LESSON 1
THE BUSINESS ENVIRONMENT
Overview
Welcome to the first lesson which will introduce you to the business environment;
what it entails and the factors that influence business operations. As an aspiring
business manager or a student, you will find that the module exposes you to a whole
new world of opportunities and avenues to make it in business. By understanding
how a business operates; and knowing what is required of you as a businessperson,
you will understand how the business organisations you know operate to produce
various products and services which satisfy various consumer needs. With the
knowledge gained you will be able to apply appropriate knowledge and skills to
implement strategies aimed at mitigating external and internal influences on the
business for sustainability and continuity.
Whether you regard yourself as an aspiring business manager or a student, you may
identify many challenges with setting up and managing a business. These changes
may be external or internal.
Umlayezo wokwamukela
Mfundi Othandekayo
Wamukelekile ku-BSM2601. Igama lami UMnumzane Stephen Maelane futhi
ngingumfundisi wakho wale mojuli. Uyelulekwa ukuthi uvakashele le sayithi nsuku
zonke, njengoba umsebenzi omningi uzokwenziwa lapha. Lemojuli ngeyokuhlola
okuqhubekayo edinga ukuthi uqedele imisebenzi ezokwenziwa. Lokhu kusho ukuthi
amamaki omsebenzi wakho ngamunye azofakwa ndawonye bese ehlukaniswa
ngenani lezabelo ukuze kubonakale amamaki akho okugcina.
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Kuzomele usebenze kanzima kule mojuli. Kumele ubuye uqinisekise ukuthi ubheka
izinsuku imisebenzi ezotholakala ngayo, kanye nezinsuku ezinqunyiwe zokulethwa
kwama asayinimenti. Wonke ama-asayinimenti afakwa anezezele kumamaki akho
okugcina.
Ngikufisela impumelelo ezifundweni zakho.
Othandekayo
Umnu. Maelane
Molaetša wa kamogelo
Baithuti ba ba rategago
Le amogetšwe mo motšuleng wa lena wa BSM2601. Leina la ka ke nna Morena
Stephen Maelane gomme ke nna mofahloši wa lena wa motšule wo. Le eletšwa
go etela saete ye letšatši le lengwe le le lengwe, ka ge bontši bja mošomo o tlo dirwa
mo go yona. Le ka se sa ngwala tlhahlo ya motšule wo. Motšule wo bjale ke wa
kelo ye e tšwelagopele (formative assessment) yeo e nyakago gore le ngwale
diasaenemente. Se se ra gore meputso ya asaenemente ya gago ye nngwe le ye
nngwe e tla hlakantšhwa gomme morago ya arolwa ka palo ya diasaenemente go
laetša moputso wa gago wa mafelelo.
Le tla swanela gore le šome ka thata mo motšuleng wo. Gape kgonthišišang gore
le tšheka gore diasaenemente di hwetšagala mo matšatšikgweding afe, gape le
matšatšikgwedi a go tswalela ga go romelwa ga diasaenemente. Diasaenemente
ka moka di tšea karolo mo moputsong wa gago wa mafelelo.
Ke le lakaletša katlego mo dithutong tša gago.
Re a leboga
Morena Maelane
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1.1 Learning outcomes
At the end of this lesson, you will be able to:
• Scan and analyse the environment in a comprehensive manner and identify
relevant threats and opportunities.
• Develop appropriate business strategies for continuous adaptation of the
business to achieve sustainability in a sound and ethical manner.
1.2 Key concepts
As you go through this lesson, you will come across the following concepts and
learn about them:
business environment, external environment, internal environment,
SWOT analysis, PESTEL, business strategy
1.3 What is business environment.
The term "business environment" refers to the internal and external
environmental factors that influence organisational activities and decisionmaking. Any company, whether it be a profit or non-profit company, has its
environment. The corporate environment is constantly complex and evolving.
Today's business changes are so frequent, and each transition carries with it so
many challenges that managers and leaders at organisations must be
constantly concerned about environmental changes. An organisation's
environment consists of its surroundings – everything that influences its
operations, positive or negative effects. This encompasses all abstract things
such as an organisation’s image and remote visible issues, like the economic
and political conditions of the country.
The abstract and observable environmental forces necessitate careful
examination and analysis. The systematic and adequate examination and
analysis produces the information necessary for making judgments about what
strategy to pursue. Managers cannot make appropriate and sound strategy
simply based on their guesses and instincts. They must use relevant
information that directly flows from the analysis of their organisation’s
environment.
Types of business environments
The word 'environment' in this context means the surroundings or conditions in
which a specific activity is carried on with. And we know that organisations are
social entities with a hierarchical structure where all necessary items are put
together and interact to reach the collective goals. Organisations, specifically
business organisations and their operations, are always being affected by the
environment. In an organisation, every action of the management body is
influenced by the environment. A business environment surrounding an
organisation includes the following:
1. internal environment / micro-environment.
2. external environment / macro-environment.
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An organisation’s operations are affected by both types of environments.
Therefore, managers need to make an in-depth analysis of the factors of
the environments so that they can develop an understanding of the internal
and external conditions of the organisation. Based on their understanding,
they will be better able to establish the required objectives for their
organisation and formulate appropriate strategies to achieve those
objectives.
In this section, we will look at the elements of the business environment,
namely the internal environment and external environment.
1.3.1 Internal environment
Factors, conditions or surroundings within the boundary of the organisation
are the elements of the internal environment of the organisation. Thus, the
internal environment generally consists of those factors that exist inside the
organisation such as physical resources, financial resources, human
resources, information resources, technological resources, organisation’s
goodwill, corporate culture and the like.
Some of these are tangible such as the physical facilities, the plant capacity
technology, proprietary technology or know-how; and some are intangible
such as information- processing and communication capabilities, reward and
task structure, performance expectations, power structure management
capability and dynamics of the organisation’s culture.
Based on those resources, the organisation can create and deliver value to
the customer. This value is fundamental to defining the organisation’s purpose
and the premise on which it seeks to be profitable. Value can be added by
research and development, by customer service, by prompt delivery or by
cutting any intermediary which reduces the customers’ costs. In this way
organisations can build capabilities, although over a long time. They
consistently invest in some areas so that they can build strong competitive
businesses based on the uniqueness they have created.
The manager’s response to the external environment would depend on the
availability and the configuration of resource deployment in the organisation.
The deployment of resources is a key managerial responsibility. Top
management is vested with the responsibility of allocating resources among
the ongoing operations and with future operations which are of a strategic
nature; that is, they might yield returns in future, which require resources to be
nurtured and to have some associated risks. The top management must
balance the conflicting demands of both, as resources are always finite.
For example, Vodacom is an aggressive innovator and marketer who has
been ruthless in its approach to changing proactively and reactively to sustain
its competitive positions in the respective industries. This implies that over the
years Vodacom has invested in developing those capabilities, systems and
processes that enable it to respond.
Factors of internal environment include the following:
1. owners and shareholders
2. board of directors
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3. employees
4. organisational culture
5. resources of the organisation
6. organisation’s image/goodwill
The internal environment mainly consists of the organisation’s owners, the board of
directors, employees and culture. Follow the link below to study the factors of the
internal environment.
Kennedy, Reed. 2020. Strategic Management. Blacksburg, VA: Virginia Tech
Publishing. https://doi.org/10.21061/strategicmanagement CC BY NC-SA 3.0
Activity 1
1
Hour
1. Business environment refers to the internal and external environmental
factors that influence organisational activities and decision-making.
a) True
b) False
2. Only for-profit companies must scan and analyse its environment.
a) True
b) False
3. Briefly explain how the following factors of internal environment can positively
and negatively affect a business.
a) Board of directors
……………………………………………………………………………………
……………………………………………………………………………………
……………………………………………………………………………………
……………………………………………………………………………………
………………………………………………………………………
b) Employees
……………………………………………………………………………………
……………………………………………………………………………………
……………………………………………………………………………………
……………………………………………………………………………………
………………………………………………………………………
c) Organisational culture
……………………………………………………………………………………
……………………………………………………………………………………
……………………………………………………………………………………
……………………………………………………………………………………
……………………………………………………………………………………
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……………………………………………………………………………………
Feedback
In your answers, you should explain how the factors of internal environment can
positively and negatively affect the business.
1.3.2 External environment
Businesses operate within an external/macro-environment that affects the
likelihood of their overall success or failure. This include factors that are
beyond the control of businesses and can obstruct the growth of a business,
or perhaps harness or propel it forward. Strategic management requires that
these external environmental factors be examined and analysed so that
opportunities may be leveraged, and threats be mitigated as strategies are
developed to improve the success of the organisation.
This section will introduce factors that help businesses to assess different
perspectives of their external environment, the PESTEL framework. The
PESTEL framework, which is an abbreviation for political, economic, sociocultural, environmental/ecological, and legal evaluates the external/macroenvironment by evaluating six external forces. Once this external analysis is
complete, a business can determine the true strategic issue(s) it faces; and
can develop strategies to work on strategic issues that move it forward
towards accomplishing its vision.
a) PESTEL Analysis
An organisation’s environment includes factors it can readily affect as well
as factors that are largely beyond its control. The latter set of factors are
said to exist in the external environment. Management must track trends
and events as they evolve and try to anticipate the implications of these
trends and events because the external environment often has a
substantial influence on an organisation’s level of success.
Before applying the PESTEL framework, it is important to identify which
industry is being evaluated. For example, when using this tool for Albany
Bread, ask the question: In which industry is Albany Bread? If the food
service industry is selected, then it includes all types of restaurants, from
McDonalds to expensive five-star restaurants. The food service industry
also includes hospital and university cafeterias and catering services. To
provide a more accurate assessment for Albany Bread, a smaller segment
of the food service industry should be chosen. How about the restaurant in
the industry? This is still too broad. Picking a segment of the restaurant
industry, the fast-casual restaurant industry is the most helpful to analyse,
using PESTEL. To help determine what industry to select, ask “Who does
the company directly compete against, head-to-head?” In this instance,
Albany Bread competes head-to-head with other fast casual restaurants.
McDonalds, for example, competes head-to-head with other fast-food
restaurants in the fast-food restaurant industry.
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Examining the external environment involves gaining an understanding of
the key factors and trends in broader society. A PESTEL analysis is a
popular framework for organising these factors and trends and isolating
how they influence industries and the businesses in them. Below we
describe each of the six dimensions associated with PESTEL analysis:
political, economic, socio-cultural, technological, environmental and legal.
P
E
S
T
E
The political factors of the general environment refer to the business–
government relationship and the overall political situation of a country.
A good business–government relationship is essential for the economy
and most importantly for the business. The government of a country
intervenes in the national economy by setting policies/rules for
business. In South Africa, we see many such policies – BBBEE, import
policy, export policy, taxation policy, investment policy, drug policy,
competition policy and consumer protection policy.
The economic factors of an organisation are the overall status of the
economic system in which the organisation operates. The important
economic factors for a business are inflation, interest rates, economic
growth, exchange rates, disposable income and unemployment rates.
These factors of the economy always affect the demand for products.
During inflation, the company pays more for its resources; and they
raise commodity prices to cover the higher costs of it.
Customs, mores, values and demographic characteristics of the society
in which the organisation operates are what make up the sociocultural factors of the general environment. The socio-cultural
dimension must be well-studied by the management. It indicates the
product, services and standards of conduct that society is likely to
value and appreciate. The standard of business conduct varies from
one culture to another and so does the taste and necessity of products
and services. Socio-cultural forces include social mobility, attitudes
towards technology and people’s values, opinions, beliefs, population
growth rate, age distribution, career attitudes, safety emphasis, health
consciousness, lifestyle attitudes, cultural barriers and so forth.
Technological factors denote the methods available for converting
resources into products or services. Management must be careful
about the technological factor. Investment decisions must be accurate
when it comes to new technologies, and they must be adaptable to
these technologies. Technological factors include information
technology, the internet, biotechnology, global transfer of technology
and so forth. Nobody can deny the fact that the pace of change in
these technological dimensions is extremely fast. Technological
changes substantially affect the operations of a business in many
ways. The advancement of industrialisation in any country depends
mostly on the technological environment. Technology has major
impacts on product development, manufacturing efficiencies and
potential competition.
The environmental segment involves the physical and ecological
conditions in which organisations operate – weather, climate,
environmental policies, climate change, pressures from NGOs.
Management needs to analyse the trends in the natural environment of
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the country where it is operating its business. The most pertinent
issues in the natural environment that management should consider
include the availability of raw materials and other inputs, changes in the
cost of energy, levels of environmental pollution and the changing role
of government ‘in environmental protection. Changes in the
physical/natural environment, such as global warming, will greatly
affect our daily lives and the functioning of our organisations with a
variety of consequences.
The legal environment consists of laws and regulatory frameworks in a
L
country. Many laws regulate the business operations of enterprises
such as the Labour Relations Act, the Consumer Act and the Company
law, to name but a few. Business laws primarily protect companies
from unfair competition and protect consumers from unfair business
practices. Business laws also protect society at large. The laws
governing a merger, acquisitions, industry regulation, employment
conditions, unionisation, workmen’s compensation and the like affect a
firm’s strategy. Even globalisation has caused significant repercussions
in the legal environment.
tributes: Kennedy, Reed. 2020. Strategic Management. Blacksburg, VA: Virginia
Tech Publishing. https://doi.org/10.21061/strategicmanagement CC BY NC-SA 3.0
Activity 2
1 Hour
Come up with a business idea. It could be based on an existing business or a
completely new business idea; map out a PESTEL analysis for it; and briefly outline
what factors you think would affect the business. Use the table given below and
complete in detail what each will mean for the business and why you think it is
important to consider such factors.
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Name of business: ___________________________________________________
Market Focus: ______________________________________________________
P
Identify relevant government policies (2 only) that will affect your business
type and operation restrictions.
