NEW FOR

2015

Edexcel AS/A
Edexcel AS/Alevel
level
BUSINESS
ECONOMICS

Dave Hall
Rob Jones
Carlo Raffo
Alain Anderton
Alain Anderton Jennifer Lee
Edited by Dave Gray Keith Hirst
Andrew Redfern
6th
5thEDITION
EDITION Edited by Dave Gray
 Edexcel AS/A level
BUSINESS

Dave Hall
Rob Jones
Carlo Raffo
Alain Anderton
Jennifer Lee
Keith Hirst
Andrew Redfern
5th EDITION Edited by Dave Gray
Published by Pearson Education Limited, 80 Strand, London, WC2R 0RL.
www.pearsonschoolsandfecolleges.co.uk
Copies of official specifications for all Edexcel qualifications may be found on the website: www.edexcel.com
Text © Dave Hall, Rob Jones, Carlo Raffo, Alain Anderton, Jennifer Lee, Keith Hirst, Andrew Redfern and Dave Gray 2015
Edited by Julia Bruce
Designed by Pearson Education
Typeset by Tech-Art
Original illustrations © Pearson Education 2015
Illustrated by Tech-Art
Cover design by Elizabeth Arnoux for Pearson Education
Picture research by Rebecca Sodergren
Cover photo/illustration © Fancy Images (George Hammerstein) / Plainpicture Ltd
The rights of Dave Hall, Rob Jones, Carlo Raffo, Alain Anderton, Jennifer Lee, Keith Hirst, Andrew Redfern and Dave Gray
to be identified as authors of this work have been asserted by them in accordance with the Copyright, Designs and Patents Act 1988.
First published 2015
18 17 16 15
10 9 8 7 6 5 4 3 2 1
British Library Cataloguing in Publication Data
A catalogue record for this book is available from the British Library
ISBN (Student Book bundle) 978 1 447 98354 5
ISBN (ActiveBook) 978 1 447 98350 7
ISBN (Kindle edition) 978 1 447 98351 4
ISBN 978 0 435 18348 6 (PDF)
Copyright notice
All rights reserved. No part of this publication may be reproduced in any form or by any means (including photocopying
or storing it in any medium by electronic means and whether or not transiently or incidentally to some other use of this
publication) without the written permission of the copyright owner, except in accordance with the provisions of the Copyright,
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Kirby Street, London EC1N 8TS (www.cla.co.uk). Applications for the copyright owner’s written permission should be addressed
to the publisher.
Some of the examples in this book are fictionalised accounts based upon real-life events. All brand names and sensitive
business data have been changed.
Printed in Slovakia by Neografia
Websites
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A note from the publisher
In order to ensure that this resource offers high-quality support for the associated Pearson qualification, it has been through
a review process by the awarding body. This process confirms that this resource fully covers the teaching and learning content
of the specification or part of a specification at which it is aimed. It also confirms that it demonstrates an appropriate balance
between the development of subject skills, knowledge and understanding, in addition to preparation for assessment.
Endorsement does not cover any guidance on assessment activities or processes (e.g. practice questions or advice on how to
answer assessment questions), included in the resource nor does it prescribe any particular approach to the teaching or delivery
of a related course.
While the publishers have made every attempt to ensure that advice on the qualification and its assessment is accurate, the
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shall include this and other appropriate resources.

ii
Contents
About this book iv Theme 3: Business decisions and strategy
Introduction AS/A Level Business viii 44 Corporate objectives 269
Theme 1: Marketing and people 45 Theories of corporate strategy 274
1 The market 1 46 SWOT analysis 281
2 Market research 8 47 Impact of external influences 285
3 Market positioning 18 48 Growth 292
4 Demand 23 49 Mergers and takeovers 298
5 Supply 27 50 Organic growth 304
6 Markets 31 51 Reasons for staying small 308
7 Price elasticity of demand 35 52 Quantitative sales forecasting 313
8 Income elasticity of demand 40 53 Investment appraisal 321
9 Product/service design 44 54 Decision trees 328
10 Branding and promotion 49 55 Critical path analysis 335
11 Pricing strategies 57 56 Corporate influences 341
12 Distribution 63 57 Corporate culture 347
13 Marketing strategy 69 58 Shareholders versus stakeholders 353
14 Approaches to staffing 77 59 Business ethics 359
15 Recruitment, selection and training 84 60 Interpretation of financial statements 367
16 Organisational design 92 61 Ratio analysis 374
17 Motivation in theory and practice 99 62 Human resources 379
18 Leadership 109 63 Causes and effects of change 386
19 Role of an entrepreneur 114 64 Key factors in change 391
20 Entrepreneurial motives and characteristics 121 65 Scenario planning 396
21 Business objectives 126 Theme 4: Global business
22 Forms of business 1 130 66 Growing economies 401
23 Forms of business 2 137 67 International trade and business growth 407
24 Business choices 141 68 Factors contributing to increased globalisation 413
25 Moving from entrepreneur to leader 145 69 Protectionism 420
Theme 2: Managing business activities 70 Trading blocs 424
26 Internal finance 149 71 Conditions that prompt trade 431
27 External finance 153 72 Assessment of a country as a market 436
28 Liability 158 73 Assessment of a country as a production location 442
29 Planning 163 74 Reasons for global mergers or joint ventures 448
30 Sales forecasting 170 75 Global competitiveness 453
31 Sales, revenue and costs 176 76 Marketing 459
32 Break-even 181 77 Niche markets 464
33 Budgets 185 78 Cultural/social factors 468
34 Profit 191 79 The impact of MNCs 473
35 Liquidity 196 80 Ethics 479
36 Business failure 203 81 Controlling MNCs 485
37 Production, productivity and efficiency 208 A Level: Preparing for your exams 491
38 Capacity utilisation 215 Index 524
39 Stock control 219 Acknowledgements 534
40 Quality management 225
41 Economic influences 232
42 Legislation 242
43 The competitive environment 250
AS Level: Preparing for your exams 255

iii
About this book
This Student Book contains a wealth of features that will help ‘Questions’ Throughout each unit you will find questions that
you to access the course content, prepare for your exams, and will test your understanding of topics and help you to build your
take your knowledge and understanding further. The pages analytical and critical thinking skills.
below show some of the key features and explain how they will
support you in developing the skills needed to succeed on your
A level Business course. Question 1
Features Coolpop Ltd sells fizzy citrus drinks in the very competitive soft
‘Key points’ These provide a clear overview of the content drinks market. In 2013, the company sold 2,000,000 cans
covered in the topic, clearly matched to the specification. of Lemon Coolpop at a price of 50p. In 2014, the company
decided to reduce the price of Lemon Coolpop to try and win a
Key points bigger market share. The price was reduced to 40p and sales
1. Calculation of price elasticity of demand. rose to 2,600,000.
2. Interpretation of numerical values of price elasticity of demand.
3. The factors influencing price elasticity of demand. (a) Calculate the price elasticity of demand for Coolpop.
4. The significance of price elasticity of demand to businesses in terms of implications for pricing.
5. Calculation and interpretation of the relationship between price elasticity of demand and (b) State whether demand is price elastic or price inelastic.
total revenue.

‘Getting started’ These activities are designed to help you ‘Thinking bigger’ These features provide opportunities
start thinking about the topics and issues you will be covering for you to explore an aspect of business studies in more
in the unit. detail. The information in these features goes beyond the
specification and will help you to deepen your understanding
and think like a business person.

