
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e) Measuring performance against targets:

Having set all objectives and implementing the managerial techniques in achieving them, the management shall
be able to quantify and measure the performance for its own assessment. Performance appraisal methods shall
be implemented to check the performance of individual departments and divisions to pick out weaker areas and
appreciate successful ones. Appraisal also includes taking feedbacks from the lower levels of management.
To carry out these functions successfully, Henry Mintzberg (1973) identified ten roles which are common to all
types of managers irrespective of what field they are working in. These 10 roles are subdivided into three main
groups mentioned in the table below:
Role Title Description of Role Activities Examples of management action to

perform the role
INTERPERSONAL ROLES (dealing with and motivating staff at all levels of the organization)
Symbolic and inspirational leader Opening new factories, manage receptions
Figurehead
doing visible work during seminars and delivering presentations.
Motivating subordinates and
Asking a lower manager to pick out his own
Leader delegating them tasks that motivates
team this time for doing an important task.
them
Making correspondence between different
Acting as a bridge between different
Liaison organizations, participating in board
divisions and organizations
meetings and business deals.
INFORMATIONAL ROLES (acting as a source, receiver and transmitter of information)
Monitor Intercept data that is relevant to the Find new exhibitions, attend seminars, do
business growth and operations research and read business journals.
Disseminator Sending information from external Using appropriate means to deliver a clear set
and internal sources to relevant of instructions to the staff and taking
departments feedback for reinforcement.
Spokesperson Act as a loyal delegate of the Compiling of prospectuses and annual
organization by praising the accounts with financial reports, media
achievements of the company and its appearances and managing press releases.
future prospects to stakeholders
DECISIONAL ROLES (taking decisions and allocating resources to meet the organization’s objectives)
Entrepreneur Work towards growth by taking more Involve the workforce in decision making
calculated risks and invest in process to kick start the process of
development areas development from within the business. This
will encourage new ideas and employee
motivation will boost.
Disturbance Handler Manage sensitive situations in the Take crucial decisions regarding competing
case of failure (competition) and with a new competitor, during recession or
downsizing, solve disputes among change in governmental policies.
subordinates and take responsibilities
of staff actions
Resource Allocator Be a good financer and spend wisely Make budgets of costs and benefits, forecasts
on growth projects which are the cashflows and decide which expenses are
extremely necessary in future. to be cut down and where there is need for
Allocate human and capital resources investment.
efficiently at the right places
Negotiator Learn to negotiate with workers and Build links with government officials to avoid
their respective trade unions and deal unfair trails and unnecessary inspections,
with governmental level issues related develop consensus between employees and
to production and human resource trade unions on mutually agreed terms.
management
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Difference between Fayol & Mintzberg approaches:
Mintzberg’s criticism regarding Fayol’s functions of management was not very exaggerated but he just thought
that the simple division of managerial task into five functions was too limiting. Mintzberg personally emphasized
on interpersonal roles of manager and pointed them out as key towards effective management as these roles
promote open-ended discussions with workers and customers.
Manager’s performance and its relation to Business Success:
Effective management can create successful businesses. The key indicators that managers are having a positive
impact on businesses performances are:
 The business regularly meets its objectives

 High levels of customer satisfaction
 High employee motivation levels and low labour turnover
 A respected brand image
 High regard from external stakeholders such as pressure groups
 Excellent internal and external business communication
Leadership and its purpose:
The term leadership means the art of motivating a group of people towards achieving a common objective.
Many studies have been conducted on what is a good leader and literature research suggest few vital factors
that a successful leader shall possess:
- They must possess the desire to succeed and be hungry for personal and organizational growth
- They must possess the ability to think beyond the obvious to be different than ordinary. This requires creativity.
- They shall be multi-talented so that they can understand all the pertaining issues.
- They must have an adaptive mind-set that requires flexibility in approach.
- They must work inside the teams they have developed or must know how to delegate tasks in a team.
- They must be emotionally intelligent and must not let emotions take over and understand emotions of others.
- They must be well qualified and know what they are doing.
- They must also be inspirational for their team members because workers would imitate them.
- They must be visionary and must be able to give vision to his team.
- They must be great planners and devise a detailed plan for workers to follow.
- They must be good motivators so that they can keep morale of workers high even in time of crisis.
- They must be swift and wise decision makers which are right and suit the need of the business.
All the managers may be good at management but it is not necessarily true that a good manager is also a leader.
The role of management is limited to the working dynamic of any business. Leadership is one step ahead from
being a manager which requires charismatic personality that subordinates may wish to follow. Employees always
respond positively to good leaders rather than good managers because they always win the staff from the heart.
Many managers focus on control and proper allocation of precious resources but they must also be a good leader
to fill the gap which mostly leads to conflicts between employees and managers.
Leadership roles in a business:

a) Directors
The position of directors are mostly seen in a limited company whose shares are listed in the stock exchange. The
directors are selected by the shareholders and are assigned various key departments such as finance, marketing,
human resources etc. Directors are thus, responsible for their department’s performance and must recruit best
staff for their department. They must also coordinate with other department directors.
b) Manager
They are basically the resource managers which includes human resource, capital equipment, raw materials and
finished goods. Directors delegate tasks to managers who then make sure they are completed. Managers have a
number of staff working under them and work according to instructions provided by the manager.
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c) Supervisors
Supervisors are lower in hierarchy to the managers and are appointed by the managers for supervision of small
tasks. They are not involved in any decision making role but they are responsible for their team’s work and
performance.
d) Workers’ representatives: Workers elect a senior or experienced member from themselves who then deliver
messages of lower ranked staff (usually production staff) to the supervisors who then send it to the higher
command. These representatives also communicate with managers for production feedback and suggestions to
improve the production line.
Leadership Styles: Leadership (management) styles refer to the ways in which managers take decisions and
communicate with their staff. There are three main leadership styles:
1. Autocratic
2. Democratic
3. Laissez-Faire
4. Paternalistic
Leadership Style Main Features Drawbacks Possible Applications

- Take decisions on their
own. - Workers become more - Armed forces or Police where swift
- One way communication dependent on their leaders and quick decision making is
because feedback is not because of task being necessary.
encouraged. delegated always. - At times of crisis when decisive
- Gives little information to action might be needed to limit the
Autocratic
staff. - Low motivational levels damage to the business.
- Supervision of work is among staff.
close and personal. - Demotivates staff who
- Workers do not have full want to contribute and
information about the accept responsibility.
business.
- Workers are engaged in - Two-way communication - Suitable when a new product is
decision making and can be time consuming. being developed and staff can
feedback is encouraged. - On the occasions of quick provide the best guidance because
- Two-way communication decision making, staff may they are closest to the product.
is possible. not be reached and they - Organization where experienced
- Managers require good may not like it. and qualified workforce is needed at
communication skills - Sensitive issues about the all levels.
themselves. business might not be - In businesses that puts employee
Democratic
- Better final decisions are suitable to discuss with culture at top.
possible. lower levels of staff. - In businesses that require workers
- Workers feel more Examples include change in to contribute fully to the production
motivated because they wages, redundancies, and decision making process e.g.
have a say. relocation, merger or school staff.
- More commitment to takeover, development of
work is seen in democratic new products etc.
businesses.
- Research and design teams.
- “Let them do it” culture. - Some workers may not - Newspaper press where journalists
- Virtually no limits to like the lack of structure in need a free hand.
decision making from the the organization and things - Where work needs extreme
Laissez Faire workers side. may seem confusing. concentration (luxury watches)
- Management has little - No communication at all - Science labs where scientists need a
input because all the leads to loss of objectives. free hand in their research and
decision-making power is - The lack of feedback may working model.
be demotivating because
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delegated to the no one is monitoring

workforce. anything.
- Managers do what they - Some workers will be - Used by managers who have
think is best for workers dissatisfied with their jobs genuine concern for workers’
- Some consultation might as they have no real power interest but feel managers know best
take place, but the final or influence. In the end.
decisions are taken by - When workers are young and
Paternalistic
managers – there is no true inexperienced this might be an
participation in decision appropriate style to employ.
making.
- Managers want workers
to be happy in their jobs.
McGregor’s Theory X and Y:
In 1950, Douglas McGregor developed a theory which described two contrasting models of workforce
motivation and its management. This theory basically outlines two sides of a management’s attitude, role and
position towards the employees. The theory is divided into two distinctive parts as Theory X and Theory Y.
Theory X:
Theory X promotes the attitude of strict supervision, immediate punishments, external rewards and penalties.
The managers feel pessimistic about their workers and consider them as shy with zero ambition and have only
individual targets to achieve which are mostly earning salary to live off. Managers believe that employees are
less intelligent and do not like to accept responsibility. The advocates of Theory X suggest that employees are
more efficient under direct supervision and according to their work, they shall be rewarded or reprimanded on
immediate basis.
According to McGregor, Theory X can be implemented in two extremes; the “hard approach” and the “soft
approach”. The hard approach is more of an autocratic approach and may create hostile environment at work
that could increase bitterness towards the management. The soft approach promotes leniency and less
regulations that may give the workers some level of space and freedom. This might increase morale. However,
too much leniency may result in low output and informal attitude towards work. McGregor suggests that a
middle ground between the hard and soft approach will prove to be most beneficial.
X-style leadership is mostly found in mass organizations which have a large scale production environment. In
these business structures, X-style management may be required or may be unavoidable because of number of
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workers who must work in a uniform to produce goods in mass quantities. It can also be useful in workplaces
where consistency is required and where the operations need to be systemic and where the chances of
promotion does not exist or are very minimal.
Theory Y:
Theory Y is the total opposite of Theory X. It does not promote strictness or close supervision of work. In it,
managers believe that workers are internally motivated and do no come to work just to earn money. They come
to be rewarded and that their work gets appreciation. The managers feel that workers enjoy their work and
would be ready to accept responsibility. Challenges are promoted in this system. The advocates of Theory Y
believe that employees are more efficient if they are not directly supervised so that they have much needed
space to produce high quality goods or services.
Managers are more involved with workers and more of a personal atmosphere is created. This democratic style
results in better relationships between workers and higher management. The firm would see less employee
turnover and many skilled and motivated workers would want to join the organization. However, as optimal as
it sounds, this approach does have some drawbacks. Leniency and freedom of work may be prone to errors in
the production or provision of service. Workers may not care about the work they do because they are ‘not
being watched’. As there are no set rules, it might lead to inconsistency and lower quality standards.
** Discuss in class, which approach is better? X or Y?
Best Leadership Style:
Best leadership style depends on various factors. A shall not keep a consistent managerial approach and shall
change it in different circumstances as they arise:
- Experience and training level of employees.

- Sensitivity of work delegated.
- Organizational culture (employee centric or product centric)
- Manager’s personality
- Sensitivity of issues or problems
- Nature of product (research based work or mass produced product)
- Response time (immediate action or can be delayed)
- Possible outcome of decision (resentment or appreciation)
- Levels of hierarchy in the organizational structure
- Number of employees working in the business
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Chapter 8: Motivation
Introduction:
Human resource management is one of the most crucial departments in any organization, primarily in labour
intensive industries. Researches till date suggest that employees play key role in improving the productivity,
quality and efficiency of the work done and that they are the ones who will actually lead the company to achieve
its aims and objectives. For employees to do that, they must be motivated. This unit has its major focus on the
theory and practice related to motivation of employees.
Motivation:
Motivation is the internal and external factors that stimulate people to take actions that lead to achieving a goal.
A well-motivated member of staff would like to see the job done well and would want to see the organization
achieve its goals as well as focusing on personal growth and development.
For any manager, he/she must take care of an employee’s internal goals because arguably, these are the ones
that initiate the drive of motivation in oneself. Consider the benefits of motivated staff and drawback of
unmotivated staff.
Benefits of motivated staff:
 High productivity levels leading to quality goods and services reaching end consumer
 Lower employee turnover leading to companies retaining their employees and reducing training costs
of mew staff
 Better relationships with higher levels of management
 Achievement of aims and objectives
 Room for personal and organizational growth
 Lower levels of absenteeism leading to fulfilment of production orders in time
 Staff gives suggestions for improvements in production line
 More responsibility can be added on employees because they will be ready to accept challenges
Drawbacks of unmotivated staff:
 Lower levels of productivity and poor quality goods because of lower levels of involvement in
production
 Lower levels of responsibility and accountability of work being done. Workers will be unwilling to accept
new responsibilities and new roles
 Higher levels of absenteeism where members of staff do not come to work because they don’t feel like
it
 Poor concentration at work will lead to accidents that can cause serious legal complications for the
business
 Staff coming to work late which halts the production process and delays in orders
 Higher levels of staff turnover with employees leaving the job and new staff coming in every now and
then. This will raise training costs and the business may lose the essence of aims and objectives
 Disputes between the workforce (unions) and the management
 More pressure on the management to automate the processes to totally avoid the use of human
resource
 Close to zero feedback from the employees with regards to production line improvement or product
related suggestions
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Human Needs:
Motivational Theories: To eliminate the problems of unmotivated staff, many researchers over the years have
laid out theories that can help managers and owners to bring motivation in their employees.
1. Taylor’s Scientific Management Theory:

The theory of management given by Fredrick Winslow Taylor is also known as “The Best Way” theory.
He used the technique of scientific management to assess the levels of productivity in US manufacturing
industry where the use of labour was extensive in the 20 th Century. Firstly, he would establish an idea
or a hypothesis, study its performance at work, alter the methods as required and lastly, record the
performance at each level for comparison. This technique was later referred to as the scientific
approach due to detailed recording and analysis of results that came out.
Taylor was of the view that money is the only motivator for a person to perform a task and the way to
improve productivity levels at work was to give more money. This approach is known as “The theory of
economic man” and it is applicable in today’s world as well. Taylor formed this as the basis of his
scientific approach theory which is detailed as under:
- Select workers to perform a task

- Observe them performing the task and note the key elements of it
- Record the time taken to do each part of the task
- Identify the quickest method recorded (identifying the ‘best way’)
- Train all workers according to this quickest method
- Supervise that all workers are following the ‘best way’
- Pay the workers according to their results based on theory of economic man.
Taylor said that man was driven or motivated by money and therefore, the staff shall be paid wages
based on the output it produce. In business terminology, this wage system is known as ‘Piece Rate
System’. This way, a workers would be motivated to produce as much units as possible in as little time
as possible so that he can earn more at the end of the day. Here, money is used as the basic human
need to motivate the employees.
Relevance of Taylor’s theory in modern world:

The result of Taylor’s work did revolutionized the industries especially those that dealt in mass
production where repetition of task was evident. More work was done because more wages were
offered. However, the latter half of 20th century adopted a more useful Japanese style of leadership
where more emphasis was given on quality and well-being of workforce.
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Taylor’s
Relevance to modern industry
Approach
Economic
Money is the main motivator but the counter argument says that human beings have other needs as well.
man
Select the
This approach is still widely accepted and accepted as only qualified and trained staff are for technical jobs and unskilled
right people
for normal work.
for the job
Observation
and This approach may create suspicion among workers and later, conflicts with management for strict supervision.
recording However, if workers are being involved in it then it might prove useful. At the end, it will be the workers benefit if the
the find the ‘best way’.
performance
Taylor’s view was of no feedback and discussion. However, today the technique is highly applicable in Japanese
Finding the
manufacturing industries but employees take the lead role in identifying the best possible way to perform a task. In
‘best way’
Japanese culture, it is known as Kaizen.
This system in not applicable in services sector such as banking or lawyers. In manufacturing industries, managers
Piece rate
discourage the use of piece rate because it may deteriorate the quality over desire for quantity. Workers may ignore
system
errors in products if rectification will take time resulting in lower personal output.
2. Mayo and the Human Relations Theory:

Elton Mayo (1880 – 1949) believed that workers are not just concerned with money but could be better
motivated by having their social needs met whilst at work (something that Taylor ignored). He
introduced the Human Relation School of thought, which focused on managers taking more of an
interest in the workers, treating them as people who have worthwhile opinions and realising that
workers enjoy interacting together.
Mayo conducted a series of experiments at the Hawthorne factory of the Western Electric Company in
Chicago. He isolated two groups of women workers and studied the effect on their productivity levels
of changing factors such as lighting, heating, rest periods and other working conditions. One group
experienced improve working conditions and the other did not. He expected to see productivity levels
decline in one and rise in the other as lighting or other conditions became progressively worse in the
first and worse in the second group. What he actually discovered surprised him: whatever the change
in lighting or working conditions, the productivity levels of the workers improved or remained the same.
He then conducted another research on assembly line workers where similar changes to work
conditions were made but this time the researchers involved the workers before implementing any
change and informed them that a change is going to occur and the research team took their feedback
before every change. This resulted in increased productivity levels and from this Mayo concluded that:
- Changes in working conditions and financial rewards have little or no effect on productivity.
- When management consult with workers and take interest in their work, then motivation is improved.
- Working in teams and developing a team spirit can improve productivity.
- A control over workers’ own life, if given, brings motivation such as taking breaks as they want.
- Establishing groups who can set their own targets and select their informal leaders for supervision and
guidance.
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Relevance of Mayo’s theory in modern world:

The result of Mayo’s work even surprised himself that change in working conditions did not significantly
increased the production levels and that other motivational factors must exist that increase motivation
among workers.
Mayo’s notion of personal communication with employees and their ‘participation’ has led to the
creation of HR Department (Human Resource) in the modern world. The idea of groups or team working
is put into practice among many organizations of the world. An evident example is of Tesco.
At Tesco the Mayo theory is seen to be operating throughout the company. Communication is an
extremely important factor in motivating employees. This may be through 1-to-1 discussions with
managers, through the company intranet or newsletters or through more formal structures such as
appraisals. Line managers hold a daily Team Meeting to update staff on what is happening for the day
and to give out Value Awards. These awards can be given from any member of staff to another as a way
of saying “thank you” and celebrating achievements . Tesco also promotes motivation through its many
training and development opportunities. Everyone has access not just to the training they need to do
their job well but also to leadership training to grow within the company. Tesco offers strategic career
planning to help staff 'achieve the extraordinary'. In 2009 Tesco appointed 3,000 managers 80%
internally. As well as an annual career discussion with every employee, the company also emphasises
the development of the whole person and has implemented a system of 360 degree feedback. This
helps employees to understand their behaviour, strengths and weaknesses within the workplace as
others see them.
3. Maslow’s Hierarchy of Human Needs:

In 1943, Abraham Maslow presented a motivational theory based on human psychology which
comprised of a five tier model. This model can be depicted in the shape of a pyramid which starts from
the basic human needs and carries on towards higher and more complex levels of needs whose
achievement requires an extra level of motivation.
This five tier model can be divided into two parts. First three levels are referred to as the deficiency
needs and the other two as the growth needs. The deficiency needs are regarded as prime motivators
to do a task if they are not present in a human being’s life. If these needs go unmet for a longer period
of time, so does the urge to meet these increases as well. For instance, if you stay hungry for a longer
period of time the more motivated you are to find any kind of food to satisfy your hunger.
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Maslow was of the view that an individual must fulfil deficiency needs in order to go up to the next
level of growth needs which are often difficult to achieve. The deficiency needs become salient or
unimportant once they are achieved and as a natural human instinct, we tend to move forward to
higher levels. Once these growth needs are satisfied with greater effort and motivation, an individual
will be able to sit on top of the pyramid to achieve the need of self-actualization.
Self-actualization is the self-fulfilment reached by feeling enriched, complete and developed by what
one has learnt and achieved. It can be accomplished by taking up more challenging work that tests a
person’s capabilities to the fullest and require an extra level of commitment so that a person can reach
his/her full potential. It is often argued that this level of satisfaction is difficult to achieve and most
members of the society often stop at belongingness and love needs level of the pyramid.
Limitations of hierarchy of needs:
- The level and extent of these needs will differ from person to person. Some may have stronger
motivation to earn good money but do not want to start a family or attend social gatherings.
- It is difficult to quantify and measure to what extent a particular level has been met. For instance an
individual might be stuck at physiological needs for a long time because he still feel there is room for
more.
- Money will always play a key role in all levels of hierarchy no matter if it physiological needs or self-
esteem needs.
- Self-actualisation is never truly achieved. A person who can reach that level will still have urge for
more challenges and opportunities that offer extra commitment. Moreover, managers would not want
an employee to reach an extreme level and then just ask for retirement. They must design more
challenging task for the motivation to work to arise again.
4. Herzberg’s Two Factor Theory:
Fredrick Herzberg based his two factor motivational theory on research conducted on 200 professionals. He
wanted to point out the factors which motivate the employees and as well demotivate the employees. After
Taylor’s work, Herzberg’s motivational has proven to be the most effective in business management.
Herzberg interviewed the employees and asked them what actually made them feel good about the job and
what made them worried or dissatisfied. What he found was that people who felt good about their jobs gave
very different responses from the people who felt bad. His conclusions are as follows:
Job satisfaction (also known as motivators) resulted from six main factors such as achievement and recognition
of that achievement from higher levels of staff. Feeling good about the work itself because it is entertaining or
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gives challenges. Workers like the responsibility given to them because this was they feel trusted. Responsibility
later leads them to take more advanced jobs that propel them towards promotions and growth.
Job dissatisfaction (also known as hygiene factors) resulted from seven factors such as company cruel policies
towards workers in terms of breaks and working hours. Supervisors may be acting too harsh and close
monitoring may make workers more pressurized and job started to feel suffocating. Autocratic supervisors being
strict in implementing company’s objectives which may be unnecessary at times. Moreover, workers feel
extremely disoriented towards working conditions as they may be directly effecting their health. Salary has been
a major morale destroyer as workers cannot justify work and earnings. Their status is not recognized by the
senior management and they are not asked about any feedback. Lastly, job is not secure due to higher employee
turnover.
Relevance of Herzberg’s theory in modern world:
1. Herzberg was of the view that in order to encourage anyone to do a job, a financial reward (salary) is
essential. He called this ‘movement’ of workers. He suggested that pay and working conditions can be
improved to ‘move’ the workforce and remove dissatisfaction but these alone cannot bring motivation
and enhance satisfaction in the job. In today’s world, for ‘movement’ to be effective it is important that
it is being pushed by motivators as well. These motivators can be improved working conditions,
challenging work and recognition.
2. Herzberg emphasised on the use of ‘Job Enrichment’ in order to place the motivators in their place. Job
enrichment means to assign a worker challenging task that he may bring out his hidden capabilities and
reach a higher level of skill and opportunity. There are three main features of job enrichment:
a) Complete units of work

This means a worker is making a complete unit and not just one part of the unit. Making complete units bring
greater satisfaction in doing work because worker feel more responsible and attached to what he’s building.
In mass production facilities, workers do not get the chance to see the final phase and completion of the
product on which they put their hands on. This is not rewarding, can be boring and worker will not get the
chance to appreciate himself and his work. Herzberg argued that complete and identifiable units of work must
be assigned to workers. Typical example is of sports car engines that are custom made by a single engineer
who loves to put his name on the engine he built from the scratch.
b) Feedback on performance
This means a two way communication shall be encouraged in the work environment where workers’ work is
recognized and praised that can motivate them to do more.
c) Variety of tasks
The last and the most important part of job enrichment is to assign workers with variety of tasks that can
stretch his/her abilities to new boundaries. This will give the workers new experience and workers may be
able to achieve Maslow’s self-actualization level in their own capacity.
Evaluation of Herzberg’s theory:
Herzberg’s two factor motivational theory has led modern businesses to apply the concept of team work and
internal promotions. Workers now have greater responsibility over their shoulders so that feel more concerned
about their jobs and that they do them well so that managers recognize them. Firms now try to create a better
internal communication methods with employees and take interest in their feedbacks.
5. McClelland Motivational Needs Theory:

David McClelland pioneered the motivational needs theory based on three types of motivations a
person can have. These are as under:
- Achievement motivation
These type of people set realistic and achievable goals where results can be brought up after some time
and effort. On the basis of the results, they assess their achievement and enjoy satisfaction. For this
motivation to be effective, feedback is really important because feedback reinforces the work being
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recognized by someone. Recognition and appraisal then gives motivation. Research suggests that these
result-oriented approach often puts extra pressure on staff to achieve desired results. Achievement
based individuals normally avoid both high risk (not achievable) and low risk (low recognition or
invaluable result) tasks.
- Authority/Power motivation
A person with this dominant need is authority motivated. These type of people place a high value on
discipline and like to control people with their authority. They like to make an impact of their work and
enjoy status recognition, winning arguments and influence others. There is a strong leadership instinct
which brings personal status and prestige.
- Affiliation Motivation
Affiliation means to be related to someone or some group. For human beings, affiliation with other
people is a natural need. People who have a strong need for affiliation tend to spend much time in their
social circles making new friends. They enjoy to socialize and want to be accepted as a peer. At
workplace, these people follow the set cultures and norms and do not deviate from them due to the
fear of rejection. They tend to be good team members and communicators.
Relevance of McClelland’s theory:

After the publication of his theory, McClelland published a subsequent research in which he regarded
‘power’ as the strongest motivator whereby people at higher levels of management do not tend to
affiliate with others. He also stated that people with high level of achievement will do their best in
completing the projects and they can serve well as low level managers. People with strong need for
affiliation may not be good top managers but can do well in non-leadership roles such as team
members.
6. Vroom’s Expectancy Theory
Victor Vroom expectancy theory is one of the many ‘process theories’ that put great importance on
people’s behaviour and the source of behaviour. These process theories focus on the thought process
of individuals when they are deciding whether or not to do a certain task.
According to Vroom, individuals choose to behave in ways that they believe will lead to outcomes they
value. He outlined several situations that can bring about a favourable motivational behaviour:
- There is a positive link between effort and performance

- Favourable performance will result in desirable reward
- The reward will satisfy an important need
- The desire to satisfy the need is strong enough to make the work effort worthwhile.
If you notice closely, these situational motivators will directly affect the behaviour of an individual
towards doing a particular task as they are interlinked to each other. According to Vroom, there are
three vital and inter-linked components that will motivate an individual to do a task. If any one of them
is missing, the motivational process will become void.
1. Valence:
Valence means attractiveness (positive valence) or aversiveness (negative valence) of an event or situation.
The extent of desire for an extrinsic reward such as money or an intrinsic reward such as self-esteem. The
greater the valence, the greater the motivation.
2. Expectancy:
Expectancy here means that how much the effort being put in a work will help to achieve an expected level
of performance.
3. Instrumentality:
It means the level of confidence and hope by the employees in achieving their desires.
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Vroom suggested that managers should try to ensure that employees shall feel confident about
their efforts and that these will efforts will increase their performance and will lead to expected
rewards.
Payment or financial reward system (Also known as Financial Motivators):
The most common payment systems are:
 Time rate
 Piece rate
 Salary
 Commission
 Performance related pay (bonus)
 Profit sharing
 Fringe benefits
Almost all the theorists agree on the fact that money is the main motivator and causes ‘movement’ in the
workers and without any financial reward, the drive for motivation is difficult to stimulate. Organizations
introduce various kinds of financial rewards system to motivate their workers in achieving aims. The details of
them are as under.
I. Time rate
Time rate is normally paid to non-office workers such as labourers according to the amount of time
(usually hours) they spend on the work floor. The rate is decided in comparison with other firms using
the same rate or by mutual agreement of workers and management. The final wages are paid on weekly
basis. It encourages workers to complete their time and reduces absenteeism but it does not directly
affects the output level.
II. Piece rate

In piece rate, the wages are paid according to the number of units produced. For piece rate to be
effective, the workers would require minimum possible time to produce a single unit of product so that
the more they produce in minimum time, the more money they get at the end of the week or month.
The higher the piece rate, the more motivation for workers to produce more. However, it can lead to
over-production and workers may produce extra or may waste raw materials in all quickness. Quality
may also deteriorate. Moreover, workers may not be willing to accept change in work as this may
reduce their output.
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III. Salary
Annual income that is usually paid on a monthly basis. This is the most common form of payment for
professional, supervisory and management staff. This is not dependent on the time rate or piece rate.
The agreed salary shows the status of the job and complexities of work as well.
IV. Commission:
This is a payment to a sales person for each sales made. This is most frequently used in personal selling,
where a salesperson is paid a commission or a proportion of the sales gained. In some organizations, it
is paid on top of the basic salary or commission is the only salary a person will get. In latter case, the
sales staff can be extremely pressurized in selling the items that it may put an annoying image of the
company. Commission is individual target so it will not encourage team work.
V. Bonus
A bonus is a lump sum payment made at the end of the year to employees who have an agreement
with management on the basis of specific level of output reached at the end of the year or sales made
or performance improved in a department. The bonuses are set on quantifiable measures where
targets are set or annual appraisals are done. This is in addition to the monthly salary paid.
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VI. Performance related pay

While bonuses are paid on quantifiable measures such as annual output reached, PRP payments cannot
be based on quantifiable measures because of nature of work such as supervisory, management and
clerical posts. Targets are set and then extra money is paid on how much the target was exceeded.
These directly increases the technical performance of employees for at least a year. Herzberg suggested
that performance related pay only ‘moves’ the worker in doing a job and does not actually motivates it
because the nature of work remains the same. PRP shall be set on departmental basis so that it can be
transferred from individual goals to a whole department. PRP can also lead to favouritism when senior
management has to decide who gets the bonus or who doesn’t.
VII. Profit sharing

In this scheme, company’s profits are shared with not only the shareholders (dividends) but with the
employees as well. They are paid as a proportion of staff’s basic salary. If bonus is related to profit then
staff will be directly motivated towards success of the business. They will strive to reduce all kinds of
costs and improve efficiency to increase profits. However, shareholders may dislike this incentive as
they believe that owners have the foremost right to the profits due to risks they have put in the
business. As a solution to this, management pays the employees in the form of shares.
Non-financial reward system
As explained by theories by Herzberg, Mayo, Maslow and McClelland, money is not the sole motivator. There
exist some non-financial rewards that prove equally or more effective in creating motivation in employees. The
important ones are discussed below:
 Job redesign
 Job rotation
 Job enlargement
 Training
 Quality circles
 Workers participation
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 Team working
 Target setting
 Delegation and empowerment
 Fringe benefits (perks)
I. Job redesign
This involves the restructuring of the job usually with employees’ involvement and agreement-to make
work more interesting, satisfying and challenging. Clearly, this is closely linked to job enrichment. E.g.
Bank employees are encouraged and trained to sell financial products to customers-not just to serve at
tills. Production lines have been reorganized in many factories and team working introduced in many
industries to more easily allow for job redesign and job enrichment.
II. Job Rotation
This allows workers to do several different jobs which increases their skill set and range of work that
they can do. Benefits include elimination of boredom, a more flexible workforce and covering of a
colleague’s job in case of emergency absence. Limitations include that it does not increase
empowerment and may not give worker a complete unit of work to perform.
III. Job enlargement
Job enlargement refers to increasing the loading of tasks on existing workers, perhaps as a result of a
shortage of employees or redundancies. It is unlikely to lead to long-term job satisfaction, unless the
tasks given to employees are made more interesting or challenging.
IV. Training
Training is referred to as improvement and development of skills of employees. It increases the ability
of workers and offers them better chances of promotion. Moreover, workers feel more motivated if
they are well trained. Training will also help them to achieve self-esteem and self-actualization levels
of motivation. Most companies spend money on their employees’ training. If employees leave the
company after some years then this can be a huge loss in terms of money and human resource.
V. Quality circles
They are voluntary groups of workers, who meet regularly to discuss work related problems and issues.
They are not just concerned with quality alone. The meetings are not formally led by managers, they
are informal and all workers are encouraged to contribute to discussions. Results are often presented
to management for action and this is a successful method and fits in well with Herzberg’s ideas of
workers accepting responsibility and being offered challenging tasks. Workers are usually paid for
attending the quality circle meetings and most successful workers may be rewarded with a team prize.
VI. Workers participation

This is when workers are actively encouraged to become involved in decision making within the
organization. Opportunities for worker participation in a workshop might include involvement in
decisions on break times, job allocations, job redesign etc. Limitations of work participation are that it
may be time consuming to involve workers in every decision. Therefore, in the strategic-level decision
making, workers must be involved whereby they are represented by a ‘workers’ director’. The benefits
of participation include better decision making, improved production procedures and lower levels of
waste.
VII. Team working

This is when production is organized so that groups of workers undertake complete units of work
instead of single workers. More challenging and interesting work as allowed by team working will lead
to:
a. Low labour turnover
b. More and better ideas from the workforce on improving the product and the manufacturing process
c. Consistently higher quality especially when TQM is incorporated.
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VIII. Target setting

This is related to the technique of management by objectives (MBOs). As well as making work more
interesting and rewarding, the purpose of target setting is to enable direct feedback to workers on how
their performance compares with agreed objectives and set targets. People are more likely to do well,
when they are working towards a goal. For this technique to work best, it is important that targets are
set after consultation from workers.
IX. Delegation and empowerment

These methods of staff motivation involves, passing down of authority to perform tasks to workers
although empowerment goes further, by allowing workers some degree of control over how the task
should be undertaken.
X. Fringe benefits
These are non-cash forms of reward- and there are many alternatives that can be used. They include,
company cars, free insurance and pension schemes, health insurance etc. They are given separately to
the salary and are often enjoyed by top managers so that they company can retain them or can attract
highly skilled managers from the market. Some types of perks may be taxed by the government in
America such as moving expenses when employee moves for less than 50 miles, clothing given by
company, non-cash awards which have a considerable value, company mileage and etc. Non-taxable
fringe benefits include health insurance, accident insurance, educational assistance, event tickets and
many more.
** For examinations, it is important that students memorize the financial and non-financial motivators by
heart. However, more important is their application in real world and real jobs around us. Students must be
able to analyze why piece rate system will be applicable in one business and not in other or why fringe benefits
may prove to be very costly for a firm who wants to increase profitability in times of recession. These sort of
scenarios will be asked in examinations and students must ‘apply’ the knowledge in real life examples.
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Chapter 10: What is marketing?

