Business AS
Syllabus Notes
By: Farida Farrag
Page 1
Unit 1.1- The Nature of Business Activity
What Do Businesses Do?
 identify needs of customers
 purchase necessary resources to allow production to take place.
 produce goods and services that satisfy consumer wants and needs
Business activity exists to produce goods and services that meet the needs of customers
Factors of Production:
 Land - not only land itself but all renewable and non-renewable resources used in production process
ex. coal, oil
 Labour - manual and skilled labor make up the workforce
 Capital - finance needed to set up business and pay for it's continuing operations but also all the
manufactured resources used in the production process.
 Enterprise - initiative and coordination provided by risk-taking individuals called entrepreneurs. They
combine the other factors of production into a unit capable of producing goods and services.
Enterprise provides the managing, decision-making and coordinating roles.
Businesses aim to create value by producing goods and services and selling them for a higher price
than the cost of bought-in materials, this is called adding value
added value: the difference between the selling price of the products sold by a business and the cost
of the materials bought in.
Opportunity cost – the lost benefit of the second best alternative foregone due to choice.
Changes in the business environment include:
 new competitors entering the market
 legal changes – examples include new safety regulations or limits on who can buy the product
 economic changes that leave customers with less money to spend
 technological changes that make the products or processes of the new business outdated.
Why Do some businesses succeed?
 good understanding of customer needs – leads to sales targets being achieved
 efficient management of operations – keeps costs under control
 flexible decision-making to adapt to new situations; allows investment in new business
opportunities
 appropriate and sufficient sources of finance – prevents cash shortages and allows for
expansion.
Why do some businesses fail?
1. Poor record keeping
For example, how can the owner of a new, busy florist shop remember:
 when the next delivery of fresh flowers is due?
 whether the flowers for last week’s big wedding have been paid for?
2. Lack of Cash
○ Finance is needed for day-to-day cash, for the holding of inventories, and to give trade credit to
customers, who then become debtors
Cash flow problems can be reduced if:
 A cash flow forecast is made and kept up-to-date. The cash needs of the business can be assessed
month by month.
 Sufficient capital is injected into the business at start-up allowing it to operate during the first months
when cash flow from customers may be slow to build up.
Page 2
Unit 1.1- The Nature of Business Activity
Local, national, and international businesses:
- Local businesses operate in small, well-defined parts of a country, owners don't aim to
expand
- National businesses have operations or branches across a country, make no attempt to
establish operations in other countries or to sell internationally
- International businesses sell products in more than one country, may be done using foreign
agents or online
- Multinational businesses: have operations in more than one country, they have an
established base for either producing or selling products outside their own domestic
country.
Page 3
Unit 1.1- The Nature of Business Activity
Intrepreneur: is the name given to people who have the same qualities as entrepreneurs and are
encouraged to demonstrate the same skills as entrepreneurs within an existing business.
Entrepreneur: an individual who has the idea for a new business, starts it up and carries most of the
risks but benefits from the rewards.
Role of entrepreneurs when creating and starting up a new business is to:
○ Have an idea for a new business
○ Create a business plan
○ Invest some of their own savings and capital
○ Accept the responsibility of managing the business
○ Accept the possible risks of failure
Role of enterprise in a country's economic development
 Employment creation
 Economic growth (increases GDP)
 Business survival and growth
Qualities of successful entrepreneurs and intrapreneurs
 Innovation: able to identify and fill market gap, and attract customers and promote products in a
innovative way
 Commitment and self-motivation: willingness to work hard, to be keen and to have the ambition
to succeed.
 Multi-skilled: entrepreneur will have to make, promote, sell, and keep accounts which are takes
someone with lots of qualities
 Leadership skills: entrepreneur must lead and motivate workers
Barriers to entrepreneurship:
1. Lack of a business opportunity. The idea of new businesses comes from:
 An entrepreneur's own skills or hobbies, ex; dressmaking
 Previous employment experience
2. Obtaining sufficient capital. Why this could be a barrier to entrepreneurs:
 Insufficient savings: many entrepreneurs have limited personal savings
 No knowledge of financial support and grants available
3. Competition
4. Lack of customer base
Entrepreneur
Intrapreneur
Main activity
○ Starting up a new business
○ Developing an innovative product or project within an
existing business
Risk
○ Taken by the entrepreneur
○ Taken by the business
Reward
○ To the entrepreneur
○ In the business
Benefits of intrapreneurship to existing businesses include:
 Injecting creativity and innovation into the business – developing new products to increase sales
or creating exciting ways of selling existing products
 Developing new ways of doing business – creativity in solving problems such as low efficiency can
be more successful than continuing to use the old ways.
 Creating a competitive advantage – by developing more innovative products
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Unit 1.1- The Nature of Business Activity
1.1.3 Purpose and key elements of business plans
The main purpose of a business plan for a new business is to obtain finance for the start-up.
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Main elements of a business plan include:
Executive summary - an overview of the new business and its strategies
Description of business opportunity - details of the entrepreneur's skills and experience
Marketing and sales strategies
Financial forecast
Benefits of Business Plan
Limitations of Business plan
 Provides evidence to investors and
lenders, which makes the finance
application more likely to be successful.
 Business owners might rely so much on their business
plan that they overlook the fact that its based on
forecasts and predictions
 Forces the owner to think seriously
about the proposal, it's strengths and
any potential weaknesses
 Business plan must be detailed and supported by
evidence (ex; market research) if not then investors
may delay financial decisions until plan is brought up
to the required standards.
 Gives the owner and managers a clear
plan of action to guide their actions and
decisions in the early months and years
of the business
 Plan might lead to entrepreneurs being inflexible, if
dynamic business enivronment throws opportunities
that aren't in the business plan then entrepreneurs
might reject.
1.2.1 Economic Sectors
Business activity and ownership can be classified in a number of ways, one of which is identifying
what type of product is being produced:
 Primary sector: economic activities that involve obtaining natural resources ex; coal mining,
farming
 Secondary sector: turning raw materials into finished goods that consumers or other businesses
can use.
 Tertiary sector: providing services to consumers and other businesses ex; transportation,
retailing
 Quaternary sector: the industry based on human knowledge which involves technology, info,
research, and development.
The growing importance of secondary sector manufacturing industries in developing countries is
called industrialization.
Benefits of industrialization
Limitations of industrialization
 Total national output increases (GDP)  The chance of work in manufacturing can
and this raises average standards of
encourage a huge movement of people from the
living
countryside to towns, which leads to housing and
social problems
 Increasing output of goods can result  Imports of raw materials and components are
in lower imports and higher exports
often needed, which can increase country's import
of such products
costs
 Expanding manufacturing businesses  A lot of the growth in the manufacturing industry
will result in more jobs being created
usually comes from multinational companies which
can have a negative impact on the economy
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Unit 1.1- The Nature of Business Activity
A decline in the relative importance of secondary sector activity and an increase in the tertiary
sector, this is called deindustrialization.
Benefits of deindustrialization
Limitations
 Job opportunities in service industries - tertiary  Job losses in agriculture, mining, and
and quaternary
manufacturing industries
 Increased need for retraining programs to
allow workers to find employment
 Movement of people towards towns and cities
which may create housing problems
Terminology of chapter 1:
Factors of production: the resources needed by business to produce goods or services
Business enterprise:
Capital goods: the physical goods used by industry to aid in the production of other goods and
services, such as machines and commercial vehicles.
Enterprise: the action of showing initiative to take the risk to set up a business
Entrepreneur: an individual who has the idea for a new business, starts it up and carries most risks
but benefits from the rewards.
Customer: an individual consumer or organization that purchases goods or services from a business.
Adding value: increasing the difference between the cost of bought-in material (inputs) and the
selling price of finished goods.
Added value: the difference between the cost of purchasing bought-in inputs (materials) and the
selling price of the finished good.
Opportunity cost: the next most desired option that is given up.
Branding: the process of differentiating a product by developing a symbol, name, image, or
trademark for it.
Intrapreneur: a business employee who takes direct responsibility for turning an idea into a
profitable new product or business venture.
Multinational business: a business organization that has its headquarters in one country but with
operating branches, factories, and assembly plans in other countries.
Business plan: a written document that describes a business, its objectives, its strategies, the market
it is in and its financial forecasts.
Page 6
Unit 1.2- Business Structure
Public sector: organizations owned and controlled by the government
 Managed with social objectives rather than
solely with profit objectives
 Tendency towards inefficiency due to lack of
strict profit targets
 Loss-making services might still be kept
 Subsidies from the government can also
operating if the social benefit is great enough
encourage inefficiencies
 Finance is raised mainly from the government  Government may intervene in business
decisions due to political issues
Sole trader: a business or organization owned and controlled by one individual who makes all
decisions, and keeps all profit. They have unlimited liability which means that the persons personal
possessions and property can be taken to pay off any debts of the business.
 Easy to set up
 Unlimited liability - all the owner's assets potentially at
risk
 Owner keeps all the profit
 Intense competition from bigger firms
 Owner can choose time and patterns
of working
 Lack of continuity- as the business don’t got a separate
legal identity
Partnerships: a business formed by 2 or more people to carry a business together with shared risk,
and responsibility.
 Partners may specialize in different areas of business
management
 All partners have unlimited
liability
 They share decision making
 No continuity
 Greater privacy and fewer legal formalities than
 In corporate organisations
 Profits are shared
Limited companies have the following that sole traders and partnerships do not have:
1. Limited liability for owners:
○ Limited companies ownership is divided into shares this means that people buy shares and
become shareholders:
This has 2 effects on a company:
 People are prepared to provide finance to enable company to expand
 Risk of company failing to pay debts is transferred from investors to creditors
2. Legal personality:
Company has a separate legal identity from owners so if they get sued, the company itself is held
accountable not the owners
3. Continuity:
In a company, the death of an owner or director does not lead to it's break up, all that happens is
ownership continues through inheritance of the shares and there is no break in ownership at all.
Page 7
Unit 1.2- Business Structure
Private Limited company: a small to medium sized business that is owned by shareholders who often
members of the same family; this company cannot sell shares to the general public
 Shareholders have limited liability
 Legal formalities involved in setting up business
 The company has a separate legal identity
 Capital cannot be raised by sales of shares to
the general public
 Original owner is often able to maintain
control over company
 Quite difficult to sell shares
Public limited company: often a large business with legal right to sell shares to the general public
 Shareholders have limited
liability
 Formation entails legal formalities
 The company has a separate legal  Can be high costs of paying for advice from business
identity
consultants when creating
 There is continuity
 Risk of takeover due to availability of the shares on the stocks
Legal formalities in setting up a company:
 A Memorandum of Association: this states the name company, the address of the head office
through which it can be contracted, the maximum share capital for which the company seeks
authorization and the declared aims of the business
 Articles of Association: this document covers the internal working and control of the business
such as the name of the directors and the procedures to be followed at meetings will be
detailed.
Cooperatives: an autonomous association of people united voluntarily to meet their common
economic, social and cultural needs and aspirations through a jointly owned and democratically
controlled business.
Features common to all cooperatives:
 All members can contribute to running the business and sharing the workload, responsibilities
and decision making
 All members have one vote at important meetings
 Profits are shared equally among members
 Buying in bulk
 Poor management skills
 Working together to solve problems and make
decisions
 Capital shortages because the sale of
shares to non-members is not allowed
 Good motivation for all members to work hard as
they will benefit from shared profits
 Slow decision making --> all members
need to think and vote on important
decisions
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Unit 1.2- Business Structure
franchise: a business that uses the name, logo and trading systems of an existing successful business
 Fewer chances of a new business failing because it  A share of the profit has to be paid to the
is using an established brand name and product,
franchiser each year
 Advice and training are offered by the franchisor
 The initial franchise license is expensive
 Franchiser pays for national advertising
 The franchisee cannot choose which
supplies or suppliers to use
 Franchiser agrees to not open another branch in
the local area
joint venture: when two or more businesses work closely together on a project and create a separate
business division to do so.
 Costs and risks are shared which is a major
consideration when the cost of developing new
products is rising rapidly.
 Styles of management and culture might be
different that the two teams do not blend
well together
 Different companies may have different strengths  Errors and mistakes might lead to one
and experiences, and therefore fit well together
company blaming the other for mistakes
 The business failure of one of the partners
would put the whole project at risk
Social enterprises: businesses that aim to make profit in socially responsible ways and not only profit
motivated.
Features:
 Directly produce goods or provide services
 Have social aims and use ethical ways of achieving them
 Need to make a profit to survive and reinvest into the business. They cannot rely on donations
as charities do.
 Access to more finance
 Legal costs and formalities
 Gaining legal identity
 Some loss of control and ownership
 Protecting owner's capital through limited liability
 Profits are shared
Page 9
Business Structure Unit 1.2 Key defintions
 Primary sector: firms engaged in farming, fishing, oil extraction and all other industries that extract
raw materials
 Secondary sector: firms that manufacture and process products from natural resources, including
brewing, baking, cloth-making and construction
 Tertiary sector: firms providing services to consumers and other businesses, such as retailing,
transport, and insurance.
 Quaternary sector: businesses providing information services, such as computing, or web design.
 Private limited company: a business that is owned by shareholders who are often members of the
same family; this company cannot sell shares to the general public.
 Initial public offering: an offer to the public to buy shares in a public limited company.
 Public limited company: a company whose shares are traded on a stock exchange and can be bought
and sold by the public.
 Public sector: organizations accountable to and controlled by central or local government.
 Private Sector: organizations owned and controlled by individuals.
 Mixed economy: economic resources are owned and controlled by both private and public sectors.
 Free economy: economic resources are owned largely by the private sector with very little
government intervention.
 Command/planned economy: economic resources are owned, planned, and controlled by the state.
 Public corporation: a business enterprise owned and controlled by the state - also known as
nationalized industry.
 Sole trader: a business in which one person provides the permanent finance and, in return, has full
control of the business and is able to keep all the profits.
 Unlimited liability: Business owners have full legal responsibility for the debts of the business.
 Partnership: a business formed by two or more people to carry on a business together, with shared
capital investment and, usually, shared responsibility.
 Limited liability: the only liability - or potential loss - a shareholder has, if the company fails, is the
amount invested in the company, not the total wealth of the shareholders.
 Share: a certificate confirming part-ownership of a company and entitling the shareholder owner to
dividends and certain shareholder rights.
 Shareholder: a person or institute owning shares in a limited company.
 Memorandum of association: this states the name of the company, the address of the head office
through which it can be contacted, the maximum share capital for which the company seeks
authorization and the declared aims of the business.
 Articles of association: this document covers the internal workings and control of the business, the
names of directors and the procedures to be followed at meetings.
 Cooperative: a jointly owned business operated by members for their mutual benefit, to produce or
distribute goods and services.
 Franchise: the legal right to use the name, logo and trading systems of an existing successful
business.
 Franchiser: a person or business that sells the right to open stores and sell products or services, using
the brand name and identity.
 Franchisee: a person or business that buys the right from the franchiser to operate the franchise.
 Joint venture: two or more businesses agree to work closely together on a particular project and
create a separate business division to do so.
 Social enterprise: a business with mainly social objectives that re-invests most of its profits into
benefiting society rather than maximizing returns to owners.
Page 10
Unit 1.3 Size of a business
Why is it useful to measure business size?
 Identifying business
 Customer preferences (some may like to deal with small business)
Problems with attempting to measure business size:
 A lot of different ways that give different comparative results, a business might appear large by
one measure but quite small by another.
 No international definition of a small, medium or large business
Different measures of business size:
 Number of employees
 Revenue
 Capital employed: the total value of all long-term finance invested in the business
 Market share: sales of the business as a proportion of total market sales
 Market Capitalization
market share: Total Sales of Business x 100
Total Sales of Industry
Significance of small businesses:
 They create employment
 Often run by dynamic entrepreneurs with new ideas for consumer goods & services
 Create competition for larger businesses
 Can be important suppliers to larger businesses
 Can be managed and controlled by the owners
 May have limited access to sources
of finance
 Often able to adapt quickly to meet changing customer
needs - especially if the owner deals directly with the
customers
 The owner has to carry a large
burden of responsibilities
 Easy to know each worker - many people prefer to work
for a small business
 Few opportunities for economies of
scale - average costs would be high
 Offer personal service to customers to help build
customer loyalty
 May not be diversified
Family run businesses: those that are actively owned and managed by at least two members of the
same family.
 Commitment: family owners often
 Informality: because most families run their businesses
show dedication in seeing the business themselves, there's usually little interest in setting clear
grow, prosper and be passed on to
and formal business practices and procedures, as the
future generations.
family and its business grow larger, this situation can
lead to inefficiencies and internal conflicts
 Reliability and pride: because the
 Conflict: problems within the family may reflect on the
family is associated with the products,
management of the business and make effective
family businesses strive to increase
decisions less likely
the quality of their output and
maintain a good relationship
Page 11
Unit 1.3 Size of a business
Business growth. Why would businesses want to grow?
- Increased profits - expanding the business and achieving higher sales is one way of becoming
more profitable
- Increased market share - will give a business a higher market share and greater bargaining
power with both retailers and suppliers
- Reduced risk of being a takeover target - a larger business may become too large a target for
a potential predatory target
Organic (internal) growth: expansion of a business by means of opening new branches, shops or
factories
External growth: involves bringing together two or more businesses
Types of external growth:
1. Horizontal integration: which is an integration with a business in the same industry, Aswell as
the same stage of production.
Impact on stakeholders:
 Consumers now have less choice and may have to pay higher prices.
 Workers may lose job security as a result of rationalisation:
○ Suppliers may have to offer lower prices to the bigger integrated business.
○ Shareholder impact depends on whether or not profit rises or not.
 it eliminates one competitor and increases
market share and power
 Rationalisation may bring bad publicity and
redundancies
 There is potential of economies of scale
 May be customer opposition to less
competition and less choice
 May be increased power over supplies to
obtain lower prices
 May lead to monopoly investigation if the
combined business exceeds certain market
share limits
2. Forward vertical integration: moving up in the same industry closer to the customer base
Impact on stakeholders:
 Workers may have greater job security because the business has secure outlets
 May be more career opportunities
 Consumers may resent the lack of competition in the retail outlet because of the withdrawal
of competitor products:
○ Shareholder impact depends on whether profit rises or not.
 Business is now able to control the promotion and
pricing of its own products
 consumers may suspect an attempt to
act uncompetitively and react
negatively
 Gives a secure outlet for the products of the business
and may now exclude competitors' products from
retail outlets
 Business may lack experience in this
sector of the industry - a successful
manufacturer does not necessarily
make a good retailer
Page 12
Unit 1.3 Size of a business
3. Backward vertical integration: moving down in the stage of production in the same industry
Impact on stakeholders:
 Workers may have more career opportunities
 Consumers may obtain improved quality and more innovative products.
 Control over supplies to competitors may limit consumption and choice for consumers.
 It gives control over quality, price
and delivery times of supplies
 The business may lack experience of managing a supplying
company - a successful steel producer will not necessarily
make a good manager of a coal mine.
 It encourages joint research and
 The supplying business may become complacent due to
development into improved quality
having a guaranteed customer
of components
4. Conglomerate integration: the process or merger of two firms that operate in different markets,
or make different products
Impact on stakeholders:
- Workers may have more career opportunities
- There may be more job security because risks are spread across more than one industry
- Profits could rise to benefit shareholders
 It diversifies the business away from its
original industry and markets
 May be lack of management experience in the
acquired business sector
 Should spread risk and may take the
business into a faster growing market
 Could be lack of clear focus and direction now that
business is spread across more than one industry
Objectives of merges & takeovers are to increase profitability & efficiency. Why might these objectives
be achieved?
 The integrated businesses will be able to share research facilities and pool ideas that achieve better
results than the two separate businesses
 The economies of operating a larger scale of business, such as buying supplies in large quantities,
should cut average costs and increase efficiency
The most common reason for a merger or takeover to fail to achieve its objectives are:
 The integrated firm is too big to manage and control effectively. This is a diseconomy of scale
 May be little benefit from combined research departments or marketing
Strategic alliance: a form of external growth that does not involve complete integration or changes in
ownership.
For example; a business might form an alliance with a university providing finance to provide new
training courses that will increase supply of suitably trained employees.
Page 13
Unit 1.3 Size of a business
 Revenue: the total value of sales made during the trading period = selling price X quantity
sold
 Capital employed: the total value of all long-term finance invested in the business
 Market capitalization: the total value of a company's issued shares.
 Market share: sales of the business as a proportion of total market sales.
 Family run businesses: those that are actively owned and managed by at least two members
of the same family.
 Organic (internal) growth: expansion of a business by means of opening new branches, shops
or factories
 External growth: involves bringing together two or more businesses.
 Merger: an agreement by owners and managers of two businesses to bring them together in
a new combined business. This is often referred to as a friendly merger.
 Takeover: when a company buys more than 50% of the shares of another company and
becomes its controlling owner. It can be called an acquisition.
 Horizontal integration: which is an integration with a business in the same industry, Aswell as
the same stage of production.
 Vertical integration: integration with a business in the same industry.
 Forward vertical integration: moving up in the same industry closer to the customer base.
 Backward vertical integration: moving down in the stage of production in the same industry.
 Conglomerate integration: the process or merger of two firms that operate in different
markets, or make different products
 Synergy: literally means that "the whole is greater than the sum of parts" - it is often assumed
that the new business will be more successful than the original separate business.
 Strategic alliance: a form of external growth that does not involve complete integration or
changes in ownership.
Page 14
Unit 1.4 Business objectives
By setting clear business objectives, managers will:
 Create a sense of direction and purpose for all employees, which will increase their motivation
 Provide specific targets for future business strategies to aim for, as new business strategies will
lack focus without an objective to work towards
Objectives of private-sector businesses
1. Profit maximisation: producing at that level of output where the greatest positive difference
between total revenue and total costs is achieved.
Limitations of this business objective:
 Many businesses seek to maximise sales to gain a higher market share, rather than to maximise
profits
 It's very difficult to assess whether the point of profit maximisation has been reached

2. Profit satisficing: aiming to achieve enough profit to keep owners satisfied, common aim for
small business owners who wish to live comfortably but do not want to work long hours.
3. Survival: main objective for businesses that are starting up
4. Maximising short-term revenue: could benefit managers & workers when salaries and bonuses
are dependent on revenue levels.
5. Corporate Social Responsibility: when businesses consider the interests of society by taking
responsibility for the impact of their decisions and activities on customers, employees,
communities, and the environment. Influential pressure groups are forcing businesses to
reconsider their approach to decision-making.
Pressure group: organisations created by people with a common interest or aim, who put pressure on
businesses and governments to change policies so that an objective is reached.