Getting started
Thinking bigger
Albert Rogers owns a milk round in Dorset. He delivers milk When using price elasticity of demand to help make pricing decisions,
to over 300 homes in the town. However, 30 years ago his businesses need to be aware of some possible drawbacks with the
business used to deliver to over 1,000 homes. The business concept. The main problem is the origin of elasticity values. A business
has been hit hard by competition from retailers, particularly might estimate the value of price elasticity by measuring the effect on
supermarkets, selling cheap milk. In 2013 he decided that he sales of previous price changes. For example, if a business cut the price
by 12 per cent four years ago and demand rose by 18 per cent, price
would need to generate more revenue. He raised the price of a elasticity would be –1.5. However, this data is historic; what happened
pint of fresh milk (delivered to the doorstep) from 50p to 60p. four years ago may not happen again in the future.
As a result sales fell from 16,000 bottles to 12,000 bottles Another way of estimating elasticity values is to carry out market
a month. research to find out how consumers will react to price changes in the
Calculate the total revenue the business earned (price x quantity future. This would give more up-to-date values, but there could be
problems with the accuracy of the data collected by market researchers.
sold) before the increase in price. Now calculate the revenue it
For example, the sample may not be representative or consumers might
earned after it increased price. Was the price increase a wise not behave in the way they said they would. Consequently the data
move for the business? Do you think the same would happen to would be flawed. Businesses need to be aware, therefore, that elasticity
any business that raised its price by 20 per cent? values may not be entirely accurate.

iv
 About this book

‘Worked examples’ and ‘Maths tips’ Practical worked ‘Key terms’ These are highlighted in the text and complex
examples will help you apply new methods or formulae to terminology or specialist business terms are clearly defined in a
your own work. Maths tips will help you to simplify complex handy box at the end of each unit.
calculations. A ‘calculator’ icon on any question identifies
opportunities for you to practise your maths skills and signposts Key terms
topics where calculations and formulae are found.
Price elastic demand – a change in price results in a greater
change in demand.
Maths tip Price elasticity of demand – the responsiveness of demand
There is a minus number in the calculation below to a change in price.
because the price fell by 40 per cent (from £10 to £6). Since Price inelastic demand – a change in price results in a
the price change was negative a minus sign must be shown. proportionately smaller change in demand.
Whenever price or demand falls in the calculation, it is proper,
and may be helpful, to show the minus sign.

‘Exam tips’ Within units you will find tips that give practical advice
Worked example and guidance to ensure you’re well prepared for your exams.
For product A in Figure 1, the price elasticity of demand would be:
20%
= ––––– = – 0.5 Exam tip
– 40% A common mistake made by students in examinations relates to
products with inelastic demand. Sometimes students say ‘demand
For product B in Figure 1, the price elasticity of demand for product x is inelastic. This means that a business can raise the
would be: price and there will be no change in demand’. This is not the case.
100% Even when demand is price inelastic, a price change will still cause
= ––––– = – 2.5 a change in demand. It is just that the percentage change in
– 40% demand is smaller than the percentage change in price.

‘Knowledge check’ Questions at the end of each unit provide ‘Links’ This feature in Themes 3 and 4 helps you to
a quick test of your understanding of the unit content. develop the synoptic skills required in your exam for
Paper 4 by suggesting ways that the topics in one unit
Knowledge check link to others. The links feature helps you to understand
how to demonstrate your accumulated knowledge and
1. What is meant by price elasticity of demand? understanding of a topic or subject area.
2. Give two examples of products that might have inelastic
demand.
Links
3. What is the formula for calculating price elasticity
Information in this unit could be used in a range of answers.
of demand?
For example, if you are discussing sources of finance for a
4. The price of a product is increased by 8 per cent; as a result business you could explain how the capital structure of the
demand falls by 12 per cent. Calculate price elasticity of business might influence the decision. Businesses that already
demand. have a large quantity of borrowings might be better to raise
5. The price elasticity of demand for a product is –0.67. What fresh capital, for example. This unit could also be linked with
will happen to total revenue if price is reduced? Internal finance (Unit 26), External finance (Unit 27), Planning
(Unit 29), Break-even (Unit 32), Profit (Unit 34), Liquidity
6. The price elasticity of demand for a product is –2.7. What
(Unit 35), SWOT analysis (Unit 46), Decision trees (Unit 54),
will happen to total revenue if price is raised?
Ratio analysis (Unit 61) and Global competitiveness (Unit 75).
7. State two factors that affect the price elasticity of demand for
a product.

v
About this book

‘Case study’ These exam-style, data response questions contain an authentic piece of writing that provides
you with an opportunity to practise your own extended writing and to develop your ability to combine your
knowledge, skills and understanding with the breadth and depth of the subject of business studies.

Case study
THOMPSON ENGINEERING LTD

Thompson Engineering Ltd is a family business based in

Chesterfield. The company makes three components for the (a) What is meant by the term ‘price elastic demand’?
engines that power microlights. The work undertaken by the (2 marks)
company is quite specialised and it was thought that few rivals
operated in the same market. At the end of 2013 the company (b) Explain one factor that might affect the price elasticity of
had to make some modifications to two of the components, A demand. (4 marks)
and C. This was to comply with some new health and safety (c) Calculate the expected change in revenue generated by
specifications. As a result the directors decided to raise the price product A in 2014 if the price is increased by 20 per cent.
of these two components by 20 per cent in 2014. Some financial (4 marks)
information for the three components is shown in Table 2. (d) Calculate the expected change in revenue generated by
Table 2 Financial information and price elasticity of product C in 2014 if the price is increased by 20 per cent.
demand (PED) for three products (2013) (4 marks)

  Price Sales PED (e) Assess the possible impact on Thompson Engineering Ltd of
the price changes. (12 marks)
Component A £10 100,000 −0.8
Component B £7 150,000 −1.1
Component C £5 300,000 −1.2

vi
 About this book

‘Preparing for your exams’ At the end of Themes 1 and 4 you’ll find detailed exam
preparation sections to help consolidate your learning. Exam-style questions, mark
schemes and answers, together with useful tips for how to approach the exams, will
give you extra confidence in your performance.

Extract D Global hotel industry revenue from 2008 to 2016

The global hotel market Revenue ($ billions)
600
550
Following a dip in 2009, possibly the result of a global downturn
500 457
in demand, revenue in the global hotel market has shown 447 419
400 395
consistent growth. It was expected to generate around $550
billion in 2016. 300
200
100
0
2008 2009 2010 2011 2016*
*Estimate Year

Source: adapted from www.statista.com

Question 2 (b), Student answer

Since 2008 revenue in the global hotel industry has grown money and having extra to spend on non-essentials, such
significantly. By 2016 it is expected to have grown by as hotel accommodation. The expansion in India planned
23 per cent from $447 billion to $550 billion. One possible by InterContinental Hotels (IHG) supports this view. IHG
reason for this pattern of spending on hotel accommodation currently operates 19 hotels across 10 cities in India. It also
could be the growth in global incomes. There is usually a expects to open another 45 hotels in the country over the
strong link between consumer incomes and the demand next few years. The company is likely to be responding to
for products. In recent years the BRIC countries of Brazil, rising demand for hotel accommodation in India resulting from
Russia, India and China, have enjoyed relatively high levels of growth in incomes. The hotels are likely to serve both Indians
economic growth. This has resulted in people earning more and overseas tourists visiting the country.

