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Chapter 1: Business activity
The economic problem: needs, wants and scarcity
Need: is a good or service essential for living, ex, shelter
Want: is a good or service which people would like to have, but which is not essential for living. Wants
are unlimited
The economic problem: is created due to scarcity. Since people have unlimited wants and limited
resources to produce goods and services that will satisfy their wants.
Scarcity: is the lack of sufficient products to fulfill the total wants of the population.
Factors of production: are the resources needed to produce goods or services. they are four resources
and are limited in supply:
Land: all the natural resources provided by nature, ex, forests
Labor: the people available to make products, ex, engineer
Capital: the finance, machinery, and equipment needed to manufacture products
Enterprise: the skill and risk-taking ability of the person who combines the factors of
production together to produce goods and services.
Limited resources: the need to choose
Since we have limited resources and too many wants then we have to choose which wants to satisfy and
which ones to forgo. This leads to opportunity cost.
Opportunity cost: is the next best alternative given up by choosing another item. For example, if the
government chooses to build a hospital and not a school. The opportunity cost would be the school.
Specialization: the best use of limited resources
Specialization: occurs when people and businesses concentrate on what they are best at.
Division of labor: is a form of specialization where the production process is split up into different tasks
and each worker performs one of these tasks.
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Advantages and disadvantages of specialization
Advantages
 Increases efficiency and output as workers are
trained in one task only
 Less time is wasted since unnecessary movement is
eliminated
Disadvantages
 Efficiency may fall if workers
become bored
 If one worker is absent,
production may be stopped as no
one else can do the job
The purpose of business activity
1. Businesses combines scarce factors of production to produce goods and services
2. Businesses produces the goods and services which are needed to satisfy the needs and wants of
the population
3. Businesses employ people as workers and pay them wages to allow them to consume products
made by other businesses.
Added value
All businesses attempt to add value.
Added value: is the difference between the selling price of a product and the cost of bought in materials
and components
Why is value added important?
Value added is important because as long as sales revenue is greater than the cost of bought in
materials then the surplus money will be used to:
1. Pay for other costs such as labor and management costs
2. Make profits after paying all other costs
How do businesses increase added value?
1. Increase selling price and keep the cost of materials the same
2. Reduce cost of materials but keep the price the same
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Chapter 2: classification of businesses
Stages of economic activity
There are three stages of economic / business activity:
1. Primary stages
Primary sector of industry extracts and uses the natural resources of the earth to produce raw
materials used other businesses. ex., farming
2. Secondary stage
Secondary sector of industry manufactures goods using the raw materials provided by primary
sector. Ex, building
3. Tertiary stage
The tertiary sector of industry provides services to consumers and the sectors of industry. Ex,
banking
Relative importance of economic sectors
The importance of each sector in an economy is measured by:
1. Percentage of a country’s total number of workers employ in each sector
Or
2. Value of output of goods and services and the proportion this is of total national output
Developing countries tend to employ many people in activities such as farming and mining where as
the most developed countries employ many people in service sector such as banking and insurance.
Also the value of output of service sector in the most developed countries will be higher than the
other two sectors.
Changes in sector importance
Deindustrialization occurred in most developed countries
Deindustrialization: occurs when there is a decline in the importance of the secondary manufacturing
sector of industry in a country.
Reasons behind the changes in relative importance of the three sectors:



Sources of some primary products depleted
Most developed economies are losing competitiveness in manufacturing to the newly
industrialized countries
As a country’s total wealth increases and living standards rise, consumers tend to spend higher
proportion of their incomes on services.
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Mixed economy
A mixed economy has both a private sector and a public sector.
Private sector: includes businesses owned by private individuals or groups. Most private sector
businesses seek for profit. The businesses will make their own decisions about what, how, for
whom to produce and what price to charge for their products. There are some governmental
controls over these decisions.
Public sector: includes businesses and organizations owned and controlled by the government. The
government takes decisions about what to produce and how much to charge customers. the
government doesn’t for profit. Its objective is to provide goods and services to the population with
reasonable prices or even free of charge.
Recent changes in the mixed economies
Privatization, selling off public sector businesses to and businesses in the private sector, occurred in
many European and Asian countries.
Arguments for privatization:


Private sector businesses are more efficient than those of public sector
due to the profit motive.
Private sector owners might invest more capital in the businesses than
government can afford leading also to more efficiency.
Arguments against privatization:


Workers in the private sector may be made redundant in order for
the business to cut cost.
Private businesses are less likely to focus on social objectives
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Chapter 3: Enterprise, business growth and size
Enterprise and entrepreneurship
Entrepreneur: is a person who organizes, operates and takes the risk for a new business
venture.
Benefits of being an entrepreneur
Independence
Can put own ideas into practice
Disadvantages of being an entrepreneur
Risk of failure especially if poor planned
Capital is limited as the have to invest their
own money in the business. The may also
need to search for additional sources of
finance
May lack knowledge and experience in starting
and operating a business
May experience opportunity cost as they lose
the income that they would have earned if
employed in another business
May become famous and successful
May become profitable and get a higher
income than if employed in another business
Can make use of personal interests and skills
Characteristics of successful entrepreneurs:
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Characteristics of
successful
entrepreneurs
Hard working
Risk taker
Creative
Optimistic
Self-confident
Innovative
Independent
Effective
communicator
Reasons why important
They work long hours and take short holidays to make their business
successful
Deciding on products which people may buy is potentially risky (wrong
decision - products will not sell)
They should find new ideas about products, services, ways of attracting
customers to differentiate their business from others
Being able to look forward to a better future is essential for success
It is important to convince other people of your skills and convince banks,
and other lenders and customers that your business is going to be
successful
Being able to put new ideas into practice in interesting and different ways
They will need to work on their own before they can afford to employ
others. They must be well motivated to work without an help
Talking clearly and confidently to banks, other lenders, customers and
government agencies about the new business will raise the profile of the
new business.
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Why governments support business start-ups?
Governments support entrepreneurs and encourage them to set up new businesses for several
reasons:
1. Reduce unemployment:
Small businesses are usually labor intensive so they create jobs to help reduce
unemployment
2. Increase competition
Increased competition allows more choices to consumers and may result in lower prices.
3. Increase output
The economy will benefit from increased output of goods and services. Living standards
will rise
4. Benefit society
Entrepreneurs may create social enterprises which benefits society such as supporting
disadvantaged groups in society
5. Can grow further
The support offered by the government may help some firms to grow and become very
large and important in the future.
What support do governments often give to start-up businesses?
1. Business idea and help
Government organizes advising and support sessions offered by experienced business
people
2. Premises
Low cost premises to start-up businesses
3. Finance
Low interest rates loans to small businesses
Grants if start-up in depressed areas of high unemployment
4. Labour
Grants to small businesses to train employees and help increase their productivity
5. research
Encourage universities to make their research facilities available to new business
enterprises.
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Business plans
A business plan: is a document containing the business objectives and important details about
the operations, finance and owners of the new business.
How a business plan assists entrepreneurs?
1. Supports an overdraft or bank loan request
Without a business plan banks will be reluctant to lend money to the business
2. Careful planning reduces risks of failure
It allows the manager to think seriously about the future and plan to meet the
challenges that they will meet.
Main parts of a business plan:
1.
2.
3.
4.
5.
Type of product
Cash flow
Business costs
Location
Resources required
Comparing the size of businesses
Businesses can vary greatly in terms of size. Business size can be measured in a number of
ways:
1. Number of employees Downloaded by Success Groups
Advantages
Limitations
Some businesses (capital intensive)
easy to calculate and compare with other
employ very few people but their value of
businesses
output is high. (i.e considered small using
number of employees method but large
using value of output or value of capital
employed)
Should two part-time workers be counted
as one employee or two?
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2. Value of output Downloaded by Success Groups
Advantages
Limitations
Useful in comparing businesses in the
Some businesses employ very few people
same industry – especially manufacturing
but their value of output is high. (i.e
industries
considered small using number of
employees method but large using value
of output)
The value of output may differ than the
value of sales at a point in time if products
aren’t sold. This five an inaccurate
measure of the size of the business
3. Value of sales
Advantages
Useful when comparing the size of
retailing businesses – especially those
selling similar products
Limitations
Misleading if used to compare size of
retailers selling very different products
such as, minimarket and retailer of luxury
handbags or perfumes
4. Value of capital employed
Advantages
Limitations
Some capital intensive businesses employ
very few people but their value of output
is high. (i.e considered small using number
of employees method but large using
value of capital employed)
Note: there is no prefect way of comparing the size of businesses. It is quite common to use
more than one method and to compare the results obtained.
Who would find it useful to compare the size of businesses?
1.
2.
3.
4.
5.
Investors : to decide which business to invest in
Governments: to charge a tax rate as the rates differ based on the size of the business
Competitors: to compare their size and importance with other businesses
Workers: to know how many people they might be working with
Banks: to determine the importance of a loan to the business compared to its overall
size
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What are the advantages of business growth?
1.
2.
3.
4.
5.
Owners will gain higher profits
Owners and managers will gain more status and prestige
Managers of bigger firms earn higher salaries
Business will produce with lower average cost due to economies of scale
Business will gain a higher market share which gives he business more influence when
dealing with suppliers and distributors. Also consumers are attracted to big names
How can businesses growth?
1. Internal growth: growth paid for by profits from existing business. For example opening
a new branch.
Advantage: this type of growth is easier to manage than external growth
Disadvantage: it is quite slow
2. External growth / integration: is when a business takes over or merges with another
business.
a. A merger: is when the owners of two businesses agree to join their firms
together to make one business.
b. A takeover / acquisition: is when one business buys out the owners of another
business which becomes part of the ‘predator’ business.
Examples of external growth:
1. Horizontal merger / horizontal integration:
Is when one firm merges with or takes over another one in the same industry at the
same stage of production.
Advantages of horizontal integration:
 Reduces the number of competitors in the industry
 Can benefit from economies of scale
 The combined business will have a bigger market share than either firm
before the integration
2. Vertical merger / vertical integration
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Is when one firm merges with or takes over another one in the same industry but at a
different stage of production.
It can be forward or backwards:
a. Forward vertical integration: is when a firm integrates with another firm
which is at a later stage of production (i.e closer to consumer) ex.: farm
integrates with supermarket
Advantages of forward vertical integration:
 Assured outlet for the products of the predator
 Profit margin made by the retailer is absorbed by the new expanded
business
 The retailer could be prevented from selling competing products
 Information about consumer needs and preferences can now be
obtained directly by the manufacturer
b. Backward vertical integration: is when a firm integrates with another firm at
an earlier stage of production (i.e closer to the raw material supplies, in the
case of a manufacturing firm) ex: a business making clothes merges with a
business supplying fabrics.
Advantages of backward vertical integration:
 Assured supply of important components
 Profit margin of the supplier is absorbed by the new expanded
business
 The supplier could be prevented from supplying competing
manufacturers.
 Cost of components and supplies for the manufacturer could be
controlled.
3. Conglomerate merger/ conglomerate integration (diversification)
Is when one firm merges with or takes over another firm in a completely different
industry. For example, a construction business merging with clothes manufacturer.
Advantages of conglomerate integration:
 Spread the risk taken by the business
 Transfer of ideas between the different sections of the business even
though they operate in different industries
Problems of business growth and how to overcome them
Business growth may fail to increase profits and achieve the other objectives set by managers
due to several reasons.
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Problem resulting from expansion
difficult to control
Possible ways to overcome problem
 Decentralization - operate the
business in small units
 Operate the business in small units
 Use latest IT equipment and
telecommunications
 Expand more slowly using profits from
existing business
 Ensure sufficient long-term finance is
available
Poor communication
Financial problems due to expansion cost
integration may lead to difficulty in managing
the business due to different management
styles or ways of doing things

Good communication with the
workforce to explain the reasons for
the change
Why do some businesses stay small?
1. The type of industry the business operates in
If the business expands, it will be difficult to offer the close and personal service
demanded by consumers. For example, hairdresser
It is very easy for new firms to set up in competition with existing ones which keeps the
existing firms relatively small.
2. The market size
The total number of customers is small thus business is likely to remain small. For
example, shops in rural areas or producers of specialized kind of products
3. The owners objectives
Owner likes to keep control of his business. Owners may also wish to avoid the stress
and worry of running a large firm.
Why some businesses fail?
1. Poor management
Lack of experience may lead to bad decisions. For example, locating in an area with high
location cost and low demand
Owner with poor management skills may be reluctant to hire a professional manager.
2. Failure to plan for change
A business may fail due to failure to respond quickly and effectively to new changes in
the business environment. For example, failure to respond to new technology, powerful
competitors and economic changes
3. Poor financial management
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Shortage of cash may lead the business to stop trading. It may be caused by failure to
plan or forecast cash flows.
4. Over expansion
Expansion may lead to management and financial problems, if not solved then the
whole business will fail.
5. Risks of new business start-ups
New businesses are at a higher risk of failing than existing, well established ones due to
lack of
a. experience and decision making skills of managers
b. finance, other resources
c. research
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Chapter 4: Types of business organizations
Important definitions:
Limited liability: means that the liability of shareholders in a company is only limited to the
amount invested.
Unlimited liability: means that the owners of a business can be held responsible for the debts
of the business they own. Their liability is not limited to the investment they made in the
business.
Unincorporated business: is one that doesn’t have a separate legal identity. Sole traders and
partnerships are unincorporated business.
Incorporated business: are companies that have separate legal status from their owners
This means that:
a. A company will still exist should one of the owners die
b. A company can make contracts or legal agreements
c. Company accounts are kept separate from the accounts of the owners
Shareholders: are the owners of a limited company. They buy shares which represent part
ownership of a company.
Dividends: payments made to shareholders from the profits (after tax) of a company. they are
the return to shareholders for investing in the company.
A. Business organizations: the private sector
The main types of organizations in the private sector are:
1. Sole trader
Is a business owned and controlled by one person.
Features:
It has few legal formalities
Owned and operated by one person
Unlimited liability
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Advantages of sole trader
Few legal regulations
Owner has completed control over his
business – doesn’t consult others before
taking decisions
Free to choose his hours of work and
holidays, prices to charge customers and
whom to employ
Owner is in direct contact with his
customers so provide them with
personalized services and can quickly
respond to their demands
Complete secrecy in business matters
Disadvantages of sole trader
Unlimited liability
No one to consult business matters with
Limited sources of finance (owners savings,
profits from previous years and small bank
loans)
Business is likely to remain small thus
cannot benefit from economies of scale
No continuity of the business after the
death of the owner
2. Partnerships
Is a form of business in which two or more people agree to jointly own and run a
business together.
Features:
Partners contribute to the capital of the business
Partners run the business together
Partners will share profits and losses
Partnership is easy to set up
Advantages of partnerships
Disadvantages of partnerships
More capital than in a sole trader business Unlimited liability
can be invested
Responsibilities of running the business is
Unincorporated business -No separate
shared – absence of one partner will not
legal identity
cause problems
Losses are shared by partners
Partners may disagree on business
decisions
Partners may be motivated to work hard
Consulting all partners is time consuming
to make profits
A dishonest or inefficient partner can
cause losses and all partners will suffer
Business growth is limited to the
investments of 20 partners only
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3. Private limited companies
Are companies that are jointly owned by the people who have invested in the business
(shareholders). Shares are sold to family and friends only and not to the general public.
Features:
The company is owned by shareholders
Directors, who are the most important or majority shareholders, run the company
The company is a separate legal unit from its owners
Shareholders have limited liability
Advantages of private limited companies
Larger sums to invest in the company as
shares can be sold to family and friends
Company is a separate legal identity and
will continue should one of the owners die
Shareholders have limited liability shareholders only lose their original
investment in the company
Original owners may be able to keep
control of their business if they didn’t sell
too many shares to other shareholders
Company has higher status than
unincorporated businesses
Disadvantages of private limited companies
Significant legal matters in order to form the
company
a. articles of association: contains rules
under which the company will be
managed
b. Memorandum of association: contains
important information about the
company and the directors
Shares cannot be sold or transferred to
anyone else without the agreement of the
other shareholder – some people will be
reluctant to invest in ltd as they may not be
able to sell their shares quickly if they require
their investment back
Accounts of the company aren’t secret as the
have to be sent to registrar of companies and
can be inspected by any person
Finance for expansion is limited as shares
cannot be sold to the general public
4. Public limited companies
Are companies that are jointly owned by the people who have invested in the business
(shareholders). Shares are sold to the general public.
Features
Owned by private individuals from the general public who have invested in the business
Controlled by directors who are elected by shareholders in the AGM
The company is a separate legal unit from its owners
The owners have limited liability
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Advantages of public limited company
Shareholders have limited liability
It is incorporated business and is a
separate legal unit
Can raise very large capital sums to invest
in the business
No restrictions on trading of shares
The business has high status which
encourages suppliers to sell on credit to
them. Banks are also willing to lend them.
Customers may also be attracted to buy
from large companies.
Disadvantages of public limited company
Complicated legal formalities and time
consuming
More regulations and controls by the
government over plc in order to protect
the interests of shareholders (publication
of accounts which can be inspected by any
person)
Selling shares to the public is expensive
due to commission taken by specialize
porkers and cost of printing thousands of
prospectus.
Original owners will lose control over their
business as they cannot keep majority of
shares to themselves
Divorce between ownership and control of
the business
There is a risk that the company will be
taken over by a competing business
Control and ownership in a public limited company
Annual General Meeting: is a legal requirement for all companies. Shareholders may
attend and vote on who they want to be on the Board of Directors for the coming year.
At the AGM:
 The directors explain the performance of the company to shareholders.
 The only decision that shareholders can have a real impact on at the AGM
is the election of professional managers as company directors who are
given the responsibilities of running the business and taking decisions.
Directors in turn appoint managers who may not be shareholders at all, to take day-today decisions. This results in divorce between ownership and control of the business.
Divorce between ownership and control of the business: means that shareholders own,
but the directors and managers control the business.
Why divorce is divorce between ownership and control of the business a problem?
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As directors and managers may run the business to meet their own objectives this might
conflict with those of the shareholders.
Directors and managers may seek for increased status, growth of the business to justify
higher salaries and thus may reduce dividends to shareholders to pay for expansion
plans.
The only decision that can be made by shareholders in this situation is to replace the
directors in the AGM which may cause bad reputation and cause instability to the
business as the new directors may lack experience.
Other private sector business organizations
1. Joint ventures
It is when two or more companies agree to start a new project together sharing the
capital, the risks and the profits.
Advantages of joint ventures
Disadvantages of joint ventures
Sharing of cost
Profits have to be shared with the joint
venture partner
Local knowledge
Disagreement over important decisions
may occur
Risks are shared
The two join venture partners might have
different ways of running a business due to
difference in culture
2. Franchising
A franchise is a business based upon the use of the brand names, promotional logos and
trading methods of an existing successful business. The franchisee buys the license to
operate this business from the franchisor.
Advantages to the franchisor
Disadvantages to the franchisor
Income from selling the license to the
Franchisee keeps profits from the outlet
franchisee
Expansion of the franchised business is
faster that if the business used internal
expansion
Less management burden as it is the
Poor management of one of the franchised
responsibility of the franchisee
outlet could lead to a bad reputation for
the whole business
Profits from selling products to the
franchisor
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Advantages to the franchisee
Less chance of business failure because a
well-known product is being sold
Advertising cost is born by the franchisor
Reliability and assured quality of supplies
since all supplies are obtained from the
franchisor
Fewer decisions to make since prices,
store layout and range of products are all
determined by franchisor
Franchisor trains staff and management
Banks find it less risky to lend franchisees
Disadvantages to the franchisee
Less independent than with operating a
non-franchised business
Unable to take decisions that suits the
local area
License fee must be paid to the franchisor
and possibly a percentage of the annual
turnover
B. Business organizations in the public sector
The public sector includes all businesses owned by the state or central government.
They are usually business that have been nationalized.
Nationalization: selling of businesses that were once owned by private individuals to
the government
Advantages of public corporations
Disadvantages of public corporations
Government ownership of important
businesses is essential. Ex., water supply
Government should own natural
monopolies businesses in order to ensure
that consumers are not taken advantage
of by monopolists. Ex. Railway lines
Government nationalizes failing businesses
to keep it operating and secure jobs
Absence of profit motive may lead to
inefficiency
Government subsidies may lead to
inefficiency. It is also unfair to subsidies a
public corporation and not to subsidize a
similar one in the private sector
There is no close competition to the public
corporations. This results in lack of incentive
to increase consumer choice and increase
efficiency.
Governments can use these businesses for
political reasons. ex., create more jobs just
before elections - inefficient
Important public services such as TV are
often in the public sector to provide nonprofitable but important programs to the
public
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Chapter 5: Business objectives and stakeholder
objectives
Business objectives – why set them?
Business objectives: are the aims or targets that a business works towards.
Benefits of setting business objectives:
1. Give workers and managers a sense of direction and an aim to work towards achieving it
thus it motivates them.
2. Taking decisions will be focused on achieving the target.
3. Help unite the business towards the same goal.
4. Help assess the performance of the business.
What objectives do businesses set?
The most common objectives for businesses in the private sector are to achieve:
1. Survival
Survival will be thought when:
a. The business has been recently set up
b. the economy is moving into recession
c. new competitors enter the market.
In any of these cases, the managers will feel threatened and would lower prices in order
to survive though the profit on each item sold will be reduced.
2. Profits
It is the total income of a business (sales revenue) less total cost. All private sector
businesses aim for profits.
Profits are need to:
a. Pay a return for th owners of the business for the capital invested and the risk taken
b. Provide finance for further expansion of the business
Consequences of raising prices to increase profits:
a. Some consumers will stop buying the product
b. New competitors may enter the market which will reduce the profits in the
long run for the original business
c. Paying too much taxes to the government
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3. Returns to shareholders
This objective helps managers to maintain their jobs as they please shareholders. Also it
discourages shareholders from selling their shares.
A higher return to shareholders is achieved in two ways:
a. Increasing profits: which in turn increases dividends
b. Increasing share price: achieved through higher profits and / or expansion plans
leading to more profits on the long-run
4. Growth of the business
Growth is obtained if the customers are satisfied with the products or services provided
by the business. It is usually measured in terms of sales value or output which has the
following benefits:
a. More secure jobs for employees
b. Increase salaries and status of managers
c. Open up new possibilities and help to spread the risk of the business by moving into
new products and new markets
d. Obtain a higher market share from growth of sales
e. Obtain economies of scale
5. Market share
The proportion of total market sales achieved by one business.
𝑐𝑜𝑚𝑝𝑎𝑛𝑦 𝑠𝑎𝑙𝑒𝑠
Market share % = 𝑡𝑜𝑡𝑎𝑙 𝑚𝑎𝑟𝑘𝑒𝑡 𝑠𝑎𝑙𝑒𝑠 × 100
Benefits of increased market share:
a. Good publicity
b. Increased influence over suppliers
c. Increased influence over consumers
6. Service to the community
A social enterprise: has social objectives as well as an aim to make a profit to reinvest
back into the business.
objectives of social enterprises:
social: to provide jobs and support for disadvantaged groups in society
environmental: to protect the environment
financial: to make profit which will be reinvested into the business to perform more
social work
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Why business objectives could change?
Business objectives change in response to changes in the business environment and economy.
For example:
a. A newly set up business would aim for survival. After they achieved that aim the
objective should change to be higher profit or higher returns to shareholders.
b. A business which already achieved higher market share may change its objective to be
higher returns for shareholders.
c. A profitable business facing recession may change its objective to be survival
Which stakeholder groups are involved in business activity?
A stakeholder: is any person or group with a direct interest in the performance and activities of
a business.
Stakeholder groups and their objectives:
1. Owners
a. profits
b. growth of the business so that the value of their investments increases
2. Consumers
a. safe and reliable products
b. reasonable prices
c. well-designed and good quality products
d. reliability of service and maintenance
3. Workers
a. receiving their payments regularly
b. having a contract of employment
c. job security
d. job satisfaction and motivation
4. Government
a. Success of the business in order to pay taxes, employ workers and increase a
country’s output
b. having all firms comply with laws
5. Managers
a. growth of the business which will give them higher status and power.
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b. higher salaries
c. Secure jobs
6. Banks
a. ensure that the business is able to pay interest and repay capital lent
7. The whole community
a. safer products that are socially responsible
b. production that doesn’t damage the environment
c. creation of jobs for the working population
Conflict of stakeholders’ objectives
Stakeholders’ objectives could conflict with each other. For example:
a. a cheap method of production increases profits but pollutes the environment
b. growth of business by reinvesting profits will lead to lower dividends to shareholders
c. growth of the business would pollute the local environment
d. introduction of environment friendly machinery could reduce jobs in a factory
Managers therefore have to compromise when they decide on the best objectives for the
business they are running.
Objectives of public-sector businesses
1. Financial: meet profit targets set by government. Profits are reinvested in the business
or handed over to the government.
2. Service: provide a service to the public and meet quality targets set by government
3. Social: protect or create employment in certain areas
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Chapter 6: Motivating Workers
Motivation: is the reason why employees want to work hard and work effectively for the
business.
Fewer days off work, less grievances, no strike actions, high productivity and increases profits in
a business are the end result of a workforce that is motivated to work efficiently and
effectively.
Why do people work?
People work for several reasons like:
a. To earn money to pay for needs and wants
b. To have a sense of security; stable job and steady pay
c. To fulfill their social needs; feeling part of a group or organization, meeting people, and
making friends at work
d. To fulfill esteem needs; feeling important due to the job you do
e. To have job satisfaction; enjoyment derived from feeling that you have done a good job
Motivation Theories
1. F.W. Taylor
He assumed that all people are motivated by personal gain and therefore, if they are
paid more, they will work more effectively. He believed that when employees work
hard, their productivity would be high and labor costs would be low.
Criticism of Taylor’s ideas:
 Too simple; people are motivated by a lot of other things rather than money
 Productivity gains will not be achieved if an employee is dissatisfied by his work
even if you pay him more
 It is hard to measure some employees output. Ex., secretary
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2. Maslow
He proposed the following hierarchy of needs:
self actualization
(succeeding to your full
potential, doing a good job
not for pesonal gains, being
promoted and given more
responsibility)
esteem needs
(having status, recogntion for
a well-done job,and
independence)
social needs
(supportive colleagues, friendship and a
sense of belonging)
safety / security needs
( protection against danger, poverty and fair
treatment)
physiological needs
(enough wages to pay for basic needse ex., food and shelter)
Explanation:
 Money is not the only motivator. For employees to be motivated and work
effectively the higher levels in the hierarchy must be made available to them.
 Each level in the hierarchy must be achieved before an employee can be
motivated by the next level.
 Managers must identify the level of the hierarchy that a particular job provides
and then look for rewards associated with the next level up the hierarchy
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Limitations:
 Some levels don’t appear to exist for certain individuals, while some rewards
appear to fit into more than one level. For example, money is a reward for basic
needs and is also a reward for status symbol.
3. Herzberg
He suggested two sets of needs; one is for the basic needs, which he called ‘hygiene’
factors , and the second is for a human being to be able to grow psychologically, which
he called ‘motivators’.
Hygiene factors must be satisfied for the motivational ones to be effective in motivating
employees. If hygiene factors are absent then they can act as de-motivators to workers.
If present they don’t motivate employees as their effects wear off quickly.
Motivators
Hygiene / maintenance factors
Achievement
Recognition
Personal growth/development
Advancement/promotion
Work itself
Status
Security
Work conditions
Company policies and administration
Relationship with supervisor
Relationship with subordinates
Salary
Motivating factors – financial rewards / motivators
There are three factors which can motivate employees:
1. Financial reward
Increased pay may be used to give incentives to employees to encourage them to work
harder or more effectively.
Pay has the following various forms:
a. Wages
It is a payment for work, usually paid weekly.
Benefits of wages
Drawback of wages
Regular payment and worker doesn’t
It is expensive and time consuming to
have to wait long for some money.
calculate wages on a weekly basis
If they work longer than normal hours,
Extra labor cost as the business has to
overtime is paid which is an incentive to employ wage clerks to perform this task
work additional hours when needed by
the business.
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Wages can be calculated in two ways:

time rate
it is a payment by hour.
(hour rate X no. of hours worked)
Advantages of time rate
It is easier to calculate than piece
rate
Workers know exactly the amount
they will earn for a certain period
of time
Disadvantages of time rate
Calculation is time consuming
Good and bad workers get paid the
same amount of money
Expensive as supervisors are hired
to make sure that workers are
producing good quality
Expensive as a clocking-in system is
needed to determine the number of
hours worked by the employee

piece rate
o it is a payment that depends on the quantity of products made.
(piece rate X no. of products produced)
o This pay system can be applied to bonus system where employees who
produce more than a set target of output can be rewarded.
Advantages of piece rate
Disadvantages of piece rate
Encourages workers to work faster Quality may be ignored due to speed
and produce more goods
– may damage reputation of business
May need quality control system
which is expensive
Unfair to careful workers as they will
be paid less than those who rush
If the machine breaks down the
employee will earn less money. To
overcome this workers are often paid
a guaranteed minimum amount of
money.
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b. Salaries
Is a payment for work, usually paid monthly. It is usually paid for office staff or
management.
Benefits of paying salaries:
 It is easy to calculate as it is an annual amount of money divided into twelve
monthly payments.
 No extra payment for extra tasks
 Better cash flow for the business as the employer has the money in their bank
account for longer than if they had to pay wages
 Easier to calculate than wages as the calculation is done only once a month
Workers may get more money if one of the following rewards is added to the salary:
c. Commission
It is a payment often paid to sales staff relating number of sales to payment. it
motivates them to sell more as the more sales they make, the more money they will
earn.
Limitation:
Sales staff may be very persuasive and may encourage people to buy things that they
don’t want leading to bad reputation of the business.
d. Profit sharing
It is a system usually paid in the service sector whereby a proportion of the
company’s profits is paid out to employees. This motivates employees to work hard
as they will receive a share of the profit made by the business.
e. Bonus
It is an additional amount of payment above the basic pay as reward for good work.
f. Performance related pay
It is a pay system used when output can be measured. it is related to the
effectiveness of the employee. An appraisal system is used to help determine the
performance related pay.
Appraisal: is a method of assessing the effectiveness of an employee. An employee’s
immediate superior observes their work, talks to colleagues and then carries out an
interview with the employee to discuss their progress and their effectiveness. During
the appraisal training needs may be identified which helps improve employees
effectiveness in the future. Training also motivates employees.
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g. Share ownership
It is where shares in the company are given to employees so that they become part
owners in the company. This is usually given to higher level manager. This
encourages employees to work hard as they will receive dividends if the company
makes profits. Also share price will increase which increases the value of their
shares.
2. Non-financial rewards / perks / fringe benefits
Non-financial rewards vary according to the seniority of the job. They may include:
 Company car (senior managers)
 Discounts on firm’s products I (staff)
 Paid health care (staff and senior managers)
 Paid children education fees (senior managers)
 Free accommodation (senior managers)
 Share options (senior managers)
 Pension paid for by the business (staff)
 Free trips abroad (senior managers) / holidays (staff)
3. Introducing ways to give job satisfaction
Job satisfaction: is the enjoyment derived from feeling that you have done a good job.
Job satisfaction can motivate employees, increase their work commitment and make them
work effectively. Sources of job satisfaction will work only if hygiene factors are present. If
hygiene factors are absent then methods of job satisfaction will not be effective.
Ways to increase job satisfaction of employees:
a. Job rotation
Involves workers swapping round and doing each specific task for only a
limited time and then changing round again
Advantages of job rotation
Disadvantages of job rotation
More variety of work - less boredom Doesn’t make the tasks more
interesting
Present workers can cover up for
absent ones
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b. Job enlargement
It is where extra tasks of a similar level of work are added to the worker’s job
description. It doesn’t add extra work or increased responsibilities to the
employee
Advantages of job enlargement
Disadvantages of job enlargement
More variety to the work and thus
Workers may perceive it as extra
more job satisfaction
work for the same pay
c. Job enrichment
It involves looking at jobs and adding tasks that require more skill and /or
responsibility
Advantages of job enrichment
Disadvantage of job enrichment
May require additional training for
Training is expensive
employees leading to more
satisfaction and increasing
productivity
d. Autonomous work group or team work
It is where a group of workers is given responsibility for a particular process,
product, or development.
Advantages of team work
Disadvantages of team work
Workers feel that they have greater
Conflict may arise between members
control over their jobs as they decide of the team
how to complete the tasks, or
organize the jobs
Employees feel more committed
which increases job satisfaction
Improves morale as well as give a
greater sense of belonging to the
company
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Chapter 7: organization and management
What is organizational structure?
Organizational structure: refers to the levels of management and division of responsibilities
within an organization. It is often presented in the form of organization chart.
The organization structure of a business changes as the business expands
chief executive
Economic forecasting manager
IT manager
operation
director
financial
director
factory
manager
financial
accountant
marketing
director
promotional
manager
human
resources
director
director of
french division
sales manager
administraton
officer
factory worker
Features of an organization chart:


It is a hierarchy.
It organized in levels. Each level has different degree of authority. People at the same
level have similar degree of authority.
It is organized into functional departments
Each department is responsible for a particular function. For example, marketing
function. They use specialist skills in their work and thus are efficient. These managers
are called line managers.
o Line managers: have direct responsibility over people below them in the
hierarchy of an organization.
Limitation: workers may feel more loyal to their department than to the whole
organization which may lead to conflicts between departments.
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


In some organizations there are regional divisions.
These divisions use specialist knowledge to help rung branches abroad.
In some organizations there are departments with no typical functions like the IT
department or Economic forecasting department. The managers of these departments
are called staff managers.
o Staff manager: are specialists who provide support, information and assistance
to the Board of directors and to line managers.
It has a chain of command
It is a structure in an organization which allows instructions to be passed down from
senior management to lower levels of management.
Advantages of an organization chart:
1. The chart shows the links between employees in an organization. All employees are aware
of the communication channel used to reach them with messages and instructions.
2. Every individual can see their own position in the organization. Employees can identify who
they are accountable to and who they have authority over.
3. It shows the links and relationship between different departments within the organization
4. Everyone is in a department and this gives them as sense of belonging.
Chain of command and span of control
Span of control: is the number of subordinates working directly under a manager.
Chain of command: is a structure in an organization which allows instructions to be passed
down from senior management to lower levels of management.
The longer the chain of command, the taller will be the organizational structure and the
narrower the span of control. Also when chain of command is short the organization will have
a wider span of control and a shorter organizational structure.
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Long chain of command and
narrow span of control
Wide span of control – short chain of
command
Advantages of short chain of command
1. Communication is quicker and more accurate
2. Top management are less remote from lower level of hierarchy
3. Wider span of control so more delegation of tasks
a. Less direct control of each worker so they will feel more trusted
b. Employees will take decisions on their own which results in job satisfaction
Disadvantages of short chain of command
1. Managers lose control of what their subordinates are doing.
2. Managers will be responsible for any mistakes done by subordinates if they were poorly
trained.
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Importance of management:
Without clear and effective management, a business is going to lack the following and fail;




Sense of control and direction
Coordination between departments, leading to wastage of effort and
resources
Control of employees
Organization or resources, leading to low output and sales
The role of management:
1. Planning
Planning for the future of the organization involves setting aims and targets which will
give the organization a sense of direction and purpose.
A manager must also plan for the resources which will be needed to fulfill the set
targets.
2. Organizing
A manager organizes people and resources effectively. Delegation an organization chart
can help to show who has the authority to do different jobs. It helps to create
specialization and avoid duplication of tasks.
3. Coordinating
A manager should make sure that all departments in the organization work together to
achieve the plans originally set by the manager. Communication and regular meetings
between people of various departments can help in this task.
4. Commanding
A manager’s role is to guide, instruct, lead and supervise people. He has to make sure
that all supervisors and workers are carrying out tasks to meet targets and deadlines.
5. Controlling
A manager has to measure and evaluate the work of all individuals and groups to make
sure that they are on target. If certain groups are failing to do their tasks then the
manager has to take corrective action. A manager has to find out the reasons behind
the failure to meet targets then correct the problem.
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Delegation
Delegation: is giving a subordinate the authority to perform particular tasks.
Only authority is delegated but the final responsibility still lies on the manager.
Advantages of delegation for a
manager
Advantages of delegation for a subordinate
Allows managers to give time to other
important issues
Less mistakes by managers
Work becomes more interesting and rewarding (job
satisfaction)
The employee feels important and believes that he
is trusted
It gives career opportunities for employees as it is
considered to be a form of training.
Easier for managers to measure the
performance of their subordinates
Why some managers don’t delegate?
1. Managers want to control everything by themselves. They are afraid that
subordinates may fail.
2. They may feel insecure if a subordinate performs a task better than the manager.
Why is it important to have good managers?
1.
2.
3.
4.
5.
To motivate employees
To give guidance and advise to employees
To inspire employees to achieve more than they thought possible
Too keep costs under control
To increase profitability of the business
Leadership
A good leader in a large business is someone who can inspire and get the best out of the
workforce, getting them to work towards a common goal.
Leadership styles: are the different approaches to dealing with people when in a position of
authority. There are three main leadership styles; autocratic, laissez faire, or democratic.
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1. Autocratic leadership
Is where a manager expects to be in charge of the business and to have their orders
followed.
 They make all the decisions.
 Employees don’t get information about the future plans – managers keep all
information for themselves.
 Communication is one way communication.
 Workers have little or no opportunity to comment on anything.
2. Democratic leadership
Is where a manager gets other employees involved in the decision making process.
 Information about future plans will be openly discussed.
 Communication is a two ways communication.
3. Laissez-faire leadership
It is where the manager makes the broad objectives of the business known to
employees, but then they are left to make their own decisions and organize their own
work.
 Clear directions will not be given
 Communication is difficult
Note: there is no best way of management style. The style of leadership can vary depending on
the situation and employees dealt with. Managers can be democratic in certain situations and
autocratic in others.
Trade unions
Trade union: is a group of workers who have joined together to ensure their interests are
protected. It is a type of pressure group.
Examples of interests:





Improving their pay
Having a pleasant work environment
Fair treatment
Proper training
Safe work environment
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Why do workers join a trade union?
1.
2.
3.
4.
5.
6.
Strength in number
Improved conditions of employment (rates of pay, holidays,..etc)
Improved environment of work (health and safety, heating,..etc)
Improved benefits for those who are sick, retired or have been made redundant
Improved job satisfaction by encouraging training
Advice / or financial support if a member is unfairly treated or is asked to do something
not in his job description
7. Other benefits/ services such as insurance, discounts in certain shops, provision of
sporting facilities or clubs
8. Employment where there is a closed shop
Closed shop: all employees must be a member of the same trade union.
9. Influence government decision by putting forward their views to the media
10. Improved communication between workers and management
Disadvantages of joining a trade union:
1. Cost money to be a member
2. May be required to take industrial action even if they don’t agree
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Chapter 8: Recruitment, selection and training of
workers
The work of the Human Resources department
1.
2.
3.
4.
5.
6.
Recruitment and selection
Wages and salaries
Industrial relations
Training programmers
Health and safe
Redundancy and dismissal
Recruitment and selection
Recruitment: is the process from identifying that the business needs to employ someone up to
the point at which applications have arrived at the business.
1. vacancy
arises
2. job analysis
3. job
description
6. applictaion
forms and
short-listing
5. job
advertisement
4. job
specification
7. interviews
and selection
8. vacancy
filled
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1. Job analysis
Is to identify and record the responsibilities and tasks relating to a job. It also identifies
the skills need to be present in the new employee.
2. Job description
It outlines the responsibilities and duties to be carried out by someone employed to do
a specific job.
Advantages of job description:
a. Candidates read it to know exactly what the job entails
b. It allows a job specification to be drawn up which helps in employing people with
the right skills for the job.
c. It will be used in assessing the performance of the employee. Also it is referred to in
cases of disputes between a manager and his subordinates over the tasks to be
carried out.
The job description will contain:
a. Job title, department
b. To whom the employee will be responsible
c. Main and occasional duties of the job
d. Conditions of employment
e. Training that will be offered
f. Opportunities for promotion
3. Job specification
Is a document which outlines the requirements, qualifications, expertise, physical
characteristics, etc. for a specific job.
It outlines the details of the person who is required to the job.
The requirements will include:
a. Educational qualification
b. Years and type of experience
c. Special skills
d. Personal characteristics, such as type of personality
4. Advertising the vacancy
It is the choice of where to advertise for the job. It can be done internally or externally.
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a. Internal recruitment:
Is when a vacancy is filled by someone who is an existing employee of the business. The
job may be advertised on a company noticeboard, newspaper or intranet.
Advantages of internal recruitment
It saves time and money
The person’s reliability, abilities and
potentials are already known
The person also knows the system of the
organization and what is expected from
employees
Can motivate others and make them work
harder.
Disadvantages of internal recruitment
The business will not get new ideas or
experiences into the business
There may be jealousy and rivalry amongst
existing employees
b. External recruitment:
Is when a vacancy is filled by someone who is not an existing employee and will be new
to the business.
Vacancies can be advertised in several places:
Local newspaper: for positions that don’t require a high level of skills
National newspaper: for senior positions, where there may be few people in the local
area with the right qualifications for them.
Specialist magazines: for particular technical people such as scientists.
Recruitment agencies: for particular type of skilled workers or when the vacancy is in
another country
Centers run by the government: for unskilled and semi-skilled jobs.
For example:
a. if the job is a basic one like secretarial, which doesn’t require a lot of qualifications
or skills, then it may be advertised in the local newspaper as many local people could
have the necessary qualifications or skills to do the job.
b. if the job is a senior one like senior financial manager, which requires many
qualifications, then it may be advertised in the national newspaper, recruitment
agencies or in the internet to make the advert seen by people in different parts of
the country or in different countries.
5. Application forms & CVs
This can be done by either filling an application form or by sending a CV. It should
contain information such as, name, address, work experience, education and
qualifications,…etc.
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6. Interviews
Interviews have many forms like skills test, aptitude test, personality tests and group
situations. The purpose of the interview is to:
 Assess applicants ability to do the job
 To know the applicants personal qualities that may be counted as an advantage
or a disadvantage
 To know whether the applicant is fit through his general character
The contract of employment
It is a legal document between the employer and employee that sets out the relationship
between them. It contains information like name of employee and his employer, job title, rate
of pay, …etc.
Types of contracts:
a. Full time: employees will usually work 35 hours or more a week.
b. Part-time: employment is often considered to be between 1 and 30-35 hours a week
(fewer hours than full time).
Advantages of employing part-time
Disadvantages of employing part-time
workers (disadvantages of full-time)
workers (advantages of full time)
More flexible hours of work
Less likely to be trained (temporary job)
Can ask employees to only work at busy
more time consumption to employee 2
times
part-time employees than one full-time
Will be able to extend business opening
Worker less committed to the business –
hours
worker may leave for a better job
Employee willing to accept lower pay
Less likely to be promoted as they will not
be as skilled as full-time employees
Less expensive than employing /paying a
More difficult to communicate with patfull time worker (ex: insurance,
time employees as they have different
trainings,..etc.)
schedules
Training
Training is important for the success of the business. It is a form of investment but in human
capital which leads to greater output in the future.
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Types of training:
a. Induction training
It is an introduction given to a new employee, explaining the firm’s activities, customs
and procedures and introducing them to their fellow workers.
It is useful when an employee is new to the post.
Advantages of induction training
Disadvantages of induction training
New employees will settle into the job quickly
Time consuming
Complies with legal requirements to give health Expensive: wages paid while worker still didn’t
and safety training at the start of a job
work yet
Workers will be less likely to make mistakes
Delays the employees start of the job
b. On-the-job training
It is when an employee watches a more experienced worker doing the job. It is suitable
for unskilled and semi-skilled jobs.
Advantages of on-the-job training
Disadvantages of on-the-job training
Saves travel cost
Trainer is less productive than usual as he
is busy training the new employee
The worker is capable of doing some
Trainer may pass bad habits to the trainee
production while training
Costs less than off-the-job training
It may not necessarily be a recognized
training qualifications outside the business
Tailored to the specific needs of the
business
c. Off-the-job training
An employee is being trained away from the workplace, usually by specialist trainers. It
may be in a different part of the building or it may be at a different place altogether.
Advantages of off-the-job training
Disadvantages of off-the-job training
A broad range of skills can be taught using a variety of
Costs are high
techniques
Cheaper if taught in the evening because the employee If done in the morning, wages are paid but no
will still carry out their normal duties during the day
productivity by the worker
The business will not lose output; it will only lose tuition The additional qualifications make it easier for
fees of the courses
the employee to leave for another job
(poaching)
Employees will become multi-skilled thus more versatile
– more fit to move around the company when the need
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arises
Expert trainers have/use up-to-date knowledge of
business practices
Advantages and disadvantages of training for management
Advantages of training for management
Multi-skilled labor force which provides
greater flexibility
Greater motivation and commitment of
employees
Increased productivity
Improved quality of output
Disadvantages of training for management
Loss of output whilst training
May raise employees expectations of
promotion
Cost of training
Employees may leave once they are trained
and then another business will benefit from
the training
Improved customer service
Ability to use new technology
Advantages and disadvantages of training for an employee
Advantages of training for an employee
May get increased pay
Disadvantages of training for an employee
May be asked to undertake additional
duties
May have to work in a different way
May be moved to different job
Improved chances of promotion
Easier to apply for jobs at other businesses
Situations in which downsizing of workforce is necessary
Workforce planning
Is establishing the workforce needed by the business for the foreseeable future in terms of the
number and skills of employees required. The number required will depend on the firm’s sales
forecasts ( will sell more or less?), its future plans (will expand or downsize?), and its objectives
(will introduce new products?).
Reasons for downsizing (reducing the number of employees):




Introduction of automation
Falling demand for their goods or services
Factor/shop/office closure
Relocating their factory abroad
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
Merger or takeover thus some jobs have become surplus to the requirements of the
new business
How does the HR department plan their workforce?




Finding out the skills of all present employees
Counting out anyone who will be leaving soon
Consulting with existing staff on who could /want to retrain to fill the new job
Prepare a recruitment plan to show how many new staff will be needed and how they
should be recruited
The business can reduce the number of employees can be done by:
1. Dismissal
Is when an employee is told to leave their job because their work or behavior is
unsatisfactory. A business will have to ensure that they followed all the laws in their
country when dismissing an employee or else it may be sued to court in case of unfair
dismissal.
2. Redundancy
is when an employee is no longer needed and so loses their job. It is not due to any
aspect of their work being unsatisfactory. Employees are usually given some money to
compensate them for losing their job.
Factors to consider when taking the decision of retaining or releasing a worker:
 Some workers may volunteer to be made redundant
 Length of time employed with the business (the longer the period of stay with
the business the more experienced the employee and the more expensive to
make him redundant)
 Workers with needed or essential skills for the business or who are flexible to
move about in a business are to be retained
 Employment history of the worker (attendance, punctuality, commitment, loyal,
appraisal record,..etc)
 Which department need to lose workers and which department need to retain
workers
Legal controls over employment issues
Laws are passed by governments to ensure:



Equal treatment in the workplace
Equal opportunity when being recruited
Equal pay for similar work
What does this mean for businesses?
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


A business has to be careful when wording an advert
All job applicants must be treated equally
A business should recruit and promote workers based on merit alone which will help
increase motivation at work.
Employees need protection in the following areas:
1. Protection against unfair discrimination at work and when applying for jobs
Discrimination means preference of an employee over another based on unfair reasons
such as:
Race and color
Different religion
Opposite sex
Considered too old/young for the job
Disabled in a way
The results of unfair discrimination are that:
 A business will fail to select a qualified worker because of one of the above reasons.
 Employees who believe that they were unfairly discriminated against can appeal to
an equal opportunities committee.
2. Health and safety at work
In most countries there are laws that forces employers to improve health and safety at
work. The laws ensure that employers:
 Protect workers from dangerous machinery
 Provide safety equipment and clothing
 Maintain reasonable workplace temperature
 Provide hygienic conditions and washing facilities
 Do not insist on excessively long shifts and provide breaks in the work timetable
Though these conditions increase business expenses however, workers cost a great deal
to recruit and train thus it is worthwhile keeping them safe and healthy. Such workers
are likely to be better motivated, work more efficiently and stay with the firm for a
longer period of time.
For these reasons some employers in countries with weak health and safety laws are
taking ethical decisions.
Ethical decisions: is a decision taken by a manager or a company because of the moral
code observed by the firm.
3. Against unfair dismissal
 Examples of unfair dismissal are:
 For joining a trade union
 For being pregnant
 When no warnings are given before dismissal
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If a worker feels that they have been unfairly dismissed they can take their case to an
industrial tribunal which will hear to both sides of the argument and may give the
worker compensation if it believes he was unfairly dismissed.
Industrial tribunal: is a legal meeting which considers workers complaints of unfair
dismissal or discrimination at work.
4. Wage protection
There should be an employment contract between the employee and employer which
lists the rights and responsibilities of the worker. It usually contains details of hours of
work, nature of the job, wage rate to be paid, how frequently wages will be paid and
what deductions to be made from the wage.
Some governments also pass legal minimum laws to protect workers from being
exploited. The law makes it illegal to pay a worker a rate below a minimum set by the
government.
Advantages of legal minimum wage
Prevent strong employers from exploiting
unskilled workers who couldn’t easily find
another work
It encourages employers to train unskilled
workers to ensure that they are more
productive
It will encourage more people to seek
work
Low paid workers will earn more and will
be able to afford to spend more
9
Disadvantages of legal minimum wage
It increases business cost which force them
to increase prices
Unemployment may rise as some
employers may not be able to afford the
higher wage rate and will make some
worker redundant
Business cost will increase as the skilled
workers who earn just above the legal
minimum wage will ask for higher pay to
keep the wage differentials between them
and the unskilled ones.
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Chapter 9: Internal and External communication
What is effective communication and why is it necessary?
Communication: is the transferring of a message from the sender to the receiver, who
understands the content of the message.
Message: is the information or instructions being passed by the sender to the receiver.
Effective communication: is when the information or message being sent is received,
understood and acted upon in the way intended.
Internal communication
Internal communication: is between members of the same organization.
Without internal communication it will be impossible for management to guide, instruct, warn
and encourage workers to do their tasks.
External communication
External communication: is between the organization and other organizations or individuals.
External communication is very important to the image and efficiency of a business. For
example, If a firm communicates ineffectively with suppliers, it may be sent the wrong
materials. If it is sends inaccurate information to customers, they may buy a product from
another firm. If it sends inaccurate information to the tax office it may be overcharged and
cause financial problems or undercharged and face legal consequences.
The process of effective communication
The process consists of the following four features:
1.
2.
3.
4.
Transmitter/ sender: is the person starting of the process by sending the message
The medium communication: is the method used to send a message
The receiver: is the person who receives the message
Feedback: is the reply from the receiver which shows whether the message has arrived,
been understood and, if necessary acted upon.
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One-way and two-way communication
One way communication: involves a message which doesn’t call for or require response. It
doesn’t allow the receiver to contribute to communication or to provide any feedback.
Two way communication: is when the receiver gives a response to the message and there is a
discussion about it. Since both people are involved in the communication process it may result
in better and clearer information.
Advantages of two-way communication:
1. It assures the sender whether the receiver has understood the message and acted upon
it. If not then the message needs to be re-sent or clarified.
2. It helps motivate the receiver since he is part of the communication process accordingly
makes real contribution to the topic being discussed.
Communication methods:
1. Verbal methods of communication: where the sender of the message speaking to the
receiver. Methods may include:
a. One to one talks
b. Telephone conversations
c. Video conferencing
d. Meetings and team briefings
Advantages of verbal communication
Disadvantages of verbal communication
Quick; efficient way of communicating to big
Cannot tell if everybody is listening in a large
numbers
meeting or has understood the message
Two way communication; opportunity of feedback If receivers give feedback then it will take
longer to use verbal than written
communication
Body language used by the speaker will put the
Verbal method is in appropriate when
message across effectively
accurate and permanent record of the
message is needed
2. Written methods of communication: includes letters, notices, posters and IT
Advantages of written communication
Disadvantages of written communication
Hard evidence of the message is available
Direct feedback is not always possible,
which can be referred to in the future
unless electronic communication is used
Essential for messages involving complicated Electronic communication may lead to
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details – laws in certain countries require
certain safety messages written and
displayed in offices in order to refer to them
when needed
Copying a written message and sending it to
many people may be more efficient than
calling them
Electronic communication is quick and cheap
way to reach a large number of people
communication overload and people will
miss out important messages
Difficult to check if message has been
received and acted upon as with verbal
messages
Message is not reinforced by body language
Too long messages may be confusing and
not interesting to readers – language used
may be difficult for some receivers
3. Visual methods of communication: includes diagrams, charts and videos
Advantages of visual communication
Disadvantages of visual communication
Information is presented in an appealing and There is no feedback and the sender of the
attractive way.
message may need to use other forms of
communication to check that the message is
understood.
They make the written message clearer
Charts and graphs are difficult for some
when a chart or a diagram is used to
people to interpret. The overall message
illustrate the point made.
might be misunderstood if thee receiver is
unsure of how to read values from a graph
or how to interpret a technical diagram.
Choosing the appropriate communication method:
Factors which the sender should consider when selecting a method of communication:
1. Speed: importance of speed should be considered
2. Cost: companies may need to consider which is more important to keep cost down or to
communicate effectively. For example, when safety matters are involved
3. Message details: written & visual communication may be chosen if technical plans,
reports, figures,..etc. are to communicated
4. Leadership style: democratic managers would use two-ways communication whereas
autocratic ones would use one way communication
5. The receiver: one-to-one conversation may be used when communicating to one person
which is not appropriate to hundreds of people
6. Importance of a written record: it is recommended when written record is needed to
refer to at some time in the future.
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7. Importance of feedback: if feedback is essential then it is recommended to
communicate verbally where there will be direct feedback.
Formal and informal communication
Formal communication: is when messages are sent through established channels using
professional language.
Informal communication: is when information is sent and received casually with the use
of everyday language.
Advantages of informal channels /
Disadvantages of informal channels
grapevine
Can be used by managers to try out the
Can spread gossip and rumor which is
reaction to new ideas before
unhelpful to managers
communicating details formally. If the
reaction to management from the
grapevine is negative, they may not
introduce the new idea at all.
The direction of communications
Downward communication: when messages are sent from managers to subordinates.
It doesn’t allow for feedback. If the message passes through too many levels it can
become distorted.
Upward communication: when a message or feedback is passed form subordinates to
managers.
Horizontal communication: when people at the same level of an organization
communicate with each other. They may use formal and informal meetings. It may
cause conflict between departments.
Communication barriers
Communication barriers: are factors that stop effective communication of messages.
Barrier
Description
How the barrier can be overcome
Problems with the  Use of difficult language or technical terms
 Sender should ensure that he
sender
uses understandable language
 Sender speaks quickly or not clearly enough
- avoid technical language
 Sender communicates the wrong messages
 Ask for feedback to ensure
or passes it to the wrong receiver
message is understood
 Too long and detailed messages prevent the

Ensure that the right person is
main points being understood.
receiving the right message
 The message should be as brief
as possible to allow the main
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points to be understood
Problems with the
medium
Problems with the
receiver
Problems with
feedback

Message is lost and receiver doesn’t see it


Use of a wrong channel


The use of a long chain of command may
result in message distortion


Breakdown of the medium


They may not be listening or paying
attention


The receiver may dislike or distrust the
sender
There is no feedback
It is received too slowly or is distorted –
perhaps message passes through too many
people before being received by the original
sender of the message




Insist on feedback. If feedback
is not received then assume
that the message is lost
The sender must select an
appropriate channel for each
message sent
The shortest possible channel
should be used
Other forms of communication
should be made available
Importance of message should
be emphasized and receiver
should be asked for feedback
Another sender should be used
who is trusted by the receiver
Direct lines of communication
between subordinates and
managers must be available.
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Chapter 10: Marketing, competition and the customer
The marketing department
The marketing department is concerned with doing research for new products, promotion
distribution, pricing and sales.
It may have many sections in it like:
1. Sales department: is responsible for the sales of the product.
2. The market research department: is responsible for finding out customers’ needs,
market changes and the impact of competitors’ actions. This information will be used to
make decisions about development of new products, pricing levels, sales strategies and
promotion strategies.
3. The promotion department: organizes the advertising for products and decides on the
types of promotions that will be included in campaigns. It will be constrained with a
marketing budget that cannot be exceeded and thus has to choose the most effective
types of advertising media.
4. The distribution department: transports the products to the market.
The role of marketing (what is marketing department doing?)
The central role of marketing is to:
1.
2.
3.
4.
5.
Identify customer needs
Satisfy customer needs
Maintain customer loyalty
Gain information about customers
Anticipate changes in customer needs
The objectives of the marketing department (why does the marketing
department do so?)
1. raise customer awareness of a product or service of the business
2. increase sales revenue and profitability
3. increase or maintain market share
market share: is the percentage of total market sales held by one brand or
business
market share = (sales of brand or business / total market sales) x 100
4. maintain or improve the image of products or a business
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5. target a new market or market segment
6. enter new markets at home or abroad
7. develop new products or improve existing products
Understanding market changes
Sales of some goods change at a rapid (ex, technology) pace and sales of others stay (ex,
cereals) the same
Why customer spending patterns change
1.
2.
3.
4.
changes in consumer tastes and fashion
changes in technology
change in incomes
ageing populations
The power and importance of changing customer needs
If the businesses fail to respond to customer needs then they are likely to fail
Why have some markets become more competitive?
1. Globalization of markets
2. Transportation improvements
3. Internet/e-commerce
How can businesses respond to changing spending patterns and increased competition?
A business will have to take action to maintain its market share and convince the customers
that the problem has been corrected:


Whenever there is growth amongst competitors.
If the image of business has been harmed by bad publicity in media
In order to remain successful a business may need to:
1.
2.
3.
4.
Maintain good customer relationships
Keep improving its existing
Bring out new products to keep customers’ interested
Keep costs low to maintain competitiveness
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What is meant by a market?
A market is made up of the total number of customers and potential customers as well as
sellers for that particular good or service.
It is measured by total number of sales or by value of sales for that good or service by all
suppliers to that particular good or service.
Mass market: is where there are a very large number of sales of a product. Products are
designed and advertised to appeal to the whole market.
Advantages of selling to a mass market
The sales to these markets are very large
Disadvantages of selling to a mass market
High level of competition between firms
The firm can benefit from economies of scale
High costs of advertising
Risks can be spread due to selling variations of
products to the masses and if one variety of the
product fails the the other products may still sell well
Opportunities for growth of the business due to large
potential sales
may not meet the specific needs of all customers or
potential customers as only standardized products are
produced, therefore leading to lost sales
Niche marketing: is a small, usually specialized segment of a much larger market. The
products are sold to small number of customers and thus quite often sold by small firms.
Advantages of selling to a niche market
Small firms are able to sell to a niche market
and avoid competition from larger firms
Disadvantages of selling to a niche market
Niche markets are small and thus have a
limited number of sales which limits the
expansion of the business
Niche market will specialize in just one
product and thus doesn’t spread the risk of
the business (demand falls = failure of
business)
Small firms will have advantage over larger
firms as they focus on the specialized needs of
consumers rather than the needs of the
masses
Market segments
Market segments: is an identifiable sub-group of a whole market in which consumers have
similar characteristics or preferences.
Market segmentation: is when a market is broken down into sub-groups which share similar
characteristics.
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Benefits of segmenting the market:




Make marketing expenditure cost effective by producing a product which closely meets
the needs of these customers and only targeting its marketing efforts on this segment.
Enjoy higher sales and profits for the business because of the cost effective marketing
Identify a market gap and therefore offer opportunity to increase sales.
Sell more products as the business makes different brands of a product and then aiming
each brand at a different market segment.
Ways of segmenting a market:






By socio-economic group: defining income groups according to how much they are
paid. Thus products will be priced differently to target certain income groups.
By age: different age groups will buy different products.
By region/location: people buy different products due to living in different parts of the
country.
By gender: some products may only be bought by women and some others by men.
By use of the product: some goods like cars can be used by consumers for domestic use
or for business use.
By lifestyle: people with different lifestyles will buy different products.
Decide the best place to advertise to increase sales:
Once the segments have been identified, this will influence how the product are packaged and
advertised. It will also affect the choice of shops the products are sold in, in order to get
maximum sales.
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Chapter 11: Market research
Product-orientated and market orientated businesses
Product orientated business: is one whose main focus activity is on the product itself.. They
produce the product first and then try to find a market for it. The main focus of manufacturer /
retailer is the quality and price. They often produce necessities required for living such as
agricultural products or technology products.
Market orientated business: is one which carries out market research to find out consumer
wants before product is developed and produced. The business must have a marketing budget.
These businesses are better able to survive and succeed because they are usually more
prepared for changes in customer tastes. They are also able to take advantage of new market
opportunities which may arise.
Marketing budget: is a financial plan for the marketing of a product or product range for some
specified period of time. It specifies how much money is available to market the product or
range, so that the marketing department knows how much it may spend.
Why is market research needed?
Market research: is the process of gathering, analyzing and interpreting information about a
market. It is important as the business needs to find out how many people would want to buy
the product they are planning to offer for sale or else it may waste resources and bankrupt.
Market research is used to find out:
Likes and dislikes for a certain product
Consumers’ willingness to buy the product
Range of prices they will pay for the product
Information about competitions
Types of information
Quantitative information: answers questions about quantity of something
Qualitative information: answers questions where opinion and judgment is necessary
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Types of research
Primary research / field research: is the collection and collation of original data via direct
contact with potential or existing customers.
Secondary research / desk research: is the use of information that has already been collected
and is available for use by others.
The process (stages) of primary research
1. what is the purpose of the market research?
2. decide on the most suitable method of research
3. decide on the size of sample needed and who is going to be asked
4. carry out the reserach
5. collate the data and analyse the results
6. produce a report of the findings
Methods of primary research
1. Questionnaires: is a set of questions asked to respondents
Advantages of questionnaires
Qualitative information can be gathered
Customers’ opinion can be obtained
Can be carried out online which makes it cheaper and
easier to collate and present the results
People can be encouraged to fill them by linking them to
prize draws
2
Disadvantages of questionnaires
Answers may not be very accurate if questions are
not well thought out
Conducting the questionnaire is expensive and time
consuming
Collating and analyzing results is also time
consuming
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2. Interviews: interviewer will ask interviewee ready-prepared questions
Advantages of interviews
Disadvantages of interviews
Interviewer is able to explain any questions that the
Interviewer bias may lead to inaccurate results as
interviewee doesn’t understand
the interviewer could lead the interviewee to
answer in a certain way
Detailed information about customers likes and dislikes
Time consuming and expensive way of gathering
can be gathered
data
3. Focus groups: is where groups of people agree to provide information about specific
product or general spending patterns over a period of time.
Advantage of focus groups
Disadvantage of focus groups
Can provide detailed information about consumers’
Can be time consuming, expensive and biased if
opinions
some people in the panel are influenced by the
opinion of others
4. Observation: it can be in the form of recording, watching and audits
Advantage of observation
Disadvantage of observation
It is an inexpensive way of gathering data
It doesn’t give the business with reasons for
consumer decisions
Samples
A sample: is the group of people who are selected to respond to a market research exercise,
such as a questionnaire. It hand s to be selected as it would be too expensive and impractical
to try to include all the relevant population.
It could be selected in two ways:
Random sample: is when people are selected at random as a source of information for market
research. Everyone in the population has an even chance of being selected.
Advantage of random sample
Everyone in the population has an even
chance of being picked
Disadvantages of random sample
Not everyone in the population may be a
consumer of the particular product being
investigated
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Quota sample: is when people are selected on the basis of certain characteristics (such as age,
gender or income) as a source of information for market research.
Advantage of quota sample
Provides more accurate data than random sample
Secondary research
The secondary information collected may be from an internal source or external source. It is a
much cheaper way of gathering information as the research has already been done by others.
1. Internal sources of information: information that can be cheaply available from the
firm’s own records. For example, sales department may provide information on which
brand is selling well and in which area. Information could also be collected from the
finance department, customer service department , distribution and public relation
departments
2. External sources of information: this is when information is obtained from outside the
company. The information collected may be of general nature as it has been gathered
for some purpose other than the research that is being undertaken.
External sources are as follows:
 Government statistics: involve information about population and its age
structure
 Newspapers: provides information about the general state of the economy and
customer expenditure patterns
 Trade associations for the industry: provides information for the business in that
industry
 Market research agencies: are specialist agencies that carry out research on
behalf of companies or anyone who commissions them.
 The internet: an easily accessible source of a very wide range of information. A
company must be careful to verify accuracy of information and when was it last
updated
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Accuracy of market research data
The accuracy of the data that has been collected depends on the following factors:
1. How carefully the sample was drawn up
2. Choice of phrases in a questionnaire to ensure honest responses. Trying the
questionnaire on a small group of people before using them on the large sample can
help and allow for rephrasing the vague questions.
3. Whether the sample selected is a true representation of the total population. Quota
sample will give more accurate results than random sample
4. Selection of the size of the sample. The larger the sample the more accurate the
results are likely to be, but the more expensive will be the research and vice versa.
5. Who carried out the research: secondary research may be inaccurate because it was
initially carried out for some other purpose and you would not know how the
information was actually gathered.
6. Bias: important information may be deliberately left out when writing articles in
newspapers
7. Age of the information: statistics can quickly become out of date, no longer relating
to the current trends in consumers’ buying habits, but reflecting what they used to
be spending their money on.
Due to the above factors information collected from research should be used carefully.
It should never be assumed straightaway that information is correct.
5
Chapter 12: The marketing mix: product
The marketing mix
The marketing mix: is a term which is used to describe all the activities which go into marketing
a product. These activities are often summarized as the four Ps – product, price, place and
promotion.
The four Ps of the marketing mix
1. Product
This involves the design, quality and packaging of the product
2. Price
This is concerned with price at which the product is sold in comparison to that of
competitors. Price should cover cost in the long run
3. Place
This refers to the channels of distribution that are selected. Will they choose direct
channel or channels with intermediaries.
4. Promotion
This involves how the product is advertised and promoted. Which media should they
advertise in and what type of sales promotion to use.
The role of product decisions in the marketing mix
The product itself is the most important element in the marketing mix, without the rest of the
product the rest of the marketing mix is pointless. Most products nowadays are market
orientated which means they spend a lot of money on researching consumers’ buying habits,
likes and dislikes in order to design a product which meets their expectations.
Types of products include:
1. Consumer goods: are goods which are consumed by people; e.g. food or furniture
2. Consumer services: are services that are produced for people; e.g. hairdressing or
education
3. Producer goods: are goods that are produced for other businesses to use. They help
with the production process; e.g. lorries or machinery
4. Producer services: are services that are produced to help other businesses; e.g.
insurance or banking
Categorizing the type of the product will help in deciding how the product will be developed
and marketed. Promotion of a producer good will be quite different from promotion of a
consumer good.
What makes a product successful?
1. It has to satisfy existing needs and wants of consumers
2. Design in terms of performance, reliability, quality should be consistent with the
product’s brand image and with the price charged
3. It should be capable of stimulating new wants from the consumer
4. Should not be too expensive to produce in order to allow for a reasonable price
5. The first business to produce new product or introduce new changes to the original
product before its competitors
6. Has a distinctive feature that makes it unique
Product development
Product development goes through the following process:
generate ideas
select the best ideas for further reserarch
decide if the company will be able to sell enough for the product to be a success
develop a prototype
launch the product in one part of the country to test the market
go to a full launch of the product to the whole market
The costs and benefits of developing new products
Developing new products has the following benefits:
1. USP: is the special feature of a product that differentiates it from the products of
competitors
2. Diversification of the business
3. Expansion into new markets
4. Expansion into the existing markets
Cost of developing new products:
1.
2.
3.
4.
Market research is expensive
Producing trial products is expensive including the costs of wasted materials
Lack of sales if the target market is wrong
Loss of company image if the new product fails to meet customer needs
The importance of brand image
Brand name: is the unique name of a product that distinguishes it from other brands




Brand names are usually rely on advertising to make consumers aware of the qualities
of the product and try to persuade them to buy it.
Brand names are usually perceived by consumers as being of higher quality than
unbranded ones.
Brands have an assured standard quality that makes consumers confident in buying
branded products. This also may lead to consumer loyalty; which keeps the customer
buying the same brand of a product instead of trying to buy similar products.
Brands will have a whole brand image; is an image or identity given to a product which
gives it a personality of its own and distinguishes it from its competitors’ brands.
The role of packaging
Packaging: is the physical container or wrapping for a product. It is also used for promotion
and selling appeal.
The packaging has the following functions:
1. Has to be suitable for the product to be put in to give protection and not allow it to
spoil. It also has to allow the product to be used easily. It Should also allow it to be
transported easily without any damages.
2. It is also used for promoting the product. It has to appeal to the consumer and reinforce
the brand image.
3. The labels on products sometimes have to carry vital information about the product;
legal requirement.
The product life cycle
Product life cycle: describes the stages a product will pass through from its introduction,
through its growth until it is mature and then finally its decline.


The exact length of the life cycle, in terms of time, varies from one product to another.
Usually it is affected by the type of product. For example, new developments in
technology will make original product obsolete and their life cycle will come to a quick
end as new products are purchased in preference to old technology. In contrast,
products like CoCa Cola have a very long life cycle.
Knowledge of the stage in which a product is in will help in marketing decisions.
A typical cycle for a product is as follows:
Stages
Product
Development Prototype is
tested and
market research
carried out
before launch
Introduction Basic model
Sales & profit
No sales – high cost
promotion
Price
Sales grow slowly
Informative
advertising – as
product is unknown



Growth

Maturity
Saturation
New models,
colors,
accessories




Decline
Slowly withdraw 
from market –

replace with
new ones
Sales grow
rapidly
Profits are
made as
development
costs are
covered
Sales increase
slowly
Profits are at
their highest
Sales are stable
at their highest
points
Profits start to
fall due to static
sales and price
reductions
Sales is too low
unprofitable
Price skimming in case
of new development &
no competition
penetration pricing in
case of competition
Promotional pricing due
to entrance of
competition

Persuasive
advertising to
encourage brand
loyalty


More persuasive
advertising to
maintain sales
growth
High and stable
level of
advertising

Competitive or
promotional pricing due
to intense competition

Price reductions to stay
competitive pricing
advertising is
reduced and is
only there to
announce price
reductions –
then it will stop

further price reductions


Extending the product life cycle
To stop sales from falling a business will start adopting extension strategies. The following
strategies will result in giving sales a boost:






introduce new variations of the original product
selling into new markets
make small changes to the product’s design, color or packaging
use a new advertising campaign
introduce new improved version of the old product
sell through additional different outlets
The effect of the extension strategies is as follows:
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Chapter 13: The marketing mix: price
The role of pricing decisions in the marketing mix
The business must be careful to select a price for its product that fits the rest of the marketing
mix. Failure to do this will send confusing messages to the consumers and thus will lead to
product failure. For example, if a high quality product, is wrapped in luxurious package, but has
low price, consumers will think it is of poor quality and will not buy it.
Some products are sold in competitive markets so competitive pricing should be used. Some
others have no competition and thus price skimming will be more suitable and allow the
success of the product.
Pricing strategies
When taking a pricing decision producer will consider the forces of demand and supply in the
market along with the following factors:
Branded products: mean that the product has a distinctive name and packaging, is aimed at a
particular segment of market so it is important to select an appropriate price to fit with the
brand image.
Value for money brands: should have lower prices
Existence of competition: then prices must remain competitive so the business will do this by
constantly researching what competitors are charging their customers.
A business will have the following objectives which will influence its pricing decisions:




Try to break into a new market
Try to increase market share
Try to increase its profits
Make sure all cost of production is covered and a particular profit is earned
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The main methods of pricing
1. Cost plus pricing
Is the cost of manufacturing the product plus a profit mark-up
= unit cost of a product + % mark-up
Example:
If the cost of producing a product 4000units of a product is $2000 and the business
decides to earn a 50% profit on each unit then they will calculate their price as follows:
Unit cost of the product = 4000 units / $2000 = $2 per item
% mark up = 50% of $2 = $1
Price per unit = $2+$1 = $3
Advantage of cost plus pricing
Disadvantage of cost plus pricing
It is easy to calculate
Could lose sales if prices are higher than those of
competitors
2. Competitive pricing
Is when the product is priced in line with or just below competitors’ prices to try to
capture more of the market.
Advantage of competitive pricing
Disadvantage of competitive pricing
Price is at a realistic level so sales are likely to be
It is expensive and time consuming to research
high
prices of competitors in order to set prices in line
with them
3. Psychological pricing
Is an approach concerned with the effect of the price of a product will have upon
consumers’ perception of the product. This may be done in several ways:
strategy
Charging high prices for high quality products
Charging a price that is just below a whole
number e.g $99.9
Supermarkets charging low prices for products
purchased on a regular basis
High price for branded products
Effect
High income customers will buy it as a status symbol
Gives the impression of being much cheaper
Gives the impression of being given value for money
Reinforcing consumer perception of the product (high
quality / high status) and thus sales will be made
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4. Penetration pricing
Is when the price is set lower than the competitors’ prices in order to be able to enter a
new market
Advantage of penetration pricing
Disadvantage of penetration pricing
Ensures sales are made and the new product
Profit per unit sold may be low as the product is
enters the market (consumers will try it and
sold at a low price
hopefully become regular consumers )
5. Price skimming
Is where a high price is set for a new product on the market. This is used usually when
the product is a new invention, or a new development of an old product and people will
buy the high price because of the novelty factor.
Advantage of price skimming
Disadvantage of price skimming
Consumers will perceive the product as being of
May putt off some potential consumers because
good quality
of the high price
6. Promotional pricing
Is when a product is sold at a very low price for a short period of time
Advantage of promotional pricing
Disadvantage of promotional pricing
Useful in getting rid of unwanted products that
Sales revenue and profits will be lower as price of
will not sell
each item will be low
Helps in renewing interest in the product if sales
are falling
7. Dynamic pricing
Is when groups (segments) of consumers are being charged different prices for basically
the same product or service because of their different demand levels.
This is done because the price sensitivity of the groups are different:
 Some groups will have high price sensitivity and thus firms will not charge very
high prices in order not to lose customers
 Some other groups will have low sensitivity and thus high prices can be charged
without losing these customers
For example, different airfare prices for different flights to the same destination
at different times in the day or year
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Dynamic pricing is also used to reflect the level of demand:


If demand increases then the prices will be raised
If demand decreases then prices will be reduced
Advantages of dynamic pricing
Increased sales revenue
Disadvantages of dynamic pricing
High cost of constantly changing prices for
business
High cost for customers in terms of time
spent trying to find the best price
Increased profits
Ensuring all seats are filled in an airplane, train,
football games,…etc
Price elasticity of demand
Price elasticity of demand: is a measure of the responsiveness of demand to a change in price.
This responsiveness is affected by how many close substitutes there are for a product.
 Price elastic demand :
Is where the percentage change in quantity demanded is greater than the percentage
change in price (high price sensitivity).
This is due to having close substitutes, such as oil and margarine, even if the price rises
by a very small % (ex. 5% rise in price) demand will fall by a higher percentage (ex. 20%
decrease in demand) as consumers will buy the substitute product instead of the
original one. This will lead to falling revenue for the business
 Price inelastic demand
Is where the percentage change in quantity demanded is lower than the percentage
change in price (demand is not sensitive to prices).
This is due to having no close substitutes and no competition. For example, petroleum ;
if price of petroleum increased by 15%, demand may decrease by only 5% as consumers
don’t have close substitutes. This will lead to increasing sales revenue for the business.
Conclusion: if demand for products of a business is price elastic then it is not wise to
raise prices unless there has been raising costs. However, if price elasticity of demand in
inelastic then it is recommended to increase prices which will lead to higher sales
revenue and profits.
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Chapter 14: The marketing mix: promotion and
technology in marketing
The role of promotion decisions in the marketing mix
Promotion gives the consumer information about the rest of the rest of the marketing mix;
without it consumers would not know about the product, the price it sells for or the place
where the product is sold. Promotion as part of the marketing mix includes:
1. Advertisements: which involves ‘above – the – line ‘ promotions such as, advertising on
TV or via internet, in newspapers,…etc.
2. Sales promotion: which involve ‘below-the - line’ promotions. Activities like money-off
coupons, free gifts,..etc. are usually used for short periods of time in order to reinforce
the above-the-line promotions.
3. Public relations / sponsorship: it is concerned with promoting a good image for the
company and / or its products.
The aims of promotions
All the promotional activities undertaken by the business have the following aims:
 Inform people about particular issues
 To introduce new products to the market
 To create a brand image
 To increase sales
 To compete with competitor’s products
 To improve the image of the company
1. Advertising
Advertising can be either informative or persuasive or have elements of both:
Informative advertising: is where the emphasis of advertising or sales promotion is to give
full information about the product.
Persuasive advertising: is advertising or promotion which is trying to persuade the
consumer that they really need the product and should buy it.
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The advertising process
1. set objectives
2. decide the advertising budget
3. create an advertising campaign
4. select the media to use
5. evaluate the effectiveness of the campaign
The following are the different types of advertisement media that businesses can use:
Television
Advantages
Disadvantage
Will reach millions of people
Very expensive form of advertising
Product is presented in an attractive way
Can reach target audience by advertising at
times of programs watched by potential
buyers
Radio
Advantages
Cheaper than TV
Reaches large number of audience
Uses a memorable song or tune which
makes it easy to remember
Disadvantages
Doesn’t use visual messages
Quite expensive
Customers cannot look back at hard copy of
the advert
Not as wide audience as TV
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Newspapers
Advantages
National newspapers are suitable for
particular types of customers
National newspapers are read by a large
number of people
Local newspapers are cheaper than other
forms of medias and thus cost effective
Adverts are permanent and can be cut out
and kept
A lot of information can be put in the advert
Disadvantage
Adverts are in black and white and thus not
eye catching
May not be noticed by readers especially if
the advert is small
Magazines
Advantages
Advertising in specialized magazines is
effective in reaching a target population
More attractive than other forms of print
media since they are usually colored
Disadvantages
Magazines are usually published once a
week or a month
Relatively more expensive than newspapers
Posters/billboards
Advantages
They are permanent
Relatively cheap
Potentially seen by all who pass them
Disadvantages
Can be missed as people go past them
Cannot include detailed information
Cinemas, DVD and blu-ray discs
Advantages
Use visual image; attractive
Disadvantages
Seen by only a limited number of people
who watch that film
Low cost
Cost effective if you target the audience of a
particular type of movie
Leaflets
Advantages
Cheap method of advertising
Reaches a wide range of people when given
out in streets
Direct mail could be delivered or mailed to
large number of people
Sometimes contain money-off voucher to
Disadvantages
May not be read
Direct mail / junk mail can be annoying and
puts customers off buying the product
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encourage the reader to keep the advert
Permanent and are kept for future reference
Internet
Advantages
Large number of information could be place
on a website which can be seen by a vast
number of people internationally
Orders can be made instantly via the
website
Direct mail sent via email is cheap
Disadvantages
Searcher may not highlight the website and
it could be missed
A lot of competition from other websites
Security issues may discourage customers
from buying online
Other forms of publicity
Advantages
Very cheap form of advertising, e.g. on
delivery vehicles, side of bags of shops,..etc
Disadvantages
May not be seen by customers in the target
market
Product placement (when branded goods and services are featured in television
programs, movies, or music videos)
Advantages
Disadvantages
Product is associated with the image of the
Expensive
program or movie
Target the specific audience who view that
If image is not attractive to consumers then
movie, program,…etc.
may have negative effect
2. Sales promotion
Promotion is used to support advertising and encourage new or existing customers to buy the
product.
Sales promotion: are incentives such as special offers or special deals aimed at consumers to
achieve short-term increases in sales.
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Types of sales promotion that can be used by a business
a. Price reductions
This include reduced prices in shops at specific times of the year and money-off coupons
used when a product is next purchased
Advantage
Disadvantage
This encourages the consumer to try the
Profit per item will be lower due to price
product and hopefully they will become a
reduction
regular customer
b. Gifts
Sometimes small gifts are placed in the packaging of a product to encourage the
consumer to buy it. Sometimes coupons are put on the back of the packet and
customers have to collect a specific number to exchange for a gift.
Advantage
Several packets of the product will be sold
Customers may still buy the product even
after the promotion ends
Disadvantage
Cost of the gift
c. BOGOF
This is where multiple purchases are encourage
Disadvantage:
Profit per unit will be less
d. Competitions
The package of a product may contain an entry form which allows the customer to enter
a competition.
Advantage
Disadvantage
Encourages the consumer to buy the
Prizes are often expensive items
product
e. Point-of-sales displays and demonstrations
Where there will be a special display of the product in a shop.
Advantage:
Demonstration in the shop may encourage customers to buy.
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f. After-sales services
Usually provided with expensive products such as cars
Advantage:
It encourages customers to buy from the shop that offers this service rather than
another. Customers are assured that if the product malfunctions, they will be able to
get it repaired with no additional charges.
g. Free samples
A free sample is given out in the shop to encourage the customer to try the product and
hopefully buy it. They may be given away also with other products
Advantages of sales promotion:
 Promote sales at times in the year when sales are traditionally low
 Encourages new customers to buy an existing product
 Encourages customers to try a new product
 Encourages existing customers to buy a product more often and in greater quantity
 Encourages customers to buy one product instead of a competing one
The importance of the marketing budget
A marketing budget: is a financial plan for the marketing of a product or product range for a
specified period of time.
The size of the marketing budget is very important. It specifies how much money is available to
market the product or range of products so that the marketing department knows how much it
may spend. If the budget is small then this will limit the places where they can advertise.
The need for cost effectiveness in spending the marketing budget is crucial. A business will
need to compare the cost of advertising with the increase in expected sales. It is not effective
to spend large sums of money on advertising where sales are expected to increase by a small
amount.
Which type of promotion should be used?
There are several factors that influence the type of promotion to be used:
a. The stage of product life cycle
For example; new products will need informative ads whereas those in maturity stage
need persuasive ads
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b. The nature of the product itself
For example; money-off coupon may be used for a consumer good whereas discounts
will be used for producer goods bought in bulk
c. The cultural issues involved in international marketing
The advertising media used will be dependent on factors such as the number of
televisions owned, literacy of the population, availability of radio and cinema.
Also the business may need to consider the types of promotion in terms of what is
acceptable to people in the countries where the product is sold.
d. The nature of the target market
Whether it is local, national or international and its size
3. Public relations / sponsorship
This has to do with promoting a good image for the company and / or its products. It can
take many forms like sponsoring football match or a company donating some of its product
for a charity.
The purpose is to raise public’s awareness of the company and its products, and increase
the likelihood of their choosing its products over its competitors.
How technology influences the marketing mix
Technology provides new opportunities to businesses to market their products and services
and thus lead to frequent changes to all elements of the marketing mix.
The product may change to respond to new technology. For example, new features added
to mobiles. Social networking changed the way products could be advertised. The internet
allows businesses to gather information about customer purchasing habits which allows for
the use of dynamic pricing. The internet also facilitated the use of e-commerce which
means that products are not necessarily sold through shops /place.
Advantages of advertising on social
networking sites (ex. Facebook)
Targeting special demographic group
Disadvantages of advertising on social
networking sites
Can alienate customers if they find the
adverts annoying
Have to pay for advertising if using pop-ups
Guarantees target customers see advert when
they login to Facebook
Speed in response to market changes
Cheap to use
Lack of control of advertising if used by others
May be altered or used in a bad way and
forwarded on to other users giving businesses
bad publicity
Reaches groups that are difficult to reach any
other way
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Advantages of advertising on a businesses’
own website
No extra cost if own website is already set up
Disadvantages of advertising on a businesses’
own website
Potential customers may not see the website
as the page may come up in a long list of
pages when using a search engine such as
Google
Relies on customers finding the website
Control of advertising as it is on your own
website
Can change adverts quickly and update
pictures
Interactive adverts can be more attractive
than other forms like those in magazines
Can provide more information in adverts and
link to other pages with further information
and pictures
Design costs, maintenance and regular update
may be high
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Chapter 15: The marketing mix: place
The role of place decisions in the marketing mix
After deciding on the other Ps, the business has to get the product to the consumer. The
product and service has to be available where and when consumers want to buy. The place
chosen will affect how well it will sell. If the product is not available where customers want to
buy it, and they have to search for it in different shops, then they may give up and buy
competitor’s product. It is very easy for a business to get the place wrong and therefore lose
sales, or even fail altogether.
Distribution channels
Distribution channel 1 / No intermediaries
producer
consumer
Advantages of channel 1
Disadvantages of channel 1
It is very simple
Impractical to many people as they don’t live
near to the factory
May not be suitable for products which cannot
easily be sent by post
Suitable for certain types of products such as,
agricultural products which are sometimes
sold straight from the farm
Lower price as it cuts out wholesaler/retailer
It may be very expensive to send the product
by post and therefore it will not be cost
effective
Products can be sold by mail order catalogue
or via the internet
Suitable when selling directly form one
manufacturer to another (business to
business)
Distribution channel 2 / One intermediary
producer
retailer
consumer
This channel is most common where retailers are large or when the product is expensive.
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Advantages of channel 2
Disadvantages of channel 2
Producer sells large quantities to retailers
Reduced distribution costs compared to
channel 3
No direct contact with customers
Distribution channel 3 / Two intermediaries
producer
wholesaler
retailer
consumer
Advantages of channel 3
Disadvantages of channel 3
Wholesaler saves storage space for small
retailer and reduces storage costs
More expensive for small shops to buy form
wholesaler than if directly bought from
manufacturer
Wholesaler may not have the full range of
products to sell
Wholesaler breaks the bulk for small retailers
– small retailers can purchase small quantities
of products with short shelf-life (better cash
flow – lower opportunity cost)
Customers may be given credit facilities to
encourage them to buy
Wholesaler may pay for transportation cost
and thus retailer saves
Wholesaler can give advice to small retailers
or manufacturer about what is selling well
Wholesaler allows the manufacturer to have
less paper work as it is the one which
processes the orders from retailers
Takes longer for fresh produce to reach the
shops and so it may not be as good quality
Wholesaler may be a long way from the small
shops
Distribution channel 4 / Three intermediaries
producer
agent
wholesaler
retailer
consumer
When the product is exported the manufacturer will use an agent in the other country. The
agent sells the product on behalf of the manufacturer, thus allows the manufacturer to have
some control over the way the product is sold to consumers.
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An agent: is an independent person or business that is appointed to deal with the sales and
distribution of a product or range of products.
Advantages of channel 4
Disadvantages of channel 4
Agents will be aware of local conditions and
will have better knowledge of the most
effective places in which to sell.
Less control over the way the product is sold
Methods of distribution
e-commerce
e-commerce: is the buying and selling of goods and services using computer systems linked to
the internet.
Note: not every product or every service will be successfully sold by e-commerce.
Opportunities of e-commerce to
business
Opportunities of e-commerce to
consumers
More convenient for customers
Internet cost of promoting the product
worldwide is much more cheaper than other
promotional methods
Orders can be electronically taken and sent
directly to warehouses for dispatch
Surfing the net or using price
comparison website make comparing
prices easier for customers
Payment by credit or debit card is very
easy
Attractive & easy to follow websites may
encourage customers to buy more than
intended by them
Businesses can easily make online purchases
of supplies and materials from other
businesses (B2B)
 Consumers can now easily access
products
and
services
from
businesses located abroad which
would have been very difficult
without e-commerce
 Consumers can buy some products
for prices much lower than they
would be without the competition of
e-commerce
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Threats of e-commerce to
business
Threats of e-commerce to
consumers
Competition between businesses is high as too In many countries consumers, especially lowmany businesses are offering it.
income ones, will have limited access to
internet
Website design should be attractive and easy
Computer system failure will frustrate the
to operate. Frequent update of the website
customers as they cannot make their
will be needed which is too expensive
purchases
Items are sold individually and thus transport
Products are not seen, touched and tried and
cost will be higher than if sold through a shop; returning the product may be inconvenient
should the customers be charged for it
Loss of useful market research feedback due
Lack of face-to-face contact with sales staff
to lack of face-to-face contact with consumers makes it difficult to find out more information
about the goods and services being sold than
that which is provided on the website
Consumers in most countries have the legal
Many consumers are concerned about identity
right to reject goods bought through etheft or fraudulent use of credit cards if they
commerce because they have not seen,
buy goods online. Security systems are
touched or worn the actual good. Returns can improving but there are still some risks
add to business costs.
A large warehouse and efficient stock control
system will be essential to meet consumers’
orders accurately and efficiently (expensive)
e-commerce not suitable for businesses that
sell personal services such as hairdressing
Selecting the distribution channel to use
What type of product is it: sold to consumers or other businesses
Is the product very technical: if technical then it should be sold to the customer by someone
with technical knowledge so direct sales or one intermediary may be used
How often is the product purchased: if sold everyday then it has to be sold in many retail
outlets.
How expensive is the product: if the product has high quality and is expensive then it will be
sold through limited number of outlet.
How perishable is the product: if the product goes rotten quickly, such as fruits, then it will
need to be widely available in many shops so that it can be sold quickly.
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Where are the customers located: a product has to sell near to where customers are located
Where the competitors sell their product: producers may want to sell their products in the
same outlet used by competitors in order to compete directly for customers
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Chapter 16: 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 or service to achieve a particular marketing objective(s).
The marketing strategy developed by a business will differ depending:




The market size
Number and size of competitors
Marketing objectives
Market budget
The marketing objective could include:





Increase sales of an existing product / service by selling to new markets or selling more
to the existing market
Increasing sales of a product or service by improving an existing product (extension
strategy) or adding new features to it
Increasing market share which will include increasing sales but also taking market share
away from competitors
Maintaining market share if competition is increasing
Increasing sales in a niche market
In order to achieve the marketing objective the business needs to combine the four
elements of the marketing mix correctly
Recommending and justifying a marketing strategy in given
circumstances
As time goes by the marketing mix will need to be changed. This may be because there are new
competitors, the product gets to a different stage of its product life cycle, consumer tastes
change or the business wants to enter a different market.
Legal controls on marketing
Nowadays products are so complicated and technical which makes it very difficult for a
consumer to know how good they are or how they are likely to work. Also modern advertising
can be so persuasive to be of poor quality or not as good as the advert claimed. Consumers
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need protection against businesses which could take advantage of their lack of knowledge and
lack of accurate product information.








Consumer protection laws might include:
Weights and measures: selling underweight goods or using inaccurate equipment that
results in selling underweight goods is an offence.
Trade description: it is illegal to give the consumer misleading impression about the
product.
Sale of goods: it is illegal to sell products which have serious flaws or problems, that
they are not of a satisfactory quality.
Supply of goods and services: a service has to be provided with reasonable skill and
care.
It is illegal for misleading pricing claims such as a discount for this week only where it
had been there the previous week as well.
The law also makes retailer and manufacturers responsible for any damage which their
faulty goods might cause. An injured person by faulty goods can take the supplier to
court and ask for compensation.
The distance selling regulations allow customer a period of seven working days in which
they can change their mind about purchasing the good or service.
The implication of these laws on a business is that they have to bare a higher cost of making
and selling products which increases prices in the shops.
Entering new markets abroad
Opportunities:
Nowadays there is a trend towards globalization of businesses due to the following reasons.



Some countries are now developing and the population enjoys rising incomes which
provides greater opportunities for entering new markets abroad.
Products may have reached saturation level in its home markets and entering a new
market will allow for higher sales.
A producer may choose to locate in a country for several reasons and this encourages it
to sell as well in these countries.
 Trade barriers have been lowered in many parts of the world making it
easier and profitable to now enter these markets.
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Problems when entering new markets abroad:





Lack of knowledge: the business usually doesn’t have enough information about
competitors overseas and consumer habits.
Cultural differences: culture or religion may restrict the sale of some products in other
markets.
Exchange rate changes: fluctuations in exchange rate may result in making the price of
the imported good too expensive for consumers in the new market.
Increased risk of non-payment: methods of payment may be difficult in those new
markets and it may be more difficult to be certain that payment for imported goods will
be made.
Increased transport costs: since products will be transported to the other country then
cost of transporting the good will increase. However, if products are shipped in large
containers this may lead to reductions in transport costs.
Methods to overcome the problems of entering new markets:




Joint ventures: it allows the business to gain important local knowledge so that culture
and customs can be adapted to enable a more successful entry into the new market.
Licensing: where the business gives permission for the firm in the new market being
entered to produce the branded or ‘patented’ products under license. The benefit is
that the product doesn’t have to be transported to the new market which saves time,
transport costs and can get round trade restrictions.
Interned franchising: where foreign franchises are used to operate a business’s
franchise abroad. The benefit is that local knowledge is take best location decision.
Localizing existing brands: which involves ‘thinking global – acting local’ which is used
by several global businesses. There will be a common brand image for the business but
it adapts to local tastes and culture therefore increasing sales.
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Chapter 17: production of goods and services
Managing resources effectively to produce goods and services



Production: is the provision of a product or a service to satisfy consumer wants and
needs. The process involves firms adding value to a product.
Adding value means that the business combines inputs / factors of production to
produce a more valuable output / final goods to satisfy consumer wants or needs.
For a business to be competitive it should combine these inputs of resources efficiently
so that the business makes the best use of resources to keep costs low and increase
profits. For example, developing countries may rely on labor intensive methods of
production since it will be cheaper than capital intensive methods and the opposite is
true.
Operation department

The role of the operation department is to change inputs into outputs for customer use.
 The operation manager is responsible for ensuring that raw materials are provided and
made into finished goods or services.
Productivity



Productivity: is the output measured against the inputs used to create it.
it is a measure of the efficiency of a business.
Increase in productivity means using fewer inputs to produce the same output or using
the same inputs to produce a much greater output which leads to reduction in average
cost of production. Thus lower prices will be charged to customers and the business
becomes competitive.
Productivity = quantity of output / quantity of inputs
Labor productivity = output (over a given period of time) / number of employees
Ways of improving productivity in a business:

Improving the layout of the machines in a factory to reduce wasted time and increase
efficiency
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




Improve labor skill by training workers sot they have more productive techniques of
working
Introducing automation
Improve inventory control
Improve employee motivation
Improve quality control / assurance thus reduce waste
Benefits of increasing efficiency / productivity




Increase output relative to the inputs required
Lower costs per unit
Fewer workers may be needed and thus lower wage costs
Higher wages for workers increases motivation
Why businesses hold inventories (stock)
Inventories can take the following forms:




Raw materials
Components
Partly finished goods
Finished products ready for delivery
 Inventory of spare parts for machinery in case of breakdowns
The business must reorder before inventories get too low to allow time for the goods to be
delivered. If inventory levels get too low they might actually rung out if there is an
unexpectedly high demand for the goods. If a too high level of inventory is held then this costs
a lot of money; the business is tying money in goods and the money could be put to better use.
The buffer inventory level / minimum stock level: is the inventory held to deal with
uncertainty in customer demand and deliveries of supplies.
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Lean production
Lean production: is a term for those techniques used by businesses to cut down on waste and
therefore increase efficiency, for example, by reducing the time it takes for a product to be
developed and become available for sale. It cuts out any activities which do not add value for
the customer and this can apply to services as well.
Types of waste that can occur in production:
1. Overproduction: results in high storage costs and possible damage to goods whilst in
storage
2. Waiting: when goods are not moving or being processed in any way then waste is
occurring
3. Transportation: moving goods around unnecessarily causes waste and is not adding
value to the product. Goods may also be damaged when they are being moved around
4. Unnecessary inventory: if there is too much inventory then this takes up space, may get
in the way of production and costs money
5. Motion: any actions, including bending or stretching movements of the body of the
employee wastes time. It may also be a health and safety risk for the employees. This
also applies to the movement of machines which may not be necessary
6. Over-processing: if complex machinery is being used to perform simple tasks then this is
wasteful. Some activities in producing the goods may not be necessary if the design of
the product is poor.
7. Defects: any faults require the goods being fixed and time can be wasted inspecting the
products.
Benefits of lean production
Costs are saved through:







Less storage of raw materials or components
Quicker production of goods or services
No need to repair defects or provide a replacement service for a dissatisfied customer
Better use of equipment
Cutting out some processes which speeds up production
Less money will be tied up in inventories
Improved health and safety leading to less time off work due to injury
Reduced cost will lead to lower prices for cut customers, businesses being more competitive
and possibly also increased profits.
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Lean production includes the following methods:
1. Kaizen
Kaizen is a Japanese term meaning ‘continuous improvement’ through the elimination of
waste.

Small groups of workers meet regularly to discuss problems and possible solutions. This
is effective as no one knows the problems that exist better than the workers who work
with them all the time, so they are often the best ones to think of ways to overcome
them.
Advantages of Kaizen:
 Increase productivity by reducing the amount of time taken for workers to walk
between jobs so that they eliminate unnecessary movements.
 Reduced amount of space needed for the production process
 Work-in-progress is reduced
 Improved layout of the factory floor may allow some jobs to be combined (machines
positioned tightly together in cells), thereby freeing up employees to carry out some
other job in the factory.
 Kaizen eliminates waste by getting rid of piles of inventory.
2. Just-in-time inventory control (JIT)
JIT is a production method that involves reducing or virtually eliminating the need to hold
inventories of raw materials or unsold inventories of the finished product. Supplies arrive just
at the time they are needed.
Advantages of JIT:
 Reduces the cost of holding inventory (inventory checking is expensive) as no raw
materials or finished goods are kept in the warehouses.
The raw materials or components are delivered just in time to be used in the
production process, the making of any parts is undertaken just in time to be used
in the next stage of production and the finished product is made just in time to
be delivered to the consumer
 Warehouse space is not needed, which reduces the cost (rent is expensive)
 The finished product is sold quickly and so money will come back to the business more
quickly, helping its cash flow.
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3. Cell production
It is where the production line is divided into separate, self-contained units (cells),each
making an identifiable part of the finished product, instead of having a flow or mass
production line.
Advantages of cell production:
 It improves the morale of employees and makes them work harder so they
become more efficient.
 Employees feel more valued and they are less likely to strike or cause disruption.
Methods of production
1. Job production
It is where a single product is made at a time and is made specifically to order.
Advantages of job production
Suitable for personal service or ‘one-off’
products
The product meets exact requirements of the
customer
The worker have more varied jobs which
increases his motivation / greater job
satisfaction
Flexible method of production
Can charge high prices as goods or services are
often of high quality
Disadvantages of job production
Relies on skilled laborers
Higher cost as it is labor intensive
Production often takes a long time
Any error can be expensive to correct
Materials may have to be specially purchased
leading to higher costs.
2. Batch production
It is where a quantity of one product is made, and then a quantity of another item will
be produced.
Advantages of batch production
It is a flexible way of working and production
can easily be changed from one product to
another
It still gives some variety to workers’ job
Disadvantages of batch production
Expensive as semi-finished or finished
products will need moving about
Delay in production and loss of output due to
the need of machines to rest between batches
Warehouse space will be needed for stocks of
raw materials and components which is
expensive.
It allows more variety to products which
would otherwise be identical allowing for
more consumer choice
Machinery breakdown will not affect
production greatly
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3. Flow production
It is where large quantities of a product are produced in a continuous process. It is
sometimes referred to as mass production because of large quantity of a standard product
that is produced.
Advantages of flow production
Disadvantages of flow production
High output of a standardized product
Workers will be bored, have little job
satisfaction and will be de-motivated
Costs are kept low and therefore prices are
Significant storage requirement: cost of
also lower
inventories of raw materials, components and
finished products can be very high
It relies on capital intensive methods of
The capital cost of setting the production line
production thus reducing labor costs and
can be very high
increasing efficiency
Capital intensive methods allow specialization If one machine breaks down the whole
of workers so unskilled workers are needed
production process will be halted
which reduces the training cost
It benefits from purchasing economies of scale
Lower average cost leading to lower prices will
result in high sales
Machines can operate 24 hours a day
Goods are produced quickly and cheaply
Time is saved as there is no need to move
goods from one part of the factory to another
as in batch production
Factors affecting which method of production to use




The nature of the product: if the product has a unique image and is specialized then job
production will be used. It the product can be mass produced using automation then flow
production method will be used.
The size of the market: if demand is higher (than job production) but not very large
quantities then batch production could be used. Niche markets will be served using job
production or batch production. International markets are served using mass production.
The nature of demand: If there is large and steady demand for a product (ex.: soap) then
flow production should be used. If demand is less frequent (ex.: furniture) then job or batch
production.
The size of the business: small businesses don’t have access to large amounts of capital and
thus cannot afford getting automated production lines. then it will operate using job or
batch production.
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How technology has changed production methods
The use of automation, robotics and CAD / CAM keeps businesses ahead of competition, keeps
costs failing, reduces prices and improves the products manufactured.
Automation
It is where the equipment used in a factory is controlled by a computer to carry out mechanical
processes. Few laborers will be needed to maintain that the process is smooth.
Mechanization
It is where the production is done by a machine but operated by people. It is useful when
unpleasant, dangerous and difficult jobs are done by machines rather than people. They are
also quick, very accurate and work non-stop 24 hours a day.
CAD
It is a computer software that draws items being designed more quickly and allows them to
rotate to been from all sides rather than having to draw it several times. It is useful when
designing new products or re-style existing products.
CAM
It is where computers monitor the production process and control machines or robots on the
factory floor.
CIM
It is the total integration of computer aided design (CAD) and computer aided manufacturing
(CAM). The computers that design the product are linked directly to the computers that aid the
manufacturing process.
How technology has changed payment methods in shops
EPOS
This is used at checkouts where the operator scans the bar code of each item individually. The
inventory record is automatically changed to show one item has been sold and if inventory is
low then more inventories can automatically be ordered.
EFTPOS
It is where the electronic cash register is connected to the retailer’s main computer and also to
banks over a wide area computer network. The money will be directly debited from the
customer’s account.
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Advantages of new technology
Disadvantages of new technology
New production methods will increase
productivity
Routine and boring jobs are done by machines
leading to more job satisfaction of workers
Unemployment rises as new technology may
replace people in factories
It is expensive to invest in, which also
increases the risks as large quantities of
products need to be sold to cover the cost of
purchasing the equipment
Employees are unhappy with the changes in
their work practices when new technology is
introduced
Businesses must offer training to improve the
skills of employees and allow them to use the
new technology which leads to their
motivation and improvement of the quality of
work.
Better quality products produced due to
better production methods and better quality
control systems
New technology is changing all the time and
will often become outdated quickly and need
to be replaced if the business is to remain
competitive.
More knowledge about consumer demand
due to computers which monitors inventory
levels (better knowledge about products that
are selling well and those which are not)
Quicker communication and fewer paperwork
which leads to increase profitability
More information available to managers
allowing them to take better and faster
decisions
New products are introduced due to the new
methods of production. The market and
tastes of the consumer have changed. (greater
variety – greater choice – more useful
products)
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Chapter 18: Costs, Scale of production and break-even
analysis
Importance of business cost
Accurate calculation of business costs is important as it allows the following important
comparisons to happen:



Cost of operating the factory is compared with sales revenue to find out whether the
business is profitable or not
Comparison of cost of two different locations which assists in location decisions.
Knowing about cost of production will assist in pricing decisions.
Fixed costs and variable costs
Fixed costs: are costs which do not vary with the number of items sold or produced in the short
run. They have to be paid whether the business is making any sales or not. They are known as
overhead costs. For example, salaries and rent paid for property.
Variable costs: are costs which vary directly with the number of items sold or produced. For
example, cost of raw materials and piece-rate labor costs.
Total cost and average cost
Total cost: are fixed and variable costs combined during a period of time.
Average cost per unit: is the total cost of production divided by total output (sometimes
referred to as ‘unit cost’.)
= total cost of production in a time period / total output in a time period
Using cost data
Cost data can be used to help make the following decisions:



Setting prices
Deciding whether to stop production
Deciding the best location
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Economies of scale and diseconomies of scale
Economies of scale: are the factors that lead to a reduction in average costs as a business
increases in size
Purchasing economies
When businesses buy large number of components they gain discounts for buying in bulk.
Marketing economies



A business might be able to afford to purchase its own vehicles to distribute goods
rather than depend on other firms
Advertising rates in papers and on TV don’t go up with the same proportion as the size
of an advertisement ordered by the business.
The business may not need to employ more sales staff if it sells more products
Financial economies
Lending to large organizations is less risky than to small ones thus a lower interest rate will be
charged.
Managerial economies
Large firms can afford to pay for specialists who will increase their efficiency and help in
reducing average costs.
Technical economies
Large firms can afford to use flow production methods which are expensive. It allows for
continuous flow of production where workers will be responsible for just one stage of
production. This reduces the average costs of the large manufacturing business.
Some machines are only made with certain high output capacity (the machinery is not divisible
into smaller capacity machines) so if used by small firms will lead to a high average cost since it
couldn’t operate it all day.
Diseconomies of scale
Diseconomies of scale: are the factors that lead to an increase in average costs as a business
grows beyond a certain size.
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Poor communication
Larger organizations may have slow and inaccurate communication which leads to serious
mistakes that will lower the efficiency and higher the average costs.
Low morale
In large businesses workers may feel unimportant and not valued by the management. Also the
lack of close relationship between workers and top managers can lead to low morale and low
efficiency amongst workers.
Slow decision making
It will take a long time for the decision made by managers to reach all groups of workers and
would take longer time for workers to respond and act upon managers’ decisions.
Also managers will be too busy to have contact with customers of the firm and they could
become too removed from the products and markets the firm operates in.
To tackle these problems, many large firms nowadays are breaking themselves up into
smaller units which can control themselves and communicate more effectively. This trend is
aimed at preventing diseconomies of scale from reducing efficiency and raising average costs.
Break-even charts: comparing costs with revenue
The concept of break-even
Breakeven level of output/ point: is the quantity that must be produced / sold for total
revenue to equal total costs.
It is important to note that at that point that neither a profit nor a loss is made. The quicker the
newly set business can reach break-even point the more likely it is to survive and go on to make
a profit.
Drawing a break-even chart
Break-even charts are graphs which show how costs and revenues of a business change with
sales. They show the level of sales the business must make in order to breakeven.
The revenue: is the income during a period of time from the sale of goods or services. Total
revenue = Quantity sold x price
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Example:
Fixed cost = $5000 per year
Variable cost of each pair of shoes are $ 3
Each pair of shoes is sold for $ 8
The factory can produce a maximum output of 2000 pairs of shoes per year
0 units
Fixed cost
Variable cost
(unit variable cost x
number of units)
Total cost
(FC +VC)
Revenue
(PxQ)
5000
0
2000 units
(Maximum output)
5000
6000
5000
1100
0
16000
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What does the graph show?
If production is below the break-even point, the business is making a loss. If production is
above the break-even point, the business is making a profit. Maximum profit is made when
maximum output is reached.
Uses of break-even charts
Advantages of break-even charts
Limitation of break-even charts
Managers can read off any expected profit or
loss at any level of output
Redrawing the graph will show the impact on
profit or loss of a certain business decision
(pricing decisions, location decisions…etc)
It can show the safety margin: the amount by
which sales exceed the break-even point
It assumes that all goods produced are sold –
inventories may build up
Fixed costs are only constant if the scale of
production doesn’t change.
It only concentrate on the break-even point
whereas there are many other important
aspects of the operations of a business which
need to be analyzed, such as, reducing
wastage
It assumes that costs and revenues can be
drawn with straight lines. The variable cost
line may slope more steeply upwards if
overtime wages are paid. Also sales revenue
line will be less steep if discounts are offered
Break-even point: the calculation method
Break-even point = Total fixed costs / contribution
The contribution of a product is its selling price less its variable costs.
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Chapter 19: Achieving quality production
What quality means and why it is important for all businesses
A business needs to try to ensure that all the products or services it sells are free of faults or
defects.
Benefits of good quality products:





Establishes a brand image
Builds brand loyalty
Will maintain a good reputation
Will help to increase sales
Attracts new customers
Consequences of poor quality:



Lose customers to other brands
Have to replace faulty products or repeat poor service which raises costs for the
business
Have customers who tell other people about their experiences and this may give the
business a bad reputation leading to lower sales and profits
Quality: means to produce a good or a service which meets customer expectations.


A manufacturing business needs a product with a good design, doesn’t have any faults
and satisfies the wishes of consumers.
A service providing business needs to match customer expectations with its level of
customer service, delivery times and convenience.
Quality control
Quality control: is the checking for quality at the end of the production process, whether it is
the production of a product or service.


The quality control department takes samples of the finished products at regular
intervals to check for errors. If errors or fault were found then a whole batch of
production might have to be scrapped or reworked.
The quality control department would check that quality was being maintained during
the production of goods, try to eliminate errors before they occurred, and find any
defective products before they went out of the factory to customers.
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Advantages of quality control
Tries to eliminate faults or errors before
the customer receives the product or
service
Less training required for the workers
Disadvantages of quality control
Expensive as employees have to be paid to
check the product or service
Identifies the fault but doesn’t find why
the fault has occurred and therefore is
difficult to remove the problem
Increased costs if products have to be
scrapped or reworked or service repeated
Quality assurance
Quality assurance: is the checking for the quality standards throughout the production process,
whether it is the production of a product or service.


The business will make sure quality standards are set and then it will apply these quality
standards throughout the business. this ensures that the customer is satisfied, with the
aim of achieving greater sales, increased added value and increased profits.
Attention must be paid to the design, of the product, the components and materials
used, delivery schedules, after-sales service and quality control procedures. The
workforce must support the use of this system or it will not be effective.
Advantages of quality assurance
Tries to eliminate faults or errors before the
customer receives the product or service
Fewer customer complaints
Disadvantages of quality assurance
Expensive to train employees to check the
product or service
Relies on employees following instructions of
standards set
Reduced costs if products do not have to be
scrapped or reworked or service repeated
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Total quality management (TQM)
Total quality management (TQM): is the continuous improvement of products and processes
by focusing on quality at each stage of production.


TQM tries to get the product right from the first time and not have any defects.
There is an emphasis on ensuring that the customer is always satisfied, and the
customer can be other people / departments in the business that you are completing
the task for and not just the final customer.
 Quality is maintained throughout the business and no faults should occur, as all
employees are concerned with ensuring that a quality good or service is delivered. TQM
should mean that costs will fall.
Advantages of TQM
Disadvantages of TQM
Quality is built into every part of the production
Expensive to train employees to check the
of a product or service and becomes central to
product or service
ethos of all employees
Eliminates all faults or errors before the
Relies on employees following TQM
customer receives the product or service as it has ideology
a ‘right first time’ approach
No customer complaints and so brand image is
improved – leading to higher sales
Reduced costs as products do not have to be
scrapped or reworked or service repeated
Waste is removed and efficiency increases
How can a customer be assured of a quality product or service?



If a customer wants to be assured that a product or service will meet particular
standards then they can look for a quality mark associated with the product or service.
For example, ISO
Ensuring a good customer service is also important to service sector businesses. They
may not use a quality mark to show they provide a good service, but by having a good
reputation and recommendations by satisfied customers they will keep repeat
customers as well as gain new ones.
Internet sites, such as TripAdvisor, are useful ways for businesses to gain a good
reputation if satisfied customers put positive reviews on the site.
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Chapter 20: Location decisions
Location of industry
A business usually considers location decisions in the following situations:



When it is first setting up
When its current location proves unsatisfactory
When expanding and thus will open branches in its home country or abroad (in case of
globalization)
Factors affecting the location of a manufacturing business
Production methods and location decisions


If a firm is using job production then it operates on a small scale and thus not important
to locate near suppliers of components
If a firm is using flow production then it operates on a large scale and thus would want
to locate near suppliers of components to save on transportation cost.
Market


If the final product is gaining wait then it is important to locate near to the market as a
heavier product will be more expensive to transport than raw materials and
components. Ex. Canned drinks
If the product perishes quickly and needs to be fresh when delivered to market, such as
milk then it will be important to locate near to retailers
Note: improved transportation systems and the availability of ways to preserve food made
nearness to the market less important nowadays.
Raw materials / components


If the raw materials or components are heavier than the final product then nearness to
raw materials will be important to save on transport cost of components or raw
materials. Ex. It is cheaper to process any ore near to the mining site than transport it
elsewhere.
In some industries the many of component suppliers are located near to one another so
it may be cheaper to locate near to these suppliers. Ex. Car manufacturing industry.
Note: improved transportation is making this point less important
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
If raw materials needs to be processed quickly whilst still fresh, locating near to the raw
materials source will be still important. Ex. Tinned fruits.
External economies of scale


Support businesses which install and maintain equipment may be better if nearby so
that they can respond quickly to breakdowns.
The local education establishments, such as universities, might have research
departments who work with the business on developing new products – being in close
contact may help the business to be more effective.
Availability of labor


A business seeking for a particular type of skill may find it easier to locate in an area
where people with the relevant skills live. (movie producer locating in Hollywood)
If a large number or unskilled workers are needed then location may be in an area
where there is high unemployment.
Government influence


The government may offer state-funded grants to encourage businesses to locate in a
particular area. (high unemployment).
The government may also refuse to allow a business to set up altogether if for example
the business will produce harmful waste.
Transport and communications


Where the product is to be transported then the ability to get easily to a port will be
important
Being near to a motorway, rail, port, and airport can reduce costs by speeding up the
time spent delivering the products to market even when the market is quite a distance
away.
Power and water supply


Having access to a reliable source of power or water and therefore no regular power
cuts is essential for certain businesses.
If large supplies of water are needed as part of the manufacturing process, for example,
for cooling purposes with a power station, then being near to a water supply, such as
the sear or a river, will be important.
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Climate

Occasionally climate may be important for instance, Silicon Valley in the USA has a very
dry climate which aids the production of silicon chips
Factors affecting the location of a service sector business
Customers


Locating near customers is important for services that requires direct contact between
the business and the customer in order to allow quick response. For example, plumbers
and electricians.
If the service is conducted by telephone, post or the internet then it is not important to
locate near the customers. Location can be in different parts of the country or in a
totally different country.
Personal preference of the owners

Owners can locate their business based on their preferences & the often locate near to
where they live.
Technology

If the service is provided by the internet, or telephone then it is not important to locate
near to customers. for example, website designers who may locate outskirts of cities to
take advantage of cheaper rent.
Availability of labor


Service businesses that need large numbers of people will have to locate near large
cities and towns.
If a particular type of skilled labors is required then it may also have to locate near to
where these labors are found.
Note: it is more often that the skilled labor will move near to the business for work and not
the other way around.
Climate

Climate will affect some businesses especially those linked to tourism. Ex. Hotels often
locate in areas known for their good weather.
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Near to other businesses


Some businesses that provide services such as maintenance for machines in bigger
companies will need to locate near to the big companies to be able to respond quickly
to any maintenance request.
Banks may need to locate near busy areas for the convenience of customers. however,
internet banking is making this less important now.
Rent / taxes

If the service doesn’t need to be on the main street in a town or city center for example
doctors then the business will locate on the outskirts of town to benefit from lower
rents and taxes.
Factors affecting the location of a retailing business
Shoppers


Retailers would want to locate in popular areas like shopping mall/center
The type of shoppers the area attracts will influence the location decision of the retailer.
For example: a. a retailer selling expensive goods will need to locate in an area
that attracts high income people.
b. a small gift shop will want to locate in an area visited by tourists
Nearby shops


Locating near to shops/businesses which are visited regularly, such as post office or
popular fast-food outlet, means that a lot of people will pass that shop on the way to
other shops and businesses and may go in to make a purchase.
Locating near to competitors encourages customers to visit the area as there is a lot of
choice, therefore increasing business.
Customer parking available / nearby

Availability of parking near to the shops will encourage shoppers to that area and
therefore possibly increase your sales.
Availability of suitable vacant premises

If a suitable vacant shop or premises is not available for purchase or rent, the business
may not be able to locate in the area it wishes.
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Rent / taxes

If the site of the premises is popular then it will be highly demanded and therefore the
cost of renting it will be high and taxes will usually be high.
Access for delivery vehicles

Access for delivery vehicles might be a consideration if it is very difficult for them to gain
access to the premises.
Security


High rates of crimes such as theft in an area may deter a business from locating in a
particular area.
Insurance companies will not insure the business if it locates in an area of high crime.
Legislation

In some countries there may be laws restricting the trading or marketing of goods in
particular areas.
Locating in different countries
Locating in different countries is the end result of two aspects:
1. Multinational companies that have offices, factories, services or shops in many different
countries.
2. The rapid growth of newly industrializing countries, increasing international trade,
improved global communications and improvements in transport have meant that many
businesses can now consider where in the world to operate rather than just considering
a single country; often called globalization.
Many businesses other than multinationals, are considering moving to another country, either
to expand their operations or to relocate mainly from developed countries to rapidly growing
economies.
Factors affecting relocation decisions:
New markets overseas

A steady increase in a business’s sales overseas may encourage a firm to relocate near
to these markets rather than transporting its products which will be more cost effective.
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
If the business operates in the service sector then it is wise to locate near to customers.
the better the forecasts for growth in these markets then the more attractive the
location for the business.
Cheaper or new sources of materials


If raw material source runs out such as, minerals, a business may need to move to a new
site in a country where it can more easily obtain these supplies.
It may be cheaper to use the raw materials at their source than transport them to
another country.
Difficulties with the labor force and wage costs


If the business is located in a country where wage costs keep on raising then it may
decide to relocate overseas to reduce wage costs and become more profitable.
If particular types of skilled labor are needed by the business thus it may locate to a
different country where it can recruit the right type of labor. Ex. Businesses which rely
on IT skills are nowadays relocating to India
Rents /taxes considerations

If other costs such as rent or taxes (on profits or personal income) keep increasing this
might cause the business to relocate to countries where these rents or taxes are lower.
Availability of government grants and other incentives

Grants, lower taxes, or other incentives provided by governments which wish to
encourage foreign businesses to locate in their countries will be considered in the
location decision of certain businesses.
Trade and tariff barriers

If there are trade barriers, such as tariffs or quotas then by locating in that country there
will be no restrictions. Ex. Japanese car manufacturers setting up factories in Europe to
avoid the European Union’s strict quotas for the import of cars.
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The role of legal controls on location decisions
Government will try to influence location decisions of companies for the following reasons:


To encourage business to set up and expand in areas of high unemployment
(development areas) in some countries
To discourage firms from locating in overcrowded areas or on sites which are noted for
their natural beauty
Measures used by governments to influence the location decisions of firms:


Planning regulations: where the government will legally restrict business activities that
can be undertaken in certain areas. For example, refusing planning permission if the
business is planning to open a factory in an area of residential housing.
Many governments provide grants or subsidies to businesses to encourage them to
locate in undeveloped parts of the country with high unemployment. This assistance
could be in the form of financial grants, such as non-repayable amount of money paid to
the business to locate in a particular area or subsidies paid to the business.
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Chapter 21: Business finance: needs and sources
What do finance departments do?
The finance department has the following responsibilities:





Recording all financial transactions
Preparing final accounts
Providing financial information for managers
Forecasting cash flows
Making important financial decisions such as deciding on the source of finance to be
used for the different business objectives
Why do businesses need finance?
Finance is money and in business it is called capital. Businesses need capital for the following in
the following situations:



Starting up a business
Expansion of an existing business
Increasing working capital
a. Starting up a business
Start-up capital: is the finance needed by a new business to pay for essential fixed (ex.:
building) and current assets (inventories of raw materials) before it can begin trading.
b. Expanding an existing business
A successful existing business may expand in order to increase profit. Expansion may be in the
form of purchasing new buildings and machinery, taking over another company, and developing
new products to reach new markets. All these forms of growth may require substantial
amounts of money.
c. Additional working capital
Working capital: is the finance needed by a business to pay its day-to-day costs. They have to
pay wages, pay for raw materials, pay electricity bills and so on. It is very important for a
business to have sufficient working capital. Failure to do this may lead to shortages of working
capital and the business may stop trading.
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So businesses may need finance to pay for either capital expenditure or revenue expenditure:
Capital expenditure: is money spent on fixed assets which will last for more than one year. It is
needed to start-up a business or when a business expands.
Revenue expenditure: is money spent on day-to-day expenses which do not involve purchase of
long-term assets, for example wages or rent.
Sources of finance
It is common to classify the sources of finance into:


Internal or external sources of finance: This is obtained from within the business itself.
Short-term or long-term sources of finance: this is obtained from sources outside of
and separate from the business.
1. Internal finance
A. Retained profits
It is profits ploughed-back in the business after paying the owners their share of profits.
Advantages of retained profits
Disadvantages of retained profits
Permanent finance
Not suitable for new businesses which don’t
(Unlike a loan, it doesn’t have to be repaid)
have retained profits
Unlike a loan, no interest to pay
Retained profits may be too low to finance the
expansion
Owners may be dissatisfied as less dividends /
profits paid to them
B. Sale of existing assets
It is selling an existing asset like a building or machine which is no longer needed by the
business.
Advantages of sale of existing assets
Disadvantages of sale of existing assets
Makes better use of the capital tied up in the
Takes time to sell assets and may be sold at a
business
lower amount than its market value
Doesn’t increase the debts of the business
Not suitable for new businesses that don’t have
surplus assets to sell
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C. Sale of inventories to reduce inventory levels
Advantage of sale of inventories
Disadvantages of sale of inventories
It reduces the opportunity cost and storage cost It must be done carefully to avoid disappointing
of high inventory levels
customers if not enough goods are kept as
inventory
D. Owner’s savings
A sole trader or one of the partners in a partnership can invest more money in their
business. it is unincorporated business so there is not separate from their business and
thus this finance is internal.
Advantages of owner’s savings
Disadvantage of owner’s savings
It should be available to the firm quickly
Savings may be too low
No interest is paid
It increases the risk taken by owners
2. External finance
A. Issue of shares
It is suitable only for limited companies
Advantages of issue of shares
It is a permanent source of finance which don’t
have to be paid back to shareholders
No interest has to be paid
Disadvantages of issue of shares
Dividends are paid after tax, whereas interest on
loan is paid before tax is deducted (considered
as a business expense)
Dividends are expected by shareholders
The ownership of the company could change
hands if many shares are sold
B. Bank loans
It is money borrowed from the bank which must be repaid with an interest.
Advantages of bank loans
Disadvantages of bank loans
Quick to arrange
Bank loans have to be repaid with an interest
rate
Can be for varying lengths of time
Security or collateral is usually required
(banks insist on the right to sell a firm’s property
if the business fails to pay interest or doesn’t
repay the loan)
Large companies are often offered low interest
rates by banks if they borrow large sums
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C. Selling debentures
These are long-term certificates issued by limited companies
Advantage of selling debentures
Disadvantage of selling debentures
It is used to raise very long-term finance
Must be repaid with interest
(ex.: 25 years)
D. Factoring debts
Debt factors are specialist agencies that buy the claims on debtors of firms for
immediate cash.
Advantages of factoring debts
Disadvantage of factoring debts
Immediate cash is available to the business The firm doesn’t receive 100 percent of
the value of its debts
The risk of collecting the debt becomes the
factor’s and not the business’s
E. Grants and subsidies from outside agencies
This includes the government
Advantage of grants and subsides
Disadvantages of grants and subsidies
Don’t have to be repaid
They are often given with ‘strings attached’
for example, locate in a particular area
F. Micro-finance
Micro finance is providing financial services – including small loans – to poor people /
poor entrepreneurs not served by traditional banks.
Short-term and long-term finance
1. Short-term finance
It provides the business with the working capital needed by businesses for day-to-day
operations.
A. Overdrafts
Advantages of overdrafts
A business gets the right to overdraw its
account (spend more than is available)
Could be used to pay wages or suppliers
Disadvantage of overdraft
Interest are variable unlike loans which are
usually fixed
The bank can ask the business to repay the
overdraft at a very short notice
It is flexible borrowing as it can vary each
month according to the need of the business
Interest will be paid only on the amount
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overdrawn
Cheaper than loans in the short run
B. Trade credit
It is when the business delays paying its suppliers, which leaves the business in a better
cash position.
Advantages of trade credit
Disadvantages of trade credit
It is almost an interest-free loan to the
The supplier may refuse to give discounts
business
or even refuse to supply any more goods if
Payment is not made quickly
C. Factoring debts
Debt factors are specialist agencies that buy the claims on debtors of firms for
immediate cash.
Advantages of factoring debts
Disadvantage of factoring debts
Immediate cash is available to the business The firm doesn’t receive 100 percent of
the value of its debts
The risk of collecting the debt becomes the
factor’s and not the business’s
2. Long-term finance
This is finance that is available for more than a year. It is usually used to purchase longterm fixed assets, to update or expand the business or to finance a takeover of another
firm.
A. Bank loans
It is money borrowed from the bank which must be repaid with an interest.
Advantages of bank loans
Disadvantages of bank loans
Quick to arrange
Bank loans have to be repaid with an interest
rate
Can be for varying lengths of time
Security or collateral is usually required
(banks insist on the right to sell a firm’s property
if the business fails to pay interest or doesn’t
repay the loan)
Large companies are often offered low interest
rates by banks if they borrow large sums
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B. Hire purchase
This allows the business to buy a fixed asset over a long period of time with monthly
payments which include an interest charge.
Advantages of hire purchase
Disadvantages of hire purchase
The firm doesn’t have to find a large cash
A cash deposit is paid at the start of the
sum to purchase the asset
period
Interest payments can be quite high
C. Leasing
 It allows the firm to use an asset but it doesn’t have to purchase it.
 Monthly leasing payments are made.
 The business could decide to purchase the asset at the end of the leasing period.
 Some businesses may decide to ‘sale and lease back’ ; sell off some fixed assets for
cash and lease them back from a leasing company
Advantages of leasing
Disadvantage of leasing
The firm doesn’t have to find a large cash The total cost of the leasing charges will
sum to purchase the asset to start with
be higher than purchasing the asset
The care and maintenance of the asset
are carried out by the leasing company
D. Issue of shares
This option is only available to limited companies. It is referred to as equity finance.
It is suitable only for limited companies
Advantages of issue of shares
Disadvantages of issue of shares
It is a permanent source of finance which don’t Dividends are paid after tax, whereas interest on
have to be paid back to shareholders
loan is paid before tax is deducted (considered
as a business expense)
No interest has to be paid
Dividends are expected by shareholders
Allows the company to raise large sums of
The ownership of the company could change
money as it sells to the general public
hands if many shares are sold
A right issue of new shares can be arranged to
Can be expensive to organize and advertise
raise capital which gives the existing
shareholders the right to buy new shares in
proportion to their current holding.
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E. Debentures
These are long-term certificates issued by limited companies
Advantage of selling debentures
Disadvantage of selling debentures
It is used to raise very long-term finance
Must be repaid with interest
(ex.: 25 years)
Factors considered by the company when they decide to use Long-term loans or
debt finance:
 Loan interest is paid before tax and is an expense
 Loan interest must be paid every year but dividends are paid only when the
business makes profits
 Loans must be repaid whereas share capital is permanent capital
 Loans are often secured against particular assets
Sources of finance: how business makes the choice
1. Purpose and time period
The business should match the source of finance to the use that will be made of it.
 If the use is long term, for example purchase of fixed asset, the source should be
long term.
 If the use is short term, for example the purchase of additional inventories to cover a
busy period, the short should be short term.
2. Amount needed
It is unwise to arrange issue of new shares if the amount needed if a small amount like
$5000 and needed for a short period of time. It would be wiser in this case to use an
overdraft
3. Legal form and size
Issuing shares or debentures is not an option for sole traders and partnerships thus they
rely on savings of their owners for expansion instead. Also the large the company the lower
the interest rate paid to banks and the opposite is true.
4. Control
Owners may have to decide which is more important, expanding the business or keeping
control of it.
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5. Risk and gearing – does the business already have loans?
The gearing of a business measures the proportion of total capital raised from long-term
loans. If this portion is high 50% and more the business is said to be highly geared. This
means that it is using a risky source of finance and banks will be reluctant to lend them.
It is risky because:
 Interest must be paid on the loans whether the business is making profits or not
 When interest rates are high the company profits will be low and the firm may
not be able to pay all of the interest.
 The future of the business will be at risk.
Will banks lend and shareholders invest?
A business owner, especially of a new start-up business, will increase the chances of obtaining
loan finance if the following is available:





Cash flow forecast which shows why the cash is needed and how it will be used
An income statement for the last time period and a forecast for the next which shows
the chances of a business making a profit in the future
Details of existing loans and sources of finance being used
Evidence that security is available to reduce the bank’s risk if it lends
A business plan to explain clearly what the business hopes to achieve in the future and
why the finance is important to these plans
Shareholders are most likely to buy additional shares when:




The company’s share price has been increasing
Dividends are high – or profits are rising so dividends might increase in the future
Other companies do not seem such a good investment
The company has a good reputation and has plans for future growth
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Chapter 22: Cash flow forecasting and working capital
Why cash is important to a business
Cash is a liquid asset which means that it is immediately available for spending on goods and
services.
Cash flow: of a business is the cash inflows and outflows over a period of time
Cash inflows: are the sums of money received by a business during a period of time
Cash outflows: are the sums of money paid out by a business during a period of time
Major problems faced if the business has too little cash or runs out of cash:



Unable to pay workers, suppliers, landlord and government
Production of goods and services may stop – if not paid; workers will not work and
suppliers will not supply raw materials
The business may be forced into liquidation: selling up everything it owns to pay its
debts
What is meant by cash flow?
The most common ways in which cash flows into the business:





Sale of products for cash
Payments made to debtors
Borrowing money from an external source
Sale of unwanted property / asset
Investors putting more money into the business
The most common five ways in which cash flows out of the business:





Purchasing goods or materials for cash
Paying wages, salaries and other expenses in cash
Purchasing fixed assets
Repaying loans
By paying creditors of the business
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Cash flow cycle
Cash flow cycle: shows the stages between paying out cash for labour, materials, etc. and
receiving cash from the sale of goods.
cash needed
to pay for
materials,
wages,
rent,etc.
cash payment
received for
goods sold
goods
produced
goods sold
The longer the time taken to complete these stages, the greater will be the firm’s need for
working capital and cash. The shorter the time taken the faster will be the cash flowing into the
company.
What cash flow is not
Cash is not the same as profit
Profit: is the surplus after total costs have been subtracted from sales revenue.
A profitable business may run out of cash (be insolvent) due to the following reasons:



Allowing customers too long credit period, perhaps to encourage sales
Purchasing too many fixed assets at once
Overtrading: expanding too quickly and keeping a high inventory level.
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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.
Uses of cash flow forecasts
Opening cash balance: is the amount of cash held by the business at the start of the month
Net cash flow: is the difference, each month, between inflows and outflows.
Closing cash balance: Is the amount of cash held by the business at the end of each month.
This becomes next month’s opening cash balance.
Example of cash flow forecast:
Cash inflows (A)
Cash outflows (B)
Opening bank balance (C)
Net cash flow (D) (=A-B)
Closing Bank Balance (=C+D)
January
35 000
30 000
10 000
5 000
15 000
February
45 000
65 000
15 000
(20 000)
(5 000)
March
50 000
40 000
(5 000)
10 000
5 000
a. Starting up a business
When planning to start a business the manager will think about the following expenses:




Rent or purchase of premises
Lease or purchase of machinery
Purchase of inventory
Cost of advertising and promoting the product
Many new businesses fail because owners do not realize how much cash is needed in the first
few crucial months. A cash flow forecast should help avoid these problems.
b. Keeping the bank managers informed
The bank manager will need to see how important a loan or overdraft to the business, how long
the finance is needed and when it might be repaid.
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c. Managing an existing business
 Borrowing money needs to be planned in advance so that the lowest rates of interest can
be arranged. It also will make the business avoid bank refusal of loan because of poor
business planning. Also it avoids being charged a high interest rate.
 If the business exceeds the overdraft limit from the bank without informing the bank
manager first, the bank could insist that the overdraft is repaid immediately and this could
force the business to close.
d. Managing cash flow
 Too much cash held in the bank account of a business means that this capital could be
better used in other areas of the business.
 If too high bank balance is available then it would be wise to pay off loans to help reduce
interest charges.
 Another option is to pay creditors quickly to take advantage of possible discounts.
How can cash flow problems be overcome?
Method of overcoming
cash flow problem on the
short - run
How it works
Limitations
Increasing bank loans
Bank loans will inject more cash into the business
-
Delaying payments to suppliers
Cash outflows will decrease in
the short term
-
Asking debtors to pay more quickly
– or insisting only on cash sales
Cash inflows will increase in
the short term

Delay or cancel purchases of capital
equipment
Cash outflows for purchase of
equipment will decrease

4
Interest must be paid
which will reduce profits.
The loan should be repaid
which will increase
outflows.
Suppliers could refuse to
supply.
Supplier could offer low
discounts for late
payment.
Customer may take their
custom to another
business that still offers
them time pay – trade
credit
The long-term efficiency
of the business could
decrease without up-todate equipment
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On the long-term a business can solve the cash-flow problem as follows:
Method
Attracting new investors by selling more
shares
Cutting costs and increasing efficiency
Developing new products that could attract
customers
Limitation
Ownership could change hands
Product quality could be affected
Takes long time and needs cash in the short
term to pay for development
The importance of working capital
Working capital: is the capital available to a business in the short-term to pay for day-to-day
expenses.
Working capital = current assets – current liabilities



Working capital assists in raising the credit reputation of a business
It is needed for a business to run effectively.
A business with sufficient working capital is always in a position to take advantage of any
favorable opportunity either to buy raw materials being offered at a discount or to
implement a customer’s special order.
Working capital may be held in different forms:



Cash is needed to pay for day-to-day costs and buy inventories
Debtors: customers who bought goods from the business on credit
Inventories: not having enough inventories may cause production to stop and too much
level will result in an opportunity cost.
The overall success of a business depends upon its working capital position. So, it should be
handled properly because it shows the efficiency and financial strength of the company.
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Chapter 23: Income statements
What are accounts and why are they necessary?
Accounts: are the financial records of a firm’s transactions - they should be kept up to date and
with great accuracy.
Accountants: are the professionally qualified people who have responsibility for keeping
accurate accounts and for producing the final accounts.
Final accounts: are produced at the end of the financial year and give details of the profit or
loss made over the year and the worth of the business.
Limited companies are required by law to publish their final accounts and these are much more
detailed than those required from non-company businesses.
Recording accounting transactions
Computer files store records of all the sales, purchases and other financial transactions made by
a firm and the information can be retrieved or printed out when required.
How a profit is made





Profit is an objective for most businesses.
Profit is surplus after all business cost have been subtracted
Profit = sales revenue – cost of making products
If costs exceed sales revenue, then the business has made a loss
Profits can be increased by increasing sales revenue by more than cost
Profits can be increased by reducing cost of making products
Why is profit important?
Why profit is important
Explanation
Reward for enterprise

Reward for risk taking



1
Profit gives reward for the important
characteristics of successful entrepreneurs
Profits reward entrepreneurs for risking
capital in the business
Returns given to entrepreneurs provide
incentives to them to make their business
even more profitable
Investors may be encouraged to put more
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capital into profitable businesses
Source of finance
 Retained profits are very important source
of finance for businesses which allows
expansion
Indicator of success
 A profitable business gives a signal to
other investors to invest in producing
similar products or services as it is
profitable
 In public sector businesses profits are an important target as it will be used as a source of
finance to develop state-owned businesses or make it more efficient.
 In social enterprises, profits are also needed for their survival but profit is not the only
objective. Managers would like to balance profit making with other aims such as protecting
the environment and benefiting disadvantaged groups in society.
Understanding income statements
Income statement: is a document that records the income of a business and all costs incurred
to earn that income over a period of time (for example one year). It is also known as a profit
and loss account.
A gross profit: is made when sales revenue is greater than the cost of goods sold.


Goss profit = sales revenue – cost of goods sold
Gross profit doesn’t make any allowance for overhead costs or expenses
The sales revenue: is the income to a business during a period of time from the sale of goods or
services.

Sales revenue = price X quantity
The cost of goods sold: is the cost of producing or buying in the goods actually sold by the
business during a time period.

Cost of goods sold is not necessarily the same as total value of goods bought by the
business as they may use inventories stored in their warehouses
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Income statement for XYZ limited
For year ending 31/10/13
$000
Sales revenue
55 000
Opening inventories
10 000
Purchases
25 000
Total inventory available
35 000
Less closing inventories
12 000
Cost of goods sold
23 000
Gross profit
32 000
Note: in a manufacturing business, rather than retailing one, the labor costs and production
costs directly incurred in making the products sold will also be deducted before arriving at the
gross profit total.
Trading account: shows how the gross profit of a business is calculated
It is not an income statement because the following information is missing:



Other costs of running the business apart from the variable labor and material costs, for
example fixed costs
Taxes on profit paid by the company
Payment of a share of the profits to owners / shareholders
Net profit (also known as ‘profit before tax’)
Net profit: is the profit made by a business after all costs have been deducted from sales
revenue. It is calculated by subtracting overhead costs from gross profits.
Example of income statement for an unincorporated business:
Gross profit
Non-trading income
$32 000
$5 000
$37 000
Less expenses:
Wages and salaries
Electricity
Rent
depreciation
Selling and advertising expenses
$12 000
$6 000
$3 000
$5 000
$5 000
$31 000
$6 000
Net profit
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Depreciation: is the fall in the value of a fixed asset over time. This is included as an annual
expense of the business. each year, this fall in value or depreciation is recorded as an expense
on the income statement.
Retained profit: is the net profit reinvested back into a company, after deducting tax and
payments to owners, such as dividends.
Example of an income statement for limited companies:
Sales revenue
Cost of sales
Gross profit
Expenses including interest paid
Net profit
Corporation tax
Profit after tax
Dividends
Retained profit for the year
2013
($000)
1250
900
350
155
195
35
160
120
40
2012
($000)
1300
900
400
160
240
40
200
130
70
The income statement for limited companies will also contain:




Corporation tax paid on the company’s net profits
The dividends paid out to shareholders
The retained profits left after these two deductions
Results from the previous year to allow for easy comparison
Using income statements in decision making
Managers can use the structure of income statements to help them in making decisions based
on profit calculations. For example: if a manager is to decide which two new products to
launch, one way of making this decision is to construct two forecasted income statements.
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Chapter 24: Balance sheets
Balance sheets
Business owners would be interested to know how much their business is worth. This
information can be found in the balance sheet. It also shows the value of assets and liabilities
of the business. It shows how much wealth or equity the owners have invested in the business.
The balance sheet: shows the value of a business’s assets and liabilities at a particular time.
Sometimes referred to as ‘statement of financial position’.
Assets: are those items of value which are owned by the business. They may be fixed / noncurrent or current assets.

Most fixed assets apart from land depreciate over time so the value of these will fall on
the balance sheet from one year to the next.
Non-current assets / fixed assets: are items owned by the business for more than one year like
land.
Current assets: are owned by a business and used within one year like cash.
Non-current liabilities / long-term liabilities: are long term debts owned by the business like a
bank loan.
Current liabilities: are short-term debts owned by the business like overdrafts.
Intangible assets: are those that do not exist physically but have a value such as brand names,
patents and copyrights.
Liabilities: are debts owed by the business.

They may be non-current liabilities (long-term liabilities) which are long-term
borrowings which do not have to be repaid within one year like a bank loan. They may
be current liabilities which are amounts owed by the business and must be repaid within
one year like an overdraft.
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Example of a balance sheet:
Assets
Non-current (fixed)assets
Land and buildings
Machinery
Current assets
Inventories (stocks)
Accounts receivable (debtors)
Cash
Total assets
Liabilities
Current liabilities
Accounts payable (creditors)
Bank overdraft
Non-current (long-term)liabilities
Long-term bank loan
Total liabilities
Total Assets – Total Liabilities
Shareholder’s equity (shareholder’s funds)
Share capital
Profit and loss account reserves
Total shareholder’s funds / equity
2014
2013
450
700
1150
440
600
1040
80
50
10
140
1290
50
60
15
125
1165
65
65
130
40
60
100
300
430
860
245
345
820
520
340
860
500
320
820
Owners’ equity (shareholders’ funds in Ltd. = Total assets – total liabilities
Explanation of balance sheet terms


Total assets less total liabilities is always equal to total shareholders’ funds or equity –
otherwise the balance sheet would not balance.
Shareholders’ equity (shareholders’ funds) is the total sum of money invested into the
business by the owners of the company / shareholders. This money is invested in two
ways:
o Share capital is the money put into the business when the shareholders bought
newly issued shares.
o Reserves arise as a result of retained profits from current and previous years.
This money belongs to shareholders but has not been paid to them in the form
of dividends. It is kept in the business as part of the shareholders’ funds.
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Interpreting balance sheet data



Shareholders can see if their stake in the business has increased or fallen in value over
the last 12 months by looking at the ‘total equity’ figures for two years.
Shareholders can also analyze how expansion by the business has been paid for ex. By
Debt finance or retained profits
Working capital can be calculated from the balance sheet data. It is important as it is
used to pay short-term debts or else creditors could force the business to stop trading
Working capital / net current asset = current assets – current liabilities

Capital employed can also be calculated from the balance sheet
Capital employed
= shareholders’ funds + non-current liabilities
= (total assets – total liabilities) + non-current liabilities

Balance sheet is also helpful to calculate ratios which are used to assess the business
performance
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Chapter 25: analysis of accounts
Analysis of published accounts
Analysis of accounts means using data from the accounts to make some useful observations
about the performance and financial strength of the business. It is important to tell whether a
business is performing better this year than last year and whether it is performing better than
other businesses.
Ratio analysis of accounts
Ratios are used to measure and compare he profitability / performance of a business or the
liquidity of a business.
Liquidity: is the ability of a business to pay back its short-term debts.
Capital employed: is shareholder’s equity plus non-current liabilities (long-term liabilities )and
is the total long-term and permanent capital invested in a business.
Profitability ratios:
1. Return on capital employed (ROCE)
X100
It shows the ratio of net profit to capital employed (money invested) in the business. the
higher the result the more successful the manager in earning profit from capital / money
invested in the business. If the percentage increases next year, it means that the managers
are running the business more efficiently (making higher profits from each dollar invested in
the business).
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2. Gross profit margin
X 100
It shows the percentage of gross profit to every $1 earned as sales revenue. This is not
the final profit earned by the company as other expenses have still to be paid for. It is
usually compared with other companies or previous years.
If the percentage increases in the following year then this means that:
 Prices have been increased by more than cost of goods have risen
Or
 Costs of goods bought in have been reduced. Probably as a result of using a new
supplier who offers lower prices.
3. Net profit margin
X 100
It shows the percentage of net profit to every $1 earned as sales revenue. This should
be lower than gross profit margin since all expenses including interest rates have been
deducting before reaching profit before tax.
The higher the result the more successful the managers are in making net profits from
sales.
The concept of liquidity
Liquidity: is the ability of a business to pay back its short-term debts.
Illiquid: means that the assets are not easily convertible into cash, thus the business is
not capable of repaying its short-term liabilities (ex. Overdraft). Creditors may force the
business to stop trading and sell its assets so that the debts are repaid.
Liquidity ratios
1. Current ratio
It shows the ability of the business to pay off its short-term debts from current assets. A
safe current ratio would be between 1.5 and 2.
If result is below 1 then the business is having a cash flow problem as it could not pay
its short-term debts from current assets.
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If the result is above 2 then this means that the business has too much working capital
tied in unprofitable current assets. This money could have been utilized in a much more
profitable activity.
Limitation: it assumes that all current assets could be turned quickly into cash. This is
not always the case as inventories may be difficult to sell in a short period of time.
2. Acid test or liquid ratio
A result of 1 would mean that the business could just pay off its short-term debts from
its most liquid assets. It is usually an acceptable result. Less than 1 would mean that
the business has cash problems and the management should take steps to improve the
liquidity of the business. for example, reduce the level of inventories by selling some for
cash.
Uses and users of accounts
The following groups have an interest in public limited company’s accounts and the
ratios based on them.
Users of accounts
Managers
Shareholders
What they use the business accounts for
 Accounts help them keep control over the performance of
each product or division of the business. it will be easier to
identify which parts of the business are performing well or
poorly
 Accounting data will help in decision making for example
whether to expand the business or change prices..etc.
 Accounts are useful in comparing profit performance or
liquidity (comparison is done with previous years or
competing businesses)
 They want to know from the income statement, how big a
profit or loss the company made.
 Profitability ratios can be compared with previous years if the
results were higher than previous years then shareholders
may invest more by buying more shares in the company.
 The balance sheet will show them the worth of the business at
the end of the year.
 They will assess the liquidity of the business. they wouldn’t
want to invest in a company with serious cash or liquidity
problems (creditors may force it to stop trading)
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Creditors