Objectives of social enterprises:
1. Economic (financial)- to make profit to re-invest back into the business and provide some
financial return to the owners
2. Social - to provide jobs or support for local, often disadvantaged, communities
3. Environmental - to protect the environment and to manage the business in a environmentally
sustainable way
Objectives of public-sector business:
- To provide an efficient, reliable service to the public, such as water supply
- To encourage economic and social development, especially in deprived areas
- To create employment or prevent major job losses if the industry is making a financial loss
Most effective business objectives meet the following SMART criteria:
 S - specific: Objectives should focus on what the business does and should apply directly to that
 business.
 M - Measurable: Objectives that have a quantitative value are likely to prove to be more
effective targets
 for directors and staff to work towards
 A - Achievable: setting objectives that are almost impossible in the time frame given will be
pointless
 R - Realistic and relevant: objective should be realistic when compared with the resources of
the company and should be expressed in terms that are relevant to the people who have to
carry out the objectives.
 T - Time- limited: a time limit should be set when an objective is established. Without a time
limit, it will be impossible to assess whether the objective has actually been met.
Page 15
Unit 1.4 Business objectives
Influences on business objectives:
- Business culture
- The size of legal form of the business: small business may concerned with a satisfactory level of
profit called satisficing, while large businesses, such as public limited companies might be more
concerned with rapid business growth
- Number of years the business has been operating: newly formed businesses are likely to be driven
by the desire to survive at all costs
Mission statements -a statement of the business's core aims, phrased in a way that motivates
employees and to stimulate interest by outside groups
* For example a college's mission statement is: to provide an academic curriculum in a supportive and caring
environment
 They inform groups outside the business
what the central aim and vision are
 Too vague and general, so that they end up saying
too little that is specific about the business and
cannot be used as actual targets
 Motivate employees, as they are associated  Virtually impossible to analyse or disagree with
with the positive qualities the statement
refers to
 Help establish what the business is about,
for the benefit of other groups
Management by objectives: a method of co-ordinating and motivating all staff in an organisation by
dividing its overall aim into specific targets for each department, manager and employee.
 The role of objectives in the stages of business decision making
1.
2.
3.
4.
5.
6.
Set objectives to provide focus for strategic decisions
Assess and clarify the problem that needs strategic action
Gather data about the problem and identify possible strategic solutions
Analyse the likely impact of all decision options on the chance of achieving business objectives
Make the strategic decision
Review its success against original business objectives. Has the business, through its decision,
achieved its objectives?
 Reasons business objectives can change over time:
 Newly formed business may have satisfied the survival objective by operating for several years
and now the owner wishes to purse objectives of growth or increased profit.
 Benefits of communicating business objectives:
 Employees and managers have a greater understanding of both individual and company - wide
goals.
 Employees understand the overall plan and how their individual goals fit into the company's
business objectives
*if managers fail to communicate with employees on objectives or changes in objectives, fear and
uncertainty might spread amongst the workforce. The could lead to resistance to change and
potential industrial action. *
Page 16
Unit 1.4 Business objectives
Following a strict ethical code in decision making can be expensive in the short term: How?
 Using ethical and fairtrade suppliers can add to business costs.
 Not taking bribes to secure business contracts can mean failing to secure significant sales
HOWEVER, in the long term, there could be substantial benefits from acting ethically:
 Avoiding potential expensive court cases
 Acting unethically can lead to customer unloyalty, bad publicity, and long - term reductions in
sales
Chapter 4 key terms:
 Business objectives: a stated measurable target that a business plans to achieve.
 Corporate social responsibility: when businesses consider the interests of society by taking
responsibilities for the impact of their decisions and activities on customers, employees,
communities and the environment.
 Pressure groups: organizations created by people with a common interest or aim, who put pressure
on businesses and governments to change policies so that an objective is reached
 Triple bottom line: the three objectives of social enterprises: economic, social, and environmental.
 SMART objectives: aims that are specific, measurable, achievable, realistic, and time-limited.
 Business aim: a long-term goal that a business hopes to achieve.
 Mission statement: a brief statement of the business's core aims, phrased in a way to motivate
employees and to stimulate interest from outside groups.
 Annual (company) report: a document that gives details of a company's activities over the year,
including its financial accounts.
 Business strategy: a long-term plan of action for a business, designed to achieve a particular
objectives.
 Tactic: a short-term action as part of an overall strategy.
 Target: a short-term goal that must be reached before an overall objective can be achieved.
 Budget: a detailed financial plan for the future.
 Ethical code: a document detailing a company's rules and guidelines on staff behaviour that must be
followed by all employees.
Page 17
Unit 1.5 Stakeholders in a Business
The main stakeholders of a business are
- Owners
- Employees, including managers and their families
- Customers
- Suppliers
Stakeholders: people or groups of people who can be affected by - and therefore have interest in any
action by an organisation
Manager: responsible for setting objectives, organisation resources and motivating employees so
that the organisation's aims are met.
Roles
Rights
responsibilities
customers
○ Purchase goods and services ○ To receive goods and
services that meet
○ Provide revenue from sales,
which allows the business to local laws regarding
health and safety,
function and expand
design and
performance
Suppliers
○ To supply goods and
services to allow the
business to offer its
products to its own
customers
Employees
○ To provide labour services ○ To be offered
to the business, in
employment
accordance with the
contracts that meet
employment contract, to
legal standards (min
allow goods and services to
wage)
be provided to customers
Managers
○ To control, command and
direct resources
○ To have contract of
○ To report to stakeholders; to
employment; to have
act legally and ethically
sufficient authority to
fulfil roles
Owners/
shareholders
○ To provide finance
○ To receive a share of ○ To set targets for managers;
profits; to receive
give managers adequate
accurate reports on
time and resources to meet
business performance targets
○ To be honest, to pay for
goods And services when
requested
○ Not to steal
○ To be paid on time as ○ To supply goods and services
stated in the service
ordered by the business in
agreement between
the time and condition laid
the business and
down by the purchase
suppliers
contract or supplier's service
agreements.
○ To be honest
○ Meet the conditions and
requirements of the
employment contract
Chapter 5 key terms:
External stakeholder: individuals or groups who can be affected by, and have an interest in, any
action taken by an organization.
Internal stakeholder: individuals or groups who work within the business, or own it, and are affected
by the operations of the business.
Stakeholder concept: the view that businesses and their managers have responsibilities to a wide
range of groups, not just shareholders.
Trade union: an organization of working people with the objective of improving the pay and working
conditions of its members and providing them with support and legal services.
Page 18
Unit 1.5 Stakeholder in a Business
Stakeholder concept: the view that businesses and their managers have responsibilities and to a wide
range of groups, not just shareholders
Impact of business decisions on stakeholders and their reactions:
Business
decision
Employees
Build a new
Impact:
- more job
factory to
expand business
opportunities
- New working
methods in this
factory might
require new skills
Local community
Customers
Impact:
- More jobs for local
residents and
increased spending in
other local businesses
Impact:
- Greater efficiency
might result in lower
prices
- Disruption caused by
increased traffic and
pollution and lose of
site for amenity use
Reaction:
More potential
employees seeking a job Reaction:
- Seek to refuse planning
permission
Reaction:
- Buy more products if
prices are lower for
the same quality
- Ban large trucks
Horizontal
integration
Impact:
- Combined
business is more
secure and more
career promo
opportunities
Reaction:
- Possible industrial
action if jobs are
under threat
Impact:
Impact:
- If business expansion is
- Economies of scale
on the existing site,
could lead to lower
then local jobs and
prices
income might increase
- Reduced prices might
lead to lower
- Rationalisation of
competition and thus
duplicate premises
maybe higher prices
might lead to closure
and job losses
Reaction:
Consumer boycott if prices
Reaction:
are raised due to less
- Encourages gov to ban
competition
the takeover if
rationalisation is
threatened
Business accountability and responsibility to stakeholders and how stakeholder aims impact business
decisions:
 Responsibilities to customers: to not break the law concerning consumer protection and accurate
advertising, benefits of accepting responsibilities include consumer loyalty, and repeat purchases
 Responsibilities to suppliers: the purchasing department should take decisions that satisfy supplier's
aims and requirements, accepting responsibilities leads to supplier loyalty, and special order
requests.
 Responsibilities to employees: providing training opportunities
Page 19
Unit 2.1 Human Resource management
Purpose and role:
Human resources management (HRM) aims to recruit capable, flexible, committed people. It
manages and rewards their performance and develops their critical skills for the organization.
If people are managed efficiently, the business is more likely to achieve its overall objectives.
HRM focuses on:
 Workplace planning to plan how many employees, and what skills are needed for the
business in the future.
 Recruitment and selection of appropriate new employees
 Developing employees by appraising and training them
 Taking responsibility for management and workforce relations
Reasons for and role of a workforce plan:
○ Workforce planning means thinking ahead to establish the number of employees and
the skills required in the future to meet the business's planned objectives.
○ The first stage of workforce planning is always a workforce audit. That is a check on the
qualifications of all existing workers/managers.
The number of employees that a business requires in the future depends on:
 Productivity level: if productivity is forecast to increase – fewer workers will be needed to
produce the same level of output
 Objectives of the business: if the business plans to expand over the coming years, then
the employee number will have to rise to accommodate this growth.
The skills of workers required is dependent on:
 Pace of technological change in the industry: for example production methods and
complexity of machinery
 The need for flexible or multi-skilled workers as businesses try to avoid excessive
specialization
Labour turnover: the rate at which employees leave a company and are replaced by new
employees
Labour turnover = Number or employees leaving in one year x 100
Average number of people employed
If labour turnover is high and increasing over time, this is an indicator of employee discontent,
low morale, possibly, a recruitment policy that leads to the wrong people being employed
 Low- skilled and less productive staff might
be leaving and could be replaced with more
carefully selected workers
 Cost of recruiting, selecting and training new
staff
 New ideas and practices brought into an
organization by new workers
 Poor output levels and customer service due
to staff vacancies before new recruits are
appointed
 High labour turnover can help a business
plan to reduce employee numbers, as
workers who leave will not be replaced
 Difficult to establish customer loyalty due to
a lack of regular, familiar contact
Page 20
Unit 2.1 Human Resource management
Recruitment & selection will be necessary when:
 The business is expanding and needs a bigger workforce
 Employees leave and need to be replaced
Process of recruitment and selection:
Advantages of the job description is that it should attract he right type of
people to apply for the job as potential recruits have an idea whether or not
they will be the right fit for the job.
Job descriptions include:
- Job title
- Details of the tasks to be performed
Then business create
- Responsibilities involved
- Place in the hierarchical structure
A person specification is an analysis of the qualities, skills, and qualifications
- Working conditions
that will be looked for in suitable applications. It helps in the selection process
by eliminating applicants that do not meet the necessary requirements.
After that, they
prepare the job advertisement; needs to reflect
the requirements of the job and the person
specifications.
Then
Make a shortlist of applicants; small number of
applicants are chosen based on their CV.
Then they select between applicants via interviews
where they interview potential people for the job on
their skills, experience, and character to see if they
are a right fit.
Internal recruitment means that the selected candidate already works for the organisation.
Advantages:
 Applicants may already be known to the
selection team.
•
 Applicants will already know the
organisation and its internal methods so
there is no need for induction training.
 Often quicker than external recruitment.
Disadvantages:
 External applicants will bring new ideas and practices to
the business, which helps to keep existing employees
focused on the future rather than the past.
 There's a wider choice of potential applicants, not just
limited to internal staff.
 The standards of applicants could be higher than if the
job is only open to internal applicants.
Employment contracts are legally binding documents, they contain the following:
 Employees responsibilities and main tasks
 Whether the contract is temporary or permanent.
 Holiday entitlement and other benefits such as pensions
Page 21
Unit 2.1 Human Resource management
Redundancy is when worker's jobs are no longer available/required.
Dismissal is when you are dismissed from a job due to incompetence or breach of discipline
Unfair dismissal is ending a workers employment contract for a reason that the law regards as being
unfair.
An employer must prove that the employees does the following
so that the court does not consider it unfair dismissal:
Reasons that dismissal could be considered
unfair or breach of employment law:
○ Inability to do the job even after sufficient training has
been given
○ Pregnancy
○ Continuous negative attitude at work
○ A discrimination reason
○ Bullying of other employees
○ Being a member of a union
Employee productivity and work satisfaction have been shown to be affected by employee morale and
welfare.
How to improve employee welfare:
- Offering advice, counselling, and other services to employees who are in need of support
- Improving work conditions with excellent hygiene facilities and safety equipment
*When workers feel that the employer wants to improve their long-term welfare, it often leads to high morale
and a strong sense of loyalty to the business, together with a desire for it to do well. If employee morale is high,
productivity often increases and labour turnover is low.*
Work- life balance: A situation in which employees are able to give the right amount of time and effort
to work and to their personal life outside work to family or other interests.
Problems in work-life balance ( needing to change hours
and times of work) occur because:
Methods some businesses have used to allow
employees to take more control of their working lives
and to allow for more leisure time:
○ Customers expect to have goods and services
available outside traditional working hours
○ flexible working
○ Organisations want to match their business needs
with the way their employees want to work
○ Teleworking - working from home for some of
the working week
○ Globalisation has led to much greater levels of
competition, so efficiency and flexibility are
important for a business to remain competitive
○ Job sharing - allows two people to fill one-time
vacancy although each worker will only receive
a proportion of the full-time pay.
Impact of diversity and equality in the workplace:
Promoting equity in the workforce means that business recruitment, dismissal, pay, promos and other
benefits are not based on employee's race, sexuality, gender, or religion.
Promoting equity in the workplace impacts on business by:
 Creating an environment with high employee morale and motivation
 Developing a good reputation and the ability to recruit top talent based on fairness
 Measuring employee performance by their achievements at work.
Workplace diversity means acknowledging differences between employees and deliberately creating an
inclusive environment that values those differences.
Promoting diversity impacts the business by:
- Capturing a bigger market share as consumers are attracted by a diverse sales force.
- Employing a more qualified workforce as recruitment is based on merit and not on discrimination
Page 22
Unit 2.1 Human Resource management
 Induction training should be given to all new recruits. It aims to introduce them to people they will
be working with most closely.
 On-the-job training involves instruction at the place of work. Often conducted by either the HR
managers or departmental training officers. Watching or working closely with existing experienced
staff members.
 Off-the-job training covers any course of instruction away from the place of work. This could take
place in a specialist training center belonging to the company itself or it could be a course organized
by an outside body. Outside training has the added potential of being a source of new ideas.
Impact of training on a business and its employees:
 Training can be expensive.
 It can also lead to well-qualified employees leaving for a better-paid job once they have
gained qualifications from a business with a good training program
 as well as poaching which is when other businesses seek to employ other businesses' trained
employees
* These factors can discourage some businesses from setting up expensive training programs. And
workers can be less productive DURING the training programs.
Development and appraisal of employees
Development might take the form of:
 new challenges and opportunities,
 additional training courses to learn new skills,
 promotion with additional delegated authority and chances for job enrichment.
Employee appraisal is often:
 undertaken annually, essential component of a staff-development program
 The analysis of performance against pre-set and agreed targets, combined with the setting of
new targets, allows the future performance of the worker to be linked to the objectives of the
business.

* Both employee appraisal and employee development are important features of Herzberg’s
motivators
Employee development to encourage intrapreneurship, many businesses have training and
development programmes with the specific aim of encouraging employees to become
successful intrapreneurs.
Most employees can demonstrate intrapreneurship if they are:
- encouraged to be independent thinkers and creative
- given opportunities to mix and work with other skilled employees from different departments
- empowered with the authority and resources they need to introduce innovations
Page 23
Unit 2.1 Human Resource management
Management and workforce relations:
 The relationship between managers and the workforce have a great impact on the success or failure
of a business. In most countries employees are able to join a trade unio
Benefits of cooperation between management and the workforce:
 Fewer days are lost through strikes and other forms of industrial action
 It will be much easier for management to introduce change in the workplace, for example, a
decision to automate part of a factory could be made with the cooperation of the workforce.
 Agreement on more efficient operations will increase the competitiveness of the business
 Impact of trade union involvement in the workplace:
 'power through solidarity', best illustrated by the unions ability to engage in collective
bargaining, (negotiating on the behalf of their members within the business)
 Unions provide legal support to employees who claim unfair dismissal or poor working
conditions
Benefits of collective bargaining:
 Employers can negotiate with one trade union officer rather than with individual workers.
This saves time and prevents workers from feeling that one individual has obtained better pay
and conditions than others.
 Unions can impose discipline on members who plan to take hasty industrial action that could
disrupt a business. This makes industrial action less likely
Problems between trade union and management:
 When cooperation between managers and the workforce does not exist, there is a great chance of
industrial action.
Trade unions can take multiple forms of industrial action. Which are:
 Continue collective bargaining, perhaps with the help of an independent arbitrator
 Go slow a form of industrial action in which workers keep working but a minimum ace
demanded by their contract of employment.
 Overtime bans - industrial action in which workers refuse to work more than the contracted
number of hours each week. During busy periods, this could lead to lost output for the
employer.
Key terms:
Human resource management: the strategic approach to the effective management of employees
so that they help the business gain a competitive advantage.
Workforce planning: forecasting the numbers of workers and the skills that will be required by the
organization to achieve its objectives.
Workforce audit: a check on the skills and qualifications of all existing workers/managers.
Labor turnover: measures the rate at which employees are leaving an organization.
Recruitment: the process of identifying the need for a new employee, defining the job to be filled
and the type of person needed to fill it, and attracting suitable candidates for the job.
Page 24
Unit 2.1 Human Resource management
Person specification: a detailed list of the qualities, skills, and qualifications that a successful
applicant will need to have.
Application form: a set of questions answered by a job applicant to give a potential employer
information about the applicant, such as educational background and work experience.
Curriculum vitae (CV): a detailed document highlighting all of a person's professional and
academic achievements, work experience and awards.
Resume: a less detailed document than a CV, which itemizes work experience, educational
background and special skills relevant to the job being applied for.
Reference: comment from a trusted person about an applicant's character or previous work
performance.
Assessment criteria: a place where a range of tests is used to judge job applicants on their
potential ability to perform a particular role.
Internal recruitment: when a business aims to fill a vacancy from within its existing workforce.
External recruitment: when a business aims to fill a vacancy with a suitable applicant from outside
of the business, such as employee of another organization.
Employee contract: a legal document that sets out the terms and conditions governing a worker's
job.
Redundancy: when a job is no longer required, the employee doing this job becomes unnecessary.
Dismissal: being dismissed or fired from a job due to incompetence or breach of discipline.
Unfair dismissal: ending a workers employment contract for a reason that the law regards as being
unfair.
Equality policy: practices and processes aimed at achieving a fair organization where everyone is
treated In the same way without prejudice and has the opportunity to fulfill their potential.
Diversity policy: practices and processes aimed at creating a mixed workforce and placing a
positive value on diversity in the workplace.
Work-life balance: a situation in which employees are able to allocate the right amount of time
and effort to work and to their personal life outside work.
Training: work-related education to increase workforce skills and efficiency.
Induction training: introductory training program to familiarize new recruits with the systems used
in the business and the layout of the business site.
On-the-Job training: instruction at the place of work on how a job should be carried out.
Off-the-Job training: training undertaken away from the place of work.
Multi-skilling: the training of an employee in several skills to allow for greater flexibility within the
business.
Employee appraisal: the process of assessing the effectiveness of an employee judged against preset objectives.
Industrial action: measures taken by the workforce or trade union to put pressure on
management to settle an industrial dispute in favor of employees.
Collective bargaining: the process of negotiating terms of employment between an employer and
a group of workers who are usually represented by a trade union official.
Trade union recognition: when an employer formally agrees to conduct negotiations on pay and
working conditions with a trade union rather than bargain individually with each worker.
Selection: the series of steps by which candidates are interviewed, tested, and screened to choose
the most suitable person for a vacant post.
Recruitment agency: a business that offers the service of recruiting applicants for vacant posts.
Job description: a detailed list of the key points about the jobs to be filled, stating all its key tasks
and responsibilities.
Page 25
Unit 2.2 Motivation
What's motivation?
Motivation gives workers the desire to work and complete a job quick and well. The highest motivation
levels result from employees being able to satisfy their own needs, but at the same time working towards
the aims of the organisation
Well- motivated workers benefit the business they work for in several ways:
 The level of productivity will be high, increasing the competitiveness of the business
 Workers will be keen to stay within the business, reducing the costs of labour turnover
 Workers will be more likely to offer useful suggestions to help the business achieve it's objectives
 Low absenteeism
 Employees being prepared to accept responsibility.
Satisfying human needs at work:
- Social connection: by working in groups or teams
- Challenge: by providing different work tasks and chance of promotion
- Significance: by praising and recognizing performance
- Certainty: by providing employment contracts and some job security
Motivation theories:
These theories focus on the assumption that individuals are motivated by the desire to fulfil their inner
needs.
These approach focuses on:
 Those human needs that energize and direct human behaviour
 How managers can create conditions that allow workers to satisfy these needs.
Taylor and scientific management:
Taylor's aim was to reduce level of inefficiency that existed in the American manufacturing industry. He
argued that any productivity gains could then be shared between business owners and workers.
Taylor's scientific approach to improving worker output or productivity:
1. Select the workers to perform a task
2. Record them performing the task and note the key elements of it
3. Record the time taken to do each part of the task
4. Identify the quickest method recorded
5. Train all the workers in this quickest method and do not allow any changes to it.
6. Supervise workers to ensure that this best way is being carried out and time them to check that
the set time is not being exceeded
7. Pay workers on the basis of results, based on the economic main theory
Page 26
Unit 2.2 Motivation
Taylor's theory suggests that people are motivated by money alone, introducing piece rate, which
means paying workers a certain amount for each unit produced
Taylor's approach
Relevance to modern industry
Economic man
Although some managers still believe that money is the only way to motivate workers,
the more common view now is that workers have a wide range of needs that can be met
from work.
Select the right people
for the job
Before Taylor there had been few attempts to select employees carefully. The
importance of this today is reflected in the emphasis on effective employee selection in
nearly all businesses.
Observe and record the
performance of workers
This was widely adopted and became known as a time and motion study. Initially this
was viewed with suspicion by workers as a way of making them work harder. In modern
industry it is still used but with the cooperation and involvement of employees.
Establish the best
method of doing a job
This method study is still accepted as important, as efficiency depends on using the best
ways of working. However, Taylor’s use of managers to give instructions to workers with
no discussion is demotivating. Worker participation in devising the best working
methods is now encouraged
Piecework payment
systems
s still used but much less widely than in Taylor’s time. In service industries, in particular,
it has become very difficult to measure the output of individual workers.
Maslow and human needs
Maslow's best known for his research into identifying and classifying the main needs that humans
have.
