Although every effort has been made to ensure that website addresses are

correct at time of going to press, Hodder Education cannot be held

responsible for the content of any website mentioned in this book. It is
sometimes possible to find a relocated web page by typing in the address of
the home page for a website in the URL window of your browser.
Hachette UK’s policy is to use papers that are natural, renewable and
recyclable products and made from wood grown in sustainable forests. The
logging and manufacturing processes are expected to conform to the
environmental regulations of the country of origin.
Orders: please contact Bookpoint Ltd, 130 Park Drive, Milton Park,
Abingdon, Oxon OX14 4SE. Telephone: (44) 01235 827827. Fax: (44) 01235
400401. Email [email protected] Lines are open from 9 a.m. to 5
p.m., Monday to Saturday, with a 24-hour message answering service. You
can also order through our website: www.hoddereducation.co.uk
ISBN: 978 1 4718 8322 4
eISBN: 978 1 4718 8324 8
© Andrew Hammond 2017
First published in 2017 by
Hodder Education,
An Hachette UK Company
Carmelite House
50 Victoria Embankment
London EC4Y 0DZ
www.hoddereducation.co.uk
Impression number 10 9 8 7 6 5 4 3 2 1
Year 2021 2020 2019 2018 2017
All rights reserved. Apart from any use permitted under UK copyright law, no
part of this publication may be reproduced or transmitted in any form or by
any means, electronic or mechanical, including photocopying and recording,
or held within any information storage and retrieval system, without
permission in writing from the publisher or under licence from the Copyright
Licensing Agency Limited. Further details of such licences (for reprographic
reproduction) may be obtained from the Copyright Licensing Agency
Limited, Saffron House, 6–10 Kirby Street, London EC1N 8TS.
Cover photo reproduced by permission of Kirill Cherezov/123RF.com
Typeset in Bembo Std Regular, 11/13 pts. by Aptara, Inc.
Printed in Spain
A catalogue record for this title is available from the British Library.
Get the most from this book
Everyone has to decide his or her own revision strategy, but it is essential to
review your work, learn it and test your understanding. These Revision Notes
will help you to do that in a planned way, topic by topic. Use this book as the
cornerstone of your revision and don’t hesitate to write in it — personalise
your notes and check your progress by ticking off each section as you revise.

Track your progress

Use the revision planner on pages 4–7 to plan your revision, topic by topic.
Make a note when you have:
• revised and understood a topic
• tested yourself
• practised the exam questions and gone online to check your answers and
complete the quick quizzes
You can also keep track of your revision by noting each topic heading in the
book. You may find it helpful to add your own notes as you work through
each topic.
Features to help you succeed
Exam tips
Expert tips are given throughout the book to help you polish your
exam technique in order to maximise your chances in the exam.

Typical mistakes
The author identifies the typical mistakes candidates make and
explains how you can avoid them.

Now test yourself

These short, knowledge-based questions provide the first step in
testing your learning. Answers are online at the Hodder website, as
below.

Definitions and key words

Clear, concise definitions of essential key terms are provided where
they first appear.
Key words from the specification are highlighted in colour throughout
the book.

Revision activities
These activities will help you to understand each topic in an
interactive way.

Exam practice
Practice exam questions are provided for each topic. Use them to
consolidate your revision and practise your exam skills.

Summaries
The summaries provide a quick-check bullet list for each topic.

Online
Go online to check your answers to the Now test yourself questions
and the exam questions and try out the extra quick quizzes at
www.hoddereducation.co.uk/myrevisionnotes
My revision planner
Theme 1 Marketing and people
1 Introduction to marketing and people
Marketing
People
2 Meeting customer needs
The market
Market research
Market positioning
3 The market
Demand
Supply
Markets and equilibrium
Price elasticity of demand
Income elasticity of demand
4 Marketing mix and strategy
Product and service design
Branding and promotion
Pricing strategies
Distribution
Product life cycle and portfolio
Marketing strategy
5 Managing people
Approaches to staffing
Recruitment, selection and training
Organisational design
Motivation in theory
Motivation in practice
Leadership
6 Entrepreneurs and leaders
Role of an entrepreneur
Entrepreneurial motives and characteristics
Business objectives
Forms of business
 Business choices
Moving from entrepreneur to leader

Theme 2 Managing business activities

7 Raising finance
Sources of finance: internal and external
Liability and finance
Planning and cash flow
8 Financial planning
Sales forecasting
Sales, revenue and costs
Break-even
Budgets
9 Managing finance
Profit
Liquidity
Business failure
10 Resource management
Production, productivity and efficiency
Capacity utilisation
Stock control
Quality management
11 External influences
Economic influences
Legislation
The competitive environment

Theme 3 Business decisions and strategy

12 Business objectives and strategy
Corporate objectives
Corporate strategy
Ansoff’s Matrix
SWOT analysis
Impact of external influences
The competitive environment
13 Business growth
 Growth
Organic growth
Mergers and takeovers
Reasons for staying small
14 Decision-making techniques
Quantitative sales forecasting
Investment appraisal
Decision trees
Critical path analysis
15 Influences on business decisions
Corporate influences
Corporate culture
Shareholders versus stakeholders
Business ethics
16 Assessing competitiveness
Interpretation of financial statements
Ratio analysis
Human resources
17 Managing change
Causes and effects of change
Key factors in change
Scenario planning

Theme 4 Global business

18 Globalisation
Growing economies
China versus India
Business potential in Africa
International trade and business growth
Factors contributing to increased globalisation
Protectionism
Trading blocs
19 Global markets and business expansion
Conditions that prompt trade
Assessment of a country as a market
Assessment of a country as a production location
 Reasons for global mergers or joint ventures
Global competitiveness
20 Global marketing
Global marketing
Global niche markets
Cultural and social factors in global marketing
21 Global industries and companies (multinational
corporations)
The impact of multinational corporations
Ethics in global business
Controlling multinational corporations
Glossary
Answers and quick quizzes at
www.hoddereducation.co.uk/myrevisionnotes
Countdown to my exams
6–8 weeks to go
• Start by looking at the specification — make sure you know exactly
what material you need to revise and the style of the examination.
Use the revision planner on pages 4 and 5 to familiarise yourself
with the topics.
• Organise your notes, making sure you have covered everything on
the specification. The revision planner will help you to group your
notes into topics.
• Work out a realistic revision plan that will allow you time for
relaxation. Set aside days and times for all the subjects that you
need to study, and stick to your timetable.
• Set yourself sensible targets. Break your revision down into
focused sessions of around 40 minutes, divided by breaks. These
Revision Notes organise the basic facts into short, memorable
sections to make revising easier.

2–6 weeks to go
• Read through the relevant sections of this book and refer to the
exam tips, exam summaries, typical mistakes and key terms. Tick
off the topics as you feel confident about them. Highlight those
topics you find difficult and look at them again in detail.
• Test your understanding of each topic by working through the ‘Now
test yourself’ questions in the book. Look up the answers at the
back of the book.
• Make a note of any problem areas as you revise, and ask your
teacher to go over these in class.
• Look at past papers. They are one of the best ways to revise and
practise your exam skills. Write or prepare planned answers to the
exam practice questions provided in this book. Check your answers
online and try out the extra quick quizzes at
www.therevisionbutton.co.uk/myrevisionnotes
• Use the revision activities to try out different revision methods. For
example, you can make notes using mind maps, spider diagrams or
flash cards.
• Track your progress using the revision planner and give yourself a
reward when you have achieved your target.
One week to go
• Try to fit in at least one more timed practice of an entire past paper
and seek feedback from your teacher, comparing your work closely
with the mark scheme.
• Check the revision planner to make sure you haven’t missed out
any topics. Brush up on any areas of difficulty by talking them over
with a friend or getting help from your teacher.
• Attend any revision classes put on by your teacher. Remember, he
or she is an expert at preparing people for examinations.

The day before the examination

• Flick through these Revision Notes for useful reminders, for
example the exam tips, exam summaries, typical mistakes and key
terms.
• Check the time and place of your examination.
• Make sure you have everything you need — extra pens and
pencils, tissues, a watch, bottled water, sweets.
• Allow some time to relax and have an early night to ensure you are
fresh and alert for the examinations.

My exams
A-level Business Paper 1
Date:…………………
Time:…………………
Location:…………………

A-level Business Paper 2

Date:…………………
Time:…………………
Location:…………………

A-level Business Paper 3

Date:…………………
Time:…………………
Location:…………………
1 Introduction to marketing and
people
Marketing
Marketing is the term used to describe the range of activities that businesses
undertake to try to create a demand among consumers for their products or
services. Marketing managers must ensure that they understand what is
happening in the markets they sell to and how and why consumers behave the
way in which they do. In order to gain this understanding, marketing
departments carry out market research aimed at developing a genuine
understanding of consumer behaviour. This allows them to make better
decisions on how to entice consumers to decide to buy the products and
services. In a modern marketing department, much of this research is gathered
in real time from social media and minutely detailed analyses of sales data.
A summary of the work done by marketing departments can be seen in Table
1.1.
Table 1.1 Work done by marketing departments
Understanding markets Making marketing
decisions
Market research Designing products and
services
Analysing factors affecting demand in a Deciding on a price
market
Deciding which markets to sell to Deciding where to
distribute
Spotting changes within markets Communicating with
customers
Understanding consumer behaviour
within markets

People
Businesses need many different resources to enable them to meet their
objectives. Physical resources such as buildings and equipment, as well as
financial resources, must be well managed. Research shows that in the long
run human resources are the most important. This is why so much time and
attention is given to ensuring that businesses get as much from their people as
possible.
Human resources departments are likely to take charge of the following
activities:
• recruitment of new staff
• selection of applicants for jobs/promotions
• training new and existing staff
• designing and administering payment systems
• planning future workforce needs.
In smaller firms, without a specialist HR department, the boss will need to
handle all these tasks, and others relating to the people who work for the
business. Some larger businesses will also expect departmental managers and
supervisors to take responsibility for other people-related tasks including:
• working out shift rotas
• coaching staff
• providing on-the-job training
• motivating staff on a day-to-day basis
• delegating authority.
A business can secure an advantage over its rivals through expert use of
marketing and people in many ways. A selection of these is shown in Figure
1.1.
Now test yourself
1 Briefly explain what makes the following successful products or
services stand out from their rivals:
(a) Apple’s iPhone
(b) Heinz Tomato Ketchup
(c) John Lewis department stores
(d) Cadbury’s chocolate
Answers online

Summary
• Marketing is the business function whose role is to create a
demand for a firm’s products or services.
• The people in a business are a critical resource that needs to be
used effectively.
• Marketing and people can both provide a competitive advantage.
2 Meeting customer needs
The market
A market exists where buyers and sellers meet in order to exchange goods or
services. Though some markets can be identified as having a physical
location, markets are best thought of as any occasion where a buyer and seller
can interact and can therefore be online, by post or in a shopping centre or
trade fair.

Mass markets and niche markets

Some businesses will produce products and services aimed at satisfying the
needs of a whole market, rather than any specific section of the market.
Attempting to sell to the whole market is called mass marketing. Other
businesses select a segment of the market and sell products specifically to
suit the needs of consumers in that segment. This process is called niche
marketing.
Table 2.1 Benefits of different marketing strategies
Benefits of mass marketing Benefits of niche marketing
Huge potential number of Meeting consumer needs more
customers precisely allows higher prices to
be charged
Higher production levels allow Higher profit margins
economies of scale – lower
production costs
Can use mass media advertising Easier to enter for firms with
limited financial resources
There are notable differences between mass and niche markets as shown in
Table 2.2.
Table 2.2 Differences between mass and niche markets
Mass market Niche market
Characteristics Generic products which are Specialist products
broadly similar in form and and services are
function required. Changes in
consumer preferences
can be rapid and
 devastating to the
market
Market size Huge markets in which large Smaller markets mean
and share firms can operate successful firms may
successfully even though achieve far higher
their market share may be shares of their niche
low, e.g. Ferrero’s 5% share than mass market
of the UK chocolate market firms
Brands Huge brands can develop Differentiation is more
with the name/logo likely to be achieved
representing a key point of through product
differentiation features and functions

Exam tip
Choosing a mass or niche market approach is a strategic choice. In
other words this choice will affect the whole business, from the
approach to marketing through to decisions on scale of production
and production methods and locations. Try to ensure that, when
writing about a firm using mass or niche marketing, you acknowledge
the impact of the choice of marketing strategy on other business
decisions.

Dynamic markets
No business can afford to stand still because markets are dynamic, they tend
to change over time. There are four major issues to consider.

Online retailing
Continued growth in online retailing has varied between different markets,
with clothing growing tremendously but growth in online sales of books
slowing to a virtual halt. This unpredictability of growth adds to the
unpredictability of dynamism in online retailing. What history has shown us
is that retailers who fail to switch to online retailing can fail completely as
online rivals steal sales. Above all, it is vital to ensure that your product or
service is available to buy wherever consumers want to buy it. In some cases
it is vital to have an online presence, or if consumers want to buy online and
collect from their local store, a click-and-collect service is needed.

How markets change

Markets change as a result of major external influences, as summarised by the
PESTLE acronym.
Examples of market changes include the following:
• Political: In 2016 the government’s new ‘Living Wage’ was brought in,
pushing the legal minimum (for over-25s) from £6.70 to £7.20 an hour; this
was great for low-paid employees, but tough on employers in low-wage
industries such as care homes.
• Economic: The economic recession of 2008–09 led to major changes in UK
grocery retailing, as price-conscious shoppers opted for Aldi and Lidl.
• Social: An increased desire for convenience has driven the rise in online
retailing.
• Technological: ‘Apps’ did not exist ten years ago, prior to the advent of the
smartphone; by 2016 they were capable of turning century-old markets on
their head, as with taxis and the arrival of Uber.
• Legal: Growth in the market for e-cigarettes is being affected by the
introduction of new laws relating to who can buy, how they can be
advertised and where they can be consumed.
• Environmental: The car industry is facing major changes in order to try to
minimise the damaging impact of exhaust fumes on the environment.

Innovation and market growth

A major cause of change within markets is innovation. With competing firms
continually trying to develop new products and services that offer features
that no rivals offer, consumer loyalties can change dramatically. Once one
innovation has been successful, other companies may be forced to try to adapt
their offerings in order to keep pace with rivals. Furthermore, many
companies will try to come up with their own innovations in order to try to
benefit from leading change in the market.

Adapting to change
Market research and an understanding of general trends in the market are vital
to successfully adapting to change. Identifying subtle changes in what
consumers are looking for in their products allows businesses to adapt their
products to better suit these needs. Whether it be removing sugar from food
products or adding features to mobile phone handsets, changing earlier than
rivals offers a major source of competitive advantage.

Typical mistake
Too often exam answers imply that adapting to change is a simple
process for a business. These responses fail to show an appreciation
of the impact on all four business functions: marketing, people,
finance and operations. Required changes may include production
methods, finding new suppliers, redeploying workers and adopting
new advertising and distribution methods.

How competition affects the market

Competition is the feature of business that most stimulates change and
development. This is especially clear in the battle between Apple and
Samsung in the smartphone market. Neither can sit back for a moment. That
was clear when the market was disappointed by Apple’s iPhone 5, leading to
significant gains for Samsung. It took a huge development effort for Apple to
regain its supremacy with the iPhone 6.
Increased levels of competition create various pressures for businesses:
• The need to drive down costs.
• The need to maintain competitive prices.
• The need to develop innovative products and services.
• The need to maintain high quality of products and services.

The difference between risk and uncertainty

Operating a business in any market involves facing up to risk and coping with
uncertainties. The key difference lies in the predictability of events occurring.
A risk is quantifiable, so if statistics show that only 1 in 20 new consumer
goods succeed, the risk involved in launching a new product can be identified
and quantified. The factors causing the risk are the uncertainties – those
factors that cause a lack of certainty in future events – such as reactions of
rivals, reactions of consumers, reactions of retailers and such unexpected
events as currency movements and economic downturns.

Typical mistake
Too many answers use the terms ‘risk’ and ‘uncertainty’
interchangeably – they are not the same thing.

Now test yourself

1 State two benefits of mass marketing.
2 State two benefits of niche marketing.
3 What are the six major external forces that lead to change in
markets?
4 State three benefits experienced by consumers as a result of
increased competition in a market.
5 What marketing activity tends to be the key to successfully
adapting to change in markets?
Answers online

Market research
Product and market orientation
Product orientation is an approach to making decisions that considers internal
factors before worrying about changes in the market. This means that
product-orientated businesses can focus on their own key strengths and this
can lead to revolutionary new ideas that consumers would never have
dreamed of. However, the danger is that the business fails to adapt its
products in line with what consumers are looking for, which could lead to
huge problems.
The opposite approach – market orientation – is more likely to lead to
marketing success since it places consumers’ views and behaviours at the
heart of decision-making within the business.

Primary and secondary research

Market research can use either secondary data or primary data, with primary
research being new research carried out for the first time, and secondary
research being research that uses data that had already been gathered for
some other purpose.
The data gathered may be quantitative or qualitative. Quantitative data
contains factual, often numerate data that is intended to be statistically
representative of the whole market. Qualitative data contains opinion and is
unlikely to have been gathered on a large enough scale to give statistically
reliable data. It is designed to give insight into why customers behave the way
they do.

Typical mistake
Primary research does not have to be carried out by individual
businesses. They can hire a market research company to do the
research for them. If it is new research, it is still primary.
Table 2.3 Advantages and disadvantages of primary and
secondary research
Secondary research Primary research
Advantages • Often free • Addresses the specific
• Provides a good issues you are interested in
market overview • Data is up to date
 •
Usually based on • Can help to understand
large-scale, reliably customer psychology
produced research
Disadvantages • Information may be • Expensive, costing
out of date thousands of pounds to do
• Not tailored to suit properly
your particular needs • Risk of bias from
• Can be expensive to questionnaire and
buy published interviewer
research reports on • May need to compare with
markets other information to
understand the meaning of
findings

Exam tip
Generally most firms will use a combination of secondary and primary
research, with secondary often conducted first to help design the
primary research needed without incurring the high cost of primary
research first.
Table 2.4 Different primary and secondary research methods
Secondary research methods Primary research methods
The internet Surveys
Trade press Retailer research
Government statistics Observation
Past internal sales figures Group or individual discussions

Limitations to market research

If all market research provided accurate and reliable data, then all businesses
would succeed. There are two major reasons why market research data may
be unreliable:
• Sample size too small: This means that there is more chance that
respondents who do not reflect the overall views of the market are over-
represented in the sample.
• Sample bias: The way that respondents are selected may over-represent
certain types of people whose views may skew the overall findings away
from the views of the total population being researched.
Exam tip
Using the wrong research method may not be the major mistake
made by a business whose research seems to let them down.
Analysing and then interpreting market research data correctly is the
most common problem within the marketing process. The best
marketing decision-makers use surveys to provide insights – but they
still take the key decisions based as much on experience and intuition
as on research.

Use of ICT to support market research

There are three main ways in which ICT can support market research:
• Company websites can gather data on visitors to the website which can
provide some information about online shoppers’ or browsers’ interests.
• Social media can also offer information on consumer attitudes to a product
or service, and even allow for an element of relationship building between
the business and consumers.
• Database technology, which has advanced so far in recent years, allows vast
quantities of data relating to consumers to be trawled in order to identify
patterns that can help to explain how consumers actually behave, with much
of this data being generated by loyalty cards.

Typical mistake
Despite their name, a major purpose of loyalty schemes is to gather
information on customers’ buying habits.

Market segmentation
One main function of market research is to help to decide on useful ways to
segment markets. Splitting markets up helps to target specific groups of
consumers who share similar needs and wants, enabling a firm to meet these
more closely. Market research can unearth insights that allow firms to identify
segments that they can fulfil profitably.
Benefits of segmenting a market include:
• Products and services can be designed to suit specific customers.
• Meeting customers’ needs precisely allows a higher price to be charged.
• Promotional activity is easier to target.

Now test yourself

6 What type of research is aimed at finding out about customer
 attitudes in the hope of gaining insights into consumer behaviour?
7 What type of research uses data that has already been gathered
for another purpose?
8 What type of research gathers brand new data?
9 What type of research is aimed at delivering statistically reliable
information?
10 Is a product-orientated or market-orientated business more likely
to come up with brand new, revolutionary product ideas?
11 State two reasons why market research may give misleading
results.
12 List three ways that ICT can help with market research.
13 State three benefits of segmenting a market.
Answers online

Market positioning
Decisions over fine tuning the product being sold must follow earlier,
strategic decisions about what products to sell to which markets. This fine
tuning is the process of market positioning.

Market mapping
The two key judgements required in successful market mapping are:
• choosing the right variables to place on each axis
• placing rival brands in the right place on the map, truly reflecting consumer
perceptions of those brands (see Figure 2.1).
With a market map produced, a business can identify the gaps in the market
more easily. Following this is a check to ensure that the gap can be filled
profitably. For example, drawing a map of the UK car market can identify a
gap for a truly luxurious sports car selling for £10,000. Of course, the reason
why this gap exists is that no firm is capable of making the product at a cost
that will let them make a profit at a price of £10,000.
With a gap identified, the firm must then decide how to use the marketing
tools at its disposal. Managers will want to create an image that matches the
product to the gap that has been identified.

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

Product differentiation
Standing out from rivals can be achieved through actual, tangible differences
between products or through manipulating consumer perceptions of your
product – a kind of psychological differentiation. Possibilities are shown in
Table 2.5.
Table 2.5 Tangible differences between products
Actual product differentiation Perceived product differentiation
Design Branding
Different functions Advertising
Taste Sponsorship
Performance Celebrity endorsement
The purposes of product differentiation are:
• insulating the product from the actions of competitors
• allowing prices to be increased without a major fall in demand or sales.
As we will see later, in Chapter 3, differentiation is the key to reducing a
product’s price elasticity.

Typical mistake
Be careful not to over-use the term ‘unique selling point’. Many
product features can differentiate a product without being actually
unique.

Adding value
Product differentiation generally helps to add value to products and services.
The ability to push prices higher without increasing the costs of producing a
product will naturally add value. Once more, added value may come about
through tangible, engineering methods, such as creating a great design or
finding a way to produce in a far cheaper manner, or it may be added through
perception, generally through promotional methods such as advertising and
branding. L’Oréal’s slogan ‘Because I’m worth it’ is the company’s clever
way of persuading customers that paying a higher price for L’Oréal products
is ‘worth it’, i.e. it adds value.

Now test yourself

14 What is market mapping designed to reveal?
15 What are the two main routes to competitive advantage?
16 Explain the effects that the arrival of Aldi and Lidl have had on
Tesco in the UK grocery market.
17 Explain the main sources of competitive advantage for each of
the following:
(a) iPhone
(b) Yorkie
(c) Nando’s
18 How can being the most efficient producer of a product create
long-term success?
19 What are the two main benefits of successful product
differentiation?
20 How can advertising add value to a product?
Answers online

Exam practice
The market for toys in the UK is highly seasonal. It is a market that
has a strong record of innovation, especially in the development of
electronic toys that use the latest audio-visual technology, and can
often throw up surprise success stories. Over the past three years the
market has grown as the UK’s economy has recovered. As well as
new toy products, some old products are also making a return. In the
niche market of sports games, a Spanish company Netcam has
relaunched Subbuteo table football in the UK. It decided to go ahead
after studying the results of some quantitative research among boys.
The game, which was first launched in the 1950s, had been
withdrawn from the market in 2007. With the game beginning to
appear in major toy retailers such as Argos and John Lewis, the
relaunch seems to be proving a modest success. Nevertheless, many
commentators have suggested that the company’s failure to launch
an e-commerce site through which Subbuteo products can be bought
directly may be harming sales growth.
Questions
1 What is meant by quantitative research?
(2)
2 What is meant by niche market?
(2)
3 Explain how the use of a familiar brand name can help Netcam
 relaunch Subbuteo products.
(4)
4 Assess the major influences on the market size of the toy market
examined in the item.
(10)
Answers and quick quiz 2 online

Summary
• Mass marketing and niche marketing are alternative approaches to
marketing that both offer benefits and drawbacks.
• Markets are dynamic. They change, raising the following issues for
businesses: how markets change, the rise of online markets,
innovation in markets and adapting to change in markets.
• Competition is a key driving force behind features within markets
such as prices, quality and innovation.
• Risk is quantifiable; uncertainty is unquantifiable and unpredictable.
• Market research can allow businesses to understand the customers
to whom they plan to sell, enabling better marketing decisions to be
made.
• Market research can gather fresh information (primary) or be based
on information already gathered (secondary).
• Market research can be carried out on a large enough scale to give
statistically reliable results (quantitative) or can be small scale, in-
depth and designed to give insights (qualitative).
• Market research methods can undermine the reliability of research
results if sample sizes are small or samples are poorly selected.
• ICT can help gather and analyse market research data.
• Market research can help to segment markets.
• Market mapping helps to make decisions over where to try to
position a product in the market.
• Successful market mapping requires good decisions on what to plot
on the map’s axes and where to place existing products.
• Having some kind of competitive advantage is crucial for the
success of any product.
• Competitive advantage can come from lowest costs or product
differentiation.
• Differentiation may be tangible or perceived.
• Differentiation helps to lessen the effects of competitors’ actions,
allows firms greater price flexibility and helps to add value to
products and services.
3 The market
Demand
Demand is such a fundamental concept in business that understanding the
factors that affect demand is critical to running a successful business. The
main factors affecting demand are listed below.

Price
Higher prices lead to lower effective demand, since fewer customers can
afford to pay. Price also affects consumers’ decisions on relative value of the
product compared to alternatives – higher prices make alternatives seem
better value. On the other hand, prices give off a signal about the product
being sold – so lower prices may damage consumer perceptions of quality.

Changes in prices of substitutes and

complements
A clear relationship exists between demand for a product and the price of its
substitutes. If the price of a tin of Roses falls, demand for Quality Street will
fall as consumers switch to buying the cheaper substitute. The same
relationship holds if the price of the substitute rises; demand for Quality Street
will increase as consumers switch away from Roses, the more expensive
substitute.
The relationship between demand for a product and the price of its
complements works in the other direction. Should the price of a
complementary product rise, demand for the original product is likely to fall.
Often complementary products can represent the ‘running costs’ of another
product, such as petrol for cars, or coffee capsules for coffee machines. If the
price of the complementary product rises, demand for the original will fall,
and vice versa.

Typical mistake
Too many candidates under pressure confuse the terms ‘complement’
and ‘substitute’ – pause before choosing the appropriate term.

Changes in consumer incomes

As income levels rise, demand for most products (normal goods) rises in line,
as consumers have more income to spend. For luxury goods such as Porsche
cars, demand will rise even faster than incomes. Of course, incomes do not
always rise. As economies go through recession, incomes will fall, and for
normal and luxury goods, demand falls as consumers try to save money.
However, some products, known as inferior goods, see demand rise when
incomes fall, as happened to Poundland in the recession-affected years 2008–
13. Inferior goods, as their name suggests, tend to be cheaper alternatives to
normal goods, which consumers can switch to in order to save money when
their income is falling. As incomes rise again, consumers will switch back to
normal and luxury goods, leading to a fall in demand for inferior goods.

Fashions, tastes and preferences

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

Advertising and branding

Successful advertising can lead to major short-term increases in demand.
Consistent advertising linked to other marketing activity may help to build a
brand, protecting it from direct competition and making sales volumes
relatively stable.

Demographics
Changes in the make-up of populations, which form the basis of any market’s
demand, can affect demand for individual products. Major demographic
trends in the UK in recent years have seen a growing population of over-60s,
a rising birth rate and increased numbers of European migrants. All these
groups provide opportunities for increased demand for carefully targeted
products.

External shocks
Natural disasters, changes in the law, unexpected traffic problems or a major
customer not renewing a contract are all examples of events that can have a
hugely damaging impact on demand for small or large businesses. The major
problem with many external shocks is their unpredictability. They are outside
the business’s control.

Seasonality
Seasonal factors affect demand for many products, whether they are related to
the weather and nature’s seasons or due to special events during the course of
a year, such as Christmas.
Now test yourself
1 List seven factors that could affect demand for a product.
2 If the price of petrol falls, what is likely to happen to demand for
cars?
3 If the price of Adidas trainers increases, what is likely to happen to
demand for Nike trainers?
4 Give two examples of external shocks that could damage demand
for a local independent coffee shop.
Answers online

Supply
Along with demand, the amount that businesses are willing and able to supply
will have a major impact on the price of all products. The general rule
governing the amount firms are willing to supply is that the more profit they
can make by supplying a product, the more they are willing to supply.

Changes in costs of production

If the cost of making a product changes, the amount that a business is willing
to supply will adjust accordingly:
• If production costs rise, the amount supplied will fall.
• If production costs fall, the amount supplied will rise.

Introduction of new technology

New technology used in production, such as industrial robots, tends to reduce
the costs of production:
• The introduction of new technology should lead to an increase in supply
• Firms willing to supply more with lower production costs offering higher
profits

Indirect taxes
Indirect taxes act just like another component of the cost of producing a
product or service. Therefore:
• An increase in indirect tax rates will increase cost and therefore reduce
supply.
• A decrease in indirect tax rates will cut total costs and therefore increase
supply.

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

External shocks
Unexpected events such as economic crises, poor harvests or natural disasters
can reduce the total quantity of an item available. This would lead to an
increase in the price of the item, meaning that production costs rise and firms
reduce the amount they are willing to supply.

Revision activity
Produce a mind map, with ‘Supply’ in the centre, which summarises
the major factors affecting supply and then how that factor affects
supply. So you will have one branch for each factor and each branch
will break off to explain how changes in that factor might increase or
decrease supply.

Now test yourself

5 Explain the relationship between costs of production and supply.
6 How might the invention of a new, more efficient production robot
affect the supply of cars?
7 Give an example of an external shock that may reduce the supply
of wheat.
8 Explain two reasons why governments might offer subsidies to
firms supplying wind turbines.
9 What would be the effect of a reduction in the rate of VAT on
supply?
Answers online

Markets and equilibrium

The interaction of supply and demand
In commodity markets, price is determined simply by the interaction of
supply and demand. Simply stated:
• If demand is higher than supply, the price of the product will rise, until
demand falls back to the level of supply.
• If supply is higher than demand, price will fall, stimulating more demand to
ensure that all that is supplied is sold.
What is happening is that price adjusts until demand and supply are in
equilibrium. This is the natural state for all markets in which price is
determined simply by demand and supply.

Supply and demand diagrams

Drawing a demand curve simply involves plotting a series of points showing
how much of a product would be demanded at a range of different price
levels. In a similar way, a supply curve can be plotted, showing how much of
a product businesses are willing to supply at a range of price levels.
Table 3.1 shows the demand and supply of sacks of coffee beans at a range of
prices.
Table 3.1 Demand and supply of sacks of coffee beans
Price ($ per sack) Demand (million sacks) Supply (million sacks)
210 175 125
230 165 140
250 155 155
270 145 170
290 135 185
This information can be used to plot both a demand curve and a supply curve
on a diagram that will show the market for coffee beans (Figure 3.1).

As Figure 3.1 clearly shows, the current equilibrium price is at $150 per sack,
i.e. the place at which the level of demand and supply are the same.
If there is a significant change in the factors that determine the demand or
supply of coffee, the lines will change. Possible reasons for these changes are
examined on pages 17–19. These will cause leftward or rightward shifts in the
demand and supply curves. Table 3.2 summarises the effect on price of shifts
in the curves.
Table 3.2 Effect on price of shifts in the demand/supply curves
If this changes Price will move
Demand curve moves to the right (rises) up
Demand curve moves to the left (falls) down
Supply curve moves to the left (falls) up
Supply curve moves to the right (rises) down

Now test yourself

10 What name is given to products that cannot be differentiated?
11 Why does a demand curve slope downwards from left to right?
12 Why does a supply curve slope upwards from left to right?
13 What name is given to the point at which demand and supply
curves cross?
14 State two factors that may cause a demand curve to shift.
15 State two factors that may cause a supply curve to shift.
Answers online

Price elasticity of demand

Price elasticity of demand measures the responsiveness of demand for a
product to a change in its price.

Calculation
Price elasticity of demand can be calculated by measuring the percentage
change in demand that follows a change in price:

Exam tip
The two percentage changes should always be in opposite directions.
The price elasticity will therefore always be a negative figure. To
calculate a percentage change, take the change between the two
figures for, say, price, divide by the original price and multiply by 100.
For example, a change in price from £80 to £100 is a 25% change
((£20/£80) × 100 = 25%).
Typical mistake
Always use percentage change figures. Do not simply use the
absolute changes in income (£s) or demand (units sold).

Interpreting price elasticity

Once elasticity has been calculated, the result can be interpreted, as shown in
Table 3.3.
Table 3.3 Differences between price elasticity and inelasticity
If price elasticity is between 0 If price elasticity is a negative
and −1 number greater than 1
Product is price inelastic Product is price elastic
Changes in price have Changes in price have a
proportionately smaller effect on proportionately larger effect on
demand/sales sales/demand

Exam tip
Check to see if the examiner’s text tells you the price elasticity of the
product/business. Use it if it does. However, you can also infer price
elasticity by assessing the extent to which the product is
differentiated; see the section below on factors affecting price
elasticity.

Price elasticity and revenue

Depending on a product’s price elasticity it is possible to make definitive
statements about the effect of price changes on its revenue (Table 3.4).
This predictability gives the opportunity to generate clear advice to offer in
answer to questions asking for recommendations about a product’s selling
price.

Exam tip
Using price elasticity as a way of justifying a recommendation on
whether a business should increase or decrease price allows you to
develop a sophisticated argument that uses theory well.

Factors influencing price elasticity

The major factors affecting price elasticity all boil down to whether the
product seems different to its rivals. They are:
• degree of product differentiation
• availability of direct substitutes
• branding and brand loyalty.
If price is a central factor in the decision, price elasticity will be high
(‘elastic’). If it’s got to be Nike, price elasticity will be low (‘inelastic’).

Significance of price elasticity

Price elasticity is a useful concept for managers for two major reasons:
• Price elasticity can help in forecasting sales, by considering the likely
impact of planned future price changes.
• Knowledge of price elasticity can help to decide on the best pricing strategy
 for increasing revenue, as shown in Table 3.4 above.
However, it is important to consider that price elasticity values tend to change
over time since in a competitive market many firms’ actions will affect the
extent to which one product stands out from its rivals (just think how many
chocolate bars there are).

Exam tip
Most businesses prefer to have price inelastic products because they
are able to increase their price if necessary as a result of perhaps an
increase in costs. This helps to explain why so much marketing
activity can be traced back to attempts to make the product stand out
from its rivals, reducing price elasticity.

Now test yourself

16 Would a well-known popular branded product be likely to be price
elastic or inelastic?
17 To increase revenue on a price elastic product, should price be
increased or decreased?
18 What three factors determine price elasticity?
19 What are the two major uses of price elasticity for marketing
managers?
20 What is the major limitation to the use of price elasticity?
Answers online

Income elasticity of demand

Income elasticity of demand measures the responsiveness of demand for a
product to a change in real incomes.

Calculating income elasticity

Income elasticity of demand can be calculated by measuring the percentage
change in demand that follows a change in real incomes:

Typical mistake
Unlike calculations of price elasticity, the result of an income elasticity
calculation can be either positive or negative. It is important to make
sure you pay attention to whether the changes in demand and
income are positive or negative and carefully note the sign of your
answer.

Typical mistake
Always use percentage change figures. Do not simply use the
absolute changes in price (£s) or demand (units sold).

Interpreting income elasticity

When categorising products and services according to their income elasticity
there are three possible types:
• Inferior goods: These will have a negative income elasticity.
• Normal goods: These are products with a positive income elasticity
between 0 and 1.
• Luxury goods: These goods and services have a positive income elasticity
that is greater than 1.

Factors affecting income elasticity

Necessity or indulgence?
The indulgences – those things we can easily live without, but love to treat
ourselves to when we can afford to – will be those that are most sensitive to
changes in income. Necessities are those more basic items that we would
always expect to buy, even when times are tight, therefore they are not as
sensitive to changes in real incomes.
Significance of income elasticity
Sales forecasting
Knowledge of the likely reaction of a product to a change in real incomes
allows a business to forecast sales if it has reliable economic forecasts
available. Of course, the reliability of economic forecasts is not always
strong.

Financial planning
If income elasticity gives sales forecasts, then this information can be factored
into budgets and financial plans. If a recession is forecast, a firm producing
luxuries can plan ways to reduce costs in advance of a probable sharp fall in
sales.

Product portfolio management

Having a product portfolio consisting entirely of luxuries or inferior goods
increases the danger of changes in real income having a critical impact on
sales. Firms intending to spread their risk will look to ensure that their
product portfolios contain products with a range of income elasticities.

Typical mistake
Income elasticities change over time. As a result, a company can
never be 100% confident that what happened to sales last time real
incomes changed will be repeated. Add to this the fact that most
economic forecasts tend to be a little inaccurate (at best) and writing
about using elasticity to forecast sales should be accompanied by
words such as ‘may’ or ‘could’ instead of ‘will’.

Now test yourself

21 If average earnings rise by 4% and prices rise by 2.5%, what is
the change in real income?
22 If a 3% fall in real income leads to a 6% rise in demand for
potatoes, what is their income elasticity?
23 What are the two main factors affecting the income elasticity of a
product?
24 State two reasons why sales forecasts based on income elasticity
may prove inaccurate.
25 What name is given to a product with a negative income
elasticity?
26 Will the demand for a product go up or down if:
(a) The price of a substitute rises
(b) The price of a substitute falls
(c) The price of a complementary good rises
(d) The price of a complementary good falls?
Answers online

Exam practice
The UK market for milk
Demand and supply of milk in the UK at different price levels
Price (pence per Demand (billion Supply (billion
litre) litres) litres)
42 15.0 14.0
43 14.8 14.3
44 14.6 14.6
45 14.4 14.9
46 14.2 15.2
The estimated income elasticity of milk in the UK is +0.1.
Questions
1 On one diagram, draw a demand and supply curve for milk in the
UK using the data in the table above.
(4)
2 Using the data in the table for demand at a price of 44p per litre
and 45p per litre, calculate the price elasticity of demand for milk.
(3)
3 Calculate the impact on demand for milk in the UK if incomes fell
by 5% in a year, if price was 42p per litre.
(3)
4 Explain two possible factors affecting supply of milk in the UK.
(10)
Answers and quick quiz 3 online

Summary
• In addition to price there are seven other major factors that could
affect demand for a product. They are:
 – changes in the prices of substitutes and complementary goods
– changes in consumer incomes
– fashions, tastes and preferences
– advertising and branding
– demographics
– external shocks
– seasonality.
• Decisions on how much to supply are governed by how much profit
a business can make.
• Changes that would increase the amount of profit a firm can make
lead to an increased willingness to supply and vice versa.
• The major factors affecting supply in most markets are: changes in
the costs of production, introduction of new technology, indirect
taxes, government subsidies, external shocks.
• In markets with undifferentiated products, price is determined by
the interaction of demand and supply.
• A demand curve shows the amount of the product that would be
demanded at a range of price levels.
• A supply curve shows the amount of a product that firms would be
willing to supply at different price levels.
• The point where the two curves cross is the equilibrium position, i.e.
the point at which the price will be stable in the short term.
• Demand and supply curves shift due to a range of different causes.
• Shifts in demand or supply cause changes in the equilibrium price
in a market.
• Price elasticity measures the responsiveness of demand to a
change in price.
• All price elasticities are negative values.
• Price inelastic products have an elasticity between 0 and −1.
• Price elastic products are those with a price elasticity greater than
−1.
• Price elasticity depends on the extent to which a product stands out
from its rivals.
• Increasing the price of a price inelastic product will lead to an
increase in revenue.
• Income elasticity of demand

• According to their income elasticity, products are classified as

 luxury goods, normal goods or inferior goods.
• Income elasticity depends on whether the product is an indulgence
or a necessity and on who buys the product.
• Income elasticity information can be used to forecast sales, aid
financial planning and design a balanced product portfolio.
4 Marketing mix and strategy
The marketing mix is the collective term for the four major marketing
decisions that a firm faces when trying to build a coherent plan, or strategy,
for how its product will be marketed. Each of the Ps (product, place,
promotion and price) should work in harmony to generate a coherent, credible
image for the product.

Product and service design

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

The design mix

Design is a compromise. Product and service designers must consider each of
the points of the triangle in Figure 4.1.

• Aesthetics is the word used to describe the look, taste, texture or feel of an
 item.
• Function relates to whether the item actually does what it is expected to do
and the extent to which it surpasses expectations of quality of performance.
• Economic manufacture considers the ease and economy with which the
item can actually be made on the scale required.
However, for many firms, one aspect will take priority over the other two, so
own-label drinks manufacturers will be far more concerned about designing a
product that can be manufactured very cheaply than quality or aesthetics.
However, not all businesses will head for the edges. As can be seen, BMW
tries to strike a fine balance between all three aspects of the mix.

Benefits of good design

• Can add value
• Can provide a point of differentiation
• Can reduce manufacturing costs, boosting profit margins
• Improves brand image and therefore brand loyalty

Changes in the design mix to reflect social

trends
Environmental concerns
As acceptance of the need to be aware of the environmental impact of
business activity grows, product design has increasingly focused on two key
environmental concerns:
• Design for waste minimisation or reuse: This describes a growing
awareness of the need to design products from the outset with the end of
their lives in mind. Designers are trying to minimise the parts of a product
that cannot be reused and must be thrown away.
• Recycling: Even those parts of products that cannot be reused may be able
to be recycled for another use.

Ethical sourcing
Media coverage over recent years has begun to examine the sources of
components and finished goods used by businesses. Reports of child labour
being used to make clothing, or unethical fishing methods used to catch tuna,
have encouraged designers to ensure that the components or ingredients used
in their products come from ethical sources.

Now test yourself

1 What are the three points of the design mix?
2 What type of business may be most concerned with economy of
manufacture?
3 State three possible benefits to a business of great design.
4 List three environmental concerns increasingly considered in
product design.
5 How can design help to ensure ethical sourcing?
Answers online

Branding and promotion

Both branding and promotion are methods of communicating, explicitly or
implicitly, information about a product or service to consumers.

Types of promotion
These are best categorised into two groups: those that are aimed at boosting
sales in the long term and those that are simply expected to generate a short-
term effect.

Long-term methods
• Persuasive advertising
• Public relations

Short-term methods
• Buy one get one free (BOGOF)
• Seasonal price-cutting promotions

Exam tip
Think carefully when answering a question about an appropriate form
of promotion. Ask yourself about the goals of the business: a short-
term boost in sales? Or are they willing to invest in long-term sales
growth?

Types of branding
Individual brand
These are single product brands, such as Marmite or Penguin (biscuits). The
firm that manufactures these brands may make little or no attempt to push
their company name, focusing instead on the single brand to provide focus.
Which company makes Penguins? And which makes Marmite?
Brand family
This is a brand name that is used across a range of related products, with
Cadbury being a prime example. The benefit of this is the ability to use the
umbrella brand name to encourage sales of each product within the family
through association with others. A strong brand family also makes it much
easier to get retail distribution when launching new products.

Corporate brand
Using the company name as a brand, in the way that Nestlé does, can
convince consumers that all products across the entire range share similar
benefits (or drawbacks!). Even for Nestlé, though, there may be individual
products that seem stronger without the corporate brand logo, such as
Nespresso (a Nestlé innovation that keeps quiet about the brand connection).

Ways to build a brand

• Advertising: This works best as a way of reinforcing the messages the
company wants to send about its brand.
• Unique selling point (USP): This may well provide the key stimulus that
launches a brand, and although the unique feature may be copied in time,
the brand may already be well established before this happens.
• Sponsorship: This is a way of brand building by association. Sponsoring an
event, a sports team or even a TV programme can help to create attachments
in consumers’ minds that build the brand’s personality: for example, Red
Bull sponsoring extreme sports.
• Digital media: From using social media to build relationships with
customers to using Google Adwords to pop up every time a particular
search is carried out, digital media offer a range of methods to help build a
brand, some of which have not even been developed yet.

Changes in branding and promotion to reflect

social trends
Viral marketing
Traditionally, businesses loved creating ‘word of mouth’ promotion, where
happy customers recommended a business to their friends and family – the
good reputation of the business was spread like a virus. In a digital world,
word of mouth became supercharged, with social media offering a faster and
wider way to spread good (and bad) recommendations about a product.

Social media
Social media, just like traditional media (TV, newspapers), are seen by many
businesses as another place where they can display their promotional
messages, through an Instagram or Snapchat account, on a Facebook page or
a Twitter feed.

Emotional branding
In some ways all branding is attempting to create some kind of emotional
response from consumers to the brand. However, some branding is more
overtly emotional than others; think about the sense of fun created by Ben and
Jerry’s. With the advent of digital media, especially social media, the
relationship between a brand and a consumer can reach new emotional levels,
with consumers following certain brands for daily updates from their brand of
choice.

Now test yourself

6 State two forms of promotion that may provide a short-term boost
in sales but undermine a firm’s brand image.
7 Give one disadvantage that can arise from creating a corporate
brand.
8 List three methods that can be used effectively to build a brand.
9 Explain why viral marketing has become more significant in recent
years.
Answers online

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

Types of pricing strategy

For NEW products
Price skimming
This involves launching a brand new product at a high price while the product
is unique.
Penetration
This involves launching a new product at a very low price to entice customers
to try it.

Exam tip
The decision over pricing strategy for new products must be
determined by the level of competition. A new product that has no
clear rivals is likely to use skimming, but a product with many close
competitors cannot use skimming as nobody would be likely to buy.
Before deciding on a sensible pricing strategy, ask how unique the
product is.
Table 4.1 Advantages and disadvantages of price skimming and
price penetration
Price skimming Price penetration
Advantages • High prices help to • Low prices encourage
create a desirable image lower-risk product
for the product sampling
• Early adopters will pay • Low prices boost sale
the high price in return volumes – cutting
for exclusivity production costs
• High prices generate • High volumes may
rapid profits – helping to persuade retailers to
recover the costs of buy the product –
innovation quickly boosting distribution
• Encourages customers
to develop the habit of
buying the product
Disadvantages • Will deter some • Product’s image may
customers with price be immediately cast as
seen as a ‘rip-off’ ‘cheap’
• Early buyers may be • Upmarket retailers
frustrated once price may be unwilling to
starts to fall stock the product
• Image may suffer when • Likely to create price
prices begin to fall sensitivity among
customers – a higher
price elasticity

For EXISTING products

Cost-plus
This involves deciding price by adding a desired percentage onto total costs
per unit:
Price charged = unit cost + (% mark-up)
• Benefit: This should guarantee a profit is made on each unit sold.
• Drawback: Ignoring the market may mean an unrealistic price is generated.
• Appropriate: When the firm is a market leader with little need to worry
about competition.
Predatory
A strategy that sets price low enough to force a competitor out of business –
often only on a local basis where competitors are smaller, local firms.
• Benefit: Once a rival has been forced to close, prices can be pushed up
higher, increasing margins.
• Drawback: If it can be proven to be specifically designed only to drive
rivals out of business, predatory pricing is illegal.
Competitive
A competitive pricing strategy means charging a price at the market average
or at a discount to the average price in the market.
• Benefit: This should ensure that price will not put customers off buying the
product.
• Drawback: Firms that use a competitive pricing strategy have little control
over the price they charge and thus the revenue they generate.
Psychological
Less of a strategy and more of a tactic used to make fine-tuned decisions on
the price to charge, prices are set just below major psychological levels, such
as £9.99 instead of £10, or £9,995 instead of £10,000.
• Advantage: This can help nudge customers into making a purchase by
helping them to believe they are not quite spending £10 or £10,000.
• Drawback: It may have little effect on many planned purchases and may in
fact mildly annoy consumers.

