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CHAPTER O N E
What is Business Management?
Andreas de Beer
Learning objectives
When you have completed this chapter you should be able to:
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explain the relationship between business management and economics;
identify the factors of production;
discuss the role of the entrepreneur in the establishment of the business;
analyse the factors that influence the choice of establishment;
determine the optimal place of establishment;
distinguish between the different business environments;
discuss the characteristics of the business environment;
identify the different variables in the micro-environment;
explain the different variables in the market environment; and
describe the different variables in the macro-environment.
1.1 Introduction
What is business management and what is the key focus of business
management? The answer to this question is embedded in the free market
system principle. In countries that function according to the free market
system, business plays a key role in the satisfaction of our multiple human
needs. However, it is important to recognise that South Africa has a mixed
market system, in other words a combination of a free market system and
a government control (command) system. A mixed system does not imply
a single combination of government control and the market instrument. In
some countries the government plays a major role, while other countries rely
more heavily on the market instrument.
Management, or the entrepreneur in the case of a business, must combine
the correct portions of the factors of production (entrepreneurship, natural
resources, labour and capital) available to them to ensure the effectiveness
and efficiency of the business, to make a profit and to satisfy society’s
multiple needs.
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1.2 The scientific framework of business management
Business management is a particular form of science. Any science must have an
object of research in the pre-scientific environment. This object of research is
a precondition for the systematisation of scientific insights. In this regard, two
questions arise. The first question addresses what is to be observed and studied,
and the second from which viewpoint the observation and study will be done.
The problem statement of business management is to maximise productivity.
The business, therefore, is the study object of business management research,
which means that business management is a systematic assimilation of
scientific insight with the objective of maximising rate of return.
Business management can be described as a science that concerns itself
with our profit-oriented market system by studying what a business is, how to
establish the business and manage it in an effective and efficient way to ensure
the highest profit for the business.
1.2.1 The relationship between business management and
economics
When looking at the problem statement of business management and
economics, these disciplines initially seem to be one and the same – studies of
those economic activities that satisfy human needs. However, when looking
at these two sciences it will be noticed that their objectives are different.
As already indicated, the objective of business management is profit, or
maximising the rate of return, whilst the objective of economics is need
satisfaction in general.
The study object of economics focuses on economic occurrence in the
national economy as a whole. By contrast, the study objective of business
management is a much smaller field, focusing on what a business is, and how
to establish and manage it in an effective and efficient way to ensure the
highest profit.
It is clear that, although business management has developed from economics
and accountancy, it has its own problem statement and study objective.
1.3 Factors of production: methods to satisfy people’s multiple
needs
The follow following factors of production can be identified.
1.3.1
Natural resources
Natural resources refer to all the means provided by nature. A characteristic of
natural resources is that they are scarce and limited. Examples include crude
oil, water, minerals, etc.
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Chapter One – What is Business Management?
1.3.2
Capital
During its establishment a business needs capital to start to operate. The
capital is used to produce other goods for purchase by consumers. Normally,
this capital is funded by the owners and investors who invest their money in
the business.
1.3.3 Labour
No business can function without people. Labour refers to all the physical and
mental human effort applied in producing goods and services. Humans have
the knowledge (technical and academic), physical capabilities and skills to
transform goods into products, provide a service and take leadership.
1.3.4
Entrepreneurship
Entrepreneurship is the process through which the individual takes capital,
labour and natural resources and combines them with the risk linked with the
provision of goods and services. Therefore the entrepreneur can be described
as the person who brings all the factors of production together and organises
them into a system that produces goods and renders services.
1.3.5
Knowledge
Traditionally, only four factors of production were identified. However, Peter
Drucker1 added a fifth factor of production: knowledge. Knowledge as a fifth
factor of production is embedded in the era of knowledge management.
Knowledge management refers to the process of discovering and harnessing
a business’s intellectual resources, or utilising the intellect of the people who
work for the business.
Information technology has revolutionised businesses, making it possible
to determine wants and needs quickly, and to respond with the desired goods
and services. The economic motive is the satisfaction of society’s multiple
needs with goods and services. The highest possible satisfaction of such needs
with scarce factors of production is known as the economic principle.
1.4 Entrepreneurship and business
The production factor of entrepreneurship in the South African economic
context is a pivot around which the economic system rotates. The importance
of entrepreneurship has been widely recognised in South Africa. The
government has made enormous efforts to identify entrepreneurs, provide
them with capital, stimulate their businesses, assist their development, and
generally make it easier for them to enter business. The entrepreneur can be
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described as a person using his or her talents and abilities, taking initiative
in acquiring capital and natural resources, and combining them with the
necessary management to convert an original idea into a business.
1.4.1 The role of the entrepreneur in the establishment of the
business
One of the most important decisions an entrepreneur must make is to determine
the physical location of the business. Each business has its own ideal place of
establishment, and each place of establishment has its own cost and income
considerations through which the input-output ratio of the business can be
quantified.
The place of establishment must be able to contribute to the optimal
performance of the business because all businesses function according to
the principle of economy. The decision on where to establish the business
is extremely important if the entrepreneur wishes to make a success of the
business. It cannot be based merely on whim or made haphazardly. The
entrepreneur must first consider and evaluate certain factors thoroughly before
he or she can decide on the best location for the business.
The place of establishment can be defined as the specific place or premises
where the business is established; it is chosen so that the resources and activities
of the business can be fully utilised to ensure the highest profitability in the
long term.
1.4.2 Common factors that influence the choice of establishment
1.4.2.1
The market
The market plays a very important role for most businesses. When the
entrepreneur decides on the establishment of a business, he or she must
take into consideration all the factors affecting turnover (in other words, the
interaction between the population composition, productivity and economic
opportunities) together with the current and potential competition.
1.4.2.2
Raw materials
In the past few years, improved exploitation, processing and transporting
methods have reduced the importance of raw materials as a factor influencing
the proposed place of establishment, and have conversely increased the
importance of a good marketing location.
Raw materials are divided into two categories: natural raw materials (for
example, mining and fishing products) and raw materials that occur naturally,
but are cultivated (for example, agricultural and forestry products).
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Chapter One – What is Business Management?
South Africa has a very large variety of raw materials of which its mineral
resources are one of the most important sources of income. In earlier years,
cultivated products, especially in the agricultural sector, played an important
role in the country’s economy.
1.4.2.3
Availability of labour
For the business to function efficiently, it is important that the quality of labour
is of a high standard. In general, skilled labour is found in the urban areas, while
the rural areas have more unskilled labour. Labour costs differ significantly from
urban to rural areas. The entrepreneur must make sure there is enough skilled and
unskilled labour in the area in which he or she wishes to establish the business.
1.4.2.4 Capital
In most cases, capital does not play a decisive role in the establishment decision.
It is necessary, however, to acquire capital at favourable interest rates, should
it be borrowed. In certain locations, for example rural areas, it may be more
difficult to acquire capital under favourable loan conditions.
In most cases, larger businesses have an advantage over smaller ones in that
they have easier access to the national and international capital markets.
1.4.2.5
Infrastructure
Infrastructure refers to the services and facilities essential to production, but
which contribute little or nothing concrete to it. The following factors create an
adequate infrastructure for the manufacture of a product.
Transport of raw materials
The role of transport of raw materials to and from factories and of products to
and from the market is very important for the entrepreneur. The high fuel price,
as a cost factor, will have a huge influence on the profitability of the business,
and therefore influence the entrepreneur in his or her decision-making process
regarding the choice of location. Transporting and delivering products and
providing services regularly, promptly and safely are in the best interests of
the business. A good water, road, railway, pipe or air transport network (each
has its own particular advantage) is extremely important to a business and
must be taken into account when decisions are made about suitable places of
establishment. A good transport system provides an industrialist with greater
freedom of choice regarding the place of establishment.
The entrepreneur, therefore, should thoroughly investigate and evaluate the
availability of existing transport facilities and their accompanying costs before
he or she establishes a business.
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Water supply
South Africa is a country with limited water resources. Each business uses
water for various reasons. For example, it is used as a raw material in soft-drink
factories; to generate electricity in power stations; for cooling in ironworks; for
washing purposes in canning factories and wool-scouring mills; as a processing
agent in paper and pulp factories, and as a medium of transport for solids in
pipelines. The availability of water to meet the needs of a business will influence
the entrepreneur’s choice of a location.
Parking space
It is very important to have sufficient parking space available for employees,
delivery vehicles and customers. Customers, particularly, will be put off if
there is insufficient convenient parking close by, or if the parking area and
the pedestrian crossings are unsafe. The entrepreneur should consider parking
space as a factor in his or her location decision.
Power
The availability of power plays an important role, especially in highly
mechanised businesses. It should be readily available, cheap and reliable
– whether it involves hydroelectric power, steam power or electricity. The
entrepreneur should investigate whether Eskom is the only provider of power
in the area, or if there are alternative providers.
Fuel is another factor that should be kept in mind, especially for heavy
industries such as iron smelting and petrochemical plants that may need to
generate their own electricity.
The existing business environment
The existing business environment can influence the establishment of a
planned business if it can supply services to the business, for example repair
and maintenance services or product components. The presence of already
established businesses that may be supplementary to the new business will
make the location more appealing to the entrepreneur.
1.4.2.6 Climate
Here, we distinguish between direct and indirect influences. When the climate
does not influence the production process directly it has an indirect influence.
This is reflected in the population concentrations in areas with favourable
climatic conditions.
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Where the climate intrinsically affects the product or production process, we
say that there is a direct influence, for example in the spinning and weaving
industry, where a damp climate is necessary for the spinning process, as the
yarn breaks if the air is too dry. And, of course, climate is a crucial factor for the
cultivation of agricultural crops.
1.4.2.7
Government intervention
In South Africa we are trying to attain a free market economic system in which
state interference and control is limited and the market forces of supply and
demand can prevail. The state may not prescribe to the entrepreneur what,
how, or how much of a product may be produced. The state’s role should be
exclusively a supportive one. Exceptions do occur, however, for example when
the state has to intervene for economic or strategic reasons.
1.4.2.8
Political stability
Political stability plays a significant role in the productivity of a successful
business, as it directly influences its profitability. Regions plagued by political
unrest and violence are unfavourable climates in which to establish businesses.
Political strife on national and local government levels and disruptive union
activities are counter-productive for businesses, and will have a negative
influence on the entrepreneur’s decision to establish businesses in such areas.
1.4.2.9
Available industrial premises
There are many factors that influence the choice of specific premises for a
business. The factors that should be carefully considered by the entrepreneur
include:
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property prices;
level land;
room for expansion;
sufficient water, light and power;
available transport networks;
absence of harmful and competitive businesses;
availability of workers; and
an attractive business environment.
1.4.2.10
Personal considerations
Small business entrepreneurs often decide to establish their businesses
close to where they know the people in the area. In such cases, personal
considerations carry more weight than economic ones. In many cases, factors
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Business Management: A Contemporary Approach
such as recreational facilities, scenery, educational facilities for children
and a preference for a specific town or city may carry more weight than the
maximisation of profit.
1.4.2.11
Characteristics of the product
The characteristics of a product may influence the location decision. Some of
the decisive factors include:
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perishability of the product;
mass and volume of the product;
size of the product;
pollution risks associated with the exploitation of the product;
production process; and
how the product will be transported.
1.4.2.12
The social environment
A business cannot be profitable if the employees are not productive and
effective, and their families are unhappy. The entrepreneur must, therefore,
take into account social factors that may affect the welfare of the families of
their employees. These include, for example, the proximity of housing, schools,
medical, recreational and shopping facilities.
1.4.3 Determining the optimal place of establishment
After the entrepreneur has weighed up all the factors that influence the choice of
a place of establishment, alternative places of establishment should be reviewed
on the basis of the general criteria. By comparing these different evaluations
he or she can then choose the optimal place of establishment. In other words,
the choice of location would be determined by where the biggest difference
between income and expenditure would occur in the long term.
It may sound easy to determine the optimal place of establishment, but the
critical factors influencing the establishment of a business differ from business
to business. The following steps may help to determine the optimal place of
establishment.
Step 1: Assign each establishment factor a weight, depending on its importance
to a specific business. In other words, arrange the establishment factors
from one to however many factors you have identified. Label the factor
that will have the greatest influence on the place of establishment as
one, the next most important as two, and so on. In the food industry,
for example, the proximity of the market is very important because
food can deteriorate if it does not reach the consumer immediately.
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Chapter One – What is Business Management?
Next in importance is the proximity of raw materials. Take bread, for
example.
Firstly, it is important for the bakery to be near the market, as bread
should be delivered as fresh as possible. Secondly, the proximity of the
raw material (namely flour) is very important, because without flour
the bread cannot be produced. The availability of labour is not quite
as important a priority, because the food industry has become very
mechanised.
Step 2: Calculate, as far as possible, the quantifiable cost and amounts for each
establishment factor of each place of establishment.
Step 3: Allocate points on a sliding scale to the non-quantifiable establishment
factors of the different places of establishment.
Step 4: Draw up a list of the information collected.
Step 5: Determine the disadvantages associated with each place of
establishment.
The information gathered from these steps should give an indication of the
optimal place of establishment.
1.5 The business management cycle
To understand the existence and development of the modern business world it
is necessary to outline the origin of, and reason for, the business management
cycle. Refer back to the problem statement of business management, namely
a study of all those economic activities that involve the provision of people’s
maximum needs satisfaction. According to the problem statement of business
management, the business management cycle starts with the consumer. The
consumer has certain needs, which are identified by the entrepreneur. The
entrepreneur will establish his or her business and, by using the production
factors, produce goods or provide a service. In return for this product or service
the consumer will pay the business, which makes a profit for the benefit of the
entrepreneur. Consequently, the business delivers the product or services to the
consumer and satisfies his or her need.
The following example explains this principle. Every day, business takes
place in South Africa. Every day, people are involved in business activities.
Every day, each of us will likely buy bread, milk, cool drinks, sweets, or other
forms of food from a business. An example of an everyday business activity
in which we are involved, is buying bread. Let us unravel all the business
activities involved in getting the bread to the consumer.
This process starts off with the farmer. The farmer buys seed from an
agricultural supplier and plants it. When the supplier sells the seed to the
farmer the main purpose is to make a profit.
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To plant the seed the farmer needs petrol or diesel for his tractor, which he or
she buys from a garage. The main purpose of the garage is to make a profit.
The farmer plants the seed and, when the time is right, harvests the wheat
and sells it to the flour mill. Farming is also a business so the farmer will want
to make a profit on the wheat sold to the mill.
The mill transforms the wheat into flour that is ready to be used, and sells
it to different businesses that will buy it. The flour mill determines its selling
price by taking into account all the costs. Remember, the flour mill is also a
business and so its aim is to make a profit. Other businesses – bakeries – buy
the flour from the mill and transform it into bread. The baker bakes the bread
and sells it to people who buy it to satisfy their needs.
One part of business management is, therefore, to engage in a conversion
process. In this example, wheat (raw material) is converted into a product to
satisfy one of our multiple needs.
1.6 The business environments
The environment in which a business functions may be defined as the sum
total of all the factors and variables that influence the establishment, growth
and continued existence of the business positively and/or negatively, thereby
promoting or hindering the achievement of the business’s objectives.
The business environment is usually divided into three components, namely
the micro-environment, the market environment, and the macro-environment.
These three business environments each have several variables that influence
the business positively or negatively. The following example contains a
summary of the most important variables in the business environment.
Figure 1.1 on page 12 gives an overall picture of the business environment:
the business is identified as the central point in this diagram.
1.6.1 Characteristics of the business environment
Note the following characteristics.
1.6.1.1
The business environment changes constantly
Factors that influence the business today will not necessarily have the same
influence tomorrow. A good example is the rapid change in technology over
the last few years.
1.6.1.2
The business must be in step with the changing environment
During the past few years, emphasis has increasingly been placed on the
environment so businesses have had to adapt by ensuring their products
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minimise carbon emissions and do not add to ozone depletion. Ozone-friendly
products are now considered the norm, and more and more companies are
marketing carbon neutral products.
1.6.1.3
There are both opportunities and threats in the business environment
Opportunities and threats arise as a result of certain occurrences in the
environment and they influence the functioning of the business. An opportunity
is a favourable situation for the business, whilst a threat may put it out of business.
The business must decide how to react to such opportunities and threats. A new
restaurant opening might pose a threat to other restaurants in the area.
1.6.1.4 The establishment, growth and continued existence of the business are
directly influenced by the business environment
If a business does not take account of the variables in the business environment
that may affect it, it may no longer be able to compete in the marketplace. This
could result in a drastic reduction of the business’s sales, and could lead to its
eventual demise.
1.6.1.5
The business environment influences the future of the business
The continued existence of the business is directly related to its future potential.
Apart from being aware of how the business is currently affected by the
business environment, the management of the business should also consider
how conditions may change in the future, and make adjustments accordingly.
1.6.2 The internal and external environments
1.6.2.1
The internal environment
This is the business itself and is generally described as the micro-business
environment.
1.6.2.2
The external environment
This is the area of the business environment outside the business, which affects
the growth and existence of the business. The external environment consists of
the market and macro-environments.
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Macro-environment
Market environment
Micro- (internal) environment
Figure 1.1: The business environments
1.6.3 The micro-environment
The micro-environment (internal environment) is the sum total of all the
factors and variables that occur internally in the business and are influenced
in a direct or indirect way by the decisions of management. These factors and
variables have a fundamental influence on the establishment, growth and
continued existence of the business.
1.6.3.1 Variables in the micro-environment
Mission statement and goals of the business
This is what the business hopes to achieve and the way in which it can be
achieved. The mission statement and goals of the business must correspond
with the demands of the external environment.
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The business’s functions
These include the general management, operations, purchasing (supply chain),
marketing, financial, administrative, human resources and public relations
functions.
The production factors
Production factors are those resources available to a business. The production
factors or resources include labour, raw materials (natural resources, such
as minerals, timber and water), capital and entrepreneurship. Using these
resources, the business must utilise opportunities or ward off threats in the
external environment. For example, if a business has sufficient capital available,
new markets and new products can be explored. On the other hand, a lack of
capital may constitute a threat to the business because it is placed in a weaker
position in the market.
1.6.3.2 The influence of management on the micro-environment
The management of a business exerts a direct influence on the mission
statement and objectives of the business. Management itself decides where the
business is going and what it will do to get there.
Management decides on the guidelines to which the business’s functions
will be managed. In other words, management decides how human resource
functions will be operated, and how the business will execute its management
function. Management can also decide how the available production factors
should be combined. For example, is the business capital-intensive, as in the
construction industry, or is it labour-intensive as in the case of nurseries and
vegetable farms?
The micro-environment is the heart of a business. It also indicates to what
extent a business is able to utilise opportunities or withstand threats in the
external environment. Although the business can influence the internal
environment by means of decision-making, it does not possess all the internal
resources needed to handle opportunities and threats from the external
environment. This confirms our point of departure that a business cannot
function, grow or survive in a vacuum.
1.6.4 The market environment
The market can be defined as the link between the business and the business
environment in which the business functions. It surrounds the microenvironment.
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The market environment is the sum total of all the factors and/or variables that
exist externally within the business industry and can positively or negatively
influence the growth and existence of the business.
The market environment is surrounded by the macro-environment (see
Figure 1.1). However, the business’s management has little or no influence on
the market environment. It is possible for the business to influence the market
on occasion, for example if the business markets a successful product that is
popular everywhere. The business can also create a need in the market that did
not exist before. A need for cell phones, for example, arose in the marketplace
after they were introduced for the first time. The market environment
therefore does not exist in isolation, but is in fact influenced by both the
micro- and macro-environments. We can explain this interaction by means of
the following examples.
1.6.4.1
How the micro-environment influences the market environment
If one business introduces a new product to the market, for example a cell
phone, this influences consumers. In many cases, the new product is preferred
to existing products on the market (in other words, it is preferred to the products
of competitors).
A business’s credit and collection policy can also influence the consumer in
the market environment. For example, the consumer may prefer to buy from a
business where credit facilities are available in difficult economic times, even if
he or she knows that the prices of the products are inflated to provide for credit
risks (the possibility of bad debts). A consumer may prefer, therefore, to buy
clothes from Edgars rather than Erica Fashions, because Edgars offers credit
facilities, whilst Erica Fashions only sells goods on a cash basis.
The market environment is also influenced by the macro-environment.
During a downward trend in the economy, for example, consumers have less
money to spend on luxury items, which leads to a reduction in the sale of
products such as expensive imported dinner services, clothing and luxury
cars.
The lifting of trade sanctions after 1994, which had been imposed on
South Africa, has made a greater variety of imported products available in the
country. Imported ceramic ware from countries like Italy, Spain and Portugal
is commonly available in chain stores, whereas before 1994, it was available
only at exclusive shops.
The variables in the market environment and the emphasis placed on
certain variables at specific times differ from business to business. However, the
branch of industry in which the business operates dictates, to a large extent,
the influence the market variables will have on the business activities (for
example the shoe industry versus the construction industry). Three variables
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are particular to the market environment, namely the market, the competition
and the suppliers of resources and services.
1.6.4.2 The market
The term ‘market’ refers in an abstract sense to the market, which concerns the
consumer and his or her needs, rather than the physical marketplace.
The business must be geared towards satisfying consumers’ needs, while at
the same time trying to achieve the objective of profitability. A fine balance
between these two objectives is essential, especially in the light of the current
emphasis on marketing-oriented business management. It is important for
the business to handle its market, which is actually the consumer, in the
right way.
Consumers have certain rights in their interaction with the business within
the marketplace. The business must take note of influences originating from
the external environment in order to keep abreast of consumers’ needs.
Institutions like the Consumer Council focus on informing consumers of
their rights, and thus prepare them to approach the marketplace as informed
people. We can summarise the rights of consumers as follows.
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The right to be informed: The consumer is informed in an objective
way about the products and services that are available and the business
must refrain from misleading or harming the consumer by withholding
information about a specific product. For example, the consumer is
entitled to know the ingredients in a tin of food.
The right to exercise personal choice: A variety of products and services
are available on the market, and consumers have the right to decide which
product or service they are going to buy. For example, the consumer has
the right to choose between All Gold and Koo products.
The right to be heard: The business must be geared towards listening and
responding to the complaints and requests of the consumer. For example,
if the consumer complains about the service he or she receives from a
business, the manager should respond to the consumer’s complaint.
The right to protection: Consumers’ safety is important and they should
be protected against unsafe products, for example by the warning on
cigarette boxes that smoking is a health risk.
The business manufactures or buys products and/or provides services with
the idea of selling these to consumers. This refers not only to individual
consumers, but also to other businesses and institutions. However, before
consumers can become active in the market, they must have financial means
(ie money). These financial means are used to acquire the available goods and/
or services in the market. The consumer has to choose between different goods
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and services because he or she has limited financial means. It can also happen,
however, that although the consumer has the necessary financial means, he or
she is not prepared to spend them on the available goods and services in the
market.
From the point of view of a business, it should be noted that the market,
therefore, includes all individuals, groups and institutions who have specific
needs for goods and services and who are prepared to use the available financial
means to acquire them.
Examples of markets
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The market for a retail shop such as Edgars includes all people with a
need for clothing. These people are prepared to spend the money they
have available on these articles. Their activities are, therefore, directed at
satisfying their clothing needs.
The market for South African Airways includes all those with a need to
travel domestically or internationally, and who have the financial means
to pay for the air ticket. These people must, therefore, be prepared to
spend money on an air ticket in order to satisfy a need (to travel).
The market for those manufacturing businesses that do not trade directly
with the general public may include, for example, all wholesalers. In
these cases, the market does not consist of individuals, but of other
businesses. For example, you cannot buy a writing pad directly from
Sappi; you have to obtain it from a retailer who sells stationery. The
retailer, in turn, buys it from its manufacturer, for example Croxley.
From the above examples it is clear that we can identify more than one type
of market.
The consumer market
This market consists of the end-consumers who carry out transactions in order
to buy and consume items, such as clothing, food or cars.
The industrial market
In this market, goods and services are purchased and used for the manufacturing
of products or the provision of services to end-consumers. Croxley, for
example, buys paper from a paper and pulp business, like Sappi, in order to
manufacture writing pads, envelopes and cards. A business such as Discount
Kitchens also utilises the industrial market when it buys pressed-wood panels
from Sappi Novaboard for the manufacturing of kitchen cupboards.
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The resale market
In this market manufactured goods are purchased by businesses or individuals
with the sole purpose of reselling them to individuals or other businesses at a
profit. Pick n Pay, for example, buys canned vegetables and fruit (such as Koo
and All Gold) to sell at a profit to its customers. Another example would be a
material shop that buys curtaining material and woollen cloth from a material
manufacturer in Cape Town to sell it at a profit to the end-consumer.
The international market
International markets exist outside the borders of a country and include all
foreign consumers, manufacturers, retailers and authorities. For example,
if European traders buy South African fruit, these transactions take place
in the international market. In the same way, transactions between South
African mohair farmers and Japanese clothing manufacturers take place in the
international market.
The government market
This refers to the goods and services that are purchased by the various
authorities with a view to providing certain services and carrying out certain
activities. These include purchases made by central government, municipal
authorities and regional services councils. Examples of purchases taking place
in the government market are:
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the purchase of furniture and equipment for use in government
schools;
the payment of salaries of teachers, the police, etc.; and
the purchase of fire-fighting equipment and mobile clinics by municipalities.
1.6.4.3 Competition
The fact that the business does not function in a vacuum has already been
mentioned. Competition is an important variable in this regard. A certain
business, for example, is probably not the only one to offer a specific product
or service to the customer. There are various businesses that compete with one
another to sell the same product or service to the same consumers.
Competition, therefore, boils down to the fact that each business tries to
convince a consumer that its products and services are the best, and that the
consumer should buy products and acquire services from that business. One
only has to consider the large number of businesses that manufacture and
sell cars. The consumer may choose which product to buy and from whom to
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Business Management: A Contemporary Approach
buy it. The choice between different products is indicative of the presence of
competition in the market.
The business must take full account of the influence and force of competition
in the business environment, because the actions of competitors may constitute
definite threats to the business. For example, a business may make a loss if the
demand for a product declines. Here we can refer to the example of video
machines, music tapes and vinyl records. Businesses are continually forced to
make adjustments, including strategic adjustments, to counteract the threats
of competitors. It is, therefore, fundamentally important to be informed about
competitors in the external business environment. Each business must know
who its competitors are, where they are situated, their geographic distribution,
the products they offer the market, the quality of the products, the specific
markets they serve, what their share of the market is, their financial resources
and their general image in the marketplace.
Businesses try to influence consumers in various ways so that they prefer
their products and services to those of competitors. This is one of the reasons
why businesses advertise their products and services to persuade the consumer
to buy their product.
Over and above the fact that businesses compete with one another’s
products and services, we can also distinguish between the following types of
competition.
Competition between the needs of consumers
A person may go to a new shopping complex prepared to spend a certain
amount of money. The person considers either buying new clothes or having
something to eat in the shopping centre. This is called competition for the
limited disposable income of the consumer.
Competition between the ways that a need can be satisfied
Suppose a person is cold sitting at their desk working. They have a need to
be warm. They can satisfy their need by buying a heater, buying a hot water
bottle, insulating the room, or buying warm clothes.
Competition between product forms
A person who wants to buy new clothes can choose between different kinds of
clothes to satisfy their clothing needs. For example, they can choose between
formal clothes (a suit), casual wear (jeans, a jersey or leather jacket) and
sportswear (running pants).
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Competition between different trademarks
The consumer decides to buy a suit and must now choose from trademarks,
such as Daisy Style, Jigsaw Clothing and Rochelle Mawona.
1.6.4.4 Suppliers of resources and services
A business decides for itself which products it is going to manufacture and
market, and in what quantities, and how much capital will be invested in
the specific projects. However, the business remains dependent on certain
institutions in the external environment in order to commence and continue
its activities. The business does not necessarily have the raw materials to
manufacture its products, and therefore uses the products or services of other
businesses and individuals in the external business environment to carry out
its activities. Consider the following examples.
Examples of resource and service suppliers
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A manufacturing business buys land and resources from other businesses
in the interests of further development. A commercial business will
purchase products such as toiletries, beauty products and cereals from
suppliers in order to resell them to various chain stores.
Businesses need resources, such as electricity, water and communication
services. These services are purchased from suppliers in the external
business environment. Electricity, for example, is obtained from Eskom,
and communication services from Telkom, at a specific rate.
It is almost impossible to run a business without the help of financial
institutions such as commercial banks and the stock exchange. It is
important for the business to have access to external sources of capital
for acquiring long- and short-term capital. Here, one can cite commercial
banks that make loans available over different periods. In the case of a
public company, the JSE constitutes an external source of capital.
The business must have labour to be able to function properly. Labour is
obtained from the external business environment. Pick n Pay, for example,
employs people in a wide variety of posts (including store managers, sales
staff and cashiers). When vacancies occur, the posts are advertised in the
open labour market, which is part of the external environment.
The business uses intermediaries to make products available to the target
market/s. For example, a manufacturing business may sell its products to
a wholesaler (an intermediary) who, in turn, sells them to a retailer (an
intermediary). The retailer then sells the product to the end-consumer.
In the same way, the business makes use of an advertising agency (an
intermediary) to advertise its products.
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1.6.5 The macro-environment
The macro-environment surrounds the business and its marketing environment.
It is made up of a wide variety of variables that can affect the business either
positively or negatively.
The macro-environment consists of all the variables and factors outside the
business that have a positive or negative influence on the growth and continued
existence of the business, and that encourage or hinder the achievement of
objectives.
The individual business has no control over this environment or the
variables that operate within it. For example, a business has no control over a
rise in interest rates or a change in the exchange rate. The macro-environment,
therefore, influences all businesses, even the competitors of the individual
business.
The constitution of the macro-environment is characterised by the existence
of a number of sub-environments that cannot be controlled by the business
but that can exert a significant influence over it. These sub-environments
may also be described as variables or forces in the macro-environment. Here
we refer to economic, socio-cultural, political and statutory, technological,
physical and international influences and forces.
These sub-environments influence one another to the extent that they
cannot be regarded as being distinct from one another. The effect that these
sub-environments have on a business differs from business to business, and
from time to time. At a specific time, for example, the economic environment
where interest rates are very high (which influences the availability of external
capital) may constitute a much greater influence than variables operating in
the technological area.
Each sub-environment is characterised by various factors peculiar to that
environment. When we talk about the economic environment of services, for
example, we immediately think of interest rates, upward or downward trends
in the economy and the growth rate of the country.
We will now briefly discuss each of the sub-environments already identified,
and illustrate the variables of each with the aid of examples.
1.6.5.1 The economic environment
The economic environment is that part of the macro-environment consisting
of factors that influence the personal disposable income of consumers as well
as their purchasing behaviour. (The term ‘consumer’ is used here in its widest
sense: it also includes other businesses.) Consumers have limited financial
means to satisfy all their needs, and are therefore forced to make choices.
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The consumer’s disposable income is influenced by many economic factors, for
example interest and exchange rates, inflation, trade cycles and the economic
growth rate.
Interest rates
An interest rate is an indication of the price at which money can be bought,
in other words the price at which money is available on the money and capital
markets. If the interest rate is 20% per annum for a long-term loan of R100 000,
this means that the borrower must pay R20 000 per year (20/100 × R100 000)
to secure the loan of R100 000. This is the price that borrowers must pay for the
money they wish to borrow.
A rise in interest rates usually results in a decrease in spending. If someone
does not have the money to buy a new car, for example, they will have to
pay more to borrow the money and, ultimately, more to buy the car. Suppose
the buyer buys a car through hire purchase financing, and interest rates
subsequently rise. This means that the buyer’s monthly instalments will also
increase so they will pay even more for the vehicle. The bond on a home loan
works in the same way. As soon as the interest rates rise, so do the monthly
loan instalments. The opposite may also be true.
Inflation
Inflation results in a continual rise in the prices of products and services. This
has a depressing effect on the economy because the purchasing power of the
Rand, and therefore that of the consumer, decreases as inflation rises. The
consumer buys fewer products for the same amount because the value of the
money has decreased as a result of inflation. Since the late seventies, South
Africa has continually had to deal with the negative effect of inflation. For
many years, the economy has had to contend with double inflation figures. The
influence of inflation is clear from the following examples. In 1980, we paid
30c for a loaf of white bread. Today, we pay R10.50 for the same loaf of bread.
In 1980, we paid 76c for a dozen eggs; in 1985, we paid R1.31 and today, we pay
R39.55.
Trade cycles
All economies are subject to certain cyclical changes. During the trade cycle,
different phases in the economy can be distinguished, namely a period of
prosperity, followed by a period of recession and depression and then a period
of recovery. A business should always take note of the phase through which the
economy is moving, as this influences the management, growth and continued
existence of the business. Each phase makes its own demands on the business:
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„„
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During a phase of prosperity in the economy, the business (the marketing
and operations divisions) has the opportunity to manufacture and market
new products. The business, therefore, has the opportunity to explore
new markets and to expand its current market share.
During a recession, consumers’ disposable incomes are less than during
a phase of prosperity so they buy less. This has a direct influence on
the demand for products and services and, therefore, on the growth of a
business.
During the recovery phase, the business must prepare itself for the economic
growth that will take place and should, for example, pay attention to
personnel training programmes, new product development and ways to
increase sales and income.
1.6.5.2 The social environment
This environment is linked to the demographics of the market and the social
and cultural aspects that may influence the market. One can distinguish
between the following demographic variables.
Size and composition of the population
Population growth
The size and composition of the market are directly influenced by the
population growth of the country. With regard to population growth and
composition, it is important to bear in mind that families have grown
smaller over the past few decades. Some countries in Europe now have a
negative growth rate.
„„
Market composition
The composition of the market in terms of different ethnic groups is
another variable that must be taken into consideration by the enterprise.
Different population groups have distinctive cultures and lifestyles that
may translate into different needs and preferences – and hence new
markets that enterprises cannot afford to ignore.
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The changing role of women
The market is influenced today by the larger percentage of women working
in the labour market than previously. The role of women in the labour
market has also changed drastically over the last few decades. Increasing
numbers of women are employed in senior management positions, so new
needs have been created in the market, for example the establishment of
crèches and nursery schools. This has also resulted in a larger disposable
income for families.
The type of product that the working woman buys may also differ from
that bought by home-makers. The clothing needs of a woman in the
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labour market differ from those of a housewife, and the working woman
may also prefer to buy ready-made foods.
Life expectancy
Life expectancy has increased as a result of better medical services and
healthier lifestyles. This has a direct influence on the market, as many people
in our society are over 60 and represent definite marketing opportunities.
For example, in the tourist industry there are many opportunities for travel
agents to develop tour packages for this target group.
Geographic location
In South Africa, markets are spread over the entire country. However, the
markets in the metropolitan areas are more concentrated. This means that
larger markets with a wider variety of products and services are found in and
around the cities. Urbanisation and the concomitant depopulation of the rural
areas have a direct influence on the demographic distribution of the market.
Development level of the market
The level of development of the consumer has a direct influence on the enterprise.
In South Africa today, great emphasis is placed on training. Consumers are more
informed as a result of training, which means that they know precisely what
they want and therefore make great demands on enterprises. The consumer is
aware of, and stands up for, his or her rights. In order to continue to exist and
grow, the business has to focus on the needs of consumers.
Changing lifestyles
Consumers today are quality-conscious. In other words, there is a change in
their lifestyles and therefore in their needs. The quality of a product is important
to the consumer. How safe it is to use a particular product and whether that
product is environmentally friendly are important considerations. Here, aspects
such as pollution, carbon emissions, products affecting the ozone layer and
optimal utilisation of scarce resources are in question.
Time
Convenience and time are important to the consumer. Modern consumers do
not wish to spend much time on shopping. Available products should help the
consumer to save time. The laptop computer, used by people to do their work
while they travel from one destination to another, is an example of a product that
allows best use of time. Pre-prepared convenience foods are another example.
A further example is the appearance of successful supermarkets in residential
areas. Someone returning home from work does not want to waste time buying
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milk and bread at large retail stores. The convenience and longer opening
hours of the smaller supermarkets in suburban areas satisfy this need. The
same principle applies to one-stop shopping centres – everything the consumer
wants is available under one roof, for example a bank, grocery shop, clothes
shop, bookseller, etc.
Healthier lifestyles
The current trend towards fitness and a healthier lifestyle is a further force with
which businesses must contend. As a result, there is a greater need for foods
without colouring agents and preservatives. The demand for products linked
to fitness, such as bicycles, running shoes and gym equipment, is now also
greater. This change in the consumer’s lifestyle offers great opportunities to
some enterprises, but it may constitute a threat to others. For example, greater
emphasis is placed on the dangers of smoking, which constitutes a threat to
cigarette manufacturers.
1.6.5.3 The technological environment
The technological environment embraces numerous aspects that give rise to
new products and services being made available on the market. The microwave
oven, today a common convenience appliance in the average household
was unknown to previous generations. This product, which is the result of
technological development, has given many enterprises the opportunity to
develop new products. In the music industry, compact discs made vinyl almost
obsolete, and is now rapidly being replaced by many different ways to transport
and listen to music, including mobile phones and USB storage devices. New
technological developments or improvements create definite opportunities for
the business, but they may also constitute threats. The development of compact
discs means that long-playing records are no longer manufactured. Factories
that used to manufacture the latter have been forced to change their strategies
because of developments on the technological front. Currently record labels
and producers are faced with new opportunities and threats of selling music
through various digital channels. In addition, think of the continual changes
in computer technology and the influence this has on banking, for example.
New technologically improved products are constantly being introduced into the
market.
If a business does not keep abreast of changes taking place on the
technological front, it will soon find that the products it sells are obsolete.
The consumer is not interested in obsolete products. Enterprises that do not
keep abreast of technological change will have to relinquish their share of the
market in the long term. A further influence of the technological environment
on the business is that provision should be made for research and development
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by means of funds allocated for this purpose. Technological changes do not
always result in new products – they can also result in improvements to existing
products. A good example of this is the cell phone industry.
1.6.5.4 The natural (physical) environment
The natural environment is related to the natural resources of a country,
and therefore incorporates the total management of these resources. Natural
resources include gold, coal, diamonds, water, natural forests, etc. In this
context we can also refer to the natural beauty of the country, as this influences
the tourist market. Natural resources include the air that we breathe, as well
as the scenic beauty around us. The following are variables in the physical
environment.
Limited and expensive resources
Natural resources are not unlimited, so it is essential to manage them efficiently.
For example, South Africa has limited water resources, and the management of
the available sources of water must be handled with great circumspection. In
South Africa the mining industry is a good example of limited and expensive
mineral resources. A lot of gold mines have already closed down because it is
not profitable to mine them anymore, or because the gold mine is depleted. In
South America the rain forests are being wiped out to meet the huge demand
for timber. This has detrimental consequences for the ecology of the area.
The world’s sea life is also threatened and the hunting of whales has been
banned. It is the responsibility of every business to achieve a balance between
its activities and the variables in the physical environment. In the execution
of its activities and in striving to achieve its objectives, the business should be
in harmony with the natural environment.
Because natural resources are limited and many of them are becoming scarcer,
technology is brought into play in order to find cheaper alternatives. An example
of a cheaper alternative is the hydroelectric power station where electricity is
generated by means of water, or similarly the use of wind to generate electricity.
Another example is solar energy that is used for heating water.
Environmentalism and pollution
The business must be fully aware of the effect its decisions will have on the
natural environment in which it functions. Enterprises are often guilty of air,
water and noise pollution resulting from their manufacturing processes.
The effects of pollution and the role played by enterprises in combating
pollution are currently receiving attention worldwide. Plastic packaging
products are very convenient but have definite disadvantages for the
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environment because plastic is not biodegradable, so recycling is being widely
encouraged. More importantly, some companies are responding by reducing
the use of plastics in packaging – or, even better, reducing the total amount of
packaging. Waste paper is recycled and reused for the manufacturing of paper.
Sappi’s ‘War on Waste Paper’ is a good example of this.
From time to time poisonous waste products, which are extremely harmful
to water and plant life, flow into rivers. The mining of minerals sometimes
elicits strong opposition from conservationists; take, for example, the polemic
regarding the mining of minerals in the St Lucia area and the Mpumalanga
province. The construction of roads can harm the natural scenery, and
conservationists have spoken out strongly against a proposed coastal road on
the Wild Coast in the Eastern Cape.
Environmental variables
A countrywide drought will have a significant influence on the owners of
stock farms and wheat farms (primary sector), but it will not influence the
manufacturers of sporting equipment. If the needs of consumers should change
with regard to recreation, however, this will have major implications for the
manufacturers of sports equipment, but will not affect the wheat farmers.
The effect that environmental variables have on a business is determined,
therefore, by the place and role of the business in the total national economy
of a country.
1.6.5.5 The political and statutory environment
The political and statutory variables in the macro-environment are linked to
the influence that authorities (for example the government, regional services
councils and municipalities) are able to exert on business by means of legislation
and regulations. They also refer to the effect that specific institutions and
pressure groups in the macro-environment have on the enterprise. These
variables influence the way in which the business carries out its activities and,
in some cases, can even limit its activities.
The government influences enterprises through the fiscal and monetary
policies of the country. The interest rates applicable to business also have
a direct effect on its net income after interest and taxes. In the same way,
current municipal rates affect the property tax which is paid monthly by the
enterprise.
The annual budget drawn up by government influences individual businesses
and the total economy of the country. Apart from the fact that government
indicates, by means of the budget, how income will be generated, likely future
spending is also laid out. Some of the government’s income is obtained from
taxes paid by individuals and enterprises.
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Variables that influence the business include the following:
Statutory provisions
There are various statutory provisions with which the business must comply.
These include the following:
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The business must have a trading license before it can do business.
The business must register as a taxpayer at the local Receiver of Revenue.
The Companies Act contains detailed prescriptions on how a company
should be established and managed.
The business cannot conclude contracts unless it complies with the
provisions of the closed contract. This means that the business is limited
during the concluding of contracts by certain statutory provisions under
contract law.
Certain enterprises, for example a restaurant, a home industry concern
or a butchery, must comply with health requirements as laid down
by the municipality. Such businesses must first obtain approval from
the municipality before they can commence trading. Inspections are
carried out on a regular basis to determine whether these enterprises are
complying with the necessary requirements.
There are also a variety of statutory provisions aimed at protecting the
consumer:
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Regulations regarding the advertising of a product. A business may not
mislead the consumer, and its advertising message may not contain any
falsehoods. The Advertising Standards Authority controls this aspect strictly.
The consumer must be properly informed about the product and its
composition.
If applicable, the consumer must be shown how to use the product. For
example, instructions for use must be included with all electrical products.
The consumer must be properly informed about the safety requirements
that should be complied with while using the product.
Product approval granted by the South African Bureau of Standards is aimed
at protecting the consumer against inferior, poor and dangerous products.
Trade unions
Every business has a responsibility towards its employees. There are various
laws that help to maintain a smooth relationship between employer and
employee. Although statutory provisions and regulations protect the rights of
the employee, the existence of trade unions is an important variable in the
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Business Management: A Contemporary Approach
macro-environment. Without them, the voices of individual employees can be
ignored by management.
Trade unions fight for the rights of workers who are in the same branch of
industry. The employee acquires bargaining power through the trade union,
which enables him or her to negotiate, for example, for higher salaries or better
working conditions. In South Africa there is a wide variety of trade unions
representing, for example mine workers, motor industry workers, and even bank
officials.
Associations and institutes
In the same way that trade unions look after the interests of organised
labour, many business associations and institutes campaign for the interests
of enterprises in their fields. Earlier, we emphasised that a business has little,
if any, influence over the macro-environment. By means of associations and
institutes, a business can promote its interests in the branch of industry in
which it functions if it works with other enterprises in the same sector.
Some well known institutes and associations that are active in the macroenvironment include:
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Afrikaanse Handelsinstituut (AHI);
South African Chamber of Business (Sacob);
Chamber of Mines;
Motor Industries Federation; and
Black Management Forum.
1.6.5.6 The international environment
We have seen that the variables influencing individual enterprises originate
from the local sphere (the business itself) and the national sphere (the market
and macro-environments). Over and above these forces, the business must also
keep abreast of variables operating in the international sphere – the environment
outside the country’s borders.
Factors in the international environment that play a role in the growth and
continued existence of the business are explained next.
International technology
Although South Africa is technologically developed in certain areas, there is
also a need to import technology and knowledge. For example, in the fields of
synthetic fuels, mining and veterinary science, South Africa makes valuable
contributions with regard to technological development (take Sasol, for example,
which is a leader in the field of synthetic fuel). However, South Africa also
imports technology from other countries, for example computer technology
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Chapter One – What is Business Management?
from the US and engineering technology from Germany and Japan. This is a
phenomenon common to all countries.
International politics
South Africa felt the effect of international politics with the trade sanctions
imposed in the mid-1980s. The country did not have access to foreign loan
capital, for example, and this had a negative effect on the economic growth rate
and job creation in the country. The current political situation in Zimbabwe,
causing people to flee to South Africa, also has a negative influence on the
labour market in South Africa.
International economies
Economic factors and variables, such as interest and exchange rates, the gold
price, the economic growth rate, inflation, the availability of capital and a
scarcity of resources occur worldwide and influence the economic conditions
of all countries. For example, think of the effect inflation has had on the
economies of Zimbabwe, Russia and Argentina. In Zimbabwe, amongst other
things, this resulted in very high food prices.
The Rand/Dollar and other exchange rates have a significant influence on
import and export activities of South African enterprise. If the Rand/Dollar
exchange rates are weak, the cost of importing goods is much higher for a
South African enterprise. The price of petrol is notably influenced by the
Rand/Dollar exchange rate, and when the petrol price rises it puts pressure on
the inflation rate to rise.
1.7 The value chain approach
Whilst the approach of this book is to focus on the different functional areas
in a business, highlighting their interaction and interdependency, it is also
important, however, to take note of the so-called value chain approach. The
success of a business depends on the business as a whole, in other words how
the enterprise operates, and the way managers make decisions and functions are
integrated. On the other hand, for a business to gain a competitive advantage,
much also depends on the individual discrete activities that a business performs.
During the 1980s, Porter2 developed the concept of the value chain approach.
This approach was based on his earlier work on industry structure, in which
he highlights the significance of the relative power of buyers and suppliers.
According to Porter, for any business to gain a competitive advantage, it must
first be considered as part of a wider system.
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Support activities
General administration
Human resource management
M
g
ar
Research, technology and systems development
in
Operations
Outbound
logistics
Marketing
and sales
Service
ar
Inbound
logistics
gin
Procurement
M
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Business Management: A Contemporary Approach
Primary activities
Figure 1.2: The value chain
Source: Pearce & Robinson3
The value chain is based on the principle of primary and support activities.
The primary activities are inbound logistics, operations, outbound logistics,
marketing and sales, and service.
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Inbound logistics are activities relating to receiving, storing and
distributing internally the inputs to the product or service. This includes
the warehousing, stock control and internal transport systems.
Operations are activities relating to the transformation of inputs into
finished products or services.
Outbound logistics are activities relating to the distribution of finished
goods and services to customers.
Marketing and sales relate to advertising and promotion, pricing and
sales force activity.
Services are those activities that are aimed at assisting buyers, such as
maintenance, enquiries, etc.
There are four support activities, namely procurement, technological
development, human resource management and the infrastructure of the
enterprise.
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Procurement refers to the activities involving the purchase and provision
of raw materials and other supplies to support the business.
Technological developments are driving massive change in the world of
business. These include research and development, product design and
process improvement.
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Chapter One – What is Business Management?
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„„
„„
Human resource management involves the three primary tasks of the
human resource section in any enterprise, namely the provision of
personnel, the training and development of personnel and the retention
of personnel.
Infrastructure of the enterprise includes the structure of the business,
planning, financial controls and quality management designed to support
the whole value chain.
According to Porter4, the success of the value chain in the business depends on
the linkages, or relationships, between the activities.
1.8 About this book
Given the multidisciplinary nature of business management, it is necessary
to divide the study field of business management in this textbook according
to the different functional areas. These are discussed, analysed and illustrated
separately in order to provide a better understanding of each, and to explain
how they relate to each other. It is important to understand that these functional
areas are interdependent and need to be aligned with each other if the business
is to succeed.
The following functional areas and contemporary issues are discussed in the
subsequent chapters.
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Chapter 2 – General Management
Chapter 3 – Financial Management
Chapter 4 – Credit Management
Chapter 5 – Corporate Citizenship
Chapter 6 – Information Management
Chapter 7 – Public Relations
Chapter 8 – Operations Management
Chapter 9 – Globalisation and International Trade
Chapter 10 – Marketing Management
Chapter 11 – Human Resource Management
Chapter 12 – Purchasing and Supply Chain Management
1.9 Summary
It is impossible for any business to function in total isolation. Without
interaction with the business environment, a business cannot continue to exist
and grow. Achieving the enterprise’s objectives will remain a dream if this
interaction does not take place.
Businesses must continually analyse the business environment. The
management of the business should also determine, with the help of research,
what the general trends are in the environment. From these analyses,
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Business Management: A Contemporary Approach
management can obtain valuable information about opportunities and
threats that will be fundamentally important during the decision-making
processes within the enterprise. The business environment offers the business
opportunities that help it achieve predetermined objectives and, in this way,
ensure its growth and continued existence. The opposite, however, is also
true. If the business does not recognise important signals in the business
environment, it may lead to its demise.
The different components of the business environment are not independent.
There is constant interaction between the different sub-environments. In this
chapter we have investigated the following three components of the business
environment.
The micro-environment. This is the business itself. Important variables
operating in this environment are:
ˆˆ the mission and objectives of the enterprise;
ˆˆ the functions of the enterprise; and
ˆˆ production factors.
„„
The market environment. This surrounds the business and is part of the
external environment. The chief variables in this environment are:
ˆˆ the consumer and his or her needs;
ˆˆ competitors; and
ˆˆ suppliers of resources and services without which the business
cannot manufacture or market its own products and/or services.
„„
The macro-environment. This component of the business environment
in turn surrounds the market environment and the enterprise. It is,
therefore, also part of the external business environment.
Variables in the macro-environment influence the establishment,
growth and continued existence of the enterprise. The enterprise can
offer no resistance to the influence of these variables. Important forces in
the macro-environment are:
ˆˆ economic conditions;
ˆˆ socio-cultural forces;
ˆˆ technological changes;
ˆˆ physical variables, for example limited and expensive resources as
well as the influence of environmental concerns;
ˆˆ political and statutory changes; and
ˆˆ international forces.
„„
1.10 Self-evaluation
Read the case study and answer the questions.
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Chapter One – What is Business Management?
Case study
Tumi Mboweni
For almost nine years, Tumi Mboweni was the chef at one of the largest hotels in
Pretoria. Although he enjoyed his job and earned a good salary, he had a dream
to start his own business. One day he resigned and started a catering business.
With only R25 000 available, he started on a very small scale, working from his
home. He bought the most important equipment. Today, after only five years
in business, he owns a successful catering business, with many of the largest
companies in the country as his clients. The business has different divisions.
They have catering services for corporate clients, private functions, weddings, a
staff restaurant for one of their corporate clients, and a restaurant at one of the
large shopping centres in Pretoria. When asked what he considered to be the
secrets of his success, he mentioned a combination of factors.
Business knowledge: if you don’t have the necessary background, appoint
someone to help you. After only two months in business, I appointed a partner,
Tau. Together we are an excellent team: I have the catering knowledge, and he
has the knowledge of business.
Planning: Tau and I planned for weeks what our objectives were and what
actions to take to get there. Before every function, we also plan everything in
detail.
Organising: the business must be organised properly. It is impossible to run a
business without proper management organisation.
Control: you can have the best products, the best marketing plan, do the best
planning and organising, but if you don’t deliver a good service, it will be the
end of your business. That is why control over all activities in the business is
important.
Finance: Tau is responsible for controlling all the financial activities in the
business. This includes the obtaining and efficient use of capital.
Marketing: you must always try to come up with something new, and make
sure the public knows about you.
Personnel: according to Tau, the human resource function is responsible for all
the activities concerned with the procurement, development, compensation,
integration and retention of personnel.
Operations: my view of operations management is that this function can be
described as those management activities that take place so that the services
can be provided to satisfy the needs of the consumer.
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Business Management: A Contemporary Approach
Supply chain: I am also responsible for the purchasing function that deals
with the acquisition of all the resources my business needs to achieve its
objectives. This includes, among other things, determining purchasing needs,
the establishment of alternative suppliers who can satisfy these needs and
the negotiation of agreements with them to the long-term advantage of the
business.
Public relations: Tau is responsible for the creation of a positive image for our
business with the public.
Information: this function is concerned with the service of obtaining,
recording and analysing information and communicating the results to Tau
and I.
Quality: we only use the highest quality products and prepare everything
ourselves, even the pasta, so that we can be sure of the quality.
Training: all our employees had intensive training, either at the Hotel School,
or at a large hotel group.
Hard work: This is very important. You cannot expect to get to the top if you
are not willing to work hard.
Questions
1.
2.
3.
4.
Explain the significance of the different production factors and give an
example of each based on the case study.
Identify the micro-environment variables of the business in the case
study.
Explain the market environment and the variables that influence the
enterprise’s growth and continued existence in the case study.
Based on the case study, identify the macro-environment and all the
forces and influences that affect the enterprise.
References
1.
2.
3.
4.
PF Drucker, Management Challenges for the 21st Century (London:
Butterworth-Heineman, 1999) pp. 142–159.
EM Porter, Competitive Strategy (New York: The Free Press/Macmillan,
1985) pp. 33–61.
JA Pearce & RB Robinson, Strategic Management: Formulation, Implementation
and Control, 9th edition (Boston: McGraw-Hill/Irwin, 2005) p. 160.
Porter, op. cit., pp. 37–38.
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CHAPTER T W O
General Management
Prof Tersia Brevis
Learning objectives
When you have completed this chapter you should be able to:
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define the term management;
explain the management process;
differentiate between the various skills that managers need to perform their task;
explain the various levels of management;
discuss the various areas of management;
explain the link between problem solving, decision making and information
management in contemporary organisations;
explain the main tasks (or functions) of a manager;
provide an overview of planning;
explain the organising process and the principles associated with planning;
provide an overview of leadership and the most prominent theories associated with
it;
provide an overview of motivation and explain the most important theories of
motivation;
discuss control and the various areas that need to be controlled within an
organisation; and
provide an overview of organisational communication.
2.1 Introduction
To navigate businesses in today’s turbulent environment requires various
skills and qualities. The field of management is undergoing a revolution that
asks managers to do even more with less, to engage employees, to see change
rather than stability as the nature of things, and to possess vision and cultural
values that allow people to create a truly collaborative workplace. Making a
difference as a manager today and tomorrow requires managers to integrate
solid management skills. Successful businesses and departments don’t just
happen; they are managed to be that way. Every day, managers solve difficult
problems, turn businesses around and achieve excellent results. To be successful,
every business needs skilled managers. This chapter introduces the process of
management by focusing on the four fundamental functions, namely planning,
organising, leading and controlling.
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Business Management: A Contemporary Approach
2.2 Definition of management
The business world is a complex system of individuals and businesses that, in
a market economy, transforms limited resources into products and services
in order to meet the unlimited needs and wants of people. These products
and services are offered to the market in exchange for a profit. The resources,
which we can also refer to as the inputs of an organisation, can be human
resources, financial resources, physical resources, information resources and/or
entrepreneurship.
Human resources are the people who perform the activities necessary to
achieve organisational goals, and they include skilled and unskilled workers,
as well as managers and their subordinates. Financial resources refer to the
capital that is needed firstly to start a new business, as well as to run and grow
it successfully over the long term. Capital may come from the owners of the
organisations (such as owners’ equity) as well as non-owners (such as loans
from the bank, creditors and selling debentures). Physical resources refer to
the buildings, equipment, assembly plants, computers, water, vehicles, and so
on that are needed to perform the activities of an organisation. Information
resources could be data on the management environment, annual financial
statements of the business, and so on. Lastly, entrepreneurship refers to the
special skills and aptitudes needed to start up a new business venture, expand
it, and manage it successfully.
An organisation’s resources, or inputs, should be transformed into certain
outputs. These include the achievement of organisational goals, the delivery
of products and/or services that satisfy the needs and wants of customers,
the achievement of certain productivity levels, the generation of jobs for the
community, and realising a profit for all stakeholders of the organisation.
In order to transform inputs into various outputs, a process is necessary.
This process can be divided into two types of sub-processes. First, a physical
transformation process is necessary where inputs are transformed physically
into products and/or services. Secondly, a management process is necessary
to combine, allocate, co-ordinate and deploy resources or inputs in such
a way that organisational goals are achieved in an effective and efficient
manner. By ‘efficient’, we mean using resources wisely and in a cost-effective
manner. By ‘effective’, we mean making the right decisions and successfully
implementing them. It is important to note that, on the one hand, the
resources available to a business are limited and scarce. On the other hand,
customers have unlimited needs and wants. Business goals can also be very
challenging, which places an even greater importance on effective and
efficient management processes.
Figure 2.1 illustrates the transformation of inputs to outputs in a business,
and the role of the physical transformation and the management processes.
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Chapter Two – General Management
Inputs
(resources)
Transformation
Outputs
(performance)
Human
Physical
transformation
process
Achievement of
goals
Financial
Physical
Information
Management
process
Entrepreneurship
Products
Services
Productivity
Job creation
Profit
Figure 2.1: The transformation of inputs to outputs in a business
All managers engage in certain interrelated activities to achieve desired
business goals. These entail four fundamental management functions, namely
planning, organising, leading and controlling.
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„„
Planning is typically the starting point in the management process.
In its simplest form, planning means determining the future position of
the business and deciding on the strategies needed to reach that position.
During the planning phase, the vision, mission and goals are determined
as well as the resources needed for the task.
Organising is the second step in the management process. A manager
must design and develop an organisational system to implement the
plans. Organising can therefore be defined as the process of delegating and
co-ordinating tasks and allocating resources to achieve goals and
objectives. Organising also involves developing a framework or
organisational structure to indicate how and when people and other
resources should be deployed in order to achieve goals. The success of a
business lies in directing the different resources towards the achievement
of a common set of goals.
A manager must lead employees as they perform their daily tasks.
Leading is the process of influencing employees, who also are resources,
to work willingly towards achieving goals. Managers must communicate
the goals to employees and motivate them to achieve those goals.
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„„
Not all employees do the things that they say they will do and the
things that they are supposed to do. Therefore, goals will not be met
without follow-up processes. Controlling is the process of establishing
and implementing mechanisms to ensure that goals are achieved.
An important part of controlling is measuring progress towards the
achievement of an objective, and taking corrective action when necessary.
Feeding back results is an important aspect of control and serves as an
input for the planning process.
The management process and the four functions of the process are
encountered at all levels and in all departments of the business. Figure 2.2
indicates this process.
Planning
F
e
e
d
b
a
c
k
Organising
Leading
Controlling
Figure 2.2: The management process
To carry out the management functions of planning, organising, leading and
controlling, managers rely on a number of management skills or competencies.
These skills are discussed in the following section.
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Chapter Two – General Management
2.3 Managerial skills
The most fundamental management skills that a manager should have are
technical, interpersonal, conceptual, diagnostic, communication, decisionmaking and time-management skills.
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Technical skills are those necessary to accomplish the specific kind of
work being done in a business. Although all levels of management need
to have some technical skills, it is especially important for first-line
or supervisory levels of management. These managers spend most of
their time training subordinates and answering questions about workrelated problems.
Interpersonal skills refer to the ability of a manager to communicate
with, understand and motivate both individuals and groups. Managers
spend a lot of time interacting with people, such as subordinates, peers,
superiors, suppliers, customers and investors. Therefore, interpersonal
skills are needed by managers on all managerial levels, but especially by
middle levels of management.
Conceptual skills refer to the manager’s ability to see and understand
the business as a whole, as well as how all the parts fit together. This
skill allows managers to think strategically, to see the ‘big picture’ and to
make decisions that affect the business as a whole. Conceptual skills are
especially important for top managers.
Diagnostic skills enable a manager to visualise the most appropriate
response to a situation. A medical doctor diagnoses a patient’s illness by
analysing symptoms and determining their probable cause. Similarly, a
manager can diagnose and analyse a problem in the business by studying
its symptoms and then developing a solution.
Communication skills refer to a manager’s ability to convey ideas and
information to others effectively and to receive ideas and information
effectively from others.
Decision-making skills refer to the manager’s ability to recognise and
identify problems and opportunities, to formulate alternative courses of
action, to select the best course of action and to implement it to solve
problems and capitalise on opportunities. Decision making will be
discussed in more detail in section 6.
Time-management skills consist of the manager’s ability to prioritise
work, to work efficiently and effectively, and to delegate responsibility
effectively.
The managerial skills discussed above are needed on all levels of management.
The various levels of management are the focus of the following section.
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2.4 Managerial levels
The term ‘manager’ usually includes any person who carries out the four
fundamental functions of management. These functions must be performed in
all businesses, but managers are responsible for different departments and they
work at different managerial levels of the business. Three levels of management
are normally distinguished, namely top managers, senior/middle managers
and first-line (supervisory) managers. These are also called strategic, tactical
and operational management.
Top managers (strategic managers) are people in executive positions who
normally have titles such as chief executive officer (CEO), president, vicepresident or managing director (MD). Most businesses have relatively few top
management positions. Top managers are responsible for managing an entire
business or major parts of it. They develop and define the purpose, goals,
strategies and long-term plans of the business. They report to other executives
and the board of directors, and they supervise the activities and performance
of senior/middle managers.
Senior/middle managers (tactical managers) have titles such as marketing
manager, operations manager or human resources manager. They are responsible
for implementing the top manager’s strategy by developing medium-term
goals, strategies and plans. They generally report to top management and
supervise the work of lower management.
First-line/supervisors (operational managers) have titles such as sales manager,
section head or office manager. They are responsible for implementing the
plans and strategies formulated by middle managers over the short term. They
generally report to senior/middle management and they supervise operative
employees. Operative employees are the workers in a business who do not hold
managerial positions. They report to first-line managers/supervisors.
2.5 Areas of management
Different functional areas can be distinguished at each managerial level.
These functional areas may include finance, operations, human resources,
procurement, research and development, public relations and marketing.
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The financial function is responsible for obtaining the necessary finances
for an organisation at the lowest cost, investing these finances in assets
that would earn greater returns than the cost of capital, and managing
the profitability, liquidity and solvency of the organisation.
The operations function includes that group of activities concerned with
the actual provision of goods and services to the organisation’s clients.
Operations management systematically designs, directs and controls the
process that transforms inputs into products and services for internal and
external customers.
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The human resources function entails the appointment, development
and maintenance of the human resources of the organisation. To enable
the organisation to operate at optimum levels, the human resources
manager must appoint the right people and provide them with the right
training in order to make the best use of them.
The procurement function is concerned with buying the materials and
resources needed to create products and services. The manager responsible
for procurement needs to balance a number of constraints. He or she
needs to ensure that the right product is available, at the right time, in
the right quantity and of the right quality, at the best possible price.
The research and development function is responsible for developing
new products and services, and improving old products and services. This
function plays a crucial role in organisations that operate in fast-changing
environments, such as information technology, communications, etc.
The public relations function of an organisation is responsible for
creating a favourable image of the organisation and establishing good
relations with those directly or indirectly concerned with the business
and its products or services.
The marketing function is responsible for getting the final customer
and client to buy the organisation’s products or services. The marketing
function is concerned with new product development, promotion and
distribution.
While these are specialised areas of management that require more specific
and specialist skills, managers in each area still plan, organise, lead and
control. A financial manager, for example, is responsible for determining the
financial goals of the organisation, thus performing the planning function
of management. The financial goal is in accordance with the overall strategic
goal of the company. The financial manager also needs to organise financial
activities by allocating financial tasks to people so that financial goals can
be achieved. The financial manager also needs to take the lead in financial
activities, motivate and direct members of staff in the financial section to
perform their duties in pursuit of the financial targets. Lastly, financial
managers need to ensure that financial goals are accomplished.
2.6 Creative problem solving, decision making and information
management
Decision making was identified as an important skill that managers at all levels
of management should have in order to be successful in their jobs. Information
is needed in order to make good decisions. In this section, we will focus on
creative problem solving, decision making and the management of information
in a business.
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2.6.1 Problems, problem solving and decision making
Setting goals and objectives is part of the planning task of managers at all
levels in a business. A goal or objective can be defined as a desired end state.
Whenever this end state is not being met, a problem exists. Problem solving
can be defined as the process of taking corrective action to meet goals and
objectives, or the desired end state. Managers need to make decisions when
problems exist. Decision making, therefore, can be defined as the process
of selecting an alternative course of action that will solve a problem. The
decision-making process includes recognising and defining the nature of the
situation, identifying alternatives, choosing the best alternative and putting it
into practice.
2.6.2 Types of managerial decisions
Decisions made by managers generally fall into one of two categories, namely
programmed and non-programmed decisions. Programmed decisions are
insignificant, repetitive and routine. Managers can usually follow rules and
regulations, standard operating procedures and specific policies in order to
reach a programmed decision. A rule and regulation can be described as a
standing plan that explains exactly how specific activities are to be carried
out. For example, certain rules and regulations may apply to tea and coffee
breaks, the use of company vehicles by employees, and so on. A standard
operating procedure outlines steps to be followed in particular circumstances.
For example, to apply for vacation or study leave, employees need to follow a
certain standard operating procedure. A policy specifies a business’s general
response to a designated problem or situation. For example, a university may
establish a policy whereby admission to certain courses will only be granted
to applicants with certain educational backgrounds.
Non-programmed decisions are significant, non-recurring and nonroutine. Such decisions are complex, and there is no established method for
handling them. Managers at all levels of the business make non-programmed
decisions. The most difficult managerial decisions involve non-programmed
decisions and require the use of creative problem solving. Businesses
normally develop single-use plans to carry out a course of action not likely
to be repeated in the future. They can use basically two types of single-use
plans, namely a programme or a project. A programme is a single-use plan
while a project is a plan of less scope and complexity than a programme.
Figure 2.3 illustrates the types of managerial decisions.
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Chapter Two – General Management
Managerial decision
Programmed decision
Non-programmed decision
Standing plan
Single-use plan
Rules and regulations
Programme
Standard operating procedure
Project
Policy
Figure 2.3: Types of managerial decisions
2.6.3 Decision-making conditions
Managerial decisions are made under different conditions, namely certainty,
risk and uncertainty. A decision made under conditions of certainty implies
that the available alternatives and the benefits or costs associated with each
are known. There is perfect knowledge about available alternatives and their
consequences. Suppose, for example, that South African Airways makes a
decision to buy five new wide-bodied jets. Their next decision is to decide
from whom they will buy the aircraft. Because there are only two companies
in the world that make wide-bodied jets, Boeing and Airbus, South African
Airways knows its options exactly. However, conditions of certainty rarely,
if ever, exist. The turbulence of the management environment makes such
conditions very rare.
A decision is made under conditions of risk when the available alternatives,
the probability of their occurrence and the potential benefits or costs associated
with them are known. Executives at Porsche faced a decision under conditions
of risk when they needed to decide whether the firm should join most of
the world’s other car manufacturers and build a sports utility vehicle (and
potentially earn higher revenues) or maintain its focus on high-performance
sports cars. Although the additional revenue was almost certain, the true risk
in the business’s ultimate decision to build its Cayenne SUV is that the brand
may have lost some of its cachet among its existing customers.
A decision is made under conditions of uncertainty when the available
alternatives, the probability of their occurrence or their potential benefits or
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costs are unknown. Uncertainty stems from the complexity of contemporary
businesses and their management environments. To make effective decisions
under conditions of uncertainty, managers must gain as much relevant
information as possible (the management of information is discussed later
in this chapter) and approach the situation from a logical and rational
perspective. Although intuition, judgment and experience always play
major roles in the decision-making process under conditions of uncertainty,
managers who follow a logical process are more likely to make effective
decisions.
2.6.4 The rational decision-making model
The rational decision-making model involves several steps to be followed
by managers. Using this approach will increase the manager’s chances
of success in problem solving and decision making. The six steps of this
approach are:
1.
2.
3.
4.
5.
6.
classify and define the problem or opportunity;
set objectives and criteria;
generate creative alternatives;
analyse alternatives and select the most feasible alternative;
plan and implement the decision; and
follow up and evaluate the results.
Each of these steps are examined in more detail below. Each step is also applied
to the following case study.
Disney’s Euro Disneyland venture1
For almost five years, the Walt Disney Company (Disney) searched for the perfect site
to open their fourth theme park. Disney has been known around the world for decades
for bringing entertainment, fun and fantasy to families through amusement parks,
television series and numerous classic live-action and animated motion pictures. After
the huge successes of their theme parks in Anaheim, Orlando and Tokyo, company
executives decided to expand to Europe, partly because Disney’s films historically have
done better in Europe than in the United States. From 1983 until 1987, Disney searched
for sites in the United Kingdom, France, Germany, Spain and Italy. Finally, they decided
on Paris, France for various reasons.