The importance of his work to business managers is:
 Our needs determine our actions - we will always try to satisfy them, and we will be motivated
to do so
 If work can be organised so that some or all needs of employees can be satisfied at work, then
they will become more productive and satisfied
Level of need
How needs may be satisfied at work by effective HRM
Self - actualisation
(fulfilment of
potential)
Challenging work that stretches the individual will give a sense of
achievement' opps to develop and apply new skills will increase potential
Esteem needs
Recognition for work done well - status, advancement and responsibility - will
gain the respect of others
Social/belonging
needs
Working in teams or groups and ensuring good communication to make
workers feel involved
Safety needs
A contract of employment with some job security; a structured organisation
that gives clear lines of authority to reduce uncertainty' ensuring health and
safety conditions are met
Physical needs
Income from employment high enough to meet essential needs
Limitations of Maslow's approach:
 Not everyone has the same needs, as is assumed by the hierarchy
 In practice it can be very difficult to identify the degree to which each has been met and which
level a worker is on.
 Money is necessary to satisfy physical needs, yet it might also play a role in satisfying the other
levels of needs. High incomes can increase status and esteem
 Self-actualization is never permanently achieved. Jobs most continually offer challenges and
opportunities for fulfillment, otherwise regression will occur.
Page 27
Unit 2.2 Motivation
Mayo and human relations theories:
Elton mayo is best known for his Hawthorne effect conclusions. He initially assumed that working
conditions, such as lighting, heating and rest periods, had a significant effect on workers’ productivity.
* Experiments were undertaken with groups of workers to establish the best working conditions.
The output of a control group was also recorded. This group experienced no changes in working
conditions at all.
As conditions of work were either improved or worsened, productivity rose in all groups including the
control group. Mayo had shown that:
 Working conditions in themselves were not important in determining productivity levels.
 Other motivational factors needed to be investigated before conclusions could be drawn
Mayo drew the following conclusions from his work:
 Changes in working conditions and pay levels have little or no effect on productivity
 Consultation with workers improves motivation
 Giving workers some control over their own working lives, such as deciding when to take
breaks, improves motivation
 Groups can establish their own targets, and these can be greatly influenced by the informal
leaders of the group
Evaluation of mayo's research for today's businesses
 Since mayo's findings have been published, there has been a trend towards giving workers
more of a role in business decision-making. This is called worker participation.
 Human resource departments have been established to try put the Hawthorne effect into
practice.
 Team or group working is applied in many types of modern business organisation. It offers the
greatest opportunities for workers and businesses to benefit from the Hawthorne effect.
Page 28
Unit 2.2 Motivation
Herzberg and the 2 factor theory
Herzberg developed the two-factor theory from research based around questionnaires and
interviews with 200 skilled employees. His aim was to discover:
 Factors that led to them having very good feelings about their jobs
 Factors that led to them having very negative feeling about their job
His conclusions were that
Job dissatisfaction also resulted from five man
Job satisfaction results from five main factors: factors:
- Achievement
- recognition for achievement
- the work itself
- responsibility
- advancement
He called these factors the motivators
- company policy and administration
- supervision
- salary
- relationships with others
- working conditions.
He named these hygiene factors.
Basically Herzberg's two factor theory suggests that it is possible to encourage someone to do a job
by paying them he called this movement.
Money is what moves people to do a job and does not motivate them to do it well and that the
motivators need to be in place for workers to be prepared and to work willingly and to give their
best always.
The motivators could be provided by adopting the principles of job enrichment.
There are three main features of job enrichment and if these are adopted then the motivators exist:
 Complete units of work: Rather than the use of mass production methods that often lead to
work boredom because they're only involved in a small part of the production. Herzberg
argued that complete and identifiable units of work should be assigned to workers, this might
involve teams rather than individuals on their own for example a complete engine in a car
factory. "if you want people motivated to do a good job give them a good job to do" he put it
 Feedback on performance: regular two way communication between workers and managers
should give recognition for work well done and could provide incentives for workers to
achieve even more
 A range of tasks: should be given to challenge and stretch a worker some of these maybe
beyond the workers current experience.
The evaluation of Herzberg's work for today's businesses:
 Team working is now much more widespread. With whole units of work being delegated to
these groups.
 Workers tend to be made much more responsible for the quality of their own work rather
than being closely supervised by quality controlled inspectors.
 Most firms are continually looking for ways to improve effective communication and group
meetings, allowing two way communication are often favored.
Page 29
Unit 2.2 Motivation
Mc Cleland and motivational needs theory:
 Cleveland. Pioneered workplace motivational thinking, he developed an achievement based
motivational theory, and promoted improvements in employee assessment methods. Best known for
describing
The three types of motivational needs: 3A's:
 Achievement motivation A person with a strong motivational need for achievement. Will seek to
reach realistic and challenging goals and job advancement. Constant need for feedback regarding
progress and achievement. This helps provide a sense of accomplishments.
 Authorities/power motivation. A person with this dominant need is motivated by having authority to
control others is a powerful motivating force. Including the need to be influential, effective and make
an impact.
 Affiliation motivation. A person whose strongest motivator is the need for affiliation has a need for
friendly relationships and is motivated by interaction with people. These people tend to be a good
teammate and they need to be liked and popular.
Process theories:
 They emphasize how and why people choose to assume behaviors in order to meet their
personal goals. And the thought processes that influence behavior. Process theories study what
people are thinking about when they decide whether to put effort into a particular activity.
 Vroom and expectancy theory:
 Victor suggested that individual choose to behave in ways in which they believe will lead to results
that they value.
 His expectancy theory states that individuals have different sets of goals and that they can be
motivated if they believe that:
 There is a positive link between effort and performance
 Favorable performance will result in a desired reward
 Their reward will satisfy an important need
 The desire to satisfy the need is strong enough to make the work effort worthwhile.
 His expectancy theory is based on the following three beliefs:
 Valence: the depth of desire of an employee for an extrinsic reward, such as money, or an
extrinsic reward, such as satisfaction.
 Expectancy: the degree to which people believe that putting effort into work will lead to a given
level of performance.
 Instrumentality: The confidence of employees that they will actually go with the desire, even if
it has been promised by the manager.
 Victor argued that even if one of these conditions or beliefs is missing workers will not have
motivation to do the job and therefore, according to vroom managers should try to ensure that
employees believe that increased work effort will improve performance and that this performance
will lead to valued rewards.
Page 30
Unit 2.2 Motivation
Motivation methods in practice:
The following methods provide examples of these motivation theories in practical solutions:
Financial motivators:
Time based wage rate means that a payment per hour is set.
advantages
disadvantages
often used in situations where.
 It offers some security over
pay levels..
 There is no incentive to
increase output as pay level is
not directly linked to output.
 The output of non managerial
jobs is not easy to measure.
 Different rates can be offered  Labor costs per unit will
to different types of workers.
depend on output to, which
may vary.
 Focus on quality is more
important than quantity.
Piece rate
piece rate is fixed for the production of each unit. The worker's wages therefore depend on the
quantity of output produced. The piece rate can be adjusted to reflect the difficulty of the job and the
standard time needed to complete it.
- It can be combined with a low basic wage and then the piece rate is paid as output rises above
asset level. This is called partial piece rate.
advantages
disadvantages
Often used in situations where
 it motivates workers to
increase output
 Quality might fall
 In many jobs individual worker
output cannot be calculated
 The output of each worker is
easy to identify and measure
 It is easy to calculate the  There is no security over the level of  There is a need to keep unit
labor cost per unit
pay(in the events of production
costs as low as possible
delays)
 Workers may become stressed and
unwell by trying to earn more
Salary
Most common form of payment for professional supervisory, and management staff. Salary level is
fixed each year not dependent on the number of hours worked or the number of units produced.
advantages
disadvantages
Often used in situations where
 It offers the security of a pay
level to employees
 There are different salary levels
for different grades of workers
 It is not directly linked to
output so complacency may
be a problem
 Status and security of
income are important
motivators in managerial or
non manual jobs
 It is suitable for jobs where
 It may lead to low
output is not measurable
achievement/motivation if
 It is often fixed for one year so
the effort and achievement
labor costs are easier to forecast
of the employee are not
regularly checked with
appraisal
 Overtime pay for extra hours
is not expected personal
money
Page 31
Unit 2.2 Motivation
Commission
usually paid to salespeople and can make up 100% of the total income or it can be in addition to a base
salary. Commission provides an effective financial incentive to sell more but they might reduce income
security.
advantages
disadvantages
 It creates the incentive to increase sales
 It discourages teamwork amongst sales
employees
 There may be an addition to a basic salary so it could  It may lead to pressurized selling which
offer some security of pay too
damages customer relationships
Bonus payment
A bonus payment is one that is made to employees in addition to their contracted wage or salary.
Bonus payments may be based on a criteria agreed between managers and workers such as an increase in
output, productivity or sales.
Advantages
disadvantages
Often used in situations where
 It is paid to individuals for
 It can cause resentment if the
outstanding work or to the teams
bonus is not received
for reaching targets
 It damages team spirit if some
 It creates the incentive for
members receive a bonus and
employees to do well
others do not
 The business wants to make
one off payments which are
not part of an employment
contract
 It is an addition to the basic salary  It reduces motivation if no
so it offers some security too
bonuses are paid
 The business wants to
reward employees for good
performance
Performance related pay
Usually a bonus payable in addition to the basic salary. It's widely used for those workers whose output is
not measurable in quantitative terms; such as management, supervisory
it requires the following procedure:
○ Setting establishing specific objectives for the individual
○ Annual appraisals of the workers performance against the preset targets
○ Paying each worker bonus when targets have been exceeded
advantages
disadvantages
Often used in situations where
 Individual bonuses for meeting  It requires frequent target setting  Managers want to
predetermined targets may
and appraisal interviews
encourage target setting
encourage workers to work
and target achievement
 If the bonus is low it may not lead
hard to meet these targets
to greater effort as motivation will
not be increased
 Target setting can form part of
the hierarchy of the objectives
to meet the company's aims
 Managers might show favoritism
 Employee performance
to some employees by giving them
cannot be measured in
generous bonus payments
terms of output produced
or sales achieved
Page 32
Unit 2.2 Motivation
Profit sharing
the essential idea behind profit sharing arrangements is that employees will feel more committed to the
success of the business and will strive to achieve higher performance and cost savings
advantages
disadvantages
Often used in situations where
 It aims to increase the
commitment of the workforce
to make the business
profitable.
 It might be only a very small
 Managers want to increase
proportion of total profits so is
employee focus on business
not motivating
profits to encourage cost
cutting and revenue increasing
 Shareholders might object as it
ideas
could reduce profit for them
 It might lead to suggestions for  It reduces profits retained for
cost cutting and waste to
expansion
increase sales
Non-financial motivators
Job rotation: allows workers to do several different jobs increasing their skill on the range of work they
can do
Benefits
Limitations
 It can give the worker several skills  It does not necessarily give a worker a complete unit of work
which makes the workforce more
to produce but just a series of a separate task of a similar
flexible
degree of difficulty
 Workers are more able to cover for  Job rotation is more limited in scope than job enrichment
a colleague 's absence
 Rotations may relieve the boredom  It does not increase empowerment or responsibility for the
of doing 1 task
work being performed
Job enlargement : an attempt to increase the scope of a job by broadening or deepening the tasks
undertaken.
Job enrichment: a reduction of direct supervision as workers take more responsibility for their own work
and are allowed some degree of decision making authority.
Advantages
Disadvantages
 Complete units of work are produced so that the
workers contribution can be identified and more
challenging work can be offered
 Challenging tasks are offered as part of a range of
activities some of which are beyond the workers
recent experience these tasks will require training
and the learning of new skills
 If their employees are just not able to cope
with the additional challenges imposed by the
job enrichment then this can lead to
frustration and demotivation.
 Employees may just see enrichment process
as an attempt to get them to do more work.
 Direct feedback on performance for example by
two way communication allows each worker to
have an awareness of their own progress
 Managers must accept reduced control and
supervision over the work of employees
which they might find difficult.
Job redesign: the restructuring of a job to make the work more interesting, satisfying, and challenging.
Page 33
Unit 2.2 Motivation
Training and development : the gaining of new or advanced skills and knowledge as well as opportunities
to apply what is gained.
advantages
Disadvantages
 Improving and widening the skills of employees
 Training can be expensive as trainers and
can increase the productivity and flexibility of the
training facilities are needed or off the job
workforce and its ability to deal with the change
courses must be paid for
 Training and development increased the status of  Training and development programs can take
workers and give them access to more challenging
employees away from their work for some time
and probably better paid jobs within the business.
so other employees will need to cover for them
Opportunities for promotion and increased status
Employee participation can be introduced all different levels of a business operation
Benefits
Limitations
 Job enrichment
 Improved motivation
 Time consuming
Team working: production is organized so that groups of workers undertake complete units of work.
Advantages
Disadvantages
 Teams are empowered by being given decision making  There may be some disruption to
authority over their work and the planning of it. This is
production as the teams establish
a good example of job enrichment
themselves
 Workers will not want to let down other team
members so absenteeism should fall
 The introduction of teamworking will
require training to improve employee
flexibility and this could be costly
Empowerment : the giving of skills, resources, authority and opportunity to employees so that they can
take decisions and be accountable for their work.
Benefits
Limitations
 Leads to quicker problem solving, as employees  Lack of experience increases risks which is why
are able to respond to problems immediately
employees must be trained in accepting the
and not take time referring to them as
additional authority that comes with
managers
empowerment
 Higher level of motivation and morale result as  Reduced supervision and control might lead to
workers are given more challenging work and
poor decisions
are recognized for it
Quality circle : a voluntary group of workers who meet regularly to discuss and resolve work related
problems and issues.
Benefits
Limitations
 Workers have hands on experience of work problems  Quality circle meetings can be time
and they often suggest the best solutions
consuming and reduce the time available for
production
 The results of the quality circle meetings are
presented to management. The most successful
ideas are often adopted not just in that location but
across the whole organization
Page 34
 Not all employees will want to be involved in
quality circles preferring to get on with their
own job already
Unit 2.2 Motivation
Key terms:
 Motivation: the internal and external factors that stimulate the desire in workers to be
continually interested in, and committed to, doing a job well.
 Piece rate: payment to a worker for each unit produced.
 Self-actualization: a sense of self-fulfillment reached by feeling enriched and developed by
what one had learned and achieved.
 Motivators (motivating factors): aspects of a worker's job that can lead to positive job
satisfaction, such as achievement, recognition, meaningful and interesting work,
responsibility, and advancement at work.
 Hygiene factors: aspects of a worker's job that have the potential cause to dissatisfaction,
such as pay, working conditions, status, and over-supervision by managers.
 Job enlargement: aims to use the full capabilities of workers by giving them the opportunity
to do more challenging and fulfilling work.
 Time-based wage rate: payment to a worker made for each period of time worked.
 Salary: annual income that is usually paid on a monthly basis.
 Commission: a payment to a salesperson for each sale made.
 Bonus: a payment made in addition to the contracted wage or salary.
 Performance-related pay: a bonus scheme to reward employee for above-average work
performance.
 Profit-sharing: a bonus for employees based on the profits of the business, usually paid as a
proportion of basic salary.
 Share-ownership scheme: a scheme that gives employees shares in the company they work
for or allows them to buy those shares at a discount.
 Fringe benefits: benefits given, separate from pay, by an employer to some or all employees.
 Job rotation: a scheme that allows employees to switch from one job to another.
 Job enlargement: an attempt to increase the scope of a job by broadening or deepening the
tasks undertaken.
 Job redesign: the restructuring of a job to make work more interesting, satisfying, and
challenging.
 Development: the gaining of new or advanced skills and knowledge as well as opportunities to
apply what is gained.
 Employee promotion: the advancement of an employee within a business to a higher level of
responsibility and status.
 Employee status: the level of recognition offered by an employer to a worker in terms of pay,
level of responsibility and benefits.
 employee participation: active encouragement of employees to become involved in decisionmaking within an organization.
 Teamworking: production is organized so that groups of workers undertake complete units of
work.
 Empowerment: the giving of skills, resources, authority, and opportunity to employees so that
they can take decisions and be accountable for their work.
 Quality Circle: a voluntary group of workers who meet regularly to discuss, and try to resolve,
work-related problems and issues.
Page 35
Unit 2.3 Management
Traditional manager Functions:
○ Planning: giving the business a direction for the future
○ Organizing: the people and other resources needed
○ Directing: leading and motivating people in the organization
○ Controlling: ensuring that the original plan is being followed
Fayol: The Functions of Management: He defined five functions of management:
1. Planning:
○ All managers need to think ahead. Senior management will establish overall objectives and these
will be translated into tactical objectives for less senior managers.
○ The planning needed to put these objectives into effect is also important. For example, new
production or marketing objectives will require the planning and preparation of sufficient
resources.
2. Organizing resources to meet objectives:
○ Employees need to be recruited carefully and encouraged, via delegation, to take some authority
and accept some accountability.
○ Senior managers should ensure that the structure of the business allows for a clear division of
tasks.
○ Each functional department, such as marketing, is organized to allow employees to work towards
the common objectives.
3. Commanding, directing and motivating employees
○ This means guiding, leading and overseeing employees to ensure that business objectives are
being met.
○ Employee development will help motivate employees to use all of their abilities at work.
○ Managers should be capable of motivating a team and encouraging employees to show initiative.
4. Coordinating activities
○ As businesses grow there is a greater need to ensure consistency and coordination between
different parts of the business.
○ The goals of each branch, division, region and employee must be welded together to achieve a
common sense of purpose.
○ At a practical level, this avoids the situation where, for example, two divisions of the same
company both spend money on researching into the same new product, resulting in wasteful
duplication of effort.
5. Controlling and measuring performance against targets
Establishing clear objectives for the business, and for each section within it, establishes targets for
all groups, divisions, and individuals.
 It is managements responsibility to appraise performance against targets and to take action if
underperformance occurs.
Page 36
Unit 2.3 Management
Mintzberg
To carry out their functions, managers have to undertake many different roles.
The roles he believed are common to the work of all managers are divided into three groups:
- Interpersonal roles: dealing with and motivating employees at all levels of the organization
- Information roles: acting as a source receiver and transmitter of information
- decisional roles: taking decisions and allocating resources to meet the organization's objectives
Role title
Description of role activities
Examples of management action
in performing the role
Interpersonal roles:
Figure head
Symbolic leader of organization, undertaking
duties of a social or legal nature
Opening new factories, hosting
receptions
Leader
Motivating subordinates; selecting and training
other managers
Any management tasks involving
subordinate employees
Liaison
Linking with managers and leaders of other
divisions of the business and other organizations
Leading and participating in
meetings
Informational roles:
Monitor
Collecting data relevant to the business's
operations
Attending seminars business
conferences research groups
Disseminator
Sending information collected from external and
internal sources to relevant people within the
organization
Communicating with staff within
the organization
Spokesperson
communicating information about the
organization its current position and
achievements to external groups and people
Presenting reports to groups of
stakeholders
Entrepreneur
Looking for new opportunities to develop the
business
Encouraging new ideas from within
the business
Disturbance
handler
Responding to the changing situations that may
put the business at risk assuming responsibility
when threatening factors develop
Taking decisions on how the
business should respond to threats.
Resource
allocator
Deciding on the spending of the organizations
financial resources and the allocation of its
physical and human resources
Drawing up and approving
estimates and budgets deciding on
staff levels for departments and
within departments
Negotiator
Representing the organization in all important
negotiations
Conducting negotiations and
building up official links between
the business and other
organizations
Decisional roles
Differences between Fayol and Mintzberg’s approaches
The differences between the approaches of Fayol and Mintzberg should not be exaggerated.
Mintzberg did not strongly disagree with Fayol. He just thought that the simple division of managerial
tasks into five functions was too closed and limiting.
He considered that the role of managers was:
 Mintzberg believed that he had demonstrated, through his systematic framework, that management is
much more than the five functions.
 It must include interpersonal relationships and open-ended discussions with workers and customers.
Despite their apparent differences
these two management thinkers have provided a useful foundation for analysing what it is that
managers must do to be effective
Page 37
Unit 2.3 Management
The key indicator that managers are having a positive impact on the business performance are:
- The business regularly meets its objectives
- High levels of customer satisfaction
- High employee motivation levels and low labor turnover
- a respected brand image
Main managerial positions in a business:
- Chief executive: highest ranking executive in a company responsibilities include managing overall
operations.
- Director: elected member of the board of directors of a company who has the responsibility for
determining and implementing the company's policy.
- Manager: any individual responsible for people resources or decision making can be termed and
manager.
- Supervisors: these are people appointed by managers to watch over the work of others.
Autocratic managers: take decisions on their own with no discussion they set business objectives,
issue instructions to workers and check to ensure their instructions are carried out.
Features
Limitation
Applications
 leader takes all decisions
 demotivates workers who want to
contribute and accept
 They give little information
responsibilities
to workers
 Decisions do not benefit from
 They supervise workers
employee input
closely
 Defense forces and police
where quick decisions are
needed and the scope for
discussion must be limited
Democratic management : democratic managers encourage discussion with workers before taking
decisions or may allow workers to take decisions themselves communication is two way.
Features
Limitation
Application
 participation encouraged
 Consultation with workers can
be time consuming
 Two way communication is used
 On occasions quick decision
which allows feedback from
workers
making will be required
 An experienced and
flexible workforce will be
likely to benefit most
from this style
Paternalistic management : Paternalistic means father like, they listen, explain issues and consult with
workers. But do not allow them to take decisions
Features
Limitation
Application
 Managers do what they think  Some workers will be
 Used by managers who have a
is best for the workers
dissatisfied with the apparent
genuine concern for workers
attempts
to
consult
while
not
interests but feel that
 Managers want workers to be
having
any
real
power
managers know the best in the
happy in their jobs
influence
end
Page 38
Unit 2.3 Management
Laissez-faire management means let them do it, and allows workers to carry out tasks and take
decisions themselves within very broad limits.
Features
Limitation
Application
 managers delegate virtually all authority
and decision making powers
 Very broad criteria or limits might be
established for the staff to work within
 Workers may not appreciate  When
the lack of structure and
managers are
direction in their work this
too busy to
could lead to a loss of security
intervene
McGregor's theory X and theory Y
 According to McGregor, the most important determinant of management style used by each
manager is the attitude of managers towards their workers.
○ McGregor identifies 2 distinct management approaches to the workforce, theory X and
theory Y.
○ Theory X managers view their workers as lazy and disliking work. These managers think
workers are unprepared to accept responsibility and need to be controlled and made to
work. Clearly, managers with this view will be likely to adopt an autocratic style of leadership.