Comment, Question 2 (b)

Questions like this require you to demonstrate knowledge, for keeping the answer in context. This answer focuses on the
application and possibly analysis. One or two marks might be hotel industry. Finally, credit may be given for analysis. In this
awarded for identifying one factor that might have led to more case, explaining how economic growth in developing nations has
spending on hotel accommodation over the time period, i.e. resulted in higher spending on hotel accommodation.
growing incomes. Up to two application marks might be awarded

Getting the most from your online

ActiveBook
This book comes with 3 years’ access to ActiveBook* – an Highlight tool
online, digital version of your textbook. Follow the instructions Use this to pick out key terms or topics so you are ready and
printed on the inside front cover to start using your ActiveBook. prepared for revision.
Your ActiveBook is the perfect way to personalise your
learning as you progress through your A level Business course. Annotations tool
You can: Use this to add your own notes; for example, links to your wider
●● access your content online, anytime, anywhere. reading, such as websites or other files. Or make a note to
●● use the inbuilt highlighting and annotation tools to remind yourself about work that you need to do.
personalise the content and make it really relevant to you.

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vii
Introduction
The 5th edition of Edexcel AS/A level Business is designed Comprehensive course coverage
to develop the skills and approaches you may need, in a variety
of contexts, when making business decisions. It develops an This book covers the material found in all four themes of the
analytical, rigorous and critical approach to the decision-making Edexcel A level Business specification:
process and to your studies of business. It does not provide a ●● Theme 1 Marketing and people
step-by-step guide to how to be ‘good at business’ as there is ●● Theme 2 Managing business activities
no simple set of rules that can be applied in all contexts that
will always be successful. It is possible that different approaches
●● Theme 3 Business decisions and strategy
may be used by different people in business and there may be ●● Theme 4 Global business
disagreement about which approach to take. By covering all four themes of the specification in detail, this
book takes you through the course, ensuring your skills and
Business is integrated and different areas of business are
understanding are developed, so that you can have confidence
interdependent. There are links, for example, between:
when approaching your exams. Units in Theme 1 and Theme 2
●● what is being produced and the funds available to pay for it allow you to gain an in-depth understanding of core business
(production and finance) concepts, with the content in Theme 3 and Theme 4 building
●● the selling of the product and ethical considerations on these topics. Theme 3 and Theme 4 extend breadth and
(marketing and ethics) depth of knowledge through focusing on business strategy and
●● the type of business and many aspects of its operation. decisions, and exploring the global context in which modern
Being aware of these aspects of business will help you to businesses operate. This focus on developing a breadth
understand how and why business decisions are made, and and depth of knowledge across the course will allow you to
how they affect a variety of people, both within and outside the develop the synopticity needed for your final paper.
business. The aim of the 5th edition of Business is to help you
as you study Edexcel AS level and A level Business to understand
business decisions and to be analytical, rigorous and critical in
your business thinking. A number of features are included in the
book to develop and extend your skills and approaches – see
About this book, page iv.

viii
 1 The market 1.1.1
Theme 1

Key points
1. Mass markets and niche markets: 3. How competition affects the market.
●● characteristics 4. The difference between risk and uncertainty.
●● market size and market share
●● brands.
2. Dynamic markets:
●● online retailing
●● how markets change
●● innovation and market growth
●● adapting to change.

Getting started
Marketing involves a range of activities that help a business sell its
The market for holidays has changed dramatically over time. products. However, marketing is not just about selling, it involves:
In the 1960s a typical holiday for a UK person might have been ●● identifying the needs and wants of consumers

an annual two-week family trip to the seaside at Blackpool, ●● designing products that meet these needs

Scarborough or Brighton, staying in a caravan, a holiday camp or ●● understanding the threats from competitors

small hotel. Today people might take several holidays a year and ●● telling customers about products

●● charging the right price

the choice of destination, duration and style is enormous. Holidays
●● persuading customers to buy products
can range from a weekend break with friends in an Eastern
●● making products available in convenient locations.
European city, such as Prague, or a romantic mini-break for two
in Paris, to a fortnight in the sun in the Caribbean, or a camping According to the Chartered Institute of Marketing, ‘Marketing
is the management process responsible for identifying,
expedition in the Lake District. There are specialist holidays, such
anticipating and satisfying customer requirements profitably’.
as trekking in the Atlas Mountains, golfing trips in Dubai or white-
water rafting down the River Wye, and theme-park holidays, The characteristics of mass markets and
such as Disneyland®. Increasingly people are going to long-haul
destinations, such as Australia, China and South Africa.
niche markets
Some businesses sell their products to mass markets. This is
How has the market for holidays changed over time? What when a business sells the same products to all consumers and
might have caused these market changes? How do people markets them in the same way. Fast-moving consumer goods,
choose their holiday destinations? What role does the internet such as crisps, breakfast cereals, computer software and
play in the sale of holidays by businesses? Coca-Cola®, are sold in mass markets. The number of customers
in these markets is huge – possibly billions if products are
sold globally. This means that businesses can produce large
Markets and marketing quantities at a lower unit cost by exploiting economies of scale.
Businesses make money by selling their goods and services This might result in higher sales and higher profits. However,
in markets. Historically, markets were places where buyers there is often a lot of competition in mass markets and therefore
and sellers would meet to exchange goods. However, today businesses may spend a lot of money on marketing. For
it is possible to trade goods and services without buyers and example, Advertising Age reported that the Coca-Cola Company
sellers meeting up. For example, trading can be done over the spent around $3.3 billion on global advertising in 2013.
telephone, using newspapers, through mail order or on the A niche market is a small market segment – a segment
internet. Some examples of markets are given below. that has sometimes gone ‘untouched’ by larger businesses.
●● Consumer goods markets – where products such as food, Niche marketing is the complete opposite of mass marketing.
cosmetics and magazines are sold. It involves selling to a small customer group, sometimes with
●● Markets for services – this can include services for specific needs. Small firms can often survive by supplying niche
individuals, such as hairdressing, or business services, such markets. They may also avoid competition. It is a lot easier to
as auditing. focus on the needs of the customer in a niche market. Also,
●● The housing market – where people buy, sell and let property. if there is no competition it may also be possible to charge
●● Commodity markets – where raw materials such as oil premium prices. An example of a business that targets niche
copper, wheat and coffee are traded. markets is Zumiez, which sells products related to surfing,
●● Financial markets – where currencies and financial products skateboarding and snowboarding.
are traded.
1
The market Unit 1