France has a large population with a sophisticated transportation network. The very
successful Tokyo Disneyland was located in a cold-weather climate and virtually the
same latitude as Paris. For this reason, Disney executives assumed they would be able to
operate in similar weather conditions in Paris.
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The French government sold Disney the 4 400-acre site at a fraction of its market value
in a region called Marne-la-VallŽe. Marne-la-VallŽe is located in an ideal geographical
location since it is 32 kilometres due east of the centre of Paris, and halfway between the
two international airports Orly and Roissy-Charles-de-Gaulle. Disney assumed that Paris
would offer Euro Disneyland a wealth of potential guests and employees.
In the agreement between Disney and the French government, the latter promised
Disney favourable loan terms, an extended railway system from Paris to the theme
park, two additional interchanges linking Euro Disney with a main highway and a
special station for high-speed trains at the theme park. Disney agreed to offer new jobs
and contracts to local suppliers. In a region that suffered from a high unemployment
rate, Disney executives believed that they could provide economic benefits to the
region.
Once the decision had been made to open Euro Disney in Paris, Disney executives
had to integrate American risk management techniques into a French environment.
They needed to cope with language barriers and France’s unfamiliar legal framework.
Disney’s dream of achieving at least the same success that they had in Japan did not
become a reality. On opening day and beyond, Disney suffered losses and numerous
operational problems.
Why?
First and foremost, Disney was overly ambitious in their estimated sales and profit
figures. They made strategic and financial miscalculations and relied on debt during
a period when European interest rates were beginning to increase. Disney also
miscalculated European habits, which impacted negatively on their sales and profit
figures. Disney also displayed no regard for bottom-line construction cost – over
expenditure also impacted negatively on sales and profit figures. Labour costs were
also underestimated – Disney Executives estimated that labour costs would be 13%
of revenue. In 1992, the actual figure was 24%, and in 1993 it increased to 40%,
contributing even further to Euro Disney’s debt. Furthermore, Euro Disney opened
during a European economic recession, during which the real estate market collapsed.
Operational problems were also experienced. For example, Euro Disney had
difficulty in allocating staff effectively and efficiently. The designated parking spaces
for buses were too small, and there were insufficient restroom facilities for bus drivers.
Different employment cultures also contributed to operational problems. In the
United States, cast members accept being sent home if they are not needed but
French cast members have a very difficult time accepting flexible work schedules.
Lastly, Disney executives estimated that guests would stay at the park for several days
but this did not happen. Many guests arrived early in the morning, spent the day at
the park, checked into the hotel late at night, and then checked out early the next
morning. Because so many guests checked in and out every day at much the same
time, Disney had to install, additional computer stations to decrease the time the
guests stood in queues.
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Business Management: A Contemporary Approach
Human resources estimates were made and Disney needed to recruit, hire, train and
house 12 000 cast members 12 months before the opening of the park. This is a challenge
for any company, but even more complex for Disney, whose cast members become
more like members of a theatre troupe. Language and cultural barriers complicated the
process even further.
Miscalculations in terms of per capita spending is probably the biggest detrimental
factor to Euro Disney’s poor financial performance. Disney had assumed that guests
visiting Euro Disney would spend large amounts of money, as they did in the US and
Tokyo. Actual spending was 12% less than predicted. Furthermore, European’s per
capita income is lower than the Japanese, and they are likely to spread their money over
long vacations, not four-day spending sprees.
The total construction cost of Euro Disney was US$4 billion, of which US$2.9 billion
was borrowed at high interest rates. Thus, from the offset, the project was highly
leveraged. Euro Disney made a huge mistake not considering the views of the French
when developing their marketing strategies. The Walt Disney Company agrees there
may have been marketing mistakes, but they blame the mistakes on a lack of data
about how Europeans would react to the ‘Disney Magic’. Investors, on the other
hand, believe that they are the victims of Euro Disney since the Walt Disney Company
communicated its difficulties poorly.
Paris winters also contributed to the financial difficulties of Euro Disney. Lastly, the
Magic Kingdom concept, successful in California and Tokyo, is apparently not compelling
enough for Europe.
The park’s future will be shaped by many outside influences over time, requiring
Disney executives to learn from past mistakes and closely monitor the main events that
will impact on its future performance and success.
Step 1: Classify and define the problem or opportunity
Problems can be classified on the basis of the type of managerial decision
(programmed or non-programmed), the decision-making conditions (certainty,
risk or uncertainty) and the decision-making model used. There are two primary
decision-making models, namely the rational and the bounded rationality
models. When using the rational model, the decision maker selects the best
possible solution. This is known as optimising. The rational model is appropriate
when the manager is making non-programmed, high-risk decisions. In the
case of the bounded rationality model, the decision maker uses satisficing,
which means selecting the first alternative that meets the minimal criteria.
The bounded rationality model is appropriate when the manager is making
programmed low-risk decisions.
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During the first step in the decision-making process, managers should also
decide who should participate in it – an individual or a group of people. The
problem should also be defined in the first step. It is important to distinguish
between the symptoms and the causes of a problem. The cause of the problem
should be eliminated, which will eventually lead to the disappearance of the
symptoms.
In the Disney case study, executives were confronted with non-programmed
decisions under conditions of uncertainty. Although they were familiar with
the company’s environment, culture, laws, and so on in the US, they had no
idea what to expect in Europe. They employed the rational decision-making
model in order to decide on a specific site (Paris). Numerous participants
(such as financial and investment managers, procurement specialists, human
resources experts, and so on) were involved in their decision to build a theme
park in Paris. Disney had an opportunity to expand to Europe, and they were
faced with the decision about the best possible site.
Step 2: Set objectives and criteria
The individual or the group should formulate objectives and set criteria. Criteria
are standards that need to be met in order to accomplish the objective. Disney’s
objective was to achieve at least the same success that they had in Japan.
Step 3: Generate creative alternatives
After the problems have been classified and defined, and objectives and
criteria are set, the next step is to generate creative alternatives. In the case
of programmed decisions, the alternative is usually predetermined. However,
in the case of non-programmed decisions, the individual or group can make
use of various techniques to generate creative alternatives, such as innovation,
creativity, information and technology, and groups. Various techniques exist
when using group participation to generate creative alternatives, such as
brainstorming, the Nominal Group Technique and the Delphi Technique. In
their search for the best possible site, Disney executives considered United
Kingdom, France, Germany, Spain and Italy.
Step 4: Analyse alternatives and select the most feasible alternative
When analysing alternatives, managers can make use of various quantitative
techniques, such as break-even analysis, capital budgeting, linear programming,
and so on. Managers should take note of these techniques and recognise their
potential to analyse alternatives and to select the most feasible alternative. In
analysing alternative locations for the fourth theme park, Disney analysed
the various alternative sites in the United Kingdom, France, Germany, Spain
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Business Management: A Contemporary Approach
and Italy in terms of their populations, transportation networks, climate, cost
of land, availability of human resources, economic climate and government
relationships, to mention only a few. Eventually, the most feasible site was Paris.
Step 5: Plan and implement the decision
After selecting the most feasible alternative, a plan of action with a schedule
for implementation should be developed. Such a plan should be communicated
to all employees. From 1983 to 1987, Disney searched for sites and decided on
Paris in 1987. Since then, they commenced with the building of the theme
park, employing French people, signed various agreements with the French
government and integrated American risk management techniques into a
French environment, to mention a few.
Step 6: Follow up and evaluate the results
A control process should be in place in order to determine if the chosen
alternative is indeed solving the problem. If this is not the case, corrective action
should follow. Disney’s decision to build a fourth theme park in Paris was, with
hindsight, not a good decision. The case study illustrates numerous reasons
for the initial failure of the park (such as an overestimation of sales and profit
figures, strategic and financial miscalculations, poor economic conditions, high
labour costs, human resources problems, and so on). Disney needs to overcome
these barriers to be successful in future. Their effectiveness in overcoming these
barriers will depend on the quality of their decisions, which is directly related
to the quality of the information available.
The next section focuses on the role of information as a managerial
resource, the characteristics of useful information and the components of an
information system.
2.6.5 The role of information as a managerial resource
Businesses process and store vast amounts of data that employees and managers
turn into useful information to solve problems and make decisions. Information
technology plays a very important role in this transformation process.
Information technology can be described as computer-based electronic systems
that help individual employees and businesses to assemble, store, transmit,
process and retrieve data and information.
The terms ‘data’ and ‘information’ are often used interchangeably, but
incorrectly. Data refers to facts, numbers and figures, whereas information is
the knowledge derived from data that has been transformed to make it useful
and meaningful. From these definitions, one can say that data is subject to a
value-added process that yields meaningful information for problem solving
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and Italy in terms of their populations, transportation networks, climate, cost
of land, availability of human resources, economic climate and government
relationships, to mention only a few. Eventually, the most feasible site was Paris.
Step 5: Plan and implement the decision
After selecting the most feasible alternative, a plan of action with a schedule
for implementation should be developed. Such a plan should be communicated
to all employees. From 1983 to 1987, Disney searched for sites and decided on
Paris in 1987. Since then, they commenced with the building of the theme
park, employing French people, signed various agreements with the French
government and integrated American risk management techniques into a
French environment, to mention a few.
Step 6: Follow up and evaluate the results
A control process should be in place in order to determine if the chosen
alternative is indeed solving the problem. If this is not the case, corrective action
should follow. Disney’s decision to build a fourth theme park in Paris was, with
hindsight, not a good decision. The case study illustrates numerous reasons
for the initial failure of the park (such as an overestimation of sales and profit
figures, strategic and financial miscalculations, poor economic conditions, high
labour costs, human resources problems, and so on). Disney needs to overcome
these barriers to be successful in future. Their effectiveness in overcoming these
barriers will depend on the quality of their decisions, which is directly related
to the quality of the information available.
The next section focuses on the role of information as a managerial
resource, the characteristics of useful information and the components of an
information system.
2.6.5 The role of information as a managerial resource
Businesses process and store vast amounts of data that employees and managers
turn into useful information to solve problems and make decisions. Information
technology plays a very important role in this transformation process.
Information technology can be described as computer-based electronic systems
that help individual employees and businesses to assemble, store, transmit,
process and retrieve data and information.
The terms ‘data’ and ‘information’ are often used interchangeably, but
incorrectly. Data refers to facts, numbers and figures, whereas information is
the knowledge derived from data that has been transformed to make it useful
and meaningful. From these definitions, one can say that data is subject to a
value-added process that yields meaningful information for problem solving
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and decision making. An information system can be defined as a system that
accepts data as input and processes it into information products as output.
2.6.6 Characteristics of useful information
Information must have certain benefits over and above raw data to be considered
a value-added resource to the business. In order for information to be useful
and of value to the organisation, it should:
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be of high quality and portray reality accurately;
be relevant, meaning that it can be used directly in the problem-solving
or decision-making processes;
be available as and when people need it in the right quantities (more isn’t
always better); and lastly
be timely, which means that information should be received before it
ceases to be useful for problem-solving or decision-making purposes.
These characteristics – quality, relevance, quantity and timeliness – are
interrelated and essential to the provision of information that serves as a
value-added managerial resource.
2.6.7 The components of an information system
An information system uses hardware, software and human resources to perform
the basic activities of a system, namely input, process, output, feedback, control
and storage. These components can be explained as follows.
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Input – data is received as input.
Process – the information system transforms data by organising and
analysing it in a meaningful way. The processing component of the
system, or the ‘brain’ of the computer, is called the central processing
unit (CPU).
Output – the result of the processing (output) is information.
Feedback – this occurs when decision makers interpret the information
to determine what should occur next. The decisions that result from the
interpretation and the use of the information are means of controlling
the system.
Hardware – the physical components of the information system, in other
words the computer, keyboard, printer, and so on, are the hardware.
Storage devices, such as hard drives and memory sticks, are also hardware
components.
Software – this refers to the various types of programmes that are used
to tell the hardware how to function, for example word processing,
spreadsheet and accounting software packages.
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People – these are the specialists whose responsibility it is to develop and
operate information systems, and end-users (such as managers) who use
the information produced by the system.
Storage – data and information should be stored in the information
system. Normally, a database is used for this purpose. A database typically
contains a vast amount of related information on company operations,
including financial records, employees and customers.
2.7 Management functions (tasks)
The four principal management functions are planning, organising, leading
and controlling, each of which is analysed in this section.
2.7.1 Planning
Planning gives guidance and direction to members of a business. It encompasses
developing goals and objectives, establishing an overall strategy for achieving
these goals and objectives, and developing a comprehensive hierarchy of plans
to integrate and co-ordinate all the business activities. Planning, therefore,
concerns itself with both the ends (what is to be done) and the means (how it
is to be done).
In contemporary business, planning is one of the most important
responsibilities of managers. Business plans provide a foundation for
co-ordinating and directing the activities of the business so that goals and
objectives can be achieved. Only through planning can managers prepare
their businesses to achieve success in both the long and the short term. Given
the highly competitive nature of the business environment today, effective
planning has never been more important.
In this section, we will first address the questions ‘What is planning?’
and ‘Why should managers plan?’ Secondly, various levels of plans will be
investigated. Lastly, we will focus on the strategic management process.
2.7.1.1 Why should managers plan?
It has often been said that ‘failing to plan is planning to fail’. However, most
experienced managers recognise that there are benefits as well as costs associated
with planning. The following are the most important benefits associated with
planning.
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Planning provides direction and it helps managers, as well as nonmanagers, to focus on forward thinking.
Planning leads to a participatory work environment. Business plans
should be developed and implemented by a wide range of stakeholders
in an organisation. This will lead to a more participative working
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environment, where stakeholders are more likely to buy into a plan that
they have helped develop.
Planning reduces the impact of change. In a turbulent environment,
planning enables managers to anticipate change and to develop
appropriate responses.
Planning reduces the overlap of activities. When the means and the ends
are clear, overlapping and wasteful activities become obvious.
Planning sets the standards to facilitate control. In planning, objectives
are set. Performance is later evaluated against these established objectives
in the controlling function of management. If significant deviations
occur, corrective steps can be taken. Without planning, control cannot
take place.
Despite the benefits of planning, it also involves some costs.
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Planning may create rigidity. Rather than remaining flexible in a changing
environment, managers may continue to do what is required to achieve
the original objectives.
If done properly, the planning process requires a substantial amount of
managerial time and energy.
Formal plans cannot replace intuition and creativity.
In some instances, planning can direct the focus towards evaluating
rather than doing. This can delay the business’s response to changes in
the industry, marketplace or internal operations.
When you weigh the potential benefits of planning against its potential costs,
it is clear that planning is an essential function of management.
2.7.1.2
Levels of planning
Three levels of planning can be distinguished, namely strategic, tactical and
operational. Strategic plans apply to the entire business. They establish the
business’s overall long-term objectives, seek to position the business in terms of
the environment and drive the business towards attaining its goals. Top-level
managers develop strategic plans. Planning at a strategic level usually includes:
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the creation of a vision of the future of the business;
translating the vision into a realistic mission statement;
translating the mission statement into measurable long-term objectives;
and
choosing strategies to attain the vision, mission and long-term objectives.
Strategic plans filter down through the business to form the basis for tactical
plans, which specify the details of how the overall medium-term objectives
are to be achieved. The focus of tactical plans could be on the functional
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areas in a business, such as marketing, finance or operations. Tactical plans
are more specific than strategic plans. They should also take synergy into
consideration, in other words, they should contribute to the attainment of the
overall goals of the business. Senior, middle and first-line managers develop
tactical plans.
Operational plans are developed by first-line managers/supervisors.
Operational plans are narrowly focused and have relatively short timescales
(for example monthly, weekly and day-to-day).
2.7.1.3
Strategic planning, strategy and goals
Strategic planning can be described as the process of developing a vision,
mission and long-term objectives – or goals – and determining in advance how
they will be accomplished. So a goal or objective is about ‘what is’ to be achieved
while a strategy entails ‘how to’ achieve it.
Three levels of strategies can be distinguished, namely corporate, business and
functional. The corporate-level strategy focuses on multiple lines of business.
The business-level strategy focuses on one line of business. The functional/
tactical level strategy focuses on one area of the business, such as marketing or
finance. Lastly, the operational strategy focuses on a subsection of a business
function. For example, advertising is a subsection of the marketing function,
debtors a subsection of the finance function.
2.7.1.4
Strategic management process
Through the strategic management process, top-level managers develop the
strategic plans and senior, middle and first-line managers or supervisors
develop the tactical and operational plans to achieve the long-term, mediumterm and short-term objectives. The strategic management process can be
divided into four phases, where each phase consists of a number of steps.
The following section focuses on these four phases, namely strategic analysis,
strategy formulation, strategy implementation and strategic control. Notice
that the strategic process is not simply linear from phase one to four and
then it ends. Managers need to return to prior steps and make changes as an
ongoing process.
Strategic analysis
The first phase of the strategic management process answers the question
‘What is the current position of the business?’ In order to analyse the current
position, a vision and mission statement needs to be formulated. An analysis of
the internal and external environment of the business is also conducted during
this phase.
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Develop a vision
Developing a vision requires managers to think about ways to carry their
organisation into the future. For top managers to lead the business to success in
the future, requires an inspiring vision that everybody in the business – as well
as external stakeholders – shares in and is excited about.
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Develop a mission
A business’s mission is its purpose of being. The vision statement of a business
guides the formulation of the mission. The mission provides strategic direction
for members of the business. Although mission statements can vary among
businesses, each should answer the following critical questions.
1.
2.
3.
What is our business, in other words our primary products and services?
Who are our clients, in other words our primary target markets?
How will we provide this product or service, in other words the technology
that will be used to provide the primary products and services?
The answers to these three questions should clearly set the organisation apart
from similar organisations.
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Analyse the environment
A business’s mission should be congruent with the capabilities of the business
and its external environment in order to create value. Therefore, the internal as
well as external environment should be analysed. The purpose of the internal
environmental analysis is to identify assets, resources, skills and processes that
represent either the strengths or weaknesses of the business. Strengths can
be defined as aspects of the business’s operations that represent a potential
competitive advantage, while weaknesses can be defined as areas that are in
need of improvement. Key areas to be assessed in the internal environmental
analysis are the business’s products and services, marketing expertise, operations,
human resources and financial performance. These areas are evaluated in terms
of the extent to which they support the competitive advantage sought by the
business. Managers will then use this information to formulate strategies that
capitalise on the business’s strengths, and remedy its weaknesses.
The purpose of the external environmental analysis is to identify
opportunities and threats in the business’s external environment. An
opportunity can be described as those environmental variables upon which
the business can capitalise to improve its competitive position. Threats are
conditions that jeopardise the business’s ability to survive and be successful in
the long term. External environmental variables include economic, political/
legal, technological, sociocultural, ecological/physical and international
forces. These forces should be analysed to identify threats and opportunities.
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The SWOT analysis (Strengths, Weaknesses, Opportunities, Threats) could be
used to analyse the organisation’s business environment.
The analysis of the internal and external environments will indicate to
management whether the mission statement is realistic. This will lead to the
second phase of the strategic process, namely strategy formulation.
Strategy formulation
The second phase of the strategic management process answers the question
‘Where does the business want to be?’ Strategy formulation, therefore, involves
setting long-term goals and formulating corporate and business strategies.
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Setting strategic goals
Strategic goals should flow from the business’s mission statement to address
strategic issues and problems identified through the strategic analysis phase.
Successful strategic management requires a commitment to a defined set of
strategic goals by management.
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Formulating generic and grand strategies
After the vision and mission have been formulated, the situation analysis has
been completed and strategic goals have been set, generic and grand strategies
should be developed. When choosing a strategy, strategic planners decide on
a core idea about how the business can best compete in the marketplace. The
term used in strategic planning for this core idea is generic strategy. There are
three types of generic strategy, namely low-cost leadership, differentiation and
focus strategy.
An overall low-cost leadership strategy attempts to maximise sales by
minimising costs per unit and hence prices.
Differentiation is the second generic strategy that distinguishes a
business’s products or services from those of its competitors. The rationale
for differentiation is that the business can charge higher prices (and make
more profit per unit) for a product that customers perceive to be different
from similar products or services offered by rivals. Differentiation may be in
terms of quality, the production process, design, reputation or any number
of other attributes.
The third generic strategy is to focus on a specific product line or a segment
of the market that gives an organisation a competitive edge. A focus strategy is
anchored in a low-cost leadership or differentiation strategy.
Once a business has chosen a generic strategy, or core idea, it should decide
on a more specific grand strategy for each business. These are referred to as
grand or overall corporate-level strategies. A grand strategy can be described as
the overall corporate-level strategy of growth and decline.
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„„
Corporate growth strategy
With a corporate growth strategy, the business makes aggressive attempts to
increase its size through increased sales. A business that wants to grow has
six major options, namely concentration, market development, product
development, integration, diversification or corporate combinations.
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Concentration growth strategy. With a concentration growth strategy,
the business grows aggressively in its existing line(s) of business. In other
words, the business continues to be in the same line of business as far as
products, markets and technology are concerned.
Market development strategy. A market development strategy is closely
related to a concentration growth strategy. It involves selling present
products (using present technology) in new markets by opening new
outlets or attracting other market segments.
Product development strategy. A product development strategy
involves a substantial change in existing products or additions to present
products. These products are sold in the existing markets using the
existing technology.
Integration strategy. With an integration strategy, the business enters a
forward or backward line of business. Forward integration occurs when a
business enters a line of business closer to the final customer. Backward
integration occurs when the business enters a line of business far away
from the final customer to get increased control over its supply sources.
Diversification strategy. With a diversification strategy, the business can
go into a related or unrelated line of business. Related diversification, also
called concentric diversification, involves the addition of related business
in terms of product, market and technology. Unrelated diversification,
also called conglomerate diversification, involves the addition of unrelated
business in terms of product, market and technology.
Corporate combination. A business can also choose to grow by means
of a corporate combination, which includes mergers, acquisitions,
takeovers, joint ventures and strategic alliances. A merger occurs when
two businesses form one new business by pooling all their resources. An
acquisition occurs when one business buys all or part of another business.
One business becomes part of an existing business. When management of
the target business rejects the purchasing company’s offer, the purchasing
company can make a bid to the target company shareholders to acquire
the company through a takeover. A joint venture is created when two or
more businesses join resources to form a separate new business in which
they share ownership. Equity positions are usually taken by participants.
A strategic alliance is an agreement between businesses, but does not
necessarily involve shared ownership.
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„„
Decline strategies
Decline strategies are followed in situations where a business needs to regroup
its activities to improve efficiency after a period of fast growth, where long-term
growth and profit opportunities are unavailable, where other opportunities
are more attractive or where there is a period of economic uncertainty. The
following forms of decline strategies exist:
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A turnaround strategy focuses on eliminating inefficiencies in a
business. Top management looks at costs and asset reduction to reverse
declining sales and profits.
Divestiture involves the sale of a business or a major component of the
business to achieve a permanent change in the scope of operations.
Harvesting is an appropriate strategy when the business seeks to
maximise cash flow in the short run, regardless of the long-term effect.
Liquidation implies that a business admits failure and recognises that
this strategy is the best way to minimise the loss to the shareholders of
the business.
Select a corporate strategy
A business now needs to select a corporate strategy or a combination of
strategies to implement. The appropriate strategies need to reflect the business’s
management environment.
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Select a business-level strategy
Once corporate-level strategies have been formulated, business-level strategies
need to be developed for each business unit.
Strategy implementation
The third phase of the strategic management process answers the question
‘How can the business get to where it wants to be?’ To implement strategies,
functional/tactical and operational departments need to set objectives (derived
from strategic goals) for the medium and short term. Objectives state what is
to be accomplished in measurable terms with a target date. To be effective,
objectives should:
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contain only one end result;
be specific and state the exact level of performance expected;
be measurable;
be time-specific, with a specific deadline set in advance;
be difficult, but achievable – in other words, realistic;
be acceptable by members of the business, so they can be committed to
them;
be flexible;
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be congruent with one another; and
involve employees in setting.
After setting objectives, strategies for the medium and short term also need to
be formulated and implemented for achieving the business-level mission and
goals. Functional/tactical strategies include marketing, operations, human
resources, finance and others; while operational strategies include advertising,
scheduling, training and development, and so on. Secondly, the strategy should
be institutionalised within the business. Institutionalising a strategy means that
every member, work group, department and division of the business subscribes
to support the business’s strategy with its plan and actions. The strategy must
fit the business’s structure, culture and leadership if it is to be institutionalised.
Strategic control
The final phase of the strategic management process answers the question
‘How will the business know when it has arrived?’ Strategic control involves
continuous monitoring of the implementation of the strategic plan and
ensuring quality and effectiveness in terms of organisational performance. An
effective strategic control process identifies problems and signals the business
that a change may be needed. The main concern when examining a business’s
total effectiveness is determining the extent to which it attains its mission and
goals. Tactical and operational control also form part of the control process.
This concludes analysis of the first fundamental management function,
planning. The next section focuses on the second function, organising.
2.7.2 Organising
Every business exists to fulfil a specific vision and mission, and to achieve
goals and objectives. If a business is to fulfil its vision and mission and attain
its goals, certain activities must be organised and resources must be allocated
to them. Increasingly, businesses are finding that their long-term success is
dependent upon their ability to organise activities effectively, efficiently and
with an emphasis on quality.
This section examines the process of organising in the business, and defines
the most important principles pertaining to organising.
2.7.2.1 A definition of organising
Organising is the process of creating a structure for the business that will
enable its people to work effectively towards its vision, mission and goals. It is
the process of determining what tasks should be done, who will do them, and
how they will be managed and co-ordinated. Organising is an ongoing and
interactive process that occurs throughout the life of a business.
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2.7.2.2 The organising process
The point of departure in the organising process is the vision, mission and
goals of the business that were formulated in the planning phase.
Example
Edcon2 may formulate goals for the group as a whole as well as for its three
division retail stores, namely Edgars division (comprising 186 Edgars stores, 39
Red Square Stores, 34 Boardmans stores and 137 Edgars Active stores), Discount
division and CNA. The first stage in the organising process involves outlining
the tasks and activities to be completed in order to achieve the goals and
objectives of the business. Edcon should outline the tasks and activities that
need to be performed in all of its stores in southern Africa in order to achieve
its objectives, as well as the objectives formulated for the three divisions. Once
these tasks and activities are outlined, jobs must be designed and assigned to
employees within the business. Worker relationships between individuals and
work groups should also be defined. The next step in the organising process is
to develop an organisational design that will support the strategic, tactical and
operational plans of the business. This requires the grouping of organisational
members into work units; developing an integrating mechanism to co-ordinate
the efforts of diverse work groups; and determining the extent to which
decision making in the business is centralised or decentralised. Lastly, a control
mechanism should be put in place.
2.7.2.3
Principles of organisation
The following are the most important principles pertaining to organisation.
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Unity of command means that each employee should report to only one
manager/supervisor.
Unity of direction means that all tasks and activities should be directed
toward the same goals and objectives.
Chain of command (also referred to as the scalar principle) states that
a clear, unbroken chain of command should link every employee with
someone at a higher level, all the way to the top of the business.
Span of control, also called span of management, refers to the number
of staff reporting to a manager. The fewer employees supervised, the
smaller or narrower the span of control. The more employees supervised,
the greater or wider the span of control. With the span of control comes
the height of the organisational levels. A fat organisation exists when
there are few levels with wide spans of control. A tall organisation exists
when there are many levels of narrow spans of control.
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With the division of work, employees have specialised jobs. Related jobs
are grouped together under a single manager/supervisor.
Standardisation is the process of developing uniform practices that
employees are to follow in doing their jobs. The purpose of standardisation
is to develop a certain amount of conformity.
Co-ordination means that all departments and individuals within the
business should work together to accomplish the strategic goals and
tactical and operational objectives. Co-ordination is the process of
integrating all organisational tasks and resources to meet objectives.
Three terms – responsibility, authority and accountability – are closely
related. Responsibility is the obligation to achieve objectives by
performing required activities. Authority is the right to make decisions,
issue orders and use resources. Accountability is the evaluation of how
well individuals meet their responsibilities. Managers are accountable for
everything that happens in their departments. Managers can delegate
responsibility and authority, but never their accountability.
Power refers to the ability to influence the behaviour of others in a
business.
Delegation is the process of assigning responsibility and authority for
attaining objectives. Responsibility and authority are delegated down the
chain of command.
2.7.2.4
Authority
Authority has been defined as the right to make decisions, issue orders and
use resources. In this section, formal and informal authority, line and staff
authority, and centralised and decentralised authority are analysed in more
detail.
Formal authority refers to the specified relationships among employees. It
is the sanctioned way of getting things done, illustrated by the organisational
chart. Informal authority refers to the patterns of relationships and
communication that evolve as employees interact and communicate – the
unsanctioned way of getting things done.
Line authority is the responsibility to make decisions and issue orders down
the chain of command. Line managers in the business are directly responsible
for attaining the business’s goals and objectives. Line functions are those
activities essential for realising the business’s goals and objectives through the
delegation of authority, allocation of work and supervision of employees. Staff
authority is the responsibility to advise and assist other personnel and is based
on expert power. Staff managers render services and advise line managers.
Staff functions are those activities that directly influence the line functions by
means of advice, recommendations, research and technical know-how.
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In centralised authority, important decisions are made by top-level managers.
In decentralised authority, important decisions are made by senior, middle and
first-line management and supervisors.
2.7.2.5
Organisational design
Also called organisational structure, organisational design refers to the
formal arrangement of positions into work units or departments and their
interrelationship within a business. The organisational design is illustrated by
an organisation chart and type of departmentalisation. An organisation chart is
a graphic illustration of the business’s management hierarchy and departments,
and their working relationships.
Departmentalisation is the logical grouping in manageable sizes of
organisational activities belonging together. The departments created in this
way constitute the organisational structure of the business as they appear
on the organisation chart. Of the various types of departmentalisation, the
following are the most common to be found in contemporary businesses.
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Functional departmentalisation groups together those jobs that involve
the same or similar activities. The term ‘function’ is used here to mean
organisational functions, such as finance, marketing, human resources,
etc.
Product departmentalisation implies that all activities concerned with
the manufacturing of a specific product or group of products are grouped
together in product sections.
Location departmentalisation is a logical structure for a business
manufacturing and selling its goods in different geographical regions.
Customer departmentalisation is used when a business concentrates on
a particular segment of the market or group of consumers, or where the
business sells its products only to a limited group of users.
Multiple departmentalisation is often used by large, complex businesses.
It involves the use of several departmental structures to create a hybrid
organisation.
Divisional departmentalisation is based on semi-autonomous strategic
business units. In essence, it involves co-ordinated companies within a
company.
Network structures subcontract some or many of the business’s activities
to other businesses (such as suppliers, customers and competitors) and
co-ordinate them through various methods to accomplish specific goals.
With matrix departmentalisation, the employee works for a functional
department, such as finance, but is also assigned to one or more products
or projects. The major advantage of matrix departmentalisation is
flexibility – it allows the organisation to organise a project temporarily.
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New venture units consist of a group of employees who volunteer to
develop new products or ventures for businesses by using a form of matrix
structure. New products become part of traditional departmentalisation
and are developed into new departments or grow into divisions.
A virtual network structure is a more contemporary organisation
design. This structure means that the business subcontracts most of its
major functions to separate businesses, and co-ordinates their activities
from a small headquarter business.
Probably the most widespread trend in departmentalisation in recent
years has been the implementation of team concepts. There are two
ways to think about using teams in businesses. Firstly, cross-functional
teams consist of employees from various functional departments who
are responsible for meeting as a team to resolve mutual problems. Team
members typically report to their functional departments, but also to the
team, one member of which may be the leader. The second approach is
to use permanent teams – groups of employees who are brought together
to a formal department. Each team brings together employees from all
functional areas focused on a specific task or project. With a team-based
structure, the entire business is made up of horizontal teams that coordinate their work and work directly with customers to accomplish the
business’s goals.
This concludes our discussion of organising, the second fundamental
management function. The next section examines the third function, namely
leadership.
2.7.3 Leading
Leading is the third function of management. This section explains leadership,
communication, motivation and discipline.
2.7.3.1 Leadership
Leadership can be defined as the ability to influence people, either individually
or in groups, to attain organisational goals. There are many managerial activities
that can fall within this definition, such as giving instructions, motivating
people, consulting with people, directing groups, rewarding people for good
performance and the like. The important thing to note is that leadership
happens among people, involves influence and is used to help reach some goal
or goals.
Three important aspects of leading effectively – implied in the definition
above – are influence, shared purpose, and organisational change. The ability
to influence others is an important part of leadership because management
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must influence the business to follow the strategic plans that they develop.
Leaders can influence others to follow a certain course of action in a number
of ways. One such way is to use the authority of the manager’s formal position
in the business. This is influence based on a given position in the business
and allows that person to say who does what, to enforce the performance of
certain duties by others and to reward or punish performance. This position
theoretically gives the manager power over subordinates so as to be able to
influence, but power is not gained only through the possession of a rank or job
title – it should also be earned by the leader. There are many different kinds of
power that a manager can have.
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Legitimate power. This refers to the authority granted to a particular
position. A manager has the right to insist on the execution of certain
duties by staff and the right to dismiss them if they fail to comply.
Reward power. This concerns the power to give or withhold rewards in
terms of salary, bonuses, recognition or interesting assignments.
Coercive power. This is the power to enforce compliance through fear,
whether psychological, emotional or physical.
Referent power. This refers to personal power and is based on identification
or charisma. The staff member obeys a leader simply because they like,
respect or identify with them.
Expert power. This is derived from expertise, knowledge or professional
ability. The more important the information and the fewer the people
who possess it, the greater the power of the person who commands it.
Although managers may have some, or even all, of the above bases of power, it
is important to note that subordinates also have power and, unless they are on
board and work with the leadership, the business will not be successful.
Today, change is a constant in most businesses simply because of
the dynamic nature of the management environment. Changes in the
management environment impact in different ways on business. Therefore,
the management environment should be analysed by business leaders in order
to forecast change and implement the most effective leadership style in the
contemporary business.
Effective managers have to be leaders too because there are distinct qualities
associated with management and leadership that provide different strengths
for the business.
Leaders should possess power qualities that are visionary, creative, flexible,
inspiring, innovative, courageous, imaginative, experimental and personal.
Managers should have power qualities that are rational, consultative,
persistent, problem-solving, tough-minded, analytical, structured, deliberate,
authoritative, stabilising and positional.
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The qualities and skills of management and leadership frequently overlap within
an individual. Ideally, a manager should develop a balance of both managerial
and leadership qualities. One important difference is that management aims
to emphasise stability and problem solving in the existing organisational
system, while leadership emphasises vision, creativity and change. In simpler
terms, a manager strives to be efficient and effective within the business’s
current position, whilst a leader aims to take the business to a new place. In
dynamic environments, the two skill sets are not mutually exclusive, and good
businesses are always looking for good managers who have the potential to be
good leaders.
Other differences between a manager and a leader include the following.
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Management is about making the organisation work; leadership is about
setting direction and change.
Management is about setting structure to perform tasks; leadership is
about aligning people.
Management controls by checking performance to targets; leaders do not
do detailed audits, but check if people are following the new direction.
Managers focus on non-behavioural aspects of management, such as goal
setting, strategy development, and control of activities. Leadership focuses
on behavioural aspects, like mobilising people and setting direction.
Managers use authority to enforce and direct the activities of others,
whilst leaders have the authority, but achieve results without having to
use force.
2.7.3.2 Leadership models
The importance of good leadership in effective management cannot be
overemphasised. It is important to determine what it is that makes a person
a good leader, which is why this subject has been so widely researched. This
section looks at the characteristics model, as well as behavioural, situational
and contemporary approaches to leadership.
The leadership trait or characteristics model
This model is based on the premise that some people are naturally gifted with
certain physical characteristics, personality traits, abilities or specific aptitudes.
Successful and unsuccessful leaders have been compared on the basis of these
factors. Research evidence has shown that there are differences between leaders
and non-leaders in terms of these characteristics, but there is no evidence to
show that leaders are born. In fact, a certain set of traits and skills does not
mean that the person will be a successful leader. This is because such traits
are good for a certain situation, but may not be good for another. The issue is
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whether the set of traits fits the situation. In fact, for every study that identified
specific traits as important for leadership, there were thousands of people who
were successful as leaders who did not possess those traits.
A recent development in terms of the personal characteristics of effective
leaders is the theory of emotional intelligence. Emotional intelligence can be
described as a group of abilities that help a person to understand his or her own
and others’ feelings and emotions, and to use this knowledge and personal
insight to guide his or her own thinking and actions. It can take a long time to
accumulate and can be shaped by the experiences of the individual.
The behavioural approach to leadership
The behavioural approach to leadership focuses on what effective leaders
do, rather than on what they are. It looks at the differences in the actions of
effective and ineffective leaders. This approach has led to an investigation of
leadership styles, a number of which have been identified. Four of the more
common styles are:
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Autocratic or task-oriented leaders. These leaders tend to be very
dominating and hold the decision-making capabilities very close to
themselves.
Democratic or employee-oriented leaders. This type of leader relies
more on teamwork for effectiveness.
Theory-X leaders. This style is based on the belief that most people are
lazy and have to be forced to work.
Theory-Y leaders. This style is based on the belief that people actually
like to work and to accept responsibility.
Research done on the traits and behavioural approaches to leadership indicate
that no single style is equally effective in all situations. Good leadership is the
result of additional variables. This conclusion led to the development of the
situational approach to leadership.
The situational or contingency approach to leadership
Research based on the situational approach to leadership has focused on
identifying the factors in each situation that influence the effectiveness of
leadership. The outcome of this research indicates that leaders’ success can be
attributed partly to certain traits and behavioural patterns, but is primarily
determined by how successful their traits and behaviour are in satisfying
the needs of their subordinates and the situation. Various models have been
developed based on this approach. The most prominent of these are Fiedler’s
contingency model, Hersey and Blanchard’s leadership cycle model, the pathgoal model, and substitutes for leadership.
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Fiedler’s contingency theory of leadership
The basic idea of Fiedler’s contingency theory is simple: match the leader’s
style with the situation most favourable for his or her success. This fit can be
achieved by understanding the style of leadership (task oriented or employee
oriented), analysing the situation to determine whether or not the style will be
effective and matching the style and the situation by adapting the leaders’ style
to fit the situation.
Hersey and Blanchard’s contingency theory of leadership
Hersey and Blanchard’s model focuses on the characteristics of employees in
determining appropriate leadership behaviour. According to these researchers,
subordinates vary in readiness level. Four levels of readiness were identified,
namely low, moderate, high and very high. A leader can adopt one of four
leadership styles to match the readiness of the subordinate. The telling style
matches a low readiness level and is a very directive style, giving explicit directions
about how tasks should be accomplished. The selling style matches a moderate
readiness level, where the leader explains decisions and give subordinates a
chance to ask questions and gain clarity and understanding about work tasks. The
participating style matches a high readiness level, where the leader shares ideas
with subordinates, giving them a chance to participate and facilitate decision
making. Lastly, the delegating style matches very high levels of readiness, where
the leader provides little direction and little support because the leader hands
over responsibility for decisions and their implementation to subordinates.
The path-goal theory of leadership
According to the path-goal theory of leadership, the leader’s responsibility is
to increase subordinates’ motivation to attain personal and organisational
goals. A leader increases motivation by either clarifying the subordinates’
path to the rewards that are available, or by increasing the rewards that the
subordinates value and desire. Path clarification means that the leader works
with subordinates to help them identify and learn behaviours that will lead
to successful task accomplishment and organisational rewards. Increasing
rewards means that the leader talks with subordinates to learn which rewards
are important to them. Whereas Fiedler’s theory suggests switching leaders as
situations change, in the path-goal model, leaders switch their behaviour to
match the situation. Leaders can adopt one of four leader behaviours:
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a supportive leadership style, where the leader shows concern for the
well-being of subordinates;
a directive leadership style, where the leader tells subordinates exactly
what they are supposed to do;
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a participative leadership style, which means that the leader consults
with subordinates about decisions; and
an achievement-oriented leadership, which occurs when the leader sets
clear and challenging goals for subordinates.
Substitutes for leadership
The contingency theories focus on the leaders’ style, the subordinates’ nature
and the characteristics of the situation. The substitutes for leadership approach
suggest that situational variables can be so powerful that they actually substitute
or neutralise the need for leadership. This approach highlights those situational
characteristics in which a leadership style is unimportant or unnecessary. The
situational characteristics are grouped into three categories, namely group, task and
organisational variables. For example, when subordinates are highly professional
and experienced (a group characteristic), a task and employee-oriented leadership
style is less important, as the employees do not need much direction.
Contemporary approaches to leadership
Research into leadership behaviour is ongoing and is moving in various directions
– all in an effort to construct the ultimate leadership model. The following are
but a few examples of the more contemporary approaches to leadership.
Transactional leadership
The traditional management function of leading is also known as transactional
leadership. Transactional leaders do what managers do. They clarify the
role of subordinates, determine structures, provide rewards and conform to
organisational norms and values. This leadership style is appropriate in stable
situations, but not in a changing and turbulent management environment.
Charismatic and visionary leadership
Charismatic leadership goes beyond a transactional leadership style.
The charismatic leader has the ability to inspire and motivate people to do
more than they would normally do, despite obstacles and personal sacrifice.
Charismatic leaders are often skilled in the art of visionary leadership. Visionary
leaders speak to the hearts of employees, letting them be part of something
bigger than themselves. These leaders see beyond current realities and help
followers believe in a brighter future.
Transformational leaders
Transformational leaders are similar to charismatic leaders, but are distinguished
by their special ability to bring about innovation and change by recognising
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Chapter Two – General Management
followers’ needs and concerns, helping them look at old problems in new ways
and encouraging them to question the status quo.
2.7.3.3 Communication
Communication is an integral part of all management functions. In order to
plan, organise, lead and control, managers have to communicate with their
subordinates. Decision making necessitates communication, and management
by objectives relies heavily on communication skills. When delegating or
co-ordinating work, managers have to communicate. Motivating and leading
subordinates would be impossible without some form of communication. For
example, when controlling activities, managers have to discuss standards,
monitor performance and take corrective action.
In the light of this, the best part of each workday is spent on communication.
Communication is becoming more complex, strategic and vital to the health
of businesses than it was in the past, and it will continue to gain importance
in an information-driven economy.
This section looks at communication from a management perspective. First,
the concept of communication is examined by looking at the communication
process.
We also look at intra-personal, interpersonal, and organisational
communication – focusing particularly on the latter. Also considered are the
communication barriers and strategies to enable managers to become better
communicators.
The communication process
Communication can be described as the process of transmitting information
and meaning. This process is used when there is something that the sender
wants the receiver to know, understand or act upon.
Communication takes place between a sender and a receiver. Top management
(sender) may want to convey to middle management (receiver) what the new
strategy for the next few years will be. Or a trade union (sender) may initiate
negotiations with top management (receiver) regarding a salary increase. The
sender initiates the communication. In a business, the sender will be a person
with information, needs or desires and a reason for communicating them to
one or more people.
Encoding takes place when the manager translates the information on the
business’s goals into a series of symbols for communication. In this case, the
symbols used could be words or pictures. Encoding poses a great challenge to
South African managers.
Encoding is necessary because information can be transferred from
one person to another only through representations or symbols. Since
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communication is the object of encoding, the sender attempts to establish
mutuality of meaning with the receiver by choosing symbols, usually in the
form of words and gestures, which the sender believes will have meaning for
the receiver.
The sender has to select a channel for transmitting the message. A manager
explaining the goals and objectives of the business to a subordinate can
choose one of the following channels: oral, non-verbal or written. He or she
can choose a one-to-one or face-to-face situation, as individual goals will have
to be set for the subordinate.
Noise may be described as any factor that disturbs, confuses or interferes
with the transmission of the communication message. Noise may arise along
the communication channel and may either be internal or external. Noise
may occur at any stage of the communication process, but is particularly
troublesome in the encoding or decoding stage. Since noise can interfere with
understanding, managers should attempt to restrict it to a level that permits
effective communication.
The receiver is the person whose senses perceive the sender’s message.
There may be only one receiver, as in the case of the manager discussing
the business’s goals and objectives with a subordinate – or there may be
many, such as when a memorandum is addressed to all the members of a
department or a business.
Decoding is the process by which the receiver interprets the message and
translates it into meaningful information. This is a two-step process. The
receiver must first perceive the message and then interpret it. Decoding is
affected by the receiver’s past experience, personal assessment of the symbols
and gestures used, and expectations. The more the receiver’s decoding matches
the sender’s intended message, the more effective the communication will be.
The receiver decides whether feedback to the sender is needed. The
subordinate, in discussing with his or her manager the business’s goals and
objectives of reducing the number of rejects in a manufacturing plant, may
decide to give feedback to the manager. He or she may tell the manager that
his or her individual goal is to reduce the number of rejects that he or she
is responsible for to less than 2%. At this moment, the role of sender and
receiver changes. The subordinate now becomes the sender and the manager
the receiver.
Organisational communication
Managerial communication occurs in three forms: intra-personal, interpersonal
and organisational.
In intra-personal communication, managers receive, process and transmit
information to themselves. In interpersonal communication, messages are
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transmitted directly between two or more people on a person-to-person
basis. In organisational communication, information is transferred between
businesses, or between different units or departments, in the same business.
Effective communication can give a business a competitive edge, and
businesses in which communication systems are effective are likely to be more
successful than those in which they are not. The question now arises as to
what differentiates an effective communication system from an ineffective
one. This question is examined next.
Organisational communication networks
There are two primary organisational communication networks: the formal
communication network and the informal communication network. The
formal network is communication that follows the hierarchical structure of
the business, or the ‘chain of command’. It follows the formal, established,
official lines of contact.
In other words, it follows the prescribed path of the hierarchical chart and
tends to be explicit in terms of ‘who should be talking to whom about what’.
The informal network involves communication that does not follow the
hierarchical path or chain of command. It tells you ‘who is really talking to
whom and about what’. Informal communication refers to links that have
grown out of relationships between employees and management, and that
have little or no correlation with the formal organisational chart. The informal
network is very strong in most businesses; it usually works much faster than
the formal network.
A manager needs to be aware of both networks. Management has more
control over the formal network than the informal, while employees have
more control over the informal network than management does.
Formal communication
Organisational communication flows in four directions: downwards, upwards,
horizontally and laterally.
Downward communication starts with top management and flows down
through the management levels to workers. The major purpose of downward
communication is to provide subordinates with information on organisational
goals, objectives, strategies, policies, and so on. Downward communication is
likely to be filtered, modified or halted at each level as managers decide what
should be passed down to employees.
When employees send a message to their superiors, they are using upward
communication. The main function of upward communication is to supply
information to the upper levels about what is happening at the lower levels.
Subordinates can communicate with managers through progress reports,
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suggestions or special requests. Middle management plays an important role
in upward communication, as these managers usually filter information before
it reaches top management. This could lead to vertical information being
inaccurate or incomplete if the message is not conveyed clearly. To encourage
open communication between subordinates and managers, managers often
make use of open-door policies.
Horizontal communication occurs between people on the same level of
the hierarchy and is designed to ensure or improve co-ordination of the work
effort; it is formal communication, but does not follow the chain of command.
When the head of marketing, for example, discusses the appointment of a new
salesperson with the head of human resources, horizontal communication
takes place.
When the production manager at a mine discusses the maintenance
schedule with the maintenance manager, communication is taking place
at a horizontal level. Horizontal communication has the basic task of
co-ordination within departments as well as between different departments.
Effective horizontal communication should prevent tunnel vision in the
organisation – the idea that a particular department is the only important
one in the organisation. Meetings play a decisive role in promoting effective
horizontal communication, provided that the right people attend them. When
the marketing department meets to discuss the possibility of a new product,
managers from the research and development, finance, purchasing and
operations departments also need to attend to ensure that the manufacture
of the new product is feasible.
Lateral communication takes place between people at different levels of
the hierarchy and is usually designed to provide information, co-ordination or
assistance to either or both parties.
However, communication occurs with the knowledge, approval and
encouragement of managers who understand that lateral communication
may help relieve their communication burden, and also reduce inaccuracy by
putting relevant people in direct contact with one another.
Informal communication
Communication in a business is seen as informal when it is not official or
sanctioned by management. Commonly called the grapevine, this type of
information can begin with anyone in the business and can flow in any
direction.
The grapevine’s prime function is to disseminate information to employees
(both managerial and non-managerial) that is relevant to their needs. It derives
its existence from employees’ social and personal interests, rather than from
formal organisational requirements.
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It is important to understand that rumour and the grapevine are not the
same. Rumours – information without a factual base – may be communicated
just as easily via formal as informal channels of communication.
Whether they view it as an asset or a liability, managers must understand
the grapevine. Since it is always present, speedy and largely accurate, managers
should use it as another means of transmitting information. They should learn
who is likely to spread information and feed these individuals selected messages.
2.7.3.4 Motivation
The concept of motivation is widely discussed, yet there is a lot of ignorance
about what motivation is and its effects.
Some say that motivation is a process whereby behaviour is activated,
directed and sustained over a period of time. From the point of view of an
organisation, one can regard motivation as the willingness of an employee to
act in a specific, goal-directed way to achieve the goals of the organisation.
In other words, motivation refers to the forces within or external to the
person stimulating, channelling and maintaining human behaviour in order
to achieve goals. The concept of motivation, therefore, has three clearly
defined dimensions: stimulation of needs, human behaviour and goals or goal
achievement. A person reacts to a need by behaving in a particular way, and
the goal of this behaviour is the satisfaction of the need.
The interaction between these intrinsic human activities is indicated in
Figure 2.4.
Action/
achievement
performance
Direct behaviour
to satisfy need/
goals
Need or
deficiency
Satisfied/
unsatisfied
Rewards/
punishment
Figure 2.4: A simple model of motivation
The model shows that the motivation process starts when a person experiences
a need or deficiency, for example a need for food or more pay, as shown in the
example above. The employee will direct his or her behaviour towards a goal
that will satisfy that need, for example by working harder. This goal setting
is followed by the subject taking the planned action and then evaluating
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the behaviour, which will result in either a reward or a punishment. If the
employee is successful in reaching the goal, he or she will be satisfied and
continue to work hard. If the reward is not forthcoming, the result is then
negative and the employee will be unsatisfied and choose another course of
action. Most human behaviour patterns may be linked in this way with some
human need that has not yet been satisfied.
A manager’s assumptions about employee motivation and use of rewards
depend on his or her perspective on motivation. Three different perspectives
on employee motivation have evolved, namely the content, process and
reinforcement theories of motivation.
Content theories of motivation
Content theories emphasise the needs that motivate people. At any point in
time, people have basic needs, such as for food or achieving monetary reward.
These needs translate into an internal drive that motivates specific behaviour
in an attempt to fulfil the needs.
Maslow’s needs hierarchy
Maslow’s theory proposes that humans are motivated by multiple needs and
that these needs exist in a hierarchical order.
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Physiological needs: the satisfaction of these needs is essential for
humans’ biological functioning and survival (for example the need for
food, water and shelter).
Safety needs: as soon as physiological needs are reasonably satisfied,
needs on the next level in the hierarchy emerge, and the importance of
the previous level of needs diminishes. People now use their energy to
satisfy the next important need, safety, which has a direct bearing on
their survival.
Social needs: once a person feels safe and in control of possible threats,
social needs are activated. These include the need for love, acceptance
and friendship.
Ego needs: these relate to a person’s self-esteem and self-respect as well as
acquiring the respect and esteem of other people.
Self-actualisation needs: if all the previously mentioned needs are
largely satisfied, or if they can be readily satisfied, people spend their time
in search of opportunities to apply their skills to the best of their ability.
Self-actualisation needs are, therefore, regarded as the most important
needs.
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According to Maslow’s theory in general, low-order needs take priority and
must be satisfied before higher order needs are activated. However, there are
exceptions to this rule.
Herzberg’s two-factor motivation theory
Herzberg’s theory is based on the premise that there is a set of factors or working
conditions which, if present in the work situation, tend to motivate people in
order to improve their performance, resulting in job satisfaction. These factors
are closely related to the nature and content of the work done. Herzberg refers
to these factors as motivators and includes achievement, recognition, the work
itself, responsibility, and advancement.
According to Herzberg, a job will tend to result in high intrinsic motivation
if it includes these factors. If these factors are not present, however, the result
is not necessarily dissatisfaction. Herzberg postulates that dissatisfaction is
caused by the absence of another set of factors, which he terms the hygiene
factors, or the maintenance factors. These factors satisfy a person’s lower-order
needs and include organisational policy and administration; supervision;
interpersonal relationships with colleagues, superiors, and subordinates;
salary; status; working conditions; and work security. Herzberg maintains
that if employees regard hygiene factors as insufficient, they are unhappy and
dissatisfied, and tend to be less productive. For example, if employees feel that
their compensation is not on par with that of other employees in the same
job at other organisations, they will be unhappy and this will affect their
performance. If, however, their remuneration equals or exceeds that of other
employees doing similar work it does not mean that they will be motivated,
as a high level of motivation is only ensured by the motivators, not by the
hygiene factors.
McClelland’s achievement-motivation theory
McClelland’s achievement-motivation theory proposes that certain types of
needs are acquired during the individual’s lifetime. People are not born with
these needs, but may learn them through their life experiences. The three
needs frequently studied are the need for achievement, affiliation, and power.
The model proposes that, when a need is strong, it will motivate the person to
engage in behaviours to satisfy that need.
Entrepreneurs frequently have a high need for achievement: they prefer to do
something better than their competitors and take sensible business decisions.
People with a high need for affiliation are successful integrators, whose job
is to co-ordinate the work of several departments in a business.
A high need for power is often associated with the successful attainment of
top levels in the organisational hierarchy.
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In summary, content theories of motivation focus on people’s underlying
needs, and label those particular needs that motivate behaviour. These theories
help contemporary managers to understand what motivates people so that they
can design work to meet needs, and hence elicit appropriate and successful
work behaviours.
Process theories of motivation
The process theories of motivation explain how workers select behavioural
actions to meet their needs and determine whether their choices were
successful.
Vroom’s expectancy theory of motivation
The assumption that individuals have expectations about outcomes, which
may manifest as a result of what they do, underlies the expectancy theory of
motivation. A further assumption is that individuals have different preferences
for different outcomes, thus they are able to choose one course of action over
another. Vroom suggests that an individual will be motivated to work well if he or
she sees that his or her efforts will result in successful performance. Furthermore,
the individual must also perceive or believe that successful performance will
result in desirable outcomes. Basic variables in Vroom’s motivation process are
expectations, outcomes, instrumentalities, valences and choices:
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Expectancy refers to the fact that the effort a person makes to obtain
a first-level outcome is influenced by his or her expectation that the
outcome will be realised. If the expectancy is that performance will not
or will probably not be affected, little or no effort will be made. If the
probability of achieving a specific performance goal is regarded as high,
every effort will be made to achieve just that.
Instrumentality means that reaching the first-level outcome may in
fact not mean anything to a person. It may, however, be instrumental
in reaching the second-level outcome or reward. Instrumentality is
the degree of belief that the first outcome (performance) will result in
attaining the second-level outcome (reward). Instrumentality, therefore,
may be regarded as a performance-to-outcome relationship.
Valence refers to the expected satisfaction which will follow a
consequence, rather than the immediate satisfaction it brings. Therefore,
the degree of importance, or the value, of second-level outcomes varies
from one person to the next. The importance or attraction of the secondlevel outcome is called valence and is based on the extent to which an
outcome satisfies an individual’s needs. In other words, valence is the
strength of an individual’s preference for an outcome.
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The expectancy theory provides a framework for understanding employees’
motivation to perform and the organisational influences that may affect such
behaviour.
Equity theory of motivation
The equity theory of motivation is based on the assumption that motivation is
influenced by the degree of equity an employee experiences in the work situation.
This boils down to a comparison of what one employee receives on the basis of
his or her effort with what other employees receive on the basis of their effort. For
example, if an employee feels that he or she is being paid less than one or more
colleagues for the same quality and quantity of work, such an employee will be
dissatisfied and attempt to reduce the inequity. The degree of inequity may be
defined in terms of the relation between an employee’s outcomes (remuneration)
and his or her inputs (effort) as compared with that of a comparable colleague. If
an employee sees that his or her outcomes and inputs are not equal to those of a
comparable employee, feelings of disequilibrium will be aroused.
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Reinforcement theory
The reinforcement theory is a motivational theory that says that a person will
learn to continue behaviours that are positively rewarded and discontinue
those that are ignored or punished.
There are four basic reinforcement strategies that can be used. Positive
reinforcement or avoidance is used to reinforce positive behaviours, while
punishment or extinction is used to reduce the undesirable behaviour. It is
important that excellent behaviour be rewarded, and that when behaviour
does not support organisational goals, extinction or if necessary, punishment
be used to end undesirable behaviours. Consistency in rewarding desirable
behaviours is what leads to positive performance in the long term.
2.7.3.5 Discipline
Handling discipline is an essential part of effective management in any
business. Disciplinary action is normally initiated by management in response
to unsatisfactory work performance or unacceptable behaviour on the part of
workers. In the context of the current employment law, such discipline should
be corrective rather than punitive. Employers should try to correct employees’
behaviour by a system of graduated discipline measures, like counselling and
warnings, and employees must know what is expected of them.
A fair procedure must be applied when taking disciplinary action.
Employers should keep records for each employee specifying the nature of any
disciplinary transgressions, the actions taken by the employer and the reasons
for the actions.
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Disciplinary actions normally entail progressive levels: verbal warnings
followed by written warnings, and final written warnings prior to dismissal.
Other measures, which could be applied short of dismissal, are the denial of
privileges for a short time. Dismissal is the most serious disciplinary penalty
that can be lawfully imposed by an employer on an employee.
The final section of this chapter examines the fourth management function,
control.
2.7.4 Controlling
The preceding sections discussed the management process in terms of
planning, organising and leading. This section focuses on controlling, the
final management function component that integrates the entire management
process. The controlling function compares actual performance against
predetermined objectives and standards. Thus controlling as a management
function ensures that the business’s resources are meaningfully deployed in
order to achieve the mission, goals and objectives. Managers should understand
the nature and importance of control as a management function, and the
relationship between control and the management process.
2.7.4.1 Definition of control
Control is the regulatory task of management that determines whether or not
there has been a deviation in the plans so that steps can be taken to prevent
and rectify errors. Without control, organisations have no indication of how
well they are performing in relation to their goals. At any point in time, control
compares where the business is in terms of performance (for example financial
performance or productivity) to where it is supposed to be.
2.7.4.2 The importance of control
Control is necessary in any business because it:
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ensures that all activities, at all levels of the business, are in accordance
with the organisation’s overall goals, thus providing a co-ordinating
mechanism that links the planning and control processes of a business;
ensures that the business’s resources are deployed in such a way that it
attains its objectives;
results in better quality, and enables management to cope with
environmental change and uncertainty;
helps to avoid costly mistakes, as even small mistakes and errors may
accumulate and become very serious if not properly controlled;
helps businesses to compete by reducing costs and boosting output; and
facilitates delegation and teamwork.
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2.7.4.3 The control process
Control is the process by which management ensures that the business’s goals
are realised or that actual performance ties in with predetermined standards.
This process consists of four steps:
Step 1: Establishing performance standards
This step involves the establishment of a standard (which is derived from goals/
objectives) against which subsequent performance will be compared.
Step 2: Measuring actual performance
The second step involves collecting data and reporting on actual performance.
The variables should be reliable and quantifiable to make meaningful
comparison possible. Observation and measurement should be in accordance
with the control system: that is, they should occur at the strategic points and
according to the standards determined by the control system.
Step 3: Evaluating deviations
The third step in the control process is comparing measured performance
against established standards. Actual performance may be higher than, lower
than or identical to the standard. If actual performance is higher than the
standard, it may mean that the standard could have been determined too
low and should be higher in future. If actual performance is lower than the
standard, the question is how much deviation from the standard to allow
before taking remedial action. Only exceptional differences between actual
and planned performance should be communicated to top management (this is
known as control by exception), whereas subordinates deal with less significant
deviations.
Step 4: Taking corrective action
The fourth and last step in the control process is to determine the need
for corrective action. This step is aimed at achieving or improving on the
performance standard and ensuring that differences do not recur in future. If
there are significant deviations, corrective action may include improving the
actual performance, revising the strategy, or lowering performance standards.
2.7.4.4 Levels of control
The management of any organisation is responsible for the performance of
the organisation as a whole, as well as the performance of individual groups
and departments. To enable management to control the performance of the
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organisation, requires that control must be broken down into different levels.
Three basic levels of control can be distinguished: strategic, tactical/functional
and operational control.
Strategic control
Strategic control is exercised at top management level and entails a close
study of the organisation’s total effectiveness, productivity and management
effectiveness.
Tactical or functional control
Tactical or functional control can be applied to all the major functional areas
in the organisation, namely finance, human resources, physical resources and
information.
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Financial control is the control of financial resources as they flow into the
organisation (such as revenues and shareholder contributions), are held
by the organisation (such as working capital and retained earnings) and
flow out of the organisation (such as expenses and salaries). Organisations
need to manage their finances so that revenues are sufficient to cover costs
and still earn a profit for the owners. The control of financial resources is
central to the control of other resources in the organisation.
Human resources are one of the organisation’s main resources and should
be controlled meaningfully. The main instrument used to control a
business’s human resources is performance measurement. From a control
point of view, the performance of groups and individuals is assessed
and compared with predetermined standards. Tasks are subdivided into
components, and the importance of each subtask is determined so that
criteria and measuring instruments can be developed. Performance
standards are then developed so that actual performance can be measured
against these standards for feedback to management, and consequent
action can be taken. Other instruments include specific ratio analysis
that can be applied in respect of labour turnover, absenteeism, and the
composition of the labour force. To maintain and increase employee
performance, managers can also engage in coaching, counselling and
disciplining.
The physical resources of a business are its tangible assets, such as land,
buildings, machinery, vehicles, equipment, office furniture, raw material,
work in progress and its finished products. Various control systems can
be established to control the physical resources of a business, such as
inventory control, operational control and quality control.
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„„
Relevant and timely information is of the greatest importance to
managers to enable them to perform the tasks of planning, organising,
leading and controlling.
Operational control
Operational control is concerned with the organisations’ processes that
entail transforming resources into products and services. For example,
suppliers, creditors and lenders (inputs) evaluate the organisations’ ability to
pay them and, while manufacturing the products or producing the service
(transformation), quality control is exercised. Finally, customers evaluate
product performance and service after the sale (outputs) when making
purchasing decisions. Operations control is exercised at different points in the
transformation process, namely when inputs are made, when transformation
takes place and when outputs are produced.
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Preliminary control concentrates on the resources or inputs – that
is, financial, human, information, entrepreneurial, physical – that the
business gets from the external environment. Preliminary control is
designed to anticipate and prevent possible problems.
Concurrent control involves taking action as inputs are transformed
into outputs to ensure that standards are met. The aim of concurrent
control is to meet standards for product or service quality or quantity.
Rework control focuses on the outputs of the organisation after the
transformation process is complete. It allows final products to be
inspected before they are sold. Although rework control alone may
not be as effective as preliminary or concurrent control, it can provide
management with information for future planning.
Damage control (customer/stakeholder satisfaction) means action is
taken to minimise the negative impacts on customers or stakeholders
due to faulty outputs. One form of damage control is warranties, which
requires refunding the purchase price, or fixing or replacing the product.
Feedback from customers and stakeholders is used to ensure continuous
improvement in products.
2.8 Interaction of general management with other business functions
As we have seen in the previous sections, general management entails the
management process as a whole, namely:
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the planning that management has to do;
the organisation that management has to establish to carry out the plans
necessary to achieve the goals and objectives of the business;
the leadership that management has to perform to get things done; and
the control that management needs to exercise on all levels.
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These four fundamental functions of management are performed on all levels
of management: top management, senior/middle management and first-line
(supervisory) management levels. Furthermore, these management functions
are also performed by managers in each functional area of management, such
as marketing, finance, operations, and so on.
2.9 Summary
This chapter has dealt with the general principles of management. Management
is an indispensable part of any business without which resources cannot be
deployed effectively and efficiently in order to reach the goals and objectives of
the business. What management is, and the various skills that a manager should
have were defined. Three managerial levels were distinguished, and creative
problem solving and decision making, as well as the role that information
plays in these processes, were examined. In addition, the four fundamental
functions of management – planning, organising, leading and controlling –
were explained.
2.10 Self-evaluation
Read the case study and answer the questions below.
Case study
MTN South Africa: best large-sized employer in South Africa3:
2010/20113
Since 1991, the Corporate Research Foundation (CRF) Institute has developed
and run a best employers methodology in South Africa, with the aim of
identifying and rating employers that are among the best in the country and
create the best working conditions for their employees. In order to be certified
as one of the country’s best employers, organisations must exceed the objective
rating standards in an in-depth benchmarked assessment of their policies in
terms of:
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organisational strategy;
the human resources function;
communication;
diversity management;
corporate social responsibility;
knowledge management;
talent management and engagement;
employee development; performance management; and
rewards and recognition.
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The CRF publishes best employer rankings in the following categories:
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Best 10 Overall Employers;
Best 10 Large-sized Employers;
Best 10 Medium-sized Employers;
Best 10 Small-sized Employers;
Best Employers in Industry; and
Best Empowered Employers.
In the Best 10 Large-sized Employers, MTN South Africa was ranked first.
MTN is a South African telecoms service provider that operates across 24
countries, predominantly in the developing world. MTN offers voice, data
and Internet solutions to clients. It employs 4 583 permanent staff with an
annual turnover of R34 billion in 2009. Although MTN is still a relatively
young company – it opened its doors in 1994 – it has 110 million subscribers
across Africa and the Middle East, of which 17 million reside in South Africa.
The company’s flair for innovation is seen to be its biggest advantage. MTN’s
simplified solutions allow people from all areas, no matter how remote, to
have access to communication. MTN is a company that gives its employees
every opportunity to realise their full potential. Like many companies in
South Africa, MTN is affected by the skills shortage, particularly within the
information communications technology (ICT) industry. There is a scarcity of
engineers in South Africa.
MTN was one of the main sponsors of the 2010 FIFA World Cup, and this
opportunity has opened a number of doors for its employees. 2010 gave
them the opportunity to enhance their broadband capabilities and improve
the network. For example, they had to ensure that people would be able to
watch the games from their handsets if desired. Their World Cup sponsorship
provided the impetus to develop new technology and infrastructure that will
be maintained post the event. The company has built 3G stations across the
country which will need continued maintenance and upkeep.
Executive managers, general managers and senior managers are provided
with mentors and coaches. These mentors come from outside the company
and are seasoned executives who have retired from other businesses and are
willing to lend MTN their skills and expertise. They assist managers in various
areas, such as their approach to market, business-related problems and issues
associated with behaviour in the organisation. This mentorship provides a
valuable input from individuals who have practical, independent experience.
MTN makes various career opportunities available to potential employees.
The backbone of the organisation comprises high-level engineers. From there,
frontline positions include solutions consultants – who take the specifications
for product design to the engineers – as well as IT, sales and customer service.
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MTN also has a retail division, which is growing at a rapid rate. In 2009, the
number of retail shops increased from 18 to 235.
MTN’s main objective for the near future is to position its South African
business strategically in the broadband space. Essentially, the voice telecoms
market has been saturated. Consumers are no longer using their mobile phones
exclusively for voice communication but also for news, banking, Internet and
the like. So the company has targeted this market, and is making opportunities
available for people to work within these specialist fields.
Questions
1.
2.
3.
4.
5.
6.
7.
Explain the management process that is encountered at all levels and in
all departments in a business such as MTN.
Discuss the managerial skills needed by MTN’s managers at the top,
middle and lower levels of management.
Since MTN has opened its doors in 1994, the company has made several
important decisions, such as the decision to sponsor the 2010 FIFA World
Cup. Discuss the steps that they should follow in the rational decisionmaking model.
Top managers at MTN have an important role to play in directing the
company towards its core purpose, namely a telecoms service provider.
Explain the phases that top managers should follow in the strategic
management process.
Discuss the various types of departmentalisation that exist, and identify
the type or types of departmentalisation that MTN follows.
Discuss the purpose of managerial control and identify the main areas
that should be controlled within MTN.
Managers at MTN are provided with mentors and coaches. Discuss the
leadership and motivational roles of these mentors and coaches in a
company like MTN. In your answer, you should differentiate between
the terms leadership and motivation and indicate the importance thereof
in the management of a business.
References
1.
2.
3.
Funding Universe, The Walt Disney Company History [online] available at
http://www.fundinguniverse.com/company-histories/The-Walt-DisneyCompany-Company-History.html (accessed 14 November 2011).
Edcon [online] available at http://www.edcon.co.za/about-retail.php
(accessed 20 March 2014).
