—---1.

Understanding Business Activity

1.1 Business Activity

The word ‘business’ is very familiar to us. We are surrounded by businesses
and we could not imagine our life without the products we buy from them.
So what is a business, or what is business studies? Here’s the very posh
definition for it: “the study of economics and management”​
Not clear? Don’t worry, by the end of this chapter, you should be getting a
clear picture of what a business is.

The Economic Problem

Need: a good or service essential for living. Examples include water and food
and shelter.

Want: a good or service that people would like to have, but is not required for
living. Examples include cars and watching movies.

Scarcity is the basic economic problem. It is a situation that exists when

there are unlimited wants and limited resources to produce the goods and
services to satisfy those wants. For example, we have a limited amount of
money but there are a lot of things we would like to buy, using the money.

ECONOMIC PROBLEM = UNLIMITED WANTS + LIMITED NEEDS = SCARCITY

Opportunity cost

Opportunity cost is the next best alternative for when choosing another item.
Due to scarcity, people are often forced to make choices. When choices are
made it leads to an opportunity cost

SCARCITY → CHOICE → OPPORTUNITY COST

Example: the government has a limited amount of money (scarcity) and must
decide on whether to use it to build a road, or construct a hospital (choice).
The government chooses to construct the hospital instead of the road. The
opportunity cost here are the benefits from the road that they have sacrificed
(opportunity cost).

Factors of Production

Factors of Production are resources required to produce goods or services.

They are classified into four categories.

●​ Land: the natural resources that can be obtained from nature. This
includes minerals, forests, oil and gas. The reward for land is rent.
●​ Labour: the physical and mental efforts put in by the workers in the
production process. The reward for labour is wage/salary
●​ Capital: the finance, machinery and equipment needed for the
production of goods and services. The reward for capital is interest
received on the capital
●​ Enterprise: the risk taking ability of the person who brings the other
factors of production together to produce a good or service. The reward
for enterprise is profit from the business.
Specialization

Specialization occurs when a person or organisation concentrates on a task

at which they are best at. Instead of everyone doing every job, the tasks are
divided among people who are skilled and efficient at them.

Advantages:

●​ Workers are trained to do a particular task and specialise in this, thus

increasing efficiency
●​ Saves time and energy: production is faster by specialising
●​ Quicker to train labourers: workers only concentrate on a task, they do
not have to be trained in all aspects of the production process
●​ Skill development: workers can develop their skills as they do the same
tasks repeatedly, mastering it.

Disadvantages:

●​ It can get monotonous/boring for workers, doing the same tasks

repeatedly
●​ Higher labour turnover as the workers may demand for higher salaries
and company is unable to keep up with their demands
●​ Over-dependency: if the worker(s) responsible for a particular task is
absent, the entire production process may halt since nobody else may
be able to do the task.

Purpose of Business Activity

So we’ve gone through factors of production, the problem of scarcity and

specialization, but what is business?

Business is any organization that uses all the factors of production

(resources) to create goods and services to satisfy human wants and
needs.

Businesses attempt to solve the problem of scarcity, using scarce resources, to

produce and sell those goods and services that consumers need and want.
Added Value

Added value is the difference between the cost of materials bought in and
the selling price of the product.​
Which is, the amount of value the business has added to the raw materials by
turning it into finished products. Every business wants to add value to their
products so they may charge a higher price for their products and gain more
profits.​
For example, logs of wood may not appeal to us as consumers and so we
won’t buy it or would pay a low price for it. But when a carpenter can use
these logs to transform it into a chair we can use, we will buy it at a higher
cost because the carpenter has added value to those logs of wood.

How to increase added value?

●​ Reducing the cost of production. Added value of a product is its price

less the cost of production. Reducing cost of production will increase
the added value.
●​ Raising prices. By increasing prices they can raise added value, in the
same way as described above.

But there will be problems that rise from both these measures. To lower cost
of production, cheap labour, raw materials etc. may have to be employed,
which will create poor quality products and only lowers the value of the
product. People may not buy it. And when prices are raised, the high price
may result in customer loss, as they will turn to cheaper products.

In a practical sense, you can add value by:

●​ Branding
●​ Adding special features
●​ Provide premium services etc.

In a practical example, how would you add value to a jewellery store?

●​ Design an attractive package to put the jewellery items in.

●​ An attractive shop-window-display.
 ●​ Well-dressed and knowledgeable shop assistants.

All of this will help the jewellery store to raise prices above the additional costs
involved.

1.2 Classification of Businesses

Primary, Secondary and Tertiary Sector

Businesses can be classified into three sectors:

Primary sector: this involves the use/extraction of natural resources.

Examples include agricultural activities, mining, fishing, wood-cutting, oil
drilling etc.

Secondary sector: this involves the manufacture of goods using the

resources from the primary sector. Examples include auto-mobile
manufacturing, steel industries, cloth production etc.

Tertiary sector: this consists of all the services provided in an economy. This
includes hotels, travel agencies, hair salons, banks etc.

Up until the mid 18th century, the primary sector was the largest sector in the
world, as agriculture was the main profession. After the industrial revolution,
more countries began to become more industrialized and urban, leading to a
rapid increase in the manufacturing sector (industrialization).

Nowadays, as countries are becoming more developed, the importance of the

tertiary sector is increasing, while the primary sector is diminishing. The
secondary sector is also slightly reducing in size (deindustrialization)
compared to the growth of the tertiary sector . This is due to the growing
incomes of consumers which raises their demand for more services like travel,
hotels etc.

Private and Public Sector

Private sector: where private individuals own and run business ventures.
Their aim is to make a profit, and all costs and risks of the business are
undertaken by the individual. Examples: Nike, McDonald’s, Virgin Airlines etc.

Public sector: where the government owns and runs business ventures.
Their aim is to provide essential public goods and services (schools, hospitals,
police etc.) in order to increase the welfare of their citizens, they don’t work to
earn a profit. It is funded by the taxpayers' money, so they work in the interest
of these citizens to provide them with services.

Example: the Indian Railways is a public sector organization owned by the

govt. of India.

In a mixed economy, both the public and private sector exist.

1.3 Enterprise, Business Growth and Size

Entrepreneurship

An entrepreneur is a person who organizes, operates and takes risks for a

new business venture. The entrepreneur brings together the various factors
of production to produce goods or services. Check below to see whether you
have what it takes to be a successful entrepreneur!

●​ Risk taker
●​ Creative
●​ Optimistic
●​ Self-confident
●​ Innovative
●​ Independent
●​ Effective communicator
●​ Hard working

Business plan
A business plan is a document containing the business objectives and
important details about the operations, finance and owners of the new
business.

It provides a complete description of a business and its plans for the first few
years; explains what the business does, who will buy the product or service
and why; provides financial forecasts demonstrating overall viability; indicates
the finance available and explains the financial requirements to start and
operate the business.

Some of the content of a regular business plan are:

●​ Executive summary: brief summary of the key features of the business

and the business plan
●​ The owner: educational background and what any previous experience
in doing previously
●​ The business: name and address of the business and detailed
description of the product or service being produced and sold; how and
where it will be produced, who is likely to buy it, and in what quantities
●​ The market: describe the market research that has been carried out,
what it has revealed and details of prospective customers and
competitors
●​ Advertising and promotion: how the business will be advertised to
potential customers and details of estimated costs of marketing
●​ Premises and equipment: details of planning regulations, costs of
premises and the need for equipment and buildings
●​ Business organisation: whether the enterprise will take the form of sole
trader, partnership, company or cooperative
●​ Costs: indication of the cost of producing the product or service, the
prices it proposes to charge for the products
●​ Finance: how much of the capital will come from savings and how
much will come from borrowings
●​ Cash flow: forecast income (revenue) and outgoings (expenditures) over
the first year
●​ Expansion: brief explanation of future plans

Making a business plan before actually starting the business can be very
helpful. By documenting the various details about the business, the owners
will find it much easier to run it. There is a lesser chance of losing sight of
the mission and vision of the business as the objectives have been written
down. Moreover, having the objectives of the business set down clearly will
help motivate the employees. A new entrepreneur will find it easier to get a
loan or overdraft from the bank if they have a business plan.

Government support for business startups

According to [Link], “a startup is a company typically in the early stages

of its development. These entrepreneurial ventures are typically started by 1-3
founders who focus on capitalizing upon a perceived market demand by
developing a viable product, service, or platform”.

Why do governments want to help new start-ups?

●​ They provide employment to a lot of people

●​ They contribute to the growth of the economy
●​ They can also, if they grow to be successful, contribute to the exports
of the country
●​ Start-ups often introduce fresh ideas and technologies into business
and industry

How do governments support businesses?

●​ Organise advice: provide business advice to potential entrepreneurs,

giving them information useful in starting a venture, including legal
and bureaucratic ones
●​ Provide low cost premises: provide land at low cost or low rent for new
firms
●​ Provide loans at low interest rates
●​ Give grants for capital: provide financial aid to new firms for
investment
●​ Give grants for training: provide financial aid for workforce training
●​ Give tax breaks/ holidays: high taxes are a disincentive for new firms to
set up. Governments can thus withdraw or lower taxation for new firms
for a certain period of time
Measuring business size

Businesses come in many sizes. They can be owned by a single individual or

have up to 50 shareholders. They can employ thousands of workers or have a
mere handful. But how can we classify a business as big or small?

Business size can be measured in the following ways:

●​ Number of employees: larger firms have larger workforce employed

●​ Value of output: larger firms are likely to produce more than smaller
ones
●​ Value of capital employed: larger businesses are likely to employ much
more capital than smaller ones

However, these methods have their limitations and are not always accurate.
Example: Using the ‘number of employees’ method to compare business size
is not accurate as a capital intensive firm ( one that employs a large amount of
capital equipment) can produce large output by employing very little labour
(workers). Similarly, the value of capital employed is not a reliable measure
when comparing a capital-intensive firm with a labour-intensive firm. Output
value is also unreliable because some different types of products are valued
differently, and the size of the firm doesn’t depend on this.

Business growth

Businesses want to grow because growth helps reduce their average costs in
the long-run, help develop increased market share, and helps them produce
and sell to new markets.

There are two ways in which a business can grow- internally and externally.

Internal growth

This occurs when a business expands its existing operations. For example,
when a fast food chain opens a new branch in another country. This is a slow
means of growth but easier to manage than external growth.
External growth

This is when a business takes over or merges with another business. It is

sometimes called integration as one firm is ‘integrated’ into the other.

A merger is when the owner of two businesses agree to join their firms
together to make one business.

A takeover occurs when one business buys out the owners of another
business , which then becomes a part of the ‘predator’ business.

External growth can largely be classified into three types:

●​ Horizontal merger/integration: This is when one firm merges

with or takes over another one in the same industry at the
same stage of production. For example, when a firm that
manufactures furniture merges with another firm that also
manufacturers furniture.​
Benefits:
●​ Reduces the number of competitors in the market,
since two firms become one.
●​ Opportunities of economies of scale.
●​ Merging will allow the businesses to have a bigger
share of the total market.
●​ Vertical merger/integration: This is when one firm merges
with or takes over another firm in the same industry but at a
different stage of production. Therefore, vertical integration
can be of two types:
●​ Backward vertical integration: When one firm
merges with or takes over another firm in the same
industry but at a stage of production that is behind
the ‘predator’ firm. For example, when a firm that
manufactures furniture merges with a firm that
supplies wood for manufacturing furniture.​
Benefits:
●​ Merger gives assured supply of essential
components.
 ●​ The profit margin of the supplying firm is
now absorbed by the expanded form.
●​ The supplying firm can be prevented from
supplying to competitors.
●​ Forward vertical integration: When one firm merges
with or takes over another firm in the same industry
but at a stage of production that is ahead of the
‘predator’ firm. For example, when a firm that
manufactures furniture merges with a furniture retail
store.​
Benefits:
●​ Merger gives an assured outlet for their
product.
●​ The profit margin of the retailer is now
absorbed by the expanded form.
●​ The retailer can be prevented from selling
the goods of competitors.
●​ Conglomerate merger/integration: This is when one firm merges with
or takes over a firm in a completely different industry. This is also
known as ‘diversification’. For example, when a firm that manufactures
furniture merges with a firm that produces clothing.​
Benefits:
●​ Conglomerate integration allows businesses to have activities
in more than one country. This allows the firms to spread its
risks.
●​ There could be a transfer of ideas between the two businesses
even though they are in different industries. This transfer of
ideas could help improve the quality and demand for the two
products.

Drawbacks of growth

●​ Difficult to control staff: as a business grows, the business organisation

in terms of departments and divisions will grow, along with the number
of employees, making it harder to control, coordinate and
communicate with everyone
●​ Lack of funds: growth requires a lot of capital.
 ●​ Lack of expertise: growth is a long and difficult process that will require
people with expertise in the field to manage and coordinate activities
●​ Diseconomies of scale: this is the term used to describe how average
costs of a firm tends to increase as it grows beyond a point, reducing
profitability. This is explored more deeply in a later section.

Why businesses stay small

Not all businesses [Link] stay small, employ a handful of workers and
have little output. Here are the reasons why.

●​ Type of industry: some firms remain small due to the industry they
operate in. Examples of these are hairdressers, car repairs, catering, etc,
which give personal services and therefore cannot grow.
●​ Market size: if the firm operates in areas where the total number of
customers is small, such as in rural areas, there is no need for the firm to
grow and thus stays small.
●​ Owners’ objectives: not all owners want to increase the size of their
firms and profits. Some of them prefer keeping their businesses small
and having a personal contact with all of their employees and
customers, having flexibility in controlling and running the business,
having more control over decision-making, and to keep it less
stressful.

Why businesses fail

Not all businesses are successful. The main reasons why they fail are:

●​ Poor management: this is a common cause of business failure for new

firms. The main reason is lack of experience and planning which
could lead to bad decision making. New entrepreneurs could make
mistakes when choosing the location of the firm, the raw materials to
be used for production, etc, all resulting in failure
●​ Over-expansion: this could lead to diseconomies of scale and greatly
increase costs, if a firms expands too quickly or over their optimum level
●​ Failure to plan for change: the demands of customers keep changing
with change in tastes and fashion. Due to this, firms must always be
 ready to change their products to meet the demand of their
customers. Failure to do so could result in losing customers and loss.
They also won’t be ready to quickly keep up with changes the
competitors are making, and changes in laws and regulations
●​ Poor financial management: if the owner of the firm does not manage
his finances properly, it could result in cash shortages. This will mean
that the employees cannot be paid and enough goods cannot be
produced. Poor cash flow can therefore also cause businesses to fail

Why new businesses are at a greater risk of failure

●​ Less experience: a lack of experience in the market or in business gets

a lot of firms easily pushed out of the market
●​ New to the market: they may still not understand the nuances and
trends of the market, that existing competitors will have mastered
●​ Don't have a lot of sales yet: only by increasing sales, can new firms
grow and find their foothold in the market. At a stage when they’re not
selling much, they are at a greater risk of failing
●​ Don’t have a lot of money to support the business yet:financial issues
can quickly get the better of new firms if they aren’t very careful with
their cash flows. It is only after they make considerable sales and start
making a profit, can they reinvest in the business and support it

1.4 Types of Business organizations

Sole Trader/Sole Proprietorship

A business organization owned and controlled by one person. Sole traders

can employ other workers, but only he/she invests and owns the business.

Advantages:

●​ Easy to set up: there are very few legal formalities involved in starting
and running a sole proprietorship. A less amount of capital is enough by
sole traders to start the business. There is no need to publish annual
financial accounts.
 ●​ Full control: the sole trader has full control over the business.
Decision-making is quick and easy, since there are no other owners to
discuss matters with.
●​ Sole trader receives all profit: Since there is only one owner, he/she will
receive all of the profits the company generates.
●​ Personal: since it is a small form of business, the owner can easily create
and maintain contact with customers, which will increase customer
loyalty to the business and also let the owner know about consumer
wants and preferences.

Disadvantages:

●​ Unlimited liability: if the business has bills/debts left unpaid, legal

actions will be taken against the investors, where even their personal
property can be seized, if their investments don’t meet the unpaid
amount. This is because the business and the investors are legally not
separate (unincorporated).
●​ Full responsibility: Since there is only one owner, the sole owner has to
undertake all running activities. He/she doesn’t have anyone to share
his responsibilities with. This workload and risks are fully concentrated
on him/her.
●​ Lack of capital: As only one owner/investor is there, the amount of
capital invested in the business will be very low. This can restrict growth
and expansion of the business. Their only sources of finance will be
personal savings or borrowing or bank loans (though banks will be
reluctant to lend to sole traders since it is risky).
●​ Lack of continuity: If the owner dies or retires, the business dies with
him/her.

Partnerships

A partnership is a legal agreement between two or more (usually, up to

twenty)people to own, finance and run a business jointly and to share all
profits.

Advantages:
 ●​ Easy to set up: Similar to sole traders, very few legal formalities are
required to start a partnership business. A partnership agreement/
partnership deed is a legal document that all partners have to sign,
which forms the partnership. There is no need to publish annual
financial accounts.
●​ Partners can provide new skills and ideas: The partners may have
some skills and ideas that can be used by the business to improve
business profits.
●​ More capital investments: Partners can invest more capital than what
a sole trade only by himself could.

Disadvantages:

●​ Conflicts: arguments may occur between partners while making

decisions. This will delay decision-making.
●​ Unlimited liability: similar to sole traders, partners to have unlimited
liability- their personal items are at risk if business goes bankrupt
●​ Lack of capital: smaller capital investments as compared to large
companies.
●​ No continuity: if an owner retires or dies, the business also dies with
them.