E
Explain how you will deal with fluctuating exchange rates and the unstable
Rand.
S
What are the safety and health regulations/laws that need to be considered
and why?
T
Substantiate how and why you think technology, innovation and automation
would influence the way in which the business operates.
E
In what way will the business be affected by the changing weather patterns,
environmental policies, climate change, pressures from NGOs (chose one or
two aspects and briefly discuss them. Write only two sentences for each
aspect.
L
Choose a piece of legislation from the list below and explain which ones
could give your business a challenge to implement/adhere to.
List: discrimination laws, antitrust laws, employment laws, consumer
protection laws, copyright and patent laws, health and safety laws.
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Feedback
In your answer, you should provide a business case, either a new or existing one
and analyse the business, using the PESTEL analysis.
1.4 SWOT Analysis
One of the approaches and strategies to deal with business challenges is to do
a SWOT analysis. A SWOT analysis is a useful method, analysing the
organisation's overall situation and identifying solutions and challenges facing
an organisation, and is often done to:
•
•
•
•
Assist the business to know and understand its purpose clearly.
Identify problems it faces and offer possible solutions to deal with business
problems.
State the organisational goals over against capabilities (including
knowledge, skills, and values of the management and staff)
Identify and offer solutions for competition in the market.
A swot analysis is explained in a quadrant below:
Strengths
These are the characteristics of a
business that make it successful and
possible to compete with others.
Examples: highly skilled labour, good
customer
relations,
healthy
communication strategies and the ability
to attract customers.
Weaknesses
These are areas of a business that render
it vulnerable to competition and outside
influences (negative). Examples: slow
consumer buying power, lack of markets
for products, high taxes, high petrol
prices, and so forth.
Opportunities
These are aspects of a business that
make it flourish and become successful.
Examples: cheaper prices, low interest
rates, low taxes and increased
consumer needs.
Threats
These are factors that threaten the
existence and sustainability of a
business. Examples: high interest rate,
too much competition from other
businesses and staff dissatisfaction.
Table 1.2: SWOT analysis
Now that we have dealt with SWOT analysis, let us see whether Damien and Tshepo
have applied some of its aspects to their respective businesses in Activity 3.
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Activity 3
2 Hours
Read the following story of two friends and apply the SWOT analysis to determine its
feasibility and potential success.
Damien and Tshepo Trendsetters
Damien and Tshepo have been friends since high school years. The two met at high
school and completed Matric at Orlando High School in Soweto. They are both
passionate about business; and, instead of going straight to university, they decided
to take a leap year and start a clothing business to cater for the fashion needs of
young people. They are aware of similar businesses in Soweto; however, they are
prepared to take a risk. Damien and Tshepo have differences of opinion as to what
format their business should adopt and what type of clothes to sell. Damien feels
strongly that they should rent a space at the Maponya Shopping Mall, whereas
Tshepo feels strongly about selling online and selling at events that are attended by
young people in Soweto.
1
If you were to advise the two friends, what advice would you give them? Use a
table and map out a SWOT analysis for discussion with them.
Feedback
In your answer, you should draw a SWOT analysis quadrant and analyse Damien
and Tshepo`s business idea.
NB: From the above exercise you will realise that a SWOT analysis may be used to
assess a business idea before implementation.
Now that we have discussed different ways in which the business can analyse its
environment, let us now look at different strategies that a business can adopt. These
strategies are necessary to help the business to adapt and to be sustainable.
1.5 Business Strategy
Business strategies are developed to set the direction in which human and
material resources of the business will be applied for a greater chance of
achieving specific goals. The strategy is a comprehensive concept; and, for this
reason, it is often used in different ways. But this difference creates a major
problem when some writers focus on the endpoints (mission, goals, objectives)
and the means of achieving them (policies and plans), but the others
emphasise the means only rather than the ends in the strategic process.
Strategy, as has already been mentioned, refers to determining the purpose or
mission and the basic long-term objectives of an enterprise, adopting courses
of action, and allocating resources necessary to achieve these aims.
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Therefore, the concepts discussed earlier (PESTEL, SWOT Analysis) are a part
of strategy formulation. Policies are general statements that guide management
to make decisions. They provide a broad boundary within which decisions
should fall. Therefore, the essence of the policy is discretion strategy; however,
they are concerned with the direction in which human and material resources
will be applied with a view to increase the chance of achieving the selected
objectives. The key function of strategies and policies is to unify and give
direction to plans. But if one of them stands alone, it can hardly ensure that an
organisation will reach its goal.
Strategic planning seems to be a simple exercise; it analyses the current and
expected future situation; decides the direction of the business and develops
the means for achieving the goal. In reality, strategic planning is a very
complicated process that demands a systematic approach to identify and
analyse factors external to the organisation and matching them with the
business’s capabilities.
1.5.1 Features of strategic plans
The following are some of the most important characteristics of
strategic plans:
1. They are long-term by nature and place an organisation within its
external environment.
2. They are comprehensive and cover a wide range of organisational
activities.
3. They integrate, guide and control organisational activities over a
short and long term.
4. They set the boundaries for managerial decision-making. Since
strategic plans are the primary documents of organising all
managerial decisions are required to be consistent with its goals.
Strategic plans, thus, set forth the long-term objectives, intermediate
objectives and main purpose or the basic role of an organisation.
1.5.2 Types of business strategies
Strategy-making is involved with the identification of the ways in which
an organisation can undertake to achieve the performance targets;
weaken the competitors; achieve competitive advantage and ensure the
long-term survival of the organisation. There are four business strategies
at each level of the organisation and are known by the name of the level.
The four levels of strategy are as follows:
1. corporate-level strategy
2. business-level strategy
3. functional-level strategy
4. operational level strategy.
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1) Corporate-level strategy
Corporate-level strategy defines the markets and industries in which
a company will operate. It is formulated at top level by the top
management of a company. Such a strategy describes the
company’s overall direction in terms of its various business and
product lines. Corporate strategy defines the long-term objectives
and generally affects all the business units under its umbrella. A
corporate strategy of P&G, for example, may be acquiring the major
tissue paper companies in Nigeria to become the unquestionable
market leader.
The corporate-level strategy is the set of business strategies from
which an organisation chooses as it manages its operations
simultaneously across several industries and several markets.
2) Business-level strategy
Business strategy defines the basis on which a business will
compete. It is a business-unit level strategy formulated by the senior
managers of the business unit. This strategy emphasises the
strengthening of a company’s competitive position of products or
services. Business strategies comprise competitive and cooperative
strategies. The business strategy encompasses all the actions and
approaches for competing against the competitors and the ways in
which management attends to various strategic issues. The business
strategy is usually formulated in line with the corporate strategy. The
main focus of the business strategy is on product development,
innovation, integration (vertical, horizontal), market development,
diversification and the like.
The competitive strategy aims at gaining competitive advantage in
the marketplace over competitors. And competitive advantage
comes from strategies that lead to some uniqueness in the
marketplace. Thus, winning competitive strategies are grounded in
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sustainable competitive advantage. An example of a competitive
strategy includes the differentiation strategy, low-cost strategy and
focus or market-niche strategy.
Business strategy is concerned with the actions that managers
undertake to improve the market position of the company through
satisfying the customers. Improving market position implies
undertaking actions against competitors in the industry. Thus, the
concept of competitive strategy (as opposed to cooperative strategy)
is competitor-oriented. The objective of competitive strategy is to win
the customers’ hearts by satisfying their needs, and finally
outcompeting the competitors (or rival companies) and attaining
competitive advantage. The success of a competitive strategy
depends on the company's capabilities, strengths and weaknesses
in the capabilities, strengths and weaknesses of its competitors.
When doing business, companies confront numerous strategic
issues. Management must deal with all these issues effectively to
survive in the marketplace. Business strategy deals with these
issues, in addition to how to compete. A business-level strategy is
the set of strategic alternatives from which an organisation chooses
as it conducts business in a specific industry or market. Such
alternatives help the organisation to focus its efforts on each industry
or market in a targeted fashion.
3) Functional strategy
A functional strategy is, in actual fact, the departmental/division
strategy designed for each organisational function. Thus, there may
be production strategy, marketing strategy, advertisement strategy,
sales strategy, human resource strategy, inventory strategy, financial
strategy, training strategy and so forth.
A functional strategy refers to a strategy that emphasises a specific
functional area of an organisation. It is formulated to achieve some
objectives of a business unit by maximising resource productivity.
Sometimes functional strategy is called departmental strategy since
each business function is usually vested with a department. For
example, the production department of a manufacturing company
develops a production strategy as the departmental strategy; or the
training department formulates a ‘training strategy’ to provide training
to the employees.
A functional strategy is concerned with developing a distinctive
competence to provide a business unit with a competitive advantage.
Each business unit or company has its own set of departments, and
every department has a functional strategy.
Functional strategies are adopted to support a competitive strategy.
For example, a company following a low-cost competitive strategy
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needs a production strategy that emphasises reducing the cost of
operations, and a human resource strategy that emphasises
retaining the lowest possible number of employees who are highly
qualified to work for the organisation. Other functional strategies
such as a marketing strategy, advertising strategy and a financial
strategy should also be formulated appropriately to support the
business-level competitive strategy.
4) Operating strategy
An operating strategy is formulated at the operating units of an
organisation. A company may, for instance, develop an operating
strategy for its factory, sales territory or small sections within a
department. Usually, the operating managers/field-level managers
develop an operating strategy to achieve immediate objectives. At
large organisations the operating managers are usually assisted by
the mid-level managers while developing the operating strategy. At
some companies, managers develop an operating strategy for each
set of annual objectives in the departments or divisions.
Attributes: Kennedy, Reed. 2020. Strategic Management. Blacksburg, VA: Virginia
Tech Publishing. https://doi.org/10.21061/strategicmanagement CC BY NC-SA 3.0
Activity 4
2 Hours
Sekunjalo Bakery (PTY) LTD is a small business operating in the Tembisa township,
Gauteng. In 2013 the business was founded by Mr Eric Khumalo and his wife,
Martha. Mr Khumalo approaches you about developing a business strategy for
Sekunjalo Bakery (PTY) LTD.
Please explain how a business strategy can be developed for Sekunjalo Bakery
(PTY) LTD. Use the four levels of strategy to provide your answer. Follow the model
below to provide your answer:
• Explain the business level strategy.
• The level of the business where the strategy belongs.
• Who are the developers and implementers of the strategy?
• How can it be implemented at Sekunjalo Bakery (PTY) LTD?
Feedback
In your answer, explain business-level strategies; show the level of the business
where these strategies belong; indicate positions in the business responsible for
developing and implementing the strategies and explain how the strategies can be
implemented at Sekunjalo Bakery (PTY) LTD.
CONCLUSION
In this lesson we discussed the nature and operation of a business venture and the
factors that can make or break a business. In this instance we discussed the
business environment, which includes the internal and external business
environment; the SWOT analysis as a tool used to analyse the business
environment and PESTEL, which is used to measure and scan the business
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environment. We also looked at and discussed business strategies, a viable tool to
plan for business goals and problem-solving. Business strategies can be developed
at corporate, business, functional and operating level.
As an aspiring manager or student, you need to demonstrate how to identify and
analyse the internal and external factors that influence the business. The SWOT
analysis is one of the widely used approaches to conduct the scanning of the
business environment. The other approach is the PESTEL analysis which involves a
comprehensive analysis of the business environment in relation to political,
environmental, social, technological, environmental and legal factors. However,
conducting a SWOT analysis and PESTEL is not a one-off process but a continuous
process in response to the dynamic nature of the business environments.
SELF-ASSESSMENT
2 Hours
If you can respond to this self-assessment, you have achieved the outcomes of this
lesson.
•
•
Explain how to scan and analyse the environment in a comprehensive manner
and identify relevant threats and opportunities.
Develop appropriate business strategies for continuous adaptation of the
organisation to achieve sustainability in a sound and ethical manner.
Attributes
Kennedy, Reed. 2020. Strategic Management. Blacksburg, VA: Virginia Tech
Publishing. https://doi.org/10.21061/strategicmanagement CC BY NC-SA 3.0
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LESSON 2
PROFITABILITY
Overview
In lesson 1, we discussed how business environmental factors influence the
sustainability of a business. We also looked at how to apply the VRIO, SWOT and
PESTEL analysis to scan the business environment, and the types of business level
strategies.
In this lesson, we are going to learn how the profitability of a business is measured.
We begin by discussing what profitability entails, and then discuss the financial
concepts affecting profitability. In this lesson, incomes and expenses are discussed
in great depth and in relation to profitability. To better understand how profitability is
measured, this lesson will explore financial statements and how break-even point is
calculated. We will also learn how to use profitability and financial ratios to measure
profitability and business performance.
To help you grasp the learning outcomes of this lesson, this lesson is structured, as
depicted in figure 2.1 below:
Figure 2.1: Structure of lesson 2
17 BSM2601
For a business to be sustainable, it must make a profit; and if it does not, then there
are reasons for concern for its failure. As a prospective business manager, this
lesson will teach you about profitability; that is, the ability to make profit. However, to
gain a clear understanding on how to apply the content of this lesson, you must go
through this lesson step by step and work through all the activities. With the
knowledge gained, you will be able to apply appropriate knowledge and skills to
measure the profitability of a business.
2.1 Learning outcomes
At the end of this lesson, you will be able to:
•
•
•
•
•
Explain what profitability entails.
Apply financial concepts affecting profitability.
Interpret the financial statements.
Calculate a break-even point.
Evaluate profitability and business performance, using profitability and
financial ratios.