Best Employers South Africa 2010/2011, pp. 246-251.
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CHAPTER T H R E E
Financial Management
Helene Weitsz and Dumisani Mabasa
Learning objectives
When you have completed this chapter you should be able to:
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describe the implications of financial management and the role of financial managers;
describe and apply the fundamental principles of financial management;
understand and manage the current assets of the business;
assess financing decisions;
analyse and interpret the financial statements of the business;
evaluate investment decisions; and
explain how the finance functions interact with other business functions.
3.1 Introduction
Financial management involves the strategic planning and budgeting of shortand long-term funds for current and future needs. Tracking past financial
transactions, controlling current revenues and expenses, and planning for
the future financial needs of the business organisation are the foundation of
financial management. When starting a business, whether small- or mediumsized, the focus should be on value creation for the customers, owners and
shareholders. It is important, therefore, to understand what the customer values
and to build in value for the customer from development through to delivery of
the product. The aim of this chapter is to consider how value can be added by
the financial manager.
3.2 The core principles of financial management
Sound financial management decisions are based on three core principles,
namely:
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the cost-benefit principle;
the risk-return principle; and
the time value of money principle.
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3.2.1 The cost-benefit principle
In any decision that is made, the benefits should be greater than the costs.
Therefore, sound financial decision making means that we analyse the total
costs and total benefits of any financial decision we make. The cost-benefit
principle is used to be clear about our objectives, to work out the costs and
benefits of different choices, to determine standards to measure choices, and
then to decide on the best course of action to take.
3.2.2 The risk-return principle
Risk is danger or exposure to loss or injury. Judging risk is part of any decisionmaking process. The financial manager must calculate the chance that the
outcome of the decision will not be what the organisation wanted or expected.
This risk may result in financial loss or waste of resources. The risk-return
principle is a trade-off between risk and return. The higher the risk that a
business takes, the higher the return it wants for taking that risk. In the same
way as with the cost-benefit principle, the return should always be greater than
the risk taken, in order to make the decision sensible.
3.2.3 The time value of money principle
The time value of money principle means that money has value over time. A
business can increase the value of an amount of money by investing it over
time in order to earn interest. If that business instead invests the money in,
for example, motor vehicles or equipment, there will be no interest earned on
these investments. So why would the business do this? From the cost-benefit
perspective, the business would do this if earning interest. From the risk-return
perspective, the business would do this if the return exceeded the risk taken.
3.3 Value chain analysis for growth and profitability
A business is created to sell goods and/or services, and of course, to make a
profit. Producing, marketing and distributing a product are important aspects
of generating a profit. Even more importantly, however, is the business’s
ability to pay for the resources required to accomplish these tasks. Without
the management of finances, there is no business. The financial manager has
an important role to fulfil as the custodian of the shareholders’ money, and
therefore needs to know what will affect the share prices of the business. If the
business’s income is not satisfactory, the shares will drop. If it makes a profit and
has good prospects for the future, the share price will climb. The challenge for
the managers is to constantly add value to the value chain so that the customer
will be satisfied.
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Chapter Three – Financial Management
3.3.1 What role does financial management play?
For any enterprise to succeed, it must have definite goals and strategies. Its
financial policies, investment goals and operational goals have to work together
to accomplish the primary goal of the enterprise – to make profit for the owners
or shareholders. A financial manager assists top management in formulating
and achieving these business goals. The primary functions of the financial
manager are to make financial decisions, to make investment decisions, and
to analyse and plan the financial operations of the enterprise. A financial
manager, sometimes referred to as a chief financial officer (CFO), oversees the
financial operations of a business.
The financial function is concerned with the flow of funds in and out of the
business. In particular, it is concerned with the acquisition of funds (known
as financing), the application of funds for the acquisition of assets (known as
investment), and the administration of, and reporting on, financial matters.
As a subsystem of the business, the financial function and its management are
also influenced by environmental factors.
Financial management is responsible for the efficient management of all
facets of the financial function. A business that does not plan and control
its finances will not be able to respond to unexpected challenges or planned
expansion. Within the broad framework of the strategies and plans of the
business, its aim is to make the highest possible contribution by:
„„
„„
„„
determining long-term investments (buildings, machinery and equipment);
obtaining long-term financing (equity or borrowings); and
managing daily financial activities (debtor and credit payments).
3.3.1.1
Determining long-term investments
Capital budgeting enables the financial manager to plan and manage the longterm investments of the business (ie buildings, machinery and equipment). It is
the process of discovering investment opportunities that deliver value over and
above the cost to the business. The asset creates a cash flow that exceeds the
cost of purchasing the asset.
The investment opportunities will be chosen according to the kind of
business that is conducted. For instance, in the petrochemical industry, the
decision by Sasol to build a new refinery can be classified as a major capital
budgeting decision.
When choosing an investment opportunity, the financial manager must
consider three important factors, namely:
„„
„„
„„
how much cash it will generate;
when the cash will be received; and
what the chances are of receiving the cash.
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3.3.1.2
Obtaining long-term financing (equity or borrowings)
Next, the financial manager must decide whether the business will make use
of equity or borrowings to finance the long-term investments. The capital
structure of the business is the mixture of long-term borrowings and equity
that the business uses. The financial manager must decide what amount
must be borrowed, and what amount must be obtained through equity. The
best mixture will take into account the cost, the risk and the value to the
business. The financial manager must also decide where to obtain the longterm financing, and whether shares must be issued to raise the funds.
3.3.1.3
Managing daily financial activities (debtor and creditor payments)
Working capital includes short-term assets, ie debtors. Net working capital is
short-term assets less short-term liabilities, ie creditors. The financial manager
must manage the daily financial activities so that the necessary cash is available
to run the business without experiencing delays that may negatively impact
the business.
Examples of the questions that the financial manager should ask include:
„„
„„
„„
What cash and inventory levels should be kept?
Will we sell on a cash basis or on a credit basis?
How will we purchase goods – on credit or with cash?
3.3.2 Analysis of the business to determine value adding
Financial analysis is necessary to monitor the general financial position of
the business and, in the process, to limit the risk of financial failure of the
business as far as possible. Financial analyses will reveal certain trends, and
also the financial strengths and weaknesses of the business, so that corrective
measures, if necessary, can be taken in time. Financial ratios show the
relationship between two items (or groups of items) in the financial statements
(especially the income statement and the balance sheet). These ratios also serve
as performance criteria to highlight potential strengths and weaknesses of the
business. However, it must be emphasised that financial ratios do not identify
the reasons for the strengths and weaknesses. They only indicate symptoms that
need to be further diagnosed by financial management. Shareholders, owners
and managers of a business determine how well the business is performing
compared to their competitors in the industry by analysing how and where
value is added throughout the business by means of ratio analysis. For example,
financial ratios of a business are used by:
„„
financial management – with a view to internal control, planning and
decision-making;
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„„
„„
„„
the suppliers of borrowed capital – to evaluate the ability of the business
to pay its debt and interest;
investment analysts – to evaluate the business as an investment
opportunity; and
labour unions – with a view to salary negotiations.
3.3.3 Ratio analysis
Ratio analysis assists in comparing a business’s performance and status to
that of competitors’ businesses, or to itself, over time. Shareholders, creditors
and managers use the information to determine how efficient and profitable
the business is. Ratio analysis is a comparison of numbers, and so is used to
compare current data to data from the previous years, competitors’ data or
industry averages. Ratios eliminate the effect of size, so that you can reasonably
compare a large business’s performance to a smaller business’s performance.
The income statement and balance sheet of the business for the specific period
are used as input for ratio analysis. A formula is used to calculate certain ratios,
but the important part is to interpret the ratio value to establish if it is too high
or too low when compared to the norm.
3.3.3.1 Analysing income statements
One of the main purposes of the income statements is to report a business’s
earnings to its shareholders. However, an income statement reveals much
more about a business, such as how effectively management controls
expenses, or how the business’s profits compare to others in its industry. The
calculations in Table 3.7 on page 106 are based on Sasol’s income statement
for the year ended 30 June 2012. Specifically, the measurements reveal that
such information are:
„„
„„
„„
gross profit margin;
operating profit margin; and
earnings per share (EPS).
Gross profit margin
A business’s profitability and efficiency can be determined at two levels:
profitability of production and profitability of operations. The gross profit
margin determines a business’s profitability of production. It indicates how
efficient management is in using its labour and raw materials to produce goods.
Gross profit margin is calculated as follows:
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„„
„„
„„
the suppliers of borrowed capital – to evaluate the ability of the business
to pay its debt and interest;
investment analysts – to evaluate the business as an investment
opportunity; and
labour unions – with a view to salary negotiations.
3.3.3 Ratio analysis
Ratio analysis assists in comparing a business’s performance and status to
that of competitors’ businesses, or to itself, over time. Shareholders, creditors
and managers use the information to determine how efficient and profitable
the business is. Ratio analysis is a comparison of numbers, and so is used to
compare current data to data from the previous years, competitors’ data or
industry averages. Ratios eliminate the effect of size, so that you can reasonably
compare a large business’s performance to a smaller business’s performance.
The income statement and balance sheet of the business for the specific period
are used as input for ratio analysis. A formula is used to calculate certain ratios,
but the important part is to interpret the ratio value to establish if it is too high
or too low when compared to the norm.
3.3.3.1 Analysing income statements
One of the main purposes of the income statements is to report a business’s
earnings to its shareholders. However, an income statement reveals much
more about a business, such as how effectively management controls
expenses, or how the business’s profits compare to others in its industry. The
calculations in Table 3.7 on page 106 are based on Sasol’s income statement
for the year ended 30 June 2012. Specifically, the measurements reveal that
such information are:
„„
„„
„„
gross profit margin;
operating profit margin; and
earnings per share (EPS).
Gross profit margin
A business’s profitability and efficiency can be determined at two levels:
profitability of production and profitability of operations. The gross profit
margin determines a business’s profitability of production. It indicates how
efficient management is in using its labour and raw materials to produce goods.
Gross profit margin is calculated as follows:
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Sasol Limited Group – (June 30 2012)
Gross profit margin
=
=
=
=
(Total revenue – Cost of goods sold)
Total revenue
(R1 69 446 000 – R1 11 042 000)
R1 69 446 000
R 58 404 000
R1 69 446 000
0.34
Operating profit margin
The operating profit margin determines a business’s profitability of operations.
It indicates how efficiently management is using business operations to generate
a profit. Operating profit margin is calculated as follows:
Sasol Limited Group – (June 30 2012)
Operating
profit
margin
=
(Total revenue – Cost of goods sold) – Operating expenses
Total revenue
(R1 69 446 000 – R1 11 042 000 + R1 416 000) – R23 062 000
R1 69 446 000
R 36 758 000
=
R169 446 000
=
0.22
=
Earnings per share
Gross profit margin and operating profit margin are equally important to both
management and investors. You may notice that they are both ratios, and ratios
are best used when comparing two or more companies. Now, the big question is
how much of the business’s profit belongs to the shareholders?
The portion of a business’s profit allocated to the shareholders on a pershare basis is determined by calculating earnings per share. Earnings per share
is calculated as follows:
Sasol Limited Group – (June 30 2012)
Earnings per share
=
Net income – Dividends on preferred stock
Average outstanding number of shares
When calculating earnings per share, it is more accurate to use a weighted
average number of shares outstanding over the reporting term, because the
number of shares outstanding can change over time. However, data sources
sometimes simplify the calculation by using the number of shares outstanding
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Chapter Three – Financial Management
at the end of the period. Diluted EPS expands on basic EPS by including the
shares of convertibles or warrants outstanding in the outstanding shares
number. Looking at the earning per share number in isolation is not completely
meaningful. For example, it might seem reasonable to assume that a business
with higher earnings per share will be a better business to invest in than one
with lower earnings per share. However, a highly efficient business can have a
low earnings per share ratio simply because it has a large number of outstanding
shares. In some instances, the pressure of maintaining a continued growth
record in net income or earnings per share has led management to ‘cook the
books’ or misrepresent financial information so that the business’s bottom
line appears better than it actually is. Such fraudulent behaviour was notable
in the downfall of well-known companies such as Enron, WorldCom and Tyco,
and is the reason why various laws, such as the Sarbanes Oxley Act of 2002 in
the US and King I, II and III in South Africa, were passed in different countries.
Therefore, it is best not to rely on only one financial measure, but also to look
at the other financial statements and information as a whole.
3.3.3.2 Analysing the balance sheet
Although looking at a balance sheet is a good way to determine the overall
financial health of a business, the data presented on the balance sheet can be
overwhelming and useless to investors if the data is not organised. As a result,
the ratio analysis is crucial when analysing financial statements. There are three
main calculations that use information from a balance sheet to determine a
business’s financial health and liquidity. All calculations in this section are
based on the statement of Sasol’s financial position for the year ended 30 June
2012, as shown in Table 3.6 on page 103. These measurements are:
„„
„„
„„
working capital (current assets – current liabilities);
current ratio (current assets ÷ current liabilities); and
debt to equity ratio (total liabilities ÷ owners’ equity)
Working capital
One of the most important reasons one looks at a business’s balance sheet is to
determine the business’s working capital. Working capital tells you what is left
over if the business pays off its short-term liabilities with its short-term assets.
Working capital ratio is calculated in the following way:
Sasol Limited Group – (June 30 2012)
Working capital
=
=
=
Current assets – Current liabilities
(R65 741 000 – R30 889 000)
R34 852 000
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Business Management: A Contemporary Approach
If a business has a positive working capital (its current assets are greater than
its current liabilities), it means that the business is able to pay off its shortterm liabilities with its current assets. If a business has a negative working
capital (its current assets are less than its current liabilities), it means that it is
unable to offset its current liabilities with its current assets. In this case, even
after adding up all of a business’s cash, collecting all funds from accounts
receivables and selling all inventories, the business would still be unable to pay
back creditors in the short term. When a business’s current liabilities surpass
its current assets, more financial difficulties incur, bankruptcy being the most
severe. It’s important to watch for changes in working capital, as a decline
in positive working capital over time can be an indication that a business’s
financial health is in trouble. For example, a business that is experiencing a
decrease in sales will have a decrease in accounts receivable (current assets).
Current ratio
Although working capital is an important measurement, it is difficult
to compare how efficient a business is to the rest of the industry or to its
competitors, especially if companies vary significantly in size. The current
ratio (sometimes called liquidity ratio) is a measurement used to determine the
extent to which a business can meet its current financial obligations. Current
ratio is calculated as:
Sasol Limited Group – (June 30 2012)
Current ratio
=
=
=
Current assets
Current liabilities
R65 741 000
R30 889 000
2.12
Current ratio allows for better comparisons, especially when comparing a
business to an industry average. Having too high of a current ratio indicates
that the business may not be very efficient with its cash; but having too low of
a current ratio may indicate the business will face potential problems paying
back its creditors.
Debt-to-equity ratio
Another way to analyse the activities of a business is to use the debt-toequity ratio. Although leverage can be beneficial by freeing up cash for other
investments, too much debt can become a problem. Companies with too much
long-term debt may end up financially overburdened with interest payments.
The debt-to-equity ratio measures how much debt a business has relative
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Chapter Three – Financial Management
to its assets by comparing a business’s total liabilities to its total owners’ (or
shareholders’) equity. Debt-to-equity ratio is calculated as:
Sasol Limited Group – (June 30 2012)
Debt-to-equity ratio
=
=
=
Total liabilities
Owner’s equity
R75 439 000
R128 314 000
0.59
The debt-to-equity ratio can give a general idea of a business’s financial leverage.
Leverage is the amount of debt used to finance a firm’s assets. The debt-toequity ratio will tell potential investors how much a business is willing to go
into debt with creditors, lenders and suppliers over debt with shareholders. A
lower debt to equity ratio number means that a business uses less leverage and
has more equity.
3.3.3.3 Economic value adding (EVA)
Measures of economic value are the economic value added (EVA) and market
value added (MVA). These measures can best be applied to public companies, in
other words, companies listed on a securities exchange such as the Johannesburg
Securities Exchange (JSE), the London Stock Exchange (LSE) and the New York
Stock Exchange (NYSE).
EVA is defined as:
EVA = EBIT (1-T) – Cost of capital expressed in rand.
Where EBIT = earnings before interest and tax
T = Tax rate
Example 3.1: Calculating the EVA
Assume a firm has achieved an EBIT of R2 400 000 and is subject to a tax rate of 29%.
The firm’s balance sheet shows owners’ equity at R8 000 000 and debt at R2 000 000.
The firm’s weighted average cost of capital (WACC) is 16%.
EVA = R 2 400 000 (1- 0.29) – 0.16 (R8 00 000 + R200 000)
= R 2 400 000 (0.71) – 0.16 (R1 000 000)
= R 1 704 000 – R160 000
= R 1 544 000
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3.3.3.4 Future cash flows – market value added (MVA)
Businesses that produce a positive return have a positive EVA and increase the
value of the business. Businesses that produce a negative return have a negative
EVA and reduce the market value of their business. A positive EVA is an additional
contribution to shareholders’ wealth made during the year. The market value of
the public company’s equity is simply the number of shares that has been issued
multiplied by the price of the share. If the market value is greater than the book
value of the shares, then the value added is called market value added (MVA). By
using MVA the future cash flow of the business is taken into account and gives
a more precise picture of how the business will add value to the shareholders/
owners.
The calculation of market value and market value added are done as follows.
Market value = capital + present value of all future EVA
Market value added = market value – capital
Example 3.2: Market value added (MVA)
EVA
Total
MVA
(present
value
– EVA)
Capital
Actual
Forecast
2006
2007
2008
2009
2010
2011–2012
Total
(Rmillion) (Rmillion) (Rmillion) (Rmillion) (Rmillion) (Rmillion) (Rmillion)
3 145
2 460
3 990
7 240
12 950
16 200
216 085
170 100
3 145
2 460
3 990
7 240
12 950
186 300
3 145
2 139
3 017
4 760
7 404
92 624
Estimated
market
value
113 089
78 631
191 720
3.3.4 Financial planning (long-term and short-term financing)
No business can exist without capital funds to enable it to purchase assets and
to finance its day-to-day business activities. A business’s financial needs are
both short-term and long-term in nature, and a financial manager must plan
for both. In addition, the financial manager must ensure that funds are used
optimally and that the firm is ultimately profitable. In order to meet these
objectives, a financial manager oversees three important processes, namely:
„„
„„
„„
forecasting financial needs;
developing budgets and plans to meet financial needs; and
establishing controls to ensure that the budgets and plans are being followed.
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3.3.4.1 Forecasting for business financial needs
In most large companies, the executive management team and the board of
directors formulate a strategic plan that sets out corporate goals and objectives.
It is the responsibility of the financial manager to develop short- and longterm financial forecasts to ensure that these strategic goals and objectives are
financially feasible. Financial managers co-ordinate with other areas of the
business to formulate answers to questions like the following:
„„
„„
„„
How many products do we need to sell?
Do we need to expand to meet demand?
Do we have the resources to expand our product line?
Financial forecasts are important especially when strategic goals include large
capital projects such as acquiring new facilities, replacing outdated technology,
or expanding into a new product line. It’s critical that such forecasts are
relatively accurate, as erroneous forecasts can have serious consequences.
In developing forecasts, the financial manager takes many factors into
consideration, including:
„„
„„
„„
the current and future plans of the business;
the current and the future state of the economy; and
the current and anticipated actions of the competition.
In addition, the financial manager must anticipate the impact such factors will
have on the business’s financial situation. If for example, national economic
forecasts predict a recession in the next six months, a financial manager knows
such a forecast will affect the business in many ways. Therefore, additional
planning is required during general economic downturns to handle the possibility
that payments might be harder to collect, or that sales could be lower. Because
of the results from either or both of these possibilities, plans for expansion of the
buildings or acquisition of new equipment might need to be postponed.
3.3.4.2 Capital budgeting
An investment can create value for the business, or it can destroy value. The
task of the financial manager is to identify the right option. Cash flow is the
money that a business receives and spends over a specific period. The cash flow
budget is a short-term budget that estimates cash inflows and outflows, and can
predict a business’s cash flow gaps. Cash flow gaps occur when cash outflows
are greater than cash inflows. Cash flow budgets help financial managers to:
„„
„„
„„
determine whether the business needs to seek outside sources of funds,
beyond sales, to manage anticipated cash shortages;
predict future investment opportunities due to surges in cash flow; and
work out whether a business will have enough cash to grow.
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Business Management: A Contemporary Approach
Moreover, the financial manager uses the cash flow budget to help plan for
debt repayment, or to cover unusual operating expenses. The following are
techniques that are available to determine which option will be the most
profitable.
Net present value (NPV)
When starting a business to manufacture and market a new product, such
as a car, one has to determine the net present value of the investment. The
net present value is determined by deducting the cost of the investment from
the estimated market value of the business. The result indicates to the owner
whether value is created or not.
The value of the business is determined by estimating its future income
and discounting the income to the present value. Say, for instance, that it will
cost R5 million to start manufacturing cars; the estimated cash flows over
a five-year period will be R1 200 000 for the first year, R1 700 000 for the
next year, R2 500 000 for the next two years and R3 000 000 for the last year.
The discount rate is 10%. Now you have to work out the total value of the
future cash flows by discounting the cash flows back to their present values.
No discounting of the discount rate of 10% is required in the first year. In the
second year, the 10% is discounted to the power of 2, for the third year to the
power of 3, for the fourth year to the power of 4, and lastly, in the fifth year,
the 10% is discounted to the power of 5.
Table 3.1: Determining NPV
Year 1
Year 2
Year 3
Year 4
Year 5
PV = R1 200 000 +
R1 700 000 +
R2 500 000 +
R2 500 000 +
R3 000 000
1.1
1.12
1.13
1.14
1.15
= R1 090 909
R1 404 959
R1 503 760
R1 700 680
R1 863 354
= R7 563 662.04
Let’s determine the value that the investment will produce. The present
value of the cash flows is R7 563 662.04, which has to be deducted from the
cost of manufacturing, namely R5 million, to come to the NPV, which is
R7 563 662.04 – R5 000 000 = R2 563 662.04. This is a viable option because
the investment will yield a positive return.
Why is monitoring cash flow important? A business can have the best-selling
product on the market, but if the flow of funds coming in and going out of the
business is not managed properly, the business can easily fail. Monitoring cash
flow is important because it measures a business’s short-term financial health and
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Chapter Three – Financial Management
financial efficiency. Cash flow specifically measures whether there are sufficient
funds to pay outstanding bills. Most businesses rely on cash flow to carry their
companies through the less busy periods, and may need the buffer of cash to help
manage periods when unfavourable conditions affect their businesses. Although
many investors focus on a business’s profitability as an indicator of strength, a
business’s liquidity is often a better indicator. Liquidity refers to how quickly
an asset can be turned into cash. After all, companies go bankrupt when they
cannot pay their bills, not necessarily because they are unprofitable. Accountants
also play a big role in helping financial managers monitor cash flows.
Payback rule
To evaluate investments with the payback rule means that the financial manager
must determine how long it will take to recover the investment money. How
long do we have to wait until the cash flow from the investment is the same
or more than the initial investment? By referring back to the investment to
manufacture the cars, it can be determined that the payback will be four years.
Table 3.2: Net investment cash flows
Year 1
Year 2
Year 3
Year 4
Year 5
R1 090 909
R1 404 959
R1 503 760
R1 700 680
R1 863 354
The original investment was R5 000 000 and this amount is covered after four
years, when the cash flows total R5 700 308.
The profitability index
The profitability index (PI) is the present value of the future cash flows
divided by the original investment. In the previous example, it will cost
R5 million to start manufacturing cars, and the cash flows over five years
totalled R7 563 662.04.
Therefore, the PI value is:
R7 563 662 ÷ R5 000 000 = 1.51.
For every Rand invested, R1.51 or a profit of R0.51 is produced.
3.3.4.3 The time value of money
The time value of money is an extremely important concept and is at the centre of
most financial decisions. It should be kept in mind, when making investment or
financial decisions, that interest has to be paid for the use of capital. Also, funds
or capital is normally required and used for either shorter or longer periods, and
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the use of capital therefore has time implications. The purpose of this discussion
is to explain the concept of the time value of money – the combined effect of
both interest and time – in the context of financial decision making.
In principle, the time value of money bears a direct relation to the opportunity
of earning interest on an investment. In finance, most decisions depend on
either the present value or future value of a stream of cash flows. The time
value of money can be approached from two different perspectives. On the
one hand, the calculation of the future value of some given present value or
amount is possible. On the other hand, the calculation of the present value of
some expected future amount is also possible. The present-value techniques
measure the cash flow at the start of the project’s life time, while future-value
techniques measure it at the end of the project’s life. These techniques will
result in the same decision, but they look at the problem differently. The process
for the calculation of future values (compounding) and for the calculation of
present values (discounting) proceed in opposite directions.
The future value of a single amount
The future value of an initial investment or principal is determined by means
of compounding, which means that the amount of interest earned in each
successive period is added to the amount of the investment at the end of the
preceding period. Interest in the period immediately following is consequently
calculated on a larger amount consisting of capital and interest. Interest is
therefore earned on both capital and interest in each successive period.
The formula for calculating the future value of an original investment is:
FV = PVn (1 + i)n
where:
„„
„„
„„
„„
FV is the future value of the investment after n periods;
PV is the original investment or present value of the investment;
i is the interest rate per period expressed as a decimal number; and
n is the number of discrete periods over which the investment extends.
The future value of an original investment can be calculated by using tables.
An extract of these tables follows in Table 3.3. The example below is for a R100
investment at an interest rate of 5% per annum, which is calculated as follows.
Example 3.3
„„ What is the future value of R100 invested for one year at an interest rate of 5% per
annum?
FV = R100 (1+0.5)1
= R100 (1.05)
= R105

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Chapter Three – Financial Management
„„ What if the investment term is three years?
FV = R100 (1 + 0.5)3
= R100 (1.1576)
= R115.76
Table: 3.3: Table used to calculate future value of an original investment
Future-value factors (1 + i)n
Periods(n)
5%
10%
15%
1
1.0500
1.1000
1.1500
2
1.1025
1.2100
1.3225
3
1.1576
1.3310
1.5209
4
1.2155
1.4641
1.7490
5
1.2763
1.6105
2.0114
The higher the interest, the faster the future value will grow for any given
investment period as a result of the compounding effect. Furthermore, interest
is earned on interest in each successive period. The concept of the compound
interest rate as a growth rate is of vital importance in financial management.
The present value of a single amount
The present value is also based on the principle that the value of money is,
inter alia, affected by the timing of receipts or disbursements, as in the case
of the future value. If it is accepted that a rand today is worth more than
a rand expected at some future date, what would the present value be now
of an amount expected in the future? The answer to this question revolves
around the:
„„
„„
investment opportunity available to the investor or the recipient; and
the future point in time at which the money is expected.
For example, an amount of R105.00 that is expected one year from now will
have a present value of R100.00, provided that the opportunity exists to invest
the R100.00 today at an interest rate of 5% per annum.
The interest rate, which is used for discounting the future value of R105.00
one year from now to a present value of R100.00, reflects the time value of
money, and is the key to the present-value approach. This interest rate – or
opportunity rate of return – is the rate of interest that could be earned on
alternative investments with similar risks if the money had been available for
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Business Management: A Contemporary Approach
investment now. Stated differently, it is the rate of return that would be foregone
by not utilising the investment opportunity. The process of discounting is
explained by means of the time line in Table 3.4 below. Consequently, the
formula for the calculation of the present value of a future single amount is:
1
PV = FV
(1 + i)n
Where:
FV = Future Value;
i = interest rate; and
n = number of periods.
1
The factor (1 + i)n is known as the present value factor – or discounting factor –
for a future single amount. Table 3.4 has also been compiled for the calculation
of present values. Extract from the table is as follows:
„„
„„
„„
Example 3.4: Calculating present values
„„ What is the present value of R105.00 expected one year from now if the investor’s
opportunity cost (discount rate) is 5% per annum?
PV = FV(1/1 + 0.05)1
= R105.00(1/1.05)1
= R100.00
„„ What is the present value of R115.76 expected in three years if it is invested under
the same circumstances as above?
PV = R115.76 (1/1 + 0.05)3
= R115.76 (0.8638)
= R100.00
Table 3.4: Table used to calculate present values
Discounting factors 1/(1 + i)n
Periods (n)
5%
10%
15%
1
0.9524
0.9091
0.8696
2
0.9070
0.8264
0.7561
3
0.8638
0.7513
0.6575
4
0.8227
0.6830
0.5718
5
0.7835
0.6209
0.4972
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Chapter Three – Financial Management
In Example 3.4, the present value of R115.76, expected three years from now,
is calculated with the aid of Table 3.4, at an opportunity rate of return or
discounting rate of 5% as follows.
PV = R115.76 (0.8638)
= R100.00
For a single amount, the present value (PV) of an FV is the monetary amount
that can be invested today at a given interest rate (i) per period in order to grow
to the same future amount after n periods.
3.3.4.4 Capital structure
The financial manager is responsible for choosing an optimal capital structure,
ie a viable combination of debt and equity. The two types of risk a financial
manager must consider are:
„„
„„
business risk – the risk of the return on its assets being insufficient if no
debt is used; and
financial risk – the onus falls on the shareholders to bear a higher risk
when the business decides to use debt.
Financial leverage is obtained when debt is used because value is added
to the business and costs are reduced. The value is added through the tax
deductibility of interest paid, which lowers the interest payment. However, if
more debt is used, it increases the risk so the bank charges a higher interest
rate. To determine how effective the financial leverage has been, the financial
manager should use the interest cover ratio to determine how many times the
business can cover its interest expenses.
3.3.4.5 Working capital management
Working capital management (short-term financial management) refers to
the management of current assets (cash, accounts receivable and stock) and
current liabilities (accounts payable, creditors and overdrafts). The financial
manager must ensure that the correct amount of capital is invested in shortterm financing to allow the business to run effectively.
The working capital refers to the current assets, ie the conversion of cash into
stock, and then to debtors, and back into cash. The business needs working
capital to ensure that cash is available to purchase stock, pay creditors, provide
credit to debtors and pay for day-to-day expenses.
Current liabilities refer to the short-term financing required to pay the debts
of the business, ie payment of suppliers, overdrafts, salaries and taxes that
must be paid within a year or less.
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Net working capital is the difference between the current assets and the current
liabilities of the business. The objective of working capital management is to
use the current assets and the current liabilities in a balanced way so that the
amount of profitability and risk adds positive value to the business.
The cash conversion cycle concentrates on the length of time between the
payments made by a business and its receipts of cash. The cash conversion
cycle model as described by Brigham and Gapenski1 is illustrated in Table 3.5.
Table 3.5: Cash conversion cycle model
Inventory
conversion
+
Receivables
collection
period
–
Payables
deferral
period
=
Cash
conversion
cycle
As an example, a business takes an average of 60 days to convert raw materials
into products and sell them, and a further 21 days to collect the money
from debtors. The cash cycle of the business would be nil if it purchased raw
materials, sold its products, collected the money from debtors and paid the
suppliers on exactly the same day. But it takes 30 days from the delivery of raw
materials to the settlement of the account, thus the cash conversion cycle is:
60 days + 21 days – 30 days = 51 days
The business must take into account that it must cover its costs for a 51-day
period. The business can shorten the cash conversion cycle if:
„„
„„
„„
it can produce and sell the products faster;
it can shorten the receivables period by obtaining the money from debtors
at a faster rate; and/or
it can stretch the payables deferral period by taking longer to pay its accounts.
These steps should only be taken if they do not increase costs or reduce sales.
3.3.5 Budgets
The definition of a budget is a plan of future activities that is expressed in
monetary terms.
Budgeting assists with the planning and control processes of the business,
because the budget functions as a financial tool indicating the expected future
activities, and acting as a standard against which actual performance can be
compared. The planning process of a business consists of:
„„
„„
„„
„„
deciding what objectives must be achieved;
deciding which alternatives can be implemented to achieve the objectives;
deciding which alternative must be chosen as the best option; and
preparing a plan to implement the best alternative.
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Chapter Three – Financial Management
Strategic planning enables the business to choose the best goal, and decide
how the business will be run to accomplish the goal. Tactical and operational
planning involves those activities required to achieve the goals of the business.
Financial planning is planning the financial aspects of the business, for
example the income, expenses, assets, liabilities and cash flow.
The annual budget is prepared for a certain period, usually a financial year.
Annual budgets can be divided into monthly intervals to ensure more realistic
planning and control. The first step in the budget procedure is to decide
on how to construct the budget, for example how to include the different
departmental budgets and then co-ordinate them.
Preparation of the annual budget starts with the sales forecast, which is
used to prepare the sales budget. Then, the sales budget forms the basis for
the tactical (functional) budgets, ie the operations, purchasing (supply chain),
marketing, human resources, administrative, financial and public relations
budgets. The capital budget indicates the supply of – and demand for – capital
that will be required for new projects in the budgeted year.
After these budgets have been prepared, the pro forma income statement is
drawn up. This shows the total expected income and expenditure related to
the planned activities of the business.
Then the cash budget, reflecting the cash income and expenditure for the
budgeted period of one year, is prepared. The expected date of inflow and
outflow of cash, as well as the amount of cash flowing in and out, are also
shown. The inflowing cash is made up of items such as cash sales, debtor
collections, interest received and dividends received. The outflowing cash is
made up of various payments, including interest, rent, salaries and wages,
creditor settlements and taxation. The cash budget is further divided into
a monthly budget to enable the business to forecast whether it will have a
positive or negative cash balance each month. The business can, therefore,
plan beforehand how it will finance the deficit.
Lastly, the pro forma balance sheet is prepared. This indicates the financial
position of the business at the end of the period for which the budget was
prepared, and shows the expected assets and liabilities of the business at that
specific date.
Budget control is applied to ensure that all the activities of the business
are performed within the limits of the budget. Budget control consists of the
following steps.
Step 1: Setting standards
The budget, with the objectives set out in monetary terms, is used as the
standard.
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Step 2: Comparing the actual performance with the standards
The business must compare the actual performance with the planned
performance as indicated in the budget.
Step 3: Evaluating and analysing the actual performance
By analysing the actual performance, the reasons for the variation can be
determined.
Step 4: Taking corrective and preventative action
If the reasons for the variation have been determined, then the business must
decide what preventative measures will be taken to correct the situation and
ensure that it does not happen again.
3.4 Financial statements
Financial statements are the formal reports of a business’s financial transactions
that accountants prepare periodically. They represent what has happened in the
past and provide management, as well as various outsiders such as the creditors
and investors, with a perspective of what is going to happen in the future.
Publicly owned companies are required to publish three financial statements.
„„
„„
„„
A balance sheet shows what the business owns and owes (borrowed) at a
fixed point in time, and shows the net worth of the business.
An income statement shows how much money is coming into a business
and how much money a business is spending over a particular period. It
shows how well a business has done in terms of profit and loss.
A cash flow statement shows the exchange of money between a business
and everyone else it deals with over a period of time. It shows where cash
was used.
3.4.1 The balance sheet
A balance sheet is a snapshot of a business‘s financial condition at a specific
moment in time. It reflects what the business owns (assets), what it owes to
outside parties (liabilities), and what it owes to the owners (owners’ equity).
The balance sheet allows the viewer to have an overall grasp of the financial
position of a business. It is also regarded as the listing, at a specific moment in
time, of all the assets and liabilities of the business, and how these net assets
(total assets less total liabilities) were financed (for example, by owners’ equity
and profits).
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Table 3.6: Statement of financial position of Sasol Limited Group at 30 June 2012
Assets
2012
Rm
2011
Rm
2010
Rm
Property, plant and equipment
Assets under construction
Goodwill
Other intangible assets
Investments in associates
Post-retirement benefits assets
Deferred tax assets
Other long-term assets
95 872
33 585
787
1 214
2 560
313
1 514
2 437
79 245
29 752
747
1 262
3 071
265
1 101
2 218
72 523
21 018
738
1 193
3 573
178
1 099
1 828
Non-current assets
138 282
117 664
102 150
Assets held for sale
Inventories
Trade and other receivables
Short-term financial assets
Cash restricted for use
Cash
18
20 668
26 299
426
5 314
12 746
54
18 512
23 174
22
3 303
14 716
16
16472
20474
50
1 41
14 870
Current assets
65 471
59 781
53 723
Total assets
203 753
177 445
155 873
Equity and liabilities
Share holders’ equity
Non-controlling interest
125 234
3 080
107 171
2 689
93 915
2 510
Total equity
128 314
109 860
96 425
Long-term debt
Long-term financial liabilities
Long-term provisions
Post-retirement benefit obligations
Long-term deferred income
Deferred tax liabilities
12 828
38
10 518
6 872
455
13 839
14 356
103
8 233
5 160
498
11 961
14 111
75
7 013
5 120
273
9 987
Non-current liabilities
44 550
40 311
36 579
Liabilities in disposal groups held for
sale
Short-term debt
Short-term financial liabilities
Other current liabilities
Bank overdraft
–
3 072
135
27 460
222
–
1 602
136
25 327
209
–
1 542
357
20 847
119
Current liabilities
30 889
27 274
22 869
Total equity and liabilities
203 753
177 445
155 873
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Business Management: A Contemporary Approach
Also, by analysing how a balance sheet changes over time, financial managers
can identify trends and then suggest strategies to manage accounts receivable
and payable in a way that is most beneficial to the business’s bottom line.
Balance sheets are based on the fundamental equation in business
accounting: Assets = Liabilities + Owners’ Equity. It is important to know that
assets (the items on the left side of the balance sheet) must always equal claims
on assets, which are the liabilities plus owner’s equities (the items on the right
side of the balance sheet). Let’s look at each of these components in a bit more
detail, and then see how they all fit together on a balance sheet.
3.4.1.1 Assets
Assets are items a business owns, including cash, investments, land and
buildings, furniture, vehicles and equipment. On a balance sheet, assets are
organised into three categories: current assets, non-current assets and intangible
assets. These categories are listed on the balance sheet in order of liquidity – the
speed at which assets can be turned into cash.
„„
„„
„„
Current assets are those assets that can be turned into cash within a year.
Examples of current assets include cash, accounts receivable, inventory
and short-term investments such as money market accounts. As you can
see from Table 3.6 as on 30 June 2012, Sasol had over R65 471 million
worth of current assets.
Non-current assets, or fixed assets, are assets that have more long-term use,
such as real estate, buildings, machinery and equipment. Often, the value
of the fixed assets, such as machinery or equipment, decreases over time due
to usage or obsolescence. To compensate for such reduction in value over
time, accountants depreciate to spread out the cost of the equipment over
its useful life. Depreciation helps keep the accounting equation in balance
by matching the expense of the asset with the revenue that asset is expected
to generate. Depreciation is defined as ‘the wear and tear of assets.’ As on
30 June 2012, Sasol had approximately (R95 872 000 + R33 585 000)
R129 457 000 in fixed assets.
Intangible assets do not have physical characteristics (you can’t touch or see
them), but they have value nonetheless. Trademarks, patents and copyrights
are examples of intangible assets, in addition to strong brand recognitions
and excellent customer or employee relations. Intangible assets are often
reflected on the financial statements and reports as goodwill. Sasol’s
goodwill and other intangible assets amount to approximately (R787 000 +
R1 214 000) R2 001 000 in 2012.
3.4.1.2 Liabilities
Liabilities are all debts and obligations owed by the business to outside creditors,
suppliers or other vendors. Liabilities are listed on the balance sheet in the
order in which they become due.
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„„
„„
Current liabilities, also known as the short-term liabilities, are
obligations a business is responsible for paying within a year or less, and
are listed first on the balance sheet. They consist of the accounts payable,
accrued expenses and short-term financing/loan. Accounts payable are
obligations a business owes to vendors and creditors. They are similar to
those bills you need to pay every month, such as credit card payments,
cell phone charges and other obligations that are paid less frequently
such as taxes. Accrued expenses include payroll, commissions and
benefits that have been earned but not paid to employees. Trade credit
and commercial paper make up short-term financing. Sasol had
approximately R30 889 000 in current liabilities in 2012.
Non-current liabilities, also known as long-term liabilities, include
debts and obligations owed by the business that are payable in more than
one year from the current date. These obligations include mortgage loans
for the purchase of land or buildings; long-term leases on equipment or
buildings; and bonds issued for large projects. Sasol’s long-term liabilities
are approximately R44 550 000 in 2012.
3.4.1.3 Owner’s equity
The easiest way to think of owner’s equity is what is left after you have accounted
for all your assets and taken away all that you owe. For small businesses,
owners’ equity is literally the amount the owners of the business can call their
own. Owner’s equity increases as the business grows, assuming debt has not
increased. It is often referred to as the owners’ capital account. For larger,
publicly-owned companies, owners’ equity becomes a bit more complicated.
Shareholders are the owners of the publicly-owned companies. Owners’ equity,
in this case, is the value of the stock issued as part of the owners’ (shareholders)
investment in the business and retained earnings, which are accumulated
profits a business has held onto for reinvestment into the business. The owner’s
equity for Sasol is approximately R128 314 000 in 2012.
3.4.2 Income statements
What does an income statement show? An income statement reflects the
profitability of a business by showing how much money the business takes
in, and how much money it spends. The difference of money in and money
out is the profit or loss, sometimes referred to as the bottom line. Besides
showing overall profitability, income statements also indicate how effectively
management is controlling expenses by pinpointing abnormal or excessive
expenditures, highlighting unexpected increases in costs of goods sold, or
showing a change in returns.
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What are the components of an income statement? Remember that the balance
sheet relates directly to the fundamental accounting equation: assets = liabilities
+ owners’ equity. Similarly, income statements also work around an equation:
Revenues – expenses = profit (or loss)
The income statement is grouped into four main categories, namely revenues,
costs of goods sold, operating expenses and net income as shown in the
following formula:
((Revenue – cost of goods) – operating expenses)) – taxes = net income (or loss)
3.4.2.1 Revenue
Revenue is the amount of money generated by a business by either selling
goods or rendering services. If a business has several different product lines or
businesses, the income statement shows each product or division in categories
to distinguish how much each has generated in revenue.
Table 3.7: Income statement of Sasol Limited Group for the year ended 30 June 2012
2012
Rm
2011
Rm
Turnover
Cost of sales and services rendered
169 446
(111 042)
142 436
(90 467)
Gross profit
Other operating income
Marketing and distribution expenditure
Administrative expenditure
Other operating expenditure
Competition-related administrative penalties
Effect of crude oil hedges
Share-based payment expenses
Effect of remeasurement items
Translation gains/losses
Other expenditure
58 404
1 416
(6 701)
(11 672)
( 4 689)
–
214
(691)
(1 860)
243
(2 595)
51 969
1 088
6 796
(9 887)
(6 424)
(112)
(118)
(2 071)
(426)
(1 016)
(2 681)
Operating profit
Finance income
Share of profits of associates (net of tax)
Finance expenses
36 758
796
479
(2 030)
29 950
991
292
(1 817)
Profit before tax
Taxation
36 003
(11 746)
29 416
(9 196)
Profit for the year
24 257
20 220
Attributable to:
Owners of Sasol limited
Non-controlling
23 583
674
19 794
426
24 257
20 220
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„„
„„
Current liabilities, also known as the short-term liabilities, are
obligations a business is responsible for paying within a year or less, and
are listed first on the balance sheet. They consist of the accounts payable,
accrued expenses and short-term financing/loan. Accounts payable are
obligations a business owes to vendors and creditors. They are similar to
those bills you need to pay every month, such as credit card payments,
cell phone charges and other obligations that are paid less frequently
such as taxes. Accrued expenses include payroll, commissions and
benefits that have been earned but not paid to employees. Trade credit
and commercial paper make up short-term financing. Sasol had
approximately R30 889 000 in current liabilities in 2012.
Non-current liabilities, also known as long-term liabilities, include
debts and obligations owed by the business that are payable in more than
one year from the current date. These obligations include mortgage loans
for the purchase of land or buildings; long-term leases on equipment or
buildings; and bonds issued for large projects. Sasol’s long-term liabilities
are approximately R44 550 000 in 2012.
3.4.1.3 Owner’s equity
The easiest way to think of owner’s equity is what is left after you have accounted
for all your assets and taken away all that you owe. For small businesses,
owners’ equity is literally the amount the owners of the business can call their
own. Owner’s equity increases as the business grows, assuming debt has not
increased. It is often referred to as the owners’ capital account. For larger,
publicly-owned companies, owners’ equity becomes a bit more complicated.
Shareholders are the owners of the publicly-owned companies. Owners’ equity,
in this case, is the value of the stock issued as part of the owners’ (shareholders)
investment in the business and retained earnings, which are accumulated
profits a business has held onto for reinvestment into the business. The owner’s
equity for Sasol is approximately R128 314 000 in 2012.
3.4.2 Income statements
What does an income statement show? An income statement reflects the
profitability of a business by showing how much money the business takes
in, and how much money it spends. The difference of money in and money
out is the profit or loss, sometimes referred to as the bottom line. Besides
showing overall profitability, income statements also indicate how effectively
management is controlling expenses by pinpointing abnormal or excessive
expenditures, highlighting unexpected increases in costs of goods sold, or
showing a change in returns.
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What are the components of an income statement? Remember that the balance
sheet relates directly to the fundamental accounting equation: assets = liabilities
+ owners’ equity. Similarly, income statements also work around an equation:
Revenues – expenses = profit (or loss)
The income statement is grouped into four main categories, namely revenues,
costs of goods sold, operating expenses and net income as shown in the
following formula:
((Revenue – cost of goods) – operating expenses)) – taxes = net income (or loss)
3.4.2.1 Revenue
Revenue is the amount of money generated by a business by either selling
goods or rendering services. If a business has several different product lines or
businesses, the income statement shows each product or division in categories
to distinguish how much each has generated in revenue.
Table 3.7: Income statement of Sasol Limited Group for the year ended 30 June 2012
2012
Rm
2011
Rm
Turnover
Cost of sales and services rendered
169 446
(111 042)
142 436
(90 467)
Gross profit
Other operating income
Marketing and distribution expenditure
Administrative expenditure
Other operating expenditure
Competition-related administrative penalties
Effect of crude oil hedges
Share-based payment expenses
Effect of remeasurement items
Translation gains/losses
Other expenditure
58 404
1 416
(6 701)
(11 672)
( 4 689)
–
214
(691)
(1 860)
243
(2 595)
51 969
1 088
6 796
(9 887)
(6 424)
(112)
(118)
(2 071)
(426)
(1 016)
(2 681)
Operating profit
Finance income
Share of profits of associates (net of tax)
Finance expenses
36 758
796
479
(2 030)
29 950
991
292
(1 817)
Profit before tax
Taxation
36 003
(11 746)
29 416
(9 196)
Profit for the year
24 257
20 220
Attributable to:
Owners of Sasol limited
Non-controlling
23 583
674
19 794
426
24 257
20 220
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Chapter Three – Financial Management
Earnings per share
Rand
Rand
Basic earnings per share
39.10
32.97
Diluted earnings per share
38.95
32.85
Diluted earnings per share are calculated taking the Sasol Share Incentive
Scheme and Sasol Inzalo share transaction into account.
3.4.2.2 Cost of goods sold
An income statement delineates several categories of expenses. The first
category of expenses, the cost of goods sold, is a separate item on an income
statement. Cost of goods sold are the variable expenses a business incurs in
manufacturing and selling a product, including the price of raw materials used
in creating the item, along with the labour costs used to produce and sell the
items. When you subtract cost of goods sold (or cost of sales) from total sales
the result is gross profit. Gross profit tells you how much money a business
makes just from its products, and how efficiently management controls costs in
the production process. In addition, analysts use gross profit to calculate one of
the most fundamental performance ratios used to compare the profitability of
companies, namely the gross profit margin.
3.4.2.3 Operating expenses
Although it is certainly important to identify the costs associated with producing
the product or service, it is also important to identify operating expenses,
which are the overhead costs incurred with the running of the business.
Operating expenses include sales, general and administrative expenses. These
costs may consist of items such as rent, salaries, wages, utilities, depreciation
and insurance. Expenses associated with research and development of new
products is also included in operating expenses. Unlike costs of goods sold,
operating expenses usually do not vary with the level of sales or production,
and are constant or fixed. Outside interested parties (lenders and investors)
watch operating expenses closely as an indication of managerial efficiency.
Management’s goal is to keep operating expenses as low as possible without
negatively affecting the underlying business. The amount of profit realised from
the business’s operations (operating income) is determined when operating
expenses are subtracted from gross profit (see Table 3.7).
Management focuses on operating income as they prepare and monitor
budgets. Some feel that operating income is a more reliable and meaningful
indicator of profitability than gross profit since it reflects management’s
ability to control operating expenses. However, it is still not the bottom
line. Adding or subtracting any other income or expense, such as interest
payments on outstanding debt obligations, or earnings from investments,
adjusts operating income further. Lastly, taxes paid to the local and national
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Business Management: A Contemporary Approach
governments are subtracted to determine net income (or net income after
taxes). Net income is the bottom line, and is usually stated on the very last
line of an income statement. For publicly owned companies, however, net
income is further adjusted by dividend payments to stockholders, resulting in
adjusted net income.
3.4.3 Statement of cash flows
What is the statement of cash flows? You have just looked at two important
financial statements, the balance sheet and the income statement. The cash
flow statement (or statement of cash flows) is the third important financial
statement and gives some information that the other two financial statements
do not show. The balance sheet is a snapshot of a business’s financial position,
and the income statement reflects a business’s profitability over a specific period.
A statement of cash flows is different because it does not reflect the amount of
incoming and outgoing transactions that have been recorded on credit. Instead,
it only displays cash transactions, similar to a check book register. As shown
in Table 3.8, the cash flow statement organises, and reports on, cash generated
and utilised in three business components, namely operating, investing and
financing activities.
„„
„„
„„
Operating activities measure cash used or provided by the core business
of the organisation.
Investing activities represent the cash involved in the purchase or
sale of investments or income-producing assets such as buildings and
equipment.
Financing activities show the cash exchanged between the firm and its
owners (or shareholders) and creditors, including dividend payments and
debt services.
Table 3.8: Cash flow statement of Sasol Limited Group
2012
Rm
2011
Rm
2010
Rm
Cash receipts from customers
Cash paid to suppliers and employees
168 934
(121 033)
138 955
(100 316)
118 129
( 90 791)
Cash generated by operating
activities
Finance income received
Finance expenses paid
Tax paid
Dividends paid
47 901
1 146
(666)
(10 760)
(600)
38 639
1 380
(898)
(6 691)
(6 614)
27 338
1 372
(1 781)
(6 040)
(5 360)
28 024
25 816
(15 529)
Cash retained from operating activities

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Chapter Three – Financial Management
Additions to non-current assets
Acquisition of interest in joint ventures
Disposal of businesses
Additional investments in associate
Other net cash flows from investing
activities
(29 160)
(24)
713
(81)
936
(20 665)
(3 823)
22
(91)
92
(16 108)
(1 248)
652
Cash utilised in investing activities
(27 616)
(24 465)
15 529
Share capital issued
Contributions from non-controlling
shareholders
Dividends paid to non-controlling
shareholders
(Decrease)/ increase in long-term debt
Decrease in short-term debt
325
11
(394)
(859)
(112)
430
27
(419)
545
(295)
(16 108)
(1 248)
652
Cash effect of financing activities
(1 029)
288
(2 701)
Translation effects on cash and cash
equivalents of foreign operations
649
(421)
(124)
Increase/decrease in cash and cash
equivalents
Cash and cash equivalents at
beginning of year
28
17 810
1 218
16 592
(4 000)
20 592
Cash and cash equivalents at the
end of year
17 838
17 810
16 592
The statement of cash flow tells a story that the income statement does not.
The income statement reports revenue receipts and expense payments. Because
revenue and expenses are often accrued (earned but not paid), the income
statement does not show how efficiently management generates and uses cash.
The statement of cash flow, because it focuses especially on cash, provides
this important information. It shows whether all the revenues booked on the
income statement have actually been collected. Looking at the Sasol cash flow
statement, it is apparent that the bulk of Sasol’s change in cash position came
from operations, rather than its investments. This information is useful to
creditors who are interested in determining a business’s short-term financial
health, particularly in its ability to pay its bills. In addition, it signals to investors
that the business is generating enough money to buy new inventory, and make
investments in the business. Accounting personnel, potential employees or
contractors may be interested in cash flow information to determine whether
a business will be able to afford salaries and other labour obligations.
The bottom number, or change in cash and cash equivalents, reflects the
overall change in the business’s cash flow. If it is positive, it means that the
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business had an overall positive cash flow. If it is negative, the business paid
out more cash than it generated. As you have learned, financial statements
– including balance sheets, income statements and statements of cash flow –
reveal a great deal about the health and prospects of a business. Although the
abundance of numbers and figures might seem overwhelming at first, they
can be analysed and assessed once you know what they all mean and how they
are calculated.
3.5 Financing business needs
When businesses, both large and small, find it necessary to expand, they must
make some important decisions regarding financing. In this section, you will
learn about what options are available for short- and long-term business needs,
and how business leaders decide which option is best for their companies.
3.5.1 Financing short-term business needs
The short-term financing decision requires finding the optimal combination of
long-term and short-term finances to finance the current assets. When financing
the operations of the business, it is important to know that different forms of
business ownership have varying short-term financial needs. It is important
that all companies have a plan to finance those needs. As it is mentioned above,
cash budgets are prepared to predict a business’s cash flow gaps (periods when
cash outflows are greater than cash inflows). When these gaps are expected,
depending on the size of the business and the cash flow gap, there are several
short-term sources available to help fill the temporary gap. The most common
forms of short-term financing of current assets are:
„„
„„
„„
„„
trade credit;
accruals;
bank overdrafts; and
factoring
Each of these forms of financing will now be briefly discussed below.
3.5.1.1 Trade credit
Larger businesses with good credit and an established relationship with their
suppliers take advantage of another credit relationship to help bridge the
temporary gap. Companies will often purchase inventory and supplies on trade
credit. Trade credit is the ability to purchase inventory and supplies on credit
without interest. Suppliers will typically request payment within 30, 60 or 90
days, depending on the credit terms. When Pick n Pay, for example, purchases
cereal on credit from Tiger Oats (the supplier), it implies that Tiger Oats finances
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Chapter Three – Financial Management
the purchase for Pick n Pay for the period for which the supplier’s credit is
granted, namely 30, 60, or 90 days.
Trade credit offers the following advantages as a source of short-term
funds.
„„
„„
„„
It is readily available to businesses that pay suppliers regularly, and is also
a source of spontaneous financing.
It is informal. If a business currently pays its bills within the discount
period, additional credit can simply be obtained by delaying payments
until the end of the net period at the cost of forgoing the discount.
Trade credit is more flexible than other forms of short-term financing
because the business does not have to negotiate a loan agreement, provide
security or adhere to a rigid repayment schedule.
3.5.1.2 Accruals
Accruals are a source of spontaneous finance. The most common expenses
accrued are wages and taxes. Accrued wages represent money that a business
owes its employees. Employees provide part of the short-term financing for the
business by waiting for a month or a week to be paid, rather than being paid
every day. Accrued tax is also a form of financing. The level of financing from
accrued taxes is determined by the amount of tax payable and the frequency
with which it is paid. Accruals have no associated cost. They are therefore a
valuable source of finance because they are cost-free substitutes for otherwise
costly short-term credit.
3.5.1.3 Bank overdrafts
An overdraft facility is an arrangement with a bank that allows a business to
make payments from a cheque account in excess of the balance in the account.
The purpose of an overdraft is to bridge the gap between cash income and
cash expenses. The interest charged on an overdraft is negotiable and relates
to the risk profile of the borrower. Interest is charged daily on the outstanding
balance. A bank overdraft is repayable on demand. It is a flexible form of a
short-term financing, and it is cost-effective if used correctly.
3.5.1.4 Invoice discount and factoring
Debtor finance consists of factoring and invoice discounting. Debtor finance
involves the sale of debtors to a debtor-financing organisation. Invoice
discounting is the sale of existing debtors to a debtor-financing organisation.
This organisation then converts credit sales to cash sales and provides the
business with a cash injection by releasing funds that were tied up in working
capital. Invoice discounting is usually confidential. In other words, debtors
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are not advised of the arrangement between the business and the finance
organisation.
In factoring, on the other hand, the financier also undertakes to administer
and control the collection of debt. In contrast to invoice discounting, debtors
are aware of the agreement between the business and the financier. The
financier to whom the debtors are sold is known as the factor. The factor buys
approved debtors from the business after carefully examining each account
individually. The factor receives commission and interest on amounts paid
to the business before the expiry date of the debt. The factor usually pays the
business 70% to 80% of the amount outstanding from debtors immediately
and the remainder when the debtor pays. Two common types of factoring
practice are non-recourse and recourse factoring.
„„
„„
Non-recourse factoring: The factor buys the debtors outright and bears
the risk of bad debts. The factor accepts responsibility for credit control,
debt collection and sales records. Customers pay the factor directly.
Recourse factoring: In recourse factoring, the factor provides the same
services as in non-recourse factoring, but the seller guarantees that debts
are recoverable.
The advantages of factoring of debtor accounts are that:
„„
„„
„„
„„
„„
the cost of debtor administration is transferred to the factor;
the turnover of current assets is increased;
less capital is required to finance debtors;
liquidity ratios improve; and
more cash is available for other purposes.
The cost of short-term funds is generally lower than that of long-term funds.
One reason is that trade credit does not really involve a cost. The choice of a
financing plan for a business’s current assets entails a trade-off between risk
and return. From a cost point of view, it is preferable to finance current asset
needs with short-term funds, while risk considerations demand the use of
long-term funds.
3.5.2 Long-term financing
This section focuses on the characteristics of the various forms of longterm financing, and the implications of the various sources of financing for
businesses.
3.5.2.1 Shareholders’ interest
Shareholders’ interest in a business is subdivided into owners’ equity and
preference shareholders’ capital. Let us briefly look at each of them.
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3.5.2.2 Owners’ equity
Owners’ equity consists of the funds made directly available by the legal
owners (ordinary shareholders) in the form of share capital, as well as indirect
contributions in the form of profit retention as reserves and undistributed
profits. Shareholders receive share certificates in exchange for the money they
make available to the business. There are two types of ordinary shares, namely
par value shares and non-par value shares. Par value shares all have the same
value, while the value of non-par value shares differs. A business can only
issue one of the two types of shares, not both. A co-owner of the business,
the ordinary shareholder, has a claim to profits. The portion of profits paid
to ordinary shareholders is known as a dividend. It is paid out in proportion
to the shareholding of each ordinary shareholder. Internal financing is
consequently an easy and inexpensive form of financing for a business.
However, from the point of view of the owners (ordinary shareholders), it has
a serious short-term disadvantage, because the retention of profit means the
forfeiting of dividends.
3.5.2.3 Preference shareholders’ capital
Preference shares fall somewhere between debentures (discussed later) and
ordinary shares in terms of risk. If a business is doing poorly, it will first pay
debenture holders their required interest, and then pay dividends to preference
shareholders. Anything left goes to ordinary shareholders. Two forms of
preference shares are distinguished. These are the ordinary preference share
and the cumulative preference share. In the case of the ordinary preference
share, ordinary preference shareholders forfeit a dividend if the directors decide
not to declare one in a particular year. Cumulative preference shareholders
retain the right to receive an arrear dividend in the following year.
From the viewpoint of the business, preference shares have an advantage
over ordinary shares in that their cost is usually lower. For the shareholder,
ordinary shares are more risky because preference shareholders have a priority
claim on net profit after tax, and on assets in the case of liquidation.
3.5.2.4 Long-term debt
Debt is capital that has to be repaid. Debt finance is usually cheaper than equity
because:
„„
„„
„„
„„
the cost of raising the funds is lower;
equity investors demand a higher rate of return on their investments;
interest is tax deductible; and
debt is less risky than equity since interest is paid before dividends and
tax.
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Debt also has preference over equity when a business is liquidated. Long-term
debt generally refers to debt that will mature (has to be repaid) in 10 to 30 years,
or even longer. It can take the form of debt securities (bonds and debentures),
term loans and leases.
Debt securities (bonds and debentures)
Bonds and debentures are the two main types of debt security, and both work
on the same principles, so there’s no fundamental difference.
„„
„„
„„
A bond is a long-term debt instrument by which the bondholders lend
money to a business in return for regular interest payments called
coupon payments (or coupon). Bonds are secured loans and are issued
against fixed assets, such as fixed property, as security (mortgage bonds).
The amount that can be raised depends primarily on the value of the
property. Typically, a mortgage bond will not exceed 75% of the value of
the property. A bond is normally a listed security, which means that it is
traded in the Johannesburg Security Exchange (JSE).
Debentures are the most common form of long-term debt in the case of
companies. The business (the borrower) issues a certificate to the lender
showing the conditions of the loan. This certificate is negotiable, which
means that it can be traded on financial markets. Payment of the loan,
consisting of a principal sum plus interest, is made to the presenter of
the certificate. A debenture has a fixed interest charged and the loan is
available to the business over a specified term. Bonds and debentures are
secured by the assets of the issuing business. A secured loan is one that
has collateral. Collateral refers to the assets that the borrower offers as
security. When the asset is named as collateral, it is encumbered, which
means that it cannot be named as collateral to other loans until the first
loan is paid off. In the event of default, the assets can be sold to pay the
debt. When a fixed property is offered as security, the loan is referred to
as a mortgage bond or mortgaged debenture.
Registered-term loans are unsecured loans and, in contrast to debentures,
are not freely negotiable. The name of the lender and the credit conditions
are recorded in the books of the lender (business). When an enterprise
needs a smaller amount, it can raise a term loan with any bank, which
will fund the loan from its own resources. Depending on the relationship
between the client and the bank, and also the size of the loan, term
loans can be secured or unsecured, and a bank may require a guarantee.
Borrowers have to repay their loans through regular payments, which are
made up of interest and capital redemption. Banks make loans available
to large and small firms (and to individuals).
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Chapter Three – Financial Management
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Financial leases
A financial lease is a contract that provides the right to the use of an asset,
legally owned by the lessor, in exchange for a specified rental paid by the lessee.
The lessor is the party who promises to make the asset available for use to
the lessee. A financial lease is a form of credit financing that should not be
confused with an operating lease. In contrast to an operating lease, financial
leasing gives the lessee the opportunity of owning the asset at the end of the
lease. An operating lease can be terminated by giving the required notice, but
a financial lease is a non-terminative agreement between the lessee and the
lessor. Hence it is a financing agreement (lease) and not an operating-lease
agreement. The three basic forms of financial leasing are the following:
„„
„„
„„
Direct financial leasing of operating equipment such as motor vehicles
and computers. In direct leasing, the lease amount, which is repayable
in regular instalments, is determined in such a way that the value of the
asset, plus an interest charge, is paid back by the end of the term of the
lease, which is usually related to the lifespan of the asset. Maintenance
and insurance of the asset are normally the responsibility of the lessee.
Financial leases are used to finance motor vehicles, plants and equipment.
A financial lease cannot be cancelled prematurely, unless the parties can
negotiate a settlement penalty. Similarly, if an asset has to be replaced
before maturity, the parties negotiate a trade-in and extend the lease.
Leaseback agreements involve assets of a more permanent nature. In
leaseback agreements, certain assets that the business owns are sold to the
credit supplier and at the same time leased back by the business according
to a long-term agreement. Leaseback agreements are usually entered into
by businesses that need to raise funds. The assets are generally of a highly
specialised nature. The business obtains cash without losing the use of
property or equipment through the leaseback arrangement. For example,
a dentist may decide to obtain additional funds by financing his or her
equipment on a leaseback arrangement. The lease payments of a financial
lease are deductible for tax purposes.
Operating leases are those in which a business has no intention of using
an asset for the whole of its useful life. The period of an operating lease
is usually much shorter than the useful life of the asset. This gives the
lessee flexibility. Should there be a need to upgrade the equipment that
is on lease, it can only be done when the lease expires, which may be
within a few months. Many companies get their photocopy machines on
operating leases. A machine may have a lifespan of five years, but one can
choose to lease it for a year only. The lessor takes responsibility for the
maintenance of the leased asset.
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3.6 Financial decisions
Decisions arising within a wider context and the conditions in this context
– as measured by the degree of certainty, risk, uncertainty and ambiguity –
materially affect the decision-making processes. Most financial decisions
are about the future, which means that financial managers do not know
how things will turn out, in other words, they have uncertainty. With some
decisions, financial managers know beforehand exactly which variables will
influence their decision, and what the results of the decision will be. So they
can state their expectations as a single number, and say definitely what the
return will be. In other words, they have certainty. With many decisions, the
outcome depends on various external factors, but how likely or probable a
particular outcome is can be worked out. This likelihood is referred to as risk.
Risk can be defined as the probability of a deviation from the expected value,
in other words, the likelihood that the outcome will not be what we expect.
The probability theory makes it possible to predict what the chances are of each
possible event happening. For example, interest rates may go down more than
expected. If the business has borrowed money, a lower interest is favourable
because the business will pay less interest, but if the business has investments,
a lower interest rate is unfavourable because the business will earn less interest.
Risk management is an important aspect of any business. The business can
fail due to:
„„
„„
„„
insufficient risk management;
not anticipating consumer needs and requirements; or
not implementing the necessary financial controls.
Entrepreneurs face risk in all business areas, namely business risk, financial
risk and investment risk.
3.6.1 Business risk
Business risk is the risk associated with the day-to-day activities of the firm.
There is always a possibility that the income of the firm won’t be enough to
cover its cost. Business risks depend mainly on factors like:
„„
„„
„„
„„
„„
the quality of management;
the labour situation;
the stability of sales;
raw materials; and
the degree of fixed costs.
Business risk is also inherent in the profit forecasts for the future, namely the
rate of return on assets (ROA). Business risk varies in different industries and
among businesses in those industries. It can change from low to high risk.
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Chapter Three – Financial Management
3.6.2 Financial risk
Financial risk is the risk that a business will not be able to pay its financial
commitments, for example interest and lease payments. Financial risk also
originates when the business decides to use both debt and equity to finance
the business. There is no risk on the use of debt (the risk lies in the inability to
pay the interest) and the interest on the debt is the risk-free rate. The risk of the
business is carried equally by the shareholders of the business. Therefore, the
financial risk is the added risk that the shareholders must bear because of the
use of debt and equity. Should the financial manager decide to use 30% debt
and 70% equity, then the shareholders will carry a higher risk than when the
business had only been financed with equity. However, the use of debt enables
the business to benefit from a higher profit because of the interest, which is
tax free. The use of debt or financial leverage will increase the return on equity
(ROE) but the risk carried by shareholders will be higher.
3.6.3 Investment risk
Investment risk is related to the probability of earning a return less than the
expected return – the greater the chance of lower negative returns, the riskier
the investment. In all the financial decisions, one must estimate:
„„
„„
the result (financial return) expected, and
the risk that the business won’t achieve the expected return.
Different investors feel differently about risk, so it is important for each investor
to decide what level of risk is acceptable. According to their risk preference
behaviour, investors can be divided into three basic categories. These are:
„„
„„
„„
risk-indifferent investors who do not mind if there is a change in risk,
as they just want their required rate of return and are not interested in
exploring the effects of changing risk;
risk-averse investors who accept an increase in risk only if the return
increases sufficiently to compensate for the increase in risk; and
risk-seeking investors who look for an increase in risk, and will accept a
lower return when the risk is higher.
3.6.4 Measurement of non-diversifiable risk – beta coefficient
According to Gitman2 ‘the total risk of a security can be viewed as consisting of
two parts. Total security risk = non-diversifiable risk + diversifiable risk’.
Diversifiable risk is an asset’s risk that is related to a particular business
event, such as a strike, and which can be overcome by diversification.
Non-diversifiable risk is the risk connected to market conditions, such as
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Business Management: A Contemporary Approach
inflation, which influences all businesses and which cannot be overcome by
diversification.
The tool to measure non-diversifiable risk is the beta coefficient. This is
used by the financial manager and other interested parties to determine the
volatility of a share in relation to the volatility of the market.
A beta coefficient of 1 would indicate that, if the market moves up or down
by 15%, the share would also move up or down by 15%, or that the share is
as volatile as the market. A beta coefficient of 0,5 would indicate that if the
market moves up or down by 15%, the share would only move up or down by
7.5%, which means that the share is only half as volatile as the market. A beta
coefficient of 2 means that the share is twice as volatile as the market. Beta
coefficients are obtainable from various sources, such as Merrill Lynch, and the
movement of the market can be obtained from the press or the stock market.
3.6.5 Demand risk, competitive risk and capability risk
Demand risk is the risk that there may be no demand for the product/service
and therefore it will not sell in the market. Demand risk also lies in the fact that
the demand for the product/service may be higher than forecasted. If this is the
case, then competitors have the opportunity to gain those customers who are not
prepared to wait until another business’s product or service becomes available.
Competitive risk is the risk that customers will be lost to competitors.
A business is exposed to competitive risk by not being prepared for the
unforeseen demand for its product or service.