○ However, Theory Y managers believe that workers enjoy work and think of it as natural as
rest or play. They think workers are prepared to accept responsibility be creative and take an
active part in contributing ideas and solutions to work related problems.
Theory X managers believe that workers Theory Y managers believe that workers
 dislike work
 Will avoid responsibility
 Are not creative
 Can derive as much enjoyment from work as from
rest and play
 Will accept responsibility
 Are creative
The management style used by each individual will depend on many factors:
○ The training and experience of the workforce and the degree of responsibility that they are
prepared to accept.
○ The amount of time available for consultation and participation
○ The attitude of managers or the management culture of the business
Key terms:
 Manager: the person responsible for setting objectives, organizing resources and motivating
workers so that he objectives of the business are met.
 Management: the organization and coordination of activities in order to achieve the defined
objectives of the business.
 Democratic management: a management style that encourages the active participation of
workers in taking decisions.
 Autocratic management: a management style where one manager takes all decisions with
very little, if any, input from others.
 Paternalistic management: a management style based on the view that the managers is in a
better position than the workers to know what is best for an organization.
 Laissez-faire management: a management style that leaves much of the business decisionmaking to the workforce.
 Theory X: the view that some managers believe that employees are lazy, fear-motivated and
in need of constant direction.
 Theory Y: the view that some managers believe employees are internally motivated, enjoy
their work and are prepared to take on additional responsibilities.
Page 39
Unit 3.1 The nature of marketing
Role of marketing
 Marketing objectives: the goals set for the marketing department to help the business achieve its
overall (corporate objectives).
 Marketing: the management task of identifying and meeting the needs of customers profitably by
getting the right products at the right price to the right place at the right time.
Marketing objectives and corporate objectives include a measurable increase in:
 Higher market share: to gain leadership
 Total sales value or volume or both
 Average number of items purchased per customer visit
 Frequency of shopping by loyal customers
To be effective, Marketing objectives should:
 Be linked to corporate objectives and be focused on helping the business achieve those overall
targets
 Be determined by senior management because the key marketing objectives will impact on the
markets and products of business trades in for years to come.
 Be smart
*
Corporate objectives: well-defined and realistic goals that are set for the whole company
Why are marketing objectives important?
 They provide a sense of focused direction for the marketing department and help the business
to achieve its overall corporate objectives
 Business success can be measured against the targets set by the objectives
 Marketing objectives can be broken down into regional and product sales targets
 They form the basis of marketing strategy.
* Marketing strategy: a plan of action giving details of how a business intends to achieve its marketing
objectives by creating competitive advantage.
Examples of marketing strategies include:
 Penetrating existing markets more fully by selling more to existing and new customers
 Entering new markets in other countries
 Developing new, or updating existing products
Coordination of marketing with other departments
Marketing objectives and marketing decisions cannot be sent or taken in isolation from the rest of
the business. There must be coordination between all departments; for example, if a marketing
objective of increasing sales by 10% has been set.
The marketing department will need to coordinate with the following departments
 Finance: the finance department will use the sales forecasts of the marketing department to
help construct cash flow forecasts and operational budgets.
 Human resources: sales forecasts will be used by human resources to help prepare a workforce
plan. For example additional workers will be needed in sales teams and production to increase
sales
 Operations: market research data will play a key role in new product development
Page 40
Unit 3.1 The nature of marketing
Demand and supply
 Equilibrium price: the price level at which demand is equal to supply.
 Demand: the quantity of a product that consumers are willing and able to buy in a specific time period.
Non price factors that can cause shifts in demand:
→ Consumer incomes
→ Prices of substitute goods and complementary goods
→ Population size and structure
→ Fashion and taste
Supply: the quantity of a product that firms are prepared to supply at a given price in a specific time
period
Non price factors that cause shifts in supply:
→ Costs of production
→ Government taxes imposed on the suppliers, raising their costs
→ Government subsidies to suppliers, reducing their costs
→ Weather conditions and other natural factors
→ Advances in technology which lower the cost of production
Markets
Markets are where buyers and seller are made to engage in exchange. The term markets also refers to
the group of customers who are interested in a product that have the resources to purchase it.
The understanding of the term market can be broken down into:
 The potential market for a product, which is the total population interested in the product.
 The target market, which is the market segment of the total available market that the business has
decided to direct its product towards.
* Market segment: a subgroup of a whole market in which consumers have similar characteristics.
Industrial markets and consumer markets
An industrial market deals with the products bought by businesses. These include specialist industrial
machines, trucks and office supplies. B2B
A consumer market deals with products bought by the final consumers of the products. These include
mobile phones, holidays and fashion clothing. B2C
Local national and international markets
- Local markets - our businesses that just sell in local areas to local customers, and that only
operate in the local markets
- National markets - includes businesses that sell their product to customers throughout the
whole country, this gives greater potential to increase sales compared to local markets;
examples include banks and supermarket chains.
- International markets- offer the greatest sales potential, businesses that market outside home
country, may be done by using foreign agents.
Page 41
Unit 3.1 The nature of marketing
Customer oriented and product oriented Marketing:
Customer orientation requires market research and market analysis to measure present and future
demand. Customers and their needs come first, the business will attempt to produce what customers
want to buy.
The benefits of consumer orientation are:
 The chances of newly developed products failing in the market are reduced effective market
research helps to prevent product failures
 Products based on consumers' needs will have a longer lifespan on be more profitable than
those that are sold using a product led approach
Product oriented businesses invest and develop product as they believe that they will find consumers
to purchase them. They concentrate their efforts on efficiently producing high quality goods. They
believe quality will be valued above market fashion.
Market share and market growth
The market size can be measured in two ways:
 By the quantity of sales
 The value of products sold by all businesses in the market over a given time.
* Market size: the total value (or quantity) of sales of all producers within a market in a given
time period.
Market size is important for three reasons:
 It allows a marketing manager to assess whether a market is worth entering or not
 It allows the business to calculate its own share of the market
 The growth or decline of the market overtime can be identified
* Market growth: the percentage change in the total size of a market (volume or value) over a
period of time.
The rate of market growth depends on several factors:
 A country's rate of economic growth
 Changes in consumer incomes
 Changes in consumer tastes
Consequences of a change in market growth:
Increased market growth
Reduced market growth
 Sales will increase if the businesses
market share remains the same
 It may be possible to increase prices and
profit per unit
 Sales will increase more slowly even if the
businesses market share remains the same
 Competitors might reduce prices to increase sales in
a slow growing market
 Increased sales could lead to cost saving
 Lower prices might result in lower profits per unit
Market share = sales of the business in time period x 100
total market share in time period
The business with the biggest market share is the brand leader: the brand with the highest share of
the market.
Page 42
Unit 3.1 The nature of marketing
If the market share of a business is increasing then the marketing of its products has been more
successful relative to most of its competitors the product with the highest market share is called
the brand leader.
Implications of an increase in market share:
Implications of a fall in market share
 The fact that an item or brand is the market
 Sales are likely to fall unless there is rapid
leader can be used in an advertising and other
market growth
promotional material, consumers are often keen  Larger discounts to retailers might have to
to buy the most popular brands
be offered
 Sales are rising faster than those of competing
businesses in the same market and this could
also lead to higher profits
 Retailers will be less keen to stock and
promote the product
Consumer marketing and industrial marketing
Distinctions can be made between goods and services produced for sale to individuals and
households (consumer products) and those produced for industrial use (industrial products).
Consumer products are often classified into:
○ Convenience products purchased frequently often bought on impulse and sold to a large
target market
○ Shopping products usually require some planning and research by consumers before being
purchased, consumers do not buy these frequently e.g washing machines.
○ Specialty products, bought infrequently, often expensive and with strong brand loyalty e.g
cars and designer brands.
Industrial products are often classified into:
- Materials and components: needed for protection to take place e.g steel electric motors for
washing machines
- Capital items: equipment, machinery and vehicles e.g IT systems and industrial buildings
- Services and supplies: business services and utilities e.g power supplies and IT support
The key differences between selling to businesses rather than consumers are:
 Most industrial products are much more complex than many consumer products so specialist
sales employees and support services will be more important with B2B selling
 Industrial buyers will rarely buy on impulse they will only purchase after long consideration
and detailed analysis of alternative products so a business selling B2B needs to keep in
regular contact with industrial customers.
 Mass marketing in consumer markets is a common strategy but in most industrial markets
there are relatively few buyers. Products may need to be adapted to meet the needs of a
particular business buyer. An example of this would be a specialist elevator system for a tall
hotel building.
Page 43
Unit 3.1 The nature of marketing
Features of Mass market
Features of Niche market
○ This large market is made-up of customers who are
willing to purchase a standardized product
○ Market research is often necessary to
establish customers special needs
○ High sales levels allows for high levels of production
○ Customers want to buy differentiated
products.
○ Low price is often a key element in selling the
product
○ Market size of a niche market is often
small
Advantages of mass market
Disadvantages of mass markets
 A mass market strategy with high sales of a standard  Lack of differentiated products and
product can lead to lower average costs of
differentiated marketing does not appeal
production
to many customers
 Cost advantages can lead to lower prices to
consumers which help to reinforce the position of
the product in the market
 The focus on low prices does not help to
establish a premium brand image for the
product
Advantage of niche marketing
Disadvantages of niche marketing
 Small businesses can survive and thrive in markets
that are dominated by larger firms.
 The business is vulnerable to market
changes
 An unexploited niche has no competitors. Selling to  Small market niches do not allow
this niche offers the chance to sell at high prices and
economies of scale to be achieved
high profit margins until competitors react by
entering too. Consumers will often pay more for an
exclusive product
Market segmentation is customer focused so it's consistent with the concept of customer orientation.
○ The aim is not just to sell one product to the whole market but different products are targeted
at different segments for market segmentation.
• To be successful, businesses must research the total market carefully, this allows them to identify the
specific consumer groups that exist within the market
Methods of market segmentation
- Geographic Differences well these might result from cultural social and climate differences.
Therefore many businesses offer different products and market them in location specific ways.
- Demographic differences: Demography is the study of population data and trends and
demographic factors such as age gender and income family size social class and ethnic
background. These can all be used to segment the market.
Advantages of market segmentation
Disadvantages of market segmentation
 Businesses with find their target market
 Research and development and production costs
precisely and design and produce goods that
might be high as a result of needing to make and
are specifically aimed at these groups
the market different product variations
leading to increased sales
 Small firms are unable to compete in the
whole market and are able to specialize in
one or two mark segments
 Extensive market research is needed to identify
market segments and their needs which could be
expensive
Page 44
Unit 3.1 The nature of marketing
Why market segmentation may be important:
 Targeted Marketing: By dividing the market into segments based on characteristics such as
demographics, psychographics, behavior, or needs, businesses can tailor their marketing
strategies and messages to specific groups. This targeted approach increases the effectiveness of
marketing efforts and improves the chances of reaching the right customers with the right
message.
 Matching of customer needs: Market segmentation allows businesses to gain a deeper
understanding of their customers' preferences, behaviors, and needs within each segment. This
understanding enables businesses to develop products and services that better meet customer
requirements and enhance customer satisfaction.
 Increased Sales and Profitability: By targeting specific market segments with products or services
that align with their needs and preferences, businesses can increase sales and profitability.
Tailoring offerings to different segments can lead to higher customer satisfaction, loyalty, and
repeat purchases.
 Competitive Advantage: Effective market segmentation helps businesses differentiate
themselves from competitors by offering unique value propositions to specific customer
segments. This can create a competitive advantage and position the business as a preferred
choice for customers within those segments.
 Resource Allocation: Market segmentation helps businesses allocate resources more efficiently
by focusing on segments that offer the greatest potential for revenue and profit. By prioritizing
segments with the highest growth potential or profitability, businesses can optimize their
marketing, sales, and product development efforts.
Why it may not be important:
 Segmentation increases costs, and extensive research is expensive
 Limited Reach: By focusing on specific market segments, businesses may miss out on potential
customers outside those segments who could also benefit from their products or services. This
can limit the overall market reach and growth opportunities.
Customer relationship market: the objective of which is to develop customer loyalty to ensure that
customers buy from the business in the future. Studies have shown it can cost between 4 and 10 times
as much to gain new customers than it does to keep existing ones
Developing effective long term relationships can be achieved by:
- Targeted marketing: giving each customer the products and services they have indicated, from
records of past purchases, that they most need.
- Customer service and support: after sales service and effective call centers are a good example
of the support essential to building customer loyalty
- Communicate regularly with customers: to give frequent updates on new products
Costs and benefits of customer relationship marketing
Costs of CRM
Benefits of CRM
 IT systems and software are needed and  For businesses with an existing customer base CRM
employees need to be trained to
has proved to be cost effective higher sales from
respond to customer feedback
effective CRM nearly always exceeds its cost
 Effective CRM campaigns may require
the use of an external marketing
consultancy at high cost
 It costs less per customer than trying to attract new
customers
Page 45
Unit 3.1 The nature of marketing
Measuring market research effectiveness:
 Comparing Forecasted vs Actual Results: One way is to compare the outcomes predicted by
the market research with the actual results achieved in the market. If there is a significant
variance, it indicates that the research might not have been effective.
 Feedback from Customers: Gathering feedback from customers about whether the products
or services meet their needs and expectations can provide insights into the effectiveness of
the research.
 Qualitative Feedback: Gathering qualitative feedback from stakeholders within the
organization on how the market research findings have influenced decision-making and
strategy can also be a valuable assessment tool.
Key terms:
 Marketing objectives: the goals set for the marketing department to help the business
achieve its overall (corporate objectives).
 Marketing: the management task of identifying and meeting the needs of customers
profitably by getting the right products at the right price to the right place at the right time.
 Corporate objectives: well-defined and realistic goals that are set for the whole company
 Marketing strategy: a plan of action giving details of how a business intends to achieve its
marketing objectives by creating competitive advantage.
 Equilibrium price: the price level at which demand is equal to supply.
 Demand: the quantity of a product that consumers are willing and able to buy in a specific
time period.
 Supply: the quantity of a product that firms are prepared to supply at a given price in a
specific time period.
 Market segment: a subgroup of a whole market in which consumers have similar
characteristics.
 Industrial market: the selling of products businesses to other businesses, also known as B2B.
 Consumer market: the selling of products by businesses to the final end user, also known as
B2C.
 Consumer products: goods and services sold to end users.
 Customer (or market) orientation: an out-ward looking approach that bases product
decisions on consumer demand, as established by market research.
 Product orientation: an inward looking approach that focuses on making products that can be
made - or have been made for a long-time and then trying to sell them.
 Industrial products: goods or services sold to businesses.
 Market size: the total value (or quantity) of sales of all producers within a market in a given
time period.
 Market growth: the percentage change in the total size of a market (volume or value) over a
period of time.
 Brand leader: the brand with the highest share of the market.
 Mass marketing: selling standardized products or ranges of products in the same way to the
whole market.
 Niche marketing: identifying and exploiting a small segment of a larger market by developing
differentiated products to suit that segment.
Page 46
Unit 3.2 Market Research
Market research
the data collected from this research impacts on most business decisions market research is not aimed at just finding out
whether consumers will buy a particular product or not it is also used to establish the characteristics of consumers (what
products they buy and why they buy them)
Market research can be used to measure customer reactions to:
 New products
 Different price levels
 Alternative forms of promotion
 New types of packaging
 Online distribution
The purpose of market research
1. Identify the main features of the market
○ Overall size - is it worthwhile for the business to be entering this market?
○ Growth - is the market becoming bigger or smaller in terms of sales?
○ Competitors - how many other businesses sell in this market and how much market power do
they have?
2. Reduce the risks of new product launches
New product development
Market research linked to it
○ Identify consumer needs and taste → Primary and secondary research into consumer
needs and competitors
○ Product idea and packaging design → Testing the product and packaging with consumer
groups
○ Brand positioning and testing of
advertising
→ Pre-testing the product image and advertisements
○ Product launch and after lunch.
→ Monitoring sales and consumer response
3. Identify customer characteristics
4. Predict main future changes
Primary research and secondary research
Primary research is the first hand collection of data by an organization for its own needs
Secondary research is the analysis of data that already exists secondary research data was originally
collected by another organization often for a different purpose
Page 47
Unit 3.2 Market Research
When a business is considering entering a new market or launching a new product it will often
undertake secondary research because:
 It is lower cost and obtainable more quickly than primary data
 It can be used to assess the main features of a market. If this appears to be too small or has too many
competitors, it might not be worthwhile proceeding with primary research.
Usefulness of secondary research data:
 They can provide information about the population, the economy, the market conditions that a
business operates in or plans to operate in and major trends in that market.
 Large samples are often used, which increases accuracy and reliability.
 If the time or finance is very limited, secondary research might be the only option.
Main sources of secondary data
Details
 Government
→ These are usually available for free on the
Internet
→ They may be several years out of date
 Market research agencies
→ These are often very expensive
→ They are not usually updated annually
There are also limitations to the usefulness of secondary research data:
- Data may be out of date as not all sources of the every year this could lead to inaccurate
conclusions based on old data
- Not all second data is available to all potential users. even if it is available, it can be expensive
to obtain, for example from market research agencies.
Usefulness of primary data research
Limitations of primary data research
 To find out about new completely new markets, for
example for innovative products for which no
secondary data for exists
 Business startups may not be able to
finance detailed primary research
 To gather qualitative data which supports and help
to explain quantitative data. For example, if a
business has falling sales in one market, it can
question consumers about why they have changed
their buying patterns.
 The selection of a sufficiently large and
representative sample greatly influences
the accuracy of data
Primary data collection method
Details
→ Questionnaire-postal, in store,
online, mobile phone
→ Questioners can include detailed, open questions which
give qualitative and quantitative data
→ Focus groups-discussions with
→ Focus groups encourage debate between consumers
potential or existing customers, with
about the product or advertisement. Discussion is
the aim of gaining qualitative data
observed and recorded.
Page 48
Unit 3.2 Market Research
Sampling
Because it's impossible to seek evidence from the total population that is the total potential target
market. A sample of the total potential market will need to be chosen. The larger that sample the more
representative of the total population it's likely to be.
limitations of sampling:
 sample may be too small
 Risk of sampling bias
 Researchers may not use the most appropriate methods of sampling
Market research data
Once research has been completed, it needs to be analyzed in ways that make it useful to business
decision makers.
Three issues need to be considered:
1. Reliability of data collected these are the three main reasons why primary data may be unreliable:
- Sampling bias: when it's not representative of target population.
- Questionnaire bias: leaning towards an answer.
- Other forms of bias: respondents not answering in a truthful way.
2. Analysis of quantitative data:
Average
measure
Uses
Advantages
mean
→ Used as an indicator of
 includes all of the data in  Affected by one or two
likely sales levels per
its calculations
extreme results
period of time this could
 Most well known average  Usually not a whole
be used to help determine
it's widely used and easily
number so might not be
reorder levels
understood
useful in making decisions
→ Used for making
comparisons between sets
of data such as attendance
at the football clubs
Mode
→ Can be used for inventory
ordering purposes
 It is easily observed and
no calculation is
necessary
 The results are a whole
number and easily
understood
Median
→ Could be used in wage
negotiations
→ Often used in advertising
 It is less influenced by
 Calculation from group
extreme results than the
data is complicated
mean. So it's more
appropriate than the
 An even number of results
mean word and there are
means the value is
a few very high or very
approximated
low results
Page 49
Disadvantages
 Does not consider all the
data therefore it cannot be
used for further statistical
analysis
 There may be more than
one model result which
could cause confusion
Unit 3.2 Market Research
Analysis of qualitative data:
Qualitative data can provide answers to questions such as:
○ Why are consumers not buying this product?
○ What features of this product do consumers find most appealing?
 The answers to these and other questions must be carefully recorded.
 They should be categorized into types of row responses and this process is called coding: the
process of labeling and organizing qualitative data to identify the main themes and the links
between.
3. Interpretation of information presented in tables charts and graphs
Research data made might be presented in many forms including:
- Tables: allow easy reference to the data and can be used to present the mass data in a precise
way
- Pie graphs: are used when data used to be presented so that the proportions of different sets
of data in relation to the total are clearly shown
- Line graphs: most commonly used for showing changes in a variable such as sales over time in
time series graphs
- Bar charts
Key terms:
 Market research: the process of collecting, recording, and analyzing data about customers,
competitors, and the market.
 Primary research: the collection of first-hand data that is directly related to the needs of the
business.
 Secondary research: the use of existing data that was originally collected for another purpose.
 Qualitive data: non-numerical data, which provides insight into the detailed motivation of
consumer and helps to explain their buying behaviour or opinions.
 Quantitative data: numerical results from research that can be statistically analyzed.
 Sampling: the process of selecting a group of respondents from a larger population.
 Sample: a group of people taking part in a market research survey selected to be representative
of the overall target market.
 Sampling Bias: when a sample is not a good representation of the whole population, because it
is chosen in ways in which give some people a greater chance of being selected.
 Arithmetic mean: the value calculated by totaling all the results and dividing by the number of
results.
 Mode: the value that occurs the most frequently in a set of data.
 Median: the value of the middle item when data has been ordered or ranked. It divides the
data into two equal parts.
 Range: the difference between the highest and lowest value.
 Coding: the process of labeling and organizing qualitative data to identify the main themes and
the links between.
Page 50
The elements of the Marketing Mix
 marketing mix: the four key decisions on product, price, promotion, and place that must be taken to
enable the effective marketing of a product.
 Product: goods or services that are the end result of the production process and are sold on the
market to satisfy customer needs.
 ‘Product’: includes industrial and consumer goods and services
Tangible and intangible attributes of a product :
 Intangible attributes: the subjective opinions of customers about a product, which cannot be
measured or compared easily.
 Tangible Attributes: the measurable features of a product, which can be easily compared with other
products.
New Product Development: the design, creation and marketing of new goods and services.
The importance of product development:
NPD is the complete process of bringing a new product to the market. This is crucial to some
business. For example, tech companies launch new products to adapt to consumers changing tastes
and enter new market segments.
Why is NYD important?
 Changing in consumer tastes and preferences - . For example, the trend towards home cinemas
means that a TV manufacturer has to consider developing new products in this market segment to
remain competitive.
 Increasing competition
 Technological advancement - It took Dyson 15 years, with thousands of failed attempts, to make a
bagless vacuum cleaner operate successfully. Now all vacuum manufacturers have adopted similar
technology.
 New opportunities for growth - If the existing markets a business operates in are mature and no
longer growing, then developing products for new markets is essential for further growth.
 Risk diversification - Pressure groups are pushing for carbon emission limits, while oil and gas
companies are investing in renewable energy to counter the risk of declining oil demand.
For a new product to succeed, it must:
 Have desirable features that consumers are prepared to pay for
 Be sufficiently different from other products to make it stand out and offer a unique selling
point.