Joint-stock companies

These companies can sell shares, unlike partnerships and sole traders, to
raise capital. Other people can buy these shares (stocks) and become a
shareholder (owner) of the company. Therefore they are jointly owned by the
people who have bought its stocks. These shareholders then receive
dividends (part of the profit; a return on investment).

The shareholders in companies have limited liabilities. That is, only their
individual investments are at risk if the business fails or leaves debts. If the
company owes money, it can be sued and taken to court, but its shareholders
cannot. The companies have a separate legal identity from their owners,
which is why the owners have a limited liability. These companies are
incorporated.​
(When they’re unincorporated, shareholders have unlimited liability and don’t
have a separate legal identity from their business).

Companies also enjoy continuity, unlike partnerships and sole traders. That is,
the business will continue even if one of its owners retire or die.

Shareholders will elect a board of directors to manage and run the company
in its day-to-day activities. In small companies, the shareholders with the
highest percentage of shares invested are directors, but directors don’t have
to be shareholders. The more shares a shareholder has, the more their voting
power.

These are two types of companies:​

Private Limited Companies: One or more owners who can sell its shares to
only the people known by the existing shareholders (family and friends).
Example: Ikea.​
Public Limited Companies: Two or more owners who can sell their shares to
any individual/organization in the general public through stock exchanges
(see Economics: topic 3.1 – Money and Banking). Example: Verizon
Communications.

Advantages:

●​ Limited Liability: this is because the company and the shareholders

have separate legal identities.
●​ Raise huge amounts of capital: selling shares to other people
(especially in Public Ltd. Co.s), raises a huge amount of capital, which is
why companies are large.
●​ Public Ltd. Companies can advertise their shares, in the form of a
prospectus, which tells interested individuals about the business, its
activities, profits, board of directors, shares on sale, share prices etc. This
will attract investors.

Disadvantages:

●​ Required to disclose financial information: Sometimes, private limited

companies are required by law to publish their financial statements
annually, while for public limited companies, it is legally compulsory to
 publish all accounts and reports. All the writing, printing and publishing
of such details can prove to be very expensive, and other competing
companies could use it to learn the company secrets.
●​ Private Limited Companies cannot sell shares to the public. Their
shares can only be sold to people they know with the agreement of
other shareholders. Transfer of shares is restricted here. This will raise
less capital than Public Ltd. Companies.
●​ Public Ltd. Companies require a lot of legal documents and
investigations before it can be listed on the stock exchange.
●​ Public and Private Limited Companies must also hold an Annual
General Meeting (AGM), where all shareholders are informed about the
performance of the company and company decisions, vote on strategic
decisions and elect board of directors. This is very expensive to set up,
especially if there are thousands of shareholders.
●​ Public Ltd. Companies may have managerial problems: since they are
very large, they become very difficult to manage. Communication
problems may occur which will slow down decision-making.
●​ In Public Ltd. Companies, there may be a divorce of ownership and
control: The shareholders can lose control of the company when other
large shareholders outvote them or when board of directors control
company decisions.

A summary of everything learned until now, in this section, in case you’re

getting confused:
Franchises

The owner of a business (the franchisor) grants a licence to another person

or business (the franchisee) to use their business idea – often in a specific
geographical area. Fast food companies such as McDonald’s and Subway
operate around the globe through lots of franchises in different countries.

ADVANTAGES DISADVANTAGES
 Rapid, low cost
Profits from the
method of business
franchise needs to be
expansion
shared with the
franchisee
Gets and income from
franchisee in the form
Loss of control over
of franchise fees and
running of business
royalties

If one franchise fails, it

Franchisee will better
can affect the
TO understand the local
reputation of the
FRANCHISO tastes and so can
entire brand
R advertise and sell
appropriately

Franchisee may not

be as skilled
Can access ideas and
suggestions from
franchisee
Need to supply raw
material/product and
provide support and
Franchisee will run
training
the operations
 Cost of setting up
business

No full control over

business- need to
An established brand strictly follow
and trademark, so franchisor’s standards
chance of business and rules
failing is low

Franchisor will give Profits have to be

TO
technical and shared with franchisor
FRANCHISE
managerial support
E

Need to pay franchisor

Franchisor will supply franchise fees and
the raw royalties
materials/products

Need to advertise and

promote the business
in the region
themselves

Joint Ventures

Joint venture is an agreement between two or more businesses to work

together on a project. The foreign business will work with a domestic
business in the same industry. Eg: Google Earth is a joint venture/project
between Google and NASA.

Advantages

●​ Reduces risks and cuts costs

●​ Each business brings different expertise to the joint venture
 ●​ The market potential for all the businesses in the joint venture is
increased
●​ Market and product knowledge can be shared to the benefit of the
businesses

Disadvantages

●​ Any mistakes made will reflect on all parties in the joint venture, which
may damage their reputations
●​ The decision-making process may be ineffective due to different
business culture or different styles of leadership

Public Sector Corporations

Public sector corporations are businesses owned by the government and

run by directors appointed by the government. They usually provide essential
services like water, electricity, health services etc. The government provides
the capital to run these corporations in the form of subsidies (grants). The
UK’s National Health Service (NHS) is an example. Public corporations aim to:
●​ to keep prices low so everybody can afford the service.
●​ to keep people employed.
●​ to offer a service to the public everywhere.

Advantages:
●​ Some businesses are considered too important to be owned by an
individual. (electricity, water, airline)
●​ Other businesses, considered natural monopolies, are controlled by the
government. (electricity, water)
●​ Reduces waste in an industry. (e.g. two railway lines in one city)
●​ Rescue important businesses when they are failing through
nationalisation
●​ Provide essential services to the people

Drawbacks:
●​ Motivation might not be as high because profit is not an objective
●​ Subsidies lead to inefficiency. It is also considered unfair for private
businesses
 ●​ There is normally no competition to public corporations, so there is no
incentive to improve
●​ Businesses could be run for government popularity

1.5 Business Objectives and Stakeholder

objectives
Business objectives

Business objectives are the aims and targets that a business works towards to
help it run successfully. Although the setting of these objectives does not
always guarantee business success, it has its benefits.

●​ Setting objectives increases motivation as employees and managers

now have clear targets to work towards.
●​ Decision making will be easier and less time consuming as there are
set targets to base decisions on. i.e., decisions will be taken in order to
achieve business objectives.
●​ Setting objectives reduces conflicts and helps unite the business
towards reaching the same goal.
●​ Managers can compare the business’ performance to its objectives
and make any changes in its activities if required.

Objectives vary with different businesses due to size, sector and many other
factors. However, many businesses in the private sector aim to achieve the
following objectives.

●​ Survival: new or small firms usually have survival as a primary

objective. Firms in a highly competitive market will also be more
concerned with survival rather than any other objective. To achieve this,
firms could decide to lower prices, which would mean forsaking other
objectives such as profit maximization.
●​ Profit: this is the income of a business from its activities after deducting
total costs. Private sector firms usually have profit making as a primary
objective. This is because profits are required for further investment
 into the business as well as for the payment of return to the
shareholders/owners of the business.
●​ Growth: once a business has passed its survival stage it will aim for
growth and expansion. This is usually measured by the value of sales or
output. Aiming for business growth can be very beneficial. A larger
business can ensure greater job security and salaries for employees.
The business can also benefit from higher market share and
economies of scale.
●​ Market share: this can be defined as the proportion of total market
sales achieved by one business. Increased market share can bring about
many benefits to the business such as increased customer loyalty,
setting up of brand image, etc.
●​ Service to the society: some operations in the private sectors such as
social enterprises do not aim for profits and prefer to set more
economical objectives. They aim to better the society by providing
social, environmental and financial aid. They help those in need, the
underprivileged, the unemployed, the economy and the government.

A business’ objectives do not remain the same forever. As market situations

change and as the business itself develops, its objectives will change to reflect
its current market and economic position. For example, a firm facing serious
economic recession could change its objective from profit maximization to
short term survival.

Stakeholders

A stakeholder is any person or group that is interested in or directly

affected by the performance or activities of a business. These stakeholder
groups can be external – groups that are outside the business or they can be
internal – those groups that work for or own the business.

Internal stakeholders:

●​ Shareholder/ Owners: these are the risk takers of the [Link]

invest capital into the business to set up and expand it. These
shareholders are liable to a share of the profits made by the business.​
Objectives:
 ●​ Shareholders are entitled to a rate of return on the capital
they have invested into the business and will therefore have
profit maximization as an objective.
●​ Business growth will also be an important objective as this
will ensure that the value of the shares will increase.
●​ Workers: these are the people that are employed by the business and
are directly involved in its activities.​
Objectives:
●​ Contract of employment that states all the rights and
responsibilities to and of the employees.
●​ Regular payment for the work done by the employees.
●​ Workers will want to benefit from job satisfaction as well as
motivation.
●​ The employees will want job security– the ability to be able to
work without the fear of being dismissed or made redundant.
●​ Managers: they are also employees but managers control the work
of others. Managers are in charge of making key business decisions.​
Objectives:
●​ Like regular employees, managers too will aim towards a
secure job.
●​ Higher salaries due to their jobs requiring more skill and
effort.
●​ Managers will also wish for business growth as a bigger
business means that managers can control a bigger and well
known business.

External Stakeholders:

●​ Customers: they are a very important part of every business. They

purchase and consume the goods and services that the business
produces/ provides. Successful businesses use market research to find
out customer preferences before producing their goods.​
Objectives:
●​ Price that reflects the quality of the good.
●​ The products must be reliable and safe. i.e., there must not be
any false advertisement of the products.
●​ The products must be well designed and of a perceived
quality.
 ●​ Government: the role of the government is to protect the workers and
customers from the business’ activities and safeguard their interests.​
Objectives:
●​ The government will want the business to grow and survive as
they will bring a lot of benefits to the economy. A successful
business will help increase the total output of the country,
will improve employment as well as increase government
revenue through payment of taxes.
●​ They will expect the firms to stay within the rules and
regulations set by the government.
●​ Banks: these banks provide financial help for the business’ operations’​
Objectives:
●​ The banks will expect the business to be able to repay the
amount that has been lent along with the interest on it. The
bank will thus have business liquidity as its objective.
●​ Community: this consists of all the stakeholder groups, especially the
third parties that are affected by the business’ activities.​
Objectives:
●​ The business must offer jobs and employ local employees.
●​ The production process of the business must in no way harm
the environment.
●​ Products must be socially responsible and must not pose any
harmful effects from consumption.

Public- sector businesses

Government owned and controlled businesses do not have the same

objectives as those in the private sector.

Objectives:

●​ Financial: although these businesses do not aim to maximize profits,

they will have to meet the profit target set by the government. This is so
that it can be reinvested into the business for meeting the needs of
the society
●​ Service: the main aim of this organization is to provide a service to the
community that must meet the quality target set by the government
 ●​ Social: most of these social enterprises are set up in order to aid the
community. This can be by providing employment to citizens, providing
good quality goods and services at an affordable rate, etc.
●​ They help the economy by contributing to GDP, decreasing
unemployment rate and raising living standards.

This is in total contrast to private sector aims like profit, growth, survival,
market share etc

Conflicts of stakeholders’ objectives

As all stakeholders have their own aims they would like to achieve, it is natural
that conflicts of stakeholders’ interests could occur. Therefore, if a business
tries to satisfy the objectives of one stakeholder, it might mean that another
stakeholders’ objectives could go unfulfilled.

For example, workers will aim towards earning higher salaries. Shareholders
might not want this to happen as paying higher salaries could mean that less
profit will be left over for payment of return to the shareholders.

Similarly, the business might want to grow by expanding operations to build

new factories. But this might conflict with the community’s want for clean
and pollution-free localities.

2 People in Business
2.1 Motivating workers
Motivation

People work for several reasons:

●​ Have a better standard of living: by earning incomes they can satisfy

their needs and wants
 ●​ Be secure: having a job means they can always maintain or grow that
standard of living
●​ Gain experience and status: work allows people to get better at the job
they do and earn a reputable status in society
●​ Have job satisfaction: people also work for the satisfaction of having a
job

Motivation is the reason why employees want to work hard and work
effectively for the business. Money is the main motivator, as explained
above. Other factors that may motivate a person to choose to do a particular
job may include social needs (need to communicate and work with others),
esteem needs (to feel important, worthwhile), job satisfaction (to enjoy good
work), security (knowing that your job and pay are secure- that you will not
lose your job).

Why motivate workers? Why do firms go to the pain of making sure their
workers are motivated? When workers are well-motivated, they become
highly productive and effective in their work, become absent less often,
and less likely to leave the job, thus increasing the firm’s efficiency and
output, leading to higher profits. For example, in the service sector, if the
employee is unhappy at his work, he may act lazy and rude to customers,
leading to low customer satisfaction, more complaints and ultimately a bad
reputation and low profits.

Motivation Theories

●​ F. W. Taylor: Taylor based his ideas on the assumption that workers

were motivated by personal gains, mainly money and that increasing
pay would increase productivity (amount of output produced).
Therefore he proposed the piece-rate system, whereby workers get
paid for the number of output they produce. So in order, to gain more
money, workers would produce more. He also suggested a scientific
management in production organisation, to break down labour
(essentially division of labour) to maximise output​
However, this theory is not entirely true. There are various other
motivators in the modern workplace, some even more important than
money. The piece rate system is not very practical in situations where
 output cannot be measured (service industries) and also will lead to
(high) output that doesn’t guarantee high quality.
●​ Maslow’s Hierarchy: Abraham Maslow’s hierarchy of needs shows that
employees are motivated by each level of the hierarchy going from
bottom to top. Managers can identify which level their workers are on
and then take the necessary action to advance them onto the next
level.​

​
One limitation of this theory is that it doesn’t apply to every worker. For
some employees, for example, social needs aren’t important but they
would be motivated by recognition and appreciation for their work
from seniors.

Herzberg’s Two-Factor Theory: Frederick Herzberg’s two-factor theory,

wherein he states that people have two sets of needs:​
Basic animal needs called ‘hygiene factors’:

●​ status
●​ security
●​ work conditions
●​ company policies and administration
●​ relationship with superiors
●​ relationship with subordinates
●​ salary

Needs that allow the human being to grow psychologically, called the
‘motivators’:
 ●​ achievement
●​ recognition
●​ personal growth/development
●​ promotion
●​ work itself

According to Herzberg, the hygiene factors need to be satisfied, if not they will
act as de-motivators to the workers. However hygiene factors don’t act as
motivators as their effect quickly wears off. Motivators will truly motivate
workers to work more effectively.

Motivating Factors

Financial Motivators

●​ Wages: often paid weekly. They can be calculated in two ways:

●​ Time-Rate: pay based on the number of hours worked.
Although output may increase, it doesn’t mean that workers
will sincerely use the time to produce more- they may simply
waste time on very little output since their pay is based only on
how long they work. The productive and unproductive worker
will get paid the same amount, irrespective of their output.
●​ Piece-Rate: pay based on the no. of output produced. Same
as time-rate, this doesn’t ensure that quality output is
produced. Thus, efficient workers may feel demotivated as
they’re getting the same pay as inefficient workers, despite
their efficiency.
●​ Salary: paid monthly or annually.
●​ Commission: paid to salesperson, based on a percentage of sales
they’ve made. The higher the sales, the more the pay. Although this will
encourage salespersons to sell more products and increase profits, it
can be very stressful for them because no sales made means no pay at
all.
●​ Bonus: additional amount paid to workers for good work
●​ Performance-related pay: paid based on performance. An appraisal
(assessing the effectiveness of an employee by senior management
through interviews, observations, comments from colleagues etc.) is
used to measure this performance and a pay is given based on this.
 ●​ Profit-sharing: a scheme whereby a proportion of the company’s
profits is distributed to workers. Workers will be motivated to work
better so that a higher profit is made.
●​ Share ownership: shares in the firm are given to employees so that
they can become part owners of the company. This will increase
employees’ loyalty to the company, as they feel a sense of belonging.

Non-Financial Motivators

●​ Fringe benefits are non-financial rewards given to employees

●​ Company vehicle/car
●​ Free healthcare
●​ Children’s education fees paid for
●​ Free accommodation
●​ Free holidays/trips
●​ Discounts on the firm’s products
●​ Job Satisfaction: the enjoyment derived from the feeling that you’ve
done a good job. Employees have different ideas about what motivates
them- it could be pay, promotional opportunities, team involvement,
relationship with superiors, level of responsibility, chances for training,
the working hours, status of the job etc. Responsibility, recognition and
satisfaction are in particular very important.

So, how can companies ensure that they’re workers are satisfied with the job,
other than the motivators mentioned above?

●​ Job Rotation: involves workers swapping around jobs and doing each
specific task for only a limited time and then changing round again.
This increases the variety in the work itself and will also make it easier
for managers to move around workers to do other jobs if somebody is ill
or absent. The tasks themselves are not made more interesting, but the
switching of tasks may avoid boredom among workers. This is very
common in factories with a huge production line where workers will
move from retrieving products from the machine to labelling the
products to packing the products to putting the products into huge
cartons.
●​ Job Enlargement: where extra tasks of similar level of work are
added to a worker’s job description. These extra tasks will not add
 greater responsibility or work for the employee, but make work more
interesting. E.g.: a worker hired to stock shelves will now, as a result of
job enlargement, arrange stock on shelves, label stock, fetch stock etc.
●​ Job Enrichment: involves adding tasks that require more skill and
responsibility to a job. This gives employees a sense of trust from senior
management and motivates them to carry out the extra tasks
effectively. Some additional training may also be given to the employee
to do so. E.g.: a receptionist employed to welcome customers will now,
as a result of job enrichment, deal with telephone enquiries,
word-process letters etc.
●​ Team-working: a group of workers is given responsibility for a
particular process, product or development. They can decide as a team
how to organize and carry out the tasks. The workers take part in
decision making and take responsibility for the process. It gives them
more control over their work and thus a sense of commitment,
increasing job satisfaction. Working as a group will also add to morale,
fulfill social needs and lead to job satisfaction.
●​ Opportunities for training: providing training will make workers feel
that their work is being valued. Training also provides them
opportunities for personal growth and development, thereby attaining
job satisfaction
●​ Opportunities of promotion: providing opportunities for promotion
will get workers to work more efficiently and fill them with a sense of
self-actualisation and job satisfaction

2.2 Organisation and management

Organizational Structure
Organizational structure refers to the levels of management and division of
responsibilities within a business. They can be represented on organizational
charts (left).