However, if a business successfully exploits a niche market Volume: This is the physical quantity of products which are
it still may attract competition. Niche markets, by their nature, produced and sold. For example, the global crude steel production
are very small and unable to support many competing firms. As in 2014 was 1,661 million tonnes (worldsteel.org). Some
a result, if a large business decides to enter a niche market they estimates of volume are based on the number or percentage of
may find it easy to overrun a smaller rival. Also, businesses that users, subscribers or viewers. This is often the case in markets
rely on a single niche market may be vulnerable because they for services, such as the number of mobile phone users, the
are not spreading their risk. If they lose a grip in their chosen number of television viewers or the percentage of households
market, they may collapse because they do not have other with digital television.
products or markets as a back-up. Different markets are likely to differ in size. For example, the
sale of savory snacks in one year is likely to be much smaller than
the sales of footwear in the same year in the UK.
Exam tip
In examinations it is helpful to give examples when explaining the
meaning of business terms and concepts. Relevant examples Market share
support your answer and show that you understand the meaning of Market share or market penetration is the term used to describe
the term or concept. It is also important to use information in the the proportion of a particular market that is held by a business, a
case material in the question to support your answer. This product, a brand or a number of businesses or products. Market
approach will show your skills in ‘application’ in your answer. share is shown as a percentage. The market share of a business
can be calculated as:
Question 1 Sales of a business × 100%
Total sales in the market
Why might the measurement of market share be important?
It might indicate a business that is a market leader. This could
influence other companies to follow the leader or influence the
leader to maintain its position. It might influence the strategy
or objectives of a business. A business that has a small market
share may set a target of increasing its share by 5 per cent over
a period of time. It may also be an indication of the success or
failure of a business or its strategy.
Figure 1 shows the market shares of supermarkets in the UK
David Algunik, a Canadian Emergency Room doctor, designed
in 2013. It shows, for example, that Tesco was the market leader
Banana Guards. He wanted to prevent bananas from being with nearly one-third of the total market. It also shows that the top
bruised and squashed during his journey from home to work, four supermarkets share 75.3 per cent of the total market, i.e. the
so designed Banana Guards from lightweight plastic. Once shut market is dominated by just four firms.
inside a Banana Guard, a banana of almost any shape or size
can be transported completely undamaged inside a lunchbox, Figure 1
bag or backpack – even when travelling on a packed tube. The UK market shares of supermarkets in 2013
contents are kept fresh by ventilation holes in the side of the Market share (percentage)
bright yellow Banana Guard, which also prevent the banana
Key
from ripening prematurely until ready for consumption. The
Tesco Morrisons
Banana Guard is also safe for the dishwasher.
Asda Co-op
Sources: adapted from www.bananaguard.com and
www.johnlewis.com Sainsbury's Lidl

Waitrose Iceland
(a) Explain what type of market the Banana Guard is aimed at.
Aldi Others
(b) Explain one possible disadvantage of targeting a niche market
for a business selling a product like Banana Guard.
Source: www.kantarworldpanel.com
(data for 12 weeks ending 10.11.2013 and from data source
Market size comparing 12 weeks ending 25.11.2012)

The size of a market can be estimated or calculated by the total

sales of all businesses in the market. Market size is usually Brands
estimated in a number of ways. Many businesses try to establish themselves in markets by
Value: This is the total amount spent by customers buying giving their products a brand name. Products are given brand
products. For example, it was estimated that the value of the names to distinguish them from other products in the market.
fast-food market in 2014 was just over £29.4 billion. This included Branding is particularly important in mass markets where lots of
branded fast-food chains and independent outlets selling hot or products are competing for a share of the market. Examples of
cold eat-in food without table service, or takeaway food. common brand names include Google, BBC, Toyota, Nike and
2
 Marketing and people

Apple. Branding might be used to: ●● Online retailing affords greater flexibility. An online store can be
●● differentiate the product from those of rivals updated instantly and as frequently as is necessary. For example,
●● create customer loyalty it is possible to promote a ‘deal of the day’ on the home page,
●● help product recognition without the need for expensive printed display material.
●● develop an image ●● Distance is no object with online retailing. Customers can buy
●● charge a premium price when the brand becomes strong. products from anywhere in the world.
Branding is discussed in more detail in Unit 10.

Dynamic markets Question 2

Most markets do not remain the same over time – they tend to
be dynamic, which means they are likely to change. They may
grow, shrink, fragment, emerge or completely disappear. For
example, there is no longer a market in the UK for cassettes.
Most people buy DVDs or download music from the internet.
Dynamic markets can have a huge impact on businesses.
A failure to adapt in a dynamic market can lead to the collapse
of a business. For example, when digital photography emerged
in the 1980s, Kodak (the camera company) continued to rely
on sales of film cameras. Eventually, the market for these types
of cameras collapsed and Kodak went into liquidation. Those
businesses that can adapt to changes in dynamic markets are
more likely to survive in the long term. The changing nature of
markets is discussed in more detail later.

Online retailing
One of the biggest changes to occur in the marketing of products
has been the development of online retailing or e-tailing. This
is a popular branch of e-commerce that has emerged along with
the development of the internet. It involves shoppers ordering
goods online and taking delivery at home. There are specialist Online grocery retailing has not quite taken off in the same way
e-tailers such as Amazon and Alibaba – retail ‘giants’ that sell a that other forms of online retailing have.
huge range of goods online. However, many retailers, both large
However, reports estimate that online grocery sales may rise
and small, now have online services. Growth in online retailing is
from 4.4 per cent to 8.3 per cent in the period 2014–2019. This
rapid and expected to continue into the future.
may be due to busier lifestyles and the further integration of
Businesses may enjoy a number of benefits from offering
mobile technology into daily life as people increasingly become
online retail services.
on-the-go consumers. Online shopping is convenient and saves
●● Retailers can market their goods to people who prefer to
time and fuel. Research shows that 27 per cent of people
shop from home or who find it difficult to get to traditional
shopped online for groceries in 2014, with 10 per cent buying
shops. For example, people who do not enjoy the physical
the majority of their groceries via the internet.
shopping experience, people too busy to go shopping and
people with conditions or disabilities that make physical It was reported in 2014 that click & collect was also being used
shopping difficult. by around a quarter of online shoppers and this figure was
●● It is easier to gather personal information from customers so
growing as more services were made available.
that they can be targeted with other products and offers in Click & collect is a good example of a trend that took off. Major
the future. retailers, including Tesco and ASDA, invested heavily to roll out
●● Selling costs such as sales staff, rent and other store the service to the majority of their stores, as well as convenient
overheads can be avoided. The savings might be enormous locations such as London travel hubs. Click & collect became
and allow online retailers to charge lower prices. available at some London tube stations, with plans to include
●● Marketing costs will also be lower. It is much cheaper, for travel hubs and workplaces as future locations, as retailers
example, to send a marketing message by e-mail to 1,000 continue to experiment and innovate.
customers than it is to send 1,000 newsletters by post.
Source: adapted from www.essentialretail.com
●● Online retailers can reach more customers. A single store in

a high street can only attract a limited number of customers. (a) Explain one reason why online grocery retailing is likely to grow
However, a website advertising a 15,000-item product range in the future.
can have a global reach. (b) Assess the benefits and drawbacks to supermarkets of
●● An online retailer is open 24/7. There are not many stores online retailing.
that can match this level of service.