Product differentiation and USP:
The most successful new products stand out from competitors and offer something unique. Product
differentiation can help a business separate itself from rivals and gain a competitive edge by creating
a unique selling proposition (USP).
 Unique selling point (USP): the special feature of a product that makes it different from competitors'
products.
 Product differentiation: the unique qualities of a product that lead to a difference between the
product and competitors' products.
Benefits of an effective USP:
 Promotion that focuses on the differentiating feature of the product or service
 Opportunities to charge higher prices due to the exclusive and unique features, design or
customer service – higher prices should lead to higher profit margins.
 customers being more willing to be identified with the brand because it is different.
Page 51
The marketing mix - product and price chapter 19
Products and Brands:
The product is the general term used to describe the nature of what is being sold. The brand is the
distinguishing name or symbol that is used to differentiate one manufacturer’s products from another.
Branding can have real influence on marketing. It can create a powerful image or perception in the
minds of consumers – either negative or positive – and it can give the products a unique identity.
 Brand: an identifying symbol, name, image, or trademark that distinguishes a product from its
competitors.
 Product positioning: consumers' view of a product or service compared to its competitors.
The first stage of product positioning is to identify the features of this type of product that have been
shown by research to be important to consumers. These key features might be price, quality of
materials, perceived image, level of comfort offered (e.g. in hotels) and so on. They will be different
for each product category.
 Product Portfolio Analysis: analyzing the range of existing products of a business to help allocate
resources effectively between them.
Product portfolio analysis helps when making decisions on when to launch a new product or update
and existing one. The two product portfolio analysis techniques to be considered are:
 Product life Cycle: the pattern of sales for a product from launch to withdrawal from the market.
 Boston Matrix: a method of analyzing the product portfolio of a business in terms of market
share and market growth.
Introduction: when the product has just been launched after
development and testing. Sales are often quite low to begin
with and may increase quite slowly
Growth: if the product is effectively promoted and well
received by consumers, should grow.
Maturity or saturation: the saturation of consumer durables market is caused by consumer already
having the product. The product's sales growth starts to slow down and eventually reaches a peak.
This stage is characterized by intense competition, as companies vie for market share and try to
differentiate their products to stand out.
 Consumer durable: a manufactured product that can be reused and is expected to have a reasonably long life, such as
a car or washing machine
Decline: sales decline steadily. Either no extension strategy has been tried or it has not worked, or else
the product is so obsolete (no longer in use) that the only option is replacement.
Extension strategies: they aim to lengthen the life of an existing
product before the market demands a completely new product.
E.X:
○ selling in new markets
○ repackaging and relaunching the product
○ finding new users for the product
○ Advertising
Page 52
The marketing mix - Product
advantages and disadvantages of each method:
Selling in new markets:
 Increased sales potential
 Cultural and regulatory challenges
 Diversification of customer base
 Higher distribution costs
 Opportunity for brand expansion
 Potential for market saturation in new areas
Repackaging and relaunching the product:
 Renewed interest from existing
customers
 High rebranding and relaunching costs
 Opportunity to modernize the product
 Risk of alienating loyal customers
 Potential for increased profitability
 Potential for consumer skepticism about the "new"
product
Finding new users for the product:
 Potential for increased market share
 Need for extensive market research
 Opportunity for product diversification
 Potential for brand dilution
 Extended product relevance
 Difficulty in shifting consumer perceptions
Advertising:
 Increased brand visibility
 High advertising costs
 Opportunity to influence consumer
behavior
 Difficulty in measuring direct impact on sales
 Ability to communicate product benefits  Risk of ad fatigue and consumer indifference
Page 53
The marketing mix - product and price chapter 19
The ability and opportunity to extend the life of a product depends, of course, on how strong consumer
associations with the brand are.
Advantages of extending PLC
Disadvantages
 It is potentially cost-effective in that it delays  Can, with bad decisions, dilute and/or damage the
the need for potentially expensive launch of
wider brand and its equity – through flawed
new products.
production extension.
 It can stretch a brand and identity and
achieve new sales revenue,
- e.g. Ralph Lauren brand extended from
clothes to home furnishing (Virgin).
 The product may not be amenable to an extension
strategy and resources could be wasted.
 Extensions can lead to diversification, not just  The extension strategy might not be well thought
extending the life of a product.
out.
 It reduces risk by exploiting the brand name  It can cause uncertainty in the mind of the
to enhance the consumer perception ofbrand consumer.
equity.
Links between the product life cycle and marketing mix decisions:
Product life
cycle stage
Price
Introduction  may be high
(skimming) or low
(penetration)
compared to
competitors prices
Promotion
Place (distribution)
Product
 High levels of
informative
advertising are
needed to make
consumers aware
of the products
arrival in the
market
 In restricted
 Basic model
outlets, possibly
with few
high-class outlets
variations
if a skimming
strategy is used
Growth
 If successful, an
 Consumers need
initial penetration
encouraging to
pricing could now
make repeat
lead to rising prices
purchases and
branding will help
win customer
loyalty
 In growing
number of
outlets in areas
that indicate
strength of
consumer
demand
 Product
improvements
and
developments
to maintain
consumer
appeal
Maturity
 As competitors
 Brand imaging
 Highest
enter the market,
continues to stress
geographical
prices for the
the positive
spread possible,
product need to
differences
including new
stay at competitive
compared to
distribution
levels
competitors'
channels
products
 New models,
colors,
accessories as
part of
extension
strategy
Decline
 Lower prices may
 Advertising likely
be needed to sell
to be very limited
off inventory, but if
and mat just be
the product has a
used to inform of
small niche
lower prices
following, prices
could even rise.
 Slowly
withdraw
product from
certain markets
and prepare to
launch new
products.
Page 54
 Unprofitable
outlets for the
products are
eliminated
The marketing mix - product and price chapter 19
Limitations of using the product life cycle for marketing decisions:
 Based on past or current data, so cannot predict future development
 Sales could crash very quickly, giving no chance for extension strategies
* The usefulness of the product life cycle analysis is increased if it is analyzed together with the
Boston Matrix, sales forecasts and management experience to assist with effective marketing
decision-making
Boston Matrix: a method of analyzing the product portfolio of a business in terms of market
share and market growth.
 It helps companies decide where to focus their resources, what products to invest in, and which
ones might need changes or be phased out
 The goal is to make the whole set of products as successful and profitable as possible.
Impact of Boston Matrix analysis on marketing decisions:
The Boston Matrix analysis has a significant impact on marketing decisions as it provides a framework for evaluating
and managing a company's product portfolio.
By identifying the position of all products of the business, a full analysis of the portfolio is possible. This
should help focus on which products need marketing support or which need corrective action.
This action could include the following marketing decisions: Holding, divesting, etc.
1. Stars:
 High market share in a growing market.
 Need a lot of attention and money to keep growing.
Holding Strategy:
Ensures continued support for star products, requiring efforts to maintain market position and
sustain sales growth.
2. Cash Cows:
 High market share in a market that's not growing much.
 Make a lot of money and don't need much investment.
1. Question Marks (Problem Children):
 Low market share in a growing market.
 Might have potential but need more investment to grow.
 Building Strategy:
Supports question mark products with additional advertising or expanded distribution, funded
by established cash cow products.
4. Dogs:
 Low market share in a slow-growing market.
 Don't make much money and may need careful management.
Milking Strategy:
Utilizes positive cash flow from established products to invest in other products within the
portfolio.
Divesting Strategy:
Involves identifying poorly performing products (dogs) and halting production, considering
workforce impact and capacity usage.
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The marketing mix - product and price chapter 19
This analytic tool has relevence when:
 Analyzing Existing Product Portfolios: Enables evaluation of product performance and
current positions within the portfolio.
 Planning action to be taken with existing products
 Planning the introduction of new products
In summary, Boston Matrix analysis influences marketing decisions by categorizing products strategically, facilitating
resource allocation, supporting high-potential products, and guiding decisions on product introductions, expansions, or
exits.
Limitations of using the Boston Matrix for marketing decisions:
 On its own, it cannot tell a manager what will happen next with any product.
 The Boston Matrix is only a planning tool and it has been criticized for simplifying the complex
set
 of factors that determine product success.
 It assumes that higher rates of profit are directly related to high market shares. This
 is not necessarily the case when sales are being gained by reducing prices and profit margins
Price is the amount paid by a customer for a product, determining the price for a product is a vital
component of the marketing mix.
It can have a great impact on the consumer demand. As well as:
 Impact on the level of value added by the business to bought-in components
 Affect the revenue and profit made by a business due to its impact on demand
 Help establish the psychological brand image of a product
Determinants of the pricing strategy decision for any product:
 Costs of production: If the business is to make a profit on the sale of a product, then, at least
in the long term, the price must cover all of the costs of producing it and of bringing it to the
market.
 Competitive conditions in the market: If the business is a monopolist, it is the only seller of a
 product. It is likely to have more freedom in price setting than if it is one of many businesses
selling the same type of product
 Price elasticity of demand: the responsiveness of demand following a change in price.
Pricing Methods:
Cost-based methods of pricing
Companies will assess their costs of producing or supplying each unit, and then add an amount for
profit to the calculated cost.
There are a number of different methods of cost-based pricing that may be adopted:
 Mark-up pricing: adding a fixed mark-up for profit to the unit cost of buying in a product.
Example:
Total cost of bought-in product = $40
50% mark-up on cost = $20
Selling price = $60
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The marketing mix - product and price chapter 19
 Cost-plus pricing: setting a price by calculating total unit cost for the product and then adding a
fixed profit mark-up.
Example: A business makes industrial training films and the annual fixed costs are $10 000. The
variable cost of producing each film is $5. The business is currently producing 5 000 units per year.
The total costs of this product each year are:
$10 000 + (5 000 × $5) = $35 000
The average or unit cost of making each film is:
$35 000/5 000 = $7
The business will have to charge at least $7 for each film in order to break even.
If a 300% profit mark-up is added, then the total selling price becomes $28
 Contribution-cost pricing: setting prices based on the variable costs of making the products, in
order to make a contribution towards fixed costs and profits.
it does not allocate the fixed costs to specific products. Instead, the business calculates a variable cost per unit of the
product. It then adds an extra amount, which is known as a contribution towards fixed costs and profit. If enough units
are sold, the total contribution will be enough to cover the fixed costs and to return a profit.
Example: A business produces a single product that has variable costs of $2 per unit. The total
fixed costs of the firm are $40 000 per year. The business wants each unit sold to make a
contribution of $1. The selling price is therefore $3. Every unit sold makes a contribution towards
the fixed costs of $1.
If the firm sells 40 000 units in the year, then the fixed costs will be covered. Every unit sold over
40,000 will mean the business makes a profit. If the firm sells 60 000 units, then the fixed costs will
be covered. and a $20 000 profit will be made.
Many businesses that have excess capacity use contribution-cost pricing to attract extra business
that will absorb the excess capacity.
The advantage of contribution-cost pricing over cost-plus or mark-up pricing is that:
 the level of competition can be considered when making the pricing decision. If competition is
very high, a low contribution per unit can be added to the variable cost per unit. This will give a
lower price than mark-up pricing as the fixed costs have not been included and vice versa.
 Competitive pricing: making pricing decision based on price set by competitors.
Two main reasons why a business might adopt competitive pricing methods:
 One dominant business in the market
 Some markets have a number of businesses of the same size selling similar products
 Price discrimination: charging different group of consumer different prices for the same good or
service.
 Often used in market where it is possible to charge different groups of consumers
 different prices for the same product. An example of price discrimination would be bus or
train
 companies charging lower prices for the elderly than they do for other adults, for the same
journey.
Dynamic pricing: offering products at a price that changes according to the level of demand and
the customer's ability to pay.
 involves setting constantly changing prices when selling products to
 different customers, especially online through e-commerce
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The marketing mix - product and price chapter 19
Methods
Advantages
Disadvantages
Cost-plus
pricing
 The price set covers all costs of
production
 Inaccurate for businesses with several
purposes where there is doubt over the
allocation of fixed costs
 Easy to calculate for single-product
firms where there's no doubt about
fixed costs
 It does not take market/competitive
conditions into account
 Suitable for businesses that are price-  Tends to be inflexible
makers due to market dominance
Contribution
pricing
 All variable costs are covered by price  Fixed costs may not be covered
and a contribution is made to fixed
 If prices vary too much, due to the
costs.
flexibility advantage, then regular
 Suitable for firms producing several
customers might be annoyed.
products and fixed costs don't have to
be allocated.
 Flexible, price can be adapted to suit
market conditions or to accept special
orders.
Competitor
pricing
 This is almost essential for firms
 with little market power – price
takers.
 It can be flexible to reflect market
and competitive conditions.
 this uses price elasticity (the
Price
responsiveness of demand to price
discrimination
 The price set may not cover all the costs of
production.
 The price may have to vary frequently due
to changing market and competitive
conditions.
 There are administrative costs of having
different pricing levels.
changes) to charge different prices to  Customers may switch to lower priced
increase total revenue.
markets.
 Consumers paying higher prices may
object and look for alternatives.
Pricing methods for new products:
 Penetration pricing: setting a relatively low price to achieve a high volume of sales.
 Market skimming: setting a high price for a new product when a firm has a unique or highly
differentiated product with low price elasticity of demand.
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The marketing mix - product and price chapter 19
Key Terms Summary:
 marketing mix: the four key decisions on product, price, promotion, and place that must be taken to
enable the effective marketing of a product.
 Product: goods or services that are the end result of the production process and are sold on the
market to satisfy customer needs.
 Goods: products that have a physical existence, such as washing machines and chocolate bars.
 Services: products who have no physical existence, but satisfy consumer needs in other ways, such
as hairdressing, car repairs, childminding, and banking.
 Brand: an identifying symbol, name, image, or trademark that distinguishes a product from its
competitors.
 Intangible attributes: the subjective opinions of customers about a product, which cannot be
measured or compared easily.
 Tangible Attributes: the measurable features of a product, which can be easily compared with other
products.
 New Product Development: the design, creation and marketing of new goods and services.
 Unique selling point (USP): the special feature of a product that makes it different from competitors'
products.
 Product differentiation: the unique qualities of a product that lead to a difference between the
product and competitors' products.
 Product positioning: consumers' view of a product or service compared to its competitors.
 Product Portfolio Analysis: analyzing the range of existing products of a business to help allocate
resources effectively between them.
 Product life Cycle: the pattern of sales for a product from launch to withdrawal from the market.
 Consumer durable: a manufactured product that can be reused and is expected to have a
reasonably long life, such as a car or washing machine.
 Boston Matrix: a method of analyzing the product portfolio of a business in terms of market share
and market growth.
 Mark-up pricing: adding a fixed mark-up for profit to the unit cost of buying in a product.
 Cost-plus pricing: setting a price by calculating total unit cost for the product and then adding a fixed
profit mark-up.
 Contribution-cost pricing: setting prices based on the variable costs of making the products, in order
to make a contribution towards fixed costs and profits.
 Competitive pricing: making pricing decision based on price set by competitors.
 Price discrimination: charging different group of consumer different prices for the same good or
service.
 Dynamic pricing: offering products at a price that changes according to the level of demand and the
customer's ability to pay.
 Penetration pricing: setting a relatively low price to achieve a high volume of sales.
 Market skimming: setting a high price for a new product when a firm has a unique or highly
differentiated product with low price elasticity of demand.
 Psychological pricing: setting a price at a level which matches consumers' views about a product's
perceived value.
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Chapter 20 - The marketing mix - Promotion
Promotion is about communicating with actual or potential customers. Effective promotion not only increases
awareness of products but also creates images and product personalities that consumers can identify with.
Advertising is only one form of promotion - other techniques include direct promotion and sales promotion.
The combination of all forms of promotion used by any business for any product is known as the promotion
mix.
 Promotion: the use of advertising, sales promotion, personal selling, direct mail, trade fairs,
sponsorship and public relation to inform consumers and persuade them to buy a good or service.
 Advertising: paid-for communication to inform and persuade consumer, using media such as TV,
newspaper and cinema.
 Promotion Mix: the combination of promotional techniques that a firm uses to sell a product.
Promotional objectives:
Businesses allocate resources to promotion to achieve certain objectives. The success of promotion
campaigns can be measured against these objectives. They can include:
 Increasing sales by raising consumer awareness of a product, which is especially important for
newly launched ones
 Increasing purchases by existing customers or attracting new customers to the brand.
 Improving the public image of the business, rather than the product, through corporate advertising
Advertising promotion
 Informative advertising: adverts that give information about a product to potential purchases,
rather than just trying to create a brand image.
 Persuasive advertising: adverts trying to create a distinct image or brand identity for the product.
Advertising agencies: (specialists that advise businesses on the most effective way to promote products. Advertising
agencies can offer a complete promotional strategy).
They will, for fees:
 Research the market, establish consumer tastes and preferences, and identify the typical
consumer profile
 Advise on the most cost-effective forms of advertising media to be used use their own
creative designers to design adverts appropriate for each medium
 film or print the adverts to be used in the campaign
Advertising methods
Print advertising: this includes adverts in newspapers, magazines, and specialist publications
 It can be directed at particular towns or regions, or
consumers who read particular special interest
magazines.
 It is expensive to gain national coverage
 It provides hard copy, which can be cut out and kept  Less effective with younger consumers
by the consumer for future reference.
than digital communications
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Chapter 20 - The marketing mix - Promotion
Broadcast advertising: this includes adverts on radios, podcasts, and cinemas.
 Adverts have a visual appeal and can create a brand
image through the actors used
 It is expensive to buy media time
 National or even international coverage is possible
 It is expensive to design and produce the
adverts
 It can linger in the memory of consumers for a long
time if visually dramatic
 There is no permanent hard copy
Outdoor advertising: this includes adverts on billboards and bus shelter posters.
 Low cost compared to other media
 The best locations are the most
expensive
 It can be located in prime positions with many
potential consumers passing by
 It can be damaged or vandalized
 It can be read/seen more than once
 Many passers-by will not notice it
Product placement advertising: products are featured in TV shows or films.
 The chosen shows or films will be targeted at a
particular time of consumer
 The show, film or actors may become less
popular
 This creates a desirable image if the product is
associated with the famous actors or shows
 It is very expensive if the show/film is
popular
 It is not explicit advertising. Some
consumers assume the product is being
used because its desirable not because a
business has paid for it
Sponsorship: involves payment by a business to become associated with an event, an individual or
sports team.
 The good publicity of being associated with big
sporting and other events
 It can be very expensive
 Global press and TV coverage of the largest events
 Failure of the event, team or individual
can reflect badly on the brand
 The success of a the team or individual can lead to
greatly increased interest in the brand
Advertising methods: Which one to use?
- Cost: marketing managers must compare the cost of each method, including the cost per
target consumer. If one TV advert costs $1m and the number of potential consumers for a
product who watch the product is 5million, then the cost per consumer is $0.20.
- The consumer profile of the target audience - age, income levels, interests: Advertising
decisions must consider the target market. Using a mass-market, low-priced daily newspaper
approach to advertise a range of luxury clothing items would be aiming at the wrong target
market as younger consumers are more likely to be on social media platforms.
- The message and image to be communicated: written forms of communication are likely to be
more effective for giving detailed information about a product. This information can be
referred to more than once by potential customers.
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Chapter 20 - The marketing mix - Promotion
 Sales promotion: incentives such as special offers or special deals directed at consumers or
retailers.
Method
Limitations
Price offers: temporary reductions in price, also  Price reductions will reduce gross profit on each
known as price discounting. The objective is to
item sold
encourage existing customers to buy more and  There could be a negative impact on the
to attract new customers as the product now
brand's reputation from the discounted prices.
appears more competitive.
Money off coupons:
 These could just encourage consumers to buy
what they would have bought anyway.
more versatile and better-focused way of
 Retailers may be surprised by the increase in
offering a price discount. Coupons can appear
demand and not hold enough inventory,
on the back of receipts, in newspaper adverts or
leading to customer disappointment.
an existing pack of the product.
 The number of consumers using coupons might
be low if the price reduction is small.
Customer loyalty schemes, such as air miles or  The discount cuts gross profit on each purchase
customer loyalty cards: The aim is to encourage  There are administration costs (e.g. informing
repeat purchases ad discourage consumers from consumers of loyalty points earned, and the
buying from competitors. Loyalty cards give the
costs may outweigh the benefits from increased
business much information about consumers'
consumer loyalty.
buying preferences, which helps in customer
relationship marketing.
Money refunds: These are offered when the
receipts is returned to the manufacturer.
 These involve the consumer completing and
posting a form, which might be a disincentive.
Buy one, get one free (BOGO):
This encourages multiple purchases, which
reduces the demand for competitors' products
too.
 There could be substantial reduction in gross
profit margin
 Consumers may conclude that the normal price
is too high
 Consumers may think goods are being sold off
because they cannot be sold at normal prices,
this may impact reputation. Consumers may
perceive a low product quality.
Role of packaging in promotion, packaging can perform the following functions:
 Protect and contain the product, both during transportation and in stores
 Give information: depending on the product - to consumers about the contents, ingredients,
cooking instructions, assembly instructions and so on.
 Support the brand image of the product created by promotional campaigns.
 Make the product more attractive and help the consumer recognize it.
However:
 Cheap and unattractive packaging of goods such as clothes or chocolates will destory and
quality and status image that a firm is attempting to establish. Distinctive packaging can help to
form the basis of a promotional theme, which will endure as long as the product.
 expensive and wasteful packaging may add unnecessarily to costs, which could reduce a
product's competitiveness.
 With increasing environmental pressure, packaging that is seen too ostentatious or cannot be
recycled may result in a negative consumer reaction.
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Chapter 20 - The marketing mix - Promotion
Direct promotion: a range of promotional activities aimed directly at target customers.
Direct promotion methods include:
The methods:
Method & Advantages
Limitations
Direct mail: sent out by post
 Low cost and well-defined areas/regions
can be targeted.
 It is easy to evaluate the success of a
campaign by checking response rates
 Many potential consumers now prefer digital
communication
 The mailing may be viewed as junk mail and
quickly thrown away.
Telemarketing: includes all marketing activities
conducted over the telephone including selling,
market researching and promoting products.
 This is lower cost than personal selling.
 It is easy to evaluate
 Many consumers object to cold-calling.
 It is very easy to monitor the response
Personal selling: salesperson is employed to sell  Customers may complain about being
to each individual customer.
pressured into buying, especially if the sales
employees are paid a high bonus for each sale
made.
 Sales employees need to be well trained. They
should avoid selling to a reluctant consumer
who later regrets the decision.
 This is a high-cost method of promotion and
selling.
Its essential that marketing manager gather as much evidence as possible about the success (or failure) of existing promotion campaigns to
allow them to take better decisions about the future.