Advantages:

●​ All employees are aware of which communication channel is used to

reach them with messages
●​ Everyone knows their position in the business. They know who they
are accountable to and who they are accountable for
●​ It shows the links and relationship between the different departments
●​ Gives everyone a sense of belonging as they appear on the
organizational chart

The span of control is the number of subordinates working directly under

a manager in the organizational structure. In the above figure, the managing
director’s span of control is four. The marketing director’s span of control is
the number of marketing managers working under him (it is not specified
how many, in the figure).
The chain of command is the structure of an organization that allows
instructions to be passed on from senior managers to lower levels of
management. In the above figure, there is a short chain of command since
there are only four levels of management shown.

Now, if you look closely,there is a link between the span of control and chain
of command. The wider the span of control the shorter the chain of
command since more people will appear horizontally aligned on the chart
than vertically. A short span of control often leads to a long chain of
command. (If you don’t understand, try visualizing it on an organizational
chart).

Advantages of a short chain of command (these are also the disadvantages of

a long chain of command):

●​ Communication is quicker and more accurate

●​ Top managers are less remote from lower employees, so employees
will be more motivated and top managers can always stay in touch with
the employees
●​ Spans of control will be wider, This means managers have more people
to control This is beneficial because it will encourage them to delegate
responsibility (give work to subordinates) and so the subordinates will
be more motivated and feel trusted. However there is the risk that
managers may lose control over the tasks.

Line Managers have authority over people directly below them in the
organizational structure. Traditional marketing/operations/sales managers are
good examples.

Staff Managers are specialists who provide support, information and

assistance to line managers. The IT department managers in most
organisations act as staff managers.

Management

So, what role do managers really have in an organization? Here are their five
primary roles:
 ●​ Planning: setting aims and targets for the organisations/department
to achieve. It will give the department and its employees a clear sense
of purpose and direction. Managers should also plan for resources
required to achieve these targets – the number of people required, the
finance needed etc.
●​ Organizing: managers should then organize the resources. This will
include allocating responsibilities to employees, possibly delegating.
●​ Coordinating: managers should ensure that each department is
coordinating with one another to achieve the organization’s aims. This
will involve effective communication between departments and
managers and decision making. For example, the sales department will
need to tell the operations dept. how much they should produce in
order to reach the target sales level. The operations dept. will in turn tell
the finance dept. how much money they need for production of those
goods. They need to come together regularly and make decisions that
will help achieve each department’s aims as well as the organization’s.
●​ Commanding: managers need to guide, lead and supervise their
employees in the tasks they do and make sure they are keeping to their
deadlines and achieving targets.
●​ Controlling: managers must try to assess and evaluate the
performance of each of their employees. If some employees fail to
achieve their target, the manager must see why it has occurred and
what he can do to correct it- maybe some training will be required or
better equipment.

​
Delegation is giving a subordinate the authority to perform some tasks.

Advantages to managers:

●​ managers cannot do all work by themselves

●​ managers can measure the efficiency and effectiveness of their
subordinates’ work

However, managers may be reluctant to delegate as they may lose their

control over the work.

Advantages to subordinates:
 ●​ the work becomes more interesting and rewarding- increased job
satisfaction
●​ employees feel more important and feel trusted– increasing loyalty to
firm
●​ can act as a method of training and opportunities for promotions, if
they do a good job.

Leadership Styles

Leadership styles refer to the different approaches used when dealing with
people when in a position of authority. There are mainly three styles you
need to learn: the autocratic, democratic and laissez-faire styles.

Autocratic style is where the managers expect to be in charge of the

business and have their orders followed. They do all the decision-making, not
involving employees at all. Communication is thus, mainly one way- from top
to bottom. This is standard in police and armed forces organizations.

Democratic style is where managers involve employees in the

decision-making and communication is two-way from top to bottom as well
as bottom to top. Information about future plans is openly communicated
and discussed with employees and a final decision is made by the manager.

Laissez-faire (French phrase for ‘leave to do') style makes the broad
objectives of the business known to employees and leaves them to do their
own decision-making and organize tasks. Communication is rather difficult
since a clear direction is not given. The manager has a very limited role to play.
 Trade Unions

A trade union is a group of workers who have joined together to ensure

their interests are protected. They negotiate with the employer (firm) for
better conditions and treatment and can threaten to take industrial action if
their requests are denied. Industrial action can include an overtime ban
(refusing to work overtime), going slow (working at the slowest speed as is
required by the employment contract), strike (refusing to work at all and
protesting instead) etc. Trade unions can also seek to put forward their views
to the media and influence government decisions relating to employment.

Benefits to workers of joining a trade union:

●​ strength in number- a sense of belonging and unity

●​ improved conditions of employment, for example, better pay, holidays,
hours of work etc
 ●​ improved working conditions, for example, health and safety
●​ improved benefits for workers who are not working, because they’re
sick, retired or made redundant (dismissed not because of any fault of
their own)
●​ financial support if a member thinks he/she has been unfairly
dismissed or treated
●​ benefits that have been negotiated for union members such as
discounts on firm’s products, provision of health services.

Disadvantages to workers of joining a trade unions:

●​ costs money to be member- a membership fee will be required

●​ may be asked to take industrial action even if they don’t agree with the
union- they may not get paid during a strike, for example.

2.3 Recruitment, Selection and training

of workers
The Role of the H.R. (Human Resource) Department

●​ Recruitment and selection: attracting and selecting the best

candidates for job posts
●​ Wages and salaries: set wages and salaries that attract and retain
employees as well as motivate them
●​ Industrial relations: there must be effective communication between
management and workforce to solve complaints and disputes as well
as discussing ideas and suggestions
●​ Training programmes: give employees training to increase their
productivity and efficiency
●​ Health and safety: all laws on health and safety conditions in the
workplace should be adhered to
●​ Redundancy and dismissal: the managers should dismiss any
unsatisfactory/misbehaving employees and make them redundant if
they are no longer needed by the business.

Recruitment
Job Analysis, Description and Specification

Recruitment is the process of identifying that the business needs to employ

someone up to the point where applications have arrived at the business.

A vacancy arises when an employee resigns from a job or is dismissed by the

management. When a vacancy arises, a job analysis has to be prepared. A job
analysis identifies and records the tasks and responsibilities relating to
the job. It will tell the managers what the job post is for.​

Then a job description is

prepared that outlines the responsibilities and duties to be carried out by
someone employed to do the job. It will have information about the
conditions of employment (salary, working hours, and pension scheme),
training offered, opportunities for promotion etc. This is given to all
prospective candidates so they know what exactly they will be required and
expected to do.​
Once this has been done, the H.R. The department will draw up a job
specification, a document that outlines the requirements, qualifications,
expertise, skills, physical/personal characteristics etc. required by an
employee to be able to take up the job.

Advertising the vacancy

Internal recruitment is when a vacancy is filled by an existing employee of

the business.

Advantages:
 ●​ Saves time and money- no need for advertising and interviewing
●​ Person already known to business
●​ Person knows business’ ways of working
●​ Motivating for other employees to see their colleagues being
promoted- urging them to work hard

Disadvantages:

●​ No new skills and experience coming into the business

●​ Jealousy among workers

External recruitment is when a vacancy is filled by someone who is not an

existing employee and will be new to the business. External recruitment
needs to be advertised, unlike internal recruitment. This can be done in
local/national newspapers, specialist magazines and journals, job centres run
by the government (where job vacancies are posted and given to interested
people; usually for unskilled or semi-skilled jobs) or even recruitment
agencies (who will recruit and send along candidates to the company when
they request it).

When advertising a job, the business needs to decide what should be

included in the advertisement, where it should be advertised, how much it
will cost and whether it will be cost-effective.

When a person is interested in a job, they should apply for it by sending in a

curriculum vitae (CV) or resume, this will detail the person’s qualifications,
experience, qualities and [Link] business will use these to see which
candidates match the job specification. It will also include statements of why
the candidate wants the job and why he/she feels they would be suitable for
the job.

Selection

Applicants who are shortlisted will be interviewed by the H.R. manager. They
will also call up the referee provided by the applicant (a referee could be the
previous employer or colleagues who can give a confidential opinion about
the applicant’s reliability, honesty and suitability for the job). Interviews will
allow the manager to assess:

●​ the applicant’s ability to do the job

●​ personal qualities of the applicant
●​ character and personality of applicant

In addition to interviews, firms can conduct certain tests to select the best
candidate. This could include skills tests (ability to do the job), aptitude tests
(candidate’s potential to gain additional skills), personality tests (what kind of
a personality the candidate has- will it be suitable for the job?), group
situation tests (how they manage and work in teams) etc.

When a successful candidate has been selected the others must be sent a
letter of rejection.

The contract of employment: a legal agreement between the employer

and the employee listing the rights and responsibilities of workers. It will
include:

●​ the name of employer and employee

●​ job title
●​ date when employment will begin
●​ hours to work
●​ rate of pay and other benefits
●​ when payment is made
●​ holiday entitlement
●​ the amount of notice to be given to terminate the employment that the
employer or employee must give to end the employment etc.

Employment contracts can be part-time or full-time. Part-time employment

is often considered to be between 1 and 30-35 hours a week whereas full-time
employment will usually work 35 hours or more a week.

Advantages to employer of part-time employment (disadvantages of full-time

employment to employer):

●​ more flexible hours of work

 ●​ easier to ask employees just to work at busy times
●​ easier to extend business opening/operating hours by working evenings
or at weekends
●​ works lesser hours so employee is willing to accept lower pay
●​ less expensive than employing and paying full-time workers.

Disadvantages to employer of part-time employment (advantages of full-time

employment to employers)

●​ less likely to be trained because the workers see the job as temporary
●​ takes longer to recruit two part-time workers than one full-time worker
●​ can be less committed to the business/ more likely to leave and go get
another job
●​ less likely to be promoted because they will not have gained the skills
and experience as full-time employees
●​ more difficult to communicate with part-time workers when they are
not in work- all work at different times.

Training

Training is important to a business as it will improve the worker’s skills and

knowledge and help the business be more efficient and productive,
especially when new processes and products are introduced. It will improve
the workers’ chances at getting promoted and raise their morale.

The three types of training are:

●​ Induction training: an introduction given to a new

employee,explaining the firm’s activities, customs and procedures and
introducing them to their fellow workers.

Advantages:

●​ Helps new employees to settle into their job quickly

●​ May be a legal requirement to give health and safety training
before the start of work
●​ Less likely to make mistakes
Disadvantages:

●​ Time-consuming
●​ Wages still have to be paid during training, even though they
aren’t working
●​ Delays the state of the employee starting the job
●​ On-the-job training: occurs by watching a more experienced worker
doing the job

Advantages:

●​ It ensures there is some production from worker whilst they

are training
●​ It usually costs less than off-the-job training
●​ It is training to the specific needs of the business

Disadvantages:

●​ The trainer will lose some production time as they are taking
some time to teach the new employee
●​ The trainer may have bad habits that can be passed onto the
trainee
●​ It may not necessarily be recognised training qualifications
outside the business
●​ Off-the-job training: involves being trained away from the workplace,
usually by specialist trainers

Advantages:

●​ A broad range of skills can be taught using these techniques

●​ Employees may be taught a variety of skills and they may
become multi-skilled that can allow them to do various jobs in
the company when the need arises.

Disadvantages:

●​ Costs are high

 ●​ It means wages are paid but no work is being done by the
worker
●​ The additional qualifications means it is easier for the
employee to leave and find another job

Workforce Planning

Workforce Planning: the establishing of the workforce needed by the

business for the foreseeable future in terms of the number and skills of
employees required.

They may have to downsize (reduce the no. of employees) the workforce
because of:

●​ Introduction of automation
●​ Falling demand for their products
●​ Factory/shop/office closure
●​ Relocating factory abroad
●​ A business has merged or been taken over and some jobs are no longer
needed

They can downsize the workforce in two ways:

●​ Dismissal: where a worker is told to leave their job because their work
or behaviour is unsatisfactory.
●​ Redundancy: when an employee is no longer needed and so loses their
work, though not due to any fault of theirs. They may be given some
money as compensation for the redundancy.

Workers could also resign (they are leaving because they have found another
job) and retire (they are getting old and want to stop working).

Legal Controls over Employment Issues

There are a lot of government laws that affect equal employment

opportunities. These laws require businesses to treat their employees equally
in the workplace and when being recruited and selected- there should be no
discrimination based on age, gender, religion, race etc.

Employees are protected in many areas including

●​ against unfair discrimination

●​ health and safety at work (protection from dangerous machinery,
safety clothing and equipment, hygiene conditions, medical aid etc.)
●​ against unfair dismissal
●​ wage protection (through the contract of employment since it will
have listed the pay and conditions). Many countries have a legal
minimum wage– the minimum wage an employer has to pay its
employee. This avoids employers from exploiting its employees, and
encourages more people to find work, but since costs are rising for the
business, they may make many workers redundant- unemployment will
rise.

An industrial tribunal is a legal meeting which considers workers’ complaints

of unfair dismissal or discrimination at work. This will hear both sides of the
case and may give the worker compensation if the dismissal was unfair.

2.4 Internal and external

communication

Effective Communication

Communication is the transferring of a message from the sender to the

receiver, who understands the message.

Internal communication is between two members of the same

organisations. Example: communication between departments, notices and
circulars to workers, signboards and labels inside factories and offices etc.

External communication is between the organisation and other

organisations or individuals. Example: orders of goods to suppliers,
advertising of products, sending customers messages about delivery, offers
etc.

Effective communication involves:

●​ A transmitter/sender of the message

●​ A medium of communication eg: letter, telephone conversation, text
message
●​ A receiver of the message
●​ A feedback/response from the receiver to confirm that the message
has beenreceived and acknowledged.

One-way communication involves a message which does not require

feedback. Example: signs saying ‘no smoking’ or an instruction saying ‘deliver
these goods to a customer’

Two-way communication is when the receiver gives a response to the

message received. Example: a letter from one manager to another about an
important matter that needs to be discussed. A two-way communication
ensures that the person receiving the message understands it and has acted
on it. It also makes the receiver feel more a part of the process- could be a way
of motivating employees.

Downward communication: messages from managers to subordinates i.e.

from top to bottom of an organization structure.

Upward communication: messages/feedback from subordinates to

managers i.e. from bottom to top of an organization structure

Horizontal communication occurs between people on the same level of an

organization structure.

Communication Methods​
Verbal methods (eg: telephone conversation, face-to-face conversation, video
conferencing, meetings)

Advantages:
 ●​ Quick and efficient
●​ There is an opportunity for immediate feedback
●​ Speaker can reinforce the message- change his tone, body language
etc. to influence the listeners.

Disadvantages:

●​ Can take long if there is feedback and therefore, discussions

●​ In a meeting, it cannot be guaranteed that everybody is listening or has
understood the message
●​ No written record of the message can be kept for later reference.

Written methods (eg: letters, memos, text-messages, reports, e-mail, social

media, faxes, notices, signboards)

Advantages:

●​ There is evidence of the message for later reference.

●​ Can include details
●​ Can be copied and sent to many people, especially with e-mail
●​ E-mail and fax is quick and cheap

Disadvantages:

●​ Direct feedback may not always be possible

●​ Cannot ensure that message has been received and/or acknowledged
●​ Language could be difficult to understand.
●​ Long messages may cause disinterest in receivers
●​ No opportunity for body language to be used to reinforce messages

Visual Methods (eg: diagrams, charts, videos, presentations, photographs,

cartoons, posters)

Advantages:

●​ Can present information in an appealing and attractive way

 ●​ Can be used along with written material (eg: reports with diagrams and
charts)

Disadvantages:

●​ No feedback
●​ May not be understood/ interpreted properly.

Factors that affect the choice of an appropriate communication method:

●​ Speed: if the receiver has to get the information quickly, then a

telephone call or text message has to be sent. If speed isn’t important, a
letter or e-mail will be more appropriate.
●​ Cost: if the company wishes to keep costs down, it may choose to use
letters or face-to-face meetings as a medium of communication.
Otherwise, telephone, posters etc. will be used.
●​ Message details: if the message is very detailed, then written and visual
methods will be used.
●​ Leadership style: a democratic style would use two-way
communication methods such as verbal mediums. An autocratic one
would use notices and announcements.
●​ The receiver: if there is only receiver, then a personal face-to-face or
telephone call will be more apt. If all the staff is to be sent a message, a
notice or e-mail will be sent.
●​ Importance of a written record: if the message is one that needs to
have a written record like a legal document or receipts of new customer
orders, then written methods will be used.
●​ Importance of feedback: if feedback is important, like for a quick
query, then a direct verbal or written method will have to be used.

Formal communication is when messages are sent through established

channels using professional language. Eg: reports, emails, memos, official
meetings.

Informal communication is when information is sent and received casually

with the use of everyday language. Eg: staff briefings. Managers can
sometimes use the ‘grapevine’ (informal communication among employees-
usually where rumours and gossip spread!) to test out the reactions to new
ideas (for example, a new shift system at a factory) before officially deciding
whether or not to make it official.

Communication Barriers

Communication barriers are factors that stop effective communication of

messages.