Capability risk is the risk that the business is not capable of providing a
product or service that is of value to the customer, and for which he or she is
willing to pay. There is also the risk that the cost of the capabilities is so high
that the business cannot earn the required profit.
3.7 Interaction of financial management with other business functions
Just as the fit indicates consistency among structural characteristics within
the organisation, internal integration recognises that different departments
and functional areas within a business should operate as part of the integrated
process. Because internal integration breaks down functional barriers and
engenders co-operation in order to meet the requirements of customers,
rather than operating within the functional silos associated with traditional
departmentalisation and specialisation, it is expected to be related to
performance. Although other businesses may still maintain functional
organisational structures – general management, finance, marketing, public
relations, human resources, operations management, purchasing and
information management functions – customer orders flow across functions
and activities. When an order is delayed, customers do not care which function
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Chapter Three – Financial Management
caused the delay, they simply want to know whether the order has been fulfilled.
This calls for an integrated customer order fulfilment process, in which all
involved activities and functions work together. Information sharing, joint
planning, cross-functional teams and working together are important elements
of the process.
3.8 Summary
The purpose of financial management is wealth maximisation, and therefore
the financial manager must learn how to identify favourable investment and
financing opportunities that will add value to the business. This chapter has
examined the basic financial principles that can be used to create value for
the business.
3.9 Self-evaluation
Read the case study and answer the questions below.
Case study
Better together … delivering solid results
Performance in 2012
The past year saw Sasol deliver solid results. Managements’ strong focus on factors
within Sasol’s control – including cost containment, operational efficiencies
and margin improvement – delivered a solid operational and cost performance,
despite a challenging environment. The year, however, was challenging,
taking into account the volatility of the macro-economic environment and
the operational challenges the business faced. Sasol is carefully monitoring
and taking mitigating actions to counter the effects of the Euro Zone crisis.
They continue to maintain a strong balance sheet, amidst a still volatile and
uncertain global economic environment, which positions the business well to
fund selected growth opportunities and provides a buffer against volatility. The
growth in dividends demonstrates their commitment to a progressive dividend
policy. Overall, Sasol is well positioned to deliver on its stakeholder’s value
proposition – being a growing organisation with a strong pipeline of growth
projects, supported by talented, high-performing employees around the world,
and underpinned by a strong financial position.
Financial performance
Earnings attributable to shareholders for the year ended 30 June 2012 increased
by 19% to R23.6 billion from the prior year, while headline earnings per
share and earnings per share increased by 25% to R42.28 and 19% to R39.10
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Business Management: A Contemporary Approach
respectively, over the same period. Operating profit of R36.8 billion increased by
23% compared to the prior year on the back of the solid operational performance
in their businesses. Operating profit was boosted by a 17% improvement in
the average crude oil (average dated Brent was US$112. 42/barrel at 30 June
2012 compared with US$96.48/barrel at 30 June 2011) and product prices as
well as an 11% weaker average rand/US dollar exchange rate (R7.78/US$ at 30
June 2012 compared with R7.01/US$ at 30 June 2011). Operating profit for the
second half of the year, compared with the first half of the financial year, was
R4 billion lower. This decrease was mainly as a result of the partial impairment
and the higher depreciation charge relating to:
„„
„„
„„
„„
Sasol’s Canadian shale gas assets;
year-end closing exchange rate adjustments, with specific reference to the
valuation of their open Canadian foreign exchange contracts;
the impact of year-end stock movements; and
an increase in their provisions for rehabilitation and other re-measurement
items.
The operating profit in the current year was negatively impacted by once-off
changes totalling R2 121 million (2011 – R1 103 million). These items relate
primarily to the partial impairment of their Canadian shale gas assets of R964
million and impairment of Block 16/19 in Mozambique amounting to R434
million; as well as the write off of an unsuccessful exploration well in Australia
amounting to R274 million. This was partly offset by the profit of R124 million
sales of Sasol Nitro Phalaborwa operations, as well as certain downstream
fertiliser businesses and the R285 million profit realised on the disposal of the
Witten plant in Germany. The overall share-based payment expense of R691
million decreased from R2 071 million in the prior year – a direct result of a
decrease of R360 million in the Sasol Inzalo black economic empowerment
(BEE) share-based payment expense and the once-off Ixia Coal BEE transaction
expense of R565 million in 2011. In addition, there was a general decrease
in the Sasol share incentive schemes expense in line with Sasol share price
performance. The increase in the effective tax rate from 31.3% to 32.6%
resulted primarily from the increase in non-deductible expenses and additional
tax losses (which have not been recognised as deferred tax assets), compared to
the prior year.
Source: Adapted from Sasol Integrated Annual Report 2012, accessed on
23 October 2013
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Chapter Three – Financial Management
Multiple choice questions
1.
2.
3.
4.
5.
6.
Which one of the following items is Sasol’s most expensive operating
expense, as being reported in the last paragraph of the case study?
1.
R124 million sales of Sasol Nitro Phalaborwa operations;
2.
the partial impairment of their Canadian shale gas assets of R964
million;
3.
impairment of Block 16/19 in Mozambique amounting to 434
million; or
4.
the disposal of the Witten plant in German of R285 million.
In the first paragraph, Sasol reports it is happy about its strong financial
position. Which financial statement shows a snapshot of a business’s
financial holdings?
1.
Cash flow statement.
2.
Profit and loss statement.
3.
Balance sheet.
4.
Income statement.
Given the overall financial report in the case study, the role of a financial
manager can be best described as:
1.
outlining the business’s short-term and long-term needs;
2.
identifying the sources and uses of funds for business operations;
3.
monitoring cash flow and investing excess funds; or
4.
all of the above.
The statement that shows how cash is used or generated by the core
business of the business is the:
1.
income statement;
2.
cash flow statement;
3.
balance sheet; or
4.
none of the above.
Which ratio tells how much a business makes just from its products, and
how efficiently management controls costs in the production process?
1.
Gross profit margin.
2.
Current ratio.
3.
Operating statement.
4.
Earnings per share.
In the second paragraph, Sasol reports about the increase in the business’s
earnings per share. Which of the following statements is true about the
earnings per share?
1.
Looking at the earning per share number in isolation is not
completely meaningful.
2.
It might seem reasonable to assume that a business with higher
earnings per share will be a better business to invest in than one
with lower earnings per share.
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3.
4.
A highly efficient business – and potential good investment – can
have a low earnings per share ratio simply because it has a large
number of outstanding shares.
All of the above.
Questions
1.
2.
3.
What are the key financial statements, and what is the importance of
financial statements to Sasol Group limited? Which statements do Sasol
shareholders typically find useful? Why? What about independent
contractors considering working with the firm?
Discuss the role of the financial manager with reference to the case study.
Explain the relationship between the balance sheet and the income
statement?
References
1.
2.
EF Brigham & L C Gapenski, Intermediate financial management,
5th edition (Orlando: Harcourt Brace College Publishers, 1996),
pp. 696-699.
LJ Gitman, Principles of managerial finance, 7th edition (Glenview, Illinois:
HarperCollins College Publishers, 1994), pp. 234.
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CHAPTER F O U R
Credit Management
Charity van Buren-Schele and Dumisani Mabasa
Learning objectives
When you have completed this chapter you should be able to:
„„
„„
„„
„„
explain how the credit function adds value to the business;
describe the role and the responsibilities of the credit manager;
explain why there is a need for credit and credit collection policies;
discuss the ways in which the credit function can contribute towards improvement
of working capital through effective credit management; and
„„ apply strategies to increase cash flow from accounts receivables.
4.1 Introduction
The basic financial aim of an organisation is the maximisation of its value.
Financial literature contains information about numerous factors that influence
the organisation’s value. Among these contributing factors is the extent of
the net working capital and the elements shaping it, such as the level of cash
tied up in accounts receivable, inventories, the early settlement of accounts
payable and operational cash balances. Therefore, the importance of credit
management has increased as top management has recognised the growth in
demand for trade and consumer credit. This means that the credit manager has
the task of managing the most important asset – debtors – on the balance sheet
of the organisation. The manner in which this asset is managed is central to the
business’s ability to generate profits or, more importantly, to survive.
Debtors (or accounts receivable) often constitute a considerable share of
current assets. The collection of accounts receivable and the management of
debt is a challenge faced by every company that sells on credit.
A debtor is generated when the organisation, having granted credit, accepts,
in lieu of cash, a written or implied promise to pay in the future for delivery
of its goods or services. Today, in the global business environment, there are
several competitive pressures, customer preferences and promotional selling
opportunities that direct most organisations to supply credit to their customers.
The availability of ready finance to consumers is provided through credit cards,
personal loans, store cards, retail finance and other forms of personal debt.
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Business Management: A Contemporary Approach
Credit managers serve the industry and the business by assessing the risks of
sales to individuals or other business on credit, and keeping a careful eye on the
flow of goods and money both locally and globally. This has a stabilising effect
on the economy, ensuring that credit is not over-extended or restricted to the
point where the survival of the organisation is threatened.
This chapter deals with:
„„
„„
„„
„„
„„
„„
the credit management function and how the credit function can add
value;
the role and responsibilities of the credit manager;
why there is a need for a credit and collection policy;
the ways in which the credit department can contribute towards
improvement of the working capital through credit management;
the contribution to owners’ wealth maximisation; and
the benchmarking of the credit department.
‘Nothing so cements and holds together all the parts of a society as faith or credit,
which can never be kept up unless men are under some force or necessity of honestly
paying what they owe to one another.’1
4.2 The credit management function
All the different activities that are carried out in the business are aimed at
achieving its strategic goals, namely to maximise profitability, and the different
departments all work together to achieve this. By extending credit to the right
levels and to the right customers, and by collecting the revenue of the business,
the credit department makes a contribution to these strategic goals.
Profitable business is all about management and planning. Just as it is
important to manage production, sales and stock, so it is important to manage
credit. Credit management, therefore, is not an isolated activity within the
business. Continuous liaison and interaction with all the other functional
departments are vital.
The credit department does more than just crunch numbers and make
collection calls. It is a valuable part of the contemporary organisation, helping
management, operations and the marketing and sales teams.
4.2.1 Interaction between the credit management function and the
other business functions
There is an old adage that states that a sale is only a sale once the goods or services
are paid for, and the money is in the bank. It is this basic principle that binds the
two most important functions in any business together – the marketing team
that sells the product or services and the credit department that manages the
process of ensuring that the money is collected. Barry2 states that ‘if the whole
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Business Management: A Contemporary Approach
Credit managers serve the industry and the business by assessing the risks of
sales to individuals or other business on credit, and keeping a careful eye on the
flow of goods and money both locally and globally. This has a stabilising effect
on the economy, ensuring that credit is not over-extended or restricted to the
point where the survival of the organisation is threatened.
This chapter deals with:
„„
„„
„„
„„
„„
„„
the credit management function and how the credit function can add
value;
the role and responsibilities of the credit manager;
why there is a need for a credit and collection policy;
the ways in which the credit department can contribute towards
improvement of the working capital through credit management;
the contribution to owners’ wealth maximisation; and
the benchmarking of the credit department.
‘Nothing so cements and holds together all the parts of a society as faith or credit,
which can never be kept up unless men are under some force or necessity of honestly
paying what they owe to one another.’1
4.2 The credit management function
All the different activities that are carried out in the business are aimed at
achieving its strategic goals, namely to maximise profitability, and the different
departments all work together to achieve this. By extending credit to the right
levels and to the right customers, and by collecting the revenue of the business,
the credit department makes a contribution to these strategic goals.
Profitable business is all about management and planning. Just as it is
important to manage production, sales and stock, so it is important to manage
credit. Credit management, therefore, is not an isolated activity within the
business. Continuous liaison and interaction with all the other functional
departments are vital.
The credit department does more than just crunch numbers and make
collection calls. It is a valuable part of the contemporary organisation, helping
management, operations and the marketing and sales teams.
4.2.1 Interaction between the credit management function and the
other business functions
There is an old adage that states that a sale is only a sale once the goods or services
are paid for, and the money is in the bank. It is this basic principle that binds the
two most important functions in any business together – the marketing team
that sells the product or services and the credit department that manages the
process of ensuring that the money is collected. Barry2 states that ‘if the whole
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Chapter Four – Credit Management
purpose of business is to get paid, every function should be geared to achieve
that result. It is that end result that ensures the success of the business.’
Every business granting credit – be it consumer, trade or financial credit – must
organise its credit and collection activities in some way or other. Depending on
the nature of the business, its activities, and size and number of credit sales, a
separate credit department may be set up. Alternatively, credit activities could
be incorporated into, for example, the marketing or finance department.
Traditionally, credit management was a financial function, but today more
and more credit managers are being appointed at board level.
Marketing
Management
General
Management
Financial
Management
Information
Management
Human
Resource
Management
Credit
Management
External
Relations
Management
Operations
Management
Supply Chain
Management
Figure 4.1: Interaction between the credit function and the other business functions
The credit department must maintain constant, effective liaison and good
relations with other departments in the business. Close co-operation between
the credit department and other business functions is important, as illustrated
by the following examples.
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4.2.1.1 General management
The credit manager supplies important information to management, like the
amount of working capital locked up in debtors, debtors’ days outstanding and
bad debt risks.
4.2.1.2 Finance
The finance department must plan the cash flow of the business and provide
for possible shortages. The credit manager gives valuable inputs to the financial
manager regarding the management of the current assets. The granting
of credit and the conversion of debtors into cash directly influences the
business’s cash flow position. Determining the status of a customer’s account
often requires close co-operation with the accounting department. The credit
department often has to account for payments received, for collateral taken in
settlement of customer accounts, credit adjustments and corrections of sales.
Credit management is, fundamentally speaking, a financial activity that has
to contribute to achieving the strategic goals like any other department or
division.
4.2.1.3 Supply chain
The supply chain function often checks the financial position of new suppliers
through the credit function to assure that the supplier will be able to deliver
products or services as arranged.
The credit function can obtain information from customers about the
quality of the products or services of the new supplier and share it with the
supply chain function.
4.2.1.4 Operations
Credit management can obtain information about the quality of the business’s
products or services from customers and pass this on to the operations
department. This enables the latter to make any necessary adjustments to
produce quality products. Consequently, collection costs and bad debts can
be minimised.
Sometimes, credit must be approved before orders are put into production,
and sometimes the customer is asked to do something (eg pay an overdue
balance) before goods are released.
4.2.1.5 Marketing
While it is essential for the credit department to cooperate with all the business
functions, co-operation with the marketing department is especially important.
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Chapter Four – Credit Management
There are several reasons why there should be close liaison between the credit
and the marketing functions. If the company’s credit terms are too strict this
will limit its sales; too lenient and profitability will be at risk.
The credit department can provide valuable information about the market
in which the business operates, and about the consumers in these markets.
Credit policy must be clearly defined to reduce misunderstandings between
the marketing and credit functions. One of the major contributions of the
credit department to the marketing function is to work with customers and
sales representatives to find ways to approve orders.
4.2.1.6 Information
This function is responsible for the distribution of usable information. The
credit function needs information regarding debtors’ payment patterns or
complaints in order to be able to make decisions regarding credit.
4.2.1.7 External relations
The credit function offers customers a variety of credit options on the basis
of their profile. Therefore, the credit function needs information regarding
customers’ perceptions, obtained from the external relations function, for the
business’s credit policy in order to ensure that existing customers are retained
and new customers are gained.
4.2.1.8 Human resources
A close relationship should be nurtured with the human resources department.
The credit manager should take an active role in creating job descriptions for
credit personnel. Appointing and retaining the right staff is extremely important.
Human resources will assist the credit department in employing staff to assist
with the credit function. For instance, salary ranges should be competitive, and
training programmes should be co-ordinated with human resources.
‘Annual income twenty pounds, annual expenditure nineteen six, result happiness.
Annual income twenty pounds, annual expenditure twenty pounds nought and six,
result misery.’3
4.2.2 Credit management’s value chain
Value chain analysis describes the activities within and around organisations and
relates them to the competitive strengths of the organisation. Value analysis was
originally introduced as an accounting analysis to shed light on the value added
by separate steps in complex manufacturing processes in order to determine
where cost improvements could be made, value creation improved, or both.
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Business Management: A Contemporary Approach
‘Michael Porter, one of the world’s greatest strategists, linked these two basic steps of
identifying separate activities and assessing the value added by each to the analysis
of an organisation’s competitive advantage.’ 4
Suppliers
Purchasing
Operations
Delivery
Customers
Flow of required information
Stream of revenue
Figure 4.2: The credit management value chain5
Active credit management in a company is an important value driver. It is
essential not only to control your receivables, but also to manage them
efficiently and successfully.
Five value drivers that are essential for the determination and evaluation of
future cash flows are:
„„
„„
„„
„„
„„
turnover and growth rate of turnover;
the profit margin of the company;
cost of capital;
investment volume of the fixed and current assets; and
cash and earning tax rate.
4.2.3 The role and responsibilities of the credit manager
‘The rise of management: if you ask managers what they do, they will most likely
tell you that they plan, organise, co-ordinate and control. Then watch what they do.
Don’t be surprised if you can’t relate what you see to those four words.’6
The credit manager must be a specialist in the field and must be able, and
authorised, to act as such. Credit management comprises two basic functions
– risk management and cash flow management. The credit manager must
ensure that all functions relating to credit sales are performed in such a manner
that profitable sales are encouraged, whilst keeping risk at a minimum. This
safeguards and accelerates cash flow, and contributes to company profits.
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Chapter Four – Credit Management
The role of the credit manager in South Africa is more challenging today
than ever before. The skills of the credit manager must be viewed against a
background of technological advances and changing attitudes towards racial
and sexual discrimination in contemporary society. The success of the credit
manager will depend on his or her ability to influence and be influenced by
the team and their common objectives. The credit manager should, therefore,
have special qualities, a variety of skills and a sophisticated information base to
do his or her job well.
4.2.3.1 The role of the credit manager
A credit manager is the individual in a business who is responsible for evaluating
customer credit applications, and who holds the power to commit business
resources in a credit transaction. The ultimate ‘bottom line’ in every credit
manager’s job is to succeed in helping a business achieve high performance by
the best utilisation of all its human and material resources.
In particular, the credit department should be providing value by:
„„
„„
„„
„„
„„
„„
„„
assisting management to operate with confidence;
caring for one of the largest assets of the company – accounts receivable;
transforming accounts receivable to cash timeously;
keeping delinquency and bad debts at appropriate levels;
assisting to increase sales levels by reducing risk and selling safely;
cooperating with marketing and sales to achieve maximum sales; and
assisting with customer relations management.
In many organisations, the credit manager has a specialised management
position in addition to the other managers, such as, for example the marketing,
operations and human resource managers.
Credit managers must ensure that credit and collection activities are carried
out in a way that contributes to achieving the department’s objectives. They
have the authority to entrust their subordinates with responsibility, and to
give them instructions. The challenge is to evaluate risk, and decide if a credit
relationship is possible between the creditor and the applicant. It is impossible
for credit managers to do all the work themselves. They have to entrust certain
tasks to subordinates so that they, as managers, can attend to those tasks that
cannot be delegated.
4.2.3.2 The credit management process
The credit management process is a series of steps that involve promoting
credit purchase options, analysing the risk of credit applicants and collecting
the payments after the debt is created. The credit management process applies
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Business Management: A Contemporary Approach
to consumer and trade credit. The credit and collection policy procedures will
ensure that each credit account is handled in a reliable, cost-effective manner.
The credit management process forms an integral part of the credit
manager’s daily activities. Figure 4.3 shows the different stages in the credit
management process.
The credit
management process
Promotion of
credit
programmes
Control of the account
Analysing the risk
of credit applicants
•
•
•
•
•
Collections
Initial screening of
applications
Credit assessment
Collecting information
Analysing information
Making decisions on
granting credit
Figure 4.3: The credit management process
At each stage in the process, the credit manager must determine specific
operating policies that will help to ensure that each credit account is handled
in a consistent, cost-effective manner.
Globalisation in today’s business world changes trading behaviour, and has
an influence on the structure, volume and risk of the accounts receivable item
on the balance sheet. The credit manager and the credit team therefore have
to react to these changes by, for example:
„„
„„
„„
adjusting payment arrangements;
maximising internal processes; and
applying a risk-orientated approach to the whole credit management
function.
Before credit is granted to a person or business, the first step is to determine
whether that person or business is creditworthy. Sellers assess the creditworthiness
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Chapter Four – Credit Management
of the buyer, and base their decision to accept the buyer’s credit on this. Assessing
the customers is part of the credit management process.
„„
„„
„„
„„
Promotion describes any effort undertaken to encourage product sales
or to increase the number of customers using credit purchase options.
The business must inform existing and potential customers about its
credit facilities. The credit facilities can be advertised (for example in
magazines, newspapers, television and on the Internet). A business that
offers trade credit facilities can introduce these to their buyers at trade
fairs or in trade journals. The sales representatives play a vital role in
this regard.
Initial screening of applications describes the efforts by the credit
department to make quick, cost-effective checks to see if an applicant
meets the basic criteria for opening a credit account.
Credit assessment is to assess the creditworthiness of the customer and
decide if credit can be granted. The credit department must decide if the
risk of selling on credit is acceptable. The first step in the process of credit
assessment is collecting information. The second step is to analyse it. To
make a decision on granting credit is the most important aspect of credit
work, and it is the third step of the assessment phase.
Collection of debts is one of the primary tasks of the credit department.
Collection activities include any attempt to get credit customers to pay
their accounts timeously. In any business the success of credit sales is
determined by how effectively any overdue amounts are collected. The
advantage of credit is only experienced by the business once the debtor
has paid the account in full. There are many methods for collecting
payments. The business will always attempt to collect their debts as
soon as possible. Keep in mind that the most carefully devised credit
policy cannot keep a business’s credit activity from becoming a problem
area if the business does not diligently collect the receivables.
It is very important that any business has an effective system of credit control
and management. Control functions are used to monitor an account to ensure
that total indebtedness is appropriate for an individual customer.
„„
„„
External control and management deals with the extension and
collection of credit. The way in which the credit department applies
the credit standard usually determines whether a customer may obtain
credit. A method that can be used to control the credit standard of the
business is to analyse the business’s bad debt.
Internal control and management deals with methods of monitoring
the level of debtors within the business. These methods are: days’ sales
outstanding (DSO), age analysis and payment pattern approach. The
payment pattern approach, also known as the accounts receivable balance
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Business Management: A Contemporary Approach
pattern, shows uncollected balances based on the month in which the
credit sales originated.
4.2.3.3 The responsibilities of the credit manager
The credit manager is responsible for the daily short-term activities needed to
accomplish the long-term goals. These include:
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„„
„„
„„
analysing the financial statements;
conducting credit investigations;
classifying debtors’ risks;
setting credit lines;
handling invoices;
managing debtors; and
dealing with problems in the credit department.
‘Business is many things, the least of which is the balance sheet. It is a fluid, ever
changing, living thing, sometimes building to great peaks, sometimes falling
to crumbled lumps. The soul of a business is a curious alchemy of needs, desires,
greed and gratifications mixed together with selflessness, sacrifices and personal
contributions far beyond material rewards.’ (Harold S. Geneen)
4.3 Credit management in practice
4.3.1 Improving working capital through credit management
The credit manager and the credit department can contribute towards the
improvement of the working capital through credit management and the
contribution to owners’ wealth maximisation. In general, the greater the
margin by which businesses’ current assets cover their current liabilities, the
easier they will make the payments as they fall due. The net working capital is
also a measure of liquidity.
On the balance sheet the net working capital can be calculated by deducting
the total current liabilities from the total current assets.
CA – CL = net current assets (net working capital)
To find the working capital on the balance sheet, you need to find the current
assets. When current assets exceed current liabilities, the business has positive
net working capital.
The current assets consist of the stock, debtors, cash in the bank and cash
in hand. The current assets are sources of cash inflow; the current liabilities
sources of cash outflow. The working capital of the company is the investment
made in current assets, which tend to be more short-term based and volatile.
It is an important comparative measure for businesses because it gives a more
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Chapter Four – Credit Management
relevant assessment of the necessary investment in short-term assets than
current assets alone.
When a business has a large amount of stock, this would show a large number
of current assets on the balance sheet. However, if the stock was purchased on
credit, the creditors’ amount would increase the current liabilities. The net
working capital, therefore, would make up for the two balances and reflect the
true investment that requires financing by the business.
Table 4.1: Balance sheet of XYZ (Pty) Ltd as at December 31 2013
CAPITAL EMPLOYED
Shareholders’ equity
Preferred shares
Regular shares (1 million shares at R5 par)
Retained earnings
Total shareholders’ equity
2,500
5,000
6,000
13,500
20,000
Long-term debt
R33,500
EMPLOYMENT OF CAPITAL
Fixed assets
Land and buildings
Machinery and equipment
Furniture and fixtures
Less accumulated depreciation
Net fixed assets
Current assets
Stock
Accounts receivable (debtors)
Cash
Total current assets
Less: Current liabilities
Accounts payable (creditors)
Accruals
Tax
Net current assets:
11,000
20,500
8,000
39,500
13,000
26,500
7,500
12,000
4,000
23,500
8,000
500
8,000
16,500
7,000
R33,500
Net working capital
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The net working capital of XYZ (Pty) Ltd is:
Net working capital
= Current assets – current liabilities
= R23 500 – R16 500
= R7 000
This figure is quite useful for internal control. Sometimes, a minimum level
of net working capital must be maintained in order to acquire a long-term
debt. This requisite tends to force the business to maintain adequate operating
liquidity and helps to protect the creditor.
The effective management of working capital determines the profitability
and continuity of the business. If these assets are effectively managed, the
business will grow and be profitable, but poor management of the working
capital will result in the income declining and a non-profitable organisation.
Current assets are short-term assets that need to be managed on a day-to-day
basis. If not, many new and growing companies are compelled to close down
because of overtrading. This happens when a company grows quickly and is
unable to fund its working capital requirements from its cash resources. In
other words, the need for working capital has got out of control.
The management of working capital is directly related to the liquidity of
the business, so that one may just as well refer to it as liquidity management.
Liquidity management includes the management of current assets and
liabilities. The term ‘liquidity’ is the measurement of the business’s ability to
satisfy its short-term obligations as they fall due.
It is important to understand that liquidity management has an effect on
the management of both current assets and current liabilities. It involves the
allocation of cash over a period of time to stock, debtors and cash.
The rest of this section focuses on the debtors that fall under the current
assets.
‘The function which distinguishes the manager above all others is his educational
one. The one contribution he is uniquely expected to make is to give others vision
and ability to perform. It is vision and more responsibility that, in the last analysis,
define the manager.’7
4.3.2 Managing debtors
Debtors arise when a business sells on credit to its clients. Debtors’ accounts
represent a considerable portion of investment in current assets in businesses,
and obviously demand efficient management. Debtor management is a strategy
that involves the process of designing and monitoring the policies that govern
how a company extends credit to its customer base. Debtor management
decisions are very complex. On the one hand, too much money can be tied up
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Chapter Four – Credit Management
in debtors because of an extremely liberal policy in giving trade credit. This
burdens the business with the higher costs of debtor services. Additional costs
are further generated by bad debts from risky customers. On the other hand,
the liberal trade credit policy could help enlarge income from sales.
The idea behind this process is to minimise the amount of bad debt that
the company will eventually incur due to customers failing to honour their
commitments to repay the total amount of the credit purchases. The term
‘accounts receivable’ is interchangeable with debtors. Debtors are to be found
in an organisation’s balance sheet under ‘current assets’.
Current assets include:
„„
„„
„„
stock (inventory);
debtors (accounts receivable); and
cash in the bank and cash in hand.
The business should be able to convert its current assets into cash as quickly as
possible (within one year or less). This includes selling merchandise on credit
and collecting all the credit on time. A debtor is regarded and treated as a
current asset. All current assets are short-term assets. The debtors form a major
area of the business where funds are tied up. The business’s aim from a finance
perspective should be to keep this figure as low as possible. However, it should
not be forgotten that, from a sales viewpoint, the practice of supplying credit
provides a business with a competitive advantage. It is often a crucial tool for
attracting customers. How a business manages that process is a fundamental
part of cash flow management. Debtors are a vital part of cash inflow, and
poorly managed credit can mean delays in converting sales to cash or, more
seriously, trading with customers who are unable or unwilling to pay.
Table 4.2: Calculating average collection period and total amount owed at any one time
XYZ (Pty) Ltd
Sales revenue
Debtors
R4,074,000
R603,000
The average collection period is useful in evaluating credit and collection policies.
Average collection period = debtors / average sales per day
= debtors / annual sales / 360
= R603,000 / R4,074,000 / 360
= R603,000 / 11,316.7
= 53.2 days
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Business Management: A Contemporary Approach
On average, it takes 53.2 days to collect a debtor. This number of days is only
meaningful in relation to the business’s credit terms, because if XYZ (Pty) Ltd extends
30-day credit terms to customers, the above figure of 53.2 days would indicate a
poorly managed credit or collection department, or both. But, on the other hand,
if a 60-day extension of credit to customers existed, the 53.2 day average collection
period would be acceptable.
When the credit sales are R4,074,000 annually and customers take almost two months
to pay, we can estimate the average total amount owed at any time as follows:
Debtors = sales x average credit period / 360
= R4,074,000 x 53.2 / 360
= R4,074,000 x 0.15
= R611,100
The average value of invoices to be paid and the current amount of funds tied
up in debtors for XYZ (Pty) Ltd is R611 000. It is clear that the number of sales
and the time it takes to collect outstanding amounts determine the value of
the debtors. The business does not want to sell on credit to customers who
are unlikely to pay for the goods or services. Credit checking is, therefore, one
factor used to slow the growth of debt.
4.3.2.1 Key factors
Key factors for the effective management of debtors include:
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the quality of the product and service;
processing and sending accounts and statements out on time;
applying a standard collection policy, and keeping strictly to stipulated
procedures set out in such a standard policy;
taking strict action against debtors with overdue accounts and those that
exceed their credit limit;
good management control system;
applying credit standards to all new customers;
regularly checking debtors’ creditworthiness by noting how they pay
their accounts;
keeping records up to date;
evaluating the performance of debtors using different methods such as
age analysis and DSO; and
ensuring credit managers are professionally qualified.
4.3.2.2 Managing debtors in a digital economy
Modern technology has changed the way in which organisations conduct
business, which has transformed the business cycle significantly resulting in
the exchange of products and services in a rapid and far more efficient way.
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Chapter Four – Credit Management
Computers and the Internet have dramatically changed and expanded business
opportunities globally. Organisations make use of web catalogues, home pages,
e-commerce and Internet storefronts to obtain and compile financial data.
Electronic payment and transfer of money have made it possible to instantly
pay and conclude business transactions.
Computers have an enormous impact on the management of accounts
receivable. Companies can use computer systems to record sales, send bills,
keep track of customers’ payments, alert the credit department to any
accounts becoming overdue and take action automatically to collect overdue
accounts. Accounting programmes can summarise the payment history of
each customer and use that information to help establish credit limits for
customers. The computer stores historical data on debtors’ credit terms and
payments, which the organisation can use when it considers making any
changes to its credit policy. The objective of credit management is, therefore,
to collect trade receivables as quickly as possible without losing customers
from high-pressure collecting methods. Achieving this objective involves
three critical aspects, namely: credit policy, credit terms and the collection
policy.
4.3.2.3 The credit policy
The credit policy spells out conditions that will determine which customers
should get credit and for how much. Customers are evaluated according to their
creditworthiness in terms of the ‘four Cs of credit’.
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Character – the customer’s record of meeting obligations in the past.
Capacity – the customer’s ability to pay.
Capital – the customer’s sources of financial resources.
Conditions – the current economic or business condition.
Your company’s credit policy is important. It should not be arrived at by
default. The board should determine your company’s credit criteria, namely:
„„
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„„
„„
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which credit rating agency you use;
who is responsible for checking prospective and existing customer
creditworthiness;
the company’s standard payment terms;
the procedure for authorising any exemptions; and
the requirements for regular reporting.
The policy should be written down and kept up to date with the current
creditworthiness of specific customers – especially ones with large lines of credit
or increasing their orders – plus warnings or notes of current poor experience.
The policy should be disseminated to all sales staff, the financial controller
and the board. The creditworthiness of customers can be evaluated by looking
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Business Management: A Contemporary Approach
at credible sources, such as the customer’s bank or financial statements, and
the assessments and ratings by credit agencies.
A credit policy manual should be developed to provide rules and
guidelines on important aspects of the work being performed within the
credit department. The credit manual will allow for the recognition and
understanding of important issues, and should ensure consistent thinking
and action on these issues by all those within the department. It is of the
utmost importance that the manual is written only after mutual agreement
of policies from management, sales and other affected departments. Credit
policies should not change very often. However, the manual should still be
reviewed yearly to keep it up to date.
4.3.2.4 The credit terms
Credit terms are the conditions of sale that are given to the credit customers.
These terms include the length of time given to customers to pay and cash
discounts offered for prompt payments. Here, management should consider:
„„
„„
„„
the usual terms of trade in the industry (eg 30 days from the date of
invoice);
the cost to the business of offering cash discounts for prompt payments
(eg reducing the profit made on selling the goods in the first place); and
the clarity of terms of sales, and whether they appear on the invoice.
The credit terms can be indicated as, for example, ‘2/10 net 30 days’.
This means the customer will receive a 2% discount if the account is paid
within 10 days of the beginning of the credit period. If not, the account must
be settled within 30 days. Cash discounts are offered to encourage quicker
payment.
4.3.2.5 The collection policy
The collection policy refers to the collection methods used to gather trade
receivables once they become due. Slow payments lengthen the average
collection period, and therefore increase the investment tied up in trade
receivables. Credit can be checked using the average collection period and by
aging trade receivables. Credit collection can be improved by using popular
collection techniques. The average collection period is calculated using the
following equation.
debtors
Average collection period =
÷ 365
credit sales
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Chapter Four – Credit Management
The level of bad debts is often regarded as a criterion of the effectiveness of
credit and collection policies. The costs of granting credit include:
„„
„„
„„
„„
loss of interest;
costs of determining the customer’s creditworthiness;
administration and record-keeping costs; and
bad debts.
These costs must be considered against the loss of goodwill if credit is denied
in a competitive market where customers may obtain the same products on
credit terms elsewhere.
4.3.2.6 Purpose of the credit policy
It should already be clear that the business cannot function without a
credit policy. The credit procedures are formulated as guidelines for the
daily tasks.
The reasons for the credit policy are:
„„
„„
„„
„„
defining the function of credit within the business;
setting out the objectives of credit management;
indicating the physical position of credit in the business by way of
organisational structure; and
outlining the duties and responsibilities of the credit function.
4.3.3 Effect of credit on liquidity
In a previous section, the term ‘liquidity’ was discussed. The first item under
current assets on the balance sheet is stock. Stock has to be turned into sales
before it can generate cash – it is not profitable to hold large stock volumes.
The next item on the balance sheet is debtors, or accounts receivable. Debtors
hold the key to the business’s liquidity.
By looking at Figure 4.4, the working capital cycle, it is clear that expenses
and repayments are paid out of the income. If the number of debtors is too
high and there is not enough income, a cash flow problem can exist. Suppliers
who regularly increase their prices, and at the same time insist on timeous
payment, can also affect the cash flow position. Additionally, high inflation
rates can also affect the cash flow.
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Business Management: A Contemporary Approach
Debtors
Stock
Area of credit risk
Raw
materials
Creditors
Labour
Manufacturing
Cash
Wages
Plant and
equipment
Overheads and
running costs
Profit/loss
Figure 4.4: The working capital cycle8
4.3.3.1 Measurement of debtors
There are several methods to measure debtors. Some are based on the average
day’s sale principle or on the working back principle, or a combination of the two.
Whichever method is used, the credit manager should ensure that:
„„
„„
valid month-to-month comparisons are possible; and
fluctuations in sales volume do not distort the trend.
4.3.3.2 Quality of debtors
The liquidity of the business is largely determined by the quality of its debtors.
Quality has two aspects, namely risk and age. Some businesses have a history
of high-risk debtors, whilst others seldom incur bad debts. Each business
should decide what level of risk it is prepared to accept if it is to remain both
competitive and profitable.
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Chapter Four – Credit Management
4.3.4 Effect of credit on profits
After a sale has been made and the goods have been delivered, the collection of
payment can take a few months. If payments are late, they may cause a business
to experience a substantial drop in its profit margin. The business often uses
extended credit to promote sales. Unless the real cost of credit is recognised and
included in the calculation of profit, the careless granting of long-term credit
can easily have the opposite effect to that intended.
One can use the example in Table 4.3 to establish where the real cost of
credit is included in the calculation of profit. Note the policies that the three
different businesses adopt.
Table 4.3: Calculating the cost of credit9
Company A
(R)
Sales
Debtor level
Net profit (5%) before
credit cost
Company B
(R)
Company C
(R)
60 000
60 000
60 000
–
50 000
150 000
(1 month)
(3 months)
30 000
30 000
30 000
Less:
1% discount for COD
payment
(6 000)
1% (cost of 1 month’s
credit)
(6 000)
3% (cost of 3 months’
credit)
(18 000)
Plus:
Interest @ 1% per month
NET PROFIT
12 000
24 000
24 000
24 000
Refer to Company ‘C’, which charges interest at a rate of 1% per month,
amounting to R12 000 per month on overdue accounts. The interest increases
the profit to R24 000. If Company ‘C’ did not charge interest on overdue
accounts, the net profit will be reduced by a further R12 000. This confirms
our analysis in section 4.3.4, which shows that overdue accounts and credit
thus directly reduce the profit.
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Business Management: A Contemporary Approach
The next example illustrates that extended credit can have the opposite effect
to that intended, since the cost of financing a higher level of debtors may
outweigh the additional profit.
Table 4.4: The cost of financing debtors10
A
(R)
B
(R)
Sales
120 000
160 000
1 150 000
180 000
Debtors
20 000
40 000
37 500
60 000
Credit terms
60 days
90 days
90 days
120 days
7 800
10 400
9 750
11 700
Credit cost (12%)
(2 400)
4 800)
(4 500)
( 7 200)
Net profit
5 400
5 600
5 250
4 500
Net Profit 6.5% before
credit cost
C
(R)
D
(R)
Less:
120 000 x 6.5% 150 000 x 6.5%
20 000 x 12% 60 000 x 12%
1.
2.
3.
4.
In column A, Company A has a net profit of R5 400.
The credit manager decided to extend the credit by another 30 days in the hope
that there would be a 33.3% increase in sales, resulting in an increase in profit of
R5,600 (find these calculations in column B).
(40 000/120 000 = 33.3%).
Look at column C and find that sales only increased by 25% and that the
increased profit is outweighed by higher credit costs.
(37 500/150 000 = 25%).
In column D the credit term is extended by another 30 days to 120 days, and the
sales increased by 50% above the original level. However, the cost of financing
120-day credit is so high that the end result is even worse.
4.3.5 Managing creditors
A creditor is a person or business that you owe money to, for example:
„„
„„
„„
„„
trade creditors;
taxation;
prepayments; and
short-term bank loans.
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Chapter Four – Credit Management
On the financial statements, the creditors are deducted from the total of
the working capital (current assets) to derive at the net working capital. The
delayed payment of creditors is used to a certain extent as a delaying tactic, but
suppliers can charge higher prices to balance the loss of interest.
4.3.6 Cash flow management (operating and cash flow cycles)
A popular measure of working capital management is the cash conversion cycle,
that is the time span between the purchases of raw materials and the collection
of sales of finished goods. A longer time span requires a larger investment
in working capital. A long cash conversion cycle might increase profitability
because it leads to higher sales. However, corporate profitability might decrease
if the costs of higher investment in working capital rise faster than the benefits
of holding more inventories and/or granting more trade credit to customers.
Cash flow management is vital to any business, since it needs a positive cash
flow to survive. At surface level, the primary reason businesses fail is that they
simply run out of cash. Business failure is common not only with new startups, but also with listed companies, and it can easily happen to organisations
of any and all sizes.
4.3.6.1 Factors to consider in successfully managing cash flow
Understanding the problem
There may be different factors that are responsible for having an adverse impact
on the liquidity position of the business, including:
„„
„„
„„
„„
poor credit vetting and/or collection procedures;
failure to negotiate appropriate credit terms;
insufficient working capital; and/or
inadequate gross profit margins.
The major reason for cash flow problems is the failure to properly manage
receivables. It is crucial to identify the problem and find a rapid solution.
The operating and cash cycles
The operating cash cycle period indicates the growth in financing needed for
additional working capital if sales levels increase.
Operating cycle
A company purchases goods (inventory) worth R1 000 on credit. Thirty days
later, it pays the account and within the next 30 days, it sells the inventory at
a selling price of R1 400. The buyer only pays 45 days later. The 60-day span
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Chapter Four – Credit Management
On the financial statements, the creditors are deducted from the total of
the working capital (current assets) to derive at the net working capital. The
delayed payment of creditors is used to a certain extent as a delaying tactic, but
suppliers can charge higher prices to balance the loss of interest.
4.3.6 Cash flow management (operating and cash flow cycles)
A popular measure of working capital management is the cash conversion cycle,
that is the time span between the purchases of raw materials and the collection
of sales of finished goods. A longer time span requires a larger investment
in working capital. A long cash conversion cycle might increase profitability
because it leads to higher sales. However, corporate profitability might decrease
if the costs of higher investment in working capital rise faster than the benefits
of holding more inventories and/or granting more trade credit to customers.
Cash flow management is vital to any business, since it needs a positive cash
flow to survive. At surface level, the primary reason businesses fail is that they
simply run out of cash. Business failure is common not only with new startups, but also with listed companies, and it can easily happen to organisations
of any and all sizes.
4.3.6.1 Factors to consider in successfully managing cash flow
Understanding the problem
There may be different factors that are responsible for having an adverse impact
on the liquidity position of the business, including:
„„
„„
„„
„„
poor credit vetting and/or collection procedures;
failure to negotiate appropriate credit terms;
insufficient working capital; and/or
inadequate gross profit margins.
The major reason for cash flow problems is the failure to properly manage
receivables. It is crucial to identify the problem and find a rapid solution.
The operating and cash cycles
The operating cash cycle period indicates the growth in financing needed for
additional working capital if sales levels increase.
Operating cycle
A company purchases goods (inventory) worth R1 000 on credit. Thirty days
later, it pays the account and within the next 30 days, it sells the inventory at
a selling price of R1 400. The buyer only pays 45 days later. The 60-day span
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Business Management: A Contemporary Approach
is called the inventory period. The 45 days it takes to make the collection is
called the accounts receivable period.
Operating cycle
= inventory period + accounts receivable
period
105 days
= 60 days + 45 days
The cash cycle, therefore, is the number of days that pass until the company
collects the cash from a sale, measuring from when it actually pays for the
inventory.
The 30 days it takes to pay the creditor is called the accounts payable
period. Cash is only collected on day 105 (operating cycle). The R1 000 needs
to be financed for 105 – 30 = 75 days. This period is called the cash cycle.
Cash cycle
= operating cycle – accounts payable
period
75 days
= 105 days – 30 days
The operating cash cycle can also be called the working capital cycle.
Different businesses have different cash flow cycles. The length of the cash
flow cycle can be measured taking account of the stockholding periods and
credit periods applicable to creditors and debtors.
Calculating the operating and cash cycles
Different ratios can be used to calculate these cycles. Information from the
balance sheet and income statement can be used to do the calculations.
„„
„„
operating cycle – inventory turnover, inventory period, receivables
turnover and receivables period; and
cash cycle – payables turnover, payable period.
Interpreting the cash cycle
The cash cycle depends on the inventory, receivables and payables periods. The
cash cycle increases as the inventory and receivables periods get longer, and
decreases if the payables periods are lengthened. The longer the cash cycle,
the greater the financing required to finance inventories and receivables. A
lengthening cycle can indicate that the business is having trouble moving
inventory or collecting on its receivables. This problem can be countered by an
increased payable cycle.
The shorter the cash cycle, the lower the business’s investment in inventories
and receivables.
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Chapter Four – Credit Management
Cash cycle process
The cash goes out to pay wages, suppliers and operating and sales expenses
before hopefully more cash is received from customers following a sale.
Finished
product
Raw
materials
Wages
Sales/services
Operating
expenses
Suppliers/
creditors
Sales
expenses
Debtors
Cash
• P roducts are bought on credit from suppliers, who are creditors of the
business until they are paid
• Employees are paid wages, usually on a weekly or monthly basis
• After the production is complete the finished product is sold
• Suppliers and expenses are paid
• Payment is received from customers
Figure 4.5: The cash cycle process
4.3.6.2 Motives for holding cash
In general, the term cash refers not only to coin and currency, but also to
cash equivalents such as interest-bearing savings and checking accounts. It is
obvious that a positive cash flow is vital for any business to survive, but what
level of cash should a business maintain? Before we answer this question,
first consider the three motives for holding cash as seen in Figure 4.6.
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Business Management: A Contemporary Approach
Operational risk
Financial risk
Transactional and
intentional cash
Specualtive cash
Precautionary cash
Figure 4.6: The working capital cycle11
The three motives for holding cash are the transaction motive, the precautionary
motive and the speculative motive.12
„„
„„
The transaction motive is the need for cash to meet payments.
Organisations guided by transactional and intentional motives are
focused on ensuring sufficient capital to cover payments arising in the
ordinary course of business – payments for things such as purchases,
labour, taxes and dividends. An organisation retains transactional cash
to ensure regular payments to vendors for its costs of materials and
raw materials for production. It retains intentional cash for tax, social
insurance and other known non-transactional payment purposes.
The precautionary motive for holding cash has to do with maintaining
a cushion or buffer to meet unexpected contingencies such as delays
in accounts receivable collection or delays in receiving other expected
monies. The more predictable the cash flows of the business, the
lower the need for precautionary balances. Ready borrowing power to
meet emergency cash drains reduces the need for this type of balance.
It is important to point out that not all the business transactions and
precautionary balances need be held in cash. A portion may be held in
marketable securities, or ‘near-money assets’.
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Chapter Four – Credit Management
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„„
The speculative motive relates to holding cash in order to take advantage
of expected changes in security prices. When one expects interest rates
to rise and security prices to fall, this motive would suggest that the
organisation should hold cash until the rise in interest rates ceases. When
interest rates are expected to fall, cash may be invested in securities. The
organisation will benefit from any subsequent fall in interest rates and
rise in security prices.
For the most part, however, companies do not hold cash for the purpose of
taking advantage of expected changes in interest rates. Consequently, we
concentrate only on the transaction and precautionary motives of the business,
with these balances held both in cash and in marketable securities.
4.3.6.3 Basic strategies to manage cash
The most liquid current assets are cash balances. The purpose of cash
management is to determine the level of cash resources at the company so that
it increases the wealth of the company owners. In other words, the objective
is to maintain a level of cash resources at the company that is optimal for the
organisation.
Billing, collection and disbursement policies and procedures are tools used
to increase the amount of cash available to the organisation. The objective
of billing, credit and collection policies is to accelerate cash receipts, while
the objective of cash disbursement policies is to slow down cash outflows.
Understanding the concept of ‘float’ is one of the most useful concepts to
implement good collections and disbursement policies. Float is the time
delay during the process that starts with the assembling of a bill and ends
with the deposit of the payment in the bank and subsequent payments to
creditors. There are four main categories of float: billing, collection, transit
and disbursement.
Table 4.5: Types of float
Billing
Collection
Transit
Disbursement
„„ Customer
receives services
„„ Bill compiled
and delivered
„„ Payment sent
„„ Payment
received
„„ Payment
processed
„„ Payment
deposited
„„ Funds available
for use
„„ Funds disbursed
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Mailing Processing
After an organisation has gone through the effort to reduce its disbursement
float, it wants to ensure that the money that has not yet been disbursed is
invested appropriately to generate a favourable return. A myriad short-term
investment instruments exist, including treasury bills, certificates of deposit,
commercial paper, money market and mutual funds.
Maintaining the appropriate cash balance requires not only ongoing
monitoring of current assets and liabilities, but also those that should be
anticipated in the future. Therefore, it is necessary to plan future cash inflows
and outflows. Cash forecasting is performed based on the cash budget. This
tool contains a forecast of recovered receivables, expenditure on inventories
and repayment of liabilities. It provides information about the cash balance,
which is a result of:
„„
„„
inflows from sales (payment of receivables); and
outflows due to purchase of materials and other costs of the company.
Basic cash management strategies
The basic strategies that the business should apply to manage cash are the
following.
„„
„„
„„
Collect debtors’ accounts as soon as possible. Cash discounts, if they
are economically justifiable, may be used to accomplish this objective.
The efficient collection of debts will avoid losing future sales, a risk
emanating from high-pressure collection techniques. The credit manager
plays a vital role in forecasting cash receipts – no-one is closer to the
debtors or more certain about when debts will be collected.
Stock must be turned over as quickly as possible. The depletion of
stock might result in a loss of sales.
Creditors must be paid as late as possible without damaging the
organisation’s credit rating or missing out on the advantage of cash discounts.
The level of cash resources depends on the trade-off between the costs of
maintaining cash balances against the costs of holding insufficient cash balances.
A business does not want too much cash because this will have a negative impact
on profitability, but it requires enough to operate ‘safely.’ So, management must
weigh up the loss in profitability against the feeling of ‘greater safety’.13
4.3.7 Bad debt provision
Bad debts are part of the cost of doing business. Provision for bad debts, also
called bad debt expense or uncollectible expense, is an estimate of accounts
receivables that will not be collected. Provision for bad debts is established
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Chapter Four – Credit Management
to charge off bad debt expenses in the accounting period matching the
creation of the debtor’s record. They are contra-assets, reducing current assets
accordingly on the business’s balance sheet. This gives a more accurate picture
of the outstanding debtors. Provisions can be established yearly, based on past
experience and on management’s willingness to accept a certain level of bad
debts, or recognising that an estimated level of bad debts is inevitable.
A responsible credit manager must not neglect concerns of provisions
against bad debts. No one else is able to make a proper assessment of the sales
ledger. The credit manager also needs to identify uncollectable accounts and
recommend reserves.
4.4 Benchmarking the credit department
The word ‘benchmarking’ has become a very important term in contemporary
business, and is used by managers on a daily basis. Benchmarking is a tool to
help improve a business’s processes. Any business process can be benchmarked.
The credit manager is also concerned about the effectiveness and efficiency
with which the credit department’s operations are carried out.
4.4.1 What is benchmarking?
Benchmarking is a way for companies that are changing nationally and
internationally to identify strengths and weaknesses, and to establish best
practice and performance. It is a constant process of measuring products,
services and practices against the toughest competitors, or those companies
recognised as the cream of the crop. Benchmarking is the process of identifying,
understanding and adapting outstanding practices from companies anywhere
in the world to help a business improve its performance.
Benchmarking is about measurement. Measurement enables the discovery
of what needs to be benchmarked through a performance gap analysis with
whom to benchmark through performance comparison with others.
The different categories of benchmarking include:
„„
„„
„„
internal benchmarking in which organisations learn from sister
companies, divisions or operating units (performance improvement may
be 10%);
competitive benchmarking that targets specific product designs, process
capabilities or administrative methods used by one’s direct competitors
(performance improvement may be 20% or more);
generic benchmarking that seeks process performance information from
outside one’s own industry, translating enablers from one organisation to
another through the interpretation of their corresponding relationship
(performance improvement may be 35% or more); and
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„„
functional benchmarking that seeks information from the same
functional area within a particular application or industry (performance
improvement may be 35% or more).
4.4.2 Meaningful measures of benchmarking
Dynamic credit managers plan and direct the credit, collection and debtor
functions to increase sales and profits. To reach these objectives, credit managers
apply their management and decision-making skills to make the most of cash
inflows, encourage growth and get the best return from their human resources.
Using suitable measures of performance is an important credit management
tool if performance in the credit, collections and debtor areas needs to be
measured. Meaningful measures will support the business’s mission and help
reach the credit function’s objectives. To make the process meaningful, the
measures need to be compared to standards. Adequate standards must be set
for each measure used, and must make use of historic business or industry
values or trends. A standard can be a set value or a range. A measure needs to
be consistent. The acceptable standard and the comparable standard cannot
change every time. It is important to assess and update measures from time to
time, usually on a yearly basis.
To measure performance in credit, collections and debtor areas will serve
no purpose if these results are not communicated and reported to the relevant
people.
The benchmarking process differs from business to business and can be
divided into many phases, depending on the needs of the business. Some
businesses have six steps, others more than 30. However, the basic phases are
planning, collection of data, analysing and implementing.
The credit department’s benchmarks should include both the credit
management performance and the credit department’s benchmarks. What
follows is a brief list of what might be included when the measures are tabulated.
Credit management benchmarks can include:
„„
„„
„„
„„
„„
„„
days sales outstanding (DSO);
best possible DSO;
debtors’ days;
percentage of current debtors;
percentage of debtors over 60 days past due; and
credit cost per sales Rand.
Credit department benchmarks can include:
„„
„„
„„
human resources – number of credit and collection staff;
number of other staff members;
additional staff handling debtor functions;
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Chapter Four – Credit Management
„„
„„
additional staff handling claims and adjustments; and
employee performance and selected expense ratios.
4.5 Summary
In contemporary credit management, the days of being purely a figure person
are over, and good credit decisions can no longer be made in a vacuum. With
increased responsibility, the credit manager has become the heart of the
business’s financial wellbeing.
This chapter has examined how the working capital of a business – the
investment made in current assets – should be professionally managed on a
daily basis, since the working capital determines the profitability and longevity
of the business. The debtors play an important role in the liquidity of the
business and therefore need to be turned into cash as soon as possible. Without
debtors, the business cannot grow, pay vendors, or invest in business activities.
The credit manager uses information it collects about credit applicants to
make decisions about granting credit. These steps form part of the credit
management process.
The business should manage its cash inflows and outflows in order to
maintain its wellbeing. If the cash levels are too low, the business cannot
succeed financially. If there is too much cash, it loses income from interest.
The business should, therefore, keep just enough cash to pay the day-to-day
obligations and provide for unforeseen circumstances.
Also important to note is that quality in the credit department is not so
much a matter of techniques or about statistical control or testing machines,
but a way of leading, adding value, integrating efforts and managing for
profitability and growth.
4.6 Self-evaluation
Read the case study and answer the questions below.
Case study
Eeze Motor Spares
Eeze Motor Spares is a company involved in the sale of both imported and
locally manufactured light and heavy vehicle automotive spares. It is the single
biggest distributor of automotive spares in southern Africa. It sells directly to the
public through 50 retail outlets and wholesale to end-users and smaller spares
outlets spread throughout South Africa. It prides itself that it sells spares that
are equal in quality to that of the original spares of the motor manufacturers.
It is a very competitive market, with the single biggest competitor being
Golden Touch Auto Parts, as well a multitude of other smaller distributors and
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Business Management: A Contemporary Approach
independent retailers. The market is extremely price-sensitive. The only way
that Eeze can compete is by granting favourable credit terms.
John Bester was recently appointed group credit manager for the company.
There had been no credit manager in charge of the credit department during
the previous 18 months. During this period, the financial manager, James
Balance, tried to manage the department but, given his own demanding duties,
was unable to give it the attention required. This resulted in the debtors’ book
being in a totally chaotic state, with overdues representing 80% of the total
book.
Terms granted are 30 days and, in exceptional cases, 60 or 90 days,
depending on the importance of the customer to Eeze. Part of the customer
base is government departments, which represent 20% of total turnover.
Government departments are notorious for their late and non-payment of
accounts. The total book is currently R120 million.
The following conversation took place between John and James:
‘James, it seems as if things are not working well regarding our financial position.
We have a well-spread portfolio of long-term contracts as well as quick turnaround
business. We are constantly on the maximum of our overdraft facility. Petrus and his
team from marketing are expanding our customer base with about four new contracts
per month, but there is no money in the bank. Surely the smaller deals can be used to
finance the longer contracts. These are the money spinners.’
James replied as follows:
‘John, I am aware of the problem. Our department is hugely under pressure. Currently,
the debtors’ collection period is getting out of hand. It varies between 50 and 60 days
for the short-term business. The long-term collection is over 120 days. This has a
dramatic influence on our cash flow. Invoices are not processed in time, statements
are late and our creditors request payment within 30 days. This is why we owe the
bank so much. I am afraid if things do not improve soon, we will have to increase our
overdraft facility. Either Petrus and his team must stop marketing, or we need to sort
out my area. This has now been going on for five months.’
‘Cash flow is everything’, said John, ‘and that goes for us, as well as any other business.
Bad debts and late payments can be a real problem. Debt recovery is important,
because bad debts can have a devastating effect on our business. A bad debt will not
only be a write-off on a ledger, it will also mean a profit loss.’
John’s brief to the regional and branch credit managers and credit controllers
was to:
„„
„„
bring the debtors’ book within company credit terms; and
reorganise the credit function into a centralised department.
The current structure was that each branch had its own credit controller reporting
to the branch manager. The result was that, because the branch managers were
being measured on turnover, no real attention was given to collecting outstanding
monies. A further problem was that, due to the competitiveness of the market,
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Chapter Four – Credit Management
no securities were in place to protect the company’s interests. On analysing the
debtors’ book, John realised that there were numerous uncollected accounts
against which legal action or even liquidation proceedings should be instituted.
John reorganised the credit department into regions in line with those of
the sales regions, and appointed regional credit managers reporting to him
to manage the controllers in the different branches. He also introduced an
incentive scheme to motivate all the credit personnel.
Abbreviated financial statements
Balance sheet as at December 31 2013
Capital employed
(R million)
Owners’ equity
50
Long-term liabilities
150
200
Employment of capital
Fixed assets
Investments
Motor vehicles
Buildings
35
5
10
20
Current assets
295
Debtors
Stock
120
175
Current liabilities
Creditors
Bank
130
100
30
200
Income statement for the year ended December 31 2013 Sales
Cost of sales
Gross profit
Total expenses
Net profit
Included in the above:
Bad debts
Written off
Provision
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(R million)
700
500
200
150
50
30
20
10
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Business Management: A Contemporary Approach
Multiple choice questions:
1.
2.
3.
4.
What is Eeze Motor Spares’ current state of affairs on account receivables?
A. Too much money is tied up in accounts receivable.
B. The business is incurring high costs by maintaining accounts
receivable.
C. Further cost is incurred through the provision of bad debts.
D. The business’s accounts receivable is still manageable.
1.
A, B and C
2.
A, B and D
3.
A, C and D
4.
A, B, C and D
Which options are relevant concerning the responsibilities of John Bester
as the new credit manager at Eeeze Motor Spares?
A. He must ensure that credit granting and collection activities are
carried out in a way that contributes to attaining the department’s
objectives.
B. He has the authority to entrust his subordinates with responsibility
and to give them instructions.
C. He has to entrust certain tasks to subordinates so that he, as a
manager, can attend to those tasks that cannot be delegated.
D. The challenge is to evaluate risk and decide if a credit relationship is
possible between the creditor and the applicant.
1.
A, B and C
2.
A, B and D
3.
A, C and D
4.
A, B, C and D
Which of the following statements justifies the efforts Petrus and his
team are making with regards to the relationship between marketing and
credit management?
A. Credit management is not compensating for the efforts committed
by the marketing department.
B. The marketing department is not compensating for the efforts
committed by the credit management.
C. The work relationship between both departments is not on par with
each other.
D. The work relationship between both departments is on par with
each other.
Which of the following tools can John Bester use to increase the amount
of cash available to the organisation?
A. billing
B. collections
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Chapter Four – Credit Management
C.
D.
5.
disbursement policies
float
1.
A, B and C
2.
A, B and D
3.
A, C and D
4.
A, B, C and D
Which of the following types of benchmarking can John Bester use to
seek process performance information from outside one’s own industry?
A. generic benchmarking
B. functional benchmarking
C. internal benchmarking
D. competitive benchmarking
Critical-thinking questions
1.
2.
3.
4.
5.
One of the ways that Sandra Pearson, a regional credit manager, can
become more valuable to John and her employers and to elevate her status
is by involving herself in cash management and forecasting. Discuss how
a regional credit manager like Sandra Pearson can have a direct influence
on the Eeze Motor Spares cash flow.
Discuss the importance of debtor control at Eeze Motor Spares and give
your recommendations on how the business can control its debtors.
‘Account collection is all about getting paid.’ According to Barry14 collection
is the weakest function of credit management. No business can afford to
have large amounts owed to it for extended periods of time. Barry suggests
that prompt account collection is, therefore, crucial to the profitability of
a business. Discuss this statement and explain what advice you would give
James on how he can improve Eeze Motor Spares’ account collection.
Indicate how Eeze Motor Spares’ liquidity can be determined by the
quality of its debtors.
Sandra wants to set a plan of action, and asks you to send her a
memorandum and explain to her how she should manage her cash flow.
Write a memorandum to Sandra Pearson in which you explain:
„„
the three motives for holding cash that will enable her to maintain
her business’s level of cash;
„„
how she can manage Eeze Motor Spares’ cash cycle in five steps; and
„„
five important qualities that a credit manager like Sandra Pearson
should have.
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Business Management: A Contemporary Approach
References
1.
MT Cicero, Cicero’s Three Books of Offices, and Other Moral Duties: Also His
Cato Major, an Essay on Old Age; Laelius, an Essay on Friendship; Paradoxes;
Scipio’s Dream; and Letter to Quintus on the Duties of a Magistrate.
2.
MA Barry, Credit Management: the Key to Profitable Trading (West Sussex,
UK: John Wiley, 1997) p. 1.
3.
Charles Dickens, David Copperfield (1850).
4.
B Moolman, Research Project on Credit Management and Debt Control for the
City of Johannesburg, (Johannesburg: unpublished, 2002) pp. 5.
5.
ibid.
6.
Henry Mintzberg in S Crainer & D Dearlove, Financial Times Handbook of
Management, 2nd edition. (London: Prentice Hall, 2001) p. 481.
7.
PF Drucker, The Practice of Mangement (New York: HarperBusiness; Reissue
edition, 2006).
8.
C Van Zijl, Credit Management III (Florida, Gauteng: Print Production,
Technikon SA, 1999) p. 109.
9.
ibid., p. 114.
10. ibid.
11. G Michalski, ‘Portfolio Management Approach in Credit Decision
Making.’ Romanian Journal of Economic Forecasting 3 (2007): 42–53, p. 52.
12. Van Zijl, op. cit., p. 109.
13. ibid., pp. 117 & 118.
14. Barry, op. cit., p. 80.
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CHAPTER F I V E
Corporate Citizenship
Prof Neil Eccles, Stephen Nicholls and Prof Derick de Jongh
Learning objectives
When you have completed this chapter you should be able to:
„„ define corporate citizenship;
„„ define sustainable development and understand how corporate citizenship and
sustainable development are linked conceptually;
„„ critically consider the business case for corporate citizenship; and
„„ begin to design a business architecture for delivering corporate citizenship.
5.1 Introduction
Read any text on corporate citizenship and, nine times out of ten, you will
be left with an overwhelming sense of uncertainty. This is because corporate
citizenship is many things to many people, as suggested by the huge and evergrowing array of standards, codes and initiatives that currently exist (Table 5.1).
It is all a matter of perspective. Consider for a minute the clash of views that
would emerge if the chief executive of a multinational company and an antiglobalisation activist were put together in the same room with the mandate to
define corporate citizenship. It could get ugly.
The aim of this chapter is to keep this uncertainty to an absolute minimum.
With this in mind, a single perspective only is presented – the perspective
of business. This is, after all, a chapter in a business textbook. As a point
of departure, we propose accepting the following definition of corporate
citizenship:
‘Corporate citizenship is the contribution a company makes to society through its
core business activities, its social investment and philanthropic programmes, and its
engagement in public policy.’ (See Table 5.1.)1
In keeping with the aim of this chapter, the conceptual background section
in which this definition is elaborated upon is concise and focused. The
overwhelming emphasis is on the ‘why?’ and the ‘how to?’ of corporate
citizenship from a business perspective.
Fundamental to this business perspective, is that corporate citizenship
is core to business, and is therefore not an additional step to the business
planning and management methods discussed elsewhere in this book. It is
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Business Management: A Contemporary Approach
an overlay, or set of considerations, that must be considered in all aspects
of business. Furthermore, while the definition focuses on the contribution
of a company to society, we should not lose sight of the idea that a business
exists in a particular context, and the ability for a business to thrive depends
on the quality of the environment and the social and economic health of its
operating conditions. As a consequence, environmental, social and economic
issues can have a profound impact on a business. Consider labour unrest
that causes a multi-billion Rand refinery to shut down for one month in the
year. This could result in material loss to the business. The concept of a triple
bottom line is dead, or at least has served its purpose. The idea of a company
measuring its performance against separate social, environmental and
finance measures has been replaced by the fact that social, environmental
and economic factors could all independently and collectively impact the
bottom line. These ideas are captured in the concept of integration that you
will see throughout this chapter.
Table 5.1: Useful standards, codes and initiatives
Types
Examples of standards, codes and initiatives
Aspirational
Principles
„„ United Nations Global Compact – http://www.unglobalcompact.
org/
„„ United Nations Principles for Responsible Investment – www.unpri.
org
„„ Business for Social Responsibility – www.bsr.org
„„ Caux Round Table Principles for Business – www.cauxroundtable.
org
„„ CERES Principles – www.ceres.org
„„ Code of Good Practice on Key Aspects of HIV/AIDS –
„„ http://www.labour.gov.za/legislation/code_display.jsp?id=8195
„„ Equator Principles – http://www.equator-principles.com/
„„ Global Sullivan Principles – http://www.thesullivanfoundation.org/
gsp/default.asp
„„ Globally Responsible Leadership Initiative – http://www.efmd.org/
attachments/tmpl_1_art_051012qnis_att_051017tovb.pdf
„„ Ethical Trading Initiative – www.ethicaltrade.org
„„ World Economic Forum Global Corporate Citizenship Initiative –
www.weforum.org/corporatecitizenship
Codes of
Conduct
„„ Codes of Conduct for Multinationals – http://www.itcilo.it/english/
actrav/telearn/global/ilo/guide/main.htm
„„ Ethical Trading Initiative – http://www.ethicaltrade.org/
„„ OECD Guidelines for Multinational Enterprises -http://www.itcilo.it/
english/actrav/telearn/global/ilo/guide/oecd.htm
„„ OECD Principles of Corporate Governance – http://www.oecd.org/
dataoecd/32/18/31557724.pdf

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Chapter Five – Corporate Citizenship
Types
Examples of standards, codes and initiatives
„„ Kyoto Protocol – http://unfccc.int/resource/docs/convkp/kpeng.html
„„ SA 8000 – http://www.sa-intl.org/index.cfm?&stopRedirect=1
„„ Codes of Good practice for Broad-Based Black Economic
Empowerment – http://bee.sabinet.co.za/bee_regulatory.html
Certification
Standards
„„ ISO 9000 – www.iso9000.com
„„ ISO 14001 – http://www.iso14000-iso14001-environmentalmanagement.com/
„„ Ecocert – http://www.ecocert.com/
„„ Fairtrade – http://www.fairtrade.net/
„„ Wine Industry Ethical Trade Association – http://www.wieta.org.za/
„„ OHSAS 18001 – http://www.ohsas-18001-occupational-health-andsafety.com/
„„ Social Accountability International (SA 8000) – http://www.sa-intl.
org/
„„ Forest Stewardship Council – http://www.fsc.org
Investment
Screening
„„ Dow Jones Sustainability Index – http://www.sustainability-index.
com/
„„ Empowerdex – www.empowerdex.co.za
„„ FTSE4Good Index – http://www.ftse.com/Indices/FTSE4Good_
Index_Series/index.jsp
„„ JSE Socially Responsible Investment Index – www.jse.co.za
„„ Responsible Competitiveness Index – www.accountability21.net
Management
and
Reporting
Guidelines
„„ Global Reporting Initiative – www.globalreporting.org
„„ SIGMA Guidelines – www.projectsigma.com
„„ US Malcom Bridge Criteria for Performance Excellence – www.
quality.nist.gov
„„ King II Report on Corporate Governance 2002 – www.iodsa.co.za
„„ The Combined Code – http://www.fsa.gov.uk/pubs/ukla/
lr_comcode2003.pdf
„„ Sarbanes-Oxley Act of 2002 – http://www.sec.gov/about/laws/
soa2002.pdf
Assurance
Standards
„„ AA 1000 Assurance Standard – http://www.accountability21.net/
aa1000/default.asp
„„ AA 1000 Stakeholder Engagement Standard – http://www.
accountability21.net/aa1000/default.asp
„„ ISAE 3000 Assurance Standard – http://www.ifac.org/IAASB/
5.2 Conceptual background
So what is this thing called corporate citizenship? The World Economic Forum
definition has already been presented as a starting point. To understand how
this definition has evolved, however, it is useful to break the phrase ‘corporate
citizenship’ down into its elements.