3
The market Unit 1

‘upmarket’ restaurants, some of which evolved around famous

Thinking bigger
chefs, for example Jamie Oliver, Marcus Wareing and Gordon
A development in online retailing is the emergence of comparison
websites. These sites provide shoppers with search engines that can filter
Ramsay. Add to this the huge range of ethnic restaurants selling,
and compare products based on price, features and other criteria. Most among others, Indian, Thai, Chinese, Vietnamese, Malaysian and
comparison shopping sites compare prices from many different retailers, Japanese cuisines.
but do not sell products themselves. They also tend to specialise in
particular product groups. For example, trivago is used to compare hotel New markets: While it is possible for some markets to
prices, skyscanner compares the prices of flights, MoneySuperMarket.com completely disappear, new markets are always developing. One
compares financial products and uSwitch.com compares energy prices. big source of new markets is from the development of ‘emerging
However, some of these sites have been criticised for not giving the economies’. These include the BRIC (Brazil, Russia, India and
best deals. For example, it was reported in 2014 that consumers were China) countries and other developing nations, such as Mexico,
missing out on the best energy deals. This was because comparison Thailand, Indonesia and some South American countries.
sites filter out the tariffs that do not pay commission. The Big Deal
New markets also appear when completely new products are
website was set up in 2013 to help consumers reduce their energy bills.
They reported that the cheapest energy deals were not presented to launched. In the 1970s no one had a mobile phone. In the
customers by the five major price comparison websites. Instead, the sites 1980s no one had a smartphone. In the 1990s no one had a
provide an option to users to click ‘yes’ if they want to see tariffs they can flat-screen television. In the 2000s few people had e-books.
switch to ‘today’ or ‘now’. Any deals that do not earn the comparison These are all examples of brand-new markets.
site commission from the energy companies are filtered out from the
search findings. Innovation and market growth
Markets can grow over time – some rapidly, some more slowly.
Growth in existing markets and new markets may occur for the
How markets change following reasons.
The size of markets: The size of some markets can remain ●● Economic growth. Global living standards tend to rise

quite stable over a period of time. For example, the size of the over time. This means that the world’s population has more
milk market in the UK probably hasn’t changed much for many money to spend. As a result businesses can supply more of
years. This is because consumption of milk is fairly constant. their output to growing global markets. Also, as people get
However, the majority of markets are likely to grow. For wealthier they are likely to demand different types of goods.
example, The Future of Global Packaging to 2018 reports that For example, the markets for holidays, electronic goods, cars,
the global packaging market stood at $799 billion in 2012, air travel, cosmetics, furniture and luxury goods will grow.
increasing by 1 per cent over 2011 with sales projected to ●● Innovation. Businesses can grow their markets through the

increase by 3 per cent. Some forecasters reckoned growth to process of innovation. They can create new wants and needs
2018 would reach 4 per cent per year, with sales reaching over and meet them with new products. A lot of innovation emerges
1 trillion US dollars. Factors for growth in packaging include through technological research and development. The arrival
increasing urbanisation, investment in construction and housing, of smartphones, tablets, the internet, 3D printing, driverless
development of retail chains, and the expanding cosmetics and cars, wearable technology and space travel have all created
healthcare sectors in the emerging economies. brand-new markets that did not exist before the technological
Some markets are in decline. For example, the market for breakthroughs. However, innovation can take other forms.
coal in the UK has fallen sharply since 1970. Markets often Businesses can use clever marketing techniques to develop
decline because the need for a product ceases to exist. In the new wants. They can supply their products in new locations
case of coal, other fuels, such as oil, gas, nuclear and renewable – for instance supermarkets offering a click & collect service
sources are now preferred by households and industry. at London tube stations. New businesses can cash in on the
inadequacies of others. For example, since the ‘credit crunch’
The nature of markets: Many markets are in a state of flux. in 2008, new businesses have been set up to compete with
This means that the structure and nature of the market is subject banks. Crowd funding and peer-to-peer websites have started
to constant change. For example, in many markets products to provide unsecured loans. At the moment their market shares
are constantly updated, modified and re-launched – the choice are relatively small. But if they prove successful the established
available increasing enormously over time. This is the result of banks will have to match these new innovations.
new entrants into the market and existing firms widening their ●● Social changes. Changes in society can have a big impact

ranges and extending their lines. For example, the restaurant on markets. For example, the decline in the number of
market in the UK, worth around £40 billion in 2014, has seen marriages, an increase in the proportion of working women
many changes. In the 1960s, the industry was dominated and the growth in the number of one-parent families have
by fish and chip shops, the occasional Chinese restaurant, increased the market size for childcare and housing.
cafés, independents and hotel restaurants. Today the sector is ●● Changes in legislation. New laws can affect markets.

large and diverse. Restaurants range from top-end fine-dining For example, environmental legislation has helped to foster
establishments to quick service takeaway outlets. UK high growth in renewable energies and ‘green goods’. Tighter laws
streets tend to be dominated by chains, such as Nando’s, Prezzo relating to payday lending has resulted in many firms leaving
and Domino’s Pizza, and café chains, such as Costa Coffee the market. A ban on tobacco advertising in the UK might
and Caffè Nero. There has been a significant development of have reduced the market size for cigarettes.
4
 Marketing and people

●● Demographic changes. Changes in the structure of the Develop a niche: If a market is in decline and a business is
population can affect the size of markets. In most countries unable to diversify, it may survive by serving a niche. A niche
the population is aging. This will help a lot of markets to grow strategy is appropriate if groups of loyal customers can be
because populations get bigger. But there will also be an served profitably. For example, Harley-Davidson survived by
increase in the markets for specialist holidays for the elderly, leaving most of the motorcycle market to the Japanese. They
healthcare, care homes and mobility aids. sold high-horsepower ‘hogs’ to a small segment of motorcycle
enthusiasts. As a result they became quite profitable and
Adapting to change survived. Generally, if firms cannot adapt quickly to the changing
If businesses do not adapt to market changes, they are likely needs of customers, they will lose out to rivals that do adapt.
to lose market share. At worst they could collapse. In 2014,
it was reported that Tesco was losing market share to other How competition affects the market
supermarkets. There were a number of reasons for this, but Competition is the rivalry that exists between businesses in a
several reports suggested that they were failing to meet market. It would be rare for a business to operate in a market
customer needs. They were losing market share to the big where there was absolutely no competition. The existence
discounters such as Aldi and Lidl. There was a need for Tesco of competition will have an impact on both businesses and
to adapt quickly, or risk losing more of their market share. What consumers in the market.
might help businesses adapt to market changes?
Businesses: Competition puts businesses under some
Flexibility: Businesses need to be prepared for change. One pressure. It means that they have to encourage customers to
way is to develop a culture of flexibility within an organisation. buy their products in preference to those of rivals. They will
A business might need flexible working practices, machinery use a range of methods to attract customers. These methods
and equipment, pricing and staff. This could mean that staff have include:
to be trained in a variety of skills and be prepared to change ●● lowering prices

the tasks they undertake in the workplace. This might help ●● making their products appear different to those of rivals

businesses to serve customers more effectively when changes ●● offering better quality products

occur. For example, if customers want access to the business ●● using more powerful or attractive advertising or promotions

during the evening, then staff might have to work shifts. If ●● offering ‘extras’ such as high-quality customer service.