The best ways of assessing the success of promotions are:
- Sales performance before and after the promotion campaign: by comparing sales of product before
and after campaign was launched.
- Social media feedback: the rapid response rate of social media users to new products or new
promotions is perhaps now the most widely used measure of marketing success or failure.
- Response rates to advertisements: Newspapers and magazines often have a tear-off slips for
consumers to request more details. Even TV adverts can ask consumers to ring in, perhaps with the
chance of winning a competition.
 Brand: the name given by a firm to a product or range of products.
The aims of branding include:
→ Aiding consumer recognition.
→ Making the product distinctive from competitors.
→ Giving the product an identity or personality that consumers can relate to.




Benefits of effective branding include:
Increases the chances of brand recall by consumers, for example, when several similar products are
available.
It clearly differentiates the product from others, including reinforcing the difference by promotion.
It allows for the establishment of a family of closely associated products with the same brand name.
It reduces the responsiveness of consumer demand to a price increase. Consumers often have
preferences for well-known brands and are prepared to pay a high price for them. This gives the
business a high profit margin.
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Chapter 20 - The marketing mix - Promotion and Place
Digital promotion: the promotion of products using digital technologies, mainly on the internet but
also including mobile phones.
Methods of digital promotion:
- Social media marketing, many social media platforms that businesses can choose to use. Most
businesses use more than one.
- Email marketing: connects with customers within their own mailboxes. Well-established method of
increasing brand loyalty and selling more products to existing customers.
- There's many different ways businesses can reach out to customers through email marketing,
including:
- Newsletter campaigns
- Purchase confirmation emails
- Thank you emails
- Email notifications about new products.
- Online advertising: Displaying pop-up banners or adverts on other websites aiming at the same
niche is the most common form of online advertising.
- Smartphone marketing: sending customers text messages, notifications through apps to get their
attention
- Search engine optimization (SEO): businesses that use e-commerce (sell online) locate their
websites on search engines results page, such as optimizing the content for specific key words.
- Viral marketing: makes use of all types of digital marketing. Essence of viral marketing is to create a
post, video, or similar short form of content that spreads across the web like a virus.
 WORLD-wide coverage: a website allows
businesses to find new markets and trade
globally.
 Time-consuming: unless digital promotion
agency is used, tasks such as optimizing
online advertising campaigns and creatin
marketing content can be time-consuming.
 Relatively low-cost: a well-planned and welltargeted digital marketing campaign can
reach the right customers at a much lower
cost than traditional forms of advertising.
 Skills and training: employees must have upto-date knowledge and expertise to carry out
digital marketing with success. Tools,
platforms and trends change rapidly.
Employees may need training to keep their
skills at the right level.
 Easy to track and measure results: web
analytics and other techniques of measuring
response rates make it easy to establish how
effective a promotion campaign has been.
Detailed information about how customers
use a website or respond to advertising is
available, which helps to improve the
effectiveness of future campaigns.
 Global competition: reaching a worldwide
audience is easy but this means competitors
can do so too! Standing out clearly against a
large number of competitors can be difficult
and costly.
 Social media and marketing builds customer  Complaints and feedback: unhappy
loyalty: involvement with social media and
customers can quickly send out negative
quick responses to customers' messages can
messages about a business or its products.
build customer loyalty and create a reputation Any negative feedback or criticism of a brand
for being easy to converse with.
can be visible to the target audience through
social media and review websites.
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Chapter 20 - The marketing mix - Place
Place decisions are about how products should pass from manufacturer to the final consumer. This
process is known as distribution.
Distribution: getting the right product to the right consumer at right time in way that is most convenient
to the consumer.
Channels of distribution: the chain of intermediaries a product passes through from the producer to final
consumer.
Channels of distribution:
1. Direct selling: Direct route from manufacturer to consumer. There are no intermediaries, so this is
also referred to as the intermediary channel.
Likely to be used when:
- When manufacturer wishes to keep complete control over the marketing mix, then direct routes
are more likely to be used. It's
- when goods are bought infrequently but in large quantities, when they are bulky and expensive to
transport, or when they have been custom built to a customer.
 No mark-up or profit margin taken by
intermediaries.
 All storage and inventory costs have to be paid
for by the producer.
 The producer has complete control over the
marketing mix.
 There are no retail outlets so consumers cannot
see and try before they buy.
 It is quicker than other channels so may lead to  No after-sale service is offered by shops.
fresher products.
 Direct contact with customers offers useful
market research.
 It is expensive to deliver each item to consumers.
2. Single intermediary channel: With the increasing size of many modern retailers, the single intermediary channel is becoming more common. These big retailers have great purchasing
power. They are able to arrange their own systems for storage and distribution to individual
stores.
- Usually used:
- For consumer goods and where goods can be easily transported to the whole country but could
also be used by an agent selling industrial products to businesses.
- Examples: holidays sold to travel agents, large supermarkets that hold their own inventory instead
of wholesales.
 Retailers incur the cost of holding
inventories
 The intermediary takes a profit mark-up, making the
product more expensive to consumers.
 Retailers display the products and offer
after-sales service
 Producers loose control over the marketing mix.
 Retailers should be in locations that are
convenient to consumers
 The outlet is not exclusive as retailers sell
competitor's products too.
 Producers focus on production, not on
selling the products to consumers
 Producers pass on delivery costs to consumers.
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Chapter 20 - The marketing mix - Place
Two- intermediaries channel: Unit recent developments in retailing and e-commerce, the traditional
two-intermediaries channel was the most common of all channels of distribution. It is still used when
wholesalers buy from producers and sell to retailers.
 Wholesalers hold the goods and buy in
bulk from producers
 Another intermediary takes a profit mark-up, making
the product even more expensive to consumers.
 It reduces producers' inventory costs.
 Producers lose further control over the marketing mix
 Wholesalers buy in large quantities and
sell in small quantities
 It slows down the distribution chain
 Wholesalers pay for the costs of
transportation to retailers
Online Marketing (e-commerce): the buying and selling of goods and services by businesses and
consumers through an electronic medium.
E-commerce is one of the fastest ways of selling and distributing to customers.
 It is relatively inexpensive if the cost is
compared to the number of consumers
reached.
 Some countries have low speed internet connection
and, in poorer countries, computer ownership is not
widespread.
 Companies can reach a worldwide
audience for a small proportion of
traditional promotion budgets.
 Consumers cannot touch, smell, feel, or try on
tangible goods before buying, which may limit their
willingness to buy certain products.
 Consumers interact with the websites and  Product returns may increase if consumers are
make purchases and leave important data
dissatisfied with their purchases once they have been
about themselves
received.
 The internet is convenient for consumers
to use if they have access to a computer
 Worriers about internet security may reduce future
growth rates.
Factors influencing the choice of distribution channel:
 Whether the product should be directly to customers or through retailers? Many industrial
products, which are sold in small numbers and are very complex, are sold directly.
 How long should the channel of distribution be (i.e how many intermediaries should there be?)
 In which locations should the product be made available?
 Should the internet be the main channel?
 How much will it cost to keep the product inventory on store shelves and in warehouses?
 How much control does the business want to have over the marketing mix?
The choice of distribution channel is important because:
 Consumers can benefit from easy access to products. This allows them to see and try products
before they buy, makes purchasing easy and allows, if necessary, for the return of goods.
 Manufacturers need outlets for their products that give a wide geographical market coverage.
However, they also want the desired image of the product to be promoted effectively.
 Retailers, which sell goods to the final consumer, add on a mark-up to cover their costs and make
a profit. If price is very important to consumers, using few or no intermediaries is an advantage
as the manufacturer should be able to charge a lower price.
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Chapter 20 - The marketing mix - Place
Digital and physical distribution
Digital Distribution: the delivery or distribution of digital media content such as audio, video, TV
programs, films, software and video games.
Physical Distribution: the activities that combine to achieve the efficient movement of finished products
from the end of the production operation to the consumer.
An integrated marketing mix: the key marketing decisions complement each other and work together to
give customers a consistent message about the product.
examples:
- If an expensive, well-known brand of perfume was for sale on a market stall, would you be
suspicious.
- If the most exclusive shop in your town sold expensive gifts and wrapped the in newspaper, would
you be surprised?
These are examples of a poorly integrated marketing mix.
This is important because consumers will avoid buying products with a confusing and inconsistent
marketing mix. This results in low long-term sales.
The best-prepared marketing plans can be destroyed by just one part if of the marketing mix not being
consistent the rest.
The most effective marketing mix decisions will, therefore be:
 Based on marketing objectives and affordable within the marketing budget
 Integrated and consistent with each other and targeted at the appropriate consumers.
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Chapter 20 - The marketing mix - Promotion and Place
 Promotion: the use of advertising, sales promotion, personal selling, direct mail, trade fairs,
sponsorship and public relation to inform consumers and persuade them to buy a good or service.
 Advertising: paid-for communication to inform and persuade consumer, using media such as TV,
newspaper and cinema.
 Promotion Mix: the combination of promotional techniques that a firm uses to sell a product.
 Direct promotion: a range of promotional activities aimed directly at target customers. Also known
as direct marketing.
 Sales promotion: incentives such as special offers or special deals directed at consumers or retailers
to achieve short-term sales increases and repeat purchases by consumers.
 Promotion mix: the combination of promotional techniques that a firm uses to sell a product.
 Digital Promotion: the promotion of products using digital technologies, mainly on the internet but
also including mobile-phones.
 E-commerce: the buying and selling of goods and services by businesses and consumers through an
electronic medium.
 Channels of distribution: the chain of intermediaries a product passes through from producer to
final consumer.
 Physical promotion: the activities that combine to achieve the efficient movement of finished
products from the end of the production operations to the consumer.
 Digital promotion: The delivery or distribution of digital media content such as audio, video, TV
programs, films, software and video games.
 Integrated marketing mix: the key marketing decisions complement each other and work together
to give customers a consistent message about the product.
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Unit 4.1 The nature of operation
Operations is concerned with the use of resources called inputs to provide outputs in the form of
goods and services
Intellectual capital: the intangible capital of a business that includes human capital (well-trained, and
skilled employees), structural capital (databases and information systems), and relational capital
(good links with suppliers and customers).
Transformational process: an activity or group of activities that transforms one or more inputs, adds
value to them and produces output to customers
Contribution of operations to added value:
Operations managers can increase added value by effectively managing:
 Efficiency in production: keeping costs as low as possible will help to give a business a
competitive advantage.
 Quality: the goods or services must be suitable for the purpose intended, higher quality allows
for a higher perceived value from consumers and thus allows a business to charge a higher
price.
 Flexibility: ability to quickly adapt to changes in the market, and customer requirements.
Operations managers need to design processes and systems that can easily adjust to changing
demands, allowing them to respond agilely to new opportunities or challenges.
 Innovation: Innovation refers to the introduction of new or improved ideas in products,
services, or processes. Operations managers play a crucial role in fostering an environment
conducive to innovation within the organization. This involves encouraging employees to think
creatively, testing new technologies and work methods, and constantly seeking ways to improve
efficiency and quality
Productivity: the ratio of outputs to inputs during production
Level of production: the number of units produced in a given time period
Production: the process that transforms inputs into outputs.
Production converts inputs to outputs, the level of production is a measure of the quantity of output a
firm produces in a period of time.
Factors that determine competitiveness of a business:
- Productivity
Labour productivity: Total output in a given time period
(number of units
Total workers employed
per worker)
4 ways productivity can be increased:
- Improving training of employees to raise skill level: Employees with higher skill level and more
flexible skills tend to be more productive. However training is expensive, and time-consuming.
- Improved worker motivation: using appropriate financial and non-financial methods of
motivation should encourage employees to work more efficiently. Non-financial methods in
particular can be used because they don't increase labor costs. Any increase in labor
productivity will lead to lower average costs of production.
- Purchase more technologically advanced equipment: modern machinery from office computers
to robot controlled production machines, should allow increased output with fewer workers.
High-cost investment will only be worthwhile if high output levels can be maintained
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Unit 4.1 The nature of operation
Raising productivity doesn't guarantee success:
- If the product is unpopular with consumers, it may not sell profitably no matter how efficiently
it's made.
- Greater effort from workers can lead to demand for higher wages. This will lead to higher costs,
which may cancel out impact of productivity gains.
- There's a difference between efficiency (that’s measured by productivity), and effectiveness
(meeting the objectives of a business by using inputs efficiently to meet customer needs)
 Efficiency is measured by productivity ( the ratio of outputs to inputs during production). But
effectiveness is achieved only if the customer's needs are met.
 Efficiency: producing output at the highest ratio of output to input
 Effectiveness: meeting the objectives of a business by using inputs productively to meet
customer's needs.
The importance of Sustainability of Operations:
 Growing global concern about pollution and climate change has put pressure on businesses to
clean up their operations, therefore businesses are becoming increasingly focused on achieving
sustainability of operations.
 Sustainability of operations: Business operations that can be maintained in the long term, for
example, by protecting the environment and not damaging the quality of life for future
generations.
They can do this in a number of ways:
○ Reducing energy use and carbon emissions.
○ Reducing the use of plastic and other non-biodegradable materials.
○ Manufacturing products that are recyclable
Why are businesses making operations more sustainable?
○ Businesses must comply with stricter laws on environmental issues
○ Pressure-group activity exposes the most environmentally damaging businesses and operations
○ More sales are likely as consumers prefer greener and more sustainable products.
Benefits of increasing sustainability
Drawbacks of increasing sustainability
 Reducing energy use can reduce energy costs buying  Increasing sustainability might require
from sustainable suppliers ensures that operations
capital investment (e.g solar panels) and
are sustainable & reduces the risk of bad publicity
investment in worker training
 Reducing use of plastic and non-biodegradable
materials will attract more demand from green
consumers.
 More environmentally friendly material
could cost more and may not protect and
preserve goods as effectively as plastic.
 Using recycled materials reduces demand for newly
produced raw material
 Supplies from sustainable sources may be
more expensive than from unsustainable
sources so costs might rise.
Page 70
Unit 4.1 The nature of operation
Labor intensive: involving a high level of labor input relative to capital equipment.
 Interesting and varied work
 Low output levels
 Low machine costs
 Skilled, high-paid workers required
 Good quality control because workers can
closely monitor the production process and
address any issues promptly.
 Product quality depends on skill level and
experience of each worker
Capital intensive: involving a high quantity of capital equipment compared with labor input.
 Economies of scale
 High fixed costs
 Consistent quality
 Cost of financing equipment
 Low unit cost of production
 High maintenance cost and the need for skilled
workers to do repairs
Which approach chosen is dependent on:
1. Nature and brand image of the product:
○ Nature of the product: Some products require more labor-intensive processes due to
complexity or skilled craftsmanship.
○ Brand image: Brands known for craftsmanship may choose labor-intensive methods to
maintain quality and uniqueness.
2. Relative cost of labor and capital:
○ Labor cost: In regions with inexpensive labor, businesses may opt for labor-intensive
approaches to reduce costs.
○ Capital cost: Where capital is cheaper, businesses may invest in technology for a capitalintensive approach.
3. Business size and access to finance:
○ Business size: Larger businesses may prefer capital-intensive methods due to economies of
scale.
○ Access to finance: Financing options influence the choice; easy access may lead to capitalintensive approaches.
Page 71
Unit 4.1 The nature of operation
Operation Methods
Job production
Definition
The production of a one-off item specifically designed for the customer. I.e each individual
product needs to be completed before the next product is started. e.g wedding rings.
Requirements
○ Highly skilled workforce
Advantages
 Allows for specialist products to be made and tends to be motivating for workers, because
they produce the whole product and can take pride in it
Disadvantages  High unit production cost
 Time-consuming
 Wide range of tools and equipment needed
Batch production
Definition
The production of a limited number of identical products, every unit in the batch goes
through each production stage before the whole batch moves onto next stage.
Requirements ○ Labor and machines must be flexible to switch to making batches of other designs
Advantages
 Some economies of scales, if batch is large enough
 Faster production, with lower unit cost than job production
 Some flexibility in design of product in each batch
Disadvantages  High levels of inventory at each production stage
 Unit costs are likely to be higher than flow production
Flow production
Definition
The production of items in a continuously moving process, i.e flow production systems are
capable of producing large quantities of products in a relatively short time.
Requirements ○ Specialized, expensive capital equipment
○ High steady demand for standardized products
Advantages
 Low unit costs due to constant working of machines
 High labor productivity and economies of scale
Disadvantages  Inflexible - it is often very difficult and time consuming to switch from making one type of
product to another.
 Expensive to set up flow-line machinery
Mass customization
Definition
The use of flexible computer-aided technology on production lines to make products that
meet individual customers' requirements for customized products.
○ Requirements ○ Many common components
○ Flexible and multi-skilled workers
Advantages
 Combines low unit costs with flexibility to meet customer's individual requirements
Disadvantages
 Expensive product re-designs many be needed to allow key components to be switched
to allow variety
 Expensive flexible capital equipment needed
Page 72
Unit 4.1 The nature of operation
Summary:
Job production
Definition
Flow production
Mass customization
○ The production of a ○ The production of ○ The production of
○ The use of flexible
one- off item
a limited number
items in a continuously computer-aided
specifically designed
of identical
moving process i.e
technology on
for the customer. I.e
products, every
flow production
production lines to
each individual
unit in the batch
systems are capable of make products that
product needs to be
goes through each
producing large
meet individual
completed before
production stage
quantities of products
customers'
the next product is
before the whole
in a relatively short
requirements for
started. e.g wedding
batch moves onto
time.
customized products.
rings.
next stage.
Requirements ○ Highly skilled
workforce
Advantages
Batch production
○ Labor and
○ Specialized, expensive ○ Many common
machines must be
capital equipment
components
flexible to switch
○ High steady demand
○ Flexible and multito making batches
for standardized
skilled workers
of other designs
products
 Allows for specialist  Some economies  low unit costs due to
products to be made of scales, if batch
constant working of
and tends to be
is large enough
machines
motivating for
 Faster production,  High labor
workers, because
with lower unit
productivity and
they produce the
cost than job
economies of scale
whole product and
production
can take pride in it
 Some flexibility in
design of product
in each batch
 Combines low unit
costs with flexibility
to meet customer's
individual
requirements
Disadvantages  High unit production  High levels of
cost
inventory at each
production stage
 Time-consuming
 Inflexible - it is often  Expensive product revery difficult and time
designs many be
consuming to switch
needed to allow key
from
making
one
type
components to be
 Wide range of tools  Unit costs are
of
product
to
another.
switched to allow
likely to be higher
and equipment
variety
than flow
 Expensive to set up
needed
production
flow-line machinery
 Expensive flexible
capital equipment
needed
Problems of changing operations methods:
Problems of changing from job or batch to flow production:
 Cost of capital equipment needed to handle large numbers in each batch may be too high
 Additional working capital is needed to finance work-in-progress inventory.
 Risk of worker demotivation because there's less need for an individual's craft skills and they could
be scared to become redundant
Page 73
4.2 Inventory Management
Inventory: Materials and goods held by a business and required to allow for the production of products
and their supply to customers.
Forms of holding inventory:
1. Raw materials and components: purchased from outside suppliers, held In storage till they're used
in production process. These inventories can be sent quick to the production line so the business
can meet rises in demand by increasing the rate of production quickly.
2. Work-in progress: any time in between where a firms is converting raw materials and components
in to finished goods. There will be work in progress inventory. The value of work-in progress
depends on the length of time needed to complete production and on the method of production
as batch production tends to have high work-in progress levels.
3. Finished goods: having been through the complete production process, goods may be held in
storage until sold and dispatched to the customer.
Inventory management: the process of ordering, storing and using a company's inventory.
Problems that rise without effective inventory management:
 Might be insufficient inventories to meet unforeseen changes in demand.
 Out-of-date or obsolete inventory might be held if an effective rotation system is not used, for
example, for fresh food or for fast changing technological products.
 High levels of inventory have high storage costs and a high opportunity cost.
Benefits of holding a high level of inventory
Drawbacks of holding a high level of inventory
 Reduces the risk of lost sales: if a business cannot  Opportunity cost: working capital tied up in
supply customers from goods held in storage, then goods in storage could be put to other uses.
sales could be lost to businesses with higher
For example, paying off bank loans. The higher
inventory levels. This is a form of poor customer
the value of inventories held and the more
service. Holding high inventory not only gives
capital is used to finance them, then the
customers more choice but reduces the risk of
greater will be this opportunity cost.
losing sales because no products are available.
 Allows for continuous production: if inventories of  Storage costs: inventories have to be held in
raw materials and components run out, then
secure warehouses. They often require special
production has to stop. This will leave expensive
conditions such as refrigeration.
equipment idle and labor with nothing to do.
 Higher risk of damaged products
 Avoids the need for special orders from suppliers:  Risk of wastage and obsolescence: if
if a business runs out of inventory, an urgent order inventories are not used or sold rapidly as
may have to be given to a supplier to deliver
expected, then there is a danger of goods
additional materials. This incurs extra costs
deteriorating or becoming damaged.
because of the administration of the order and
possibly also special delivery charges.
Advantages of holding a low level of inventory
Disadvantages of holding a low level of inventory
 Low tied up capital --> better use of cash in
business so it can avoid a liquidation problem
 Frequent reorder of supplies
 Less risk of damaged products and obsolescence
 Cannot meet sudden high demand
 Less warehouse space is needed --> save storage
costs
 Avoids economies of scale as continuous
production is not available.
Page 74
4.2 Inventory Management
Optimum order size: purchasing the right level of inventories
Economic order quantity: the optimum or least cost quantity of stock to re-order taking into account the
delivery costs and stock-holding costs.
Inventory control charts: these charts record, overtime, the number of goods held, inventory deliveries,
buffer levels, and maximum inventory. They help inventory managers determine the appropriate order
time and quantity. They also allow an analysis of what would happen to inventory levels if an unusual
event occurred, such as a competitor operating a very successful promotion campaign.
Key features of a inventory chart:
- Buffer inventories: Minimum inventory level that should be held to ensure that continuous
production is possible should delivery delays occur or output increase.
- Maximum inventory level: this may be limited to space or by the financial costs of holding even
higher inventories, one way to calculate this maximum level is to add the economic order quantity
of each component to the buffer level for that item.
- Reorder quantity: number of units ordered each time. This will be influenced by the economic
order quantity.
- Lead time: the time in between ordering new supplies and their delivery. The longer this period of
time, the higher the re-order level. If suppliers are unreliable and the lead time is long, the buffer
inventory level will have to be relatively high.
- Re-order level: The level of inventory that triggers a new order to be sent to suppliers. This
depends on how long it takes suppliers to deliver new supplies and the rate of usage of
inventories. Most businesses use a computer program to keep a record of every sale and delivery
of stock.