Factors that determine the most appropriate

pricing strategy
• Level of product differentiation: Highly differentiated products will have
more control over pricing, potentially allowing them to use cost-plus
pricing.
• Price elasticity of demand: Inelastic demand means that firms can adjust
prices however they wish without seeing major impacts on demand,
 whereas a producer of a price elastic product is pushed into a competitive
pricing strategy.
• Level of competition: The higher the level of competition, the less scope a
firm has for moving away from a purely competitive strategy.
• Strength of brand: Strong brands differentiate products, reducing their price
elasticity. This all adds up to the ability to take control over their own
pricing, probably allowing a cost-plus approach.
• Stage in the product life cycle: During the introduction phase there’s a key
decision to make – penetration or skimming; pricing will often change as
the product moves through growth and into maturity.
• Costs and the need to make a profit: Pricing below unit costs will lead to
loss-making, which is unsustainable in the long term. However, a balance
must be struck between pushing price above costs to maximise profit and
ensuring that the price is relatively competitive.

Changes in pricing to reflect social trends

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

Now test yourself

10 Why would a firm launching a copycat product into a competitive
market be wrong to choose price skimming as a pricing strategy?
11 Why might a luxury brand avoid penetration pricing for new
products?
12 To calculate price using cost-plus pricing, a percentage mark-up
is added on to what?
13 What level of market share are firms using competitive pricing
likely to have?
14 Why does the absence of a strong brand name on a product
suggest competitive pricing is a sensible choice?
15 A bakery makes 600 hot cross buns for Easter Saturday. Each
bun has 4p of ingredients, 3p of labour and will go into a 1p bag.
The energy cost for the 600 buns is £24 and the mark-up is 200%
 on unit cost. Using cost-plus pricing, what is the selling price per
bun?
Answers online

Distribution
Place, or distribution, is a vital part of the marketing mix, because if
consumers cannot get access to the product, they will not be able to buy it.

Typical mistake
Too many answers show naivety in implying that any manufacturing
business can get their product into any retailer. Especially for small
businesses, securing distribution for their product can be one of their
biggest challenges. In the UK a huge proportion of grocery items are
sold through four supermarket chains. If a manufacturer can convince
one of the big four to sell its product, that may be the key to success.
However, with limited space available on supermarket shelves, the
level of competition for that space is huge.

Distribution channels
Traditional physical channel
Many producers sell their products to wholesalers who act as suppliers to
smaller retailers. This channel pushes selling prices up as wholesalers and
retailers will both add their own markup. However, this channel helps smaller
firms to achieve a wide distribution across many outlets.

Direct to retailer
Larger producers can ignore wholesalers and sell their products in bulk to
major retail chains, saving on the wholesalers’ markup but exposing them to
tough negotiations with retail chains on price and credit terms.

Be your own retailer

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

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

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

Changes in distribution to reflect social trends

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

From product to service

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

Now test yourself

16 Briefly explain why getting the ‘place’ element of the marketing
mix wrong can destroy a product’s chances of success.
17 Explain the role of wholesalers in a traditional channel of
distribution.
18 Identify one benefit and one drawback to a producer of opening
 its own retail outlets.
19 How has the growth of e-commerce helped small producers?
Answers online

Product life cycle and portfolio

The product life cycle
The product life cycle is a pattern of sales over time that most products tend
to follow. The life cycle model has four phases following the launch of a
product:
• Introduction
• Growth
• Maturity
• Decline
Sometimes an additional phase – development – is identified as happening
before the product is launched.
Each phase is characterised by what is happening to sales of the product
(Table 4.2).
Table 4.2 Phases of the product life cycle
Introduction Sales are low and rise only slowly
Growth Sales begin to rise much more quickly
Maturity Growth in sales now slows and sales stabilise at their
highest level
Decline During this phase sales of the product begin to fall, until
the product is phased out or an extension strategy is
launched
The key decision-making benefit of the product life cycle model is to help
make effective marketing decisions. Examples include pricing decisions and
advertising spending.

Extension strategies
Of course, many businesses faced with a product nearing the end of its
maturity stage or even entering the decline stage may be keen to squeeze
more life out of their product. Changes can be made to the product’s
marketing mix that provide not just a quick burst of sales but a medium- to
long-term effect of sales – preventing decline or even boosting sales.
The two major adjustments that can lead to successful extension strategies
are shown in Table 4.3.
Table 4.3 Changes that can lead to successful extension
strategies
Changes to the product • Adding extra functions or features
• Changing ingredients/materials
• Launching slightly different
variants on the product –
shapes/sizes, etc.
Changes to promotion (not • Targeting a different market
simply a new advertising segment
campaign) • Finding new uses for the product
• Increasing use of the product
among existing customers

Exam tip
An extension strategy is an attempt to solve a business problem. As
with all problem-solving, the best solutions will always address the
specific causes of the problem. Recognising whether this is
happening in a case study offers excellent scope for evaluation.

Typical mistake
Do not always assume that every extension strategy will be a
success. There is often a reason why the product is starting to fade.

The product portfolio

Large businesses normally sell a range (or portfolio) of different products. A
company such as Unilever sells a wide range of products including:
• Comfort
• Domestos
• Dove
• Hellman’s
• Flora
• Knorr
• Lynx
• Magnum
• Sure
• Persil
• Brut
• Cif
• Cornetto
• I can’t believe it’s not butter
With such a wide range of different brands and products to manage, it is
important that Unilever marketing managers continually develop new
products and kill off those products whose sales are falling – and
consequently draining resources that could be better used on other products
within their portfolio. In order to manage their portfolio of brands
successfully, marketing managers will analyse their product portfolio
regularly, often using a tool called the Boston Matrix.

The Boston Matrix

The matrix assesses each product within a firm’s product portfolio. The two
key variables considered are market share and growth of the market in which
the product is being sold. Once these two figures have been discovered, each
product in the portfolio can be plotted on the axes shown in Figure 4.3.
Each quadrant of the diagram above is labelled with a memorable tag:
• Problem child
• Rising star
• Cash cow
• Dog
Typical characteristics of each type of product are shown in Table 4.4.
Table 4.4 Typical characteristics of the Boston Matrix categories
Problem These products may be successful in the future but
child currently have low market share. Their potential, however,
is based on the fact that they are being sold in rapidly
growing markets offering the chance of rapid sales growth if
supported by the right marketing.
Rising These are products in exciting and rapidly growing markets
star that currently hold a high share and are the future money-
makers for the firm. Although these products will need a lot
of money spent on them at the moment – fighting off all the
competitors attracted to these high growth markets – if high
share can be maintained, future profitability is likely.
Cash These are products in stable markets that hold a high
cows share, and can therefore generate relatively high sales with
relatively low marketing expenditure. As a result they are
likely to generate significant profits that the business can
use to help further develop other products within its
portfolio.
Dogs These products have a low share of a low growth market
and are thus generally unattractive members of the
portfolio. They are the most likely candidates to be killed off.

Now test yourself

20 List the four stages of the product life cycle.
21 What is the stage of the life cycle sometimes called before a
product is launched?
22 What are the three main influences on the success of the new
product development process?
23 What four labels are given to the four quarters of the Boston
Matrix?
Answers online

Marketing strategy
Successful marketing strategy is likely to be characterised in three ways:
• Strategy is about the future: Success in most markets relies on predicting
the future market conditions and ensuring that the plan devised for
marketing the business’s products suits the market conditions that will
develop during the life of the strategy.
• Strategy is company specific: There is usually only space in a market for
 one business following a particular strategy, so one firm may be able to
trade successfully on being the cheapest, while another will need to find a
key point of differentiation if consumers are to recognise their product as
offering any significant difference to its rivals.

Choosing marketing strategies

Mass market strategies
A basic choice faced by a business is whether to attempt to sell a standard
product to almost all consumers in a market – a mass market strategy – or
whether to concentrate their efforts on selling specialised products to smaller
subsections of the market – a niche market strategy.
Table 4.5 Benefits of mass market and niche market strategies
Benefits of successful mass Benefits of successful niche
market strategy market strategy
High distribution levels Able to meet consumer needs more
precisely
Greater control over advertising Able to charge a higher price than
and promotion mass market products
A degree of influence over Less direct competition
pricing within the market
Successful mass marketing probably relies on one major balancing act – the
need to differentiate the product from all rivals without making it less
appealing to any particular group of consumers. This can be a very tricky
balance as many methods of product differentiation will reduce the appeal of
the product to some groups of consumers. An example of this is
differentiation through quality, excluding consumers unwilling to pay the
associated higher price.

Niche market strategies

Although marketing to small subsections of the market is a fertile area for
small specialist businesses to achieve success, some larger firms do use a
niche marketing approach. Often the key to successful niche marketing is a
depth of understanding of the product and consumer tastes that takes many
years to build up. As a result, entering a niche market tends to be something
that cannot be rushed – a patient approach is needed to ensure that consumers’
needs are met appropriately.

Business to consumer (B2C) strategies

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

Business to business (B2B) strategies

Business to business marketing is, of course, underpinned by the same
principles as business to consumer marketing – that of developing customer
loyalty. What differs tends to be the key characteristics of product or service
that business customers are looking for. What is missing in business to
business transactions is emotion, something that can often play a key role in
business to consumer marketing. Instead, what matters most to business is
price and reliability.
Figure 4.4 helps to summarise the key differences and shared end-goal of
business to consumer and business to business marketing.

Consumer behaviour – developing customer

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

Now test yourself

24 What are the three general characteristics of successful
marketing strategy?
25 State two benefits of successful mass marketing.
26 State two benefits of successful niche marketing.
27 Briefly explain the reasons why successful business to business
marketing differs from successful business to consumer marketing.
Answers online

Exam practice
A major multinational producer of household products has identified
the following features of six of its major brands:
Product Market share Market growth
Brand A High High
Brand B Low High
Brand C High Low
Brand D Low High
Brand E Low High
Brand F Low Low
The company’s marketing managers are devising their marketing
strategy for the next three years and face a number of decisions.
Questions
1 Which brand is a cash cow?
(2 marks)
2 What pricing strategies are most likely to have been used for the
newly launched Brand E?
(2 marks)
3 Using the Boston Matrix, advise the company on the strategies it
might adopt in managing its portfolio over the next three years.
(10 marks)
Answers and quick quiz 4 online

Summary
• Design can be a key tool in positioning a product within the market.
• Design involves balancing aesthetics, function and economy of
manufacture.
• Good design brings a range of benefits to firms.
• In many businesses, design is influenced by environmental and
ethical concerns.
• Different forms of promotion tend to have either a long- or a short-
term impact.
• Promotions aimed at a short-term sales boost may damage brand
image.
• Branding is a key form of product differentiation.
• Brands may be created for an individual product, for a range of
products or for a whole business.
• Promotional methods that are effective at helping to build a brand
include advertising, a USP, sponsorship or use of digital media.
• Recent developments in promotion and brand building have include
viral marketing, use of social media and increased use of emotional
branding.
• Pricing strategies set out the broad approach a firm will take to
setting price.
• Two alternative strategies are available for firms launching new
products: skimming and penetration.
• Four strategies (cost-plus, competitive, predatory and
psychological) are used by firms selling existing products.
• The main factors determining the right pricing strategy all relate to
the level of product differentiation (brand, competition, price
elasticity).
• Other factors affecting the choice of pricing strategy include costs
and the stage in the product life cycle.
• Distribution is crucial because it involves ensuring that consumers
can buy the product where they want to buy it.
• Gaining distribution in retailers cannot be taken for granted.
• There are five main channels of distribution available to producers.
• Intermediaries can help spread products to a wider range of
consumers but add to the final selling price of the product.
• The internet has opened significant opportunities in changing the
way products are distributed.
• The product life cycle consists of four stages once the product has
been launched.
• The stage of the product life cycle is likely to affect the marketing
mix used for a product.
• New product development is often unsuccessful.
• Firms use the Boston Matrix to analyse their product portfolio.
• Mass marketing and niche marketing offer different benefits.
• Business to consumer and business to business marketing need to
be addressed in different ways.
5 Managing people
Approaches to staffing
Staff as an asset vs staff as a cost
Some senior managers see the people that work for the firm as a source of
potential competitive advantage. Others take a different approach, seeing staff
as just another cost to be minimised. Key features of these approaches are
shown in Table 5.1.
Table 5.1 Different ways of treating staff
Treating staff as an asset Treating staff as a cost
Permanent contracts Flexible contracts, perhaps zero hours
Develop staff skills with Minimal training offered
training
Pay staff a salary Low pay, often at an hourly rate
Builds loyalty from staff Often leads to a high staff turnover
rate
While it suits some businesses to keep their costs as low as possible, others
will adopt a strategy of providing high-quality service which would
encourage them to treat staff more as an asset to be nurtured and developed.

Flexible workforce
Flexibility refers to the ability of a business to adapt its operations to changes
in patterns of demand. The way that staff are employed and managed can
have a major impact on the flexibility of a business.

How to achieve it
There are a number of actions that a business can take to ensure that its
human resources can be deployed as flexibly as necessary. Four key methods
are explained below.
Multi-skilling
Using training to ensure that staff can perform a range of different roles
within the business brings greater workforce flexibility. Instead of employing
staff to perform just a single role, employees who are multi-skilled can cover
for absent colleagues and also switch to roles that need to be filled when
patterns in demand change.
Multi-skilling also tends to bring motivational benefits.
Part-time and temporary
Around a third of the UK’s workforce are employed in part-time jobs. For
some people, part-time hours allow them to fit work in alongside other
commitments. This can help to bring people into the workplace who may
offer excellent skills and experience but are unable to commit to full-time
work. Temporary staff are employed on short-term contracts, meaning that if
the employer no longer needs them, the contract is not renewed.
Flexible hours and home-working
For companies that treat their employees as an asset, staff may be allowed to
choose when they work a set number of hours. Another way of increasing the
flexibility of a job’s requirements is to allow employees to work at home, or
from home. This gives the staff greater flexibility to manage their time around
other commitments. Developments in technology have made greater
flexibility in location possible, with mobile phones and video messaging
services such as Skype allowing face-to-face, immediate communication
between people in different locations.
Outsourcing
Another method to increase capacity during times of high demand is to use
other businesses to perform business functions. This is called outsourcing.
Benefits of outsourcing include:
• Ongoing fixed costs can be kept at a low level within the business.
• Sudden surges in demand can be met quickly.
Drawbacks of outsourcing:
• The company to which work is outsourced needs to make its own profit,
adding to costs.
• Outsourcing arrangements may take time to work out.

Dismissal vs redundancy
Getting rid of staff can happen for a number of reasons, but these boil down
to either a reduction in demand or incompetence or disruption from staff. In
the first case, staff will be made redundant. Although making redundancies
will reduce ongoing costs, the law requires businesses to compensate those
made redundant according to how long they have worked for the business.

Exam tip
Although redundancies are an effective way of reducing costs in the
long term, the need to make redundancy payments to staff means
that in the short term there will be a significant cash outflow. This
means that making redundancies is not a good way to resolve a cash
flow problem.
Dismissal occurs either when an employee, having been fairly warned, is
deemed ‘not up to the job’ or they have committed a major breach of their
terms of employment – perhaps theft or some other dishonesty. In the case of
an employee being fairly dismissed, no payments are made.

Employer/employee relations
There are times when an employer needs to discuss and agree certain changes
with its entire workforce or at least groups of employees. This process of
discussion and agreement is what is referred to when the term
‘employer/employee relations’ is used.

Collective bargaining
Collective bargaining occurs when an employer deals with one or a few
representatives for the whole workforce when discussing problems, or
negotiating pay rises or changes to working conditions. Most commonly,
employees are represented by a trade union which will have a local
representative who carries out bargaining with the employer on behalf of all
the members. This approach is beneficial because:
• Employers only need to negotiate with one or two people on behalf of the
whole workforce, thus saving time.
• Employees benefit because acting together gives them more power in their
relationship with the employer.

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

Now test yourself

1 State three ways of creating a more flexible workforce.
2 What effect does redundancy have on the cash flow of a business?
3 What is the name given to the process of agreeing changes to pay
and working conditions, with a trade union acting on behalf of its
 members?
Answers online

Recruitment, selection and training

Recruitment
The need to recruit could be triggered by:
• existing staff leaving
• growth of the business
• new activities needing new skills
Initially the recruitment process is designed to attract potential applicants.
Then the selection part of the process begins in order to reduce the field of
applicants to the best person for the job. The decision on whether to recruit
internally or externally will depend on the:
• cost of the recruitment method
• size of the recruitment budget
• location and characteristics of the likely candidates.
Table 5.2 Advantages and disadvantages of internal recruitment
Advantages of internal Disadvantages of internal
recruitment recruitment
Quicker and cheaper than external Limits the number of potential
recruitment applicants
Chance of promotion may help Fails to bring in new ideas from
boost morale within a business that outside the business
frequently recruits internally
The skills and attitudes of internal Creates a vacancy elsewhere in
candidates will already be known by the business that will still need
the business to be filled externally

Selection
Once applications for a vacancy have been received, the business must now
narrow down the field so that it is left with the best candidate for the vacancy.
The selection process may require candidates to undergo a number of
different procedures. The most common are outlined in Table 5.3.
Table 5.3 Common methods of selection for job vacancies
Method of Explanation Analysis
selection
Interviews Still the most common method, Bias or prejudice on
interviews can take place face to behalf of the
face or by telephone. They offer interviewer may
the chance to hold a conversation,skew the results of
allowing follow-up questions and interviews,
some freedom of which areas to undermining the
probe usefulness of this
method when used
on its own
Testing and Attempting to bring objectivity to Purely objective
profiling the selection process, aptitude selection methods
tests can uncover just how high a can mean screening
candidate’s skill levels are in out great candidates
certain tasks. Meanwhile, profiling who do not fit the
helps to identify the personality- ‘traditional profile’ of
type of candidates the job
Assessment Candidates may be invited to This method tends to
centres attend an assessment centre be more expensive
where a range of selection than others and is
methods from role plays to group more likely to be
tasks and interviews can be used only for more
combined to better assess their senior positions
abilities and performance in a
simulated environment

Training
Seen by Herzberg as the most powerful tool at a manager’s disposal, training
allows employees to develop new skills, thus boosting the range of tasks they
are capable of performing.
The benefits and costs of training for a business are shown in Table 5.4.
Table 5.4 Benefits and costs of training for a business
Benefits Costs
Higher skill levels can boost Providing training can carry a large
productivity and innovation financial cost
A wider range of skills can While training is being provided, the
enhance the business’s normal operations of the business can
flexibility be disrupted
Motivates staff who feel they Better-trained staff are more attractive
have been invested in by the to other businesses which may try to
business poach them

On-the-job versus off-the-job training

Figure 5.1 shows the advantages and disadvantages of on-the-job training.
Choosing to use off-the-job training prevents the two disadvantages but
means the business can miss out on the advantages offered by on-the-job
training.

Typical mistake
Do not be tempted to use the term ‘induction training’ to describe all
training that offers employees new skills. It relates only to the training
provided at the beginning of a member of staff’s employment.

Now test yourself

4 State two reasons why on-the-job training may be more effective
than off-the-job training.
5 State two reasons why off-the-job training may be more effective
than on-the-job training.
6 Why can interviews be an unreliable method of selection?
7 Give two benefits of internal recruitment.
8 Give two benefits of external recruitment.
Answers online

Organisational design
Structure
As organisations begin to grow, thought must be given to the way in which
the different people and jobs are to be structured. This helps in ensuring that
the work is co-ordinated effectively and the organisation is following its
correct strategic path. Most organisations have a hierarchical system, with the
main decisions taken at the top and those lower down the structure putting
those decisions into practice. These structures are usually split vertically into
business functions.
Each manager should not be expected to supervise too many members of
staff, otherwise they would not be able to perform this role effectively.
Therefore it is important to design an organisation where individual
managers’ spans of control are not too wide.
Limiting spans of control means that for larger organisations, many levels of
hierarchy are needed. Therefore, management levels can run from functional
managers (such as the marketing manager), through other senior management
roles (brand manager), to regional managers, location managers and then
supervisors and team leaders. At each layer, different levels of power and
responsibility are found – the nearer the top, the more power and
responsibility (and pay).
Vertical paths through the organisation, through which communication passes,
are referred to as chains of command.
Subtle differences can be found between organisations, especially when
relating to where key decisions are made. In a centralised organisational
structure, to aid co-ordination, most significant decisions will be made at the
very top of the structure. In other organisations, perhaps those where local
conditions vary greatly, it makes more sense to allow local managers to make
decisions for their branch. Figure 5.2 helps to explain the potential benefits of
both centralised and decentralised decision-making.
Typical mistake
Delegation does not mean simply telling someone to do something –
that is simply issuing orders. For delegation to take place, some
actual decision-making power over how to do a job must be passed
down to a subordinate.

Types of structure
A further fundamental difference in organisational structure concerns the
basic shape of the structure.

Tall
A tall structure is one with many layers and narrow spans of control. Table 5.5
summarises the advantages and disadvantages of a tall structure with narrow
spans of control.
Table 5.5 Advantages and disadvantages of a tall structure with
narrow spans of control
Advantages Disadvantages
Allows close supervision of staff Staff may feel over-supervised
and not trusted by their
management
Communication within the Communications as a whole
immediate team (boss and may be poor with so many
immediate subordinates) is likely to layers for messages to pass
be excellent through
Many layers of hierarchy means With narrow spans, there may
plenty of opportunities for promotion be little scope for staff to use
to the next level their initiative

Flat
A flat structure has fewer levels within the hierarchy, but wider spans of
control. This forces increased delegation by managers who are unable to
closely supervise far higher numbers of subordinates. Of course, this can
result in more mistakes. It can also lead to far greater motivation from staff,
who are expected to use their own initiative. A flat structure also has the
benefit of reducing the number of layers between the top of the structure and
the very lowest level. This may make it easier for senior managers to develop
an understanding of the real day-to-day challenges faced by staff dealing with
customers, for example. This can increase the ability of the firm to respond to
changes in customers’ tastes, boosting competitiveness.

Matrix
A matrix structure differs from traditional structures in one very significant
way. Instead of only having one line manager, staff may have two, or even
more. Though a traditional functional structure is likely to exist, cross-
functional project teams are formed, with staff from different departments
working together on a project, under the leadership of the project leader.
Table 5.6 Advantages and disadvantages of a matrix structure
Advantages of a matrix structure Disadvantages of a
matrix structure
Working together allows expertise from each Each project team
department to be immediately available, member will have at
preventing possible delays in projects least two bosses
The focus of the project team should be on Two bosses means it
success of the project, rather than making can be unclear whose
their functional department more important orders should take
than others priority
Learning from the views of colleagues in other Getting staff from
departments helps to develop each team different functional
member areas to agree can be
difficult

Impact of structure on motivation and

efficiency
It is remarkable how many ways structure can affect efficiency and
motivation and therefore costs and profit. Effects on efficiency and therefore
unit costs include:
• poor communication leading to mistakes
• duplication of tasks
• tasks being overlooked and not done
• departments failing to work together effectively.
Meanwhile, structure can affect motivation by encouraging or preventing the
following key issues:
• Scope to show initiative
• Extent of delegation
• Responsibility
• Receiving all information required to perform a job
• Opportunities for promotion

Exam tip
Whenever relevant, look to build chains of logic that interweave
organisational structure, motivation theory, productivity (efficiency)
and unit costs.

Now test yourself

9 In what type of structure may staff have more than one line
manager?
10 Why does a flat structure encourage delegation?
11 How does a tall structure offer more scope for promotion?
12 Who makes major decisions in a centralised structure?
13 Look ahead to the next section which deals with motivation in
theory. Link up each of the five bullet points above to the work of at
least one theorist to understand how you can use motivation
theory alongside organisational structure when building a chain of
argument in an exam answer.
Answers online

Motivation in theory
The desire to understand what motivates people to work is driven by the
commercial need to fully use the human resources at the firm’s disposal. For
over a century, academics have been trying to put together viable theories that
help to explain what motivates people to work. The four key theorists are
explained below.

F.W. Taylor (scientific management)

Taylor’s approach to motivation can be summarised simply as ‘money
motivates’. His theory suggests that people only work in order to maximise
their own income. This means that to get people to work harder, money
should be used as an incentive (or removal of money as a threat). This
approach to motivation was accompanied by Taylor’s beliefs as to how work
as a whole should be organised, summarised below:
• Break the task down into small, simple repetitive parts.
• Design a payment system that rewards each worker each time they
complete their task.
F.W. Taylor’s work is still visible in many jobs today, where commission or
piece rate pay is used to incentivise more work being completed. However,
Taylor’s ideas of how a business should be organised became extremely
unpopular with workers. They felt treated like pieces of machinery and denied
the opportunity to use their minds at work. They were also resentful of the
level of control that the work process and payment method gave employers.

Elton Mayo (human relations theory)

Mayo’s work stemmed from a range of experiments he conducted into the
effectiveness of ‘Taylorism’. Mayo discovered that there were more factors
affecting workplace performance than money. Mayo’s findings centred on the
importance of interpersonal relations as a factor affecting productivity, thus
the name ‘human relations theory’. The factors Mayo identified are
summarised below:
• Workers gain satisfaction from a certain level of freedom and control over
 their working environment.
• Workers who feel they belong to a team tend to work more effectively.
• Group norms (what people in a team expect of each other) tend to have a
strong influence over workers’ behaviour and productivity.
• Managers taking an active personal interest in their employees has a
beneficial impact on workers’ performance.

Maslow (hierarchy of needs)

Maslow’s hierarchy of needs, shown in Figure 5.3, summarises his beliefs

about what explains human behaviour, both in general and in the workplace.
He believed that all humans have five sets of needs. These can be arranged in
a hierarchy, with the most basic needs for life at the bottom and the higher-
level needs at the top. Meeting each level of needs is a priority until they are
met, when a person will focus on the next unsatisfied level of needs. Table 5.7
shows how each level of need has workplace implications.
Table 5.7 Maslow’s hierarchy of needs: implications for business
Maslow’s level of human need Business implications
Physical needs, e.g. food, shelter, Pay levels and working
warmth conditions
Safety needs, e.g. security, a safe Job security, a clear job
structured environment, stability, role/description, clear lines of
freedom from anxiety accountability (only one boss)
Social needs, e.g. belonging, Team working,
friendship, contact communications, social
facilities
Esteem needs, e.g. strength, self- Status, recognition for
respect, confidence, status and achievement, power, trust
recognition
Self-actualisation, e.g. self-fulfilment; Scope to develop new skills
‘to become everything that one is and meet new challenges, and
capable of becoming’, wrote Maslow to develop one’s full potential

Frederick Herzberg (two-factor theory)

Herzberg’s theory relies on accepting his definition of motivation – of doing
something because you want to do it. He distinguished this from movement,
which he defined as doing something to get a reward or avoid a punishment.
Herzberg was clear – motivated workers give you their best performance all
the time, are willing to embrace change and are great at solving problems.
Professor Herzberg’s two-factor theory suggests that factors affecting people
at work can be grouped into ‘motivators’ and ‘hygiene factors’. He identifies
five common features of instances when workers are genuinely motivated.
Providing the opportunity for staff to experience these can lead to job
satisfaction. Herzberg’s motivators are:
• achievement
• recognition for achievement
• meaningful, interesting work
• responsibility
• advancement – a sense of growth as a person.

Typical mistake
Suggesting that Herzberg claimed that pay and bonuses motivate
staff is wrong. Herzberg was clear that money is a hygiene factor and
while offering bonuses can generate movement (better than average
work), it does not motivate.
The other set of needs all relate to the context, or environment, in which you
expect an employee to do their job. These needs, which Herzberg called
hygiene factors, must be met to prevent an employee feeling dissatisfied.
• Company policy and administration (the rules and paperwork involved in
working for the business)
• Supervision
• Pay
• Interpersonal relations (with peers, bosses or subordinates)
• Working conditions
These hygiene needs do not motivate staff, however they must be satisfied to
prevent dissatisfaction. Herzberg argued it is impossible to motivate a
dissatisfied worker. Three possible scenarios are explained in Table 5.8.
Table 5.8 Three scenarios under Herzberg’s two-factor theory
Hygiene needs Worker will give movement (not their best – only
met, no enough to gain reward or avoid threat)
motivators
Motivators met, Employee will be resentful of their job and, no
but hygiene not matter how interesting the work is, will perform
satisfied poorly – and look for another job
Hygiene needs Employees can focus on their job and will do it to
and motivators the best of their ability
met

Now test yourself

14 Explain how Taylor’s belief in why people work ties in with paying
people for each unit they produce.
15 Explain how this means a firm should be able to pay staff and
make a profit.
16 What did Taylor say was the only thing that motivated people to
work?
17 What did Mayo discover also played a part in motivation?
18 List Maslow’s five levels of needs.
19 State two examples of Herzberg’s hygiene factors and three of his
motivators.
20 Explain in your own words the difference between motivation and
movement, giving an example from your school/college life.
Answers online

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

Exam tip
For any financial method, Taylor’s theory – that money motivates –
can be used to justify why the method should work.

Non-financial techniques
Now test yourself
21 State three motivation methods that F.W. Taylor would advocate.
22 State three motivation methods that Herzberg would advise a
business to use.
23 What motivation method could be used if workers are struggling
to meet their social needs at work?
24 Explain why delegation may need to be accompanied by training.
25 Which motivation methods are designed to align a worker’s
personal financial rewards with the company’s financial success?
Answers online

Exam tip
Wherever possible, use a motivation theorist when explaining a
method of motivation. Explain how the theory suggests the method
would actually help to improve motivation of staff.
Leadership
Leaders and managers
The roles of manager and leader are different, although in many businesses,
especially smaller firms, the same person may be expected to fulfil both roles.
Peter Drucker’s quotation ‘Managers do things right; leaders do the right
thing’ sums up the difference nicely.
Table 5.10 Responses of leaders and managers to different
circumstances
Circumstances What managers do What leaders do
Key staff are Recruit new staff withRethink the design and
leaving care responsibilities within the job
An important Get staff to smooth Take personal responsibility
customer is things over as best for the customer’s
threatening to go they can disappointment and sort the
elsewhere problem out
A downturn Hire an HR specialist Call a staff meeting, explain
means company to handle what is happening and deal
redundancies are the whole process with the whole thing
necessary personally
A very promising Take control of the Delegate the project to a
new product idea development and bright young manager,
has been assemble a large providing extra resources
proposed project team when needed

Typical mistake
Although some leaders are charismatic characters, with outgoing
personalities that subordinates love to follow, many highly successful
leaders may go unnoticed – not all great leaders lead by example.

Types of leadership style

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

Now test yourself

26 Name the leadership style being explained:
(a) The leader seeks and listens to the views of staff, delegating
with a clear sense of purpose.
(b) The manager cares about the welfare of staff and considers
this when making decisions.
(c) The manager expects their instructions to be followed and
keeps all decision-making power.
(d) The manager leaves staff to get on with their work without
any clear direction.
27 Explain why the leader and manager are likely to be the same
person in a small business.
Answers online

Exam practice
HMRC – the UK organisation responsible for collecting taxes –
attracted news headlines in 2016 as a result of its decision to
outsource the cleaning of its offices. This meant that cleaners,
formerly employed by HMRC, might lose their pension benefits and
legal entitlement to sick pay. The company to which the cleaning work
was outsourced used staff employed on zero-hours contracts. This
shifted the risk involved in employing staff away from HMRC to the
subcontractor. In turn, the subcontractor shifts risk to the people they
employ. The zero-hours contracts mean the subcontractor does not
have to pay staff when there’s no work, therefore avoiding
unnecessary costs.
Questions
1 What is meant by a zero-hours contract?
(2)
2 What is meant by outsourcing?
(2)
3 Using a motivation theory of your choice, explain why HMRC’s new
cleaners, employed by the subcontractor, are likely to do a poorer
job than cleaners who were previously employed by HMRC.
(6)
4 Assess whether HMRC has made the right decision about how to
have its offices cleaned.
(10)
Answers and quick quiz 5 online

Summary
• Different employers may view their staff either as a critical asset to
the business’s success or simply as a cost to be minimised.
• Having a flexible workforce makes it easier to run a business
successfully.
• Employer/employee relations can be based on either collective or
individual bargaining.
• The need to recruit staff could be triggered by existing staff leaving,
growth of the business, or new activities being performed by the
business.
• Staff may be recruited internally or externally.
• Selection methods including interviews, testing and profiling, and
assessment centres are used to decide which applicants to employ.
• Training staff has both benefits and costs.
• Initial training is called induction training.
• Training can be carried out on the job or off the job.
• Organisational structures can be classified as tall, flat or matrix.
• Key issues affecting the shape of organisational structure are
spans of control and levels of hierarchy.
• Organisational structure can have major impacts on efficiency and
motivation.
• Methods of motivating staff can fall into two categories: financial
and non-financial methods.
• The five financial methods are: piecework, commission, bonus,
profit-sharing and performance-related pay.
• Non-financial methods are: delegation, empowerment, consultation,
team-working, flexible working, job rotation and job enrichment.
• Clear links can be drawn from the motivation theorists’ work to
explain why these methods should work.
• The roles of leader and manager are significantly different.
• Different leaders treat their staff in different ways. This is called
their leadership style.
• The main leadership styles to focus on are: autocratic, paternalistic,
democratic and laissez-faire.
6 Entrepreneurs and leaders
Role of an entrepreneur
Businesses could not exist without entrepreneurs. They are the individuals
who spot business opportunities and then act in order to exploit the
opportunity. Entrepreneurs must fulfil a number of roles within their
businesses, as outlined below.

Creating and setting up a business

Generating a business idea
At the very heart of any entrepreneur’s success is a good idea, probably based
on an understanding of consumers. The main sources of business ideas are:
• Observation: Watching what other businesses are doing or how consumers
behave may give an idea that can be copied elsewhere. Or it may suggest an
idea that can be adjusted to work even more successfully.
• Thinking ahead: This is spotting trends that will lead to changes in the
future that will offer business opportunities, for example noting a
government initiative to boost the number of apprenticeships and setting up
a website specialising in advertising apprenticeships.
• Personal or business experience: Noticing that certain needs are not met
through personal experience or within a workplace.
• Innovations: Scientific breakthroughs or major overhauls of an existing
type of product may generate viable business ideas.

Spotting an opportunity
An idea will only become a viable business if a market exists for it. The
ability to identify chances to turn ideas into saleable products or services
relies on spotting an opportunity. Typical sources of opportunity tend to be
centred on changes occurring in the wider world:
• Changes in technology: Increased computing power in mobile handsets
broadens the range of possible apps that could be produced to meet a need
for consumers to control something on the move.
• Changes in society: Trends in the way people behave, such as increased
part-time work opportunities for the semi-retired, can represent an
opportunity, such as a recruitment agency for retired workers.
• Changes in the economy: Differing rates of national or regional economic
growth may offer opportunities to be exploited.
Running and expanding a business
There are four key habits that successful entrepreneurs commonly
demonstrate in the way they run their businesses:
• They measure performance in an unbiased way: If there are problems these
must be identified rather than ignored.
• They have an eye for detail: It is unlikely that anybody other than the
entrepreneur will be as worried about getting the little things right.
• They have the ability to step back from the day-to-day issues: Only by
thinking strategically will a new business be able to secure a long-term
future.
• They love what they are doing: Without this, the motivation needed to do
the three things above will drain away.
Some businesses are not suited to expansion as the idea and opportunities
remain small-scale or localised. For other entrepreneurs, expansion may be
vital to prevent others from developing an idea more successfully. The three
major problems to avoid as an entrepreneur considering expansion are:
• Over-estimating demand: What works in one place may not work
elsewhere.
• Failing to raise sufficient finance: It is a lack of cash that ultimately leads to
all business failure. Without having made sure that the business has enough
finance to support operating on a larger scale, the danger of running out of
cash becomes acute.
• Not recruiting enough or the right people: As entrepreneurs expand their
business they will find their limited time more stretched, with more to
oversee (perhaps causing too much stress). It is therefore vital that when
they recruit they get the right staff who understand the business philosophy
and have the skills needed.

Innovation within a business

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

Barriers to entrepreneurship
Funding
Following the financial crash of the last decade, banks in the UK have been
less willing to lend to small firms and business start-ups, considering them
relatively high risk for relatively low return as they are often believed to be
relatively unprofitable. Without institutions willing to lend, entrepreneurship
may die back in the UK.

Gender bias
UK entrepreneurs are three times as likely to be male as female. This
statistical mismatch between the population/market and the people starting
new businesses is likely to mean that much entrepreneurial talent in the UK is
going to waste.

Lack of public sector support

Although the image of the entrepreneur has improved significantly in the UK
over the past twenty years, some who work in the public sector view
entrepreneurs sceptically, suspecting tax avoidance or motives based on
greed. This perception in the public sector may lead to an education system
that fails to value entrepreneurial skills or other barriers to entrepreneurship.

Anticipating risk and uncertainty in the

business environment
Risk and uncertainty characterise the business environment for many firms.
This is because of the wide number of external variables that the business
cannot control, and may not even be able to influence. The role of the
entrepreneur must include understanding the ways that uncertainty affects the
business. In some cases the main cause of uncertainty can be reduced, such as
introducing new products into the firm’s portfolio, thereby reducing the
dependence on the sales of one brand.

Now test yourself

1 State two ways that walking around the local town may help to
identify a business opportunity.
2 Explain why entrepreneurs may find it harder to secure funding
from banks than fifteen years ago.
3 What four habits are important for any entrepreneur to develop if
they want to successfully start up their business?
Answers online
Entrepreneurial motives and characteristics
Characteristics and skills
The main characteristics required to become a successful entrepreneur are:
• understanding the market
• determination
• passion
• resilience
• the ability to cope with risk.
Taking sensible risks involves weighing up the risk and rewards that a course
of action offers. Risk consists of the likelihood of things going wrong and the
size of the consequences of things going wrong. Good entrepreneurs accept
risk but will not take on any risk they consider to be too great.
Good entrepreneurs will need to be able to demonstrate a range of common
skills:
• Financial skills: This involves understanding key financial documents and,
more fundamentally, how finance allows a business to function.
• Persuasive abilities: Good entrepreneurs find a way of persuading many
people to do many things that their business needs, from suppliers to staff to
customers.
• Problem-solving skills: These are frequently shown by the ability to
identify causes of the problem and solve the problem by addressing these
causes.
• Networking skills: With a wide range of possible business contacts,
entrepreneurs are more likely to find someone who can help when the
business needs help.

Reasons why people set up businesses

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

Exam tip
An entrepreneur’s motives will be a major determining factor behind
their decision-making. Decisions taken by an entrepreneur who is
seeking to maximise profit will differ greatly from those taken by an
entrepreneur driven by an ethical stance.

Now test yourself

4 What are two common financial motives for starting a business?
5 Briefly explain a good entrepreneur’s attitude to risk.
6 State three types of people on whom an entrepreneur may need to
use their persuasive abilities.
7 Why can profit maximisation damage a firm’s long-term chances of
success?
8 Why may entrepreneurs who take an ethical stance struggle to
make a profit, even in the long term?
Answers online

Business objectives
Business objectives are targets set in order to ensure that the whole business
is working towards the same goals. Objectives are set by those in charge of
the firm, such as the chief executive. Once objectives have been set, a plan for
achieving the objectives – a strategy – can be devised. The strategy will lay
out what each department of the business will need to do in order to enable
the business to reach its objectives.
SMART objectives
To gain most from objectives, they should be SMART:
• Specific
• Measurable
• Achievable
• Realistic
• Time-bound

Common business objectives

Common business objectives can be seen in Table 6.1.
Table 6.1 Common business objectives
Typical Explanation Typical circumstances
objective
Survival Focusing on generating When starting up, or when a
sufficient cash to challenging external
sustain the business environment threatens the
future of the business, such as
a recession or the arrival of a
powerful new competitor
Profit Earning the most profit A common objective for
maximisation possible in a given time businesses – reflecting the
period need to generate profit for
owners as a primary purpose
of business
Sales Growing the number of In a rapidly growing market,
maximisation customers, without a firms may try to maximise their
major focus on share of the market, with an
controlling costs expectation of generating
profits once the market growth
has slowed and competition
reduces
Market share Increasing market Market leaders will often seek
share to a dominant to increase their lead and thus
level helps to ensure power by enhancing market
long-term success share
through greater
distribution and
preventing new
entrants from
challenging in the
market
Cost A focus on seeking to This objective will be key for
efficiency minimise the costs of firms that are trying to follow a
producing a product or strategy where they will aim to
service and the running undercut all their rivals on
costs of the business price. If they can keep costs
low, they should still be able to
make a profit even with a low
selling price
Employee Looking after staff, by Where people play a key role
welfare treating them well, and in gaining a competitive
looking to develop advantage, whether that be in
them using training and customer service or through
internal recruitment innovation
Customer Prioritising the need to This will be crucial where
satisfaction ensure that every attracting new customers is
customer has a positive costly and losing existing
interaction with the customers is very expensive,
business such as when providing a
 regular service such as mobile
phone networks or banking
Social Objectives that relate to Some businesses see
objectives the beneficial role a improving society as a key
business can play purpose and will therefore set
within society social objectives in a
meaningful way. Social
enterprises will have social
objectives as a top priority

Now test yourself

9 Why do businesses set objectives?
10 What does SMART stand for?
11 What are the eight common business objectives?
Answers online

Exam tip
Successful firms choose the right objectives to suit their
circumstances. Carefully read the right-hand column of Table 6.1 to
ensure you understand when different objectives are most
appropriate.

Forms of business
The topic referred to as ‘forms of business’ refers primarily to the legal status
of the organisation. However, later in this topic, ‘Other forms of business’
covers issues such as licensing the use of a business’s name, running a
business enterprise to improve society, running a business as part of a lifestyle
choice and running a business purely online.
Table 6.2 Different forms of business
Legal forms of business Other ‘forms of business’ covered – not
covered in this topic specifically relating to legal status
Sole trader Franchising
Partnership Social enterprise
Private limited company Lifestyle businesses
Public limited company Online businesses
Businesses with unlimited liability
Sole trader
A sole trader is a person who starts and runs a business without turning it into
a company. This explains why the law sees the business and the owner of the
business as the same. As a result, the owner is personally liable for any debts
built up in running their business. If the business goes bust, the owner has to
use personal assets to repay those to whom the business owes money.
Key benefits:
• Owner has full control over decisions
• Owner keeps all profits made
• Minimal paperwork needed to start up
Key drawbacks:
• Owner has unlimited liability for debts
• Hard to raise finance

Typical mistake
Sole traders can employ staff. Too many exam answers wrongly state
that a sole trader has to run the business by themselves, mistakenly
believing sole traders are literally one-person businesses. The ‘sole’
refers to the owner – just one owner. There can be as many staff
employed as the owner wishes.

Partnership
While a sole trader is the single owner of a business, a partnership is perhaps
best thought of as a sole trader where several owners are allowed. This helps
to raise finance as each partner can bring capital into the business. In addition,
the burden of responsibility for running the business can be shared,
potentially among people with varied skills and experience. As with a sole
trader, partners still have unlimited liability for debts incurred in running the
business.
Key benefits:
• More owners can allow more finance to be raised
• Partners may bring varied skills and experience
• Shared burden of responsibility among partners
Key drawbacks:
• Partners have unlimited liability
• Potential for disagreement among partners
Typical mistake
Liability for debt only becomes an issue if the business goes bust.
The owners’ personal assets will only be taken if the business goes
under, but still owes money after the assets bought for use in the
business have been sold to raise money.

Businesses with limited liability

For businesses happy to undergo increased legal formalities, limited liability
for owners offers a great safety net from which to build a much larger
business. Without this protection, far fewer investors would be willing to
invest their money into multi-billion pound firms whose debts could run into
billions of pounds.

Private limited company

The simpler form of limited company to start is a private limited company
with no minimum share capital. Increased legal formalities include having
accounts independently audited each year at a probable cost of several
thousand pounds.

Typical mistake
Some exam answers wrongly suggest that private limited companies
can keep their accounts hidden from public view. In fact, one
responsibility for all limited companies is to send a simplified copy of
their accounts to Companies House. Anyone can inspect any
business’s accounts at Companies House or via the Companies
House website (for a small fee).

Public limited company

A public limited company is the only type of business that can sell shares via
the stock market to the general public. This allows them to raise vast sums of
share capital. However, in order to become a public limited company, a
business must have a minimum of £50,000 share capital. In addition, there are
considerable regulatory requirements involved in floating the company on the
stock market. Continuing to meet the annual requirements of the stock market
will cost tens or hundreds of times more than running a private limited
company.

Typical mistake
Private limited companies are required to use the letters Ltd as part of
their name. The letters PLC are reserved for public limited
companies.

Other forms of business

Franchising
Franchising offers the opportunity to start a business using a tried and tested
formula. For the franchisor, franchising can be a relatively cheap and quick
way of expanding their business rapidly. For the franchisee, there are both
benefits and drawbacks relative to starting entirely independently, as shown
below.
Benefits:
• Access to a tried and tested formula for business success
• Support from the franchisor in providing materials and fixtures and fittings
• Advice and training on all business functions
• Possibility of a national advertising campaign from the franchisor
• Easier access to loans as banks recognise the lower risk involved in starting
as a franchisee
Drawbacks:
• The franchisee may feel frustrated at being unable to make decisions
dictated by the franchisor.
• There is likely to be an initial franchise fee to buy the licence (perhaps
several hundred thousand pounds for the most popular franchised brands).
• The franchisor will also expect royalties, a percentage of revenue.

Social enterprise
Social enterprises place the desire to fix a social problem above the profit
motive when making decisions. This is, of course, a terribly broad definition
but that is necessary given the wide range of businesses that can be classed as
being, in some way, social enterprises.

Lifestyle businesses
Some entrepreneurs start up a business because it suits their desired lifestyle.
This may mean that maximising profit is far from the most important issue
considered when making decisions for these businesses. For some, running
their own business may give flexibility in working hours to fit around family
commitments: for example, leaving a highly paid job that requires long
periods away from home in order to start up a small computer repair business
could allow an entrepreneur to fit work commitments round their children’s
sports days and Christmas plays.

Online businesses
As the internet has grown over the past 30 years to become a huge part of
modern life, business opportunities have grown out of the technology. Most
important is the way the internet has enabled businesses to connect with
consumers effectively without the need to ever meet face to face. The result is
that traditional ‘bricks and mortar’ businesses now face competition from
many online-only companies. In general, online offers two powerful
advantages over traditional ‘bricks and mortar’ businesses:
• Lower costs (with no need to spend on physical premises)
• Higher potential revenues (with the scope to sell worldwide)

Now test yourself

12 Which two types of business organisation offer their owners no
limited liability?
13 What is the minimum share capital required to form a public
limited company?
14 State two benefits of starting a business by buying a franchise.
15 State two drawbacks of buying a franchise rather than starting a
business independently.
Answers online

Business choices
Rather than worrying about learning too much in this topic, being aware of
opportunity cost, choices and trade-offs should help to structure the thought
processes needed to write excellent responses to examination questions.

Opportunity cost
Too often business decisions are made without a real appreciation of the
opportunity cost. In order to genuinely understand the opportunity cost of any
decision, it is vital to ensure that all possible options are appropriately
quantified. However, this generally needs accurate forecasting, a challenge
that most businesses struggle to achieve.
Frequently, decisions may be based on personal preferences of business
leaders – leaders in a position to influence the data on which the decision will
be made. Though this may sound conspiratorial, it may in fact simply be a
reflection of the enthusiasm that the leader has for their ‘great idea’. If the
best decisions are to be made, cool heads must carefully identify the
opportunity costs involved in making a particular business choice.
Identifying opportunity costs requires careful thought and analysis. Figure 6.2
helps to illustrate this.

Choices and trade-offs

The choices a business faces are likely to involve some form of compromise –
a trade-off between competing objectives – such as minimising costs and
maintaining quality standards. Successfully managing these trade-offs will
need several attributes on behalf of decision-makers including:
• experience
• understanding of consumer tastes
• a broad understanding of the business’s current position
• an understanding of the external issues influencing the decision.

Now test yourself

16 Explain the meaning of the term ‘opportunity cost’.
17 Explain the meaning of the term ‘trade-off’.
Answers online

Moving from entrepreneur to leader

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

Common personal issues when moving from

entrepreneur to leader
• Delegating
• Maintaining effective communication
• Co-ordinating far more people
• Keeping an eye on the big issues

Delegating
A successful entrepreneur, used to making all the decisions about the
business, can find it hard to let go of authority. But for the delegation to
succeed, the subordinate must feel trusted to make decisions without
interference from the boss. If the business is to grow, letting go of control can
often be the single hardest challenge faced by an entrepreneur.