Introduction:
As defined by the Chartered Institute of Marketing (CIM), the term marketing can be defined as the process of
management responsible for identifying, anticipating and satisfying consumers’ requirements profitably by
working on management functions of
- Market research
- Product design
- Pricing
- Advertising
- Distribution
- Customer Service
- Packaging
Few researchers also define the concept of marketing as the achievement of corporate goals through meeting
and exceeding customer needs and expectations better than the competition. Many individuals regard
marketing as only something related to better sales and capturing new markets. This is not it. In modern
management, marketing has three main components to it.
Firstly, modern marketing says that company activities should focus on providing customer satisfaction rather
than making things better for the producer or manufacturer. This means customer is placed at the centre of
business activity.
Secondly, this customer satisfaction is relies on an integrated effort from all the departments of the business.
All units of staff in every department (finance, production, research and development, engineering and etc.) are
responsible for creating customer satisfaction and must be closely coordinated.
Thirdly, the belief that corporate goals can be achieved through customer satisfaction.
Marketing Objectives VS Corporate Objectives:
Marketing objectives can be defined as goals set by marketing department to help achieve the aims of satisfying
consumer wants. To achieve these marketing objectives, a business firstly creates marketing strategy which is a
long-term plan based on four key components such as product, price, placement and promotions. These are also
known as the four Ps of marketing.
As mentioned in third component of modern marketing belief, corporate aims are closely linked with marketing
objectives. To be effective, these marketing objectives should:
- Reflect the aims of the whole organization and should aid other departments in achieving these aims.
- Be set up by senior and experienced managers who will decide what products and what markets they
will be capturing in many years to come. So therefore, these should be well thought.
- Be realistic, measureable and achievable and must be clearly communicated to all the departments.
Setting up these marketing objectives is important because of the following reasons:
- Sense of direction for the marketing departments

- Measurement of targets
- Division of targets into region wise or product wise
- Forming the basis of complete marketing strategy for instance the strategy of market penetration into
new regions or developing new or updating existing products.
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Examples of typical marketing objectives include:
- Increasing total sales volume

- Customer loyalty rate (returning customers)
- New customers rate
- Brand identity
- Customer satisfaction rate
- Increasing the market share
Coordination of marketing with other departments:
It is certain that marketing objectives and marketing decisions will affect all other functional departments.
Therefore, any marketing decision cannot be taken in isolation from the rest of the business. Below are few
scenarios explaining how marketing and other departments are coordinated.
Finance vs marketing:
Cash flow forecasts and budgets can be accurately created by looking at the sales forecasts figure given by
marketing department. Moreover, in case marketing department needs budget for new advertising campaign
then finance department would ensure it has allocated enough budget to see the campaign as successful.
Human resource vs marketing:
The HR department will ensure it has recruited qualified marketing personnel who can produce and sell the
goods when demand for the firm’s products increase. The HR will also use sales forecasts figures to make a
workforce plan that how many workers would be needed in order to meet the sales forecast production targets.
Operations vs marketing:
New product development (NPD) is one of the key tasks of operations department and marketing research data
will help in developing these NPDs. Moreover, the forecasts created by marketing department will help in
deciding if the business needs new machines or new materials.
Local, National and International Businesses:
In the past 10 years, advancement in telecommunication and transportation links have greatly triggered the
trend of many multinational businesses operating all around the globe. The path from being a small scale
business to becoming a substantial and wealth pounding multinational business can be understood by explaining
the terms of local, national and international business.
Local business operates in a small and dwell-defined part of the country. Expansion is not their objective as its
nature may not suit it or simply is not one of the primary objectives. Examples may include a boutique, local
book shop and a local school.
National business is one step ahead of local. They have branches spread around the country but have no plans
to carry their operations in other countries. Examples may include national mobile network providers,
supermarket chains and banks.
International businesses operate at the highest scale of operations whereby they have setup production plants
or distribution links in other countries. They are also referred to as Multi-National businesses. Examples can
include car assembly plants, international banks, and food chains.
The issue of international businesses has been on the upfront because sometimes the movement of capital
(human and financial) is considerable and it can favourably or adversely affect the financial position of a country.
By trading together, countries can build up improved political and social links and this can help to resolve
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differences between them. Trading internationally can also have drawbacks so they must be considered
seriously by a government. These drawbacks may be:
 There may be loss of output and jobs from those domestic that cannot compete effectively with
imported goods.
 There may be a decline, due to imports, in domestic industries that produce very important strategic
goods for example coal or foodstuff.
 Manufacturing the good in which a country has comparative advantage may take a lot of time. All the
investment to one major industry will require retraining of labour and social and political reforms will
be needed.
 Major problem arises for newly established businesses because they will find it difficult to compete
against already well settled imported goods. Infant industries will not grow.
 Dumping by industry’s major producer may eliminate the whole industry of a country because they
dump goods at a very lost cost which cannot be matched by local producers.
 There will be loss of foreign exchange if there is Balance of Payment deficit for many years. More money
will flow out of the country than what is coming in. Local currency will devalue at a faster rate.
Market orientation and Product orientation:
Researchers in marketing suggest that those businesses which have fully adopted the ‘concept of marketing’
withdraw themselves to the preferences of the market. They say that market-orientation is an external or
outward-looking approach whereby decisions about the products are based upon consumer preferences known
through market research.
Market orientated companies focus on customer needs. Change in consumer preferences is regarded as vital
and its adoption is very crucial. For example, the change towards ethical consumption has created opportunities
for many businesses such as Danone (French multi-national food company) which aimed at malnutrition Indian
children to take their daily nutritional diet.
On the opposite, product orientation is an internal or inward-looking approach that focuses on making products
without much consultation of the market needs. These firms are cost focused and produce a narrow range of
products. They implement aggressive sales effort to drive sales. These companies just rely on the hope that
customers will somehow buy their products. Therefore, in order to make the product, extensive internal and
product-related research is conducted which results in very high quality products which often surpasses market
expectations.
Contrasting Businesses: Market oriented vs Product oriented

Market Oriented Product Oriented
Customer concern throughout business Convenience comes first
Invest in market research Rely on internal research and wisdom
Welcome change Cherish status quo (change or maintain existing
patterns)
Try to understand competition Ignore competition
Efficient and effective Only efficient and effectiveness is not guaranteed
Knowledge of customer choice Assumes price and product performance is key to
generating sales
Evaluation of market vs product orientation:
Market oriented business tend to stay with latest trends so one would think that it will adopt all the latest
changes. However, it can be argued that opting for every passing change will make marketing very difficult and
constant revision of marketing objectives which were at first in-line with corporate objectives. Resources will be
over-stretched.
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Product-oriented businesses, on the other hand, rely on extensive research which must lead to an innovative
product. It requires many hours of difficult research work and huge sums of finance as well. These businesses
still thrive but they are fast disappearing because of ever changing market needs. A typical example is of Kodak
which introduced the first ever digital camera in 1991 (a product-oriented approach) but failed to comply with
marketing needs which then demanded the new smart phones (easier to carry around). Kodak’s final fall came
with advent of iPhone 4s which offered a better camera and recording abilities.
Industrial markets vs Consumer markets:
Markets are where buyers and sellers meet to engage in exchange. An industrial market deals with products
bought by other businesses such as industrial machines, trucks, IT equipment and raw materials etc. Industrial
markets engage in industrial marketing also known as B2B. Consumer market deals with products bought by
final users such as mobile phones, clothing, holiday packages and private cars. Consumer markets engage in
consumer marketing (B2C).
Industrial marketing (B2B) vs Consumer Marketing (B2C):
The key differences between selling to businesses rather than consumers are:
• Most industrial products, such as equipment for power stations, are much more complex than many consumer
products so specialist sales employees and support services will be more important with B2B selling.
• Industrial buyers often have much more market power and are better informed than the average consumer.
They need to be sold products by well-trained and experienced sales employees.
• Industrial buyers will rarely buy on impulse. They will only purchase after long consideration and detailed
analysis of alternative products. A business selling B2B needs to keep in regular contact with industrial
customers.
• Traditional mass media advertising and sales promotion techniques are not used in most industrial markets.
Selling can be via trade fairs or direct contact with industrial buyers, often, initially, via websites.
• Mass marketing in consumer markets is a common strategy but in most industrial markets there are relatively
few buyers. Products may need to be adapted to meet the needs of a particular business buyer. An example of
this would be a specialist elevator system for a very tall hotel building.
Features of Markets:
There are certain features of a firm’s market that are important to understand if an effective marketing strategy
is to be designed and implemented. These features include the study of location, size, growth, share and
competitors.
a) Market location
Market locations can be subdivided into three types.
i) Local markets: These can be local retail shops who do not offer goods and services at a large
scale because of their business nature. Examples may include businesses like hair dressers or
laundries. They tend to offer their services to a very limited amount of people. These local
businesses can eventually grow to sell their services and goods at a regional level.
ii) Regional markets: These markets are larger in size than a local one. They cover up a greater
geographical area such as a city or even a province. Therefore, their sales level is higher than
local markets and they can quickly grow to sell their products at a national level. Example may
include Al-fatah grocery store which started as a local grocery store in Lahore and has now
expanded its operations at regional level in Punjab.
iii) International markets: Many large scale firms capture international market which knows no
boundaries. These markets offer greatest sales potential but is very sensitive to international
market changes. Expanding into international markets requires detailed and well thought
marketing strategy which will vary country by country and culture by culture.
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b) Market size
Market size can be defined as the total level of sales by all the producers of a particular product. This
can be measured in two ways: volume of sales (number of units sold) or value of goods sold (total
revenue). It is important for the marketer to know about the size of his market because:
- To assess whether it will be beneficial to enter a new market
- To calculate what will be the firm’s own share in total market (market share)
- To know whether the market will grow in future or not
Many new businesses enter in a market because they see attraction in its size and prospects of growth.
What they don’t foresee is whether this market will sustain its size in future or not.
Consider the example of Pakistan’s milk industry. In totality, its size in terms of revenue is $26 billion
dollars. Out of this $26 billion, Engro foods is the leader in terms of packaged and treated milk with only
2.2% share in the whole of milk industry in Pakistan. The rest is open milk or non-tetra pack milk
industry. (Express Tribune, 2012)
c) Market growth
Market growth is the rate of expansion of a size of a particular market in terms of volume or revenue.
Many new businesses tend to enter a rapidly growing market such as that of mobile accessories. By
2025, it is forecasted that its size will reach to $13bn annually (future market insights, 2015). This may
seem advantageous in the beginning but many new entrants will join the market making profitability
much lower for everyone. The pace of growth of any market can depend of several factors such as:
- Global economic situation
- Changes in consumer trends
- Changes in consumer incomes
- Rate of development of under-developed nations
- Ease of global transport (globalization level)
- Paradigm shifts in technology
- Levels of trade protectionism
- Saturation of market (for durable goods)
d) Market share:
Market share is the percentage of sales in the total market sold by one business. In part (b), we saw
that Engro foods enjoys 2.2% share of total milk industry in Pakistan. This is the market share of Engro
foods in terms of the whole industry of milk. It can be calculated as:
Firm’s sales in time period x 100
Total market sales in time period
Businesses often call themselves as ‘brand leaders’. By this they mean they have the highest market
share in a particular product’s industry. These brand leader enjoy the following benefits:
- Higher level of sales as compared to that of competitors
- Retailers will be willing to place the firm’s products in prominent shelves in their shops and
will pay for the goods in cash
- Brand leader can be the price setter
- Natural advantage in promotional campaigns
- Enjoy the status of most popular brand
- Sponsorship opportunities
- Attract the best skilled labour from the market
It is always confusing for the business analysts and consumers to interpret the figure of market
share. Firstly, there is always a huge undocumented market that is not accounted for in the
calculations so the figure may be misleading. Secondly, on what basis did the firm calculated its
brand leading market share? Was it in value terms of volume terms? Both give very contrasting
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results altogether. Example can be of a cosmetic company that specializes in selling low volumes
of expensive products is likely to have a higher market share in value terms but not it volume terms.
e) Competitors:
Competitors are those businesses that provide the same level of service of goods to the market (direct
competitors). Many industries of the world such as mobile phones (Apple and Samsung), beverages
(Coca Cola and PepsiCo), sports apparel and equipment (Nike and Adidas) are the typical examples of
fierce competition. If a business is market oriented, it is very likely that it will compete on the basis of
price. If it is product oriented, it will compete on the basis of quality it offers.
Important marketing concepts:
1. Adding Value:
Added value simply means how much is the difference between the cost of bough-in and processed materials
and the selling price. A chocolate maker combines milk powder, cocoa powder, nuts, wafers with honey and also
packs may have paid $2 altogether but is selling the chocolate to the consumer at $6. This means he has added
$4 value to the product. This added value, of course, contains the profit margin but it is not same as profit.
Any business can add value to its product and can signify this value by the means of effective marketing. As a
consumer, you would think why am I paying $6 for bar of chocolate that has a total cost of $2? This is where
convincing power of marketing comes in. following marketing strategies can help to add value to the product:
- A restaurant can create exclusive fine dining and clean environment where food will be served in warm
plates. Comfortable seats with luxurious table covers will give an extravagant and royal look to the
ambiance of the restaurant. Waiters who might be better looking and better dressed than the customer
bringing in crispy fish crackers with a boiling bowl of freshly prepared soup and may offer to serve you
in your bowl instead of you taking the pain yourself. At the end of your meal, they may bring a couple
of hot scented towels to clean up your dirty lips and smelly hands alongside few mint chocolates as a
complement to freshen up your breath as well after you went to war with delicious garlic prawns which
were cooked to perfection. Will you not pay extra for such a fine dining experience?
- Many business use high quality packaging to differentiate the product from other brands. Packaging is
the first experience a customer will enjoy in a product. A bottle of wine can be a good example.
- Create a luxurious and exclusive retail environment such as Rolex Stores, Bvlgari Boutiques, Apple Store
and etc. This will make customers feel more prepared to pay higher prices and may have the
psychological effect on convincing them that the product is of high quality.
- Add endorsements to your brand by famous celebrities so that customers may feel associated to them
and will be willing to pay higher price.
- Create a USP (Unique Selling Point) that clearly differentiates a product from that of other
manufacturers. Finger print scanner from Apple was a USP. Other examples include Nike’s self-lacing
shoes, Rolex’s golden ring dial and crown, Harvard’s world’s leading research and guaranteed high
salary job, Royal London’s exclusive design tea pots, Turkish Silk carpets and etc.
2. Mass marketing
Mass marketing means selling the same products to the whole market with no attempt to target groups
within it. The products sold in mass markets can be used by all and is a less risky approach towards a market.
Advantages of mass marketing includes:
- Greater possibility of economies of scale because of higher level of production which reduces
average cost of production.
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- Fewer risks involved because of a large and undifferentiated customer base. Firms are not required
to be flexible and production methods do not need frequent changing as products are
standardized.
3. Niche Marketing
Niche means small. Niche marketing is when a particular segment of the whole market is identified and
targeted by developing and selling a good which suits the needs of that niche.
As niche is a smaller segment of the market, its features and requirements will be unique. Niche markets
has usually huge market gaps in it and higher potential of growth because not many competitors have
risked their resources to exploit it. Niche marketing is mostly done for highly luxurious goods such as
luxury watches, yachts, one-time jewellery designs, custom-made laptops (Dell’s Alienware) among
many. Niche markets may also exist in non-luxury markets such as Poundland in the UK which sells
everything for 1 pound and attracts a relatively lower income group of the population.
Advantages of niche marketing includes:

- Small firms may be able to survive if they successfully identify and market niche and can maintain high
quality.
- Exclusivity complements higher prices so higher profits are possible
- Niche market products will attract a higher status segment of the population (Patek Phillips pocket
watches).
4. Market segmentation (differentiated marketing):

It is the process of identifying individuals or organizations with similar characteristics that have
significant implications for the determination of marketing strategy. Market segmentation involves
dividing a diverse market into a number of smaller, more similar sub-markets. The objective of
segmentation is to identify groups of customers with similar requirements so that they can be served
efficiently.
For the process of market segmentation and targeting to be implemented successfully all relevant
people in the organization should be made aware of the reasons for segmentation and its importance.
By gaining involvement, staff will be more committed to results, leading to better implementation in
later stages.
There are few advantages of market segmentation:
a) Target market selection:

Segmentation allows the basis of selection of target markets. A target market is a chosen segment
of the market that a company has decided to serve. As customers in the target market segment
have similar characteristics, a single marketing mix strategy can be developed to match those
requirements.
b) Tailored marketing mix:

Segmentation allows the grouping of customers based upon similarities (e.g. benefits sought) that
are important when designing the marketing strategies. This allows marketers to understand the
in-depth requirements of a segment and tailor a marketing mix package that meet their needs.
Consider the example of BMW 3 series that is suitable for middle managers as compared to BMW
X5 which is targeted for well-off couples with children.
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c) Differentiation:
Segmentation allows the construction of differential marketing strategies which means breaking a
large market into sub-segments. This allows the company to differentiate its product range.
d) Opportunities and threats:

Segmentation allows company to identify its threats and opportunities. New segments are always
emerging because customers’ demands are ever changing. The company that first spots a new and
under-served market segment and meets its needs better than the competition can benefit from
increasing sales. The success of NEXT, the UK clothing retailer, was founded on identifying a new
market segment: working women who wanted smart fashionable clothing ate affordable prices.
Similarly, the neglect of a market segment can pose a threat if competition use it as a gateway to
market entry. Can you think of any example of threat?
Implementing a successful market segmentation:
Successful market segmentation requires a business to have a very clear picture of the consumers in the target
market it is aiming to sell in. A picture of the typical consumer needs to be built up with the help of market
research (to be done later). This process if called as consumer profiling.
A consumer profile will contain consumer information such as age, gender, social class, and location and income
levels among many other. Consumer profiling can be done on three basis:
- Behavioural
- Psychographic
- Personal profile
Factor Example
Behavioural Focuses on consumer behaviour before or after buying a product
Benefits sought Convenience, status, performance and price
Purchase occasion Self-buy, special occasion and eating occasions
Purchase behaviour Innovators (who buy product immediately after launch), brand switching and
brand loyalty.
Usage Heavy-users, light-users or non-users. Heavy users receive most marketing
attention so that brand loyalty can be created. Marketing mix will also contain
few elements to convince non-users to start using a product.
Perceptions, beliefs and Favourable or unfavourable. People with favourable beliefs are easier to target
values and segment. People with unfavourable beliefs and values may needed to be
worked upon for better convincing.
Psychographic Grouping people according to their lifestyles and personality traits.
Lifestyle Trendsetters, conservatives and sophisticates. People ae segmented according
to their way of living which is reflected in their daily activities, interest and
opinions. SKY cable networks has introduced sky sports channel range for
people with high interest in sports.
Personality Extroverts (outgoing and socially confident person), introverts (shy people),
aggressive and submissive (who just take anything offered to them). Many
people make purchases on the basis that “I choose this brand to say this about
me and this is how I would like you to see me.” This is called as personality
segmentation
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Profile Focuses of individual aspects of a typical consumer and this requires extensive
research.
Age Under 12, 12-18, 19-25, 26-35, 36-49, 50-64, 65+. An example can be of children
who receive their own television programmes, cereals and computer games or
L’Oréal’s Age Perfect of Revitalift brand for 50+ women.
Gender Female and male.
Life-cycle Young single, young couples, young parents, middle-aged and retired. Young
couples may be targeted by electronics and furnishing companies as these
couples look to start-up a family and build new homes.
Social-class Upper middle (higher managerial roles, white collar professionals or directors
of big companies), middle (managerial staff including professions such as
teachers), lower-middle class (supervisors, clerical jobs or junior managers),
skilled working (technicians, computer experts, car mechanics) and unwaged
Income Income level breakdown according to city and country. Urban income level as
compared to rural income levels will help companies to segment the market
with appropriate products offering suitable prices.
Geographic North vs South, urban vs rural. For example, variation in food preferences may
form the basis of geographic segments: France, Spain and Italy are oil-based
cooking markets, while Germany and the UK are mainly margarine and butter
orientated. Geographic segmentation can also be done on the basis of religion,
language, culture and ethical values.
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Chapter 11: Market Research

Introduction:
As a manufacturer, the owner will ask several key questions before marketing his products to the customers
such as what kinds of people buy my products, what they value, where they buy, what kinds of new products
they would like to see on the market. Understanding and answering these questions is the key to informed and
effective marketing decision-making. Managers can develop knowledge about their customers and the
marketing environment through marketing research. In the previous chapter, a comparison between product
oriented and market oriented businesses was made. In it, market oriented businesses particularly relied on solid
market research.
Market research is a broad concept. It just not only informs manager what products consumers are demanding
but it also helps in profiling consumers in the target market. Therefore, it can be defined as the process of
collecting, recording and analysing data about customers, competitors and the market itself.
It is due to market research that many small businesses such as Innocent Drinks have grown exponentially over
the past few years. There now exists many specialists marketing research companies that provide statistical data
of consumer spending patterns, buying habits, price reactions, effect of promotions and etc.
The need for marketing research:
Following factors explain why market research is important for businesses.
i. Reduction of risk in New Product Development launch:

The most worrying thing about launching a new product is the desired level of sales. Market research
will allow managers to predict some level of sales which will be satisfactory. However, these statistics
are on ‘chance’ basis so are not always accurate. Market research can help a business in its new product
development (NPD) in following ways:
Identifying consumer needs and tastes  primary and secondary research into consumer needs and
competitors
Product idea and packaging designs  testing of product and packaging with selective consumer groups
Brand positioning and advertising testing  pre-testing of the product image and advertisement
Product launch and after launch period  monitoring of sales and consumer response
ii. To predict future demand changes:

Many businesses predict future demand by the means of market research data. Pakistan has seen a
dramatic surge in number of teenage and middle age clothing brands because market research data
shows increase in young population around the country. Similarly, many banquet halls and wedding
event planners have emerged just because they have predicted an increase in marriage of these young
chunk of population.
iii. To explain patterns in sales of existing products and market trends

Many new businesses extensively study markets of existing and famous products to analyse the sales
pattern, price reactions and consumer desires. New businesses can then predict future sales patterns
and market their product accordingly.
iv. To assess the most favoured designs, flavour, styles, promotions and packages for a product
Perhaps the most important aspect of market research is its final result which picturizes a potential
product. A business is able to identify all the important aspects of a product which a consumer wants
to see. These results then can be incorporated into the final product. Market research can, therefore,
be used to discover information about:
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- Market size and consumer taste and trends

- The product and its perceived strengths and weaknesses
- The promotion used and its effectiveness
- Competitors and their claimed unique selling propositions
- Distribution methods most preferred by consumers
- Consumers’ preferences for packaging of the product
The market research process:
Following are the steps that are involved in starting the market research process.
1. Management problem identification

Before conducting market research, a business must make sure what is it looking for in the market or
what problems does it need to solve through market research. On the basis of these problems, the
structure of market research is set. If the business fails to identify the management problem then
market research will be useless. A business may face following management problems:
- What is the size of our market?
- Why are our sales falling?
- What price shall we charge in the upcoming holiday season?
- Why consumers are liking the competitors packaging?
- Is there any chance of expanding market in another country?
- Is the size of our target market shrinking? Why?
2. Research Objectives
The above mentioned management problems can be translated into smaller objectives. Upon achieving
these objectives, the structure of market research will start to give proper shape. For instance, consider
these examples below which are in line with above mentioned management problems:
- What is the size of our market?  How far are we from the market leader?
- Is there any chance of expanding market in another country?  How many people are likely to buy
our products in that country?
- Is the size of our target market shrinking?  Why our customer complaints about our products
increasing?
3. Sources of market research data – Primary vs Secondary Market Research

Sources of market research data means from where we can collect the required data which will help in
conducting market research. In marketing, there are two major sources of market research.
a) Primary Research (field research)

It is the collection of first hand data as it is being collected for the very first time by the
company for its own needs. The data collected from primary research is brand new and as the
company itself carries it out, it will give first hand and accurate data which will address
management problems. Primary research data comes from sources such as interviews,
questionnaires, focus groups and surveys.
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b) Secondary Research
It is called as secondary because the data come to the researcher ‘second-hand’ (other people
or businesses have compiled the data for their own needs). Secondary data come from sources
such as company own previous records and reports, government statistics, chamber of
commerce journals, published reports, banks and many more. Most businesses do secondary
research first as a starting point of market analysis. Secondary research then tells what we
shall focus on our primary research which is also necessary.
Sources of Secondary Research Data:
As explained above, secondary research consists of second hand data so it is obvious that most of the research
data will come from external sources. Following are some key sources from where research data can be
collected.
1. Government Publications
Government is one of the biggest researchers in almost every field of work. In the UK, following publications from
the government are extensively used for market research data:
- Population Census (for age analysis and population densities)
- Social trends (political, ethical, societal and etc.)
- Economic trends (boom, recession or growth prospects can greatly affect upcoming market trends)
- Annual statistics such as import vs export analysis, agriculture sector analysis, inflation and unemployment etc.
- Family expenditure surveys (annual incomes and spending rate and patterns)
These reports can greatly help any new business or any other business looking for growth or introducing a new
product. A strict recent policy towards property holding rights and taxations in Pakistan has lead the market of real
estate towards decline because market research data shows negative trends in growth. Moreover, if a person was
looking to import solar energy systems into Pakistan, he would look at government publications related to
allowance of solar panels to analyse the potential of this market.
2. Local libraries and local government offices

Data obtained from these sources would be suitable for local businesses. A new laundry shop in town would want
to collect research data from local councils regarding housing proportion in the area and also the income patterns
of the residents who live closely. Following data will be useful:
- Local population census including number of people, age distribution and occupation distribution.
- Number of families or single households
- Ethnic and cultural diversification in the area.
3. Trade Organizations
Trade organizations can be industry specific such as a trade organization for food and restaurant businesses, trade
organization for furniture retailers or trade organizations of general importers. These organizations produce
monthly or annual reports on the conditions of the market.
For instance, an owner of a large electronics retail shop want to stock new LED televisions. He would want to know
what size of TV is popular among consumers and what the appropriate price range consumers happily accept is.
The owner can get this type of information from Electronics Trade Association.
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4. Market intelligence reports

Perhaps the most sophisticated and relevant secondary research data comes from market intelligence reports such
as Mintel. These are specialist organizations that prepare a range of market analysis of different products and
services in different countries. These reports are expensive and not every business can afford them. Some of the
reports are available at local business associations such as the chamber of commerce and industry.
A small travel agency which wants to expand in another metropolitan city but at large scale can utilize a market
report on travel and tourism which will include data such as consumer incomes, spending pattern on holidays,
airline preferences and class, family tours or business and etc.
5. Newspaper reports and specialist publications

Many popular newspaper publications also help in collecting secondary market research data. Among them are
Financial Times, The Economist, Huffington Post Business, Huffington Post Lifestyle, Marketing and etc. these
reports are mostly verified.
6. Internal company records

Many older businesses who are trading and manufacturing for many years have extensive research data already
available. This data is of course free of cost but it needs proper maintenance and accuracy to be useful for market
research purposes. The records will include:
- Sales records
- Customer feedback forms
- Guarantee claims over the years
- Sales trend (monthly, weekly or half yearly)
- Delivery schedules
- Profit ratios
7. The internet
Internet, probably, has the largest resource market research data but it has a lot of irrelevant and unverified
information which can be misleading for the companies. The source must always be checked. Facebook has
transformed market research techniques by introducing ‘Pages’ feature for businesses. These pages give proper
insights about consumer likeness and dislikeness towards a certain brand and these insights can also help to
understand behaviour of consumers.
Methods of Primary Research
Primary research can be divided into two types such as Qualitative Research and Quantitative Research.
Qualitative Research
Qualitative research is the research that focuses on the conduct and processes of the society and motivations
behind consumer buying behaviour or their opinions. It seeks to understand the ‘why’ and ‘how’ of consumer
behaviour. It brings together consumer personal encounters, life events and understandings into a more
meaningful context. The main forms of qualitative research used in market research which helps us to
understand the complex patterns of human behaviour are:
Focus Groups
It is the group of people who are asked about their attitude towards a product, service, advertisement or new
style of packaging. This is like a group interview where unstructured questions are asked from the focus group
and there is a moderator (group leader), who is mostly a psychologist, who manages the conversation.
All members of the focus group are free to talk with other group members. The discussions are recorded for
data collection purposes.
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Advantages:
 By arranging groups of 6-12 people to discuss their beliefs, attitudes, motivation, behaviour and preferences, a
good deal of knowledge may be gained about an average consumer.
 The information collected can be used to make questionnaires.
 Findings from the focus group may provide rich insights into consumer motivation.
 Group discussions often bring out more natural response from participants as compared to individual interviews
because groups have discussion opportunities.
Disadvantages:
 It takes a lot of time to conduct the group discussion.