businesses have flexible operations it will be a lot easier for All of these methods cost money and generally reduce the
them to adapt to market changes. amount of profit a business can make. However, businesses
have to use such methods in order to survive in the market.
Market research: Businesses must keep in touch with Because competition makes running a business more
developments in the market. One way to do this is to undertake challenging and reduces the profit potential, owners and
regular market research. This might be aimed at current customers managers might try to reduce competition in the market. One
or potential customers. Firms need to be aware of any changes way of doing this is to take over their rivals. This might be
in customer needs or tastes. Communication with customers and achieved by purchasing a rival in the market. Alternatively, they
potential customers should be an ongoing process if firms want to might try to create obstacles that make it difficult for others to
keep completely up to date. Market research is discussed in Unit 2. enter the market. For example, they may spend huge amounts
of money on advertising, which potential entrants might struggle
Investment: Those businesses that invest in new product to match. It is generally the larger businesses in the market
development are likely to survive for longer in the market. which are able to reduce competition in this way. However, there
Although expenditure on research and development is is a range of legislation which prevents businesses restricting
expensive, a failure to innovate could be costly. A unique new competition using practices that are considered unfair.
version of a product or a brand-new model could rejuvenate
sales and help win a larger share of the market. In the car Consumers: Consumers will generally benefit from competition
industry, firms spend very large sums of money in product in markets. In markets where there are lots of businesses
development. BMW has enjoyed a larger slice of the small car competing with each other, there will be more choice. Most
market by extending the range of its Minis. Investment might people enjoy having lots of choice because it makes their life
also be needed in training and use of flexible machinery. more interesting. For example, when people buy a car they can
choose from a huge range of different models, styles, colours
Continuous improvement in the increasingly and endless variations in specifications. Consumers may also
competitive environment: Businesses need to make continual enjoy better quality products and lower prices.
improvements in all aspects of their operations. For example, if In the absence of competition consumers might be exploited.
they can improve efficiency, costs will be lower and prices can be A business with little or no competition might raise prices and
held or reduced. If customer service is flawless, customers are restrict choice. They will lack the incentive to innovate. For
more likely to return. If new product ideas are encouraged, they example, they are unlikely to invest money to develop new
may gain a competitive edge. A culture of continuous improvement products. Consequently, one of the roles of a government is to
can help businesses be more adaptable in the market. ensure that competition exists in markets.

5
The market Unit 1

The difference between risk and ●● consumer tastes might change as a result of a new social trend
the government might introduce a new policy or piece
uncertainty ●●

of legislation
One of the challenges when running a business is dealing with
●● some new technology might be invented
risk and uncertainty. Although both risk and uncertainty are likely
●● there may be a natural disaster such as a flood
to pose threats to a business, they are not the same.
●● the economy might go into recession.

Unfortunately, such influences are very difficult to predict. This

Risk: Owners take risks when running a business. This means means that businesses have to operate all of the time in an
they take actions where the outcomes are unknown. More
environment of uncertainty.
specifically, they commit resources that could be lost. Initially,
However, the consequences of uncertainty are not always
they take a risk when setting up a business. This is because they
negative. For example, new technologies can provide new
invest their own money to get the business ‘up and running’ and
opportunities. The introduction of the internet has resulted in an
there is a chance that the business will not succeed. If the worst
enormous range of new business opportunities. Generally though,
happens and the business collapses it is possible that all the
businesses do not like uncertainty. It makes decision making more
money invested by the owner is lost.
difficult – particularly when making investments for the future.
In the UK, around 23,000 businesses each year are
expected to fail. It is also reckoned that about 90 per cent of all Key terms
new businesses do not survive beyond five years.
Brand name – a name, term, sign, symbol, design or any
other feature that allows consumers to identify the goods
and services of a business and to differentiate them from
those of competitors.
E-commerce – conducting business transactions online.
Online retailing or e-tailing – the retailing of goods online.
Market – a set of arrangements that allows buyers and
sellers to communicate and trade in a particular range of
goods and services.
Marketing – a management process involved in identifying,
anticipating and satisfying consumer requirements profitably.
Market share – the proportion of total sales in a particular
market for which one or more businesses or brands are
responsible. It is expressed as a percentage and can be
calculated by value or volume.
Mass market – a very large market in which products with
mass appeal are targeted.
Niche market – a smaller market, usually within a large
market or industry.

Even when businesses are established, they may continue to Knowledge check
take risks. This is because they often spend money on ventures
that may not yield positive results. For example, they may invest 1. What is the difference between a mass market and a
in a new product which subsequently fails in the market. If the niche market?
product is withdrawn, most of the money spent on development 2. What is a key advantage of selling in a mass market?
and launch will be lost.
In 2014, Amazon, the online retailer, launched a mobile 3. State two disadvantages of selling in a niche market.
phone called the Amazon Fire Phone. It failed in the market and 4. How is market share calculated?
the price was reduced very quickly from $199 to just 99 cents.
5. State three advantages of giving products brand names.
It was reported that Amazon lost $170 million as a result.
6. State two advantages to customers of online retailing.
Uncertainty: The markets in which businesses operate are 7. What is meant by a dynamic market?
often subject to external influences. This means that events
which are completely beyond the control of businesses can have 8. How might the nature of a market change over time?
an impact in the market, which can have financial consequences. 9. State three reasons why a market might grow.
For example:
10. Describe two ways a business might adapt to changes
●● a new competitor might enter the market with a
in markets.
superior product

6
 Marketing and people

Case study
Figure 2

HYBRID AND
UK sales of electric vehicles between 2010 and 2014
Sales
55,000

ELECTRIC CARS 50,000

45,000
40,000
Growing concerns about the environment, and agreements 35,000
by many countries in the world to cut carbon emissions, 30,000
25,000
have helped to encourage sales of hybrid vehicles, electric 20,000
cars and other alternatively fuelled vehicles (AFVs). A hybrid 15,000
vehicle is one that uses two or more power sources. Hybrid 10,000
electrical vehicles (HEVs) combine an internal combustion 5,000
0
engine and an electric motor. These vehicles are now 2010 2011 2012 2013 2014
beginning to grab market share from traditional petrol and Key Year

diesel models. Petrol/electric hybrid

Diesel/electric hybrid
It was reported by the Society of Motor Manufacturers Other electric (plug-in hybrid/range extender)
Pure electric
and Traders (SMMT) that 9,955 AFVs were registered in
September 2014, a 56 per cent rise on the same time in 2013. www.smmt.co.uk
This accounted for 2.3 per cent of the total market –
a 44 per cent year-on-year rise. for recharging batteries. In 2014 awareness about the locations
An SMMT spokesman said the AFV market is seeing the of recharging facilities was not yet widespread. Figure 2 shows
benefit of more models coming on to the market – in UK sales of electric vehicles between 2010 and 2014. Figure 3
2014 there were more than 20 plug-in vehicles available shows oil prices from 2000 to 2014.
compared to six in 2011, ranging from hatchbacks and Sources: adapted from www.smmt.co.uk and
saloons to sports utility vehicles (SUVs) and sports cars. www.blueandgreentomorrow.com
Of the 9,955 AFVs registered in September 2014, 3,090
were eligible for the government’s plug-in grant that (a) What is meant by market share? (2 marks)
offered up to £5,000 off the cost of a pure-electric or plug-
(b) Explain one reason why the global car market is likely to
in hybrid vehicle. The volumes started off small, but with
grow in the next five years. (4 marks)
the government investing £500 million in supporting the
market and car makers unveiling an even wider range of (c) Assess how a car manufacturer might adapt to changes in
models, the direction of travel is increasingly clear. the market. (8 marks)
One of the barriers to rapid growth in the market is uncertainty (d) Assess the factors that might affect the growth of the hybrid
about supporting infrastructure – stations that provide facilities and electrical vehicles markets in the future. (12 marks)

Figure 3
Crude oil price
Oil prices from 2000 to 2014 69.31 USD/bbl
4 December 2014
180
160
140
Crude oil price (USD/bbl)

120
100
80
60
40
20
0
May 22 Dec 24 Jul 31 Mar 7
2000 2004 2009 2014
Source: www.infomine.com

7
 2 Market research 1.1.2
Theme 1

Key points
1. Product and market orientation.
2. Primary and secondary market research data (qualitative and quantitative) used to identify and
anticipate customer needs and wants, quantify likely demand and gain insight into consumer behaviour.
3. Limitations of market research, sample size and bias.
4. Use of ICT to support market research: websites, social networking and databases.
5. Market segmentation.