Maintaining effective communication

Once an organisational structure begins to develop within a growing business,
communication is vital, but harder to ensure. The boss will still need to know
what customers are saying or what morale is like among shop-floor staff. For
this to happen, information must be able to flow upwards through supervisors
and managers who may be hesitant to tell the boss about problems.
In addition, if the boss is still going to set the direction for the firm and exert a
strong influence over how things get done within the business, top-down
communication will be vital. But in a bigger organisation, orders and
instructions may get distorted as they pass through several layers of
management.

Co-ordinating far more people

In a start-up the boss is likely to know all staff on a personal level. Once the
total workforce of a business passes a certain size, the boss may struggle to
develop the personal relationships that had marked out their successful start-
up. However, all staff (and other business resources) will still need to be
heading in the same direction. It is down to the boss to ensure this still takes
place, even without the ability to personally work with all members of staff on
a regular basis.
Growth requires an entrepreneur to make the change from hands-on boss to
leader/manager. As discussed on page 54, these two roles – manager and
leader – are different. In order for effective growth to take place, the
entrepreneur will have to develop management skills of co-ordination or
employ effective managers who can take over this role.

Keeping an eye on the big issues

The role of leader, as explained on page 54, involves being able to understand
exactly where the business should be heading and inspiring others with a
vision of how the business is going to get there. As a business grows, subtle
changes of direction can take place. The entrepreneur-turned-leader will need
to keep an eye on the big issues facing the firm, such as what to sell and
whom to sell to, while ensuring the management of resources is still taking
place efficiently.

Now test yourself

18 Why is retained profit unlikely to be a source of finance for the
early stages of the growth of a business?
19 In what two ways does a loan result in cash draining out of a
business?
20 Why do many entrepreneurs find delegation so hard?
Answers online

Exam practice
After a successful career in banking, Robert Southey had already
started one business trading company debt and other financial
products. His first business had not been as successful as he had
hoped. Robert was disappointed with how little work his partner had
been doing, so for his new venture he decided to ‘go it alone’ with
Southey Capital Ltd. Much of the finance was raised with his own
personal savings. Robert was keen to avoid loans as banks were not
offering attractive rates of interest. With the need to build up his
turnover as quickly as possible, in order to build a reputation in the
markets he was dealing with, Robert’s initial goal was to maximise
revenue in the first year of the business. He employed four staff to
help manage the office and research the deals he uncovered.
However, Robert watched them like a hawk, always with a keen eye
for detail and unwilling to let his business suffer from somebody else’s
mistake. There is no doubt that Robert has that vital skill for an
entrepreneur – the ability to cope with risk – but he is not willing to
take risks without trying to minimise the chances of failure. His overall
strategy, of trying to minimise costs wherever possible in order to
enable Southey Capital Ltd to make a profit on deals that competitors
would find loss-making, is paying off.
Questions
1 Identify two benefits to Robert of starting his business as a private
limited company.
(2)
2 Identify two benefits to Southey Capital Ltd of having a clear
business objective.
(2)
3 Explain the potential opportunity costs to Robert’s new business
start-up of employing four staff.
(6)
4 Assess whether a strategy of minimising costs is always likely to
lead to business success?
(10)
Answers and quick quiz 6 online

Summary
• Five major sources of business ideas are: observation,
brainstorming, thinking ahead, personal or business experience,
and innovation.
• Business opportunities may arise as a result of changes in
technology, society, the economy, the housing market or the use of
market research.
• The market research that precedes business start-ups will almost
always be done on a very small budget.
• Common habits for successful entrepreneurs include: measuring
performance accurately, stepping back from the day-to-day work, an
eye for detail and loving what they do.
• The major characteristics of an entrepreneur include:
understanding the market, determination, passion, resilience, the
 ability to cope with risk.
• The key skills required by an entrepreneur are: financial skills,
persuasive abilities, problem-solving skills and networking skills.
• Major motives for starting up your own business are: profit
maximisation, profit satisficing, independence, home-working,
ethical stance and social entrepreneurship.
• Objectives are targets for a business.
• A strategy must be devised to achieve objectives.
• Objectives provide a clear sense of direction for all parts of the
business.
• Common objectives include: survival, profit maximisation, sales
maximisation, market share, cost efficiency, employee welfare,
customer satisfaction and social objectives.
• Sole traders and partnerships are legal business forms whose
owners have unlimited liability.
• Limited companies can be private or public, depending upon whom
shares can be sold to.
• Good decision-making requires an understanding of opportunity
cost.
• Most business decisions involve trade-offs.
• As small businesses grow they face a range of problems.
• Many problems of growth are personal challenges faced as the role
of entrepreneur changes to that of manager/leader.
7 Raising finance
Sources of finance: internal and external
Several circumstances may lead to a business needing to raise finance:
• Starting up
• Growing
• Dealing with a cash flow problem
• Financing extra materials needed when a large order is received

Internal sources of finance

Owner’s capital: personal savings
Most likely to be used as a source of start-up finance, an owner’s own
personal savings, or even redundancy payment, is considered to be an internal
source of finance. This money could be provided in the form of share capital
or lent to the business as a loan.

Retained profit
Once all costs have been covered and dividends paid to shareholders, any
profit left is retained in the business and can be used as a source of finance. It
is probably the safest and most common form of internal finance for
established businesses.

Exam tip
As retained profit must still be available in the form of cash if it is to
be used as a source of finance, look on the statement of financial
position (balance sheet) for evidence that there is sufficient cash
available within the business. Bear in mind that where retained profit
appears on a statement of financial position, this is merely an
indicator that money has been retained. It does not imply that this
money is still available as a source of finance. Look instead under
current assets at the cash figure.

Sale of assets
Another internal source, especially available when established businesses are
changing strategy, is cash generated by the sale of assets. Especially where a
firm has adjusted its strategy, there may be assets that will no longer be
needed and can thus be sold in order to generate the cash necessary for other
projects.

External sources of finance

Places from which a business can generate finance may also be considered as
external to the business itself. These include the following:

Family and friends

In many cases, family and friends provide extra start-up capital necessary for
business start-ups. This may be by taking an equity (shareholding) stake in a
business set up as a limited company. Alternatively, family and friends may
provide loans where banks are unwilling.

Typical mistake
Do not always assume that family and friends will provide interest-
free loans or gifts. Those who are rich enough to consider providing
finance to a friend or family member may well be so because they are
financially wise enough to ensure that even in seemingly personal
circumstances they do not lose out financially.

Banks
Loans to start-ups are not very common. Banks see start-ups as an extremely
risky proposition. Where a loan is provided, banks will insist on some
collateral as security, either a business asset or a personal asset belonging to
an owner.

Typical mistake
If the owner of a private limited company takes out a personal loan
and then uses this money to invest in their business, they remain fully
liable for the debt. Their decision to invest the loan made to them as
an individual means that they are investing that money into the
business, and the money can be lost if the business goes bust.

Peer-to-peer funding
A recent development as a source of finance, peer-to-peer funding relies on
websites that can match investors willing to lend to business start-ups with
start-ups needing finance. These loans will generally be at a fairly high rate of
interest, but provide an option where banks are unwilling to lend.

Business angels
These are extremely rich individuals who provide capital to high-risk, small
business ventures or start-ups. The Dragons in BBC’s Dragons’ Den are best
thought of as business angels, willing to invest in risky business start-ups and
become involved in the strategic management of the business in the hope of
high returns.

Crowdfunding
Another source of finance that has risen to prominence thanks to the internet
is crowdfunding. It allows small investors to find business start-ups in which
they are willing to invest through crowdfunding websites. No single investor
is likely to be big enough to provide all the finance needed for each business
using the site, but the beauty of crowdfunding is that many small investors
can be gathered in order to provide all the finance necessary.

Other businesses
Some businesses, especially large firms, actively seek out small businesses
either starting up or in their early stages and help them out by providing
finance. In return they will take a shareholding. Commonly, this practice
occurs in technology-based industries with large tech firms looking to find
and cash in on ‘the next big thing’, even if they did not develop it themselves.

Methods of finance
Loans
Loans can be provided by banks, but could also be provided by friends,
family or directors of the business. A loan involves providing a lump sum of
cash, which will be repaid over an agreed period of time. In addition, interest
payments will also be made over the course of the loan: these represent the
‘cost’ of the loan. Interest rates may be variable or fixed, decided at the time
the loan is taken out. Many lenders, certainly banks, will expect collateral to
provide security for the loan.

Typical mistake
A limited company only receives capital when each share is first sold.
If the shareholder subsequently sells that share on, either privately or,
for a public limited company, via the stock market, the company
receives none of the proceeds of this onward sale.

Share capital
When a private company is formed, the ownership of the business is split into
shares. These shares can be sold to investors who become shareholders. When
the share is first sold, capital enters the business.

Venture capital
Where selling shares through the stock market or taking out a bank loan are
not viable options, especially where a business opportunity is considered high
risk, a venture capital company may provide finance, generally through a
mix of loans and share capital. As the investment is high risk, the loan is
likely to be at a relatively high interest rate and the venture capitalist is likely
to expect a relatively large shareholding, as well as a meaningful say in
decision-making. Venture capital is generally used to fund a significant period
of growth for an established small business.

Overdrafts
Overdrafts offer a flexibility that other methods fail to offer. A business
using an overdraft only pays interest on the overdraft when it is using the
facility; in other words, when the account is negative. Admittedly the interest
rate charged is likely to be higher than that on a loan but, as long as the
business stays out of its overdraft most of the time, the total cost of this
method of finance may not be prohibitive.

Leasing
Leasing is a sensible method of avoiding large chunks of cash outflows each
time a major new asset is purchased. Although in the long term leasing will be
more expensive than purchasing an asset outright, buying assets can put too
great a strain on a business’s cash flow.

Trade credit
Trade credit is incredibly common in business to business transactions. On
average, two months’ credit is offered to customers, acting as a method of
financing the purchase of, most frequently, materials used in production. Not
all businesses will be able to access trade credit. Start-ups or those with a poor
record of payment in the past may be refused credit by suppliers.

Grants
Grants are handouts, usually to small businesses, from local or central
government. They are very rare, no matter what politicians claim, amounting
to less than 2% of UK start-up finance. The only start-ups that may receive a
grant are those likely to create jobs in areas of economic deprivation, or hi-
tech firms competing with foreign rivals.
Different methods and sources of finance tend to be more or less appropriate
in different circumstances. Table 7.1 summarises key issues.
Table 7.1 Methods of finance
Category Source/method Appropriateness
Internal Owner’s Only relevant in a start-up or small
sources capital/personal business context
of finance savings
Retained profit The business must have made a profit
and not spent it on anything else. Do not
suggest this method for a new business
start-up
Sale of assets Only for an established business – look
especially for those planning to do
something new, which may make existing
assets redundant, thus available to sell
External Family and Almost certainly limited to small business
sources friends contexts – most commonly at start-up
of finance Bank Most widely applicable source of finance,
but many businesses continue to find it
hard to get help from banks, certainly at
reasonable interest rates
Peer-to-peer Rare, most likely to be used for a
funding particularly risky start-up
Business angels Another rare source, most likely for a
start-up or recently started business that
may offer high rewards
Crowdfunding Another source that tends to be limited to
start-ups rather than established
businesses
Other Rare – only a few businesses are likely to
businesses offer this and almost always in hi-tech
sectors to new start-ups
Methods Loans Note that some collateral will be needed
of finance and start-ups may find it hard to negotiate
a loan at an affordable rate of interest
Share capital Can only be used by a limited company –
sole traders and partnerships cannot sell
 shares without converting
Venture capital Only used for higher-risk businesses.
They tend to be small businesses looking
to achieve a significant spell of growth
Overdraft Only to be used infrequently – a business
that uses an overdraft as a long-term
source of finance will pay a lot of interest.
OK for a short-term cash flow problem,
not for purchasing new assets
Leasing Can only be used for major assets
Trade credit Start-ups will struggle to convince
suppliers to offer them credit
Grants Only likely to be relevant to a business
creating jobs in an area of economic
deprivation or very high-tech firms trying
to compete internationally

Now test yourself

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

Liability and finance

The concept of limited liability was first explored on page 63. There are
major implications to a business of its choice of ownership type with
particular reference to the liability of owners for business debts.

Implications of limited and unlimited liability

Table 7.2 Limited and unlimited liability
Unlimited liability Limited liability
Sole trader Private limited company (Ltd)
Partnership Public limited company (PLC)
Those businesses whose owners have unlimited liability (sole traders and
partnerships) are unlikely to grow significantly due to the potential downside
of business problems. As the owners’ liability for business debts is unlimited,
they can lose all of their personal assets if the business goes into
administration. This is because the businesses/people owed money can chase
the owners to settle those debts incurred by their business. This can include
customers who have paid in advance and not received the products or services
promised, or suppliers who have supplied goods on credit but not been paid.
In many ways, this makes doing business with a sole trader or a partnership
less risky because in the event of the business running into problems,
customers or suppliers know that they can legally pursue the owners for debts
owed.
This, though, means that running a sole trader or partnership can feel riskier
as the owners have no protection of their personal assets in the event of things
going badly wrong.
Owners of limited companies (shareholders) have the legal protection of
limited liability. This means they cannot lose any more than they invest in the
business. Without this protection, it is unlikely that businesses would grow to
the size of many large businesses today. Individuals would be unwilling to
take such large risks if it weren’t for the protection of limited liability.
There is a downside to limited liability and that is the ability of unscrupulous
individuals to set up limited liability companies, which then rack up debts
before the owners place the business into voluntary liquidation. If it can be
proved that they had fraudulent motives, then limited liability is no protection
against a prosecution for fraud. However, business incompetence is not
fraudulent, and if a limited company goes into liquidation and still owes
money after all its assets have been sold, then those to whom money is owed
may lose every penny.

Effect of liability on sources of finance

Sole traders and partnerships are likely to rely on the following sources of
finance:
• Owners’ capital
• Bank finance (loans and overdraft)
• Leasing
• Trade credit
Private and public limited companies can use:
• Share capital
• Bank finance (loans and overdraft)
• Angel or venture capital investment
• Peer to peer or crowdfunding
• Leasing
• Trade credit
For all established businesses, the most likely and probably the safest form of
finance is retained profit.

Exam tip
Note that any external provider of finance may be wary of offering
funding to a newly created limited company, because of the
protection offered to the company’s shareholders by limited liability.
Often, newly formed limited companies will be refused trade credit in
the first months of their existence for this reason.

Now test yourself

4 Which two types of business offer unlimited liability to their
owners?
5 What name is given to the owners of a limited company?
6 State two sources of finance that are available to limited
companies but not to sole traders or partnerships.
7 Briefly explain why offering credit to a sole trader is less risky than
supplying on credit to a limited company.
Answers online

Planning and cash flow

The business plan
A business plan is a must for any start-up business or small business looking
to grow that needs to attract external finance. Any provider of finance,
whether a bank, business angel or other potential shareholder, will expect to
see a carefully prepared, logical and viable plan.
Not only will the plan be useful in attracting finance, but preparation of the
plan also:
• helps to ensure the entrepreneur has carefully considered potential problems
• has a reference point to maintain a clear sense of direction
• has some quantitative targets to aim for.
The main sections of a business plan should include:
1 Executive summary
2 The product/service
3 The market
4 Marketing plan
5 Operational plan
6 Financial plan
7 Conclusion
At the heart of the financial plan should be the cash flow forecast.

Interpreting cash flow forecasts

The example of a cash flow forecast in Table 7.3 helps to show the key
sections of the document.
• Cash inflow shows the places and timings from which cash flows into the
business.
• Cash outflow shows how much cash leaves the business in each month.

• Monthly balance, sometimes called net cash flow, shows the net effect of
the month on cash flow (cash inflow minus cash outflow).
• Opening balance (usually at the top of the table) shows the amount of cash
the business had at the beginning of the month. This will be last month’s
closing balance.
• Closing balance shows the amount of cash in the business at the end of the
month, calculated by adding the monthly balance (net cash flow) to the
opening balance.

Exam tip
Watch out for the effects of seasonality on a cash flow forecast when
you are interpreting it. Think about what type of business is being
analysed before deciding whether cash flow looks dangerous.
Remember that a toy firm, for which 80% of sales may be made in
the run-up to Christmas, may experience poor cash flow during the
rest of the year. As long as it is able to maintain a healthy closing
balance, there will be enough cash to carry it through to cash-rich
months.
The main figures to consider when analysing a cash flow forecast are:
• Closing balance: If negative this shows the need for extra finance, quite
possibly the need to arrange an overdraft so that the business can continue
to spend after its bank balance has fallen to zero.
• Monthly balance (net cash flow): This will indicate how well each month is
expected to go for the business.
Negative values for either of these indicate the key benefit of a cash flow
forecast, such as the ability to spot problems in advance, in time to do
something about them, such as arranging an overdraft or delaying a payment.

Exam tip
Be careful not to over-react to one negative figure on a cash flow
forecast. One bad month does not spell the end for a business.
However, examiners will really be looking to see whether you can
spot upward, or more likely downward, trends on a cash flow
forecast. A consistent reduction in monthly balance could spell
trouble.

Uses of cash flow forecasts

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

Limitations of cash flow forecasts

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

Now test yourself

8 For whom are most business plans primarily produced?
9 What forms the heart of the financial plan within a business plan?
10 What is cash inflow minus cash outflow called?
11 How can many businesses survive a short time with a negative
closing cash balance?
Answers online

Exam practice
Fresh out of school, Phoebe Hart was ready to start her new
business, a business she had been planning throughout her time
studying Business in the Sixth Form. With no local tanning salon, but
a consumer base increasingly ‘beauty conscious’, Phoebe’s
suspicions were confirmed when she found secondary research
confirming strong growth in the tanning market.
Slightly worryingly, her secondary research had also revealed some
major claims for damages from customers of other tanning salons
who had suffered injuries and burns following their treatment.
However, Phoebe was confident she could avoid these problems and
set about planning how to raise the finance she needed to start up.
Her elder sister, who had been saving to buy a flat, was persuaded to
lend Phoebe £10,000 at a low rate of interest, while Phoebe’s other
savings were also ploughed into buying the equipment and lease
needed to start up. In addition, Phoebe approached her bank about
arranging an overdraft to help her through quieter periods. Phoebe
employed a 16-year-old college leaver to help her run the salon as he
was willing to work for a low wage.
With her plans firming up, Phoebe produced a thorough business
plan, which she showed to the bank. Included was a cash flow
forecast. Extracts from the cash flow forecast are shown below.
Questions
1 Fill in the gaps on the cash flow, labelled a–d.
(2 marks each)
2 Explain two benefits to Phoebe of producing a business plan.
(4)
3 Assess whether Phoebe was right to start her business as a sole
trader.
(10)
Answers and quick quiz 7 online

Summary
• Common situations in which a business needs to raise finance
include starting up, growing or trying to solve a cash flow problem.
• Sources of finance can be internal or external.
• Different methods can be used to raise finance.
• Unlimited liability businesses cannot raise finance by selling shares.
• Limited companies have a wider range of sources and methods of
finance available.
• Producing a detailed business plan helps attract finance.
• A business plan is also useful to the entrepreneur in planning and
running their business.
• Forecasting future cash flows helps to spot problems early enough
to take action.
• Several quick calculations can help to analyse what a cash flow
forecast is showing about a business’s finances.
• Always consider the context of the business when making
judgements on what a cash flow forecast shows.
8 Financial planning
Sales forecasting
Sales forecasting forms the basis of almost all future planning. Without plans
for the future, businesses would be left to simply react to changes, and fail to
deliver effective products and services when consumers want them.

Purpose of sales forecasts

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

Factors affecting sales forecasts

Consumer trends – tastes and habits – change as time passes. Effective sales
forecasting must therefore allow for the effect on demand of these changing
tastes and habits. Examples of changes in consumer tastes and habits could
include:
• increased demand for more convenient foods
• a trend towards healthier eating for some consumers.
Other consumer trends may be based on:
• Demographics: The UK has an ageing population, meaning increased
demand for products aimed at the elderly.
• Globalisation: This is an increased willingness to buy products, from food
to holidays, which recognise the global nature of today’s world.
• Affluence: Despite short-term economic problems, over the past 70 years,
UK consumers have become wealthier, thus are more able and willing to
spend on luxuries.
• Economic variables: As explained in detail in Chapter 3, pages 23–25,
income elasticity is the calculation of the impact on demand for a product of
a change in consumers’ incomes. Therefore, an economic fluctuation, such
as a recession, can have a major impact on sales, especially of income
elastic products. Therefore, to forecast sales effectively, a business must pay
attention to economic forecasts and use knowledge of its products’ income
elasticity to help forecast future sales.
In addition to changes in the economic cycle, changes in individual economic
variables can affect sales:
• Value of the pound: A decrease in the value of the pound makes imports
more expensive and may push consumers to favour UK-produced products.
• Changes in taxation: Taxes on individual items, such as petrol or alcohol,
can affect demand, as well as changes in general taxation, such as the rate of
VAT.
• Inflation: If inflation is higher than the rate of increase of average incomes,
consumers will need to tighten their belts, spending less and damaging sales
of some products and services.
Taken together, these issues mean that no sales forecast should be conducted
without paying attention to expert economic forecasts. Many economic
changes can have a significant effect on sales for a wide range of businesses,
especially those with income elastic products and services.

Exam tip
Examiners love to see you combining knowledge from different areas
of the specification into one argument. If answering a question about
sales forecasting, you are extremely likely to be able to use income,
or even price elasticity, within your argument to effectively develop
the point you are trying to make.

Actions of competitors
Even harder to predict are the potential actions of competitors and the impact
these may have on sales. Key competitors’ actions that may affect sales are:
• Changing price: A competitor that begins to undercut our prices is likely,
depending on price elasticity, to steal sales, thus rendering our sales forecast
overly optimistic. If we respond by cutting prices, although we may still sell
 the same number of products, sales revenue may be lower than expected,
affecting profit and cash flow forecasts.
• Launching new products: A competitor launching a new product, or a new
competitor entering our market, can have a dramatic negative effect on
forecasted sales.
• Promotional campaigns: Competitors running successful promotional
campaigns to try to steal market share from our product can again leave
sales forecasts looking overly optimistic.
More than any of the other factors affecting sales forecasts, the actions of
competitors are usually likely to have a solely negative impact. Worryingly,
they are also harder to predict than economic changes or change in consumer
tastes.

Difficulties of sales forecasting

Most sales forecasts use a technique called extrapolation, meaning assuming
that past trends will continue. However, as explained above, there are many
reasons why past trends can change. It is the ability to forecast these changes
to past trends that marks out the best sales forecasters. In many ways, great
sales forecasting is as much an art as a science, as the ability to spot future
changes in trends may be impossible to find in past data.

Exam tip
The further ahead a sales forecast looks, the less likely it is to be
accurate. The reason is that with more time to pass, there is more
scope for changes in trends to take pace that will render the forecast
nonsense. An established business in a stable market should be able
to forecast the next few weeks or months fairly accurately. Forecasts
that look far into the future must be treated with care.

Now test yourself

1 State three types of plan that rely on a forecast of sales as their
basis.
2 List three broad categories of factors where changes may have a
major influence on the accuracy of sales forecasts.
3 Explain why forecasts lose accuracy as they look further into the
future.
Answers online

Sales, revenue and costs

Calculating sales volume and sales revenue
The two ways to measure how much a business has sold are:
• sales volume
• sales revenue.

Exam tip
The formula for calculating sales revenue is: sales volume × selling
price.
Knowing how many products have actually been sold is fairly
straightforward, even for a large business, as long as the business has
effective internal accounting systems. Calculating the value that those sales
have generated is trickier as sales revenue is calculated by multiplying sales
volume by selling price. For a business selling a range of products at different
prices this adds complication. If a business sells the same product at different
prices depending on where or when the product is sold, even more careful
recording is needed to generate an accurate figure for sales revenue.
To boost revenue, businesses can either increase their selling price (as long as
sales volume is not hit too hard) without having a major impact on sales
volume, or look to increase sales volume without reducing their selling price
significantly.
The choice here is likely to depend on price elasticity (Chapter 3, pages
23–26).
Table 8.1 Price elasticity
Price elasticity Change to price Effect on sales revenue
Price elastic Increase Revenue falls
Decrease Revenue rises
Price inelastic Increase Revenue rises
Decrease Revenue falls

Exam tip
Notice again that using elasticity as part of an argument about a
question on how to increase sales revenue can show an examiner
how good you are at combining different business concepts to help
build an argument.

Calculating fixed and variable costs

To run a successful business, managers must understand not just how much
they are selling but also whether they are receiving more in revenue than it is
costing to run their business. No business can survive in the long term if its
costs exceed revenues. Recording and monitoring running costs is thus vital.
When calculating the costs of producing a product or providing a service, a
common classification for costs is to split them into:
• fixed costs
• variable costs.
When added together, these figures allow a firm to see its total costs for a
time period, which can be compared with sales revenue.

Fixed costs
These are costs that do not change as output changes. They are linked to time
(e.g. rent per month) rather than to how busy the business is. Fixed costs have
to be paid even when a business is not producing. However, they will be the
same whether the business had a great month or an awful month in terms of
sales volume.
Table 8.2 Examples of fixed costs
Rent Business rates (local tax) Management salaries
Interest charges Advertising spending Heating and lighting

Typical mistake
Fixed costs do change as time goes by, for example the landlord may
decide to put up rent next month. They are fixed in relation to the
amount produced, not for ever.
As these costs won’t change as output changes, a rise in sales will spread
these fixed costs over more units, meaning the fixed cost per unit is lower.
This is especially important for a business for which fixed costs are higher
than variable costs.

Exam tip
This concept of spreading fixed costs in directly with the concept of
capacity utilisation is explored in Chapter 10, page 97.

Variable costs
These are costs that change in direct proportion to the level of output. So, if a
manufacturer doubles the amount produced, the cost of materials will double.
Table 8.3 Examples of variable costs
Raw materials Piece rate pay
Fuel costs Packaging

Exam tip
Questions frequently state the variable costs of one unit of output. To
calculate the total variable costs it is crucial to remember to multiply
this figure by the number of units produced:
Total variable costs

= variable cost per unit × number of units produced (output)

Variable costs may not actually rise in direct proportion to output. The
simplest reason is that as a business increases its output, it may be able to
negotiate a lower price from material suppliers, meaning that the cost of
materials may not quite double as output doubles. However, for the purposes
of simple profit calculations and break-even analysis, this effect tends to be
ignored.

Typical mistake
As variable costs are often stated ‘per unit’, students sometimes get
confused because the variable cost per unit does not change. They
are variable in the sense that the total amount spent on, say, raw
materials will double if the output doubles.

Total costs
Adding together variable costs and fixed costs shows the total costs of
running a business for a period of time. This is the figure that is deducted
from sales revenue to calculate profit.
Analysing the proportion of total costs that is fixed against the proportion that
is variable can help a business to understand the importance of boosting sales
volumes. Remember that:
• A business with a high proportion of fixed costs is better off trying to boost
sales volumes so that fixed costs are spread over more units of output.
• For a business with relatively low fixed costs but higher variable costs, it is
easier to operate at low levels of output, since its fixed outgoings each
month will be relatively low.
Now test yourself
4 State the two ways in which the sales of a business can be
measured.
5 Define fixed costs.
6 Define variable costs.
7 Explain why a business with high fixed costs should seek to
maximise sales volumes.
Answers online

Break-even
Knowing the break-even point is useful to managers of a business as it
allows them to have a minimum target of sales to aim for to ensure that they
are not making a loss.

Break-even point
To calculate the break-even point, a business needs to know the following:
• selling price
• variable cost per unit
• fixed costs.
Break-even is calculated using the following formula:

The bottom line of the formula shows the amount each unit sold contributes
towards covering the fixed costs of the business.

Using contribution to calculate break-even

Selling price minus variable cost per unit (the bottom line of the break-even
formula) is called contribution per unit. This figure can be used to calculate
break-even:

Break-even charts
It is possible to illustrate the break-even point on a graph, known as a break-
even chart. This shows costs, revenues and therefore profit at any possible
level of output for a business. On the horizontal axis, all possible levels of
output are shown, while the vertical axis shows costs and revenues, measured
in pounds.
The example break-even chart in Figure 8.1 shows the break-even point,
which occurs at the point where total costs and total revenue are the same.

Note the following features of the graph:

• The fixed cost line is flat, showing that fixed costs are the same at all levels
of output.
• The total cost line shows the effect of adding fixed costs and variable costs
together. It therefore starts on the left at the fixed cost line and moves
upwards in line with the rate of increase of variable costs.
• The total revenue line begins at point (0,0) since no revenue is generated if
nothing is sold.
• The break-even output is identified by dropping a vertical line down from
the point at which total revenue and total costs cross to read off the amount
of output that needs to be sold to cover costs.
Measuring the vertical gap between total revenue and total costs at any level
of output allows the profit to be easily identified. For example, the profit
when 50,000 kg is produced is £50,000.

Margin of safety
The horizontal distance between the actual output of a business and its break-
even output is called the margin of safety. This shows how far demand can
fall before the firm slips into a loss-making position and can be a vital figure
to look out for during difficult trading periods.
Figure 8.2 shows the margin of safety if the business sells 40,000 kg. The
margin of safety is 40,000 kg × 25,000 kg = 15,000 kg.

Interpreting break-even charts

In addition to showing the break-even point and margin of safety, break-even
charts also serve useful planning purposes.
Being able to read off profit or loss at any given level of output can help a
business plan for success or failure.
The chart can also allow other ‘what if’ questions to be asked, relating to what
would happen to profit, break-even or margin of safety if:
• selling price is reduced or increased
• variable cost per unit reduces or increases
• fixed costs change.
Each of these requires a fresh line to be drawn on the graph, showing the
effect of the possible change.
Typical mistake
A change in sales or output does not change any lines on the graph.
The effect would simply be shown by moving along the horizontal
axis to read off the new figures at the new level of output.

Limitations of break-even analysis

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

Exam tip
Calculating the break-even point for individual products sold by a
multi-product firm is quite possible, and very useful. However, this
relies on splitting up the firm’s overhead costs and allocating some
to each product.
• Any break-even chart is a static model, showing only the possible situation
at one moment in time. The business environment is dynamic, so break-
even is not well suited to showing the effects of changing external variables
such as consumer tastes or the state of the economy.

Exam tip
Although these assumptions weaken the power of break-even
analysis, exam answers should never underestimate just how
important this type of, albeit flawed, analysis is to business planning.

Now test yourself

8 What formula is used to calculate the break-even point?
9 What is the formula for calculating profit using a break-even
chart?
10 What three lines are drawn on a break-even chart?
11 How is margin of safety calculated?
12 If the variable cost per unit of a product decreases, what will be
the effect on the break-even point?
13 What would be the effect on a firm’s break-even point of deciding
to cut the selling price?
Answers online

Budgets
Budgets represent the way in which most medium to large businesses manage
their finances. Budgets will be set for both income and expenditure:
• Income budget: This sets a target for the value of sales to be achieved.
• Expenditure budget: This gives budget-holders a limit under which they
must keep their department’s costs.
An example of a simple budget statement is shown in Table 8.5.

Note that setting both income and expenditure budgets allows for a budgeted
profit figure to be identified in each month.

Purpose of budgets
• They focus expenditure on the company’s main objectives for a time period.
• Expenditure budgets are set to ensure that no department or individual
spends more than the company expects.
• All budgets provide a yardstick against which performance can be
measured.
• Expenditure budgets allow spending power to be delegated to local
managers, who may understand local conditions better and be better placed
to decide how money should be spent at a local level.
• Both income and expenditure budgets can help to motivate staff in a certain
department to try to hit targets.
Types of budget
The process of setting budgets can take place in two broad ways:
• A historical budget is set using last year’s budget as a guide and then
making adjustments based on known changes in circumstances for the
department, so if 10% more staff have been employed at a branch, that
branch’s income and expenditure budgets may be increased by 10%.
• Zero-based budgeting involves setting each budget to zero each year and
then expects each budget-holder to justify a budget figure that they can
work to for the coming year. This is very time-consuming, but can prevent
the wastage that occurs if all budgets simply creep upwards year after year
under a system of historical budgeting.
In reality, to prevent too much time being wasted, many businesses will use
zero-based budgeting every few years before a period of historical budgeting.
The result is shown in Figure 8.4.
Exam tip
Whichever method of setting budgets is used, perhaps a more
important concept is the extent to which budgets are agreed or
imposed. Imposing budgets reduces the sense of responsibility that a
budget-holder feels compared to their desire to hit targets that they
have agreed with their managers.

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

Typical mistake
Budget variances should not be recorded as positive or negative, as
an income figure higher than budget is a good thing but an
expenditure figure higher than budget has a negative impact on profit.
This is why the words ‘adverse’ and ‘favourable’ are used.

Budget variances can occur for three underlying reasons. Only one should
really result in the budget-holder being blamed:
• The original budget was unrealistic.
• The target was not met due to factors beyond the budget-holder’s control.
• The target was not met due to factors within the budget-holder’s control.
Holding a manager to account for either failing to meet an unrealistic target or
missing a target as a result of issues over which they had no control will only
demotivate that manager and probably others within the business. Senior
managers should therefore take care over investigating the causes of budget
variances before taking action as a result of those variances.

Typical mistake
Whenever calculating a budget variance it is vital to note whether the
variance is adverse or favourable. The answer to a question asking
you to calculate a variance should be the actual size of the variance
and the word ‘adverse’ or ‘favourable’.

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

Now test yourself

14 State three purposes of budgets.
15 What are the two main methods of setting budgets?
16 If actual income is lower than the budgeted figure, will the
variance be adverse or favourable?
17 If actual expenditure is lower than the budgeted figure, will the
budget variance be adverse or favourable?
Answers online

Exam practice
Andy Hemmings plans to set up a small firm manufacturing specialist
signalling devices for use in vehicles. As an experienced
entrepreneur, he has taken care to produce an accurate sales
forecast. He has also carefully planned his finances, in order to
identify his break-even point. In addition, he has set budgets as a way
of checking the success of the business as he goes along. A range of
information about his business is provided below:
Sales forecast for first three months:
January – 1,600 units

February – 2,400 units

March – 3,000 units

Selling price = £20

Variable cost per unit = £8
Fixed costs = £24,000 per month
Questions
1 Using the information provided, calculate Andy’s:
(a) Break-even point
(3)
(b) Profit or loss in January
(3)
(c) Margin of safety in March
(3)
2 Explain two factors that may cause Andy’s sales forecasts to be
inaccurate.
(4)
3 Assess how useful break-even analysis will be to Andy in starting
up and running his new business.
(10)
Answers and quick quiz 8 online

Summary
• Sales forecasts are at the heart of most business planning.
• Sales forecasts begin by assuming past trends will continue.
• The art of successful sales forecasting lies in being able to spot
when the future will not reflect the past.
• Sales can be measured by volume or value (revenue).
• Costs of production can be split into variable costs and fixed costs.
• Total costs are calculated by adding total variable costs to fixed
costs for a time period.
• The break-even point is a useful piece of information for managers.
• Break-even charts show profit or loss at any possible level of
output.
• Contribution can be used to calculate profit.
• Break-even analysis has several limitations.
• Break-even analysis allows a business to ask ‘what if’ questions.
• Budgets are used to manage a firm’s finances.
• Variance calculations allow performance to be measured against
budgeted targets.
• Budget variances can be adverse or favourable.
9 Managing finance
Profit
Profit is a simple concept. What can make it less clear is when businesses
report on different kinds of profit. This is done so that businesses can identify
where things are doing well or badly for them, by analysing the differences
between the different types of profit.

Calculating different types of profit

Each type of profit is calculated after allowing for different types of cost.

Gross profit
This is a raw measure of profit that deducts the cost of sales from total
revenue to show what is left after taking away the costs directly involved in
making a product or providing a service.

Operating profit
Fixed overheads are deducted from gross profit to calculate operating profit.
This is perhaps the clearest indicator of just how well a business has been run
during a year. As the name suggests, this is the profit generated by the normal
operating activities of the business.

Profit for the year (net profit)

The final measure of profit on your specification shows profit net of all costs
except for corporation (profit) tax, which is usually charged at 20%.

Ways to improve profit

Improving profit can sound simple. There are only three basic routes:
• Increase revenue
• Reduce costs
• Do a combination of the two
Unfortunately, each choice tends to involve a trade-off. Increasing revenue
can be achieved by spending more on advertising, but that pushes up costs.
Reducing costs may involve making sacrifices on quality or customer service,
which could damage revenue too. Put simply, this is why running a business
is hard.

Statement of comprehensive income

All public limited companies are required to produce and publish a financial
document known as the statement of comprehensive income. Most people
refer to this as the profit and loss account. This is the document on which the
different types of profit can be found. In addition, comparing this document
with previous years allows judgements to be made about the performance of
the business for the current financial year.

Measuring profitability
While profit is an absolute number of pounds, each different profit figure can
only tell us so much about the performance of a business. More powerful than
figures for profit are figures that show profitability. Profitability allows us to
make meaningful comparisons between firms of different sizes in order to
judge who has been more successful.

Typical mistake
Do not confuse profit (measured as a number of pounds) with
profitability (measured as a percentage).

Gross profit margin

This shows gross profit as a percentage of sales revenue:

A business that is able to take relatively cheap raw materials and turn them
into highly priced products would have a high gross profit margin. A good
example is a coffee shop.

Exam tip
For all profit margins, the higher the better.

Operating profit margin

This is the main focus for the analysis of overall company performance. It
shows operating profit as a percentage of sales, and therefore includes the
impact that deducting fixed overheads has on profitability.
Profit for the year (net profit) margin
The profit for the year (net profit) margin shows profitability after allowing
for all business costs (apart from tax).

Ways to improve profitability

In order to increase profit margins, a business faces two simple options:
• Increase selling price
• Cut costs
Increasing the selling price will increase profit margin but may decrease
overall profit. This is because an increase in price may lead to a drastic fall in
sales volume. The wisdom of increasing price hinges on price elasticity. For a
price inelastic product, the fall in demand that results from a price rise may be
so small as to be outweighed by the increased revenue per unit. However, for
a price elastic product, increasing price is almost certain to reduce profits.
As explained above, cutting costs is rarely simple. Using cheaper materials or
employing fewer staff can damage a company’s reputation and thus revenue.
Only where genuine waste can be identified and painlessly removed from the
business is cost reduction likely to lead to a straightforward increase in
profitability.

Exam tip
Look for the trade-offs involved in cutting costs as a way of boosting
profitability. This helps you to identify a two-sided argument, perhaps
arguing about whether to buy cheaper materials and whether
consumers will stop buying your brand. This offers opportunities to
display the skill of evaluation by offering and justifying your
judgement as to which option is best for the business.

Typical mistake
In the real world, businesses would never deliberately pay too much
for something. If they pay more than rivals, there is likely to be a good
reason. You should therefore never state that a business can improve
by simply cutting costs; there is likely to be a reason they have not
done so before.

Distinction between cash and profit

Profit is not the same as net cash flow. The reasons are two-fold:
• Sales revenue does not equal cash inflows.
• Costs do not equal cash outflows.
The simplest way to illustrate is to consider a business that offers credit to its
customers and receives credit from a supplier. Sales revenue is recorded when
a product changes hands, so selling an item on 60 days’ credit generates sales
revenue, but will not lead to a cash inflow for at least 60 days. Likewise,
when the business buys materials on credit, the cost is incurred when the
materials are delivered. However, no cash flows out until the supplier is
actually paid, 30 days later.
Table 9.1 helps to illustrate this and other differences for a number of typical
business transactions.
Table 9.1 Differences between cash inflows and revenue
Financial item Cash inflow Revenue
Cash sales made to customers ✓ ✓
Credit sales made to customers ✓
Capital raised from share sales ✓
Charge rent on flat upstairs ✓ ✓
Take out a £20,000 bank loan ✓
Carry out a sale and leaseback ✓
It is this difference between cash flow and profit that explains why profitable
businesses can go bust when they run out of cash. Selling on credit especially
can be very dangerous. As long as the bank manager believes credit
customers will pay, an overdraft will still be available. However, a bank may
withdraw the overdraft facility, leaving the business with no cash to pay its
bills on a day-to-day basis.

Exam tip
Examiners will be impressed if you can show an understanding of the
difference between cash flow and profit (as this is something so few
students seem to grasp). Explaining how boosting sales can boost
profit, but that doing so by offering more credit could damage cash
flow, would score well.

Typical mistake
Never use the word ‘profit’ when explaining what a cash flow forecast
shows. Likewise, do not state that cash flow must be good if a
business makes a profit. The distinction should be clear.

Now test yourself

1 What are the three most commonly quoted types of profit?
2 What is the difference between profit and profitability?
3 What financial document shows different types of profit for a public
limited company?
4 Give an example to illustrate why cash flow and profit are different.
Answers online

Liquidity
Statement of financial position (balance sheet)
Every year, all limited companies are required to send a statement of financial
position, commonly known as a balance sheet, to Companies House. This
shows what the business owns, as well as what it owes and where it got its
money from.
For the AS part of your specification, the key question answered by a
statement of financial position is: Does the firm have enough cash to pay its
bills? This question means testing the firm’s liquidity.

Measuring liquidity
A balance sheet shows more information than is needed to measure liquidity.
If looking at a whole balance sheet, the section to be concerned with is just
above halfway up – the section that shows current assets and current
liabilities.
Measuring liquidity involves comparing the value of current assets against the
current liabilities that will need to be paid. This can be done in two ways.

Calculating current ratio

The current ratio is a calculation that enables a simple judgement to be made
about a firm’s liquidity. Accountants tend to state that the ideal current ratio is
1.5:1. The formula used to calculate the ratio is:

This therefore means that if a company has a current ratio of 1.5:1, it will
have £1.50 of current assets for each £1 of short-term debt it has. If the ratio
is significantly lower than 1.5:1, this could mean that it will face problems
settling its short-term debts. If the ratio is significantly higher than 1.5:1, the
business could be criticised for having too much of its resources tied up in
non-productive current assets.

Calculating acid test ratio

Often referred to as a tougher test of liquidity, the acid test ratio does not
count inventories (or stock) as a liquid asset that can be set against current
liabilities. The formula is therefore:

The ideal value for the acid test ratio is 1:1. This would mean that a firm has
£1 of cash or money owed by customers for every £1 of short-term debt, so
liquidity is sound. If the acid test falls far below 1:1, that really could spell
trouble for a business trying to find the cash to pay its bills.
Some firms can trade on surprisingly low acid test ratios, notably Tesco,
which rarely has an acid test of more than 0.5:1. This is less of a problem for
a business that can generate millions of pounds through its tills every day or
one that is large enough to be likely to access bank finance fairly easily when
needed.

Exam tip
Notice that inventories form the difference between the two liquidity
ratios. A company with a high current ratio but low acid test is likely to
have high stock levels, which could cause a problem. The size of the
problem will depend upon how quickly it can turn its stocks into cash.

Improving liquidity
Improving liquidity relies upon bringing extra cash onto the balance sheet.
This could involve one or more of the following:
• Selling under-used fixed assets such as equipment or machinery
• Raising more share capital
• Increasing long-term borrowing through loans
• Postponing planned investments

Managing working capital

Figure 9.1 shows the different stages through which working capital passes
as a business buys, produces and sells products or services. Managing this
cycle, to ensure that there is always enough working capital in the system to
prevent blockages or delays, is crucial to successful financial management.
Actively managing the working capital cycle involves:
• ensuring there is enough money in the system altogether
• making sure cash moves through the cycle as quickly as possible.
If these two requirements are to be met financial managers are likely to
consider the following actions:
• Control cash used. This involves keeping the amount of cash used as low as
possible, by reducing stock levels, controlling credit periods offered to
customers and gaining as much credit as possible from suppliers, and
getting products on sale as quickly as possible.
• Minimise spending on fixed assets. This can be helped by leasing rather
than buying new assets, which prevents large outflows of cash draining
working capital from the system.
• Plan ahead to estimate carefully the amount of cash that will be needed in
the next few months. This will ensure that adjustments to the cycle can be
made in good time.

Now test yourself

5 On which financial document can the information to test liquidity be
found?
6 (a) What two ratios can be calculated to test liquidity?
(b) What is the ideal value for each?
7 State three methods for improving liquidity.
8 Why is working capital management crucial for a firm’s survival?
Answers online

Business failure
Ultimately, any business that fails will do so because it does not have enough
cash to pay the bills. However, the reasons why businesses run out of cash can
be complex. Not all, or even many, of these are caused by financial issues. It
is other causes that lead to the financial problems that bring down the
business. Major issues tend to focus on marketing or strategic problems such
as:
• not really understanding consumers
• failing to differentiate from rivals
• failing to communicate what is special about your business to consumers
• poor leadership
• not being able to find enough ways to generate revenue.

Internal causes of business failure

Marketing failure
Problems understanding changes in the marketplace, or even what consumers
are really looking for, will lead to a shortage of revenue. Poor decisions
relating to the marketing mix can often result from this.

Financial failure
Managers need to manage finances actively, planning ahead and making
adjustments when necessary. Failing companies sometimes stumble into cash
flow crises without seeing them coming.

Systems or operations failure

If IT systems simply do not provide the right people within the business with
the information they need, things start to go wrong. If physical systems break
down, such as manufacturing or ordering stock, the business will find itself
unable to satisfy demand for its product and will rapidly lose customers.

External causes of business failure

Shifts in the external environment within which a business is operating can
lead to business failure. In these cases, it is perhaps easier to find sympathy
for business managers brought down by factors that are outside their direct
control. However, really good leaders are adept at anticipating and adapting to
external changes.
Change in technology
A major technological advancement can destroy a company’s sales very
rapidly. As its product struggles to compete against a better product, price
cutting is almost assured and, ultimately, the company may fail to operate at
its break-even point.

New competitor
A new rival entering a market that is able to operate far more efficiently,
perhaps as a result of innovative processes or distribution channels, may
cause such a large effect as to drive existing businesses out of the market and
out of business.

Economic change
In times of economic downturn, orders for luxury goods tend to dry up. If
economic growth does not recover quickly, some businesses will find it hard
to continue operating above their break-even point – those with insufficient
cash will fail.

Behaviour of banks
The banks have a vital role to play in providing finance to business:
• To fund long-term investments designed to raise competitiveness
• To provide short-term finance to help working capital management
A failure to supply credit to businesses, or forcing businesses to accept
unreasonably high interest rates, can both lead to business failure. This helps
to explain why banking is a crucial but controversial sector of the UK’s
economy.

Now test yourself

9 How can marketing mistakes lead to business failure?
10 Why are consistent stock control problems likely to lead to
business failure?
11 State three external causes of business failure.
Answers online

Exam practice
Hickmet and Hickmet Ltd was a trading firm that imported speciality
foodstuffs from Turkey for the UK market. In early 2017, the business
failed. Analysts suggested that the failure was down to external
causes. The directors were convinced there was nothing they could
have done to tackle the twin external factors of:
• declining value of the pound from late 2015 onwards; and
• the arrival, in 2014, of a larger new competitor that had previously
focused on importing similar products from Greece.
However, analysis of extracts from the company’s accounts
suggested that the directors could have seen problems coming.
Extracts from statement of comprehensive income

Extracts from statement of financial position (balance sheet)

Questions
1 For each of the three years shown, calculate:
(a) Gross profit margin
(4)
(b) Operating profit margin
(4)
(c) Profit for the year (net) margin
(4)
2 Use these results to comment on trends in the firm’s profitability.
(4)
3 For each of the three years shown, calculate:
(a) Current ratio
(4)
(b) Acid test ratio
(4)
4 Use these results to comment on the firm’s liquidity.
(4)
5 Assess the directors’ view that the failure of the business was
entirely due to external factors.
(10)
Answers and quick quiz 9 online

Summary
• There are three main types of profit.
• Profit and profitability show different things.
• Cash flow and profit are not the same.
• Liquidity measures the availability of cash to meet short-term debts.
• Liquidity can be measured using the current and acid test ratios.
• Successful working capital management is the key to ensuring
healthy liquidity.
• Internal causes of business failure could include poor marketing,
poor financial management or systems failure.
• External causes of business failure may include technological
change, the arrival of a new competitor, economic problems or the
behaviour of banks.
• Ultimately most business failures are the result of the business
running out of cash.
10 Resource management
Production, productivity and efficiency
The process of creating a product or delivering a service can be a crucial
source of competitive advantage. Choosing how to organise production and
ensuring it is efficient are vital in making sure business resources are
managed effectively.