Importance of Supply chain management: Operational efficiency can be improved by managing the supply chain with
the aim of minimizing all costs and improving customer service. Supply chain management is a management function of
growing importance in nearly all businesses.
Supply chain: the network of all the businesses and activities involved in creating a product for sale,
starting with the delivery of raw materials and finishing with the delivery of the finished product.
Supply chain management: Handling the entire production flow of a product to minimize costs but
improve customer service.
Supply chain management aims to reduce the period of the time raw materials take in order to be converted into
completed products available for sale by:
- Establishing excellent communications with supplier companies, which helps ensure the right
number of goods of the right quality are received exactly when needed.
- Cutting the time taken to deliver all materials required for production by improving transport
systems.
- Speeding up production process with new machinery and equipment.
Benefits of effective supply chain management:
- Improves customer service: ensures customers receive product more quickly and of appropriate
quality.
- Reduces operating costs: ESM allows business to reduce costs, in particular purchasing costs and
inventory costs should fall.
 Improves profitability: By reducing wasted time, improving inventory management and creating a
low-cost but efficient supply chain, business profits should increase.
Page 75
4.2 Inventory Management
Just-in-time inventory management: aims to avoid holding inventories by requiring supplies to arrive
just as they are needed in production and completed products are produced to order.
Just-in-case inventory management: aims to reduce the risk of running out of inventory to the
minimum by holding high buffer inventory levels.
Impact on business of adopting a JIT( low inventory) approach
 Capital invested in inventory is reduced and the
opportunity cost of inventory holding is reduced.
 Any failure to receive supplies of
materials or components in time, caused
by, for example, a strike at the supplier's
factory, or transport problems, will lead
to expensive production delas.
 Costs of storage and inventory holdings are reduced.
Space released from holding inventories can be used
for a more productive purpose.
 Delivery costs will increase as frequent
small deliveries are an essential feature
of
 There is much less chance of inventories becoming
outdated or obsolete. Fewer goods are held in
storage also reduces the risk of damage or wastage.
 Order administration costs may rise
because so many small orders need to be
processed.
 The greater flexibility needed for JIT leads to quicker
response times to changes in consumer demand or
tastes.
 There could be a reduction in the bulk
discounts offered by supplies because
each order is likely to be very small.
 The multi-skilled and adaptable staff required for JIT
to work may gain improved motivation.
 The reputation of the business depends
significantly on outside factors such as
the reliability of suppliers and traffic
delays.
Impact on business of adopting a JIC (high inventory) approach:
 Very little chance of running out of inventory.
 High capital cost of finance invested in
Production levels can be maintained even if there are
inventories.
major delays in the supply of materials/components.
 There is much less need for accurate sales forecasting  High storage, insurance and other costs
than with JIT.
are associated with inventory holdings.
 Economies of scale from very large order of
supplies/components are possible.
 Inventories could lose value if fashion or
technology changes while they are being
held.
Conditions of JIT to operate successfully:
○ Excellent supplier relationships: suppliers must be prepared and able to deliver supplies at very
short notice.
○ Production employees must be multi-skilled and flexible: its wasteful for a worker to produce
the same item all the time.
○ Equipment and machinery must be flexible: they must be able to quickly adjust to changes in
what is needed, when it is needed, and how much is needed. This flexibility allows for efficient
and smooth production without long delays when switching to different products or quantities.
JIT evaluation:
○ There may be limits to the use of JIT, the costs resulting from production being halted when
supplies are delayed, far exceed the costs of holding buffer inventories of key components.
○ Small businesses may not be able to finance the expensive IT systems needed to operate JIT.
○ Global inflation could make holding inventories of raw materials more beneficial. It may be
cheaper to buy high quantities now, rather than small quantities in the future when prices have
risen.
Page 76
4.3 Capacity Utilization and Outsourcing
Capacity utilization: the proportion of maximum output capacity currently being achieved
Outsourcing: Using another business (a third party) to undertake a part of the production process
rather than doing it within the business using the firm's own employees.
Maximum capacity: the highest level of sustained output that can be achieved in a given time period.
Rate of capacity Utilization: current output level x 100
maximum output level
* If a businesses is working at full capacity, it is achieving 100& capacity utilization. There is no
spare capacity.
The impact of Capacity Utilization on average fixed costs:
○ CU low --> average fixed costs high because costs are allocated to fewer units.
○ CU High --> average fixed costs low because costs are allocated to more units.
Benefits of being at full capacity:
- Unit fixed costs at lowest possible level, this should help increase profits.
- Business is able to claim how successful it is, as it has no spare capacity.
- Employees feel their jobs are secure and may have a sense of pride that the products they
produce are so popular.
Drawbacks of being at full capacity:
- Employees may feel under pressure due to the workload and this could raise stress levels.
Operation managers cannot afford to make any production scheduling mistakes, as there is no
slack time to make up for lost output.
- Regular customers who wish to increase their orders will have to be turned away or kept
waiting for long periods. This could encourage them to use other suppliers, with the danger
that they might be lost as long-term clients.
- Machinery will be working continuously and there may be insufficient time for maintenance
and repairs. This lack of servicing may store up trouble in the form of increased unreliability in
the future.
Evaluation: most businesses attempt to maintain a high level of capacity utilization, while also
keeping some spare capacity for the unforeseen events that can always occur.
Excess capacity: this exists when the current levels of output are less than the full-capacity output of
a business; also known as spare capacity.
Operating at over maximum capacity:
The definition of maximum capacity contains an important term: 'sustained'. This suggests that it is
the highest output level that can be maintained over a reasonable period of time. It might be
possible, during emergency situations, to achieve higher output levels for very short time periods.
This could be done by using machines beyond their safe working limits and by asking labor to work
longer than the contractually permitted hours. Obviously, this situation is not sustainable or
recommended. It could result both in machines breaking down, and in workers being too stressed to
sustain high levels of output in future.
Operating at under maximum capacity
When a business is operating at less than full capacity it means that there is excess capacity. Low
levels of capacity utilization lead to high unit fixed costs. What options do businesses have when
trying to improve capacity utilization? Options for improving capacity utilization depend on whether
the excess capacity is a short-term or long-term problem.
Page 77
4.3 Capacity Utilization and Outsourcing
Short-term excess capacity:
This might be caused by low seasonal demand. Options for improving capacity utilization in the short
term include:
 Maintaining high output levels. This strategy adds to inventories and could be expensive and risky
if sales do not recover.
 Adopting a more flexible production system, allowing other products to be made that could be
sold at other times of the year. This needs a flexible workforce and production resources.
 Insisting on flexible employment contracts so that, during periods of low demand and excess
capacity, workers work fewer hours to reduce capacity and costs. This may have a negative impact
on employee morale and motivation.
Long-term excess capacity Options a business has when experiencing long-term excess capacity:
Options
Advantages
Disadvantages
Rationalization closing factories or
other production
units
- This reduces overheads
- It results in higher capacity
utilization from the remaining
production units.
- Redundancies might have to be paid.
- Workers may worry about job security.
- Capacity may be needed later if the
economy picks up or if the business
develops new products
Research and develop - New products will replace existing - This may be expensive.
new products
products and make the business - It may take too long to prevent cutbacks
more competitive
in capacity and rationalization.
- If introduced quickly enough, new - Without long-term planning, new
products might prevent
products are introduced too quickly,
rationalization and associated
without a clear market strategy, and may
problems.
be unsuccessful.
Capacity shortage: when demand for a business's products exceeds production capacity.
Methods of reducing long-term capacity shortages:
Options
Advantages
Disadvantages
Use subcontractors or  No major capital investment is
outsourcing of
required.
supplies, components  It should be quite quick to arrange.
 It offers much greater flexibility
or even finished
goods.
than expansion of facilities - if
demand falls back, then contracts
with other firms can be ended
 It gives less control over the quality
of output.
 It may add to administration and
transport costs
 There may be uncertainty over
delivery times and reliability of
delivery.
Invest capital in the
expansion of
production facilities
 The capital cost may be high.
 There may be problems with raising
capital.
 It increases total capacity, but
problems could occur if demand
should fall for a long period.
 It takes time to build and equip a
new facility and customers may not
wait.
 It increase capacity for the longterm.
 The business is in control of the
quality and final delivery times.
 The new facilities should be able to
use the latest equipment and
methods.
 Other economies of scale should be
possible too.
Page 78
4.3.2 Outsourcing
Outsourcing: using another business (a third party) to undertake a part of the production process rather
than doing it within the business using the firm's own employees.
Reasons/Benefits of outsourcing:
 Reduction and control of operating costs: instead of employing expensive specialists who might
not be required at all times, it could be cheaper to buy in specialist services as and when they are
needed. These specialist service providers may be cheaper because they benefit from economies
of scale, as they provide similar services to other businesses as well.
 Increased flexibility: by removing departments altogether and buying in services when needed,
the fixed costs of office and factory space and salaried employees are converted into variable
costs. Additional capacity can be obtained from outsourcing just when needed. If demand falls,
contracts can be cancelled much more quickly than rationalization of existing production units
owned by the business.
 Improved company focus: by outsourcing peripheral activities, the management can concentrate
on the main objectives and tasks of the business. These are called the core parts of the business.
So, a small hotel owner might use management time to improve customer service and
outsourcing the accounting function completely.
 Access to quality service or resources that are not available internally: may outsourcing firms
employ quality specialists that small to medium-sized businesses could not afford to employ
directly.
Drawbacks to outsourcing:
 Lose of jobs within the business: this can have a negative impact on employee motivation.
Workers who remain directly employed may experience a loss of job security. Bad publicity may
result in redundancies too, especially if the business is accused of employing very low-wage
employees, especially if the business is accused of employing very low-wage employees in other
countries in place of the jobs lost. This could lead to the firm's ethical standard being questioned.
 Quality issues: the quality levels of the goods or services being outsourced will be difficult to
check on. A clear contact with minimum service or product quality standards will be needed. The
company outsourcing the functions may have to send the employees responsible for quality
control to the business used for outsourcing, in order to ensure that product quality and customer
service standards will be met.
 Customer resistance: This could take several forms. Overseas telephone call centers have led to
criticism from customers about their inability to understand foreign language.
Outsourcing Evaluation:
 The global trend towards outsourcing will continue as businesses look for further ways of
improving operational efficiency, and as more opportunities arise due to globalization. The
process is not without risks, however.
 Before any substantial business process outsourcing (BPO) of complete functions is undertaken or
before any stage of the production process is outsourced, the company must evaluate the a
substantial cost-benefit analysis of the decision.
 Having closed or run down a whole department to outsource its functions, it would be timeconsuming and expensive to reopen and re-establish the department if the outsourcing fails to
deliver.
 One of the key factors in any business decision on outsourcing is to identify the core activities that
must be kept within direct control of the business.
Page 79
Unit 4 Key Definitions
 Intellectual capital: the intangible capital of a business that includes human capital (well-trained and
skilled employees), structural capital (databases and information systems) and relational capital (good
links with suppliers and customers
 Transformational process: an activity or group of activities that transform one more inputs, adds value to
them, and produces output for customers.
 Productivity: the ratio of outputs to inputs during production. (e.g: output per worker per time period).
 Level of production: the number of units produced during a time period.
 Production: the process that transforms inputs into outputs.
 Efficiency: producing output at the highest ratio of output to input.
 Effectiveness: meeting the objectives of the business by using inputs productively to meet customers'
needs.
 Sustainability of operations: business operations that can be maintained in the long term, for example,
by protecting the environment and not damaging the quality of life for future generations.
 Labor intensive: involving a high level of labor input compared with capital equipment.
 Capital intensive: involving a high quantity of capital equipment compared with labor input.
 Job production: the production of a single one-off item specifically designed for the customer.
 Batch production: the production of a limited number of identical products - each item in the batch
passes through one stage of production before passing onto the next stage.
 Flow production: the production of identical products in a continually moving process.
 Mass customization: the use of flexible computer aided technology on production lines to make products
that meet individual requirements for customized products.
 Inventory: Materials and goods held by a business and required to allow for the production of products
and their supply to customers.
 Inventory management: the process of ordering, storing and using a company's inventory.
 Optimum order size: purchasing the right level of inventories
 Economic order quantity: the optimum or least cost quantity of stock to re-order taking into account the
delivery costs and stock-holding costs.
 Buffer inventories: Minimum inventory level that should be held to ensure that continuous production is
possible should delivery delays occur or output increase.
 Reorder quantity: number of units ordered each time.
 Lead time: the time in between ordering new supplies and their delivery.
 Re-order level: The level of inventory that triggers a new order to be sent to suppliers.
 Supply chain: the network of all the businesses and activities involved in creating a product for sale,
starting with the delivery of raw materials and finishing with the delivery of the finished product.
 Supply chain management: Handling the entire production flow of a product to minimize costs but
improve customer service.
 Just-in-time inventory management: aims to avoid holding inventories by requiring supplies to arrive just
as they are needed in production and completed products are produced to order.
 Just-in-case inventory management: aims to reduce the risk of running out of inventory to the minimum
by holding high buffer inventory levels.
 Capacity utilization: the proportion of maximum output capacity currently being achieved
 Outsourcing: Using another business (a third party) to undertake a part of the production process rather
than doing it within the business using the firm's own employees.
 Maximum capacity: the highest level of sustained output that can be achieved in a given time period.
 Excess capacity: this exists when the current levels of output are less than the full-capacity output of a
business; also known as spare capacity.
 Rationalization: reducing capacity by closing factories/production units.
 Capacity shortage: when demand for a business's products exceeds production capacity.
 Business process outsourcing: a form of outsourcing that uses specialist contractors to take
responsibility for certain business functions, such as human resources and finance.
Page 80
5.1-2 Business finance
Why businesses need finance:
 A Start-up a business will require cash injections from the owner to purchase essential equipment
and possibly premises this is called startup capital.
 All the businesses need to finance their working capital. (The day-to-day finance needed to pay
bills and expenses and to build up inventories.)
 Working capital = current assets - current liabilities.
 When businesses grow, further finance will be needed to buy more assets to pay for higher
working capital needs. Growth through developing new products will require finance for research
and development.
The distinction between short term and long term need for finance
Short-term finance: money required for short periods of time of up to one year. Most businesses
especially small ones need short term finance instead of long-term.
Short term loans are helpful to businesses that experience seasonal demand, such as retail businesses
and a tourist region, would have to hold more inventory for the holiday season.
Long term finance: money required for more than one year.
Some activities and situations need finance for many years or even permanently this is when the long
term need for finance arises.
For example, when a business is expanding by buying more buildings and equipment, a short-term loan
of less than one year would be inappropriate.
Difference between cash and profit
Cash flow shows how much money moves in and out of your business, while prophets illustrates how
much money is left over after all expenses are paid.
Profit: the value of goods sold (revenue) less costs.
Administration, bankruptcy and liquidation
If a business fails due to lack of finance, it's often placed in administration where specialist
administration accountants are appointed to try and keep the business operational and to find a buyer
for it. and if this proves impossible, then bankruptcy will result. This means that a legal process begins,
which will lead to liquidation of the assets of the business and the aim of liquidation is to raise as much
finance as possible to pay back those people and companies the bankrupt business owes money to.
Meaning and importance of working capital:
Working capital: the capital needed to pay for raw material, day-to-day running costs and credit offered
to customers such as wages, and buying inventory.
 Its important because without it a business will be illiquid
and unable to pay its immediate or short-term debts.
However, there is an opportunity cost of having too much
capital tied up in inventories.
 The working capital requirement for any business will
depend upon the length of its working capital cycle
 The longer the time period from buying materials and
paying for them to receiving payment from the customers,
the greater the working capital needs of the business.
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5.1-2 Business finance
Managing the level of working capital can be achieved by: managing inventory, trade receivables and trade payables.
Inventory can be managed in the following ways:
 Keeping smaller inventory levels
 Using computer systems to record sales and inventory levels
 Efficient inventory control, inventory use and inventory handling so as to reduce losses through
damage, wastage and shrinkage
Trade payables can be managed by:
 Delaying payments to suppliers to increase the credit period.
 Only buying goods from suppliers who will offer credit.
Trade receivables can be managed by:
 Only selling products for cash and not on credit
 Reducing the credit period offered to customers
Capital expenditure and revenue expenditure will be financed in different ways. A major factor
influencing the finance choice is the length of time each of these types of expenditure is required for.
limited companies
Retained profits
○ Profit that remains after taxation this can be used as a source of finance for
future activities.
Sale of unwanted
assets
○ Sale of assets that are no longer fully employed and they could be sold to raise
cash
Sale and leaseback
of non current
assets
○ Some businesses will sell non current assets that they still intend to use but
which they do not need to own so the asset can be sold to a specific financial
institution and released back by the company
Working capital
○ When companies reduce the finance held in working capital, finance is released
for other uses
Bank overdrafts
○ A bank overdraft is the most flexible of all sources of finance, this overdrawn
amount should always be agreed in advance and always has a limit beyond
which the business should not go
Trade credit
○ By delaying payments to suppliers for goods and services received a business is
in effect obtaining finance its suppliers become trade payables drawbacks is that
discounts for quick payments are often lost when the business takes too long to
pay suppliers
Debt factoring
○ When a business sells good on credit I create trade receivables the longer the
time allowed to pay up the more financed the business has to find to carry on
trading
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5.1-2 Business finance
Long term external
sources of finance
Details
Higher purchase
and leasing
○ This is a form of credit for purchasing an asset over a period of time, this avoids
making a large initial cash payment to buy the assets.
○ The hire purchase agreement allows the purchasing business to own the asset.
Leasing involves a contract with a leasing company to acquire an asset but not
necessarily to purchase.
Bank loans
(long-term)
○ These can be for any period of time over one year. For example, machinery or
vehicles are often purchased with loans of up to five years until repayment, bank
loans may be offered at either a variable or a fixed interest rate.
Debentures
○ A company wanting to raise fine funds can issue or sell debentures to interested
investors. The company agrees to pay a fixed rate of interest for the life of the
departure, which can be up to 25 years.
○ The buyers may resell to other investors if they want to raise cash before the
debenture matures the debentures can be very important source of long term
finance as no collateral security will be required over any non-current assets
convertible debentures convert it into shares after a certain period of time.
○ Its like a long term loan but from a private company and not bank.
Share capital
○ Both private and public limited companies can sell further shares to existing
shareholders. Owners of a private limited company can also decide to go public
and obtain the necessary authority to sell shares to the wider public. This has the
potential to raise much more capital than from just existing shareholders
Business mortgage
○ Banks and other financial institutions may offer loans to a business specifically for
the purpose of buying premises um these are called business mortgages
Venture capital
○ Small companies that are not listed on the Stock Exchange can gain long term
investment funds from venture capitalists. These are specialist organizations or
wealthy individuals. They are prepared to lend the risk capital too, or purchase
shares in, business startups or small to medium sized businesses that find it
difficult to raise capital from other sources
Government grants ○ Agencies that are prepared, under certain circumstances, to grant funds to
business. Grants from the central bank are usually given to small businesses or
those expanding in developing regions of the country.
○ They often come with conditions attached, such as a number of job creations.
○ If these conditions are met, then the grant does not have to be repaid.
Advantages of Loans
Advantages of share capital
 No shares are sold so ownership of the company does
not change and is not diluted by the issue of additional
shares
 It never has to be repaid. It is permanent
capital, unlike loans which must eventually
be repaid.
 Lenders have no voting rights at the annual general
meetings
 Dividends do not have to be paid every
year. Directors can decide to retain more
earnings by reducing dividend payments.
 Loans will be repaid eventually so there is no permanent
increase in the liabilities of the business
Evaluation of loan capital and share capital: Which methods should a company choose?
Some companies will use a combination of loans and share equity capital for very large projects.
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5.1-2 Business finance
Finance for unincorporated businesses which are soul traders and partnerships
They cannot refinance from the sales of shares and are unlikely to be successful in selling debentures as they are likely to be
relatively unknown firms.
These businesses can obtain finance from:
 Bank overdrafts and bank loans
 Crowdfunding
 Credit from suppliers
 Loans from family and friends
Microfinance: provides small capital sums to entrepreneurs. It's a very important source of finance in
developing, relatively low-income countries.
drawback of microfinance:
 interest rates can be quite high as the administration costs of many very small loans are
considerable.
Crowd funding: this is an increasingly significant source of finance for new business startups. The idea
behind it is that entrepreneurs rarely have sufficient finance to set up their own businesses. Banks may
be unwilling to lend or may charge very high interest rates especially if the entrepreneur has no proven
business record. Crowdfunding websites allowed individuals to promote their new business idea to
many thousands, perhaps millions of people who may be willing to each invest a small sum such as $10.
In business ventures that are successful, the crowd funding investors will receive either:
 Their initial Capital back plus interest -this is sometimes known as purity pure lending.
 An equity stake in the business and sharing profits when these are eventually made.
Factors affecting the sources of finance:
A source which is too costly and flexible or can be withdrawn quickly might end up destroying the
business.
Factors influencing financial
choice
Why factor is important
Why finance is needed in the time  It is risky and expensive to use long term finance to pay for short
period it is needed for
term needs businesses should match up the sources of finance
to the length of the time it is needed for
 Permanent capital such as issues of shares may be needed for
long term business expansion or long term research projects
Cost
 Obtaining finance is never free even internal finance may have
an opportunity cost
 Loans may become very costly during a period of rising interest
rates
Amount required
 Issues of new shares and debentures because of administration
and other costs are generally used only for large capital sums.
 Small bank loans overdrafts or reducing trade receivables
payment period could be used to raise small sums
Form of business ownership and
desire to retain control
 Share issues can only be used by limited companies and only
public limited companies can sell shares directly to the public
 Issuing an additional share risks the current owners losing some
control unless they all buy shares with the rights issue
Level of existing borrowing
 The higher the existing debt of the business, the greater the risk
of borrowing more. Banks and other lenders will become
anxious about lending more finance
Flexibility
 When a firm has a variable need for finance, the flexible form of
finance is better than a long term and flexible source
Page 84
5.1-2 Business finance Key definitions
 Start-up capital: the capital needed by an entrepreneur to set up a business.
 Working capital: the capital needed to pay for raw materials, day-to-day running costs and credit offered
to customers.
 Short-term finance: money required for short periods of time, up to one year.
 Long-term finance: money required for more than one year.
 Cash: The physical currency and coins, as well as the balances held in checking accounts and savings
accounts that are easily accessible for transactions and business operations. Cash is considered a liquid
asset and is essential for conducting day-to-day business activities.
 Profit: the value of goods sold (revenue) minus costs.
 Liquidity: the ability of a business to pay its short-term debts.