production of other goods, has to produce a final product which

Getting started
exactly matches a technical specification. However, because
In 2014, Alok Hossain decided to set up a Bangladeshi of increased competition, such firms are being forced to take
takeaway food service in Great Harwood, Lancashire. Before he consumers’ needs into account. The technical specification to
started trading he gathered information about the market for which a machine-tool business produces might be influenced by
takeaway food in the town. He spent a lot of time finding out what customers want, for example.
about competitors. He found out about the: Product-orientated businesses thus place their emphasis on
developing a technically sound product, producing that product
• number and location of takeaway restaurants in Great Harwood
and then selling it. Contact with the consumer comes largely
• menus and prices charged
at this final stage. There will always be a place for product
• opening times orientation. A great deal of pure research, for example, with no
• advertising and promotions used regard to consumers’ needs, still takes place in industry, as it
• additional services offered such as delivery does in the development of pharmaceuticals.
• speed of service
• types of customers who bought Bangladeshi cuisine. Market orientation: A business that is market orientated
The information gathered by Alok was very helpful. For example, is one which continually identifies, reviews and analyses
he found that one of the main criticisms of current takeaways consumers’ needs. It is led by the market. A market orientated
was the slow speed of service. When Alok opened Chittagong business is much more likely to be engaged in effective
Paradise his speed of service was a unique selling point. marketing if it is market orientated. Henry Ford was one of the
first industrialists to adopt a market orientated approach. When
Why would it have been a mistake for Alok not to carry out the Ford Motor Company produced the Model T, it did not just
research? Alok used primary or field research. What does design a car, produce it as cheaply as possible, and then try
this mean? Is market research expensive? What might be the to sell it to the public. Instead, in advance of production, Ford
limitations of Alok’s research? identified the price at which he believed he could sell large
numbers of Model Ts. His starting point was the market and
the Model T became one of the first ‘mass-market’ products.
Product and market orientation This illustrates the market orientated approach – consumers are
Some businesses are said to be relatively product orientated
central to a firm’s decision making. Sony is one of many modern
or market orientated.
businesses that has taken a market orientated approach. The
iPhone® 6 by Apple is an example of a product being developed
Product orientation: Many businesses in the past, and
in response to the wishes of consumers.
some today, could be described as product orientated. This
A more market orientated business may have several
means that the business focuses on the production process
advantages over one which is more product orientated.
and the product itself. It puts most of its efforts into developing
●● It can respond more quickly to changes in the market
and making products which it believes consumers want and
because of its use of market information.
which will sell well.
●● It will be in a stronger position to meet the challenge of new
In the past, businesses producing radios and televisions
competition entering the market.
could be said to have been relatively product orientated. It was
●● It will be more able to anticipate market changes.
their novelty and the technical ‘wonder’ of the product that sold
●● It will be more confident that the launch of a new product will
them. There were few companies to compete against each other,
be a success.
and there was a growing domestic market. There were also few
What effect will taking a market orientated approach have on a
overseas competitors. The product sold itself.
business? It must:
Some industries today are still said to be product orientated.
●● consult the consumer continuously (market research)
The machine-tool industry, which produces machines used in the
8
 Marketing and people

●● design the product according to the wishes of the consumer

●● produce the product in the quantities that consumers want
Figure 1
to buy Product vs market orientation
●● distribute the product according to the buying habits and

delivery requirements of the consumer

More product orientated More market orientated
●● set the price of the product at a level that the consumer is

prepared to pay.
The business must produce the right product at the right
Examples Examples
price and in the right place, and it must let the consumer know Coal mining business Clothing retailer
that it is available. This is known as the marketing mix. Wheat farmer Soap powder manufacturer
The adoption of a market orientated approach will not Water supply business Supermarket chain
always guarantee success. Many well-researched products
have been failures. Coloroll was a business which started in
the wallpaper market and expanded into home textiles and soft
furnishings. Its attempt to enter the DIY burglar alarm market, Question 1
however, was a failure. The company’s reputation and design
skills had little value in that section of the DIY market compared AstraZeneca is a large British-Swedish pharmaceuticals company,
with other companies, whose reputations were based on home which serves the global market. It focuses on particular areas of
security or electronics. Whether a business places a greater healthcare, including treatments for cancer and heart diseases.
emphasis on the product or on the market will depend on a The company has around 57,500 employees globally and has
number of factors. manufacturing sites in 16 different countries. In 2014, its total sales
revenue was just over $26 billion.
The nature of the product: Where a firm operates in an The UK is the major location for AstraZeneca’s research and
industry at the edge of new innovation, such as bio-technology,
development of new medicines. One research and development
pharmaceuticals or electronics, it must innovate to survive.
(R&D) centre in Alderley Park plays a vital role in their strategy
Although a firm may try to anticipate consumer demand,
as the lead centre for cancer research. The site houses the
research is often ‘pure’ research, i.e. the researcher does not
Advanced Lead Discovery Centre, which has innovative
have a specific end product in mind.
compound management and high throughput screening facilities
Policy decisions: A business will have certain objectives. to assist with the drug discovery process. AstraZeneca is one of
Where these are set in terms of technical quality or safety, the the world’s largest spenders in R&D. Figure 2 shows the amount
emphasis is likely to be on production. Where objectives are in spent on R&D between 2006 and 2013.
terms of market share or turnover, the emphasis is likely to be
on marketing. Figure 2
AstraZeneca R&D expenditure 2006–2013
The views of those in control: An accountant or a
($ million)
managing director may place emphasis on factors such as
cash flow and profit forecasts, a production engineer may give 6,000
5,523
5,162 5,179 5,138 5,243
technical quality control and research a high priority and a 5,000
4,821
marketing person may be particularly concerned with market 4,409
3,902
research and consumer relations. 4,000

3,000
The nature and size of the market: If production costs
are very high, then a company is likely to be market orientated. 2,000
Only by being so can a company ensure it meets consumers’
needs and avoid unsold goods and possible losses. 1,000

0
The degree of competition: A company faced with a 2006 2007 2008 2009 2010 2011 2012 2013
lack of competition may devote resources to research with Year
little concern about a loss of market share. Businesses in Source: www.statista.com
competitive markets are likely to spend more on marketing for
fear of losing their share of the market. (a) Comment on the pattern of R&D expenditure shown in Figure 2.
The distinction between product and market orientation
(b) Explain one benefit to AstraZeneca of being product orientated.
can be seen as a spectrum, as in Figure 1. Most business are
(c) Assess to what extent AstraZeneca is product orientated.
somewhere along the spectrum. For example, supermarkets
may be more market orientated and a copper mining company
more product orientated.