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The corporate part is fairly simple. A corporation is a collection of people or other
legal entities that has a separate legal identity in its own right – technically, a
juristic person. As a legal entity, a corporation receives certain legal rights and
is bound by certain duties. In a nutshell, the five rights that are implicit for a
corporation are:
„„
„„
„„
„„
„„
the right to govern internal affairs;
the right to enter into contracts;
the right to hold assets;
the right to hire; and
the right to sue and be sued.
In the modern sense, these collectives are most frequently understood to be
engaged in business, and this is certainly the subset that this chapter focuses
on. In this context, modern business corporations generally have the following
additional characteristics, which essentially provide the platform for ownership.
The first is the notion of shares that are transferable. This means that the
membership of the corporation can change without affecting the existence of
the corporation as a legal entity. The second is the notion of perpetual succession,
which means that a corporation can continue despite the withdrawal of any of
its members. The final legal characteristic is the notion of limited liability, where
the responsibilities of the owners for the acts of the corporation are limited.
Clearly, this basic set of the rights and duties of a corporation is fairly
limited, particularly on the duties side of the equation. Because of this, the
idea was born of extending the legal notion of a corporation by binding it with
the rights and, perhaps more importantly, the responsibilities inherent in the
modern interpretation of citizenship.
Citizenship is simply membership of a community, which carries with it
certain rights and responsibilities. The notion of citizenship has a long history,
dating back at least to the ancient Greeks and probably even further. Any
concept that has developed over such a long history has inevitably seen many
formulations and even today, there is an almost infinite array of interpretations
of where the rights and responsibilities of citizenship begin and end. However,
inherent in just about any one of these is the notion of working towards the
betterment of one’s community through participation in efforts to improve
the lives of all fellow citizens. This is the spirit that advocates of corporate
citizenship have tried to advance.
What is needed to demonstrate this spirit has been formalised to some extent
through the development of the concept of sustainable development. Unlike
the concepts of the corporation and citizenship, the concept of sustainable
development has evolved over a period of decades, rather than millennia. It
really emerged out of the growing recognition that humanity had exhausted
all migratory options (on planet Earth, at any rate) to fulfil people’s present
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Chapter Five – Corporate Citizenship
and future needs. Essentially, humanity had expanded to the limits of the
planet, both in terms of the natural environment and society as a whole.
Despite the relative youth of this concept, there is fairly universal consensus
on its definition as articulated in the Brundland Report:
‘Development that meets the needs of the present without compromising the ability
of future generations to meet their own needs’2
Table 5.2: Global and South African corporate citizenship issues
„„ Corporate governance and ethics – appropriate board composition and
committees; ethical practices and risk management for financial and non-financial
issues
„„ Employment equity – equitable, non-discriminatory recruitment and employment
practices; set employment equity targets and measure progress
„„ Employee relations and support – progressive HR policies, fair labour practices
and workplace conditions; freedom of association, collective bargaining and a
rejection of child and forced labour
„„ Employee skills development – job-specific, vocational and broad-based training;
mentorship and career development programmes
„„ Health and safety – workplace conditions that ensure employees’ safety, health,
welfare and satisfaction
„„ Black ownership control – meaningful equity ownership and genuine participation
by black partners (South Africa specific)
„„ HIV and Aids – prevalence testing; prevention measures; clinical and medical
support; business risk and impact assessment
„„ Preferential procurement and enterprise support – financial and non-financial
support for emerging businesses by procuring services from them (in South Africa
the focus is on businesses owned by previously disadvantaged people)
„„ Supply chain compliance – extent to which the company ensures that supply
chain partners are themselves responsible corporate citizens
„„ Product development – products and services that address the needs of society,
especially previously underserved sectors or individuals
„„ Marketplace stewardship – responsible advertising and brand management,
monitoring and mitigating the impact of company’s products and services
„„ Corporate social investment (CSI) – investing in communities around operations
and in broader society
„„ Environmental impact of operations – protecting the environment, monitoring
and mitigating operational impacts beyond legislative compliance
„„ Climate change – the change in global weather patterns attributed to rising levels
of atmospheric carbon dioxide. The scientific consensus view currently is human
activities (such as fossil fuel burning) are contributing significantly to this
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Sustainable development embraces the centrality of social and environmental
issues in addition to financial issues in all human activities, including those
activities that had previously focused on the financial aspects only. Some of
the more generally applicable social and environmental issues are presented in
Table 5.2. Society, the environment and finance then become the three pillars
that are usually associated with corporate citizenship. It is important to note
that environmental, social and financial issues are impacted on by company
behaviour, but that they are also a primary determinant on the operating
context, and therefore also impact on the company. The glue that binds this all
together and provides the framework for resolving the almost inevitable tension
that will emerge between these three pillars is corporate governance (Figure 5.1).
Governance
Environmental
Social
Financial
Figure 5.1: The three pillars of corporate citizenship and the governance glue
Businesses are embedded in their economies (global, local, and often both)
and as a consequence businesses need to develop a strategic awareness of how
these economies are changing. Business’s impact on the environment and the
‘health’ of our society are often not priced into existing business models. These
unaccounted-for costs are referred to as externalities by economists. Globally,
country-level governments are looking to shift their economies towards
a ‘green economy’ that takes into account the true costs to society and the
environment. Through a variety of policy measures, governments are looking
to price these externalities into markets, and to incentivise different kinds of
production and consumption. The proposed carbon tax is just one example.
Many businesses are responding by recognising this as an opportunity, and
considering alternative business models and approaches to thinking about the
economy. Two examples worth exploring are the sharing economy3 and the
circular economy.
The circular economy and shared economy are both potentially innovative
approaches to economic efficiency. Each is concerned with the efficient use
of resources within the current take, make and dispose nature of modern
supply chains. The circular economy seeks to create resource feedback loops
where waste products of one process become inputs of another process (this is
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Chapter Five – Corporate Citizenship
often referred to as industrial symbiosis). This may require changes in business
models, for example where we lease certain goods rather than buying them,
as we seek to use resources differently. The shared economy acknowledges that
certain products or services can be provided to multiple users alleviating the
need for every individual to own that item or receive that service. For example,
car sharing services like ZipCar (www.zipcar.com) or accommodation sharing
like AirB&B (www.airbnb.com). Both systems mean less resources would be
needed in the overall economy.
Effectively, businesses must question their role in society. The rising
consensus to this question is that they cannot operate independently of their
context when the hard lines between business, labour, government and civil
society stakeholders are becoming blurred.
One final concept needs to be elaborated on before proceeding to the main
substance of this chapter – the concept of globalisation. More and more frequently,
business corporations operate in many jurisdictions. In other words, they are
‘citizens’ of multiple domains. And where it comes to responsibilities, the devil
is definitely in the detail. Inevitably, certain domains are strict, others more
lax. This variation has been used very effectively by business corporations
to avoid responsibilities. Thus, while complying with the letter of citizenship
requirements, these organisations are perhaps not really complying with the
spirit. (See Chapter 9 for more information in this area.)
In summary then, corporate citizenship can be defined as ‘the contribution
a company makes to society through its core business activities, its social
investment and philanthropic programmes, and its engagement in public
policy.’4 Fundamental to this definition is that corporate citizenship is included
into the core business, and is not limited to philanthropic efforts.
5.3 The business case for corporate citizenship
It was stated in the introduction that the aim of this chapter is to present a view
of corporate citizenship from the perspective of business. With this in mind,
the focus of this section is to attempt to answer the question: ‘Why should a
business consider embracing the concept of corporate citizenship?’
After all, it is clear from the above discussion that this is a framework that
has evolved out of the desire to expand the responsibilities of businesses. It is
also safe to assume that executing additional responsibilities will more often
than not make doing business more difficult. So it’s a good question and one
that is frequently asked.
To get to the real root of this, though, it is useful to step back a little and
consider why a business would do anything at all. For example, why would a
business produce widgets in China and then ship them half way around the
world to sell in the US? Why would a business sell widgets, rather than widget
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Business Management: A Contemporary Approach
integration consulting services? The list of similar questions is endless. There
are probably lots of general theories to explain this, but arguably the most
commonly held contemporary view (from within business, at any rate) is that a
business ultimately does what it does in order to generate profits for its owners.
In other words, it takes risks in order to realise returns. It is possible that some
readers of this text may view this as a somewhat hard-line position. This is,
after all, essentially the line taken by Milton Friedman5, a central advocate of
a business hard line. However, adopting a softer position would only make any
discussion of the business case vulnerable to criticism from the hard line.
Besides wanting to avoid attack from the hard line, this paradigm also
provides a very useful and simple framework for thinking about the business
case (see Figure 5.2). Basically, this says that profit is the difference between
how much money a company gets in (revenue) and how much money goes out
(costs). In order to increase profits, a business can either do things to increase
revenue or, alternatively, do things to reduce costs.
Revenue
Profit
Base cost
Cost
Cost of CC
Figure 5.2: The profit equation: why business would do anything
Expanding this model slightly to take into consideration what we already
know about corporate citizenship, it is appropriate at the outset to include
the cost of corporate citizenship onto the cost side of the model. So, on the
surface, some might then argue that a corporate citizenship programme
is likely to be at odds with the common purpose of business to generate
profits before we even begin. However, this is obviously a naïve view. After
all, buying a machine to manufacture widgets more effectively would also
add to the costs. However, this cost would be offset elsewhere in the profit
equation. The same might be said for a well-thought-out corporate citizenship
programme.
With this general framework for considering the business case of corporate
citizenship, it is now possible to consider or evaluate the usual reasons that
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Chapter Five – Corporate Citizenship
have been advanced for why businesses should consider embracing corporate
citizenship. Complex discussions aside, there are basically three reasons:
„„
„„
„„
they believe it’s the right thing to do;
they are forced to; or
they can protect or increase their profitability by doing so.
„„
They believe it’s the right thing to do:
In itself, this reason in no way speaks to the business framework (the profit
equation) just discussed. Essentially, it suggests that because of some sort of
voluntary moral position held by the individual owners, they would collectively
be prepared to incur the almost inevitable cost of the corporate citizenship
programme without any promise of this cost being offset. Clearly, this line of
reasoning is very vulnerable to criticism from business hardliners. In fact, the
vulnerability of this rationale to criticisms, and the fact that it is often the first
reason advanced, has frequently been used by hardliners to simply abandon
further thought of corporate citizenship as a legitimate dimension of business.
Not everyone in business, of course, is a hardliner. In fact, most individuals
will have certain moral views that they will put before profit. However, unless
the individual moral position becomes a consensus view held by the majority
of owners, it is unlikely to be a sustainable reason for the collective action
towards a corporate citizenship programme. In the short term, a charismatic
leader who holds a moral view might be able to drive the programme. However,
charismatic business leaders eventually retire, and without their leadership,
programmes will inevitably collapse. Once an individual moral position
becomes a consensus view, on the other hand, it moves into the dimension of
being a law of sorts – the ‘rules of the game’, if you like. At this point, it really
falls within the ‘they are forced to do it’ line of reasoning, rather than ‘they
believe it’s the right thing to do’.
So, while discounting this ethical/moral motivation for pursuing a corporate
citizenship programme is not likely to be popular with a large contingency of
citizens outside of the business perspective, we do it secure in the knowledge
that there is more than enough of a business case to be made within the
general paradigm of business as a profit-generating entity. This is not to say
that some companies in some situations do not do things because they seem
like the right thing to do. It just means that this response is not guaranteed by
the essence of what business, in today’s formulation, is all about.
„„
They are forced to:
This reason is far more compelling than the previous from the perspective of
the profit paradigm outlined above. The basic feature here is that there are
certain rules or laws that insist on elements of corporate citizenship, and that
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Business Management: A Contemporary Approach
there is some external regulatory agent that is able to force the business to
comply with these rules irrespective of any impact on profitability. Strictly
speaking, these agents do not pull revenue or cost levers, they simply say, ‘do it,
or else’. The implication is that they can ultimately revoke the business’s licence
to generate profit if there is non-compliance.
The most obvious examples of this type of driver would be:
ˆˆ
ˆˆ
ˆˆ
local or national legal systems that are mediated by the machinery of
government;
international legal systems that are generally mediated by transnational
bodies in collaboration with national governments; and
religious legal systems, where the ultimate external regulatory agent is a
god.
Whether the form of censure for non-compliance is explicit or implicit,
the effect is the same. Business has no choice but to comply within the
jurisdiction of the regulatory agent. From this point of view, a god as a
regulatory agent is particularly powerful since gods are generally believed to
be omnipresent.
For this very same reason, local and national legal systems and, in particular,
the variations between them, have presented business with a wonderful
opportunity to avoid the costs of corporate citizenship by simply moving
operations to countries or zones where the rules are lax, or the regulatory agent
is weak or corruptible. This is an inherent risk when operating on a global
scale (refer to the concept of globalisation discussed in section 5.2). Ostensibly,
international legal systems are evolving to cope with this situation but these
have, unfortunately, proved to be fairly ineffective to date.
„„
They can protect or increase their profitability by doing so
And so we come to the very heart of the business case – where the corporate
citizenship costs are offset elsewhere in the profit equation. Technically, the
above reason (they are forced to do so) is an extreme case of this. The corporate
citizenship cost is essentially offset against the fundamental licence to generate
profit. Besides this, though, a large and ever-growing array of opportunities
exist to offset the corporate citizenship cost in the profit equations through
either cost or revenue levers. On the cost side, some of the more commonly
cited levers include:
ˆˆ
ˆˆ
ˆˆ
ˆˆ
ˆˆ
avoidance of fines;
avoidance of legal costs;
efficient use of resources, eg reduced energy or paper bills;
alternative raw material sources, eg recycled materials;
reduced recruiting costs;
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Chapter Five – Corporate Citizenship
ˆˆ
ˆˆ
ˆˆ
ˆˆ
reduced travel costs through telecommuting;
enhanced productivity (through lower absenteeism and happier
employees who spend less time in traffic);
increased staff retention; and
reduced cost of capital driven by the global surge in ‘responsible
investment’6
On the revenue side, common levers might include:
ˆˆ
ˆˆ
ˆˆ
ˆˆ
ˆˆ
new products or services, eg carbon trading; 3D printing; low emission
vehicles;
growing a market for services, eg through general programmes, such as
job creation or social upliftment, or more specific interventions, such as
bridging the digital divide;
improving access to markets, eg government procurement;
avoidance of boycotts; and
corporate citizenship premium – the premium clients might be prepared
to pay for good corporate citizenship.
5.3.1 Time and the business case
This simplistic profit model presented is grounded in the value-based
management paradigm.7 A critical consideration of this approach is the need
to take a long-term view, and to manage the balance sheet. In other words, time
is a critical variable in the definition of a business case or value proposition.
Some of the levers described above are likely to yield immediate returns. For
example, increased resource use efficiency is likely to have an immediate
impact on the cost of operations. Others are only likely to yield returns in
the medium to long term. For example, growing the market for services
through job creation is likely to yield return over the much longer term. This
distinction has led some commentators in the corporate citizenship arena
to draw a distinction between a traditional business case, which focuses on
short-term costs and benefits, and the strategic business case that focuses on
longer-term returns. Clearly, balancing the need to show short-term returns
with the need to ensure long-term financial sustainability of a company
is a central challenge facing directors of all companies when making any
investment decision. This is not restricted to corporate citizenship. Sound
decisions can only be made if there is a thorough understanding of the
opportunities and risks, and how these relate to the general framework for a
business case described above.
To drive home the case for considering a wider scope of issues we refer you
to the World Economic Forum Global Risks report released in Davos each year
in January. The 2014 report lists the top 10 risks facing the global economy as:
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Business Management: A Contemporary Approach
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
fiscal crises in key economies;
structurally high unemployment/underemployment;
water crises;
severe economic disparity;
failure of climate change mitigation and adaptation;
greater incidence of extreme weather events;
global governance failures;
food crises;
failure of a major financial mechanism/institution; and
profound political and social instability.
5.3.2 Conclusion
To conclude this section, what we have done here is present a framework for
thinking about the business case for pursuing corporate citizenship. We have
not presented a generalised, universally applicable business case for pursuing
corporate citizenship. Such a case does not exist. Ultimately, the business case
or value proposition will vary from business to business, and context to context.
However, there is a universal business case for at least investing in exploring the
opportunities and risks that corporate citizenship might present, recognising
that individual businesses are embedded in their context.
5.4 Corporate citizenship architecture
Having discussed why a business should at least consider embarking on a
corporate citizenship programme, we now come to the question of what is
required to establish and sustain a successful corporate citizenship programme
– in other words, the ‘how to’ of corporate citizenship. In essence, a successful
corporate citizenship programme will have all the elements that any other
business programmes might have. This is where true integration happens.
To successfully incorporate corporate citizenship thinking you need to
consider non-financial issues in all aspects of business, and you need to
manage the organisation to accept this new way of thinking (often referred
to as transformational change management). The following sections therefore
highlight specific corporate citizenship considerations within a business
management framework that should already be largely familiar to you, and is
really an expounding of the classic MBA Plan, Do, Check, Act cycle.
The framework presented in this chapter (see figure 5.3) contains seven
key elements. Two of these – leadership and governance, and stakeholder
engagement – are transversal elements. They provide input into and receive
feedback out of all the process stages of the programme. The remaining five
elements (planning, establishment, managing, reporting and assurance) are
really stages in a process. What is critically important is that, while this process
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Chapter Five – Corporate Citizenship
is presented linearly in the graphical representation, the imperative for a truly
successful corporate citizenship programme to be a learning process means
that such a process will in fact be iterative. Feedback and adjustment between
the process steps is mediated by the transversal elements.
Leadership & governance
Stakeholder engagement
Reporting
Planning
Establishment
Managing
Assurance
Figure 5.3: A corporate citizenship framework
5.4.1 Leadership and governance
The old cliché goes, ‘a journey of a thousand miles begins with the first step’.
Actually, it begins with the decision to take the first step, and is more often
than not sustained through troughs of despair by grim determination. In the
context of a corporation (which, as discussed, is a collective of people) this is
where leadership enters the equation. In essence, for any corporate citizenship
programme to get off the ground, leaders within the corporation must either
believe in the business case, or at the very least, believe that the business case
is worth further investigation. This is necessary to mobilise the resources that
will inevitably be needed for the programme and give credibility to it. What is
more, true leadership cannot come from middle management alone. It must be
driven by top-level executives and the board.
In contrast with leadership, for which there is no real recipe, governance as a
discipline is far more systematised or mechanical. Simply speaking, corporate
governance is the practice by which companies are managed and controlled.
We have also seen that it is the essential glue that is needed to ensure that a
company is able to balance the often conflicting demands of environmental,
social and financial dimensions of business activities (see figure 5.1). There are
numerous frameworks, processes and systems available. Many of these apply
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Business Management: A Contemporary Approach
at national level (eg The Combined Code in the UK; Sarbanes Oxley in the US;
King III in South Africa), although some are more global in reach (eg OECD
Principles of Corporate Governance (see table 5.1)). What is more, the business
management literature is peppered with examples of best and worst practice.
Best corporate governance practice applies to corporate citizenship in exactly
the same way as it does to any other dimension of corporate activity. However,
a number of elements of corporate governance deserve specific comment in
the context of a corporate citizenship programme.
5.4.1.1 The board and board responsibilities
We have already emphasised the fact that a successful corporate citizenship
programme is fundamentally dependent on commitment at the top. Indeed,
the most successful corporate citizenship programmes are always those where
this top-level leadership is translated into specific board-level structures (such
as a corporate citizenship committee), which has specific responsibility for
issues of corporate citizenship. It also stands to reason that, in order for a
director or a committee to fulfil their responsibilities, they need to have a clear
understanding of corporate citizenship. For this reason, inclusion of corporate
citizenship into director induction programmes is crucial.
In some jurisdictions the governance responsibility to consider non-financial
issues is mandated by law. For example, in South Africa the Companies Act
requires the establishment of a board sub-committee on social and ethics that
considers the broad principles of sustainability and corporate citizenship in
board planning. It also makes provision for prosecution of individual board
members for the negligent treatment of the environment and society with
the first cases of individual directors receiving significant fines and jail terms
recorded in early 2014.
5.4.1.2 Risk management and internal control
Risk management and internal control are at the very heart of all corporate
governance practices. In fact, many of the elements of the corporate citizenship
framework that we go on to discuss are all about the management of risks (and
value opportunities) and the internal control systems by which business activities
are managed. What is important to establish at this level of the discussion, is
that corporate citizenship must ideally be embedded into the company’s core
risk management and internal control systems, and not managed as a sideshow.
5.4.1.3 Ethics, values and policies
In describing the business case for corporate citizenship, we took what would
probably be considered a fairly hard-line position on the business of business.
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Chapter Five – Corporate Citizenship
One might be led to conclude that, within this context, the place for values and
ethics might be somewhat limited. However, this is not the case at all. Firstly,
there are certain basic principles of business that even the most inveterate
hardliner would embrace as essential. For example, Friedman8 emphasised the
importance of free and fair competition and an absence of fraud. Other principles
that are commonly articulated would inevitably include discipline, transparency,
accountability and responsibility. These in themselves form a pretty strong basis
for a code of ethics, or the definition of a set of corporate values.
In addition to these basic business principles, however, once the business case
for considering broader issues (which might include social and environmental
ones) has been established, a key mechanism to ensure that these issues are
acted upon in a consistent manner is to write them into corporate ethical
codes and corporate values, and to transcribe them into formal policies.
5.4.1.4 Stakeholder governance
As the second transversal element of a corporate citizenship framework,
stakeholder engagement is certainly central to a corporate citizenship
programme. This is so much so that many proponents have attributed to it the
central status. However, some caution is needed when considering stakeholder
engagement and the governance of that engagement process. At the end of
the day, a company cannot be all things to all stakeholders. Companies must
obviously apply common sense and judgement to the demands of stakeholders,
and this common sense should ultimately emit from the leadership and
governance transversal element of the programme.
5.4.1.5 Strategy and opportunity
The King Code on Corporate Governance, 20099 states that ‘the board should
appreciate that strategy, risk, performance and sustainability are inseparable.’ The
implication being that sustainability thinking should be incorporated into all
aspects of strategy, risk, and performance. Strategy is a primary responsibility of the
board, and no strategy could be conceived of without thinking about the broader
operating context of the business, and how this context can lead to opportunities
for revenue enhancement. We refer the reader to the United Nations Global
Compact CEO survey of 2013.10 Contemporary CEOs consider their internal
and external operating context – thinking about social, environmental and
broad economic issues – and have concluded that the challenges of establishing
sustainable economies (globally and locally) cannot be done by each stakeholder
operating independently. This is echoed by international business bodies like the
World Business Council for Sustainable Development in launching their Action
2020 programme, the aim of which is to recommend sustainable solutions to
government and actively partner to deliver them.
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Business Management: A Contemporary Approach
5.4.2 Stakeholder engagement
Stakeholder engagement is the second transversal element in our framework for
corporate citizenship. The conventional wisdom behind stakeholder engagement
is that it is a crucial mechanism by which a company understands and relates to
its external and internal social context (Figure 5.4). This understanding is central
to the development of a business plan as we discuss in Section 5.4.3.
Shareholders
Investment
community
Customers
Employees &
contractors
Unions
The corporation
Business
partners
Local
communities
Media
NGOs &
civil society
Government
Figure 5.4: Stakeholders – the usual suspects
The basic steps in a stakeholder engagement process are illustrated in the
following simple process flow (see Figure 5.5):
Identify impact
ON
corporation
Identify &
characterise
stakeholders
Test
materiality
Define
engagement
approaches
Prioritise
issues
Identify impact
OF
corporation
Figure 5.5: Basic stakeholder engagement steps
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Figure 5.6: Stakeholder characterisation inventory
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Business Management: A Contemporary Approach
These feed into the planning stage of the corporate citizenship framework
(Figure 5.3). Most of these steps are fairly self-explanatory and really need
no elaboration. It is quite easy to visualise this process being translated
into a management information system. For example, it is easy to build
a stakeholder characterisation inventory, as illustrated in Figure 5.6, to
support the first step in the process. Similar inventories for impacts and
issues can easily be conceived, and engagement approaches can be managed
by extending the traditional customer relationship management (CRM)
systems of a business.
The range of engagement approaches available is relatively limited. For
example, the International Association for Public Participation has published
a list of about 50 possible engagement techniques in their Public Participation
Toolbox. Materiality and prioritisation, however, require some elaboration.
5.4.2.1
Materiality and prioritisation
We have already drawn attention to the link between governance and
stakeholder engagement, and emphasised the importance of applying
judgement and common sense to stakeholders and stakeholder expectations.
It is through prioritisation and the concept of materiality that this judgement
can best be executed. The first port of call in prioritisation is more often than
not to prioritise stakeholders themselves. With one or two notable exceptions,
the conventional corporate view on stakeholder priority would be something
like this:
1. Shareholders
2. Shareholders
.
.
.
.
50. Shareholders
51. Senior executives
52. Clients
53. Suppliers
54. Management
55. Employees
56. Other stakeholders
In terms of the notable exceptions, senior executives have frequently abused
their positions of power to place their interests ahead of all others. This is
commonly referred to as the ‘agency problem’. It is really a corporate governance
issue and has been at the centre of many of the major corporate scandals (eg
Enron in the US, or Fidentia in South Africa). Another exception might well
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Chapter Five – Corporate Citizenship
be government as a stakeholder. Clearly, government is one stakeholder that
has the power to play the ‘they are forced to’ card through its ultimate control
over licence to operate.
These exceptions aside, shareholders are widely acknowledged as being the
highest priority stakeholders. This relates directly back to our earlier discussion
in Section 5.3 on how business defines itself: ‘a business ultimately does what
it does in order to generate profits for its owners’. It is important to remember,
though, that the general groups of stakeholders presented in Figure 5.4 are
unlikely to be mutually exclusive. In particular, employees, governments,
unions and the man on the street are all very likely to be represented in the
shareholder group through a variety of collective investment vehicles, most
notably pension funds. Furthermore, although previously disadvantaged
groups traditionally may not have been aware of their ownership rights as
shareholders, this situation is changing. This is evident in the growing levels
of shareholder activism.
The basic point here is that no stakeholder group can be discounted out
of hand, and perhaps it is more prudent to focus on prioritisation of issues
and impacts based on the materiality of these to the company or on the
materiality of the broader social response to these, rather than to focus
on priority stakeholders (usually shareholders) only. Here, material issues
are issues that are likely to have an influence on financial assessments or
decision making.
For example, the recent social and labour unrest in South Africa is having
a material impact on business. In order for business to effectively manage this
risk they would need to take into account the way they treat their labour force,
but also the communities around their operations. They would also have to
consider the socio-economic context of those communities and the quality of
their interaction with other stakeholders (including local government). Were
companies to simply focus on the employee as a stakeholder, they may miss
the inherent risk in the system.
5.4.3 Planning
Planning is about figuring out how things are currently, deciding how they
should be, and mapping the path to this new state. It is a stage of strategy
formulation and the stage at which the value proposition of the corporate
citizenship programme should be defined. The three main steps are:
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diagnosing;
defining a direction; and
defining an operating strategy and architecture.
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5.4.3.1 Diagnosis
Ideally, this step can be carried out using the same tools that would be used
by businesses to evaluate their competitive context.11 In general, these involve
developing a clear understanding of the business’s context, from both an
internal and an external perspective. Clearly, this contextual understanding is
likely to emerge out of the leadership and governance element of our framework
interrogating the outcomes of stakeholder engagement activities.
Ultimately, this evaluation of context provides an inventory of opportunities
and risks. These opportunities and risks are then prioritised, ideally with
reference to a value-based framework, such as the one presented above (see
Section 5.3) for evaluating the corporate citizenship-business case. As already
mentioned, it is important to emphasise that, although the major elements
in our framework are presented in a linear fashion, in a healthy business this
should be an ongoing, iterative activity. This implies setting up a corporate
citizenship radar to facilitate ongoing re-evaluation of the business context
and, where necessary, a re-prioritisation of risks and opportunities.
5.4.3.2 Defining a direction
Having identified and prioritised opportunities and risks, the next step is to try
and figure out where the company might want to go in relation to these. What
is important to realise is that this is not a woolly activity. On the contrary, the
key word is here is ‘defining’. In relation to prioritised opportunities and risks,
the company needs to define specific goals and expectations. These goals and
expectations need to be associated with specific measures or metrics. And for
each measure, specific targets need to be defined.
5.4.3.3 Defining operating strategy and architecture
With the desired end state specified, the last step in the planning phase is to
design what it will take to get to this end state. There are really two parts to this.
The first of these is to develop a list of the specific activities and projects that
will be required, in other words, to develop a project inventory. Once again,
it is important to emphasise that, whilst this step is presented as part of an
apparently linear process that follows defining the direction, it is unlikely that
a team thinking about the targets will not already have given some significant
thought to projects to achieve these. This step then represents a formalisation
of this thinking rather than a completely new step.
The second part is really to plan the ‘who?’ of the programme. Defining
the ‘who?’, however, is not limited to allocating projects to people. It involves
designing everything that will be needed to support them. There are at
least four dimensions to this. Firstly, there are the people themselves. At an
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Chapter Five – Corporate Citizenship
individual level these people will require specific skills. They will need to be
placed within an organisation of other people, and the whole organisation
will be imbued with a particular culture. Secondly, there will be policies and
processes that will dictate how the people will go about their activities. Thirdly,
there will be systems that are necessary to support these activities. These
might include things such as communication systems, information systems or
knowledge management systems. Finally, there are the physical infrastructure
and facilities that these people will need.
Effectively a company should investigate the impacts of corporate citizenship
on its strategy and may end up making no changes. However, many companies
are led to reformulate their strategy, and must therefore think carefully about
the business model and how they organise themselves as well. It is important
that this process is overseen by the most senior people in the company
(leadership).
5.4.4 Establishment
Establishment is a very mechanical response to the strategy and architecture
defined in the planning phase. During this phase, the systems are rolled
out and the infrastructure and facilities are procured. Once this supporting
environment is set up, the necessary people are either deployed if they already
exist within the company, or alternatively are recruited. A fundamental aspect to
any organisational transformation is orientation and training (transformational
change management).
5.4.5 Managing
In general, the managing phase is all about monitoring progress towards the
delivery of the value-creating projects specified in the planning phase, and
removal of any impediments (in the form of issues or risks) to the achievement
of goals or targets. Issues and risks may arise from within the programme
architecture, from within the wider business, and even from the external
context. Given the iterative nature of a corporate citizenship programme as
discussed in the introduction to this section (see Section 5.4), the managing
phase may also involve returning projects to the planning phase if the issues
are insurmountable.
5.4.6 Reporting
There’s an old adage, ‘begin with the end in sight’ – and there can hardly be
any business discipline where this has been more avidly applied than in the
area of corporate citizenship. That is, at any rate, if the end is the corporate
citizenship report. This has been driven by two things at least. The first is the
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Business Management: A Contemporary Approach
overwhelming emphasis that corporates have placed on corporate citizenship
as a tool for reputation management. Presenting a polished report on corporate
citizenship is relatively easy to do, and it can be the difference between a good
reputation and an average-to-poor one.
The second reason is that reporting frameworks and, in particular, the Global
Reporting Initiative (GRI) (see Table 5.1), have presented corporates with a tangible
structure onto which they can anchor their corporate citizenship programmes.
We spoke about the uncertainty inherent in corporate citizenship literature and,
in this sea of uncertainty the GRI has presented something to tie up against.
Of course, this framework-ised approach has had its pros and cons. Certainly,
it was very helpful in getting companies started on a reasonably solid track
and in facilitating some level of reporting consistency between companies.
However, all too often, an obsession with reporting frameworks led corporates
down the path of blind compliance and box ticking.
5.4.6.1
Integrated reporting
Of course, reporting frameworks can never be a satisfactory substitute for
thinking (leadership and governance) and planning. Enter the latest trend
in reporting: integrated reporting. This is the logical extension of integrating
corporate citizenship within business thinking.
Until very recently, there were really no guidelines for how to actually
do integrated reporting. There was just a mythical notion that it might be
a good idea if the various strands of corporate reporting became integrated.
This however changed late in 2013 with the publication of The International
<IR> Framework by the International Integrated Reporting Council (IIRC).12 In
addition to providing some conceptual background to integrated reporting,
the framework presents seven guiding principles as well as eight content
elements. The guiding principles are:
A.
B.
C.
D.
E.
F.
G.
strategic focus and future orientation;
connectivity of information;
stakeholder relationships;
materiality;
conciseness;
reliability and completeness; and
consistency and comparability.
Some of these don’t really add anything new. The place of stakeholder
relationships (C) in defining the corporate citizenship activities was always
something we liked to see. And conciseness (E), reliability and completeness (F)
and consistency and comparability (G) were really principles that would have
been at least implicit elements in previous reporting expectations.
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Chapter Five – Corporate Citizenship
It is principles (A) strategic focus and future orientation; (B) connectivity of
information; and (D) materiality that contain the essential improvements
associated with integrated reporting over earlier corporate citizenship reporting
notions. Principles (A) and (B) capture the fact that integrated reporting is a
corporate reporting approach that attempts to dissolve any distinction between
a company’s corporate citizenship reporting, and its financial reporting;
between its sustainability report and its annual financial statements.
Principle (D), better than any other, really explains the reasoning behind this.
The emphasis on materiality really puts our discussion on the business case for
corporate citizenship at centre stage. It is the recognition that corporate citizenship
activities may significantly (materially) impact on the ability of a business to do
its business that should drive a company to react. And if a corporate citizenship
programme is a reaction to an imperative, then it stands to reason that it should
be reported on alongside other imperatives in an integrated fashion.
5.4.6.2
A word on performance reporting
This is really a word of caution. With its emphasis on future orientation,
principle (A), the IIRC’s integrated reporting principles might be interpreted as
suggesting a relegation of reporting on performance. If taken to the extreme,
this would represent a grave error. A complete report on a company’s corporate
citizenship activities must contain a robust report on past performance in
precisely the same way as a company’s annual report would be naked without
the financial statements and notes.
The key to reconciling the principle of future orientation with the essential
job of reporting on past performance is target setting. We saw under the
description of the planning phase of our corporate citizenship framework
(Figure 5.3) how targets would emerge as a specific outcome associated with
defining the future direction. Targets represent a very precise specification of
a future orientation.
In this regard, the first thing a performance report must present is the original
targets set. Ideally, it should be possible to trace these from one reporting cycle
to the next. However, priorities may shift within a reporting period and with
these shifts, targets are likely to change. The reasons for any variation between
the original targets and the final reported targets must be clearly explained.
Once the original targets and any variance between these and the reported
targets have been presented, the actual progress against the priority targets
must be presented. In presenting performance against targets it is also very
useful to present benchmarks. These may be external benchmarks (eg sector
average performance), internal benchmarking across operation division or
facilities, or prior internal performance to show the period-on-period change.
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The last word on integrated reporting – the tail wagging the dog
When we introduced this section on reporting, one of the first things that
we emphasised was the role that corporate citizenship reporting has played
in shaping corporate citizenship thinking and action. In many instances it
seems as though the tail of reporting has frequently been wagging the dog
of corporate citizenship. Integrated reporting in general, and certainly the
integrated reporting envisaged in the IIRC’s integrated reporting framework,
seeks to take this to another level altogether. The reporting that is envisaged
could only emerge out of:
„„
„„
„„
an integrated business philosophy held by business leaders;
governance that is integrated; and
management actions that were constructed with integration in mind.
5.4.7 Assurance
Reporting is about building trust. You are trying to provide information to
your stakeholders that will allow them to make effective decisions. The greater
the level of stakeholder trust in your organisation’s processes and data, the
greater the level of comfort they will have in making those decisions. In order
to reinforce this decision process many companies seek assurance, effectively
increasing the credibility of their publically reported information.
In the broadest sense, assurance is the sum of all the steps taken to increase
confidence in the reported performance of an organisation. In our linear
presentation of the corporate citizenship framework (Figure 5.3), this step
goes hand in hand with reporting, and ought to provide an indication of
the overall quality of the entire corporate citizenship programme, namely
leadership and governance, stakeholder engagement, planning, establishment,
managing and reporting. Clearly, there is a spectrum of activities that can
contribute to increasing confidence in reported performance. These might
include describing the processes that contributed to the performance; not
presenting a greenwashed glowing report; the use of external benchmarks;
and the inclusion of honest external commentary (both positive and negative).
However, the ultimate step in providing an indication of confidence must be
the audit process and the assurance report, so this is focus of this section.
As board awareness of the materiality of sustainability and climate change
issues increases, so the complexity and cost of management responses also
increases. As a consequence, management committees place a greater level of
reliance (trust) on the data they are using to make decisions. Assurance therefore
provides an additional level of comfort to internal decision makers and allows
them to better understand how to effectively mitigate against identified risks.
As a consequence, the outputs of a good assurance process should support
two objectives. One is to give comfort to your external stakeholders, and
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Chapter Five – Corporate Citizenship
the other is to support internal decision making. The physical outputs are
twofold – an assurance opinion to be inserted into the integrated report that
provides comfort to stakeholders; and a management report that identifies
areas of accounting and reporting weaknesses allowing annual, incremental
improvement in company processes.
Assurance can and should be provided by two parties, the internal audit
department and an external and independent assurance provider. The internal
audit team, who are employees of the company, are referred to as 1st party
and the external, independent provider is referred to as 3rd party. The external
provider must be independent, or one could debate their status as truly external.
Typically 3rd-party assurance is only conducted once a year, and the benefit
to the company accrues through the additional comfort provided to their
stakeholders from someone who has no interest in the organisation confirming
that their data and processes are correct. Furthermore, management will
benefit from the 3rd-party assurance provider when they share experiences
from similar organisations as well as their wide experience within other sectors.
However, because 3rd-party assurance is often only conducted once a year,
its support of decision making is limited. Furthermore, a 3rd-party assurance
provider will only find errors long after they have been made, and where that
information may have already been used to make a specific decision.
In this context 1st-party assurance brings a lot of value. It allows you to
monitor controls and data gathering throughout the year, and pick up errors
early. Decisions are therefore based on more reliable data when they are made.
An especially important consideration is that an effective implementation of
3rd-party assurance can rely on the work of an internal audit with a potentially
positive impact on 3rd-party assurance costs.
5.4.7.1
The assurance opinion
The assurance opinion is the ultimate deliverable of an audit and assurance
process. It must contain a clear description of the parties involved as described
above. It must also contain a clear description of the scope of assurance,
including the rationale for this scope. It should then describe the work done by
the assurance provider to enable them to provide a statement of confidence, as
well as how they are qualified to deliver the work. Finally, it is also valuable to
include specific recommendations for improvement.
5.4.7.2
Standards
No discussion of assurance would be complete without a mention of assurance
standards (see Table 5.1). In terms of assuring corporate citizenship programmes,
there are essentially two globally recognised standards. These are:
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„„
„„
the ISAE 3000 and ISAE 3402 standards, issued by the International
Auditing and Assurance Standards Board; and
the AA1000 standard, issued by AccountAbility.
Both provide basic assurance principles and essential procedures to ensure that
assurance engagements are conducted in a systematic and consistent manner.
The AA1000 standard, however, places a particularly strong emphasis on the
stakeholder perspective. It, therefore, emphasises particular aspects of the
principles of completeness and materiality, and also introduces the principle of
responsiveness.
In addition to these assurance standards, a large number of certification
systems also contribute to the overall assurance picture. They range from
certification standards that apply to management systems (eg ISO 14001),
right through to industry-specific standards (eg Forest Stewardship Council).
In general, they all involve some sort of external verification and, as such,
contribute to the level of confidence that a stakeholder might place in a
corporate citizenship programme.
5.4.7.3 Warnings
Finally, some warnings for the drafter or the reader of an assurance report. The
first warning is that simply including an external assurance report does not in
itself provide an indication that a great deal of confidence can be given to the
programme. The devil is in the detail, and the reader should always be on the
lookout for indemnification, limited scope, competence, lack of independence,
or a faulty audit process.
In this sense, assurance is far more than simply an independent assurance
statement at the back of the corporate citizenship report. True assurance
comes from understanding policy frameworks, internal control and technical
processes underpinning the performance. Very often, taking the time to
explain these may go further towards providing assurance than a two-page
assurance statement at the back of a report.
5.5 Summary
The three major aspects of corporate citizenship are:
„„
„„
„„
the conceptual background;
the ‘why do it?’; and
the basic elements of ‘how to do it’.
In terms of the conceptual background, key concepts were defined associated
with corporate citizenship, including the corporation, citizenship and
sustainable development. The narrative briefly touched on the concept of
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CHAPTER S I X
Information Management
Prof Edmund Ferreira
Learning objectives
When you have completed this chapter you should be able to:
„„
„„
„„
„„
„„
„„
„„
„„
„„
„„
„„
„„
discuss the role of information management in a business;
discuss the information function;
discuss the objectives of the information manager;
discuss the information needs of the business;
discuss the information needs of external role players;
discuss the relationship between the information function and the other functions
in a business;
discuss the records management sub process;
explain the systems approach in a business by making use of examples;
list the elements of an information system;
identify the characteristics of an efficient information system;
explain the steps to develop an information system; and
write an essay on communicating information.
6.1 Introduction
Information management is one of the functions, departments, or sections of
any business. The aim of the information function is to manage the information
needs of the business so that timely, relevant and accurate information can be
given to managers on all the different levels to enable them to make meaningful
decisions. Without such information it is not possible to manage any business
function or process effectively.
This chapter covers, firstly, the role of information management and
the information manager within a business. A basic knowledge and an
understanding of these are provided. Although the role of the information
manager may differ from one business to another, there are certain
responsibilities and tasks common to most information managers.
Secondly, the chapter looks at various aspects of information systems,
including the elements that make up information systems, the characteristics
of an effective information system, the implementation and modification of
an information system, and the different types of information systems.
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Finally, communication, both written and electronic, is briefly discussed from
the perspective of communicating information.
Throughout this chapter you will read about data, information and systems.
The following definitions will suffice for the purpose of this chapter.
Data (plural noun) refer to facts (words and numbers) about objects, people
and events. It also refers to unprocessed material that can be seen as potential
information. Lessing and Scheepers1 consider data as ‘… objective measurements
of the attributes (characteristics) of entities (such as events, things, people and
places)’. Data is generally used by machines, and is useless unless it is processed
to create information.
Information (singular noun) refers to data that has been converted or
processed into a meaningful and useful context for specific end users, at
a specific point in time, for a specific purpose, and presented in a specific
format. Information is used by managers to initiate actions, make decisions
and manage their sections. The three prominent types of information most
commonly used in businesses are:
„„
„„
„„
descriptive information that indicates change taking place (for example,
rising interest rates);
explanatory information that indicates the consequences of occurrences
(for example, less credit being used as a consequence of higher interest
rates); and
comparative information that indicates, for example, the comparison
between this year’s and last year’s profit figures.
An information system is a group or set of people, procedures and resources
that collect, transform and distribute information in an organisation. There
are manual (paper and pencil), informal (oral) and computer-based (using
information technology) information systems.
6.2 The role of information management and the information
manager within a business
Information management encompasses the processes of planning, organising
and controlling all information-related activities. It is concerned with the
collecting, processing, storing and distributing of information by means of
computerised and/or manual information systems. It is often also concerned
with cost accounting, archive control and general office activities. The
information manager, also sometimes referred to as the administrative
manager, is mainly responsible for the abovementioned functions, but in
many cases is also responsible for effective communication, office layout,
equipment, furniture and procedures, workflow, systems analysis and design,
automation, form analysis and controlling staff relations. The size and
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Chapter Six – Information Management
composition of the business usually determine the responsibilities of the
information manager.
In most large businesses the information manager is appointed as one of
the functional (tactical or middle) managers. The information function in the
contemporary business is responsible for the orderly collection, processing,
storing and distribution of information to decision makers and managers in the
business to enable them to execute their tasks. Information is also distributed
to role players outside the business. These include shareholders, suppliers and
clients. The information manager, whose authority and responsibility are
delegated by top management, is responsible for ensuring that the information
activities, which are supportive functions, run smoothly and contribute to the
effective management of the business.
The nature and responsibilities of information managers in different
businesses tend to vary, as do their job titles, which may be information
office manager, administrative manager, office administrator, office support
manager, or director of information or information services. The title of
information manager is used throughout this chapter.
To enable managers to manage the business successfully, they need usable
(ie timely, relevant, and accurate) information in order to make the right
decisions. It is impossible to manage and make decisions if only data is available
and not information.
6.2.1 The information function
Information management does not comprise one position, office or department,
but rather the entire management component that works in an information
capacity. All the other business functions also perform certain informationrelated tasks and activities that are not performed centrally by the information
division or department. These include telephone calls, duplicating documents
and handling mail on a daily basis.
The information function does not generate an income for the business. It
renders a service and provides specialised support to individuals and other
management functions, which enables the business to be more cost-effective.
It relieves individuals of many of their information responsibilities and enables
them to give attention to more important matters. For example, a manager
who appoints an office professional to take care of office tasks, such as filing,
data capturing and correspondence, frees himself or herself up to take care of
the management issues.
In addition to the manager’s field of specialisation, information is regarded as
the most important management tool, as well as one of the most fundamental
and valuable of the various business elements. Never before have managers had
at their disposal so much information that could influence their objectives.
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Business Management: A Contemporary Approach
Most managers will also agree that the effectiveness with which information is
managed determines its usefulness. The information function is able to make
a significant contribution to the success of the business through the provision
of specialised support in supplying useful information. Therefore, it is crucial
for the information manager to keep up with technological development in
this field.
6.2.1.1 Information activities
Information activities are diverse, and include handling information in all its
forms – mail, filing, indexing, copying and duplication, and mechanisation.
It could even include reception, word processing, correspondence, costing,
credit control, accounting and bookkeeping, and ordering. In small businesses,
many other functions are frequently classified as administration, such as sales,
warehouse management, and deliveries. Information managers must, therefore,
possess a thorough understanding of the different aspects of the business to
work effectively and efficiently.
The information manager is responsible for the general management of
the information function. This person is also constantly in contact with
the other functional managers and users of information systems. These
functional managers need to co-ordinate their needs, especially their
information needs. This will ensure an efficient flow of information, and
enable each function to plan realistically and reach their objectives in the
most efficient manner.
6.2.1.2 Objectives of the information manager
The primary objective of the information manager is to present relevant
information in time, in a relevant format and at an acceptable cost to specific
decision makers in the organisation. The information manager is responsible
for combining people, technology, material, money and sources of information
in such a way that the objectives of the information function and those of
the business are achieved. The information manager, like any other manager,
is responsible for certain key objectives in the business. The most common
objectives are to:
„„
„„
„„
„„
determine the information needs of role players inside as well as outside
the business, and endeavour to meet those needs;
develop and maintain information systems to ensure the overall
productivity of the business;
store documents and data in the most effective manner;
provide an effective and reliable infrastructure for maintaining
information, including hardware, software and network technologies
that meet the needs of the entire business;
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„„
„„
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„„
„„
„„
„„
„„
„„
„„
„„
„„
„„
„„
„„
provide useful information to internal and external role players through
different media;
compile, submit and/or distribute reports accurately and timeously;
respond to information requests from other departments in a userfriendly format, accurately and on time;
maintain reasonable qualitative and quantitative standards so the
workers know how long it it will take them to compile a specific report
according to a specific pro forma;
proactively provide information to support different initiatives, which
necessitates the information manager being included in top management
discussions and planning sessions;
participate in decision processes related to systems and operational
issues throughout the entire business;
improve accessibility to data sources for all users;
support all information-related issues in the business;
develop satisfactory lines of communication;
develop and manage a productive working team;
provide training to maintain and enhance skills on information issues
and technology by keeping up to date with the latest equipment, and
ensuring that all workers receive the necessary training to enable them
to work with it;
provide a satisfactory physical and mental working environment for
the employees of the business by for example, ensuring employees have
adequate equipment and a comfortable work environment;
help define duties and responsibilities of the information department
by giving each employee a list of duties or a job description stating the
tasks for which he or she is responsible, and to whom he or she must
report;
develop and manage a budget; and
plan, organise, lead and control all processes and personnel to ensure
that the information needs of the business are adequately met.
With the increasing importance of the information function in the business,
information managers in future will be more involved in policy decisions at top
management level. Information managers will have to contribute to decisions
regarding automated systems, and stay at the forefront of new technology and
systems design.
6.2.2 The information needs of the business
Businesses have different objectives and products; consequently, their managers
have different information needs. The information needs within the various
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management levels are also different. Then there are also external role players
who need information. Let us consider these different needs.
6.2.2.1 The internal information needs of the business
Information needed by the business itself should be gathered from the external
environment as well as within the business. To survive and compete in the
global market, a business not only needs information about its internal
environment, but also about the external environment. All this information
must be analysed, and the relevant information should be incorporated in the
decision-making process.
The information needed on each management level will differ and is
determined by the types of decisions that need to be taken and how quickly
they need to be taken.
Information needs of top management
Top management need information from outside the business about the
following.
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„„
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„„
General economic variables, especially if they are doing business in the
global market. The value of the Rand against other currencies can make
a huge difference if it drops while you are in the process of buying goods
from overseas. Domestic interest rates can change or certain materials
might become scarce.
Government Acts and regulations. Depending on the type of industry,
changes concerning Acts and regulations may force the business to make
changes that will cost money.
Technological changes and new developments. The most recent
computers are usually faster and can handle more information. This can
give a business that vital edge that they need over their competitors.
Competition. They need to know how strong their competitors are and
what they are doing regarding marketing and product strategies.
Top management relies on direct information for strategic planning and
policy decisions. Regarding the business itself, it looks at changing consumer
patterns, the trends of income and expenditure involved in product lines,
and the impact of new technology, population and other social trends. This
information enables top management to make strategic decisions, such as
counteracting any activity from competitors that could affect the business
negatively. With all this external information in place, they can then look
internally and decide whether the business is properly aligned to face the
future.
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The information needs of senior/middle level managers
Strategies and decisions made by top management are passed to the senior/
middle level managers, who need information to enable them to assist top
management in the planning, development and implementation of policies
and to manage their individual departments effectively. Examples of the type
of information they need are shown in Table 6.1.
Table 6.1: Examples of information needed by functional managers
Function
External information
Internal information
Marketing
„„ Clients and potential clients:
number, tastes, preferences,
opinions, expenditure
ability, geographical
situation, markets, market
sectors and needs
„„ Competitors: their
products, prices, marketing
communication
„„ Strategies of top management
„„ The products/services and
their characteristics
„„ Budgeted and actual sales
quantities
„„ Marketing costs
Purchasing
(supply chain)
„„ Everything about existing
and potential suppliers
„„ Quality and prices of raw
materials and equipment
„„ Acquisition costs
„„ Quality and availability of
other similar products
„„ Stock levels
„„ Rate of consumption
„„ Production quantities
„„ Machine utilisation
Operations
„„ Suppliers and potential
suppliers
„„ Different materials and
products available for
production and their prices
„„ Budgeted and actual
production quantities
„„ Production costs
„„ The application of equipment
and staff
„„ Stock quantities required and
stock quantities available
Human
resources
„„ Alternative sources of HR
requirements
„„ Relevant labour regulations
and Acts
„„ Trends regarding all facets of
the labour force
„„ Salaries paid in businesses of
the same industry
„„ Staff requirements
„„ Leave
„„ Salary scales
„„ Conditions of employment
„„ Training statistics
„„ HR needs in other functions
„„ Merit assessment results
„„ Training needs

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Finance
„„ Capital sources and interest
rates
„„ Capital movement
„„ Investment opportunities
„„ Creditors and debtors
„„ Stock levels
„„ Turnover
„„ Information to calculate the
financial ratios to ensure sound
financial management
Public
relations
„„ Interest groups
„„ The image of the business
„„ Products and strategies of the
business to enable them to
project the correct image
The information needs of first-line managers/supervisors
First-line managers, or supervisors, need information to enable them to
function on a day-to-day basis in order to control the daily operations. This
can be obtained from various sources, such as predetermined schedules,
Gantt diagrams, observation, feedback from subordinates and budgets. This
data or information is then processed to enable the supervisors to make
decisions regarding, for example, corrective action or the need for changes.
The relevant information is also given to senior/middle management on a
weekly or monthly basis as feedback regarding production, work processes
and productivity.
The flow of information in the business
Managers and employees on all levels of the business need information to make
decisions and solve problems in their daily work. Information flows vertically
and horizontally within the business. As we have seen, top managers need
information for strategic planning, whilst senior/middle and first-line managers
need information for the implementation of these plans and daily operations.
Employees need information to accomplish their tasks. Figure 6.1 illustrates the
flow of information and the information needs in a business.
Information flows vertically and horizontally within the business to
facilitate problem solving and decision making.
Figure 6.1 shows the different management levels; the senior/middle and
first-line levels consist of the different business functions. In each of these
areas, employees execute their daily tasks, and it is here where data is captured
and analysed internally.
The information needed by all these levels must be gathered, processed,
stored, distributed and communicated when needed. Those businesses that
are quickest at analysing and extracting relevant information to use in their
decision-making process usually have a competitive advantage.
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Chapter Six – Information Management
Gather information from external
environment
Distribute information to the
external environment
Top management
Strategic planning
Senior/middle level management
Tactical planning
First-line managers/supervisors
Control daily operations
Figure 6.1: External and internal information needs of a business
6.2.2.2 Information needs of external role players
External role players include:
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government, requiring information on matters such as profit, human
resources and health issues;
governing bodies for certain groups of businesses, which need statistics
about the specific industry;
suppliers, who need to know about order quantities;
shareholders, who need to know how their business is performing;
banks, that need to know how their clients are doing; and
any other external person or entity that requires information.
The business has to determine the need for information and develop a system
whereby the relevant information can be collected, processed and distributed
wherever and whenever required. Information can be supplied to the external
environment in the form advertisements, image building and annual and
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financial reporting. Supplying this information to the external environment
is usually the task of the marketing and external/public relations functions.
6.2.3 The relationship between the information function and the
other functions in a business
In most large businesses the functions that operate at senior/middle management
level usually include:
„„
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„„
„„
information (also referred to as administration);
marketing, production (also referred to as operations);
purchasing and supply;
human resources;
finance; and
public relations.
It is the responsibility of the information manager to make available to the
other functional managers information that they do not have or collect
themselves. Examples can be seen in table 6.1 on page 193. It is also essential
that the information manager be aware of the different levels of management
in the business (as indicated in Figure 6.1), the types of decisions made at
each level, and the need for management information required at the each
particular level. Only if this is the case can useful and relevant information
be communicated to the different levels and departments.
An information system needs to be created to facilitate the gathering of
relevant information from all the functions and different levels of management.
This system must be able to process the information and store it so that it can
be extracted easily. This process must be co-ordinated and managed by the
information manager.
If the information is complete, accurate, on time, and logical, then
management decisions will accordingly be of high quality. Similarly, when
the information is inaccurate, unsuitable or obsolete, the decisions will be
poor.
Information managers must make use of the available technology to assist
them in managing the available information. They must stay abreast of
developments in the information and technology fields. Computer equipment
is part of the information system for the business as well as the information
manager’s own job specification regarding decision making and problem
solving at a personal level.
6.2.4 The records management sub-process
A record can be described as written or oral evidence that information has been
collected and it is kept for use in the decision-making process. Strict control
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Chapter Six – Information Management
is, therefore, essential so that records can be effectively stored, retrieved and
maintained. The records management sub-process is only effective when
the system is able to supply the correct information to the correct person in
the shortest possible time at the lowest possible cost. Records can be stored
by means of a manual system as well as by means of an automated system.
With today’s information technology, records are produced with relative
ease, quickly, in great numbers and at low cost. The records management
sub-process entails the management of the record cycle, which consists of the
following stages.
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The creation of records Decisions have to be made concerning the format
of information, who will use it, and for how long it has to be stored.
Utilisation Records are created to be used. They must, therefore, be stored
in such a way that they can be easily and readily retrieved.
Storage During this stage, decisions regarding filing methods, equipment
and the effective use of space are made.
Retrieval With regard to retrieval, the speed with which the records can
be traced is of importance. Factors that influence the speed are the storage
methods, classification methods and filing procedures.
Maintenance Records have to be maintained, some for long periods
of time. Decisions have to be made concerning the suitable space
and equipment for storage, while some records have to be destroyed
completely.
6.3 Information systems
The information manager must implement an information system, creating
an environment that makes it possible to manage information and to reach
the objectives of the information section. Information has to be collected
from outside as well as inside the business. Employees and management at
all levels are involved and make a contribution towards the effectiveness
and efficiency of the information system. Information systems in a business
have to be integrated and managed in such a way that they operate in a
co-ordinated and productive manner. Because there are different interests,
objectives, specialities and levels in a business, there are different kinds of
systems. All the information needed in a business cannot be gathered from
one system only.
A system is a series of subsystems comprised of interrelated procedures that
help achieve a well-defined objective. While procedures consist of related
methods necessary to complete various work processes, methods consist
of specific clerical or mechanical operations or activities. 2 Subsystems are
functioning components of a larger system. Procedures are series of related
and consecutive steps that must be followed to enable someone to perform
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a specific task. A method is the manner in which each step of a procedure
is performed.
Procedures and
methods within
each subsystem
Sections within
the information
function
Information
function
Figure 6.2: The design of a system3
Let us use the business as an example to explain these definitions. The
business as a whole can be seen as a system, while the functions of the business
(information, marketing, operations, purchasing and supply, human resources,
finance and public relations) are its subsystems. Each one of these functions
can also be seen as a system by itself.
If, for example, the information function is the system, the different
sections or divisions within this function are the subsystems. Depending on
the business nature of the information function, these sections, divisions,
or subsystems could be programming, facilities, network operations, user
assistance, and strategic planning and research. They could also be the
mailroom, reproduction, communications and document storage.
Within these subsystems there are certain procedures and methods that
must be followed to ensure the effective and efficient functioning of that
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Chapter Six – Information Management
section. In the mailroom, for example, the procedures that must be followed
when dealing with incoming mail may be to:
„„
„„
„„
„„
open mail;
date stamp mail;
sort according to section; and
distribute mail.
Each of these procedures consists of specific methods used to execute each
step. These are likely to differ from one business to the other. The method for
receiving and opening mail could be:
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„„
„„
fetch the mail at the post office before 10:00 every morning;
separate confidential and personal mail for delivery; and
open the rest of the mail.
In a computer system, methods and procedures would be executed electronically.
A system includes all the people, technology, machinery, and facilities
that form part of that specific unit. A system can be open or closed. The
business is an open system, because it has a particular interaction with the
environment. The information function is also an open system, because it
functions within the business (its environment), and is interrelated with all
the other functions of the business as well as the external environment. A
closed system is self-sufficient and can exist independently of a particular
environment.
6.3.1 The elements in information systems
All systems comprise the following elements.
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In any system there is an input of some sort. It could be data, information
or any other resource. Input may be available in other subsystems or it
may have to be originated by the system itself. Input also includes the
staff executing the tasks, and the equipment needed for them. In the
information department this is usually seen as the task of gathering
information.
The input or data then has to be calculated, analysed, classified, counted,
grouped, sorted, compared, evaluated, summarised or prepared as graphs
to be useful information. This is the element of processing. One of
the basic objectives of the information function is to convert data into
information.
Processing is done in a certain manner and produces a specific outcome,
called the output. The output has to be in the required form and of the
specified quality to meet the need of the user. Often this output becomes
the input of the following subsystem.
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„„
„„
„„
The processed information, now rendered useful, is stored, either
manually in different types of files or electronically on a computer, until
it is needed by the decision makers in the business. Today information is
mostly stored electronically.
One should also have some form of feedback in a system. The amount of
feedback required is determined by the importance of the system for the
survival of the business. The more important the system or the desired
output, the more important it is to have proper feedback. Feedback is
necessary to determine whether the desired input is received, the proper
processes are executed, and the required output is available. Feedback is
received as a controlling measure to make sure that the system remains
effective and efficient.
Some businesses also include the environment and communication
channels as elements of their information systems. The system has to
interact with the environment, and this interaction needs to be identified
and assessed. Potential communication channels need to be recognised
and the most appropriate channels selected in terms of volume and
quality of data transmitted.
Potential available data
Collect data
Process data
Feedback
Store data
Changes
Distribute data
Users of data
Figure 6.3: The different components found in an information system
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Chapter Six – Information Management
6.3.2 The characteristics of an efficient information system
An effective information system should satisfy certain requirements.
It must supply the decision maker with information that is new and relevant.
Managers do not need information that they are already familiar with: they
need information that leads to action or that is essential for background study
regarding a certain issue. To be able to provide information that satisfies these
requirements, the information system should:
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facilitate decision making and serve the purpose for which it was
intended;
allow effective data processing by exercising adequate control over the
entire process, as well as the hardware and software used;
allow effective data management by continually updating files,
ensuring accurate data input, and protecting data integrity by putting in
an adequate security system;
be flexible to accommodate special or unusual circumstances;
be adaptable to accommodate any changes in the needs of the business,
or in technology, without destroying or hindering its functioning;
be systematic and logical; and
be user friendly and as simple as circumstances allow so that the tasks
can be performed effectively and efficiently.
6.3.3 The implementation and modification of an information
system
If a business has an information system, it has to be managed. If the current
information system is out of date, it has to be modified to meet the present
needs. If the organisation does not have an information system but needs one,
they will have to design and implement one. The management, modification
and implementation of the information system are the responsibilities of the
information manager.
When designing a new information system, it should be done within a
planned framework, and be created from scratch. It is not a good thing to
patch different smaller subsystems together. A system is usually changed when
it has lost its competitiveness or when it does not meet the need anymore.
Developing a system is not simple. It requires a thorough understanding of the
existing processes and a vision on how an organisation should operate. It also
requires discipline, knowledge and excellent communication skills.
Once the need for an information system has been identified, the planning
and development thereof will follow. The planning phase provides the
framework within which the information system will be implemented. Once
the decision is made to implement a new system, the process of developing it
will begin. There are many different ideas and methods that can be followed
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to implement a new system. For the purpose of this chapter, the steps we will
use to develop an information system are:
1.
2.
3.
4.
5.
6.
7.
analysis;
feasibility study;
design;
testing;
implementation;
documentation; and
support
Step 1: Analysis
The beginning is always an important step. It is like a foundation on which
the rest will be built. An investigation is needed to determine whether there
is, in fact, a need for an information system. A committee consisting of system
analysts, some users, as well as the manager leading the initiative could perform
a preliminary investigation. Information could be obtained from managers
and present users of the system by interviewing and observing them. Existing
manuals, where available, could also be studied. A written report about the
information gathered is given to top management. The committee needs to
look at the entire organisation, how the information is managed at the present
time, and how the present system (if there is one) is working. In order to get the
entire picture, the committee will have to look at many different issues, such as:
„„
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„„
„„
„„
„„
the objectives of the system;
the technology that is available or needed;
other resources that will be needed;
all the costs involved;
the knowledge, skills and capabilities of the users of the system;
the needs of management; and
other/external systems that will be linked to this system.
Step 2: Feasibility study
The feasibility study is done by looking at the general requirements of the
proposed system to determine whether it will be possible to develop the system at
an affordable cost. This study should include technical (hardware, software and
telecommunications), economic (the return on investment), and operational
issues (it should fit into the culture of the organisation). Decision makers need
to investigate and research the proposed system, and decide whether to proceed
or not. Once management accepts that the system will be feasible, a project
team is established that will develop the system until it is ready for delivery.
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Chapter Six – Information Management
Such a team usually includes system analysts, programmers and representatives
from the departments that will form part of the system.
Step 3: Design
Once the requirements are known, the project team can commence with
designing the system. The requirements determined in steps 1 and 2 should be
satisfied. The team must evaluate alternative solutions, and specify:
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outputs such as
ˆˆ the form of output required,
ˆˆ the output files that will capture the processed data, and
ˆˆ the files that will record input by all the other users of the system;
inputs such as
ˆˆ files that will be used to capture the input data,
ˆˆ the procedures used to process the input,
ˆˆ the type and amount of data required,
ˆˆ where the data will be collected from,
ˆˆ how the data will be entered into the system, and
ˆˆ how the system will interface with users and interact with other
systems;
hardware or technology, including communication technology, that is
suited for the system;
software packages, including databases and word processing; and
construction specifying how the input, processing and output of the
system will fit together.
Step 4: Testing
A system needs to be tested before being used to make sure it does what it is
supposed to do. Use different data (correct/normal data and data containing errors)
and measure output, processing times and quality. Do the necessary adjustments.
Step 5: Implementation
If the current system is still in operation, then you need to decide if you are
going to stop that operation and introduce the new system immediately, or
whether you are going to run the two systems consecutively. Whatever the
decision, the users need to be trained to use the new system. Giving background
knowledge of the new system as well as on-the-job training might be necessary.
Remember, when changing from an old to a new system, productivity may go
down initially, and mistakes could occur. Prepare for such irregularities.
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Step 6: Documentation
Ensure there is sufficient and appropriate:
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technical documentation, for the IT analysts/programmers who manage
and maintain the system; and
user manuals that contain information about methods and procedures of
how to work the system.
Step 7: Support
Any system needs maintenance and this consists of addressing problems as they
arise. This may include user problems as well as changes to the system itself
where shortcomings are identified. To assist users, a help-desk is often provided.
6.3.4 Different types of information systems
Within business, one encounters many different types of systems and
information systems. The nature and application of these systems will be
affected by the level of decision, the use of the information and the source and
destination of the information. An information system mostly consists of many
subsystems. Each of these subsystems has its own goal and reason for existence,
but operates within the bigger system and serves the business as a whole.
Classifying information systems is not simple. As new uses are found for
computer-based information systems, so new categories of information
systems are developed. Information systems are mainly conceptualised in
terms of three types of systems, namely Transactional Processing Systems
(TPS), Management Information Systems (MIS) and Expert Systems (ES). MISs
can be further subdivided into Decision Support Systems (DSS) and Executive
Information Systems (EIS).
6.3.4.1 Transaction processing system (TPS)
This is the basic business system that serves the operational (lower) level of the
business. A TPS is a computerised system that performs and records the daily
routine transactions found in all businesses. Examples of these activities are
sales, receipts, orders, payments, banking transactions, payroll, hours worked
and the flow of material in an operations department. The transaction is added
to the system or database as soon as it is received or as soon as it happens.
The main purpose is to track the flow of transactions through the business,
and to answer routine questions. The information here is used to manage the
lower-level activities in the business. These systems can only carry out the tasks
for which they are designed, and cannot easily be changed by the user. When
designing such a system, it is important that the programmers understand
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Chapter Six – Information Management
the exact needs of the business. The system must do what the business/users
require. The inflexibility of these types of systems was one of the reasons for
the development of more advanced systems that could support the decisionmaking process of managers. These systems are the backbone of a business as
they can provide updated information at any given time.
6.3.4.2 Management information system (MIS)
In order for managers of a business to make decisions on all levels, they need
information. It is therefore necessary to have information available in an
organised form, and for this an MIS can be used. An MIS can provide managers
with reports in an accurate and timely manner. It could also provide them with
online access to the business’s current performance and historical records. An
MIS gathers relevant data and information from inside as well as outside the
business. This data and information is processed and stored on a database. It
is updated regularly and can be accessed by managers whenever needed. This
information is also used for control purposes. An example could be a report for
the month regarding the budget, noting where actual costs exceeded budgeted
costs. The MIS is specifically designed to use IT to meet the information needs
of lower and middle managers as they make a variety of decisions on a day-today basis. The MIS provides managers with the information they need to carry
out their function. It generates regular performance-monitoring information,
maintains co-ordination, and provides background information about business
activities. The MIS does not directly support the decision-making process but
makes information available that managers use to base their decisions on. The
MIS provides the business information about its past performance. The system
does not do any forecasting. Databases from which the information is gathered
must be updated before the MIS can provide the information to managers. This
can cause a delay in the decision-making process. Computer-generated reports
are an important part of the MIS.
Different subsystems exist to supply information to functional managers.
The subsystems are the marketing, production, purchasing and supply, human
resources, financial and public relations information systems. The data and
information regarding the operations of these functions are recorded on a
database. Each function supplies the information regarding its own operations
(see Table 6.1).
Some information processed or gathered by each business function is only
for its own use. However, there is also information that needs to be supplied to
the other functions so they can function effectively. An example of this is the
financial function that has to supply information to all the other functions
regarding the budget. Each function needs to draw up a budget and this cannot
be done without getting guidelines regarding the financial situation. Another
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example is the human resources function supplying all the other functions
with information on the policies of the business.
6.3.4.3
Decision support systems (DSS)
One of the subsystems that could be found in an MIS is the Decision Support
Systems (DSS). It is a computer system designed to provide assistance to
managers in determining and evaluating different courses of action. It uses
special software to allow users to interact directly with a computer to help
make decisions for solving complex and sometimes unstructured problems.