 Participants may start to discuss unrelated topics not required for the research
 Qualitative data is difficult to analyse and can based on personal understanding of the interpreter (subjective).
 The group leader or the moderator may channel the discussion towards his own opinion resulting in biased
conclusions.
 Small sample size (6-12) people cannot accurately reflect behaviour or opinions of the general population.
In-depth interviews
It involves the interviewing of consumers individually for perhaps one or two hours about a topic. The aims are
broadly similar to that of a focus group. It is mostly used if there is a fear of irrelevant group discussions or when
it is difficult to gather groups of consumers. It is also used to understand individual decision-making process.
Ethnography
It is a form of observation that involves detailed and prolonged observation of consumers. This research
investigates how people behave actually in their own casual environments (natural behaviour) and interact with
the world around them. In ethnography, the researchers goes to the consumer instead of consumer coming to
the researcher.
It has been used in technology field to understand how people really use products. The findings showed that
people will use technology in ways its inventors never imagined. For instance, a family owned two play stations
whereby one was used to play video games and the other was used to play audio CDs. Consumers bought an
expensive iPhone not to make phone calls but to take great photos, a study of 10 families revealed that 2 out of
them left their TVs on even when they were not home. This is something people don’t admit in focus groups.
Quantitative Research
Quantitative research leads to numerical results that can be statically analysed. The methods of quantitative
research includes observation and recording, test marketing and consumer surveys.
Observation and Recording
This involves physical observation of consumers for instance how many people visited the shop when a new
product was launched, what was the reaction of consumer upon seeing the new product, number of cars passing
by a certain location and inventory checks to understand sales level. People, however, do not like being watched
if they suspect such action they may change their natural feelings. Also, observation does not give researchers
the opportunity to ask for explanations of behaviour. There is just recording of data.
Test Marketing
Test marketing is like a small and limited scale launch of a new product where it is introduced to few people in
order to understand consumer reaction before the big national launch. It involves promoting and selling the
product in a limited geographical area and then recording consumer reactions and sales figures. The selected
region is closely related to the brand’s eventual target market which is spread country-wide. The advantage of
test marketing is that it can prevent a potential failure of a nation-wide launch.
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Consumer Surveys
Survey is directly asking consumers or potential consumers for their opinions and preferences. These surveys
can be used for both qualitative and quantitative research. A typical survey involves a series of questions that
are asked from the consumer. These series of questions is referred to as the ‘questionnaire.’
For example, a survey conducted outside clothing retail shop may include questions like:
- How often do you shop for clothes?

- What is your benchmark of quality clothing?
The first question will give quantitative data which can be represented by numbers. The second question will
give qualitative data about consumer opinions and choice. Before conducting surveys, a marketer must check
the following issues before preparing a questionnaire:
 Who to ask?  A sample from total population must be made from which survey will be taken. This sample is the
group of people who knowingly or unknowingly take part in a market research survey and represent the overall
target market.
 What to ask?  For a useful result, unbiased, easier and direct questionnaire must be constructed.
 How to ask?  What is the chosen method to ask the consumers? Is it by face-to-face, by telephone, by internet
or by mail?
 How accurate is it?  After results are obtained, they must be interpreted accurately by using graphs, ratios and
numbers.
A comparison of face-to-face, telephone, mail and internet surveys

Face to face Telephone Mail Internet
Questionnaire
Use of open-ended questions (full
HIGH MEDIUM LOW LOW
answers)
Ability to review the questions HIGH MEDIUM LOW LOW
Use of visual aids HIGH POOR HIGH HIGH
Sensitive questions MEDIUM LOW HUGH LOW
Resources
Cost HIGH MEDIUM LOW LOW
Sampling
Widely dispersed populations LOW MEDIUM HIGH HIGH
Response Rates HIGH MEDIUM LOW LOW
Experimental Control HIGH MEDIUM LOW LOW
Interviewing
Control of who completes the
HIGH HIGH LOW LOW
questionnaire
Interviewer Bias POSSIBLE POSSIBLE LOW LOW
Poorly worded questions and how to avoid them

Question Problem and Solution
‘Type’ is confusing; respondents could say ‘French, Red, Claret or
white’ depending upon their interpretation. Showing the
What type of wine do you prefer?
respondent a list and asking ‘from this list …’ would avoid the
problem.
Leading question favouring ASDA; a better question would be ‘Do
Do you think prices at cheaper at ASDA than at ALDI? you think that prices at ASDA are higher, lower or about the same
as at ALDI?’
Two questions in one; Ariel may be more powerful but Tide may be
Which is more powerful and kind to your hands? Ariel or Tide?
kinder to the hands. Ask the two questions separately.
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Unfamiliar word: a study as shown that only less than a quarter of

Do you find it paradoxical that X lasts longer and yet is cheaper the population of UK understands the word paradoxical which
than Y? means impossible or ironic. Test understanding before using such
words
Essential differences between qualitative and quantitative research

Qualitative Research Quantitative Research
Focus is on Verbal data Numerical data
Research purpose and outcome Rich, in-depth insights Broad generalizations
Research means Focus groups or depth interviews Structured questionnaires
Operation High flexibility in data collection Low flexibility in data collection
Data capture Audio recording Pre-coded response categories on the
structured questionnaires
Sampling Small samples Large samples
Analysis Content analysis of consumer Statistical analysis or pre-coded
statements from the audio recording responses
Reporting Identifying major themes from the In terms of percentages, tables,
analysis such as summary statements graphs and averages.
(‘most consumers stated or some
consumers though’)
Sample and Sampling Methods:
Sample in marketing terminology can be defined as the group of people who take part in market research survey
selected to be representative of the overall market. In the above discussion of primary and secondary market
research, the people who are involved in surveys, focus groups, interviews and ethnography will classified as the
‘sample.’
Sampling is important to be done because businesses cannot accurately predict or analyse the desires of the
whole population. They cannot fully understand the total potential of the market because it is too extensive. A
sample is selected from such an extensive market which can, somehow, help businesses to create an image of
its consumer.
For sampling to be effective, a business must take care of following factors:
 Number of people involved or sample size  a sample of just 20 people to research a potential toothpaste market
of millions is not sufficient.
 Time constraint  how much does the company have to conduct the research? The more the time invested, the
more accuracy in results
 Variety of samples  is the research sample taken from a similar geographical area? Is the research sample based
on different demographics? The more the variety in sample, the more variation in research results.
 Cost involved  primary research usually involves higher costs in conducting interviews and distributing and
receiving questionnaires.
 Interpretation of data  sampling results can only be effective if interpretation of collected data is correct and
detailed.
Sampling Methods
Probability Sampling:
A probability sampling method is any method of sampling that utilizes some form of random selection. In order
to have a random selection method, one must set up some process or procedure that assures that the different
units in your population have equal ‘probabilities’ of being chosen.
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This sampling method is very reliable because of it removes selection bias when sample is being made. Following
are the most common probability sampling methods:
1. Random Sampling:
In this, people from the target market are selected at random. Therefore, everyone has an equal chance
of being selected. To select random sample the following are needed:
 A list of all the people in the target population
 As people are selected, they are allotted a number which is in sequence (1 – 100)
 Use of computer or manual method to select the numbers from the sequence.
If a sample of 500 is required for initial research then 500 random numbers will be selected and they
will form the sample.
2. Stratified Sampling:
In stratified sampling, specific groups of people with identical characteristics are selected from the
population. These groups of people are called as population strata. From this strata, random people
are selected to make a stratified sample.
Stratified sampling is used when the target population is made up of different groups of people. Taking
example of toothpaste which is consumed by every human being, its manufacturer can make strata of
children, females, males, adults and senior citizens. Here the strata is made on the basis of age.
3. Quota Sampling
In this method of sampling, quotas are allotted to each strata of the population. These quotas can be
in terms of percentages. For instance, if it is already known that out of all consumers of green tea:
45% are male
55% are female
25% are aged 20 – 25
35% are aged 26 – 35
40% are aged 35 and above
Then the sample which is to be selected will also be in the same proportion (quota). Therefore, if there
was a sample of 300 people, 135 would be male, 165 would be female, and 75 will be aged between 20
to 25 years and so on. This proportion will give the researcher a specific quota of people to research in
each strata.
Limitations of Sampling:
 A sample never fully represents the full potential and scale of the total population.
 Sampling methods and sample content needs revision after few years to include the changes in
geography, demography and incomes.
 Sampling is dependent upon the researcher opinions so it can be biased. For instance an interviewer
on a high street who supposed to interview shoppers on a particular research may only interview
attractive or easier to approach people. This destroys the essence of the original sample.
 It is very time consuming especially the product to be produced is for the mass market.
 The bigger the sample, the more costs it will incur.
Interpretation of Market Research Data:
** As per syllabus guidelines, students will not be asked to construct bar graphs, histograms, tables or pie charts
in exams. However, it is important that every student must know how to interpret these forms of data and get
meaningful results from them.
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Limitations of Market Research:
 The results of market research are very vague as it is carried out on consumers, suppliers,
intermediaries, etc. who are humans. Humans have a tendency to behave artificially when they know
that they are being observed. Thus, the consumers and respondents upon whom the research is carried
behave artificially when they are aware that their attitudes, beliefs, views, etc. are being observed.
 Market research is not free from bias. The research conclusions cannot be verified. The reproduction
of the same project on the same class of respondents give different research results.
 Many business executives and researchers have ambiguity about the research problem and its
objectives. They have limited experience of the notion of the decision-making process. This leads to
carelessness in research and researchers are not able to do anything real.
 Market research faces time constraint. The firms are required to maintain a balance between the
requirement for having a broader perspective of customer needs and the need for quick decision
making so as to have competitive advantage.
 Huge cost is involved in market research as collection and processing of data can be costly. Many firms
do not have the proficiency to carry wide surveys for collecting primary data, and might not also able
to hire specialized market experts and research agencies to collect primary data. Thus, in that case, they
go for obtaining secondary data that is cheaper to obtain but not very relevant.
 The value of any research findings depend critically on the accuracy of the data collected. Data quality
can be compromised via a number of potential factors, e.g., leading questions, unrepresentative
samples and biased interviewers. Efforts which ensure that data is accurate, samples are representative
and interviewers are objective will all add to the costs of the research but such costs are necessary if
poor decisions and expensive mistakes are to be avoided.
 The Data Protection Act (1998) is a good example of a law that has a number of implications for market
researchers collecting and holding personal data. For instance, researchers must ensure that the data
they obtain is kept secure, is only used for lawful purposes and is only kept for as long as it is necessary.
It must be made clear as to why data is being collected and the consent of participants must be
obtained.
Cost-effectiveness of Market Research:
Many new business who start small do not have sufficient budgets to carry out primary market research. This is
often one of the main reasons these business’s product fail to make an impact on consumers. Medium and large
businesses also face budget constraint because for them, the sample size would be large.
Even if secondary data is preferred which is easily available but expensive, it might prove to be irrelevant for the
business in question. However, internet tools such as survey monkey, Facebook polls, twitter hashtags, emails
and smartphone applications have made marketing research at a substantial scale possible.
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Chapter 12: Marketing Mix – Product and Price

Introduction to Marketing Mix:
The original concept of marketing mix consists of four major elements: product, price, promotion and place.
These ‘4-Ps’ are the four key decisions that marketers must manage so that they satisfy or exceed customer
needs better than the competition. However, the growth of the services industries has given rise to an extended
marketing mix of ‘7-Ps’ which adds people, process and physical evidence into the mix. The emphasis of each of
the elements of the mix will vary depending on the products and services offered by an organization.
For example, BMW and Rolex watches are market orientated companies that focus primarily on the 4-Ps as they
are product manufacturers, but Pizza Hut and KFC focus primarily on the elements of the extended mix, as
service, process and physical evidence are at the heart of their fast-food restaurants.
These inter-related 4 Ps are explained in detail in this chapter and the next. However, a small introduction is
given below.
Product  This includes the design and performance of the product. Any aspect of the product that defines its use and
appearance. These products can be existing ones or development of a new range.
Price  Price tells a lot about a product. If set too low then it may portray a poor quality. If set too high then consumers may
not be able to buy it and lose interest.
Promotions  This includes advertising of a product. To sell a product, its advertisement must be effective and convincing.
Promotions play important role in beating the competition and setting up a unique brand image.
Place  This is where and how a product is sold (distribution channels). Products must be available all the time and must be
placed at the right locations of the market.
The 4 Cs – Role of Customers
This is the new development in marketing as most marketers now think that old 4Ps approach is outdated and
is company-centric. Companies now should focus on the ultimate factor of success and that is the consumer. For
this, the 4Cs approach has been approached and it is used as an alternative to 4Ps. These can be summarised
as:
Customer Solution  What the firm needs to provide to meet the customers’ needs and wants
Cost to Customer  The total cost of the product including extended guarantees, delivery charges and financing costs are
included which were not considered in Price factor of 4Ps.
Communication with Customer  Easier communication links with customer which delivers the message (advertising) and
also receives it (feedback).
Convenience to Customer  Consumer must have access to pre-sales information, demonstration of the product and
convenient locations for buying the product.
Many companies tend to focus just on the 4Ps because the thought is old school and its practice is well
researched. The implementation of 4Cs approach is rather new and as its individual components suggest, will
require extensive research into consumer behaviour. Only then an effective framework of 4Cs will be developed
but it will require good amount of financial budgets which most companies do not have. The 4Cs are important
whatsoever and play important role in customer relationship management (CRM).
Customer Relationship Management (CRM):
It is a process which aims to establish successful customer relationships so that existing customer loyalty can be
maintained. As you may have noticed in this definition, CRM only focuses on retention of existing customers and
does not focus on making new ones. At the heart of CRM is communication with the customer to gain
information. The aim is to gain as much information as possible about each existing customer. This includes
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income, product preferences, and buying habits and so on. Using this information, marketing tactics can then
be adapted to meet the customer’s needs. CRM can be achieved by:
Using Social media  Facebook insights is a good example because customers (likers) can be tracked and communicated
with.
Transparency  This involves informing the customers about every detail of the product, material used and features (The
Body Shop does it).
Customer Service/Support Centres  This is very important to create long-lasting impression and loyalty. Recently, many
telecom companies were criticised for providing false support, poor response levels and poor information to its customers.
Many businesses now focus on improving these.
Understanding the Target Market  Analysing customer past purchases and feedbacks. This helps in improving existing
products and installing features in them most required by the customers. For instance, mobile companies started making
large handsets because it was a consumer trend, food manufacturers now use more organic ingredients because consumer
liked these.
What is a Product?
The term product includes consumer and industrial goods and services. The product decision involves deciding
what goods or services should be offered to a group of customers. An important element here is the new product
development (NPD). As technology and tastes change, products become out of date and inferior to those of the
competition, so companies must replace them with features that customer value. As new products are
developed that give greater benefit than old ones, market leadership can change.
For instance, the Samsung MP3 player was the market leader in digital music players, but following its launch,
the Apple iPod soon outsold the MP3 player. Samsung has been market leader in various consumer electronic
markets especially in flat-screen televisions.
New product development (NPD):
New product development (NPD) is crucial to the success of some businesses, for example, in the rapidly
changing world of computer games. In other markets, it is possible to sell the same product for many years or
to adjust and adapt it slightly to meet changing tastes and to enter new segments. One example of new product
development is Pepsi NEXT, a new low-calorie soft drink from Pepsi. Why is new product development so
important? There are seven possible reasons:
• Changing consumer tastes and preferences For example, the trend towards home cinemas means that a TV
manufacturer has to consider developing new products in this market segment to remain competitive.
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• Increasing competition Apple started the smartphone revolution, yet it cannot stand still as competition is
greater than ever in this market. The iPhone 11 Pro had just been launched when this book was written. What
is the latest version now?
• Technological advancement It took Dyson 15 years, with thousands of failed attempts, to make a bag-less
vacuum cleaner operate successfully. Now all vacuum manufacturers have adopted similar technology.
• New opportunities for growth If the existing markets a business operates in are mature and no longer
growing, then developing products for new markets is essential for further growth. IKEA now offers complete
kitchen design and installation services.
• Risk diversification Climate change pressure groups are succeeding in forcing governments to place limits
on carbon emissions. Oil and gas companies are investing in new forms of renewable energies to create sources
of revenue and profit to address the risk of falling demand for oil.
• Improved brand image For example, by developing the Lexus brand of luxury cars, Toyota has taken the
strategic move to improve the overall image of the company.
• Use of excess capacity For example, hotels increasingly offer spa and beauty treatments to increase demand
for empty hotel rooms (excess capacity).
Unique Selling Point (USP):
Extending the concept of NPD further, an important aspect related to it is the Unique Selling Point (USP). It can
be defined as differentiating a product from competitors’ and offer something special (unique). It is important
that products are well differentiated from the close substitutes so that a business can distance itself (positively)
from competition.
An effective USP can give following benefits to the business:
 Chance to charge higher price due to exclusivity.

 Effective promotional campaigns
 Free publicity by word of mouth if loyal customers spread the word.
 Higher level of sales because product or a service is one of a kind.
 Customers feel attached to the brand make a self-image of them being associated with the brand. Typical example
can be of Converse shoes or UGG trademark winter shoes.
Important concept related to Product:
With a solid understanding of the term ‘Product’ established, it is now feasible that its individual components
are discussed in detail.
1. Product vs Brand
A brand is an identifying symbol, name, image or trademark that distinguishes a product from its
competitors. A product, on the other hand, carries the brand on itself and is the result of a lengthy
production process.
A laptop is a product sold in the market. The term laptop will include all kinds of laptops in the market.
Dell is a brand. Dell uses its logo and design to distinguish its product from the competitors.
2. Tangible and intangible attributes

A brand includes all names, symbols, characters or product features that allow customers to distinguish
your brand from competitors. These detectible symbols are tangible. The intangible parts of a brand
are the subjective opinions, meanings and perceptions customers take from these brand traits. For
example, ‘I like Mercedes S600 model because it is the most luxurious car in its class.’
3. Product Positioning
Product positioning is at what level or what perception the consumer of your target market keeps for
your brand. These levels can be defined on various terms but normally price vs quality dimensions are
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used. Marketers can use this perception to understand their position in the market when they will
launch a new product and can make market maps (perceptual maps).
If correction analyses about positioning is made, the brand will be designed in a way that will definitely
appeal to customers. Marketers will identify core aspects of a brand that matter most to the consumer.
As mentioned above, these core aspects are normally price and quality. Consider a perceptual map
below and fill it out by using some brands known to you in a particular product category. You can work
in groups.
4. Product life cycle

Before understanding product life cycle, let us first go through the concepts of product portfolio
analysis and product line.
Product line is the group of related products sold by one single company. For example, NIKE’s product
line includes sports equipment, sports apparel and sports shoes. These lines can be separated on the
basis of sports, gender and age. Take for example Nike Shoes. Shoes for adult women, men and children
can be a different line. These lines can be further separated in terms of sports such as tennis male adult
shoes, tennis children shoes or tennis female adult shoes.
Product portfolio is analysing the range of a company’s existing product line to help allocate resources
effectively between them. This way, a company can prevent failure if it suspects a diminishing product
line and can work well within time to make it popular again. How company’s actually do this? The
answer is Product life cycle.
Product life cycle is the pattern of sales recorded by a product from launch to withdrawal from the
market and is one of the main forms of product portfolio analysis. A classic product life cycle has four
stages; introduction, growth, maturity and decline. The period of research and development is not
included in product life cycle because at that stage the product is still under process and has not yet
come to life (come to the market).
 Introduction stage: The product has just been launched but sales are low. There is high expenditure on
advertising and its further research and development. An example can be of 3D televisions. As consumers
widely accept the new technology, it will be mass produced later on.
 Growth stage: After successful and heavy advertising, sales can grow but it will not last long as
competition enters the market or new technology is introduced or consumer tastes change. An example
can be of Blu-ray discs which are now widely accepted and is picking up growth.
 Maturity (saturation) stage: Sales now fail to grow any further but sales level will be continuous and may
last for years. DVDs can be an example as they have matured enough and has global acceptance.
 Decline stage: Sales will experience and steady decline because no ‘extension strategy’ was introduced.
The product is eventually withdrawn from the market. Video cassettes can be an example of declining
product as newer technology is easily and widely available.
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Extension strategies are marketing techniques or tools which extend the maturity stage of the product
before a brand new one is needed or to be introduced later. A company can do this by:
 Selling product in a new market (in a new country)
 Introduce a new packaging
 Introduce a new range (new flavours/fragrances of shampoo)
 Relaunch with a new brand logo (Pepsi did it recently)
 Find new uses for the product (P.E.T bottles have many other uses)
Uses of Product Life Cycle:
The product life cycle has three main uses.
- Assisting with marketing objectives, marketing strategies and marketing mix decisions (See table below).
- Identifying how cash flow might depend on the cycle.
- Recognizing the need for a balanced product portfolio.
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1. Assisting with marketing objectives, strategies and marketing mix decisions

INTRODUCTION GROWTH MATURITY DECLINE
Strategic marketing Build Build Hold Harvest/manage
objective for
cash/dissociate
Strategic focus Expand market Penetration Protect market Productivity
share/innovation
Brand objective Product Brand Brand loyalty Brand
awareness/trial preference exploitation
Products Basic model Differentiated Differentiated Rationalized
Promotion Creating Creating Maintaining Cut/eliminate
awareness/trial awareness/trial/ awareness/repeat
repeat purchases purchases
Price High Lower lowest Reduction
Distribution Patchy Wider Intensive Selective
2. Identifying how cash flow might depend on product life cycle
 Cashflow is usually negative at development stage because the product has not yet been sold.
 During introduction, development completes and product is finally selling. However, there are
extensive promotional costs (as seen in table above) which will take much of the sales revenue
and incur additional expenses.
 At growth stage, advertising expenditure will still continue in order to obtain more sales but
cash flow negativity is quickly absorbed. It is important to know that cashflow will heavily
depend on the credit offered to consumers or credit taken from suppliers.
 During maturity, positive cashflows final come in because of high and sustained sales, lower
promotional expenditure and some level of customer loyalty.
 At decline, prices see reduction because sales are falling. Level of positive cashflow falls. To
prevent this, the product line concept comes in which is discussed again later.
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3. Identifying the need for a balanced product portfolio
The above graph shows an ideal position for a business to be in. As soon as product A is coming out of
maturity stage, another product B comes in to play and save the company from failure. This was
cashflows can be managed because a company has various products at different stages of product life
cycle ready to off-set the negative effect of other non-performing or declining products and also cover
the costs of products in development stages.
Evaluation of Product life cycle:
 Not all products follow the classic S-shaped curve. The sales of some products rise like a rocket and
then fell like a stick. There are several products that have denied to enter the decline stage such the
very famous Snickers and Mars chocolate bars.
 Product life cycle is the result of marketing techniques and has not occurred naturally. Clearly, the sales
of a product may flatten out just because it may have not received much marketing attention.
 The individual stages of product life cycle is unpredictable. This limits its use as a forecasting tool since
it is not possible to predict when maturity or decline will begin. However, a company can carefully
monitor the competition and rising trends to predict with some accuracy but it will involve much
research costs and time.
Like many marketing tools, the product life cycle should not be viewed as a remedy to marketing thinking
and decision-making, but as an aid to managerial judgement. It should be used with proper marketing
experience and sales forecasts.
It is important to understand that product cannot just be launched and forgotten but they must be
managed, further developed and marketed to make it a decades’ long success. However, product is just one
part of overall marketing mix strategy. Price, promotions and place are also key factors in making products
successful.
Boston Matrix – Product Portfolio Analysis:
It is matrix that helps in analyzing the product portfolio of a business in terms of two main elements of market;
the market growth rate and market share. It was developed by Boston Consulting Group and it aims to guide
firms in strategically managing their extensive product portfolios. See the diagram below:
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1. Low Market Growth – High market Share  CASH COWS:

 Product exists in a mature market and its position is well established.
 Helps in creating high cashflows which are continuous.
 Lower promotional costs because of brand loyalty created years ago.
 Cash injections from these products is milked (transferred) to other needy products such as dogs and
problem child.
2. High Market Growth – High Market Share  STAR:

 A well performing product in an expanding market.
 Expanding markets may take up many dimensions so promotional costs will be high for STAR.
 Promotion is important to reinforce the product and differentiate it from growing competition
as well.
 Quick revenue in a short period of time can be generated.
3. High Market Growth – Low Market Share  PROBLEM CHILD:

 A product in a new market with a lot of uncertainties.
 Consumes many resources such as finance on R&D and promotions but returns low. Resources
may come from cash cows.
 If success does not come as expected then divesting or building may be required (see below
for divesting and building).
 Promises high potential if redesigning and relaunching is successful.
4. Low Market Growth – Low Market Share  DOG:

 It exists in a failing market. The market fails probably because competition has better product
or consumer tastes have changed.
 It offer little to the business and may be considered for withdrawal from market.
 It can point out when a firm needs a new product or shall it look into a completely new market
(international).
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Relevance of Boston Matrix to Marketing Strategy:
The application of Boston Matrix to product portfolio will help a business to focus on which products need
support or which need corrective action. These actions can include following strategic moves:
a. Building:
Building can be done for problem child products by doing additional advertising so that market share
can increase by repetitive purchases by consumers. Moreover, additional distribution channels such as
new wholesalers can be sought out. This strategy requires finance which can be provided by established
Cash Cows.
b. Holding:
Star products need explicit holding strategy whereby they can maintain their market position. They can
provide a business with quick cash. Strategically, it is important that these products are “refreshed” so
that market growth and share can be maintained.
c. Milking:
Taking the positive cashflow from established products and investing in other products in the portfolio.
These established products are cash cows but they also need to be maintained at the level which they
are so that continuous inflow of money is kept within the business.
d. Divesting: This strategy could be applied to Dogs by stopping their production and supply probably
because they are not even covering the variable costs. This strategy must be applied carefully because
of its impact on the workforce or a business unit which was responsible to produce this product.
Advantages of Boston Matrix:
 It highlights the position of each of the firm’s products when measured by market share and growth
and also highlights those products that might need action to be taken at strategic level.
 It can help in devising future strategies of a firm regarding managing products in the portfolio i.e. which
ones to divest and which ones to support.
 It may also guide a business when is the right time to introduce new products.
Limitations of Boston Matrix:
 It avoids external influences on product portfolio such as competitors’ actions, technological changes
and economic environment of the country.
 It cannot predict future success of the product, which is dependent upon extensive research and
development.
 The assumption is made that higher rates of profit are directly related to high market shares – this is
not necessarily the case when sales are being gained by reducing prices and profit margins.
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Price (as a key element of Marketing Mix):
Price is the odd-one-out of the marketing mix, because it is the revenue earner. The other three elements of the
marketing mix – product, promotion and place – are costs.
The price of a product is what the company gets back in return for all the effort that is put into producing and
marketing the product. It can also be defined as the amount customers pay for a product in order to consume
it. Therefore, no matter how good the product, how creative the promotion or how efficient the distribution,
unless price covers costs the company will make a loss. Managers need to understand how to set prices, because
both undercharging (lost margin) and overcharging (lost sales) can have dramatic effects on profitability.
One of the key factors that marketing managers need to remember is that price is just one of the element of the
marketing mix. Price should not be set in isolation; it should be blended with product, promotion and place to
form a uniform and logical (coherent) mix that provides superior customer value.
Setting the prices:
Understanding how to set prices is an important aspect of marketing decision-making because price levels will:
- Determine the degree of value added by the business to bought-in components.