2.2 Key concepts
As you go through this lesson, you will come across and learn about the
following concepts:
profitability, income, expenditure, statement of comprehensive income,
statement of financial position, profitability ratios, financial ratios
2.3 What is profitability?
Profitability refers to the ability of a business to earn a profit. This is the primary
goal of all business ventures, without which a business will not survive in the
long run. A profit can be explained as what is left of the revenue generated by
a business after paying all expenses directly related to the generation of the
revenue. As we have stated in the overview, a business must make a profit;
and if it does not, then there are causes for concern for its sustainability.
Therefore, managers must measure the profitability of a business to ascertain
its sustainability.
To ascertain the sustainability of a business, managers must measure the
current and past profitability and project the future profitability of the business.
When measuring profitability, a manager will rely on profitability ratios to
determine different levels of profit generated or loss incurred by the business.
The profitability ratios are calculated, using income received and expenses
incurred by the business for the given year. As such, for a business to make a
profit, there should be a clear relationship as to what its income versus
expenses looks like. These two concepts are discussed in the next section.
2.4 Financial concepts affecting profitability
Profitability is measured with income and expenses. A business makes profit
when its income exceeds the expenses incurred by the business. Accordingly,
when a business' income falls short to the expenses incurred, the business
makes a loss.
18 BSM2601
2.4.1 Income
Income is money generated from the activities of the business. For
example, a bread- making company generates income by baking and
packaging bread products and selling it to retailers or households. This
is called revenue in a for-profit business. Other forms of income that may
flow to the business operations include rent income and interest income
in the event of a for-profit business; or grants, donations, fundraising
amounts and other funding sources in a non-profit organisation. Other
monies flowing into the business from borrowing activities do not form an
income to the business. This is because such transactions between the
business and its lenders generate money for operating the business or
buying assets and not as revenue.
Now let us illustrate with the following example:
Example A: Illustration of
income exceeding
expenses
Total
Income
1000.00
Total
Expenses
(800.00)
Net Profit
200
Attributes:
• Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition,
Blacksburg, VA: VT Publishing. http://hdl.handle.net/10919/84848.
Licensed
with
CC
BY-NC-SA
4.0
https://creativecommons.org/licenses/by-nc-sa/4.0.
2.4.2 Expenses
Expenses are the costs associated with operating the business such as
salaries, rent, insurance, utilities and the cost of purchasing inventory.
For example, the flour used to make bread at the bread-making
company is an expense of the business because flower is used in the
production process. The repayment of a loan is not an expense, it is
merely a cash transfer between the business and the lender. However,
the interests on the loan are expenses to the business.
This can be illustrated with the following example:
Example B: Illustration of
expenses exceeding
income
Total
Income
Total
Expenses
Net Loss
8000.00
(1000.00)
-200
Because profitability is measured with income and expenses, these
financial concepts are represented in the "statement of comprehensive
19 BSM2601
income". The statement of comprehensive income is essentially a list of
income and expenses during a given period, usually a year, for the
business. The following example illustrates the statement of income and
expenses:
Revenue
Cost of sales
Gross profit/loss
Other income
*Interest income
*Dividend income
*Profit on sale of non-current assets
Expenses
*Advertising
*Bank charges
*Telephone
*Water and electricity
*Salaries
*Depreciation
Operating profit
Finance costs
*Interest on long-term
*Interest on mortgage
Profit before tax
Income tax expense
Profit for the year
56 000
(38 000)
18 000
8 000
1 500
6 000
500
(12 000)
2 000
800
900
700
6 000
1 600
14 000
(2 500)
1 000
1 500
11 500
(2 500)
9 000
Illustration of income and expenses in the statement of comprehensive
income
Attributes:
• Skripak, S.J. 2018. Fundamentals of Business, 2nd Edition,
Blacksburg, VA: VT Publishing. http://hdl.handle.net/10919/84848.
Licensed
with
CC
BY-NC-SA
4.0
https://creativecommons.org/licenses/by-nc-sa/4.0
Activity 2.1
1. Briefly describe, in your own words, what the term “profitability” means.
2. Explain, with examples, the meaning of the term “incomes”.
3. Explain, with examples, the meaning of the term “expenses”.
Feedback
You should be able to discuss how you understand profitability, income and
expenses independent of the discussions in the study material.
2.5 Understanding financial statements
We hope that, so far, at least one thing is clear: managers need to understand
financial statements. This is because financial statements offer a window into
the health of a company, which can be difficult to gauge by other means. While
accountants and finance specialists are trained to read and understand these
20 BSM2601
documents, many business professionals are not. As a result, critical
information which could help managers to understand the business's financial
position and performance is obfuscated.
To understand the financial position and performance of the business, the
manager needs to review and analyse several financial statements. like the
statement of comprehensive incomes, the statement of financial position, the
statement of change in equity, and the statement of cash flow. These financial
statements are simply financial information produced to help managers identify
signs of impending trouble before it is too late.
Businesses prepare financial statements on a 12-month basis; that is, for a
fiscal year which ends on December 31; or some other logical date, such as
June 30 or September 30. The fiscal years can vary because companies
generally pick a fiscal year end date that coincides with the end of a peak
selling period; thus, a farm business might end its fiscal year in June when the
crop harvesting has dwindled. Most businesses also produce financial
statements on a quarterly or monthly basis. The manager of a small bakery
business may want to prepare financial statements monthly to stay on top of
how the business is doing.
Managers are expected to conduct financial analysis. To be effective in this
role, they need to have a basic understanding of financial statements; how they
are drawn up, and how to analyse them. There are, of course, other reasons
why acquainted with financial statements may be important. Investors may be
interested in investing in a business and want to evaluate the financial conditions of the business; We may be employed in a job that requires an
understanding of financial statements; we may simply want to make informed
decisions that influence the financial conditions of business in which we have
an interest; or we may have an interest in learning about the profitability of the
business, and one way of doing this is to examine their financial statements.
The sub-sections that follow provide a basic understanding of financial
statements and will focus on how to analyse the statement to measure
profitability in a business. In this lesson, we will focus our attention on the
statement of comprehensive income and the statement of financial position.
Attributes:
• Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition, Blacksburg, VA:
VT Publishing. http://hdl.handle.net/10919/84848. Licensed with CC BY-NCSA 4.0 https://creativecommons.org/licenses/by-nc-sa/4.0.
2.5.1 Statement of comprehensive income
The statement of comprehensive income presents the results of the
operating activities of the business for a specific period, usually the fiscal
year. The statement summarises the income (revenue) and expenses
and reveals the net profit or loss of the business during the period
covered. While all financial instruments help to paint a picture of the
business’ financial health, a statement of comprehensive income is one
of the most important instruments the manager can review, because it
21 BSM2601
includes a detailed breakdown of income and expenses over the course
of a reporting period. Income and expenses are discussed under 2.4 and
will not be discussed in this section. Let us illustrate a sample structure
of the statement of comprehensive income below:
Revenue
Cost of sales
Gross profit/loss
Other income
*Interest income
*Dividend income
*Profit on sale of non-current assets
Expenses
*Advertising
*Bank charges
*Telephone
*Water and electricity
*Salaries
*Depreciation
Operating profit
Finance costs
*Interest on long-term
*Interest on mortgage
Profit before tax
Income tax expense
Profit for the year
9 000
56 000
(38 000)
18 000
8 000
1 500
6 000
500
(12 000)
2 000
800
900
700
6 000
1 600
14 000
(2 500)
1 000
1 500
11 500
(2 500)
Illustration of the statement of comprehensive income
• Revenue refers to the money generated by the business during a
reporting period.
• Costs of sales refers to the cost of the component parts of what it takes
to make whatever a business is selling.
• Gross profit refers to the amount left after total revenue less costs of
sales.
• Other income refers to amounts coming from other sources than normal
sales.
• Operating expenses refer to the amount of money a business spends
during a reporting period.
• Operating profit refers to the amount left after taking gross profit and
adding other income less operating expenses.
• Finance costs refer to the amount of money paid to finance borrowings.
• Profit before taxes refers to profit made before paying tax.
• Profit/loss for the year refers to the amount made after paying tax.
The net profits or losses reported in the business's statement of
comprehensive income are reflected in its statement of financial position
as an increase or decrease in equity. Therefore, the business's
statement of financial position provides the details that explain changes
in the business's equity.
•
Attributes:
Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition, Blacksburg,
VA: VT Publishing. http://hdl.handle.net/10919/84848. Licensed with CC
BY-NC-SA 4.0 https://creativecommons.org/licenses/by-nc-sa/4.0.
22 BSM2601
Activity 2.2
1 Hour
1. Discuss, what a statement of comprehensive income is, with reference to income
and expenses.
Feedback
Discuss what a statement of comprehensive income is and explain what income and
expenses constitute.
2.5.2 Statement of financial position
A statement of financial position is an instrument drawn up to
communicate exactly how much a business is worth, or its “book value”
(listing and corresponding a summary of the business' assets, liabilities,
and shareholder’s equity). In the statement of financial position, the sum
of the assets must equal the sum of the liabilities and shareholder’s
equity.
The underlying principle for drawing up the statement of financial
position is the fundamental accounting equation: Assets = Liabilities +
Equity. The fundamental accounting equation declares that each of the
business's assets must be financed either by liabilities (funds provided
by those outside the business; or equity (funds provided by the owners
of the business.). Moreover, the fundamental accounting equation
separates a business's assets from its liabilities and equity on the
statement of financial position, as illustrated below.
23 BSM2601
Assets
Non-current assets
R 000
150 000
*Property, plant, and equipment
100 000
*Fixed deposits
Current Assets
50 000
50 000
*Inventory
10 000
*Trade and other receivable
15 000
*Cash and cash equivalent
20 000
*Prepayments
5 000
200 000
Total Assets
Equity and liabilities
Total equity
75 000
*Capital contribution
66 000
*Retained earnings
9 000
Non-current liabilities
80 000
*Mortgage loan
50 000
*Long-term loan
30 000
Current liabilities
45 000
*Trade and other payables
30 000
*Current portion of long-term loan
10 000
Total equity and liabilities
200 000
2.5.2.1 Assets
Assets represent everything of value that the business controls.
Assets have value to the business, mostly because they
represent what can be used to generate earnings. The
business's assets are typically listed in order of liquidity, or
nearness to cash. In most cases asset liquidity depends on the
ease or cost of converting them into cash.
a) Current assets.
Current assets are cash and near-cash assets that are
expected to be converted into cash during the next year.
Current assets are typically assets, the conversion of which
will not significantly disrupt the operation of the business.
This includes inventories on hand, cash balances, interestbearing deposits and accounts receivable.
b) Long-term assets.
Long-term assets yield services to the business for more
than one year. Conversion of long-term assets would
typically disrupt the operations of the business and would
24 BSM2601
occur only if the business were facing a solvency crisis or
replacing long-term assets with more productive ones. Longterm asserts can be distinguished by whether or not they
depreciate. Depreciable long-term assets include machinery
and equipment, while non-depreciable long-term assets are
mostly land.
2.5.2.2 Liabilities
Liabilities are obligations to repay debt and accrued interest
charges. They are listed according to the date they become due.
a) Current liabilities.
Current liabilities are debt and interest payments due during
the current period and pose the greatest liquidity demands
on the business' resources. Current liabilities include shortterm debt, current portion of long-term debt, accounts
payable, and accrued liabilities, such as accrued expenses,
include taxes payable, interest payable and salary and
wages payable.
b) Non-current long-term liabilities
Non-current liabilities are the portion of the business's debt
due after the current period. These are usually long-term
notes payable, mortgages or bond obligations.
2.5.2.3 Equity
Equity is the difference between assets and liabilities – the
difference between what one owns and what one owes. This
represents the estimation of what the owners of the business
would have left if they sold all their assets at book value and paid
all their liabilities valued at market value. Therefore, equity is an
important indicator of a business' financial health. Equity
consists of accumulated retained earnings and contributed
capital by the owners of the business.
Attributes:
• Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition,
Blacksburg, VA: VT Publishing. http://hdl.handle.net/10919/84848.
Licensed
with
CC
BY-NC-SA
4.0
https://creativecommons.org/licenses/by-nc-sa/4.0.
Activity 2.3
1 Hour
1. Discuss what the statement of financial position is with reference to assets,
liabilities and equity.
25 BSM2601
Feedback
Discuss what the statement of financial position is, and explain what assets, liabilities
and equity are, and how they form part of the statement of financial position.
2.6 Calculating break-even point
It is very important for a business to calculate the break-even point when
determining the profitability. Before calculating break-even point, let us first
define the break-even point. The break-even point is the point at which total
revenue equals total costs. Revenue is the total money that is received by a
business from sales. At break-even point the business has neither made profit
nor loss. It is calculated by using fixed costs: costs that do not change with the
level of production and variable costs: costs that change with the level of
production and the contribution.
Before calculating the break-even point, let us first discuss the meaning and
relevance of contribution. When setting the selling price for an item, it should
cover both fixed costs and variable costs. It should also give us some profit. Put
in another way: Selling price = Fixed costs + variable costs + profit.
The above relationship can be written as follows:
Selling price – variable costs = fixed costs + profit
The right hand-side of the above equation = contribution. This means that,
Contribution = Fixed costs + profit
Using this, we can define contribution as the part of the selling price that covers
fixed costs and give the business a profit.
Selling price – variable costs = contribution.
Let us consider the following example:
If our selling price is R25.00 and the variable costs of production is R5.00, the
contribution will be as follows:
Contribution = Selling price – variable costs
= R25 – R5
= R20
Contribution is very important, because we know that if we cannot cover fixed
costs, our business can close down. For example, if we cannot pay rent, the
landlord can lock us out. So, we must know whether our selling price will allow
us to cover fixed costs, then we remain with some profit.