It acquires data from a range of routine transactions, analysing it by using
advanced statistical techniques to create useful information, and even narrows
down different decision options to assist managers. The DSS has arisen from
an ever-increasing need for information system support in non-routine, nonrepetitive, uncertain situations where success criteria are by no means clear. It
was developed to overcome the rigidity of the MIS with its reporting structures
and limitations. The DSS can be used in a number of different ways, such as in
financial services where insurance agents need to structure sales situations and
respond to clients’ requests by choosing the best combinations from a set of
options. The DSS does not provide the decision, but provides information about
different options that the manager will use to make the decision.
6.3.4.4
Executive Support Systems (ESS)
Senior and top managers also use Executive Support Systems (ESS) to make
decisions and serve the strategic level of the business. They address non-routine
decisions requiring judgement, evaluation and insight. ESSs create a generalised
computing and communications environment rather than a fixed application
or specific capability. The focus is on long-term trends, internally and externally.
External changes must be noted in order to make internal adjustments, and
thereby remain competitive. Examples are the long-term industry trends and
future products of the industry. The information must, of course, be relevant to
the decisions they need to make. This information will be on matters such as
competitors, the economy, politics, customer needs and government rules and
regulations. The information must be presented graphically where possible, and
summarised to save time when working through it. Detail must be available
on request. This system makes use of the available databases, internally and
externally, as well as a database specifically designed for this purpose.
6.3.4.5 Expert systems
Some businesses also make use of an Expert System (ES). This system is more
advanced than the DSS and is capable of arriving at a decision when certain
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Chapter Six – Information Management
facts are given to it. The system is programmed to select specific options when
receiving certain inputs. When designing such a system, you need a specialist
in the field of application to assist the developer/programmer. Data about the
specific field are collected from a specialist and placed in a database. Managers
can then extract this expertise when a problem arises. Once the system is in
operation, you need not be a specialist to use the system.
6.3.5 System integration and the flow of information
The systems in most businesses are also specialised to serve each of the
functional areas, such as sales and marketing, manufacturing and production,
and human resources. A system is not necessarily used only by one section or
one management level. For example, it is possible for a middle manager to get
information from a TPS.
Systems are often developed as stand-alone systems and are not linked to
other systems in the business. System integration looks at a business as a whole
and the needs of the business. System analysts then look at the possibility of
integrating the different systems within the business so that information can
flow between them and that this information can be made available to all the
users with any of these systems.
Although each function is managed individually, they are still part of the
business and must function interdependently as integrated systems. Each
functional manager has to produce certain outputs in order for the business as
a whole to be profitable.
The question is: ‘Who must take care of this integration?’ We can generally
say that this is the function of top management, but each functional manager
is also responsible. Each functional manager, for example, cannot do planning
in isolation. There is no use in expanding one of the functions without
informing the human resources function. Who will recruit and employ the
necessary staff? The matter will therefore be facilitated if a team approach
is followed in the management process. To ensure successful integration and
co-ordination in the business:
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there must be mutual co-operation between individuals and the different
functions;
each function and its subdivisions must be aware of their share in the
goal of the business (the output they need to provide that becomes the
input of the other functions); and
each function must be flexible and able to adapt to changing circumstances.
6.3.6 Safeguarding information systems
Most computer crimes go undetected, and only a few are reported to the
authorities. Many businesses are not willing to report the crimes, because of the
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possibility of losing potential customers who may think that their data is not
secure.
The increasing use of the Internet means that computer crime is no longer
limited to the users of a system, but can now be executed from anywhere in the
world. This raises concerns for those businesses that work online because they
need to ensure that their internal operations cannot be compromised.
Information professionals and other individuals in the business need to
guard against computer technology becoming the object of crime. Managers
need to guard against illegal access and use, data alteration and deletion,
information and equipment theft, software and Internet piracy, computerrelated scams and international computer crime. In today’s technological
era, the use of smartphones, laptops, and tablets have caused us to require
more security and protection concerning data. Information that is easily and
regularly shared and posted can be protected by encryption or the use of a
firewall. Deriving from the Greek kruptos, meaning ‘to hide’, encryption is
accomplished by converting the data into a complex code using mathematical
formulae to both encrypt and decrypt information.
A firewall is a general term that refers to both hardware and software used
to restrict access to data and information on a network. The firewall acts as a
protective shield between the outside world and the network. The purpose of
firewalls and other security is to deny access to outsiders and restrict access to
employees who are authorised to use the system.
6.4 Communicating information
Communication is a carrier of information and makes it productive. When
information is distributed by means of communication, it will activate the
receiver of the information. Feedback is that element that describes a task
done or completed. When feedback is successfully practised in the business,
interaction will take place and this will lead to the successful integration of the
various functional areas in the business. An effective feedback mechanism has
to be designed to achieve synergy between the various functional areas. The
flow of information binds the different management levels together. Employees
are empowered by access to information, and regular feedback usually has a
positive impact on their morale. Each has a clear direction of what to do next,
and this should have a positive impact on productivity. Finally, feedback of
information contributes to employees’ ability to react – the more regularly
feedback is received, the faster employees can react to new information. A
manager’s job consists mostly of handling information. When managers
receive information, they act as assimilators or monitors of their departments
and immediate environment. This role is described as the information role.
Managers play the assimilator role when they receive information, correctly
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Chapter Six – Information Management
place it into perspective in the relevant context and distribute it to the relevant
people. As monitors, managers should be aware, through available information,
of all activities in their departments and, as a result, be in a position to manage
their departments effectively.
The flow of information is just the transfer of information from one
variable to another one in a given process. This is influenced by the following
factors.
6.4.1
Culture and structure
The business culture consists of the beliefs, commitment, norms, values,
standards, perceptions, attitudes, priorities and the form of business. The
communication pattern in a business, for example, is determined by the nature
of the business structure. In more traditional businesses, information is often
filtered (omitted or changed) as it moves up in the hierarchy, the intention being
to serve management with relevant information only, and to avoid information
overload. The danger is that management may be prevented from having a
complete picture of a particular situation because not all the information is
supplied.
6.4.2
Distribution methods
A business can use a number of methods to distribute hard copy information
within and outside the business, including a mail system, messengers,
conveyor systems or self-propelled delivery vehicles. To distribute electronic
information, they can make use of local area networks and telecommunication
systems, such as telephones, fax machines, email, wide area networks and
teleconferencing. Some of these methods are quicker than others, some
cannot be used for confidential information, and some are more reliable
than others.
6.4.3 People
People are certainly key players in the facilitation of the flow of information
and can influence it not only positively, but also very negatively. The reason
for this statement is that people are not always fully informed, sometimes keep
information to themselves, sometimes do not supply the correct information,
sometimes supply incomplete information, sometimes do not react on
information, do not always keep records up to date and, finally, cannot always
anticipate the impact of information.
Information is communicated either verbally, in written format, or
electronically. In this section, written and electronic formats are briefly
examined.
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6.5 Communication format
6.5.1 Written format
Written communication includes recorded messages, such as letters,
memorandums and reports, by which information is transmitted from senders
to receivers. The sender is the writer and the receiver the reader, both of whom
have responsibilities to ensure the efficiency of the communication process and
the accuracy of the information involved. Written communication is done by
making use of business letters, reports, memorandums and effective writing
techniques.
Writing remains a key skill for all managers, and is obtained through
exposure and practice. It is important to be aware of the basics of written
communications. Good, clear writing should be the aim of all managers and
it is important to have a flexible style that can be adapted to meet the needs
of the receivers.
6.5.2 Electronic format
Information can be communicated electronically by making use of cell
phones, email, voice-mail, faxing, teleconferencing, videoconferencing, data
conferencing, groupware, electronic bulletin boards, discussion groups and
chat lines.
Communication networks can also be developed within a business, making
it possible to transmit data and information between two sites. A network
refers to two or more connections that can communicate with each other
and share information. There are a number of different ways to organise
telecommunications components to form a network. In most businesses,
computers are linked together to form a network, bringing together the
information that businesses need to function.
Electronic communication is mostly used today, not just amongst employees
in one building, but also with employees in other regions, countries and
branches all over the world.
Communicated information forms the backbone of all transactions in any
business, so its accuracy can never be overemphasised.
6.6 Summary
Information is one of the resources available to management, and should be
managed just as other resources. In larger businesses, information management
is a separate function, on the same level and managed in the same way as
the other business functions. Information managers are constantly challenged
by the changing environment, especially by the continuous development of
technology. They have to remain up to date with these changes to maintain
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Chapter Six – Information Management
competitive advantage. The large volume of information today is another
challenge that must be kept in mind and managed accordingly. To assist the
task of information management, information systems are developed and
monitored to ensure the efficient flow of information.
6.7 Self-evaluation
Read the case study and answer the questions below.
Case study
The Jackson Manufacturing Company
The Jackson Manufacturing Company, located in Port Elizabeth, was founded
by two brothers, Peter and John. The company has manufactured several
different products during its existence, but has experienced its greatest success
in the manufacture of car axles. The growth of the company has been slow,
but steady. The managerial philosophy has always been rather traditional, and
neither of the brothers believed in implementing any of the newer managerial
or personnel concepts.
Peter’s son, Carl, recently became CEO of the company after his father and
uncle retired. His managerial philosophy is more progressive. He believes in
implementing new personnel programmes and managerial concepts, all of
which have been successful.
Carl is concerned about the lack of co-ordination of the office activities.
Presently, each of the 20 office supervisors is totally responsible for all office
activities under his or her jurisdiction. Although some of the units are efficiently
administered, others are not. The new CEO believes that a new employee
with the title of information manager is needed. A primary function of this
individual would be the co-ordination of all the office activities throughout
the organisation.
Questions
1.
2.
3.
4.
What would the likely objectives of this person be?
List five areas of this person’s responsibilities.
What qualifications would likely be required of this person?
Discuss the information flow between the section that does the
manufacturing and the other sections of the business.
References
1.
N Lessing & C Scheepers, (eds) Information is a management issue
(Johannesburg: ISIC, 2006) p. 11.
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2.
3.
ZK Quible, Administrative Office Management: An Introduction, 8th edition.
(New Jersey: Pearson Education, 2005) p. 361.
ibid., p. 361.
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CHAPTER S E V E N
Public Relations
Daniel B Tshabalala
Learning objectives
When you have completed this chapter you should be able to:
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understand what is meant by public relations;
define public relations;
identify the objectives of public relations;
identify the different interest groups or publics;
evaluate the importance of corporate image;
distinguish between the various methods of communication;
describe the action plan in public relations;
describe the instruments of public relations;
discuss special events;
discuss digital communication; and
explain the interaction between public relations and other functions in business.
7.1 Introduction
The approach of this chapter will provide the reader with the foundation to
make strategic communicating decisions and to provide the reader with an
understanding of the organisation, its nature, its operating environment and
the publics it interacts with. (A public is a group of people who have a common
interest or common values in a particular situation.) The modern business
is highly competitive, it is therefore important that organisations maintain
a good image in the eyes of the public at large, consumers, as well as other
interest groups. Having a good image implies that consumers will readily
support the organisation, and other interest groups will wish to be involved. A
good workforce is necessary to keep the business functioning. It is, therefore,
paramount that the employer creates the right supportive climate in the
business to satisfy employees’ needs, and to ensure that they perform as well
as possible.
The responsibility of any public relations practitioner is to communicate
with different publics – each with its own special needs and requiring different
types of communication – not just the general public.
Publics can be the press, stockholders, investment community, competitors,
suppliers, special interest groups, community, banks, trade associations,
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Business Management: A Contemporary Approach
dealers, customers, the academic community, labour unions, employees and
managers.
Successful public relations is based on open and honest communication,
transparent and ethical business principles, efficient public relations
practitioners and regular monitoring in order to build sound relationships.
There is controlled and uncontrolled media. Media that is controlled include
those media where the public relations practitioner has a say over the content
of the message, how it is said, and even when it is said. Examples of controlled
media include corporate print material (such as pamphlets and annual reports),
company-sponsored audio-visual material and corporate speeches. Uncontrolled
media are those in which the practitioner does not have any direct influence
over media content, such as editorial features, news stories and conferences.
In this chapter, the process that is followed to build these sound relationships
between the organisation and its stakeholders will be explained as well as the
instruments used to reach the contact points, and to promote an organisation’s
corporate image.
Finally, the relationship between public relations and other functions and
how they have to work together to ensure the success and survival of the
organisation will be discussed.
7.2 Definition of public relations
Public relations is not easy to define, and authors do not always agree on the
best definition. But, utilising a number of different sources, public relations is
generally considered to be:
the management function that establishes and maintains mutually beneficial
relationships between an organisation and its publics.
Another collective definition, and the one we will use for discussion, is:
a deliberate, planned, and sustained process of communication between a business
and its publics for the purpose of obtaining, maintaining, or improving good strategic
relations and mutual understanding between the organisation and its various publics,
both internal and external.1
In the many different approaches, one must understand that everything
revolves around creating a positive image of the organisation. Due to the nature
of public relations, the above definition is acceptable because it includes the
main elements of the function, as discussed below.
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It is a deliberate activity: the efforts to communicate specific information
to the stakeholders are deliberate and clearly defined. Therefore, public
relations is a conscious, purposeful activity of business management.
Each programme is designed to realise clearly formulated objectives.
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Chapter Seven – Public Relations
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It is a planned activity: it is not an incidental activity, but an
operation that anticipates events, and is prepared for problems as well as
contingencies. Most large companies have specific plans in place to deal
with a crisis if it were to arise. Public relations is supposed to be proactive
as opposed to reactive. For example, an oil company will have a plan
ready in the event that a major oil spill takes place.
It is a sustained activity: public relations is not a once off event – it is a
continuous process. It takes into consideration that the public is dynamic,
that people are versatile, and that it must compete for their attention.
People tend to forget about the business so they need to be continually
reminded of its existence.
It is an established activity: the focus of public relations management
is to establish a climate of understanding between the business and the
stakeholders.
It is a maintained activity: it is pointless if a positive relationship has
been established, but has not been kept in place or maintained. This
means that the business must listen to the feedback it gets from its
stakeholders.
There is mutual understanding: there can be no relationship if the
different parties do not understand each other.
It is a communication process: communication is the process of
transmitting information from one person to another person. It
presupposes communication between stakeholders and the business.
Communication can be applied through formal or informal channels
in the business. Formal channels can move upwards, downwards,
horizontally and diagonally. The informal communication channel
refers to communication that does not follow the normal structures of
the business.
It is internal and external: management and the employees at various
levels within the business are usually regarded as the internal stakeholders
working together in order to reach organisational goals, while external
stakeholders are groups – such as customers, financial institutions,
unions, media and shareholders – who are outside the business.
The main purpose of public relations may be seen as a process that promotes
and improves the image of the business among the public so as to establish a
healthy relationship between the business and the public. It entails decision
making to help the businesses’ ability to listen to, appreciate and respond
appropriately to those persons and groups with whom the business needs
to foster mutually beneficial relationships as it strives to achieve its mission
and vision.
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7.3 The role of public relations
One of the tasks of public relations is to create and maintain a favourable
opinion of the business (or a positive image of what the public is supposed to
see when the organisation is mentioned – how the organisation is perceived)
in our modern society. The business must build an image of, and reputation
for, itself that will be acceptable to both the external and internal stakeholders
so that they, and other interest groups, will be eager to support it. This role is
fulfilled by the public relations function.
Public relations involves:
„„
evaluation of stakeholders’ attitudes;
formulation and implementation of the business’s procedures and policy
regarding communications programmes;
developing a rapport and goodwill through a two-way communication
process;
fostering a positive relationship between the business and its stakeholders;
dealing with relations between the business and it stakeholders;
analysing the impact of policies, procedures, and actions of the
stakeholders;
establishing and maintaining two-way communication between the
business and its stakeholders;
producing specific changes in awareness, opinions, attitudes and
behaviours inside and outside the business; and
creating and maintaining goodwill towards the business.
7.4
Affiliation2
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The Public Relations Institute of South Africa (PRISA) was established in 1957.
It represents professionals in public relations and communication management
throughout the southern African region, and has registered practitioners in
Botswana, Namibia, Lesotho, Swaziland and South Africa. It is a founding
member of the Global Alliance for Public Relations and Communication
Management, and it initiated the formation of the Council for Communication
Management (CCM) in South Africa. It has a Code of Ethics and Professional
Standards for the practice of public relations and communication management.
7.5 What are publics?
Publics are groups of people who have a common interest or common values
in a particular situation. When interest and values of particular publics
come into action with the interests and values of a particular organisation,
relationships are born. Organisations form relationships with publics, because
those publics have resources that those organisations need to fulfil their value-
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Chapter Seven – Public Relations
driven goals. Publics that can be affected by the actions of an organisation
are called stakeholders. Generally speaking, there are two main groups of
publics for all businesses. These are external publics – all those stakeholders
outside of the business that are important to the business.3 Traditional publics
in public relations include employees, the media, investors, government,
customers/consumers, multicultural community groups, constituents/voters
and businesses.
Every business has to interact with its environment, and included in this
environment are role players that could have a significance influence on the
fortunes of the organisation. Some of the role players, such as customers,
employees and shareholders, could have a direct impact. On the other hand,
some role players, such as the press and government, might have an indirect
impact. The interaction with role players is not always positive. It is wise then
to be proactive in managing interactions with stakeholders so as to help the
organisation attain its strategic objectives. The most notable stakeholders
include the following.
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Consumers of the business’ products and services without whom
a business cannot survive. Businesses must be sensitive to issues of
importance to consumers, which include religious, gender and cultural
issues. It is important for the business to know and understand what
consumers, both new and old, think about the business, its products and
services, as well as its staff.
People and institutions that play a role in training and recruiting
potential employees such as schools, universities, trade unions and
recruiting agencies.
The media such as radio, television and the press, which can help report
positively on the organisation.
Suppliers of production used by the business to manufacture products
and render services. Examples include suppliers of raw materials and
trading stock, and those rendering municipal services. Both parties must
strive for a mutually beneficial, long-term relationship.
Financial institutions, as many businesses are dependent on financial
institutions to finance their business or facets of it. So the business must
keep good relationships with the investors in the business or with the
bank that financed it.
Some interest groups are more important to a business than others. It is therefore
important for a business to establish exactly which stakeholders are important
in terms of its success and survival, and to establish sound relationships with
these interest groups.
To determine which stakeholders are most important, the business must
draw up a preferences list dividing stakeholders into:
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main contact points (the most important ones);
subordinate contact points (less important ones); and
unimportant contact points (those that have little effect on the
business).
It is important to place details of contact points on record and keep these up
to date, since events in the external environment may change the relative
importance of the contact points. Changing circumstances may also necessitate
the addition of new contact points, while others may become unimportant,
allowing them to be removed from the list.
Public relations is based on regular communication. This communication
refers to more than talking – it includes attitude towards customers, the general
neatness of the buildings and other infrastructure, and the quality and layout
of the documentation. The purpose of internal relations is to keep people up to
date with current events and company successes, as well as focusing on team
and individual relations.
7.6 Corporate image of a business
Corporate image refers to more than just the organisation’s good name.
The image is what the public is supposed to visualise when the business is
mentioned. The concept is usually associated with large businesses, but small
businesses also have a corporate image.
The corporate image of a business consists of:
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how society perceives the business (buildings, products, trademarks);
and
how the business’s management and employees behave – dressing
appropriately, cultivating good manners and choosing their words
carefully in order to come across as competent, likeable and reliable.
Many people form an impression of a business before they even know it,
merely on the basis of its reputation (what they have heard about the business
from others or from what they have read about it). It is just as important for a
business to have a favourable image as it is for a person to have a good name.
It is therefore important that businesses protect their image.
The elements of an image include:
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the core business and how the business performs financially;
reputation brand performance;
how the business keeps up with technology and innovation;
staff policies; and
the business’s relationship with its external stakeholders, customers and
the community at large – particularly where it operates.
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A business with a good image:
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delivers products of a good quality and renders an efficient and a reliable
service;
does not use false advertising so consumers regard its advertising messages
as credible;
aims not only to make a profit, but is also concerned about contributing
to the welfare of the environment within which it operates;
follows ethical business principles;
has a positive attitude towards consumers and employees, and goes out of
its way to keep clients happy and satisfied, and
treats its employees with respect.
7.6.1 Measuring the corporate image of the business
The image of the business needs to be evaluated from time to time. Before
launching projects and programs to build the corporate image of the
business, it is important to find out exactly what the current corporation
image is. If the business already has a good corporate image, it will not be
necessary to launch a very aggressive public relations programme. However,
if the corporate image is bad, it will be necessary for a business to restore and
enhance its corporate image. There are two methods of determining how
good or bad the business’s corporate image is. These are direct evaluation and
indirect evaluation.
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Direct evaluation takes place when the business communicates directly
with the stakeholders to establish precisely what they think of the
business (like a marketing survey).
Indirect evaluation does not involve personal interaction between the
public relations officer and the stakeholders. Examples include Internet
searches, online discussions and postal interviews. Any change in sales
performance will also indicate a change in the way people feel about
the company. The results will have a decisive effect on the selection of a
strategy to achieve the public relations objectives of the business.
7.7 Objectives of public relations
The main objective or aim of public relations is to enhance and improve
the image of the business among various publics, and to establish a healthy
relationship between the business and the public.4 This positive image must
be reinforced. It is naturally important to ensure that a good relationship
(knowledge and understanding) is established between the business and the
stakeholders. However, to ensure that the business succeeds and grows, the
relationship is not just established, but also maintained.
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The primary objectives of the public relations functions are derived from the
main objectives of the business, namely:
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maximisation of wealth or to make a profit;
building awareness;
generating consumer attention through the media and special events;
creating interest about a product or service;
providing information to customers about the product or service; and
stimulating demand through various media such as newspapers, radio
and TV.
To achieve this objective requires the support of various business functions,
which will be discussed later in the chapter.
The secondary objectives of the public relation function are:
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promoting the prosperity of the business;
establishing goodwill amongst the public, which is particularly
important: the need for businesses such as charities or foundations that
are dependent on the public for support;
releasing information in the case of a crisis, such as a fire at the business
headquarters;
damage control and counteracting negative publicity by presenting news
in the most favourable manner;
handling internal communication; and
promoting and planning events.
There are many objectives that can be set for the public relations function, but
they should be realistic, measurable and sustainable.
Objectives for campaigns can:
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be different for different campaigns;
be planned to merely inform the target publics about an issue, a cause or
a new product;
seek to persuade publics to change their attitudes in favour of the
organisation’s products;
educate the public about the usage of its products; and/or
urge the public to act in a particular way, for example to ‘buy now!’
A campaign always has a specific beginning and end.
7.8 The requirements of succesful public relations
The characteristics of successful PR include:
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open and honest communication because stating untruths, concealing
errors or misleading the public in any way will adversely affect the
business’s public image;
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Chapter Seven – Public Relations
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regular monitoring and evaluation to ensure projects are running as
planned, and are within the budget;
regular and effective communication with stakeholders;
ethical business principles;
performance that is consistent with stated values such as, for example,
environmental concern; and
efficiency.
7.9 The role of communication in public relations
Communicator
Message
Signs and
symbols
Recipient
Source
Figure 7.1: The communication process5
The basis of public relations is good communication with all stakeholders
that can influence the business’s success. It is therefore important that you
understand what is meant by communication, and know which elements are
involved in the communication process. According to Mersham, Skinner6 and
Van Staden et al7 the elements of communication are the following.
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The sender is the source or the originator of the message. It may be
an individual or several individuals working together, the source may
also be an institution or an organisation. The sender initiates the
communication activity and formulates the message. The sender sends
the message because of a need to convey information, express feelings,
obtain feedback or satisfy needs. Communication occurs if the sender
and recipient have some minimum degree of prior common experience
or some level of shared meaning. Many failures to communicate are due
to mistaken assumptions by the sender or recipient about the meaning of
symbols they have exchanged.
Encoding is the act of putting the thoughts or feelings into a symbolic
form that conveys the intended meaning, and ensures that the receiver
recognises and understands what the sender wants to convey. These signs
and symbols can be verbal, in the form of a language, or non-verbal, such
as hand or facial gestures, or any other body movements and images.
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Decoding translates messages into a form that has meaning to the
receiver. A receiver, just as the sender, is limited in the decoding of a
message because of his or her skills, attitudes, knowledge and social
cultural system.
The message is the ideas it contains – the verbal (spoken or audio-visual)
symbols and non-verbal cues representing the information that the sender
wants to convey to the receiver. Messages normally contain information
or data.
The channel is the means by which a message travels from source to
recipient. It is the path along which the message is physically transmitted.
The recipient is the person to whom the message is directed. The recipient
must accept and interpret the message.
Feedback, which is also referred to as reaction or response, may be
thought of as a measure of the effectiveness of communication. Positive
feedback informs the source that the intended effect of the message was
achieved. Negative feedback informs the source that the intended effect
of the message was not achieved.
Communication barriers, which are also referred to as noise or
interference, may prevent communication from taking place successfully.
These could be anything that causes a communication breakdown or
prevents the receiver from receiving the message.
Communication is a complex term, and can be defined (in its simplest form)
as the process of transmitting information from one person to another. It is
estimated that managers spend over 80 per cent of their day communicating
with others.8 All business matters depend on the exchange of information,
and the success of the organisation’s performance depends on the effective
exchange of this information.
We distinguish between internal and external communication. Internal
communication is communication with fellow employees and management
within the business, whereas external communication is with the stakeholders
outside the business. Internal communication is very important, as good
relations within the business can significantly affect employee morale, loyalty
and performance. External communication is equally important as good
relations outside the business can build trust and loyalty with other businesses,
clients, the government and members of the public at large.
7.10 The public relations process
The public relations process is aimed at establishing, maintaining and/
or improving the relationship between a business and its stakeholders. An
effective public relations effort is the result of mutual understanding between
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Chapter Seven – Public Relations
an organisation and its publics. The development of this understanding can be
regarded as a four-step process, namely:9
Step 1: research;
Step 2: strategic planning and programming;
Step 3: taking action and communicating; and
Step 4: evaluating.
Step 1: Research – defining the problem
The initial fact-finding step defines the problem areas and differentiates between
the publics. This first step involves probing and monitoring the knowledge,
opinions, attitudes and behaviours of those concerned with and affected by
the acts and policies of an organisation’s intelligence function. It provides the
foundation for all the other steps in the problem-solving process by deciding:
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what’s happening now;
what must be done;
the order of execution;
time and date of completion; and
to whom feedback should be provided.
Step 2: Planning and programming
Information gathered in the first step is used to make decisions about
programmes, action and communication strategies, tactics and goals. This
involves factoring the findings from the first step into the policies and
programmes of the organisation. This step has to do with what we have learned
and what we can change or do and say. Once the facts have been gathered
from various publics, decisions must be made regarding their importance and
potential impact on the organisation. Based on these decisions, strategies must
be developed to enable the organisation to achieve its goals.
Step 3: Taking action and communicating
The third step involves implementing the programme of action/strategies
and communication (designed to achieve the specific objectives for each of
the publics) as new organisational policies and/or projects to accomplish the
programme goal. Messages are then constructed to reach the publics.
Step 4: Evaluating the programme
The final step in the process involves assessing the preparation of the
programme. Once a public relations campaign is developed and implemented,
it should be followed by evaluating its effectiveness in meeting the criteria that
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were set. The results of the evaluation are used to assess the effectiveness of the
effort and to plan for future action by determining whether the objectives were
achieved, and whether the program added value to the business’s image.
In the next section we briefly examine the steps in the public relations
process.
7.10.1 The development of a public relations programme
Once the corporate image has been determined, the business must decide
whether the image is good enough, and also whether the image (perception)
that the stakeholders hold of the business is the image that it wishes to project
and maintain at all times. This image will be jealously guarded and protected
as the pride of the business. The steps to follow in developing a public relations
programme include:
Step 1: define and write down the communication objectives for your public
relation or media plan;
Step 2: define specific and measurable goals and objectives;
Step 3: determine the stakeholders (contact points) that need to be reached
with the programme;
Step 4: develop a schedule for your public relation campaign, and create
synergy between your public relations plan and other efforts;
Step 5: develop your plan of attack, deciding what communication medium
and public relations instruments and media to use to reach the specific
stakeholders; and
Step 6: put measures in place to track the results of the campaign to see if
the set objectives and goals were achieved, or if the plan should be
modified.
Case Study
The issues facing Radebe motors
Radebe Motors is a dealer in new and second-hand motor bikes to consumers.
It deals with suppliers that supply the business with bikes, and it interacts
with financial institutions that enable Radebe Motors to arrange financing for
clients and provide loans when the business requires capital. The business has
employees who sell, repair and service the bikes. The media helps with positive
reporting to build a positive image for the business.
The clients (stakeholders) where happy with the customer care and service
rendered by the business until there was a change in management.
An expert was called in to undertake an evaluation of Radebe Motors’
corporate image. The results indicated that the business is unpopular with
its stakeholders. Consumer support is low since consumers feel that the sales
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Chapter Seven – Public Relations
staff do not know their products well, and are unable to give reliable advice
on which bikes to purchase. Suppliers find that there are unnecessary delays
in completing transactions when selling bikes to the business. Financial
institutions are unhappy and unwilling to finance Radebe Motors’ clients, as
the sales people do not complete the application forms promptly and accurately,
resulting in delays in financial transactions.
In the case of Radebe Motors, more than one programme must be developed.
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The first is a programme to make sales people aware of the effect they
have on the image of the business. They need to be trained in product
knowledge, giving quotes, completing application forms for finance and
completing purchase transactions with suppliers promptly.
The second is a public relations programme to repair the image of the business
and convince clients the business has overcome its service problems.
The stakeholders to be addressed are the consumers, suppliers and financial
institutions in Soweto. These stakeholders are broadly representative of the
community as a whole, since any member of the community is a potential client
or supplier of business. The message to be conveyed to these stakeholders is that the
business has changed completely, and now focuses on the needs of the consumers,
suppliers, financial institutions and other members of the community.
A very important aspect that should be given attention when developing
a public relations programme is the instruments and the media that will be
used to reach the respective publics. We must take note of the fact that the
public relations programme must be cost-effective. Maximum results must
be achieved with the available funds. Public relations officers must carefully
consider which instruments and media the business can afford. Examples of
instruments that can be used are publicity and advertisements, and the media
that can be used are radio, television, newspapers and the Internet.
7.10.2 How to draw up an action plan
Effective public relations involves deeds as well as words, and strong
programmes can be built only on solid and consistent action. Ideally, action
and messages work hand in hand, complementing each other as the business
interacts with its stakeholders. This step of the planning process will focus
on decisions about action strategies to achieve the objectives. After careful
consideration has been given to the aspects discussed, an action plan must be
drawn up. A programme cannot be executed successfully without an action
plan that clearly indicates what must be done when, and by whom. The action
plan sets out what must be done (each step must be described in full), the order
in which the different steps must be executed, the time that each step will
take, and the date on which it must be completed. It should also indicate to
whom feedback must be provided after each step has been completed, so that
the programme can be managed successfully.
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Business Management: A Contemporary Approach
7.10.3 Implementing the action plan
Once the action plan is in place, it needs to be implemented. Turning the
inventory of tactics into a logical and cohesive programme is the most important
of the many factors that need to be considered in the implementation of this
step. The public relations manager must ensure that the steps are completed by
the planned date, and that the right people complete these steps in the right
way so that the planned objectives can be achieved.
7.10.4 Evaluating the success achieved with the action plan
The programme evaluation is the systematic measurement of the outcomes of
a programme based on the extent to which stated objectives were achieved,
and also whether the programme added value to the corporate image of the
business. The latter aspect is particularly difficult to measure. The value
that a specific programme adds to the corporate image of a business is not
always visible, and the different public relations programmes gradually build
the image of the business. Regarding specific objectives, formal measuring
instruments can be used in certain instances to determine the success of a
specific project. In other cases informal observation is sufficient. Examples
include questionnaires sent out to stakeholders, as well as telephonic or
personal interviews to determine whether the objectives of the programme
have been achieved.
In the case of Radebe motors the business must determine whether:
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the sales people are aware of the effect that they have on the image of the
business, and whether their product knowledge and ability to complete
forms are sufficient;
the stakeholders of the business are convinced that the service problems
experienced at Radebe Motors have been eliminated;
the image of Radebe Motors has been restored in the eyes of its publics
(communication objective); and
the clients of Radebe Motors believe that the business has turned the
corner and will now focus on their needs.
7.10.5 Revising the action plan
The revision of the public relations programme has to do with establishing if
the set objectives have been achieved. If found that the objectives, as initially
set, have not been achieved then the programme must be changed. The steps
in the action plan can, for example, be changed if it is found that the original
objectives were unrealistic. This entails planning from the beginning, or the
whole exercise will have to be undertaken again.
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Chapter Seven – Public Relations
7.11 Instruments of public relations
When developing the public relations programme it is vital that consideration
be given to the instruments that are to be included in the action plan. In
considering the various instruments for inclusion in the action plan you need
always bear in mind:
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the communication objectives;
the stakeholders or contact points;
the message; and
the costs associated with each instrument.
It should always be kept in mind that the best instrument for a particular
contact point is the one that conveys the public relations message in the most
effective way, given the availability of funds for the programme.
7.11.1 Publicity
The news media generally reaches large audiences who may encompass most
residents of a particular community, most members of a certain profession, or
most people who are seriously interested in a particular topic. Thus publicity
can further an organisation’s pursuit of awareness objectives.
The publicity that can be generated is free. No price tag is associated with
publicity. The impact of publicity has two dimensions. On the one hand, there
is added credibility associated with positive publicity. On the other hand,
publicity can be negative and thus damaging to the business. In the past, large
commercial banks received negative publicity due to the fact that some of their
high-ranking officials were involved in fraud that was reported in the media.
The public relations officers of the organisation must strive for good publicity.
This is possible only by making an occasion newsworthy and bringing it to the
media’s attention, but miracles cannot be expected. Negative publicity should
be avoided at all costs. However, when this does occur, a concerted effort
should be made to restore the image of the business in the eyes of the public.
7.11.2 Advertising
The power of advertising is limited to persuasion. It cannot coerce or force
consumers. Used skilfully, advertising may stimulate audience predisposition
to buy a product, use a service or accept an idea. Advertising has proven itself to
be economically efficient at persuasion, because it works on the principle that
you attract more bees with honey than with vinegar. Most advertising is used
for marketing purposes: to sell a particular product or service, or to position a
particular brand in the minds of its customers. However, advertising in public
relations is used to market the image of the business. The advertisement will
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therefore not focus on the business products and/or services, but on the image
the business wants to project to its publics.
Advertising is associated with costs. Sometimes the marketing and public
relations functions work together. When a new product is launched, the public
relations function can help gain consumer acceptance of the product. The
public relations function will place advertisements that promote the image of
the organisation, whereas the marketing function will place advertisements
that market the new product. Advertisements aimed at building up the
organisation’s image are called prestige advertisements. They have to do with
persuading the receiver to take a certain standpoint on an issue of general
concern, inform the stakeholders of the business aims and policy, and thus
create a positive image, aimed specifically at the public which indirectly elicits
their goodwill.
7.11.3 Publications
Public relations can use a variety of publications for specific purposes, and
on different occasions. Any publication that is distributed by an organisation
must be attractive and interesting. Information should be brief and concise, in
a clearly understandable language. Illustrations or photographs must be clear.
Typical publications include:
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„„
serial publications such as newsletters and bulletins;
stand-alone publications such as brochures, fliers, booklets, folders,
pamphlets, tracts or circulars; and
progress reports such as annual reports, quarterly reports and research
reports.
We will look specifically at the role of annual reports and newsletters in public
relations.
7.11.4 Corporate publications
Annual reports are publications required by public companies as a way of
documenting fiscal soundness and chronicling the year’s events. Many privately
held companies and non-profit organisations also produce annual reports,
although they are aren’t required by law to do so. Whether public, private or
non-profit, many annual reports seem to have one thing in common – difficult
language. They have become a very important instrument in the past few years.
Businesses compete to publish the most attractive annual reports containing
articles on the results, activities and prospects of the business.
The public relations function is usually involved in the panning and distribution
of annual reports because they are involved with the business image. The
financial function is responsible for making sure that the figures in the annual
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Chapter Seven – Public Relations
report are complete and correct. Public relations also decides to whom the
annual reports should be distributed, and where the extracts will be published.
Businesses often find that annual reports are a convenient vehicle for attracting
new customers by demonstrating the work they have previously undertaken.
They also enhance the business’s reputation with financial analysts and the
financial media.
A Newsletter is the organisational publication that combines the informative
approach of newspapers and magazines with the relationship-building feature
of mail. We distinguish between internal and external newsletters.
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Internal newsletters are intended for internal consumption by staff.
Reports are usually personal and are written in a confidential style.
Preferably, it should be distributed to employees and not shareholders or
clients. Newsletters are an important form of communication between
employers and employees. Their purpose is to inform employees of the
activities and policy of the business and also to build team spirit. Some
businesses use digital media, like email, to convey their newsletters.
External newsletters are published to inform the public of the activities
of the business and staff. This information must be made known to the
staff as well. These newsletters can make a significant contribution to
staff recruitment, because they convey a good image of the business as an
employer, attracting professional, qualified and competent people who
like to be associated with a reputable business or organisation.
7.11.5 Spoken word
The main purpose of the spoken word as a medium is to exchange information
or to make decisions. The spoken word is used in public relations and face-toface communication.
When managing a business, employee communication takes place on a daily
basis. This communication can take place either in person or via telephonic
conversation. Managers, as well as other employees, often make presentations
using the spoken word in meetings and seminars. Communication also takes
place through the grapevine – an informal method of personal communication
for passing information from person to person, regardless of whether this
information is true or not. How the communication is done has an effect on the
image of the business. It is essential that all members of the business are trained
in communication to be professional, polite, friendly and competent about the
organisation’s product/service, and to be effective in their communication.
It is essential that the communicator and the receiver speak the same
language in order for them to understand each other. In South Africa there
are eleven official languages, which can make it difficult for communication
to be effective.
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Business Management: A Contemporary Approach
7.11.6 Photographs
Photographs are very important instruments of the public relations function.
Photographs require technical skill and a fine sense of art. Photographs are
useful in attracting a reader’s attention in publications such as staff journals.
A number of businesses use photographs in their annual reports to make them
attractive and interesting. Many advertisements use photographs to attract the
attention of their stakeholders and to convey the business’s messages to the
stakeholders effectively.
7.11.7 Press conferences
Press conferences, usually organised and managed by the public relations
department, are special events that afford the business an opportunity to
communicate with the public through the mass media. Both the spoken and
written words are used at these events. News reporters usually get a copy of a
specially formulated statement made by the spokesperson, after which questions
are allowed. This is followed by a news report in the mass media. Publicity is
then gained by the organisation.
7.12 Media for conveying public relations messages
A variety of media can be used to convey the public relations message to contact
points. A spokesperson needs to be appointed in order to prevent ordinary
employees from freely communicating with the media. The media that will be
discussed are print media, broadcast media, the public, the community and the
Internet.
7.12.1 Print media
Although the Internet and intranet have replaced printed publications in many
organisations, magazines and newspapers can still be powerful public relations
tools. In choosing the best print media you should consider:
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„„
circulation figures (the number of people who buy or receive the
newspaper);
target group;
contact points; and
costs and available funds.
7.12.1.1
Newspapers
There are a variety of newspapers available – morning, evening and Sunday
newspapers in urban and most rural areas. National newspapers such as The
Sowetan, The Sun, Sunday Times and Rapport are examples of newspapers that are
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Chapter Seven – Public Relations
read by thousands of people. Local newspapers are distributed in only certain
regions or towns. The Citizen and Beeld are read mainly by people living in
Gauteng, while Pretoria News is distributed mainly in Tshwane.
Newspapers can also be classified according to size and frequency of
publication. There are broadsheets and tabloids. Broadsheets are the traditional,
large-page newspapers, such as The Sunday Times. Tabloids, such as The Sowetan,
are smaller. Regarding frequency of publication, newspapers can be divided
into daily and weekly newspapers.
Daily newspapers appear five, six or seven times a week, or even twice per
day. Examples are The Sowetan, Beeld and Pretoria News. They appear twice a
day in an early and a late edition. News reports are rigorously selected and it is
by no means easy for a public relations department to get their press releases
accepted.
7.12.1.2
Magazines
There are also a great number and variety of magazines that appear weekly,
fortnightly or monthly. The different types of magazines aimed at particular
readerships include:
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general magazines;
magazines aimed at a particular section of the public;
specialised publications; and
professional journals.
Some of the advantages include the fact that magazines:
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„„
allow for a greater depth of treatment than many other media;
permit more vivid and attractive layout;
enable writers to compose messages for specific target publics;
are usually printed on glossy paper and use a great deal of colour and
photographs; and
have a longer lifespan than newspapers, which are often bought, read
and thrown away on the same day.
Magazines that can be classified as business publications include occupational
journals, trade journals and company publications. Some publications, for
example Mining Weekly, target specific industries. While niche magazines like
Satlwater Girl or Leadership are aimed at a specific age and gender, or even race,
some general magazines, such as You and Huisgenoot, are aimed at a broad
demographic. These contain a wide variety of articles on current affairs,
celebrity news and lifestyle.
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7.12.2 Broadcast media
The most effective method of conveying a message combines sight and sound.
7.12.2.1
Radio
Radio listeners are more involved owing to the use of the human voice, which
utilises their sense of hearing. Radio is a powerful communication medium,
because there is a radio station for virtually every population group and
language. Radios are affordable, and messages promoting the corporate image
can therefore reach almost every member of the South African population, no
matter what their language.
The reception areas of the regional radio services, such as Khaya FM or
Jacaranda (Gauteng), are far more limited than the national radio stations such
as Metro or 5FM. There are independent radio stations that are not controlled
by the SABC, such as Radio 702. Regional radio services are more affordable
than national radio stations. A business therefore, if it decides to use radio as a
medium to reach its contact points, must investigate the various radio stations
to determine which one will reach its contact points in the most effective way,
taking into consideration the availability of funds.
7.12.2.2
Television
Television has a unique advantage in that it uses two senses, ie the sense of
hearing and sight. Viewers can hear the message (words, music and other
sounds) and see pictures. Television is without doubt a persuasive and powerful
medium of communication, not only in terms of the number of viewers, but
also as a result of the impact thereof. However, it is very expensive.
7.12.3 Video
Video, by which we mean DVDs and downloadable or streamed content, play
an important role in public relations. Corporate videos are used by many
organisations to showcase their products or processes.
7.12.4 Special events
Exhibitions, launches and open days are occasions that present opportunities
for communicating messages. The arrangement of such events is a responsibility
of public relations.
7.12.4.1
Exhibitions
The main reason for attending an exhibition is to introduce the business’s
image, products, services or projects to the public, and to interact with existing
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Chapter Seven – Public Relations
and potential customers. Exhibitions enable the business to meet many people
within a short time. Before the business decides to participate in an exhibition,
it must decide if the purpose of this participation is to promote the image or to
promote sales.
7.12.4.2
Launches
Businesses often use some type of occasion such as the opening of a new
shopping mall or the release of a new film to entertain stakeholders. These
occasions are accompanied by a fair amount of advertising and publicity. It is
important for public relations to ensure that these occasions are well organised
and stylish, so that a professional impression is created. The primary objective
is usually to further the image of the business rather than to promote sales.
7.12.4.3
Open days
Another way in which the business can meet its stakeholders is through inviting
them to visit the business. Groups of students, scholars, business people or
members of an association are invited to visit the business. Visitors are often
given a small token ranging from a brochure, CD’s to a useful article containing
the name and/or logo of the business. Visits are usually encouraged because they
create opportunities for the business to give information that will foster goodwill.
7.12.5 Community outreach
Businesses use community outreach to show stakeholders that the business
takes an interest in the community and the environment. To meet this
requirement, publicity must be used to inform stakeholders of the support
a business gives to its community. Financial support to the community may
be direct or indirect. Direct support is given through bursaries, sponsorship
and donations to sport, cultural, educational institutions and place-of-safety
institutions such as orphanages. Indirect support is given through the
provision of office space and equipment at a nominal rate, or even facilities
made available for free by, for example, offering premises to be used for church
services over weekends when the facilities are not in use by the business.
7.12.6 Internet
The digital world is forcing organisations to react to change, and giving
them the tools to stay abreast. In the last 20 years, the two most important
communication innovations to affect organisations have been the personal
computer and the Internet. Now, through the digital convergence revolution,
organisations are combining older, traditional mass media and newer cellular,
satellite and radio technologies to create a whole new communication
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Business Management: A Contemporary Approach
environment.10 PR professionals need to understand how the widespread use
of smart phones, tablets and laptop computers has changed the way people
communicate online.
The Internet is used to exchange information between individuals and
organisations through the World Wide Web, which stores information on
computer servers throughout the world. The World Wide Web has developed
into an excellent public relations instrument for the organisation. An
organisation with access to the Internet must ensure that the image reflected
by its home page, and the way in which the rest of the information is made
available on the Web, is professional and attractive. Subscribers across the world
can obtain information through their computers, and they can send messages
through email. They can also order products from a business by filling in an
order form and providing their credit card details for payments.
The Internet is a relatively inexpensive medium. Its main advantage is
that millions of subscribers throughout the world have 24-hour access to
information on the organisation and its activities. Public relations must ensure
that they are using the Internet to the benefit of the organisation.
7.13 Interaction between the public relations and other business
functons
7.13.1 Public relations and general management
General management involves being responsible, on a day to day basis, for the
direction of a business, or part thereof, against the backdrop of an increasingly
global marketplace and how the business achieves and sustains a high level
of success.
Large businesses usually have managers in each division who are responsible
for the management and successful functioning of the different functions.
These tactical managers normally report to a general manager, or directly to
the managing director (chief executive officer) of the business. The managing
director is ultimately responsible for ensuring that the business achieves
its strategic goals, and that its survival is assured. The managing director
cannot manage the business functions alone so he or she relies heavily on
the managers responsible for the functions, including the public relations
function. The public relations manager will therefore assist the chief executive
officer or managing director in promoting the corporate image of the whole
business/organisation.
7.13.2 Public relations and the administrative function
The administrative function does not generate an income for the organisation.
It renders a service and provides specialised support to individuals and
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Chapter Seven – Public Relations
other organisational functions, such as public relations, allowing these
functions to be cost-effective. Administrative management deals with the
establishment of systems, procedures and techniques to collect, classify and
process information, and make it available in a usable format. An example
would include the provision of a report to people who require specific
information for decision making and strategic planning. Communication
can take place in two ways, namely written and oral. Written communication
may be in the form of memorandums, reports and press releases, while and
oral communication takes place during meetings, discussions and telephone
conversations. Public relations can support the administrative function,
especially with regard to written communication. Public relations can also
assist in presenting reports in an interesting way so that they make a good
impression on the readers as stakeholders.
7.13.3 Public relations and the human resource function
The human resource function is a crucial element in organisational
success. Human resource management strategies should be integrated with
organisational plans, and should be in line with the broad organisation strategy.
Human resource strategies should clearly demonstrate the organisation strategy
regarding people, profit and overall effectiveness. Working conditions and
general welfare of employees are the responsibility of the human resource
function. They are also responsible for the recruitment and selection of
applicants to determine which are suitable for the positions in questions. It is
also the duty of the human resource function to ensure that new employees
follow a thorough induction programme so that they can orientate themselves
within the business. Furthermore, the human resource function is also
responsible for the remuneration and training of employees.
It is important to bear in mind that the employees of the business are very
important stakeholders, and have a major influence on the corporate image
projected by the business. Employees live in specific residential areas and form
part of local communities. Therefore, their opinions about the business carry
authority within their communities. Public relations can help the human
resource function by publishing a staff newsletter or email that informs
employees about events that are happening, both inside and outside the
business, and that keeps them abreast of strategic plans and activities. When
new employees are appointed, they can be provided with information on the
corporate image of the business.
When industrial unrest occurs and members participate in actions such
as strikes, public relations will be responsible for press releases issued to the
media.
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7.13.4 Public relations and financial function
Financial management is the art and science of obtaining enough finance
for an organisation at the lowest costs, investing in assets earning a return
greater than the cost of capital, and managing the liquidity and solvency of
the organisation. A public relations programme cannot be launched without
funds. The finance function deals with the budget, costs, profit and cash-flow
of the business. It is important for the public relations manager, together with
the financial manager, to budget for the public relations programmes. When
the budget for a specific public relations programme has been finalised, it is
the duty of the public relations manager to see to it that the implementation of
the programme remains within budget. If the budget is exceeded, the manager
must explain the reasons for the overspending to the financial manager. The
public relations manager must therefore apply effective budgetary control.
7.13.5 Public relations and the marketing function
The marketing function is central. It:
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is the bridge between an organisation and its environment;
brings into contact the business and its market/consumers;
provides an important input in the development of the organisation’s
mission and strategy; and
helps correlate the resources of the market with the demand of the market.
Public relations focuses on metaphorically selling the business to promote the
corporate image, whereas marketing focuses on literally selling the products
and services of the business to increase turnover. Public relations can work
together with marketing in promoting both the business and its product. As
an example, if a motor manufacturer launches a new car, a glamorous banquet
can be organised at a hotel or at the dealer’s premises. Representatives of banks
that provide car finance, as well as other interest groups can be invited to the
banquet. The aim is to introduce the new car to these stakeholders, and to
promote the image of the organisation in the eyes of these interest groups by
making the occasion a grand one. Arranging the function, reserving the venue,
drawing up the menu and wine list, preparing the programme and all other
activities surrounding the occasion will be carried out by the public relations
function. The marketing function can also contribute to the promotional
event by handing out brochures on the new car at the event, and a car display
can be created with marketing representatives to answer the questions of the
dealers and other stakeholders.
When the marketing function launches an advertising campaign to advertise
the products and services of the business, it is important that the advertisement
be designed in such a way that it supports the corporate identity of the business.
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Chapter Seven – Public Relations
It is therefore important for public relations to work together with marketing
when planning major advertising campaigns to ensure that their activities are
in synergy.
7.13.6 Public relations and operations function
The operation function is that function of the organisation aimed at executing
the transformation process. The operations function, as well as the management
thereof, is directly involved with the creation of products and the provision of
services in order to realise the objectives of the organisation. The quality of its
products and services affects the corporate image of the business. If the public
relations function becomes aware of quality and service problems that have a
negative effect on the corporate image of the business, these problems must
be brought to the attention of the operations manager so that they can be
addressed and solved.
The way that the business disposes of waste can have a negative effect
on the business environment. If hazardous waste and refuse are disposed
irresponsibly, resulting in damage to the environment or a threat to the health
of the community, the corporate image of the business will be negatively
influenced. The operations function must therefore ensure that these problems
are prevented through the responsible disposal of waste. This forms part of the
business’s social responsibility towards the environment in which it operates.
7.13.7 Public relations and purchasing function
The purchasing function entails the planning, organisation, leading and
controlling of all activities relating to the purchasing of materials and services
from an external source. It is aimed at maintaining and increasing the business’s
profitability and efficiency of customer service. The purpose of purchasing
is to get raw materials and components of good quality and quantity at the
lowest possible costs. If these inputs are not delivered on time, the production
process will come to a halt, causing the loss of valuable production time. In
extreme cases production may be delayed, orders may be delivered late and
dissatisfaction may arise among customers. Good relations with suppliers will
ensure that the business can rely on suppliers to deliver correct orders for raw
materials and components at the agreed time.
Public relations can support the purchasing function in building good
relations with suppliers. The public relations function should regularly arrange
social events such as golf or soccer days, to which representatives and suppliers
are invited. In this way the purchasing staff can introduce themselves to the
representatives, and build sound relations to ensure that these individuals can
be relied upon in both normal and extraordinary purchasing situations.
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Business Management: A Contemporary Approach
Efficient purchasing also promotes the internal image of the business. If
activities are delayed by inefficiencies, a feeling of frustration and a negative
impression may be created among staff.
7.14 Summary
Public relations is a tool that can be used to support and maintain the positive
image of the organisation with its many publics. The primary objective of public
relations is to promote the corporate image of the business in such a way that
there is a healthy relationship between the business and all interest groups
(publics). Therefore, the corporate image of a business has a major effect on its
success and survival. A revised public relations programme should be created if
it is found that the corporate image of the business is not acceptable. When an
action plan for a public relations programme is developed, it is essential that
the correct instruments are used to convey the right message to the identified
contact points. In order to make the correct choice, the public relations officer
must have a good knowledge of each instrument, and the costs associated with
each one.
The various media that could be used to convey the correct message to its
stakeholders were discussed. These media include print media, broadcast media,
the public and the Internet. Each media has certain advantages, disadvantages
and cost implications that must be considered when choosing a suitable media
for a particular programme. The best media for a particular contact point is
one that conveys the message in the most effective way, given the cost of the
media and the funds available to finance the programme.
Public relations does not operate in isolation. The activities of this business
function affect the activities of all the other business functions, and vice versa.
It is therefore very important for the public relations manager of a business to
understand the interdependency between the public relations and the other
functions to ensure the success and survival of the business.
7.15 Self-evaluation
Case study
The success story of Sipho
Background: Phumelele Tours and Transfers
Phumelele tours and transfers are based in Orlando West Soweto. It offers
personalised chauffer and transfer services in and around Johannesburg. The
company also offers personalised local tours of Soweto and local attractions
such as Lesedi Cultural Village, De Wild Cheetah Farm, the Apartheid Museum,
and many more. Tours can also be booked to out-of town places of interest such
as Pilansberg, Sterkfontein Caves, or the Kruger National Park.
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Chapter Seven – Public Relations
To drive a dream
The shiny black Chrysler 300 pulls smoothly into a parking bay, glistening in the lazy
afternoon sunshine in downtown Jozi. Inside sits Sipho, a proud owner and director
of Soweto-based Phumelele Tours and Transfers.
Life wasn’t always so peaceful for this soft spoken soccer fanatic, who only
five years ago was staring unemployment in the face along with millions of
South Africans. His story is remarkable – a tale of perseverance, endurance and
passion, underpinned by an undying love for soccer.
Sipho, an ardent football fan, knocked on the door of the South African
Football Association (SAFA) for employment as a driver. Unfortunately, SAFA
couldn’t accommodate him on their payroll as all vacancies were full. He
just wouldn’t take no for an answer, and his luck turned when SAFA urgently
required a driver to transport dignitaries when France toured South Africa
in 2001.
Sipho went on to become a full-time driver for SAFA, going on to specialise
in protocol. His skills with handling dignitary transfers earned him the right
to accompany the South African delegation to Zurich to present the 2010
world cup bid. He also earned the honour of chauffeuring the FIFA world cup
committee on their reconnaissance visit to South Africa.
‘I knew that I had to do everything right for the delegation,’ says Sipho. ‘I was their
interface with South Africa, and I had to make sure they receive the best impression
of our country by ensuring that their tours arrived on time, that their luggage was
always where it was supposed to be, and that they were comfortable.’
He realised, through his 2010 experience, the massive opportunity there was
for entrepreneurship in the tourism and hospitality industry. ‘I had a vision of
starting Phumelele tours and transfers so I worked hard to save R40 000, which
I used to buy my first Chrysler bus,’ says Sipho. Operating Phumelele Tours
and Transfers from his home for the first year, he was able to land some hefty
backing from ABSA bank which helped him expand his fleet from one Chrysler
bus to three Voyagers, two Toyota Quantums and a 300C.
‘ABSA Incubator Fund assisted me in growing my business, and I now have a fleet of
five vehicles and five fulltime drivers, a secretary and a cleaner. In addition they have
provided me with valuable input and advice on how to manage and grow my business
in a sustainable way.’
Phumelele Tours and Transfers is now accredited with the South African
Tourism Services Association (SATSA). ‘I need to ensure my team is trained to
the highest level and we have all the relevant licenses and permits in place,’
says Sipho of his accreditation.11
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Business Management: A Contemporary Approach
Present
Sipho is also involved in community engagement. He helps destitute families in
the area next to his business and surrounding areas. He also provides his cars
to ferry mourners to funerals in the area. He often has visits and exhibitions at
his business premises in order to connect with the stakeholder and expose his
businesses.
Sipho, a young man from Soweto, has pushed against the tide to make it
in life, breaking boundaries and doing the impossible. He recently opened a
restaurant in the most famous street of Soweto called Vilakazi Street – a street
that boasts the two world-renowned icons as former residents, namely the late
Nelson Mandela and the archbishop Desmond Tutu.
Future
Phumelele Tours and Tourism has extended the business to the Bed & Breakfast
business. Sipho aims to have many such businesses by 2017.
Scenario
Sipho would like to expand his business to operate a new tourist attraction in
Ekhurhuleni and to open a new B&B in 2015. He also intends expanding his
businesses to more areas by 2017. He will, however, be based in Sandton.
Questions
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Define public relations and explain its primary objectives.
List three stakeholders that Sipho should consider and explain why each
is important to his business.
What are the characteristics of a business with a good image?
Help Sipho define a contact point, and identify three contact points that
can be reached by means of a public relations programme in his business.
Explain to Sipho what is meant by ‘successful communication’.
Sipho must inform his stakeholders of the new tourist attractions in
Ekhurhuleni. Explain to him the factors he must consider when choosing
the type of newspaper for informing his publics.
List the requirements of publications to Sipho.
Discuss the role of photographs in a public relations programme for
Sipho.
Explain to Sipho how he can use the public to promote his business’s
image.
Explain to Sipho what the Internet is, and how he can use this medium
in his public relations activities.
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Chapter Seven – Public Relations
References
1.
2.
3.
4.
5.
6.
7
8.
9.
10.
11.
B Lubbe & G Puth, Public relations in South African: management reader, 6th
edition (Isando: Heinemann, 2000) pp. 17–20, 61–73.
Public Relations Institute of southern Africa, About Us [online] available
at www.prisa.co.za (accessed 29 July 2014).
E Hoffmann, D Farrell, N Lilford, M Ellis & M Cant, Operations management
for contact centres (Cape Town: Juta, 2007) pp. 327–333, 344–366.
C Nieuwenhuizen, Business management for entrepreneurs, 2nd edition
(Cape Town: Juta, 2007) pp. 242–243.
E van Staden, S Marx & L Erasmus-Kritzinger, Corporate communication;
getting the message across in business (Pretoria: Van Schaik, 2002) pp. 13–15.
G Mersham, & C Skinner, New insights into business and organisational
communication (Sandown: Heinemann, 2001) pp. 13–14, 150.
Van Staden, Marx & Erasmus-Kritzinger, op. cit., pp. 13–15
C Williams, Effective Management. A multimedia approach, 5th edition
(Canada: South-Western, Cengage, 2012) p. 434.
RS van Rensburg & MC Cant, Public relations: A South African perspective.
(Sandown: Heinemann, 2009) p. 208.
Mersham & Skinner, op. cit., p. 150.
Adapted from ABSA Bank, ‘Phumelele Tours and Transfers’, Abacus
Magazine, October 2006.
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CHAPTER
EIGHT
Operations Management
Prof Rigard J Steenkamp
Learning objectives
When you have completed this chapter you should be able to:
„„
„„
„„
„„
„„
„„
„„
„„
„„
„„
define OM and understand the importance of OM for any organisation;
understand the nature and dynamics of OM;
link OM with creativity, design, technology and innovation;
explain the essence of OM in terms of value and time;
understand OM as the transformation function;
distinguish the different OM systems in terms of the types of operations;
understand the concepts of OM in terms of process management;
explain OM in terms of productivity and the performance objectives;
understand operations strategy;
explain OM planning and control in terms of demand management and capacity
management;
„„ explain OM planning and control in terms of techniques used for forecasting,
inventory management and scheduling; and
„„ understand the OM body of knowledge in terms of project management, TQM and
SHE management.
8.1 Introduction
The aim of this chapter is to establish a learning foundation for what is known
as operations management (OM), or production and operations management
(POM). The broad definition of POM is all those value-adding actions, activities
and processes needed for the fulfilment of customer expectations, requests
and needs. Making products and providing services is the ultimate purpose of
business so all managers are, in fact operations managers. This chapter focuses
on general OM terms, core concepts, principles and functions.
We are created to be creative. Operations management (OM) is challenging
and satisfying because it creates all valuable, therefore sellable, things, and
everyone lives by selling something. OM, therefore, is for those who want to
be creative and make things happen, and not for those who just dream, watch
things happen and wonder what happened.
OM passed through several historical stages of development. Stone-age
implements used for food production became more refined over time, and
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Chapter Eight – Operations Management
later metal was used to make tools for processing food and making clothing
and shelter. This phase overlapped with the development of more modern
craftsmanship, including weaving and pottery. Copper and bronze ushered
in a new era of metallurgy – the Bronze Age – and today we use platinum
for computers and jewellery. Private property was introduced, and laid a
foundation for a free-market economy.
OM has its origins in the Industrial Revolution. Adam Smith, for instance,
was known for his emphasis on the specialisation of labour. Frederick Taylor,
Henry Gantt and Frank Gilbreth are among the prominent contributors to OM.
Henry Gantt devised charts for scheduling and Frank Gilbreth (and his wife,
Lilian) used time-and-motion studies. Taylor used process analysis, Shewhart
used statistical sampling and Deming applied other statistical methods. The
list goes on. The first OM textbooks were written in the 1950s by Robert Fetter
and Elwood Buffa. In the last 100 years, production management has evolved
from a set of newly discovered ideas to a portfolio of developed and integrated
concepts. Frederick Taylor is the father of scientific management with the accent
on the efficient use of time in the workplace. His time studies were taken to the
Midvale Steel Company where he tried to discover the relationship between the
horsepower a man exerts and the tiring effect that this work has on a worker.
Frank Gilbreth is another pioneer in scientific management. As a bricklayer
and building contractor he became interested in saving time by studying
needless, ill-directed and ineffective motions in the construction process.
In his most famous study, he analysed the motions of some bricklayers,
and reduced them from 18 to five, and more than doubled a bricklayer’s
productivity without the need to increase his effort. Today, we still learn from
these pioneers, as value and time become increasingly important.
The principle of mass production was invented in ancient Egypt, and the
wealth earned by this led to the founding of the great Egyptian nation state.
With the advent of the Industrial Revolution in the 19th Century, a new factor
of production began to emerge, namely industrial technology. Centres of
wealth and power shifted to the factory and the industrial sector. In the 20th
Century, production began to flourish with the invention of electricity, the
internal combustion engine, the steam engine, railways, cars and other means of
transport. Henry Ford was the first to use the assembly line to mass-produce the
Model-T Ford.
It is clear that economies are dependent on these inventions. No small
or large business can be a business without a value-added operation.
Unfortunately many operations are not safe and healthy to its employees and/
or the environment. Quality output cannot be regarded as such if human
beings and other resources are at risk during and after the production process.
OM therefore also focuses on the science of OHS (occupational health and
safety). Business management centres on OM and without this function no
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Business Management: A Contemporary Approach
other business function is possible. This is emphasised through the devotion
of various qualifications to the concept of OM at many tertiary educational
institutions in South Africa. The following section elaborates on the importance
and dynamics of OM.
8.2 Operations management is dynamic
Pycraft et al1 provide several reasons why operations management is regarded
as dynamic. The first is its importance in terms of adding value and creating
products and services upon which we all depend. This is the very reason for any
organisation’s existence. Secondly, OM is also exciting in terms of creativity and
the changes in customer preferences. OM therefore contributes to promoting
creativity and building capacity and capabilities that will allow organisations
to respond to so many changes.
8.2.1 The nature of operations
Any machine, factory, workshop, plant, assembly line or combination of these
is associated with an operation. By definition, an operation is something (also
referred to as the technical core) that produces, works, is in action and has a
value-adding effect. The operation of anything relates to a movement, planned
campaign, piece of work, project or something that works. Any event, activity
or process where inputs are changed, improved, converted, transformed
or assembled to a planned, designed or anticipated output is an operation.
Stevenson2 provides a simple definition for an operation by referring to it as the
core or the ‘engine’ of the organisation. Operations management is responsible
for managing that core. No car, business or institution of any sort can exist
without this ‘engine’ – needless to say; engines differ in size, effectiveness,
power, speed, efficiency, and so forth. If an operation is creative and possesses
these characteristics, it is also certainly dynamic.
8.2.2 Creativity is always linked to operations
Operations management (OM) gets as close as we can in business life to the act
of creation. It is concerned with creating the products and services upon which
we all depend. OM is about change, creativity, value adding and productivity.
Since this is the very reason for any organisation’s existence, operations
management should be at the heart of its affairs.
Operations management involves:
„„
„„
„„
„„
„„
product and service design;
demand and capacity planning;
production system design;
production planning and control; and
improvement, problem solving and maintenance.
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Chapter Eight – Operations Management
All managers, irrespective of their job title, create products and services for
customers. In that sense all managers are operations managers. Slack et al3
state how challenging OM is becoming. Managers have to find solutions
to technological and environmental challenges, the pressures to be
socially responsible, the increasing globalisation of markets and knowledge
management.
Humans are creative beings, talented and commissioned to create and
recreate. This attribute is important to overcome all the operational challenges
of this imperfect world. Creative ideas can have a large impact on operations –
on processes, concepts, product packages, systems, technology, infrastructure,
layout, resources and combinations thereof. If simple techniques, like learning
to think and innovate, can generate ideas causing significant savings or
improvements, then one can understand why OM is associated with the
excitement experienced by innovative organisations. It can have an enormous
financial impact on a business. Researchers therefore need to live in an
environment in which ideas spawn new concepts, which in turn lead to new
products, patents and technology or system designs that may lead to new
business operations.
All operations have certain process technologies, which assist the
transformation process and make production easier. Here, we refer to all sorts
of machines, alarms, gadgets and gauges to support the primary process.
Trolleys, scales, racks, cleaning tools, mechanical tools, calibration of filters
and machinery setup are a few examples.
Measurement is central to any operation, such as in an inspection process.
Quality demands accuracy, precision, reproducibility and calibration. Some of
the gauges used for inspection are:
„„
„„
„„
„„
„„
digital gauges;
ring gauges (used to measure outside diameters of parts);
line-graduated gauges (eg rulers and tapes);
snap gauges; and
gauge blocks (used as a precision measurement standard for calibration of
other measuring instruments).
8.2.3 Creative design is inherently part of operations
Everything that exists started as a design. Good things come from good designs
and good OM. Conversely, bad things usually originate from bad designs. A
good construction business can hardly build a good house if the design is not
good. If the design of a house is not good, the construction will cause endless
frustration. It is difficult – or even impossible – to improve faulty designs of
products or systems. If the re-engineering of a design is not necessary, the
original design was not too bad. OM therefore includes the science of design.
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Designers must try to design for ease of assembling, joining, coupling and
handling (for example one-way assembly). Other guidelines avoid using special
fasteners and fragile designs. In general, one must design for operability,
quality and cost-effectiveness. The durability of an acrylic product (such as a
custom-made hearing protector) makes it much less costly than a disposable
foam ear-plug over a short period of time.
8.2.4 Operations are associated with technology and innovation
Technology is associated with new gadgets, devices, machines or processing that
make life easier. Technology involves all applicable operations, materials and
knowledge in order to satisfy a need with a view to improving people’s private
or work environments. This includes discoveries and inventions, provided that
they can be applied economically.
In most cases, technology originates when people want to overcome problems,
which leads them to search for a solution. During the research process the
conflict must be managed correctly so that it can lead to the development
of a new way to get things done. Technological innovation follows when an
idea is converted into a usable technique or technical application. Innovation,
therefore, refers to technology that is applied for the first time. Technology
refers to the application of existing knowledge to methods.
To give the business a competitive advantage, the process of innovation
must be managed effectively. Innovation may lead to diversification or
the elimination of some existing products. Innovation, in the sense of the
development of new markets and products, is of decisive importance for the
continued existence and growth of technologically sophisticated businesses.
Rapid prototyping (RP) is an example of a computer-based technology for
quickly building physical prototypes. This technology enables businesses to
move to a superior performance curve in terms of faster service and lower
cost. Davis and Heineke4 list some examples of technology applications for
automation. These are:
„„
„„
„„
„„
„„
machining centres where machine tools are changed automatically as
part of the process;
product design using computer-aided design (CAD);
industrial robots – programmable machines that can perform multiple
functions;
flexible manufacturing systems – facilities that are automated to some
extent, and produce a wide variety of products; and
information system technology in manufacturing – software systems that
help with enterprise resource planning (ERP), supply chain management
(SCM), customer relationship management (CRM) and new product
development (NDP).
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Chapter Eight – Operations Management
8.2.5 Value and time are of the essence for any operation
No factory produces goods for the sake of staying busy, or transforms or
assembles resources just for fun. All operations managers are value driven, a
pursuit during which the worth of all inputs is increased by each transformation
process in the eyes of the next customer in the process. Hence, the focus of this
chapter is on value, and more specifically, on its main dimension, time and the
processes linked by people as value chains.
The purpose of any process is to create, improve or make things usable. Raw
iron has a relatively low value compared to the steel in a vehicle. The economic
value of the output must be higher than the economic value of the input. For
the complete supply chain, ‘value added’ can be described as the difference
between the value of inputs at the beginning of the supply chain and the
product value at the end of the supply chain.5 Stevenson6 defines ‘value added’
as the difference between the cost of inputs and the value or price of outputs.