3 Marketing
3.1 Marketing, Competition and the
customer
A market consists of all buyers and sellers of a particular good.

What is marketing?

By definition, marketing is the management process responsible for

identifying, anticipating and satisfying consumers’ requirements profitably.

The role of marketing in a business is as follows:

●​ Identifying customer needs through market research

●​ Satisfying customer needs by producing and selling goods and
services
●​ Maintaining customer loyalty: building customer relationships
through a variety of methods that encourage customers to keep buying
one firm’s products instead of their rivals’. For example, loyalty card
schemes, discounts for continuous purchases, after-sales services,
messages that inform past customers of new products and offers etc.
●​ Gain information on customers: by understanding why customers buy
their products, a firm can develop and sell better products in the future
●​ Anticipate changes in customer needs: the business will need to keep
looking for any changes in customer spending patterns and see if they
can produce goods that customers want that are not currently available
in the market.

Some objectives the marketing department in a firm may have:

●​ Raise awareness of their product(s)

●​ Increase sales revenue and profits
●​ Increase or maintain market share (this is the proportion of sales a
company has in the overall market sales. For example, if in a market, $1
million worth of toys were sold in a year and company A’s total sales was
$30,000 in that year, company A’s market share for the year is
($300,000/ $1000000) *100 = 30%)
 ●​ Enter new markets at home or abroad
●​ Develop new products or improve existing products.

Market Changes

Why customer spending patterns may change:

●​ change in their tastes and preferences

●​ change in technology: as new technology becomes available, the old
versions of products become outdated and people want more
sophisticated features on products
●​ change in income: the higher the income, the more expensive goods
consumers will buy and vice versa
●​ ageing population: in many countries, the proportion of older people is
increasing and so demand for products for seniors are increasing (such
as anti-ageing creams, medical assistance etc.)

The power and importance of changing customer needs:

Firms need to always know what their consumers want (and they will need to
undertake lots of research and development to do so) in order to stay ahead
of competitors and stay profitable. If they don’t produce and sell what
customers want, they will buy competitors’ products and the firm will fail to
survive.

Why some markets have become more competitive:

●​ Globalization: products are being sold in markets all over the world, so
there are more competitors in the market
●​ Improvement in transportation infrastructures: better transport
systems means that it is easier and cheaper to distribute and sell
products everywhere
●​ Internet/E-Commerce: customers can now buy products over the
internet from anywhere in the world, making the market more
competitive
How business can respond to changing spending patterns and increased
competition:

A business has to ensure that it maintains its market share and remains
competitive in the market. It can ensure this by:

●​ maintaining good customer relationships: by ensuring that

customers keep buying from their business only, they can keep up their
market share. By doing so, they can also get information about their
spending patterns and respond to their wants and needs to increase
market share
●​ keep improving its existing products, so that sales is maintained.
●​ introduce new products to keep customers coming back, and drive
them away from competitors’ products
●​ keep costs low to maintain profitability: low costs means the firm can
afford to charge low prices. And low prices generally means more
demand and sales, and thus market share.

Niche & Mass Marketing

Niche Marketing: identifying and exploiting a small segment of a larger

market by developing products to suit it. For example, Versace designs and
Clique perfumes have niche markets- the rich, high-status consumer group.

Advantages:

●​ Small firms can thrive in niche markets where large firms have not yet
been established
●​ If there are no or very few competitors, firms can sell products at a
high price and gain high profit margins because customers will be
willing be willing to pay more for exclusive products
●​ Firms can focus on the needs of just one customer group,thereby
giving them an advantage over large firms who only sell to the mass
market

Limitations:
 ●​ Lack of economies of scale (can’t benefit from the lower costs that
arise from a larger operations/market)
●​ Risk of over-dependence on a single product or market: if the
demand for the product falls, the firm won’t have a mass product they
can fall back on
●​ Likely to attract competition if successful

​
Mass Marketing: selling the same product to the whole market with no
attempt to target groups within it. For example, the iPhone sold is the same
everywhere, there are no variations in design over location or income.

Advantages:

●​ Larger amount of sales when compared to a niche market

●​ Can benefit from economies of scale: a large volume of products are
produced and so the average costs will be low when compared to a
niche market
●​ Risks are spread, unlike in a niche market. If the product isn’t successful
in one market, it’s fine as there are several other markets
●​ More chances for the business to grow since there is a large market. In
niche markets, this is difficult as the product is only targeted towards a
particular group.

Limitations:

●​ They will have to face more competition

●​ Can’t charge a higher price than competition because they’re all selling
similar products

Market Segmentation

A market segment is an identifiable subgroup of a larger market in which

consumers have similar characteristics and preferences

Market segmentation is the process of dividing a market of potential

customers into groups, or segments, based on different characteristics. For
example, PepsiCo identified the health-conscious market segment and
targeted/marketed the Diet Coke towards them.

Markets can be segmented on the basis of socio-economic groups(income),

age, location, gender, lifestyle, use of the product(home/ work/ leisure/
business) etc.​
Each segment will require different methods of promotion and distribution.
For example, products aimed towards kids would be distributed through
popular retail stores and products for businessmen would be advertised in
exclusive business magazines.

Advantages:

●​ Makes marketing cost-effective, as it only targets a specific segment

and meets their needs.
●​ The above leads to higher sales and profitability
●​ Increased opportunities to increase sales

3.2 Market research

Product-oriented business: such firms produce the product first and then try
to find a market for it. Their concentration is on the product – its quality and
price. Firms producing electrical and digital goods such as refrigerators and
computers are examples of product-oriented businesses.

Market-oriented businesses: such firms will conduct market research to see

what consumers want and then produce goods and services to satisfy them.
They will set a marketing budget and undertake the different methods of
researching consumer tastes and spending patterns, as well as market
conditions. Example, mobile phone markets.

Market research is the process of collecting, analysing and interpreting

information about a product.

Why is market research important/needed?​

Firms need to conduct market research in order to ensure that they are
producing goods and services that will sell successfully in the market and
generate profits. If they don’t, they could lose a lot of money and fail to
survive. Market research will answer a lot of the business’s questions prior to
product development such as ‘will customers be willing to buy this product?’,
‘what is the biggest factor that influences customers’ buying preferences-
price or quality?’, ‘what is the competition in the market like?’ and so on.

Market research data can be quantitative (numerical-what percentage of

teenagers in the city have internet access) or qualitative (opinion/
judgement- why do more women buy the company’s product than men?)

Market research methods can be categorized into two: primary and

secondary market research.

Primary Market Research (Field Research)

The collection of original data. It involves directly collecting information from

existing or potential customers. First-hand data is collected by people who
want to use the data (i.e. the firm). Examples of primary market research
methods include questionnaires, focus groups, interviews, observation, and
online surveys and so on.

The process of primary research:

1.​ Establish the purpose of the market research

2.​ Decide on the most suitable market research method
3.​ Decide the size of the sample (customers to conduct research on) and
identify the sample
4.​ Carry out the research
5.​ Collect and analyse the data
6.​ Produce a report of the findings

Sample is a subset of a population that is used to represent the entire group

as a whole. When doing research, it is often impractical to survey every
member of a particular population because the number of people is simply
too large. Selecting a sample is called sampling. Random sampling occurs
when people are selected at random for research, while quota sampling is
when people are selected on the basis of certain characteristics (age, gender,
location etc.) for research.

Methods of primary research

●​ Questionnaires: Can be done face-to-face, through telephone, post or

the internet. Online surveys can also be conducted whereby
researchers will email the sample members to go onto a particular
website and fill out a questionnaire posted there. These questions need
to be unbiased, clear and easy to answer to ensure that reliable and
accurate answers are logged in. (The first part of this wikiHow article
will give you the basic idea of how a questionnaire should be prepared.)

Advantages:

●​ Detailed information can be collected

●​ Customer’s opinions about the product can be obtained
●​ Online surveys will be cheaper and easier to collate and
analyse
●​ Can be linked to prize draws and prize draw websites to
encourage customers to fill out surveys

Disadvantages:

●​ If questions are not clear or are misleading, then unreliable

answers will be given
●​ Time-consuming and expensive to carry out research, collate
and analyse them.
●​ Interviews: interviewer will have ready-made questions for the
interviewee.

Advantages:

●​ Interviewer is able to explain questions that the interviewee

doesn’t understand and can also ask follow-up questions
●​ Can gather detailed responses and interpret body-language,
allowing interviewers to come to accurate conclusions about
the customer’s opinions.
Disadvantages:

●​ The interviewer could lead and influence the interviewee to

answer a certain way. For example, by rephrasing a question
such as ‘Would you buy this product’ to ‘But, you would
definitely buy this product, right?’ to which the customer in
order to appear polite would say yes when in actuality they
wouldn’t buy the product.
●​ Time-consuming and expensive to interview everyone in the
sample
●​ Focus Groups: A group of people representative of the target market (a
focus group) agree to provide information about a particular product or
general spending patterns over time. They can also test the company’s
products and give opinions on them.

Advantage:

●​ They can provide detailed information about the consumer’s

opinions

Disadvantages:

●​ Time-consuming
●​ Expensive
●​ Opinions could be influenced by others in the group.
●​ Observation: This can take the form of recording (eg: meters fitted to
TV screens to see what channels are being watched), watching (eg:
counting how many people enter a shop), auditing (e.g.: counting of
stock in shops to see which products sold well).

Advantage:

●​ Inexpensive

Disadvantage:

●​ Only gives basic figures. Does not tell the firm why the
consumer buys them.
Secondary Market Research (Desk Research)

The collection of information that has already been made available by others.
Second-hand data about consumers and markets is collected from already
published sources.

Internal sources of information:

●​ Sales department’s sales records, pricing data, customer records, sales

reports
●​ Opinions of distributors and public relations officers
●​ Finance department
●​ Customer Services department

External sources of information:

●​ Government statistics: will have information about populations and

age structures in the economy.
●​ Newspapers: articles about economic conditions and forecast
spending patterns.
●​ Trade associations: if there is a trade association for a particular
industry, it will have several reports on that industry’s markets.
●​ Market research agencies: these agencies carry out market research
on behalf of the company and provide detailed reports.
●​ Internet: will have a wide range of articles about companies,
government statistics, newspapers and blogs.

Accuracy of Market Research Data

The reliability and accuracy of market research depends upon a large number
of factors:

●​ How carefully the sample was drawn up, its size, the types of people
selected etc.
●​ How questions were phrased in questionnaires and surveys
 ●​ Who carried out the research: secondary research is likely to be less
reliable since it was drawn up by others for different purposes at an
earlier time.
●​ Bias: newspaper articles are often biased and may leave out crucial
information deliberately.
●​ Age of information: researched data shouldn’t be too outdated.
Customer tastes, fashions, economic conditions, technology all move
fast and the old data will be of no use now.

Presentation of Data from Market Research

Different data handling methods can be used to present data from market
research. This will include:

●​ Tally Tables: used to record data in its original form. The tally table below
shows the number and type of vehicles passing by a shop at different
times of the day:​

●​ Charts: show the total figures for each piece of data (bar/ column charts)
or the proportion of each piece of data in terms of the total number (pie
charts). For example the above tally table data can be recorded in a bar
chart as shown below:​
 ​
The pie chart above could show a company’s market share in different
countries.
●​ Graphs: used to show the relationship between two sets of data. For
example how average temperature varied across the year.​

3.3 Marketing mix

Marketing mix refers to the different elements involved in the marketing of a
good or service- the 4 P’s- Product, Price, Promotion and Place.

Product

Product is the good or service being produced and sold in the market. This
includes all the features of the product as well as its final packaging.

Types of products include: consumer goods, consumer services, producer

goods, producer services.

What makes a successful product?

●​ It satisfies existing needs and wants of the customers

●​ It is able to stimulate new wants from the consumers
●​ Its design – performance, reliability, quality etc. should all be consistent
with the product’s brand image
●​ It is distinctive from its competitors and stands out
●​ It is not too expensive to produce, and the price will be able to cover the
costs

New Product Development: development of a new product by a business.

The process:

1.​ Generate ideas: the firm brainstorms new product concepts, using
customer suggestions, competitors’ products, employees’ ideas, sales
department data and the information provided by the research and
development department
2.​ Select the best ideas for further research: the firm decides which
ideas to abandon and which to research further. If the product is too
costly or may not sell well, it will be abandoned
3.​ Decide if the firm will be able to sell enough units for the product to
be a success: this research includes looking into forecast sales, size of
market share, cost-benefit analysis etc. for each product idea,
undertaken by the marketing department
 4.​ Develop a prototype: by making a prototype of the new product, the
operations department can see how the product can be manufactured,
any problems arising from it and how to fix them. Computer
simulations are usually used to produce 3D prototypes on screen
5.​ Test launch: the developed product is sold to one section of the market
to see how well it sells, before producing more, and to identify what
changes need to be made to increase sales. Today a lot of digital
products like apps and software run beta versions, which is basically a
market test
6.​ Full launch of the product: the product is launched to the entire
market

Advantages:

●​ Can create a Unique Selling Point (USP) by developing a new

innovative product for the first time in the market. This USP can be
used to charge a high price for the product as well as be used in
advertising.
●​ Charge higher prices for new products (price skimming as explained
later)
●​ Increase potential sales, revenue and profit
●​ Helps spreads risks because having more products mean that even if
one fails, the other will keep generating a profit for the company

Disadvantages:

●​ Market research is expensive and time consuming

●​ Investment can be very expensive

Why is brand image important?

Brand image is an identity given to a product that differentiates it from

competitors’ products.​
Brand loyalty is the tendency of customers to keep buying the same brand
continuously instead of switching over to competitors’ products.
 ●​ Consumers recognize the firm’s product more easily when looking at
similar products- helps differentiate the company’s product from
another.
●​ Their product can be charged higher than less well-known brands – if
there is an established high brand image, then it is easier to charge
high prices because customers will buy it nonetheless.
●​ Easier to launch new products into the market if the brand image is
already established. Apple is one such company- their brand image is so
reputed that new products that they launch now become an
immediate success.

Why is packaging important?

●​ It protects the product

●​ It provides information about the product (its ingredients, price,
manufacturing and expiry dates etc.)
●​ To help consumers recognize the product (the brand name and logo on
the packaging will help identify what product it is)
●​ It keeps the product fresh

​
Product Life Cycle (PLC)

The product life cycle refers to the stages a product goes through from its
introduction to its retirement in terms of sales.
At these different stages, the product will need different marketing
decisions/strategies in terms of the 4Ps.

Extension strategies: marketing techniques used to extend the maturity

stage of a product (to keep the product in the market):

●​ Finding new markets for the product

●​ Finding new uses for the product
●​ Redesigning the product or the packaging to improve its appeal to
consumers
●​ Increasing advertising and other promotional activities

The effect on the PLC of a product of a successful extension strategy:

Price

Price is the amount of money producers are willing to sell or consumers are
willing to buy the product for.

Different methods of pricing:

●​ Market skimming: Setting a high price for a new product that is unique
or very different from other products on the market.

Advantages:

●​ Profit earned is very high

●​ Helps recover/compensate research and development costs

Disadvantage:

●​ It may backfire if competitors produce similar products at a

lower price
●​ Penetration pricing: Setting a very low price to attract customers to
buy a new product

Advantages:
 ●​ Attracts customers more quickly
●​ Can increase market share quickly

Disadvantages:

●​ Low revenue due to lower prices

●​ Cannot recover development costs quickly
●​ Competitive pricing: Setting a price similar to that of competitors’
products which are already available in the market

Advantage:

●​ Business can compete on other matters such as service and

quality

Disadvantage:

●​ Still need to find ways of competing to attract sales.

●​ Cost plus pricing: Setting price by adding a fixed amount to the cost of
making the product

Advantages:

●​ Quick and easy to work out the price

●​ Makes sure that the price covers all of the costs

Disadvantage:

●​ Price might be set higher than competitors or more than

customers are willing to pay, which reduces sales and profits
●​ Loss leader pricing/Promotional pricing: Setting the price of a few
products at below cost to attract customers into the shop in the hope
that they will buy other products as well

Advantages:

●​ Helps to sell off unwanted stock before it becomes out of date

 ●​ A good way of increasing short term sales and market share

Disadvantage:

●​ Revenue on each item is lower so profits may also be lower

Factors that affect what pricing method should be used:

●​ Is it a new or existing product?​

If it’s new, then price skimming or penetration pricing will be most
suitable. If it’s an existing product, competitive pricing or promotional
pricing will be appropriate.
●​ Is the product unique?​
If yes, then price skimming will be beneficial, otherwise competitive or
promotional pricing.
●​ Is there a lot of competition in the market?​
If yes, competitive pricing will need to be used.
●​ Does the business have a well-known brand image?​
If yes, price skimming will be highly successful.
●​ What are the costs of producing and supplying the product?​
If there are high costs, costs plus pricing will be needed to cover the
costs. If costs are low, market penetration and promotional pricing will
be appropriate.
●​ What are the marketing objectives of the business?​
If the business objective is to quickly gain a market share and customer
base, then penetration pricing could be used. If the objective is to
simply maintain sales, competitive pricing will be appropriate.

Price Elasticity

The PED of a product refers to the responsiveness of the quantity

demanded for it to changes in its price.

PED (of a product) = % change in quantity demanded / % change in price

When the PED is >1, that is there is a higher % change in demand in response
to a change in price, the PED is said to be elastic.​
When the PED is <1, that is there is a lower % change in demand in response
to a change in price, the PED is said to be inelastic.

Producers can calculate the PED of their product and take suitable action to
make the product more profitable.