- Influence the revenue (price x quantity sold) and profit (revenue earned – costs paid) made by a
business due to impact on demand.
- Reflect on the marketing objectives of the business and help establish the psychological image and
identity of a product.
Many people’s introduction to the issue of pricing comes from Economics. We will now consider, very briefly,
some of the ideas discussed by economists when considering price.
Demand:
Price directly affects the level of demand for a product made by consumers. Demand can be defined as the
willingness and ability of consumers to buy goods and services. In economics, the law of demand states that as
prices tend to rise, the demand for products made by consumers tend to fall and vice versa.
Price ↑↑ Quantity demanded for a product ↓↓

Price ↓↓ Quantity demanded for a product ↑↑
The demand curve above shows that as prices of Ketchup tend to increase, the level of quantity demanded for
a ketchup tends to fall. The demand curve is downward sloping.
Non-price Factors influencing demand:
- Income of consumers
- Prices of substitute goods and complimentary goods
- Population size and population structure
- Fashion and taste
- Advertising and promotional spending
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All non-price factors of demand will shift the level of demand curve and create a new demand curve.
Supply:
Supply is the willingness and ability of producers to supply goods at various levels of price. In economics, the law
of supply states that as prices tend to rise, the supply for products made by consumers tend to rise and vice
versa.
Price ↑↑ Quantity supplied for a product ↑↑

Price ↓↓ Quantity supplied for a product ↓↓
Non-price Factors influencing supply:
- Cost of production such as increase or decrease in material cost or labour cost

- Government taxes such as sales tax or any other indirect tax
- Government subsidies given or revoked
- Weather conditions especially in the case of agricultural goods
- Advances in technology which can lead to lower production costs
All non-price factors of demand will shift the level of supply curve and create a new supply curve.
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Equilibrium price:
Equilibrium price is that price where the level of demand and supply are exactly equal. The diagram below shows
what will happen to the market of gasoline if price rises above or falls below the equilibrium price.
The pricing decision – how do managers determine the appropriate price?
There are many determinants of the pricing decision for any product. Here are the main ones.
i. Cost of production
Price must be set at that level which covers the costs incurred in making a product. These costs include
variable costs (they change with level of production) and fixed costs (these do not change with level of
production).
ii. Level of competition

If a firm is a monopoly or has the highest market share, it will be price setter. Desired prices can be
charged. However, if high level of competition exists then prices may be set similar to that set by the
competitor.
iii. Competitors’ price

Many businesses closely follow the price variation of its closest competition. A business can avoid this
if it has a USP in its product which will justify an increased price level compared to that of the
competitor’s.
iv. Business and marketing objectives

Prices may vary according to the objectives set by a business. For instance:
- A business aiming to target niche market will charge high prices because it will be offering premium
product.
- A business dealing in mass market will follow the general trend of price.
- Establishing a premium brand cannot be justified by rock bottom prices so prices are set high.
- A newly developed product may need to penetrate the market by the means of low prices
(penetration) or by high prices (skimming).
v. Price elasticity of demand (P.E.D)

This will be discussed in A-level syllabus.
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Pricing Methods:
A business may choose a combination or a single type of pricing method to set an ideal and justifiable price for
its product. These types are discussed in detail below.
A. Cost-based pricing
In this, prices are set in accordance to the costs incurred by the business. Normally, total cost of producing a
single unit is calculated and on it, a margin is charged which actually earns the profit for the business. There are
a number of methods of cost-based pricing that may be adopted.
1) Mark-up Pricing
In this, a fixed mark-up percentage on the cost of product or on the price of bought-in materials is
added to get a final selling price. This fixed percentage of mark-up will depend on factors such as
demand level for the product, number of suppliers of the same product or the age of the product. For
instance, a retailer buys a branded t-shirt of a new design from a producer for $50. He wants to add a
mark-up of 50% on the bought-in price because he forecasts higher demand for the new design.
Total cost of bought-in materials $50
Mark-up percentage = 50% = $25
Final selling price to consumer = $50 + $25 = $75.
2) Contribution Cost (Marginal Cost) Pricing

** Total Cost = Total Fixed Cost + Total Variable Cost.
As explained earlier, fixed costs are those costs that do no change with the level of output. Example can
be of rent of premises that remains same every month. Many businesses add a percentage on the cost
of production to arrive at a price. However, there is a concept of contribution (margin) that also helps
in setting up a price level. Here is how it works:
Contribution means how much money is being ‘contributed’ towards covering fixed costs incurred by a
business while production. It is important for any business to cover its fixed costs otherwise it will go
bankrupt because fixed costs have to be paid no matter if you produce anything or not. Therefore,
businesses calculate a contribution margin which they add to the cost of the product. Take a look at
this example.
Melon Enterprise produces fruit jellies. Monthly rent of the factory is $6000. Variable cost of producing
one unit of jelly are as follows:
Labour wages = $1
Electricity = $1
Raw materials = $2
Total variable costs amount to $4. Melon must sell the product at least at $4 so that it does not make
a loss. However, it also has to cover its fixed costs of $6000. For this, Melon adds a contribution of $2
per jelly to the $4 cost of the single jelly. Therefore, the final price it arrives at will be $6/jelly.
Here we notice two things. Variable costs are already covered at the price of $6 because it was $4. Now
the question remains of covering fixed costs of $6000. These fixed costs are covered by the additional
$2 added as contribution. Melon must sell ($6000/$2) 3,000 units of jellies to cover all the costs because
every unit sold will add $2 contribution towards covering fixed costs. Any additional jelly sold will start
giving profits to the firm.
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Firms use this pricing method when they are producing a range of products in the factory. Then they
decide which product’s contribution quickly covers the fixed costs and start giving profits and they go
ahead with it. Those products that do not contribute positively or contribute slowly towards covering
fixed costs and giving back profits are thrown away from production.
3) Full-cost (absorption-cost) pricing:
In this, a full cost of producing a single product is first calculated. This cost of producing a single unit is
called as ‘unit cost or average cost.’ Then a fixed profit margin is added to this cost to arrive at a price.
Here is an example.
Pakola makes ice-cream soda drinks. It has a yearly fixed overheads of $10,000. The variable cost of
producing a single bottle of ice cream soda drink is $1. This year, Pakola has produced 5,000 units of
soda. Total costs will be as follows:
Total Cost = FC + VC
TC = $10,000 + (5,000 x $1) = $15000
Unit cost = $3
Pakola must charge above $3 to make a profit. So it decides to add a fixed margin of 100% on the
average cost of $3. The final price will be $6 [$3 + $3].
B. Competition based pricing
This pricing strategy states that a firm will set its prices according to that of its competitors. If there is strong
competition in a market, customers are faced with a wide choice of who to buy from. They may buy from the
cheapest provider or perhaps from the one which offers the best customer service. But customers will certainly
be mindful of what is a reasonable or normal price in the market.
An advantage of using competitive pricing is that selling prices should be line with rivals, so price should not be
a competitive disadvantage. The main problem is that the business needs some other way to attract customers.
It has to use non-price methods to compete – e.g. providing distinct customer service or better availability.
There are several scenarios involved in competition based pricing.

 A market leader of a product usually is the price setter. Other firms which are smaller in scale but are
providing similar kind of product will ‘follow the price’ and will be price takers. If the price set by the
big firm is too low then small firms may be forced out of business because it just cannot set such a low
price.
 Oligopolies exist in markets. These are group of firms that offer the same service and charge a uniform
price. Typical example is of petrol suppliers. All petrol companies supply petrol at a uniform price to
avoid ‘price wars.’
 Destroyer pricing also exists when firms note the price of competitors’ products and then deliberately
undercut them in order to try force them out of market.
 Market based pricing also exists where price is charged according to the market preferences (demand
and supply). A number of different pricing strategies come under the heading of market orientated
pricing.
 Perceived value pricing: In this, prices are set according to what consumers perceive or think about the
value of the product. The more prestigious the brand, the more value consumers perceive hence, more
price can be charged. Example can be of Hugo Boss clothes.
 Price discrimination: This pricing can only happen where different prices can be charged for different
consumers for the same product. Example can be of an exporting business that charge different prices
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for different countries because buyers do not have complete market information. Other example can be
of airline tickets.
C. Pricing strategies for new products:
This is divided into two different types.

i. Penetration pricing: Prices are set relatively low in order to penetrate (break through) into a
market where competition is already very high. The effect of low prices is off-set by high sales
volume supported by influential advertising campaigns. Firms use this mass marketing strategy
to gain high sales at the beginning to capture a suitable market share. Example can be of Good
Milk as compared to that of Milk Pak or Olper’s.
ii. Price Skimming: Prices are set very high at the beginning because either the product as
inelastic demand or it has a very unique selling point to offer. The prices go down after some
time as competition enters the market and start copying or provide a better product. Here,
short-term profits are high but as competition enters, prices must go low.
Many firms that invest a lot of money in latest technology for the collective good of society are given a
fixed time period during which they are legally allowed to exploit consumers by charging a high price.
This is legal so that these firms can cover their research and development costs and make profits. Later
on, new firms are allowed to copy the product or produce similar kind of product to increase the supply
of the product for welfare of consumers. An example can be of improved drugs and medicines,
technological equipment and communication innovations.
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Additional Pricing Issues:
Loss Leaders:
Loss leading means selling an expensive product (profit making product) along with a much reduced price
product which acts as an attraction or motivator towards purchase. These reduced price products motivate the
instance of sale being made by consumer but also forces the consumer to buy with it an expensive product. For
example, buy 2 fish fillets (expensive) and get one chicken nuggets pack (cheap) free. The chicken nuggets
become loss leader.
Psychological Pricing:
Firms set the prices of their products just below a key price level in order to make them more attractive. Such
as, $2.99 instead of $3 or $995 instead of $1000. Another type of psychological pricing is when firms set prices
according to the consumer general perception about a product. For example, perfumes are normally very
expensive. A firm selling a nee perfume at a lower price may not be able to an impression on consumer just
because he/she thought that its low price would mean a cheap fragrance. Same applies for setting a very high
price for an average rated product by consumer. Sales would fall because high price was just not justifiable or
inappropriate.
Evaluation of pricing decisions:
 Firstly, prices must justify the whole of the marketing mix. High price may not often mean high quality.
Consumers are impressed by the complete feel of their purchasing experience and price must include
all these experiences. Therefore, when setting a price, a marketing manager must ask that will this price
justifies the provided ‘value’ to the consumer. A restaurant charging high prices for its very famous
signature dish but its ambiance is poor and service quality is poor cannot justify the whole experience
and value for the customer.
 Secondly, many consumers perceive the status of the product on the basis of its price. Consumers see
their own lifestyle when consumer a product. The prices set must also reflect these aspects. A
prestigious product offered at low price may not go hand in hand with other elements of the marketing
mix and the whole brand image can be destroyed. This is why luxury wrist watches cannot afford to
lower their prices even, if competition is quickly picking up, just because it is a matter of company’s
long established prestige and brand image in eyes of consumers.
 Level of prices can have powerful influence on consumer purchasing behaviour that marketing
managers should ensure that market research is used to test the impact of different levels of price on
potential demand.
 Firms must use different pricing strategies for its product portfolio. It is because market conditions and
dynamics vary for every product it will sell.
 A business must ensure that its price is covering every single cost it is incurring while producing goods
and services. Not only this, the price shall also give profits.
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Chapter 13: The Marketing Mix – Promotion and Place

Introduction:
Previously in chapter 12, the role of first two Ps of marketing – Product and Price – were discussed. No matter
how good the product and how reasonable the price is, businesses must find best and effective a way to
communicate with customers. This is the role or promotions.
As far as Place is concerned, it refers to how the product will be sold to the customer, meaning, the channels of
distribution used from producer to consumer. We will look at the both the remaining Ps in full detail in this
chapter to wrap up marketing mix.
Promotion and its importance:
Promotion is defined as the use of advertising, sales promotion, personal selling, direct mail, trade fairs,
sponsorships, social media, e-commerce and public relations to inform consumers and persuade them to make
a purchase.
Good communication are the lifeblood of successful market-orientated companies and their brands, but creating
good communication systems is always a challenge. Companies mostly communicate what they stand for and
the benefits they have on offer related to their product. However, the way businesses communicate with
customers is constantly evolving.
Currently, digital technology is reshaping the tools through which businesses communicate. Social media are
used by companies and individuals as a means of extending their communications network. This increase in
number of opportunities to communicate has created a greater need for coordination of all of the organization’s
communication activities. Promotion is important for marketing mix because:
 It increases awareness about the product.

 Effective and well-designed promotion campaigns can create a unique brand image and personality of the product
and the company itself.
 Promotional campaigns are very expensive so it is important that companies spend on them wisely.
 Promotions trigger the urge in consumers to make a purchase.
 It is a sign to the competitors that a business is active ready to compete in the market.
Promotional objectives:
Like any other departmental objectives of an organization, the promotional objectives are also in-line to achieve
the organizational objectives. These objectives are as follows:
 Increase in sales of NPDs by informing and persuading customers to buy the product.
 Increase in sales of existing products by the means of persuasive advertising.
 Promotions gives chance to demonstrate the unique qualities of the product as compared to that of competitors
(very common in Pakistani telecom agencies).
 Main promotional objective is to create the brand’s personality because substitutes are available for every kind of
product. There needs to be some sort of differentiation.
 Correct the misleading reports about the product (Lay’s Pakistan used a religious scholar Junaid Jamshed to certify
their chips as completely Halal on television promotion).
 Promotion can be used to enhance the corporate image. For instance, Pepsi Pakistan used the promotional
campaign of providing electricity to rural areas of Pakistan by using their used bottles as covers for light bulbs.
 Encourage retailers to stock and actively promote products to final consumers.
The promotion mix:
In order to effectively send the desired message to the target audience, a suitable promotion mix is needed in
which various forms of promotional strategies will be used. It is the combination of promotional techniques that
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a firm uses to sell a product. The promotion mix can be divided into two major types; ‘above-the-line’ promotion
and ‘below-the-line’ promotion.
“Above the line” promotion is that in which the business pays for the communication with consumers. This
promotion is done when the message is needed to be sent to a mass audience. A typical example is of Advertising
which is discussed below in detail.
“Below the line” promotion is that in which the business does not directly pays for the communication with
consumers. This promotion is done when the message is needed to be sent to a limited audience so it is more
focused. A typical example is of Sales promotion discussed in detail below.
Advertising (Above the line):
It is also known as above the line promotion. Advertising is simply any paid for non-personal communication of
ideas or products in the primary form of media such as televisions, the press, outdoor, cinema, radio and the
internet. These advertisements are usually directed towards the appropriate large target market by selecting
the right media – but it is possible that many people who are unlikely to purchase the product may see the
advertisements too. Advertisements, in their essence, are of two types:
Informative Advertising:
- Main aim is to give exact and relevant information to the consumer of the product.
- Creating brand image is not the aim here but the advertisement can be designed in a way that its content can
create its image in the eyes of consumer.
- Informs consumer about the price and variants in the products.
- Can also be used if brand logo is changed, price is changed or new packaging is introduced.
Persuasive Advertising:
- Main aim is to persuade (convince or force) consumers to buy the product instead of the competitors’.
- A distinct image or brand identity is shown in these promotions.
- Mostly used by those companies who make mass products which have many close substitutes and differentiation
is necessary.
- Example can be of tempting advertisement of Coke Zero which recently aired on Pakistani channels showing a cold
glass of sparkling Coca Cola.
Advertising Methods:
- Print advertising including magazines, newspapers, specialist publications.

- Broadcast advertising on TV, cinema and radio.
- Outdoor advertising on billboards and on buses.
- Product placement on movies and shows.
- Guerrilla advertising on unconventional places such as graffiti or a staged performance.
Advertising Agencies:
Making an advertisement that reflects the purpose and features of the product is task of a genius. There are
specialist agencies who advise businesses on the most effective way to promote their products. These agencies
can provide a complete promotional mix and this can be invaluable to a business that does not have its own
marketing experts. The tasks done by advertising agencies involve:
- Conducting market research to identify a typical consumer profile.

- Devise the most cost-effective way of promotion.
- Use their design team to produce adverts.
- Film the advertisements or print them (animations, pictures, videos).
- Monitor the public reaction and evaluate the effectiveness of the campaign (success or failure).
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Which media to use?
Entrepreneurs usually think the more budget they invest the more successful the advertising campaign will be.
This is not always the case. The issue is selecting the right media to showcase the advertisement. It can be done
by the following tips:
1. Cost:
TV, cinema and radio can be very expensive. Super Bowl ads in the USA costs millions of dollars to the companies
for just few seconds of the ad. Costs of advertisements on TV and radio depend on which time of day it is being
aired. Press ads on the front page are very expensive because that space is precious. The costs of advertisements
further increase if celebrity endorsements are being done or filming at a posh location. The issue of cost now has
been reduced to none thanks to social media platforms which are virtually free.
2. Size of Audience:
If the size of target audience is big, a mass media like TV will be suitable. Marketing managers carefully calculate
their target audience and divide their advertising cost per member of audience. The greater the size of audience,
the greater the cost will be but the greater the chances of reaching the right customers.
3. Profile of Target Audience:

The profile of the target audience will include their age, income, interests and so on. Consumer profiling is
important for advertising so that it can serve the exact purpose it was aimed for. For instance, most house cleaning
products are advertised during afternoon time when housewives are free from domestic duties and have some
spare time. Similar case is with morning shows. Children advertisements are not shown after 9pm because they
sleep at that time.
4. Message to be communicated:
Written forms of communication is most effective (newspaper ad or pamphlets) especially when the information
to be delivered is long and vital. Example can be of ad in the newspaper for admissions opening at a university
which not only details the advertising procedure but also shows the list of courses for potential students
(customers) to check and refer to.
5. Legal constraints:
Recently in many countries, the advertisements of face whitening beauty creams have been banned because it
created inferiority complex among women who had dark complexion. Moreover, the last time a cigarette ad was
seen on TV was back in 2000 when Morven Gold ad used to air on Pakistani media. These ads were banned because
they promoted a harmful product to the masses. For these products, other forms of media such as direct mail or
personal selling will be useful. Moreover, in the UK the ASA (Advertising Standards Authority and Ofcom regulates
the use of true and honest advertisements.
Advertising Expenditure and the Economic Cycle:
 Most countries tend to spend more when the economy is booming than when it is in recession.
 Is spending less on promotion during a recession the right strategy to adopt? It could be argued that
adverts are needed most when sales are slowing down-perhaps consumers could still be encouraged
to buy if they were exposed to really influential adverts.
 There are some who believe that advertising is a luxury that can be afforded only when sales and profits
are booming.
Sales Promotion (Below the line):
It is also known as below the line promotion. Most business practice sales promotion because it helps in
achieving short term increase in sales. Advertising, as discussed above, was used to benefit the business for the
long run because it has long-lasting effects. Sales promotion itself is an umbrella term and cab divided into
various practices such as:
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 Price Deals: This is a temporary reduction in price for a fixed period of time after which the deal expires.
 Reward Cards: These are points system which are recorded on a card issued to loyal customers only. To claim
loyalty, a customer has to spend a certain amount of money (Privilege card of NEXT) or must stay with the business
for a specified period of time (banks do this). These points can be redeemed later on instead of money.
 Money off coupons: These are coupons that act as a discount on the next purchase. Businesses may apply
conditions on these coupons such as a customer has to spend certain amount of money to avail a coupon for the
next time they shop.
 Point of sale displays: Attractive displays of products being centrally placed in a shop.
 Buy one get one free: Get a free product on purchase of a specific product.
 Games and competition: Many product packaging are interactive means they have games on them or a code that
can be used online to play games and win prizes. Moreover, products have competitions based on lucky draws of
luxury items.
Can you think of advantages and disadvantages of these sales promotion methods?
As noticed above, these forms of sales promotion are directed to stimulate purchase of a product. Sales
promotion can be directed either at:
 The final consumer, to encourage purchase. This is known as PULL STRATEGY.

 The distribution channel, e.g. the retailer, to encourage stocking and display of the product. This is
known as PUSH STRATEGY.
Other forms of Promotions:
I. Personal Selling:
This is when a company’s representative visits the potential customer to sell them a product. This is
usually expensive and reach to the target audience is very limited. It is applicable to industry related
such as heavy machinery which cannot be displayed in a shop or cannot be advertised on televisions.
Have you ever seen an advertisement of an agricultural harvester? Many businesses which deal in
expensive and unique items also use personal selling such as cars, home improvements, furniture or
medications. It is important that sales staff are well trained and are well qualified in order to make
better communication. Market research surveys show that many customer complain about the
convincing nature of salesmen and they later regret their purchase decision.
II. Direct Mail:

For instance, you buy shoes from a local retail shop and they request for your number and address
saying that they would like to keep in touch with you for future promotions and new arrivals. You
happily give it. After a month you receive a text message or a mail which informs you about upcoming
winter collection at their store with pictures of shoes. This is a typical example of direct mail whereby
business directs information to potential customers. As they are extremely customer focused so very
cost-effective. A disadvantage can be that mails be ignored.
III. Trade fairs & Exhibitions:

China’s Canton fair and Shanghai Textile Fair, TEDx, CES and IDEAS Pakistan are one of the biggest trade
fairs in the world. These fairs or exhibitions are not directed towards the final customer but are
intended for ‘trade’ purposes with wholesalers and retailers. Selling is not done at trade fairs but the
intention is to make contacts and create awareness about new products.
IV. Sponsorships:
Sponsorships is a payment by a company to the organizers of an event/famous individual/sports team
so that the company name become associated with that event/famous individual or sports team. The
Olympic Games at London in 2012 saw total sponsorship money of £1bn in which Coca Cola, ACER,
McDonalds, Panasonic, VISA and Samsung contributed $100mn each (The Guardian, 2012). Events like
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the Olympics and other sporting events such as Wimbledon, Tour De France, and season ending F1
Dubai Grand Prix or UEFA Champions League final attract global audience of billions. Sponsoring these
events can create publicity to a scale which is impossible to achieve via TV or any other media.
V. Public Relations (PR)

Many multinational companies have established PR departments with the sole aim to establish positive
relationship with media outlets for free publicity of their brands and so that they can portray a positive
image of the company. Apple’s keynote which happens every year in September is no less than a PR
event. They invite famous journalists and media persons to test the prototypes with the hope that they
will publish their reviews in the press which will be read by millions of potential consumers out there.
PR departments are also responsible to repair the damaging image of the company in case of an
unfortunate event. Samsung Galaxy Note 7 faced severe backlash from consumer safety groups from
around the world and its PR team failed to overturn the issue and Samsung was forced to recall the
product at a global level.
The Concept of Digital Promotion:
Promoting the brand or product through digital platforms such as email, social media applications, search engine
optimisation (SEO) and Viral Marketing.
Email marketing:
Email marketing connects with customers within their own mailboxes. It is a well-established method of
increasing brand loyalty and selling more products to existing customers. There are many different ways
businesses can reach out to customers through email marketing, including:
• Newsletter campaigns • Purchase confirmation emails • Thank you emails • Email notifications about new
products.
Social media:
There are many social media platforms businesses can choose to use. Promotion managers need to consider
Facebook, Twitter, Instagram and other platforms, and decide which are most relevant to the target group of
consumers they are trying to communicate with. Twitter and Facebook advertisements, hashtag campaigns and
influencer marketing are among the most popular methods of social media marketing.
Search engine optimisation:

Businesses that use e-commerce (sell online) locate their websites on search engines such as Google, Bing, Yahoo
and Baidu (China). They need to use SEO to make sure that their content appears among the first results of a
search. Without SEO, it is very difficult indeed for a business trading online to remain competitive.
Viral Marketing:
A marketing technique that uses social media networks to increase brand awareness of products and services.
Idea is to generate an 'infection' of thought among the base users which is passed on and multiplied. Advantages
of viral marketing includes:
- Viral marketing adds to the traditional methods of marketing the messages of a business.
- Viral marketing can build brand recognition very quickly.
- Viral marketing may well be a highly effective and cost efficient tool in the marketing mix in exploiting
social networks to produce exponential
- Increases in brand awareness.
- Viral marketing becomes very attractive as traditional channels become more competitive and
expensive.
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- Very attractive to start-up ventures with limited marketing budgets and can deliver outstanding results
in a short space of time.
- Viral marketing needs to be integrated with the other variables in a marketing mix, and can significantly
improve a marketing ROI.
So viral marketing can be an important part of a marketing strategy, but there are risks as controlling something
going on viral is difficult.
Benefits of digital promotion:

• Worldwide coverage – a website allows businesses to find new markets and trade globally, increasing potential
market size.
• Relatively low cost – a well-planned and well-targeted digital marketing campaign can reach the right
customers at a much lower cost than traditional forms of advertising.
• Easy to track and measure results – web analytics and other techniques of measuring response rates make it
easy to establish how effective a promotion campaign has been.
• Personalisation – Each customer can be made to feel that only they are being sent a special offer.
• Social media communication builds customer loyalty – involvement with social media and quick responses to
customers’ messages can build customer loyalty and create a reputation.
• Content marketing – digital marketing allows a business to create engaging campaigns using content
marketing. This means producing varied content such as images, videos and articles, which can help a business
gain social currency, especially if it goes viral.
Limitations of digital promotion:

• Time-consuming – unless a digital promotion agency is used (which can be high cost), tasks such as optimising
online advertising campaigns and creating marketing content can be time-consuming.
• Skills and training – employees must have up-to-date knowledge and expertise to carry out digital marketing
with success. Tools, platforms and trends change rapidly.
• Global competition – reaching a worldwide audience is easy but this means competitors can do so too!
• Complaints and feedback – unhappy customers can quickly send out negative messages about a business or
its products. Any negative feedback or criticism of a brand can be visible to the target audience through social
media and review websites. It is essential for a business to respond quickly and effectively to such criticism.
The Concept of Branding:
The idea of branding is simple. It means to differentiate the product from those of the competition by the means
of assigning a name or a logo to the product. It has three main aims:
 Aiding the customer recognition

 Distinction of the product from competition
 Assigning an identity to the product that defines its personality which customers can relate to
The construction of the logos and assigning of names is very crucial. Too long a name can be forgotten. Too short
a name may be too vague or meaningless. It is important that the chosen brand logo and name is not registered
by any other firm to avoid costly legal consequences of copyright infringements. Many business try to create a
brand identity so that they produce products in the future under the same brand umbrella. This way, new
products get instant recognition and loyalty.
Advantages of Brand identity:
 Increasing the chance of brand recall by consumers when several similar products are available on the shelves.
 Reduce the price elasticity of demand as consumers show loyalty to the brand and ignore the price changes.
 Increase customer loyalty.
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Brand Extension:
Extending the brand means to increase the product range that carries the primary brand name and logo. This
can only be used if the brand itself has a very strong presence in a particular market and the extension must be
used in the same market as well. For instance, Phillips is a well-known electronics brand. It started in 1892 by
producing the carbon-filament lamps. Along the way it entered a similar market of consumer electrical products
and home appliances. Using the same name in this way helps to create a family of products and the advertising
of one supports sales of the other products too.
Promotion and the Product Life Cycle:
Promotion and product life cycle has a solid connection. An insight of their relation is given below:
Stage of product life cycle Promotional options

Introduction - Informative advertising for consumer awareness about price, features
and availability options
- Sales promotions by free samples to test
- Incentives given to retailers and stockists to sell the product
Growth - Some level of informative advertising but slowly shifting focus to
building the brand image/identity by persuasive advertising
- Sales promotion on larger scales
- Attempt to develop brand loyalty
Maturity - Advertising to differentiate product from competitors
- Few informative advertisements about new variations and reminding
people that product exists
- Sales promotions to maintain brand loyalty and creating new customers
Decline – assuming no - Minimal advertising to clear stocks from the market.
extension strategy - Sales promotion will only exist to flush out the product
Packaging:
It is the material by which the product is packed in order to protect it from the outside environment and prevents
from damage. Packaging is also used to showcase the brand logo and name of the product and it contains vital
information about the features of the product for the ease of consumers. Packaging can perform following
functions:
 Protect and contain the product