Methods of production
How to organise production tends to be a trade-off between uniformity and
speed on one hand against the ability to adapt a product to meet individual
customers’ needs on the other.

Job production
Job production, making tailor-made products to suit customer tastes, brings
benefits and drawbacks.
Table 10.1 Benefits and drawbacks of job production
Benefits of job production Drawbacks of job production
Can charge a higher price as Cost per unit is very high, due to
products can be tailored to meet high level of skill and low rates of
exact specifications production
Work should be more interesting Finding staff with sufficient skill
for staff can be hard and pay will have to
be high

Batch production
Batch production is really a kind of compromise between job production and
flow production (see below).
Table 10.2 Benefits and drawbacks of batch production
Benefits of batch production Drawbacks of batch production
Allows variation in the product More costly to set up than job
being made production as some specialist
machinery will be needed
Speedier than job production Cost per unit will still be higher than
as making a batch of identical flow production as machinery will
products speeds up production need to be adjusted between
batches

Flow production
Flow production allows huge volumes of output to be produced extremely
quickly and cost effectively. It is likely to rely heavily on automation.
Table 10.3 Benefits and drawbacks of flow production
Benefits of flow production Drawbacks of flow production
Unit labour costs are extremely High initial costs of installing
low production machinery
Huge volumes allow huge Products need to be identical – no
demand in mass markets to be tailoring to suit different tastes
met

Cell production
Cell production, with its roots in the Japanese philosophy of lean production,
harnesses the power of group working to increase productivity, yet maintains
the scope to tailor-make different variations on a product within the cell.
Table 10.4 Benefits and drawbacks of cell production
Benefits of cell production Drawbacks of cell production
Group working allows ideas to be As it is still heavily reliant on
generated within the cell for people rather than automation,
improvements to processes costs are relatively high
The small highly skilled cell can Production volumes will not be
adjust products to suit customers’ as high as flow production
needs
Due to the benefits and drawbacks of each, different methods are suited to
different circumstances, as shown in Table 10.5.
Productivity
Productivity generally refers to output per worker. It is the speed at which an
employee completes their task. It is calculated using the formula:

Typical mistake
Productivity is not the same as production or output. Output can be
increased by simply employing more staff, working at the same rate.
To increase productivity, the output produced by each worker must be
improved.

Factors influencing productivity

Many factors influence productivity. The speed at which workers can produce
units of output may depend on the workers or on the environment in which
they are working. Key factors affecting productivity include:
• quality and age of machinery
• skills and experience of workers
• level of employee motivation.

Link between productivity and competitiveness

Higher levels of productivity lead to lower unit costs. This is because the
labour cost involved in making each unit falls as workers work faster. If a
worker is paid £10 per hour and makes £10 of units each hour, the labour cost
of each unit is £1. If that worker’s productivity doubles, the labour cost per
unit would only be 50p (£10/20 units). Lower unit costs allow businesses to
cut prices while maintaining the same profit margin.
Efficiency
Efficiency differs from productivity in that it considers waste. A process may
have a high rate of productivity, but generate a lot of waste. Therefore, it is
not efficient. Wasted time, which is reduced as productivity rises, is certainly
a factor, but a highly productive system may come with a cost in terms of
quality, meaning many of the items produced are faulty and must be thrown
away.

Factors influencing efficiency

The factors that determine efficiency are the same as those affecting
productivity. It is only the measurement that differs.
Table 10.6 Factors affecting production and efficiency
Factor Affects productivity Also affects efficiency
affecting because because
production
Quality andNewer machinery may work Fewer breakdowns mean
age of faster, and break down less fewer faults and newer
machinery machinery may produce
with less variation
Skills and Highly skilled staff can Skilled staff are likely to
experience produce things faster, while make fewer mistakes, while
of workers experience brings experience can mean staff
knowledge of how to spot the problems that lead
complete tasks with high to faults before they occur
efficiency and quality
Level of Motivated staff are likely to Motivation brings pride in
employee focus on the task without work, so motivated staff will
motivation distraction and to work as be careful not to make
quickly as they can errors, and to lose
concentration less

Labour intensive versus capital intensive production

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

Now test yourself

1 Is job production likely to be labour or capital intensive?
2 What is the key difference between productivity and efficiency?
3 State three key factors that affect productivity.
4 What formula is used to calculate productivity?
Answers online

Capacity utilisation
Having unused assets sitting around in a business producing no profit is
inefficient. Therefore, businesses continually aim to operate close to full
capacity to avoid waste and boost profitability.

Calculating capacity utilisation

The formula used to calculate capacity utilisation is:

A firm’s capacity utilisation is expressed as a percentage figure.

Implications of under-utilisation of capacity

The major negative implication of under-used capacity is that fixed costs per
unit will be higher. The following worked example illustrates this:
Maximum capacity = 5,000 units per month
Total fixed costs = £10,000 per month
When capacity utilisation is 100%, fixed costs per unit = £10,000/5,000 = £2
per unit.
When capacity utilisation is only 50%, fixed costs per unit = £10,000/2,500 =
£4 per unit.
That means that with under-used capacity, a greater amount of the revenue
generated by each product must be used to cover fixed costs. This reduces
operating margins significantly.
In addition, under-utilisation of capacity can:
• lead to fears for job security among staff, damaging motivation
• cause poor morale among managers
• contribute to a poor reputation for the business, especially in the service
sector; imagine a restaurant that usually has many tables empty even during
busy periods.

Typical mistake
Given the implications of capacity utilisation for fixed cost per unit,
some students falsely believe that all businesses should try to reach
100% capacity utilisation at all times. There are problems associated
with this, as shown by the implications of over-utilisation of capacity
(below).

Implications of over-utilisation of capacity

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

Ways of improving capacity utilisation

There are two basic ways to boost the proportion of maximum output being
used:
• Increase current output: This is likely to be accomplished using marketing
methods to boost the volume of sales made by the business, perhaps through
advertising or cutting the selling price. Alternatively, the business could use
its capacity to make products for other businesses looking to subcontract
work.
• Reduce maximum capacity: This will involve selling off assets or laying off
staff. Although redundancies can be costly in the short term, reducing
maximum capacity reduces fixed costs.
Now test yourself
5 What formula is used to calculate capacity utilisation?
6 How does a high capacity utilisation help to boost profitability?
7 State two reasons why 100% capacity utilisation can be a problem.
8 What are the two basic solutions to under-utilisation of capacity?
9 If a business has monthly fixed costs of £120,000, a maximum
monthly output of 1,000 units, and a contribution per unit of £250,
calculate profit when:
(a) The firm is operating at 100% capacity utilisation
(b) The firm is operating at 60% capacity utilisation
Assume all output is sold.
Answers online

Exam tip
If the causes of under-used capacity are short term, for example poor
weather, it would be foolish to reduce maximum capacity. Instead, the
solution is likely to lie in boosting current demand using marketing
methods. If, however, the causes are long term, such as a change in
consumer lifestyles, a longer-term solution – such as reducing
maximum capacity – would be more appropriate.

Stock control
Stock or inventory is often viewed as a necessary evil in business. Holding
stock costs money and ties up cash, but with no stock, production can grind to
a halt or customers may be disappointed.

Interpreting stock control diagrams

One method used to help control stock levels is a stock control diagram. A
typical stock control chart is shown in Figure 10.1.
Key features of the diagram include:
• The maximum stock level set by the business, strongly affected by the
amount of space available and the firm’s stock-holding policy.
• The minimum or buffer stock level, i.e. the amount of stock of that item that
the business aims to always have available.
• The re-order level, which is the amount at which a new order for stock is
triggered.
• The re-order quantity, which is the vertical jump upwards in stock level that
occurs at the start of months 4 and 7 on the diagram. This is the amount of
stock that is ordered each time an order is placed.
• The lead time, or delivery time, which is the horizontal gap between a re-
order being placed and the delivery of stock arriving – in this case, one
month as stock is re-ordered at the start of months 3 and 6 and arrives at the
start of months 4 and 7.

Exam tip
On a stock control diagram, any vertical gaps or changes refer to the
quantity of stock. Any horizontal distances are times.

Buffer stocks
Most businesses aim to keep minimum stock levels of raw materials used in
production and also, in many cases, finished goods at all times. The reasons
for this are shown in Table 10.7.
Table 10.7 Reasons for keeping buffer stocks
Reasons for keeping buffer Reasons for keeping buffer stock of
stock of raw materials finished goods
If deliveries are delayed, Helps to ensure that the business can
buffer stock allows production always supply customers when they
to continue need a product, with the right size or
colour
If a batch of supplies is found Allows the firm to accept rush orders
to be faulty, the buffer stock from customers
can be used to continue
production

Implications of poor stock control

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

Just-in-time stock management

Just-in-time stock management, with no buffer stock, relies entirely on
frequent, small deliveries of materials from suppliers being delivered without
delay and without any quality problems. This brings many benefits,
eliminating costs involved in stock-holding, but increases the danger of
production halting due to a lack of materials.
Key issues to consider for a firm using just-in-time stock management:
• Suppliers must be willing to deliver frequently (often several times a day).
• Deliveries must be absolutely reliable; missed deliveries leave the firm
without stock.
• Suppliers may need to relocate close to the company using just-in-time.
• Will smaller, more frequent deliveries lead to a loss of bulk-buying
discounts?
• Will frequent deliveries lead to increased congestion and pollution from
lorries?

Exam tip
Overall, the introduction of just-in-time stock management increases
the importance of the relationship between a business and its
suppliers. Look for evidence in any case study of how well a company
gets on with its suppliers to help decide whether a switch to just-in-
time would work well.

Waste minimisation
Waste minimisation is a just-in-time approach that helps to reduce waste in
several ways:
• Less stock is held, meaning there is far less likelihood of stock wastage.
• Cash is not tied up in stock, effectively wasting it.
• Removing buffer stocks helps to highlight bottlenecks and problems in
production processes. These can be ironed out by adjusting the production
system.

Competitive advantage from lean production

Lean production, featuring just-in-time stock management, continuous
improvement linked with total quality management, as well as cell
production, can improve how businesses are run in a number of ways:
• More input from staff
• A focus on quality
• Fewer wasted resources through just-in-time and total quality management
• A focus on reducing wasted time, so speed can become a source of
competitive advantage
These features lead to the following sources of competitive advantage:
• Higher levels of productivity, reducing labour cost per unit
• Less space used to hold lower stock levels, reducing fixed costs
• Higher quality, leading to reputational advantages and greater repeat custom
• Faster development of new products, allowing the firm to be first to market
with new ideas

Now test yourself

10 What name is given to the minimum level of stock a business
aims to keep at all times?
11 How does a stock control diagram show the time taken to deliver
by suppliers?
12 State three problems of having too much stock.
13 State two problems of having too little stock.
14 Briefly explain how introducing just-in-time stock management
increases a firm’s reliance on suppliers.
15 How would an increase in the level of production for a short time
show up on a stock control diagram?
Answers online

Quality management
When consumers buy a product or service, they expect it to be of a certain
quality. At a minimum level, customers expect the product to be fit to perform
the purpose for which it was bought. Some businesses use quality as a point
of differentiation.
There are three main methods of managing quality.

Managing quality
Quality control (QC)
This system involves checking output to find any faults in a production
system. It is the traditional method used and relies on inspecting output, with
inspection carried out by a person not involved in working on or making the
products.

Quality assurance (QA)

This system focuses on producing methods to prevent quality problems
arising. These methods are checklists or procedures that form a part of
company policy. If employees follow these procedures, the systems are
designed to prevent any quality problems.

Typical mistake
Too many students suggest that quality assurance ensures top-
quality products. In reality, quality may simply be okay; what will be
excellent are the systems of paperwork designed to try to manage
quality.

Total quality management (TQM)

This is less of a system and more a way of encouraging all staff to think about
the business. In order for this to work, everyone in the organisation has to
understand and ‘buy into’ the idea of getting things ‘right first time’. Quality
becomes a part of everybody’s job, not just production workers, but designers,
accountants and sales people.

Quality circles
The people involved in doing a job tend to have real expertise in getting that
job done. This expertise includes understanding how they could get the job
done even better. Giving staff a formal system for discussing these
improvements in their working area – a quality circle – encourages an
approach of continuous improvement throughout the business.
Exam tip
Involving staff in quality circles can be highly motivating. Look to tie in
answers about this effect with the work of either Maslow or Herzberg.

Continuous improvement (kaizen)

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

Competitive advantage from quality

management
Spending money on quality management systems to ensure high-quality
production and service delivery brings rewards:
• It allows a price premium to be charged (often greater than the extra cost of
producing high quality).
• It helps to gain distribution, with retailers confident they will not need to
deal with product returns and refunds.
• It creates brand loyalty and repeat purchase.
• It can help to build a brand reputation that spreads to other products within
a firm’s portfolio.

Now test yourself

16 Who is responsible for ensuring quality in a quality control
system?
17 What type of production is ideally suited to a system of
continuous improvement?
18 What name is given to the meetings where small groups of staff
discuss possible improvements within their area?
19 What is the main source of ideas for improvement in a kaizen
 system?
20 How can each of the four benefit, of quality management listed
above lead to increased profits?
Answers online

Exam practice
Evaluate the likely impact on a UK-based manufacturer of high-
quality, branded clothing of introducing a system of lean production.
(20)
Answers and quick quiz 10 online

Summary
• Job, batch, flow and cell production all have pros and cons,
meaning each is best suited to different circumstances.
• Increasing productivity leads to lower costs per unit.
• Efficiency differs from productivity in that it measures wastage as
well as speed.
• Firms face a choice between labour or capital intensive production
methods.
• Capacity utilisation has major impact on fixed cost per unit and thus
profit margins.
• Increasing capacity utilisation can be done through increasing
current output and sales or reducing maximum capacity.
• Stock control diagrams can be used to help manage stock and
show a range of different features of stock management.
• Firms can face problems from having either too much or too little
stock.
• Just-in-time stock management aims to eliminate buffer stock.
• Lean production is an approach to production that includes JIT,
TQM, cell production and continuous improvement.
• Quality management systems include quality control, quality
assurance and total quality management.
• Good quality management can bring competitive advantage.
11 External influences
Economic influences
Effects on the business of economic changes
The economic environment within which businesses operate can have a major
impact on both revenues and costs. It is therefore a vital determinant of profit.
Changes in several key economic variables influence business performance in
different ways.

Inflation
If prices are rising throughout an economy, the costs paid by a business for
raw materials, property and labour (wages) will be rising. However, if
consumers are used to prices rising, firms may be able to increase their selling
prices in order to protect profit margins. The circumstances in which inflation
has a major effect are:
• when rates of inflation are significantly above 2%
• when prices are rising faster than average earnings
• when UK inflation is higher than that in most other countries.

Typical mistake
If the rate of inflation is falling, say from 2% to 1%, prices are not
going down. They are simply rising more slowly. Deflation – a
situation where average prices are falling – is rare in the UK and
would be shown by a negative rate of inflation, e.g. −1.5%.

Typical mistake
Too many student answers to questions on inflation simply consider
the effect of inflation on costs, ignoring the fact that firms may well be
able to increase their selling prices to protect profit margins.

Effects of inflation on businesses

• A firm with a long-term fixed price contract may find that if costs rise
rapidly while the contract is being completed, the fixed price does not even
cover its higher level of costs, damaging profitability.
• Firms with substantial long-term borrowings will find the real value of the
money they repay will be lower following a period of high inflation, as
inflation has the effect of reducing the real value of money.
• If inflation in the UK is higher than in other countries, UK businesses may
lose competitiveness against foreign rivals whose costs are likely to be
rising more slowly. This would allow foreign firms to charge lower prices.

Exam tip
Look for evidence of a company’s revenues and costs being affected
differently by inflation to show whether profits would be harmed or
not. If many resources are imported from countries with low inflation,
costs may be rising more slowly than the business can push up
domestic selling prices, meaning profit margins may actually rise due
to inflation.

Exchange rates
It is changes in the exchange rate of the pound that will affect UK
businesses. Most directly affected will be UK businesses that export their
products and services, and UK businesses that buy materials or other supplies
from abroad.
Effects of exchange rates on businesses

A handy way to remember the effect of a stronger pound is the word SPICED:
• Strong
• Pound
• Imports
• Cheaper
• Exports
• Dearer

Interest rates
Although different lenders will charge different rates of interest, most will
adjust their rates in line with those charged by the Bank of England. This is
why the Bank of England’s base rate is such an important economic variable.
Effects of interest rates on businesses
An increase in interest rates tends to have negative effects on businesses in
four ways:
• Consumers are likely to have less money to spend as payments on
mortgages or other borrowings will increase. This is likely to reduce
demand.
• The amount paid in interest on any borrowing by the business will rise,
pushing up costs.
• Consumers are less likely to ‘borrow to buy’, so products that are often
bought on credit, such as cars or sofas, will see demand fall, as the credit
will cost more.
• Businesses are less likely to invest as the opportunity cost of investment
(keeping the money in the bank to earn interest with no risk) will be greater.
Reducing interest rates is likely to have the same effects in reverse, being
mainly beneficial to businesses.

Taxation and government spending

In the UK, government spending (on the NHS, defence, education, etc.)
accounts for roughly 40% of all spending in the economy. So government
decisions on spending and how to raise the money to spend (taxation) have a
major impact on businesses.
Many private sector businesses are largely dependent upon the state for their
income, such as:
• publishers of textbooks
• road-building firms
• pharmaceutical firms (producers of medicines)
• railway companies (given government subsidies).
Companies in general tend to press governments to cut their spending (and
taxes), but many are heavily dependent on that government money.
Effects of taxation and government spending on
businesses
Governments change levels of taxation and government spending to try to
manage the economy. Their goal is to create stable economic growth. Table
11.2 shows government aims combined with the effects of changes in taxation
and government spending.
The business cycle
Economic growth does not tend to follow a stable path. At times, economies
grow quickly; at other times, growth is slower, or economies even shrink from
year to year. The pattern of economic growth in the UK tends to follow a
pattern where strong growth (boom) is followed by periods of recession,
where the economy actually contracts.
Effects of the business cycle on businesses
The key impact that the business cycle has on businesses is primarily related
to demand for products. If the economy slows, consumers will, on average,
reduce their spending, while in a boom period, consumer demand rises
rapidly. Changes in consumers’ incomes are the result of changes in wages or
even changes in the level of unemployment.
The effect of the business cycle on businesses is therefore mainly dependent
on one thing:
• income elasticity of demand.
This was covered in depth in Chapter 3, pages 25–27. Table 3.5 summarises
the effect of the changes in income brought on by economic boom and
economic recession, according to the income elasticity of the product being
sold.

Effect of economic uncertainty

Predicting the economy is a little like trying to predict sales for every business
in the UK. In Chapter 8, pages 80–82, we explored why forecasting sales of
just one product is difficult. It is therefore vital to remember that forecasting
the economy is an inexact science.
Business decision-makers love certainty. When devising plans for investment
over the next five to ten years, directors want to be sure that the money they
spend will be recovered and generate a profit. Uncertainty means they cannot
be sure. In Chapter 2, page 11, we explored the reasons for uncertainty.
Featuring high on the list of reasons for uncertainty in business, along with
the reasons why sales forecasting is difficult, is economic change.
No business decision-makers will make any long-term decisions without
thinking first about the likely state of the economy in the future. Therefore,
business leaders prefer economic stability to the uncertainty that comes with
cyclical economic growth.

Now test yourself

1 Briefly explain what is happening to prices when the rate of
inflation falls from 2% to 1%.
2 Why can many businesses maintain profit margins during times of
inflation when their costs are rising?
3 Which word is helpful in remembering the effects on UK
businesses of a stronger pound?
4 Identify three ways in which an increase in interest rates has a
negative effect on businesses.
5 What type of products find sales particularly hard hit during a
recession?
Answers online

Legislation
Laws passed by parliament are needed to ensure that businesses behave in
what is generally considered to be an acceptable way. Although many
specialist areas of the law exist covering business activities, the five main
areas in which legislation affects business are explained below.

Effects of consumer protection laws on

business
The main goal of consumer protection legislation is to ensure that businesses
actually deliver on what they promise the consumer.
Aspects of this include:
• Does the product do what it claims to do?
• Is the product correctly labelled?
• Is the product sold in the correct weight or measure?
• The rights of consumers to refunds or to exchange faulty products.
The driving force behind consumer protection legislation is to ensure that no
business can gain an unfair advantage over its rivals through deceitfulness.
Ultimately, competition should be based on the product and price at which it
is sold, not claims that bend the truth.
Two major Acts of Parliament covering consumer protection are:
• the Sale of Goods Act
• the Trade Descriptions Act.

Exam tip
Many argue that businesses that mistreat customers will ultimately
gain a poor reputation and lose business, making consumer
protection legislation unnecessary. However, too many examples
exist of ‘cowboys’ who mistreat customers, then set up under another
name to rip people off again, to suggest that these laws are
unnecessary.

Effects of employee protection on business

Employee protection law aims to state and uphold minimum standards of
treatment that employees can expect from their employer. Major issues
covered include:
• fair pay
• sick leave
• maternity and paternity leave
• employment contracts
• relationships with trade unions
• the ability of businesses to get rid of staff
• the responsibilities of businesses to employees who are made redundant.
Almost all businesses would prefer less protection for staff, since this gives
them greater flexibility in terms of their human resources. Businesses tend to
argue against increased rights for workers, claiming that increased costs will
result and this will make it harder for them to compete with international
rivals. A summary of the effects on businesses of employee protection
legislation is shown in Table 11.3.
Table 11.3 Implications of employment legislation
Key area of Possible implications for firms
employment
law
Minimum Increased labour costs, which may lead to increased
wage automation in the longer term and increased
unemployment; on the plus side, employees may be
more motivated by a fair wage satisfying basic needs
Right to a Meets employees’ security needs but can reduce
contract of employers’ flexibility in how they use their staff
employment
Increased Increased cost of paying for cover for these staff;
right to sick, however, staff may feel more valued as they feel well
maternity and treated by employers, reducing staff turnover levels,
paternity which saves the costs of recruiting new staff
leave
Redundancy Reducing capacity becomes expensive due to statutory
payments to staff made redundant; this can mean that
closing a factory or office has a negative impact on
cash flow in the short term
Trade union Employers can be forced to deal with a trade union if
rights enough staff are members; this does bring benefits as
well as drawbacks

Effects of environmental protection on

business
Given the broadly accepted need to regulate the effect of business on the
environment, a range of legislation now governs how businesses treat the
natural environment. Major areas include:
• materials that firms must use for certain products
• processes firms are allowed to use to make certain products
• the need to use recyclable materials for certain products
• landfill tax
• the need to carry out environmental risk assessments for different parts of a
business’s activities.
Once again, businesses tend to resist new, tougher legislation, claiming it will
increase their costs in a way that foreign rivals will not have to cope with.
Much of the recent legislation on the environment came from the European
Union. Now that Britain has voted to leave the EU, the UK government will
have to replace many of the EU laws that governed the way UK businesses
had to treat the environment. Businesses and many others will be interested to
see what decisions are taken.

Effects of competition policy on business

When businesses compete with one another, they tend to keep prices at a
sensibly low level, provide a good service and generate new innovative
products and services. With no competition, prices can be pushed high,
service standards can slip and innovation can dry up. Therefore, governments
seek, through legislation, to ensure that there is competition in all markets.
The key legislation is the creation in 2014 of a government-funded body
called the Competition and Markets Authority (CMA). The CMA is
responsible for:
• investigating proposed takeovers and mergers
• investigating allegations of anti-competitive practices
• taking legal action against those who collude to maintain high prices within
a market, such as cartels.

The work of the CMA should, indirectly or directly, ensure that:

• companies have to set competitive prices
• companies do not collude with others in their market to the detriment of
consumers
• mergers and takeovers that will create overly powerful firms are prevented.

Effects of health and safety on business

Health and safety law is designed to protect employees and customers in the
workplace. The major piece of legislation – the Health and Safety at Work
Act 1974 – places the burden on employers. Key aspects of this burden are:
• safe physical conditions
• precautions that firms are required to take when planning their work
• the way in which hazardous substances should be treated in the workplace.
Complying with health and safety legislation has both positive and negative
effects on businesses as shown in Table 11.4.
Table 11.4 Positive and negative effects of health and safety
legislation on businesses
Positive effects on businesses Negative effects on
businesses
Should prevent incidents that create Extra paperwork
negative publicity
Should help to motivate employees, Need to pay for extra safety
who feel safe equipment
Accidents can delay or halt production – Need to pay to adjust
these should be avoided physical work conditions
The role of the publicly funded body, the Health and Safety Executive, is to
find and prosecute companies guilty of major breaches of this legislation.

Exam tip
In spite of the fact that legislation exists to prevent unscrupulous firms
stealing an advantage, illegal practice still occurs. Although some
may argue that consumers will avoid these firms, forcing them out of
business, virtually no businesses are forced to close as a result of
breaking the laws that govern business. It can be argued that the
penalties for breaking the law are simply not strong enough.

Now test yourself

6 State two potential impacts on a business of complying with new,
tougher environmental legislation.
7 What is the name of the organisation responsible for enforcing
health and safety legislation?
8 Whose responsibility is it to ensure employees work in a safe
environment?
9 State two areas the Competition and Markets Authority can
investigate.
Answers online

The competitive environment

The number of businesses supplying products or services in a market can
have a major effect on how businesses operate. From monopoly markets with
only one dominant supplier to fiercely competitive markets with many
businesses fighting one another for consumers, business behaviour can vary
dramatically.

Exam tip
The best exam answers recognise the level of competition within the
market, suggesting courses of action appropriate to the level of
competition found in the market being examined.

Competition
One dominant business
A market dominated by a single business, described as a monopoly, is bad for
consumers because:
• Consumers have little choice.
• Prices tend to be high.
• There is little incentive for the dominant firm to innovate or provide great
customer service.
As described on page 112, governments generally try to prevent monopolies
occurring to prevent consumers suffering.
However, companies strive to become an effective monopoly. A key focus of
this activity is trying to build barriers to entry that prevent new firms entering
the market. Examples of possible barriers to entry include:
• patents and technological breakthroughs
• incredibly strong brands and high advertising budgets
• heavy spending on infrastructure (such as mobile phone network masts).

Competition between a few giants

In an oligopoly market, rivalries are intense, as it is clear that in most cases
one firm can only gain market share by directly taking it from one of just a
handful of rivals.
Given the intense rivalries, it may appear odd that companies in an oligopoly
rarely compete on price. The reason is that they fear a price war would start,
leading to lower profit margins for all in the industry. Instead, non-price
competition exists, focusing on aspects such as:
• branding
• product features
• product design
• advertising
• technical innovations.

The fiercely competitive market

These markets tend to be characterised by many small businesses competing
with one another, often on the basis of price. This keeps profit margins low
and ensures consumers usually get a bargain. However, a business that is able
to find an effective method of differentiation within a fiercely competitive
market will stand a far better chance of success.
Many of these markets tend to be for commodity products which, by
definition, are hard to differentiate. For businesses selling these, there may be
little choice of strategy other than keeping costs as low as possible in the hope
of undercutting rivals’ prices and still making some profit.

Market size
Big markets
Larger markets, even those with a few fairly dominant firms, offer scope for
new competition, usually through carving out a niche. Therefore in a large
market there is likely to be a fair degree of competition. This is likely to keep
even dominant producers from becoming complacent, as they recognise the
need to offer good service to avoid opening an opportunity to a rival.

Small markets
In a smaller market, with fewer customers and lower total sales, it may be
easier to build up barriers to entry, carving up the market between just a few
businesses.

Markets whose size is changing

Markets tend to grow or shrink in size over time. Predictably, the direction of
this change in size will affect the level of competition:
• Growing markets … attract new entrants … seeking higher profits on offer.
• Shrinking markets … see established firms exiting … as profitability tends
to be low and thus unattractive.

Business responses to a tougher competitive

environment
When new competitors arrive, or the intensity with which an existing rival is
fighting increases, businesses face a choice of how to respond.

Price cutting
Attracting new customers, or hanging on to existing customers, could be
achieved by cutting the selling price. Unless this is accompanied by cutting
the costs of production, profit margins will fall. This is why price cutting is
rarely a successful long-term answer.

Increased product differentiation

Finding or stressing new ways to show that our product is different to those of
our existing or new rivals is likely to be the key to success in a tougher
environment. Methods of product differentiation could include:
• branding
• product features
• product design
• advertising
• technical innovations.

Collusion
Through desperation or deliberate cunning, companies trying to survive in a
really tough competitive environment may be tempted to behave illegally. It is
easy to understand why a desperate business may be willing to break the law
in this way. It is harder to see it as a sensible choice, given the strength of
anti-collusion legislation in the UK.

Now test yourself

10 What name is given to a market dominated by just a few large
companies?
11 State two reasons why monopolies tend to be bad for consumers.
12 List three methods of non-price competition.
13 What is meant by a barrier to entry?
Answers online
Exam practice
Evaluate whether uncertainties in the current external environment in
the UK mean that business success is, more than ever, down to luck
rather than good decision-making.
(20)
Answers and quick quiz 11 online

Summary
• The major economic changes that can affect businesses are: the
business cycle; government spending and taxation; inflation;
exchange rates; interest rates.
• Economic change is a source of great uncertainty for business
decision-makers.
• There are five main areas in which the law can affect businesses:
consumer protection; employee protection; environmental
protection; competition law; health and safety.
• Most changes to the law lead to an increase in costs for a business.
• The competitive environment faced by a business will affect its
strategy.
• The number of firms in a market affects the degree of competition.
• The size and growth rate of a market affect the degree of
competition.
• Firms can compete on price and non-price aspects, including
branding, advertising, product features, design and innovation.
12 Business objectives and
strategy
Corporate objectives
A sense of direction or a clear target provides focus for any activity.
Productivity and co-ordination can be enhanced if staff know how their jobs
will help the firm achieve its goals. All businesses are likely to have
corporate objectives. These may be specifically stated and measurable
targets or, more likely for small businesses, implicit from the entrepreneur’s
behaviour and priorities.

Corporate aims
An aim provides a general sense of what is to be achieved. The key benefit to
having a clear aim is the sense of purpose and drive that the aim can bring to
day-to-day tasks. If everyone in a business is aware of what the firm is trying
to achieve, they will be more driven to achieve their part of that whole.
Typical corporate aims could include:
• growth
• maximising profit
• entering new markets
• surviving the first two years of being in business
• improving the communities in which we operate.
Focusing on any one of these would help employees to understand what
factors should be prioritised when making decisions. This should allow
decisions to be made quickly, without the need for lengthy consultation with
senior management.

Exam tip
Corporate aims can help to explain unethical business behaviour. An
employee who has understood that the business’s primary aim is to
maximise profit may persuade a customer to buy a product or service
she or he doesn’t really need, in order to boost profit. Many low-grade
savings products have been sold in this way.

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

Influences on business mission

Major factors affecting the actual sense of mission created within a business
are:
• Purpose: Why the business exists — likely to be rooted in the founder’s
beliefs.
• Values: What the business believes in doing and guiding principles behind
how it should be done.
• Standards and behaviours: The way that people in the business actually act,
both towards others in the business and towards stakeholders. Behaviours of
managers are likely to have a very strong influence over the behaviours
exhibited by their staff.

Exam tip
Standards and behaviours in particular can be the root cause of a
business acting in a way that does not seem to reflect its founding
purpose or stated values. If staff copy managers behaving in a way
that seems to follow some other goal, such as maximising profit, what
the business actually does may seem very different to its stated
mission. In some schools, teachers are placed under such pressure
for results that they may feel expected to abuse regulations relating to
coursework or controlled assessment.

Now test yourself

1 Explain the difference between corporate aims and mission.
2 State four factors that may influence a firm’s mission.
3 Briefly explain why a sense of mission can be a powerful
advantage to any business.
Answers online

Corporate strategy
Strategy can be thought of as the plan for achieving objectives. So, a
corporate strategy refers to the overall plan that a business chooses to follow
in order to reach its overall objectives. Strategic decisions are large in scale
and hard to reverse, so a corporate strategy will address major issues for a
firm for the medium- to long-term, perhaps most significantly, what to sell
and who to sell to.
Strategy should not be devised in a vacuum. A successful strategy should
consider two broad sets of influences, as shown in Figure 12.1.

A successful strategy must find a way to use the firm’s strength(s) to meet the
conditions presented by the external environment faced by the business over
the coming years.

Typical mistake
Student responses to answers asking for advice on ‘the best strategy’
can fall victim to ignoring one or both of these major influences on
strategy. The best strategic recommendations will always make clear
how the strategy plays to a firm’s strengths and addresses the
external environmental conditions faced by the business.

Porter’s (Generic) Strategy Matrix

Michael Porter’s Generic Strategy Matrix provides advice to any business on
the potential routes to choosing a successful corporate strategy. Porter sees
this as a crucial element in achieving a long-term competitive advantage.

The matrix shows the four major strategic choices that Porter suggests can
lead to long-term success. The key issues to consider when analysing a
company’s strategy are whether it is selling to a mass or a niche market and
how it makes itself stand out from its rivals — either through being the lowest
cost operator or having a significant point of differentiation.

Porter’s low-cost strategy

Being sufficiently efficient in its operations allows a business to be able to
undercut rivals on price and still make a profit. The key to successful cost
leadership is likely to lie in harnessing an operational advantage, such as
better economies of scale than rivals, or higher productivity in factories than
anyone else can manage. To be effective in the long-term, the low-cost
strategy must be based on an advantage that rivals cannot easily copy, so
outsourcing to China may not prove the heart of a successful low-cost
strategy, as that is relatively easily copied.

Typical mistake
Low cost does not necessarily mean lowest price. Having the lowest
costs in an industry does give firms the chance to charge a lower
price than rivals while remaining profitable. But a low-cost strategy
may be a success because a firm can charge average market prices
with higher profit margins than any rivals.

Porter’s differentiation strategy

Differentiation works. The challenge is to find a way to differentiate the
product which is:
• Cost effective: Adding features that cost more to add than a consumer is
willing to pay is not profitable.
• Sustainable: A method of differentiation that lasts is the key: doing
something to a product that rivals can quickly copy will not provide long-
term success.
Although branding and image building marketing methods can provide
successful, protectable sources of differentiation, these are not the only
methods. Great design or amazing customer service can differentiate a
business just as effectively through the work of the operations management
function.

Exam tip
When considering a case study featuring a business trying to use a
strategy of differentiation, consider carefully whether their point of
differentiation is something that will appeal to consumers and whether
it is hard for competitors to adapt this, destroying their differentiation.

Focused low cost

A strategy that focuses on a niche market and succeeds in being the lowest
cost provider within that niche can also bring success. Here, the key is less
likely to be cost reduction through economies of scale and more likely to be
based on operational efficiencies and high productivity levels.

Focused differentiation
Successful differentiation within a niche market can also lead to long-term
success, generally with a very high margin, relatively low volume business
model.

Competitive advantage through distinctive

capabilities
A business that is clear on its core strengths has the beginning of a successful
route to long-term strategic advantage. If core strengths, such as innovative
R&D departments, hugely committed staff or creative marketing departments
can be used to provide a competitive edge over rivals, then these can be the
basis of long-term success.

Exam tip
A distinctive capability need not be quite so obviously related to a
business function as those listed above. A business that has a proven
track record of reacting quickly to changes in the market, or one that
has shown it learns well from mistakes, can build a competitive
advantage around these attributes. Look for evidence of ‘softer’
capabilities such as these when analysing a business case study.

Now test yourself

4 Distinguish between corporate strategy and corporate objectives.
5 State three methods of differentiating a product.
6 Briefly explain why a company choosing a low-cost strategy may
earn high margins, when rivals struggle to break even.
Answers online

Ansoff’s Matrix
Strategic direction
Few decisions are more fundamental in business strategy than:
• What products do we sell?
• Which markets should we target?
Making these decisions sets a firm’s course for the medium to long term and
adjusting these choices is likely to take a long time and affect the whole of the
business. Therefore these are considered to be the major choices made in
choosing the strategic direction a firm will follow with its corporate strategy.

Strategic direction and Ansoff’s Matrix

Business academic Igor Ansoff devised his Strategic Matrix to show the
major choices open to a business considering its strategic direction, and
highlight the level of risk involved in each choice.
The level of risk is lowest in the top left-hand corner of the matrix, rising as a
company’s choices move further away, with the highest level of risk
associated with the bottom right corner of the matrix, representing extreme
diversification.

Exam tip
When using Ansoff’s Matrix to analyse a company’s strategic choice,
focus your argument on the level of risk associated with the choice
and explain carefully why the risk is relatively high or low.

Market penetration
The commonest and lowest risk strategy involves boosting market share
through selling more of the same product to the same target market. Methods
to do this include:
• finding new customers within the target market
• taking new customers from competitors
• increasing usage of the product among existing customers.
Risks are low as the company is still operating on familiar ground with tried
and tested products.

Market development
While still selling existing products, the business now aims the products at
new markets. This can be done most obviously by looking for new
geographical markets, often breaking into foreign markets, or by repositioning
the product to aim at a different type of customer, as Land Rover has done,
moving from targeting farmers to wealthy city dwellers.
The major risk factor here is that the company may not understand consumer
behaviours in the new market they are entering. Although market research can
help to reduce this risk, even thorough research is unlikely to equip a firm
with the depth of understanding of consumer behaviour possessed by
established rivals in these new markets.

Product development
The new feature here is the product. A business choosing product
development as their strategic direction will still be selling to current markets,
so is likely to have a sound understanding of customers’ needs, wants and
preferences. However, the plan will be to sell new products to these
customers. Developing new products successfully is tough; there are so many
reasons why new product launches can fail, from design problems to
manufacturing issues to, most commonly, a failure to actually meet
customers’ needs. New products can either be:
• changes made to an existing product
• developing and launching brand new products.
The first option may be slightly lower risk, although adding new features or
ingredients can still backfire. Developing and launching brand new products
presents more hurdles and thus involves greater risk.

Diversification
Ansoff’s Matrix highlights the dangers involved in attempts to diversify. A
business choosing this strategic direction faces the problems of product
development and market development combined. Selling new products to
customers whose tastes you have no experience of is likely to be very tough
to do successfully.
Diversification can, however, bring exceptionally high rewards. As is
normally found in business, higher risks are associated with the potential to
achieve higher rewards if the risks can be successfully managed.
Table 12.1 Risks and rewards in different strategies
Risks Rewards
Market • Few risks should arise, other • You know the
penetration than decline in the product customers and the
life cycle competitors, so
• Lack of ambition may make should make error-
your best staff look for more free decisions
 challenge elsewhere • Returns on extra
investment will be
predictable
Market • Subtle cultural differences • There are huge
development add hugely to risk, e.g. many potential economies
UK retailers have flopped in of scale if your
the US product succeeds
• Practical differences matter elsewhere, e.g.
too, such as distribution Fever-Tree
channels, consumer • If you take the time
legislation and differences in to understand the
managing staff cultural differences,
you may be able to
localise your product
range effectively, as
McDonald’s does
Product • Most new products fail (at a • As shown by Apple,
development rate of about 6/7 in the UK) nothing adds value
so the risk level is very high and creates
• Because new product differentiation more
success is tough, companies than innovative
put their best people on it; product development
this can mean too little • Continuous,
brainpower devoted to successful product
ordinary brands (or, in development should
Tesco’s case, its UK mean the
supermarket heartland) organisation lives
forever
Diversification • Not knowing the market and • When diversification
having a brand new product works, it can
means the risk level is transform the size of
multiplied by two and opportunities for
• Therefore it is vital to plan for the business, e.g.
the operational risk of Apple in the era
diversifying by making sure since the iPod
your financial position is breakthrough
especially secure • Radical
diversification
(Google making
 cars) can be hugely
exciting for the
workforce, helping
you recruit the best

Typical mistake
Just as many failed leaders have done in the past, defining the
market in which a business operates is key to using Ansoff’s Matrix
successfully. Assumptions about products being similar or markets
being similar to existing ones lead to a failure to understand the risks
involved in straying from existing products and existing markets.

Now test yourself

7 Draw a properly labelled diagram of Ansoff’s Matrix (remember to
label the axes).
8 What are the main dangers of:
a) market development
b) product development?
9 Briefly explain how Ansoff’s Matrix illustrates the risk involved in
different choices of strategic direction.
Answers online

SWOT analysis
Purpose
If a good corporate strategy involves matching a business’s strengths to the
external environment within which it is operating, an analytical framework
that picks these out has to be a helpful strategic tool. A SWOT analysis sets
out to gain a full understanding of what a firm does well and badly and what
major issues it must address in the future. It is therefore a framework used to
help begin the process of strategic planning.

How to conduct a SWOT analysis

Top down approach
This method tends to use external management consultants working directly
with the boss of the business.
Benefits include:
• A dispassionate approach to identifying strengths and especially
weaknesses.
• Detachment from the company culture may allow aspects of the business to
be seen in a new light.
Drawbacks include:
• Managers may fail to share all necessary information with those conducting
the SWOT in an attempt to present their area of responsibility in a more
favourable light.

Consultative approach
A boss who takes the opportunity to travel around the business, engaging in
conversations with those who understand each aspect best, can conduct, albeit
perhaps more slowly than consultants, a more thorough analysis, really
beginning to understand what works well and less well within the business.
Benefits include:
• Greater insight from a wider range of contributors.
• The chance for the boss to gain first-hand understanding of the whole
business.
Drawbacks:
• Staff may be even less willing to point out problems if they feel this will
reflect badly on the leadership of the person they are talking to.

Exam tip
Consider how the SWOT analysis has been conducted before
assessing just how reliable its results are. If a case study suggests a
top down approach has been taken, it is worth considering whether
the SWOT will have really revealed all of the internal problems.

Internal considerations: strengths and

weaknesses
The skill in identifying strengths and weaknesses for a business is in picking
out the areas that really matter to the business’s performance. This is
something of an art form as many managers who focus simply on financial
data may miss a ‘softer strength’ on which a future strategy may be based.
However, a key part of ensuring a robust identification of strengths and
weaknesses is to focus the analysis on a few Key Performance Indicators
(KPIs). Examples of commonly used KPIs include:
• like for like sales
• market share
• capacity utilisation
• unit cost
• brand recognition
• staff turnover.
If compared with industry rivals and/or previous years’ figures these KPIs can
offer clear statements of strengths or weaknesses.

Typical mistake
Be careful not to consider external factors, such as a growing market,
as a strength. Strengths and weaknesses are internally controllable
factors. Operating in a market which is growing simply represents an
opportunity to boost sales in an existing market.

External considerations: opportunities and

threats
The external environment in which a business operates is subject to
significant changes. Few changes leave a firm unaffected. Therefore, in order
to understand the situation in which they are operating it is vital to include an
assessment of the external environment. This is done by assessing the
opportunities and threats brought about by the environment. Key areas to
consider when looking for opportunities and threats include the following.

Demography
Changes to the population, especially in its structure, could be relevant.
Britain’s increasingly ageing population offers opportunities to sell to more
retired people, while the effects of immigration have opened up new market
niches for some UK businesses. These issues can simultaneously represent
threats to businesses that fail to find a way to turn these changes to their
advantage.

New laws and regulations

Changes in laws and regulations can open up opportunities or make existing
products obsolete overnight. The introduction of a sugar tax on soft drinks has
had a significant impact on manufacturers. Perhaps even bigger still will be
changes to UK law necessitated by Britain’s decision to leave the EU.

Technological factors
A further source of both opportunity and threat is changes in technology. For
those who drive technological change, the factor tends to be an opportunity
seized, but for some businesses, a change in technology can destroy sales of
now outdated products within a matter of months.

Economic factors
Changes in the whole range of economic variables will affect a business’s
operations. Depending on the direction of the change and the business being
considered, changes in variables such as:
• economic growth
• inflation
• exchange rates
• unemployment
• interest rates
• government taxation and spending could represent either an opportunity or
a threat.
For more detail on this see Chapter 12 of the AS revision guide.

Exam tip
When assessing the effects of economic changes on a business’s
external environment, don’t forget to use tools learned in the first year
of your course to help understand the impact, notably income
elasticity.

Now test yourself

10 State three common KPIs used by businesses to assess
strengths and weaknesses.
11 State three common areas of external environmental change that
may represent opportunities or threats to a business.
12 What are two broad ways in which a business may carry out a
SWOT analysis?
Answers online

Impact of external influences

In order for a firm to better understand the external environment within which
it is operating, it may carry out a PESTLE analysis. This acronym sets out the
six main areas of external influences:
• Political
• Economic
• Social
• Technological
• Legal
• Environmental.
This structure can be a helpful way to ensure that no opportunities or threats
are overlooked when compiling the SWOT analysis.

Political factors
Decisions made in the political arena can affect businesses’ fortunes.
Government policies encouraging investment in infrastructure or exports can
represent significant opportunities to some firms. However, without a doubt,
the most significant political factor that affects, and will continue to affect,
UK businesses for the foreseeable future is the decision to leave the European
Union. The impacts of this decision will be many and various and could
include factor such as:
• harder to access EU markets
• harder to fill lower paid job vacancies without free movement of labour
• more expensive imported materials due to the reduction in the value of the
pound
• less foreign direct investment to the UK from foreign multinationals
• EU laws will need to be replaced, which may allow the UK Parliament to
relax legal responsibilities placed on firms in areas such as employment
protection or environmental standards
• a weaker pound may make exporting to non-EU markets easier for
businesses that have previously only traded domestically
• UK businesses will find it easier to compete on price with more expensive
foreign imports due to the exchange rate shift.
The media are likely to be reporting on the effects of Brexit on a daily basis
over the next few years. It is important to stay abreast of current
developments.

Exam tip
Be careful to ensure that you support arguments relating to Brexit
with data and evidence: such a hotly debated political issue tends to
encourage assertions with no justification from case study material
provided.

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

Social factors
Changes in social attitudes and behaviour frequently relate to lifestyle. Trends
such as:
• greater awareness of the need to eat healthily
• changed attitudes to smoking
• an increased desire for convenience and speed of service
• an ageing population
can represent both opportunity and threat to different firms. While some will
find their products becoming less desirable as society changes its attitudes,
others will see the chance to cater to new lifestyle choices. Of course, a
business that sees a change damaging sales of one product may be able to
launch new products specifically designed to cater for new tastes — if it is
practising effective strategic planning.

Technological factors
Changes in technology (not just information technology, but new scientific
endeavours in any field) can affect businesses in a range of ways.
Technological changes can allow new ways of making existing products,
lowering costs, improving quality, reliability, durability or recyclability. They
can also enable the development of brand new products, similar to existing
ones, such as electric cars, or the launch of really new product concepts, such
as fitness trackers like the Fitbit watch.
Generally, businesses that develop these new technologies, or harness them
early, will be able to see technological change as an opportunity. For those
without access to the technology, or whose competitors introduce the
technologies earlier, these changes are likely to represent a threat.

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

Environmental factors
Environmental pressures, applied to businesses to ensure that their operations
do not have a harmful impact on the natural environment, are generally seen
as a threat since mostly businesses are encouraged to change their methods of
operating. However, many businesses see improving their environmental
impact in the light of environmental pressures as an opportunity. This can be
brought about by adopting more efficient methods that also reduce costs or
through using their environmental record as a point of differentiation from
rivals.

Typical mistake
Do not always consider that tightening environmental regulations and
legislation represent a threat to all businesses. They could lead to
certain niche markets growing, thereby offering an opportunity.