If the product is found to have an elastic demand, the producer can lower
prices to increase profitability. The law of demand states that a fall in price
increases the demand. And since it is an elastic product (change in demand is
higher than change in price), the demand of the product will increase highly.
The producers get more profit.​
If the product is found to have an inelastic demand, the producer can raise
prices to increase profitability. Since quantity demanded wouldn’t fall much
as it is inelastic, the high prices will make way for higher revenue and thus
higher profits.

For a detailed explanation about PED, click here

Place

Place refers to how the product is distributed from the producer to the final
consumer. There are different distribution channels that a product can be
sold through.

Distribution Disadvantag
Explanation Advantages
Channel es
 – Delivery
costs may be
high if there
are
customers
– All of the profit is
The product is sold to over a wide
earned by the
the consumer area
producer
straight from the
Manufactur manufacturer. A – All storage
– The producer
er good example is a costs must be
controls all parts of
factory outlet where paid for by
the marketing mix
to products directly the producer
Consumer arrive at their own
– Quickest method
shop from the factory – All
of getting the
and are sold to promotional
product to the
customers. activities
consumer
must be
carried out
and financed
by the
producer
 – The retailer
takes some of
the profit
away from
the producer
The manufacturer – The cost of
will sell its products holding inventories – The
to a retailer (who will of the product is producer
have stocks of paid by the retailer loses some
products from other control of the
Manufactur
manufacturers as – The retailer will marketing
er to
well) who will then pay for advertising mix
Retailer
sell them to and other
customers who visit promotional – The
to
the shop. For activities producer
Consumer
example, brands like must pay for
Sony, Canon and – Retailers are more delivery of
Panasonic sell their conveniently products to
products to various located for the retailers
retailers. consumers
– Retailers
usually sell
competitors’
products as
well
 The manufacturer
– Another
will sell large
middleman is
volumes of its
added so
products to a
more profit is
Manufactur wholesaler – Wholesalers will
taken away
er to (wholesalers will have advertise and
from the
Wholesaler stocks from different promote the
producer
manufacturers). product to retailers
to Retailer Retailers will buy
– The
small quantities of – Wholesalers pay
producer
to the product from the for transport and
loses even
Consumer wholesaler and sell it storage costs
more control
to the consumers.
of the
One good example is
marketing
the distribution of
mix
medicinal drugs.

The manufacturer
will sell their
Manufactur products to an agent
er who has specialized
information about
– Another
to Agent the market and will
middleman is
know the best – The agent has
added so
to wholesalers to sell specialised
even more
Wholesaler them to. This is knowledge of the
profit is taken
common when firms market
away from
to Retailer are exporting their
the producer
products to a foreign
to country. They will
Consumer need a
knowledgeable
agent to take care of
the products’
 distribution in
another country

What affects place decisions?

●​ The type of product it is: if it’s sold to producers of other goods,

distribution would either be direct (specialist machinery) or wholesaler
(nuts, bolts, screws etc.).
●​ The technicality of the product: as lots of technical information needs
to be passed to the customer, direct selling is usually preferred.
●​ How often the product is purchased: if the product is bought on a
daily basis, it should be sold through retail stores that customers can
easily access.
●​ The price of the product: if the product is an expensive, luxury good, it
would only be sold through a few specialist, high-end outlets For
example, luxury watches and jewellery.
●​ The durability of the product: if it’s an easily perishable product like
fruits, it will need to be sold through a wide number of retailers to be
sold quickly.
●​ Location of customers: the products should be easily accessible by its
customers. If customers are located all over the world, e-commerce
(explained below) will be required.
●​ Where competitors sell their product: in order to directly compete
with competitors, the products need to be sold where competitors are
selling too.

Promotion

Promotion: marketing activities used to communicate with customers and

potential customers to inform and persuade them to buy a business’s
products.

Aims of promotion:

●​ Inform customers about a new product

 ●​ Persuade customers to buy the product
●​ Create a brand image
●​ Increase sales and market share

Types of promotion

●​ Advertising: Paid-for communication with consumers which uses

printed and visual media like television, radio, newspapers, magazines,
billboards, flyers, cinema etc. This can be informative (create product
awareness) or persuasive (persuade consumers to buy the product). The
process of advertising:​

●​ Sales Promotion: using techniques such as ‘buy one get one free’,
occasional price reductions, free after-sales services, gifts, competitions,
point-of–sale displays (a special display stand for a product in a shop),
free samples etc. to encourage sales.
●​ Below-the-line promotion: promotion that is not paid for
communication but uses incentives to encourage consumers to buy.
Incentives include money-off coupons or vouchers, loyalty reward
schemes, competitions and games with cash or other prizes.
●​ Personal selling: sales staff communicate directly with consumers to
achieve a sale and form a long-term relationship between the firm and
consumer.
●​ Direct mail: also known as mailshots, printed materials like flyers,
newsletters and brochures which are sent directly to the addresses of
customers.
●​ Sponsorship: payment by a business to have its name or products
associated with a particular event. For example Emirates is Spanish
football club Real Madrid’s jersey sponsor- Emirates pays the club to be
its sponsor and gains a high customer awareness and brand image in
return.

What affects promotion decisions?

 ●​ Stage of product on the PLC: different stages of the PLC will require
different promotional strategies; see above.
●​ The nature of the product: If it’s a consumer good, a firm could use
persuasive advertising and use billboards and TV commercials.
Producer goods would have bulk-buy-discounts to encourage more
sales. The kind of product it is can affect the type of advertising, the
media of advertising and the method of sales promotion.
●​ The nature of the target market: a local market would only need small
amounts of advertising while national markets will need TV and
billboard advertising. If the product is sold to a mass market, extensive
advertising would be needed. But niche market products such as water
skis would only need advertising in special sports and lifestyle
magazines.
●​ Cost-effectiveness: the amount of money put into promotion (out of
the total marketing budget) should be not too much that it fails to
bring in the sales revenue enough to cover those costs at least.
Promotional activities are highly dependent on the budget.

Technology and the Marketing Mix

It is also worth noting that the internet/ e-commerce is now widely used to

distribute products. E-Commerce is the use of the internet and other

technologies used by businesses to market and sell goods and services to

customers. Examples of e-commerce include online shopping, internet

banking, online ticket-booking, online hotel reservations etc.

Websites like Amazon and eBay act as online retailers.​

Online selling is favoured by producers because it is cheaper in the long-run
and they can sell products to a larger customer base/ market. However
there will be increased competition from lots of producers.​
Consumers prefer online shopping because there are wider choices of
detailed products that are also cheaper and they can buy things at their own
convenience 24×7. However, there is no personal communication with the
producer and online security issues may occur.

However, e-commerce means an entire new type of marketing strategy is

also required – online promotions, new channel of distribution, new pricing
strategies (since price competition in e-commerce is very high and demand is
very price elastic). It requires a lot of money to set up – online websites,
promotions, web developers and technicians to run and maintain the system
etc.

The internet is also used for promotion and advertising of products in the
form of paid social media ads and sponsors, pop-ups, email newsletters etc.
It helps reach target customers, is relatively cheap and helps the firm
respond to market changes quicker(since online ads can be easily
altered/updated rather than billboards and TV ads). But it can alienate and
chase customers away if they see it too frequently and find it annoying.
There is also the risk of the adverts being publicised negatively if it has
annoying or offensive content that customers quickly criticise (since content
is more easily shareable online).

3.4 Marketing strategy

Marketing Strategy

A marketing strategy is a plan to combine the right combination of the four

elements of the marketing mix for a product to achieve its marketing
objectives. Marketing objectives could include maintaining market shares,
increasing sales in a niche market, increasing sales of an existing product by
using extension strategies etc.

Factors that affect the marketing strategy:

Legal Controls on Marketing

There are various laws that can affect marketing decisions on quality, price
and the contents of advertisements.
●​ laws that protect consumers from being sold faulty and dangerous
goods
●​ laws that prevent the firms from using misleading information in
advertising Example: Volkswagen falsely advertised environmentally
friendly diesel cars and were legally forced to pull all cars from the
market
●​ laws that protect consumers from being exploited in industries where
there is little or no competition, known as monopolising.

Entering New Markets

Growing business in other countries can increase sales, revenue and profits.
This is because the business is now available to a wider group of people,
which increases potential customers. If the home markets have saturated
(product is in maturity stage), firms take their products to international
markets. Trade barriers and restrictions have also reduced significantly over
the years, along with new transport infrastructures, so it is now cheaper and
easier to export products to other countries.

Problems of entering foreign markets:

●​ Difference in language and culture: It may be difficult to

communicate with people in other countries because of language
barriers and as for culture, different images, colors and symbols have
different meanings and importance in different places. For example,
McDonald’s had to make its menu more vegetarian in Indian markets
●​ Lack of market knowledge: The business won’t know much about the
market it is entering and the customers won’t be familiar with the new
business brand, and so getting established in the market will be difficult
and expensive
●​ Economic differences: The cost and prices may be lower or higher in
different countries so businesses may not be able to sell the product at
the price which will give them a profit
●​ High transport costs
●​ Social differences: Different people will have different needs and wants
from people in other countries, and so the product may not be
successful in all countries
●​ Difference in legal controls to protect consumers: The business may
have to spend more money on producing the products in a way that
complies with that country’s laws.

How to overcome such problems:

●​ Joint venture: an agreement between two or more businesses to

work together on a project. The foreign business will work with a
domestic business in the same industry. Eg: Japan’s Suzuki Motor
Corporation created a joint venture with India’s Maruti Udyog Limited to
form Maruti Suzuki, a highly successful car manufacturing project in
India.

Advantages:

●​ Reduces risks and cuts costs

●​ Each business brings different expertise to the joint venture
 ●​ The market potential for all the businesses in the joint venture
is increased
●​ Market and product knowledge can be shared to the benefit of
the businesses

Disadvantages:

●​ Any mistakes made will reflect on all parties in the joint

venture, which may damage their reputations
●​ The decision-making process may be ineffective due to
different business culture or different styles of leadership
​ Franchise/License: the owner of a business (the franchisor) grants a
licence to another person or business (the franchisee) to use their
business idea – often in a specific geographical area. Fast food
companies such as McDonald’s and Subway operate around the globe
through lots of franchises in different countries.

ADVANTAGES DISADVANTAGES

Profits from the

Rapid, low cost franchise needs to be
method of business shared with the
expansion franchisee

Gets an income from Loss of control over

TO
franchisee in the form running of business
FRANCHISO
of franchise fees and
R
royalties
If one franchise fails, it
can affect the
Franchisee will better reputation of the
understand the local entire brand
tastes and so can
 advertise and sell Franchisee may not be
appropriately as skilled

Can access ideas and Need to supply raw

suggestions from material/product and
franchisee provide support and
training

Franchisee will run

the operations

Cost of setting up
business

Working with an No full control over

established brand business- need to
means chance of strictly follow
business failing is low franchisor’s standards
and rules
Franchisor will give
TO
technical and
FRANCHISE
managerial support Profits have to be
E
shared with franchisor

Franchisor will supply

the raw Need to pay franchisor
materials/products franchise fees and
royalties

Need to advertise and

promote the business
 in the region
themselves

4 Operations management
4.1 Production and of goods and
services
Production is the effective management of resources in producing goods
and services.

The operations department in a firm overlooks the production process. They

must:

●​ Use the resources in a cost-effective and efficient manner

●​ Manage inventory effectively
●​ Produce the required output to meet customer demands
●​ Meet the quality standards expected by customers

Productivity
Productivity is a measure of the efficiency of inputs used in the production
process over a period of time. It is the output measured against the inputs
used to produce it. The formula is:

Businesses often measure the labour productivity to see how efficient their
employees are in producing output. The formula for it is:

Businesses look to increase productivity, as the output will increase per

employee and so the average costs of production will fall. This way, they will
be able to sell more while also being able to lower prices.

Ways to increase productivity:

●​ improving labour skills by training them so they work more

productively and waste lesser resources
●​ introducing automation (using machinery and IT equipment to control
production) so that production is faster and error-free
●​ improve employee motivation so that they will be willing to produce
more and efficiently.
●​ improved quality control and assurance systems to ensure that there
are no wastage of resources

Inventory Management

Firms can hold inventory (stock) of raw materials, goods that are not
completed yet (a.k.a work-in-progress) and finished unsold goods. Finished
good stocks are kept so that any unexpected rise in demand is fulfilled.
 ●​ When inventory gets to a certain point (reorder level), they will be
reordered by the firm to bring the level of inventory back up to the
maximum level again. The business has to reorder inventory before they
go too low since the reorder supply will take time to arrive at the firm
●​ The time it takes for the reorder supply to arrive is known as lead time.
●​ If too high inventory is held, the costs of holding and maintaining it will
be very high.
●​ The buffer inventory level is the level of inventory the business should
hold at the very minimum to satisfy customer demand at all times.
During the lead time the inventory will have hit the buffer level and as
reorder arrives, it will shoot back up to the maximum level.

Lean Production

Lean production refers to the various techniques a firm can adopt to reduce
wastage and increase efficiency/productivity.

The seven types of wastage that can occur in a firm:

●​ Overproduction– producing goods before they have been ordered by

customers. This results in too much output and so high inventory costs
●​ Waiting– when goods are not being moved or processed in any way,
then waste is occurring
●​ Transportation-moving goods around unnecessarily is simply wasting
time. They also risk damage during movement
 ●​ Unnecessary inventory-too much inventory takes up valuable space
and incurs cost
●​ Motion-unnecessary moving of employees and operation of machinery
is a waste of time and cost respectively.
●​ Over-processing-using complex machinery and equipment to perform
simple tasks may be unnecessary and is a waste of time, effort and
money
●​ Defects– any fault in equipment can halt production and waste
valuable time. Goods can also turn out to be faulty and need to be fixed-
taking up more money and time

By avoiding such wastage, a firm can benefit in many ways

●​ less storage of raw materials, components and finished goods- less

money and time tied up in inventory
●​ quicker production of goods and services
●​ no need to repair faulty goods- leads to good customer satisfaction
●​ ultimately, costs will lower, which helps reduce prices, making the
business more competitive and earn higher profits as well

Now, how to implement lean production? The different methods are:

●​ Kaizen: it’s a Japanese term meaning ‘continuous improvement’. It

aims to increase efficiency and reduce wastage by getting workers to
get together in small groups and discuss problems and suggest
solutions. Since they’re the ones directly involved in production they
will know best to identify issues. When kaizen is implemented, the
factory floor, for example, is rearranged by re-positioning machinery
and equipment so that production can flow smoothly through the
 factory in the least possible time.​

Benefits:

●​ increased productivity
●​ reduced amount of space needed for production
●​ improved factory layout may allow some jobs to be
combined, `freeing up employees to do other jobs in
the factory
​ Just-in-Time inventory control: this technique eliminates the need to
hold any kind of inventory by ensuring that supplies arrive just in time
they are needed for production. The making of any parts is done just in
time to be used in the next stage of production and finished goods are
made just in time they are needed for delivery to the customer/shop.
The firm will need very reliable suppliers and an efficient system for
reordering supplies.​
Benefits:Reduces cost of holding inventory
●​ Warehouse space is not needed any more, so more space is
available for other uses
●​ Finished goods are immediately sold off, so cash flows in
quickly
​ Cell Production: the production line is divided into separate,
self-contained units each making a part of the finished product. This
 works because it improves worker morale when they are put into teams
and concentrate on one part alone.

Methods of Production

●​ Job Production: products are made specifically to order, customized for

each customer. Eg: wedding cakes, made-to-measure suits, films etc.​
Advantages:Most suitable for one-off products and personal services
●​ The product meets the exact requirement of the customer
●​ Workers will have more varied jobs as each order is different,
improving morale
●​ very flexible method of production
●​ ​
Disadvantages:Skilled labour will often be required which is expensive
●​ Costs are higher for job production firms because they are
usually labour-intensive
●​ Production often takes a long time
●​ Since they are made to order, any errors may be expensive to
fix
●​ Materials may have to be specially purchased for different
orders, which is expensive
●​ Batch Production: similar products are made in batches or blocks. A
small quantity of one product is made, then a small quantity of another.
Eg: cookies, building houses of the same design etc.​
Advantages:Flexible way of working- production can be easily switched
between products
●​ Gives some variety to workers
●​ More variety means more consumer choice
●​ Even if one product’s machinery breaks down, other products
can still be made
●​ ​
Disadvantages:Can be expensive since finished and semi-finished
goods will need moving about
●​ Machines have to be reset between production batches which
delays production
●​ Lots of raw materials will be needed for different product
batches, which can be expensive.
Flow Production: large quantities of products are produced in a continuous
process on the production line. Eg: a soft drinks factory.​
Advantages:There is a high output of standardized (identical) products

●​ Costs are low in the long run and so prices can be kept low
●​ Can benefit from economies of scale in purchasing
●​ Automated production lines can run 24×7
●​ Goods are produced quickly and cheaply
●​ Capital-intensive production, so reduced labour costs and
increases efficiency
●​ ​
Disadvantages:A very boring system for the workers, leads to low job
satisfaction and motivation
●​ Lots of raw materials and finished goods need to be held in
inventory- this is expensive
●​ Capital cost of setting up the flow line is very high
●​ If one machinery breaks down, entire production will be
affected

Factors that affect which production method to use:

●​ The nature of the product: Whether it is a personal,

customized-to-order product, in which case job production will be used.
If it is a standard product, then flow production will be used
●​ The size of the market: For a large market, flow production will be
required. Small local and niche markets may make use of batch and
flow production. Goods that are highly demanded but not in very large
quantities, batch production is most suitable.
●​ The nature of demand: If there is a fair and steady demand for the
product, it would be more suitable to run a production line for the
product. For less frequent demand, batch and job will be appropriate.
●​ The size of the business: Small firms with little capital access will not
produce using large automated production lines, but will use batch and
job production.