Calculating break-even point helps a manager to know at what unit of sales the
business should expect to start making profit. To calculate the break-even point,
the manager must take fixed costs and divide it by contribution margin. That is
Break-even in units = fixed costs ÷ contribution margin
26 BSM2601
Let us consider the following example:
If the business's fixed costs is R6000.00 and the contribution margin is R50.00, then
the break-even point will be as follows:
Break-even in units= fixed costs ÷ contribution margin
= R6000 ÷ R50
= 120
From the calculation above, at 120 units, the business is neither making profit
or loss.
Work through the following activity to understand more about how to calculate the
break-even point.
Attributes:
• Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition, Blacksburg, VA: VT
Publishing. http://hdl.handle.net/10919/84848. Licensed with CC BY-NC-SA 4.0
https://creativecommons.org/licenses/by-nc-sa/4.0.
Activity 2.4
1 Hour
Bakwena Bakery (PTY) LTD makes bread and sells it to the community of
Ga-Rankuwa. The business's total fixed costs is R20 000, the variable costs R2 and
her selling price is R12 per loaf of bread
1 Calculate the contribution margin.
2 Calculate the break-even point.
Feedback
1. Use the contribution formula to calculate the contribution margin.
2. Use the break-even formula to calculate the break-even point.
2.7 Evaluate business performance, using profitability and financial ratios
Now that you understand financial statements, we will spend a little time talking
about how they are used to help owners, managers, investors and creditors to
assess a business' performance and financial strength. Our focus will be on how
a manager can use the financial statements to calculate profitability and financial
ratios.
2.7.1 Profitability ratios
Earlier in this lesson we learned that profitability is about the ability of the
business to earn a profit, and that profit is the primary goal of the business
without which it will not be sustainable. A manager uses the profitability ratios
to measure the ability of the business to make profit. These ratios can inform
the manager on how much profit is made relative to the amount invested
27 BSM2601
(return on investment) or the amount of good sold (return on sales). In the
earlier discussions, we also learned that profitability ratios are calculated,
using income received and expenses incurred in the business for the given
year. In this lesson, we will focus on three types of profitability ratios, as
discussed below.
a) Gross profit margin
The gross profit margin is a profitability ratio that is used to measure the
ability of the business to generate gross profit from revenue. The gross
profit margin also indicates the percentage of income that is left from
revenue to meet other operating expenses after deducting the costs of
sales. This ratio also shows how effective management is in producing
goods or services, using its labour and raw materials. The gross profit
margin is calculated by dividing the gross profit by the revenue. The
following is formula to calculate the gross profit margin.
Gross profit margin = Gross profit x 100
Revenue
b) Operating profit margin
The operating profit margin is a profitability ratio that is used to measure
how much profit the business generates from revenue after paying for
variable costs, such as wages and raw materials, but before paying
interest or tax. This ratio also shows how efficient management is in
generating profits by managing the operations of the business. The
operating profit margin is calculated by dividing the business's operating
profit by the revenue. The operating profit margin is calculated by the
following formula:
Operating profit margin = Operating profit x 100
Revenue
c) Net profit margin
The net profit margin is a profitability ratio that is used to measure how
much of the revenue collected by the business is profit. The net profit
margin shows how much of the money collected by a business as
revenue is translated into profit. We will use the following formula to
calculate the net profit margin:
Net profit margin = Net profit x 100
Revenue
Attributes:
• Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition,
Blacksburg, VA: VT Publishing. http://hdl.handle.net/10919/84848.
Licensed
with
CC
BY-NC-SA
4.0
https://creativecommons.org/licenses/by-nc-sa/4.0.
28 BSM2601
Activity 2.5
1 Hour
The manager must use the statement of comprehensive incomes to calculate
profitability ratios. The statement of comprehensive income shows items of income
generated and expenses incurred in a given financial period. Use the following link to
access the statement of comprehensive income of Telkom Limited for the 2018
financial year.
Link: http://telkom-reports.co.za/reports/ar-2018/pdf/full-integrated.pdf
Use the condensed consolidated annual statement of profit and loss and other
comprehensive income of Telkom Limited on page 51 to calculate the following
profitability ratios. Also, interpret what the answer means.
1. gross profit margin
2. operating profit margin
3. net profit margin
Feedback
1. Use the appropriate formulas to interpret what the answer means.
2.7.2 Financial ratios
The financial ratios are a tool for measuring the business' financial situation;
that is, whether or not the situation is healthy. Thus, the financial ratio helps
investors, creditors and business managers to understand how the business
is performing. Ratios are just a raw computation of financial position and
performance. The ratios can also be used to compare different companies in
different industries. Since a ratio is simply a mathematical comparison based
on proportions, large and small businesses can use ratios to compare their
financial information. In a sense, financial ratios do not take the size of a
business or industry into consideration.
Financial ratios are often divided into several categories. In this lesson, we will
focus on liquidity and solvency ratios.
2.7.2.1
Liquidity ratios
Liquidity refers to how quickly an asset can be turned into cash.
Liquidity ratios measure the ability of the business to pay off its
current liabilities as they become due as well as their long-term
liabilities as they become current. In other words, these ratios show
the cash levels of the business and the ability to turn other assets
into cash to pay off liabilities and other current obligations. The
liquidity ratios include current ratio and acid test.
a)
Current ratio
The current ratio is a liquidity ratio that measures a business's
ability to pay off its short-term liabilities with its current assets.
29 BSM2601
The current ratio is an important measure of liquidity because
short-term liabilities are due within the next year. The current
ratio is calculated by dividing current assets by current liabilities.
The following is the formula to calculate the current ratio:
Current ratio = Current assets
Current liabilities
b) Acid test ratio
The acid test ratio is a liquidity ratio that measures the ability of
the business to pay its current liabilities when they are due with
only quick assets. Quick assets are current assets that can be
converted into cash within 90 days or in the short-term. Cash,
cash equivalents, short-term investments or marketable
securities and current accounts receivable are considered quick
assets. The acid test ratio is calculated by adding cash, cash
equivalents, short-term investments and current receivables
together and divide them by current liabilities. Below is the
formula to calculate the acid test ratio:
Acid-test = Cash+cash equivalent+short-term investments+current receivables
Current liabilities
2.7.2.2
Solvency ratios
Solvency ratios measure the business's ability to sustain operations
indefinitely by comparing debt levels with equity, assets and
earnings. In other words, solvency ratios identify going concern
issues and the business’s ability to pay its bills in the long term.
Many people confuse solvency ratios with liquidity ratios. Although
they both measure the ability of a company to pay off its obligations,
solvency ratios focus more on the long-term sustainability of a
business instead of the current liability payments. In this module, we
will focus on debt ratio.
a) Debt ratio
Debt ratio is a solvency ratio that measures the business's total
liabilities as a percentage of its total assets. In a sense, the debt
ratio shows a business' ability to pay off its liabilities with its
assets. In other words, this shows how many assets the business
must sell to pay off its liabilities. The ratio helps investors and
creditors to measure the overall debt burden on the business and
the ability of the business to pay off the debt in future, uncertain
economic times. The debt ratio is calculated by dividing total
liabilities by total assets. Both these numbers can easily be
found in the statement of financial position. Below is the debt
ratio formula:
Debt ratio = Total Liabilities
Total Assets
30 BSM2601
Attributes:
• Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition, Blacksburg, VA:
VT Publishing. http://hdl.handle.net/10919/84848. Licensed with CC BY-NCSA 4.0 https://creativecommons.org/licenses/by-nc-sa/4.0.(Chapter 17)
Activity 2.6
1 Hour
The manager must use the statement of financial position to calculate financial
ratios. The statement of financial position shows items of assets, liabilities and the
owner's equity in a given financial period. Use the following link to access the
statement of financial position of Telkom Limited for the 2018 financial year.
Link: http://telkom-reports.co.za/reports/ar-2018/pdf/full-integrated.pdf
Use the condensed consolidated statement of financial position of Telkom Limited on
page 52 to calculate the following profitability ratios and interpret what the answers
mean:
1. current ratio
2. acid test ratio
3. debt ratio
Feedback
1. Use the appropriate formulas and interpret what the answers means.
CONCLUSION
In this lesson, we discussed what profitability entails, including the financial concepts
that affect profitability. We also looked at and discussed financial statements; and
this was only limited to the statement of comprehensive income and the statement of
financial position. This lesson also looked at how a break-even point is calculated in
a business. Lastly, the profitability and financial ratio were undertaken.
SELF-ASSESSMENT
2 Hour
If you can respond to this self-assessment, you have achieved the outcomes of this
lesson.
1.
2.
3.
4.
5.
Explain what profitability entails.
Apply the financial concepts affecting profitability. (current & future).
Interpret the financial statements.
Calculate a break-even point.
Evaluate profitability and business performance, using profitability and financial
ratios.
31 BSM2601
Attributes
Skripak, S. J. 2018. Fundamentals of Business, 2nd Edition, Blacksburg, VA: VT
Publishing. http://hdl.handle.net/10919/84848. Licensed with CC BY-NC-SA 4.0
https://creativecommons.org/licenses/by-nc-sa/4.0.
GLOSSARY
Profitability
Income
Expenses
Statement of comprehensive income
Statement of financial position
Assets
Liabilities
Equity
Break-even-point
Financial ratios
32 BSM2601
LESSON 3
BUSINESS RESPONSE TO BUSINESS ENVIRONMENT
Overview
In lesson 2, we discussed profitability. In this lesson, we are going to focus on
business response to changes in the environment. We begin our discussion by
defining the concept of change. Change is also discussed in great depth when
exploring organisational change and change management. Furthermore, we discuss
factors that drive organisational change and manage change.
This lesson is structured, as depicted in figure 3.1 below, to help you grasp the
learning outcomes of this lesson.
Figure 3.1: Structure of lesson 3
The rapid and often discontinuous change that is taking place in the environment has
a direct impact on the way in which businesses are managed. Managers find that old
proven recipes for success and specialised routines are no longer effective and that
it is necessary to adopt new approaches to manage their businesses. These
changes in the environment have an impact on the operations and profitability of the
business. Managers need to be aware of these changes so that they can adapt new
methods to meet, and even anticipate, the changing demands of the business
environment. However, to learn how to apply the content of this lesson, you need to
through the lesson step by step and work through all the activities. You will be able
to apply the knowledge and skills you gained in this lesson to manage a profitable
and sustainable business.
33 BSM2601
3.1 Learning outcomes
At the end of this lesson, you will be able to:
•
•
•
•
Know what change is.
Discuss organisational change and change management.
Establish what drives organisational change.
How to manage change.
3.2 Key concepts
As you go through this lesson, you will come across and learn about the
following concepts:
change, managing change, organisational change
3.3 Defining change
Change can be defined as a difference in some specific way – a radical
difference, a change in position, course, or direction and a shift from one
change to another. Change is continuous and brought about by a
transformation process. It may come actively in a planned way, or it may occur
naturally with an organisation or industry adapting or evolving.
In any event, change, in itself, is not inherently good or bad. Successful change
within an organisation is about good leadership rather than effective
management and is therefore not a process but an approach. However, change
is one of the most critical aspects of effective management. Even in the
smallest organisations, changes are likely to be fundamentally interlinked and
even interwoven.
Change also occurs in the business environment, businesses either evolve or
adapt. It occurs when there is dissatisfaction with the old business environment
and adoption of a new environment. When a change in business environment
emerges, it means businesses must turn in another direction and fundamentally
modify the way in which things are being done, change the structure and
provide organisational members with a whole new vision for the future.
From the above definitions it is evident that change represents a movement
from the current state of a business to a desired future state.
3.4 Business change and change management
To improve is to change, to be perfect is to change often. This statement
suggests that change may be considered a sign of improvement and progress.
At its simplest business change can be defined as new ways of organising and
working. It is when a business goes through transformation, restructuring or
reorganising. Business change takes place with the alteration of the core
aspects (structure, technology, culture, personnel and leadership) of a
business's operation, or when the business adopts a new idea or activities. It is
a way of altering an existing business to increase organisational effectiveness
for achieving the business objective.
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For businesses to be successful, they must change continually in response to
major environmental changes, such as changing customer preferences and
technological innovations. This is called change management. Change
management is the leadership and direction of the process of business
transformation, especially when it comes to evolving or adapting to the changes
in the business environment. As such, change management is a task that can
either be embraced proactively or reactively.
Today, we live in a world that is constantly changing which affects businesses.
As a result, the ability to engage in meaningful change is critical to a business`
competitive success. To be able to manage change effectively, businesses
need to go through a process of identifying possible weaknesses caused by the
presented change; developing possible solutions and weighing up the pros and
cons of these solutions; taking decisions on the future state of the business and
implementing the necessary changes.
Activity 3.1
1 hour
2.
3.
Define change in a business context?
Differentiate between business change and change management. Provide examples.
Feedback
In your answer, you should discuss change in a business context and differentiate between
business and management changes.
3.5
What drives organisational change
Understanding what drives change is critical because the drivers establish the overall
context in which business change occurs. They create the motivation for change and
form the purpose of those leading the change and those who are targets of the
change. The drivers of change clarify what drives the need for change.
It is important to note that businesses operate in an increasingly turbulent
environment, where environments have become much more competitive and
expectations, attitudes and moralities have been transformed. Thus, increased
competitiveness is one of the major drivers of change. A university, for
example, can be viewed as an institution that is constantly undergoing change
to attract candidates to apply for its courses, but students also see themselves
as paying customers and demand more from those who are providing the
educational experience. In this respect, universities will re-engineer the
strategic planning process and focus on quality management, financial
accounting and technology.
A business must monitor its internal and external environments to survive and
ultimately prosper. The external drivers refer to those forces that are outside
the business and mainly consist of four categories: economic, political,
technological and social-cultural. The internal drivers, by contrast, refer to those
forces within an organisation and may include the changing work climate,
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declining effectiveness of employees, changes in leadership, strained finances,
inadequate finances and changing employee expectations.