What to do about external influences

• Make the most of favourable external factors while they last: An external
change that works in a business’s favour should be capitalised upon, giving
the business time and money to help prepare contingency plans in the event
that the factor moves against it.
• Minimise the impact of unfavourable external influences: This can be
through adjustments to controllable aspects of the business’s performance,
so cope with a negative exchange rate movement by considering shifting
factory location, for example.

Now test yourself

13 What does PESTLE stand for?
14 State two possible positive and two possible negative effects of
Brexit for British firms.
15 Which aspects of a SWOT analysis does PESTLE help to
develop?
Answers online

The competitive environment

The importance of the structure and nature of competition within a business’s
market was introduced in Chapter 45 of the AS book. In the context of
studying corporate strategy, this theme is developed by considering a
framework commonly used for analysing the attractiveness of the competitive
environment for businesses.

Porter’s Five Forces

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

Rivalry among existing competitors

At the heart of Porter’s Five Forces is the intensity of rivalry between
competitors in the industry. Profitability is more likely where rivalry is less
intense.
Table 12.2 Characteristics of markets where rivalry is low and
high
Where intensity of rivalry is low
Where intensity of rivalry is
high
• A few companies dominate the • Many competitors of roughly
 market equal size
• Branding is very important to • Products are relatively
consumers undifferentiated
• Booming market gives • Market growth is slow
opportunities for all • Capacity utilisation is low
• Little spare capacity • Low barriers to entry, so it is
• High barriers to entry, e.g. a new cheap and easy to enter the
Chinese aeroplane facing market
consumer credibility issues • Directly faces overseas
• No direct competition from competition, e.g. manufactured
abroad, e.g. ‘bricks’ retailing such goods and some services
as retail petrol
Where the intensity of rivalry is high, pressure to maintain a low price and
thus keep costs low enough to still make a profit is great. Those companies
which are unable to keep their costs under control are likely to disappear.
Where rivalry among competitors is less intense, non-price competition on
marketing, branding or innovation is more likely — offering scope for some
firms to survive without necessarily going through the pain of continually
looking for the efficiency gains that bring cost reductions.

Threat of new entrants

The danger of new companies entering the market, thus creating extra
competition, is largely dependent on the existence of barriers to entry.
Typical barriers to entry include:
• patents and technical knowhow of staff
• strong brand identity and customer loyalty
• high costs to customers of switching supplier
• substantial network infrastructure (such as physically building the masts
and cabling needed to construct a mobile phone network).
If the threat of new entrants is low, companies in the market may be able to
keep prices relatively high, enjoying strong margins, without the need to
worry about new rivals entering the market and undercutting them.

Changes in the buying power of customers

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

Changes in the selling power of suppliers

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

Threat of substitutes
Whereas Porter’s threat of new entrants considers the risk of a new firm
entering our market, the threat of substitutes considers the chances that a
product or service in another market may become seen by customers as a
viable substitute for our product. So while airlines offering domestic UK
flights from London to Manchester or Scotland may enjoy a time advantage
over other forms of transport, building a high speed rail link to speed up train
times on longer domestic journeys may transform rail travel into a viable
substitute considered by those needing to make rapid domestic journeys
within the UK.

Typical mistake
Do not confuse this force with the threat of new entrants. The threat
of substitutes considers the threat posed by indirect competitors,
rather than companies selling exactly the same type of product or
service.

How the five forces shape strategy

The use of Porter’s Five Forces model may identify changes in the balance of
one or more forces against the business. In these cases, the business can look
to produce a strategy that addresses this issue before it causes the firm major
problems. For example, if a company considers that the power of suppliers is
increasing, it may be tempted to take over a supplier, to shift that force right
back into its favour.
Above all, Five Forces analysis should be seen as another model to be used to
help to analyse a business’s situation. Using the Five Forces should help to
ensure that strategic decision-making is wiser, and more effective.

Now test yourself

16 Briefly explain why Porter’s Five Forces model should be used on
a regular, perhaps annual, basis by sensible firms.
17 State three typical barriers to entry that may reduce the threat of
new entrants.
18 If a business is to be profitable, state which forces it would like to
be high and which it would prefer to be low.
Answers online

Exam practice
1 To what extent are methods of analysing a company’s position,
such as SWOT, PESTLE or Porter’s Five Forces, of limited value
due to the increased speed of change in markets such as mobile
phone handsets and other consumer electronics products?
(20)
N and N Ltd have experienced great success since launching a new
range of remote control toys ten years ago. Priced a little above the
market average, these toys used recycled materials and completely
recycled packaging. This is allied to the company’s mission ‘to enrich
the lives of children while improving the environment’. N and N Ltd
have taken the decision to pursue an objective of growth. The
strategy they are considering is to maintain their point of
differentiation as the most environmentally friendly supplier of remote
control toys. However, as a result of a range of external factors,
including new regulations, stalling economic growth and intense
rivalry among existing rivals in the UK market, the decision has been
made to launch the product in three European markets: Austria,
Germany and Switzerland. With no experience of operating abroad, N
and N Ltd plan to conduct thorough market research in these
markets.
2 (a) Explain why Ansoff would consider N and N Ltd’s strategy as
riskier than remaining in the UK.
(4)
(b) Analyse the likely impact on N and N Ltd of stalling economic
growth and intense rivalry among existing rivals in the UK.
 (6)
(c) Assess the importance to N and N Ltd of maintaining the clear
sense of corporate mission that led to their initial success.
(10)
Answers and quick quiz 12 online

Summary
• Mission explains primarily to staff why a business exists, creating a
shared purpose.
• Corporate aims provide a general statement of direction for a
business.
• Corporate strategy is the plan a company devises to achieve its
corporate objectives.
• Michael Porter’s Generic Strategy Matrix shows four potentially
successful strategic choices available to all businesses:
– Low cost
– Differentiation
– Focused low cost
– Focused differentiation.
• Porter’s strategies focus on the need to develop a distinct capability
as a long-term source of competitive advantage.
• Ansoff’s Matrix clarifies key choices in deciding on strategic
direction.
• The matrix highlights the choices of market and product faced by a
business.
• SWOT analysis is a framework used to help inform strategic
planning.
• SWOT considers both internal strengths/weaknesses and external
opportunities and threats.
• PESTLE is an analytical framework that focuses on a business’s
external environment, using the following headings:
– Political
– Economic
– Social
– Technological
– Legal
– Environmental.
• Another method of considering a firm’s competitive position is
Porter’s Five Forces Analysis.
• Porter’s Five Forces are:
– Competitive rivalry
– Threat of new entrants
– Buying power of customers
– Selling power of suppliers
– Threat of substitutes.
• Where all Five Forces are in a business’s favour, the business is
likely to be highly profitable
13 Business growth
Growth
Not all businesses grow, but many aim to do so either through a planned
strategy of gradually expanding capacity or, more radically, through taking
over other businesses. Some growth can be unplanned, where owners are
caught unawares by the success of their product. In all cases, growth can
bring benefits, but also presents potential dangers.

Reasons why firms grow

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

To achieve economies of scale

Growth should bring benefits in terms of lower running costs for the firm.
Typical economies of scale include:
• Purchasing economies of scale: This is where firms are able to negotiate a
cheaper unit cost for supplies they buy as they buy in greater bulk following
an increase in the scale of their operations.
• Managerial economies of scale: Growing businesses are more likely to be
able to hire specialist managers to handle particular areas within the
business, so instead of having one HR manager, a business that has grown
may be able to justify employing a specialist training manager and a
specialist recruitment manager. Specialists are likely to bring greater
expertise to their role, thus reducing unit costs.
• Technical economies of scale: This is where growth allows a firm to afford
to buy in specialised machinery and equipment, so reduced unit costs may
follow.

Typical mistake
Too often any reduction in unit costs is referred to by weaker students
as an economy of scale. Unit costs may fall for many reasons.
Economies of scale only come into play if the reduction in unit costs
is a direct result of an increase in total capacity.
In addition, as a whole industry grows, there can be ‘external’ economies of
scale. Benefits may emerge such as local colleges offering specialist training
courses to improve the relevant skill levels of the local workforce. In addition,
other specialist services such as waste disposal or specialist component
suppliers are more likely to open in an area where an industry has grown.

Increased market power over customers and suppliers

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

Increased market share and brand recognition

Growth that boosts market share will, by definition, involve taking share from
rivals. This will help to boost power over customers as explained above.
Growth will also lead to wider recognition of a company’s brand. The benefits
of this are twofold:
• Customers tend to buy brands they recognise, thus increased recognition
can lead to a further boost in sales as consumers start choosing its, more
recognisable, brand.
• As brand recognition increases, it is possible to make cuts to marketing
budgets if awareness-boosting advertising is no longer necessary. This
reduces the firm’s overall operating expenses.

Problems arising from growth

Though undoubted benefits can flow from growth of a business, there are also
problems involved in growth. These can be managed and their effects
lessened. However, these help to explain why, for some firms, growth can
lead to disaster.

Diseconomies of scale
Growth can make organisations harder to manage. A small business that was
once efficient, with a massively committed staff, can become a large business
which suffers from one or more of the following problems:
Poor internal communication
Growth can lead to a worsening of communication within an organisation for
several reasons:
• Larger organisations tend to rely on more written forms of communication
than oral. This can harm the effectiveness of communication.
• Larger organisations need to add more layers of organisational structure to
ensure spans of control do not become too wide. This means that messages
need to pass through more layers of structure.
• The effectiveness of communication is affected by the motivation levels of
sender and receiver. As motivation can suffer in larger businesses (see
below), this can have a negative impact on communication.
Poor employee motivation
As a business grows and personal contact is reduced between staff members
and managers, employees can feel a growing sense of alienation. They may
feel their work goes unnoticed and may struggle to see how their
achievements can impact on the success of the business. The result can be
falling motivation levels.
Poor managerial co-ordination
Ensuring that everyone is heading in the same direction in a small business
can be achieved by the boss maintaining regular contact with everyone and
monitoring their progress. As an organisation grows, the boss will struggle to
keep an eye on everything. The result may be hiring managers, but these can
head off in subtly different directions unless the boss ensures that they meet
on a regular basis. These meetings can take up valuable time and become
ignored. Controlling more resources will always be tougher in a bigger
business. A failure to co-ordinate effectively can cause mistakes that drive up
costs.

Exam tip
It is worth noting that economies of scale tend to be easier to
measure, or quantify, than diseconomies. For this reason, advocates
of growth can often justify their case numerically by calculating the
likely cost savings that come from economies of scale. It is less likely
that growth projections will manage to quantify the effects of
diseconomies of scale.

Overtrading
Organic growth that happens too fast can cause overtrading. If a business
grows rapidly, its level of cash outflows rises consistently as it expands. As
most firms need to wait several weeks or even months between spending
money on materials or assets and when those assets generate a return or the
materials can be processed and sold, cash inflows only rise to a higher level
after that period of time. This can create a situation where a business is trying
to fund a large-scale operation with cash inflows from the smaller
organisation it was several weeks or months previously. The result can be a
cash crisis.

Now test yourself

1 State three different types of economy of scale.
2 State three different diseconomies of scale.
3 List three possible reasons why a business may choose to grow.
Answers online

Organic growth
Inorganic vs organic growth
The difference between these two types of growth concerns whether growth
comes from within the business or outside it. Inorganic growth involves
growing by taking over other businesses. Typically, inorganic growth
strategies would be used by businesses fitting one or more of the following
criteria:
• a poor record of new product development and innovation
• a need to grow very quickly
• a business looking to eliminate a competitor.

Typical mistake
Consider the criteria that make inorganic growth a sensible choice.
Just because organic growth carries less risk does not always mean
it is the best choice for a business.
Organic growth does not involve the purchase of other businesses; instead,
the business grows ‘from within’, expanding its own capacity or opening new
branches.

Methods of growing organically

Organic growth involves harnessing the power of a business’s resources,
primarily its staff and its financial resources. Staff, especially the culture
developed within a business, if nurtured and successful, can allow the firm to
naturally expand its operations following the same blueprint with the same
leaders doing things the same way, simply on a larger scale. Meanwhile,
organic growth tends to allow a business to finance the growth through
retained profits, rather than seeking riskier sources of external finance, such
as loans.

Exam tip
When considering growth of a business, how the growth is funded will
provide rich material for analysing the wisdom of a growth strategy.

Advantages of organic growth

The leader’s influence stays strong
Organic growth prevents the need to merge two workforces and replace a
leadership team in a business that has been taken over. In these cases, the
leader of the predator company will need to assert their leadership and find a
way to get new staff to embrace the original company’s culture. This is
avoided as growth is organic; there is a far greater chance of preserving the
original business culture which is likely to be successful as it has put the
company in the position to grow.

Reduction of financial risk

As organic growth will tend to be far slower than inorganic methods, the
finance required is likely to be needed in smaller, more steady batches. This
suits the use of retained profit as a source, since using the profit generated
each year to continually grow the business should enable the firm to grow
steadily, without the need to take on debt, with its extra cost of interest and
the cash-draining impact of repayments.

Secure career paths

As a business grows over time, the management team who have led the
growth may be looking to turn their success into higher powered and higher
status jobs. If the business continues to grow, its structure will grow and more
senior managerial positions will open up. Internal promotions to fill these will
prevent middle and junior managers leaving the business to develop their
careers: their skills, talents and experience are retained within the business.

Disadvantages of organic growth

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

Failing to fully exploit a short-lived opportunity

With shortening product life cycles as rates of change in many markets
increase, a firm that fails to fully expand its capacity before the product enters
the decline phase in the marketplace may have missed out on significant
levels of sales as a result of ignoring opportunities to grow inorganically.

Predictability
Organic growth will often (not always) involve doing the same thing in a new
place year after year after year. This can prevent staff looking for new and
exciting challenges from staying with the business in the long-term, leading to
the loss of potentially innovative and entrepreneurial staff.

Now test yourself

4 Briefly explain why organic growth may be less risky financially
than inorganic growth.
5 Which is generally faster, organic or inorganic growth?
6 State three potential drawbacks of choosing to grow organically.
Answers online

Mergers and takeovers

Growth can be achieved through merging with or taking over another
business.

Reasons for mergers and takeovers

• Growth: The ability to increase the size of an organisation is the general
motive behind any merger or takeover. The specific benefits expected are
likely to be one or more of those below:
• Cost synergies: When a business grows through merger or takeover, its
increased size is likely to lead to economies of scale, allowing it to reduce
their unit costs. Other cost savings can come by eliminating duplicated
functions and jobs.
• Diversification: A company that wants to spread the level of risk for its
business can do so by using a merger or takeover to enter new markets with
new products, reducing its reliance on one market or product in case of
problems.
• Market power: When two firms in the same market come together, the
 combined business is likely to increase their power over customers, perhaps
enabling them to raise prices to boost margins, while also benefiting from
increased power over suppliers.

Distinction between mergers and takeovers

Typical mistake
The terms merger and takeover should not be used interchangeably.
They are different types of transaction.
A merger occurs when two businesses of roughly the same size agree to come
together to create a brand new single business, where the owners of the two
businesses will share the ownership of the new firm.
A takeover occurs when one business buys over 50% of another business’s
shares, thus effectively gaining control.

Exam tip
Mergers may be less successful than takeovers as managers from
both the original firms may tussle for a long time in a bid to assert
their dominance in the new business, without a dominant partner — a
scenario takeovers would avoid.

Exam tip
Some takeovers are considered hostile, when the directors of the
target company do not recommend the offer to their shareholders.
Friendly takeovers occur when directors of the target company do
recommend that shareholders accept the offer made by the predator
for their shares. This would be because they feel this represents good
value, given the company’s relative prospects without and with the
takeover.

Types of integration
Vertical integration
Vertical integration refers to a merger or takeover involving two companies at
different stages of the same supply chain. Forward vertical integration, where
a company buys a customer, may involve a manufacturer buying a retailer to
secure distribution for its products. Backward vertical integration occurs
when a company buys a supplier, so a retailer may buy a distributor or a
manufacturer.

Horizontal integration
Where a business buys or merges with a rival, in the same industry at the
same stage of the supply chain, the deal is called horizontal integration.
Economies of scale, reductions in costs as a result of elimination of duplicated
roles and one less competitor allowing prices to be increased should all lead
to increased profit margins.

Conglomerate integration
Where a merger or takeover involves the coming together of two unrelated
businesses, the deal is called conglomerate integration. The main benefit is
that the new business is no longer reliant on just one market or product. This
is designed to spread risk for the new business. If one product or market
suffers, the firm’s other product or market is unlikely to be affected.
The key benefits and potential drawbacks of each type of integration are
shown in Table 13.1.
Table 13.1 The key benefits and drawbacks of integration
Type of Benefits Drawbacks
integration
Backward • Secures supplies • Can tie the business into a
vertical • Should lower the supplier that may not always
cost of supplies offer the best option
Forward • Guaranteed outlet • Consumers may resent the
vertical for the business’s loss of choice — with one
products firm’s products dominating
these outlets
Horizontal • Likely to provide • Can lead to diseconomies
clear economies of • Could be confusion over
scale which firm’s culture should be
adopted in some areas
Conglomerate • Diversifies the • Potential failure to understand
business — the target company as it will
spreading risk into be in an unfamiliar market
different markets • May distract management
from original business due to
unfamiliarity and slowness to
integrate

Financial risks and rewards

Most takeovers are funded by debt. Borrowing to grow makes sense as long
as the rewards from the growth outweigh the cost of the borrowing:

This is more likely to be the case when the economy is performing well or
interest rates are particularly low. However, if sales dry up due to economic
downturn, or the Bank of England pushes interest rates up, the equation could
turn. In such circumstances, the funding of takeovers through debt could lead
to the demise of a previously sound business.

Exam tip
When assessing the likely success of a takeover, consider the long
term as well as the short term. Even a deal that is currently likely to
succeed could fail in the longer term as external conditions change.

Problems of rapid growth

Inorganic growth, through merger or takeover, sees much more rapid
transformation than organic growth. The speed of growth can present
significant issues mainly focused on relationships:
• With new management structures in place, staff may find themselves
working for a new boss.
• At least one set of staff are likely to need to make adjustments to operate in
a new business culture; many will feel uncomfortable.
• Customers and suppliers who may have had a long-standing relationship
with their contact in the business may be discomforted by the need to deal
with somebody else, or to be dealing with a larger, perhaps less personal
organisation.

Now test yourself

7 State three possible reasons, other than pure growth, behind a
merger or takeover.
8 Describe each of the following transactions using the correct
terminology:
(a) A manufacturer buys one of its customers
(b) A supplier of car parts buys another supplier of similar car
parts
(c) A coffee manufacturer buys a coffee plantation
(d) A manufacturer of mobile phone handsets buys a specialist
wooden furniture retailer
(e) Two airlines agree to come together to share costs and routes
within their global networks
9 When does borrowing to finance a takeover stop making sense?
Answers online

Typical mistake
Do not assume that all businesses aim to grow as large as possible.
As discussed above, there are problems that come with scale. Many
large businesses attempt to structure themselves internally to mimic
small businesses so they can take advantage of the benefits of being
small.

Reasons for staying small

Growth can certainly bring advantages to a business. However, it also brings
problems. Some businesses will choose to avoid growth to avoid the
associated problems. Many other businesses will stay small because their
objectives do not require growth; in fact, growth may directly contradict their
objectives.
Survival in competitive markets
The ability to cope with rapid change in the marketplace may be the key
strength of small businesses. They do not have large, unwieldy decision-
making structures. Often, the boss will be able to make rapid and effective
decisions to respond to changes in market conditions. In this way, small firms
can stay ahead of larger rivals in the hunt for differentiation.

Reasons to stay small

Product differentiation and USPs
Porter’s Generic Strategy Matrix helps to explain how some small firms can
trade successfully in the long term. A strategy of focused differentiation,
whereby a business finds a point of differentiation while selling to a niche
market, is perhaps easiest for small businesses. Without the need to push for
growth by looking for a wider market, or finding other ways to differentiate, a
small business can spend all its time protecting and deepening its point of
differentiation.

Flexibility in responding to customer needs

With nimble management structures and less need to worry about what the
stock market may think, small businesses will have greater speed of response
to market changes. In addition, decision-makers are likely to know about
changes in the market quicker. With fewer layers between bosses and
customer-facing lower level staff, feedback from the shop floor is likely to
reach managers quicker, enabling quicker response times than larger
businesses.

Exam tip
To gain better analysis marks when explaining a point such as the
flexibility of small firms, be sure to spell out why small equals nimble.
The ability to show the sequence that leads from small to nimble, i.e.
small = fewer layers = decision-makers closer to customers = quicker
response to changing tastes, shows good analytical skills.

Customer service
Great customer service will only be delivered by highly motivated staff.
Where staff are part of a small, close-knit workforce, they will understand
clearly how their performance affects the overall success of the business. This
should be highly motivating. Contrasted with staff who work in one of many
branches of a large organisation who may feel little loyalty to the business, it
is clear to see how small businesses may survive through delivering great
customer service.

E-commerce
The magic of e-commerce for small businesses is the ability to reach a global
market. The worldwide web is just that: a medium through which the smallest
business can reach customers anywhere in the world. It is this that can allow
businesses to carve out incredibly specialist niche markets, which would not
be large enough to support a business on a national scale. However, a business
that specialises only in selling, for example, one brand of second-hand vintage
toy can be viable if selling to collectors worldwide.

Now test yourself

10 State two business objectives which may be easier for small firms
to achieve than for large ones.
11 Which of Porter’s generic strategies is ideal for a small business
with an unusual idea?
12 Briefly explain why great customer service may be easier to
achieve for a small business.
Answers online

Exam practice
1 To what extent is a strategy of growth essential if UK-based plcs
are going to continue to offer the continual growth in earnings
expected by the stock market?
(20)
Wilson Hooper Holdings PLC (WHH Plc) has been manufacturing
high quality wooden furniture for the last 30 years. Started in a single
workshop, the firm grew slowly, reinvesting profits to expand to
operating from a factory, allowing it to service the whole UK market.
During this period, the firm enjoyed low levels of labour turnover; a
loyal and highly skilled workforce emerged. The fall in the value of the
pound, allied to quality problems with the materials delivered, has led
the company to decide to buy a timber supplier in Finland. Concerns
were raised at the directors’ meeting about the potential clash of
cultures between the UK business and its proposed Finnish
subsidiary. Part of the firm’s original success has been founded on
the reputation for customer service and on-time delivery, which stem
from great internal communication systems. The Chief Executive was
confident that the takeover would improve, rather than worsen, this
aspect of the business’s operations.
2 (a) Explain two benefits that WHH Plc may have received by
pursuing organic growth.
(4)
(b) Identify the type of integration that the purchase of the timber
supplier would represent.
(1)
(c) How would Ansoff classify this takeover?
(1)
(d) Analyse the likely benefits and problems that the proposed
takeover may create for WHH Plc.
(14)
Answers and quick quiz 13 online

Summary
• Reasons for growth include: increased profitability, economies of
scale and increased power in the market.
• Diseconomies of scale can arise from growth, namely problems
with co-ordination, communication and motivation.
• A business that grows too quickly for its capital base to cope with
may fall victim to overtrading.
• Organic growth occurs without mergers or takeovers and tends to
be a slower but safer option than inorganic growth.
• A merger occurs when two firms agree to come together to form a
single business.
• A takeover occurs when one business buys another.
• Types of integration are classified according to the extent to which
the two businesses operate in different industries or at different
stages of the supply chain.
• Ansoff’s Matrix is a useful tool for analysing the risks associated
with takeovers.
• Some firms choose to stay small as this brings advantages over
bigger rivals, such as faster reaction to change, easier
differentiation and potential for better levels of customer service.
14 Decision-making techniques
Quantitative sales forecasting
Chapter 9 in the AS revision guide introduced the importance of sales
forecasting for businesses. Sales forecasting is necessary as it underpins most
of the forward planning needed to run a business:
• HR plan
• cash flow forecast
• profit forecasts and budgets
• production planning
In order to forecast sales for an existing business, the commonest method
used is to identify past trends. These trends form the basis of the three
quantitative sales forecasting techniques you need to understand:
• moving averages
• extrapolation
• correlation

Moving averages
To identify an underlying trend in a set of data with strong seasonal variations
or an erratic pattern, a moving average is useful. Table 14.1 shows how the
moving average is calculated, firstly by adding several months’ worth of raw
data (the three-month total in column 2), then calculating the average for
those months and centring that figure on the middle of the period (the centred
three-month average in column three).
The graph in Figure 14.1 shows just how effectively this technique helps to
understand the long-term trend, even when the raw data seems erratic.

Typical mistake
It is vital, when looking for trends in data that have a strong seasonal
peak, such as toy sales, that a 12-month or four-quarter average is
calculated. This eliminates the effect of seasonal variations, by
including one peak period in every average.

Forecasting sales using extrapolation

Basic human behaviour, and consequently most businesses, predict the future
by assuming that past trends will continue: the future will be just like the past.
In simple terms, the long-term trend identified in time series data is extended
into the future, as shown in Figure 14.2.
The challenge in using extrapolation comes when the trend is not quite as
clear cut. Figure 14.3 illustrates a situation in which the sales forecaster must
decide whether the recent downward trend is a blip and the longer-term
upward trend will dominate, or whether the recent downward movement is a
trend that will continue for the foreseeable future.

This indicates the art and skill involved in sales forecasting. Even using
quantitative techniques, thought is required to examine and understand
underlying causes behind the data being used to extrapolate.

Scatter graphs (correlation)

Plotting the relationship between two variables on a scatter graph can provide
great insight relating to the extent to which those variables are linked. Where
there is a link between sales and another variable, the relationship can be used
to forecast sales if the other variable is controllable or predictable. Such links
include:
• sales and advertising expenditure
• sales and temperature
• sales and the number of stores open
• sales and the level of staff bonuses available.
Plotting the data from the past, on advertising expenditure and sales, for
example, as shown in Figure 14.4, shows a clear relationship between the two
variables.

Clearly, as one variable rises, the other rises in line. This indicates that there
may be cause and effect at work. Forecasters will then need to decide which
variable causes the other; in this case it is likely (though not certain) that
changes in advertising expenditure have a strong impact on sales. When a
strong correlation exists, as shown by a line of best fit that passes close to all
the points on the scatter graph, the relationship may be a helpful forecasting
tool. Once a business has decided how much it plans to spend on advertising
in a given period, it can plot the level of expected sales that is likely to result.

Exam tip
When exploring causality, consider all possibilities. Although, in
Figure 14.4, it may be assumed that changes in advertising
expenditure cause changes in sales, it is also possible that the firm
deliberately spends more on advertising in months when it expects to
be busy: to capitalise perhaps on seasonal trends.
Typical mistake
Too often correlation is assumed to imply causality. Relationships can
occur by chance; it takes judgement to decide whether one variable
causes movements in the other, or vice versa, or whether any
correlation is merely down to chance.

Limitations of quantitative forecasting

techniques
There are two major limitations to quantitative forecasting techniques, which
help to explain almost all false predictions:
1 The future may not be like the past: Changes in any number of external
factors may have a significant impact on sales. Many of these external
events may be highly unpredictable, such as changes in tastes and fashion
or new entrants to the market.
2 The quality of a forecast is reliant on the ability of the forecaster to
interpret the data being used to generate the forecast. Decision-making is
needed when forecasting, such as whether a dip in trend growth is likely to
continue in the long term or just be a short-term change to trend. In the case
of correlation, the challenge is in understanding which variables to pair up,
and then exploring the causality, if any, involved in the relationship.

Now test yourself

1 What do moving averages help to identify within a set of data?
2 What is the name of the forecasting technique that predicts the
future by assuming past trends will continue?
3 Briefly explain how a clear correlation between the hours worked
by sales staff and total sales volume will help to predict next
month’s sales.
Answers online

Investment appraisal
The three methods of investment appraisal are:
• Payback period
• Average rate of return
• Net present value.
All three methods begin with a table or graph showing the forecast cash flows
involved in the investment (see Table 14.2).
Exam tip
Examiners may only present you with cash inflows and cash outflows.
You may need to construct the last two columns yourself.

Payback period
Assessing the period of time a business must wait until its initial investment
has been recovered allows a firm to prioritise risk reduction when making
investment decisions.

Calculation
Payback occurs when the cumulative cash flow reaches zero. In the example
above (Table 14.2), this point is easy to identify as it occurs exactly at the end
of year 3. Not all forecasts work out as neatly. If payback occurs part-way
through a year, you must calculate how far through the year it occurs. Apply
this formula:
In Table 14.2, if year 3’s net cash flow was £30,000 instead of £20,000,
payback would happen after two years and:

Interpretation
Payback calculates the length of time that the money invested is ‘at risk’.
Once payback has occurred, the firm is at least not losing money on its
investment. Therefore, a quicker payback is best. However, projects with a
quick payback may not turn out to be most profitable in the long term, so
ideally, another method of investment appraisal should be considered
alongside the payback period.

Average Rate of Return (ARR)

This method considers the profit generated by an investment. It involves
calculating the average annual profit as a percentage of the initial outlay.

Calculation
There are three steps involved in calculating the ARR:
• Step 1: Calculate the total profit over the lifetime of the project by adding
all net cash flows and deducting the initial outlay.
• Step 2: Divide by the number of years the project lasts.
• Step 3: Apply the formula:

A simple worked example is shown in Tables 14.3 and 14.4.

Table 14.3
Year Net cash flow Cumulative cash flow
0 (£20,000) (£20,000)
1 + £5,000 (£15,000)
2 + £11,000 (4,000)
3 + £10,000 + £6,000
4 + £10,000 + £16,000
Table 14.4 Applying the three steps
Step Identify lifetime profit £16,000
1
Step Divide by number of years (4) £4,000
2
Step Calculate annual profit as a percentage £4,000/£20,000 × 100
3 of initial outlay = 20%

Exam tip
To contextualise an ARR result it can be compared with the
company’s overall Return on Capital Employed (ROCE). A project
whose ARR is lower than the current ROCE generated by the whole
business is unlikely to be attractive, since it would reduce the overall
ROCE for the business if accepted.

Interpretation
Simply put, the higher the ARR, the more profitable the investment.

Net Present Value (NPV) using discounted

cash flows
Future cash flows may not be worth what they seem. This is not a reference to
inaccurate forecasting, but noting that money that is received sooner can be
used for other purposes. In other words, money tied up in an investment has
an opportunity cost. This can be accounted for by discounting the value of
future cash flows to allow for a given percentage return that could be
achieved if the money were available now and generated that return.
Considering the likely rate of interest that will be missed out on by tying
money up in the investment allows the choice of a discount factor to use, for
example a 10% discount factor allows for a return of 10%.

Exam tip
You would never be expected to calculate the discount factors
required for an NPV calculation.

Calculation
Each year’s net cash flow is multiplied by the relevant discount factor to
calculate the present value of the cash flow. These are then totalled to give the
overall net present value (NPV) of the project. The example shown in Table
14.5 compares two projects, using 10% discount factors.
Interpretation
A positive NPV shows that a project generates a greater return on its initial
outlay than simply putting the money in the bank at an interest rate equal to
the percentage discount factor used. The higher the figure, the more profitable
it will be.

Strengths and limitations of quantitative

investment appraisal techniques
Table 14.6 Strengths and limitations of quantitative investment
appraisal techniques
Investment Strengths of the method Limitations of the method
appraisal
method
Payback • Easy to calculate and • Tells us nothing about
understand profitability
• May be more accurate • Ignores what happens after
as it ignores longer-term payback is achieved
forecasts which may be • May encourage a short-
less accurate termist attitude
• Takes into account the
timing of cash flows
• Very useful for
businesses with weak
cash flow
Average • Clear focus on • Ignores the timing of cash
rate of profitability flows
return • Considers cash flows • Therefore values far distant
over the whole project’s inflows as much as more
lifetime immediate inflows, which
 • Easy to compare with are ‘worth’ more
other measures of return • Including forecast data
expressed as from far in the future may
percentages, such as reduce the reliability of the
interest rates forecasts and therefore
results
Net • Takes the opportunity • Complex to calculate and
present cost of money into communicate
value account • Meaning is often
• Considers both amount misunderstood
and timing of cash flows • Only comparable between
to indicate profitability different projects if the initial
outlay is the same

Other factors affecting investment decisions

Non-financial factors
Even if all the numbers (the results of calculations of quantitative measures of
investment appraisal) point one way, sensible decision-makers consider other,
non-financial factors. These include:
• Corporate objectives: Does the chosen investment focus on achieving the
agreed objectives of the business?
• Company finances: Expensive investments that may place the firm’s
financial health at risk if they require external finance may be better
ignored.
• Confidence in the data: It is always worth considering the likely accuracy of
the forecasts on which calculations are based: who prepared the forecasts;
do they have a record of success in forecasting; do they have some bias that
could cause them to over or underestimate cash flows?
• Social responsibilities: If an investment clearly helps to meet a business’s
social responsibilities, some businesses may be willing to proceed even if
the project is not the most financially attractive option.

Investment criteria
These are specific targets that directors may set that any investment is
required to reach before it can be approved. They will include targets for one
or more of the investment appraisal methods, such as:
• payback within three years
• ARR of at least 15%
• positive NPV using 10% discount factors.
Now test yourself
4 Which investment appraisal method is likely to be favoured by
firms looking to reduce the risks involved in their investments?
5 Which investment appraisal method considers both the timing of
cash flows and profitability?
6 Calculate the payback period, ARR and NPV for the following
investment:
Year Net cash flow
0 (120,000)
1 50,000
2 50,000
3 50,000
Use 10% discount factors: Year 1 = 0.91, Year 2 = 0.83, Year 3 =
0.75
Answers online

Decision trees
When faced with quantifiable decisions, an analytical approach to setting out
the problem and assessing the alternatives is to draw a decision tree. These
diagrams allow the calculation of expected outcomes of alternative courses of
action. This can help to provide a clearly favourable option on numerate
grounds — it can help managers to see the wood for the trees!

Step-by-step approach
The basics
A decision tree sets out a decision problem from left to right. At the left is a
square, representing the initial decision to be made. Sprouting off to the right
are the possible options as branches of the tree. The branches consist of:
• a decision to be made, shown by a square (see Figure 14.6)
• chance events beyond the firm’s control, shown by a circle (see Figure
14.7)
The possible outcomes following chance events must have a probability
attached. The probabilities following each chance event must add to 1.
At any square, the business can choose which branch to take. The most
profitable option will always be chosen. Figure 14.8 shows the initial decision
followed by the chance event that follows the installation of a robot welder.
Drawing the tree
• Begin drawing the tree from the left with a single square.
• Run a branch from each option out to the right of the square.
• Note the cost (if any) of each option by the line.
• Draw a circle whenever a chance event could occur.
• Run a branch out of the right of each circle to show each possible outcome.
• Record the probability next to each branch.
• Add squares and circles in the order in which they occur as explained
within the case study, representing decisions and chance events as required.
• When a branch has no further chance events or decisions to follow, note the
expected returns at the end of the branch, as shown in Figure 14.9.

Exam tip
If presented with a decision tree in a case study, it is always worth
checking where the data came from and whether there may have
been any bias generated by the source of the data favouring one
option over others.

Making calculations
With the tree drawn, a series of calculations are required to help identify the
most attractive option at each decision square. Working from right to left, for
each chance event (circle), multiply each expected return by the probability of
each possible outcome. So in Figure 14.9, the calculation would be:

This is known as the expected value attached to a chance event.

Typical mistake
Students and some managers can too often be fooled into believing
that decision trees show facts, as they generate a clear numerical
result. It is vital to consider the likely accuracy of the numbers that
have been put into the tree when assessing the reliability of results it
generates.

Showing decisions
Working from left to right again, once a square is encountered, compare the
expected values of each decision option. The business will choose the higher
value. Cross through the other options to show these choices would not be
taken.

The value of using decision trees

Decision trees as a technique to aid decision making can be useful, but it is
vital that users are fully aware of their limitations.
Table 14.7 Advantages and disadvantages of using decision trees
Advantages of using Limitations of decision trees
decision trees
The technique allows for Gathering the data required is hard and is
uncertainty likely to involve an element of guesswork
Trees force managers to New problems mean previous
consider all possible occurrences cannot be used to base
options estimated probabilities and outcomes on,
reducing the reliability of the data still
further
Problems are set out An element of bias can be introduced by
clearly, encouraging a whoever is estimating probabilities and
logical approach outcomes if they wish to influence the
outcome of the decision
Quantification of problems Decision trees can lead to a failure to
is encouraged by the consider qualitative aspects of decisions
drawing of the tree and
subsequent calculations

Now test yourself

7 What shapes are used to represent (a) chance events and (b)
decisions on the tree diagram?
8 How is the expected value of a chance event calculated?
9 Using calculations, state whether option A or option B should be
chosen based on the decision tree below.

Answers online

Critical path analysis

When a complex project needs to be completed as quickly as possible,
critical path analysis can help. Time can be crucial in order to:
• get a product to market as quickly as possible
• construct new premises to move into as quickly as possible
• move offices or production facilities to a new location.
The technique involves constructing a network diagram which shows:
• the order in which tasks must be undertaken
• an estimated length of each task
• the earliest date when each task can begin.

Drawing critical path analysis diagrams

The two key components of a network diagram are:
• lines which represent activities to be completed as part of the overall project
• nodes placed at the start and end of activities.
Five handy rules for drawing network diagrams are:
1 Networks must start and end on a single node.
2 No lines should cross one another.
3 Do not draw the node at the end of an activity until you are sure which
activity follows.
4 There must be no lines that do not represent an activity.
5 Nodes should be drawn large (to make room for the figures that must be
recorded in them), while lines should be drawn short, to keep the diagram
manageable.
Figure 14.10 shows a network diagram drawn to show the tasks involved in
running a ‘3p off’ price promotion.

Earliest start times and latest finish times

The power of critical path analysis becomes evident once earliest start times
(ESTs) and latest finish times (LFTs) are added to the diagram.
Figure 14.11 shows the ‘3p off’ promotion network with ESTs and LFTs
added and the descriptions of the activities replaced by letters.
The ESTs are shown in the top right-hand corner of the node before each
activity. The LFT of an activity can be found in the bottom right-hand corner
of the node following the activity.

The earliest start time shown in the first node is always 0, showing that any
activity not dependent on prior activities can start immediately.
Node 2 shows the earliest start time of activities C, D and E, none of which
can begin until activities A and B are complete.
Because activity B must be completed, C, D and E cannot begin until day 14,
even if activity A was done within 4 days.
ESTs are calculated from left to right, before any LFTs are filled in.
In the final node, the EST represents the shortest possible time in which the
entire project can be completed. This becomes the ‘deadline’ for the whole
project and thus the LFT of preceding activities (in this case I).
To calculate earlier LFTs, deduct the duration of the activity from its LFT —
in this case 70 − 7 means F and H must be completed by day 63, shown in
node 4.
Table 14.8 ESTs and LFTs clarified
ESTs tell you LFTs tell you
The earliest date resources Deadlines for each activity
specially required for an activity
may be needed, preventing
wasting money on them before
they are needed
The earliest completion date for The float time (if any for each
the whole project activity)
The critical path of the project

The critical path

The critical path consists of the series of activities that take the longest to
complete. Because they take the longest time, they are the ones whose on-
time completion is critical in ensuring that the project is not delayed. On the
‘3p off network’ the critical path is B, D, F and I.
The simplest way to spot the critical path is to look for activities whose nodes
show ESTs and LFTs as equal. The longest activity between these nodes will
be the critical path.
Show the critical path on a diagram by drawing two short lines across the
critical activities.
Identifying the critical path allows managers to focus their attention on these
and their smooth running. Non-critical activities can be delayed by a certain
amount (the float time) without delaying the project. A delay on a critical
activity will delay the whole project.

Float time
Having float time on an activity, such as the 10 days of float time on activity
A in our example, shows that some slippage on that activity is available. The
formula for calculating the float time on any activity is:
Remember that activities on the critical path have zero float time.

Benefits and limitations of critical path

analysis
Benefits
• The careful planning required to work out each activity involved, its likely
duration and what activities must be completed before another can begin,
forces a thorough planning process.
• Identifying activities that can be carried out simultaneously shortens the
overall duration of the project.
• Resources needed for a given activity can be delivered or hired just in time
for the activity to begin. This delays cash outflows and avoids having
expensive resources sitting around waiting to be used.
• The network diagram shows possible ways of dealing with any unforeseen
delays and getting back on track (perhaps by allocating extra resources to
subsequent critical activities).

Limitations
• The diagram can lull managers into a false sense of security. It shows what
can happen. To hit deadlines work must actually be completed, which will
need careful monitoring.
• Diagrams for really complex projects may become unmanageably large.
• Not drawing activity lines to scale could be said to devalue the diagram’s
visual use.

Now test yourself

10 What formula is used to calculate the float time on an activity?
11 How can critical path analysis enable a JIT approach to managing
a project?
12 Calculate the critical path on the project shown below:

Answers online

Exam practice
1 Given the weaknesses in quantitative techniques such as decision
trees and critical path analysis, their value rarely outweighs the
costs of conducting the techniques. To what extent do you agree
with this statement?
(20)
2 Calculate the best course of action shown by the following decision
tree.
(8)

3 Calculate payback, ARR and NPV for the following investments.

(12)
Project A — Net cash Project B — Net cash flow
flow (£m) (£m)
Year 0 (100) (100)
Year 1 50 80
Year 2 100 80
Year 3 200 200
Use 10% discount factors: Year 1 = 0.91; Year 2 = 0.83; Year 3 =
0.75
4
 (a) Calculate the minimum time necessary to complete the project
shown in the network diagram above.
(6)
(b) Identify the critical path.
(1)
(c) Calculate the float time available on activities A and E.
(2)
Answers and quick quiz 14 online

Summary
• Moving averages, extrapolation and correlation can be used to
forecast sales.
• Calculating a moving average allows the identification of an
underlying trend in time series data.
• Extrapolation means projecting a past trend into the future as a way
of forecasting.
• Correlation can be used to forecast sales by spotting a relationship
between sales and a controllable variable, such as advertising
spend.
• Using correlation needs very careful consideration of whether and
how two variables are causally linked.
• Payback is a method of investment appraisal that calculates how
long the initial investment takes to be returned.
• Payback’s key weakness is to ignore profit.
• Average rate of return (ARR) is a simple to understand measure of
the profitability of an investment.
• ARR ignores the timing of cash flows.
• Discounting future cash flows allows investment appraisal to
account for the time value of money.
• Net present value (NPV) uses discounted cash flows to assess a
project’s profitability.
• Qualitative factors should be considered when making an
 investment appraisal decision.
• Decision trees set out the options and chance events associated
with a decision.
• Calculations allow decision trees to give a clear, numerate outcome
to a decision.
• Decision trees are usually constructed based on a series of
estimates.
• Critical path analysis is a useful tool for planning and managing
projects.
• ESTs and LFTs for each activity provide vital information in planning
the smooth running of a project.
• The critical path of a project is the series of activities on which any
delay will delay the whole project.
15 Influences on business
decisions
Corporate influences
Fundamental internal factors affecting business decision-making have a
tremendous impact on the way a business is run. These corporate influences
have such a deep-rooted effect because they are likely to influence most major
decisions made within the business.

Corporate timescales
When using data to help make decisions, or considering the targets that are
important to decision-makers, some companies find it hard to look beyond
next month or this year. Others will be willing to overlook short-term
problems, able to look further into the future to assess what effect decisions
will have in the long term. They will show patience.

Causes of short-termism
There are four main causes of short-termism within the UK:
• The relationship between plcs and financial markets: City investors control
far more shares in UK plcs than private investors. The performance of these
investors, running pension funds and similar investment vehicles, tends to
be judged quarterly. This encourages them to look for companies whose
performance is strong now, not in a few years’ time.
• The use of short-term performance measures such as earnings per share to
award bonuses: If bonuses for plc bosses are based on indicators which can
be quickly affected by short-term action, the personal temptation will be to
look to enhance bonuses through actions such as buying back shares.
• The threat of takeover: Boosting short-term profit tends to push a
company’s share price higher. This means that anyone sniffing around with
a takeover in mind will find the business more expensive to buy, perhaps
dissuading them from bidding.
• The functional background of many UK bosses: Many UK plc bosses have
risen through the finance department. Managers from other functional areas,
such as engineering or marketing, have a far better understanding of the
need for a long-term perspective when making decisions.

Exam tip
Look for evidence of one or more of these causes of short-termism
when analysing a business case study. If the evidence is there, you
can build a chain of logic to explain how these causes can lead to the
effects covered below.

Effects of short-termism
As a focus on the short term takes hold in a business, many indicators may
arise, which frequently intensify the focus on the short term:
• Inadequate expenditure on research and development
• Accounting adjustments that inflate current earnings
• A bias towards using profit for high dividend payments or to buy back
shares, at the expense of investment
• Adopting pay schemes for directors that focus on achieving short-term
financial objectives
• A willingness to cut the workforce quickly, leading to high labour turnover
and a loss of experience and skills that may be needed in the future
• Ignoring long-term risks with products and services, such as shifts in
consumer habits or potential obsolescence
• A focus on takeovers to grow rather than the use of organic growth
• A shortage of investment in image-building advertising
• Minimal training budgets.

Long-term thinking
Companies willing to show more patience will often find themselves in a
better position competitively in the long term. However, to do this requires
the removal of many of the pressures that lead to short-termism. A great
example of long-term thinking can be found in Germany. Major plcs play a
far smaller role in the German economy, which is dominated instead by
medium-sized private limited companies, often family owned. These
companies are collectively referred to as the Mittelstand. Common features of
a Mittelstand company are:
• family owned
• family run
• people-centred management
• long-term thinking
• a focus on doing one thing well.
This focus allows a firm to specialise in that one thing: an example of Porter’s
focused differentiation strategy. The result is that Germany has a
disproportionately high number of world market leaders, admittedly in
specialised niche markets. However, market leadership offers excellent
prospects for long-term profitability.
A comparison of a typical UK plc and a typical Mittelstand company is shown
in Table 15.1.
Table 15.1 The short-termist plc vs the long-termist Mittelstand
Plc Mittelstand
Typical Strong base of share Strong base of share capital
financial capital with moderate with moderate gearing
structure gearing
Typical Owned by many relatively Family-owned or majority
ownership small shareholders family-owned with some
structure shares listed on the stock
market
Typical Varies, but many will look Desire for very long-term
approach to for a low-spend model with success and a sense of
spending on high levels of outsourcing moral duty creates a culture
R&D and (and low investment in of investment in people and
trainee staff staff) technology
Typical Maximise short-term share Maintain a world-leading
business price to keep the market position to hand over a
objectives happy, and to enjoy a big continuingly successful
bonus due to the high business to the next
share price generation

Evidence-based versus subjective decision-

making
Evidence-based decision-making
Large businesses, with access to sophisticated computer systems, make many
routine decisions automatically. A sales forecast, based on recent trends and
figures for the same time last year, can automatically generate decisions on
issues such as how much stock to order or how many staff need to be at work
on a given day. This type of decision-making — evidence-based or scientific
decision-making — dates back at least as far as F.W. Taylor, who advocated
managers finding the one best way to do tasks. He used time and motion
study — a method of experimenting with processes — to identify the best
way to complete a task. This approach generated the desire to measure
performance and use the data offered by measurement to manage the
business.
The weakness of evidence-based decision-making is its basis in extrapolation.
The expectation that the future will be similar to the past can prevent
revolutionary thinking and decisions. As a result, evidence-based decision-
making is less effective when facing strategic decisions, for which limited
data may be available.