Technology and Production

 ●​ Automation: equipment used in the factory is controlled by computers
to carry out mechanical processes, such as spray painting a car body.
●​ Mechanization: production is done by machines but is operated by
people
●​ CAD (computer aided designing): a computer software that draws
items being designed more quickly and allows them to be rotated,
zoomed in and viewed from all angles.
●​ CAM (computer aided manufacturing): computers monitor the
production process and controls machines and robots-similar to
automation
●​ CIM (computer integrated manufacturing): the integration of CAD and
CAM. The computers that design the product using CAD are connected
to the CAM software to directly produce the physical design.
●​ EPOS (electronic point-of-sale): used at checkouts/tills where the
operator scans the bar-code of each item bought by the customer
individually. The item details and price appear on screen and are
printed in the receipt. They can also automatically update and reorder
stock as items are bought.
●​ EFTPOS (electronic funds transfer at point-of-sale): the electronic cash
register at the till will be connected to the retailer’s main computer and
different banks. When the customer swipes the debit card at the till,
information is read by the scanner and an amount is withdrawn from
the customer’s bank account (after the PIN is entered).

Advantages of technology in production

●​ Greater productivity
●​ Greater job satisfaction among workers as boring, routine jobs are done
by machines
●​ Better quality products
●​ Quicker communication and less paperwork
●​ More accurate demand levels are forecast since computer monitor
inventory levels
●​ New products can be introduced as new production methods are
introduced

Disadvantages of technology in production

 ●​ Unemployment rises as machines and computers replace human
labour
●​ Expensive to set up
●​ New technology quickly becomes outdated and frequent updating of
systems will be needed- this is expensive and time-consuming.
●​ Employees may take time to adjust to new technology or even resist it
as their work practices change.

4.2 Costs, Scale of production and break

even analysis
Costs

Fixed Costs are costs that do not vary with output produced or sold in the
short run. They are incurred even when the output is 0 and will remain the
same in the short run. In the long-run they may change. Also known as
overhead costs.​
E.g.: rent, even if production has not started, the firm still has to pay the rent.

Variable Costs are costs that directly vary with the output produced or sold.
E.g.: material costs and wage rates that are only paid according to the output
produced.

TOTAL COST = TOTAL FIXED COSTS + TOTAL VARIABLE COSTS

TOTAL COST = AVERAGE COST * OUTPUT

AVERAGE COST (unit cost) = TOTAL COST/ TOTAL OUTPUT

A business can use these cost data to make different decisions. Some
examples are: setting prices (if the average cost of one unit is $3, then the
price would be set at $4 to make a profit of $1 on each unit), deciding
whether to stop production (if the total cost exceeds the total revenue, a loss
is being made, and so the production might be stopped), deciding on the
best location(locations with the cheaper costs will be chosen) etc.
Scale of production

As output increases, a firm’s average cost decreases.

Economies of scale are the factors that lead to a reduction in average costs
as a business increases in size. The five economies of scale are:

●​ Purchasing economies: For large output, a large amount of

components have to be bought. This will give them some bulk-buying
discounts that reduce costs
●​ Marketing economies: Larger businesses will be able to afford their
own vehicles to distribute goods and advertise on paper and TV. They
can cut down on marketing labour costs. The advertising rates costs
also do not rise as much as the size of the advertisement ordered by the
business. Average costs will thus reduce.
●​ Financial economies: Bank managers will be more willing to lend
money to large businesses as they are more likely to be able to pay off
the loan than small businesses. Thus they will be charged a low rate of
interest on their borrowings, reducing average costs.
●​ Managerial economies: Large businesses may be able to afford to hire
specialist managers who are very efficient and can reduce the business’
costs.
●​ Technical economies: Large businesses can afford to buy large
machinery such as a flow production line that can produce a large
output and reduce average costs.

Diseconomies of scale are the factors that lead to an increase in the average
costs of a business as it grows beyond a certain size. They are:

●​ Poor communication: as a business grows large, more departments

and managers and employees will be added and communication can
get difficult. Messages may be inaccurate and slow to receive, leading to
lower efficiency and higher average costs in the business.
●​ Low morale: when there are lots of workers in the business and they
have non-contact with their senior managers, the workers may feel
unimportant and not valued by management. This would lead to
inefficiency and higher average costs.
 ●​ Slow decision-making: As a business grows larger, its chain of
command will get longer. Communication will get very slow and so any
decision-making will also take time, since all employees and
departments may need to be consulted with.

Businesses are now dividing themselves into small units that can control
themselves and communicate more effectively, to avoid any diseconomies
from arising.

Break-even

Break-even level of output is the output that needs to be produced and sold
in order to start making a profit. So, the break-even output is the output at
which total revenue equals total costs(neither a profit nor loss is made, all
costs are covered).

A break-even chart can be drawn that shows the costs and revenues of a
business across different levels of output and the output needed to break
even.

Example:​
In the chart below, costs and revenues are being calculated over the output of
2000 units.​
The fixed cost is 5000 across all output (since it is fixed!).​
The variable cost is $3 per unit so will be $0 at output 0 and $6000 at output
2000- so you just draw a straight line from $0 to $6000.​
The total costs will then start from the point where fixed cost starts and be
parallel to the variable costs (since T.C.= F.C.+V.C. You can manually calculate
the total cost at output 2000: ($6000+$5000=$11000).​
The price per unit is $8 so the total revenue is $16000 at output 2000.

Now the break-even point can be calculated at the point where total
revenue and total cost equals– at an output of 1000. (In order to find the
sales revenue at output 1000, just do $8*1000= $8000. The business needs to
make $8000 in sales revenue to start making a profit).
Advantages of break-even charts:

●​ Managers can look at the graph to find out the profit or loss at each
level of output
●​ Managers can change the costs and revenues and redraw the graph to
see how that would affect profit and loss, for example, if the selling price
is increased or variable cost is reduced.
●​ The break-even chart can also help calculate the safety margin- the
amount by which sales exceed break-even point. In the above graph, if
the business decided to sell 2000 units, their margin of safety would be
1000 units. In sales terms, the margin of safety would be 1000*8 =
$8000. They are $8000 safe from making a loss.​
Margin of Safety (units) = Units being produced and sold –
Break-even output

Limitations of break-even charts:

 ●​ They are constructed assuming that all units being produced are sold.
In practice, there is always an inventory of finished goods. Not
everything produced is sold off.
●​ Fixed costs may not always be fixed if the scale of production
changes. If more output is to be produced, an additional factory or
machinery may be needed that increases fixed costs.
●​ Break-even charts assume that costs can always be drawn using
straight lines. Costs may increase or decrease due to various reasons. If
more output is produced, workers may be given an overtime wage that
increases the variable cost per unit and causes the variable cost line to
steep upwards.

Break-even can also be calculated without drawing a chart. A formula can be

used:

Break-even level of production =Total fixed costs/ Contribution per unit

Contribution = Selling price – Variable cost per unit (this is the value
added/contributed to the product when sold)

In the above example, the contribution is $8 -$3 =$5, so the break-even level
is:​
$5000/$5 = 1000 units!

4.3 Achieving quality production

Quality means to produce a good or service which meets customer
expectations. The products should be free of faults or defects. Quality is
important because it:

●​ establishes a brand image

●​ builds brand loyalty
●​ maintains good reputation
●​ increase sales
●​ attract new customers

If there is no quality, the firm will

 ●​ lose customers to other brands
●​ have to replace faulty products and repeat poor service, increasing costs
●​ bad reputation leading to low sales and profits

There are three methods a business can implement to achieve quality: quality
control, quality assurance and total quality management.

Quality Control

Quality control is the checking for quality at the end of the production
process, whether a good or a service.​
Advantages:

●​ Eliminates the fault or defect before the customer receives it, so better
customer satisfaction
●​ Not much training required for conducting this quality check

Disadvantages:

●​ Still expensive to hire employees to check for quality

●​ Quality control may find faults and errors but doesn’t find out why the
fault has occurred, so the it’s difficult to solve the problem
●​ if product has to be replaced and reworked, then it is very expensive
for the firm

Quality Assurance

Quality assurance is the checking for quality throughout the production

process of a good or service.

Advantages:

●​ Eliminates the fault or defect before the customer receives it, so better
customer satisfaction
●​ Since each stage of production is checked for quality, faults and errors
can be easily identified and solved
 ●​ Products don’t have to be scrapped or reworked as often, so less
expensive than quality control

Disadvantages:

●​ Expensive to carry out since quality checks have to be carried

throughout the entire process, which will require manpower and
appropriate technology at every stage.
●​ How well will employees follow quality standards? The firm will have to
ensure that every employee follows quality standards consistently and
prudently, and knows how to address quality issues.

Total Quality Management (TQM)

Total Quality Management or TQM is the continuous improvement of

products and production processes by focusing on quality at each stage
of production. There is great emphasis on ensuring that customers are
satisfied. In TQM, customers just aren’t the consumers of the final product. It
is every worker at each stage of production. Workers at one stage have to
ensure the quality standards are met for the product in production at their
stage before they are passed onto the next stage and so on. Thus, quality is
maintained throughout production and products are error-free.

TQM also involves quality circles and like Kaizen, workers come together and
discuss issues and solutions, to reduce waste and ensure zero defects.

Advantages:

●​ quality is built into every part of the production process and becomes
central to the workers principles
●​ eliminates all faults before the product gets to the final customer
●​ no customer complaints and so improved brand image
●​ products don’t have to be scrapped or reworked, so lesser costs
●​ waste is removed and efficiency is improved

Disadvantages:

●​ Expensive to train employees all employees

 ●​ Relies on all employees following TQM– how well are they motivated
to follow the procedures?

How can customers be assured of the quality of a product or service?

They can look for a quality mark on the product like ISO (International
Organization for Standardization). The business with these quality marks
would have followed certain quality procedures to keep the quality mark. For
services, a good reputation and positive customer reviews are good indicators
of the service’s quality.

4.4 Location decisions

Owners need to decide a location for their firm to operate in, at the time of
setting up, when it needs to expand operations, and when the current
location proves unsatisfactory for some reason. Location is important because
it can affect the firm’s costs, profits, efficiency and the market base it reaches
out to.

Factors that affect the location decisions of a manufacturing firm:

●​ Production Method: when job production is used, the business will

operate on a small scale, so the nearness to components/raw materials
won’t be that important. For flow production, on the other hand,
production will be on a large scale- there will be a huge amount of
components and transport costs will be high- so components need to
be close by.
●​ Market: if the product is a consumer good and perishable, the factories
need to be close to the markets to sell out quickly before it perishes.
●​ Raw Materials/Components: the factories may need to be located
close to where raw materials can be acquired, especially if the raw
material is to be processed while still fresh, like fruits for fruit juice.
●​ External economies: the business may locate near other firms that
support the business by providing services- eg: business that install and
maintain factory equipment.
●​ Availability of labour: Businesses will need to locate near areas where
they can get workers of the skills they need in the factory. If lots of
 unskilled workers are needed in the factories, firms locate in areas of
high unemployment. Wage rates also vary by location and firms will
want to set up in locations where wage rates are low.
●​ Government Influence: the government sometimes gives incentives
and grants to firms that set up in low-development, rural and
high-unemployment areas. There may also be a government. rules and
restrictions in setting up, e.g.: in some areas of great natural beauty. The
business needs to consider these.
●​ Transport & Communication infrastructure: the factories need to be
located near areas where there are good road/rail/port/air transport
systems. If goods are to be exported, they need to be set up near ports.
●​ Power and water supply: factories need water and power to operate
and a reliable and steady supply of both should be ensured by setting
up in areas where they are available.
●​ Climate: not the most important factor but can influence certain
sectors. Eg: the dry climate in Silicon Valley aids the manufacturing of
silicon chips.
●​ Owner’s personal preferences

Factors that affect the location decisions of a service-sector firm:

●​ Customers: service-sector businesses that have direct contact with

customers need to locate in customer-accessible and convenient
places. Eg; restaurants, hairdressers, post offices etc.
●​ Technology: today, with increasing use of IT to shop and make
payments, customers do not need direct access to services and
proximity to the market/customer is not a very important factor in
location decisions. They locate away from customers in places where
there are low rent and wage rates. Eg: banks
●​ Availability of labour: if a large number of workers are required in the
firm, then it will need to be located close to residential areas. If they
want certain types of worker skills, they will need to locate in places
where such skilled workers can be found. However, with
work-from-home and technology, this is not that big of a factor
nowadays.
●​ Climate: tourism services need to be located in places of good climate.
●​ Nearness to other business: some services serve the needs of large
companies, such as firm equipment servicing and so they need to be
 very close to such businesses. Businesses may also set up where close
competitors are to watch them and snatch away their customers.
●​ Rent/taxes
●​ Owner’s personal preferences

Factors that affect the location decisions of a retailing firm:

●​ Shoppers: retailers need to be located in areas where shoppers

frequent, like malls, to attract as many customers as possible.
●​ Nearby shops: being located to other shops that are visited regularly
will also attract attention of customers into the shop. Being near
competitors also helps keep an eye on competition and snatch away
customers.
●​ Customer parking availability: when parking is available nearby, more
people will find it convenient to shop in that area.
●​ Availability of suitable vacant premises: Obviously, there needs to be a
vacant premise available to set up the business. Vacant premises can
also help the business expand their premises in the future.
●​ Rent/taxes: rents and taxes on the locations need to be affordable.
●​ Access to delivery vehicles: if the retailer has home delivery services,
then delivery vehicles will be required.
●​ Security: high rates of crime and theft can happen in shops. Shopping
complexes with security guards will thus be preferred by firms.

Why do businesses locate in different countries?

●​ New markets overseas.

●​ Cheaper or new raw materials available in other countries.
●​ Cheaper and/or skilled workers are available overseas.
●​ Rent/ taxes are lower..
●​ Availability of government grants and other incentives
●​ Avoid trade barriers and tariffs: when exporting goods to other
countries, there will be some tariffs, rules and regulations to get by. In
order to avoid this, firms start operating in the country itself, since there
is no exporting/importing involved now.

The role of legal controls on location decisions

Governments influence location decisions:

●​ to encourage businesses to set up and expand in areas of high

unemployment and under-development. Grants and subsidies can be
given to businesses that set up in such areas.
●​ to discourage firms from setting in areas that are overcrowded or
renowned for natural beauty. Planning restrictions can be put into
place to do so.

5. Financial information
and decisions
5.1 Business finance; Needs and sources
Finance is the money required in the business. Finance is needed to set up
the business, expand it and increase working capital (the day-to-day running
expenses).

Start-up capital is the initial capital used in the business to buy fixed and
current assets before it can start trading.

Working Capital finance needed by a business to pay its day-to-day running

expenses

Capital expenditure is the money spent on fixed assets (assets that will last
for more than a year). Eg: vehicles, machinery, buildings etc. These are
long-term capital needs.

Revenue Expenditure, similar to working capital, is the money spent on

day-to-day expenses which does not involve the purchase of long-term assets.
Eg: wages, rent. These are short-term capital needs.

Sources of Finance
Internal finance is obtained from within the business itself.

●​ Retained Profit: profit kept in the business after owners have been
given their share of the profit. Firms can invest this profit back in the
businesses.​
Advantages:​
– Does not have to be repaid, unlike a loan.​
– No interest has to be paid​
Disadvantages:​
– A new business will not have retained profit​
– Profits may be too low to finance​
– Keeping more profits to be used as capital will reduce the owner's
share of profit and they may resist the decision.
●​ Sale of existing assets: assets that the business doesn’t need anymore,
for example, unused buildings or spare equipment can be sold to raise
finance​
Advantages:​
– Makes better use of capital tied up in the business​
– Does not become debt for the business, unlike a loan.​
Disadvantages:​
– Surplus assets will not be available with new businesses​
– Takes time to sell the asset and the expected amount may not be
gained for the asset
●​ Sale of inventories: sell of finished goods or unwanted components in
inventory.​
Advantage: ​
– Reduces costs of inventory holding​
Disadvantage:​
– If not enough inventory is kept, unexpected increase demand from
customers cannot be fulfilled
●​ Owner’s savings: For a sole trader and partnership, since they’re
unincorporated (owners and business is not separate), any finance the
owner directly invests from his own savings will be internal finance.​
Advantages:​
– Will be available to the firm quickly​
– No interest has to be paid.​
Disadvantages:​
– Increases the risk taken by the owners.
External finance is obtained from sources outside of the business.

●​ Issue of share: only for limited companies.

Advantage:

●​ A permanent source of capital, no need to repay the money to

shareholders​
no interest has to be paid

Disadvantages:

●​ Dividends have to be paid to the shareholders

●​ If many shares are bought, the ownership of the business will
change hands. (The ownership is decided by who has the
highest percentage of shares in the company)
​ Bank loans: money borrowed from banks

Advantages:

●​ Quick to arrange a loan

●​ Can be for varying lengths of time
●​ Large companies can get very low rates of interest on their
loans

Disadvantages:

●​ Need to pay interest on the loan periodically

●​ It has to be repaid after a specified length of time
●​ Need to give the bank a collateral security (the bank will ask for
some valued asset, usually some part of the business, as a
security they can use if at all the business cannot repay the
loan in the future. For a sole trader, his house might be
collateral. So there is a risk of losing highly valuable assets)
​ Debenture issues: debentures are long-term loan certificates issued by
companies. Like shares, debentures will be issued, people will buy them
and the business can raise money. But this finance acts as a loan- it will
 have to be repaid after a specified period of time and interest will have
to be paid for it as well.

Advantage:

●​ Can be used to raise very long-term finance, for example, 25

years

Disadvantage:

●​ Interest has to be paid and it has to be repaid

​ Debt factoring: a debtor is a person who owes the business money for
the goods they have bought from the business. Debt factors are
specialist agents that can collect all the business’ debts from debtors.

