Rehab A. Gawad: 0559665739 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. Downloaded by Success Groups [Type text] Rehab A. Gawad: 0559665739 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 Downloaded by Success Groups [Type text] Rehab A. Gawad: 0559665739 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. Downloaded by Success Groups 1 Rehab A. Gawad: 0559665739 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 Downloaded by Success Groups 2 Rehab A. Gawad: 0559665739 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: Downloaded by Success Groups 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. 1 Rehab A. Gawad: 0559665739 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. 2 Rehab A. Gawad: 0559665739 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? 3 Rehab A. Gawad: 0559665739 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 4 Rehab A. Gawad: 0559665739 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 Downloaded by Success Groups 5 Rehab A. Gawad: 0559665739 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. 6 Rehab A. Gawad: 0559665739 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 7 Rehab A. Gawad: 0559665739 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 8 Rehab A. Gawad: 0559665739 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 1 Rehab A. Gawad: 0559665739 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 2 Rehab A. Gawad: 0559665739 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 3 Rehab A. Gawad: 0559665739 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? 4 Rehab A. Gawad: 0559665739 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 5 Rehab A. Gawad: 0559665739 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 6 Rehab A. Gawad: 0559665739 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 1 Rehab A. Gawad: 0559665739 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 2 Rehab A. Gawad: 0559665739 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. 3 Rehab A. Gawad: 0559665739 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 4 Rehab A. Gawad: 0559665739 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 1 Rehab A. Gawad: 0559665739 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 2 Rehab A. Gawad: 0559665739 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. 3 Rehab A. Gawad: 0559665739 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. 4 Rehab A. Gawad: 0559665739 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. 5 Rehab A. Gawad: 0559665739 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 6 Rehab A. Gawad: 0559665739 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 7 Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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 Rehab A. Gawad: 0559665739 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 Rehab A. Gawad: 0559665739 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 1 Rehab A. Gawad: 0559665739 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. 2 Rehab A. Gawad: 0559665739 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. 3 Rehab A. Gawad: 0559665739 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. 4 Rehab A. Gawad: 0559665739 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 5 Rehab A. Gawad: 0559665739 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 6 Rehab A. Gawad: 0559665739 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? 7 Rehab A. Gawad: 0559665739 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 8 Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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 Rehab A. Gawad: 0559665739 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. Rehab A. Gawad: 0559665739 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 Rehab A. Gawad: 0559665739 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. Rehab Abdelgawad: 0559665739 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 1 Rehab Abdelgawad: 0559665739 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 2 Rehab Abdelgawad: 0559665739 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. 3 Rehab Abdelgawad: 0559665739 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. 4 Rehab A. Gawad: 0559665739 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 1 Rehab A. Gawad: 0559665739 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 Rehab A. Gawad: 0559665739 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 3 Rehab A. Gawad: 0559665739 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 4 Rehab A. Gawad: 0559665739 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: Rehab Abdelgawad: 0559665739 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 1 Rehab Abdelgawad: 0559665739 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 2 Rehab Abdelgawad: 0559665739 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 3 Rehab Abdelgawad: 0559665739 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. 4 Rehab Abdelgawad: 0559665739 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. 1 Rehab Abdelgawad: 0559665739 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 2 Rehab Abdelgawad: 0559665739 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 3 Rehab Abdelgawad: 0559665739 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. 4 Rehab Abdelgawad: 0559665739 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. 5 Rehab Abdelgawad: 0559665739 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 6 Rehab Abdelgawad: 0559665739 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 7 Rehab Abdelgawad: 0559665739 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 8 Rehab Abdelgawad: 0559665739 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. 1 Rehab Abdelgawad: 0559665739 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. 2 Rehab Abdelgawad: 0559665739 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 3 Rehab Abdelgawad: 0559665739 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. 4 Rehab Abdelgawad: 0559665739 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 5 Rehab Abdelgawad: 0559665739 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 1 Rehab Abdelgawad: 0559665739 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. 