Subjective decision-making
Subjective decision-making — or the use of intuition by managers — allows
human judgement to take precedent over data. It can be thought of as the
artistic side of business decision-making, in contrast to the scientific
approach. Of course, sometimes intuitive decision-makers have the wrong
hunch, but, without demoting the importance of data, many great business
decisions would never have been made without hunches. Table 15.2 shows
examples of good and bad decisions that would have been made more on the
basis of intuition than data.
Table 15.2 Some good and some awful real business decisions
Good business decisions Bad business decisions
Coca-Cola buys Innocent drinks – Waterstones bookshop decides
giving it a real competitor to to stop selling books online,
PepsiCo’s Tropicana. The £200 because ‘online will never be
million deal was completed in 2013 more than 10% of the market’
In June 2000, Nick Robertson and Malcolm Walker, owner of
Quentin Griffiths launch ‘As Seen on Iceland Frozen Foods, takes
Screen’; first year sales are £3.6 the business upmarket –
million. By 2014 ASOS has sales of focusing on organic products: it
£1,000 million didn’t last
Unloved Mondelez (owner of Rupert Murdoch, media mogul,
Cadbury) launches Belvita Breakfast sells MySpace website for $35
Biscuits in 2010. The grocery trade million, having bought it for
laughed at the idea, but by 2013 $580 million six years before
Belvita sales had grown to £58
million – that is more than Jaffa
Cakes
With recession biting, Waitrose Nestlé relaunches its Willy
launches its Essentials range of Wonka chocolate bar range in
lower-priced groceries. By 2015 2013 (sales were poor when it
sales of Essentials exceeded £1 first launched in 2005); time is
billion a year and Waitrose extended no healer and the whole range
the range to 400 more items was discontinued in 2014
Typical mistake
There is not a right or wrong way to make decisions. Although routine
decisions are better suited to evidence-based decision-making and
strategic decisions may be hard to make in an evidence-based way,
much effective decision-making involves elements of both
approaches.

Now test yourself

1 List three main causes of short-termism.
2 State three likely consequences of short-termism.
3 For which type of decisions is evidence-based decision-making
most useful?
Answers online

Corporate culture
Easiest thought of as ‘the way we do things round here’, corporate culture
impacts on the way businesses behave, as it strongly influences the way the
people working for the business behave. Culture will be determined by
several key factors, including:
• the aims or mission of the business
• the behaviour of company directors and senior staff
• the attitude of senior managers to risk and enterprising behaviour
• recruitment and training procedures.

Strong and weak cultures

Where a clear sense of shared beliefs and behaviours exists, a company can
be said to have a strong culture. The difference between a strong and a weak
culture can be summarised in the answers to two questions:
• Is there a ‘can-do’ attitude or a ‘must we?’ attitude?
• Is there a conviction among staff that the organisation is a force for good,
rather than just a money-making machine?
Table 15.3 Strong vs weak corporate culture
Signs of a strong culture Signs of a weak culture
• Focusing on customers’ real • Staff follow a script when dealing
needs, allowing staff to make with customers (not trusted to
decisions, e.g. refunds know what is right)
• Staff show a real feeling for the • ‘Us’ tends to be a department,
 organisation as ‘us’, as a long- not the business as a whole;
term commitment there may even be a feeling of
them and us
• A united view among staff that • A cynical view among many
the organisation is a force for staff, doubting the company’s
good, e.g. staff at Greggs taking supposed principles and ethos;
pride in the company’s support suspecting that there is too much
for school breakfast clubs PR spin; too little commitment
• Sticking together and working • When things look bad, better
together at a time of crisis qualified staff look to find another
job

Handy’s classification of cultures

Charles Handy classified business culture into four types. Identifying the
underlying cultural type of a business can help to explain its actions.

Exam tip
If you can use case study information to decide what type of culture is
evident within a business, you can use Handy’s cultural types to
explain how culture affects issues such as speed of decision-making,
responsiveness to change and motivation.

Power culture
A power culture will occur when there is one or a small group of extremely
powerful people leading an organisation. Characteristics include:
• Everything goes through the boss.
• Few rules or procedures are laid down.
• Communication is through personal contact.
• Decision-making is likely to be governed by the desire to please the boss.
• The leadership style is autocratic.
Power cultures can work effectively under great leaders, but too often can
lead to unethical behaviour as the desire to please the boss drives staff to
make poor decisions.

Role culture
This is likely to exist in an established organisation dominated by rules and
procedures. Characteristics include:
• Power depends on the position held within the organisational structure.
• All employees are expected to follow the rules.
• Career progress will be predictable and based on who follows procedure
best.
• The culture is bureaucratic, focused on avoiding mistakes.
• The organisation will struggle to cope with rapid change, especially
problematic if there is rapid change in the market.
• Leadership style is likely to be autocratic or paternalistic.
Role culture can be an effective culture for maintaining a company’s current
position but really struggles in dynamic environments.

Task culture
In a task culture, the project being worked on is the central focus. Senior
managers allocate projects to teams of employees from different functional
areas. Project teams become the normal working environment for staff.
Characteristics of a task culture include:
• Each project team is formed for a single project, then disbanded once the
project is complete.
• An individual’s power depends on their expertise rather than status within
the organisational structure.
• Employees become used to working with staff from other departments —
helping employees to understand the different perspectives of each
functional area.
This culture works when dealing with rapid change. However, a potential
drawback is the chance of project teams developing their own objectives
rather than sticking to the corporate objectives.

Person culture
Operating in organisations with highly skilled, professional staff, a person
culture sees individuals form groups in which they share their knowledge and
expertise. In this way individuals can develop new skills and knowledge.
Characteristics include:
• Staff are well paid and treated.
• Leadership style is democratic.
• Staff feel a sense of personal development which is likely to be highly
motivating.

How corporate culture is formed

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

Difficulties in changing corporate culture

Most humans have an aversion to changing firmly established routines and
therefore changing the way people do things is not easy. The problem of
organisational change in general is detailed in Topic 23 (see A-level textbook,
p. 166). Reasons why people will resist attempts to change culture include:
• self-interest
• low tolerance to change
• misunderstanding of the proposed change
• different assessments of the need to change.

Typical mistake
Students looking to explain that a company needs to change the way
it operates can too often throw in the phrase ‘change the corporate
culture’ without fully acknowledging just how difficult cultural change
is to achieve. References to changing culture should always be
accompanied by an explanation of the difficulties in so doing.
Cultural change, if it is to be successful, needs a combination of several key
factors:
• a clear purpose
• education and training
• consistency of communication methods and messages
• effective communication that change is going to happen.

Now test yourself

4 State three factors that will influence the formation of corporate
culture.
5 List Handy’s four cultural types.
6 State three reasons why changing culture may be hard to achieve.
Answers online

Shareholders versus stakeholders

Stakeholders are dealt with by businesses on a daily basis. Customers,
suppliers and staff are all affected by and have an effect on businesses. It
therefore seems sensible, when making decisions, to try to meet the needs of
all stakeholder groups, in order to ensure their continued positive relationship
with the business. This approach to running a business is known as the
stakeholder approach.
In contrast, some believe that the sole, or at least dominant, responsibility a
business has is to its shareholders: the owners of the business. This
philosophy — the shareholder approach — places increasing shareholder
value, through increased profit and share price, above all other
responsibilities. Under the shareholder approach, other stakeholder groups
can have their interests ignored.

Internal and external stakeholders

Typical mistake
Small shareholders, especially in large plcs, have little real influence
over the business and take no major part in its day-to-day decision-
making. They should therefore be considered as external
stakeholders. Where a major shareholder is actively involved in the
business as its owner, they should be considered as an internal
stakeholder.
A business is more likely to keep stakeholders happy if they draw them
towards the category of internal stakeholders, since these groups are more
likely to feel a part of the business.
An example here is franchisees of a business such as Subway, where if the
organisation makes franchisees feel valued as internal stakeholders, they will
be much more co-operative and the franchises are far more likely to be run
along the lines the franchisor wants.

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

Stakeholder and shareholder influences

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

Conflict between shareholder and stakeholder

objectives
By their nature, different stakeholder groups have different priorities when it
comes to what they want from a business. It is therefore no surprise that
conflict exists between shareholder objectives and those of other stakeholder
groups. Some businesses manage to balance the needs of these groups
effectively in certain situations. For others, conflict can result in poor
performance. Examples of shared and conflicting stakeholder objectives are
shown in Table 15.4.

Exam tip
When considering which stakeholder group is likely to win out in a
situation of conflicting objectives, look for evidence elsewhere within
the case study as to whether the business seems to follow the
stakeholder or shareholder approach.
Table 15.4 Stakeholder needs in different business circumstances
Situation Shared Conflicting
interests/needs stakeholder
between interests/needs
stakeholders
Productivity advance — Shareholders, Managers and
perhaps coming from a managers and employees (threats of
staff suggestion scheme customers redundancy)
Fashion or weather turns Shareholders, Green campaigners
in the business’s favour managers, may object to
suppliers and increased resource
employees use
Consumer demand Shareholders and Managers and
switches from shops to e- customers employees
and m-commerce
High and rising inflation Shareholders and Employees, suppliers
managers and customers

Now test yourself

7 State three internal stakeholders and three external stakeholders
of a plc.
8 Briefly explain how satisfying stakeholder needs helps a business.
9 Give two examples of business decisions where shareholders’
needs may conflict with those of staff.
Answers online

Business ethics
What are business ethics?
Making an ethical decision means taking a course of action which is morally
right. The extent to which business decisions consider the moral dimension
will be determined by two key aspects:
1 The personal moral beliefs of the individual making the decision — what
they consider to be morally justifiable
2 The corporate culture, which will influence the beliefs of the decision-
maker as to what would be considered morally acceptable by the company
as a whole.
Ethical considerations can be found throughout the operations of a business.
A few examples include:
• dealing fairly and honestly with customers and suppliers
• protecting the natural environment
• dealing effectively with bullying, harassment and discrimination in the
workplace
• providing accurate and transparent financial information
• anticompetitive actions
• testing products on animals
• whistleblowing of unethical actions by members of staff.

The ethics of strategic decisions

Given the importance of strategic decisions — defined as decisions that affect
the whole firm and are hard to reverse — the morality of these decisions
should be carefully considered.
Two key aspects of ethics in strategic decision-making arise regularly:
1 Whether the moral aspects of a decision have been fully considered. Some
simple decisions such as selling off part of a business to a new owner may
seem logical financially, but have the owners thought through the effect on
their soon-to-be former employees and the communities that rely on their
incomes, if the division may be quickly closed down by its new owners?
2 The level of risk and who bears the risk. In the scenario above, where part
of a business is sold to new owners, the new owners may be confident that
they can close the division, sell its assets and fully cover the costs of the
purchase. In this case, the deal carries little risk to the new owners. The risk
is borne by the staff and their dependents — if the deal does not work well,
they will have lost their jobs. In many cases, those that stand to profit from
business decisions bear only a small part of the consequences of any
possible downside. This is morally wrong.

Trade-offs between ethics and profit

Perhaps the truest test of ethical behaviour from a business is their willingness
to sacrifice profit in order to do what is right. In the short term at least, ethical
behaviour often means paying a little more or making a little less on a
business transaction. Alternatively, ethical behaviour may involve spending
money on workers’ conditions without expecting any financial return. There
is almost always a clear trade-off between what is morally right and what is
most profitable.
That is not to suggest that profit is unethical. Without profit, businesses would
fail, creating redundancies and financial hardship. The grey area tends to be
how much profit is made. Firms that behave unethically do so in order to
maximise the possible profit they can receive. Ethically run businesses aim to
behave well in making a level of profit that represents a satisfactory return on
the risks they take.

Typical mistake
Confusing a company that paints itself as being ‘ethically concerned’
merely as a marketing ploy to try to add value or differentiate its
products with one that considers the morality of its decisions is
wrong. It is rare to find that genuine ethical behaviour has a positive
effect on profit. It is not unheard of, but it certainly doesn’t happen as
often as companies launch ‘ethically branded’ products or services.

Pay and rewards

The major ethical issue related to pay and rewards is the disparity between the
pay of bosses and workers. When CEOs of plcs total up the value of their
salary, pension contributions, share options and bonuses, these will be many
times higher than the pay received by those who work for their business and
allow it to keep functioning. Of course, executives probably should be paid
more given the level of responsibility, need for major decision-making and
the likely rarity of the skills and experience they need to get the job done.
John Lewis’s constitution — the rules of how the business is run — limits the
chief executive’s pay to no more than 75 times the average salary. Although
that sounds a lot, there is general acceptance that this is a fair pay multiple; if
the average worker gets £20,000 a year, the boss should not be paid more than
£1.5 million. If that sounds a lot, a study of the pay of other CEOs would
reveal much higher pay multiples. The question is whether the extra pay
offered to top bosses has outstripped the extra risk involved in doing their
jobs.

Corporate Social Responsibility

CSR could be a phenomenal way of self-regulating business activity. If
businesses commit to behaving responsibly so that their actions contribute
positively to the societies in which they operate, perhaps our world would be
better. However, although some businesses take their social responsibilities
seriously, some will use the CSR label merely as a marketing tool without
fully committing to behaving in a socially responsible manner.
Table 15.5 Advantages and disadvantages of CSR
Reasons for Corporate Social Reasons for doubting CSR
Responsibility (CSR)
Companies that behave, or seem to Shareholders and other
behave, in a responsible way stakeholders reject the
towards their stakeholders can gain usefulness of CSR for reasons
from doing so: that include:
Marketing advantages: Consumers Reduced profitability:
who have enough disposable income Genuinely embracing CSR is
will often pay a premium so that they likely to mean higher costs and
can buy with a clear conscience from perhaps lower revenues, with
businesses that behave in a socially suppliers paid a fair price and
responsible way. CSR can be a point selling prices set at a
of differentiation for some reasonable rather than a rip-off
businesses. level.
Reduced growth prospects:
Some business opportunities
may need to be turned down if
they involve compromising the
morality needed to be socially
responsible.
Positive effects on the workforce: Rejection of CSR as a PR tool:
Recruiting high-flying staff may be There is plenty of evidence to
easier if they do not wish to work for suggest that CSR is often
a morally corrupt enterprise. treated as a marketing tool
Meanwhile, staff motivation may be rather than an inherent shift in
enhanced as they feel happier corporate culture, in which
working for a socially responsible case, it serves no valid
business with a clear sense of moral purpose.
purpose. If social responsibility means
hiking up the price of food that
low-income consumers need to
eat healthily, perhaps it is better
to sacrifice the needs of
suppliers to ensure that even
those on low incomes can
access fresh fruit and
vegetables.

Now test yourself

10 What two key factors will influence the ethics of any business
decision?
11 In strategic decision-making, unethical decisions may be taken if
what two features are unfairly shared by different stakeholder
groups?
12 What is the major ethical issue relating to executive pay?
Answers online

Typical mistake
Please get your spelling right — moral relates to right and wrong.
Morale is the sense of togetherness that a group of people have.
When discussing the effects of a moral approach to decision-making
it is right to suggest this can have a positive effect on staff morale. It
is wrong to say that staff morals can be enhanced by good morale in
decision-making.

Exam practice
The John Lewis partnership, consisting of John Lewis department
stores and the Waitrose supermarket chain, is frequently held up as
an embodiment of socially responsible business practice. What
makes the partnership unusual is its ownership type. The group is
owned by its staff, so there are no shareholders expecting dividends
and no shares in the business whose price must be monitored
closely.
Retiring Chief Executive of the department stores Andy Street has
pointed out that the CEOs of his competitors, such as Debenhams,
are paid far more than him, but John Lewis’s constitution limits his
pay to 75 times the pay of the average John Lewis employee.
However, whenever interviewed, his commitment to the organisation
was clear and he clearly enjoyed running a business with a
difference.
Once a year, the staff wait with eager anticipation to discover what
bonus they will receive. Once the annual profit is calculated and
some retained for further investment within the partnership, the rest of
the profit is shared among the partners: the owners of the business.
1 (a) Analyse the likely reasons for the John Lewis partnership’s
reputation for ethical behaviour.
(8)
(b) Explain why John Lewis is likely to take a long-term approach
to decision-making.
 (8)
(c) To what extent is the limit to the John Lewis CEO’s pay likely to
damage the business’s ability to compete with its rivals?
(20)
2 ‘Creating the right corporate culture is the single most important
part of a leader’s job.’ Assess the validity of this statement.
(20)
Answers and quick quiz 15 online

Summary
• Key influences on decision-making within organisations include:
– the timescales considered when making decisions: short-
termism versus long-term thinking
– whether decisions are made in an evidence-based or intuitive or
subjective manner.
• Strategic decisions tend to involve more subjectivity while routine
decisions are better suited to evidence-based decision-making.
• Plcs are naturally more likely to consider the short-term effects of
decisions. Long-term thinking is more likely to be found in private
limited companies.
• Corporate culture affects every aspect of business activity.
• Handy proposed four common types of corporate culture to explain
how most businesses do things.
• Key influences on corporate culture include:
– ownership type
– the founder’s personal philosophy
– recruitment procedures.
• Corporate culture is hard to change.
• The stakeholder approach and the shareholder approach represent
differing attitudes as to whom a business is responsible.
• Different stakeholder groups have different objectives.
• The objectives of different stakeholder groups are likely to conflict.
• Business ethics are the moral principles underpinning business
decision-making.
• There is usually a trade-off between ethics and profits.
16 Assessing competitiveness
Interpretation of financial statements
Accounts are produced to provide information on the finances of a business to
its stakeholders. Shareholders, managers, bankers and suppliers will all be
interested to know one or more of the following about the business they are
dealing with:
• The amount of cash available to the business
• How that cash compares with the amount of short-term debt owed by the
business
• How much of the firm’s long-term finance is borrowed
• How profitable the business is.
The two major documents that all companies are required, by law, to publish
each year can provide this information. They are:
• The statement of comprehensive income, usually called the profit and loss
account. This shows the revenue generated by the business this year and the
costs that were incurred in generating that revenue.
• The statement of financial position, usually called the balance sheet. This
details what the business owns, owes and where the money came from.

Balance sheets (statement of financial

position)
Balance sheets show how wealthy a business is. They do this by listing
everything the business owns.
In addition, a balance sheet lists the money owed by the business — its
liabilities. The final part of a balance sheet details the shareholders’
contribution to the business — the capital they have provided.
Table 16.1 An example of a simplified balance sheet
Simplified balance sheet
£
Long-term (non-current) assets 300,000
Short-term (current) assets 100,000
Total assets 400,000
Balancing with: Total capital 400,000

Types of asset
Long-term (non-current) assets are used over and over again by a business to
generate profit. Examples include:
• land and buildings
• machinery and equipment
• vehicles
• patents or copyright.
Current assets are short-term assets that change regularly. There are three
main types:
• Inventories: This is the value of any stocks of raw materials, partially
finished goods or finished products owned by the business.
• Receivables: This is money owed to the business, usually by customers who
have bought on credit.
• Cash: This is money available in the bank that can be immediately accessed
along with physical cash.

Capital on the balance sheet

There are three sources of capital shown on a balance sheet:
• Banks: Loans from banks carry interest payments and must be repaid.
• Shareholders: When the company sells shares, it receives share capital in
return. This is theoretically owed to shareholders but is very rarely ever
repaid.
• Profits: The reserves figure on a balance sheet shows the total amount of
retained profit that has been kept in the business as a source of finance.

Typical mistake
Note that reserves are not money that the firm has available to
spend. This simply shows where money has come from; it is likely
that most has already been spent on assets, shown on the top part of
the balance sheet.
A final version of a balance sheet is shown in Table 16.2. Note that the
column to the right shows sub-totals from figures in the other column.
Table 16.2 An example of the final version of a balance sheet
Balance sheet for 31 December last year
£ £
Property 180,000
Machinery and vehicles 120,000 300,000
Inventories 80,000
Receivables and cash 60,000
Current liabilities (40,000)
Total assets less current liabilities 400,000
Loan capital (250,000)
Net assets 150,000
Share capital 50,000
Reserves 100,000
Total equity 150,000

Key information: assessing financial

performance using a balance sheet
Typically, a business’s financial performance is measured by profit, as shown
on the profit and loss account. However, longer-term performance can be
assessed using the balance sheet by seeing the movements in reserves over
time. Reserves build up over time (for a successful firm) because any profit
the firm makes after tax that is not paid out in dividends is retained in the
business. This annual retained profit is added to the reserves figure on the
balance sheet. If the firm makes a loss for the year, this figure is deducted
from reserves on the balance sheet. This means that if the reserves figure is
consistently rising over time, the firm has been consistently profitable.

Stakeholder interest in balance sheets

Published accounts exist in order to ensure that stakeholders have access to
the information that helps them make informed dealings with a business.
Table 16.3 Different interests in the balance sheet
Stakeholder Interest in the balance sheet
Bankers Keen to understand a business’s reliance on debt for its
long-term finance, bankers will study the relationship
between long-term borrowings and total equity.
Suppliers More interested in the short-term financial health of the
business, suppliers considering offering credit will want
to see the relationship between the company’s available
cash and its existing short-term debt.
Staff May be looking at reserves to assess whether the
‘wealth’ of the business has gone up or down over time,
perhaps wondering whether they are receiving a fair
reward for their efforts if reserves have rocketed.
Profit and loss accounts (statement of
comprehensive income)
The profit and loss account is the record of how well a firm has done,
financially, in a given period of time. The financial measure of performance is
profit, therefore the profit and loss account shows a variety of different types
of profit to help stakeholders studying the account understand the business’s
performance.

How a P&L account shows profit or loss

In simple terms, a profit and loss account starts with annual revenue, then
deducts different costs and expenses to calculate different types of profit. A
basic profit and loss account is shown in Table 16.4.
Table 16.4 The basic structure of a profit and loss account
£m
Revenue 26.0
Less Cost of sales (17.0)
Gives Gross profit 9.0
Less Overheads (4.0)
Gives Operating profit 5.0
Less Financing costs 1.5*
Gives Profit before taxation 6.5
Less Tax (2.0)
Gives Profit after taxation for the year 4.5
*In this case more interest was earned than was paid out

Gross profit
Gross profit is a raw measure of basic trading profit. It shows what is left
from revenue once the cost of making or buying the goods sold (cost of sales)
has been deducted.

Operating profit
To move from gross to operating profit, overhead expenses are deducted.
Expenses include items such as wages and salaries, rent and rates, heat and
light and distribution and marketing costs. Therefore, operating profit shows
the amount of profit left after deducting the normal costs of operating the
business for the year.

Profit before and after tax

Beneath operating profit, the profit and loss account deals with issues such as
the cost of financing the business, taxation and how profits are used. First, an
entry is made for net financing costs. This is simply:

A negative figure is typical as many businesses borrow greater sums than they
keep at any time in the bank (and interest rates on loans will be higher than
those paid out on money in the bank). This figure is deducted from operating
profit to calculate the profit before tax is deducted. With corporation tax taken
away, the business is left with profit after tax — also referred to as net profit
for the year. This is the profit that ‘belongs’ to the shareholders.
Table 16.5 shows the profit and loss account for SuperGroup plc for the year
ending 31 March 2015, with equivalent 2014 figures also shown.
Table 16.5 Summarised profit and loss account for SuperGroup
plc (year ended 31 March 2015)
2015 (£m) 2014 (3m)
Revenue (sales excluding VAT) 486 431
Cost of sales (190) (174)
Gross profit 296 257
Administrative and other expenses (236) (212)
Operating profit 60 45
Net finance expense (0.5) −
Profit before tax 59.9 45
Taxation (13.5) (17.5)
Net profit for the year 46 27.5

Using profit
Shareholders are left with a simple choice: should they withdraw profit after
tax for their own benefit, or leave that money in the business to finance extra
spending by the firm? It is directors who will recommend the balance
between these two uses of profit. They are likely to consider:
• How much money the firm needs to finance future plans
• How much dividend shareholders have received in the past
• Shareholders’ expectations for this year’s dividend.
If the majority of shareholders are unhappy with the recommendation, they
can vote against this at the annual general meeting.

Key information: assessing financial

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

Now test yourself

1 Using 140 characters or less, what does a balance sheet show?
2 Using 140 characters or less, what does a profit and loss account
show?
3 Using 140 characters or less, what is meant by reserves?
4 State three stakeholders who will be interested in seeing a
company’s accounts and, for each, briefly explain why.
Answers online

Exam tip
Look out for profit and loss accounts where different profit figures
move in different directions. These can provide great opportunities to
show insight. If gross profit rises but operating profit falls, the firm has
probably struggled to control its expenses for the year. A company
whose gross and operating profits rise, but net profit falls, may have
taken on significant extra borrowings, pushing up the net financing
cost of the business.
Ratio analysis
Financial accounting statements provide useful data that can be helpful in
assessing the performance and health of a business. However, the raw data
itself can only tell the reader so much. More powerful analysis can be
achieved by looking at financial variables in relation to others, calculating
financial ratios.

Types of ratio
The three main classifications of ratio are:
• Profitability: This shows the relationship between gross/operating/net profit
and revenue, assets and capital.
• Liquidity: This shows the ability of a firm to meet its short-term debts with
cash or near cash assets.
• Gearing: This shows the proportion of the long-term finance in a business
that has come from loans.
Each tells us about a different aspect of the company’s performance
(profitability) and financial health (liquidity and gearing). Taken together,
they can really unveil some of the secrets of the financial statements.

Liquidity ratios
Both liquidity ratios — current and acid test — are calculated in order to
understand the balance between the company’s short-term debt and the assets
it can use to meet that debt: cash or other current assets that can be speedily
turned into cash.

Current ratio

The ideal value for the current ratio is 1.5, meaning that a business would
have £1.50 of current assets for every £1 of short-term debt, which is deemed
enough to be able to cover the debts comfortably without holding too many
resources in unproductive forms, where they could be better invested
elsewhere. If the ratio falls too low, this may indicate that the firm is suffering
from a liquidity crisis, so is unable to find enough cash to settle debts as they
become due.

Exam tip
If either liquidity ratio goes too high, the firm may have too much
money tied up in stock, debtors or cash. This money could generate a
far greater return if invested in non-current assets. Holding excessive
current assets may feel safe but is likely to damage a company’s
return on capital employed (ROCE) ratio.

Acid test ratio

A stiffer test of liquidity than the current ratio — the acid test ratio —
discounts inventories as something that can be quickly converted to cash.

The ideal value for this ratio is 1. This would mean a company has £1 of cash
or receivables to cover every £1 of short-term debt.

Typical mistake
Low liquidity ratios, acid test well below 1 or a current ratio close to or
below 1, can indicate financial problems. However, for many
companies, getting hold of extra cash in the short term is not a
problem, so they do not need to maintain a high cash balance to
cover short-term debt. For a supermarket such as Tesco (with an acid
test usually around 0.5), millions of pounds of cash enter the
business every single day, cash that can be diverted to meet short-
term debt should the need arise.

Gearing
Measuring the long-term financial health of a business, the gearing ratio
expresses long-term liabilities as a percentage of the total amount of long-
term capital in the business.

In other words, if a business is financed by £50m of loans and £50m of equity,

the gearing ratio would be 50%. Indeed, 50% is regarded as the danger level
over which it is normally inadvisable to pass. The problem with a high
gearing is the cash drain it represents: with interest payments to make, as well
as loan repayments, high levels of debt can suck the lifeblood from a business
rapidly.
To reduce an unhealthily high gearing ratio, several options are open:
• Issue more shares
• Retain more profits
• Repay some loans.
Profitability ratios
Assessing how profitable a business has been can be done using the actual
figures for profit over several years. However, more powerfully, profitability
can be assessed by calculating profit margins. These show profit as a
percentage of revenue. The most profitable firms are able to ensure that a
greater proportion of every £1 in revenue is left over as profit once costs have
been deducted. Profit margins were covered in more detail in Topic 20 (see A-
level textbook, p. 144). A summary is provided in Table 16.6.

Return on Capital Employed (ROCE)

Another measure of profitability is the ROCE ratio. This expresses operating
profit as a percentage of the capital that has been invested in the business.
Therefore it shows a return on that capital that is comparable with other
potential uses of capital, such as simply leaving money in the bank to earn
interest.

Higher is better for this ratio, since a higher return means the money invested
in the business is generating a higher return on that investment. Where ROCE
falls below current interest rates, a business may question whether it would be
better off closing, liquidating its assets and putting all the money in the risk-
free bank for a higher return than the risky option of running a business.

Exam tip
Improving ROCE can be achieved by buying back shares from
shareholders. It is this fact that explains the strange sounding notion
of returning cash to shareholders; if share capital is reduced, capital
employed falls, yet the transaction has no impact on operating profit.
Table 16.7 shows ROCE figures for several plcs; notice how significant the
variations are.

In order to boost the ROCE ratio, two options are available:

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

Interpreting ratios to make business decisions

Ratios can help to make key business decisions. Gearing and liquidity ratios
help to identify whether a business can afford to invest money in new
projects. Meanwhile, return on capital employed can help to assess the
attractiveness of a new investment (alongside ARR), or identify
underperforming parts of a business.
Table 16.8 shows how ratios can be useful.
Table 16.8 Interpreting ratios to make decisions
Decision Ratios Evaluation
Can we afford to Acid test 0.95 Finance can come from extra
spend £50 million Gearing 24.5% borrowing (to a 50% gearing
on launching in maximum) plus some use of
China? working capital (to an acid test
minimum of 0.6)
Do we need to Gross margin The problem should be
put our prices This year: 8.7% addressed, but price elasticity
up? of demand must also be
Last year: 10.2% considered before proceeding
Should we focus ROCE figures for: Unless Division C produces
on Divisions A Division A 22.6% something of value to Division
and B and sell off A or B, there is a strong case
Division C? Division B 31.4% for selling it off and focusing on
Division C 5.7% the strongest areas of the
 business

Limitations of ratio analysis

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

Now test yourself

5 Which ratio would be most useful to use when:
(a) deciding whether prices are too low
(b) deciding whether to borrow to buy new machinery
(c) assessing whether to offer credit to new customer?
6 State two actions a business can take to reduce its gearing ratio.
7 What are the ideal values for the (a) current and (b) acid test
ratios?
8 What is considered the danger level for the gearing ratio?
9 State two ways to boost a company’s ROCE ratio.
Answers online

Human resources
Monitoring the effectiveness of human
resources
Just as effective management of any business resource involves assessing
how effectively it is being used, so HR management must find ways to assess
the effectiveness of the way that people are managed in the business. As a
result, a number of important HR indicators will be regularly monitored,
especially:
• labour productivity
• labour turnover
• absenteeism.

Labour productivity
Perhaps the single most important measure of the effectiveness of staff is
labour productivity.

A business that is able to boost labour productivity without increasing pay

will enjoy lower labour costs per unit. This should boost its competitiveness,
allowing prices to be cut if needed, or a higher profit margin.

Labour turnover
Measuring the percentage of the workforce that has left during a year, this
indicator can indicate staff discontent with how they are treated if it increases.

Causes of increasing labour turnover could include those shown in Table 16.9.
Table 16.9 Some internal and external causes of increasing labour
turnover
Internal causes External causes
Poor recruitment and selection, More local vacancies arising,
resulting in the wrong people being tempting staff to look for better
appointed opportunities
Poor motivation or leadership Better transport links allowing
Wage rates below the local norms staff to look for alternative jobs
further away

Exam tip
The context may determine the importance of employee performance
data. During periods of rapid growth for a business, ideas and
solutions, which are virtually unmeasurable, may be critical to
ensuring that a business successfully moves to a new stage in its
development. It is in mature businesses that indicators such as
productivity can be crucial, since productivity gains may represent the
best chance to increase profits — by boosting margins.
High labour turnover has, on the whole, negative effects in most cases.
However, some positives can be found in the right circumstances. The
negatives of a high labour turnover include:
• extra recruitment costs to find replacements
• extra training costs for replacements
• time taken for replacements to settle in and become productive
• loss of productivity while replacements are found, trained and find their
feet.
Potential positives of a high labour turnover include:
• new workers with new ideas and enthusiasm
• new workers with appropriate skills may be brought in to prevent the need
to re-train existing staff where skill requirements have changed
• a new way of looking at problems in the business could bring solutions to
long-standing issues.

Absenteeism
Measuring the amount of time missed by workers who do not come to work
when they are supposed to can indicate discontent in the workplace. However,
the weakness of this measure is that it fails to distinguish between avoidable
and unavoidable absences.

There is no doubt that a high level of absenteeism causes extra costs and lost
productivity that damages a firm’s competitiveness.

Typical mistake
Be careful with both absenteeism and labour turnover. They are both
indicators where high numbers are bad: beware interpreting rising
levels of everything in business as good.

Using employee performance data to help

make business decisions
As with most data gathered by businesses, employee performance data can
highlight areas where problems exist. The data is unlikely to pin down the
cause, or provide the solution. However, analysis of data in this way can
uncover major areas where improvements need to be made. This is especially
true where comparative data for rivals is available. Where a business’s HR
data shows it is lagging behind rivals, competitiveness will suffer.
Human resource strategies to improve
employee performance
To improve employee performance, a range of strategies is available. Each
may be appropriate in different circumstances.

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

Employee share ownership

Though hypothetically logical, employee share ownership is more likely to
work in small businesses than large ones, where staff may feel their own
performance has no serious impact on the overall profits of the business.
Share ownership should work by aligning the goals of the business with those
of staff. If staff work better, the company will make more profit, allowing
higher dividends to be paid to shareholders, including the employees.

Consultation strategies
Finding an appropriate way to gather employees’ views and, even harder,
show that they are being genuinely considered, can boost employee
engagement and performance. In small businesses, consultation can be a
doddle — the boss chats things through with all five members of staff. If the
business has 50,000 staff in 50 countries, this method is not viable. The use of
technology can help — by setting up internal chat rooms or a forum where
staff can have their say — but the challenge of consultation grows as a
business grows.

Empowerment strategies
Harnessing the theoretical ideas of Maslow and Herzberg, genuinely
empowering staff can bring significant increases in employee performance.
However, empowerment can be terrifying to managers, who will still be held
accountable for the work of subordinates but cannot even tell them what to
do, let alone how to do it. The key conditions required if empowerment is to
be effective are:
• clear corporate aims and objectives
• a strong culture of trust
• a skilled and talented workforce.

Now test yourself

10 Briefly explain what the data shows is happening at this business:

11 Identify two strategies the firm above could use to help improve
employee performance.
12 State two possible reasons why the rise in labour turnover could
be causing the increase in productivity.
Answers online

Exam practice
Use the following information to answer the question about assessing
this business’s performance.
Extracts from profit and loss account
This year £m Last year £m
Revenue 3,500 3,200
Cost of sales 2,500 2,000
Gross profit 1,000 1,200
Expenses 800 700
Operating profit 200 500
Net cost of finance 50 20
Tax 30 25
Net profit 120 455
Summary of current balance sheet
£m £m
Non-current assets 250
Inventories 50
Receivables and cash 20
Current liabilities (40)
Total assets less current liabilities 280
Long-term liabilities (180)
Net assets 100
Share capital 25
Reserves 75
Total equity 100
HR data
This Industry
business average
Labour productivity (units per worker 45 58
per week)
Labour turnover (annual %) 23 15
Absenteeism (annual %) 8 5
1 Analyse the information provided to help discuss whether the
business should invest in new automated production machinery to
replace staff on their production line.
(20)
2 Assessing a business’s competitiveness should not solely rely on
basic financial and HR data. Do you agree? Justify your view.
(20)
Answers and quick quiz 16 online

Summary
• A balance sheet (statement of financial position) shows what a
business owns, owes and how much shareholders have invested.
• A profit and loss account (statement of comprehensive income)
shows revenues and costs for a time period.
• Published financial statements provide useful insight for a range of
stakeholders.
• Calculating financial ratios helps to uncover what a business’s
accounts show.
• The ratios you need to know focus on assessing three areas:
– profitability
– liquidity
 – gearing.
• Key measures of the effectiveness of HR management in a
business are:
– labour productivity
– labour turnover
– absenteeism.
• Strategies to improve HR effectiveness include:
– financial rewards
– employee share ownership
– consultation strategies
– empowerment strategies.
17 Managing change
Causes and effects of change
The value of change
Though continuity may bring comfort, change brings opportunities. It is
change that forces progress — which is generally positive.

Internal causes of change

A number of internally controllable issues can bring about the need to change.
These include:
• Changes in organisational size: As a business grows, or shrinks, internal
change is inevitable. Expansion can lead to the need to adjust budgets and
add extra supervisory layers to the structure to prevent spans of control
becoming too wide. Contraction is likely to lead to redundancies and the
damaging impacts that can have on staff morale.
• Poor business performance: When profit, profitability or revenue growth
are consistently below par, change is often made at the top of an
organisation. The need to change a senior decision-maker is implied since
they have the ultimate responsibility for underperformance of the business.
• New ownership: Following a takeover, aims, objectives, policies and
procedures may well change in order to satisfy the vision that the new
owners have for the firm. Even when a successful business has new owners,
some change is likely since without the expectation that new owners can
improve a business, takeover is unlikely to take place.
• Transformational leadership: For businesses that are struggling to survive, a
new ‘transformational leader’ may be appointed to radically adjust almost
everything the business does and how it does it, in the hope that they can
find a new mission or purpose and thus revive performance.

Typical mistake
Do not slip into the misguided belief that it is only external factors that
lead to businesses needing to make major changes. There are
several internal factors that can lead to the introduction of major
change programmes.

External causes of change

Frequently, it is changes in the external environment in which the business
operates that will cause change to take place. These focus on the acronym
PESTLE, while adding changes to the market as a sixth cause:
• Changes in the market: The emergence of new competitors, or radical
change in relative market shares, can lead to major change being required
within an organisation in order to counter threats. On the other hand, rapid
growth in demand caused by fashion or trends may require swift changes in
order to capitalise on this demand.
• Political change: Changes in the political party in government can have
significant impacts, especially in businesses providing services at least
partially financed by government spending. Less broadly, even a change of
policy from a political party can bring about the need for a change in
approach from a business, which perhaps will now need to adjust its
approach to selling.

Exam tip
When multiple causes of change hit a business at the same time, this
can explain why the business struggles to deal with these scenarios
effectively. Revising for one exam can be hard enough, the problems
become far greater when you have several papers in several subjects
to revise for at the same time.
• Economic change: Changes in economic growth, as the economy follows
its cycle of expansion and slowdown, affect most businesses depending on
their income elasticity. The major impact is likely to be on demand, and
therefore an element of business change will be required to adjust capacity
to suit current demand.
• Social change: How society expects to live — lifestyle changes — can
create huge forces for change for businesses, which may need to adjust what
they sell, how they deliver products and services or what alternative
functions consumers may expect from existing products. Anticipating social
change can be a tremendous way to steal market share from rivals, if change
can be spotted and acted upon rapidly.
• Technological change: New technologies can create whole new markets for
products that may not have existed a few years earlier. In addition,
technology can make new processes possible, allowing new ways to
manufacture or deliver products and services.
• Environmental change: For business, perhaps the most important aspect of
environmental change to consider is consumers’ attitudes to the
environment. No doubt many consumers care enough about the environment
to factor this into their buying decisions. The trick for businesses is to react
to the shifting environmental concerns of their consumers.
Possible effects of change
• Effect of change on competitiveness: Much change is focused on the need
to improve a firm’s ability to compete in the market with its rivals.
Following Porter’s advice, cost leadership or differentiation are the only two
viable long-term routes to improved competitiveness (see Table 17.1).
Table 17.1 Possible changes designed to boost competitiveness
through cost leadership and differentiation
Possible changes designed to Possible changes to boost
boost competitiveness through competitiveness through
cost leadership differentiation
Finding new suppliers Redesigning the product
Redesigning the product to reduce Re-branding the product or
the cost of making it service
Boosting capacity utilisation through Adding extra features to the
branch closures product or service
• Effect of change on productivity: In a manufacturing context, change that is
focused on processes is likely to have as a fundamental goal the desire to
increase productivity, thus reducing unit costs. This may come from
automation or simply updating the technology already being used. In the
service sector productivity improvements are harder to find, with generally
more labour-intensive processes meaning that it is improvements in
motivation that can make a difference, but perhaps only marginal
improvements.
• Effect of change on financial performance: Change generally means short-
term pain for long-term gain (see Table 17.2).
Table 17.2 Long-term financial improvement and short-term pain
Long-term financial improvement Short-term pain
Reducing labour costs Redundancy payments
Lower unit costs Investment in new production
robots
Improved revenue growth Increased advertising budget
Better profit margins through Cost of redesigning product
increased price
• Effect of change on stakeholders: Change brought on by an external threat
or negative internal aspects is likely to have painful impacts on several
stakeholder groups. To deal with poor financial performance, cost-cutting
 may well hurt staff, suppliers and customers.

Now test yourself

1 In addition to PESTLE factors, what is the other major external
cause of change?
2 State three internal causes of change.
3 How might the need to cope with a surge in demand caused by a
social change affect (a) suppliers and (b) staff of a food
manufacturer?
Answers online

Key factors in change

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

Organisational culture
Organisational culture affects the success of change in two main ways:
1 Some organisations have cultures that welcome change as a chance to
improve, to enhance the way the business strives to achieve its mission.
Successfully managing change in these organisations is far easier than in
those where the culture is wary of any change to the current way of doing
things.
2 Major change can require a change in culture within the organisation.
Success comes when change managers find ways to subtly adjust the
culture, without trying to radically move it in an opposite direction.
Attempts to change culture that try to shift perspective on ‘how we do
things’ through 180 degrees are unlikely to succeed, generating far more
 resistance to proposed changes.

Size of the organisation

Instinctively, many believe that successful change is easier in a small
organisation than a large one. Little evidence exists to support this view.
Issues faced by managers of small- to medium-sized firms include:
• Smaller firms may have fewer financial resources to help to move the
change forward and ensure a smooth transition.
• Often dominated by one person or family, the alternative perspectives
required to understand the need for change and method of change may be
lacking.
• With a smaller workforce, the range of skills available may be limited,
reducing the flexibility of the workforce to adjust to new ways of working.
In larger firms, problems are still likely to exist:
• Senior managers may struggle to get a real feel for the views of their
thousands or tens of thousands of staff.
• Different parts of the business may need different approaches from the
change programme; these differences can be hard to accommodate in a
coherent plan.
• Explaining change to staff can be hard. Even if the CEO can passionately
explain the change to her underlings, they are likely to explain the change in
a slightly less effective way to their subordinates, and so on, until junior
managers struggle to generate any enthusiasm explaining the changes to
staff.
• Changing the way the organisation functions creates chances for co-
ordination problems as different departments must adjust to different
working relationships.

Typical mistake
Avoid lazy assertions that change is easier in a large or small
organisation. Use the issues raised here to recognise that managing
change is tough in both large and small firms but for different
reasons.

Time and speed of change

External change factors can lead to a changed environment over an extended
period of time, perhaps a decade or two. The result is that a business can
manage the internal changes needed more easily, making small adjustments
over a period of time that are more easily introduced. When change happens
more rapidly, perhaps through the release of a new technology, radical
adjustments are required. These disruptive changes force major internal
shifts which may well be difficult to pull off effectively for managers.

Managing resistance to change

Kotter and Schlesinger suggested three successful approaches to managing
the resistance to change generally experienced by firms looking to make
significant internal changes.
1 Education and communication: Effectively explaining to staff why change
is needed, then how the proposed changes will address the problems
causing the need to change, can work well. If much resistance to change is
caused by staff not understanding exactly why the current status quo is not
good enough, enlightening them as to what makes change necessary can
break this barrier.
2 Participation and involvement: If unofficial leaders are consulted on how to
make changes, allowing them to feed colleagues’ views into a change
process, the changes are more likely to be successful. The reason is that if
people feel they ‘own’ the changes, they will try hard to make them work,
instead of dragging their feet if change is imposed.
3 Negotiation and agreement: Sometimes resistors may need to be ‘bribed’ to
accept changes, perhaps with a pay rise or adjustment to working
conditions. Trade unions may often be involved in this process, with the
union negotiating on behalf of their members to reach an agreeable solution
to the problems preventing successful change.

Exam tip
When trying to explain why a change has not succeeded, if there is
little evidence of Kotter and Schlesinger’s suggested approaches,
perhaps their least favoured method has been used. Kotter and
Schlesinger were clear that using force and coercion is the least likely
method to successfully overcome resistance to change.

Now test yourself

4 State the three basic challenges that successful change
management must meet.
5 Briefly explain why change may be easier to manage in a young
technology business than a long-established DIY retailer.
6 State the three main successful ways to overcome resistance to
change.
Answers online
Scenario planning
Planning ahead allows better decision-making. This is because:
• time can be taken to analyse possible actions
• resources needed can be secured.
In order to plan ahead, it is necessary to imagine the future. Scenario
planning looks to harness the benefits of planning ahead. It does so by
regularly imagining issues that may affect the business in the future. The most
common purpose of scenario planning is in preparing for threats, though it
can be used to plan future growth paths.

Identifying key risks through risk assessment

The first stage to scenario planning is risk assessment. This involves:
• identifying possible major risks or threats faced by the business
• quantifying the possible cost to the business if the event occurs
• attaching a probability to the chance of the risk occurring.
This allows a firm to make a considered judgement as to which risks to
prioritise preparing to handle, by combining the magnitude of their effect with
the probability of the risk occurring.
Common risks that many businesses identify include:
• Natural disasters: Floods, storms, earthquakes and other natural disasters
can cause havoc, especially for manufacturers whose supply chains can be
disrupted. Suppliers may be unable to harvest, mine, produce or deliver
materials and components. The company’s own manufacturing facilities
may be disrupted if the disaster strikes locally, while onward distribution
can be hampered by damage to infrastructure.
• IT systems failure: The trouble with computerising operations systems,
such as ordering and replenishment, automated banking and online sales, is
that an extra area of significant vulnerability is added to businesses. From an
internal system malfunction, to viruses and malware, to major hacking
events, companies whose IT systems fail to function effectively may find
the consequences are a failure to deliver their product or service. This is
likely to lead to reputational damage.
• Loss of key staff: While more staff than you may expect can be replaced
with relative ease, some businesses have ‘superstars’ who are so special at
their role that they may be irreplaceable. Apple designer Jonathan Ive or Ted
Baker’s Ray Kelvin may be irreplaceable. The business would need to find a
way to try to work around their loss, often by bringing in several people
who can each do part of what their superstar once did.

Typical mistake
Do not assume that a natural disaster only represents a problem to
businesses local to the site of the disaster. Perhaps the most
significant business problem of natural disasters is the disruption they
can cause to a well-oiled supply chain, potentially messing up the
entire chain of production. This could be true even if the disaster
occurred on the other side of the world if that is where the supplies
come from.

Planning for risk mitigation

The whole point of scenario planning is to give decision-makers time to
consider how they might deal with the effects of a major risk occurring.
Mitigation involves lessening the impact of the risk, generally through laying
out plans in advance showing what will be done if a crisis strikes. The idea of
contingency planning builds on the benefits of planning in advance which
was outlined at the start of this topic.
Table 17.3 Examples of risk mitigation planning
Potential Risk mitigation
crisis
Natural Have relationships in place with alternative suppliers
disaster Organise potential outsourcing of production
Figure out alternative transport routes for major items
within the supply chain
IT systems Have a back-up system ready to switch on
failure
Loss of key Succession planning
staff
Identifying and training potential replacements for key personnel —
succession planning — allows a business to gain the benefits of internal
recruitment for key positions. Knowing the logic behind existing business
strategies can really help a new leader seamlessly take over the helm of a
business, in a way that an external replacement would find impossible.
Business continuity relies on a number of components:
• A secure financial position that will enable a firm to spend the cash required
to deal with an emergency without threatening its long-term financial
stability.
• Clearly defined responsibilities laid out in advance, confirming who will
deal with what aspects of possible problems. This allows training to be
 provided in crisis management to these personnel.
• Effective communication systems prepared, perhaps including special
emergency numbers to call for stakeholders who want to contact the
business and also methods for the business to contact the media to begin
handling the marketing and PR implications of a crisis.

Exam tip
Management in scenario planning and crisis management illustrate
how there is no one right management style. Preparing for a disaster
relies on consultation in order to get a rounded perspective on likely
risks and possible mitigating actions. Once a crisis strikes, however,
speed of decision-making is key, for which autocratic decision-making
is the best way. This illustrates nicely how different styles suit different
situations.