Activity 3.2
1 hour
1.
2.
Discuss how competitiveness drive change.
Discuss how the four categories of external environment can drive change.
Feedback
In your answer, you should discuss how competitiveness drive change and the four
categories that drive change.
5.6 Managing change
Successful change management can be both intense and challenging. When
change is well-planned, the process should be exciting, rewarding and
ultimately successful. Managers of change need to find ways to get every
member of the business on board and to move towards the same goal. Failure
to do so makes implementation efforts difficult. It is possible to make an
organisation worse than it was before the attempted change. Change can also
fail due to business members’ resistance or lack of motivation for the
challenges of change. No matter how cleverly crafted the plan or how carefully
prepared the strategy, making a business change is only successful as far as
its implementation. This implies that change managers are pivotal to the
success of the business change because they do not only devise the content of
change, but also formulate and adjust the method of its introduction.
There are no leading rules for managing change, rather it involves linking action
by people at all levels of the business. Below are some points for managing
change successfully.
•
•
•
•
Environmental assessment – The businesses, at all levels, need to develop
the ability to collect and utilise information about their internal and external
environments.
Leading change – This requires the creation of a positive climate for
change; the identification of future directions; and the linking together of
action by people at all levels in the organisation.
Linking strategic and operational change – This is a two-way process of
ensuring that strategic decisions lead to operational changes and that
operational changes influence strategic decisions.
Human resource as assets and liabilities – Just as the pool of knowledge,
skills and attitudes possessed by an organisation is crucial to its success, it
can also be a threat to the organisation’s success if the combination is
inappropriate or managed poorly.
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•
Coherence of purpose – This concerns the need to ensure that the
decisions and actions that flow from the above four factors complement and
reinforce one another.
Sometimes change tends to be so rapid that there is no time to adjust before
more change takes place. Yet, it is the ability to plan for, implement and
manage change that seems to be the core factor that separates successful
businesses from unsuccessful ones. Successful businesses do not believe in
change per se but in proactive change, reinventing themselves as and when
necessary. The following steps can be used to successfully manage change:
1. Establish a sense of urgency – inspire people to move and make objectives
real and relevant.
2. Create a guiding team – get the right people in place with the right
emotional commitment, and the right mix of skills and levels.
3. Develop a vision and strategy – get the team to establish a simple vision
and strategy; and focus on emotional and creative aspects necessary for
driving service and efficiency.
4. Communicate the change vision/buy-in – Involve as many people as
possible; communicate the essentials, simply to appeal and respond to
people's needs. De-clutter communications – make technology work for
you rather than against you.
5. Empower employees for action – Remove obstacles; enable constructive
feedback and lots of support from leaders by rewarding and recognising
progress and achievements.
6. Create short-term wins – Set aims that are easy to achieve in bite-size
chunks. The number of initiatives must be manageable. Finish current
stages before starting with new ones.
7. Consolidating gains and producing more change – Foster and encourage
determination and persistence – ongoing change – encourage on-going
progress reporting – highlight achieved and future milestones.
8. Anchoring new approaches – Reinforce the value of successful change
via recruitment, promotion and new change leaders. Weave change into
culture.
Activity 3.3
1 hour
1.
Apply and provide examples, how managers can use the five points to manage
change successfully.
Feedback
In your answer, you should explain with examples how managers can use five points
to manage change successfully.
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CONCLUSION
In this lesson, we focused on business response to changes in the environment. We
began our discussion by defining the concept of change. Change was also
discussed in great depth when exploring organisational change and change
management. Furthermore, we discussed the drivers of organisational change and
change management.
SELF-ASSESSMENT
2 Hours
If you can respond to this self-assessment, then you have achieved the outcomes of
this lesson.
6.
7.
8.
9.
What is change?
Discuss organisational change and change management.
Establish what drives organisational change.
Describe how to manage change.
Attributes
Brauns, M. 2015. The management of change in a changing environment: to change
or not to change? Corporate Board: Role, Duties & Composition, 11(3):37-42.
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LESSON 4
BUSINESS SUSTAINABILITY
Overview
In lesson 3, we discussed how a business responds to environmental demands. We
also looked at how innovation can be applied in responding and mitigating
challenges brought by business environment.
In this lesson, we are going to focus on business sustainability. We begin our
discussion with an overview of the three concepts of business sustainability, namely
the environment, social and economic. The three concepts are also discussed in
great depth as part of the triple bottom line. To better understand how sustainability
is measured, this lesson will discuss sustainability reporting.
To help you grasp the learning outcomes of this lesson, this lesson is structured, as
depicted in figure 4.1 below:
Figure 4.1: Structure of lesson 4
A business's success is commonly measured by the profits or economic value it
generates. However, for the business to continue generating economic values, its
impact on the environment and society must be balanced with economic objectives.
If there is no balance between the environmental, social and economic objectives,
then there are reasons for concern for its sustainability. This lesson will teach a
prospective business manager about business sustainability. However, to gain a
clear understanding of how to apply the content of this lesson, you must follow this
lesson step by step and work through all the activities. With the knowledge you have
gained, you will be able to apply appropriate knowledge and skills to manage a
sustainable business.
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4.1 Learning outcomes
At the end of this lesson, you will be able to:
• Explain what business sustainability entails.
• Understand the concepts of triple bottom line.
• Apply sustainability reporting.
4.2 Key concepts
As you go through this lesson, you will come across and learn about the
following concepts:
sustainability, triple bottom line, economic, environment, social
4.3 An overview of business sustainability
Managing a business that strives to contribute to sustainability necessitates a
different perspective from what many businesses currently have. Most
businesses are concerned with profitability, frequently on a short-term –
annually, or even monthly. Sustainable business practices necessitate a longterm and systems-level view of how a company's actions affect the
environment and society. It necessitates that managers are cognisant of not
only economic activities, but also of the consequences of their activities for the
physical environment and the society.
A systems approach to sustainability can give valuable insight. Societal wellbeing and the sustainability of the environment are interrelated and relevant for
industries, individual businesses and for individuals, cities and towns, nations
and the entire planet. For example, on a local community scale, a resourcedependent community economy (a fishing community in Kalk Bay, Cape Town)
cannot achieve economic sustainability if it depletes its most valuable local
natural resource –fisheries. On a global scale, economic activity by individuals,
households and businesses collectively that contributes significantly to global
warming, cannot be sustained if natural resources and human population and
health are adversely affected.
Every business has an influence on society and the environment through its
normal business activities and vice versa. Starting with the most basic systems
viewpoint, we may divide the interconnectedness of a single organisation and
society into two categories. First is the “inside-out” linkages, for example, CocaCola with its packaging of soft drinks influence the society; and ZZ2 has an
impact on the environment with its farming of tomatoes. Then there are
“outside-in” linkages with external environmental and societal conditions
influencing businesses. For example, Coca-Cola depending on the supply of
water from the environment and ZZ2 depending on the soil for plantation.
Another way of thinking about this system is to first consider the consequences
of business such as how each business affects the economy, the natural
environment and society (consumers and employees), and then consider the
context in which businesses operate.
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A more complex and dynamic systems approach defines a system as a set of
things that affect one another within an environment and form a larger pattern
that is different from any of the parts. When viewed from a systems approach,
businesses engage in continual stages of input, processing and output in an
open or closed context. A closed system has no interaction with its
environment. It does not absorb information; and, as a result, it is prone to
atrophy – to disappear. An open system, on the other hand, collects information
and utilises it to interact dynamically with its environment. Thus, openness
improves one's chances of survival and success.
Business sustainability requires an open systems approach and consideration
of how business activities not only impacts on economic generation, but also on
the environment and the sustainability of the natural and social systems
businesses belong to.
Activity 4.1
2 hours
4.
Critically justify the statement that “an open system is sustainable while a
closed system is not” Come up with specific examples to support your
assertion.
5.
In your own words, define what is meant by outside-in linkages and inside-out
linkages in a business context. Provide a specific example of each type of
linkage.
Feedback
In your answer, you should discuss an open system as well as the outside-in and
inside-out linkages.
4.4 The triple bottom line concepts
Sustainability involves understanding the relationship between the triple bottom
line concepts: economic, social and environment. A clean and productive
environment is fundamental to social survival and a business's existence.
Consider what life would be like if we did not have clean air to breathe, clean
water to drink or food to eat. And what businesses would do if they did not have
all these resources and healthy, productive employees. Environmental
resources and social wellbeing are often taken for granted and are not
appreciated for their essentiality to business operations and sustainability.
Sustainability has grown into a comprehensive science that integrates
environmental system studies with social sciences, such as economics and
sociology, to better comprehend the complex social, environmental and
economic interrelationships that exist between society, businesses and the
environment. This section, therefore, focuses on a discussion of the triple
bottom line, namely the economic, environment and social.
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4.4.1 Economic sustainability
According to the "limits to growth" concept, unlimited economic growth is not
possible, because at some point the world’s growing population will consume
too great a quantity of natural resources, such as clean water and fossil fuels,
for human society to exist. The limits to growth concept states that continued
growth in the economy would lead to population and economic collapse as a
result of increased environmental damage and decreased resources. The
concepts also suggest that collapse could be avoided with changes in strategy
and behaviour. Therefore, there is a need to stabilise growth so that humans
could live within the ability of the earth’s natural system to provide a sustainable
yield of resources that are essential to human life.
For example, assume that five acres of grassland are required to sustainably
feed one cow annually. This means that five acres can regenerate itself and
support the grazing of one cow and that this same cycle of growth and
consumption can occur annually. In other words, the carrying capacity of five
acres of grassland is one cow. If you were a farmer with one hundred acres of
grassland and you had one cow, there would be more than enough grass
available to feed one cow and have the grass regenerate itself for perpetuity.
The farmer could add up to 20 cows on 100 acres and every year the grassland
would produce enough grass to feed all 20 cows.
Suppose the farmer wanted to increase his annual profits and he adds another
ten cows to the 100 acres. There would probably be enough grass to feed
those cows for a year, but overgrazing would compromise the ability of the
grass to replenish itself. The resource base degrades because the demands on
the grassland would be greater than its capacity. Perhaps only 90% of the
grass would grow back the next year and the grass would not be as healthy as
before. Continuous overgrazing would further degrade the grassland until it is
no longer capable of supporting any cattle.
What would happen instead if the farmer decided to increase the herd size
each year by another ten cows, believing that he could push profits even
further? The degradation of grassland would proceed at an even faster rate.
Even if the farmer achieved some short-term profitability increase by exploiting
the grassland, it would be at the expense of productive grassland in the future.
Once damaged, it might take years or decades for the grassland to recover, or
it might never return to its former productive capacity. This example illustrates
the basic concept of limits to growth – at some point rising resource demand
runs into some very hard resource limitations.
It may be argued that the dominant worldview in industrialised countries during
the greatest part of the 19th and 20th centuries was that there were few
boundaries to economic growth and that economic growth was always sought.
The “No limits to growth” concept has become modern economic thinking. The
effectiveness of the private market is highlighted by "no limit to growth" thinking.
The assumption that resource scarcity, a significant component in "limits to
growth" thinking, may be efficiently dealt with by economic rules of supply and
demand. The laws of supply and demand are in effect when resources become
scarce; the market will restrict utilisation by raising the price of those resources.
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The market and the rules of supply and demand can assist lower demand for
scarce resources while also directing resource allocation to technology and
innovation initiatives that can help alleviate scarce resource problems.
The two concepts of limits to growth are both important for the business context
of sustainability. Fundamentally, both views influence sustainability discussions
at national, business and societal level. The earth has limited resources and
business activity can have a negative impact on the environment. Market forces
are often effective in providing signals to society of resource scarcity and the
need to change, innovate and adapt. But even with the overall efficacy of
markets, there are limits to the efficacy of the market perspective. Markets often
fail to properly price natural resources that are treated as free goods, and this
makes limits to growth a reality. Both arguments make important points that
frame discussions of sustainability.
4.4.2 Environmental sustainability
Environmental sustainability finds its roots in ecology. Ecology is the study of
living forms and their interactions with the environment, with an emphasis on
ecosystems. Ecosystems are 'webs' or intricate patterns of interactions among
a network of life in a specific location on earth. Ecosystems include wetlands,
forests, grasslands, coral reefs and coastal estuaries. They are an interaction of
living (biotic) and non-living (abiotic) elements in a specific geographic area.
Human civilisation values healthy ecosystems because they provide lifesustaining commodities and services such as clean air to breathe, clean water
to drink, plants and animals as food sources and raw materials for clothing and
shelter. The goods and services produced by natural systems that benefit
humans are called ecosystem services. These goods and services do not have
a formal market and are thus excluded from standard economic measurements,
such as GDP, and are often viewed as 'public goods' or societal benefits.
Environmental changes can have an impact on the life that an ecosystem can
sustain. Severe or rapid changes can reduce the carrying capacity of an
ecosystem and result in the loss of living organisms. A basic understanding of
the key resources that support the earth is essential for businesses that are
concerned with sustainability. These resources support a healthy planet with
rich and diverse plant and animal life. Sustainable businesses consider the
impacts of their actions on the key resources.
Energy
Energy is defined as the ability to do work, while work is defined as the
application of a force over a distance. The earth system has three primary
sources that affect the flow of energy on earth: sun (solar), geothermal and
tidal. Solar is a powerful source of energy on earth, and life on earth could not
exist without it. Geothermal is the energy from within the earth and includes
volcanoes and earthquakes. Tidal movement of the oceans is caused by the
moon around earth. Energy can also be divided into two broad categories:
potential and kinetic. Potential energy is stored energy that has the potential to
do work, such as the energy stored in a battery or fuel while kinetic energy is
energy in motion, such as waves crashing on a beach. Energy can be
transferred from one form to another. Within the broad categories of potential
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and kinetic energy, energy can come in many different forms such as chemical,
nuclear, mechanical, thermal, electrical, solar and so forth.