The essence of any transformation process (be it micro-, macro- or any
manufacturing system) is to add value and eliminate waste. This brings us
to the familiar age-old concepts of productivity, effectiveness and efficiency.
All OM concepts relate to optimising resources, which implies value. Most of
these OM principles relate to the well-known JIT (just-in-time) philosophy.
JIT systems eliminate waste, promote value-adding activities and quality, and
focus on lead time reduction. JIT is also referred to as ‘lean production’ (to
use less of everything and to focus only on adding value). Both JIT and TQM
(total quality management) are seen as part of the same movement to deliver
what the internal and external customer wants. Since TQM is a holistic and
integrative approach to quality, it does not exclude any area of the organisation.
It focuses on all resources, processes, products, functions and other areas; with
several objectives. Quality ‘chains’ and quality ‘circles’ are concepts that relate
to value. A value chain is the ideal series of transformational processes whereby
each step increases the value of an item. OM promotes a systematic approach
(for example value analysis) to reducing the cost of a product without impairing
its quality, value or function. OM also teaches the theory of constraints so
as to maximise flow rate through bottlenecks and constraints. Schonberger
and Knod7 advocate lean production that saves time and space. Principles that
promote value and save time include:
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„„
„„
„„
cutting flow time (lead time, waiting time, etc.), distance and inventory
(subassemblies and idle work-in-process) along the chains of customers;
cutting set-up, changeover, get-ready and start-up lead times;
just-in-time production, or at the customer’s rate of use;
decreasing cycle intervals and lot size;
knowing and teaming up with the next and final customer, who is
referred to as the next process;
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„„
„„
„„
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„„
„„
„„
„„
„„
„„
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committing to continual and rapid improvement in quality, cost, response
time, flexibility, variability and service;
creating a unified purpose via shared information and team involvement
in the planning and implementation of change;
reducing the number of product or service components and operations
(processes), and the number of suppliers to a few good ones;
organising resources into multiple chains of customers, each focused on
a product or service (or customer family); creating workflow teams, cells
and ‘plants in a plant’;
utilising human resource potential and creativity by investing in human
capital or capacity (as the internal customer) and QWL (quality of work
life);
investing in cross-training for mastery of multiple skills;
maintaining and improving present equipment and human capital before
considering new resources;
automating incrementally when process variability cannot be reduced by
other means;
aiming for streamlining and simplicity by making it easy to provide
goods or services without error or process variation;
minimising administration and reporting by recording and processing
one’s own data at the workplace; and
ensuring that process owners and front-line improvement teams have the
first chance at problem solving before experts are brought in.
8.3 Operations management defined
8.3.1 Operations is the transformation function
Some resources are for the transformation process (transforming resources)
while other resources are being transformed (transformed resources). Any
manufactured product we see around us, sit on, eat, read, wear, buy and enjoy
comes to us courtesy of operations managers who planned and controlled the
transformation processes (production systems) involved. It is clear that OM is
a dynamic and creative discipline. Business life is primarily concerned with
creating goods and services, putting operations management at the heart of
its existence. Whether micro- or macro-processes are concerned, students will
realise that all managers directly and indirectly transform resources and create
products and/or services for internal and external customers.
All operations should be value-adding processes in which inputs are
transformed into outputs. The single most important input-transforming
resource is the human component. Human beings act upon transformed
resources, and are present in all operations. Productivity depends directly on
human capabilities (competence, qualification and motivation) to produce
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Chapter Eight – Operations Management
effectively and efficiently. These capabilities must be maintained and sustained.
QWL is one strategy that directly affects operations.
OM deals with the planning and control of the inputs, process and outputs
of operations. Planning and control of inputs refer to transforming resources
(people, creativity, capital, R&D, technology, learning, market information
and feedback) and transformed resources (energy, materials and clients). The
planning and control of transformation systems refer to macro-processes, microprocesses, productive systems (service shops, work centres, assembly lines and
job shops) and process technologies. And the planning and control of outputs
refer to value, goods and services, improvements, new designs, technology,
delighted markets, competitive advantages, sustainability, and so on.
The examples in Table 8.1 provide a better understanding of the
transformation process.
Table 8.1: Examples of transformation processes
Business type
Inputs
Transformation
Outputs
Hospital
Patients,
doctors, nurses,
theatres, rooms,
ambulances,
equipment
Medical
procedures,
therapy, service
delivery,
professional
handling and
care of patients,
application and
administration of
medicine
Improved quality of
life, satisfied clients,
recovered and
healthy patients,
extended life
expectancies
Bakery
Flour, sugar
(ingredients),
equipment (eg
ovens), trained
people (bakers,
knowledge of
recipes)
Food preparation
according to
specifications,
machine set-up,
mix, mould, bake
and pack
Cakes, pies, bread
ready for delivery
Custom-made
ear plugs (eg
Variphone)
Trained
audiometrists,
materials and
equipment to take
moulds, transport
to visit factories,
laboratory
Filters calibrated,
soft moulds are
transformed to
acrylic ear plugs,
filters and cords
assembled, names
embedded, ear
plugs neatly
packed, workers
personally fitted
and seal test done
Workers have
personalised
hearing protectors,
comfortable ear
plugs worn with
ease, protecting
them from noise so
that noise-induced
hearing loss is
eliminated
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8.3.2 Process management is inherent to OM
OM is relevant to all functions of the organisation because all functions manage
processes. In this context, operations refer to an activity, while operations as
a function remains as a part of the organisation that produces products and
services.8 It is therefore important to understand that the transformation process
is not confined to the factory. A process view of the business is important,
because an organisation is only as effective as its processes. Processes cut across
departmental boundaries and this view goes beyond the main manufacturing
process. This nested-process concept reinforces the need to understand the
interconnectivity of all processes and operations in the business. This also
helps people to understand how their small contribution adds value to the
whole operating value chain, which is the cumulative work of all the processes
in the business. Value to the customer at a loss or expense for the business is
not productive, sustainable or profitable. The people in any operation are the
catalyst that makes the whole operation come alive.9
8.3.2.1 Different types of operations systems
Pycraft et al10 summarise the main differences of how operations output vary in
terms of volume, variety, visibility, velocity and variation in demand for output.
Process design is primarily influenced by the volume-variety relationship.
For example, project processes provide low volumes with high variety, while
continuous/repetitive processes provide low variety at high volumes. Again,
where service operations are concerned, professional services offer variety and
low volumes, while mass services offer low variety at high volumes. Operations
that can customise their variety of offerings on a large scale will obviously have
an edge.
Process design, however, should not be optimised at the expense of others.
It should seek strategic fit as building blocks for the whole value chain. This
also implies that particular attention must be paid to interfaces and the need
for cross-functional co-ordination.11
The basic nature of all operational processes is similar in that they transform
input resources into outputs. Processes have the following characteristics that
distinguish them from one another.
„„
The number of items that are produced by the operation over a given
period of time determines the process type. The greater the volume of
items of one type of product that is made, the greater the economies
of scale benefits that may be obtained through standardisation and
repeatability of the process. The most important implication of this
characteristic with regard to the operational process is its influence over
the cost to make a product or deliver a service. This characteristic may
lead to mass production systems such as repetitive production systems.
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The market segment and product range determine the different items
that are produced by the operation. The more types of products (or
greater variety of items) that are made by the same operation, the greater
the flexibility, cost and ability to provide non-standardised products or
services.
Process velocity refers to process performance in terms of the ratio of
total throughput time for a product in terms of the value-added time.
Davis and Heineke12 define value-added time as that time when work is
actually being done to complete the product or deliver the service.
The visibility of output refers to how much of the operation’s activities
the customer/client is exposed to. In high-visibility operations, the
customer/client experiences most of the value-adding activities first-hand
and so must be able to deal with short waiting tolerance. In low-visibility
operations, the customer/client does not have much contact with the
operation itself or no contact at all.
A particular demand pattern for the output of the operation, which may
be highly variable, irregular, non-routine and unpredictable, is another
process characteristic. The important implication of this characteristic
is the possibility of a sudden and dramatic change in the operations
capacity required to supply products and services. Operations likely
to receive seasonal variations (for instance hotel resorts in coastal
locations) must be able to deal with variation in demand levels from
full occupancy during peak season to mostly under-utilisation for the
remainder.
All processes have different lead times. OM always attempts to reduce or
eliminate lead time elements in a process. The primary lead time elements are:
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queue time (the period for which a job stays in the queue at a work centre);
processing time (the actual time needed to process the job);
set-up time (the time needed to prepare equipment for processing a new
job);
waiting time (the idle time between the processing of a job and its
transportation to the next work centre);
inspection time (the time needed to check whether the job complies with
quality standards); and
transportation time (the time needed to transport the job from one work
centre to the next).
8.3.2.2 Process flowcharting
Process re-engineering is defined as the fundamental rethinking and radical
redesign of business processes to achieve dramatic improvements in critical
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contemporary measures of performance, such as cost, quality, service and speed.
In contrast to the continuous improvement approach in which incremental
changes are sought, business process re-engineering aims at radical change.
It is impossible to control or improve quality if the process is not thoroughly
understood. Process flowcharting is an entrenched and powerful technique
used to analyse, describe and display any process clearly, accurately and
concisely. Certain standard symbols are used on the chart. The principle
behind flowcharting is to promote understanding of business processes, which
involves cross-functional interaction and teamwork.
Critical questioning forms part of flowcharting and is used for the critical
examination of existing processes. The aim of the technique is to discover
ways of improving existing process flows by eliminating unnecessary parts
of a job and/or combining, rearranging or simplifying activities in order to
achieve more effective results and reduce waste.
8.3.3 OM performance objectives
Large, well-known companies, such as Mercedes-Benz, General Electric,
McDonalds and Vodacom, are all known for service delivery or other features,
such as quality, speed or cost-effectiveness. These are referred to as performance
objectives. The many dimensions of quality (such as reliability, consistency,
low variability, responsiveness and others) can also be regarded as performance
objectives. Even health and safety becomes ‘core business’ for some business,
for example mines. It could be a strategic performance objective such as to
eliminate noise-induced hearing loss.
What are the main performance objectives? In addition to the quality
objective, operations managers also contribute to business strategy by achieving
world-class status by other means.
JIT (just-in-time) is associated with advantages, such as:
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low lead times;
inventory reduction;
dependability;
speediness;
flexibility; and
low cost and affordability.
The saying ‘there is no such thing as a free lunch’ can be taken as the bottom
line of the trade-off theory. Operations managers must consider trading off one
aspect of performance against another. This trade-off model of performance
has been challenged to give the best of both worlds to the market. The best
example is the quality versus cost trade-off.
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Chapter Eight – Operations Management
The main job of operations managers is to change whatever in the operation is
causing one performance objective to deteriorate as the other improves. So the
trade-off is the mainstay of continuous improvement.
8.3.4 Productivity is central to OM
If a small business manufactures a table ineffectively and inefficiently it has
nevertheless been ‘productive’ in the sense that it actually produced something,
although the output did not fully justify the input. Hence, we need measures
of productivity, since the operations manager’s key challenge will always be to
increase the value of output relative to the cost of input. More output with the
same amount of input increases productivity, but the same level of output using
less input also increases productivity. There are many configurations, but the
bottom line is that sustainable profitability is impossible without productivity.
This means the output value (usable outputs), after being exposed to a uniquely
designed transformation process, must be higher than the value of the separate
pieces of available inputs (resources).
8.3.5 Macro-productivity
Macro-productivity refers to the context of a nation’s entire production. The
gross domestic product (GDP) per capita is the measure of the value of the
total output of a country divided by its total population (seen as the inputs to
produce the outputs). A national economy is made up of individual businesses
and the productivity of the country is the sum of the productivity of all its
individual operations. A macro-perspective on productivity management refers
to the country/economy as a whole and the governance of productivity growth.
The National Productivity Institute offers many suggestions such as:
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infrastructural programmes and investments;
a well-functioning legal and accounting framework, creating a marketfriendly environment;
research and technology support;
promotion of small and medium enterprises;
export trade stimulation;
education and training policies; and
a healthy labour market.
8.3.6 Micro-productivity
Micro-productivity refers to individual business’s operations. It focuses on how
well operations perform in terms of value, effectiveness, efficiency, utilisation,
impact and quality. The first measure is the ability to achieve production.
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Secondly, productivity is measured by means of the following quotient: ‘output
divided by input’.
8.3.6.1 Productivity measurement defined
It is imperative to define productivity correctly. Merely saying it is ‘output
divided by input’ is not the whole story. One can be ‘productive’ without really
producing usable output. In other words, we can have high efficiency, but low
effectiveness. Effectiveness is the ‘how good’ or ‘how valuable’ dimension as
related to market needs. Productivity is, therefore, not only efficiency, but
also the quality of inputs, resource utilisation and effectiveness. These are
terms associated with quality management, which is vital for productivity.
These qualitative improvements in inputs are significant because they create
sustainability, durability and stability, and cause output to increase without any
additional capital or human resource inputs. This brings us to a more accurate
quotient for productivity:
Output income (ie usable output quantity)
= (P) Productivity
Input expenses (ie available input quantity)
Productivity is a complex topic because of the different measures of productivity.
The ability to achieve production is simply not enough. For instance, one may
produce things without having a market to sell them to. An entrepreneur may
manufacture hundreds of items without selling many of them. Suddenly the
ability to produce has a nasty flavour.
If there is a market, then the ability to produce for that given market is
also not enough. This is because the cost of manufacturing may not be costeffective. Another nasty surprise! Thus a productive system must have the
ability to be effective and efficient. Without these it would be difficult to
make sense of productivity. Effectiveness refers to how good the output of
the transformation process is in relation to market needs. This is the value
and quality definition. Productivity is the value of outputs, such as goods and
services, divided by the value of input resources, such as wages, materials and
cost of equipment. Value also has a cost dimension. This means output must
be effective and efficient. The danger is to focus only on efficiency at the cost
of effectiveness.
8.3.6.2 Value-added productivity measurement
The term ‘value added’ also refers to company-wide productivity in terms of
total sales or ways of looking at total wealth created (not only profit, but also
labour costs, depreciation and taxation) through the company’s production
process. This concept is important because it gives the whole picture of labour
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Chapter Eight – Operations Management
costs and how the operation creates and distributes wealth. All the things done
to make the business work boil down to the pursuit of profit, and the bottomline measure is profit after tax. The financial statements (the income statement
and balance sheet) of a business are used as sources of data for measuring
productivity.
8.3.6.3 How to increase or improve productivity
This simple formula of productivity shown on page 254 (outputs divided by
inputs) clearly shows how ‘P’ can be increased. Possible combinations include:
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keeping output the same but reducing input;
increasing output but reducing input; or
keeping input the same but increasing output.
8.3.6.4 External components of productivity improvement
‘External’ in this context refers to factors beyond the control of business
management such as the physical or natural environment, the market and
legislation.
8.3.6.5 Internal soft components of productivity improvement
‘Soft’ refers to intangible (or mathematically indefinable) factors that are
consequently difficult to change. Examples of these are the human resource
component in terms of training, culture and the organisation.
8.3.6.6 Internal hard components of productivity improvement
‘Hard’ refers to tangible (or mathematically definable) factors that are easy to
change. Examples are new methods, machines, equipment, process technologies,
work measurement and other elements (resource inputs) of the process.
Humans are extremely resourceful creatures, able to execute procedures
and methods dexterously, and capable of achieving spectacular results. All of
a person’s actions require deliberate, systematic and orderly procedures and
methods. In today’s production process, which is mostly profit-driven, cheap,
effective and speedy procedures and methods are of cardinal importance.
It is important to bear in mind that work study is a management tool based
on method study and work measurement techniques. Work study must be
employed to examine all facets of human labour in a corporate context with
the objective of increasing the enterprise’s efficiency and productivity by
means of systematic research. In every management function the manager
can apply work study to make his or her task easier, particularly where correct
decision making is concerned.
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8.3.6.7 Work study
In general, work study can be defined as a management tool based on method
study, work measurement and various other specialised techniques. Work study
is applied in the investigation of all aspects of human labour and is aimed at
developing improved procedures and methods through systematic research in
order to improve the enterprise’s productivity.
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Method study can be defined as the systematic selection, recording and
critical investigation of the factors involved in an existing or planned
work method in order to develop a simpler, easier and cheaper method so
that efficiency can be increased and costs reduced.
Work measurement refers to the application of techniques that are
specially designed to determine the time within which an average
trained worker can complete a specific task in a particular situation at
a specific rate. The objective of work measurement is to determine time
standards so that work performance can be measured. Time standards for
particular work can only be determined after a proper method study has
been conducted, since correct time standards for incorrect procedures
and methods are a waste of time.
8.4 Operations strategy and operations design
8.4.1 Operations strategy
The operations function is the driver of the corporate business strategy.
Strategy refers to actions or decisions that commit the business to moving
in a certain direction or adopting a position in the market. Carefully made
decisions that help the business to achieve its goals and that have a high
impact and particular significance can be regarded as strategies. Slack et al13
define operations strategy as the total pattern of decisions and actions that
formulate the role, objectives and activities of each part of the operation
so that they contribute to and support the organisation’s business strategy.
The most powerful strategy is to obtain unique capabilities and capacities
for competing through operations that will lead to very high visibility for
operations strategy. Some strategic choices may include unique technology,
choice of process, and infrastructure. These strategies may be integrated with
best management practices such as total quality management, just-in-time,
business process re-engineering (BPR) and others.
A strategy is a broad plan with far-reaching effects that serves as the
foundation for several more specific plans. Operations strategy, therefore, is a
carefully chosen plan for having effective and competitive operations.
The business triad, which affects operations strategy in many ways, consists
of:
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customers;
competitors; and
internal capability such as resources, innovation, products, process
technologies and other means of operations.
The first two (customers and competitors) usually dictate the third (internal
capability).
Business strategy needs to be translated into a lower-level operational
strategy (also referred to as a tactical/functional strategy). The operation puts
strategy into practice. The most creative or original idea may be worthless if
strategy is not deployed or ‘operationalised’. A corporate strategy to become
more prominent in terms of time-based competition will need an operation
that is more streamlined with fewer bottlenecks, shorter lead times, quick
response, accurate anticipation and effective scheduling. A marketing
strategy to diversify requires a flexible operation, and so on. Any business
will always seek a distinctive competency or competencies – strengths
that set it apart from competitors. This distinctive and core competency is
found in the operations function. These distinct competencies centre on
clever operations design. If the business can be distinctively competent in
several ways, the world markets will take notice. Examples of these distinct
competencies, or performance objectives, are efficient process controls for
product and service uniformity, fast response to customer orders (such as
McDonald’s), flexibility and quality. These competencies are important since
they are derived directly from the basic wants of customers, namely: quality,
speed, dependability, reliability, low cost, flexibility, service, respect and
predictability. Most of these will be discussed under ‘operations performance
objectives’.
Strategy can hardly address everything. Every business will have a unique
SWOT (strengths, weaknesses, opportunities and threats) situation that will
dictate strategic choices and strategic fit. The biggest challenge in life and in
business is to obtain balance in everything. Costly trade-offs make balanced
performance important. Financial measures must be complemented by
operational measures. Improve operational measures such as cycle times,
lead times, cost of quality, order-winning responsiveness and defect rates,
and the financial results will follow. The balanced scorecard from Kaplan
and Norton14 provides a set of measures that gives top managers a fast but
comprehensive view of the business. This technique links performance
measures with the answers to four basic questions.
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The market: how do customers see us? Is their view our view?
The internal customer: what must we excel at? Safety, health and the
environment?
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The value-adding perspective: can we keep on improving, innovating
and creating value?
The financial perspective: how do shareholders see us?
These indicate how the value-based concept complements four popular
movements today, namely:
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the total quality school (pursuit of quality ramifies across economic,
environmental and social imperatives);
the systems school;
the process school (the need to accommodate horizontal workflows/
value chains and strengthen internal interaction and interfacing); and
the balanced assessment school (the need to see measure beyond
financial results, as also proposed by the balanced scorecard).
In general, the OM function has three important strategic roles namely:
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implementer of corporate business strategy;
driver of corporate business strategy; and
a support to corporate business strategy.15
8.4.2 Operations design
Business managers need to take note that their product and service range will
demand a specific operations design. Many factors need to be considered during
this process including occupational safety and health (OSH). The product
should fit the operations design, for example lean or agile. The basic differences
between lean and agile operations are shown in Table 8.2.
Table 8.2: Lean supply vs agile supply
Lean supply
Agile supply
low product variety and long life cycles
high product variety and short life cycle
lower profit margins
higher profit margins
more predictable
less predictable
stable stock demand
volatile stock demand
The agile supply operation is market sensitive, responsive, flexible, and can
respond nimbly to demand. It needs unconventional mechanisms to hear
the daily voice of the market and have direct access to customer requirements
data to create a virtual supply chain that is information-based rather than
inventory-based. Electronic data interchange enables partners in the supply
chain to react to the same data (real demand), rather than to the distorted
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Chapter Eight – Operations Management
picture when orders are transmitted from one to another in the chain. The
route to sustainable advantage lies in being able to leverage the respective
strengths of network partners to achieve greater market responsiveness.
The operations design for very high volume and very low variety is
a continuous mode of operation. The layout will therefore suit a highly
mechanised plant. The operations design for a unique functional need, low
volume (one item) with high flexibility, will suit a project mode of operation.
The layout is temporary with no clear flow lines and, because the product
position is fixed, the layout is referred to as a fixed-position layout. The same
three dimensions (variety, volume and product scope) are used to come up
with a job mode of operations design, batch-operation design, or repetitiveoperation design.
Product design will determine process type (intermittent or continuous),
as well as layout and flow of work. The entire network of micro- and macroprocesses will consist of the basic flow (and layout type), the technologies used
(process technologies, equipment and machines) and job design. Process design
is not merely an assembly line. It may also include network decisions relating
to the capacity level of each operation in the supply network and – if the
business is backwardly integrated into the supply chain – decision pertaining
to suppliers. Each operation in the network will select a process type based on
the variety-volume characteristics of the operation. Small variety and large
quantities will dictate a specific process type. Process type may then dictate
layout type, although process type and layout type are not always totally
deterministic.
8.4.3 Types of productive systems and their characteristics
As mentioned earlier, process characteristics determine the type of operations
or productive system. All transformation systems convert inputs into outputs.
All of these operations share the same operations management model,
principles and performance objectives. These systems are also referred to as
transforming resources because they convert a combination of inputs, which
are referred to as transformed resources.16 They are designed for the particular
aggregate demand that will determine the system’s dimensions, nature, scope
and scale. This leads to different production system designs, such as service
shops, job shops, production lines, batch operations, mass services, projects
and other combinations.
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Table 8.3: Comparison of the characteristics of the three main categories of operations
systems
Continuous
or repetitive
operations
system
Job/batch
operations
system
Project operations
system
Product type
Standardised
Diversified
Unique
Product flow
Standardised
According to
requirements of
particular product
Virtually none
Materials handling
Materials flow
determinable,
systemised and
often automated
Handling depends
on the product,
therefore highly
variable and
expensive
Special equipment
often necessary;
high cost
Raw materials
inventory
High turnover
Low turnover
Variable because of
production time
Work-in-process
Small quantities
Large quantities
Single product
Production cost
components
Relatively high
fixed cost; low
variable cost per
unit
Relatively low fixed
cost; high variable
cost per unit
Relatively high fixed
cost; high variable
cost
Labour
requirements
Highly specialised
routine tasks at a
specific rate
Highly skilled
artisans working
without supervision
and with moderate
adaptability
High degree of
adaptability to
various tasks
commissioned
8.4.4 Relationship between operation system type and layout type
Decisions concerning the layout type will not merely depend on choosing
between the basic types, but also on understanding the advantages and
disadvantages of the different types or combinations of layouts. The flow
of transformed resources will be determined by both the feasibility and
importance of the degree of regular flow. The opposite of this is high variety
(when regular flow is difficult) and low volume (when regular flow is not
feasible). The relationship between basic processes and basic layout types are:
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projects and large jobs = fixed-position layout;
jobs and batch processes = process layout or functional grouping (layout
according to similar processes);
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large batches and small continuous processes = cell layout; and
mass processes or pure continuous repetitive processes = product layout
or flow grouping (layout according to the product).
The layout of the productive unit, therefore, only governs the general
configuration of facilities. Mode shifting is also possible after process
re-engineering. This means the mode of operation design (and layout type)
may change from job to project or from batch to continuous (from custom
to commodity). The purpose of effective layout is to streamline workflow by
minimising handling distance and increasing facility utilisation.
The machinery, equipment, workplaces, store rooms, tool racks and
other facilities should be positioned so that they do not impede the flow of
production. The four possible configurations of machinery are:
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plant, fixed assembly points or fixed-position layout in which raw
materials are stored in one spot and all the other means of production
are brought to the raw materials;
horizontal grouping of machinery, process layout or functional grouping
in which similar machines are grouped together in sections of their
own (eg all sawing machines will be grouped together as will planning
machines, assembly machines and painting machines);
vertical layout of machinery, product layout or flow grouping in which
machines are placed in a straight line, one behind the other, and in which
the capacities of the machines are attuned; and
any combination of the above methods of grouping machinery.
The physical organisation found at a facility or work centre is a function of
its layout. The layout of the productive unit does not imply that the work or
job is already scheduled. Layout provides a basic routing, while scheduling
(using several scheduling techniques) is the practical day-to-day sizing, line
balancing, sequencing, and dispatching of orders through work centres.
Proper understanding of work stations (offices, floor layout, work cells,
centres) and how they affect human performance (possible strain or injury)
are the essence of ergonomics as part of job design. Repetitive strain injury
is fairly rare in South Africa, but is extremely common in the western world.
Slack et al.17 describe ergonomic workplace design in terms of:
„„
„„
anthropometric data such as people’s size, shape, physical strength and
other characteristics; and.
the neurological aspects of job design that subsist in the engagement
of people’s sensory capabilities when interfacing with their workplaces
– usually some sort of process technology (such as a machine) and its
interface with the person to form a ‘machine-person loop’.
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8.5 Operations planning and control
8.5.1 Operations planning and control activities
Planning is about who, what, when, how, and where. Operations planning is
governed by OM policy, which can be defined as: a set of guidelines for execution
and control, as based on the operations strategy, which determines the prescribed
accepted actions within the operations function in order to achieve continuity,
consistency and integration. The result is that the operations manager’s decisions
are focused, thereby becoming consistent with planning done by the business,
and that the operations function contributes to the creation of a competitive
base.
Strategic (long-term) planning involves factors such as fixed-capacity
planning (eg deciding on the location and layout of a factory) and product
planning (which incorporates product development and aggregate forecasting).
These activities have a strategic element and decisions flowing from them
would affect the operations system in the long term.
Tactical (medium-term) and operational (short-term) planning involve
factors such as aggregate or variable capacity planning, item forecasting,
master scheduling, operations scheduling and inventory management. The
activities of tactical planning are based on the decisions made during strategic
planning, since these to some extent determine the parameters within which
the medium-term planning will be done. Furthermore, the operations manager
organises the operations function by allocating responsibilities and creating
structures (eg arranging departments and sections, as well as setting up chains
of authority). This function also includes the creation of supplier networks.
Leadership involves motivating the workers within the operations function,
for example being committed to the implementation of a total quality
programme. A new development in the field of operations management is the
focus on the human aspects of the transformation process.
Finally, the operations manager is responsible for control over the
transformation process. This function includes all the steps taken to set
standards and to evaluate the operations system against these standards. Some
of the control functions exercised by the operations manager include quantity
control (the measurement of productivity), quality control and cost control.
Various models can be utilised to improve planning and design and represent
reality, namely schematic models, physical models and mathematical models.
„„
„„
A schematic model is a representation that makes use of lines and colours
to represent something. Examples of schematic models are graphs, maps
and diagrams.
A physical model is usually a three-dimensional representation of an
object, for example a scale model of an aircraft or building. This type of
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Chapter Eight – Operations Management
„„
model can simulate the functions of the object it represents, and is often
called a prototype.
Mathematical models use symbols to represent reality. This is usually
in the form of mathematical equations, so mathematical models are
in the form of algorithms. An algorithm is a formulaic description of a
procedure to be followed in order to solve a problem.
In cases where absolute certainty exists – in other words, all information about
the situation is known – algebraic approaches (such as the break-even analysis)
or mathematical programming techniques (such as linear programming) may
be used to determine the optimum solution. If a situation of uncertainty or
risk exists, this implies that the relevant information is only partly known.
Methods that apply in this type of situation include statistical analysis (eg
correlation and regression and decision analysis), queuing theory, network
analysis (eg PERT/CPM and decision trees) and simulation. If no information is
available, the situation is one of absolute uncertainty.
Aggregate planning refers to the anticipation of aggregate demand in broad
terms, and encompasses capacity planning. It is a broad view of the market
and what an operation can handle in capacity terms. No operation can
prepare itself without knowing what the market demands are. An operation
prepares itself in terms of types of capacity for different time periods. This
is the capacity planning and control function as based on demand. Capacity
decisions boil down to setting capacity levels for the short and medium
term. The focus is not on item demand, and aggregate plans assume that all
the different products and services will remain relatively stable during the
planning period. Master scheduling follows aggregate planning, and results in
a master production schedule (MPS) statement as the main input to materials
requirements planning (MRP).
8.5.2 Demand management and forecasting
OM is frequently occupied with matching demand with capacity. Capacity refers
to the limited means of a productive unit to manufacture a certain quantity of
products within a particular fixed period. POM may refer to capacity planning
as planning for adjustable (variable) resources, such as labour and aggregate
inventory over the medium term. It should actually also refer to fixed (nonadjustable) resources. Capacity control refers to the loading of resources and
keeping work centres busy but not overloaded. Planning for future production
capacity occurs in three stages, namely:
„„
„„
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demand forecasting;
attuning the capacity of various machines/resources/facilities; and
determining strategies for the full utilisation of capacity.
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Demand management implies a good feeling for market needs, accurate
market research, professional anticipation and scientific forecasting. The
long-term objective (strategic goal) of demand management relates to fixed
capacity planning, while the medium-term objectives (tactical objectives) are
more specific and are used to determine aggregate demand. Usually this is
the demand for a group of products sharing the same capacity in the plant.
Aggregate demand is utilised for adjustable capacity planning. Recording
orders is another important component of demand management. The delivery
promise can only be made once the order has been positioned in the master
schedule, which in turn, is dependent on the availability of finished product
assemblies and components (parts).
Forecasting can be defined as determining the demand for a product
produced by the business, but with a view to accommodating a future event.
People make forecasts all the time and these affect decisions and activities
throughout the organisation. Forecasting is also an important component of
yield management, which relates to the percentage of capacity being used.18
Accurate forecasts can help managers plan tactics to match capacity with
demand, thereby achieving high yield levels. Properly defined forecasts should
be timely, accurate, reliable, in meaningful units, in writing, cost-effective and
understandable. Some of the categories of forecasting techniques are:
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qualitative techniques, which are based mainly on feelings and judgement
rather than data or actual calculations);
time-series analysis, which is quantitative and manipulates the data
mathematically to arrive at a forecast;
causal methods that use a mathematical expression or model to
determine a cause-and-effect relationship;
multi-period pattern projections, which are time-series that produce
forecasts for more than one future period working on the assumption
that no trend or seasonal component is present in the demand pattern;
and
single-period patternless projections that make use of historical data
(to a limited extent) to forecast only for the next (single) period. The
historical data usually reflects the most recent demand quantities.
8.5.3 Capacity determinants
Operations capacity is the greatest workload (input) that a business can handle
in terms of demanded transformational output. The ‘Ms’ are used to describe the
limits of any operation. These are methods (also methods of communication),
machines, money, material and manpower (including management). Capacity
is made up of combinations of the Ms and the optimisation of capacity is
important to maximise production ability. Factors such as the learning curve
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Chapter Eight – Operations Management
have a huge impact on capacity. Trained and experienced manpower affects the
rest of the capacity configuration in the sense that it determines how the other
Ms are utilised.
According to Stevenson19 the determinants of effective capacity are:
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„„
the design of facilities and locational factors;
product and service design factors;
process factors – process improvements that increase quality and productivity
can result in increased capacity;
human empowerment, skills, conditions of work and conditions of service;
operational factors (process design, scheduling, inventory management);
and
supply chain factors.
8.5.4 Fixed-capacity planning
Fixed-capacity planning is the first long-term question facing POM. This
planning must be done thoroughly in order to place the productive unit on a
firm footing from the start. In this context, the term ‘productive unit’ means
the factory office, bank, shop or any institution in which goods and/or services
are manufactured or provided. The elements of fixed-capacity planning are:
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„„
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„„
occupational safety;
identifying a suitable location;
determining the size of the productive unit;
the layout of the productive unit; and
the choice and design of, and specifications for, machinery and equipment.
8.5.4.1 The optimal production volume
The short-term productive optimum (optimal production volume) is achieved
in the short term, but the optimal size of the productive unit is achieved in the
long term. Various factors can have a direct influence on the eventual size of a
productive unit. The main factors are:
„„
„„
„„
the scope of the activities that can be handled with the existing
infrastructure (if the infrastructure is poor, the productive unit will
remain relatively small);
the scope of the economically favourable quantitative ratio (if the
business uses more machinery than labour, the limiting factor will be
capital);
the degree to which the products and processes can be altered to
meet demand (a productive unit may expand its product range when too
much surplus capacity occurs);
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the nature of the competition (competition may be so strong that it
prevents the productive unit from growing);
the break-even point (the break-even point is that volume of production
and sales at which income from sales equals costs); and
the availability of means of production, such as raw materials, labour,
machinery and equipment.
The optimal size of the productive unit can be determined by the optimal
production volume and the size of the optimal productive unit. The optimal
production volume is achieved in the short term. This refers to the scope of the
activities where the productive unit’s capacity remains constant, and goods are
manufactured at the lowest possible unit cost. This is also known as the shortterm productive optimum. The optimal productive unit size is achieved in
the long term. This refers to the scope of activities where the productive unit’s
capacity expands and the production costs per unit are at their lowest.
8.5.5 Match capacity to a change in demand
The following strategies can be followed to make full use of production capacity:
Example
An operations unit consisting of, for example, a single experienced joiner can assemble
12 coffee tables per week. Demand increases to 20 tables so capacity is too small to
satisfy demand for the product.
If capacity is too small for demand, capacity can be increased by:
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appointing another joiner who can work at almost the same pace as the
existing one;
increasing capacity by acquiring additional fixed assets;
introducing overtime;
choosing to differentiate products;
introducing an additional shift;
using temporary means of production (a popular strategy for seasonal
productive units such as holiday hotels that employ additional staff
during busy periods);
generating capacity by a transfer of surplus capacity from other divisions;
reducing the number of products and specialising in one; or
obtaining additional machines.
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Chapter Eight – Operations Management
Example
Assume a subassembly of the ‘Eagle-GOLF’ golf cart needs to move through three
machines in the production process as follows:
Work station
Machine
Capacity golf carts per day
Extrude
D
60
Weld
E
20
Paint
F
30
The machines with the smallest capacity (E and F) will limit the capacity of the entire
process. Machine D has surplus capacity, and more machines may be required (given
that demand is higher than capacity). Calculate the smallest value into which each of
the three capacity figures (60, 20 and 30) can be divided, and determine how many
additional machines are required.
Work station
Machine
Calculation
Additional machines needed
Extrude
D
120/60 = 2
1
Weld
E
120/20 = 6
5
Paint
F
120/30 = 4
3
If capacity is greater than demand the productive unit can:
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work fewer shifts;
integrate products;
close a section of the factory;
lay off some of the workers;
phase out the temporary means of production; or
move surplus capacity that was brought in from another department
back to that department.
Schedules are statements of volume and timing in different types of operations
systems. Operations scheduling refers to the determination of the quantity
of jobs and sequence in which jobs and activities are to be completed in the
manufacturing plant. The scheduling activity is one of the most complex
functions of POM because:
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„„
schedulers must deal with different types of capacity/resources
simultaneously;
machines and staff will have different capabilities; and
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„„
the number of possible schedules increases as the number of activities
and processes increases.
8.5.6 Operations scheduling
Scheduling is associated with timing, routing and loading. The master
production schedule (MPS) is central to OM and is regarded as the core planning
document of any operation. It is a disaggregated plan, and usually indicates
the planned production per time interval (eg per month). The basic activity of
scheduling is the pushing, pulling, routing, sizing and timing of work through
work centres. Push and pull control refers to the system that triggers the work.
MRP, for instance, pushes out the work without considering the exact time
or use of the customer, while in a pull system, the pace is determined by the
customer as the next process.
The aggregate plan for a small business indicates what final products
(families or product groups) it plans to manufacture. Trapsix Trays (for
example) primarily produces approximately 400 trays per year, but also plans
to manufacture 300 chairs and 55 coffee tables.
Operations scheduling comprises four distinct activities. Firstly, the
operations must be timed and routed. Timing involves making a decision
about when a particular operation will take place, and routing is done to
establish the place where, or on which piece of equipment, the operation will
be performed. The second activity is known as dispatching. This involves
issuing a shop order so that the operation can take place. The third activity
concerns control, or establishing the status of the shop order. This is necessary,
since the progress of the shop order must be known at all times. If necessary, a
shop order may have to be expected so as not to delay the delivery of the final
product, or to minimise the lateness on an order. Expediting is the fourth
activity of operations scheduling.
8.5.6.1 Effective scheduling
The nature of scheduling will depend on the type of operations system (eg
make-to-stock, resource-to-order or make-to-order). Planning and control
therefore differ for each product or operation. Slack et al20 refer to the P:D ratios
of speculation. D = the demand time (total length the customer must wait)
and P = throughput time, which is the entire lead time of sourcing, production
and delivery. Low-volume operations have more speculation because of the
different variables in the throughput process. For high-volume make-to-stock
operations, the demand time is very short compared to the total throughput
cycle (P). If one compares this P:D ratio to a make-to-order or resource-to-order
P:D ratio, then one can see how different it is. P is slightly longer than D in a
make-to-order operation (see the ‘Noise Clipper’ example on page 270) and
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Chapter Eight – Operations Management
P = D in a resource-to-order situation. The larger P is compared to D, the higher
the speculative activity in the operation will be.
Effective scheduling may be influenced by the particular operations system,
but it will be characterised by:
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„„
„„
„„
being realistic and allowing for any essential changes;
allowing enough time for all the operations (the time before, during and
after operations);
having capacity available; and
assigning to the workers or operators the responsibility for keeping to
schedules.
Apart from the fact that scheduling is much easier in a continuous or repetitive
manufacturing situation, the success of the so-called ‘process operations’ also
depends on a number of other factors, such as:
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avoiding quality problems where possible and assuring reliability of
suppliers;
monitoring the process and product design;
rigorous preventive maintenance;
optimal mixes and rapid changeover; and
regular schedules and linear output.
Undercapacity scheduling means that less than the total available capacity is
scheduled, for example 95% of available capacity for a particular shift. This
means that the required output for the shift is only 95% of what could be
produced at full capacity.
8.5.6.2 Forward and backward scheduling
The point of departure used in scheduling has a critical influence on the
scheduling itself. The first approach is to begin at the present date and schedule
forward according to the times needed to complete all the operations necessary
to complete the order. When all times have been added, the manufacturer can
give the customer an indication of when the order will be ready. This approach
is known as forward scheduling. On the other hand, in backward scheduling,
the required date (or moment) as prescribed by the customer can be used as a
starting point so that the time for each activity is subtracted from the due date.
8.5.6.3 Gantt charts and other techniques
Gantt charts (time charts) are the most commonly used scheduling technique.
They are simple to construct and easy to understand. This chart gives a visual
impression of the progress made on the project or subproject. The work packages
of the job/project with its work package descriptors (tasks or activities) are on
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Business Management: A Contemporary Approach
the left-hand side and the work duration at the bottom. Another technique
that can be applied to schedule any number of jobs on two or three machines
is known as Johnson’s algorithm. The algorithm ensures that the optimal
sequence is found – that is, the sequence that will minimise the total processing
time. Johnson’s algorithm has as its point of departure the existence of a fixed
sequence according to which the job moves through the work centres or
machines.
The very simple Johnson’s algorithm is a good example of how powerful an
OM technique can be. This algorithm is widely used in small job shops where
volume is low and variety is high. By determining the optimal processing
sequence (that is, which job follows which), as opposed to scheduling work
on a random thumb-suck or first-come-first-served basis, can save operations
managers a great deal of time and other resources.
The jobs in the following example of Noise Clipper (Pty) Ltd (Table 8.4) are
cutting, transforming to acrylic and finally assembling and packaging.
Table 8.4: Five different jobs and three work centres
Noise
Clipper
jobs
Processing time in the
cutting work centre (1)
Processing time
in the acrylic
work centre (2)
Processing time in the
assembly work centre
(3)
P
4
3
7
Q
8
3
6
R
4
2
7
S
3
2
10
T
7
5
6
The steps of the algorithm are:
1.
2.
3.
4.
5.
Add the times of work centres 1 and 2 and add the times of work centres
2 and 3.
Create two columns: A (total time of 1 and 2) and B (total time of 2 and 3).
Choose the shortest processing times if the shortest time is in column
A, schedule that job first (or as close to first as possible if other jobs have
been placed in sequence).
If the shortest time is in column B, schedule that job last in the sequence
(or as close to last if other jobs have already been placed in sequence).
Solution: S-R-P-Q-T.
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Chapter Eight – Operations Management
Jobs
Work centre 1 and 2
Work centre 2 and 3
P
7
10
Q
11
9
R
6
9
S
5
12
T
12
11
Following these steps of the algorithm, the optimal sequence therefore is: S-RP-Q-T. Noise Clipper (Pty) Ltd can therefore optimise its time per job and gain
additional capacity. If the sequence is randomly determined by thumb suck,
it will be found that there is a large error margin. A manager who plans to
do five jobs on a thumb-suck basis will waste time. If operations managers
do not use this technique, they will waste several hours per week. Applying
this simple algorithm can therefore save a considerable amount of time, thus
creating spare capacity.
8.5.7 Project management demand network techniques
Projects are a type of production system. Project management is a special
kind of management philosophy and approach needed for unique and
demanding projects. Project management is needed when the scope of a
unique job is comprehensive. Project management is governed by a body
of knowledge (PMBOK). Different planning tools are used in project
management to enable project managers to assess the impact of time and cost
uncertainty on project completion, and to weigh trade-offs between project
schedules, costs and resource allocation. The basic difference between PERT
(program evaluation and review technique) and CPM (critical path method)
is as follows.
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„„
PERT uses the AOA (activity on arrow) method and is basically a way
of incorporating uncertainty into schedule estimates. It was developed
for application in certain project types where uncertainty is associated
with the nature and duration of activities. It uses three time estimates,
namely optimistic, most likely and pessimistic. This method may answer
questions such as: ‘What is the probability of completing the project in
20 days?’
CPM uses the AON (activity on node) method and explicitly includes
cost as a scheduling consideration. It is a deterministic approach with
only one time estimate (and no statistical treatment of uncertainty). It
includes a mathematical procedure for estimating the trade-off between
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Business Management: A Contemporary Approach
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project duration and project cost. This method may show, for instance,
how the project crash cost can be reduced by stretching non-critical jobs
with the greatest cost slope.
Network diagramming is a popular planning document. Project
activities with their respective durations are positioned in a specific
sequence and in terms of their respective interdependencies (activities
with their immediate followers and predecessors). The longest route from
the first to the last activity of the project represents the ‘critical path’.
The duration of activities on this path is critical and may not increase
because it will extend the project duration. The other activities not on the
critical path may be delayed because they do have slack time available.
In order to determine the amount of slack available per activity, one has
to calculate the earliest start (ES) times and the latest start (LS) for those
activities not on the critical path. Drawing networks like these will help
project managers in many ways.
8.5.8 Inventory management
Inventory management is the function of planning and controlling all types of
inventory (raw materials, subassemblies, consumables, finished products, and
so on). Inventory management is crucial since capital must be tied up in other
investments and cash, and not in idle stock. The inventory function has several
interfaces with purchasing, warehousing, marketing and OM. The essence of
inventory management (planning and control) is to have just enough inventory
at any given time. This implies two major dimensions, namely timing of
inventory and quantity determination. Several techniques exist for timing (eg
MRP, JIT and ROP) and for quantity determination (eg MRP, EOQ and EMQ),
as explained below.
The mode of operation will determine the type of timing and quantity
planning and control. Resource-to-order (project operations) will keep no
stock. Make-to-order (eg job shops) will hold the minimum inventory and will
obtain inventory according to the custom order by the client. Make-to-stock
(eg batch and repetitive operations) will do planning and control based on
forecasting, safety stock levels and economic order quantities.
The purpose of inventory management can be set out as follows.
„„
Control must be exercised over the financial investment in inventory,
thereby saving on interest and cost. Keeping inventory goes hand-inhand with certain cost factors such as obsolescence, interest on capital
investment, physical wear and tear and damages, transportation and
insurance. If inventory control does not enjoy management’s full
attention, these cost factors can take on serious proportions.
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„„
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„„
„„
„„
„„
„„
„„
„„
A scientific, factual method to simplify purchases (by using mathematical
models) needs to be created.
There should be a reduction in possible losses as a result of obsolescence
and incorrect or excessive purchases. Good inventory control turnover
rates are necessary.
Dead or slow-moving stock should be identified.
Inventory control must serve as a source of information for management
decisions.
Losses should be prevented by controlling all incoming inventory as
regards quality, quantity and the requirements as determined in the
purchase order. This is important since it impacts directly on the quality
of the finished product.
Excessive variety should be avoided. The advantages of standardisation
and simplification must be considered.
Production should never be delayed because of a shortage of a certain
inventory item. Such delays make an extremely bad impression on the
customer (internal as well as external).
Ordering the most economical quantities through an effective control
system is essential.
All internal customers (the next process) and external customers should
be given good service.
8.5.8.1 Carrying cost
Inventory ties up capital and is referred to as ‘carrying cost’. There are several
inventory-carrying cost elements. Total carrying cost usually includes the
following, and may be direct or indirect.
„„
„„
Direct inventory-carrying cost elements are capital cost (interest or
opportunity cost) and holding cost. Holding cost refers to the cost
involved in renting storage facilities, warehouse equipment, electricity,
insurance, security, handling, bookkeeping, warehousing, labour and
damage. (Note: I = the annual carrying cost rate, which is based on the
direct inventory-carrying cost elements, namely capital cost and holding
cost.)
Indirect inventory-carrying cost elements are the costs attached to
obsolescence, recordkeeping, physical stocktaking, inventory planning
and control by management. Other hidden cost elements are the cost of
production floor space utilised for work-in-process, scrap and rework, as
well as the cost involved in handling and containerisation.
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Example
The entrepreneurs of custom-made hearing protection devices in South Africa need
to be flexible and adaptable to the high demand of quality ear plugs. Assume it would
cost R2 750 to rearrange the Noise Clipper (Pty) Ltd laboratory facilities inside one of
their work centres in order to eliminate R5 500 worth of inventory. If I = 0.25, will the
rearrangement be worth it?
This is a saving of 0.25 x R5 500 per year (ie R1 375 per year), which means that the
R2 750 will be recovered within two years. Hence, this would be worth considering.
8.5.8.2 Order cost
Order cost can be defined as the cost that must be incurred to place an order.
An item may be ordered twice, three times or more per year – and even daily
in JIT systems. If orders are placed only twice a year, such orders will therefore
make up 50% of the annual demand. If these orders are to be manufactured
internally, the cost will consist mainly of machinery set-ups.
8.5.8.3 Inventory timing by means of the reorder point (ROP)
Inventory timing by means of the reorder point can be regarded as the
traditional model. This technique is as old as manufacturing itself. However,
it is still a popular method and is found, for example, in every household. A
reorder point indicates a certain level of stocks at which the stock must be
replenished or ordered.
There are variations of ROP. The periodic inventory system is used by
restaurants, service stations and other retailers, where inventory is ordered
daily or weekly. Some manufacturers include the ROP in the product. Examples
of this are cheque books and boxes of tissues. The two-bin system is also a
continuous inventory system often used in small warehouses. As soon as one
bin is empty an order is placed.
ROPs are calculated according to experience of consumer patterns, rule-ofthumb judgement or by applying a formula. However, the formula also demands
a degree of judgement, since it incorporates safety stock and demand patterns.
The ROP formula is:
ROP
=
D(LT) + SS
where ROP
=
reorder point
D
=
average demand per time period
LT
=
average lead time
D(LT)
=
average demand during lead time
SS
=
safety stock
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Chapter Eight – Operations Management
Example
The one laboratory of Noise Clipper’s average monthly demand for Mr.cl-EAR cleaning
spray (for occupational hygiene) is 105 litres. If the order lead time is one week and a
safety stock of five litres is applicable, what will the ROP be?
ROP
=
D(LT) + SS
ROP
=
105(7/30) + (105/30)5
=
24.5 + 17.5
=
42 litres of Mr.cl-EAR cleaning spray
8.5.9 Material requirements planning (MRP)
Material requirements planning (MRP) plans for various periods in the future,
and is also referred to as a ‘push system’. A simplified example of an MRP
exercise is as follows: The master schedule for three sizes of screwdriver is given
in the table below. All three screwdrivers (2 mm, 7 mm, and Star 5) use the same
handle. The item master file shows that the following planning factors are:
„„
„„
„„
„„
batches are set at quantities of 20;
safety stock is set at two handles;
the available inventory is 70; and
the lead time for orders is two weeks.
Question: When will orders be issued, and what will the planned orders be?
Week
Item
1
2
3
2 mm
7 mm
Star 5
10
18
8
8
18
8
4
5
10
8
18
8
Answer: the planned order in week 1 must be 20, since provision must be made
for safety stock of two handles; the order lead time is two weeks; and quantities
of 20 only may be ordered as follows:
Week
Item
1
2
3
4
5
Gross requirements
Scheduled receipts
Available inventory = 70
Planned orders
36
8
26
18
26
34
20
26
20
40
2
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8.5.10 Determining inventory quantities
8.5.10.1 The lot-for-lot approach
The easiest way to determine inventory quantities is to make the batch size
equal to net requirements. Only the quantity required for the parent item is
bought or manufactured. There is no batching in larger batches. Orders must
therefore be placed frequently, which results in high order costs or set-up costs.
8.5.10.2 The economic ordering quantity (EOQ) formula
The EOQ model is one of the oldest, having been developed by F. W. Harris in
1915. Although the assumptions are not always applicable in practice, they are still
usually close enough to make the model useful. The assumptions are as follows:
„„
„„
„„
„„
„„
demand (‘D’) is known and constant, with no seasonality;
the order cost (‘S’ = set-up cost) is known and constant;
cost per unit is constant (no quantity discounts);
the entire batch is delivered at once. Typically, this is the case with
purchased items, but not so with items manufactured in-house; and
the carrying cost (‘I’) is known and constant, and is a linear function of
the quantity ordered.
8.5.11 Break-even analysis
This is a technique for determining the volume at which total revenues are equal
to total cost, or when the cost to make equals the total cost to buy. One can use
this in a make-or-buy decision, or when two production methods are compared.
It may also be used to determine the profit potential of a new product.
Example
The Noise Clipper laboratory considers a new hearing protection fitment procedure
to be offered at R200 per patient/client. The fixed cost (portion of the total cost that
remains constant regardless of changes in levels of output) is R100 000 per year. The
variable cost (the portion of the total cost that varies directly with volume of output) is
R100 per patient. What is the break-even quantity for this service?
Solution: One can use the algebraic or graphic approaches. For the laboratory to
break even, the number of patients (‘Q’) must equal the fixed cost per year (‘F’) divided
by the unit profit margin (price minus cost). This gives us the following formula for the
break-even number of patients:
Q = F = 100 000 = 1 000 patients (the minimum quantity needed)
P–C 200–100
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Chapter Eight – Operations Management
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8.5.11.1 Break-even case study using the algebraic approach
Noise Clipper (Pty) Ltd has developed and patented a new cleaning device
for hearing protectors. Before trying to commercialise the device and add it
to their existing product line, they wish to get an idea of possible success by
determining the minimum break-even demand or volume. The fixed cost is
R56 000 per year, the variable cost per unit is R7 and the selling price is set
at R25. Expected initial demand is ± 415 units per month. Use the formula
to establish the break-even quantity (‘Q’). The answer is Q = 3 111 units. If
demand is 4 980 cleaning tools per year, commercialising should be considered.
8.6 Operations improvement
This function of ‘operations improvement’ is creative and dynamic due to its
philosophy that nothing and nobody is perfect. It is more than quality control,
and reaches far beyond the operations function. The fundamentals of quality
are the best vantage point in terms of understanding quality concepts, designing
and assuring quality, and implementing, sustaining and improving quality.
Amongst others it refers to performance improvement of all resources, failure
prevention and recovery, improving the operation’s reliability, maintenance
and eventual total quality management (TQM). This section introduces the
core concepts of operations improvement.
8.6.1 Leadership for quality
Values precede action and several important foundations are needed before
TQM can be implemented as best practice. Evans21 provides such a foundation
for performance excellence in terms of internal organisational quality,
customer-supplier relationships, healthy organisational behaviour (teamwork
and effective empowerment of the internal customer) and an organisational
change culture. True leaders have an innate passion for quality and they lead
by their own example and influential power. However, they do need to take
cognisance of a few important issues, namely:
„„
„„
„„
„„
effective and constant communication;
creating the right attitude and motivation for employees to serve the
customers to the best of their ability;
identifying and developing the abilities of employees so that they can
contribute in the areas in which they are operationally active; and
helping employees to understand the basics of sound management.
A good leader has the ability to see the big picture, strengthen the vision and
then inspire employees to strive for its realisation. Leaders have a big impact
on the culture of the organisation. Leadership hinges on vision, strategy and
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Business Management: A Contemporary Approach
people empowerment. Management by fear is a sign of leadership inadequacy.
Leadership determines the components of the quality culture. These nontangible (or soft) components include:
„„
„„
„„
„„
„„
behaviours;
norms;
dominant values;
rules of the game for getting on; and
climate.
8.6.2 Continuous improvement through total quality management
(TQM)
TQM is a holistic approach to quality at the source. It refers to quality planning,
control and improvement by everyone, everywhere on a continual basis. The
three main reasons why total quality management (TQM) is so popular is that:
„„
„„
„„
all people find it intuitively attractive;
the principles of TQM make sense unconventionally; and
a TQM approach to management can dramatically increase operational
effectiveness.
TQM is primarily concerned with the improvement of all aspects of operations
performance. The TQM approach is far more than quality assurance (QA)
or the detection mode of quality control. It is an approach to improving
the smartness, competitiveness, flexibility and effectiveness of the entire
organisation. It also removes the burden of wasted effort from people’s lives
by bringing everyone into the processes of improvement so that results are
achieved in less time.22
8.6.2.1 TQM is a holistic approach to quality
Quality is a need of both the internal customer (the organisation and the
operation) and the external customer. Quality matters to external customers
because they want:
„„
„„
„„
„„
„„
to be respected and do not want any hassles;
a product and service that offer value for money;
a product and service that are reliable and meet all their requirements;
a product and service that are available on time; and
a product and service that improve their quality of life.
The main reason and justification for quality is the fact that quality is absent
in people’s lives and we consequently seek measures to restore this quality. One
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Chapter Eight – Operations Management
way to obtain quality is by closing quality gaps and applying TQM. Quality
management is therefore not only relevant in business, but in:
„„
„„
„„
„„
„„
„„
„„
quality of product;
quality of service;
quality of organisation;
quality of processes;
quality of work life;
quality of life; and
quality of being (body, soul and spirit)
Quality of product can be defined as:
„„
„„
„„
„„
conformance to the purchase order;
fitness for the intended function;
the degree to which the client or customer is satisfied; and
a total composite of product and service dimensions that meets the
customer’s expectations.
The overview of what quality is shows us that it is not easy to define and is
often in the eye of the beholder. What do people look for when they consider
the quality of a product or service? The best way is to use different quality
dimensions. Examples of quality dimensions pertaining to services are:
„„
„„
„„
reliability, meaning that one can depend on a service dimension as
expected;
responsiveness, which is the willingness of the service provider to meet
the customer’s needs when these needs are expressed; and
competence, which refers to the service provider’s possession of skills
and knowledge to perform the service.
The following attributes relate specifically to goods.
„„
„„
„„
„„
„„
„„
„„
Performance is the way that a product actually operates. Does it do what
it promises to do?
Features are the little extras that go with a product and make it unique.
Reliability refers to the promise that it will perform and keep on
performing as promised over a specific time span (eg the guarantee
period).
Conformance is the meeting of present standards.
Durability is the length of the useful life of the product – its life span.
Aesthetics involve the physical qualities of the product that make it
pleasant to look at.
Perceived quality is the indirect evaluation of quality, for example the
reputation of a specific brand.
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8.6.3 Benchmarking
Benchmarking is a good practice on its own, but is usually part of the continuous
improvement drive. There are several types of benchmarking, including:
„„
„„
„„
„„
generic processes that are similar are compared, regardless of the
industry;
internal benchmarking that means comparing internal processes and
operations;
functional benchmarking that involves comparisons with similar
functions among industry leaders; and
competitive benchmarking that refers to very specific competitor
comparisons.
The process to ensure conformance to benchmarks or specifications involves:
„„
„„
„„
„„
defining the quality characteristic clearly and deciding how to measure
each one;
determining a standard for each quality characteristic (note that this
standard is not the ultimate ideal, since perfection may never be possible.
Zero defects are always the target, but a standard may be the range of
acceptance or minimum requirements);
measuring the quality of output against these standards; and
identifying quality gaps and initiating corrective action and ongoing
improvement.
8.6.4 Measuring quality costs
Is quality always expensive? Does quality cost or save money? To find out, one
needs to understand the different categories of the costs of quality (COQ).
COQ = CONC + COC.
COC (cost of conformance) will lead to a decrease of CONC (cost of nonconformance) to such an extent that COC and COQ also decrease. The PAF
(prevention, appraisal and failure) model refers to the COQ elements, which
are the following broad quality cost categories:
„„
„„
„„
„„
prevention costs;
appraisal costs;
internal failure costs; and
external failure costs.
It is important to note how increasing quality awareness (and quality level)
has a positive effect on quality-related costs. It is said that quality is not a gift
but is ‘free’.
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Chapter Eight – Operations Management
8.6.5 Statistical process control
It is essential to gain background knowledge of statistical process control (SPC)
as a tool and system to monitor and analyse any process. SPC is not only a
toolkit, but also a strategy for reducing variability and providing stability
prediction and consistency in a process. SPC is a useful set of tools (diagrams,
charts, sampling techniques, figures, and so on) available to help management
in their decision making for quality improvement. SPC is applied on a priority
or exception basis, alerting management when something goes wrong and
requires correction. Variation in processes is controlled, and only when a
process is brought under statistical control (ie stable and predictable with no
assignable causes), can its capability be assured.
In short, SPC:
„„
„„
„„
leads to better quality and productivity;
provides knowledge of process behaviour and process capability; and
means less inspection.
The specific purpose of SPC charts is to:
„„
„„
„„
„„
„„
control the quality of processes and products;
monitor consistency and stability;
improve processes by reducing process variability;
observe trends; and
increase predictability and forecastability.
8.6.6 Maintenance and replacement
Machinery and equipment are subject to a substantial degree of wear because their
moving parts are in constant use. Machinery and equipment operating in dusty
conditions are inclined to wear more quickly and require more maintenance.
The consequences of defective machinery and equipment are the following.
„„
„„
Reduced production capacity. Machinery and equipment failures
mean that no production can take place and this leads to a reduction in
production capacity.
Increased production costs. Failures in machinery and equipment result
in a higher hourly cost. Machine operators are idle while the machinery
and equipment are being repaired; moreover, the salaries and wages
of the maintenance teams, as well as the cost of replacing the broken
components, have to be discounted. Sometimes back-up machinery must
be hired or purchased, which also means extra cost.
Lower-quality products and services.
Threats to safety.
„„
Customer dissatisfaction.
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Mixed maintenance strategies are adopted according to circumstances. Usually
it is a combination of breakdown maintenance, condition-based maintenance
(ie one performs maintenance when the resources require it) and preventive
maintenance. These types may also be categorised as follows:
„„
„„
„„
„„
„„
corrective maintenance;
preventive maintenance;
centralised maintenance;
decentralised maintenance; and
subcontracted maintenance.
8.6.7 Preventive maintenance
The following maintenance programme can be instituted to ensure effective
preventive maintenance.
„„
„„
„„
Training of maintenance teams. The members of the maintenance
teams must be properly trained so that any possible failure can be dealt
with effectively.
Determining/predicting the possible time of failure. The possible
time of failure of the machinery and equipment should be scientifically
determined. Proper records must be kept of the intervals between
failures of the relevant components so that their average life-span can be
calculated.
Implementing Japanese principles. The Japanese preventive maintenance
programmes are based on the principle that workers accept responsibility
for preventing possible failures.
The business must, at all times, try to minimise the maintenance cost. This can
only be done by creating a proper balance between corrective maintenance
and preventive maintenance.
Preventive maintenance becomes more expensive than corrective maintenance
as the amount of maintenance increases. Preventive maintenance can, therefore,
only be justified when:
„„
„„
the possible machine failure can be predicted with a fair measure of
accuracy, so that the machine can be repaired before it fails; and
the time spent on preventive maintenance is less than it would take to
repair a machine that has already failed.
8.6.8 Safety, health and environmental management
OM is not only a quantitative subject, but also has a strong humanitarian side,
since many operational solutions lie in employee motivation and wellbeing.
Unfortunately, many businesses do not concern themselves about health
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Chapter Eight – Operations Management
and safety. This can be detrimental. Even large mining organisations tend to
neglect health and safety. Today, the role of OM is moving increasingly towards
safety, health and environmental management (SHE). Many businesses prefer
the more conventional term in terms of the OSH-act namely occupational
safety, and health (OSH) management. A case in point is the new focus on the
wellbeing of the ‘internal customer’. Workplace health promotion is a strategic
issue. The changing role of operations managers includes a new paradigm
towards labour and work. Their challenge to create and sustain a workplace of
health and safety excellence is increasing and there is a culture shift towards the
philosophy of work and productivity within an SHE culture. The behavioural
and human approaches to management will support the operations strategy of
sustainable development and social responsibility because it is believed that HR
managers support the organisation as a staff function, and not in the POM line
function, where most people work. This means POM has a more direct positive
and negative influence on its human resources than the HR function.
Steenkamp and Van Schoor23 provide a useful framework for OSH
management within a TQM context. It is based on the quality of work life
(QWL) of the internal customer, organisational culture (an OSH personality
of the organisation), a holistic overview of global OSH, the fundamental
responsibilities of the OSH function, the fundamentals of occupational
hygiene and the effect of OM on QWL and self-management.
8.6.9 Good housekeeping
Good housekeeping helps prevent incidents, just as cleanliness helps cut down
on germs. A clean, orderly workplace will help workers in many instances. It
helps to make workplaces more pleasant, makes workers feel better about their
work and prevents incidents. Treating a work area with respect will help avoid
slips, trips, falls and bumps.
The basic principles that are part of good housekeeping include:
„„
„„
„„
„„
„„
wiping up accidental spills without delay;
stacking materials (and other means) neatly;
keeping cabinet doors and drawers closed;
returning equipment and tools to their proper place after use; and
disposing of waste promptly (including flammable liquids, oily and paintcovered rags and paper).
8.7 Operations and the other functions of the business
In conclusion, it must be mentioned that OM is viewed more integrally than
in earlier decades. Operations is the drivers of business strategy. All managers,
irrespective of their job title, create products and services. All managers,
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Business Management: A Contemporary Approach
therefore, either work in a close relationship with operations or directly manage
the operations function.
The operation, like the engine of a car, is central to any organisation. The
engine needs fuel, electricity, maintenance and a driver that determines the
route, the direction, the load and the speed. One can view the operations
function as a line function with several support functions. The operations
system’s transformation processes’ ability to function smoothly depends on
several support functions (eg purchasing and marketing). This co-operation
and interface can also be a cause for conflict, especially if things go wrong.
Sound communication and functional integration is crucial for business
success. The operations function is not a silo or factory standing in isolation – it
is increasingly seen as the integral function of any business and supply chain.
The operations function is heavily dependent on:
„„
„„
„„
„„
„„
„„
„„
„„
„„
research and development;
marketing, demand management and forecasting;
financial management (which can assist OM in many ways, eg costing
and make-or-buy decisions);
work study, method study, engineering and design;
quality assurance, maintenance and facilities management;
purchasing and material management;
human resources management (humanity and fairness issues);
storage, handling and transportation; and
quality of work life, health, safety, ergonomics and TQM.
It should be clear that decisions about production processes (the management
of the conversion process) cannot be made in a vacuum and must align with
the corporate business strategy, goals and functions of the organisation. OM
makes decisions that relate to both structural ‘bricks-and-mortar’ issues, as
well as infrastructural/procedural issues 24 Although OM makes things happen,
it needs all other functional areas for support, and only then can it be the
intended spearhead function of the business.
8.8 Summary
The chapter has aimed to condense the comprehensive OM body of knowledge.
The dynamics of OM and the inherent importance of creativity introduced the
chapter, and the typical OM principles were listed. OM and process management
were defined, and the OM performance objectives were discussed. The
characteristics of processes were dealt with in detail. Productivity was briefly
introduced and related to OM. This was followed by operations planning and
control. Operations improvement covered the popular themes of quality, TQM
and SHE management.
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Chapter Eight – Operations Management
8.9 Self-evaluation
Read the case study and answer the questions below.
Case study
Hearing Coach Africa (Pty) Ltd
This international company is situated near the Innovation Hub in Pretoria.
Hearing Coach Africa has invented a unique hearing conservation programme,
which is being used as a foundation for a new international standard (ISO).
The industry at large is in desperate need of such a programme due to
thousands of tragic hearing-loss cases. More workers in industry are exposed to
potentially dangerous noise levels than to similar levels of any other noxious
agent. Factories and mining operations are noisy, and environmentalists and
governments are seeking solutions for noise pollution resulting in noiseinduced hearing loss (NIHL).
The Hearing Coach programme
The Hearing Coach programme is a holistic and personal one. This implies that
the full spectrum of hearing conservation is covered and that the programme is
personal for each worker. Every worker exposed to noise is managed according
to his or her needs and situation. A risk profile is determined for every worker,
and coaching is based on this profile. Education and training are integral to this
programme and the worker is also issued with a personal custom-fit hearing
protector. The hearing protector is also verified in terms of comfort and a seal
test to eliminate leaks. Attenuation is verified by means of the worker’s risk
profile and attenuation needed. Filters of the hearing protector are calibrated
accordingly, and real-world attenuation is verified by means of an attenuation
control unit. Owing to the personal nature of the programme, it is based on
custom-made hearing protectors, such as Variphone and Noise Clipper.
Variphone
Variphone is a sophisticated custom-made product with special features. It
is a concept that is integrated with a professional service and maintenance
plan. Buyers are actually ‘forced’ to buy a service contract or the Hearing
Coach programme if they consider implementing Variphone. Features of this
unconventional hearing protector are very different from the ear-muff or the
one-size-fits-all basic ear plugs. The Variphone is durable (made of transparent
acrylic material) and has an adjustable filter (to adjust or calibrate the
attenuation level according to noise levels on site), which also offers ventilation,
communication ability and localisation. The filter is not tamperproof and needs
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Business Management: A Contemporary Approach
to be adjusted or recalibrated periodically. The Variphone is cost-effective over
the long term, since workers do not replace it every day and can use it for years.
Variphone needs an effective and efficient operation system because
operators (audiometrists) must visit workers at the plants to do impressions
(take moulds), manufacture to specification and revisit the plant for personal
fitments of the Variphone. This describes the transformation process in terms
of a labour-intensive professional service (appointments, work station set-up,
basic training, impressions, fitments, and so on) and the manufacturing
transformation process in the laboratory, where imprints are transformed to a
completed packed acrylic unit with assembled cords and filters.
Noise Clipper
The company strives for lean manufacturing and practice principles, such as
small lot sizes, simplicity, working just-in-time or at the customer’s rate of use,
and decreased cycle intervals. The product is similar to Variphone and also ideal
to be used as part of the Hearing Coach programme. The idea was to design
and patent a hearing protector for African conditions. It is less sophisticated
and more cost-effective than the Variphone, without compromising on product
effectiveness. It was also decided to offer the Noise Clipper in different colours
with each user’s name embedded in the product, and the filter is a fixed
factory setting and tamperproof (non-adjustable, therefore it does not demand
recalibration and additional servicing costs). This filter was also not calibrated
at the premises of the client. Noise Clipper also developed their own process
technologies, such as the ‘Sealometer’ (for seal tests) and the ‘Calometer’ (to
calibrate filters). The operation is labour-intensive because of the custom-made
process and the capacity could be adjusted fairly easily to meet demand. Noise
Clipper’s primary marketing strategy was to do marketing through effective
operations.