Advantages:

●​ Immediate cash is available to the business

●​ Business doesn’t have to handle the debt collecting

Disadvantage:

●​ The debt factor will get a percent of the debts collected as

reward. Thus, the business doesn’t get all of their debts
​ Grants and subsidies: government agencies and other external sources
can give the business a grant or subsidy

Advantage:

●​ Do not have to be repaid, is free

Disadvantage:

●​ There are usually certain conditions to fulfil to get a grant.

Example, to locate in a particular under-developed area.
​ Micro-finance: special institutes are set up in poorly-developed
countries where financially-lacking people looking to start or expand
 small businesses can get small sums of money. They provide all sorts of
financial services
​ Crowdfunding: raises capital by asking small funds from a large pool of
people, e.g. via Kickstarter. These funds are voluntary ‘donations’ and
don’t have to be returned or paid a dividend.

Short-term finance provides the working capital a business needs for its
day-to-day operations.

●​ Overdrafts: similar to loans, the bank can arrange overdrafts by allowing

businesses to spend more than what is in their bank account. The
overdraft will vary with each month, based on how much extra money
the business needs.

Advantages:

●​ Flexible form of borrowing since overdrawn amounts can be

varied each month
●​ Interest has to be paid only on the amount overdrawn
●​ Overdrafts are generally cheaper than loans in the long-term

Disadvantages:

●​ Interest rates can vary periodically, unlike loans which have a

fixed interest rate.
●​ The bank can ask for the overdraft to be repaid at a
short-notice.
​ Trade Credits: this is when a business delays paying suppliers for some
time, improving their cash position

Advantage:

●​ No interests, repayments involved

Disadvantage:
 ●​ If the payments are not made quickly, suppliers may refuse to
give discounts in the future or refuse to supply at all
​ Debt Factoring: (see above)
​ ​
Long-term finance is the finance that is available for more than a year.
●​ Loans: from banks or private individuals.
●​ Debentures
●​ Issue of Shares
●​ Hire Purchase: allows the business to buy a fixed asset and pay for it in
monthly installments that include interest charges. This is not a method
to raise capital but gives the business time to raise the capital.

Advantage:

●​ The firms doesn’t need a large sum of cash to acquire the asset

Disadvantage:

●​ A cash deposit has to be paid in the beginning

●​ Can carry large interest charges.
​ Leasing: this allows a business to use an asset without purchasing it.
Monthly leasing payments are instead made to the owner of the asset.
The business can decide to buy the asset at the end of the leasing
period. Some firms sell their assets for cash and then lease them back
from a leasing company. This is called sale and leaseback.

Advantages:

●​ The firm doesn’t need a large sum of money to use the asset
●​ The care and maintenance of the asset is done by the leasing
company

Disadvantage:

●​ The total costs of leasing the asset could finally end up being
more than the cost of purchasing the asset!

Factors that affect choice of source of finance

 ●​ Purpose: if a fixed asset is to be bought, hire purchase or leasing will be
appropriate, but if finance is needed to pay off rents and wages, debt
factoring, overdrafts will be used.
●​ Time-period: for long-term uses of finance, loans, debenture and share
issues are used, but for a short period, overdrafts are more suitable.
●​ Amount needed: for large amounts, loans and share issues can be
used. For smaller amounts, overdrafts, sale of assets, debt factoring will
be used.
●​ Legal form and size: only a limited company can issue shares and
debentures. Small firms have limited sources of finances available to
choose from
●​ Control: if limited companies issue too many shares, the current owners
may lose control of the business. They need to decide whether they
would risk losing control for business expansion.
●​ Risk- gearing: if a business has existing loans, borrowing more capital
can increase gearing- risk of the business- as high interests have to be
paid even when there is no profit, loans and debentures need to be
repaid etc. Banks and shareholders will be reluctant to invest in risky
businesses.

Finance from banks and shareholders

Chances of a bank willing to lend a business finance is higher when:

●​ A cash flow forecast is presented detailing why finance is needed and

how it will be used
●​ An income statement from the last trading year and the forecast
income statement for the next year, to see how much profit the
business makes and will make.
●​ Details of existing loans and sources of finance being used
●​ Evidence that a security/collateral is available with the business to
reduce the bank’s risk of lending
●​ A business plan is presented to explain clearly what the business hopes
to achieve in the future and why finance is important to these plans

Chances of a shareholder willing to invest in a business is higher when:

 ●​ the company’s share prices are increasing- this is a good indicator of
improving performance
●​ dividends and profits are high
●​ the company has a good reputations and future growth plans

5.2 Cash flow forecasting and working

capital
Why is cash important?

If a firm doesn’t have any cash to pay its workers, suppliers, landlord and
government, the business could go into liquidation– selling everything it
owns to pay its debts. The business needs to have an adequate amount of
cash to be able to pay for all its short-term payments.

Cash Flow

The cash flow of a business is its cash inflows and cash outflows over a period
of time.

Cash inflows are the sums of money received by the business over a period of
time. E.g.:

●​ sales revenue from sale of products

●​ payment from debtors– debtors are customers who have already
purchased goods from the business but didn’t pay for them at that
time
●​ money borrowed from external sources, like loans
●​ the money from the sale of business assets
●​ investors putting more money into the business

Cash outflows are the sums of money paid out by the business over a period
of time. Eg:

●​ purchasing goods and materials for cash

●​ paying wages, salaries and other expenses in cash
 ●​ purchasing fixed assets
●​ repaying loans (cash is going out of the business)
●​ by paying creditors of the business- creditors are suppliers who
supplied items to the business but were not paid at the time of supply.

The cash flow cycle:

Cash flow is not the same as profit! Profit is the surplus amount after total
costs have been deducted from sales. It includes all income and payments
incurred in the year, whether already received or paid or to not yet received or
paid respectfully. In a cash flow, only those elements paid by cash are
considered.

Cash Flow Forecasts

A cash flow forecast is an estimate of future cash inflows and outflows of a

business, usually on a month-by-month basis. This then shows the expected
cash balance at the end of each month. It can help tell the manager:

●​ how much cash is available for paying bills, purchasing fixed assets or
repaying loans
 ●​ how much cash the bank will need to lend to the business to avoid
insolvency (running out of liquid cash)
●​ whether the business has too much cash that can be put to a profitable
use in the business

Example of a cash flow forecast for the four months:

The cash inflows are listed first and then the cash outflows. The total inflows
and outflows have to be calculated after each section.

The opening cash/bank balance is the amount of cash held by the business
at the start of the month

Net Cash Flow = Total Cash Inflow – Total Cash Outflow

The net cash flow is added to the opening cash balance to find the closing
cash/bank balance– the amount of cash held by the business at the end of
the month. Remember, the closing cash/bank balance for one month is the
opening cash/bank balance for the next month!

The figures in bracket denote a negative balance, i.e., a net cash outflow
(outflows > inflows)
Uses of cash flow forecasts:

●​ When setting up the business the manager needs to know how much
cash is required to set up the business. The cash flow forecast helps
calculate the cash outflows such as rent, purchase of assets, advertising
etc.
●​ A statement of cash flow forecast is required by bank managers when
the business applies for a loan. The bank manager will need to know
how much to lend to the business for its operations, when the loan is
needed, for how long it is needed and when it can be repaid.
●​ Managing cash flow– if the cash flow forecast gives a negative cash
flow for a month(s), then the business will need to plan ahead and apply
for an overdraft so that the negative balance is avoided (as cash comes
in and the inflow exceeds the outflow). If there is too much cash, the
business may decide to repay loans (so that interest payment in the
future will be low) or pay off creditors/suppliers (to maintain healthy
relationships with suppliers).

How can cash flow problems be overcome?

When a negative cash flow is forecast (lack of cash) the following methods
can be used to correct it:

●​ Increase bank loans: bank loans will inject more cash into the business,
but the firm will have to pay regular interest payments on the loans and
it will eventually have to be repaid, causing future cash outflows
●​ Delay payment to suppliers: asking for more time to pay suppliers will
help decrease cash outflows in the short-run. However, suppliers could
refuse to supply on credit and may reduce discounts for late payment
●​ Ask debtors to pay more quickly: if debtors are asked to pay all the
debts they have to the firm quicker, the firm’s cash inflows would
increase in the short-run. These debtors will include credit customers,
who can be asked to make cash sales as opposed to credit sales for
purchases (cash will have to be paid on the spot, credit will mean they
can pay in the future, thus becoming debtors). However, customers
may move to other businesses that still offers them time to pay
●​ Delay or cancel purchases of capital equipment: this will greatly help
reduce cash outflows in the short-run, but at the cost of the efficiency
 the firm loses out on not buying new technology and still using old
equipment.

In the long-term, to improve cash flow, the business will need to attract more
investors, cut costs by increasing efficiency, develop more products to
attract customers and increase inflows.

Working Capital

Working capital is the capital required by the business to pay its short-term
day-to-day expenses. Working capital is all of the liquid assets of the
business– the assets that can be quickly converted to cash to pay off the
business’ debts. Working capital can be in the form of:

●​ cash needed to pay expenses

●​ cash due from debtors – debtors/credit customers can be asked to
quickly pay off what they owe to the business in order for the business
to raise cash
●​ cash in the form of inventory – Inventory of finished goods can be
quickly sold off to build cash inflows. Too much inventory results in high
costs, too low inventory may cause production to stop.

5.3 Income statements

Accounts are the financial records of a firm’s transactions.​
Final Accounts are prepared at the end of the financial year and give details
of the profit or loss made as well as the worth of the business.

Profit

Profit = Sales Revenue – Total cost

When the total costs exceed the sales revenue, then a loss is made.

How to increase profit?

 ●​ Increase sales revenue
●​ Cut costs

Why is profit important to a business?

●​ It is a reward for enterprise: entrepreneurs start businesses to make a

profit
●​ It is a reward for risk-taking: entrepreneurs has to take considerable
risks when they invest capital in a venture, and profits are a
compensation/reward to them for taking these risks (paid in the form of
profits or dividends)
●​ It is a source of finance: after payments to owners, profits are
reinvested back into the business for further expansion (this is called
retained earnings)
●​ It is an indicator of success: more profits indicate to investors that the
business/industry is worth their time and money, and they will invest
more either in the firm or new firms of their own, in the hopes of
gaining good returns on their investment

For social enterprises, profit is not one of their primary objectives, but welfare
of the society is. However, they will also strive to make some profit to reinvest
it back into the business and help it grow.

Profit is not the same as cash flow! Profit is the surplus amount after total
costs have been deducted from sales. It includes all income and payments
incurred in the year, whether already received or paid or to not yet received or
paid respectfully. In a cash flow, only those elements paid in cash immediately
are considered.

Income Statement

An income statement is a financial document of the business that records all

income generated by the business as well as the costs incurred by the
business and thus the profit or loss made over the financial year. Also known
as profit and loss account.
 A simple Income
Statement

Sales Revenue = total sales​

Cost of Sales = total variable cost of production + (opening inventory of
finished goods – closing inventory of finished goods)​
Gross Profit = Sales Revenue – Cost of Sales​
Expenses: all overheads/fixed costs​
Net Profit = Gross Profit – Expenses​
​
Profit after Tax = Net Profit – Tax​
Dividends: share of profit given to shareholders; return on shares​
Retained Profit for the year = Profit after Tax – Dividends. This retained
earnings is then kept aside for use in the business.

Only a
very small portion of the sales revenue ends up being the retained profit. All costs, taxes
and dividends have to be deducted from sales.
​
Uses of Income Statement

Income statements are used by managers to:

●​ know the profit/loss made by the business

●​ compare their performance with that of previous years’ and with that
of competitors’. If profit is lower than that of last year's, why is it falling
and what can they do to correct the issue? If it is lower than that of
competitors’ what can they do to be more profitable and be
competitive in the market?
●​ know the profitability of individual products by preparing separate
income statements for each product. They may decide to stop
production of products that are making losses.
●​ help decide what products to launch by preparing forecast income
statements for the first few years. Whichever product is forecast to have
a higher profit, the business will choose to launch that product

5.4 Statement of financial position

The balance sheet, along with the income statement is prepared at the end
of the financial year. It shows the value of a business’ assets and liabilities
at a particular time. It is also known as a statement of financial position’.

Assets are those items of value owned by the business.

●​ Fixed/non-current assets (buildings, vehicles, equipment etc.) are

assets that remain in the business for more than a year – their values fall
over time in a process called depreciation every year.
●​ Short-term/current assets (inventory, trade receivables (debts from
customers), cash etc) are owned only for a very short time.
●​ There can also be intangible (cannot be touched or felt) non-current
assets like copyrights and patents that add value to the business.

Liabilities are the debts owed by the business to its creditors.

 ●​ Long-term/non-current liabilities (loans, debentures etc.)- they do not
have to be repaid within a year.
●​ Short-term/current liabilities (trade payables (to suppliers), overdraft
etc.)- these need to be repaid within a year.

CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL​

This is because the liquid cash a company has with them will be the liquid
(short-term) assets they own less the short-term debts they have to pay.

Shareholder’s Equity is the total amount of money invested in the company

by shareholders. This will include both the share capital (invested directly by
shareholders) and reserves (retained earnings reserve, general reserve etc.).​
Shareholders can see if their stake in the business has risen or fallen by
looking at the total equity figure on the balance sheet.
Check whether the equations on the right are satisfied in this balance sheet!

​
SHAREHOLDERS EQUITY = TOTAL ASSETS – TOTAL LIABILITIES

TOTAL ASSETS = TOTAL LIABILITIES + SHAREHOLDERS EQUITY

CAPITAL EMPLOYED = SHAREHOLDERS EQUITY + NON-CURRENT

LIABILITIES​
This is because non-current liabilities like loans are also used for permanent
investment in the company.

Uses of a statement of financial position

●​ When the current assets subtotal is compared to the current liabilities

subtotal, investors can estimate whether a firm has access to sufficient
funds in the short term to pay off its short-term obligations i.e., whether
it is liquid
●​ One can also compare the total amount of debt (liabilities) to the total
amount of equity listed on the balance sheet, to see if the resulting
debt-equity ratio indicates a dangerously high level of borrowing. This
information is especially useful for lenders and creditors, (especially
banks) who want to know if the firm will be able to pay back its debt
●​ Investors like to examine the amount of cash on the balance sheet to
see if there is enough available to pay them a dividend
●​ Managers can examine its balance sheet to see if there are any assets
that could potentially be sold off without harming the underlying
business. For example, they can compare the reported inventory assets
to the sales to derive an inventory turnover level, which can indicate the
presence of excess inventory, so they will sell off the excess inventory to
raise finance

5.5 Analysis of accounts

The data contained in the financial statements are used to make some useful
observations about the performance and financial strength of the
business. This is the analysis of accounts of a business. To do so, ratio analysis
is employed.

Ratio Analysis

●​ Profitability Ratios: profitability is the ability of a company to use its

resources to generate revenues in excess of its [Link] ratios
are used to see how profitable the business has been in the year ended.
●​ Return on Capital Employed (ROCE): this calculates the
return (net profit) in terms of the capital invested in the
business (shareholder’s equity + non-current liabilities) i.e. the
% of net profit earned on each unit of capital employed. The
higher the ROCE the better the profitability is. The formula is:​

●​ Gross Profit Margin: this calculates the gross profit (sales –

cost of production) in terms of the sales, or in other words, the
% of gross profit made on each unit of sales revenue. The
higher the GPM, the better. The formula is:​

●​ Net profit Margin: this calculates the net profit (gross

profit-expenses) in terms of the sales, i.e. the % of net profit
generated on each unit of sales revenue. The higher the NPM,
the better. The formula is:​

●​ Liquidity Ratios: liquidity is the ability of the company to pay back its
short-term debts. If it doesn’t have the necessary working capital to do
so, it will go illiquid (forced to pay off its debts by selling assets). In the
previous topic, we said that working capital = current assets – current
liabilities. So a business needs current assets to be able to pay off its
current liabilities. The two liquidity ratios shown below, use this concept.
 ●​ Current Ratio: this is the basic liquidity ratio that calculates
how many current assets are there in proportion to every
current liability, so the higher the current ratio the better (a
value above 1 is favourable). the formula is:​

●​ Liquid Ratio/ Acid Test Ratio: this is very similar to current

ratio but this ratio doesn’t consider inventory to be a liquid
asset, since it will take time for it to be sold and made into
cash. A high level of inventory in a business can cause a big
difference between its current and liquidity ratios. So there is a
slight difference in the formula:​

Uses and users of accounts

●​ Managers: they will use the accounts to help them keep control over
the performance of each product or each division since they can see
which products are profitably performing and which are not.
●​ This will allow them to make better decisions. If for example,
product A has a good gross profit margin of 35% but its net
profit margin is only 5%, this means that the business has very
high expenses that is causing the huge difference between
the two ratios. They will try to reduce expenses in the coming
year. In the case of liquidity, if both ratios are very low, they will
try to pay off current liabilities to improve the ratios.
●​ Ratios can be compared with other firms in the
industry/competitors and also with previous years to see how
they’re doing. Businesses will definitely want to perform better
than their rivals to attract shareholders to invest in their
business and to stay competitive in the market. Businesses will
also try to improve their profitability and liquidity positions
each year.
 ●​ Shareholders: since they are the owners of a limited company, it is a
legal requirement that they be presented with the financial accounts of
the company. From the income statements and the profitability ratios,
especially the ROCE, existing shareholders and potential investors can
see whether they should invest in the business by buying shares. A
higher profitability, the higher the chance of getting dividends. They will
also compare the ratios with other companies and with previous
years to take the most profitable decision. The balance sheet will tell
shareholders whether the business was worth more at the end of the
year than at the beginning of the year, and the liquidity ratios will be
used to ascertain how risky it will be to invest in the company- they
won’t want to invest in businesses with serious liquidity problems.
●​ Creditors: The balance sheet and liquidity ratios will tell creditors
(suppliers) the cash position and debts of the business. They will only be
ready to supply to the business if they will be able to pay them. If there
are liquidity problems, they won’t supply the business as it is risky for
them.
●​ Banks: Similar to how suppliers use accounts, they will look at how
risky it is to lend to the business. They will only lend to profitable and
liquid firms.
●​ Government: the government and tax officials will look at the profits of
the company to fix a tax rate and to see if the business is profitable and
liquid enough to continue operations and thus if the worker’s jobs will
be protected.
●​ Workers and trade unions: they will want to see if the business’ future
is secure or not. If the business is continuously running a loss and is in
risk of insolvency (not being liquid), it may shut down operations and
workers will lose their jobs!
●​ Other businesses: managers of competing companies may want to
compare their performance too or may want to take over the business
and want to see if the takeover will be beneficial.