Biodiversity
Biodiversity is the result of 3.5 billion years of evolution. Biodiversity is an
indicator of the health of an ecosystem. Higher degrees of biodiversity imply
greater ecosystem health. Biodiversity does not only strengthen the overall
health of the planet, but also provides vital benefits to humans. Biodiversity is
important in agriculture as it provides varieties of plants and animals for human
consumption. Biodiversity helps protect other natural resources, including water
and soil. Businesses and industries rely on biological inputs such as timber,
paper and fibre. Biodiversity also provides leisure, cultural and aesthetic value.
The loss of biodiversity reduces the productivity of ecosystems. It weakens
ecosystems and reduces their ability to be resilient to extreme natural events
such as floods, droughts and human activity stresses. This loss of life does not
only reduce the ecosystems’ goods and services available to the current
generation of humans, but also harms future generations.
Water
Water covers more than 70% of the earth’s surface and is vital to all forms of
life. Oceans hold 97%of surface waters, glaciers and ice caps hold 2.4%, with
lakes, rivers and other land surface waters making up the remaining 0.6% .
Water is a vital resource to humans as it is required as drinking water; it is an
essential input for agriculture; and provides for sanitation, transportation,
energy generation, food processing and power generation (through
hydroelectric plants or dams). Increases in population and current water use
practices are expected to increase water consumption in food production by up
to 90%.
Currently, one in six people in the world lack safe drinking water, and
waterborne diseases are the leading cause of the death of human beings. In
1989, there were 9,000 cubic meters of freshwater per capita available for
human use. By 2000, it dropped to 7,800 cubic meters, and it is expected to
continue decreasing as human population increases. Global per capita figures
on water availability are somewhat misleading as the world’s available
freshwater supply is not evenly distributed geographically, seasonally or
annually. The movement of water is part of a natural cycle of evaporation into
the atmosphere, precipitation, and then run off across the land into streams,
rivers and lakes. This cycle is powered by the sun, which serves to move clean
water about the planet.
Soil
Soil consists of layers of minerals that vary in characteristics across different
geographic regions and ecosystems. Soil consists of organic and inorganic
components. Soil is a primary nutrient base for plants and is therefore important
to humans for agriculture. Without soil, the earth cannot support a rich base of
plant and animal life, and it is an essential resource to consider in human
interactions with the environment.
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4.4.3 Social sustainability
Businesses activities can be direct threats to ecosystems. Business
operations can stress the environment in which they operate, diminishing its
general health; and the aggregation of all negative impacts from human
activities can eventually surpass the planet's ecological threshold. They can
cause destruction, degradation and the impairment of biodiversity and other
natural resources. Ecosystem threats include (1) climate change, (2) pollution,
(3) habitat destruction and (4) overexploitation.
Climate change
Climate change is a controversial and contested topic and one of the greatest
threats to sustainability. As highlighted in the previous section, the earth’s
climate fluctuates over time due to a variety of factors. However, there is a
significant body of scientific research that indicates that global temperatures
are rising and that rising global temperatures are directly linked to business
and human activities involving the emissions of greenhouse gases (GHG).
GHG traps heat in the atmosphere, allowing the planet to be a habitable
place. The primary GHG of interest is carbon dioxide (CO2), which is a vital
gas in our earth system and is released from various sources, including the
combustion of fossil fuels. Over the last three centuries, rapid industrialisation
and the corresponding increased burning of fossil fuels and deforestation of
large tracts of land globally have caused the concentration of greenhouse
gases to increase significantly in the atmosphere. Current atmospheric carbon
dioxide levels exceed the natural range observed over at least the last
800,000 years and are rapidly rising.
Pollution
Pollution is the contamination, harm to or disruption of the natural environment
through emissions of harmful substances. Pollution is most typically
associated with anthropogenic sources but can also occur from natural
activity, such as volcanic eruptions. Pollution can impact air, water and land
and include domestic, industrial, and agricultural waste. It comes in many
different forms and can be chemical substances or noise, heat or light.
Pollution can be point source or nonpoint source. Point source is a specific
and easily identifiable source of pollution, such as a factory or power plant.
Nonpoint sources consist of many small, distributed sources of a pollutant that
are difficult to individually identify and on their own may not be that harmful,
but in aggregate they are significant sources of pollution. A classic example of
nonpoint source would be soap detergents, fertilisers, and other commonly
used chemicals and products from many residences and businesses that then
contaminate watersheds with high levels of nitrogen. Nonpoint sources tend to
be more complex to regulate for pollution emissions.
Habitat destruction
Habitat destruction, brought on by the activity of humans, threatens resident
species and ecosystems. Two examples of habitat destruction are
deforestation and desertification. Deforestation occurs when a forest or stand
of trees is removed, converting the land to non-forest use. This changes the
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ecosystem drastically and results in a dramatic loss of biodiversity.
Deforestation can be the result of timber harvesting or clearing land for
agricultural, commercial or residential use. The loss of biodiversity and trees
alters the ecosystem and can result in aridity and erosion. It also results in
climate change and extinction, and it can lead to desertification if on a scale
that is significant enough. The social impacts can include displacement of
indigenous peoples. Desertification is the degradation of land quality and
features low biodiversity, dry conditions and poor soil quality. Deserts are
formed through natural processes and human activity. However,
desertification is occurring at a greater rate than past geological time scales
due to business and human activities.
Overexploitation
Overexploitation is a major threat to ecosystems and therefore sustainability.
It is the consumption of a natural resource at a rate greater than that such a
natural resource can maintain itself. Overuse of water is one of the clearest
examples of overexploitation, but there are other forms. Land degradations
are human-induced changes that impair the capacity of the land to sustain life.
Deforestation and overgrazing exploit the land and result in exceeding
sustainable yield.
Activity 4.2
4 hours
1. Discuss the merits of the “no limits to growth” concept and provide examples.
2. Discuss the merits of “limits to growth” concept and provide examples.
3. Describe how a business can have an impact on the key environmental
resources: energy and biodiversity.
4. Critically discuss the importance of the key environmental resources for
sustainability of a business: water and soil.
5. Describe how a business can influence the ecosystem threats: climate change
and pollution.
6. Critically discuss with examples, how a business can reduce or mitigate its
impact on ecosystem threats: habitant destruction and overexploitation.
Feedback
In your answer, you should discuss the components of triple bottom line.
4.5 Sustainability reporting
How do a business and its stakeholders know how “sustainable” the business
is? This is not an easy question to answer, as all business activities have
economic, social and environmental impacts. It is very difficult to determine
whether the total impact of all activities of a company makes it “sustainable” or
“unsustainable.” A more useful approach is to consider an organisation’s
actions on a continuum with a goal of continuous improvement in decreasing its
negative overall societal impact and improving its positive overall societal
impact. Any change in any business can be challenging to implement; and
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viewing business operations from a triple bottom line perspective, especially
businesses typically only focussed on profit can be extremely challenging.
Progressive and small changes when approaching sustainability often will be a
more effective strategy than implementing more widespread changes.
There is an axiom in business that “you can only manage what you measure.”
Measurement is at the core of performance-based management. This
statement is true, whether the business is a small sole proprietorship or a
large multinational company. For any business to understand its current
sustainability status and progress on its business activities, it is essential that it
has clearly defined business metrics that can be collected, analysed, evaluated
and acted on.
Businesses traditionally focused their performance on economic information
(financial and accounting). It is only in recent years that the business
community has shifted to additional metrics in terms of environmental and
social impact. Over the past decade, corporations worldwide have increasingly
adopted sustainability reporting. In 2008, nearly 80% of the largest 250
companies worldwide issued some form of reporting that incorporated
environmental or societal impact, an increase of more than 50% since 2005.
Sustainability reporting typically focuses on comparing performance in the
current year to that of the previous year and comparing it to specific goals and
targets. It can also include a long-term focus and comparisons with other
companies in similar industries and in the same geographic areas.
Sustainability reporting is also referred to as “triple bottom line” reporting,
meaning that it does not only take economic “financial” reporting of a business
into account, but also environmental and social reporting.
For businesses to understand and improve business sustainability
performance, they need accurate carbon, energy, toxics, waste and other
sustainability data. While traditional business financial statements, such as
balance sheets and income statements, may help a business determine if it is
economically sustainable, on their own they are inadequate in measuring a
business’s environmental and social progress. Just as there are financial
standards, such as international financial reporting standards (IFRS) to provide
businesses with a common “language” of reporting financial information, there
are also standards and processes that have been developed for businesses to
measure and communicate their position and progress on sustainability.
The process for sustainability reporting is like all performance-based business
management processes. It involves the same steps, including goal-setting,
measurement, analysis and action, but differs as far as the type of information
collected is concerned. Sustainability reporting applies the steps depicted in
figure 4.2 below.
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Figure 4.2: sustainability reporting cycle
The steps in the sustainability reporting cycle define performance goals and metrics;
measure performance (data collection); evaluate performance (includes analysis and
reporting) and manage performance. As with any business initiative, it is essential
that management is supportive of sustainability, in this instance; and that
management provides the necessary financial, technical and human resources to
support each step of the process. The success of sustainability reporting depends on
the commitment of the senior management in the business.
Define performance goals and metrics
The first step is to define the sustainability goals of the company. This is an
important action and should guide the rest of the process. While sustainability
reporting is meant to be broad and comprehensive to provide a full “360 degree”
view of the business or documentation of the complete environmental and societal
impact of a company, it must be bound at a level that is pragmatic and appropriately
focused for the business.
The business should have an overall vision of why it wants to integrate sustainability
efforts into its business operations. Is the goal of the business to “change the world”;
or simply to document the company’s progress on environmental and social
impacts? Is the audience for the reporting internal, external or both? A company will
have to evaluate whether its focus is on continuous improvement of its individual
actions, or if it is measuring its performance relative to a broader target, such as a
reduction in greenhouse gas (GHG) emissions.
The next step is to develop key performance indicators (KPIs) that will be used to
measure progress towards those goals. A key performance indicator is a
performance measure from operational data used by organisations to track a
particular activity. There are different methods for establishing KPIs, but one typical
method is the SMART criteria. In SMART, a measure has a specific business
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purpose and is measurable, achievable, relevant to the success of the business and
can be measured over a specific period.
In sustainability reporting, a KPI is referred to as a sustainable performance indicator
(SPI). SPIs are used as a tool to measure a company’s sustainability performance
and to monitor and report on future progress. SPIs can be further categorised into
the three areas covering either the economic, environmental or social aspects of
sustainability.
Table 4.1: Categories of Sustainable Performance Indicators
SPI Type
Types of Information
Economic performance indicator
Business turnover, profit, quantity of products sold and market
share
Labour practices, human rights, diversity, philanthropy, salaries
and benefits.
GHG emissions, water usage, resource depletion, waste
generated, pollutants released, biodiversity, and land use
Social performance indicator
Environmental performance
indicator
Measure performance
Once SPIs are established and business processes are modified to allow for the
necessary data to be captured and recorded, the process of measurement begins.
Data needs to be collected, validated for accuracy and stored (typically by using
database technology or computer spreadsheets). Data collection processes must be
straightforward; and data must be collected systematically and consistently.
Sometimes multiple data sources may be required to offset limitations in any one
source of data.
In this phase, it is important to assign responsibility of data collection to ensure that it
is collected correctly. This includes quality control to ensure that the data is accurate.
For example, errors in measurement devices or communication can lead to false
data being collected. As the popular saying goes, “Garbage in, garbage out,” which
means that that the quality of the analysis is only as accurate or insightful as the
quality of the information collected.
Evaluate performance
The goal of the evaluation phase is to convert raw data into useful performance
information and knowledge so that businesses can make informed decisions. The
key components of the evaluation phase are data compilation, data analysis and
communication. The evaluation phase includes organising, synthesising and
aggregating data. Data analysis is then performed to provide insight by converting
data facts into useful knowledge. This includes the calculation of SPIs. Analysis of
data is required before performance can be interpreted. Reporting and
communication, a component of performance evaluation, is the dissemination of
information to stakeholders in a form that they can understand results and their
implications and realise what actions are needed.
Data analysis can include a variety of techniques such as database-driven reporting,
spreadsheet analysis and statistical tests. A business analyst is typically involved in
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managing this aspect of the sustainable reporting process and requires business and
technical skills to perform the job. Often data analysis involves looking for trends
when analysing SPIs. It can also include comparing performance with a goal or
standard or to competitors or peers. This typically involves comparing a performance
measure to a baseline. While there are many different tools and techniques that can
be applied to analyse data and SPIs, two that have specific relevance to
sustainability reporting are normalisation and benchmarking.
Normalisation is the process of removing the impact of factors that may influence
direct comparison of SPIs. For example, weather has an impact on the energy use of
a building and varies from one year to another. Frequently, an annual energy use
SPI will be normalised for weather (controlled for the coldness of a winter season) to
allow for relevant comparison of energy use on an annual basis.
One useful strategy to use when analysing sustainability performance is to compare
SPIs with those of other businesses. This can help a business to gauge the potential
and success of its sustainability efforts relative to other companies in its industry and
peer businesses. In the process of benchmarking, the best businesses in a
company’s industry or industries with similar business processes are targeted, and
the company then compares its own results and processes with the results and
processes of the targeted organisations. This provides insight into how well the
business compares to an industry’s top performers and can provide insight into the
business processes and practices that explain why these businesses are the “best.”
Benchmarking can also include assessing a business' relative position to that of
other organisations. Is an SPI below average, average, or above average? For
example, a company may use benchmarking to see how its GHG emissions
compare with those of other businesses in its industry. If a company’s emissions are
above average, it would indicate that they have the potential to reduce their
emissions. The business benefit is that as GHG emissions are linked to energy
usage, the business has potential cost savings by implementing measures to reduce
its energy consumption.