Source: Based on a personal interview with the general manager, T Pienaar,
(2007)
Questions
1.
2.
Hearing Coach Africa provides a professional service. One important
element of its programme is a custom-made hearing protector. Which
operations strategy should be considered by Hearing Coach? Should it
consider developing its own hearing protector or should it co-operate
with Variphone and/or Noise Clipper?
What type of operations system is used by Variphone? Does it primarily
offer a service, a product or both?
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Chapter Eight – Operations Management
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3.
4.
5.
6.
Today, the role of OM is changing towards SHE (safety, health and
environment) management. Workplace health promotion becomes a
strategic issue. Noise negatively affects tasks requiring accuracy rather
than speed, and noise detrimentally affects demanding tasks, especially
those requiring attention to multiple signal sources. Hearing Coach is in
the business of preventing NIHL. Explain the meaning of the statement
that the value of quality hearing conservation goes beyond hearing
protection.
Why does this product need an effective and efficient operation system?
The Noise Clipper is similar to Variphone and both are ideal to be used as
part of the Hearing Coach programme. The concept is the same, but the
products have some significant differences. These product differences had
several major operational implications. What are they? What influence
can this have on the perception regarding service in the market?
Hearing Coach uses several process technologies, such as the attenuation
control unit (ACU), otoacoustic emission (OAE) grams and doze meters.
Variphone also uses sophisticated machines, and it is reported that Noise
Clipper developed their own process technologies such as the ‘Sealometer’
(for seal tests) and the ‘Calometer’ (to calibrate filters). What impact can
this ability have on cost, capacity and a marketing strategy in terms of
effective operations?
References
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
M Pycraft, H Sing, K Phihlela, N Slack, S Chambers, C Harland, A Harrison
& R Johnston, Operations Management – global and Southern African
perspectives, 2nd edition (Cape Town: Pearson, 2010).
WJ Stevenson, Operations Management – International Student Edition with
Global Readings, 9th edition (New York: McGraw-Hill Irwin, 2007) p. 4.
N Slack, S Chambers & R Johnston, Operations Management, 4th edition
(London: Prentice Hall, 2004) p. 11.
DD Davis & J Heineke, Operations Management: Integrating Manufacturing
and Services, 5th edition (np: McGraw-Hill Irwin, 2005) pp. 80–82
DL Waller, Operations Management – a Supply Chain Approach (London:
Thomson, 2003) p. 17.
Stevenson, op. cit., p 5.
RJ Schonberger & EM Knod, Operations Management, 5th edition (Burr
Ridge: Irwin, 1994).
Pycraft et al, op. cit., pp 14–15.
Slack et al, op. cit., p. 121.
Pycraft et al, op. cit., p. 17.
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11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
LJ Krajewski & LP Ritzman, Operations Management – Processes and Value
Chains, 7th edition (New Jersey: Pearson Prentice Hall, 2004) p. 91.
Davis & Heineke, op. cit., p. 219.
Slack et al, op. cit., p. 77.
RS Kaplan & DP Norton, ‘The Balanced Scorecard – Measures that Drive
Performance’, Harvard Business Review (Jan–Feb 1992), [online] available
at www.marketmatch.com/content/download/.../Balanced%20Scorecard.
pdf (accessed 10 September 2014).
Slack et al, op. cit., p. 45.
ibid., p. 45.
ibid., pp. 331–332.
Stevenson, op. cit., p. 68.
ibid., p. 181.
Slack et al, op. cit., p. 364.
JR Evans, Quality and performance excellence: management, organization and
stategy, 5th edition (USA: Thomson, 2008) p. iii.
JS Oakland, Total Quality Management (London: Butterworth-Heinemann,
2000) p. 19.
RJ Steenkamp & A Van Schoor, Occupational safety and health (OSH) – a
TQM and Quality of Work Life approach (Cape Town: Juta, 2013).
Davis & Heineke, op. cit., p. 1.
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CHAPTER N I N E
Globalisation and International Trade
Prof René Pellissier
Learning objectives
When you have completed this chapter you should be able to:
„„ understand globalisation and international trade;
„„ learn about international trade theories, how these developed and how they are
implemented;
„„ study the impact of the digital economy, innovation and globalisation;
„„ understand and develop globalisation strategies;
„„ understand competitiveness in international trade and globalisation;
„„ understand the nature of trade and the dependencies or interdependencies
between countries;
„„ develop an understanding of the role of globalisation and international trade in the
world of business; and
„„ apply the principles of globalisation and international trade to business.
9.1 Introduction
There is little doubt that the world of business is undergoing its own radical
change. Stability and order have made way for continued change through
disruptive technologies and a profusion of knowledge. The linear world of cause
and effect has made way for a digital economy based on new relationships
and alliances. One of the showcases for economic change is Toffler’s1 waves of
economic value added over time. Toffler suggested that the economic world has
undergone several substantive changes (or waves) based on the economic needs
of society at specific periods in time. He postulated that these waves occur
at shorter intervals of time, and that each wave designs its own destruction
by creating the need for the next one. With the advent of the microchip,
the industrial wave of the mid-1900s has been replaced by the digital wave
as shown in Table 9.1. The industrial wave embraced order and stability by
focusing on rules and structure, whereas the digital wave allows for rapid
change and flexibility by focusing on technology and information, both of
which of course, manifests a higher connection and relationship.
Of course, globalisation can impact on whole industries, or parts of industries.
With advancing technology and the resultant increased competitiveness
worldwide, business is becoming increasingly global and porous with respect
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Business Management: A Contemporary Approach
to internal and external conditions and global markets. These changes
complicate management issues such as strategy, customers, goods and services,
and distribution channels.
9.2 The digital world of work
Within the new world of work, the current shift from an industrial, machinelike structure to a non-linear alternative brings about new rules for business
and new drivers for growth. These present opposing views on the nature of
work with respect to markets, business focus and collaboration and thinking
skills.
Table 9.1: The industrial vs digital worlds of work 2
Industrial world of work
Digital world of work
Focus on
The present
The future
Certainties
Possibilities
Real and structured
Improvising in unanticipated ways
Rules and laws
Flexibility and openness
Distinguish between
Form
Function
Nature of knowledge
Knowledge confirmation
Knowledge development
Static language
Dynamic language
Set within an industry
Focused on creating an industry
Implicit assumptions
Explicit assumptions
Rules of collaboration
Advocacy
Communications, networks
Competition
Co-opetition
Authoritative
Hypothetical
Reach for closure
Open new conversations
Need for expertise
Need for generalists
Get a decision
Keep learning

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Chapter Nine – Globalisation and International Trade
Elements of the economy
Continuity is key
Discontinuity is key
High growth
Low/no growth
Mass markets
Fragmenting markets
Loyal customers
Volatile customers
Mass media
Fragmenting media
Weak retailers
Strong retailers
Innovation is important
Innovation is vital
Technology is important
Technology is critical
Tribalism
Global village
The impact on the world of work
Learn a skill
Lifelong learning
Business security
Business risk-taking
Job preservation
Job creation
Capital equipment is the key
Intellectual capital is the key
Status quo is important
Flexibility, speed and change are vital
Business is hierarchical and regulated
Business is distributed and networked
Zero sum economy
Win-win economies
Measure inputs
Measure outputs
Linear thinking
Complex thinking
The changing nature of work shown in Table 9.1 seriously impacts upon
relationships, and how we interact socially and in the world of business. It also
impacts on links inside and between businesses, and allows organisations to
transcend existing barriers to entry. Specifically, globalisation benefits from
the high density of technology and knowledge, as individuals and business,
nationally and internationally, become new collaborators and form new
alliances that span the globe.
Look around you at the diverse range of products and services that are
available. How often do we see ‘Made in China’, ‘Made in Hong Kong’, ‘Made
in Taiwan’? We are used to these slogans without questioning how this takes
place and how something that was manufactured out there, is available here.
How does a product originate in one country, but find its way into another?
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Business Management: A Contemporary Approach
In this chapter, we will build on the management tools and techniques you
have mastered up to now, and apply them to a global world. In globalisation
and in international trade, the focus is on the bigger picture where business
(or trade) takes place in the international arena. This is of course complicated
because the same management principles are at play, but country differences
and regulations add to the complexity of the mix. Just think of the advantages
and disadvantages of South Africa joining the BRICS, which is a trade alliance
between Brazil, Russia, India, China, and now South Africa. This creates new
opportunities but can also highlight weaknesses, and produce new threats to
the business or to the parent or host country where the trade takes place. These
trade alliances continue to form and grow. For instance, recently the MINT
economies came together as an alliance between Mexico, Indonesia, Nigeria
and Turkey. We will look at reasons for globalisation, the main international
trade theories, business in the international context, and what Government
can do to support these ventures.
9.3 Globalisation
Globalisation is a popular, though controversial and divisive, topic. It can be
frightening and destructive, or creative and revitalising, as it creates permeable
boundaries that allow for the infusion of goods and services from one country
into another despite their physical or legislative boundaries. Globalisation
encompasses trade growth, liberalisation policies, reduction in production and
transport costs, and increased technology and knowledge transfer. It can also
provide a better life, provided that it is subject to appropriate strategies, good
governance practices, and strong environmental principles.
Globalisation is a more advanced form of internationalisation.
Internationalisation refers to the increasing geographical dispersion of
economic activities across national borders. Globalisation expands the business
into new country markets through the mechanism of international trade. We
will deal with the concept of international trade in this chapter.
Globalisation is far more than an economic phenomenon as it builds a world
of business over a world of nations. Globalisation can be defined as the growing
interdependence of countries worldwide through the increased volume and
variety of cross-border transactions in goods and services, the rapid and
widespread diffusion of technology and improved communications. It therefore
integrates economies, industries, markets, cultures and policy-making around
the world. It describes the process by which national and regional economies,
societies and cultures become integrated through a global network of trade,
communication, immigration and transportation made possible by technology,
the relaxing of trade barriers and the building of international alliances. In the
recent past, globalisation was often primarily focused on the economic side of
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Chapter Nine – Globalisation and International Trade
the world, such as trade, foreign direct investment and international capital
flows. More recently, globalisation has been expanded to include a broader
range of areas and activities such as culture, media, technology, socio-cultural,
political, and even biological factors, eg climate change. Goods and services
produced in one part of the world are sold in another part. Or goods are produced
in a cheaper environment for international consumption somewhere else. An
example is the shift of production from developed countries to developing
countries in order to reduce production costs in cases where lower skill levels
and higher volumes are required.
Figure 9.1: The global network linking countries
Although globalisation focuses on international market expansions, it impacts
locally on jobs, health, education and the economy. It connects disparate
entities and ignores traditional boundaries and models. It brings about value
to, or destruction of, entities depending on the nature of the globalisation
and the role players involved (eg the donor and the recipient country or
geographical area).
9.4 Business in an international context
In the 21st Century, business activities and social links transcend national
boundaries. One of the most significant tendencies is the interdependency of
the world caused by transnational relationships and alliances. Globalisation is a
way of increasing long-distance interconnectedness across national boundaries
and between countries or continents. Linkages across borders include a
restructuring of business domains and a disappearance of the traditional links
between villages, towns, cities and national borders.
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Business Management: A Contemporary Approach
9.4.1 Political perspective
The link between international business and political conflict is complex and
multidirectional. While multinational business certainly feels the impact of
operating in a riskier and more dangerous environment, international business
itself may cause or exacerbate conflicts by providing financial networks to
channel violent activities. International trade in natural resources has both
fuelled regional conflicts (eg conflict diamonds in Africa or oil in Sudan) and
strained international relations (eg Russia’s energy policies towards Western
Europe).
The most intensive globalisation processes have taken place over the last
30 years. We refer to this as an accelerated phase of globalisation. During
this period, a global network of flows, processes and links has formed across
international borders. European colonialism and the worldwide expansion
of capitalism during the 19th and 20th Centuries had already signified an
intensification of worldwide networks. External elements of culture quickly
became local ones, the net result being that individuals are involved in more
than one culture at a time.
Reflection: From your point of view, is it good or bad for industries to be
involved in more than one culture at a time?
9.4.2 A blurring of boundaries
In the 21st Century, conflict and international trade and investment have
greater reach. Civil wars, terrorist attacks, drug and human trafficking and
laundered funds across borders create new sources of risk. At the same time,
internationalisation has taken on new dimensions with the revival of economic
nationalism in countries like Russia, Bolivia and Venezuela. The global world
has become one in which the traditional boundaries between international
relations and international business have become blurred. This new world
presents opportunities and threats for international business, including the
growing weapons industry where arms manufacturers in one country trade
with partners in another country that may or may not be at war with them at
some stage. More notably, good economies reside side by side with bad ones (for
instance, South Africa and Zimbabwe). Can you think of other ones?
9.4.3 Complexity
It appears we have moved into a conflictual period for multinational enterprises.
In this turbulent environment, new efforts are needed to understand the role of
international business in areas such as conflict and crisis management, regional
security and local trade. There is a need to link studies in international affairs
and international relations, which focus on security and conflict analysis, with
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Chapter Nine – Globalisation and International Trade
studies in international business in order to come up with new insights that
reflect the role of international business in a rapidly changing, unstable and
conflict-ridden international environment.
9.5 Globalisation in a business context
The decision to globalise is a significant one, but the implementation is far more
significant, as it impacts on radical changes within the business. Businesses
competing in a global market have to manage an array of new challenges. Study
the following challenges.
„„
„„
„„
„„
The adherence to the laws and regulations of the host country includes
specific industry charters and requirements, taxation, pollution, the
rights of the employees, and fair and honest business practices.
The extent of localisation of the business operations measures the
contribution to the local economy. For example, a motor manufacturer
may be inclined to erect a production plant in a specific country to
utilise cheaper labour and subsequently experience a lack of technology
adoption in that location, which has needs to be addressed.
The extent of social responsibility looks at the relationship with the
local business in a developmental and constructive way over and above
the maximisation of profits. We will return to this when we discuss the
triple bottom line approach in Section 9.9.2.
Managing the culture gap between host and parent countries and their
respective markets can be difficult. Care should always be taken that
the differences in culture between nations, economies or businesses are
recognised and managed. The parent country may propose an incentive it
believes to be advantageous to the host, whilst the host country disagrees
and feels threatened by the changes.
9.5.1 Opening up globalisation
Globalisation impacts on both the business and on the industry. The fact that
businesses keep themselves closed as entities has advantages and disadvantages.
All businesses have styles and structures that keep them separate. They
are uniquely defined in terms of their strategy, vision, mission and values.
Usually, the tendency is not to share information with suppliers, customers
or competitors. This is a machine-like approach (see Section 9.2) that may
induce harmony and consistency, but inhibits learning and growth. It also
discourages innovation. Every business might be an economic web in its own
right, but it exists and operates within a larger connected global web. Thus, a
sense of adaptiveness and boundarylessness is required, as well as openness to
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Business Management: A Contemporary Approach
learning and growth from the outside – in this case, specifically outside the
parent country.
Having a permeable business boundary allows for new opportunities,
markets, products and customers. It even allows for new strategies, a new
vision and mission and new values. The environment may signal shifts in
demand, innovation, requirements, or technologies that make quick response
times critical. Thus, business benefits from an open policy by enhancing
competitiveness. Moreover, global clients requiring similar products open new
markets for existing goods and services, whilst existing markets may require
new goods and services.
Globalisation comes at a cost to the parent company because of the increased
requirement for co-ordination and reporting, and the possible decrease in
local morale because of decentralisation. The global strategy needs to assess
and accommodate all aspects of the resultant plan, and take into account the
change that can be incurred.
9.5.2 Industry globalisation
Industry globalisation depends on customer behaviour and the structure of
distribution channels. Opportunities arise for standardised products when
customers in different countries require essentially the same products. However,
not all products can be standardised and care should be taken that the right
product base is used. Industry globalisation results in standardised products that
do not necessarily satisfy either market requirements, or the digital economy
objective of small batch sizes and flexibility.
9.5.3 Environmental management
Organisational or industry goals should be mindful of the environment. What
may be perceived as advantageous on one level may indeed be detrimental
on another level. For example, the provision of employment in the host
country with a high unemployment rate whilst simultaneously ruining local
entrepreneurship is counterproductive. Or, the host country may have little
means to embrace new technologies or be able to provide infrastructure for
continued support after the parent has left. The parent company should be
specifically required to ensure that the local environment benefits in the long
term. Examples of such requirements include present industry charters that
prescribe behaviour in the local domain. Can you think of more?
9.6 International trade definitions, theories and applications
Up to now we have discussed globalisation. We now turn to international trade
as the mechanism that activates globalisation.
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Chapter Nine – Globalisation and International Trade
9.6.1 International trade
Companies (and countries) trade to increase their expected profit. Therefore,
companies trade to increase revenues, to reduce costs and/or to mitigate risk.
Companies increase their (world) markets in order to use excess capacity and
grow their businesses. One way of reducing cost, is for a company to increase
production and sales so that the cost per unit will decrease. Companies increase
their profits through international sales because the same item often sells at a
higher price, and therefore makes a bigger profit elsewhere because of differences
in the product life cycle or difference in exchange rates. International sales
by diversification can reduce risk. In order to ensure growth, firms need to
adapt to changing markets and maturing products. One reason for entering
foreign markets is the opportunity for long-term growth. For example, many
large firms are attempting to enter Eastern Europe, Russia or China in an effort
to adapt to changes.
International trade can be defined as the exchange of capital, goods and
services across international borders or territories.3 In most countries, such
trade represents a significant share of their gross domestic product (GDP).
International trade has been present throughout history, but its growing
importance to the social, economic and political domains are made
more significant due to advancements in technology, innovation and
communications. Industrialisation, advanced transportation, globalisation,
multinational corporations and outsourcing all impact on the international
trade system. Increasing international trade is crucial to the continuance
of globalisation. Without international trade, nations will be limited to the
goods and services produced within their own borders. It allows for the use of
external (foreign) resources to increase growth and assists with economies of
scale through cross-border trading.
International trade is, in principle, not different from domestic trade as the
motivation and the behaviour of parties involved in a trade do not change
fundamentally regardless of whether trade is across a border or not. The main
difference is that international trade is typically more costly than domestic
trade. The reason is that borders may impose additional costs such as tariffs,
time costs due to border delays and costs associated with country differences
such as language, the legal system or culture.
Another difference between domestic and international trade is that factors
of production such as capital and labour are typically more mobile within a
country than across countries. Thus international trade is mostly restricted
to trade in goods and services, and only to a lesser extent to trade in capital,
labour or other factors of production. Trade in goods and services can serve as
a substitute for trade in factors of production.
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9.6.2 Concepts of international trade
We now know that international trade can bring benefits by allowing countries
to exploit their comparative advantage, reap the benefits of scale economies
and ensure competition, greater variety and, potentially, more stable markets
and prices. The gains from this type of trade are usually not evenly distributed
within, or between, the trading countries so there is opposition by some parties
to free trade. There are two very important determinants of international trade
flows – these are factor endowments and demand conditions.
9.6.2.1 Factor endowments and demand conditions
The concept of factor endowments is important in international trade. By
factor endowments, we mean a nation’s position in factors of production
such as skilled labour or infrastructure necessary to compete in a given
industry. There are basic factor endowments and there are advanced factor
endowments.
Basic factor endowments are present in a country and include natural
resources, climate, geographic location and demographics. While basic factors
can provide an initial advantage, they have to be supported by advanced
factors to maintain success.
Advanced factor endowments are the results of investments by people,
companies and government, and are more likely to lead to competitive
advantage. If a country has no basic factors, it must invest in advanced factors.
Advanced endowments factors include communications, skilled labour,
research, technology and education.
Another concept that is fundamental to international trade is demand
conditions. The demand creates capabilities and demanding consumers. The
demand impacts on quality and innovation.
9.6.2.2 Independence, interdependence and dependence between countries
Depending upon the nature of the trade between countries, there are three
possibilities that can exist. Countries can be independent, interdependent or
dependent upon each other.
Independence between countries with regards to trade means that the
country stands alone and apart with regards to trade. For example, for a long
time, China was independent of other countries in regards to trade, whilst
South Africa used to be blocked from trading internationally due to sanctions.
In the international world, Zimbabwe is not allowed to trade.
Interdependence between countries with regards to trade involves
networks of mutual trade exchanges. Generally, this relationship decreases the
possibility of economic or political war between the countries.
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Chapter Nine – Globalisation and International Trade
Dependence between countries with regards to trade occurs in two forms.
There could either be a monopolist agreement (where there is a single supplier
and the others will find a substitute), or there is a monopsonist agreement
(where there is a single buyer and the others may lose interest in producing the
goods). One-way dependence is dangerous because the dependent country is
vulnerable and has no safety net in case of a problem.
9.6.2.3 Obtaining advantage in the international trade arena
There are three ways to obtain advantage in international trade and international
markets. These are:
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„„
„„
absolute advantage – the ability to produce something more efficiently
than any other country can;
comparative advantage – the ability to produce some product more
efficiently or better than other products; and
national competitive advantage – an international competitive
advantage because of the combined effect of factor conditions, demand
conditions, industry specifics, and an organisation’s strategy, structure,
and competition (see Porter’s diamond in Section 9.6.3.7).
9.6.3 Theories on international trade
Over time, we have dealt with international trade in differing ways,
which has resulted in the development of differing theories; and we have
experienced differing ways of dealing with international trade. The seven
most important trade theories are: mercantilism, the (classical) absolute
advantage principle, comparative advantage, factor proportions trade,
international product cycle, the new trade theory and, more recently, the
national competitive advantage.
9.6.3.1 Mercantilism (mid-16th Century)
This theory states that a nation’s wealth depends on its accumulated treasures,
and requires that there should be a trade surplus. In order to achieve a trade
surplus, exports should be maximised through subsidies, and imports should
be minimised using tariffs and quota systems. The currency of trade is gold
and silver. The problem with the theory is that it restricts trade (because of
the limitations on imports) and impairs growth. Mercantilism is therefore
defined as a trade theory holding that nations should accumulate financial
wealth, usually in the form of gold (forget things like living standards or
human development) by encouraging exports and discouraging imports.
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9.6.3.2 The theory of absolute advantage
In 1776, Adam Smith, in his book The Wealth of Nations argued that the capability
of one country to produce more of a product with the same amount of input than
another country, gives absolute advantage. He also stated that a country should
only produce goods where it is most efficient, and trade for those in which it is
not efficient in itself. Therefore, in this theory, trade between countries should be
beneficial to all partners. It assumes that there exists an absolute balance between
the trading nations. The theory of absolute advantage:
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extinguishes the mercantilist idea because there are gains to be had by
both the countries involved in the exchange;
questions the objective of national governments to acquire wealth
through restrictive trade policies; and
measures a nation’s wealth by the living standards of its people.
Examples of the theories of absolute advantage are the Canadian Timber
industry and the Brazilian Coffee industry.
9.6.3.3 The theory of comparative advantage
In organisations, comparative advantage refers to an entity’s ability to produce
goods or services at a lower marginal and opportunity cost than another. The
more efficient company has a comparative advantage over the other with regards
to one activity, whilst the less efficient company has an advantage with regards
to another activity. In international trade, they can both gain advantage by
sharing. The theory makes better use of resources by seeing trade as a positivesum game. It is based on David Ricardo’s 1818 publication Principles of Political
Economy.4 The theory proposes that imports should take place even if the country
is more efficient in the product’s production than the country from which it
is buying by looking to see to what extent the country is more efficient in
importing, even if the country doing the importing is only comparatively more
efficient. Examples are movie production in the United States, Bollywood in
India, the Guatemalan textile industry or the South Korean electronics industry.
There are several assumptions and limitations embedded in the theory of
comparative advantage. Let us consider the example of France and South Africa
as wine and cheese makers and assume the unit costs to make each are as in
the table below.
Table 9.2: Unit costs for wine and cheese making in France and in South Africa
Wine
Cheese
South Africa
100
120
France
80
70
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Chapter Nine – Globalisation and International Trade
If transportation cost is not an important factor, it is efficient for South Africa
to produce wine and for France to produce cheese. That is because of the
cheaper unit costs and assuming that wine and cheese trade at equal prices (ie
one wine unit is equivalent to one cheese unit). That means that South Africa
can obtain their cheese at a cost of 100 units by producing wine and trading,
rather than producing 120 units by producing the cheese itself. Furthermore,
France can obtain their wine at a cost of 70 units by trading rather than at
80 units through production themselves. Of course, with the advent of some
technology that assists with transportation, the comparative advantage may
increase.
For one, the theory of comparative advantage is driven only by maximising
production and consumption. There is no consideration for any learning
in the theory. It is not feasible that only two countries should be engaged
in production and consumption of just two goods according to this theory.
Labour as a resource is not transferable from one country to another. Moreover,
trade costs, particularly transportation costs, reduce and eliminate the benefits
from trade, including comparative advantage.
9.6.3.4 The factor proportions theory
Also known as the Heckscher-Ohlin model,5 the factor proportions theory that
goods that are locally abundant should be exported. From this follows that
goods made from locally scarce factors are imported. Furthermore, patterns
of trade are determined by differences in factor endowments and not by
productivity. The focus of the theory of factor proportions focuses on relative
advantage and not on the absolute advantage, and it focuses on two factors
of production, namely labour and capital. A country that is relatively labourabundant should capitalise in the production and export of products that are
relatively labour-intensive.
9.6.3.5 Product life cycle theory
The product life cycle theory6 was developed in response to the failure of the
Heckscher-Ohlin model above in order to explain the observed pattern of
international trade. The product life cycle trade theory proposes that a company
will begin by producing and trading the product in the area where it is invented.
Exports into international markets come after adoption of the product in the
local market as the product moves through its life cycle. As products mature,
both the location of sales and the optimal production can change. Naturally,
this change affects the direction and flow of imports and exports. However,
globalisation and integration of the economy makes this theory less valid. The
product life cycle trade theory leads to increased emphasis on product cost.
Figure 9.2 identifies the five stages in a product’s life cycle as being:
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„„
„„
„„
„„
„„
introduction when new products are introduced to meet local (ie
national) needs and are first exported to similar countries that have
similar preferences and incomes;
growth, when a copy product is produced elsewhere and introduced into
the home country and other countries to capture growth in the home
market, thus moving production to other countries – usually on the basis
of the cost of production;
maturity during which the industry contracts and concentrates with the
focus generally on the lowest cost;
saturation is the period of stability where sales reach the peak and there
is no further possibility for increase either through sales, substitutes or
marketing; and
decline in which poor countries constitute the only markets for the
product. This explains why almost all declining products are produced
in underdeveloped countries.
Maturity
Decline
Growth
Introduction
Time
Figure 9.2: The product life cycle curve7
9.6.3.6 New trade theory
The new trade theory is typically used by industries with high fixed costs.
In industries where there are high fixed costs, specialisation increases
output, which subsequently increases the ability to enhance economies of
scale. The learning effects are high although the cost savings come from
learning by doing. In this theory, competitors may form because of firstmover advantage where the economies of scale may very well preclude new
entrants. Therefore the role of the government becomes significant. One
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Chapter Nine – Globalisation and International Trade
criticism is that the theory generates government intervention and strategic
trade policies.
9.6.3.7 The theory of national competitive advantage
The theory of national competitive advantage attempts to analyse the
reasons for a nation’s success in a particular industry. Porter8 studied over
a hundred industries across ten nations and found that the four major
attributes that determine competitive advantage for a nation are: factor
endowments; demand conditions; related and supporting industries; and
firm strategy, structure and rivalry. According to Porter, success occurs
where these factors exist. In fact, the better the attribute, the higher the
likelihood of success.
Successful international industries are normally situated in particular
regions or cities because geographic concentration plays an important
part in the efficient sharing of resources and capabilities. These industry
clusters are due to the fact that the proximity allows for sharing of
culture, organisational learning, capabilities with regards to supply and
local infrastructure. Industry clusters are geographical concentrations
of interconnected businesses, suppliers and associated institutions in a
particular field. The consequence of this is an increase in productivity and
innovation and the development of new businesses. Porter’s opinion is that
productivity is the main factor for international competitiveness and, in
fact, the national standard of living can be improved as a direct result of
higher productivity.
There are different forms of clusters. Some clusters between firms can be
the result of firms producing different products across value-added chains
or between firms producing similar products at different stages of the same
chain. An obvious example is the emergence of the IT cluster in Silicon Valley
in California.
Porter continued his argument by introducing the diamond as shown in
Figure 9.3. Porter explained that a firm needs a strong corporate vision as
determinant to their success, a management ideology and structure that
can support its international trade activities, and that domestic rivalry
increases competitiveness. His diamond shows that countries should export
products from those industries where all four components of the diamond
are promising, while importing in those areas where the components are
not favourable. There are also two external factors that influence the four
determinants: factors based on chance or based on government, making up
a total of six factors for national competitive advantage.
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Due to chance
Firm strategy,
structure,
policy
Demand
conditions
Factor
endowment
Related and
supporting
industries
Due to
government
Figure 9.3: Porter’s diamond for national competitive advantage9
Factor conditions. Important determinants of a nation’s competiveness is
denoted by its relative position in the critical industrial production factors
such as skilled labour or infrastructure. The level of individual factors and the
combination of the overall resource mix must be considered. Factors can be
country-specific or industry-specific. For example, South Africa has identified
engineers as scarce skills resources for its economic growth, whilst much of
Japan’s success has been attributed to its strong engineering focus.
Demand conditions. The nature of the home country’s demand for an
industry’s products and services requires considering both the quantity and
quality of the demand. For example, Japanese camera buyers assisted in
improving and innovating products.
Related and supporting industries. A key factor is the presence (or absence)
of internationally competitive suppliers and related industries. For example,
the United States has access to their own petroleum which greatly advances
the motor industry in the country.
Firm strategy, structure and rivalry. Some national conditions impact
upon how companies are created, organised and managed. These conditions
can also impact on the nature and extent of domestic rivalry. For example,
in South Africa, small business development is a priority for the government.
South Africa, as opposed to the United Sates, does not allow comparative
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Chapter Nine – Globalisation and International Trade
marketing where a company is allowed to criticise a competitor product in
their marketing campaign.
Porter stated two additional variables that indirectly influence the diamond:
Chance events. There are always disruptive developments outside the control
of firms and governments that change the industry and that consequently
allow new entrants to enter the domain. For example, turbulence in
international politics, wars, new technologies (especially radical innovations)
radical innovations and natural disasters.
Government. Policy changes made at governmental level can greatly change
the competitiveness by impacting on one or more of the above determinants.
Successful government policies should strengthen successful industries, whilst
it is possible for government to negatively influence possible competitiveness
by lack of power, incentives or rigorous regulations.
These six attributes promote or impede the creation of competitive
advantages of firms, clusters and nations. All conditions need to be present
and need to be favourable for an industry or a company to become and remain
competitive.
International business managers employ the diamond model during their
internationalisation efforts to determine if the home market can support and
sustain a successful internationalisation effort or to asses in which country to
invest next. Also, the model can inform entrepreneurs where to start a new
business venture, whilst governments can use the model in order to develop a
policy framework supporting international trade and global business.
Porter’s diamond should predict the pattern of international trade as we
experience it. This framework has three immediate implications for business,
namely:
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„„
„„
location implications (companies diversify production activities to
countries where they can be performed most efficiently);
first-mover implications (companies invest substantial financial
resources in building a first-mover or early-mover advantage); and
policy implications (promoting free trade is in the best interest of the
home country but may not be in the best interest of the firm).
9.6.4 Determining trade partners
There are numerous ways to determine which partners to trade with. The two
most important theories are the country differences theory, and the country
similarity theory.
The country differences theory holds that the greater the differences, the
greater the amount of trade. These differences refer to the various country
and product factors, for instance, climate, factor endowments and innovation
capabilities.
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According to country similarity theory, the greater the similarities between
two counties, the bigger the amount of trade. This is known as the small theory
because, as a product is developed in one country, the next best place to sell it
is the most similar country. For example, Canada is the largest trading partner
with the United States because these countries are similar.
9.7 International trade blocs and alliances
What is a trade bloc? It is some form of agreement between governments that
often forms part of a regional intergovernmental organisation. The barriers
to trade (tariffs and non-tariff barriers), are decreased or totally eradicated
between the entities in the agreement. One of the first examples is the German
Customs Union (1834) that formed the basis of the German Confederation, and
subsequently the eventual German Empire in 1871.
Members of successful trade blocs usually share four common traits, namely:
„„
„„
„„
„„
similar levels of per capita GNP;
geographic proximity;
similar or compatible trading regimes; and
political commitment to regional organisation.
Advocates of worldwide free trade are generally opposed to trading blocs,
which, they argue, encourage regional as opposed to global free trade. Scholars
and economists continue to debate whether regional trade blocs are leading
to a more fragmented world economy or encouraging the extension of the
existing global multilateral trading system. Trade blocs can be stand-alone
agreements between several states (such as the North American Free Trade
Agreement (NAFTA)) or part of a regional organisation (such as the European
Union). Depending on the level of economic integration, trade blocs can fall
into different categories, such as: preferential trading areas, free trade areas,
customs unions, common markets and economic and monetary unions.
9.7.1 Advantages of trade blocs
Of course, there are advantages and disadvantages of trade blocs. Free trade
allows nations to operate with the efficiency that comparative advantage brings
to every part of bilateral trade partners. The reduction of trade barriers typically
associated with free trade pacts encourages more trade, increasing exports,
competition and the growth in the use of surplus materials.
„„
The theory of comparative advantage specifies that countries with lower
relative costs should specialise in goods in which they have comparative
advantages. This increases the theoretical welfare of all countries engaged
in such trade.
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Chapter Nine – Globalisation and International Trade
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„„
„„
„„
„„
Reduction of tariff barriers leads to trade creation when production
moves from high-cost producers to low-cost producers. Simultaneously,
the removal of tariffs leads to lower consumer prices and an increases
in the valuation of consumer welfare as consumer surplus in goods
significantly affected rises. It has been shown that the magnitude of this
increase depends upon the elasticity of supply and demand.
Increased exports brought by lower tariffs not only bring benefits for
those consumers importing goods, but also for the firms and countries
exporting goods when they have a large comparative advantage. The
increases in production create unambiguous increases in jobs and growth
through local multiplier effects.
Countries specialising in those goods for which they hold comparative
advantage benefit from the associated economies of scale and lower
average costs. Such gains are especially important in industries with high
fixed costs or that require high levels of investment. More trade of course
makes domestic firms face greater competition from abroad. This in turn
creates significant incentives to cut costs and increase efficiency.
It seems that trade is an engine of growth. Countries with surfeits of
resources, like oil or agricultural land, overproduce relative to domestic
demands when they know they can sell in other countries with fewer
resources. And countries with few natural resources can become
reasonably wealthy by trading for the natural resources the industrial
production that their labour can produce. ‘Big conclusion?’ There is no
doubt that trade has become the engine of growth that it has by allowing
the countries of the world to play with their comparatively advantaged
resources.
9.7.2 Disadvantages of trade blocs
Some advantages have been listed above, but there are also disadvantages of
trade blocs. If developing countries have industries that are relatively new, then
these emerging industries would struggle against international competition.
However, if they invested in the industry, then in the future they may be able
to gain comparative advantage. This shows that comparative advantage can
change over time and, therefore, protection would allow them to progress and
gain experience to enable them to be able to compete in the future.
If industries are declining and inefficient, they may require large investment
to make them efficient again. Protection for these senile industries would
act as an incentive for firms to invest and reinvent themselves. However,
protectionism could also be an excuse for protecting inefficient firms.
Many developing countries rely on producing primary products in which
they currently have a comparative advantage. However, relying on agricultural
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products has several disadvantages, and trade blocs can help to diversify the
economy. Prices can fluctuate due to environmental factors and goods have a
low income elasticity of demand. Therefore, with economic growth, demand
will only increase a little.
Import taxes can be used to raise revenue for the government, but it will
only be a small amount of money.
Reducing imports can help the balance of payments. However, in the long
term this is likely to lead to retaliation.
This is not really an economic argument but more political and cultural.
Many countries wish to protect their cultural identity from what they see as
Americanisation or commercialisation.
Trade blocs can offer protection against dumping. In the past, the EU sold
a lot of its food surplus from the CAP at very low prices on the world market.
This caused problems for world farmers because they saw a big fall in their
market prices.
It is believed that free trade can harm the environment because LDCs
may use up natural reserves of raw materials to export. Also countries with
strict pollution controls may find that consumers import the goods from
other countries where legislation is lax, and pollution allowed. However,
supporters of free trade would argue that it is up to individual countries to
create environmental legislation.
9.7.3 Major trade blocs
The major trade blocs are the European Union, the European Free Trade
Agreement, the North American Free Trade Agreement and the Southern
African Customs Union, which is discussed in 9.7.4.
The European Union (EU) is the world’s largest trading bloc, and second
largest economy, after the USA. The EU was originally called the Economic
Community (Common Market, or The Six) after its formation following
the Treaty of Rome in 1957. The original six members were Germany, France,
Italy, Belgium, Netherlands and Luxembourg. The initial aim was to create a
single market for goods, services, capital and labour by eliminating barriers to
trade, and promoting free trade between members. In terms of dealing with
non-members, common tariff barriers were erected against cheap imports,
such as those from Japan, whose goods prices were artificially low because of
the undervalued yen.
The European Free Trade Agreement (EFTA ) is a free trade organisation
between four European countries that operate in parallel but are linked to
the European Union (EU). The EFTA was established in 1960 as a trade blocalternative for European countries either unable or unwilling to join the
erstwhile European Economic Community (EEC), now known as the EU.
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Chapter Nine – Globalisation and International Trade
The Stockholm Convention, establishing the EFTA, was signed on 4 January
1960 in Sweden by seven countries (known as the ‘outer seven’). Current
EFTA members are Iceland, the Principality of Liechtenstein, Norway and
Switzerland, of which the latter two were founding members.
The North American Free Trade Agreement (NAFTA ) is an agreement
signed by Canada, Mexico, and the United States, thus creating a trilateral
rules-based trade bloc in North America. The agreement was initiated on
1 January 1994. It superseded the free trade agreement between the US and
Canada. In terms of combined purchasing power parity of its members, this
trade bloc is the largest in the world and second largest by nominal GDP
comparison. It immediately effected the elimination of tariffs on more than
50% of Mexico’s exports to the US and more than a third of US exports to
Mexico and may well eliminate all Mexico-US tariffs at some point. NAFTA
also seeks to eliminate non-tariff trade barriers and to protect the intellectual
property right of the products.
Discussion block: Can you think of any other trade blocs that are valuable
to South Africa?
9.7.4 African trading blocs
Some regional trading blocs in Africa include the Economic Community
of West Africa, the Common Market of Eastern and Southern Africa, the
Southern African Development Community and the Southern African
Customs Union.
Economic Community of West African States (ECOWAS) consists of a
regional grouping of 16 western African countries. Its objective is to promote
co-operation and integration in economic, social and cultural activity
ultimately leading to the establishment of an economic and monetary union.
The union wants to eliminate tariffs and other obstructions to trade in
member states and the establishment of a common tariff for non-member
countries.
Common Market of Eastern and Southern Africa (COMESA) consists
of 21 states in the eastern and southern parts of Africa. Its objective is to
promote co-operation and integration in economic, social and cultural
activity ultimately leading to the establishment of an economic and monetary
union. The union wants to eliminate tariffs and other obstructions to trade
in member states and the establishment of a common tariff for non-member
countries.
Southern African Development Community (SADC) consists of 10 African
countries including South Africa and Mauritius. Its objective is to create a
southern African common market for 130 million people that is committed to
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the ideals of free trade, free movement of people, a single currency, democracy
and respect for human rights.
Southern African Customs Union (SACU) is an agreement between
the governments of the Republic of Botswana, the Kingdom of Lesotho,
the Republic of Namibia, the Republic of South Africa and the Kingdom of
Swaziland. Its objective is to allow for free interchange of goods between
these countries and applying the same tariffs and trade regulations to goods
imported from outside the common customs area. They recognised that the
Customs Agreement concluded on 29 June 1910, as amended from time to
time, required modification to:
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„„
provide for the continuance of the customs union arrangements in the
changed circumstances on a basis designed to ensure the continued
economic development of the customs union area as a whole;
ensure, in particular, that these arrangements encourage the development
of the less advanced members of the customs union and the diversification
of their economies; and
afford to all parties equitable benefits arising from trade among themselves
and with other countries.
These blocs have not been very successful, as some countries belong to more
than one bloc, which defeats the objectives set for the individual blocs and the
overall objective of preferential trade blocs.
9.7.5 The BRICS
The BRICS, originally BRIC before the inclusion of South Africa, is the name
given to the association of emerging national economies: Brazil, Russia,
India, China and South Africa. This is not a typical trading bloc as discussed
in Section 9.7, but rather an economic association formed by the member
countries. With the possible exception of Russia, the BRICS member countries
are all developing or newly industrialised countries. They are characterised
by their large, fast-growing economies and significant influence on regional
and global affairs. Before South Africa joined, the entity was known as the
BRIC.
In 2010, South Africa joined the BRIC, which thus became BRICS. At that
time, Brazil, Russia, India, China and South Africa met in India to discuss the
formation of a development bank to pool resources. At that point, the BRIC
countries were responsible for about 18% of the world’s gross domestic product
and were home to 40% of the earth’s population.
The BRIC philosophy states that China and India will become the world’s
dominant suppliers of manufactured goods and services, respectively, while
Brazil and Russia will become similarly dominant as suppliers of raw materials.
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Chapter Nine – Globalisation and International Trade
According to Goldman Sachs, these countries are a political alliance (like the
European Union) or a formal trading association – but they have the potential
to form a powerful economic bloc. BRIC is now also used as a more generic
marketing term to refer to these four emerging economies. Due to lower labour
and production costs, many companies also cite BRIC as a source of foreign
expansion opportunity.
The BRICS do not form a uniform group in terms of the group’s
competitiveness. India is seen as a factor-driven economy, China and South
Africa as efficiency-driven economies, and Brazil and the Russian Federation
as economies in transition from efficiency-driven to innovation-driven
economies. According to the 2012–2013 Report, China is ranked as number
29, Brazil as 48, South Africa as 52, India as 59 and Russia as 67 on the overall
index. This seems quite a wide spread for a group of countries intending to
trade together.
The most direct economic benefits from international trade arise from
the fact that countries are not all the same in their production capabilities.
They vary from each other and discuss which countries they should trade
with because of differences in natural resources, levels of education of their
workforces, relative amounts and qualities of physical capital, technical
knowledge, and so on. Without trade, each country must make everything
it needs – including things it is not very efficient at producing. By contrast,
when trade is allowed, each country can concentrate its efforts on what
it does best relative to other countries, and export some of its output in
exchange for imports of products it is less good at producing. As countries do
that, the total world output increases. World output may also grow because
of greater use of economies of scale (eg a factory in one country can serve a
market the size of two or more countries rather than one). Trade can benefit
countries’ economies in a number of other ways as well, such as by expanding
the variety of goods available to businesses and consumers, by increasing
competition and thereby reducing the extent of monopolistic pricing and
the inefficiency that results from it, and possibly by pushing up the rate of
productivity growth.
Market forces generally ensure that all countries involved in the trade
share in the benefits from the increased outputs. Trade blocs can contribute
to internalise global externalities and foster the adoption of co-ordination
mechanisms among countries that may facilitate the multilateral process
toward global trade liberalisation. Hence, trade blocs can also be regarded
as an endogenous response to the multilateral system, with the view to
complementing multilateral liberalisation, and addressing economic, political
and institutional concerns beyond the scope of the multilateral trade system.
A trade bloc can be defined as a ‘preferential trade agreement (PTA) between a
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subset of countries, designed to significantly reduce or remove trade barriers within
member countries.’ 10
When a trade bloc comprises neighbouring or geographically close countries,
it is referred to as a ‘regional trade (or integration) agreement’. This is sometimes
referred to as a ‘natural’ trade bloc to underline that the preferential trade
is between countries that have presumably low transport costs, or that trade
intensively with one another. The two main characteristics of a trade bloc are
that it:
„„
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implies a reduction or elimination of barriers to trade; and
is discriminatory, in the sense that it applies only to the member countries
of the trade bloc, outside countries being discriminated against in their
trade relations with trade bloc members.
Although limited, there exists regional integration agreements in which
co-operation rather than preferential market access is emphasised. Trade
blocs can also entail deeper forms of integration in terms of international
competition, investment, labour and capital markets (including movements
of factors of production), monetary policy, and so on. The integration of
countries into trade blocs is commonly referred to as ‘regionalism’, irrespective
of whether the trade bloc has a geographical basis or not. The first waves of
such trade blocs appeared in the 1930s leading to a fragmentation of the world
into trade blocs. This ‘old (first) regionalism’ is also associated with regional
initiatives involving developing countries in the 1950s and 1960s.
Based on the objective of import-substitution industrialisation, the rationale
was that developing countries could reap the benefit from economies of scale
by opening up their trade preferentially among themselves, hence reducing
the cost of their individual import-substitution strategy while the trade bloc
became more self-sufficient. More successful experiences followed with the
recent proliferation of trade blocs, or so-called ‘new (second) regionalism’,
which involves mostly countries from the north with the south (the northsouth trade blocs).
9.7.6 The MINT
As the world becomes more global, newer alliances keep on forming. One
such alliance is the formation of the MINT as the next economic powerhouse.
This term refers to the combination of economic forces of Mexico, Indonesia,
Nigeria and Turkey. They are linked by the following keystones: young
populations, useful geographical placement and (Turkey excepted) by being
commodity producers. Nigeria is seen by many economists as having a stronger
economy than South Africa, primarily because of a recent reassessment of
the country’s GDP.
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Chapter Nine – Globalisation and International Trade
Together, the BRICS and the MINT constitute the fastest growing economic
powers in the world, even though they are all emerging economies. Global
companies experience huge successes by focusing on these entities. However,
the underperformance of the BRICS over the past three years has put many
investors off investing just because of economic growth. In fact, corporate
governance problems and questionable accounting are two of the issues the
countries need to deal with. Russia is at risk because of its invasion into Crimea;
Turkey and Nigeria have been mired in political squabbles that have hurt their
currencies. Like their BRICS predecessors, each of MINT countries has numerous
systemic problems similar to those of their BRICS predecessors. Nigeria, like
Russia, is one of the more corrupt countries in the world. Despite claims to
the contrary, this seems unlikely to change for the better with an expanding
economy. Turkey’s recent issues with currency stability parallel financial issues
currently at play with Brazil. Indonesia and India both fight soaring inflation,
with current outlooks grim for both states. However, the governments in
India and in Indonesia have done much to develop sustainable growth and
expansion policies, whilst China and Mexico are growing due to a special trade
relationship with the United States.
Last thought, in addition to BRICS and MINT, there is also CIVETS (Colombia,
Indonesia, Vietnam, Egypt, Turkey and South Africa), MIST (Mexico, Indonesia,
South Korea and Turkey) and the Next 11 (Bangladesh, Egypt, Indonesia, South
Korea, Mexico, Nigeria, Pakistan, Philippines, Vietnam and Turkey).
9.8 Enablers to globalisation
From what we have discussed so far we know that successful global businesses:
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are outward looking and challenge established ideas;
facilitate communication and dialogue;
are open to new ideas;
accept and learn from failures; and
promote evaluation and reflection.
We have already mentioned that certain styles disable organisational learning
and growth (see Section 9.1). There are specific business drivers that allow for
globalisation as a form of growth. The most important are an outward culture,
technology, information and open innovation.
9.8.1 Outward business culture
Culture is the set of values and beliefs that define how an entity lives and
operates. Culture is embedded in all activities of the business and regulates
the human interface. An inward-looking culture is closed to outside
influences and will not allow for globalisation. An outward business culture
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Business Management: A Contemporary Approach
emphasises competitiveness with regard to other companies and focuses on
market leadership. In such a culture, there is a high regard for innovation and
development. Leadership tends to be entrepreneurial and constantly looks
for new markets and products. There is a certain amount of risk taking and
embracing diversity, which allows for globalisation.
9.8.2 Technology
In the non-linear economy, technology, is embedded in most goods and
services. Technology and globalisation go hand in hand. Globalisation
unleashes technology which, in turn, drives entities to plan production
and sales on a global basis. Technology changes the way we work, and thus
the way business operates as it transforms relationships between suppliers,
producers, retailers and customers. Survival in global markets calls for
improved productivity and increased competition. This, in turn, creates the
need for entities to upgrade or renew their products and services. Technology
is ideally suited for this.
Technology can be defined as the human activity devoted to the production
of ‘technics’ (or technically related intellectual products), with the major aim
of expanding the area of practical human possibility.
Thus, technology is concerned with the practical knowledge of how to do
things and how to make them. For example, computer technology is used in
communications, manufacturing and research. Technology, and specifically
information technology, is an enabler for globalisation.
As technology advances, newer, faster and better goods and services become
available and are in higher demand. To fulfill consumer demand, there is
a shift in the labour market towards workers who are trained in the skills
that can provide such goods and services. The downside, however, is that
increased levels of automation may eliminate jobs. Technology should be used
to enhance products and services, and allow space for labour to become more
actively involved in knowledge-based activities.
9.8.3 Information
The entire information industry has grown out of the demand for, and supply
of, information. Silicon Valley companies (this is the term used for the high
tech companies based in northern California) provide information and reports
through computer or telephone enquiry services. Information services include
operational and strategic reports and snapshots of different levels in business.
Information services can be specialised to cater for needs in the fields of
medicine, architecture or law, or information can be obtained as standardised,
packaged solutions.
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Chapter Nine – Globalisation and International Trade
Information is defined as the result of processing, manipulating and organising
data in such a way that it adds value and gives meaning. It is a unique resource
as it is intangible, growable and resellable. It allows for relationships and
communication across boundaries. The goal of information is to provide
strategic and just-in-time decision support at all functional levels of the
business. The main functions of information are:
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to add value to customers (by aggressively and continually obtaining
customer information);
to reduce costs of transactions and processes (by continually optimising
process and product);
to minimise risks of businesses by using information to monitor, maintain
and control systems (setting up risk portfolios); and
to create new realities and innovate by leveraging understanding of key
developments (ie social or technological) as innovation and regeneration
strategies are critical to surviving in a quantum world.
Information is received and distributed with no knowledge of geographical
boundaries or rules, thus enabling globalisation. An example of an informationbased system is manufacturing companies that have immediate access to all
aspects of raw materials available, batch sizes or quality indicators, whilst
executives have access to dashboards for quick decision making. Access to large
amounts of information enhances the quality and quantity of products and
facilitates the online order receipt and billing systems that co-ordinate orders
and invoices for multi-branched worldwide companies.
9.8.4 Open innovation
Henry Chesbrough11 defines open innovation as ‘the use of purposive inflows
and outflows of knowledge to accelerate internal innovation and expand markets for
external use of innovation respectively’. In a global environment, businesses can
(and should) use external and internal knowledge, and internal and external
links to the marketplace. Open innovation creates value by combining internal
and external aspects. It presupposes that useful knowledge is widely distributed
and leverages external sources as a core process for growth. From a globalisation
perspective, open innovation looks for, and develops new ideas found outside
the business. It acts as a catalyst for renewal and regeneration to the firm itself
as well as its products and services.
9.9 Legislation and fair globalisation
The World Commission on the Social Dimension of Globalisation report12 was
the first step in ascertaining the impact of globalisation on ordinary citizens.
The report presented a positive but critical message for globalisation. It proposes
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Business Management: A Contemporary Approach
that the potential of globalisation (for example, growing connectivity and
productive capacity) is substantial, but that the governance of globalisation
at national and international levels has not achieved its objectives. Following
on the 2008 financial crisis, the International Labour Organisation (ILO)
brought out a special report assessing global economic recovery. They show
a global labour market in utmost distress, with one out of three people in
the labour market currently either unemployed or poor, and call for decisive,
co-ordinated action to reduce uncertainties to restart the engine of global job
creation. The ILO believes that economic convergence between developing
countries and advanced economies is gathering momentum with the first
mentioned growing on average much faster than advanced economies.
They believe that global policy makers should co-ordinate globally in order
to rebalance growth and foster global growth engines whilst focusing on
unemployment.
Globalisation has not met the needs of ordinary citizens for jobs and a
decent livelihood. This is mainly due to persistent imbalances in the global
economy, despite these ethically unacceptable and politically unsustainable?
There is an urgent need to rethink global economic governance, where rules
and policies are generally determined by the most dominant countries and
businesses. The failure of policies is due to the fact that market-opening
measures and financial and economic considerations have consistently
outweighed social ones.
The World Commission on the Social Dimension of Globalisation
envisions a system of global governance that is genuinely supportive of, and
conducive to, national development strategies, maintaining that there can
be no successful globalisation without successful localisation. Role players
should be held accountable, and efforts to achieve coherence between
economic and social objectives should focus on the development needs of
the ordinary citizen.
9.9.1 The role of government
Few regions can benefit from isolation. At the moment, the United Nations
has the best means to respond to globalisation challenges. However, all states
should develop national competencies, regulate economic activity, promote
labour equality and provide the relevant services for international alliances.
The state should enhance education levels and develop technological skills.
This includes retaining skills rather than losing them to developed countries.
Furthermore, regional integration allows for a far more inclusive form of
globalisation. Geographically close countries are better able to develop
and manage joint social and economic challenges for globalisation. This
is especially relevant under the general notion of the global notion of ‘one
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Chapter Nine – Globalisation and International Trade
size fits all’. Thus, regional agreements can provide an effective medium for
integrating poorer countries into the international markets.
There are specific actions that a host government can take to protect the local
business community, whilst at the same time benefiting from globalisation
initiatives. These include:
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acknowledging responsibility for a healthy environment for all business;
ensuring that the legal environment regulates business behaviour, ensures
market order and protects investors’ interests and the environment;
improving antimonopoly activity;
emphasising scientific development and innovation;
regulating the behaviour of provincial governments to encourage
localised economic growth and protect the environment;
ensuring quality in goods and services;
rewarding collaboration through trade incentives, whilst protecting
the local environment through import tariffs and quotas, by setting
local content requirements on goods and services made elsewhere, and
regulating the prices of imported goods and services;
developing information and technology skills;
providing subsidies and low interest loans to local business to assist in
competing against the international ones;
offering foreign companies subsidies and market access, if there is a need
for foreign business;
maintaining strong policy development; and
keeping exchange rates constant.
9.9.2 The triple bottom line approach
The term ‘triple bottom line’ (or 3BL) was created by Elkington13 in 1997.
Triple bottom line reporting defines a business’s ultimate worth in financial,
social and environmental terms and, hence, assesses its strategy. Thus, more
than focusing on the financial impact, the 3BL approach requires responses
to how the business impacts positively or negatively on individuals or
communities. It improves good corporate citizenship as it takes into
account social and environmental responsibilities along with financial ones
Although there are numerous studies that question whether 3BL is indeed
implementable, it assists in providing a big picture of impact, particularly
in a global sense.
9.10 The impact of globalisation
Globalisation can impact on culture and identity, thus threatening the life
of communities. Nevertheless, there are advantages in overturning tradition
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and introducing modern attitudes and gender equality. People are generally
positive about the resultant openness and interconnectedness, but concerned
about the possible loss of, or changes in, jobs. Small businesses generally do
not benefit from globalisation, and yet do provide employment on a vast
scale. There is little impact on rural areas, which remain largely poor and
marginalised.
9.10.1 Redefining assumptions
A strong culture may sometimes inhibit looking outward. Some see globalisation
as leading to a global society transcending national units, but this view
overlooks the continued importance of national institutions and international
relationships, and the emergence of strong regional businesses in a society that
is essentially multilevel rather than global in character.
9.10.2 Competing in international markets
The decision to globalise is a complex one determined by a variety of important
factors. Generally, businesses decide to explore international markets in order
to stay competitive by finding new markets and/or accessing natural resources
in other countries. When doing so, the host country should be evaluated in
terms of:
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different buyer patterns;
distribution channels;
potential for growth;
driving forces;
political and economic stability; and
competitive forces.
Other areas for consideration include government strategy and management,
and the economic and developmental needs and direction of the host country.
These are discussed below.
Government strategy affects business, particularly in terms of macroeconomic, micro-economic and foreign investment. For instance, a large
national budget deficit can lead to an increase in interest rates, and economic
performance impacts on exchange rates.
The key ingredients needed by a country to create successful economic
growth should focus on:
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sound fiscal and monetary policies;
secure property rights;
high savings and investment;
an absence of corruption;
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„„
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exports that are competitive in enough areas to eventually balance
imports; and
policies that allow for globalisation while ensuring little risk to the local
economy.
The direction that the country is taking with regards to its own development
can affect the decision to invest. For example, Singapore, China and India are
doing well and, pending political stability, so is Russia. Mexico, Saudi Arabia
and South Africa all have significant competitive problems. Italy, Japan and
the US have issues of maturity, either labour or structural problems (Italy),
demographic and entrepreneurial problems (Japan), or excessive consumption
and debt problems (US).
Government management and is critical as bad government practices will
lead to a demise of business ventures.
9.10.3 The Global Competitiveness Index
The economic success of a country depends on its:
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capacity to apply activities that create a competitive advantage;
ability to create an environment of transformation and progress; and
capacity to innovate.14
Competitive intelligence (CI) has long been recognised as a strategic
management tool that could enhance competitiveness. This perception of CI
as a strategic tool is not exclusive to developed countries. CI is expected to
play a key developmental role in developing countries as well. The need to
enhance companies’ and, by extension, countries’ competitiveness has grown
rapidly. CI is essential and will increasingly be a challenge in the years to
come, especially for emerging economies.
Competitiveness is a multifaceted concept and, according to Garelli,15 the
competitiveness of nations ‘focuses on the policies implemented by nations
to shape the environment around enterprises’ and economic value is only
created within the context of an enterprise. According to Waheeduzzaman,16
the ultimate goal of competitiveness is to improve the standard of living
or the real income of the citizens of a country. Since companies actually
compete in the global economy, many authors are of the opinion that when
studying competitiveness, the focus should be on companies since they are
the main engines that drive a country’s competitiveness.
As globalisation increases, it has serious implications for developing
countries since the growing interdependencies between national economies
accelerate the process of economic integration in the knowledge economy.
With the globalisation of markets, the need to enhance companies’ and
countries’ competitiveness has grown rapidly. If government supports and
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encourages the application of CI, then it would have a more positive impact
on the economy of a country and the quality of the lives of citizens.
The global competitiveness report and country indices define competitiveness
as the set of institutions, policies and factors that determine the level of
productivity of a country. The level of productivity, in turn, sets the level
of prosperity that can be earned by an economy. The productivity level also
determines the rates of return obtained by investments in an economy, which
in turn are the fundamental drivers of its growth rates. In other words, a more
competitive economy is one that is likely to sustain growth. The concept of
competitiveness thus involves static and dynamic components. Although
the productivity of a country determines its ability to sustain a high level of
income, it is also one of the central determinants of its returns on investment,
which is one of the key factors explaining an economy’s growth potential.
As outlined in Table 9.3, the twelve pillars that are assessed are institutions,
infrastructure, macroeconomic environment, health and primary education,
higher education and training, goods market efficiency, financial market
development, labour market efficiency, technological readiness, market size,
business sophistication and innovation.
Table 9.3: The global competitiveness index framework
Sub index
Basic
requirements
Efficiency
enhancers
Innovation and
sophistication
factors
Pillars
1.
2.
3.
5.
Higher
education and
training
6. Goods market
efficiency
7. Labour market
efficiency
8. Financial
market
development
9. Technological
readiness
10. Market size
11. Business
sophistication
12. Innovation
Key for efficiencydriven economies
Key for innovationdriven economies
4.
Institutions
Infrastructure
Macroeconomic
environment
Health and
primary
education
Key for factordriven economies
Source: World Economic Forum17
9.11 Assessing globalisation
Globalisation has benefits, but is generally unpopular in host countries. Big
business has been relatively silent because it thinks that it will aggravate the
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Chapter Nine – Globalisation and International Trade
debate. Much of the communication around globalisation is defensive, as
businesses must explain what they want from globalisation and what its impact
would be. Businesses must also focus on those excluded from globalisation,
and address their needs. Corporate social responsibility is about growth
and innovation, not about philanthropy, so this is the only way forward for
business success.
9.11.1 The globalisation paradox
Globalisation is paradoxical, as perceptions differ widely of who its beneficiaries
are. The fact of the matter is that there can be benefits to both parent and host
countries, albeit in different forms. Globalisation looks for increased growth in
regional economies and taps into them. The globalisation debate is about risk,
and who will bear its cost. In this, businesses can play a role in helping to mitigate
risk. Risks include developing insurance products, dealing with healthcare costs
by forming pools and keeping pressure on building skills through education.
On the whole, countries gain more than they lose, although that does not
necessarily mean that individuals are better off. The most successful strategies
find some balance between over-globalisation and under-globalisation. The
ideal strategy is to match the level of globalisation to the globalisation potential
of the country.
9.11.2 Development of a global business strategy
Although globalisation as a growth strategy is seen as good, one should be
careful to understand how and why it is accepted. Competing in international
markets poses new rules and structures, and new business questions need to
be addressed. Moreover, some markets are difficult to access, for instance
Japan and China. Following on our definition of globalisation in Section
9.3, a globalisation strategy will focus on how we build, reinforce and lead
the business to gain and maintain a competitive position based on its core
competencies across the global marketplace. The ability of a globalisation
strategy to maximise worldwide performance through sharing and integration
of activities and knowledge can seriously impact on the business operations.
There are three stages in the development of a total global strategy, namely
development, internationalisation and globalisation.
Developing the core strategy remains the basis of competitive advantage
and is usually developed in the home country. The core strategy should
incorporate the elements of a global strategy by identifying the countries for
potential global contribution, and reasons why this is necessary.
Internationalising the core strategy is done through the expansion and/or
adaptation of activities using the core strategy.
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Business Management: A Contemporary Approach
And finally, globalising the strategy is done by implementing across countries,
thereby integrating the strategy worldwide to the countries identified in the
first stage.
Internationalise
the core
strategy
Develop the core
strategy
Expand the core
strategy into the
international
domain
Identifying
opportunities
and strengths,
weaknesses and
threats
Globalise the
strategy
Integrate the strategy
into selected countries
focusing on markets,
costs, technology,
resources and decisions on
standardised or specialised
products
Figure 9.4: The global business strategy process
The first two phases are part of general strategy practices, but the third is
new for business. The process involves identification of industry globalisation
drivers, like markets, costs and technologies. A decision should be taken as
to whether the offering of goods and services is standardised or specialised.
Resources should be properly investigated and allocated. The global strategy
will consist of several dimensions (see Table 9.4).
Table 9.4: Dimensions of a global strategy18
Dimension of
strategy
Factors
Position and
resources of
business and the
parent company
Current situation, competitive forces, new entrants, new
technologies

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Chapter Nine – Globalisation and International Trade
Industry
globalisation
drivers
Market: current situation, competitive forces, new entrants,
new technologies
Costs: economies of scale and mass production versus
customised products and services. Labour requirements and
cheaper technologies
Environment: current situation, competitive forces, new
entrants, new technologies
Competition: new technologies, new products and services
and new entrants
Global strategy
levers
Market participation: countries are selected for their potential
contribution to global benefits
Product standardisation: the ideal is to standardise core
goods and services that require the minimum local adaptation.
Example: Boeing 737 sales decreased so the developing
countries were targeted with a modified version of the aircraft
for the shorter runways
Uniform marketing: this depends on the specific market and
trends of clients
Integrated competitive moves: This depends on the
competitive forces in the industry and the specific location
Ability to
implement global
strategy
Resources, skills, training, structure and understanding of
global markets and diverse cultures
Benefits and costs
Thorough cost benefit analyses for the global initiative,
including soft and hard benefits and a clear understanding of
the long-term benefits
Each of the dimensions in Table 9.3 leads to a specific element in the global
strategy that has to be studied and addressed insofar as the impact on the
business and its future is concerned. A global strategy is not more of the same
in a different location. It is a unique opportunity for growth and completely
new circumstances and market dynamics.
9.11.3 Common mistakes in globalisation
The global versus local debate is complex. Business success in a local environment
is no guarantee for success in a complex global market. The main reasons why
globalisation initiatives fail are the following.
Local and global are different. The accepted approach to globalisation is
to move from local to regional to global markets. This is a piecemeal approach
that does not touch on the fundamental difference between a local and a
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Business Management: A Contemporary Approach
global market in a new country. It separates the strategies for the different
geographical regions rather than building one cohesive multidimensional one.
Moreover, regional strategies tend to dilute resources by trying to adapt to the
cultural differences, rather than using these differences as an opportunity.
One solution may be to identify regions that have common characteristics.
There may be no link between the strategy, the business and the
implementation. Businesses tend to develop a sound global strategy only to
see it fail in terms of implementation as the changing resource requirements are
not addressed. These resources include knowledge transfer, human resources,
infrastructure, processes and culture. It does not help to develop a powerful
global strategy and not be ready to implement this immediately, as this will
provide competitors with the opportunity to enter the market.
Globalisation is a good imperative for success. However, it is not easy to
execute as it is complex to move from a local to a global strategy without first
ensuring that the plan is viable and implementable. New risks emerge and new
partners bring new cultures and business rules.
9.11.4 Advantages of globalisation
There are obvious advantages to globalisation. The most important advantages
are:
„„
„„
„„
„„
cost reductions by using economies of scale, cheaper labour or lower
plant costs;
improved quality of goods or services because of a specific location,
manufacturer or supplier;
customer satisfaction because of extended product offering, ease of access
or localisation; and
competitive position because of the global market share.
The most important value of globalisation is the possibility of sharing and
collaboration between different economic entities that previously have been in
competition. This changes the nature of strategy from a competitive approach
to one of collaboration. This is called ‘co-opetition’ (ie collaborating with the
competition with advantages to both). Can you think of more advantages?
What are the disadvantages?
Globalisation is the obvious strategy for business growth. It naturally utilises
the drivers of the digital economy to make it work. Globalisation is not simple
because:
„„
„„
it is more than a local strategy implemented somewhere else;
it is complex because of the natural differences between the parent and
host economies involved; and
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Chapter Nine – Globalisation and International Trade
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„„
9.12
it is paradoxical because of its advantages and disadvantages and the fine
line between them in terms of who gets to benefit.
Summary
Globalisation depends upon a sustainable strategy and a government that
appreciates the value of international trade. Such a government will provide a
good platform for international business by ensuring that that there is benefit
for the country (eg the local content is not compromised) and that systems are
in place to draw investments (eg exchange rates and trade incentives).
Globalisation is enacted through the complex mechanisms of international
trade. Over time, many trade theories have developed, each with its own benefits
and disadvantages depending on the needs of the moment. International trade
benefits the global economy, the countries, industries and firms involved, as
well as the individual. However, it can also destroy the local environment if
not carefully planned and implemented.
The process of globalisation needs to be carefully monitored to ensure that
its impact on the local host is positive and results in sustainable economic
upliftment. From this perspective globalisation provides learning and growing
opportunities for both the developing host and parent economies. Successful
globalisation changes the face of competition to collaboration, and forms new
rules in business. It creates ‘co-opetition’ in a world of business overarching a
world of nations.
Key terms
Globalisation
International trade
International trade theories
Mercantilism
BRICS
MINT
Trade blocs
Product life cycle
International business strategy
9.13
Self-evaluation
1.
3.
Do you think that globalisation is a good thing from an economic or a
social point of view?
What do you see as the main differences between globalisation,
international trade and international business?
What drives globalisation?
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2.
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Business Management: A Contemporary Approach
4.
5.
6.
7.
South Africa recently joined the BRICS. Is this good for South Africa?
Which international trade theory do you believe is the most relevant to
South Africa and why?
Study the most recent Global Competitiveness Report and comment on
South Africa’s (or any country of your choice) strengths and weaknesses
as they relate to global markets and international trade.
Study the MINT and BRICS environments. Do you think that the MINT
can be seen as a threat to the BRICS alliance?
Case studies
Study the Amazon.com strategy on the Internet and comment on the role
globalisation plays for Amazon.com. Now turn this around. What impact does
Amazon.com have on international trade?
Experiential exercises
Exercise 1
Take a look at your cell phone. According to the make, you know the origin
of the phone. Did you ever think how the device becomes available to you
from its country of origin? Now repeat this with any other product that you
regularly use. Make a list of some of your favourite products and check the
country of origin. Is there a local product available? Why did you buy this
product? Are there products that are cheaper coming from outside South
Africa? So why did you buy them? Now complete the table below for at least
five items you use regularly.
Country
of
origin
Local
replacement
available?
Why did
you choose
this product
over its
competitors?
International
competitors?
[name
competitors]
Would
you have
preferred
to use
a local
product?
Product 1
[name product]
Product 2
[name product]
Product 3
[name product]
Product 4
[name product]
Product 5
[name product]
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