Now test yourself

7 What three-step process is involved in risk assessment?
8 List three common risks for which businesses can prepare in
advance.
9 Briefly explain why scenario planning is a better alternative than
dealing with a crisis once it has happened.
Answers online

Exam practice
1 ‘The ability to effectively manage change is the key to long-term
financial success in all markets in the twenty-first century.’ Discuss.
(20)
2 Assess the impact of Britain leaving the EU on a UK-based
manufacturer which exports 80% of its output to EU markets.
(20)
Answers and quick quiz 17 online

Summary
• Internal causes of change include:
– changes in organisational size
– poor business performance
– new ownership
– transformational leadership.
• External causes of change include:
– changes in the market
– political change
– economic change
– social change
– technological change
– legal change
– environmental change.
• Change is likely to have significant effects on:
– competitiveness
– productivity
– financial performance.
• Successful change management relies on:
– all staff understanding the need for change
– all staff understanding, in advance, what the new changed world
will be like
– all staff understanding the plan for moving from A to B.
• Managing change is influenced by:
– corporate culture
– time and speed of change
– size of the organisation.
• Managing resistance to change is best done through:
– education and communication
– participation and involvement or
– negotiation and agreement.
• Scenario planning starts with risk assessment.
• Scenario planning helps businesses deal with major crises by
preparing in advance.
• Preparing in advance means risk mitigation can take place.
18 Globalisation
Growing economies
Economic development is happening: a greater proportion of the world’s
population is now living above the poverty line. The cause is not
redistribution of the world’s wealth; it is the development of economies which
had previously been relatively inefficient and unproductive. The key drivers
behind economic development for the countries that have developed
significantly in recent years have been:
• willingness to accept inward investment from multinationals
• more enterprising behaviour from local businesses
• more stable government
• easier access to export markets due to improvements in communication and
transport: globalisation.

Growth of UK economy compared to

developing economies
To contextualise the term developing economies, it is worth comparing
growth rates around the world with the economy of the UK. For the past 200
years, economic growth in the UK has averaged 2.25% per year. That means
the size of the economy doubles every 30 years or so. Other economies that
would be classified as developing economies have recently been experiencing
more rapid growth (see Table 18.1).
Table 18.1 Economic growth of selected developing countries
Country Average annual growth in real GDP per head 1990–
2013 (%)
Bangladesh 3.8
China 9.4
India 5.0
Bolivia 1.8
Nigeria 3.4

Typical mistake
Do not underestimate the growth rates of countries such as
Bangladesh. As growth rates are cumulative, Bangladesh’s growth
rate means their economy will double in size every 18 years. This
level of economic development makes a significant impact on life in
developing economies — just 3.8% per year.

Growing economic power of countries within

Asia and Africa
The next two topics will cover China, India and Africa in more detail. What
needs to be raised here is the broader impact of development in the wider
South East Asia. China has acted as something of a hub. Manufacturers in
China are looking for suppliers from whom transport costs will not be great.
As a result, other Asian economies, notably Vietnam, Indonesia and
Cambodia have seen rapid growth in the last two decades. Not only do these
countries represent a viable source of supply for China, they are also building
their own manufacturing base. They offer lower cost production than China,
where increases in real wages and other costs are putting off some companies
looking for cheap production locations.

Implications of economic growth for

businesses
New export opportunities
As developing countries see incomes rising, UK businesses may discover new
markets to which they can export. The UK is particularly good at providing
services including:
• fashion design
• design engineering and architecture
• culture (books and entertainment)
• financial and other business services.
As economies reach the latter stages of development, the demand for services
grows, meaning that UK exporters should be targeting China right now.

Offshoring production
Many UK manufacturers have closed their UK manufacturing facilities and
re-opened them in developing countries. Dyson’s move to Malaysia some 20
years ago is an example. The goal is to exploit the lower production costs,
boosting profit margins, even if transport costs rise as a result. In recent years,
more service businesses have found ways to offshore their work, with jobs as
diverse as call-centre enquiry and complaint handling and basic analysis of
medical x-rays being shifted to lower cost economies.

Increased domestic competition

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

Implications of economic growth for

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

Indicators of growth
GDP per capita
Rising levels of income per person should be a clear indicator of economic
development. If, on average, the people of a country are earning more, they
will spend more, creating a virtuous circle. Therefore, watching GDP per
capita over time provides an excellent indicator as to the level of purely
economic development taking place within a country.

Literacy
Although money is a component, there is more to economic development than
just rising incomes. Illiteracy rates — the number of people who cannot read
or write — should see a dramatic improvement as an economy passes through
the stages of economic development.
A literate workforce will be more productive, capable of performing tasks that
add more value to production, thus hastening further economic development.

Health
Levels of health should improve as an economy develops. Key ways to
measure health focus on the start and end of life. Simply measuring life
expectancy gives a good clue as to the health of a nation; economic
development leads to healthier living along with better treatment of later life
diseases.
Human Development Index (HDI)
The HDI combines measures of economic progress with health and education
to try to provide a well-rounded picture of a country’s economic development.
The figures in Table 18.2 illustrate HDI for selected countries.
Table 18.2 HDI ranking and scores, selected countries 2014
Source: Courtesy of the United Nations and reproduced under the Creative Commons
License. http://creativecommons.org/licenses/by/3.0/igo/legalcode

Rank (out of 180 countries) HDI score (out of 1.0)

Norway 1 0.944
UK 14 0.892
Cuba 44 0.815
Mexico 71 0.756
China 91 0.719
India 135 0.586
Kenya 147 0.535
Nigeria 152 0.504
These figures help to illustrate that, as with any weighted average, there will
often be debate over the relative importance of different factors. Cuba has
relatively low GDP per capita, but the government prioritises both health and
education, perhaps nudging the country higher than expected. Mexico’s
performance reflects what is not there; crime rates are not included.

Now test yourself

1 State four key drivers of economic development.
2 List three major implications of economic development in Asia,
Africa and South America for UK businesses.
3 What three factors does the HDI combine to assess economic
development?
Answers online

China versus India

China and India matter because of their populations. Both are home to around
1.3 billion people: two countries, each with early 20 times the population of
the UK. Neither country has reached the level of development of the UK,
however both are catching up. China is further down the path of development
than India, but both will be enormous features of the global economy for the
foreseeable future.

China?
Not only does China have a huge population, it has also undergone an
incredible period of economic growth over the past 25 years. A growth rate
that has averaged around 10% per year in that period has transformed the
country. That 10% growth means the economy doubled in size every eight
years or so. The result has been an explosion in markets for a range of
consumer goods.
As GDP per head grows in China, and total GDP continues to grow at around
7% per year, China’s economy seems likely to wrestle the title of global
economic superpower from the USA.

Or India?
India has one major advantage over China in the race to be the twenty-second
century’s dominant economic power: its population. India’s population is
growing faster than China’s. In addition, its population is younger, the result
of Chinese attempts to limit their population over the past 20 years.

Which has been growing faster?

China. Largely as a result of investment in construction and infrastructure,
allied with huge export growth, China is well ahead. The investment has
come from two main sources:
• Government spending: This focused first on infrastructure (roads and dams,
for power and water). Subsequently the focus has turned to housing,
railways, schools and hospitals. Spending on these areas helps to reinforce
the growth path on which the Chinese economy continues to travel.
• Foreign Direct Investment: Western companies have been building factories
in China for the past 20 years to take advantage of low wage costs.
India has lagged behind on this kind of fixed capital formation although its
performance has improved in the last ten years or so.
China’s export growth was originally built on incredibly low-cost labour.
However, as wage rates have risen, China has retained its place as the world’s
largest exporter of manufactured goods. Notably, these exports contain a huge
proportion of high technology products: higher than India, the UK or even the
USA.
India’s exports are less obvious. Its major export successes have been
‘invisibles’ such as software engineering and running call centres. Its export
advantages over China are:
• English (the global language) is widely spoken.
• The outstanding top end of the education system turns out world class
managers and software engineers.

Can India grow rapidly and consistently?

The three key weaknesses facing the Indian economy are:
• Poor infrastructure: India’s democratic system of government (China is not
a democracy) means that if the voters don’t agree with a policy, the
government cannot ultimately force it on the population. China’s
government can dictate that over 40% of spending will be on investment in
improving infrastructure, notably motorways and utilities such as water and
electricity supply. India’s road system is far worse than China’s and
undoubtedly a drag factor on attempts to grow the economy.
• Narrow education system: Despite the very top end of India’s education
system being excellent, education for the masses is poor, with 29% of the
population being unable to read and write. These individuals will not be able
to effectively take on higher skilled jobs needed as the economy looks to
grow. In China, 96.5% of the population is literate.
• Balance of payments deficit: Compared to China’s current account surplus
of $290 billion in 2015, India’s deficit of $25 billion shows that Indian
consumers are buying more imports than foreigners want to buy Indian
exports. Without a fall in the value of the rupee (which will prompt even
more inflation), this problem will be hard to fix.
A further issue is the tendency of the Indian economy to ‘overheat’ when
industrial production accelerates. This overheating shows as inflation, which
the Bank of India curbs by increasing interest rates, thus halting growth.
India’s inflation rate has been consistently higher than China’s.

Can China outstrip America?

Wages present the key challenge to China for sustaining its remarkable
growth. As the economy develops, wage rates rise. This is already evident in
China. The problem is that much of China’s growth has come because it
offers low wage manufacturing. As multinationals interested only in low
wage locations pull out, the question is whether enough higher added value
manufacturing can be attracted to sustain the overall growth.
China’s GDP has overtaken the US, if measured at PPP. Of course, this
adjustment for the cost of living is significant: prices in the US are
significantly higher for many items than in China.
As China’s economy, especially its manufacturing sector, continues to steam
ahead, emissions present a major concern. Environmental legislation and
regulation in China leave much to be desired. Although the Chinese
government is now taking active steps to ensure better environmental
standards, particularly regarding air pollution, scenes of smog in Chinese
cities are all too common.

Typical mistake
Although China’s GDP will outstrip America’s, it is more interesting to
ask whether GDP per capita will get close in the foreseeable future.
With a population over four times the size of the US, China’s
economy would need to be over four times the size of America’s for
that to happen. Make sure you state clearly whether you are
discussing total GDP or GDP per capita.

What are the opportunities for British

business?
Export opportunities, along with scope to directly invest in China and India,
exist. However, British firms have not yet shown significant levels of success
in either country, despite the odd one-off hit, such as Jaguar Land Rover in
China (though it is Indian-owned). Major stumbling blocks include:
• Short-termism in UK plcs: Cracking such major markets will take time.
Shareholders have often shown themselves unwilling to wait.
• Underestimating market potential: Over the past 20 years, during which
China has seen such astounding growth, many British commentators have
continually predicted that its economy would implode; it’s still going strong.
• Ponderous decision-making: Some UK firms have dithered over China and
India. Waiting for too long to commit has allowed foreign competitors,
notably Germany, to get into China, and to a lesser extent India, and
establish themselves securely.
However, two key opportunities do present themselves:
1 India may be a more comfortable market for UK businesses, given the
countries’ shared past (India was a British colony for some 150 years).
Having more cultural similarities than with China, British firms may stand
more chance in India, which continues to offer opportunities that have
already been missed in China.
2 As China’s economy continues to develop, its service sector is likely to
show higher growth rates. Of course, many of the UK’s global success
 stories can be found in the service sector. There may still be time for British
financial services companies, designers and musicians to establish
themselves in a rapidly growing sector of the Chinese economy.

Now test yourself

4 To the nearest 100 million, what is the population of both China
and India?
5 State three key drivers of Chinese growth over the past 25 years.
6 State two factors that have held the Indian economy back relative
to China.
7 Why do UK businesses have reason to be optimistic about (a)
China and (b) India?
Answers online

Business potential in Africa

What is Africa like?
Although some generalities can be made about ‘all’ African countries, vast
differences exist: there is wealth and development (South Africa, Nigeria) as
well as great poverty and underdevelopment (Malawi). Meanwhile Africa is
frequently split along economic, religious and social lines, between North
Africa (Egypt, Tunisia, etc.) and sub-Saharan Africa.

Typical mistake
Africa is a continent. Never refer to it as a country.
The focus of this topic is mainly sub-Saharan Africa. North African countries
are further along the path to development, and represent a smaller population
than the part of the continent that lies south of the Sahara desert. Some
generalities include:
• It is less economically developed than most other parts of the world.
• Huge reserves of natural resources are yet to be exploited.
• There are difficulties in maintaining reliable stable government (not true for
all countries).
• Corruption represents a significant disincentive to foreign investment.
However, other, less ‘known’ common threads are developing:
• Many countries are experiencing strong economic growth around the 5%
per year mark.
• There is major FDI especially from China and Japan.
• There is a broad improvement in governance, with fewer civil wars and a
 slow growth in democracy.

Opportunities for business in Africa

In Africa’s richest nations, especially oil-rich Nigeria, there is tremendous
wealth in the very top few per cent of the population. This wealth can be
attracted by British retailers, hotels and public schools and, perhaps in the
future, a broader range of high-end UK businesses.
As countries like Nigeria lead the continent in economic development, middle
classes will emerge. Indeed, soft drinks sales in Nigeria and Cameroon have
rocketed in recent years as shown in Figure 18.1.

Consumer goods markets are beginning to mature, with international brands

starting to make their mark. Britain’s Unilever has made strong inroads into
the continent. Other multinationals to have invested directly in Africa in a
major way are Wal-Mart and Microsoft.

Problems doing business in Africa

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

Investor concern about stability

Health epidemics, government collapse and inconsistent application of the
rule of law create instability in many African nations. Even the mighty
Nigeria has not managed to effectively deal with terrorist insurgents in the
northeast of the country. These concerns over stability represent a major
obstacle to investment — which by its nature takes time to pay back —
during which investors are more likely to meet major disruption.

Exam tip
If exploring problems of investing in Africa, consider the length of time
most major investments take to pay off: years rather than months.
The continent is changing so rapidly, this brings uncertainty, which
investors hate. Meanwhile, it is often not a single problem, but instead
several problematic factors working together.

Now test yourself

8 Which two countries have already made significant investment in
many sub-Saharan African countries?
9 List three major problems of doing business in Africa.
Answers online

International trade and business growth

The logic behind foreign trade: international
specialisation
Trade is necessary because economic history has taught the world that if each
country specialises in the things they do best, then trades with others to get
products and services they do not produce domestically, the global economy
is more productive as a whole.

Distinguishing between imports and exports

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

Exports
Exporting offers businesses the chance to increase sales, to achieve growth
which enables them to enjoy economies of scale. Another major reason for
exporting is to avoid reliance on the domestic market. If a firm’s home
economy enters recession, there may be a drastic fall in sales. If the firm can
export to a country unaffected by recession, the damage caused by the fall in
domestic sales is less significant.

Exam tip
Remember that for imports, goods and services arrive and cash flows
out of the UK. For exports, it is goods and services that flow out and
cash that flows in to the UK.

The link between business specialisation and

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

How specialisation can boost efficiency

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

How efficiency gains created by specialisation can

create competitive advantage
Increased efficiency has one simple but substantial benefit: lower unit costs. If
specialisation can be used to lower unit costs, a business finds itself with an
ideal choice of two attractive options:
1 Lower selling price by the same amount as unit costs have been reduced.
This preserves the profit margin on each unit, but lowering prices boosts
competitiveness of the business within its market, thus boosting sales.
2 Alternatively, a company may simply decide not to adjust prices or its price
competitiveness and settle for a higher profit margin on every unit it sells as
a result of lower unit costs.

Exam tip
Perhaps the key determinant of which route to choose is price
elasticity. For a firm selling a price elastic product, the former option
should lead to a significant increase in sales, boosting total revenues.
For a company whose product is price inelastic, cutting price makes
no sense, since the increase in unit sales will be relatively small.

Foreign Direct Investment (FDI) and business

growth
Outward Foreign Direct Investment (FDI) occurs when a British business
buys assets abroad. Typically this may involve building production facilities
or buying retail outlets, although takeovers of foreign businesses are also
considered as outward FDI. FDI can also flow inwards. When foreign
companies buy British assets, buying property or building factories in the UK,
money flows in to Britain. It is important to note that subsequent earnings
from these investments will flow out of the UK, so rent on a foreign-owned
UK property leaves the UK.
Outward FDI offers businesses opportunities to grow abroad. The key
benefits of actual FDI, rather than simply exporting products made in the UK,
include:
• Avoiding problems involved in exporting
• Avoiding transport costs
• Avoiding trade barriers
• Access to natural resources
• Lower operating costs.
Typical mistake
Too many simplistic responses to questions about the benefits of FDI
never make it past lower operating costs. Note that several other
benefits exist, some of which may be of particular relevance in the
context provided.

Now test yourself

10 Why does international specialisation create the need for
countries to trade with one another?
11 When you pay for a hotel room in Ayia Napa for a week, does that
count as an export or an import for the UK?
12 List three potential benefits of FDI instead of exporting
domestically produced products.
Answers online

Factors contributing to increased globalisation

It is the growth in international trade that best illustrates the concept of
globalisation. Figure 18.2 shows 25 years of strong growth, then raises the
interesting question of whether the pace of globalisation has slowed,
especially with the US moving towards a more isolationist stance.

Trade liberalisation
Trade liberalisation involves removing trade barriers, such as:
• Tariffs: This is a tax imposed on imports that raises the price of imported
 products, aiding sales of domestic rivals.
• Quotas: These are physical limits on the quantity of a type of good that can
be imported in a year. Once the limit is reached, consumers must buy from
domestic producers.
• Regulations: Rules, paperwork and systems can be put in place to make it
harder for imports to enter a country.
Liberalisation will generally follow a new trade agreement between two
countries, on the basis that both remove trade barriers between one another.
Table 18.3 Opportunities and threats caused by trade
liberalisation
Opportunities from trade Threats caused by trade liberalisation
liberalisation
Companies that rely on Allowing imports into a domestic market
imported materials and does increase competition for domestic
components will enjoy lower firms. The most efficient should survive;
costs, enabling them to those who could only survive due to the
reduce prices to compete barriers will lose that protection and
with cheaper imported rivals possibly face closure
Due to the bilateral nature
of trade agreements,
liberalisation can lead to
increased export
opportunities with the
removal of barriers in the
other direction

Political change
The key political change prompting the wave of globalisation shown above is
political change in China. Following the death of Chairman Mao, the 1980s
and 1990s saw a move away from hard-line communism, with private
ownership of business allowed. Then, in 2001, China joined the WTO (World
Trade Organization), giving it access to rich western markets and offering the
country the chance to enjoy an amazing export-led boom.
Britain’s decision to leave the EU, along with the election of Donald Trump
as US president during 2016, offer hints that political changes may now slow
down the march of globalisation.

Reduced cost of transport and communication

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

Increased significance of transnational

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

Increased investment
Communication and trade liberalisation have both driven increased trans-
border capital flows. As financial markets are more willing to invest capital in
businesses based elsewhere in the world, so the world seems to become a
smaller place. The downside to this globalisation of financial markets is the
interconnectedness which has evolved. With banks in one country investing
elsewhere in the world, and lending to foreign customers, a financial crisis in
one part of the world can spread rapidly throughout the whole global financial
system, as seen in 2008.

Migration
Many people who migrate to other countries do so for economic reasons. The
vast majority of these migrants tend to share two key characteristics:
1 They are proactive and determined, willing to uproot and move to an
entirely new country to work and live.
2 They tend to be relatively well-educated.
These traits help to explain why increased migration can stimulate economic
growth.

Typical mistake
There is a huge amount of well-researched evidence to show that
inward migration has a strong positive effect on the success of UK
businesses.

Growth of the global labour force

Companies have managed to reduce their labour costs by seeing the market
for labour as global, rather than local or national. Many UK businesses have
offshored production in order to benefit from cheaper labour elsewhere in the
world. Meanwhile, other UK businesses facing shortages of skilled staff have
recognised the benefits of recruiting from abroad in order to fill jobs that
would otherwise have to be offshored, or left undone — losing sales.

Structural change
All economies that experience economic development see structural change,
with reduced reliance on agriculture as economic activity shifts first to
manufacturing, and then into services. Major economies that have
experienced rapid development in the past 40 years have increasingly
specialised in order to improve their international competitiveness. They have
been able to find export markets that have enabled the acceleration of
development and the related trade to sustain the rise of globalisation.

Now test yourself

13 State three barriers to trade that a government can use to hamper
imports.
14 Briefly explain two potential benefits to domestic businesses of
agreements to liberalise trade.
15 List three technological developments that have encouraged
globalisation.
Answers online

Protectionism
The goal of protectionism is to increasing a nation’s prosperity by increasing
the amount exported and/or decreasing the amount imported to the country. It
is the opposite of free trade. Protectionism usually features the use of trade
barriers to make it harder for foreign firms to import their goods. The three
major forms of trade barrier are:
• tariffs
• quotas
• legislation and regulation.

Tariffs
Imposing a tax on a product being imported automatically reduces its
competitiveness, as the tariff will drive up the price. This reduces the ability
of the product to compete with domestically produced rivals.
The two main scenarios in which governments tend to use tariffs are:
1 To protect a declining industry
2 To protect ‘infant’ industries.
Table 18.4 Benefits and drawbacks of tariffs
Benefits of tariffs Drawbacks of tariffs
As tariffs help firms to survive, Imposing tariffs pushes up prices,
they protect jobs of firms whose reducing consumers’ ability to buy
rivals are being taxed the product, reducing standards of
living
Tariffs also indirectly protect the Tariffs help inefficient firms to
other businesses that rely on survive, potentially harming
these firms for trade: suppliers competitiveness. Without tariffs
and local firms that would suffer there is far greater incentive for
if unemployment rose these firms to improve what they do
Tariffs raise tax revenues,
allowing governments to
increase spending on public
services

Import quotas
The effects of quotas are almost identical to tariffs. The mechanism differs,
since instead of directly manipulating the price of imports, this control
happens indirectly, through the market mechanism.
Quotas are designed to protect and encourage domestic producers. If imports
are limited, this is likely to push prices up. This should encourage domestic
producers to increase the amount they are willing to supply. In addition,
quotas are likely to improve the current account of a country’s balance of
payments.
Table 18.5 Benefits and drawbacks of quotas
Benefits of quotas Drawbacks of
quotas
Domestic firms face less competition, improving No extra tax
their competitiveness. This improves profit for revenue is gained
shareholders and job security for workers by the
government
Preventing unemployment theoretically reduces They push up
government spending on benefits prices
domestically for
consumers

Government legislation
Legislation relating to consumer protection and environmental protection can
act as a barrier to imports. If a government imposes new, stronger standards
for safety or emissions in certain industries, importers may find their products
suddenly become illegal. This in turn necessitates design change, which takes
a significant period of time, before importing can resume.
In trading blocs, such as the EU, where one goal is the harmonisation of laws
within the bloc, these problems are less likely since the same standards apply
across the whole trading bloc.

Domestic subsidies
Instead of acting to make importing harder, domestic subsidies are a
protectionist measure that looks to actively support domestic firms. The
government pays a figure, usually per unit of output, to sustain firms that
would otherwise be unable to compete.
The subsidy can be thought of as reducing the unit costs by the amount of the
subsidy, thus boosting margins, or allowing companies to cut their selling
price. Boosting margins may keep some businesses operating in markets from
which they would otherwise withdraw, protecting jobs and domestic supply of
that product.
The other consequence is to make it easier to export these products, as with a
lower selling price they may be more price competitive in foreign markets.
Table 18.6 Benefits and drawbacks of paying subsidies
Benefits of paying subsidies Drawbacks of paying subsidies
Subsidies in effect stimulate Artificially inflating profit margins of
demand, perhaps allowing inefficient businesses can prevent
struggling businesses to boost them pushing for efficiency gains
order books, allowing investment that would allow them to compete
in more efficient production without the subsidies
Subsidies have a positive effect Subsidies must be funded,
on the balance of payments by meaning the government must
reducing imports and boosting increase taxation — in a sense
exports from firms receiving the punishing firms in industries where
subsidies no subsidies are provided

Exam tip
The USA is clearly heading towards a protectionist outlook under the
presidency of Donald Trump. This gives you a great opportunity to
bring in examples from your reading of business news stories to help
illustrate answers to questions on protectionism with current
examples.

Now test yourself

16 In what two types of industry are governments most likely to use
tariffs?
17 State one protectionist measure designed to cut imports and one
that also stimulates exports.
18 List three stakeholder groups who would support paying subsidies
to a struggling manufacturer.
Answers online

Trading blocs
The latter half of the twentieth century saw a move away from protectionism
in favour of free trade. One result has been the creation of a number of major
trading blocs allowing free trade between member states.
In addition to free trade, some trading blocs have, or are working towards:
• harmonisation of laws (all members have the same legal standards
governing business operations)
• free movement of labour.
The attractions of trading blocs
Despite Britain’s decision to leave the EU trading bloc, attractions of
belonging to a trading bloc remain. These include:
• Harmonisation of laws allows one product to be made that meets legal
requirements in all member countries. This allows companies to benefit
from economies of scale.
• Countries working together within a trading bloc have more power than
individual nations to stand up to non-member countries using techniques
such as dumping.
• Competing in a larger ‘home’ market incentivises the boosting of efficiency
for firms in member states.

Expansion of trading blocs

Table 18.7 shows a selection of the biggest trading blocs around the world.
The EU and the single market
Although Britain is currently in the process of leaving the EU, the post-Brexit
EU will still have 27 members and a total population of around 445 million
consumers. These consumers, in global terms, are relatively affluent. The
EU’s single market remains an incredibly attractive market for EU companies
to access. This explains why probably the critical aspect of Brexit
negotiations is the terms of access to the EU’s single market for British firms.
What the EU has achieved, which other trading blocs have yet to do, is to
introduce a single currency (though not among all members). It is perhaps
here that EU supporters may have gone too far.

The ASEAN trading bloc

The ten full members of ASEAN (see Table 18.8) operate in an Asia
dominated by the economic success of China, Japan and South Korea.
ASEAN’s members try to work constructively alongside these giant
neighbours. After all, much of ASEAN’s success has been in feeding the
might of their bigger neighbours’ manufacturing machines.

NAFTA trading bloc

With only three members — Canada, Mexico and the USA — NAFTA is a
tense trading bloc. At the heart of the tension is low-cost Mexico’s ability to
attract companies looking for a low-cost manufacturing base from which they
can import freely to the world’s largest domestic market: the USA.
Resentment of this aspect of NAFTA’s existence was probably the
underpinning reason behind the election of Donald Trump to the US
presidency in 2016. The next few years will be interesting for NAFTA.

Exam tip
With the Trump administration in the USA looking to build a wall on
the US–Mexican border, the very existence of NAFTA may be in
question between 2017 and 2021, when the next US election is due.
Watch the news to monitor what is happening in this major current
business issue.

Impact on businesses of trading blocs

Typical mistake
A mistake made by some students and most campaigners in the
Brexit referendum is to try to generalise about the impact of trading
bloc membership on all businesses in a country. Factors such as
whether they import supplies, export finished products, whether they
are a manufacturer or service provider, or whether suitably skilled
staff are available domestically mean that generalisation about the
positivity of trading bloc membership should never be made.
It is impossible to generalise about whether membership of a trading bloc is
overall beneficial or negative to businesses in any country. Different
industries will benefit more from free trade than others. In general, it tends to
be manufacturing firms that benefit more than others from membership of a
trading bloc. However, even within an economic sector, the balance of
benefits to drawbacks can vary widely. The key impacts on business of being
located in a country within a trading bloc are summarised in Table 18.9.
Table 18.9 Advantages and drawbacks of trading blocs to
businesses
Advantages of trading blocs Drawbacks of trading blocs
• Free movement of goods • Competition increases due to
between members gives the freer trade, so those with
potential to create a large monopoly power may find it
‘single market’ competed away
• External tariff walls insulate • To create a single market, new
the business from competition rules and regulations may be
from another part of the world agreed, including minimum wage
rates
• As trade grows between • The availability of easily accessed
neighbours, it becomes neighbouring markets may reduce
economic (and necessary) for enterprise in relation to distant but
governments to provide dynamic ones such as China
infrastructure support
• The advantages become • Within a geographically proximate
much greater if there is free bloc, there may be common
movement of labour as well as factors that together become
free movement of goods common problems, e.g. low
commodity prices
Now test yourself
19 State three major trading blocs and in which part of the world they
can be found.
20 Briefly explain how being based in a free trade area helps to
make economies of scale available.
21 State two possible features of a trading bloc apart from free
movement of goods and services.
Answers online

Exam practice
Keith Glazebrook, owner of Lamination Station Ltd, a successful
chain of high street printing and copying stores throughout the UK,
decided that the time was right for expansion. With contacts all over
the world, Keith, an entrepreneur who valued networking, had figured
out that, in order to grow his business, he wanted to enter a rapidly
growing market. He had narrowed down his choices to just two
potential markets: India and Kenya. His research had discovered the
following information:
India Kenya
Population (million 2014) 1,262 46
GDP per capita at PPP $5,900 $3,100
Economic growth % change 2014 7.2% 5.3%
% of GDP from agriculture 29.3% 17.9%
% of population working in agriculture 75% 49%
Adult literacy (as % of population) 71.2% 78%
Keith knew that much of his custom would come from people who
would have no copying or printing facilities at home. Some trade
would come from entrepreneurs looking to produce promotional
materials. Much of the rest would come from normal householders
looking to copy legal or other important documents. In order to grow
his business, Keith wanted to find the market with the most growth
potential. With healthy profits from his UK operations, he is willing to
wait for his investment to pay off, but his goal is to double the size of
his business in the next 15 years.
1 (a) Explain two potential problems that Keith may face doing
business in either country.
 (6)
(b) The current Indian government have launched a number of
protectionist measures. Explain two possible protectionist
measures and the effect they may have on Keith if he opens
branches in India.
(6)
(c) Should Keith choose to expand to India or Kenya? Justify your
decision.
(12)
2 ‘An increasing trend to protectionism, led by Donald Trump’s US
Government, will inevitably lead to negative consequences for a UK
business that exports 50% of its output to the US.’ To what extent
do you agree?
(20)
Answers and quick quiz 18 online

Summary
• Economic growth can be measured in several ways:
– GDP per capita at PPP
– literacy
– health
– HDI.
• Major economic growth has been evident in several countries within
Asia and Africa in the last 20–30 years.
• China is now arguably the world’s largest, or at least second
largest, economy.
• China and India have roughly similarly sized populations, and thus
markets.
• China has grown more rapidly than India for the last 25 years.
• China is more developed as an economy than India.
• Factors holding India back include:
– poor infrastructure
– narrow education system
– balance of payments deficit.
• Africa may be the last major opportunity for massive growth
available to multinationals.
• Problems doing business in Africa include:
– corruption
– poor infrastructure
 – lack of stability.
• International trade allows international specialisation.
• International trade consists of:
– imports
– exports
– foreign direct investment (FDI).
• Eight major factors have contributed to increased globalisation in
the last 30–40 years:
– trade liberalisation
– political change
– reduced cost of transport and communication
– increased significance of transnational corporations
– increased investment flows
– migration
– growth of global labour force
– structural change.
• Protectionism is the opposite of free trade.
• Protectionist measures include:
– tariffs
– quotas
– government legislation and regulations
– domestic subsidies.
• Protectionism seeks to take action to discourage imports and
encourage exports.
• Major global trading blocs include NAFTA, EU, ASEAN.
• Membership of a trading bloc allows significant benefits to
businesses located within them, especially a much larger market to
sell to without any barriers to trade.
19 Global markets and business
expansion
Conditions that prompt trade
Trade between businesses in different countries, or a business in one country
and consumers in another, tends to be prompted by one or more of a number
of common factors. These factors can be grouped into two categories:
1 Push factors: These are reasons driving a firm away from its domestic
market.
2 Pull factors: These are reasons to attract a business to a new foreign
market.
Although the desire to trade internationally is often driven by a corporate
objective of growth, other goals may be survival, cost minimisation or
reduction of risk.

Push factors
Reasons why a firm may wish to leave its domestic market, or at least remove
a sole reliance on it, include:

Saturated markets
Where a firm is keen to grow, new customers must be sought. If everyone in a
domestic market that wants the product has already bought it, especially in the
case of consumer durables such as TVs, growth can only come in one of two
ways:
1 Widen the range of products being sold
2 Sell to new markets.
For a business that does not feel it has the talent or assets to broaden its
product range, new markets must be found.

Exam tip
Don’t forget to use Ansoff’s Matrix when assessing the risk and
causes of risk involved in entering a new international market. The
lack of understanding of the market is what causes this strategy to be
higher risk than simple market penetration.

Competition
Particularly if a giant new competitor enters a market, existing businesses
may recognise that in the long term, their survival lies in fleeing the
competition. A huge new player entering a market could call upon
tremendous financial and distributive strengths to quickly eliminate smaller
rivals. Those smaller rivals may decide to leave the market and seek their
fortune in new international markets as a route to survival.

Extending product life cycle

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

Pull factors
The pull factors are features of international trade which operate as a force
attracting a business into foreign markets.

Exam tip
Generally speaking, push factors are threats which drive a business
to trade internationally, while pull factors are more likely to be
opportunities a business recognises as being involved in trading
internationally.

Economies of scale
The opportunity to boost unit sales through successfully entering new
international markets brings with it the opportunity to benefit from economies
of scale. These will be accentuated if production is concentrated in a few
locations globally. Not only will purchasing economies of scale be likely, but
also managerial and technical economies of scale may arise. With economies
of scale comes a reduction in unit costs, boosting profit margins.

Possibility of offshoring and outsourcing

The lure of lower costs is great, especially when the differentials between the
costs of land, labour and support services are so great between the UK and
many developing economies. Therefore, this opportunity to significantly
reduce costs can act as a very strong pull factor for UK-based businesses to
shift production abroad.
Risk spreading
Selling in only one country is a little like putting all your eggs in one basket.
Entering more international markets is an effective way of spreading risk. If
sales fail in one country, there are other markets where sales may remain
stable. Although the process of entering a new market may carry an element
of risk, as Ansoff pointed out, if that entry is successful, the overall risk faced
by the business is reduced.

Now test yourself

1 State three pull factors encouraging international trade.
2 List three push factors that encourage international trade.
3 List three possible corporate objectives that may be behind a
business’s decision to begin to trade internationally.
Answers online

Typical mistake
Do not use the terms outsourcing and offshoring interchangeably.
While they may both be actions designed to reduce costs, they are
distinctly different and examiners expect to see the best students use
terminology with accuracy.

Assessment of a country as a market

Once a business has decided to pursue a strategy involving overseas
expansion, it must choose carefully which markets to enter. This decision-
making process will focus on a range of factors that determine the
attractiveness of a market.

Market attractiveness
Assessing a market’s attractiveness should be done in the most objective
manner possible. The result is that companies considering overseas expansion
are likely to set a range of criteria that will apply across potential markets.
The country that scores best when assessed against all the criteria will be
chosen as the market most likely to offer success.
Common criteria are shown in Table 19.1.
Table 19.1 Common factors determining market attractiveness
Common factors determining market attractiveness
Levels of disposable Growth of disposable Ease of doing
income income business
Quality of infrastructure Political stability Exchange rates

Exam tip
Many businesses will add a level of sophistication to this type of
analysis by weighting some of the factors more heavily than others.
So a bank considering entering a new market may place greater
weight on the scores for political stability and ease of doing business
than would a chain of coffee shops.

Levels and growth of disposable income

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

Ease of doing business

The World Bank (among others), regularly produces statistics on the ease of
doing business in different countries. The way ‘ease of doing business’ is
measured is typically via an assessment of the time taken for many common
business activities such as:
• days to start a business
• days to wait for a construction permit
• days to get electricity
• total tax rate as a % of profit
• days to import an item
• days to enforce a contract.
Quality of infrastructure
Infrastructure describes the services needed to make modern life function,
including:
• roads
• railways
• running water
• reliable electricity
• WiFi and broadband connection.
Transport networks and basic services matter for businesses looking to enter a
market. The speed with which goods can be transported has a major
operational impact, while for service providers as well as manufacturers,
basic utilities are crucial.

Political stability
The term ‘political stability’ covers issues such as:
• policy instability
• tax regulations
• labour regulations
• government bureaucracy
• corruption.
The level of political stability is vital in the planning process for any business.
The more stable a potential market, the more confident a business will feel
about forecasts of its future performance in that market. Some firms will
favour stability over other factors, while more entrepreneurial businesses may
be willing to accept the risks involved in instability if other factors make a
market attractive.

Exchange rates
Exchange rates fluctuate, meaning that any firm that expects them to remain
stable is being naïve. Although some currencies may gain or lose strength in
the long term, perhaps dependent upon long-term economic performance, the
volatility of exchange rates makes them seem a factor that is hard to assess
usefully. Indeed, exchange rates are unlikely to affect a decision as to whether
to enter a new market. They will, however, be an important consideration in
deciding when to enter a new market.

Now test yourself

4 For what type of products might levels of disposable income be a
more important factor than growth in disposable income?
5 State three aspects considered when measuring the ease of doing
business in a new market.
6 List three components of infrastructure required by modern
businesses.
Answers online

Assessment of a country as a production

location
As a company decides to expand, or shift production to another country,
several factors will be considered. For UK businesses moving abroad, costs of
production will play a key part in the decision. However, several other factors
that affect costs directly or indirectly will also play a part.

Costs of production
Given the fact that cost is often the key driver behind decisions to move
production to a new country, the costs of production in that country will be
assessed carefully. Table 19.2 shows costs of manufacturing in selected
countries relative to the USA. Perhaps most notable is the rise in the costs of
manufacturing in China between 2004 and 2014.
Table 19.2 Boston Consulting Group data on manufacturing costs
in selected countries relative to the cost of manufacturing in the
USA
Source: www.bcgperspectives.com

Country Indexed manufacturing Indexed manufacturing

costs 2004 (USA = 100) costs 2014 (USA = 100)
China 86.5 95.6
Germany 117.4 121.1
Japan 107.2 111
UK 107.4 108.7
Indonesia 82.3 83.1
India 86.8 87.2
Mexico 92.1 91.5
The assumed reason for lower costs in many countries is lower wage costs.
However, this factor can be overstated. The key is to consider how labour
intensive the production process is. For many products, even in a lower cost
country, production will be capital intensive. This is shown well by the
breakdown in Jaguar Land Rover’s costs in Figure 19.1.

Often the cost differential will be down to the ability to source materials and
components more cheaply abroad, along with lower costs of land and
business services.

Skills and availability of workforce

Producing abroad needs a skilled, or at least semi-skilled, workforce. The
skills required to operate machinery may not be available in many less
economically developed locations. In addition, to function in a modern
manufacturing plant, literacy will be an important skill. Topic 25 showed
literacy to be an important indicator of the level of development of an
economy. Without a strong education system to provide literate staff with the
necessary skills, some countries will struggle to be seen as attractive locations
for production.

Infrastructure
As for firms assessing the attractiveness of a new country as a market (Topic
33), so infrastructure will be an important consideration for those looking for
a production base. Transport and utilities must be up to scratch for a modern
manufacturing facility to be able to reliably service the markets it is designed
to serve. This explains why some major multinationals will take responsibility
for improving local infrastructure in a location they choose, as well as
building their own production facilities.

Location in a trading bloc

Often a vital pull factor for a location will be its presence within a trading
bloc. When Britain was still a member of the EU, it became an extremely
attractive manufacturing base for non-European firms. The reason was that
for a company such as Toyota, seeking to serve the European market, building
their cars in the UK meant that they avoided tariffs that would have been
charged on cars imported from Japan, or indeed anywhere outside the EU.

Exam tip
With the UK outside the EU, there is no doubt that its attractiveness
as a production location for global businesses will be reduced.
Without tariff-free access to the single market, foreign direct
investment flows may fall considerably. It is well worth monitoring the
terms of Brexit that will be thrashed out between 2017 and 2019 to
see whether the UK can find a way to maintain tariff-free access to
the single European market.

Government incentives
National governments may well be keen to attract foreign companies to set up
production facilities in their country. Reasons for this include:
• job creation
• extra tax revenues
• a boost for local suppliers
• increasing skill levels among local labour force
• potential for a positive impact on the balance of payments.
In order to attract businesses to their country, governments will use a variety
of possible incentives, such as:
• grants to help purchase land and machinery
• tax breaks
• investment in local infrastructure
• investment in local training.

Ease of doing business

As explained in Topic 33, a business planning to operate in a new country will
need to assess how much regulation, government interference and
bureaucratic inefficiency it may suffer from. Typical issues to consider
include:
• days to start a business
• days to wait for a construction permit
• days to get electricity
• total tax rate as a % of profit
• days to import an item
• days to enforce a contract.
Political stability
As well as assessing a country as a potential market, it will also need to be
assessed as a production location. Businesses expect to be able to plan for the
future, something which is made almost impossible if governments change
frequently and make drastic policy changes as a result. This factor is likely to
be more important when assessing a country as a manufacturing base, rather
than simply a market to sell to. This is because the level of investment needed
to start producing is likely to be higher, thus these investments will take
longer to pay back and generate a positive return on investment.

Natural resources
It is likely that the availability of natural resources will play a key role in
attractiveness for businesses further back along the supply chain. Generally,
companies that initially process raw materials at the start of a supply chain
will need large quantities of relatively bulky resources. These will be
expensive to transport over large distances. This makes it logical for these
firms to select locations near a plentiful supply of natural resources.

Likely return on investment

Ultimately the test of a production location will boil down to the likely return
on investment. Cheaper locations will seem more attractive, since the initial
investment will be lower. However, where a cheap location provides
limitations to the likely future revenues the location can earn, this may be a
false economy. A country where the investment will be 50% higher that can
generate revenues that are 100% higher will ultimately offer a better return on
investment for firms that are willing to take a long-term view.

Now test yourself

7 Are low wages in a country more important for capital or labour
intensive businesses?
8 Based on Table 19.2, was production in India or China cheaper in
2014?
9 State three reasons why a country’s government may offer
incentives to businesses setting up production facilities.
Answers online

Reasons for global mergers or joint ventures

As we saw in Topics 8 and 9, growth can occur organically or inorganically
through mergers and takeovers. With speed of reaction to changing markets
and technologies globally, inorganic growth, via merger or takeover, can
represent a huge temptation to companies from different countries. For those
unwilling to make adjustments to the ownership structure of their business, a
joint venture represents an alternative approach to working with a business
in another country.

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

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

Entering new markets/trade blocs

Having explored the benefits of operating in a trading bloc in Topic 31, the
reasons for operating production facilities in a new country, especially as a
way of avoiding trade barriers such as tariffs, are clear. Similarly, entering a
new foreign market in order to boost sales is a common strategic approach to
achieving a growth objective.
However, as Ansoff stressed, the danger of entering a new market is a lack of
understanding of that market, and a failure to comprehend how deep the lack
of understanding may be. Mergers or takeovers can be a smart way to
overcome this problem; buying a business filled with local experts can be the
route to acquiring that missing local understanding. Alternatively, joint
ventures with domestic firms, without the permanence of a takeover or
merger, can also overcome this initial lack of understanding.

Exam tip
The Chinese government does not allow foreigners to take over large
Chinese businesses. This is why so many large western firms have
entered China using joint ventures with Chinese partners.
Acquiring national/international brand
names/patents
The opportunity to buy intellectual property — especially brands and patents
— can drive global mergers or takeovers. Buying up a strong portfolio of
brands offers a lower risk way to penetrate new international markets. Though
expensive, global players are likely to have access to the finance needed to
buy nationally dominant brands. Thus, by using their substantial financial
muscle, large firms can enter new international markets by buying up market
leaders and harnessing the power of their brand and distribution networks in
each market.
Buying businesses that hold patents is a quick route to effective new product
development. Once an idea or new process has been patented, the resources of
a global firm may be able to bring that idea to market more successfully than
smaller, national businesses. With design and marketing departments, along
with distribution networks, this can be clever strategy for international
growth.

Securing resources and supplies

For companies using natural resources, especially minerals that can only be
found in far-flung corners of the world, ensuring secure, reliable and
reasonably priced supplies can represent a problem. The solution can be
setting up a joint venture, with the company extracting the resources.
However, this can lead to problems if the joint venture partner is not
maintaining standards of quality or ethical treatment of staff. Bad publicity
would rub off on both partners. To gain more control, a full takeover may be a
better option. This gives full control over how the former supplier operates, in
a way that a joint venture does not. This form of backward vertical integration
is increasingly common in both Africa and South America.

Maintaining/increasing global competitiveness

Boosting competitiveness by driving down unit costs may help to explain
many global mergers or takeovers. It is the economies of scale that such deals
promise that entice firms to come together, as a means to drive costs down
ensuring that the business can undercut any rivals it may need to. Porter’s
low-cost strategy could be a perfectly viable route for one business in each
market. As Porter pointed out, there is only room for one cost leader in any
market. However, following Porter’s generic strategies suggests that
competitiveness can be maintained by ensuring differentiation. Buying similar
businesses across the world, with similar points of differentiation, can also
explain a number of global mergers and takeovers.

Typical mistake
In the heat of an examination, too many students forget Porter’s
truism: that there can only be one cost leader in any market. Using
the phrase ‘this could help them become another cost leader’
screams of a lack of understanding.

Challenges of global growth via merger or

takeover
Just as discussed in Topic 9, the major problem of any merger or takeover is
overcoming the potential for a clash of cultures as two businesses come
together. These problems are likely to be intensified when the deal crosses
national boundaries. Of course, other problems of mergers and takeovers may
also arise, including:
• synchronising IT systems
• agreeing new policies and procedures
• adjusting organisational structure
• dealing with staff uncertainties over job security.

Now test yourself

10 Briefly explain the difference between a merger and a joint
venture.
11 Explain why a takeover may be preferable to a joint venture when
a business wants to work closely with a supplier in a low wage
country with minimal labour laws.
12 How does a joint venture help to overcome Ansoff’s concerns
over market development?
Answers online

Global competitiveness
If a business can achieve the ability to compete effectively on a global scale,
the key benefits are likely to be:
• dominating their domestic markets with minimal penetration from imports
• ease of entry and strong competitiveness in foreign markets due to global
brand recognition.
As Porter has pointed out, competitiveness can be achieved through cost
leadership, since the firm with the lowest costs should always be able to
undercut their rivals’ prices. Porter’s alternative strategy is to compete
through a high level of product differentiation. This is especially feasible in
wealthier markets where price is likely to be less important, with consumers
valuing other features such as design, branding and functionality.

The impact of movements in exchange rates

on competitiveness
Movements in the relative values of currencies can have a major impact on
the competitiveness of global firms. The three major contexts to consider are:
1 Companies which rely on export markets
2 Companies whose domestic market is subject to competition from imports
3 Companies which need to import significant quantities of raw materials or
components.

Impacts of a high exchange rate

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

Impacts of a low exchange rate

The effects of depreciation in the value of the pound will be the precise
opposite of those shown above when the pound rises in value, as shown in
Table 19.3.
Table 19.3 Effects of depreciation in the value of the pound
Context Effect of a falling pound
Companies which rely on Products will seem cheaper in foreign
export markets markets, boosting export sales
Companies whose Imported products will become more
domestic market is expensive in sterling terms, increasing the
subject to competition competitiveness of domestic producers in
from imports their home markets
Companies which need to Imported materials will now cost more,
import significant pushing up production costs unless the
quantities of raw same materials can be sourced at home
materials or components

Competitive advantage through cost

competitiveness
The ability to produce goods and deliver services cheaper than anyone else in
the market provides a secure competitive position for a business. The ability
to lower its prices below any rival yet still make a profit when others are
making a loss means the business can always rely on value-seeking
customers. However, being the cheapest supplier in a market is a difficult and
relentless challenge. Three key strategies to achieving cost leadership are
outlined below.

Raising productivity
Productivity gains will come from increasingly efficient use of resources. Key
resources from which more efficiency may be squeezed are:
• human resources
• tangible non-current assets.
Finding a way to increase labour productivity is a fundamental principle
behind Topics 16–21. Clearly, motivated staff are likely to achieve higher
levels of productivity. However, it is important to consider that overall
productivity within a business may have just as much to do with how well
planned and organised processes are. Therefore management and organisation
play a key role in the quest for higher productivity, thus lower unit costs.
The assets that a business uses to generate revenue include property,
machinery and equipment. If a way can be found to gain more output or
revenue from the same assets, the unit cost will fall. Opening an automated
car wash for longer hours can generate higher revenues without adding too
much to the costs. Finding a way to ensure that a piece of machinery breaks
down less often — thus producing more output — will again reduce average
cost per unit.