Banks

Government


Workers and trade
unions


Other businesses
especially those in
the same industry

The balance sheet will indicate to creditors the total value of
debts that the company has to pay back and the cash position
of the company.
Liquidity ratios, especially when compared to previous year,
will indicate the ability of the company to pay back all of its
creditors on time.
If these results suggest the company has a liquidity problem,
suppliers may refuse to supply goods on credit.
If the business seems to be at a risk of becoming illiquid, it is
unlikely that a bank will be willing to lend it more.
The tax office will want to check on the profit tax paid by the
company.
If the company is making a loss then this is bad news to the
government’s control of the whole economy, especially if it
means that workers’ jobs may be lost.
They will want to assess whether the future of the company is
secure or not.
They will want to assess whether the profits of the company
are increasing or not to support their request for a pay rise.
The managers of other companies may be considering a bid to
take over the company of they may just wish to compare the
performance of the business with that of their own.
Limitations of using accounts and ratio analysis
 Managers get access to detailed data while external users will only get access to the
published accounts which contain only data required by law.
 Ratios are based on past accounting data and may not indicate how a business will
perform in the future.
 Accounting data may be affected by inflation (rising prices) and comparison between
years may be misleading.
 Different companies may be using slightly different accounting methods, for
example in valuing their fixed assets. These different methods could lead to
different ratio results, therefore, making comparisons difficult.
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Chapter 26: Government economic objectives and policies
Government economic objectives
Most governments have the following economic objectives:
1. Low inflation
 Inflation: is the increase in the average price level of goods and services over time.
2. Low unemployment
 Unemployment: exists when people who are willing and able to work cannot find a
job
3. Economic growth
 Economic growth: Is when a country’s gross domestic product increases – more goods
and services are produced than in the previous year.
4. Balance of payments
 The balance of payments: records the difference between a country’s exports and
imports.
1. Low inflation
The following problems may result due to rapid inflation:
 People’s real income will fall thus workers will demand higher wages so that their real income
increases.
Real income: is the value of income and it falls when prices rise faster than money income.
 Prices of local goods will be higher than prices of goods abroad so people will buy foreign goods
instead. Jobs in that country will be lost.
 Business will not want to expand and thus will not create more jobs in near future. The living
standards are likely to fall.
Low inflation can encourage businesses to expand and it makes it easier for a country to sell its
goods and services abroad (if inflation rate is lower than that abroad)
2. Low unemployment
Unemployment will result in the following problems:
 The total level of output in a country will be lower than it could be
 A high level of unemployment will cost the government a lot as it will pay more unemployment
benefits. There is an opportunity cost for this money spent on unemployment.
Low unemployment will help increase the output of a country and improve worker’s living
standards.
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3. Economic growth
An economy is said to grow if the GDP in the country increases. Growth will lead to higher living
standard of the population.
Gross domestic product (GDP): is the value of output of goods and services in a country in one
year.
Problems that may arise if the economy is not growing:
 Unemployment as output is falling.
 Decline in the average standard of living of the population; the number of goods and services
they can afford to buy in one year will decline.
 Businesses will not expand as people will have less money to spend on their products.
Economic growth makes a country richer and allows living standards to rise.
The business cycle
GDP ($)
Economic growth is not achieved steadily ever year. It follows a pattern which has four main stages;
growth, boom, recession and slump/depression
Years
Explanation of the trade cycle:
Growth:
Boom:
GDP is rising
Unemployment falling
Higher living standards
Businesses doing well at this time
cause by too much spending
Prices rise quickly
Shortage of skilled workers
Business costs will be rising
Businesses uncertain about the future
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caused by too little spending
GDP falls
Businesses experience falling demand and profits
Workers may lose their jobs
Slump:
it is a serious and long-drawn-out recession
Unemployment reaches very high levels
Prices may fall
Businesses will fail to survive this period
Governments try to avoid the economy moving towards recession or a slump and reduce the
chances of a boom. A boom with rapid inflation will result in recession.
Recession:
4. Balance of payments
Government aims to achieve equality or balance between its exports and imports over a period of
time.
Exports: are goods and services sold by one country to people and businesses in another country.
They bring foreign currency into a country.
Imports: are goods bought in from other countries. It leads to foreign currency flowing out of the
country.
A deficit occurs if the value of country’s imports is greater than the value of its exports and would
lead to the following problems:
 Government runs out of foreign currencies and it may have to borrow from abroad.
 The exchange rate depreciates
o Exchange rate: is the price of one currency in terms of another currency.
o Depreciation in exchange rate: is the fall in the value of a currency compared with
other currencies.
Government economic policies
Governments have power to control the economy through raising taxes and spending on a wide
range of services and state benefits. They use their power to achieve their economic objectives. The
economic policies are:
1. Fiscal policy – taxes and government spending
2. Monetary policy – interest rates
3. Supply side policies
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1. Fiscal policy: taxes and government
The government will collect taxes from individuals and businesses to use it on its expenditure on
schools, hospitals, roads, defense, and so on.
There are two main types of taxes:
a. Direct taxes: are paid directly from incomes – for example, income tax or profits tax.
b. Indirect taxes: are added to the prices of goods and taxpayers pay the tax as they purchase
the goods – for example, VAT
a. Income tax
This is a tax on people’s income. Usually the higher the income the greater will be the amount of tax
they have to pay to the government (progressive tax).
How would businesses be affected by an increase in the rate of income tax?
increase in
tax rate
less
disposable
income
less
money to
spend
businesses
have falling
sales
businesses
produce
fewer goods
unemployment
rises
Which businesses are likely to be most affected by this increase in income tax rates?
Businesses which produce luxury goods are likely to be most affected than those producing essential
goods and services.
b. Profit tax (or corporation tax)
It is a tax on the profits made by businesses usually companies.
How would an increase in the rate of corporation tax affect businesses?
businesses have
lower profits
after tax
less money to
reinvest in the
business
businesses have
lower profits
afer tax
less dividends to
pay for
shareholders
4
difficult o
expnad
new projecs
may have to be
cancelled
share price
could fall
few owners will
want to start
their own
business
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c. Indirect taxes
Indirect taxes are added to the prices of products we all buy, such as VAT. They make goods and
services more expensive for consumers. Governments usually avoid putting these taxes on essential
items such as food, as it would be considered unfair to poorer consumers.
How would businesses be affected by an increase in an expenditure tax?
prices of goods
would rise
prices of
goods would
rise
consumers buy
fewer items
workers' real
income
declined
fewer demand on
products
businesses
may be
pressurized to
raise wages
business cost
rises
d. Import tariffs and quotas
Governments reduce the import of products from other countries by putting import tariffs / tax on
them. This also raises money for the government. They may also introduce an import quota which is
a physical limit to the quantity of a product that can be imported.
How would businesses in a country be affected if the government put tariffs on imports into the
country?
increase in sales of local
businesses producing similar
goods
imported goods will be expensive
imported raw
materials will be
expensive
higher costs for
businesses using
imported raw
materials
businesses will raise
their prices
import tariff
other countries
retaliate
busineses exporting
to these countries
will sell fewer goods
than before
e. Changes in government spending
When governments want to boost economic growth, they can raise their spending on education,
health, defense, law and order and transport. This will create more demand in the economy, more
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jobs and GDP will increase. If the government wants to save money they will cut expenditure on
these programs.
2. Monetary policy – interest rates
Monetary policy: is a change in interest rate by the government or central bank.
In most countries the government through its central bank fixes the interest rates (cost of
borrowing money) to control the economy.
What are the effects of a higher interest rate?
more payment to banks by firms
with existing variable interest rate
less dividends
paid to
shareholders
reduces their
profits
delay in expansion plans of existine
businesses - enterpreneurs hoping to start
a new business will not be able to borrow
reduce investtments
in business activity
less retained
profits for
exapansion
few factories and
offices are built
consumers with morgages
will pay more to banks
reduces their available
income
demand for all goods and
services could fall
fall on demand for
expensive products like
houses and cars
these businesses reduce
output
workers may be made
redundant
foreign banks and
investors encouraged
to deposit money in
this country
increasing
demand on the
country's
currency
exchange rate
appreciation
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imported goods will
be cheaper and
exported ones will be
expensive
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3. Supply side policies
The aim of these policies is to make the country more efficient, increase the competitiveness of a
country’s industries against those from other countries. This would allow their businesses to expand,
produce more and employ more workers. The following supply side policies are trying to improve
the efficient supply of goods and services.
 Privatization: aims at using profit motive to improve efficiency
 Improve training and education: improving the skills of workers especially for important
industries such as computer software which are often very short of skilled staff.
 Increase competition in all industries: this is done by reducing government controls over
industry or by acting against monopolies.
How business might react to changes in economic policy
Government policy change
Increase income tax
Increase tariffs on imports
Increase interest rates
Possible business decision
Lower prices on existing
products to increase demand
Problems with this decision
Less profit on each item sold
which reduces gross profit margin
Produce cheaper products to
allow for lower prices
Brand image of the product may
be damaged by using cheaper
versions of the product
It might still be more profitable to
export
Focus on selling in domestic
markets as local goods will
seem to be cheaper
Switch from buying imported
materials and components to
locally produced ones
Reduce investments so future
growth will be less
Foreign materials and components
might be of higher quality
Develop cheaper products that
consumers will be better able
to afford
Consumers may think that quality
and brand image are lower
Sell assets for cash to reduce
existing loans
These assets might be needed for
future expansion
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Market share may be lost as other
companies may still grow
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Chapter 27: environmental and ethical issues
Business activity and the environment
Business activity aims to satisfy customers’ demands for goods and services but it often has an
impact on the environment; natural world including air, clean water and undeveloped countryside.
Examples of impacts on the environment:
 Atmospheric pollution form aircraft jet engine
 Air pollution from factory chimneys
 Water pollution from waste disposal in rivers and seas
 Carbon emissions that may cause global warming and climate change as a result of
transport of goods by ship and trucks.
Managers may have to types of arguments related to the environmental issues:
Argument A: using environmentally friendly production methods is expensive and will lead to
lower profits.
Argument B: businesses should have social responsibility
Social responsibility: is when a business decision benefits stakeholders other than
shareholders, for example, a decision to protect the environment by reducing
pollution by using the latest and ‘greenest’ production equipment.
Argument A: businesses should produce profitably and not worry about the environment
 If pollution is a problem then the government should pay to clean it up
 There is not enough proof that business activity is doing permanent damage to the
environment.
reducing waste,
recycling waste
and reducing
pollution smoke
are expensive and
reduces profits
firms may
become
uncompetitive
and they could
lose sales to
businesses that
are not
environmentally
friendly
firms may have to
increase prices to
pay for
environmentally
friendly policis
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consumers will
buy less if they
have to pay
higher prices
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Argument B: Businesses have a social responsibility towards the environment and this can
benefit them too
global warming and golbal
pollution affect us all and
businesses should have a
social responsibility to
reduce these problems
using scarce nonrenewable natural
resources leaves less for
future generations and
raises prices
why social
responsibility?
consumers are becoming
more socially aware: they
are increasingly demanding
products from
environmentally friendly
firms and this can become a
marketing advantage
pressue groups could take
action to harm the firm's
reputation and sales if
they are not
environmentally friendly
scientists and
environmentalists believe
that business activity can
damage the environment
permanently
Externalities
Business decisions may lead to many of the following costs and / or benefits:
Private costs: of an activity are the costs paid for by business. ex: cost of land, labor, transport,
raw materials,…etc.
Private benefits: of an activity are the gains to a business. ex: sales revenue and profits
External costs: are costs paid for by the rest of society, other than the business, as a result of
business activity. Ex: pollution, damage to health of residents, a park not utilized by
residents,…etc.
External benefits: are the gains to the rest of the society, other than the business, resulting from
business activity. Ex: job creation, taxes paid to the gov. which increases gov. expenditure,…etc.
Social cost: external costs + private costs
Social benefit: external benefits + private benefits
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Note: Before the government approval for any request by the business, such as location request, it
will do the cost benefit analysis. If the total social benefit is greater than the total social cost, the
government will approve the request. However, it the total social cost is greater than the total
social benefit, the government will refuse the request.
Sustainable development
Sustainable development: is development which doesn’t put at risk the living standards of future
generations.
Sustainable production methods: are those that do minimum damage to the environment
Sustainable development: what can businesses do?
1. Use renewable energy : ex. Wind or tidal power
2. Recycle waste: ex. Re-using water
3. Use fewer resources: ex. Use lean production to help in this
4. Develop new environmentally friendly products and production methods: use
biodegradable packaging instead of cans and bottles
Responding to environmental pressures and opportunities
Society is doing the following actions to make businesses more environmentally friendly:
1. Pressure groups
Pressure group: is made up of people who want to change business (or government)
decisions and they take action such as organizing consumer boycotts.
 Pressure groups are becoming increasingly powerful. They can take some effective
actions against businesses that are not socially responsible such as creating bad
publicity.
 If a firm is reported to harm the environment in any way, many consumers will stop
buying from it. if sales fell, then the business may have to quickly change its
products or its production methods.
Consumer boycott: is when consumers decide not to buy products from businesses that do
not act in a socially responsible way
Pressure group activity will be effective in the following cases:
 They have popular public support and receive much media coverage
 Consumer boycotts resulted in reduced sales
 The group is well organized and financed
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Pressure group activity will not be effective in the following cases:
 Firms doing unpopular but legal activities. Ex; testing drugs on animals
 The cost of changing production methods of the business is much more higher that
the losses due to bad image and boycotts
 If the firm sells to other businesses rather than consumers. Ex: selling raw materials
2. Laws passed by government
Governments can make the following business activities illegal;
 Locating in environmentally sensitive areas such as national parks
 Dumping waste products into rivers and seas (difficult to prove which firm is
responsible for this)
 Making products that cannot be easily recycled
How do these laws affect businesses?
expensive to
produce
raise prices to
consumers
fall in sales revenue
and profits
Note: Some governments may tackle this issue by not passing such strict laws on the
environment, hoping that firms will be encouraged to produce in their country to create
jobs.
3. Financial penalties, including pollution permits
Pollution permits: are licenses to pollute up to a certain level.
This has two effects:
1. Encourages businesses to use clean production method. They will be rewarded for this by
selling their pollution permits to other firms that use environmentally unfriendly methods
of production
2. Other businesses that exceed their pollution limit will be penalized by either paying heavy
fines or having increased cost as they will have to go search and buy permits from clean
firms
Note: being environmentally friendly can create a positive public opinion of a business
and lead to opportunities for sustainable growth.
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Ethical issues
Ethical decisions: are based on a moral code. Sometimes referred to as ‘doing the right thing’.
Examples of ethical issues:





Take or offer bribes
Employ children even though it is not illegal in some countries
Buy in supplies from an unethical supplier
Agree to fix high prices with competitors
Pay directors large bonuses and owners of the businesses large profit payouts at the same
time as reducing workforce?
People have different views related to the above issues but the two of our concern are:
1. Businesses have profit as its main objective so any decision would be acceptable as long as
the business doesn’t deliberately break the law.
2. Even if certain activities are not illegal, it is unethical and therefore wrong to do them
despite any increase in profits might occur.
Impact on business of ethical decisions
Potential benefits of ethical decisions:
ethical
consumers
will buy from
ethical
companies
good publicity
about the co.
ethical
decisions provide free
promotion
increase in
profits on the
long-term
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the co. may
find it easier
to find
workers and
raise more
capital from
investors
less risk of
legal action
being taken
against the co.
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Potential limitations of ethical decisions:
higher cost (adult
wrokers are more
expensive than
children + improving
working conditions
is expensive)
prices may
increase to
cover the
higher cost
sales of the
company
could fall if
consumers
are only
interested in
low prices
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short-term
profits may
fall
in some
countries if
children are not
employed the
incomes of their
families will fall
to very low
levels
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Chapter 28: Business and the international economy
Globalization
Globalization: is the term now widely used to describe increases in worldwide trade and
movement of people and capital between countries.
Reasons for the increase in global trade and movement of products, people and capital
(globalization):
1. Increased number of free trade agreements and economic unions between countries
which reduced protection for industries allowed consumers to buy goods and services
from other countries with few or no controls such as tariffs.
o Free trade agreements: exist when countries agree to trade imports/exports
with no barriers such as tariffs and quotas.
2. Improved and cheaper travel links and communications between all parts of the world
have made it easier to transport products globally. Internet also allows customers to
compare prices of goods in many countries and order on-line from anywhere in the
world.
3. Many countries are emerging rapidly thus they export in large quantities at very
competitive prices
Globalization – opportunities and threats
Globalization: potential opportunities for businesses
Opportunity
Exporting to other countries – opens up
foreign markets
Impact on businesses
+ Increase potential sales – online selling
allows for goods to be sent in from abroad.
Selling products abroad may be
expensive.
Products may not be popular abroad
so consumers may not buy them
+ cheaper to make goods in other countries
than at home
- Quality may be lower than at home
- Ethical issues may be involved like poor
working conditions
- Expensive to set up operations in other
countries
+ importing goods and services from other
countries and selling them domestically may
Open factories/operations in other countries
(become a multinational – high status)
Import products from other countries to sell
to customers in home country
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be profitable.
Products may need maintenance and
support which may not be provided by the
foreign producer.
+ may be cheaper and easier to purchase
these supplies from other countries due to the
free trade and e-commerce.
- Suppliers may not be reliable.
- Transport cost may be expensive.
Import materials and components from other
countries to produce final goods in home
country
Globalization: potential threats to businesses
Threats
increased competition at home due to
increased imports
Impact on businesses
+ local businesses may be forced to become
more efficient as they fear competition
Sales of local business may fall if the
imported products are cheaper or of better
quality
+ some local firms could become suppliers to
these multinationals and their sales could
increase
- Multinationals create further competition
- Multinationals may have economies of
scale and able to afford the best
employees
+ this may encourage local businesses to use
a range of motivational methods to keep their
workers
Employees will have greater choice
about where to work and for which business
which will make it harder for local businesses
to keep their best employees.
Increased investment from multinationals to
set up operations in home country
Employees may leave businesses that cannot
pay the same or more than international
competitors
Summary:
Golbalization lead to:
+ More consumer choice
+ Lower prices
+ Businesses trying to be more efficient
+ Many mergers with foreign businesses to sell in foreign markets
- Loss of jobs in poorest countries
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Why some governments introduce tariffs and quotas
Tariffs and quotas on imports are used by governments to protect domestic industries from
competition that might otherwise close them.
An import quota: is a restriction on the quantity of a product that can be imported.
Protectionism: is when a government protects domestic firms from foreign competition using
tariffs and quotas.
Argument for protectionism:
Foreign competitors may be producing much more cheaply than local ones and when allowed to
import from them without restrictions then local firms might be force out of business. This
would reduce employment and incomes.
Argument against protectionism:
It is better to allow local consumers to buy imported goods as cheaply as possible which will
increase their living standards. Local businesses should also be allowed to produce and export
goods and services in which they have competitive advantage. The end result will be that living
standards across the globe can be increased.
Multinational businesses
Multinational businesses: are those with factories, production or service operations in more
than one country. These are sometimes known as transitional businesses.
Why do firms become multinational?
Businesses become multinational organizations for several reasons:
-
To get advantage of low wages in certain countries which reduces cost of production
To get access to raw materials which are needed for production
To produce goods nearer to the market and thus reduce transport costs
To avoid trade barriers put by governments
To expand into different market areas to spread the risk
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Advantages of multinationals operating in a
country
Job creation which reduces unemployment
Disadvantages of multinationals operating in
a country
The jobs created are often unskilled assemblyline tasks
Local firms may be forced out of business as a
result of the efficiency and lower cost of
multinationals
Repatriation of profits: profits sent back to
multinational’s home country
Multinationals often use up scarce and nonrenewable natural resources in the host
country
Multinationals could have a lot of influence on
the government and the economy of the host
country.
New investments in buildings and machinery
increases output of goods and services in the
country
New technology can benefit the country by
bringing new ideas and methods
More goods are now produced which will
reduce imports and increase exports of the
country
Taxes are paid by multinationals which
increases the funds of the government
More product choice for consumers and more
competition
Exchange rates
The exchange rate: is the price of one currency in terms of another, for example £1:$1.5
How are exchange rates determined?
Most currencies are allowed to vary or float on the foreign exchange market according to the
demand and supply of each currency.
How are businesses affected by changing exchange rates?
Changes in exchange rate affects the businesses in several ways:
Currency appreciation: occurs when the value of a currency rises – it buys more of another
currency than before.
Effect on exporting companies:
- Appreciation of exchange rate will make exported goods more expensive abroad thus leads
to fewer sales and exports.
- Alternatively the business will maintain the same price charged in the foreign country
(using foreign currency) and earn less revenue on each product in terms of his domestic
currency.
For example: if exchange rate was $1: €1.6 then it became $1: €2 (appreciation of the $). And
an American product was sold in France with €480. The company will have now the following
options after the appreciation of the $:
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Option A: use the new exchange rate and charge consumers in France €600 to continue earning
$300. This means that the product is more expensive abroad now
Option B: keep price charged in France the same €480 and earn less revenue per item which is
$240.
Effect on importing companies:
Imports will be cheaper now due to the appreciation of the currency.
- Importing companies can keep charging same prices for imported products and earn higher
revenue per item
- Alternatively the can charge lower prices for imported products and have higher demand
and sales revenue on imported products that they sell.
Currency depreciation: occurs when the value of a currency falls – buys less of anther currency.
Effect on importing companies:
An importing company will have higher costs if the exchange rate of its currency depreciates
Effect on exporting companies:
Products will be cheaper abroad as a result of depreciation of exchange rate so more demand
and sales revenue will follow
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