The final step in the evaluation process is communicating analysed information so
that stakeholders can understand and learn how a company performs in relation to
its sustainability efforts. The information communicated is different, depending on the
target audience of the information. Management will look for information in a different
format than an investor, consumer or another stakeholder. Communication outside
the company through company websites, annual sustainability reports and other
forms of disclosure about organisations’ environmental and social performance has
become standard business practice. There is no universal method of external
communication of sustainability performance, although many standards exist. The
trend in sustainability reporting has moved towards standardised reporting, using
frameworks, such as the Global Reporting Initiative (GRI) or the Greenhouse Gas
Protocol (GHG Protocol). Standards allow for meaningful comparisons between
sustainability information reported by different businesses.
The business annual sustainability report has become a common way for businesses
to report on annual progress on sustainability initiatives. Businesses may not always
call this document an annual sustainability report; it could also be called a corporate
social responsibility report, corporate responsibility report, global responsibility report
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or many other variants, but they all represent an annual report that discusses the
ecological, economic and social impacts of the business. While each business`
annual sustainability reports are different and tailored to the business, there are often
several key common features in a sustainability report.
Manage performance
The final step of sustainability reporting is taking action, and this is executed by
management. Management should be prepared to react to sustainability
performance with all the basic management functions: planning, organising,
controlling and leading. Management should review sustainable performance
information routinely. The frequency of the reviews depends on the business and its
ability to act on information learned through sustainability reporting. Management is
the final step in the sustainability reporting process; if management does not react
and change based on the insight provided by the sustainability reporting, there is
little value to the entire process. The reporting process is a cycle and the
management phase then proceed back into the first step of defining goals and
establishing SPIs. Management activity allows a business to continually improve on
its sustainability performance.
Activity 4.3
1 hour
1. Discuss the four steps of the sustainability reporting cycle.
2. Why is it important that the process is a cycle?
Feedback
In your answer, you should discuss the four steps of sustainability reporting cycle.
CONCLUSION
In this lesson, we focused on business sustainability. We started our discussion with
an overview of the concepts of business sustainability. The three concepts were
discussed in great depth as part of the triple bottom line concept. This lesson
discussed sustainability reporting to give you a better understanding of how
sustainability is measured.
SELF-ASSESSMENT
If you can respond to this self-assessment, then you have achieved the outcomes of
this lesson.
10. Explain what business sustainability entails.
11. Discuss the concepts of triple bottom line.
12. Describe the sustainability reporting cycle.
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Attributes
Gittell, R., Magnusson, M., and Merenda, M. 2012. The sustainable business case
book. Saylor Foundation. Licensed with CC BY-NC-SA 3.0 The Sustainable
Business Case Book - Open Textbook Library (umn.edu)
Jain, S. 2015. 6 effective ways to build a sustainable business.
https://www.entrepreneur.com/article/252029
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LESSON 5
CORPORATE SOCIAL RESPONSIBILITY
Overview
In lesson 4, we discussed business sustainability. We also looked at the overview of
the three concepts of business sustainability: the environment, social and economic;
and how sustainability is measured.
In this lesson, we are going to focus on corporate social responsibility (CSR). We
begin our discussion with an overview of the concept of CSR, which is also
discussed in great depth when we explore how businesses meet their social
responsibilities to various stakeholders. Furthermore, we discuss some trends in
CSR.
This lesson is structured, as depicted in figure 5.1 below, to help you grasp the
learning outcomes of this lesson.
Figure 5.1: Structure of lesson 5
Every day, managers and business owners make business decisions based on what
they believe to be right or wrong. Through their actions, they demonstrate to their
employees what behaviour is acceptable or unacceptable and shape the moral
standard of the business. As you will see in this lesson, corporate social
responsibility is an important cornerstone of a business and shapes its profitability
53 BSM2601
and sustainability. However, to learn how to apply the content of this lesson, you
must work through all the activities step by step. With the knowledge gained, you will
be able to apply appropriate knowledge and skills to manage a profitable and
sustainable business.
5.1 Learning outcomes
At the end of this lesson, you will be able to:
• Explain corporate social responsibility.
• Discuss how businesses meet their social responsibilities to various
stakeholders.
• Establish the key trends in corporate social responsibility.
5.2 Key concepts
As you go through this lesson, you will come across and learn about the
following terms and concepts:
corporate social responsibility, philanthropy, stakeholders.
5.3 What is corporate social responsibility?
Corporate social responsibility (CSR) refers to the concern of businesses for
the welfare of society. It consists of obligations beyond those required by law or
social contract. This definition makes two important points. First, CSR is
voluntary. Beneficial activities that are mandated by law, such as cleaning up
toxic factories or paying employees, are not voluntary. Second, the obligations
of CSR are broad. A business obligation extends beyond investors to include
labour, suppliers, consumers, communities and society at large.
Economic responsibility is depicted in figure 5.2 as the foundation for the other
three responsibilities. At the same time a business pursues profits (economic
responsibility) it is also expected to obey the law (legal responsibility); and to do
what is right, just and fair (ethical responsibility); and to be a good corporate
citizen (philanthropic responsibility). These four elements are unique, but
together they constitute a whole. If a business does not make a profit, the other
three responsibilities will not matter.
Many businesses continue to work hard to make the world a better place to live
in. Recent data suggests that multinational businesses spend billions annually
on CSR activities. Consider the following examples:
•
•
•
A business donating tens of thousands of meals to local communities.
A business encouraging its employees to volunteer in community activities
and paying or rewarding them for doing so.
A business providing scholarship for the needy and deserving children in
the local community.
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Figure 5.2: Components of corporate social responsibility
5.3.1 Understanding social responsibility
Peter Drucker, the late globally respected management expert and scholar,
said that we should first look at what a business does to society and second at
what it can do for society. This suggests that social responsibility has two
basic dimensions: legality and responsibility.
a) Illegal and irresponsible behaviour
The concept of CSR is so widespread today that it is hard to understand
why a business continually acts in illegal and irresponsible ways.
Nevertheless, such behaviour does sometimes occur, which can create
financial ruin for a business, extreme financial hardships for many retired
employees and general struggles for the communities in which the
business operate. Unfortunately, top executives still walk away with
millions. Some, however, will ultimately face the law, pay large fines and
spend time in prison for their actions.
b) Irresponsible but legal behaviour
Sometimes businesses act irresponsibly, yet their actions are legal. For
example, a Durban-based business that manufactures electric blankets
was recently fined R1 million by the Department of Health for making
unsubstantiated claims that the “most comfortable blanket you’ll ever own”
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could help alleviate medical conditions such as snoring, fibromyalgia,
migraines and other disorders. The CEO countered that the claims were
made by customers; these testimonials were posted on the business's
website but later removed. In addition to the fine, the business faced
several class-action lawsuits, and the South African Bureau of Standards
has revoked the blanket’s accreditation.
c) Legal and responsible behaviour
Most business activities fall into the category of behaviour that is both
legal and responsible. Most businesses act legally, and most try to be
socially responsible. Research shows that consumers, especially those
under 30 years old, are likely to buy brands that have excellent ethical
track records and community involvement.
Activity 5.1
1 hour
6. Define corporate social responsibility with reference to the components CSR.
7. Illustrate an example of illegal but irresponsible behaviour.
8. Illustrate an example of legal but responsible behaviour.
Feedback
In your answer, you should define CSR in line with its components. You should also
provide examples of illegal but irresponsible behaviour and legal but responsible
behaviour.
5.4 Responsibilities towards stakeholders
How do businesses meet their social responsibilities towards various
stakeholders? What makes a business to be admired or perceived as socially
responsible? The answer is, such a business meets its obligations to its
stakeholders. Stakeholders are the individuals or groups towards whom a
business has a responsibility. The stakeholders of a business are its employees,
its customers, the general public and its investors. The responsibilities of a
business to stakeholders are illustrated in figure 5.3 and discussed.
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Figure 5.3: Responsibilities to stakeholders
a) Responsibility to employees
A business's first responsibility is to provide a job to employees. Keeping
people employed and letting them have time to enjoy the fruits of their
labour is the finest thing a business can do for society. Beyond this
fundamental responsibility, employers must provide a clean, safe working
environment that is free from all forms of discrimination. Businesses should
also strive to provide job security whenever possible. Enlightened
businesses are also empowering employees to make decisions on their
own and suggest solutions to operational and strategic problems.
Empowerment contributes to an employee’s self-worth, which, in turn,
increases productivity and reduces absenteeism. Some companies offer
unusual benefits to their employees. For example, a business may offer
employee compensation for taking alternative methods of transportation to
work, such as walking or cycling to work. Also, a business may offer free
commuter bus service to all employees.
b) Responsibility to customers
To be successful in today’s business environment, a business must satisfy
its customers. A business must deliver what it promises and should be
honest and forthright in everyday interactions with customers, suppliers and
others. Recent research suggests that many consumers, particularly
millennials, prefer to do business with companies and brands that
communicate socially responsible messages; utilise sustainable
manufacturing processes and practice ethical business standards.
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c) Responsibility to society
A business must also be responsible to society. A business provides a
community with jobs, goods and services. It also pays taxes that go
towards supporting schools, hospitals and building better roads. Some
businesses have taken an additional step to demonstrate their commitment
to stakeholders and society by sparing a percentage of their profit to
support society.
d) Responsibility to the environmental
A business is also responsible for protecting and improving the world’s
fragile environment. The world’s forests are being destroyed fast. Every
second, an area the size of a football field is laid bare. Plant and animal
species are becoming extinct at the rate of 17 per hour. A continent-size
hole is opening in the earth’s protective ozone shield. Each year we throw
out 80% more refuse than we did in 1960; as a result, more than half the
nation’s landfills are filled to capacity.
To slow the erosion of the world’s natural resources, many businesses
have become more environmentally responsible. For example, a business
may use renewable energy sources such as solar, wind, geothermal, and
waterpower for electricity to run its facilities.
e) Corporate philanthropy
Businesses also display their social responsibility through corporate
philanthropy. Corporate philanthropy includes cash contributions,
donations of equipment and products and support for the volunteer efforts
of the business's employees. Non-profit organisations, such as Gift of the
Givers, rely almost entirely on charitable gifts to carry out their programmes
and services, which include disaster relief and humanitarian relief. The
funds provided by businesses enable non-profit organisations to deliver
humanitarian relief to victims of numerous disasters around the world.
f)
Responsibilities to investors
The relationships of businesses with investors also entail social
responsibility. Although a business's economic responsibility to make a
profit might seem to be its main obligation to its shareholders, some
investors increasingly put more emphasis on other aspects of social
responsibility. Some investors are limiting their investments to securities
(stocks and bonds) that coincide with their beliefs about ethical and social
responsibility. This is called social investing. For example, a social
investment fund may not even consider the securities of all businesses that
make tobacco products or liquor, manufacture weapons, or have a history
of being environmentally irresponsible. Not all social investment strategies
are alike. Some ethical mutual funds will not invest in government securities
because they help to fund the military; others freely buy government
securities with managers noting that government funds also support the
arts and pay for AIDS research. Today, assets invested, using socially
responsible strategies amount to trillions.
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Over the last several years businesses have tried to meet their responsibilities to
investors and other stakeholders, perhaps partly as the result of the global recession
that lasted from 2007 to 2009. Recent research suggests that CEOs are increasingly
being tied to higher standards by boards of directors, investors, governments, media,
and even employees when it comes to corporate accountability and ethical
behaviour. A recent global study by PwC reveals that over the last several years,
there has been a large increase in the number of CEOs being forced out due to
some sort of ethical lapse in their businesses. Strategies to prevent such missteps
should include establishing a culture of integrity to prevent anyone from breaking the
rules to ensure that business goals and metrics do not create undue pressure on
employees to cut corners, and to implement effective processes and controls to
minimise the opportunity for unethical behaviour.
Activity 5.2
2 hours
3. Explain how businesses carry out their corporate social responsibility to
consumers and employees.
4. Define corporate philanthropy and give two examples.
5. Substantiate the following statement and provide relevant examples to support
your assertion “a business is only responsible to its investors to make profit”.
Feedback
In your answer, you should explain how businesses carry out CSR. Define corporate
philanthropy.
5.5 Trends in corporate social responsibility
What are the trends in corporate social responsibility? Three important trends
related to corporate social responsibility are strategic changes in corporate
philanthropy, a new social contract between employers and employees and the
growth of global corporate social responsibility.
5.5.1 Changes in corporate philanthropy
Historically, corporate philanthropy typically involved businesses seeking
out charitable groups, giving them money or donating business products
or services. Today, the focus has shifted to strategic giving, which ties
philanthropy and corporate social responsibility efforts closely to a
business's mission or goals and targets donations to the communities
where a company does business. Some top businesses are recognised
for their efforts to give back to communities.
5.5.2 Social contract between employer and employee
Another trend in social responsibility is the effort by businesses to redefine
their relationship with their employees. Many people have viewed social
responsibility as a one-way street that focuses on the obligations of
business to society, employees and others. Now, businesses recognise
that the social contract between employer and employee is an important
aspect of the workplace and that both groups must be committed to
working together for the business to prosper. The social contract can be
59 BSM2601
defined in terms of four important aspects: compensation, management,
culture and learning and development.
When it comes to compensation, businesses today must accept that most
employees do not stay with one business for decades. Thus, businesses
need to change their compensation structure to acknowledge the
importance of short-term performance; and to update their methods of
determining compensation, including benefits and other non-traditional
perks, such as increased paid leave and telecommuting options.
In the current workplace environment where employees are likely to jump
to new jobs every couple of years, managers need to take a more active
and engaged approach to supervising employees and perhaps changing
the way they think about loyalty, which may be difficult for managers who
are used to supervising the same group of employees for a long period.