2 Rehab Abdelgawad: 0559665739 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. 3 Rehab Abdelgawad: 0559665739 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 1 Rehab Abdelgawad: 0559665739 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. 2 Rehab Abdelgawad: 0559665739 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. 3 Rehab Abdelgawad: 0559665739 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. 4 Rehab Abdelgawad: 0559665739 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 5 Rehab Abdelgawad: 0559665739 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. 6 Rehab Abdelgawad: 0559665739 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. 7 Rehab Abdelgawad: 0559665739 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) 8 Rehab Abdelgawad: 0559665739 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 1 Rehab Abdelgawad: 0559665739 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. 2 Rehab Abdelgawad: 0559665739 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 3 Rehab Abdelgawad: 0559665739 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 4 Rehab Abdelgawad: 0559665739 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. 5 Rehab Abdelgawad: 0559665739 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. 1 Rehab Abdelgawad: 0559665739 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 2 Rehab Abdelgawad: 0559665739 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. 3 Rehab abdlegawad: 0559665739 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 1 Rehab abdlegawad: 0559665739 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. 2 Rehab abdlegawad: 0559665739 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. 3 Rehab abdlegawad: 0559665739 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. 4 Rehab abdlegawad: 0559665739 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. 5 Rehab abdlegawad: 0559665739 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. 6 Rehab abdlegawad: 0559665739 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. 7 Rehab abdelgawad: 0559665739 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. 1 Rehab abdelgawad: 0559665739 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 2 Rehab abdelgawad: 0559665739 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 3 Rehab abdelgawad: 0559665739 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 4 Rehab abdelgawad: 0559665739 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 5 Rehab abdelgawad: 0559665739 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. 6 Rehab abdelgawad: 0559665739 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. 7 Rehab abdelgawad: 0559665739 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 8 Rehab Abdelgawad: 0559665739 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 1 Rehab Abdelgawad: 0559665739 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. 2 Rehab Abdelgawad: 0559665739 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. 3 Rehab Abdelgawad: 0559665739 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 Rehab Abdelgawad: 0559665739 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. 5 Rehab Abdelgawad: 0559665739 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 Rehab Abdelgawad: 0559665739 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 2 Rehab Abdelgawad: 0559665739 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 3 Rehab Abdelgawad: 0559665739 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. 4 Rehab Abdelgawad: 0559665739 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. 1 Rehab Abdelgawad: 0559665739 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. 2 Rehab Abdelgawad: 0559665739 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 3 Prepared by: Rehab Abdelgawad 0559665739 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). 1 Prepared by: Rehab Abdelgawad 0559665739 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. 2 Prepared by: Rehab Abdelgawad 0559665739 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) 3 Prepared by: Rehab Abdelgawad 0559665739 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. 4 Prepared by: Rehab Abdelgawad 0559665739 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. 1 Prepared by: Rehab Abdelgawad 0559665739 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 2 Prepared by: Rehab Abdelgawad 0559665739 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 3 Prepared by: Rehab Abdelgawad 0559665739 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 Prepared by: Rehab Abdelgawad 0559665739 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 5 Prepared by: Rehab Abdelgawad 0559665739 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 6 imported goods will be cheaper and exported ones will be expensive Prepared by: Rehab Abdelgawad 0559665739 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 7 Market share may be lost as other companies may still grow Rehab Abdelgawad: 0559665739 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 1 consumers will buy less if they have to pay higher prices Rehab Abdelgawad: 0559665739 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 2 Rehab Abdelgawad: 0559665739 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 3 Rehab Abdelgawad: 0559665739 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. 4 Rehab Abdelgawad: 0559665739 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 5 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. Rehab Abdelgawad: 0559665739 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 6 short-term profits may fall in some countries if children are not employed the incomes of their families will fall to very low levels Rehab Abdelgawad: 0559665739 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 1 Rehab Abdelgawad: 0559665739 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 2 Rehab Abdelgawad: 0559665739 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 3 Rehab Abdelgawad: 0559665739 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 $: 4 Rehab Abdelgawad: 0559665739 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 5