Outsourcing
One way to reduce costs is to find another business that can perform a
business function more efficiently than you can ‘in-house’. This is called
outsourcing. Not only can this reduce running costs, it can also free up
capital and space to invest further in those processes which you can do
cheaper than anyone else.

Offshoring
If a business can do something more efficiently than any other, but unit costs
are high simply because of the prevailing local rates of wages and land, the
solution may be offshoring: transferring the business’s successful methods
and expertise abroad.

Typical mistake
Remember that with offshoring, the original business still owns the
facilities that have been moved abroad. Outsourcing, which need not
mean a change of country, means paying another company to
perform a process for you.

Competitive advantage through product

differentiation
Businesses based in the UK (or other developed economies) will find it hard
to be cost competitive. Instead, they are far more likely to achieve global
competitiveness through effective and long-lasting product differentiation. As
outlined in Topic 4, differentiation can come from several possible sources
shown in Table 19.4.
Table 19.4 Possible sources of product differentiation
Actual product differentiation Perceived product differentiation
Design Branding
Different functions Advertising
Engineering Sponsorship
Performance Celebrity endorsement

Skills shortages and their impact on

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

Now test yourself

13 What type of businesses will benefit from a strong pound?
14 List three potential strategies that a firm might follow to try to
achieve cost leadership.
15 State four methods to achieve long-term product differentiation.
Answers online

Exam practice
1 ‘A company adopting a strategy of global cost leadership will
always be more vulnerable to changes in exchange rates than a
company using differentiation as a strategy.’ To what extent do you
agree?
(20)
2 Key issues that businesses usually consider when choosing an
international market to enter are:
– levels and growth of disposable income
– ease of doing business
– quality of infrastructure
– political stability
 – exchange rates.
Assess which ONE is likely to be most important for a UK mobile
phone network provider looking to build new overseas markets.
(20)
Answers and quick quiz 19 online

Summary
• Trading internationally is likely to be prompted by push and/or pull
factors.
• Push factors that prompt trade include:
– saturated markets
– competition
– extending the product life cycle.
• Pull factors that prompt trade include:
– economies of scale
– possibility of offshoring or outsourcing
– risk spreading.
• Key considerations when assessing new international markets
include:
– levels and growth of disposable income
– ease of doing business
– quality of infrastructure
– political stability
– exchange rates.
• Key considerations when assessing international production
locations include:
– costs of production
– skills and availability of workforce
– infrastructure
– location in a trading bloc
– government incentives
– ease of doing business
– natural resources
– likely return on investment.
• Global expansion may be pursued through joint ventures or
mergers and takeovers.
• Motives for global mergers or joint ventures include:
– spreading risk
– entering new markets or trading blocs
 – acquiring brand names or patents
– securing resources or supplies
– boosting global competitiveness.
• Global competitive advantage can come through cost
competitiveness or product differentiation.
• To boost competitiveness through cost competitiveness, three clear
strategies can be followed:
– raising productivity
– outsourcing
– offshoring.
• Changes in exchange rates have an impact on global
competitiveness.
• Global competitiveness can be affected by skills shortages.
20 Global marketing
Global marketing
Global marketing strategy and glocalisation
During the twentieth century, some brands were able to spread their sales
worldwide through a consistent and unchanging product and promotional
approach. Coca-Cola’s success is unlikely to be repeated, as the nature of
global markets has changed. The need to adapt products to suit local market
tastes has led to an approach to global marketing known as glocalisation.
A summary of the strengths of both approaches is shown in Table 20.1.
Table 20.1 Global versus glocal branding
Strengths of global brands Strengths of localising your
brands (glocalisation)
• Huge sales provide production • Tailoring to local tastes and
opportunities to enjoy significant habits should boost market
economies of scale share, e.g. green tea Magnums
in Japan
• Over 1.1 billion people travelled • Local buyers can assume you
abroad in 2014; global brands are a local producer, which may
can be bought for reassurance help sales (e.g. many British
and familiarity, i.e. globalisation people believe Ford to be a
helps sales British car maker, not
American)
• Many promotional tools are • An innovative product designed
global (e.g. sponsoring Formula 1 for local tastes may end up
or buying the rights to Arsenal’s being a global success, e.g. the
shirt front) and can only be Nissan Qashqai, designed in
economic if the brands sell Sunderland, but now an
globally (e.g. Emirates airline) important global brand
• Global scale provides strong • Localising brands probably
negotiating power with retailers means localised production,
(helping those ‘power brands’ get which cuts costs and may help
better display and distribution) establish a greener image for
the business
Exam tip
It is only at the higher priced end of markets where global consistency
still pays. Luxury brands seem loved throughout the world without
adaptations. It is in mass markets where local changes tend to be
needed.

Different approaches
Domestic/ethnocentric
This approach to global marketing stays focused on the home country. The
attitudes of the company’s senior managers will be heavily influenced by their
national culture. This leads to an approach that expects consumers in foreign
markets to welcome the company’s products as they are.
Ethnocentric attitudes can also be found among consumers, sometimes
unwilling to consider imported products worthy of their attention. This gives
domestic producers a competitive advantage in their home markets. However,
when it comes to breaking into foreign markets, this could breed an
ethnocentric approach from managers, who will assume foreign consumers
will buy products just because they come from their country.

International/polycentric
A polycentric approach is founded in the belief that all markets are different.
Thus, decisions are made at a local level, specifically designed to suit the
needs of local customers. The empowerment of local managers to develop
new products and brands with local tastes in mind can undo some of the
advantages of operating on a global scale. However, the firm will still look to
benefit from advantages of size, such as purchasing economies of scale.

Mixed/geocentric
Perhaps the best approach, this combines ethnocentric and polycentric
perspectives. The approach is underpinned with the belief that people all over
the world share some characteristics, thus the creation of global brands with a
level of consistency worldwide is possible. However, the approach also
accepts that local differences exist, necessitating localisation. The geocentric
approach would empower local managers, but on the understanding that
where possible, global is best. So local managers can take decisions that suit
their area where the company’s global approach cannot be applied effectively.

Applying the marketing mix to global markets

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

Applying Ansoff’s Matrix to global markets

Ansoff helps businesses assess the level of risk associated with their choice of
strategic direction. Measuring markets and products on its two axes, as firms
consider entering new foreign markets, they can assess how similar or
different new markets are to their existing markets. On the other axis, they
can judge risk by the extent to which local market conditions require them to
change their product portfolio or enter the market with existing products.

Now test yourself

1 Which approach to global marketing is founded on the belief that
all international markets have such significant differences that a
global approach to marketing will fail?
2 What name is given to the recognition that successful global
marketing needs some recognition of local differences?
Answers online

Global niche markets

Differences between different countries’ markets mean that from a global
perspective, each country could be seen as a niche within the global market.
As covered in Topic 15 of the AS book, selling products to a niche market
tends to allow firms to take advantage of the following benefits:
• benefits of successful niche market strategy
• able to meet consumer needs more precisely
• able to charge a higher price than mass market products
• less direct competition.

Cultural diversity
Typical mistake
Do not confuse national cultures with corporate cultures, as covered
in Topic 16. Although both refer to common acceptable norms of
behaviour, one refers to behaviours acceptable in a country while the
other refers, far more specifically, to those behavioural norms found
in a business.
Cultural diversity is caused by many factors, but predominantly driven by:
• Economic factors: Particularly differing levels of average disposable
income in different countries.
• Weather: Particularly temperature influences how and where people work,
relax, eat or generally live their lives.
• History and tradition: These features of a country may have a wide-ranging
impact on so many issues relevant to business, including diet, attitudes to
religion, gender, racial diversity and lifestyle.
The impact of cultural diversity is to make the delivery of a single global
strategy very hard to pull off. With consumers in different niches sharing
different needs and wants, the pressure to adapt to local diversity is great.

Features of global niche markets

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

Adapting the marketing mix to fit global niche

markets
Critical aspects of a successful global marketing mix vary according to the
type of market. For businesses aiming at those top end luxury niches, key
features include:
• aspirational price levels
• products with a strong brand heritage
• distribution through world famous luxury stores such as Harrods and at
airports
• promotion in glossy style and travel magazines and through glamourous PR
 events.
However, for companies attempting to compete in other global niche markets,
with less commonality, a deep understanding of local tastes is critical in
designing the marketing mix. Cultural diversity can affect each aspect of the
mix:
• Different features expected of the product
• Different price expectations depending on the value placed on the product
or service locally as well as levels of income
• Differences in traditional channels of distribution from country to country
• Different expectations of how promotional messages are received from
country to country and market to market.

Exam tip
Carrying out market research in a foreign market may fail to uncover
every relevant aspect of consumer behaviour. Market research
exercises tend to be limited in scope: they only discover what they set
out to ask. Too often, a failure to understand local markets means
that research fails to ask the right questions.
Without the availability of staff with a deep understanding and experience of
local market differences, the marketing mix produced for a global brand may
fall victim to failing to appropriately read the conditions that would allow a
successful brand launch.

Now test yourself

3 State three key sources of cultural diversity within markets.
4 Which niche markets are most likely to share common features
globally?
5 What is likely to be the key for successfully marketing a product in
a new country in markets typified by cultural diversity?
Answers online

Cultural and social factors in global marketing

As discussed in the previous two topics, there can be remarkable differences
between different national markets. This makes global marketing fraught with
possible problems. The previous topic suggested that a deep understanding of
local conditions is likely to be the key to a successful marketing mix. This
topic summarises six common causes of marketing mistakes for firms looking
to market their products in different national markets.
Cultural differences
Behavioural norms can be very different from country to country. The way
people meet and greet one another in formal and informal settings can be
vastly different from country to country. Similarly, typical behaviours within
business meetings can vary. Even yes and no can mean different things in
different countries, with yes often meaning perhaps in some environments.
Meanwhile, societies may have vastly different perceptions of certain
marketing methods; consider the use of singing and dancing cows, which are
amusing and brand-building in the UK, but likely to cause offence in cultures
where cows are sacred animals. Indeed, religious beliefs can form a strong
part of the set of values that influence cultural differences.

Exam tip
It is hard to overestimate how many businesses fail to fully grasp
cultural differences when entering new international markets. Linking
this to the problems of carrying out effective market research explains
why so many firms get it wrong when trying to break into an
unfamiliar market.

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

Language
Assuming your level of English is close to fluent, you can consider yourself
lucky in a global business sense. Table 20.2 shows the popularity of English
as a language of international communication in a business environment.
Table 20.2 The five most popular languages being learned around
the world 2015
 Source: www.themindunleashed.org

Language Learners (million people)

English 1,500
French 82
Chinese 30
Spanish 14.5
German 14.5
It is clear which language many people want to be able to speak to ‘get on’ in
the world. However, English is not the most commonly spoken language
globally. Table 20.3 shows it only features mid-way up the most commonly
spoken languages in the world.
Table 20.3 The five most widely spoken languages in the world
2015
Source: www.themindunleashed.org

Language Speakers (million people)

Chinese 1,197
Spanish 399
English 335
Hindi 260
Arabic 242
Combining these facts with the widely recognised business practice that
speaking to a consumer in their own language helps hugely in successfully
selling to them, should help you see why studying a foreign language can
increase your employability. Fluent linguists working for a business offer two
key benefits in trying to sell to foreign markets:
1 Customers will be impressed if spoken to in their own tongue.
2 Marketing errors caused by linguistic misunderstanding in product naming,
branding or promotion are likely to be avoided.

Typical mistakes
General references to language barriers do not impress examiners.
Try to be specific as to the types of language problems that can occur
in global marketing.

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

Inappropriate or inaccurate translations

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

Inappropriate branding or promotion

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

Now test yourself

6 List the six major causes of international marketing mistakes
caused by cultural and social factors.
7 List three markets in which different local tastes can lead to the
need to make adjustments to products.
8 Is it more important to speak somebody else’s language when you
are buying from them or selling to them?
Answers online

Exam practice
Edwards and Edwards is a high street food retailer, specialising in
high-end, luxury, specialist food products including caviar,
champagne and specialist cold meats. Edwards and Edwards has
been successfully operating across a number of European markets
for the last ten years. In order to satisfy its shareholders’ desire for
continued growth, the company has now decided to enter both the
Japanese and Chinese markets. With no previous experience of
these markets, the firm has commissioned local market research
companies to gauge local consumers’ reactions to the likely success
of the expansion. Results have been broadly positive and are
summarised below.
Question % of positive % of positive
responses in responses in
China Japan
Would you like to be able to buy 46 32
high-end European food
products?
Have you ever heard of Edwards 18 12
and Edwards?
Would you be willing to pay a 55 12
price premium for these
products?
Would you expect to see 12 67
premium locally sourced
products in-store?
1 (a) To what extent does the research data support the use of an
ethnocentric/domestic marketing strategy?
(20)
(b) Evaluate the main marketing challenges that Edwards and
Edwards may face in entering these two new markets.
(20)
2 ‘Increased globalisation will inevitably lead to reduced differences
between national markets for consumer goods over the next 20
years.’ Do you agree? Justify your answer.
(20)
Answers and quick quiz 20 online

Summary
• Glocalisation means thinking globally and acting locally.
• There are three broadly different approaches to global marketing:
– ethnocentric/domestic
– polycentric/international
 – geocentric/mixed.
• The marketing mix is likely to need adapting to suit local markets.
• The Boston Matrix can be used to help to assess the attractiveness
of new international markets.
• Cultural diversity means local markets can have major differences,
based especially on economic factors, weather and history and
tradition.
• Major causes of problems in operating in international markets
include cultural differences, different tastes and language issues.
21 Global industries and
companies (multinational
corporations)
The impact of multinational corporations
The impact of MNCs on the local economy
Employment
Table 21.1 Positive and negative impacts of multinational
companies
Positive impact of Negative impact of MNCs
MNCs
Local • Western training • Western employers may
labour methods may make the attract over-qualified people
local workforce more — possibly stripping local
productive/ employable businesses and public
services of skilled staff
Wages • MNCs usually pay • Some locals may feel bitter
higher wage rates than that they are paid less than
local firms, improving westerners for doing exactly
standards of living the same job
Working • MNCs have • Conditions may be above
conditions international reputations average, yet still quite
to maintain, so they will shocking to westerners
tend to provide above- • Some MNCs may have
average conditions impressive policies in place,
• Yum Foods has a yet the workplace reality may
‘Human and Labour be worse than the paper
Rights Policy’ and theory
claims to employ it in all
125 countries
Job • Yum Foods employs • The success of MNCs may
creation 1.5 million people sometimes be at the expense
worldwide; in Africa it of local independent firms; the
 provides more than key measure is net job
20,000 jobs creation

Local businesses
When a multinational sets up operations in a new area, the impact on most
local businesses is likely to be positive. A new factory that creates hundreds
of jobs will look to local businesses for some supplies, will create more
spending power locally — to be spent in local shops and restaurants — and
will add income to the area that local entrepreneurs can exploit. However, if
the operation started by a multinational provides direct competition to an
existing business, it may have too much power for local rivals.

Local communities and the environment

The impact of multinationals on local communities and the environment is too
complex to be considered in absolute terms. Examples of multinationals
investing in local communities, raising standards of healthcare, education and
infrastructure can be found. Alongside these are examples of multinationals
whose approach can cause damage to local communities, disrupting social
structures and indirectly bringing problems of crime that can be associated
with suddenly newly found wealth.
Likewise, although there are examples of multinationals that have had a
damaging effect on the physical environment, local businesses may be just as,
if not more, guilty of causing environmental damage. This may be especially
true where local environmental regulations are minimal or non-existent: at
least a multinational may need to stick to globally laid down internal
environmental standards.

The impact of MNCs on the national economy

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

Balance of payments
Countries that import more than they export run a current account deficit.
This is likely to lead to a fall in the value of the currency, which creates a risk
of inflation. However, if the country attracts FDI, the inflow of cash from
multinationals cancels out the current account deficit.
The potential problem to this occurs when a multinational decides to
withdraw its FDI. This represents a further outflow from the country, thus
further damaging the balance of payments current account. One company’s
decision to withdraw FDI would have a minimal impact on a major economy,
but the effect of a large multinational withdrawing from a smaller less
economically developed country can be significant.

Technology and skills transfer

When multinationals open facilities in a new host nation, they are likely to
introduce ideas and methods that may be new to the country. This allows the
local economy to copy or ‘borrow’ the techniques and methods being used,
improving the efficiency of local businesses. Access to new technology can
be the key to unlocking economic development. Skills can be developed
among the local workforce, which sustains the ongoing development.

Consumers
As multinationals enter new countries, consumers within those countries gain
more choice. This is broadly seen as a good thing. However, problems may
emerge if the competition from the multinational drives domestic firms out of
business. Though this is the reality of capitalism, concerns over the fairness of
the competition are often attached to the entry of multinationals to foreign
markets.

Exam tip
The impact of multinationals on consumers in host countries is a
classic example of one where you should be able to introduce ethical
concerns as a counter-argument against classic benefits such as
increased choice. Introducing the ethical issues involved in the
operations of multinationals can be a handy way to produce counter-
arguments or offer evaluative thoughts within an exam answer.

Business culture
Multinational businesses are run in a professional and generally consistent
way. This consistency of operation may not be commonly found in host
countries. In just the same way that technology and skills transfer helps
domestic businesses, so will the experience of seeing how a multinational
operates. As domestic suppliers deal with the multinational they are likely to
adapt a more consistent and professional business culture.
Typical mistake
Most multinationals that use transfer pricing, or base themselves in
tax havens, are not actually breaking the law. The term used for not
paying tax which is legally due is tax evasion. The multinationals are
using tax avoidance strategies: not illegal, but ethically dubious.

Tax revenues and transfer pricing

Different countries charge different rates of tax on business profits. As
multinationals operate across several countries, it is logical for a multinational
to try to maximise their profits in countries where tax rates are lowest,
declaring minimal or no profits in high tax countries.
The mechanism that multinationals use to engineer this is transfer pricing. A
multinational will move products between its different locations, charging an
‘internal price’ for components or partially finished goods as they are
transferred between the multinational’s locations.
This allows high prices (therefore low profits) to be charged by branches in
high tax countries, with most profits engineered into the operations based in
low tax countries.
Laws on transfer pricing vary from country to country, but clever tax
accountants can generally ensure that multinationals using this technique are
not breaking any laws.
The implication for host countries is that multinationals are able to minimise
the tax they pay locally using transfer pricing. This potentially places undue
pressure on host countries’ governments to keep tax rates low.

Now test yourself

1 Briefly explain why the reputation for environmental damage that
tarnishes multinationals may not be deserved.
2 What global inconsistency makes transfer pricing possible?
3 State three negative impacts that a multinational may have on local
labour markets.
Answers online

Ethics in global business

What are business ethics?
First covered in Topic 18, business ethics concerns the morality of business
decision-making and actions. The natural conflict between operating in a
morally acceptable way and boosting profit can be intensified when a
multinational begins operating in a less economically developed country.

Stakeholder conflicts
Large businesses operating on a global scale are most likely to be pursuing an
objective of maximising profit, under pressure from their shareholders. Given
the power of large shareholders, they are likely to be the dominant
stakeholder group, who get their way. Table 21.2 shows examples of
stakeholder conflicts and summaries of the ethical problems posed.
Table 21.2 Conflicting stakeholders – ethical solutions
Conflicting Example Ethical problem
stakeholders
Retailers and In 2015, Arcadia plc Price negotiations should
their (Topshop) cut 2% from all be tough, but once a price
suppliers payments to suppliers from is agreed, it is unethical to
1 September. Young bully a small supplier into
designers squealed at the receiving less
threat to their finances
Directors and In May 2015, Tesco told Staff understand that
staff staff it would in future bosses receive higher
contribute 5% of pay remuneration, but
towards their pensions; unfairness such as this is
before it was 11%. New quite simply unethical
boss Dave Lewis gets 25%
of his salary paid ‘in lieu of
pension’!
Management Bafflingly, owners of bank Ethics should apply in all
and shares have allowed senior cases; using negotiating
shareholders bank staff to pay power is fine, but many
themselves bonuses that bonuses were for things
strip the banks of their that cost the bank in the
profitability (Lloyds Bank long term, e.g. mis-selling
shares: 976p in 1999; 575p Payment Protection
in 2007; 75p in 2015) Insurance (PPI)

Pay and working conditions

Before deciding on the morality of pay rates around the world, it is imperative
to view local pay rates in a local context. Paying a factory worker the same in
Vietnam as a factory worker in the UK fails to take account of differences in
the costs of living.
Ethical issues relating to pay and working conditions include:
• Should wealthy consumers feel comfortable wearing clothes made by
factory workers paid pence, rather than pounds, per hour?
• Should firms in less economically developed countries be allowed to
produce goods for developed economies in working conditions that would
be unacceptable in the markets being sold to, but which are legal in the host
country?
• Should a multinational company that outsources some of its production be
responsible for the pay and working conditions in their suppliers’ factories?
Table 21.3 indicates how a line can be drawn between ethically acceptable
and unacceptable working conditions in developing economies.
Table 21.3 Working conditions and ethics
Working conditions that could Working conditions that are
be seen to be ethically unconditionally unacceptable
acceptable
• Cramped and hot, where profit • Dangerous conditions with
margins are too low to allow machinery and fire risk — and
more space and air conditioning perhaps chemical air pollution
• Long working hours, perhaps up • Forcing people to work long
to 12 hours a day hours. perhaps by threats of
dismissal
• Agricultural workers planting rice • Long back-breaking hours in
— bending over for perhaps 12 agriculture with little pay — while
hours a day farmers and dealers get rich

Environmental considerations
Emissions
For products that produce emissions that are harmful to the environment —
perhaps most obviously cars — the emissions produced are regulated in all
developed countries. In addition, consumers may also be attracted by products
with lower emissions.
Ethical issues arise when considering who measures emissions. Although
independent testing takes place, if the manufacturer itself has to pay an
independent tester, the company doing the testing may be tempted to adjust
results in the hope of securing a long-term customer. A further issue can be
seen if a company discovers an emissions problem with a product. Failure to
communicate this information externally, perhaps in the hope of fixing it
quickly without tarnishing the company’s brand, is unethical.

Waste disposal
Many products produced by businesses pose problems of disposal when their
life is complete. Getting rid of old consumer electronics products which often
contain poisonous elements presents problems with an ethical dimension. In
developed economies, disposal of hazardous substances is highly regulated
and thus expensive. However, some businesses see less economically
developed countries with their weaker or non-existent regulations as a cheap
solution. Dumping hazardous products or by-products on less developed
countries is unethical.

Supply chain considerations

The major ethical issues highlighted on the specification are the exploitation
of workers and child labour. Both of these practices are clearly wrong.
However, two interesting issues can be raised:
1 What is the alternative for the worker or the child? If this is the only job
available to the worker, no matter how exploitative, how else could they
feed their family? Should the job be withdrawn? If the child is working for
their parents, perhaps on a family farm or in a family factory, would the
removal of that extra pair of hands cause the business insurmountable
problems?
2 Should a business be responsible for the employment practices of their
suppliers, or their suppliers’ suppliers? Large businesses producing or
selling complex products may well be buying from suppliers who buy
materials from other suppliers. If one of the suppliers’ suppliers is using
child labour, does the original business deserve censure?

Marketing considerations
Misleading product labelling
Although tight product labelling legislation is in place to ensure that labels
don’t lie, ethical issues still surround labelling. Many of these relate to food
products, but by no means all. Issues include:
• implications of messages about the vague benefits of a product
• inferences about a product’s ingredients or methods of production, perhaps
implying it is ‘all natural’ but without being clear about the level of highly
processed ingredients used in it
• unhelpful imagery on packaging or in adverts, which is designed to infer,
 suggest or imply something untrue, without explicitly claiming an untruth.

Inappropriate promotional activities

A range of promotional activity that businesses undertake can be criticised for
being unethical. Examples include:
• Promotions that encourage consumers to buy more than they need can lead
to food waste.
• Food retailers have also received criticism for running Buy One Get One
Free promotions on sugary drinks and foods, encouraging over-consumption
of foods best consumed in small quantities.
• Advertising has also been blamed for social issues, such as body image
issues, especially among teens, by using touched up images of models to set
unattainable beauty goals.
• Companies offering credit to try to encourage people to buy products they
really cannot afford can also be accused of unethical promotion.
The fundamental issue here is where to draw the line between a business
objective of maximising sales and consumers’ inability to resist the
bombardment of promotional messages they receive every day.

Now test yourself

4 State one ethical issue relating to pay or working conditions that
affects multinationals.
5 In what two ways do the operations of multinationals raise
environmental issues?
6 Define business ethics.
Answers online

Controlling multinational corporations

Influence or control?
The subtle difference between influence and control can be illustrated by
considering a company’s stakeholders. While stakeholder groups such as
pressure groups and customers may influence a business, control lies with
major shareholders and the directors they appoint, as well as with government
(through laws and regulations).
Figure 21.1 shows different stakeholder groups according to their level of
control or merely influence.
Notice the dotted arrow showing that pressure groups can influence
governments as well as businesses.

Exam tip
Some argue that customers can exert control over businesses, while
many would suggest that they merely have influence over what
businesses do. Examples can be found to illustrate both, but, as the
zone of uncertainty marked on Figure 21.1 shows, customer power
can offer excellent opportunities to explore the issue of control versus
influence.

The need to control MNCs

Unlike most governments, the leaders of multinationals are not answerable to
the citizens of the countries in which they operate. Instead multinationals do
the bidding of their directors, appointed by major shareholders. It is this issue
that lies behind the belief that the activities of multinational companies need
to be controlled to an extent by external agencies such as governments.
Specific situations raised are outlined below.

Safety concerns
Multinationals producing in less developed countries with lax regulations on
factory safety may be able to squeeze extra life out of unsafe machinery that
has had to be retired from plants elsewhere. If local regulations cannot ensure
safe equipment for workers, some other form of control may be needed.

Short-term mineral extraction

By their nature, minerals can only be extracted once. Where a multinational
enters a host country to extract minerals, it is therefore crucial that the country
receives appropriate reward for its irreplaceable natural resources. What an
appropriate level of reward is can be debated. However, in circumstances like
these, with vast sums of money changing hands, it can be too easy for local
politicians to benefit personally by allowing the multinational in, rather than
ensuring that rewards are shared equitably within the host country.

Weakening local cultures

Using their marketing budgets and techniques, honed over many years,
multinationals can be highly adept at selling foreign products to locals.
Concerns are often raised when the success of a multinational’s marketing
leads to consumers changing their habits and lifestyles as a result. This can
lead to a loss of traditional local cultures, to be replaced by some kind of
global corporate consumerist culture.

Lack of commitment to the host country

A multinational lacks the strong bonds tying it to a country that characterises
domestic focused companies. As a result, multinationals may be willing to
leave a country, perhaps creating significant unemployment or social
problems, in the event of problems that a domestic producer may have the
commitment to work through, such as a recession.

MNCs and political influence

Lobbying key political decision-makers is something that multinationals tend
to do exceptionally well. With money and power, multinationals can exert a
worrying level of influence over politicians.
This influence can be used to achieve many things that aid the operations of
multinationals, including:
• granting licenses to run phone, rail or electricity networks
• granting licences to extract raw materials
• encouraging changes in laws and regulations affecting the multinationals’
operations
• offering tax breaks
• overlooking instances where a multinational has failed to adhere to
regulations.

Typical mistake
These actions, which multinationals can influence politicians to take,
may all seem to refer to less economically developed countries. Look
more carefully and you can see that all could apply to developed
countries too. There are plenty of examples of multinationals gaining
political influence in countries such as the UK in order to get their
way; this is not simply a developing world phenomenon.

Legal control
Multinationals have to abide by the laws of each country in which they
operate. However, the two legal areas where multinationals cause confusion
are in takeover law and tax law.
Although takeover deals involving domestic companies will be dealt with by
competition authorities in that country, who can stop a multinational from one
country taking over a multinational based in another country? Even though
trading blocs such as the EU can exert control, cross-border takeover
involving multinationals can in some ways seem ungoverned by any law.
As covered in Topic 40, multinationals can use transfer pricing between the
different countries in which they operate in order to avoid paying tax in
countries where corporation tax rates are high. Without an effective global
body to police the operations of multinationals in areas such as this, there is
no clear legal control over this.
In developing economies the issue of legal control may be more fundamental.
In some countries, laws governing the operations of companies, such as they
exist, may not be effectively enforced. In some ways, this allows businesses,
especially large, powerful multinationals, to operate beyond the law in some
parts of the world.

Pressure groups
There is no doubt that powerful pressure groups can exert some influence
over multinationals. They can also influence governments in order to try to
curb business actions they do not support. Their power, though, is limited to
influencing rather than controlling the actions of multinationals. However, in
many cases, multinationals have stopped or adjusted activities that powerful
pressure groups objected to.

Social media
Table 21.4 Impact of social media on company behaviour
Why social media may impact on company Why social media
behaviour may have little
impact on company
behaviour
Social media’s power is to be able to almost The speed with which
instantaneously shine a light on events to issues appear on
audiences of millions. Bosses of multinational social media is
businesses are aware of the potential number tremendous, but they
of customers who may discover mistakes or also disappear from
malpractice that cast their business in a poor social media quickly
light. If this publicity leads to customers going too. If a company can
to rivals to buy, it is little surprise that ‘weather the storm’ for
multinational bosses will pay close attention to a week or so, Twitter
how their businesses operate in order to avoid users are likely to
a potentially catastrophic social media storm. have moved on to the
next issue.

Now test yourself

7 State two stakeholder groups that (a) have some control over
multinationals and (b) merely influence but do not control
multinationals.
8 Briefly explain two examples of situations that illustrate the need to
control multinationals.
9 What two areas of business operations does the law find it hard to
deal with where multinationals are involved?
Answers online

Exam practice
1 ‘As multinationals operate across borders and have such huge
financial resources, national governments now lack the ability to
control their operations.’ To what extent do you agree with this
statement?
(20 marks)
2 ‘The experience of China shows that inviting multinationals to set
up in any developing economy brings more positives than
negatives.’ To what extent do you agree with this statement?
(20 marks)
Answers and quick quiz 21 online

Summary
• The major impacts of multinationals on local economies are:
– effects on local labour markets
– effects on local businesses
 – effects on the local community and environment.
• These effects can be both positive and negative.
• Effects of multinationals on national economies of host countries
include:
– FDI flows
– balance of payments
– technology and skills transfer
– effects on consumers
– development of business culture
– tax revenues.
• Again, these impacts can be both positive and negative.
• The operations of multinationals raise a number of ethical issues,
particularly relating to:
– stakeholder conflicts
– pay and working conditions
– environmental impacts
– supply chains
– marketing methods.
• The need to control multinationals’ operations is highlighted by
issues including:
– safety concerns
– mineral extraction
– loss of traditional local cultures.
• Multinationals have proved capable of softening the control exerted
over them by:
– laws
– politicians
– pressure groups.
Glossary
Added value is the difference between the cost of bought-in goods and
services and the selling price of a product.
An asset is any item owned by a business.
Automation means replacing people with machines, switching from a labour
intensive to a capital intensive approach to a task.
Automation means using machines to complete tasks within a process.
A balance sheet is a financial document showing a business’s assets and
liabilities at a point in time.
Barriers to entry are factors in a market that can make it hard for new
companies to break into the market.
Batch production makes a group of products to one specification at a time,
allowing some variation in products, yet some specialisation.
A brand is a recognisable name or logo that helps to differentiate a product or
business.
Break-even describes a position where a business is selling just enough to
cover its costs without making a profit.
A budget is a target for revenue or costs for a future time period.
In a bureaucratic organisation initiative is stifled by paperwork and
checking and re-checking of actions.
Business angels or angel investors are individuals who invest in the very
early stages of a business, taking a significant equity (share) stake.
Business continuity means getting a crisis-hit business back to functioning
normality as quickly as possible after a major disruption.
Business ethics are the moral principles that underpin decision-making.
Business functions are the main departments working within a business. The
traditional business functions are marketing, finance, human resource
management and operations management.
A business plan is a document setting out a business idea and how it will be
financed, marketed and put into practice.
Capacity utilisation is the proportion of maximum capacity being used by
the business.
Capacity is the term used to describe the maximum possible output of a
business.
Capital employed adds shareholders’ capital (total equity) to loan capital
(long-term liabilities) to work out the total long-term finance in the business.
Capital intensive production uses high levels of automation, reducing the
role of humans as much as possible, replacing them with machines.
Capital intensive describes a business process that relies more on machinery
than people.
A cartel is a group of companies operating in the same market who make
agreements to control supply and thus prices.
Cell production involves organising workers into small groups or cells that
can produce a range of different products more quickly than job production
allows.
Centralised structure describes an organisational structure where most
major decisions are taken at the very top of the organisation by the most
senior managers.
Collateral is something of value that is used as security when a loan is
offered. In the event of the business being unable to pay the loan back, the
asset is transferred to the bank and sold in order to generate the money due for
repayment.
Collusion occurs when two or more rival businesses agree to fix supply or
prices within their market. This is illegal.
Commodity markets are markets for undifferentiated products, generally
raw materials such as gold, crude oil or rice.
The competitive environment experienced by a business refers not just to
how many competitors it faces, but to how directly other firms’ products are
in competition and how fierce rivalries are.
A complement is a product whose use accompanies another, so petrol is a
complementary product to cars.
Consultation means asking the views of staff affected as part of a decision-
making process, although the manager retains the power to make the decision.
Consultation means seeking and listening to the views of employees as part
of a decision-making process.
Contingency planning means preparing plans in advance that can be
implemented if a company is hit by a major crisis.
Corporate culture sums up the spirit, attitudes, behaviours and the ethos of
an organisation.
Corporate objectives are targets set for the whole firm to reach in a given
time period.
Corporate Social Responsibility (CSR) describes the desire to run a
business in a morally correct way, attempting to balance the needs of all
stakeholder groups.
A corporate strategy is a medium- to long-term plan for achieving the
corporate objectives.
Correlation expresses a relationship between two variables.
Cost of sales is the collective name given to the costs directly associated with
making a product, such as materials, and costs of running the factory.
Cost of sales is the cost of buying or making the products sold to generate the
revenue for the year.
Critical path analysis is a technique used in planning the most time-efficient
way to complete complex projects.
The critical path of a project is the sequence of activities on which any delay
will delay the whole project: the activities with zero float time.
Crowdfunding is obtaining external finance from many small investments,
usually through a web-based appeal for investors.
Cultural diversity describes the differing interests and values of people from
different national backgrounds.
Culture describes normal, acceptable behaviours in a certain context.
Current assets are items the business owns that are in the form of cash or can
be easily turned into cash quickly without a major loss in their value. There
are three current assets: cash, money owed by customers (receivables/debtors)
and stock.
Current liabilities are debts owed by the business that are due to be paid
within the next 12 months. The two main current liabilities are trade creditors
and overdrafts.
Decentralised structure is the opposite of a centralised structure and is
where decision-making is passed lower down the organisation structure
through the process of delegation.
A decision tree is a diagram showing the options and possible outcomes
involved in making a decision along with the probabilities of outcomes
occurring.
Delegation means passing decision-making power down the organisational
structure to a lower level.
Delegation means passing authority down the structure to a subordinate,
giving them some decision-making power over how a task is done.
Demand is the term used to describe the level of interest customers have in a
product.
The flipside of economies of scale, diseconomies of scale, are the
inefficiencies related to growing as a business that can lead to upward
pressure on unit costs.
Disposable income is the money a household has available to spend from
income after income tax has been deducted.
Disruptive change occurs suddenly, unpredictably, and has major effect on
entire markets.
The route a product takes from producer to consumer is called the
distribution channel.
Diversification, as defined by Ansoff, means selling new products to new
markets.
Dumping is a term used to describe the practice of selling off excess
production in a foreign market at an exceptionally low price, which destroys
sales for local producers. China is frequently accused of dumping excess
products, such as steel, elsewhere in the world.
The earliest start time (EST) of an activity is the earliest possible date on
which it is possible to begin the activity.
Economies of scale are reductions in unit cost caused by the growth of a
business.
Effective demand is interest backed by the ability to pay.
Efficiency measures the extent to which the resources used in a process
generate output without wastage.
Empowerment is a slightly stronger form of delegation in which the
subordinate is given some decision-making power over what tasks need to be
done, not simply told how to do them.
Empowerment means giving staff the authority not just to decide how to do a
task, but to decide what tasks need doing in the first place.
Equilibrium describes a situation in a market where supply and demand are
balanced, making the price stable.
An exchange rate is the value of one currency expressed in terms of another.
Expected value is the average outcome expected following a chance event.
Exports are products and services that are produced domestically and
consumed overseas.
An extension strategy is a medium- to long-term plan for extending the life
cycle of a product.
External recruitment means filling a job vacancy with somebody who does
not currently work for the business.
Extrapolation means predicting by projecting past trends into the future.
Fixed assets are items owned by the business which it intends to use over and
over to generate profit. Examples include property and machinery.
Fixed capital formation is the term used to describe investment in long-term
assets from roads to buildings.
Fixed overheads are the costs that have to be paid no matter how well the
business is performing, such as management salaries and rent on the head
office.
Float time describes any slack time available attached to an activity. The LFT
minus the duration of the activity minus the EST of the activity shows if there
is float time.
Flow production refers to continuous production of a single, standardised
product.
Foreign Direct Investment (FDI) occurs when a business purchases non-
current assets in another country.
A franchise is a licence to use another business’s name and business model in
return for payment.
A franchisee is an entrepreneur or company that buys a licence to use another
business’s name and business model in return for payment.
A franchisor is a business that sells the right to use its name and logo to other
businesses or entrepreneurs.
GDP per capita, or strictly Gross Domestic Product per head of population at
Purchasing Power Parity, needs a little unpicking. Gross Domestic Product
(GDP) is a measure of the total output of a country’s economy. Dividing this
by the population adjusts for countries with much larger populations.
Purchasing Power Parity is a further adjustment that factors in differences in
the cost of living.
Global competitiveness measures the ability of a business to succeed against
both domestic rivals and foreign competitors in international markets.
Globalisation is the trend towards closer ties between economies and
businesses within the global economy.
Glocalisation is a term used to describe an approach to global marketing that
maintains a consistent brand and image across the world, but makes
adaptations, especially to products, to suit local markets.
The Human Development Index (HDI) is an attempt to provide a single
measure of economic development encompassing income, education and
health.
Imports are products and services produced abroad and consumed
domestically.
Incremental change occurs when change is slow and happens in small steps.
Indirect taxes are taxes that the government imposes on goods and services,
for example VAT.
Induction training is the term that specifically describes initial training when
an employee begins a job that is designed to familiarise them with the
workplace and the business.
Inflation is the percentage rate at which average prices rise during a year
within the whole UK economy.
Inorganic growth means growth that occurs as a result of taking over or
merging with another business.
Intermediaries are businesses between the producer and the consumer in a
distribution channel, such as retailers.
Internal recruitment means filling a job vacancy with somebody who
already works for the business.
Intrapreneurship is the name given to the encouragement of entrepreneurial
behaviour within larger businesses.
Investment appraisal is the process of using forecast cash flows to assess the
financial attractiveness of an investment decision, linked with a consideration
of non-financial factors.
Isolationism refers to a nation whose trade policies are designed to put the
interests of domestic businesses first by imposing trade barriers to hamper
imports.
Job enlargement is the term used to describe any increase in the scope of a
job and this describes both job rotation and job enrichment.
Herzberg used the term job enrichment to describe designing jobs that
include the motivators. Possible methods include: a complete unit of work,
direct feedback on performance and the ability to communicate directly with
any other member of staff.
Job production involves making one-off items to suit each customer’s
individual requirements.
A joint venture is a formal agreement between two separate businesses to
work together for a fixed time on a specific project.
Just-in-time stock management is a Japanese-rooted approach to stock
management that aims to eliminate buffer stock completely.
Key Performance Indicators (KPIs) are quantifiable measures of aspects of
a business’s performance that the business considers to be the main
determinants of its commercial success.
Labour intensive production means that a production process relies heavily
on human input with little use of automation.
Labour intensive describes a business process that relies more on people
than machinery.
The latest finish time (LFT) for an activity is the last possible date by which
it must be complete to avoid delaying the overall project.
The role of a leader is to identify key issues to be addressed, set objectives
and decide what should be done to address those issues and who should do it.
Lean production is a collective term for a range of Japanese techniques
designed to eliminate waste from business processes.
Leasing an asset is an alternative to buying the asset outright. Instead, the
asset is rented for a monthly fee for a set period of time.
Liability refers to the extent to which the owner(s) of the business must repay
debts incurred in the running of the business.
Limited liability is a form of legal protection for business owners which
ensures that owners of a limited company can only lose the money they have
invested in the business.
Liquidation occurs when a company’s owners close down the company,
selling off its assets to generate cash to pay off the debts of the business.
Liquidity is the ability of a business to find the cash it needs to pay its bills.
The cash must be readily available either in the bank account or in the form of
a payment from a customer that is due very soon.
Liquidity is the term used to describe a firm’s ability to pay its bills and
finance short-term spending.
Lobbying describes the process of directly trying to influence key political
decision-makers to act in the best interests of a business.
A manager is a person fulfilling a role whose major job is to oversee putting
plans into action, getting the details right and ensuring that the resources
allocated are used correctly.
Market positioning means deciding exactly what image you are trying to
create for your product relative to its rivals.
A market segment is a subsection of a larger market in which consumers
share similar needs and wants.
Market segmentation means discovering useful ways to split up a market
into different groups of consumers who share similar characteristics and
needs.
Marketing strategy is the term used to describe the general approach to
marketing used by a business.
A merger occurs when two firms agree to come together to create a new,
single business.
A method of finance is the process through which a source of finance
provides money to a business.
A mission statement is a catchy summary of the reason why a business
exists.
Mission is the underpinning purpose behind the existence of a business.
A monopoly is a single business that dominates supply in a given market.
A moving average is a quantitative method used to identify underlying trends
in a set of raw data.
A multinational company is one that has branches or manufacturing plants in
several countries.
Net financing cost is the income from interest on bank deposits minus the
interest charges from overdrafts and loans. It will usually be a negative
number.
A niche market is a small segment of a larger market.
An objective is a specific target set by a business.
Offshoring means moving a business function to another country, generally
in order to lower costs.
Offshoring means moving one or more business functions to a foreign
country, usually to take advantage of lower labour costs.
An oligopoly is the name given to a market dominated by just a few major
suppliers.
Opportunity cost is the value of the next best option forgone when a
business decision is made.
Organic growth is growth which takes place without any merger or takeover
activity.
Organisational culture is the term used to describe acceptable norms of
behaviour within a business: ‘the way we do things round here’.
Outsourcing means contracting another business to perform a business
function on your behalf. Frequently that function will be production, often
performed by a business located in a lower cost country.
Outsourcing means contracting another business to perform certain business
functions, allowing significant increases in capacity when needed.
An overdraft is a facility offered by a bank to allow a customer to continue
spending money even when their account becomes negative. There will be an
agreed limit to the overdraft.
Overhead costs are those that are incurred by the business as a whole but can
be difficult to attribute to a particular section of the business. For example, the
costs of running Nestlé’s Head Office can be hard to attribute to the actual
production of any one of its hundreds of different products.
Overheads, or expenses, or overhead expenses are payments for something
that is of immediate use to the business, other than the actual products they
sell.
Overtrading occurs when a business experiences cash flow problems as a
result of expanding too quickly without sufficient cash in the bank.
PESTLE highlights the major sources of external changes faced by
businesses: Political, Economic, Social, Technological, Legal and
Environmental.
Primary research is new research conducted for a particular purpose.
Product differentiation describes a business’s attempts to make its product
stand out from those of rivals, perhaps through marketing, design or quality.
Product differentiation means attempting to make your product seem
different, in the minds of consumers, to any other rival in the market.
Productivity is a measure of the efficiency of the production process. It is
usually measured as output per worker per time period.
A profit and loss account shows a firm’s revenue for a time period along
with all the costs associated with generating that revenue.
Profit satisficing means blending a desire for profit with other factors, such
as building a good reputation or having a good work–life balance.
Profit is the difference between the revenue of a business and the costs
generated by the business during a period of time.
Profitability states profit as a percentage of sales revenue.
Promotion describes methods used by the business to communicate
information and persuade consumers to purchase a product.
Protectionism means giving preference to domestic producers by making it
harder for foreign companies to export to your country.
Public relations describes attempts by a business to create publicity that is
reported as news, such as staging a glitzy launch party for a new product.
Qualitative research is unlikely to be carried out on a large-enough scale to
give statistically valid data, but is instead aimed at providing insights as to
why customers behave the way they do.
A quality circle is a group of staff who meet regularly to find quality
improvements.
Quantitative research is research conducted on a large-enough scale to
provide statistically reliable data, usually aimed at discovering factual
information about how customers behave.
A quota is a physical limit on the volume of a product that can be imported in
a year. Once the quota is used, only domestically produced goods will be
available.
A rate of interest is the amount charged by a lender per year for borrowing
money. This is expressed as a percentage of the amount of money
outstanding.
Real income is the amount by which average incomes have adjusted for
inflation – the amount by which prices have risen. For example: average
household incomes up 3% in the past year; inflation at 1.2% – so real incomes
are up by 3% – 1.2% = 1.8%.
A risk assessment is a process used to identify, quantify and decide on the
likelihood of negative future events occurring.
Scenario planning means visualising possible future situations for a business
and then devising plans for how to exploit likely opportunities and minimise
the effects of likely threats.
Secondary research uses pre-existing data that has been gathered for another
purpose.
Short termism is the tendency to focus on achieving short-term objectives by
taking decisions that may preclude better, longer-term options.
Short-termism is when the actions of managers show total prioritisation of
immediate issues, ignoring long-term ones.
Places from which businesses may gain finance are referred to as sources of
finance.
Span of control is the term used to describe the number of subordinates
directly answerable to one manager.
Staff turnover is also called labour turnover and is the proportion of staff that
leave a business during a year.
Stakeholders are groups that are influenced by and influence the operations
of a business.
A statement of comprehensive income is a document produced by public
limited companies that shows revenue, a break-down of different types of cost
and different types of profit for a year.
Stock or inventory is the name given to the materials, partially made
products and finished goods owned by a business, which have not been sold.
The strategy is the plan devised by the business to achieve its objectives.
A subsidy is a payment made by government to a business producing a
certain product or located in a particular area that the government wishes to
support.
A substitute is a similar, rival product that consumers may choose instead.
Succession planning means preparing replacements for key personnel in
advance of their departure.
SWOT analysis identifies a business’s strengths and weaknesses along with
the opportunities and threats it faces.
Synergies are the benefits of two things coming together that could not exist
when they are separate — such as economies of scale resulting from a merger
of two businesses.
A takeover occurs when one business buys a controlling interest in another
business.
A tariff is a tax imposed on an imported product to allow it to enter a country.
Time series data is a series of figures covering an extended period of time.
Trade credit means that goods or services provided by a supplier are not paid
for immediately.
A trading bloc is a group of countries that sign up to free trade between
them, protected by a tariff wall against imports from outside.
Training is designed to enhance employees’ existing skills or develop new
skills.
Transfer pricing is a technique used by multinationals to adjust the internal
prices paid by one branch of their operations to another as a way of
minimising the total tax bill paid by the company.
A trend is the general path that a variable takes over a period of time.
A unique selling point (USP) is a particular feature of a product or service
that no rival provides.
Unlimited liability means that the owners of the business must take personal
responsibility for covering debts run up by their business. If the business goes
bust, the owner can be forced to sell their own personal assets to repay
lenders, suppliers or employees to whom money is owed.
Variance analysis involves looking back to calculate the difference between
a budgeted figure and the actual figure that occurred.
Venture capital is a method of providing finance in higher-risk investments
generally through a combination of loans and shares.
Waste minimisation is the aspect of lean production that to focuses on
reducing waste in any business process, such as wasted time, labour on
materials.
Working capital is the money that is available for the day-to-day running of
the business.