 Give information, depending on the product, to consumers about contents, ingredients, cooking instructions,
assembly instructions and so on
 Aid the recognition of the product from many substitutes
 Support the image of the product created by other aspects of promotion
Neat and attractive packaging gives an instant positive response from consumers and also stimulate purchase.
The best combination of colours is important which shall match the subtleness or funky element of the brand
image. In recent years, recycle packaging is gaining momentum because of increasing environmental pressures.
Can you recall any packaging of a product which was one of a kind?
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Place (An important part of Marketing Mix):
Place is the final ‘P’ in the marketing mix. Place decisions are about how products should pass from manufacturer
to the final customer. This process is known as distribution. Distribution, along with the location of services,
makes up the place element of the marketing mix. Products need to available in adequate quantities, in
convenient locations and at times when consumers want to buy them. Producers should not only consider the
needs of their ultimate customer but also the requirement of channel intermediaries (these are organizations
which facilitate the distribution of products to customers).
For example, success of Muller yoghurt in the UK was dependent on convincing a powerful retailer group (TESCO)
to stock the brand. The high margins which the yoghurt supported were a key influence in Tesco’s decision.
Without retailer support Muller would have found it uneconomic to supply consumers with its yoghurt. Clearly,
establishing a supply chain that is efficient and meets customers’ needs is vital for marketing success. This supply
chain is termed a Channel of Distribution.
Channels of Distribution:
These are the means by which products are moved from the producer to the ultimate customer. The choice of
the most effective channel of distribution is important because:
 Consumers sometimes require to see the product before they decide to purchase it (especially expensive
electronics equipment). This also allows easier return of goods if the service offered by the product was
unsatisfactory.
 Manufacturers need outlets for their products so that their hard-worked marketing strategy is completed. They
need market coverage integrated with the desired image of the product which place will try to reflect.
 Retailers’ margins need to be analysed. Retailers are penultimate intermediary. They stack up huge margins in
return to stock the manufacturer’s product in their shops. If price is important to the manufacturer, he may decide
to bypass retailer and sell consumers directly. The saved margin results in lower price to consumer.
The figure above draws out 4 types of channel of distribution. The selection of these channels will vary according
to the level of customer service to be offered to the final consumer. Where high customer service level is needed,
the producer would want to keep control of supply chain to himself rather than giving powers to other
intermediaries. Other factors that may affect the choice of distribution channel may include:
- Technicalities of the product  Industrial related products involves specialized and direct selling. Consumer goods
have more intermediaries because of less technicalities in its usage.
- Geographical dispersion of target market  If the target market is huge and widely dispersed then it is advisable
to use more intermediaries to support the supply chain system
- Unit value of the product  If the single unit costs a fortune, a collector’s edition Mercedes Benz for example, then
selling directly to the consumer would be fine. Selling a cheap new type of baby pamper personally will cost greater
than the unit value.
- Number of potential customers  Goods such as everyday soap or tea is used by millions and multiple times in a
day. These items can be sold by intermediaries to cover up all the customers. If selling a product whose customers
are very few such as oil paintings, air crafts or textile machinery then a single or no intermediary would be used.
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Benefits and limitations of the distribution channels:
Type and main feature Examples of products or Possible Benefits Possible drawbacks
services
Direct Selling: Zero - Organic market of fresh - No intermediaries mean - Storage costs to be
intermediary channel vegetables. saving up on the margins endured by the producer.
- Airline tickets sold directly which would otherwise be - Direct selling means
by the company. charged by retailers, consumers cannot try the
- Home furniture. wholesalers and agents. product first before making
- Complete control of a purchase.
manufacturer over - After sale services to be
marketing mix. offered by the producers
- Saves time. adding more pressure.
- Direct contact with - Transportation costs will
consumers which will help be higher as items would
in future market research. have to be delivered to
every customer.
One intermediary channel - Airline tickets selling via an - Retailers will be storing the - Intermediary will charge in
agent. stocks so producers don’t terms of profit margin
- Food manufacturers have to. which they will add on the
selling directly to retailers. - Retailers will take the pain price paid by consumer.
- Large supermarkets that of displays and offer - Producers lose control
hold their own stocks rather customer services. over the marketing mix.
than using wholesalers. - Producers can focus on - Retailers will also sell close
production and maintain substitutes of competitors.
quality. They may want incentives
to prioritise a particular
producer’s product.
- Producer will bear the
delivery costs to the
retailer’s shop.
Two or more intermediaries - Goods that have a mass - The wholesaler takes the - Wholesaler may take up a
market such as soft drinks, pain of buying the goods in huge margin because of the
clothing brands, consumer bulk from the producer and efforts they put.
electronics. sells it to the retailer. - They may demand lower
- Producer has zero stock prices because of the
holding costs. convenience they cause to
- Wholesaler selects the the producers. Some
retailers and also wholesalers also advertise
distributes goods to them. the products.
- Wholesaler ‘breaks bulk’ - Producer has minimal
into smaller quantities control over the product.
which are bought by - Distribution channel
retailers. further slows down.
- Best way to enter - Higher prices to
unknown or foreign consumers due to added
markets where producer margins of intermediaries.
has no experience of selling.
The internet and the 4Ps/4Cs:
The internet has transformed every kind of communication. From mobile phones to other hand held devices,
the uses and applications of internet are limitless. Businesses has taken huge advantage of internet especially
after the spread of social media craze all around the globe.
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Recent developments show that many retail stores are now focusing to go out of retail business completely
because it has a lot of fixed costs associated to it. Moreover, labour has to be hired for retail management.
Online selling has decreased the use of man power and also reduced the physicality of shops. Banks are
increasingly using e-commerce approach whereby consumers do banking from home.
Internet or online marketing refers to advertising and marketing activities that use the internet, email, and
mobile communications to encourage direct sales via electronic commerce (e-commerce). Marketing over the
internet can involve several different marketing functions which impact on the 4Ps and also the 4Cs.
 Goods are sold directly to the consumer (B2C) or to other businesses (B2C). Typical example is of eBay
and Amazon. These are e-commerce giants that sell directly to the buyer via internet. Delivery charges
and product charges are either taken at electronic check-out on the website or can be paid upon
delivery. This has transformed the ‘convenience’ element of 4Cs or ‘place’ factor of the 4Ps.
 Social media is now increasingly using pop-up ads that take the user to a company’s website where
they can browse through all the variety of products. These adverts are actually targeted geographically
and also take into account the interests of the user. Facebook newsfeed does this. (Communication
element of 4Cs and Promotion element of 4Ps.)
 Sales made online are recorded on the spot as buyers are required to leave their address and other
contact information. Later on, any promotional campaigns are directed towards them easily.
(Communication and Promotion).
 Dynamic Pricing  It is when customers are charged different prices according to their ability to pay
and level of demand. Online, we cannot see who paid how much for a particular product. This gives
online sellers a chance to charge various consumers various prices. This can happen according to the
location of the customer. However, these prices are still lower than traditional retailer prices so
customers don’t complain. (Cost to customer or Price).
 As online selling is recorded and cab be coded in many useful ways, the data can be used for future
market research which can help in development of better products according to consumer demand.
Customers get better quality and prices in return. (Customer Solution or Product).
E-commerce:
The buying and selling of goods and services by businesses and consumers through an electronic medium.
Benefits and limitations of e-commerce are mentioned ahead.
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Digital and Physical Distribution:
Products that can be converted into digital format are now being widely distributed to consumers by digital
means over the internet rather than in a physical form. Digital distribution bypasses the traditional physical
distribution formats, such as paper, optical discs and film cassettes.
The processes involved in digital distribution include streaming and downloading of content. The key difference
is that a streaming file is simply played as it becomes available, while a download is stored onto a computer’s
memory. Both processes involve the act of downloading, but only a download leaves the consumer with a copy
that can be accessed at any time from the device without having to download the data again. The promoters of
this form of distribution claim that music writers or music performers of the content can:
• Get their music output distributed globally on platforms such as iTunes, Spotify and Google Play
• Avoid the high costs of traditional physical distribution such as transport and inventory holding costs
• Expand a global fan base
• Keep 100% of the revenue earned
• Achieve a low carbon footprint method of distribution (e.g. no transport and no packaging).
Integrated marketing mix:
Carefully study the above image and comprehend what you see. This is what happens in marketing strategy.
These strategies are naturally complex because it involves a lot of minor elements to it that arranging them into
a meaningful and understandable is very important.
Integrated marketing mix teaches us the every single element of the marketing mix shall be ‘integrated’ with
each other and most importantly integrated with the aims and objectives of the company.
Integrated marketing is a marketing strategy that stresses the importance of a consistent, seamless, multi-
dimensional brand experience for the consumer. This means that each branding effort – product features, price
range, adverts on television, radio, print, Internet, and in person – is presented in a similar style that reinforces
the brand’s ultimate message.
The 2012 summer blockbuster ‘The Dark Knight Rises,’ the third movie in the Batman series, integrated its
marketing across all platforms. It started with an arrest warrant for “the Batman” being posted on the Warner
Bros. website. The press release accompanying the warrant explained that Batman had left graffiti all over the
world. Thus, director Christopher Nolan informed fans that they had to work to see this long-awaited trailer. By
tracking down hundreds of physical pieces of graffiti from around the world and uploading them via social media
or sending them over email, a new frame of the trailer was unlocked.
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Red bull is probably the best example of integrated marketing mix. Starting from its product, it is one of a kind
with exclusive silver slim tin packing and great tasting energetic drink that supposedly ‘gives you wings.’ This
gives you wings slogan has been carefully integrated into every element of their marketing campaigns. The
television ads are adventurous, the events Red Bull sponsors are of extreme sports category seen only by handful
of people. They involve local adventure sports lovers to upload extreme videos on their YouTube page which
gets millions of views, they sell the product by installing an exclusive fridge that only stores Red Bull cans. They
hire sports cars carrying a big can of Red Bull which roams around popular spots in the city. They also have their
Formula 1 team and hired Sebastian Vettel (former Formula 1 champion) to drive their car. The brand logo is
powerful and defines an aggressive personality of the product. All of these are well integrated and gives one
single feeling which is ‘Red Bull gives you wings.’ A perfect integration of marketing mix.
The best laid marketing plans can be destroyed by just one part of the marketing mix not being consistent or
working with the rest. The most effective marketing mix decisions will, therefore be:
 Based on marketing objectives and affordable within the marketing budget.

 Integrated and consistent with each other and targeted at the appropriate consumers.
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Chapter 14: The Nature of Operations

Introduction:
In the very first chapter, the term ‘Factors of Production’ came across which included the four basic resources
which any business uses to produce goods and services. These resources (FOPs) were Land, Labour, Capital and
Entrepreneur.
Managing these resources in a way that results in output of consumable goods and services is called as
Operations Management and the people who manage these resources are known as Operations Managers.
In very simpler terms, the factors of production are termed as ‘inputs’ which go through ‘production processes’
resulting in ‘outputs’. This can be shown diagrammatically below:
For the above transformation process to be successful, an operations manager must be concerned with three
vital elements of production:
- Efficiency of Production: Efficiency generally has many meanings. In business terminology, it would always
mean doing more in less. In efficiency of production, it would mean keeping costs lower to generate higher
profits or keeping raw material usage lower and producing high quality products.
- Quality: Generically, quality is anything that fulfils the intended purpose of the product being made. The
product must fulfil the purpose for which it is being produced or consumed.
- Flexibility and Innovation: As business environment is constantly changing and dynamic, it is important that an
operations manager develop new processes which give birth to new products.
The Importance of Transformation Process (The revision of Added Value concept):
The main aim of transformation process or production process is to add value to the inputs that are bought in
by the business so that the resulting output can be sold at a profit. This concept was covered in chapter 1 but it
is important to revise it here.
As well established before, added value is the difference between the cost of purchasing raw materials and the
price the finished goods are sold for. Consumers are normally willing to pay a higher price for certain goods
because it may have three notable factors such as:
The design of the product  an appealing design that is economical and fulfils the purpose of the product. The
operations manager must be aware of new designs and trends and apply them in the transformation process to
add more value to the product.
Management of Inputs  if the inputs are efficiently managed to produce a remarkable output such as by
reducing waste, the operations management department will increase the scale of how much value they can
add. Per unit costs will reduce hence leading to more profits.
Ability to convince consumers to pay extra  the operations department must closely work with the marketing
department to design a marketing strategy that convinces consumers to pay extra for the product than they
normally do.
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Other tasks of Operations Management Department:
Apart from just managing the inputs of resources, the production process and the output of products, the
operations department performs additional tasks that are of equal importance. These include:
 Converting a consumer need into a product that can be produced efficiently. This involves a thinking
process in conjunction with all operational departments of a business such as the OP department itself,
marketing department, finance department, supply chain department, quality assurance department
and technical department.
 Organising operations so that production is carried out efficiently. An example can be of ordering the
stocks of raw material on time so that delays are avoided. Moreover, designing of the assembly line
whereby all operations can be monitored and production process runs smoothly without repetitions.
 Deciding on suitable production methods. This will include the decision whether to adopt job, batch or
flow production methods and whether to use labour-intensive production or capital-intensive
production. This will be discussed in detail later.
 Setting quality standards. Quality maintenance is the inner culture of operations management. Right
from the thinking process towards the end delivery of the product to final consumer, quality essence
must be maintained in all forms whether it is the design, production process layout which saves time
and materials, storage of goods, intake or orders and their timely and safe delivery to the consumer.
Resources:
All business operations require resources – these are the production inputs classified into four types already
discussed above.
Land: Land refers to the location from where a business operates. It can be just a room for a person who designs
home interiors on his computer or a large field of tennis courts for a Coach who runs an international standard
tennis academy. Mines are also classified as land to those business whose main operation is extraction of oil or
coal. For retailers who sell ready-to-use products classify their retail shops the land. The location of land is highly
important in success of any business.
Labour: Every single kind of business requires a certain amount of labour (skilled or unskilled). For an overall
operational success of the business, the quality of labour is highly important.
Capital: Capital can be classified as the tangible tools, machineries and equipment used for the production
process. Recently, Intellectual Capital is increasingly becoming important in many knowledge-based economies.
It is defined as the intangible capital of a business that includes human capital (knowledgeable employees),
structural capital (information management systems) and relational capital (good links with suppliers,
wholesalers and consumers).
Production and Productivity:
Students confuse between the terms production and productivity. Production simply means the quantity of
goods being produced. It is an absolute measure of quantity of input that a firm produces in a given period of
time. For instance, a luxury shoemaker can make 5 handmade shoes in one day.
Productivity, on the other hand, is a relative measure meaning it is related to another factor’s performance. Put
simply, it is how much outputs are produced given a certain amount of inputs. The most common measures of
productivity are:
Labour productivity = Total output in a given time

Total workers employed
= 5 shoes = 5 shoes per worker.

1
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Capital Productivity = Output

Capital Employed
= $10,000,000 = $10 worth of goods produced per $1 of capital invested.

$1,000,000
Methods to increase levels of productivity:
There are four main ways by which productivity levels could be increased.
1. Improve the training of staff to raise skill level:

A flexible skill level staff is that which can perform different tasks equally well. This increases
productivity levels as their skill set increases the speed of operations and they show more interest as
well. One drawback of experienced staff is that they demand higher wages and further training is
expensive. Trained staff can eventually leave the company for rival business.
2. Improve worker motivation:

Worker motivation can be increased by various methods including raising their pay as identified by
Herzberg’s movement of workers theory by the means of money. However, increasing the pay scales
must be linked with the levels of productivity. If pay is raised by $10 but the productivity levels increase
only by $5 then it will result in increased costs of production. This is not what companies aim for. In
order to reduce the costs, an increase in pay must be justified with the increase in productivity levels
as well. Therefore, in this case, non-financial rewards such as hygiene factors, decision making powers,
self-esteem realization, delegation and involvement of quality circles can prove crucially advantageous
for raising productivity levels.
3. Install more technologically advanced equipment:

Technologically advanced machinery will fasten production and may lower costs as fewer workers will
be needed then. It will also reduce errors in production leading to higher quality goods and lower need
of quality checks. However, skilled staff would be needed or existing staff would require retraining.
Moreover, initial investment of advanced machinery is highly expensive and the sales volume and value
both shall justify the capital investment being made. Only then it will be worthwhile.
4. More efficient management:

Management handles the basic operations of any relevant department. Ineffective management can
both prove costly in terms of errors and delays and lead to poor internal running of the business. They
will lead to poor purchasing and prediction of raw materials, improper quality checks, mishandling of
machinery and wastage of office stationery. Management must work in harmony and with
consideration of a business’s aims and objectives so that operations are run smoothly.
**Management tip  Management and the quality and effectiveness of management is an important
determinant of operational efficiency. It is not all about machines and making people work harder – the
management of resources, processes and people are just as important.
Is raising productivity always the answer?
Managers often find themselves in trouble when it comes to raising the productivity levels. Throughout this
syllabus, one thing is established for sure that one department cannot win the overall business. It is important
that one department of the business is supported and backed up by the other departments.
For instance, if production department has been able to increase the productivity levels then the sales
department must make sure that extra units are sold in the market so that actual advantage of productivity can
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be realized. Moreover, the marketing department must also try to make the product popular among people
because unpopular products do not sell even if the company producing those products is internally productive
and efficient. This point concludes that there is a difference between efficiency and effectiveness. The business
here in our example is efficient internally but its efficiency is worthless because it has not been in effective in
the market as the product is unpopular leading to lower sales.
It has also been noted that labour unions and worker representatives are increasingly fearful of rising
productivity levels of businesses. Because, HR department can now convince the production department to get
rid of unwanted staff so that costs can be further reduced. Many workers, as a result of increased productivity,
find themselves without jobs.
Efficiency and Effectiveness:
Efficiency is measured in terms of productivity. Effectiveness is rather different. Effectiveness is achieved only if
the customers’ needs are met (sales being made repeatedly). In broader terms, effectiveness is achieved when
the business profitably realizes its objectives as well. Therefore, we can make a clear distinction between the
two by defining them such as:
Efficiency is producing output at the highest level with the given level of resources whereby output to input ratio
is maximum.
Effectiveness is meeting the objectives of the enterprise by using inputs productively to meet customers’ needs
profitably.
Labour intensive VS Capital intensive:
Labour intensity businesses use high amount of labour as compared to capital intensity businesses that produce
goods and services by the means of machinery. In order to decide which approach is best following factors can
be considered:
 The nature of the product and the product image which firm desires to establish.
 The relative prices of the two inputs (labour and capital). If labour costs are high due to string Unions then capital
intensity may be preferred to get rid of labour issues forever.
 The size of the firm and its ability to afford expensive capital equipment.
Labour Intensive Businesses Capital Intensive Businesses

High usage of labour both skilled and unskilled for the production High usage of capital equipment and electronically controlled
of goods and services. equipment for the production of goods and services.
Suitable for job production businesses which mainly make Suitable for batch and mass production facilities where identical
handmade artefacts such as furniture, carpets and paintings and products are produced in mass quantities such as cars, televisions,
where capital equipment cannot be efficiently used such as fruit processed food items, transportation and IT.
farming, hair-dressers, restaurants and bespoke tailors etc.
Labour costs are higher than capital costs. Capital costs are higher than labour costs.
Only a handful of essential machinery is required. Only a handful of essential skilled labour is required.
Beneficial for firms in finding relevant labour if skill level Costly for firms to find the suitable machinery as machinery changes
requirement is low. very often as new techniques are introduced.
Output level is low but that is compensated by high value of the Output level is high but costs are very low due to economies of scale.
product because of hand-built image. Prices per unit are also low but that is compensated because of
higher level of sales.
Labour intensive businesses need less financing. Capital intensive businesses need more and continuous financing.
Maintenance cost is minimal. Maintenance cost is sky high because machinery needs cleaning and
repairs. Imagine a break baking facility which needs high standards
of cleanliness and hygiene.
They are not directly affected by change in technology. They are directly affected by change in technology as the whole
production setup needs changing. If delayed, competition may take
over the market.
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Chapter 15: Operations Planning

Introduction:
Throughout the course, a strong emphasis has been laid upon the fact that all departments of the business shall
be coordinated in a single direction to achieve aims and objectives of the business. Production decisions cannot
be made independently of the rest of the business. For instance, if the marketing operations manager
announced to achieve the increase market share by 20% without coordinating this information to other
departments then several problems will arise such as:
 Not enough budget available from the finance department to design and implement the new marketing strategy
that will help in achieving the extra 20% market share.
 Not enough capital to pay for stocks and new machinery in the production department to sell extra goods to
capture the desired market share.
 Not enough customers who would be interested in buying the product.
These problems highlight how crucial the problems can arise because of discoordination if operations planning
is not linked with all departments. Operations planning can be defined as ‘preparing input resources to supply
products to meet expected demand.’
Operations Decisions:
Normally, the operations decisions taken by operations managers are influenced by three key factors:
 Marketing factors
 Availability of resources
 Technology
Marketing Factors:
Perhaps the key information needed by an operations manager when planning future production levels is the
estimated or forecast market demand. This can be summed as matching the supply with the demand. This
process is called as sales and operations planning. If the sales forecast are reasonable accurate, then the
operations manager will have following advantages:
 Matching the output with demand levels whereby the warehouse has enough stock of goods to cater for excess
demand if it may arise.
 Keep inventories level to the minimum possible level so that storage costs can be avoided.
 Reduction is wastage during production especially if the firm is dealing is perishable/edible goods.
 Appropriate number of staff will be needed and hired.
 Produce the right product mix; a range of products which also distributes the risk.
The Availability of Resources:
For operations to run smoothly, the availability of resources play a very crucial role. Resources will include all
the inputs summed up as land, labour, capital and entrepreneurs. Some examples related to availability of
resources which can affect operations management include:
 Location: a business might locate in a region where supply of desired raw material is abundant. For instance, most
fishmongers and seafood restaurants locate near the sea.
 Nature of production method: deciding between a labour-intensive or capital-intensive production will depend on
the availability of capital and labour resources.
 Automation: if the cost of automated equipment is falling then a business could decide to change production
methods in favour of IT-based systems.
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Technology:
Production methods have been overhauled by the introduction of Information Technology (IT) into business
operations. Perhaps the two most common and important technological innovations in IT have been CAD and
CAM.
The need for flexibility and innovation:
Due to persisting dynamism in the consumer market world, the demand for goods is always changing. Given this
situation of unpredictable demand patterns, the operations management of a business shall show some level of
flexibility and innovation. This concept can be referred to as Operational Flexibility.
Operational flexibility is the ability of a business to vary both the level of production and the range of products
following changes in customer demand. This flexibility can be achieved in a number of ways:
 Increasing the scale of production by physically expanding the company. This can be done by hiring
more machinery or extending existing buildings.
 Higher levels of inventories can be kept in case of unforeseen demand. It has a disadvantage though
such as higher levels of inventories will require stock management. Moreover, hold-up stock is actually
money tied up in shape of unprocessed or unsold goods.
 Hire adaptable and flexible workforce. This can be done by hiring a combination of part-time and
contract workforce.
 Opt for flow production methods but it is only suitable when the demand is constant throughout the
year.
Production Methods:
There are several different ways in which goods and services can be produced. They are usually classified into:
 Job Production
 Batch production
 Flow production
 Mass customisation
Job Production:
By definition, job production is producing a one-off item (customised product for a single customer). The
business or an individual worker has ‘one job’ to produce a particular kind of product exactly according to
customer demands. Here are several key features of Job Production:
o The products produced may be small or large.

o Only one product is made at a time (thus, called as job production).
o Each individual product has to be completed before a new one can be produced.
o Normally the business is labour-intensive but if affordable, machines are also used.
o Enables specialised products to be produced so workers feel motivated when they deliver a complete product.
o Highly skilled labour is usually required.
o Expensive because as products are customised so it increases the complexity of the raw materials used as every
product is different
o Job production takes longer time to complete.
o Examples include: bespoke suits, wedding jewellery, wedding or birthday cakes, luxury watches such as Patek
Phillips and Breguet, Rolls Royce cars, luxury culinary dishes, civil engineering projects such as Dams and tunnels.
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Batch Production:
By definition, batch production is producing a limited number of identical products – each item in the batch
passes through one stage of production before passing on to the next stage. This is the defining feature of batch
production. Here are several key features of Batch production:
o Production process involves number of distinct stages of process which are notable.
o It enables economies of scale if batches are large enough.
o It allows the use of machinery alongside labourers.
o Usually used in those industries where batches of identical products are required. For instance, 500 school
uniforms for school students.
o The specification of batches can be varied according to customer demands.
o Batch production leaves unfinished stocks.
o Work may become boring for workers because of repetition.
o Average costs will tend to rise if batches are small.
o Machinery breakdown can cause disruption in the whole process.
o Examples include: bakery items, newspapers, milk cartons, furniture items for a school and medicines.
Flow Production:
By definition, flow production is a method in which products move continuously throughout the production
process without having to be stopped. The products move in a flow. Individual products do not wait for other
products but instead they are moved on to the next process as soon as they are ready. Here are several key
features of flow production:
o These systems are capable of producing large quantities of output in a short time because the system is highly
mechanized. Only those industries use flow production which have a continuous demand.
o Standardized items are produced whereby individual products are identical.
o Changes to the items can be made by using CAD and CAM software without disturbing the whole process. For
instance, Coca Cola beverage is able to produce Cola, Fanta and Sprite without having to alter their production
system.
o It needs very careful planning. Planning of flow production systems will involve the accurate understanding of the
design and specifications of the product.
o Changes in the product may make the whole flow production line useless because the new product design may
not fit in the machines.
o As the process is capital intensive, labour costs are low.
o Planning of inputs become very predictable and inventory management becomes easier.
o Quality of all products is consistent.
o The initial set-up cost is very high as flow production machines are first planned and then built according to
requirements of the factory.
o Those few workers involved will be highly demotivated because their input is only left to turning the machine on
or off.
o Examples are: car assembly plant, sports factory making footballs and electronic devices.
Mass Customization:
Mass customization is the latest development in flow production methodology. By definition, it is the use of
flexible computer aided production systems to produce items to meet individual customers’ requirements at
mass-production cost levels. It requires the use of multi-skilled labour force to use a flow production line to
produce a variety of products. This allows the business to move away from mass marketing concept and move
into the concept of differentiated marketing which allows for higher added value – an essential objective of all
operations manager. Examples are customised shoes offered by Nike and Adidas which the company can
produce in a matter of few hours in flow production line alongside other different shoes.
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Summary of main production methods:
Job Batch Flow Mass Customization

Main feature - Single-off items - Group of identical - Mass production of - flow production of products with
products pass standardized many standardized components
through each stage products but customized differences too.
together
Essential - Highly skilled - Labour and - Specialised, often - Many common components
requirements workforce machines must be expensive capital - Flexible and multi-skilled workers
flexible to switch to equipment is - Flexible equipment – often
making batches of required. computer controlled to allow for
other designs - High steady variations in the product
demand for
standardized
products
Main advantages - Able to undertake - Some economies of - Low unit costs due - Combines low unit costs with
specialist projects or scale to constant working flexibility to meet customers’
jobs, often with high - Faster production of machines, high individual requirements.
value added with lower unit costs labour productivity
- High levels of than job production and economies of
worker motivation - Some flexibility in scale.
design of product of
each batch
Main disadvantages - High unit - High levels of stock - Inflexible – often - Expensive product redesign may
production costs at each stage of very difficult and be needed to allow key
- Time consuming production time consuming to components to be switched to
- Wide range of tools - unit costs likely to switch from one type allow variety.
and equipment be higher than with of product to - Expensive flexible capital
needed flow production another equipment needed.
- Expensive to setup
flow-line machinery.
Production Methods (Making the best choice):
There are several factors which can help an operations manager to decide which of the four production methods
is best suited for business needs.
Size of the market: Niche products have a very limited market scope so it is better for this kind of business to go
with job production method. Flow production method can be used if the scope of market is very large and is
continuous. It is also important that if a company is using flow production method then it shall adopt mass
marketing strategy to create a suitable level of demand. If size of the market varies according to seasons, then
during season-in period flow or batch production may be used.
The amount of capital available: Flow production lines are always purpose built according to factory needs.
Therefore small firms cannot affords the capital requirements for it. They may survive by applying job or batch
production methods.
Availability of other resources: Other resources means those resources which support the production method.
For instance, flow production facility requires a large area of land where transportation of goods and raw
materials is easier and where goods can be easily moved around. Batch and job production may need skilled
workers. The unavailability of these resources will greatly affect the choice of production method.
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Meeting customer requirements: Most firms want to capture a large section of the market alongside meeting
unique needs of some of the customers. Mass customization is best suited for these firms so that they can alter
some goods according to customer requirements. The use of technology and CAD/CAM designs have made mass
customization much easier for firms to adopt.
Problems associated with changing production methods:
Job to Batch:
 Batch production requires equipment in the shape of machines and relevant tools. So production costs
may go up.
 Additional working capital is required so that liquidity can be maintained.
 Staff may be demotivated as in job production the attachment with the product was evident as each
job was new. Batch production may lead to boredom.
Job or Batch to Flow:
 Flow production, as mentioned earlier, will require proper investment and cost of machinery will
surpass that of in batch.
 Staff must be trained so that they remain flexible in their work in the factory. Otherwise repetition of
tasks will bore them and demotivate them.
 Predicting demand is very difficult so it makes operations planning difficult.
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Chapter 16: Inventory Management

Introduction:
The word inventory in business terminology means ‘the materials and goods required for the production process
and the supply of final goods to the customer’.
All kinds of businesses hold some kind of inventory at their location. A bank will hold inventory of stationary and
documents whereas a retailer clothes will have inventory of clothes and shoes. As the scale of a business
expands, so does its need of inventory management because mass production will require and continuous flow
of materials and finished goods. This chapter will allows us to understand us some ways by which inventory can
be maintained at the minimum possible costs along with better management of its arrivals and usage on the
production floor.
Mainly, our main concern in this chapter will be with manufacturing business which holds inventory of three
kinds mentioned below:
1. Raw materials and components:

Purchased from outside suppliers and are kept in the storage room or the warehouse until they are required on
the production floor. Some businesses keep a high level of inventory in warehouse and some keep low.
2. Work-in-Progress:
When raw materials move to the production floor, they undergo a transformation process whereby they are
combined and assembled to form finished goods. Some goods are not entirely finished as there is still ‘work to be
done’ on them. These are called as Work in progress inventory. The reason for WIP inventory can be finishing of
shift, delay in the readiness of the next process on the assembly line, absenteeism of workers, wait for the previous
batches and etc.
3. Finished Goods:
These are those goods that have undergone the complete production process and are ready to be delivered to the
final consumer. Before delivery, these finished goods are kept in the storage room where they are kept safe.
Businesses usually keep a suitable amount of inventory of finished goods so that they are able to supply goods to
the market in case of shortage.
Inventory Management:
If a business fails to manage its inventories, following consequences can occur: (Importance of inventory
management)
 In case of unforeseen shortage in the market, a firm will have difficult in supplying the extra needed
goods. The competitor may do so earning a good share of the profit.
 Management of inventories also discourages keeping of outdates inventories. Especially in the case of
clothing where retailers get rid of non-seasonal clothes as soon as season is about to end.
 Keeping too much inventory increases the risk of damage or theft.
 High levels of inventory requires more loading/unloading machinery. Staff may have to be hired which
will record the inventory at each process. This increases inventory handling costs.
 If inventory not managed properly, the production department may buy too much resulting in excessive
handling costs or may buy late resulting in late production and late delivery of goods.
Given all these reasons, it is important that a business must adopt to an efficient inventory management system
otherwise it will serious costs associated with inventory. These costs are stated below in detail.
Inventory-holding Costs:
Opportunity cost: When businesses buy stock, they either buy it on credit or pay cash for it. Both results as a
credit in the accounts and cause reduction in the working capital. If a business has paid a lot of cash for inventory
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and has not been able to utilize that stock because, may be the demand was low, then it has wasted that cash.
That cash could have been used to pay off creditors which were long due or put to some other use, for example
repairs of an old building. These alternative uses of the capital which could have benefitted the business in
another way is called as the opportunity cost of holding stock. A business shall aim to use the stock as soon as
possible or, in the first place, must not buy extra because that stock has blocked out the cash.
Storage Cost: Businesses that deal in trade of fruits can know how substantial storage costs for such a fragile
item are. They must install specific equipment that keeps the temperature of the warehouse at an ideal point
that does not destroy the fruit or its taste. They also need to hire skilled and knowledgeable staff that has the
knowhow of such inventory management.
Risk of wastage and obsolescence: Unsold or unused inventories can result in costs of wastage if kept in the
warehouse for a longer period of time or obsolescence (out of fashion) if not sold in time to the market. This will
lower the value of such inventory.
What if a business does not hold enough inventory?
Seeing the above cases of holding too much inventory, many businesses keep the inventories level very low.
Most business employ the Japanese JIT stock system if they keep the inventory level very low. Managing a JIT
system is very difficult and requires proper advanced planning. In all the other cases where JIT is not employed
and inventory level is kept below, several financial risks can arise.
Lost sales:
A sudden drop in temperature in Asian region put an emergency in clothing retail outlets and manufacturers as
they believed winters will not arrive. The present month of January brought severe cold which alarmed many
retailers and manufacturers to immediately stock the shop with warm clothing inventories. If they didn’t do it
then they would lose sales to competitors who were well prepared and had held inventories of warm clothing
in shops. Therefore, keeping a low level of inventory due to lower demand may cause such financial losses.
Idle production resources:
Lower levels of inventory also lead to halts in production if all the material is used and the next delivery is at a
later date. This will leave expensive equipment idle and fixed costs will not be covered for that period of time as
there is no production nor sales that may contribute towards covering fixed costs.
Special order could be expensive:
If an urgent order is given to the supplier to deliver additional materials due to shortages, then extra costs might
be incurred in administration of the order and in special delivery charges.
Small order quantities:
Any firm that orders small quantities of inventories will lose out on bulk-buying discounts. Smaller quantities
also mean that frequent deliveries will be required and transport cost will also rise.
Optimum Order Size:
The optimum order size for any business will depend upon its nature of raw materials and its scale of operations.
Therefore, this will be different for every single business. Keeping too much stock does have the advantages of
bulk-buying discounts, less transport costs, less administrative costs and a guaranteed flow production.
However, excess stock will lead to higher storage costs, higher opportunity costs and danger of goods becoming
obsolete or damaged.
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Due to these reasons, every business has an Economic Order Quantity (EOQ). This is the optimum or least-cost
quantity of stock to re-order taking into account delivery costs and stock-holding costs. Refer to the graph below
which will help in understanding the concept of EOQ.
Controlling inventory levels – A graphical approach:
Inventory controlling charts or graphs are widely used to monitor a firm’s inventory position. These charts record
the following:
o The number of goods held at one point

o Inventory deliveries
o Buffer levels
o Maximum inventory
These aspects of inventory can be shown graphically below. The individual components of the graph are
explained later.
Buffer inventory level: It is the minimum inventory level that should be held to ensure that production could still
take place should a delay in delivery occur or should production rates increase. The level of buffer stock will
depend whether uncertain demands are higher or lower. Higher unexpected demands will lead to a higher need
of buffer stock and vice versa. Moreover, if the cost of restarting production in case of zero stock is very high
then the firm will be more likely to keep higher levels of buffer stock.
Maximum inventory level: Maximum inventory is the maximum number of inventory a firm can keep. The limit
depends on the space available in the warehouse, the maximum production capacity or the severity of stock
holding costs (fragile items for example).
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Re-order Quantity: This is the number of units ordered each time when the stock falls below a standard. This
standard is called as re-order level explained shortly.
Lead time: It is the normal time taken between ordering new stocks and their delivery at the door step of the
firm. The longer the lead time (especially if inventory is being imported) then the re-order level will be higher.
The less reliable the suppliers are, the greater the buffer stock level might have to be.
Re-order stock level: This is that level of stock that warns the purchasing manager to call the supplier for stock
re-ordering. Many businesses have now began to use computerized stock systems in which a threat level stock
is programmed. When the physical stock reaches that level, it displays a message that stock must be re-ordered.
Just-in-Time Inventory Control (JIT):
As established before, the JIT approach originated from Japan as part of their Kaizen management concept. JIT
has following main features:
 There is no need to hold any type of buffer stock.

 Inventories arrive just as they are needed for production.
 Goods are always made on order.
 Finished goods are sent for delivery to the customer as soon as they get out of the production floor.
In words, this system seems very suitable and easy but in application and practice, it is very difficult. For a
successful application of JIT system in a firm, following requirements must be met:
1. Excellent relationships with suppliers:

JIT usually requires emergency need of the stock if orders arrive unexpectedly. Therefore, the suppliers
must have the capacity and show willingness to deliver the materials at a short lead time. For the
supplier’s point of view, they must be rewarded handsomely. Usually firms that use JIT have only one
or two major suppliers.
2. Multi-skilled production staff:

Each worker in JIT system must be able to switch jobs and make different items at a short notice so that
no excess supplies are kept on the production floor. For example, a worker who can assemble fans must
be able to assemble air coolers if demand for fans fall.
3. Equipment and Machinery must be flexible:

JIT based systems discourage the use of old fashioned and technically low machinery as it cannot be
easily made to adopt to changes in product specifications. Modern and computer-controlled equipment
is much more flexible and adaptable. They use even small batches of inventory can be used to produce
unique goods.
4. Accurate demand forecasts needed:

If it is very difficult for a firm to predict likely future sales levels, then keeping zero inventories of
materials, parts and finished goods could be a very risky strategy. Demand forecasts can be converted
into production schedules that allow calculation of the precise number of components of each type
needed over a certain time period.
5. Quality is a priority:
As there are no excess inventories in the warehouse, all the workers must ensure that wastage level is
zero. All the products must be right the first time. Any poor quality goods mean that customers will not
get goods on time and therefore, the main purpose of JIT is jeopardized.
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6. Excellent Employer-Employee relationship:

For JIT to run smoothly, the employers and senior managers must ensure that the labour force is
motivated and hygienically taken care of. All the non-financial rewards must also exist. If there are no
strikes then production will never halt.
Advantages and Disadvantages of JIT:
Just In Case (JIC) Inventory Management System:
In JIC inventory management system, the business never runs out of stock by keeping a high level of buffer
inventory levels. Meaning, keeping more inventory than what is required “just in case” there is a hold-up or
delay in supplies
Advantages and disadvantages of JIC:
Importance of Supply chain management:
Supply chain management is managing the flow of goods and services and includes all processes that transform
raw materials into final products. The aim of supply chain is to minimize the processes in operations and reduce
the time it takes for operations to complete.
Supply chain will aim to reduce the time it takes for raw materials to convert into finished goods by following
techniques:
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 Establishing excellent communications with supplier companies, which helps to ensure the right number
of goods of the right quality are received exactly when needed.
 Cutting the time taken to deliver all materials required for production by improving transport systems
 Speeding up the new product development process to improve the competitiveness of the business
 Speeding up the production process with technology and flexible workforces
 Minimising waste at all production stages to cut costs.
Benefits of Supply Chain:
• Improves customer service: Good supply chain management ensures that customers receive products more
quickly and of the appropriate quality. This increases customer satisfaction.
• Reduces operating costs: Purchasing costs and inventory costs should fall. Also, production costs are cut as
time is saved in converting raw materials into finished products.
• Improves profitability: By reducing wasted time, improving inventory management and creating a low-cost
but efficient supply chain, business profits should increase.
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Chapter 17: Capacity Utilisation

Introduction:
Here’s a topical example of capacity utilisation in action which will help you in understanding the concept.
Easyjet increased the capacity of its low-cost airline by 6.7% during the last three months of 2008. It did this by
adding new aircraft to the fleet and by increasing the number of flights and destinations. That means an increase
in operating costs. The good news for Easyjet - it increased passenger volumes by 10% - i.e. more than the
increase in capacity. This means that Easyjet increased its capacity utilisation - the proportion of total potential
output that was actually achieved.
In the airline industry, capacity utilisation is commonly measured by a term known as “load factor”. EasyJet’s
load factor, or the amount of seats sold per flight, rose from 80.8% in the same period in 2007 to 83.4%. Total
revenue grew by 32% to £550m while the average revenue per passenger, a key indicator of whether EasyJet is
slashing prices and profits just to fill its expanding fleet, rose by 23% to £45.57.
Capacity utilisation is calculated by the formula:
Current output level X 100 = Rate of Capacity Utilisation

Maximum output level
By definition, capacity utilisation is the proportion of maximum output capacity currently being achieved with
the existing level of resources. The degree of total capacity being used is a major factor in determining the
operational efficiency of a business. Maximum capacity is the total level of output that a business can achieve
in a certain time period. So, for a hotel, monthly total capacity will be the number of room nights available during
this period. For a factory, it will be total level of output that all of the existing resources – land, labour and capital
– can produce. If a firm is working at full capacity, it is achieving 100% capacity utilisation. There is no spare
capacity.
Impact on Average Fixed Costs:
The concept of capacity utilisation is important to know whether a firm is at an operational efficiency level. It is
said that when capacity is utilised at a higher level, average fixed costs will be spread out over a large number
of units and per unit fixed costs will be relatively low. The opposite is also true in case capacity utilisation level
is low.
Businesses can utilize higher capacity utilisation because if unit fixed costs are lower, this gives producers chance
to maintain the same price level but earn more profits. Businesses who operate at full capacity can also use it as
a positive marketing strategy. Airlines can put up “no seats available” on their websites and hotels can put up
“no vacancy” boards in their lobbies. Consumers would then think there must be something very attractive
about the businesses that it is always operating at its maximum capacity. Apart from these advantages, working
at full capacity may also pose certain drawbacks which are mentioned under:
 Production managers would be operating at a high stress and risk level because they cannot afford even
a smaller delay in production schedules.
 Assembly line workers would also feel the workload and may feel worn out. Higher wages may be
demanded.
 Loyal or frequent customers may be put off if they experience successive delays or waiting periods.
They may start to find alternatives.
 Machinery would be operating at a flat out level which gives no time for cleaning and maintenance.
This may increase unreliability in future. For this reason, many large scale producers always keep a
certain level of spare capacity in order to use it during time of unforeseen breakdowns.
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Excess Capacity:
Excess capacity exists when the current levels of demand are less than the full capacity output of a business.
This is also known as spare capacity. Dealing with spare capacity is considered under the scope of time periods
such as short-term and long-term and both time periods will offer different solutions to deal with spare capacity.
Short-Term Spare Capacity:
Short-term spare capacity are usually seasonal problems and can be dealt with in following ways:
 Higher production schedule can still be maintained but stocks of unsold goods must be kept. This can
ensure timely delivery of goods when sales recover in near future but there will be added risk of theft,
breakage, loss of stock and perishability of food items. Warehousing costs must be considered as well.
 Flexible production system can be maintained whereby workers and machinery both will be able to
produce other goods. Flexibility will not come cheap as workers will have to be trained for multiple
goods production and machines may have to be modified.
 Flexible employment contracts can be offered in which employees are not needed during off seasons.
This can save significant labour wages but will also result in lower staff morale and demotivation.
Long-Term Spare Capacity:
Long-term excess capacity can arise when there are fashion changes, technological advancements or recession
or boom in the market. In this situation if demand cannot be revived by promotions then a cut in productive
capacity may be considered. This is often referred to as Rationalisation.
 Rationalisation:
By definition, rationalisation is reducing capacity by cutting overheads to increase efficiency of
operations, such as closing a factory or office department, often involving redundancies. There are
many drawbacks of rationalisation.
 Large scale rationalisation may permanently disable the firm and recovery from which may
become impossible if market recovers sooner than expected.
 There will disappointed customers who will find alternative brands.
 Staff redundancies will lead to lost job security and low worker motivation. There are
redundancy costs as well in which staff have to be paid some salaries to let them go through
the period of unemployment.
 Bad publicity in media will prevail and competition may see as an incentive to invest to capture
the vacant market share.
 Research and develop new products:

Advantages of this approach include increase in competitiveness of the business as it will replace old
products with new quite often. Moreover, rationalisation can also be prevented if R&D becomes culture
of the business.
However, R&D requires a set budget which can prove to be costly.
Capacity Shortage:
Capacity shortage happens when the demand for a business’s products exceeds production capacity. This is the
case of excess demand in the market whereby the firm is operating at full capacity but the demand has exceeded
expectations and the firm cannot keep up. This is the situation of a long-term capacity shortage and must be
taken seriously because the firm is losing potential profits.
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Moreover, in short-term, capacity shortage can also be the result of a temporary breakdown of machinery which
may get back to normal condition in few weeks. In this case, drastic changes to increase capacity may not be
needed.
Dealing with long-term capacity shortage:
OPTION 1  Using subcontractors or outsourcing of supplies, components or even finished goods.
This method overcoming problem of long-term capacity shortage will be beneficial in a way that no major capital
investments will be required and it will be quick to arrange. This will save firm capital which can be invested in
other profitable areas by the result of diversifying for future. In the case when demand falls due to any reason
then contracts with outsourcing companies may be ended by mutual consent.
Drawbacks of this method will be that firm will not have control over the production and hence, the quality. For
monitoring of products, managers may have to be sent which is again an additional cost. The firm’s supply chain
will now increase and thus, transportation costs will also be increasing. When the production is in-house then
production schedules can be customised to meet deadlines however, in the case of subcontracting and
outsourcing, delays are expected as these firms may not be working for us alone. Lastly, the subcontractors will
charge their profit margin which will result in higher end prices for consumers.
OPTION 2  Capital investment in expansion of production facilities.
This is rather an expensive option but may be suitable for the firm in the long-run in a way that capacity will be
increased permanently. The firm will be controlling all the production activities and quality levels will be as
according to the set benchmark. With increase in capacity, the firm creates opportunity to add latest technology
and IT equipment which may help in establishment of ERP systems. Average costs may be higher just after
implementation but it will surely result in economies of scale as well.
Drawbacks of this method will be that firm may have to find a suitable source of finance to raise capital. New
offering of shares of invitation to new partners may be the option. Investments can go wasted if demand does
not pick up the upwards trend even after a long time. Moreover, while the firm is busy in increasing capacity,
the previously dissatisfied customers may have already shifted to other brands so future sales may not be as the
forecast said so.
Outsourcing:
By definition, outsourcing means using other business (a third party) to undertake a part of the production
process rather than doing it within the business using the firm’s own employees.
Outsourcing can also be other than production related such as Business Process Outsourcing (BPO). The kinds
of outsourcing work performed vary widely across industry sectors. Some common outsourcing activities
include: human resource management, facilities management, supply chain management, accounting,
customer support and service, marketing, computer aided design, research, design, content writing,
engineering, diagnostic services, and legal documentation.
Here are examples of top global companies that perform these outsourcing activities:
Accenture (High Performance. Delivered):
Accenture moved its headquarters to Dublin, Ireland in 2009, but that didn’t stop us from naming the
outsourcing specialist the top outsourcing company in the world. Accenture’s net revenue sailed to $21.55 billion
in 2010. Major clients include three-fourths of the Fortune Global 500 and Accenture’s outsourcing services
range from application and infrastructure to BPO and bundled outsourcing. It has offices in more than 200 cities
in 53 countries. It also headlines the WGC Accenture Match Play Championship in Tucson, Ariz., one of the most
bad ass golf tournaments in the world. Well played, Accenture.
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IBM
The technology giant is based in Armonk, New York, but maintains a reputation as a global entity that specializes
in technology outsourcing service. IBM started touting “Next-Generation BPO” in 2010 and the company gives
customers every available resource to make an informed decision on whether to outsource its technology needs.
(Trust us, this is a smart play) Key figures from IBM include supply chain savings anywhere from $3 to 5 billion
each year and over $500 million in productivity improvement.
Infosys Technologies:
Infosys has the most humble beginnings of any company on our list as seven partners with $250 to their name
started the IT service provider in 1981 in Bengaluru, India. Today, the company rakes in more than $5.4 billion
annually and designs and delivers technology-enabled business solutions. The company has a long history of
praise from Bill Clinton to Business Today.
Here are examples of companies that outsource most of its activities:
Apple
Apple’s relationship with Chinese manufacturing firm Foxconn is well known. While it is almost certain that Apple
would not be able to sell its iPhones, iPads and other popular products at a reasonable price were it not for
overseas manufacturing, the company has been criticized for having most of its production done overseas rather
than at home. Even so, Apple notes that a shortage of skilled workers in the United States means that it could
take up to nine months for the company to find experienced employees who could create Apple’s products. In
China, this took only fifteen days.
Nike
Sportswear giant Nike outsources the production of all its footwear to various overseas manufacturing plants.
China has a larger share of Nike manufacturing plants than other countries, but Nike does maintain quite a few
manufacturing plants in Thailand, South Korea, Vietnam and India.
IBM
The fact that IBM currently employs more workers in India than it does in the United States underscores how
interested the company is in creating a global workforce. China is also a popular destination for this large
company, as IBM outsources literally thousands of high paying programming jobs to China in an attempt to lower
costs for the company and consumers alike.
Wal-Mart
Wal-Mart benefits greatly from having the vast majority of its goods manufactured in China. While the company
has recently vowed to invest up to $10 million in moving some of its manufacturing work back to the United
States, this is a nothing when compared to the fact that the company still works with about ten thousand
different manufacturing plants in various parts of China.
Why firms do outsourcing?
1. Reduction and Control of Operating Costs:

Instead of employing expensive specialists that might not be fully used at all times by the business it
could be cheaper to ‘buy in’ specialist services as and when they are needed. These specialist firms may
prove to be cheaper because they benefit from economies of scale.
2. Increased flexibility:
With some operations being driven by outsourced companies, the firm can save on fixed costs which
may become variable costs. Additional capacity can be obtained from outsourcing only when needed
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and contracts can be cancelled if demand falls much more quickly than closing down whole factories
owned by the business.
3. Improved company focus:

If peripheral activities are outsourced then the firm can focus on major core business processes. For
instance a sports goods manufacturer can outsource its normal selling boxing gloves but use its
production capacity to make its bestselling boxing attire in house to maintain quality.
4. Access to quality service and resources:

Some quality resources such as business development advisors and lawyers may not be available
internally or is too expensive to employee. So specialist outsourcing companies can provide these
essential business services cheaper.
5. Freed-up internal resources:

If the HR department of an insurance company is closed and the functions bought in, then the office
space and computer facilities could be made available to improve customer service.
Threats posed by Outsourcing:
1. Loss of jobs within business:

Staff motivation is adversely effected if major operations are now outsourced. Workers who remain
with the organisation will fear from job insecurity and workers who are made redundant may spread
bad word-of-mouth regarding the business.
2. Quality issues:
A very pertinent issue will be of quality control. Internal processes will be monitored by the firm’s own
quality assurance system. This will not be so easy when outside contractors are performing important
functions. This can be avoided by specific quality maintenance laws in the outsourcing agreement but
checks are still required.
3. Customer resistance:
This could take several forms. Overseas telephone call centres have led to criticism about inability to
understand foreign operators. Customers may object to dealing with overseas outsourced operations.
Bought-in components and functions may raise doubts in the customers’ minds over quality and
reliability.
4. Security:
Outsourced services such as accountancy, legal documentation and tax filings, premises security
systems, social media teams or website developers and maintainers may pose a security threat of
leakage of vital information to competitors or inside breach of security protocols.
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Chapter 18: Business Finance

Introduction:
This chapter includes all the basic information about how businesses raise finance when they start a new venture
or expand existing operations. The nature of these finances will depend on various needs of entrepreneurs.
Finance Department:
The finance department is the main treasurer of a business. Its sole purpose is to handle the money that is
coming in and out of a business. It is that department that advises whether an investment will be worthy in
future or not. It is handled by a skilled finance manager who makes critical decisions about where money shall
be spent and from where it can be obtained. It has following responsibilities:
- Recording all financial transactions

- Preparation of final accounts (income statements and balance sheets)
- Producing valuable accounting information for managers and owners
- Managing cash flows (money coming in and out of business)
- Making important financial decisions such as investments, purchasing of fixed assets, acquiring another
business.
Why do businesses need finance?
Businesses need finance for various reasons. Few of the prominent ones are as follows:
1. Starting up a new business:

Starting a new business is a difficult task and may need unforeseen requirements of money when assets
have to be bought. A new business will need land, a new office building, delivery vehicles, computer
equipment, inventories and furniture. These assets are called as fixed assets and they help to produce
goods and services. The money that is required to start a new business is called as start-up capital.
2. Expanding an existing business:

After a new business has been successfully set up and operational, the owners might want to expand it
to reach new customers or to increase its market share. For this, additional fixed assets will be bought
such as buildings and machinery. Moreover, a business can acquire (takeover) another similar business
(e.g. a furniture manufacturer bought a timber supplier). Businesses also need finance to invest in new
products by doing research and development and this requires huge funds of money.
3. Acquiring or take-over of another business:

Businesses also expand by taking-over a similar kind of firm or a different type of firm. For the buy-out
of that firm, the buying business will need large sums of finance to carry out the deal.
4. Additional working capital:

Working Capital = Current Assets – Current Liabilities
Working capital is often referred to as ‘life blood” of any business. In business terminology, it is that
money that is spent to meet the daily financial requirements of a business. On a daily basis, business
needs to pay wages, repair bills, electricity charges, for buying new stock or insurance premium.
It is vital for a firm to have a sufficient level of working capital otherwise it will have liquidity problems
(liquidity is ability of a business to pay its short-term debt obligations). If a firm fails to pay its debts, it
will be forced into ‘”liquidation”. Liquidation happens when a firm ceases to trade and all of its assets
are sold for cash to pay suppliers and other creditors.
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It must be noted that too much working capital is also not beneficial because excess will have
opportunity costs. The money must be put to some use where it will help in production or generate
future positive cash flows. The working capital requirement for any business will depend upon the
length of its ‘working capital cycle’. The longer the time period from buying materials to receiving
payment from customers, the greater will be the working capital needs of the business.
 Capital Expenditure:
It is the money spent on purchasing those fixed assets that give benefit to the firm for more than
1 year. Examples include buildings, cars, furniture and machines. These are often needed at the
start of the business.
 Revenue Expenditure:
It is the money spent on day to day expenses such as materials, wages, repairs of assets and bills.
5. Special Situations:
Special or unforeseen situations can arise in a business such as a decline in sales or a default on payment
by a major customer. Decline in sales usually happen when the economy is in recession so a business
must influx some cash in to keep business’s health stable. A default by major customer of a business
may immediately an expected cash inflow. The failure to receive that money will delay wages, bills and
raw materials purchase for future. So finance is needed to carry on the business for the time being and
avoid complete halt in production.
6. For Research and Development (R&D):

Apart from purchasing fixed assets, finance is often used to pay for research and development into new
products or to invest in marketing strategies, such as opening up an overseas market.
Administration, bankruptcy and liquidation:
Businesses are placed into administration when they are failing due to lack of finance. This phase is called as
administration because specialist accountants are hired to keep business operational and find a buyer to buy
the business. If there is no buyer then business will be referred to as bankrupt. When bankruptcy is filed, a legal
process of liquidating the assets of the business to raise as much finance as possible to pay back people and
other businesses.
Sources of Finance:
Sources of finance means from where the money is coming from for spending or investment purposes. These
sources can be classified into four types:
1. Internal sources of finance (finance obtained from within the business itself)
2. External sources of finance (finance obtained from sources outside and separate from a business)
3. Short-term sources of finance (finance that is small in sum and shall be repaid within 1 year)
4. Long-term sources of finance (finance that is in large sum and shall be repaid after an year or more)
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1. Internal sources of finance:
a) Retained Profit:
A profit that is invested back into the business after owners have taken their share of the profit
(dividends) and after corporation tax has been paid to the government is called as retained profit.
It is retained in the business for expansion and growth purposes. Newly formed companies will not
have the luxury of retained profits. This source of finance is also called as permanent source of
finance because once invested, it does not have to be repaid back to anyone.
Advantages:
 Owners who use retained profit as a source of finance will be tension free because they are not
supposed to pay back this money like in the cases of loan from bank.
 Moreover, there is no interest to be paid on this as this is the business’s own money.
Disadvantages:
 New business does not have retained profits from previous years because it is their first year in
operation. They will have to look for sources outside the business to raise finance.
 Small companies may not have decent levels of retained profit which can be used for financing
investments and growth projects.
 If retained profits are kept too much, the owners and shareholders are sacrificing their share of
profit as a result. This might prove demotivating and non-rewarding.
b) Sale of fixed assets:

In any business, there will be some fixed assets that are no longer being used or are outdated.
These can be converted into money by selling to raise finance.
Some companies may sell an existing asset but still intend to use it. This can happen if the company
sells the asset to a leasing company and then lease it back to use it. Recently, HSBC sold its huge
London headquarters for $2bn, but will stay in the building and lease it back from the new owners
– at an annual rent of $80mn.
Advantages:
 Retained profits are not affected.
 Business can use the money tied up in an asset which is no longer needed.
 It will not increase debts of the business
Disadvantages:
 Obsolete assets may also not be wanted by other business so selling them will be difficult or buyers
not pay the price which is demanded.
 Small businesses do not have large assets of value so they will have to look for other sources
c) Sale of inventories:
Many businesses keep a high level of inventory which might remain unsold for longer periods of
time. Money is blocked in the shape of this inventory so it can be sold to raise finance.
Advantages:
 Selling inventories to raise finance will help in maintaining a low level of inventory and this means
low storage costs.
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Disadvantages:
 It be must be taken care of that businesses do not sell excess inventory. If any day customer
demand more and business does not have stock then they may be disappointed and go to your
competitor.
d) Owner’ savings:
Many sole traders and members of partnership business can put their personal savings into the
business as a source of finance. Sole traders and partnerships are businesses that do not have
separate legal identity. This means owners of the business and the business itself is considered as
one body. Therefore money invested by owners of partners will be referred to as internal finance.
Advantages:
 Finance is readily available without any wait.
 No interest is paid because it is not a loan.
Disadvantages:
 Owners’ savings may be too low to be used to buy a fixed asset.
 Member of partnership might then demand a higher share in profit or more role because they have
now invested more. This can create conflicts and end partnership.
 It increases the risk taken by owners.
Evaluation of Internal Sources of Finance:
 This type of finance has no direct cost to the company. Only if the asset is sold and then leased,
then there will be leasing charges.
 Owners do not lose the original control over the business.
 It does not increase the liabilities of the business.
 It is not available for all the companies especially newly formed ones or struggling ones.
 If a company solely depends on internal sources of finance then growth or expansion will be
slow because profits come after a year.
 Due to these reasons, external sources of finance are also taken up by companies.
2. External sources of finance:
a) Issue of Shares (Equity Finance):

Public limited companies issue their shares to general public via stock exchange where anyone can buy
these shares to claim ownership in the business. On the return of these shares, the limited company
pays dividends to the shareholders as their reward for investment. The capital raised from the sale of
shares is used to buy assets or to expand.
The money raised by shares issue never has to be repaid unless the company completely goes bankrupt.
In future if a company needs more finance, it can sell more shares to existing shareholders; also known
as Rights Issue (in the same proportion as they had before to retain the same level of control) or to new
shareholders. Selling shares to new shareholders has one problem though. This is of losing the control
over the business. More new shareholders mean more owners and more dividend payments and more
people to have say in the AGMs.
Advantages:
 This is a permanent source of capital which would not have to be repaid to the shareholders like in
the case of bank loans which are payable at all costs.
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 There is no interest to be paid, only dividends. Dividends are only paid when company has made
profit after tax.
Disadvantages:
 Shareholders impatiently expect dividends and this puts pressure on the management to earn
greater profit.
 Dividend is paid on profit that remains after tax. Interest is paid on profit before tax so dividends
ratio may reduce.
 The more the shares sold, the more the loss of ownership from the original owners. Some
shareholders might gain control of the company.
b) Bank Loans (Debts):
This source of finance is obtained from any commercial bank and it must be repaid within a certain
number of years. Banks charge interest on the money borrowed by the business because that is bank’s
profit for giving you money.
Advantages:
 They are usually quick to arrange.
 A business can pay back the loan within the time which it can set with approval from bank.
 Many large businesses are offered lower rates of interest on loans because they are risk free.
Disadvantages:
 Interest must be paid on loan no matter if the business is profitable or not.