Engaging employees on a regular basis, setting realistic expectations and
identifying specific development paths may help retain key employees.
Thanks to today’s tight labour market, some employees feel empowered
to demand more from their employer and its overall culture via strategies
such as increased flexibility, transparency and fairness. This increased
importance of the employee’s role in the business's culture helps workers
to stay engaged in the mission of the business and perhaps makes it less
likely that they would look elsewhere for employment.
Finally, rapidly changing technology used in today’s workplace continues
to shift the learning and development component of the employer–
employee contract, causing immense challenges to both business and
workers. It may be more difficult to identify the employee skills that
will be critical over the next several years, causing employers either to
improve the training of current workers or to look outside the business
for other individuals who already possess the technical skills needed to
get the job done.
5.5.3 Global social responsibility
When expanding into global markets, South African businesses must take
their policies on corporate social responsibility with them. As a citizen of
several countries, a South African business operating abroad has several
responsibilities. These include respecting local practices and customs,
ensuring that there is harmony between the business's staff and the host
population, providing management leadership and developing a solid
group of local managers who will be an asset to their community. When a
South African business operating abroad makes an investment in a
foreign country, it should commit to a long-term relationship which means
involving all stakeholders in the host country in decision-making. Finally, a
responsible South African business operating abroad will implement CSR
policies and guidelines within the business in the host country. By fulfilling
these responsibilities, the business will foster respect for both local and
international laws. A South African business operating abroad must often
balance conflicting interests of stakeholders when making decisions on
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social responsibilities, especially in the area of human rights. Questions
involving child labour, forced labour, minimum wages and workplace
safety can be particularly difficult.
Activity 5.3
1 hour
2. Describe strategic giving.
3. Describe what role employees play in improving their job security.
Feedback
In your answer, you should describe the concept of strategic giving and the role that
employees play in improving job security.
CONCLUSION
In this lesson, we focused on corporate social responsibility (CSR). We began our
discussion with an overview of the concept of CSR which was also discussed in
great depth when we explored how businesses meet their social responsibilities to
various stakeholders. Furthermore, we discussed some trends in CSR.
SELF-ASSESSMENT
2 hours
If you can respond to this self-assessment, then you have achieved the outcomes of
this lesson.
13. Explain what corporate social responsibility entails.
14. Discuss how businesses meet their social responsibility to various stakeholder.
15. Describe the key trends in corporate social responsibility.
Attributes
Rice University. 2018. Introduction to business. Houston, Texas: OpenStax.
Licensed
with
CC
BY
4.0
Download
for
free
at
https://openstax.org/details/books/introduction-business
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LESSON 6
BUSINESS ETHICS
Overview
In lesson 5, we discussed corporate social responsibility (CSR). We looked at the
overview of the concept of CSR which was discussed in great depth when we
explored how businesses meet their social responsibilities to various stakeholders.
We also discussed some trends in CSR.
In this lesson, we are going to focus on business ethics. We begin our discussion
with an overview of the concept of business ethics. Business ethics is also discussed
in great depth when we explore ethical issues encountered in a business
environment. Furthermore, we discuss how to identify ethical businesses.
This lesson is structured, as depicted in figure 6.1 below, to help you grasp the
learning outcomes of this lesson.
Figure 6.1: Structure of lesson 6
Operating ethically is in the best interests of any business. Ethical businesses are better at
attracting and keeping customers, talented employees and investments. Those businesses
tainted by questionable ethics suffer from diminishing customer bases, a high employee
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turnover and investor mistrust. As you will see in this lesson, business ethics is an important
discipline in a business and shapes its sustainability. However, to learn how to apply the
content of this lesson, you must work through all the activities step by step. With the
knowledge gained, you will be able to apply adequate knowledge and skills to manage a
sustainable business.
6.1 Learning outcomes
At the end of this lesson, you will be able to:
• Explain what business ethics entails.
• Discuss ethical issues that might be encountered in a business.
• Discuss how to identify ethical businesses.
6.2 Key concepts
As you go through this lesson, you will come across and learn about the
following terms and concepts:
ethical, sexual harassment, workplace diversity, conflict of interest
6.3.1 What is business ethics?
You probably already know what it means to be ethical: to know right from
wrong and to know when you are acting unethically. Business ethics may be
defined as the application of ethical behaviour in a business context. In
business, acting ethically entails more than merely following all the relevant
rules and regulations: It also entails being truthful; not harming others;
competing fairly and refusing to prioritise your personal interests over those of
your business, its owners and employees. If you are in business, you
obviously need a strong sense of what is right and what is wrong. You must
have personal conviction to do what is right, even if it is difficult or personally
unfavourable. In an ideal world, prison sentences, large fines and civil actions
would deter business misbehaviour, but many experts believe that this
assumption is overly optimistic. Whatever the state of the ethical environment
in the near future, one thing is certain, the next generation of businesspeople,
which includes most of you, will join a world that is vastly different from the
one the previous generation was living in. For example, consider cyberethics
and how user behaviour and artificial intelligence may affect people and
society.
Recent history demonstrates that today's business owners require a far better
knowledge of what is ethically acceptable and what is not. One of your main
responsibilities, as a future business owner, is to understand how to detect
and deal with ethical dilemmas. When asked what he looked for in a new hire,
Warren Buffett, CEO of Berkshire Hathaway and one of the world’s most
successful investors, replied: “I look for three things. The first is personal
integrity, the second is intelligence, and the third is a high energy level.” He
paused and then added, “But if you don’t have the first, the second two don’t
matter.”
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6.3.2 Ethical issues encountered in a business
Ethical issues are the difficult social questions that involve some level of
controversy over what is the right thing to do. Environmental protection is an
example of a commonly discussed ethical issue because there can be tradeoffs between environmental and economic factors. Make no mistake, when
entering the business world, you will be confronted with circumstances in
which you must pick the proper course of action. You will be confronted with
answering questions like the following?
•
•
•
•
Is it acceptable to accept a pair of sports tickets from a supplier?
Can I buy office supplies from my brother-in-law?
Is it appropriate to donate company funds to a local charity?
If I find out that a friend is about to be fired, can I warn her?
Obviously, there are many different types of scenarios. Fortunately, we can
break them down into a few basic categories: issues of honesty and integrity,
conflicts of interest and loyalty, bribes versus gifts and whistleblowing. Let us
take a closer look at each of these categories.
a) Issues of honesty and integrity
Master investor, Warren Buffet, once told a group of business students the
following: “I cannot tell you that honesty is the best policy. I can’t tell you
that if you behave with perfect honesty and integrity somebody
somewhere won’t behave the other way and make more money. But
honesty is a good policy. You’ll do fine, you’ll sleep well at night, and you’ll
feel good about the example you are setting for your co-workers and the
other people who care about you.” If you work for a company that settles for
its employees’ merely obeying the law and following a few internal
regulations, you might think about moving on. If you are asked to deceive
customers about the quality or value of your product, you are in an ethically
unhealthy environment.
b) Conflicts of interest
Individuals face conflicts of interest when they must choose between acts
that promote their own personal interests above the interests of others and
actions that do not. When an employee's personal interests are in conflict
with or have the potential to be in conflict with the best interests of the
business's stakeholders (management, customers and owners), a conflict
may arise.
Let us say that you work for a business with a contract to cater for events at
your college and that your uncle owns a local bakery. Obviously, this
situation could create a conflict of interest (or at least give the appearance
of one, which is a 'problem in itself). When you are called on to provide
desserts for a luncheon, you might be tempted to send some business your
uncle’s way, even if it is not in the best interest of your employer. What
should you do? You should disclose the connection to your boss, who can
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then arrange things in such a manner that your personal interests are not in
conflict with that of the business.
A similar principle holds that an employee must not use private information
about an employer for personal financial benefit. Assume you learned from
a colleague at your pharmaceutical business that one of your business’s
most profitable products would be withdrawn from the market due to
serious side effects. The business financial performance would be
negatively affected as a result of the recall, and its stock price would
collapse. You then sell all your shares in the business before the news
becomes public. What you have done is called insider trading, acting on
information that is not available to the general public, either by trading on
the information or providing the information to others who trade in it. Insider
trading is illegal, and you could go to jail for it.
c) Conflicts of loyalty
You may find yourself in a situation where you must choose between being
loyal to your employer or a friend or family member. Let's say you just
learned that a colleague, a friend of yours, is about to be retrenched from
his job. You also happen to know that he and his wife are getting ready to
make a deposit on a house near the offices where he works. From a work
standpoint, you know that you should not divulge the information. From a
friendship standpoint, though, you feel it is your duty to tell your friend. So,
what do you do? As tempting as it is to be loyal to your friend, you should
not tell. As an employee, your primary responsibility is to your employer.
You might be able to soften your dilemma by convincing a manager with
the appropriate authority to tell your friend the bad news before he puts
down his deposit.
d) Bribes versus gifts
It is not uncommon in business to give and receive small gifts of
appreciation, but when is a gift unacceptable? When is it really a bribe?
There is often a fine line between a gift and a bribe. The following
information may help you to draw a line because it raises key issues in
determining how a gesture should be interpreted: the cost of the item; the
timing of the gift; the type of gift and the connection between the giver
and the receiver. If you are on the receiving end, it is a good idea to refuse
any item that is overly generous or given for the purpose of influencing a
decision. Because accepting even small gifts may violate your business's
rules, always check the business policy.
Google’s Code of Conduct, for instance, has an entire section on avoiding
conflicts of interest. They outline where these conflicts might occur such as
accepting gifts, personal investments and outside employment and provide
guidelines: “In each of these situations, the rule is the same, if you are
considering entering into a business situation that creates a conflict of
interest, don’t. If you are in a business situation that may create a conflict of
interest, or the appearance of a conflict of interest, review the situation with
your manager and Ethics & Compliance.”
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e) Whistleblowing
Whistleblowing is an act by any individual of exposing illegal or unethical
behaviour. Whistleblowing is not easy, and it takes courage to expose
people who are committing illegal or unethical behaviour in a business. As
a result of whistleblowing actions, managers may be able to curtail
wrongdoing in the business. Although whistleblowing is the right thing to do,
the experience might not be gratifying. Many people may applaud the
action, but many colleagues may shun the whistle-blower blaming him or
her for causing trouble in the business. Whistleblowing is sometimes career
suicide. Whistle-blowers often get fired for blowing the whistle. Even those
who keep their jobs can experience repercussions. As long as they stay,
some will treat them like skunks at a picnic. If they leave their jobs, they
may be blackballed in the industry.
Activity 6.1
1 Hour
9. Define business ethics.
10. Explain how people in business are often confronted with ethical issues, using
ethical categories.
Feedback
In your answer, you should define business ethics and how people confront ethical
issues.
5.4 How to identify ethical businesses
A primary goal of any business should be to foster ethical behaviour in the
business environment. However, the question: How do we know when a
business is behaving ethically? comes up. The following requirements are
found in most lists of ethical business activities:
• Treat employees, customers, investors and the public fairly.
• Hold every member personally accountable for his or her activity.
• Communicate core values and principles to all members.
• Demand and reward integrity from all members in all situations.
By contrast, employees with the following intuitions tend to suspect that their
employers are not as ethical as they should be:
• They consistently feel uneasy about the work they do.
• They object to the way they are being treated.
• They are uncomfortable with the way in which colleagues are being treated.
• They question the appropriateness of management directives and policies.
In common practice, many businesses use policies to promote ethical
behaviours and to guard against, or prevent, unethical behaviours. Some
policies found in businesses today include the following:
a) Sexual Harassment Policy
Sexual harassment occurs when an employee makes “unwelcome sexual
advances, requests for sexual favours, and other verbal or physical conduct
of a sexual nature” to another employee. “[S]ubmission to or rejection of
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this conduct explicitly or implicitly affects an individual’s employment,
unreasonably interferes with an individual’s work performance or creates an
intimidating, hostile or offensive work environment” is also considered as
sexual harassment.
Ethical businesses prevent sexual harassment or at least minimise its
likelihood by adopting a formal anti-harassment policy; describing prohibited
conduct; asserting its objections to the behaviour and detailing penalties for
violating the policy.
b) Workforce diversity
In addition to complying with equal employment opportunity laws, many
businesses make special efforts to recruit employees who are
underrepresented in the workforce in terms of sex, race or some other
characteristics. Initiatives, like helping to build more diverse workforces,
contribute to competitive advantage for two reasons:
• People from diverse backgrounds bring new talents and fresh
perspectives to a business, typically enhancing creativity in the
development of new products.
• By reflecting the demographics of the marketplace more accurately, a
diverse workforce improves a business's ability to serve an ethnically
diverse population.
Activity 6.2
1 hour
6. Discuss two policies commonly used to promote ethical behaviours and to guard
against or prevent unethical behaviours.
Feedback
In your answer, you should discuss policies used to promote ethical behaviours and
prevent unethical behaviours.
CONCLUSION
In this lesson, we focused on business ethics. We began our discussion with an
overview of the concept of business ethics. Business ethics was also discussed in
great depth when we explored ethical issues encountered in a business
environment. Furthermore, we discussed how to identify ethical businesses.
SELF-ASSESSMENT
2 hours
If you can respond to this self-assessment, you have achieved the outcomes of this
lesson.
16. Explain what business ethics entails.
17. Discuss ethical issues that might be encountered in a business.
18. Describe how to identify ethical businesses.
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Attributes
Skripak, Stephen & Poff, Ron. 2020 Fundamentals of Business, 3rd edition.
Blacksburg, VA: Pamplin College of Business in association with Virginia Tech
Publishing. CC BY NC SA 4.0. https://doi.org/10.21061/fundamentalsofbusiness3e
(Chapter 4)
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