Limitations of using accounts and ratio analysis

●​ Ratios are based on past accounting data and will not indicate how
the business will perform in the future
 ●​ Managers will have all accounts, but the external users will only have
those published accounts that contain only the data required by law-
they may not get the ‘full-picture’ about the business’ performance.
●​ Comparing accounting data over the years can lead to misleading
assumptions since the data will be affected by inflation (rising prices)
●​ Different companies may use different accounting methods and so
will have different ratio results, making comparisons between
companies unreliable.

6. External influences on
business activity
6.1 Economic issue
The Business/ Trade Cycle

An economy will not always go through an economic growth; there is usually

a cycle, as shown below.

Growth– when GDP is rising,

unemployment is falling and there are higher living standards in the country.
Businesses will look to expand and produce more and will earn high profits.
Boom– when GDP is at its highest and there is too much spending, causing
inflation to rapidly rise. Business costs will rise and firms will become worried
about how they are going to stay profitable in the near future.

Recession– when GDP starts to fall due to high prices, as demand and
spending falls. Firms will cut back production to stay profitable and
unemployment may rise as a result.

Slump– when GDP is so low that prices start to fall (deflation) and
unemployment will reach very high levels. Many businesses will close down as
they cannot survive the very low demand level. The economy will suffer.

(When the government takes measures to increase demand and spending in

the economy to take it from a slump to growth, it is called the ‘recovery’
period). The cycle repeats.

Economic Objectives

Here, we’ll look at the different economic objectives a government might

have and how their absence/negligence will affect the economy as well as
businesses.

●​ Maintain economic growth: economic growth occurs when a country’s

Gross Domestic Product (GDP) increases i.e. more goods and services
are produced than in the previous year. This will increase the country’s
incomes and achieve greater living standards.​
Effects of reducing GDP (recession):
●​ As output falls, fewer workers will be needed by firms, so
unemployment will rise
●​ As goods and services that can be consumed by the people
falls, the standard of living in the economy will also fall
●​ Achieve price stability: inflation is the increase in average prices of
goods and services over time. (Note that inflation, in the real world,
always exists. It is natural for prices to increase as the years go by. In the
case there is a fall in the price level, it is called a deflation) Maintaining a
low inflation will help the economy to develop and grow better.​
Effects of high inflation:
 ●​ As cost of living will have risen and peoples’ real incomes (the
value of income) will have fallen (when prices increase and
incomes haven’t, the income will buy lesser goods and
services- the purchasing power will fall).
●​ Prices of domestic goods will rise as opposed to foreign goods
in the market. The country’s exports will become less
competitive in the international market. Domestic workers
may lose their jobs if their products and firms don’t do well.
●​ When prices rise, demand will fall and all costs will rise (as
wages, material costs, overheads will all rise)- causing profits to
fall. Thus, they will be unwilling to expand and produce more
in the future.
●​ The living standards (quality of life) in the country may fall
when costs of living rise.
●​ Reduce unemployment: unemployment exists when people who are
willing and able to work cannot find a job. A low unemployment means
high output, incomes, living standards etc.​
Effects of high unemployment:
●​ Unemployed people do not produce anything and so, the total
output/GDP in the country will fall. This will in turn, lead to a
fall in economic growth.
●​ Unemployed people receive no incomes, thus income
inequality can rise in the economy and living standards will fall.
It also means that businesses will face low demand due to low
incomes.
●​ The government pays out unemployment benefits to the
unemployed and this will rise during high unemployment and
the government will not have enough money left over to
spend on other services like education and health.
●​ Maintain balance of payments stability: this records the difference
between a country’s exports (goods and services sold from the country
to another) and imports (goods and services bought in by the country
from another country). The exports and imports need to equal each
other, thus balanced.​
Effect of a disequilibrium in the balance of payments:
●​ If the imports of a country exceed its exports, it will cause
depreciation in the exchange rate– the value of the country’s
 currency will fall against other foreign currencies (this will be
explained in detail here).
●​ If the exports exceed the imports it indicates that the country
is selling more goods than it is consuming- the country itself
doesn’t benefit from any high output consumption.
●​ Reduce income equality/achieve effective income redistribution: the
difference/gap between the incomes of rich and poor people should
narrow down for income equality to improve. Improved income equality
will ensure better living standards and help the economy to grow faster
and become more developed.​
Effects of poor income equality:
●​ Unequal distribution of goods and services- the poor cannot
buy as many goods as the rich- poor living standards will arise.

Government Economic Policies

Government can influence the economic conditions in a country by taking a

variety of policies.

Fiscal policy is a government policy which adjusts government spending and

taxation to influence the economy. It is the budgetary policy, because it
manages the government expenditure and revenue. Government aims for a
balanced budget and tries to achieve it using fiscal policy.​
Increasing government spending and reducing taxes will encourage more
production and increase employment, driving up GDP growth. This is
because government spending creates employment and increases economic
activity in the economy and lower taxes means people have more money to
consume and firms have to pay lesser tax on their profits. On the other hand,
reducing government spending and increasing taxes will discourage
production and consumption, and unemployment and GDP will fall.

Monetary policy is a government policy that adjusts the interest rate and
foreign exchange rates to influence the demand and supply of money in the
economy, and thus demand and supply. It is usually conducted by the
country’s central bank and usually used to maintain price stability, low
unemployment and economic growth.​
Increasing interest rates will discourage investments and consumption,
causing employment and GDP to fall (as the cost of borrowing-interest on
loans – has increased, and people prefer to earn more interest by saving
rather than spend). Similarly, reducing interest rates will boost investment,
consumption, employment, and thus GDP.

​
Supply-side policies: both the fiscal and monetary policies directly affect
demand, but the policies that influence supply are very different. It can
include:

●​ Privatisation: selling government organizations to private individuals-

this will increase efficiency and productivity that increase supply as well
encourage competitors to enter and further increase supply.
●​ Improve training and education: governments can spend more on
schools, colleges and training centres so that people in the economy
can become better skilled and knowledgeable, helping increase
productivity.
●​ Increased competition: by acting against monopolies (firms that
restrict competitors to enter that industry/having full dominance in the
market- refer xxx for more details) and reducing government rules and
regulations (often termed ‘deregulation’), the competitive environment
can be improved and thus become more productive.

For more details on government policies, check out our Economics notes.

*EXAM TIP: Remember that economic conditions and policies are all
interconnected; one change will lead to an effect which will lead to another
effect and so on, like a chain reaction in many different ways. In your exams,
you should take care to explain those effects that are relevant and appropriate
to the business or economy in the question*​
How might businesses react to policy changes? It will depend on how much
impact the policy change will have on the particular
business/industry/economy. Here are a few examples:
6.2 Environmental and ethical issues
Business’ Impact on the Environment

Social responsibility is when a business decision benefits stakeholders other

than shareholders i.e. workers, community, suppliers, banks etc.

This is very important when coming to environmental issues. Businesses can

pollute the air by releasing smoke and poisonous gases, pollute water bodies
around it by releasing waste and chemicals into them, and damage the
natural beauty of a place and so on.

WHY BUSINESSES DO NOT

WHY BUSINESSES WANT TO
WANT TO BE
BE ENVIRONMENT- FRIENDLY
ENVIRONMENT-FRIENDLY
 It is expensive to reduce and
Sense of social responsibility
recycle waste for the business.
that comes from the fact that
It means that expensive
their activities are
machinery and skilled labour
contributing to global
will be required by the
warming and pollution
business – reducing profits.

Firms will have to increase

Using up scarce
prices to compensate for the
non-renewable resources
expensive
(such as rainforest wood and
environment-friendly
coal) will raise their prices in
methods used in production-
the future, so businesses won’t
higher prices mean lower
use them now
demand.

Consumers are becoming

High prices can make firms
socially-aware and are willing
less competitive in the market
to buy only environmentally
and they could lose sales
friendly products.

Governments, environmental
organisations, even the
Businesses claim that it is the
community could take action
government’s duty to clean up
against the business if they do
pollution
serious damage to the
environment

Externalities
A business’ decisions and actions can have significant effects on its
stakeholders. These effects are termed ‘externalities’. Externalities can be
categorized into six groups given below and we’ll take examples from a
scenario where a business builds a new production factory.

Private Costs: costs paid by the business for an activity.​

Examples: costs of building the factory, hiring extra employees, purchasing
new machinery, running a production unit etc.​
Private Benefits: gains for the business resulting from an activity.​
Example: the extra money made from the sale of the produced goods etc.​
External Costs: costs paid by the rest of the society (other than the business)
as a result of the business’ activity.​
Examples: machinery noise, air pollution that leads to health problems
among nearby residents, loss of land (it could have been farmland before) etc.​
External Benefits: gains enjoyed by the rest of the society as a result of a
business activity.​
Example: new jobs created for residents, government will get more tax from
the business, other firms may move into the area to support the firm-helping
develop the region, new roads might be built that can be enjoyed by
residents etc.

Social Costs = Private Costs + External Costs

Social Benefits = Private Benefits + External Benefits

Governments use the cost-benefit-analysis (CBA) to decide whether to

proceed with a scheme or not and businesses have also adopted it. In CBA,
the government weighs up all the social costs and benefits that will arise if
the scheme is put into effect and gives them all monetary values (this is not
easy- what is the value of losing natural beauty?). They will only allow the
scheme to proceed if the social benefits exceed the social costs, if the costs
exceed the benefits, it is not allowed to proceed.

Sustainable Development

Sustainable development is development that does not put at risk the

living standards of future generations. It means trying to achieve economic
growth in a way that does not harm future generations. Few examples of a
sustainable development are:

●​ using renewable energy- so that resources are conserved for the future
●​ recycle waste
●​ use fewer resources
●​ develop new environment-friendly products and processes- reduce

health and climatic problems for future generations

Environmental Pressures

Pressure groups are organisations/groups of people who change business

(and government) decisions. If a business is seen to behave in a socially
irresponsible way, they can conduct consumer boycotts (encourage
consumers to stop buying their products) and take other actions. They are
often very powerful because they have public support and media coverage
and are well-financed and equipped by the public. If a pressure group is
powerful it can result in a bad reputation for the business that can affect it in
future endeavours, so the business will give in to the pressure groups’
demands. Example: Greenpeace

The government can also pass laws that can restrict business decisions such
as not permitting factories to locate in places of natural beauty.

There can also be penalties set in place that will penalize firms that
excessively pollute. Pollution permits are licenses to pollute up to a certain
limit. These are very expensive to acquire, so firms will try to avoid buying the
pollution permit and will have to reduce pollution levels to do so. Firms that
pollute less can sell their pollution permits to more polluting firms to earn
money. Taxes can also be levied on polluting goods and services.

Ethical Decisions

Ethical decisions are based on a moral code. It means ‘doing the right thing’.
Businesses could be faced with decisions regarding, for example,
employment of children, taking or offering bribes, associating with
people/organisations with a bad reputation etc. In these cases, even if they
are legal, they need to take a decision that they feel is right.

Taking ethical/’right’ decisions can make the business’ products popular

among customers, encourage the government to favour them in any future
disputes/demands and avoid pressure group threats. However, these can end
up being expensive as the business will lose out on using cheaper unethical
opportunities.

6.3 Business and international economy

Globalization

Globalization is a term used to describe the increases in worldwide trade

and movement of people and capital between countries. The same goods
and services are sold across the globe; workers are finding it easier to find
work by going abroad for work; money is sent from and to countries
everywhere.​
Some reasons how globalization has occurred are:

●​ Increasing number of free trade agreements– these are agreements

between countries that allow them to import and export goods and
services with no tariffs or quotas.
●​ Improved and cheaper transport (water, land, air) and
communications (internet) infrastructure
●​ Developing and emerging countries such as China and India are
becoming rapidly industrialized and so can export large volumes of
goods and services. This has caused an increase in the output and
opportunities in international trade, allowing for globalisation

Advantages of globalisation

●​ Allows businesses to start selling in new foreign markets, increasing

sales and profits
●​ Can open factories and production units in other countries, possibly at a
cheaper rate (cheaper materials and labour can be available in other
countries)
 ●​ Import products from other countries and sell it to customers in the
domestic market- this could be more profitable and producing and
selling the good themselves
●​ Import materials and components for production from foreign
countries at a cheaper rate.

Disadvantages of globalisation

●​ Increasing imports into the country from foreign competitors- now that
foreign firms can compete in other countries, it puts up much
competition for domestic firms. If these domestic firms cannot
compete with the foreign goods’ cheap prices and high quality, they
may be forced to close down operations.
●​ Increasing investment by multinationals in home country- this could
further add to competition in the domestic market (although small
local firms can become suppliers to the large multinational firms)
●​ Employees may leave domestic firms if they don’t pay as well as the
foreign multinationals in the country- businesses will have to increase
pay and conditions to recruit and retain employees.

When looking at an economy’s point of view, globalisation brings

consumers more choice and lower prices and forces domestic firms to be
more efficient (in order to remain competitive). However, competition from
foreign producers can force domestic firms to close down and jobs will be
lost.

Protectionism

Protectionism refers to when governments protect domestic firms from

foreign competition using trade barriers such as tariffs and quotas; i.e. the
opposite of free trade.

Import quota is a restriction on the quantity of goods that can be imported

into the country.​
Tariffs are taxes on imports.
Imposing these two measures will reduce the number of foreign goods in
the domestic market and make them expensive to buy, respectively. This
will reduce the competitiveness of the foreign goods and make it easy for
domestic firms to produce and sell their goods. However, it reduces free trade
and globalisation.​
Free trade supporters say that it is better to allow consumers to buy imported
goods and domestic firms should produce and export goods and services
that they have a competitive advantage in. In this way, living standards across
the globe will improve.

Multinational Companies (MNCs)

Multinational businesses are firms with operations (production/service) in

more than one country. Also known as transnational businesses. Examples:
Shell, McDonald’s, Nissan etc.

Why do firms become multinationals?

●​ To produce goods with lower costs– cheaper material and labour may
be available in other countries
●​ To extract raw materials for production, available in a few other
countries. For example: crude oil in the Middle East
●​ To produce goods nearer to the markets to avoid transport costs.
●​ To avoid trade barriers on imports. If they produce the goods in
foreign countries, the firms will not have to pay import tariffs or be
faced with a quota restriction
●​ To expand into different markets and spread their risks
●​ To remain competitive with rival firms which may also be expanding
abroad

Advantages to a country of a multinational setting up in their country:

●​ More jobs created by multinationals

●​ Increases GDP of the country
●​ The technology that the multinational brings in can bring in new ideas
and methods into the country
●​ As more goods are being produced in the country, the imports will be
reduced and some output can even be exported
 ●​ Multinationals will also pay taxes, thereby increasing the government’s
tax revenue
●​ More product choice for consumers

Disadvantages to a country of a multinational setting up in their country:

●​ The jobs created are often for unskilled tasks. The more skilled jobs will
be done by workers that come from the firm’s home country. The
unskilled workers may also be exploited with very low wages and
unhygienic working conditions.
●​ Since multinationals benefit from economies of scale, local firms may
be forced out of business, unable to survive the competition
●​ Multinationals can use up the scarce, non-renewable resources in the
country
●​ Repatriation of profit can occur. The profits earned by the
multinational could be sent back to their home country and the
government will not be able to levy tax on it.
●​ As multinationals are large, they can influence the government and
economy. They could threaten the government that they will close
down and make workers unemployed if they are not given financial
grants and so on.

Exchange Rates

The exchange rate is the price of one currency in terms of another

currency.

For example, €1= $1.2. To buy one euro, you’ll need 1.2 dollars. The demand
and supply of the currencies determine their exchange rate. In the above
example, if the €’s demand was greater than the $’s, or if the supply of €
reduced more than the $, then the €’s price in terms of $ will increase. It
could now be €1= $1.5. Each € now buys more $.

A currency appreciates when its value rises. The example above is an

appreciation of the Euro. A European exporting firm will find an appreciation
disadvantageous as their American consumers will now have to pay more $ to
buy a €1 good (exports become expensive). Their competitiveness has
reduced. A European importing firm will find an appreciation of benefit. They
can buy American products for lesser Euros (imports become cheaper).

A currency depreciates when its value falls. In the example above, the
Dollar depreciated. An American exporting firm will find a depreciation
advantageous as their European consumers will now have to pay less € to buy
a $1 good (exports become cheaper). Their competitiveness has increased.
An American importing firm will find a depreciation disadvantageous. They
will have to buy European products for more dollars (imports become
expensive).

In summary, an appreciations is good for importers, bad for exporters; a

depreciation is good for exporters, bad for importers; given that the goods
are price elastic (if the price didn’t matter much to consumers, sales and
revenue would not be affected by price- so no worries for producers).