 Small businesses have to offer collateral as a security for the money borrowed in case the amount
is not paid back. This collateral might be difficult to arrange and loan may not be approved.
 It is not recommended on some religious terms especially in Islam where interest is forbidden.
c) Selling Debentures (Long-term Bonds):

These are long-term loan certificates issued by limited companies. These are like loans which a limited
company takes from the general public. As it is a loan, so the business has to pay interest to the
debenture holder and also pay back the principal amount of debenture when it matures (its time
expires). Debentures can be secured against an asset but it is not a compulsory requirement.
Advantage:
 Debentures are usually for a very long period of time e.g. 10 years or 15 years. So the company can
easily pay back the principal along with monthly interest payments when it expires.
Disadvantage:
 As with the case of loans, interest must be paid.

d) Mortgages:
These are simply long-term loans granted by financial institutions solely for the purchase of land and
buildings. The land or building in question is used as security for the loan; they act as collateral. These
loans can be for long periods of time – up to 50 years. Mortgages can have fixed or variable rates of
interest and are particularly suitable when a business wishes to raise large sums of money.
Some businesses may choose to re-mortgage their premises to raise capital. A re-mortgage either
increases the existing mortgage or establishes a mortgage where one did not exist before. This source
of finance is particularly popular with small businesses.
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Advantages of Mortgages:
- They have lower interest rates as compared to other long term sources of finance such as a bank loan.
- Capital gains (rise in property value in market) can be realised if a property is bought via mortgage.
- If there is extra space on the mortgaged property then it can be legally rented out to earn extra
income.
- Commercial property mortgage payment plans usually extend for a number of years which allows a
business to focus on other important business matters such as sales, monitoring overheads and training
staff.
- Monthly mortgage payments are mostly equal to any rent of the same type of property. Rent
payments will not make you eventual owner of the property but monthly mortgages payments will.
Disadvantages of Mortgages:
- Initial deposit is substantial
- All property maintenance and up-keeping costs are borne by the owner.
- Mortgages that are based on variable interest rates instead of fixed interest rates are more prone to
interest rate fluctuations.
- Having a mortgage means you are under enormous debt for a very long period of time.
e) Debt Factoring:
A debtor is a customer who owes a firm some money for goods bought. Debt factors are specialist
agencies that ‘buy’ the claims on debtors of firms for immediate cash. For example, a debt factor may
offer 90% of an existing debt. The debtor will then pay the factor in full and the 10% represents the
factor’s profit when the factor collects payment from the debtor.
Advantages:
 Immediate cash is made available to the business
 The risk of collecting the debt becomes the factor’s and not the business’s
Disadvantages:
 The firm does not receive 100% of the value of its debts.
f) Grant and Subsidies from government:
Advantages:
 These subsidies and grants are not supposed to be paid back.
 They help in reducing the cost of production
 Small businesses are often qualified for these grants.
Disadvantages:
 These grants are only or mostly available to certain size or nature of businesses. For example in
Pakistan, subsidy is provided to textile firms in the shape of lower electricity bills.
 There are certain locations that are grant qualified. Industries located in other regions may not
qualify for the grant.
g) Micro-finance:
There are some financial institutions that aim to help smaller businesses because commercial banks
consider them as too small to make profit or see them as risk. Micro-finance institutions provide very
small loans to very small businesses so that they can start an enterprise.
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This practice is mostly common in developing countries to meet the financial needs of poor people.
Advantages:
 Poverty can be reduced.
 Social cohesion will enhance.
 Poor people can also play economic role in the economy.
Disadvantages:
 Interest rates are usually high because too many small loans have to be administered.
 Poor people who don’t have enough business knowhow often fail to start up the business. So they
end in unnecessary debt.
h) Crowd Funding:
By definition, it is raising finance in small amounts from a large number of investors by showcasing
them your business plan online. This is becoming increasingly significant source of finance for new
business start-ups. The basic idea behind is same as of micro-finance that new entrepreneurs do not
have enough money to start a business and banks are unwilling to loan them because they see risk.
Crowd funding websites allow an individual to promote their new business idea to thousands of people
by showing a video or sharing with them business prospects and evaluations. The entrepreneurs just
ask a very nominal amount, for instance $10, as a donation. Investors collectively invest small amounts
until the total amount becomes substantial enough to start the business.
If a business start by crowd- funding capital, the investors will get return as follows:
- Either their initial capital plus with the interest.
- Or an equity (shares) stake in the business and a share in future profits.
Advantages:
 The start-up business will have access to finance without much havoc and trouble of going to banks.
 Crowd funding websites are used by thousands of people.
 Cost of doing crowd funding is very low.
Disadvantages:
 The business must keep accurate records of thousands of investors to pay them back interest or
shares.
 Exposing a new idea on the internet may be copied by big fish in a very short time and before the
new business has successfully raised required finance, someone else may have already made a
good market share.
i) Venture Capital:
By definition, it is a long-term risk capital invested in a business start-up or an expanding business that
has good potential of profit but finds it difficult to raise finance from other sources. The people or
organizations which invest in these businesses are known as Venture Capitalists.
Small companies are not usually quoted on the stock exchange so the option of issuing shares or
obtaining loan from banks is ruled out. If these businesses need large sums of finance, perhaps because
of a new and advanced technology they are dealing in which is deemed as too risky by other lenders,
they look for venture capitalists. They take great risks because they see it as ‘high risk high return
phenomenon’.
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If the new technology usage is successful, then these small businesses can grow exponentially
generating huge profits and great returns for the venture capitalists. These venture capitalists can also
ask for a stake in the business.
3. Short-term finance
As explained earlier, short term finances give benefit to the business for 1 year. Short-term finance is
mostly used to meet the working capital needs of the business so that day to day business activities are
run smoothly.
a) Overdrafts
Suppose Smith has $30,000 in his bank account but needs more cash on immediate basis because
he has unexpected demand for his goods. He wants money to buy stock to produce more goods.
The stock will cost $35,000 so he asks his bank if he can withdraw more than what he has in his
account.
The bank approves his requirement and allows him to withdraw more than what he has. In business
terminology, the bank is providing him with an overdraft facility in which a person can withdraw
more than what they have in their account.
The bank however, will charge interest on the overdrawn amount. In the case of Smith, the interest
will be charged on $5,000.
Advantages:
 A business can quickly meet their financial needs.
 Overdraft facility renews for every month so it can be used multiple times in a year.
 Interest is only paid on the overdraft amount.
 It is cheaper than loan because amount is small so less risky.
Disadvantages:
 Interest rates can vary bank to bank and amount to amount. They are not fixed.
 Overdraft must be paid at a short notice.
b) Trade Credit
In this situation, the business asks its creditors to allow them more time to pay back the money.
This allows businesses to manage their cashflows.
Advantages:
 It is totally interest free.
Disadvantages:
 The supplier might not like if the payment is delayed after the specified time and may refuse to
give future discounts and credit.
c) Debt Factoring
Discussed already in external sources of finance
4. Long-term finance
This is that finance which is available for more than one year. The amount is usually big and the money
is used to pay for expensive fixed assets or to expand existing business.
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a) Bank Loans:
The most commonly used long-term source of finance is a bank loan in which a commercial bank
provides the business with a sum of money with the promise to repayment along with monthly
interest. See external finance for details.
b) Hire Purchase:
This allows a business to buy a fixed asset over a long period of time with monthly payments which
include an interest charge. The person who is using the asset becomes the owner of the asset.
Advantages:
 The firm does not have to find a large cash sum to purchase the asset.
 The fixed asset can be made instantly available
Disadvantages:
 A cash deposit is required at the beginning of hire purchase for security purposes.
 Interest payments are quite high.
c) Leasing:
In leasing, the firm can avail an asset but it cannot not become the owner of the asset as was the
case with hire purchase. The firm doesn’t purchase the asset but leases it for a fixed number of
years. Monthly leasing payments are made which includes a heavy amount of interest. The
business can purchase the asset at the end of the lease period.
Advantages:
 Large sum of cash is not required to purchase the asset and asset can be easily available.
 The care and maintenance of the asset is the responsibility of the lessor.
Disadvantages:
 The total cost of monthly instalments and interest charges are higher as compared to the original
cost of the asset.
d) Issue of Shares:
See external sources of finance section.
e) Debentures:
f) Crowd Funding
g) Venture Capital
See external sources of finance.
How to choose between sources of finance? Which is the best?
There are many factors that any type of business shall consider before deciding which source of finance they
shall go with.
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1. Purpose and time period:

A business must ask for what purpose the finance is required. Is it for the use of fixed assets or just to
make your working capital better? The check is simple. A business must check for how long the finance
will be used for?
- If the finance is used for a long period of time, the source shall also be long term. Examples include a
purchase of new heavy machinery which will be used for 25 years.
- If the use is short term let’s say to buy additional levels of stock, the finance shall be of short-term
nature like an overdraft.
2. Amount needed:
The bigger the amount, the better it is for the business to allow itself enough time to pay it back. A sum
of $10,000 to buy a new delivery vehicle can be financed from owner’s personal savings of from
retained profits rather than taking a loan from bank.
Share issues and sale of debentures, because of the administration and other costs, would generally be
used only for large capital funds.
3. Legal form and size:

Public limited companies usually have a wide choice of sources of finance because of their bigger scale.
They can issue shares and debentures and even sell expensive fixed assets. If public companies issue
shares, the real or original owners also have the risk of losing control.
Sole traders or small partnerships may not have bigger assets and legally, they cannot issue debentures
or shares. Smaller businesses also have to pay higher interest on loans.
4. Control:
An issue with external source of finance is that original owners may lose control with increased
borrowing from outside investors. This is the case with limited companies where original owners may
not have the entire control with increased number of new shares offered to the general public. A sole
trader who asks an investor to become a partner in his business will have to give 50% control
(depending on the amount of investment) to the partner.
5. Risk and Gearing:

Gearing is the degree to which companies operations are funded by lenders and shareholders. Capital
generated by shareholders is good because it shall not be repaid. Capital raised by loans are supposed
to be paid back. It is calculated as:
Gearing = Long-term liabilities x 100

Capital Employed
If this ratio is more than 50% then the company is said to be highly geared and thus, more risky. It is
risky because the more loan there is, the more interest will have to be paid. Investors do not like to
invest in an already heavily geared company because most of the profit will be paid to the lenders in
the shape of interest and loan repayments.
6. Cost:
Obtaining finance is never free, even the internal source of finance will have opportunity costs. If we
talk about external sources of finance, then loans may become very expensive if the government has
raised interest rates.
Also, selling shares on the stock exchange is a very costly process as prospectuses have to be printed
and published along with the marketing costs of shares. The stock exchange will also charge substantial
fees in administering the issuance of shares to the general public.
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When will Banks agree to lend?
Banks being one of the most important financial intermediary in our financial system, keep a list of checks which
help them to decide whether they should give the loan to a party or not. This is especially applicable for a new
business because of the level of risk involved with new businesses.
Following factors will increase the chance of banks agreeing to finance a business:
- A proper and understandable cash flow statement which shows why finance is needed and what will
be the flow of money be like if loan is invested.
- An income statement which shows profits and losses of previous years if applicable and a forecast for
the upcoming year.
- Details of any other existing loans or investors and how much capital has been lend so far.
- An evidence of collateral shall be provided.
- A complete business plan stating aims and objectives.
- The company is not heavily geared.
When will Shareholders invest?
As with banks, shareholders also need to check whether investment in a company will reap benefits in the shape
of share value and dividends or not. Shareholders will most likely buy new shares when:
- The company’s share price is increasing in the stock exchange market.

- Dividends are high and will be paid for the upcoming years and will not be delayed until a certain level
of profit is achieved.
- Other companies are not performing well financially.
- The company has good prospects for future growth.
- The company is not heavily geared.
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Chapter 19: Forecasting and Managing Cashflows

Introduction:
By definition, cashflow is the sum of cash receipts to a business (inflows) less the sum of cash payments out of
the business (outflows). It is important for an efficient cash flow management that the timing of cash receipts
and cash payments are balanced. This is because there is always chances of unforeseen circumstances of lower
cash deposits even if profit is high.
If cash is not managed properly, the suppliers and other creditors to the business may force the business to go
into liquidation if they see that business will go into insolvency.
Why cashflow management is important?
 Especially important for new business start-ups because suppliers do not trust them at first and they
are offered shorter credit periods.
 Banks and other lenders may not believe the promises of new business owners as they have no trading
record.
 Finance is very crucial at the start so not planning cash flows accurately is of even more significance for
new businesses.
The difference between Cash and Profit:
If your boss came up to you right now and asked what the difference between profit and cash flow is, would you
be able to respond? Or even worse, what if you were asked this question in a job interview. What would you
say? If you are at a loss, don’t worry – most people don’t know there is a difference between the two. But while
profit and cash flow may appear to be the same thing, they aren’t, and recognizing how each one impacts the
business is extremely important. First, let’s take a look at how both profit and cash flow are recorded.
“Cash flow is the difference between actual cash received and actual cash used in the process of doing business
(from core operations). Each day, month, quarter, and year, a company receives a certain amount of cash and
pays out a certain amount of cash. It’s that simple. Analysts look at cash flow carefully because it’s a very real
measure of how a company is doing (whether it will be able to pay its bills tomorrow or next week or next
month).
Profit, on the other hand, is revenue from the sale of services and products–whether payment in the form of
cash has been received yet or not–minus all expenses–expenses paid in cash, expenses to be paid in cash at a
later date, and expenses accounted for in other ways.
Example: Sanjit is concerned about competition for his jewellery shop. He buys most of his stock over the
internet for cash but has decided to increase the credit terms he gives to his customers to two months. This
month he bought some rings for $3 000 and paid in cash. He sold them all during the month for $7000 but will
not receive payment for another two months. Sanjit made $4 000 profit. The rings have been sold and revenue
recorded from the sale even though no cash payment has been made. However, this month he recorded a
negative cash outflow of $3 000. He may be very short of cash until he receives payment from his customers.
During this month, cash is not the same as profit for this business. There is a real danger that Sanjit could run
out of cash to pay everyday costs, such as wages and rent. His business may have a low level of liquidity.
Forecasting the Cashflows:
By definition, a cashflow forecast is a monthly estimate of a business’s cash inflows and outflows. Inflow is any
cash that comes into the business e.g. a debtor has paid us back. Outflow is any money that the business has
paid out e.g. electricity bills were paid.
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Cash inflows can be analysed or measured by:
- Owner’s personal injections

- Approval of Bank Loans
- Debtors paying us back
- Customers paying in cash for goods bought from the business
Cash outflows can be analysed or measured by:
- Lease payment for the building in use for the production house.
- Monthly rental payments for the shop.
- Utility bills such as water, electricity and gas.
- Payment of wages to workers
- All other variable costs such as payments for raw materials, repairs of machinery and transportation.
The structure of cashflow forecasting:
For a business to efficiently manage its flow of cash, a monthly cashflow statement is made which helps an
entrepreneur in assessing its net cashflow (inflows – outflows).
Every cashflow forecast statement must have three fundamental sections.
Section 1  Cash Inflows: This section records the cash payments to the business, including cash sales, payments
for credit sales and capital inflows.
Section 2  Cash outflows: This section records the cash payments made by the business, including wages,
materials, rent and other costs.
Section 3  Net Monthly Cashflow and opening and closing balance of cash: This shows the net cash flow for
the period and the cash balances at the start and end of the period – the opening and the closing cash balance.
If the closing balance is negative then a ban overdraft will almost certainly become a necessity.
Cash Inflows: ($000s) January February March April

Owner’s Capital 6 0 0 0
Injection
Cash Sales 3 4 6 6
Payments by trade 0 2 2 3
receivables
Total Cash Inflow 9 6 8 9
Cash Outflows:
Lease payments 8 0 0 0
Rent 1 1 1 1
Materials bought 0.5 1 3 2
Labour rates 1 2 3 3
Other costs 0.5 1 0.5 1.5
Total Cash Outflow 11 5 7.5 7.5
Net Cash Flow Net Monthly Cash Flow (2) 1 0.5 1.5
Opening balance 0 (2) (1) (0.5)
Closing balance (2) (1) (0.5) 1
This is general structure of a how cash flow forecast is made. It involves few key features such as the total cash
inflow, the total cash outflow and the net monthly cashflow. Now please refer to an exercise below and calculate
the missing figures.
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Uses of Cashflow forecast:
There are several advantages to a business of building up a cashflow forecast:
 If negative cashflows are predicted in upcoming month, advance preparation of finance can be made
to avoid illiquid position.
 If negative cashflows are appearing for most of the upcoming months then a permanent solution has
to be derived by the finance manager. This can be done by changing the supplier who provides quality
material at lower price and is willing to give credit. Moreover, customers can be encouraged to pay in
cash or reduce their payment period.
 Bank managers always see a business’s cashflow forecasts before giving out loans especially new
businesses. On the basis of these projected cashflows, the bank managers will calculate risks for bank
and decide how much loan they shall approve and what shall be the interest rate.
 Apart from new businesses, older or well established businesses need to forecast their cashflows so
that they do not become insolvent. Banks especially keep an eye on cashflow performances so that
they can decide on future loans. For business owners, they must forecast accurately so that they can
plan stock buying, fixed assets purchase or other investments without running out of cash.
 It is a general practice that any new business needs a good amount of cash in first few months of its
operations due to several unforeseen expenses. Cashflow forecasting helps owners to make an
estimate of cash inflows and outflows so that they can manage all important transactions (rent, wages
machinery, revenue expenses and etc.)
Limitation of Cashflow forecasting:
It is very important to note that cashflows are a ‘forecast’ and not a real and accurate estimate. In reality when
a business actually trades, produces and sells goods and services, there is a chance that things may not go
according to plans. There are internal and external factors that can give a blow to the cashflow forecast.
Therefore, it is always advisable that cashflow forecasts are made with caution and must not be followed
religiously. Here are some limitations to cashflow forecasting:
 Cashflow forecasting drawn up inexperienced or new owners or accountants may be inaccurate.

 Unexpected costs increases, assume that material shortage causes its price to rise, will lead to
imbalance in cash outflows and can disturb the whole cashflow forecast.
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 Sales revenue is often predicted on the basis of market research. If these research are conducted poorly
then of course the forecasted sales revenue will also be inaccurate. This will lead to inaccurate inflows.
 Variable costs cannot be 100% accurately predicted because they change with production. A sudden
and imminent increase in electricity bills will disturb the forecasted cashflow.
The Causes of Cashflow Problems:
For any business manager or an entrepreneur, earning hard cash is very difficult unless the nature of your
business is cash orientated (restaurants for instance). There are several cashflow problems that can arise for a
business and we shall now see why they happen in the first place.
1. Lack of Planning:
Any business started without long-run planning will certainly face cashflow problems at the very start
of the trading period. Moreover, a business must also prepare itself from external activities of the
economy such as the interest rates, exchange rates and the prices of oil.
2. Poor Credit Control:

Credit control means to handle the accounts of all the debtors of the business and see that they do not
convert into bad debts. In controlling this, the good debts must be allowed future credits and bad debts
must be disallowed future credits.
3. Allowing debtors extra credit period:

In many trading situations, businesses will have to offer trade credit to customers in order to be
competitive. Assume a customer has a choice between two suppliers selling very similar products. If
one insists in cash payment on delivery and the other allows two months credit then customer will go
for the credit provider and not the cash desirer. However, not in any circumstances a customer be
allowed extra-long period to pay us back.
4. Expanding too rapidly:

Expansion costs can be considerable and often poorly predicted. There will be increased wages,
increased rent, more machinery and more managers. Expansion always start to pay us after many
months but to achieve expansion, a business pays in cash. This is often called as over-trading and can
lead to serious cashflow shortages.
5. Unforeseen Circumstances:
As mentioned before, the cashflow statement is a forecast and not 100% accurate. Raw materials costs
can go up or forceful dip in price has to be made because a very close competitor has launched a
promotional campaign which is diverting sales to that business. This may lead to negative cashflows.
Ways to improve the Cashflows:
Generally speaking, cashflows can be improved by either increasing the cash inflows or reducing the cash
outflows. Care needs to be taken here – the aim is to improve the cash position of the business, not sales revenue
or profits. For example, a decision to advertise more in order to increase sales, which will eventually lead to
increased cashflow, will make the short-term cash position worse as the advertising has to be paid for.
As a concluding remark of this chapter and of AS syllabus, we will look at ways by which cashflows of a business
can be improved.
1. Managing Trade Receivables (Debtors):

Trade receivables can be managed in many different ways:
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i. No Extension of Credit period:

Allowing shorter periods for credit to your debtors will start to improve cashflows immediately
but this method has a drawback. It will create conflict between the marketing and finance
department. The marketing department in every business encourages business to give credit
to customers as this is now a general trend.
The finance department, which is trying to improve the flow of cash, will not like the idea of
extending or giving credit to customers.
Moreover, there is a very likely chance that customers will switch to those suppliers who are
offering favourable credit terms
ii. Selling claims to debt factors:

These debt factoring businesses will take up your debts and pay you some percentage of the
credit amount. This will fix a business’s cash needs immediately. A cost of this method will be
that debt factors will keep the remaining percentage with themselves as their profit after
receiving full payment from the debtor.
iii. Selecting Debtors carefully:

A business must never to be hasty in giving credit to its customers. They must be scrutinised
first by using market references.
iv. Offering discounts for customer who pay promptly:

Discounts to customers who pay in advance will create a solid supplier-customer relationship.
Discounts allowed on sales are actually an expense and are recorded under expenses section
of the income statement. Therefore discounts allowed will reduce profit margins.
2. Creditors or Trade Payables:

Trade payables can be managed in a couple of ways:
i. Get extension on the payment period:

Getting extension on the payment date is not always beneficial for a business’s reputation but
it does improve its cashflow. Getting an extension may require certain conditions to be met
such as the business must be big enough to put pressure on the supplier.
Furthermore, a great credit reputation in the market may also help in extending an upcoming
due date of payment.
A drawback of this approach is that it may put-off the suppliers that this particular is a ‘late
payer’. This will lead to reluctance of credit refusal on future orders.
ii. Buy from more than one supplier:

Buying from more than one supplier will allow for flexibility in managing the cash outflows.
However, keeping an accurate record may be difficult and even if one supplier’s payment is
delayed then other suppliers may be reluctant in giving credit for future.
3. Inventory:
Inventory is also considered as the near cash item so it is also important that it is managed properly for
a better cashflow management. It can be managed in following ways:
i. Keeping the inventory level smaller so that not much cash is stuck on them.
ii. To avoid any loss in inventory electronic records must be kept. Electronic records will also help
in identifying the exact stock levels in real time.
iii. JIT inventory management system can be applied to avoid unnecessary stock-handling costs,
avoid damages and deliver goods to customers as soon as they are finished. This will help in
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accurately predicting the inventory needs and relevant expenses. In turn, cash needs will be
predicted as well for a better cashflow management.
4. Cash:
Several methods can be used to manage the cash itself.
i. Preparing monthly cashflow forecasts with maximum of care and flexibility.
ii. Wise use of excess cash in those investments that pay out fast.
iii. Planning in advance for recession or off-season periods when the expected levels of sales will
fall.
Other Methods to improve Cash Inflow:
Methods How it works Possible drawbacks

Overdraft Flexible loans from bank of a  Interest on overdraft
minor amount which is according amount can be high.
to an agree limit and must be paid  Banks may disallow
back soon. overdrafts if the business
requests for them too
often. Banks will see the
business as near to
insolvency
Short-term loan A fixed amount can be borrowed  The interest costs have
for an agreed length of time. to be paid.
 Must be paid back by
due date.
Sale of fixed asset Cash receipts can be obtained  Selling assets quickly
from selling of obsolete assets. may not get the best
price.
 Asset may be required at
a later date especially
during expansion.
 Asset could have been
used as a collateral for
future loans.
Sale and leaseback Assets can be sold to a finance  Leasing interest will add
company but the asset can be in the expenses and this
leased back from the new owner. must be paid in cash.
 The asset could have
been used as a collateral
for future loans.
Reduced credit terms for debtors Cashflow can be brought forward  Customers may start
by reducing credit terms. purchasing from those
firms that offer extended
credit period.
Debt factoring Debt factoring companies can buy  The customer has the debt
the customer’s bills from a collected by the finance
business and offer immediate company – this could
suggest that business is in
cash – reduction of bad debts.
trouble
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Other methods to reduce Cash Outflows:
Methods How it works Possible Drawbacks

Delay payments to suppliers Cash outflow will fall in the short  Suppliers will reduce any
term if bills are delayed. discount on prompt
payments
 For future, suppliers can
demand cash on delivery
or refuse credit entirely.
Delay spending on assets By not buying equipment or  Continuous use of
vehicles. outdated equipment
may reduce productivity
or increase errors.
 Expansion becomes very
difficult.
Use leasing instead of buying the The leasing company owns the  The asset is not owned
asset completely asset and no large cash outlay is by the business
required.  Leasing charges include
an interest cost which
adds to annual
overheads
Cut overhead spending that does These costs will not reduce  Future demand may be
not affect output. production capacity and cash reduced by failing to
payments will be reduced. promote the products
effectively.
Working Capital Conclusions:
So far in this chapter, the true essence of a business’s success, the cashflows were discussed. They are directly
related to the working capital needs of a business. Therefore any effect on the cashflows will always have
preceding effect on the working capital of a business. Following conclusions regarding cashflow and working
capital can be drawn.
 Too much liquidity is always wasteful. A business must find ways to invest cash and create further cash.
 Too little liquidity can cause unforeseen liquidity problems.
 A balanced working capital must be devised
 There is no correct working capital for all businesses as their requirements will depend upon factors
including nature of products, production method (job, batch or flow), and market structure, market
position of the producer, price levels and more.
 Working capital management is not only supported by efficient handling of cash inflows and outflows.
It must be backed up by efficient operations management which reduces waste, accurate marketing
strategy which triggers sales, efficient stock handling which reduces opportunity costs of keeping stocks
and lastly better human resource management that controls the level of salaries to be paid out.
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Chapter 20: Costs

Introduction:
In recent years, we have come across many international companies that have announced cost reductions in
order to increase their profitability. One reason of so much concentration on reducing cost can be combined
with globalization and the access to consumer to global markets easily.
With increased competition, many businesses have been forced to reduce their costs so that they can lower
prices of their goods and services. Lower prices makes them attractive and affordable and hence, will generate
much needed sales to survive in such a dynamic and fast moving business scope.
In strive to reduce costs, many businesses firstly aimed to decrease the amount of labour they use. Deliberate
redundancies has led to mass unemployment. Notable examples include the following:
 November 2016 when Volkswagen announced to axe 30,000 jobs worldwide.