 Administration: when administrators manage a business that is unable to pay its debt with the intention
of selling it as a going concern.
 Bankruptcy: the legal procedure for liquidating a business (or property owned by a sole trader) which
cannot fully pay its debts out if its current assets.
 Liquidation: when a business ceases trading and its assets are sold to pay suppliers and other creditors.
 Current assets: assets that are either cash or likely to be turned into cash within 12months (inventory
and trade receivables or debtors).
 Current liabilities: debts that usually have to be paid within one year.
 Capital expenditure: the purchase of non-current assets that are expected to last for more than one
year, such as buildings and machinery.
 Revenue expenditure: spending on all costs and assets other than non-current assets, which includes
wages, salaries and inventory of materials.
 Internal sources: raising finance from the business's own assets or from profits left in the business
(retained earnings).
 External sources: raising finance from sources outside the business, for example banks.
 Retained earnings: profit after tax retained in a company rather than paid out to shareholders as
dividends.
 Non-current assets: assets kept and used by the business for more than one year.
 Bank overdrafts: a credit that a bank agrees can be borrowed by a business up to an agreed limit as and
when required.
 Debt factoring: selling of claims over trade receivables (debtors) to a specialist organization (debt factor)
in exchange for immediate liquidity.
 Hire purchase: a company purchases an asset and agrees to pay fixed repayments over an agreed time
period. The assets belong to the purchasing company once the final payment has been made.
 Long term loans: loans that do not have to be repaid for at least one year.
 Debentures: long-term bonds issued by companies to raise debt finance, often with a fixed rate of
interest.
 Share capital: permanent finance raised by companies through the sales of shares.
 Business mortgage: long-term loans companies purchasing a property for business premises, with the
property acting as collateral security on the loan.
 Venture capital: risk capital invested in business startups or expanding small businesses that have good
profit potential but do not find it easy to gain finance from other sources.
 Collateral security: an asset which a business pledges to a lender and which must be sold off to pay a
debt if the loan is not repaid.
 Rights issue: existing shareholders are given the right to buy additional shares at a discounted price.
 Microfinance: providing finance services for poor and low-income customers who do not have access to
the banking services, such as loans and overdrafts, offered by traditional commercial banks.
 Crowd-funding: the use of small amounts of capital from a large number of individuals to finance a new
business venture.
Page 85
5.3 Forecasting and managing cash flows
Cash flow forecast: meaning and purpose:
Without positive cash flow any company no matter how promising its business model will become
insolvent and bankrupt.
The planning of cash flows using cash flow forecasts is particularly important for entrepreneurs starting a
new business because:
 New business startups are often offered much shorter credit to pay suppliers than larger, well
established firms.
 Banks and lenders will need to see evidence of cash flow forecast before making any finance
available.
 Finance is often very tight at startups, so accurate planning is much more significant for new
businesses.
Forecasting cash flow means trying to estimate future cash inflows and cash outflows, usually on a month
by month basis.
Forecasting Cash inflows sources:
○ Owners own capital injection: this is easy to forecast as it's under owners direct control
○ Bank loan payments: these are easy to forecast if they have been agreed with the bank in advance,
in terms of both amounts and timing.
○ Customers cash purchases: these are difficult to forecast as they depend on sales, so a sales forecast
will be necessary.
○ Trade receivables payments: these are difficult to forecast as they depend on 2 unknowns. What
proportion of sales will be on credit? When will trade receivables actually pay?
Forecasting Cash outflow:
○ Lease payment for premises: this is easy to forecast as it will be in the estates agent details of
property.
○ Annual rent payment: this is easy to forecast as this will be fixed and agreed for a certain period.
However, the landlord may increase the rent after this.
○ Electricity, gas, water and telephone bills are difficult to forecast as these will vary with many
factors, such as the number of customers, seasonal weather conditions and energy prices.
○ Cost of materials and payments to suppliers: the cost of materials should vary with the level of
output or sales. The longer the period of credit offered by suppliers, the lower the initial startup
cash needs for business will be.
The structure of cash flow forecasts:
- Cash inflows: this section records the cash payments to the business, including cash sales, payment
for credit sales, and capital inflows.
- Cash outflows: this section records the cash payments made by the business, including wages,
materials, rent and other costs.
- Net cash flow and opening and closing balance: this shows the net cash flow for the period and the
cash balances at the start and end of the period (opening cash balance and the closing cash
balance). If the closing balance is negative, then a bank overdraft will almost certainly be necessary
to finance this. Negative cash flow balance is placed in brackets (3)
The closing cash balance at the end of the first month is calculated by this formula:
opening cash balance + [cash inflows – cash outflows]
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5.3 Forecasting and managing cash flows
Benefits of cash flow forecasting
Limitations of cash flow forecasting
 They show negative closing cash flows. This
 Mistakes can be made in preparing the revenue
means the plans can be made to source
and cost forecasts, or they may be drawn up by
additional finance, such as a bank overdraft or
inexperienced entrepreneurs or staff.
the injection of more capital from the owner.
 Unexpected costs increases lead to major
inaccuracies in forecasts. Incorrect assumptions
 They indicate periods of time when negative net
can be made in estimating the sales of the
cash flows are excessive. The business can plan
business, perhaps based on poor market
to reduce these by taking measures to improve
research, this will make the cash inflow forecast
cash flow.
inaccurate.
 They are essential to all business plans. A
business startup will never gain finance unless
advisors and bankers have access to a cash flow
forecast on the assumptions behind it.
Causes of cash flow problems
1. Lack of planning: Cash flow forecasts help greatly in predicting future cash problems for business.
○ Financial planning can be used to predict potential cash flow problems so that business images
can take action to overcome them in plenty of time. Some businesses have insufficient plans for
cash flow management and this is a major cause of cash flow problems.
2. Poor credit control: The credit control department of a business keeps a check on all customers' accounts.
They record who has paid, who is paying on time and which customers are not paying on time.
○ If this credit control is badly managed, then trade receivables will not be chased for payment and
potential bad debts will not be identified
3. Allowing customers to long to pay debts, this means reducing short term cash inflows, which leads
to cash flow problems.
4. Expanding too rapidly: when the business expands rapidly it has to pay for the expansion and for increased
wages and materials months before it even receives cash from additional sales.
○ This overtraining can lead to serious cash flow shortages even though the business is successful
and expanding
5. Unexpected events
Methods of improving cash flow
1. Increase cash inflow(revenue from sales)
2. Reduce cash outflow(costs of production)
Methods of increasing cash Inflow:
Method
How it works
Possible drawbacks
Overdraft
○ it’s a flexible source of cash from a
bank which a business can draw on as
necessary up to an agreed limit
 Interest rates can be high and there may be
an arrangement fee.
 Overdrafts can be withdrawn by the bank,
which is often causes insolvency.
Short term
loan
○ A fixed amount can be borrowed for an  The interest costs have to be paid.
agreed length of time
 The loan must be repaid by the due date.
Sale and
lease back
○ Assets can be sold (for example to
 The leasing costs add to annual overheads.
finance a company). But the assets can  There could be loss of potential profit if the
be leased back from the new owner
assets rise in price
Page 87
5.3 Forecasting and managing cash flows
Improving cash flow by managing trade receivables :
Trade receivables can be managed to improve cash flow in several ways:
 Not extending credit to customers or asking customers to pay more quickly
 Selling claims on trade receivables to specialist financial institutions called debt factors
 Finding out whether new customers are creditworthy
 Offering a discount to customers who pay promptly
Method to reduce cash outflow How it works
Possible drawbacks
Delay capital expenditure
○ By not buying equipment,
vehicles
 The efficiency of the business
may fall if inefficient equipment
is not replaced
 Expansion may become very
difficult
Use leasing instead of outright
purchase of capital
○ The leasing company owns the  The asset is not owned by the
asset and no large cash outlay
business
is required
 Leasing charges include an
interest costs and add to annual
overheads
Cut overheads that do not
directly affect the output
○ These costs will not reduce
production capacity and cash
outflow will be reduced
 Future demand may be reduced
by failing to promote the
products effectively
Improving cash flow by managing trade payables:
 Purchasing more supplies on credit and not cash: if a business has a good credit rating, this may be
easy, but in other circumstances it can be difficult.
 Extend the period of time taken to pay: The larger a business is, the easier it is to insist on longer
credit periods from suppliers. This will improve the business's cash flow.
Key definitions:
 Cash flow: the sum of cash payments to a business minus the sum of cash payments from the
business.
 Insolvent: when a business cannot meet its short-term debts.
 Cashflow forecasts: an estimate of the future cash inflows and outflow of a business.
 Cash inflow: cash payments into a business.
 Cash outflow: Cash payments out of a business.
 Net cash flow: estimated difference between cash inflows and cash outflows for the period. For
example a month.
 Opening cash balance: cash held by the business at the start of the month.
 Closing cash balance: cash held by the business at the end of the month. Which becomes next
month's opening balance.
 Credit control: monitoring of debts to ensure that credit periods are not exceeded.
 Bad debts: unpaid customers' bills that are now very unlikely to ever be paid.
 Overtrading: expanding a business rapidly without obtaining all of the necessary finance, resulting
in a cash flow shortage.
 Trade receivables are the amount that customers owe a business for the goods or services
provided.
 Trade payables are short-term debts owed by a business to its suppliers or vendors for goods or
services purchased on credit. These payables arise when a business receives goods or services but
agrees to pay for them at a later date, usually within a specified credit period.
Page 88
5.4 Costs
5.4.2 The need for accurate cost information
Business uses of cost information:
- Calculations of profit or loss: costs are a key factor in the profit equation period to calculate profits
or losses, accurate cost information is required. If businesses do not keep a record of their costs,
they will be unable to take profitable decisions, such as where to locate.
- Pricing decisions: marketing managers use cost data to help make pricing decisions for new and
existing products.
- Measuring performance: cost information allows comparisons to be made with past periods of
time. In this way, the efficiency of a department or the profitability of a product may be measured
and assessed over time.
- Setting budgets: cost information can help to set budgets and plans. These can act as targets for
departments to work towards. Actual cost levels can then be compared with budgets.
Types of costs
Direct costs: are costs that directly go into producing goods or providing services. Like raw materials
Indirect costs: often referred to as overheads. They are incurred by the business, but they cannot easily
be divided up between cost centers.
Examples of Indirect costs include:
 For farmers; the purchase of a tractor
 In a garage; it is the rent
Fixed and variable costs
○ Fixed costs: do not change when the level of output changes e.g the rent of a factory or shop
○ Variable costs: these vary as output changes, for example, the direct costs of materials used in
making a washing machine or the electricity used to cook a fast food meal.
○ Semi variable costs include both a fixed and a variable element examples of these single to the
facts monthly cost of electricity plus the cost per unit used.
○ The fixed and variable costs of a business can be added together to give total costs.
Approaches to costing
Important concepts:
A Cost center is a part of a business where the costs can be calculated and controlled.
Examples of Cost Centers are:
 In a manufacturing business: products, departments, factories, particular processes.
 In a hotel: the restaurant, reception, bar, room letting and conference section
 In a school: different subject departments
A Profits center is a part of a business where costs and revenue can be calculated and controlled.
examples of them:
 Each branch of a chain of shops
 Each department of a department store
 In a multi product firm, each product in the overall portfolio of the business
Benefits of using cost and profit centers:
 Managers and employees have something to word towards. If these are reasonable and
achievable, this should have a positive impact on motivation.
 These targets can be used to compare with actual performance and help identify those areas that
are performing well and not so well.
Page 89
5.4 Costs
Overheads: are ongoing expenses of a business that are not directly related to the production of goods or
services. These costs are necessary for the day-to-day operations of a business and include items such as
rent, utilities, salaries, insurance, and marketing.
They are usually classified into 4 main groups:
 Productive overheads: including factory rent and rates
 Selling and distribution overheads: packaging and distribution costs
 Administration overheads: including office rent and rates
 Finance overheads: including interest on loans
Average cost = total cost of producing the product
number of units produced
Full costing technique
Full costing allocates all costs each product. If the business is only producing one type of product, then there
is no problem. The business is able to distinguish Direct and Indirect costs.
In this case, the stages in full costing are:
- Identify and add up all of the direct costs.
- Calculate the total overheads of the business for a given period of time.
- Add the total direct cost of making the product
- Calculate the average cost of producing each product by dividing total costs by output.
Methods of allocating fixed costs:
1. Proportion of factory space taken by each product.
2. Proportion of total labor costs incurred.
3. Proportion of sales revenue percentage.
Uses of full costing
Limitations of full costing
○ Full costing is particularly relevant for single product
businesses . In these businesses there is no
uncertainty about the share of overheads to be
allocated to the product.
○ All costs are allocated so no costs are left out of the
calculation of total full cost or unit full cost.
 Inappropriate methods of overhead allocation
can lead to inconsistencies between
departments and projects
 It can be risky to use this costing method for
making decisions. The cost figures arrived at can
be misleading.
Total cost of a particular product = Total direct costs + Allocated fixed costs.
Page 90
5.4 Costs
Contribution or marginal costing
Contribution costing is a costing method that allocates only direct costs to cost centers and profit, not
overhead costs. It focuses on:
• Marginal cost: the cost of producing an extra unit is the variable direct cost
• The contribution of a product is the revenue gained from selling a product - its marginal costs.
• Contribution costing is where only direct costs are allocated to products
• And profit is contribution - overheads
Situations where contribution costing would be
used
Situations where contribution costing would not used
○ contribution costing avoids inaccuracies and can ○ By ignoring indirect costs, contribution costing does
therefore be used in setting prices that just cover not take into account that some products may result
the direct costs of production.
in much higher indirect cost than others. In addition,
single product firms have to cover the fixed costs
with revenue from the single product, so using
○ Decisions about the product or profit center are
contribution costing would not be used in this case.
made on the basis of its contribution to indirect
costs not profit or loss based on, what may be an
○ Contribution costing may lead managers to choose to
inaccurate full cost calculation. Contribution
costing can therefore be used in decision making maintain the production of goods just because of a
over whether to close a cost profit center.
positive contribution. Perhaps a brand-new product
should be launched instead that could, in
○ time, make an even greater contribution.
Break even analysis is widely used in business as it provides useful information for decision making.
The graphical method the break even chart, usually shows three pieces of information:
- Fixed cost: will not vary with the level of output and which must be paid whether the firm produces
anything or not
- Total costs: are the addition of fixed and variable costs
Break even formulae: fixed cost
- variable costs: vary in direct proportion to output
contribution per unit
- Revenue: obtained by multiplying selling price by output low
 Charts are relatively easy to
construct and interpret
 The assumption that costs and
revenues are always represented
by straight lines is unrealistic.
 Financial Planning: BreakSome variable costs do not
change directly with output. For
even helps businesses
example, labour costs may
determine the quantity of
increase as output reaches its
sales needed to cover fixed
and variable costs, providing a
maximum due to higher shift
solid foundation for financial
payments or overtime rates.
planning.
 The revenue line could be
influenced by the price
reductions needed to sell a high
 Decision Making: Knowledge
level of output. The combined
of the break-even point
effects of these changing
allows businesses to assess
assumptions could create two
the impact of changes in
break-even points in practice
prices, costs, and sales
volume, facilitating strategic
decision-making
Page 91
Contribution per unit =
selling price - variable price.
5.4 Costs Key Definitions
 Break-even point: the level of output at which total costs = total revenue
 Cost center: the section of a business, such as a department or a product, that incurs the cost.
 Direct costs: these costs can be clearly identified with each unit of production and can be allocated to a
cost center.
 Indirect costs: costs that cannot be identified with a unit of production or allocated accurately to a cost
center.
 Fixed costs: costs that do not vary with output.
 Variable costs: costs that vary with output.
 Total costs: variable cost plus fixed cost.
 Profit center: a section of a business to which both costs and revenues can be allocated, so profit can be
calculated.
 Average costs: total cost divided by the number of units produced.
 Full costing: a method of costing in which all indirect and direct costs are allocated to the products, services
or divisions of a business.
 Contribution costing: costing method that allocates only direct costs to costs centers and profit centers, not
overhead costs.
 Marginal cost: the additional cost of producing one more unit of output.
 Break-even analysis: uses cost and revenue data to determine the break-even point of production.
 Margin of safety: the amount by which the current output level exceeds the break-even level of output.
 Contribution per unit: the price of a product - the direct (variable) cost of producing it.
Page 92
5.5 Budgets
The meaning and purpose of budgets
What is a budget? a financial plan that outlines the expected revenues and expenses of a business over a
specific period of time. It serves as a roadmap for the allocation of financial resources and helps in tracking
and managing the company's financial performance.
Financial planning for the future is important for all businesses. If no plans are made, a business will:
 be without a direction or purpose
 be unable to allocate the scarce resources of the business effectively
 Have demotivated employees with no plans or targets to work towards.
Measurement of performance:
All business managers should consider how they might measure the performance of their business.
 Knowing how the different departments and divisions of the business are performing helps managers
assess the strengths and weaknesses of the organization.
 Management action can then be taken to build upon strength and correct the weaknesses.
 Assessing actual performance against preset targets is the best way of measuring the performance,
over time, of each section of a business.
Non financial targets can be established as well as financial ones in order to review the financial
performance of a business, financial targets will need to be set.
These targets are called the budgets of the business and they should be established for all divisions and
sections of the business. Measuring point also performance is one of the benefits of budgeting.
Benefits of budgeting
Limitations of budgets
 Planning: The budgetary process makes
managers consider future plans carefully so
that realistic targets can be set. With a clear
sales budget, for example, departments in the
business will know how much to produce or
how much to spend on sales promotion.
 Lack of flexibility: If budgets are set with no flexibility
built into them, then sudden and unexpected
changes in the external environment can make them
very unrealistic. Unrealistic budgets will demotivate
the budget holder and other employees.
 Focus on the short term: Budgets tend to be set for
the relatively short term, for example, the next 12
 Allocating resources: Budgets can be an
months. Managers may take a short-term decision to
effective way of making sure that the business
stay within budget that may not be in the best longdoes not spend more resources than it has
term interests of the business. For example, cutting
access to. Without a detailed and coordinated
the size of the workforce to stay within the labour
set of plans for allocating the business’s money
budget may restrict the ability of the business to
and resources, who would decide ‘who gets
increase output if sales rise quickly in the future.
what
 Setting targets: Most people work better if
they have a realistic target to aim for. This
motivation will be greater if the budget holder
or profit centre manager has been delegated
some accountability for setting and reaching
budget levels.
 Training on budgets: Setting and keeping to budgets
is not easy and all managers with delegated
responsibility for budgets will need extensive
training in this role
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5.5 Budgets
Key features of effective budgeting:
 Managers who are responsible for meeting targets should be involved in setting the budget.
This involvement creates a sense of ownership, motivating the department to achieve the
targets and leading to more realistic goals. This approach is called "delegated budgets''.
 Budgets are used to review the performance of each manager controlling a cost or profit
centre. The managers will be appraised on their effectiveness in reaching targets. Successful
and unsuccessful managers can therefore be identified.
Setting and using budgets
There are several ways in which the budget level can be set.
1. Incremental budgeting
This method takes last year’s budget and makes changes for this year based on last year’s
budget. The revised budget might be raised or lowered, depending on market conditions.
2. Zero budgeting
The zero budgeting approach requires all departments and budget holders to justify their
whole budget each year. This is time-consuming, as a fundamental review of the work and
importance of each budget holding section is needed each year. However, it does provide
added incentive for managers to defend the work of their own section.
3. Flexible budgeting
Most budgets are fixed for the time period under review. Flexible budgeting is a budget that
adjusts for changes in the level of activity or output.
 They are more motivating for budget-holding managers as they will not be criticized for
adverse variances, which might occur just because output was lower than budgeted.
Variance analysis
A variance is the difference between a budget and the actual figures achieved
- Its used to compare actual performance with the original budgets.
Favorable variance: when costs are lower than budgeted
Adverse variance: when costs are higher than budgeted
It is important to calculate and analyse the reasons for these variances because:
○ Variances measure differences from the planned performance of each department over a
given period. Measuring performance is a key benefit of budgets.
○ Finding out the reasons for variances can help set more realistic budgets in the future.
Possible causes of adverse variance
Possible causes of favorable variances
○ Revenue is below budget because either fewer
○ Revenue is above budget, due to higherunits were sold or the selling price had to be
than-expected economic growth or a
lowered due to competition.
competitor closing down.
○ Actual raw material costs are higher than planned ○ Raw material costs are lower because either
output was below budget or the unit cost of
because either output was higher than budgeted
materials was below budget.
or the cost per unit of materials increased.
○ Overhead costs are higher than budgeted,
perhaps because the annual rent rise was above
the forecast.
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5.5 Budgets Key Definitions
 Budgeting: planning future activities by establishing performance targets, especially financial
ones.
 Budget holder: the individual responsible for the initial setting and achievement of a budget.
 Variance analysis: calculation of the differences between budgets and actual figures, and analysis
of the reasons for such differences.
 Delegated budgets: budgets for which junior managers have been given some authority for
setting and achieving.
 Incremental budgeting: uses last year's budget as a basis, and an adjustment is made for the
coming year.
 Zero budgeting: sets budgets to zero each year and budget holders have to argue their case for
target levels and to receive any finance.
 Favorable variance: a change from the budget that leads to higher than planned profit.
 Adverse variance: a change from the budget that leads to lower than planned profit.
 Flexible budgeting: costs budgets for each expense are allowed to vary if sales or output vary
from budgeted levels.
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All AS Formulas
Average cost:
Average cost = Total cost of producing this product
Number of units produced
Break-even:
Break-even level of output = Fixed cost
contribution per unit
Capacity Utilization:
Rate of capacity utilization = current output level X 100
Maximum output level
Closing cash balance =
Opening cash balance + [cash inflow - cash outflow]
Labor productivity:
Labor productivity (number of units per worker) = Total output in given time period
Total workers employed
Margin of safety:
Margin of safety = Break-even level of output - current output level
Market capitalization:
Market capitalization = current share price X total number of shares issued
Median value:
Median value = Number of values + 1
2
Production over break-even point (%):
Production over break-even point = Margin of safety
Break-even output
Profit:
Profit = Contribution - Fixed costs or Overheads.
Range:
Range = highest result - lowest result
Revenue:
The total value of sales made during the trade period = Selling price X Quantity sold
Section angle (pie graph):
Angle of section = value of one section X 360 degrees
Total value of all sections
Total Contribution:
Unit contribution X Output
Unit contribution:
Unit contribution = Price of unit - Direct (variable) cost of unit.
Working capital:
Working capital = current assets - current liabilities.
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Additional Notes/Things I HAVE to memorize:
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Additional Notes/Things I HAVE to memorize:
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Additional Notes/Things I HAVE to memorize:
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