 December 2016 when American Apparel decided to close down 12 of its 13 stores in the UK.
 The Great Recession in 2007 led to millions of job losses.
 As per prediction by CNN Money, the world could see a job loss of 5 million due to increased use of
technology.
Throughout our syllabus, we have identified that Cost is the main reason that business decides its operations
accordingly. Marketing decisions, location decisions, scale or operations decisions, need of human resource
decisions, need of finance decisions and much more.
So why costs are so important for a business and what are they actually? We shall see in this chapter.
Costs:
By definition, cost is anything that a business has to pay out in order to produce goods and services. The
information of costing data can be used in various ways by a business:
1. To estimate the profits:

Costs are always compared with the potential revenues that a business will earn. This is done to
calculate the profit that will be earned by business operations. Therefore, profits are calculated as:
Profit = Revenues – Costs
A business must keep accurate and all the cost data in order to calculate accurate profits.
2. Departmental use:
In marketing chapter we discussed the pricing decisions that a business takes. For these pricing
decisions about their products, the availability of all costs are important. Marketing managers will use
cost data to inform all other departments about pricing decisions.
3. Comparison over the years:

Keeping cost records also allows comparisons to be made with past periods of time. In this way, the
efficiency of a department or the profitability of a product may be measured and assessed over time.
4. Budgeting for future:

The cost records of previous years will help business to allocate budgets for the upcoming years. These
cost budgets will help in target selection.
5. Decision making for managers:

A business always has many different options to choose from. The finality of a decision will always
depend on the cost-benefit analysis that a business manager does. For example, comparing the costs
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of different production methods or alternative locations can increase the chances of the most profitable
option being decided on.
Types of Costs:
Before discussing different types of costs, it is important to understand the concept of Cost Centres.
It is that section of a business, such as a department, to which costs can be allocated or charged. Examples may
include the following:
 In a manufacturing business: products, departments, factories, particular processes or stages in the

production, such as assembly
 In a hotel: the restaurant, reception, bar, room letting and conference section
 In a school: different subject departments
Different businesses will use different cost centres that are appropriate to their own needs.
The financial costs incurred in making a product or providing a service can be classified in several ways. The most
important of these costs is the calculation of average cost. This cost tells us how much a business is paying out
in order to make one unit of a product. Costs can be classified into several categories:
 Direct costs
 Indirect costs
 Fixed costs
 Variable costs
 Marginal costs
Direct Costs:
By definition, these costs can be clearly identified with each unit of production and can be allocated to a cost
centre. Examples include the following:
- Cost of labour
- Cost of raw materials bought
- Piece rate wages
- Cost of meat in a chicken burger
- Cost of bricks in constructing a building
- The salary of a business studies teacher to the department of Business studies in a university.
Indirect Costs:
By definition, these are those costs that cannot be identified with a unit of production or allocated accurately to
a cost centre. The other name of indirect costs are overheads. Its examples include the following:
- Purchase of a machinery
- Repairs and maintenance
- Rent payments
- Electricity bills
Following costs are incurred by a factory on the production of identical cupboards:
1. Labourers’ wages 2. Synthetic wood

3. Power consumption 4. Glass
5. Nails and screws 6. Factory insurance
7. Handles, locks and hinges 8. Wood
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9. Supervisors' salaries 10. Factory depreciation

11. Varnish, glue, paints 12. Factory manager's salary
**Classify the above costs as direct or indirect.
Fixed Costs (FC):
It is that type of cost which remains fixed throughout any level of output produced. Whether a firm produces
100 units or 1000 units or 0 units, the fixed cost will always remain fixed and they will have to be paid even if
firm is not making any profit. Examples of fixed costs include rent, interest, insurance premium, salaries of
permanent staff etc. It can be shown graphically below:
Variable Cost (VC):
It is that type of cost which will vary or change with the level of output. If a firm produces zero output then there
will be no fixed costs. Examples include cost of raw materials, cost of transportation, cost of electricity etc. It can
be shown graphically below:
Marginal Cost (MC):
These are additional costs of producing one more unit of output. Technically, these are extra variable costs of
producing an additional unit. For example, the marginal costs involved in making one more wooden table are
the additional costs of wood, glue and screws plus the labour costs incurred. Marginal cost tends to fall as the
output level is increased but with more increased number of units, the cost will start to rise as shown in graph
below.
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Total Costs (TC):
Total cost is the overall cost of producing a specific number of units. Therefore, it will include fixed costs and
variable costs of production. It is calculated by the formula  TC = FC + VC. The graph of TC can be seen below:
Drawing of Cost Curves:
Suppose there is a fixed cost (FC) of $100. Variable cost (VC) is $5 for each unit produced. Calculate Total Cost
(TC) for each unit produced if a firm starts producing 0 units to 5 units.
Quantity
FC VC TC = FC + VC
Produced
0 100 0 10
1 100 5 15
2 100 10 20
3 100 15 25
4 100 20 30
5 100 25 35
Important points about the graph:
 TC curve always start from the fixed cost point and never from zero.
 TC curve will always be parallel to VC curve.
 VC curve will always start from zero and will go upwards.
 FC is always constant and will be parallel to x-axis at all levels of output.
Problem in costing:
In calculating the cost of a product, both direct labour and direct materials should be easy to identify and allocate
or charge to each product. For example, the materials used in making product X are allocated directly to the cost
of that product. These are not the only costs involved. Overheads, or indirect costs, cannot be allocated directly
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to particular units of production but must be shared between all of the items produced by a business. There is
more than one way of sharing or apportioning these costs and therefore, there may be more than one answer
to the question: ‘How much does a product cost to produce?’ this uncertainty causes problems when pricing
products and when deciding whether to continue producing it.
Important Costing Concepts:
1. Cost Centres:
These are those departments, stages or processes in a business to which costs can be allocated or
charged. For a hotel business, the cost centre would be the restaurant, reception, rooms and
conference section.
It must be noted that different business will have different cost centres.
2. Profit Centres:
These are those business sections to which both costs and revenues can be allocated so that profit can
be calculated. Examples include various branches of a franchising business, various products in a
product portfolio and etc.
Advantages of identifying cost and profit centres:

 Managers and staff can set targets which will act as motivators.
 Identification of best performing centres and also encourage comparisons with previous years.
 Can be used to assess departmental performance and also of the departmental managers.
Disadvantages of identifying cost and profit centres:
 This can make managers more responsive to their personal and departmental objectives and
may ignore overall aims and objectives of the business.
 As costs are difficult to allocate accurately primarily due to indirect costs, arbitration will have
to be done which may be very subjective.
 Reasons for good or bad performance of one particular profit centre may be due to external
factors not under its control.
3. Overheads:
A business usually incurs four basic types of operational overheads such as:
a) Production overheads  rent, depreciation of machinery and energy usage.
b) Selling and distribution  warehousing maintenance expenses, packing, vehicle maintenance and
salaries of sales staff.
c) Admin overheads  these include office rent and rates, clerical and executive salaries.
d) Finance overheads  these include interest and loans.
4. Unit costs (Average costs):

As discussed many times, unit cost is the average cost of producing a product. It is calculated by total
costs of production with number of units produced.
Costing Methods:
1. FULL COSTING TECHNIQUE (Absorption Costing):

It is a method of costing in which all fixed and variable costs are allocated to products, services or
divisions of a business. Absorption costing can take up various appropriation forms. Two are discussed
below. The example of Spurs Toy Shop will detail out absorption costing according to department type
and the example of ABC Limited will detail out a normal absorption costing method on the basis of units
produced.
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Spurs Toy Shop:

Spurs toy shop is divided into two main sections. The children section and the adult toy section. The
children section takes up 70% of the toy shop floor and the remaining by adult section. Consider the
following table:
Children ($) Adult ($)
Stock cost 20,000 30,000
Direct labour 7,000 2,000
Total floor overheads 15,000
Apportioned overheads 70% of 15,000 = 10,500 30% of 15,000 = 4,500
Total cost or full cost 37,500 36,500
ABC Limited:
Absorption costing can also be used in manufacturing. In absorption costing, cost of a manufactured
product includes direct costs + an apportioned share of the indirect overheads costs associated with
manufacturing the good.
The indirect overhead costs are apportioned into the COST by assigning a per unit amount of
manufacturing overhead to each unit of production. The cost that make up the total manufactured cost
of a good include the production labour, raw materials, and utility costs throughout the manufacturing
facility. These costs vary as production varies.
The indirect costs may include rent and insurance on the manufacturing facility. These costs have to be
paid regardless of production levels.
For example: ABC limited produces Tyres. The cost of labour to manufacture one tyre is $50. The cost
of raw material is $25 per tyre. ABC’s monthly rent payment for its tyre factory is $30,000. Monthly
insurance on the tyre factory is $4000. Let’s assume that ABC ltd makes 10,000 tyres in the month. So
now the total cost per tyre is as follows:
Labour = $50
Raw material = $25
Rent ($30,000/10,000) = $3
Insurance ($6,000/10,000) = $0.60
Total Absorption cost = $78.6
If ABC ltd produces 20,000 units in the month, rent costs per unit drops to $1.5 ($30,000/20,000).
Evaluation of Absorption Costing:
Usefulness:
 Absorption costing can be used for mark-up pricing in firms that make single product type. Full unit
costs can be calculated and mark-up can be added on it to derive per unit selling price. A mark-up is
added onto the total cost incurred by the producer of a good or service in order to cover the costs of
doing business and create a profit. Mark-up can be expressed as a fixed amount or as a percentage of
the total cost or selling price.
 Every type of cost from various cost centres is considered in absorption costing so no cost is ignored.
 It is better to use absorption costing in single-product firms so that there is no uncertainty about what
share of overheads should be allocated to which product.
 Full costing is relatively easy to calculate and understand. If each overhead is allocated on different
basis then it will make absorption costing more complex.
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Limitations:
 If full-costing used, it is essential to allocate on the same basis overtime; otherwise, sensible year-on-
year comparisons cannot be made. Inconsistent allocation basis will lead to arbitration which is not
recommended when calculating costs.
 Actual production levels must be considered in absorption costing because changing production levels
will vary the direct and indirect costs and absorption costing may result in inaccurate calculations.
 There is no attempt to allocate each overhead to the respective cost/profit centres on the basis of
actual expenditure incurred. For instance, our example of Spurs Toy shop allocated overheads on the
basis of shop floor but children section may be using less energy or normal employees as compared to
high energy usage and skilled sellers in adult section.
Contribution or Marginal Costing:
In contribution costing, only the direct costs are allocated to the cost centres and no overhead costs are
incorporated at all. This is simply done due to the fact that apportioning overhead costs to different cost centres
using various methods resulted in inaccuracies and poor representation of cost absorbed by individual cost
centres. Therefore, contribution costing does not apportion them at all.
Contribution costing method relies on two main accounting principles:
i. Marginal Cost:
Marginal cost is the cost incurred by the business of producing an extra unit. This is basically the
increase in variable costs because fixed costs do not change with change in production. If a firm is
producing 10,000 units of candles at a total cost of $23,000 and produces 10,001th unit at the cost
of $23,010 then the marginal cost of producing the 10,001th unit of candle was $10.
ii. Contribution:
The contribution is basically the excess of sales price over and above the marginal (variable cost)
of each extra unit. Contribution is calculated by deducting variable costs from the selling price of
the product. It is important to note that contribution is not same as profit because fixed costs and
other overheads are yet to be deducted. For instance if sales price of a unit of Printer is $250 and
the marginal cost of it was $180 then $70 was the contribution which will used to cover the fixed
costs of producing printers.
Usefulness of Contribution Costing in decision-making:
As said earlier, overheads are not incorporated in calculation of contribution. So where do these overheads go?
These overheads are used to calculate profit of loss for a business. See the table below:
Havana Furniture Corp. Garden Furniture ($000) Dining Furniture ($000)

Sales Revenue 25 50
Direct Materials (wood, nails, 5 10
polish)
Direct Labour (carpenters) 3 6
Other direct costs (packing) 2 4
Total Direct Costs 10 20
Contribution 15 30
As seen from table, there is no overhead costs included. Havana has made a total contribution of $45,000. If
overheads amount to $38,000 then Havana has made a profit of $7,000. This has shown that the contribution
of $45,000 has covered $38,000 worth of overheads of the business and has also given business profit of $7,000.
Using this, a business can set its price accordingly to earn a reasonable amount of profit.
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Usefulness of Contribution in Production Continuity of a product:
Contribution costing comes in handy especially when a firm is making a range of products. It is possible that few
products are cash cows and few are incurring losses. The ones which are cash cows usually make a very high
contribution and the ones with losses usually have no contribution or not enough contribution to cover up the
overheads; resulting in losses.
If a business would have used full-costing method, a business manager would immediately ceased production
of a product which was apparently making a loss. This decision was pre-mature and was not well thought as the
manager should have considered the contribution of that product. Any positive contribution (which means
selling price > marginal cost) is good for business and means production can continue because at least all variable
costs were covered. Moreover, even a small contribution will cover some fixed costs. Therefore, only products
can be ceased to be produced if their contribution is negative.
Usefulness of Contribution Costing in accepting contracts or usual sales?
We may have noticed that many hotel rooms or theme parks offer very low prices during off-season. These
prices may not even cover their full-costs. So why do they do it?
The rationale behind such pricing is that in the beginning it might appear to be unwise to accept an order or
contract that does not immediately create additional value for the business, but as long as additional
contribution can be earned then this could be the best decision – especially if it leads to further future orders
that create further value. There are dangers in this policy:
 Customers may also ask for discounted prices in on-seasons because they experienced lower prices
before. If this habit continues then profit earning can become unlikely.
 Businesses that offer premium prices owing to good quality cannot really charge lower prices to some
customers. That will jeopardize the premium image.
 Where there is no excess capacity, sales at contribution cost may be losing sales based on full cost price.
The following example illustrates this principle of using marginal costing in accepting new business.
Example: Yelena is a dress maker who pays $45 rent per day to use a workshop. This covers all the fixed costs of
her small business. She makes three dresses per day and sells them for $30 each. Materials cost her $8 a dress.
One day she has orders for only two dresses and a new customer telephones and wants to buy a dress but for
only $20. Should she accept the offer? According to absorption costing, the total cost per dress is $23 so selling
a dress at $20 will surely make a loss but  
If she “does not” accept the offer then according to marginal costing:
Variable costs = (2 x $8) = $16.
Sales price = (2 x $30) = $60
Contribution = $44.
Fixed overheads = $45
Loss = $1.
If she “does” accept the order then according to marginal costing:
Variable costs = (3 x $8) = $24.
Sales price = (2 x $30) + $20 = $80
Contribution = $56.
Fixed overheads = $45

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Profit = $11 (she should accept the order because that additional order has contributed towards covering the
fixed overheads.
Advantages of Marginal Costing:
 Excess capacity is more likely to be effectively used, as orders or contracts that make a positive
contribution will be accepted.
 Decisions about a product or department are made on the basis of contribution to overheads and not
‘profit or loss’ basis.
 Overhead costs are not allocated to cost centres so arbitration is avoided.
Limitations of Marginal Costing:
 Positive contribution make hinder future prospects of growth in a way that managers may be satisfied
if a product is barely making a positive contribution. May be there is a need of a new product rather
than being content with minimal contributions.
 Qualitative factors are ignored in contribution costing such as premium image of the business may be
disturbed if contribution pricing is practiced.
 Products with low contribution may be popular among consumers and discontinuing it may shift
consumers’ loyalty elsewhere.
 Some products or cost centres incur a higher fixed costs than others so delaying the charge of overheads
until the very last may seem inappropriate.
 Single product firms will find contribution costing less useful because the same product will be
contributing in fixed costs coverage instead of a range of products.
Evaluation of Costing Methods:
Full Costing:
 Useful for single product firms but not helpful for multi-product firms as overheads apportionment is
arbitrary or on poor basis.
 Full costing data shall only be used to compare costs on the same basis so inter-departmental
comparisons will always be useless owing to different nature of departments or cost centres.
Marginal Costing:
 Widely used method of costing and helpful for multi-product firms.

 It incorporates the charge of overheads irrespective of production levels.
 Useful when making optional decisions about expanding operations or accepting new business
opportunity.
 Overheads may be overlooked at the end.
 Contribution can be confused with profits which is a serious error.
Break-Even Analysis:
The break-even analysis is widely used in business as it provides useful information for decision making
purposes. In business terminology, break-even is any point in production level where your costs are same as
your revenues.
Break-even analysis can be shown graphically. These are charts that show how costs and revenues of a business
change with sales. They show the particular level of sales a business must make in order to break-even. This level
of sales is often called as the “break-even point”.
By definition, the Break-even point of production is that level of output at which total costs equal the total
revenue. Therefore, at this level of output there is neither loss nor profit.
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The earlier a business achieves the break-even, the better it is otherwise it will have to sell a large number of
quantities to make revenues and costs equal.
Break-even  Total Revenue = Total Cost
For example, TR for a firm producing pencils was $10,000 after selling 20,000 units of pencils.
It found out that it cost the firm $10,000 for producing those 20,000 units of pencils. Calculate profit or loss.
Profit/-Loss = TR – TC
0 = 10,000 – 10,000
Break-even analysis can be undertaken in two ways:
1. The graphical method

2. The equation method
A. The Graphical Method:
The Margin of Safety:
By definition, it is the amount by which the sales level exceeds the break-even level of output. This is
a useful indication of how much sales could fall without the firm falling to loss. For example, if the
break-even output is 400 units and current production is 600 units, the margin of safety is 200 units.
If a firm is producing below the break-even point, it is in danger. This sometimes expressed as a
negative safety of margin. Hence, if break-even output is 400 and the firm is producing at 350 units, it
has a margin of safety of –50.
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B. The Equation Method:

A formula can be used to calculate the break-even point.
Break-even level of output = Fixed Costs

Contribution per unit
Here, the contribution per unit has a very important meaning.
In our analysis before while studying fixed costs, we understood that these costs have to be paid no
matter what. Therefore, it is extremely important for a business to cover up these costs in order to
survive.
The idea of contribution per unit helps a lot in covering these fixed costs. The formula for contribution
per unit is as follows:
Contribution per unit = Sales Price per unit – Variable Costs per unit
= $15 - $7 = $8
In the formula above, the sales price has already covered the variable costs of production of a single
unit and still has $8 extra. Now remains the fixed costs. Every unit sold will contribute $8 towards
covering the fixed costs and in order to find out how many units will the business has to sell to cover
these fixed costs is shown in the above break-even equation. Now for instance,
Fixed costs = $24,000

How many units will the business has to sell in order to cover all the costs and break-even?
The same break-eve equation can also be used by managers to determine a target level of profit and
find out how many units they will have to sell in order to break-even plus achieve profit. Let us say the
business wants a $5,000 profit. This can be done as:
Break-even plus profit = Fixed Costs + Profit

Contribution per unit
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= $24,000 + $5,000 = 3625 units

$8
So the business has to sell 3625 units at the price of $15 to make a profit of $5,000.
Advantages of Break-Even charts:
- Managers are able to read off from the graph the expected profit or loss to be made at any level of
output.
- Managers can make several break-even charts to decide which selling price will the best for the business
and what will be the sales and revenue projections from the new sales price.
- Break-even charts help businesses to figure out the safety margin. This the margin which is “after” the
break-even point has been achieved. It shows how much loss of sales a business can afford to have
before moving into the zone of loss.
- They help in deciding the sales price. The higher the sales price, the quicker it will make business to
cover the costs.
- They can help in deciding when it is best to start promotional activities to boost sales by offering
discounts.
- The break-even equation produces a precise break-even result in terms of outputs.
Limitations of Break-even:
- The break-even chart is constructed assuming that all the goods have been actually sold in the market.
In reality, this does not always happen. Therefore, the chart is only a projection and not real.
- It does not take into account aspects of businesses such as waste or unsold inventories. They do not
even tell methods to increase sales.
- It is important to remember that break-even graph or calculation is only accurate for a limited period
of time, e.g. because of costs changes or changes in market conditions that mean the price has to be
changed.
- In our study, the lines of fixed, variable and revenues can be drawn with straight lines. In reality, this
does not happen. Costs and revenues curves in reality are much complex. For instance, if a factory
wants to increase production it will pay its workers more to do extra time. In this case, the variable cost
curve will be steeper and may be a curve. Likewise, this can influence the total cost line. This can create
two break-even points rather than 1. See graph below:
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Chapter 21: Budgets

Introduction:
The idea of budgets can be linked with financial planning from household to personal to business level. We
should all plan for our future finances to some degree to have some sort of certainty regarding how much will
we have and how much we would spend. These financial planning range from short-term planning to long-term
planning.
The process of financial planning for better management of money trials in future is called as budgeting. The
real reason behind budgeting is a simple one which states that without budgeting, a business would spend
aimlessly without any records and appraisals. Moreover, budgets would also make yearly comparison easier in
terms of reviewing performances.
Purposes of Budgeting:
1. Planning:
The budgetary process makes managers consider future plans carefully so that realistic targets can be
set.
2. Effective allocation of resources:

Budgeting allows for affordable amount of spending by the business otherwise it may overspend
without any reasonable yield. This happens because major things are prioritized and then choices are
made in production, investments and recruitments for best possible use of budgets.
3. Setting targets to be achieved:

Budgeting can be done in a form of delegation as well. Managers of profit centres and cost centres
(budget holders) can be motivated if they are delegated a set amount of budget. This will motivate
them to design their own strategies which will automatically make them more responsible for their
department. Realization of targets will become realistic.
** Budget holders are people responsible for the initial setting and achievement of a budget.
4. Coordination:
Discussion over the allocation of resources to different departments and divisions requires coordination
between these departments. Once budgets have been set, people will have to work effectively together
of targets set are to be achieved.
5. Monitoring and Controlling:

Budgeting allows for continuous check whether financial objectives are being achieved or not. All kinds
of internal and external business conditions may change and businesses cannot afford to assume that
everything is fine.
6. Modifying:
Budgeting allows for modifications in the business dynamics if they are not being met regularly. This
shows that either the budgets were unrealistic or existing business model may need changing.
7. Measuring and assessing performance:

Once the budgeted period has ended, variance analysis will be used to compare actual performance
with the original budget. This is an important way of assessing managers’ performance. Variance
analysis will be discussed later.
174
Key Features of Budgeting Process:
 Budgets are prepared from forecasted data so they may not be 100% accurate.
 Budgets are not just firm specific but can also be department specific.
 It allows for coordination between departments. Budgeting allows departments to avoid making
conflicting plans. For instance, the marketing department may be planning to increase sales by lowering
prices, yet the production department may be planning to reduce output and lower the direct labour
cost budget. These targets will conflict and need to be reconciled.
 Budgets must be made in cooperation of subordinate managers because usually they are ones who are
the budget holders and the budgets are delegated to them. This sense of ‘ownership’ motivates junior
managers. This practice also manifests Herzberg’s two factor theory whereby challenging and
rewarding work are one of the motivators.
How to prepare Budget?
There are 7 main stages to prepare a realistic budget. These stages will be generic to all types of businesses.
1. Setting of objectives:
Objectives for the coming year will be established by taking in consideration following factors:
- Previous years’ performances.

- External economic and market changes that would affect the business.
- Sales forecasting data of upcoming yearns and previous years.
2. Identification of Key-Factor and Limiting Factor:

Key factor is that factor that is essential to be met for successful utilization of budget and its associated
objective. Limiting factor is that factor which may influence the growth of the business and may lead to
failure of budget along with associated objective.
Many business regard Sales as both; limiting and key factor. Sales budget is usually given such
importance because upon this, other budgets are set such as labour, production and cash. If sales
budget is too high then it will make budgeting for other cost centres unrealistic.
3. Preparation of Sales Budget:

Sales budget is prepared with careful advices from all departmental managers and divisions of the
business.
4. Preparation of Subsidiary Budgets:

Subsidiary budgets are cash, materials, labour-cost, administration, transport, marketing and etc. The
budget holders, e.g. cost and profit centre managers, should be involved in this process if the aim of
delegated responsibility for budgets is to be achieved.
5. Distribution and Coordination of Budgets:

Coordination of budgets is monitored by a special budgetary committee that ensures that budget of
one department does not conflict with the other. They also ensure that allocated budgets are well
distributed among departments and departments do not exceed their spending limit.
6. Deliverance of Master Budget:

A master budget is prepared that contains the main details of all other budgets and concludes with a
budgeted income statement and Statement of Financial Position.
175
7. Presentation:
The master budget is presented to the board of directors for final approval. After approval, the budgets
will become the main basis for operational planning.
The master plan is based on a longer period of time so it is divided into months or weeks for better
understanding and control. See figure below of how budgeting works.
Setting Up Budget Levels:
Budget levels means how much money a particular department can set in forthcoming year. There is a usual
practice that those businesses that operate in highly competitive markets usually set high levels of sales budget
176
and then force other cost centres to lower their budgets. This puts added pressure on cost centres to become
more productive with limited resources. The budgeting levels will be of three types such as:
- Incremental Budgeting
- Zero Budgeting
- Flexible Budgeting
Incremental Budgeting:
Incremental budgeting uses last year’s budget as a basis and an adjustment is made for the upcoming year. Every
department asks for an increment as compared to the previous year’s budget and only has to justify the
incremental amount instead of the whole budget. These incremental budgets does not allow for unforeseen
events such as external economic changes or entry of a strong competition.
Zero Budgeting:
This is a hard approach to allocation of budgets to departments whereby every year each department starts
from Zero and then has to justify the complete budget. This process is time consuming as a fundamental review
of the work and importance of each budget-holding section is needed each year. In contrast to incremental
budgeting, zero budgeting allows for proper justification of whole budget requirement and managers can
properly assess the markets before they ask for a set-figure of budget.
Flexible Budgeting:
The above two budget levels are based on fixed budgets approach which states that output level remains at the
predicted or budgeted level. If actual output fell or rose above this level, then this could lead to obvious
variances. These variances, under fixed budget approach, will not indicate real efficiency problems. That is why,
flexible budgets are used.
Flexible budgeting allows cost budgets for each type of expense to vary if sales or production vary from budgeted
levels. See below:
Budgeted Level Actual Level

Output 100 units 80 units
Direct Material $20,000 $18,000
The above table shows favourable variance of $2,000 because direct materials are lower than expected and
profits shall rise. However, this ignores the fact that output level is also 20% below budget. This will obviously
lead to lower material usage. A more realistic direct material budget would be to adjust for the lower output
figure. This is called as Flexible Budgeting. This allows for new budget levels depending upon the actual output
level achieved.
Fixed Budget Flexible Budget Actual

Output 100 80
Direct Materials $20,000 $16,000 $18,000
The flexible budget is down 20% to $16,000 than the fixed budget because the actual output is down 20% from
100 units to 80 units. This now gives a more realistic adverse Direct Material Variance of $2,000 reflecting the
fact that materials seem to be used less efficiently or are costing more per unit than originally budgeted.
Flexible budgets are more motivating for middle managers as they will not be criticized for adverse variances
that might occur just because output was lower than budgeted. The flexed targets they are given are more
177
realistic. Also, flexible budgets make it easier to produce valid and accurate variance analyses as they will now
highlight changes in efficiency, not changes in output.
Variance Analysis:
A variance is the difference between a budget and the actual figures achieved at the end of the budget period.
It is important to calculate and analyse the reasons for these variances because:
• Variances measure differences from the planned performance of each department over a given period.
Measuring performance is a key benefit of budgets.
• Finding out the reasons for variances can help set more realistic budgets in the future.
• Finding out the reasons for variances can help the business take better decisions. For example, if the revenue
variance for a business was negative because of lower sales caused by an economic recession, then reducing
prices might be the right decision to make.
• The performance of each individual cost centre and profit centre may be appraised in an accurate and objective
way.
If the variance has had the effect of increasing profit above budget, then it is called a favourable variance. If the
variance has had the effect of reducing profit below budget, then it is called an unfavourable or adverse variance.
Example of Variance:
The variance calculations for this business can be verified by checking the operating profit variance ($2 500
adverse) against the net sum of the other variances ($3 500 adverse – $1 000 favourable = $2 500 adverse).
178
Benefits of using Budgets:
• Planning: The budgetary process makes managers consider future plans carefully so that realistic targets can
be set.
• Allocating resources: Without a detailed and coordinated set of plans for allocating the business’s money and
resources, who would decide ‘who gets what’?
• Setting targets: Most people work better if they have a realistic target to aim for. This motivation will be
greater if the budget holder or profit centre manager has been delegated some accountability for setting and
reaching budget levels.
• Coordination: Discussion about the allocation of resources to different departments and divisions requires
coordination between these departments. Once budgets have been set, people will have to work effectively
together if targets are to be achieved.
• Controlling and monitoring a business: Checks must be undertaken regularly to control and monitor the
performance of the budget holder and their department. Many factors might have changed since the budget
was set.
• Measuring and assessing performance: Once the budgeted period ends, variance analysis is used to compare
actual performance with the original budgets. This is an important way of assessing managers’ performance.
Drawbacks of using Budgets:

• Lack of flexibility: If budgets are set with no flexibility built into them, then sudden and unexpected changes
in the external environment can make them very unrealistic. Unrealistic budgets will demotivate the budget
holder and other employees.
• Focus on the short term: Budgets tend to be set for the relatively short term, for example, the next 12 months.
Managers may take a short-term decision to stay within budget that may not be in the best long-term interests
of the business.
• Unnecessary spending: If managers have underspent their budgets just before the end of the budgeting
period, they might make decisions to spend unnecessarily so that the same level of budget can be justified next
year.
• Training on budgets: Setting and keeping to budgets is not easy and all managers with delegated responsibility
for budgets will need extensive training in this role.
• Budgets for new projects: Setting budgets for big new projects is very difficult and often inaccurate. This is
particularly true if similar projects – like a super-fast train line – have not been undertaken before.
179
Specimen Papers for 2023-2025 AS Syllabus
Paper 1: Business Concepts 1

Time allowed: 1 hour 15 minutes
Marks: 40
180
Paper 2: Business Concepts 2

Time allowed: 1 hour 30 minutes
Marks: 60
181

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AS-LEVEL BUSINESS (2023-2025)

Prepared by: Sikander Ayub

AS-LEVEL BUSINESS (9609)

PREPARED BY: Sikander Ayub

How to write an essay?

Essay Term Definition

Up to 6 marks for why they might earn more e.g.:

Up to 6 marks for why they might not earn more e.g.:

Maximum of 4 marks for a list-like approach.

What do businesses do?

The idea of Creating and Adding Value:

The concept of opportunity cost:

Dynamic Business Environment:

- New competitors entering the market

Reasons for business failure:

Local, National and International Businesses:

Advantages of becoming a Multinational:

Disadvantages of becoming a Multinational:

1. Initial setting up costs may be very high.

Potential Benefits of MNC for Host Country:

Potential Threats of MNC for Host Country:

Role of Entrepreneurs and Intrapreneurs:

- Have an idea for new business

Characteristics of a successful Entrepreneur:

Challenges in business environment:

1. Identifying successful business opportunities:

3. Determining a suitable location:

5. Building a customer base:

Role of enterprise in a country’s economic development:

Following are few benefits that economy enjoys because of enterprises:

The Business Plan:

 Executive summary − an overview of the new business and its strategies.

Benefits of Business Plan:

 It will be used to obtain finance from banks for new start-up.

Limitations of Business Plan:

Chapter 2: Business Structure

The three sectors of an economy:

Public and Private Sectors:

Industrialization & Change in Business Activity:

1. Command Economic System:

2. Free market system:

Legal Structure of Firms:

Advantages and Disadvantages of Private Limited

Advantages and Disadvantages of Public Limited Companies

Legal formalities in setting up a company:

Other forms of business organizations:

Chapter 3: Size of Business

Different measures of size:

Why profit is not a good measure of size of a business?

The significance of small and micro businesses:

Importance of small businesses:

How governments support small businesses:

Advantages and Disadvantages of Small Businesses:

Advantages and Disadvantages of Large Businesses:

Extract from Express Tribune (18th September 2013):

Strengths of Family Businesses:

ii. Reliability and pride:

iii. Passing on the skills and knowledge:

Weaknesses of Family Business:

Why some businesses want to grow?