9
Market research Unit 2

Market research ●● whether customers take out holiday insurance

Market research involves gathering, presenting and analysing ●● how people travel to the airport.
information about the marketing and consumption of goods and Getting an insight into how people behave will help a business
services. Businesses spend money on market research because to meet customer needs more effectively. This is qualitative
it helps to reduce the risk of failure. Products that are well data and might also help them to identify new opportunities.
researched are more likely to be successful. Market research Businesses can use a number of different methods to gather
data can be used for the following specific purposes. market research data. Some of these methods are explained in
detail below.
Identify and anticipate customer needs and wants:
Businesses will benefit if they can clarify the specific needs and
Primary research
Primary research or field research involves collecting primary
wants of consumers. In order to design products that are likely
data. This is information which did not exist before the research
to sell, they need to identify as precisely as possible the product
began. In other words, it has to be collected by the researcher.
features that people desire. For example, a car manufacturer
It can either be carried out by a business itself or by a market
will need to find out which product features are important to
research agency. Because of the high costs of using the services
potential customers. Examples include:
of a market research agency, many small businesses choose to
●● body design and style
conduct market research themselves.
●● colour
Most primary information is gathered by asking consumers
●● interior design and style
questions or by monitoring their behaviour. The most accurate
●● economy
way to do this would be to question or observe all consumers
●● ease of maintenance
of a particular product (known as the population). However, in
●● durability
all but a few instances this would be either impractical to carry
●● performance (e.g. acceleration and top speed).
out or expensive. It is usual to carry out a survey of a sample of
The data that market researchers gather need to be as
people who are thought to be representative of the total market.
comprehensive as possible so that all the needs and wants are
identified. This data will be qualitative. This is explained later
in the unit.
Methods of primary research
Some of the main methods of gathering data are discussed
briefly below.
Quantify the likely demand for a product: It is important
to find out how much of a product a business might expect to
Questionnaires: A questionnaire is a list of written questions.
sell in a market. This data will be quantitative. This is discussed
They are very common in market research and are used
in detail later in the unit. One reason for this is to help determine
to record the views and opinions of respondents. A good
whether or not a particular product is going to be commercially
questionnaire will display the following qualities.
viable. If market research finds that demand is inadequate, a
●● Have a balance of open and closed questions.
business might cancel the launch of a product. This could save
o Closed questions allow respondents a limited range of
the business a lot of money. This is one of the reasons why
responses. An example would be ‘How many times have
businesses carry out research.
you flown with Emirates this year?’ The answers to closed
Assuming that demand is adequate, a business will need
questions are easier to analyse and represent numerically.
to know how much it should produce. Once demand has been
o Open questions let people say whatever they want. They
quantified a business can plan production of the product. This
do not have to choose from a list of responses. Open
means that it can start to organise the resources that will be
questions are best used if there are a large number of
needed for production and draw up production schedules.
possible responses. An example would be ‘How would you
For example, it might need to recruit more staff to work in the
improve the quality of service provided by Emirates?’
factory and co-ordinate with different departments to ensure that
●● Contain clear and simple questions. Questions must be clear,
the necessary resources can be acquired.
avoiding the use of jargon, poor grammar and bad spelling.
●● Not contain leading questions. Leading questions are those
Provide an insight into consumer behaviour: Some that ‘suggest’ a certain answer. They should be avoided
market research is aimed at analysing consumer behaviour.
because otherwise the results will be biased.
Businesses might be more successful if they can identify and
●● Not be too long. If questionnaires are too long people will not
understand patterns of consumer behaviour. For example, a
give up their time to answer them.
holiday company selling package holidays abroad might use
market research to find out:
Questionnaires can be used in different situations.
●● when consumers book their holidays
●● Postal surveys. Questionnaires are sent out to people and
●● when consumers are most likely to go on holiday
they are asked to complete them in their own time. They
●● the number of holidays people take each year
may be more convenient for people but the vast majority of
●● which methods consumers use to book their holidays, e.g.
questionnaires are never returned. This means that resources
online or travel agent
are wasted.
●● how much money people spend on holiday

10
 Marketing and people

●● Telephone interviews. The main advantage of interviewing External data: Secondary data will also be available from
people over the telephone is that it is cheaper. People from sources outside the business. Individuals or other organisations
a wide geographical area can be covered. However, some will have collected data for their own reasons. A business might
people do not like being telephoned by businesses. be able to use this for its own market research. Examples are
●● Personal interviews. These are often carried out in given below.
the street and the interviewer fills in the answers. The ●● Information from competitors. This may be, for example, in

advantage is that questions can be explained if a respondent the form of promotional materials, product specifications or
is confused. It may be possible to collect more detailed price lists.
information. However, many people do not like being ●● Government publications. There are many government

approached in the street. publications that businesses can use. These include general
●● Focus groups or consumer panels. If a business wants statistical publications such as Social Trends, the Census of
very detailed information from customers it might use focus Population and the Annual Abstract of Statistics. Many are
groups or consumer panels. A focus group is where a now online.
number of customers are invited to attend a discussion led ●● Data from customer services on complaints which have been

by market researchers. The group must be representative received about a product.

of the whole population and be prepared to answer detailed ●● The European Union. The EU now provides a wide range of

questions. This is a relatively cost-effective method of secondary data which can be highly valuable to businesses
collecting information but the group may be a little small. operating within EU countries. Such publications include
Consumer panels are similar to focus groups except that Eurostatistics, which is published by Eurostat (the Statistical
groups of customers are asked for feedback over a period of Office of the European Union).
time. This approach allows businesses to see how consumers ●● International publications. There is a huge amount of

react to changes in their products. information about overseas marketing published each year by
●● Observation. This is where market researchers ‘watch’ the organisations such as the World Bank and the International
behaviour of customers. This approach might be used in Monetary Fund.
retail outlets. Observers might record the amount of time ●● Commercial publications. A number of organisations exist to

customers spend looking at particular products and displays gather data about particular markets. This information is often
in the store. However, because there is no feedback when highly detailed and specialised. Mintel, Dun & Bradstreet and
using this method a lot of questions go unanswered. Verdict are examples of such organisations.
●● Test marketing. This involves selling a new product in a ●● Retail audits. The widespread use of EPoS (electronic

restricted geographical area to test it before a national launch. point of sale) has meant that it is now much easier to
After a period of time feedback is gathered from customers. collect detailed and up-to-the-minute data on sales in
The feedback is used to make modifications to the product retail outlets such as supermarkets and other retail chains.
before the final launch. This reduces the risk of failure. Retail audits provide manageable data by monitoring and
recording sales in a sample of retail outlets. Businesses
Secondary research find these audits especially helpful because of the way
Secondary research or desk research involves the collection of in which they provide a continuous monitoring of their
secondary data. This is information which already exists in some performance in the market. A well-known example is data
form. It can be internal data, from records within the business, or on the best-selling CDs which make up weekly music
external data, from sources outside the business. charts. The data to compile the official charts is drawn
from a highly complex tracking service representing
Internal data: This may be collected from existing business one of the most sophisticated ongoing market research
documents or other publications, including the following. programmes anywhere in the world. Traditionally, this data
●● Existing market research reports.
has been limited to sales of vinyl and CDs – but this has
●● Sales figures. The more sophisticated these are the better.
been enhanced with the addition of digital download sales
For example, sales figures which have been broken down (of singles and albums) and also streaming information –
according to market segments can be particularly useful. which was added to the singles chart in July 2014 and the
●● Reports from members of the sales force resulting from
official albums chart in February 2015.
●● General publications. A business may use a range of
direct contact with customers.
●● Annual report and accounts published by businesses.
publications widely available to members of the public for
●● Businesses increasingly make use of company intranets
its market research. These include newspaper and
to provide up-to-date information. These are restricted to magazine articles.
●● Internet website pages. Increasingly businesses make use of
company employees. But some information may be available
on the internet on company websites. the internet to search for secondary data outside of their own
●● Stock movements. These can often provide the most up-to-
organisations. Many of the sources of secondary information
date information on patterns of demand in the market. This above (including, for example, government publications) can
is because they are often recorded instantly, as opposed to now be found on the internet.
sales figures, which tend to be collected at a later date.

11
Market research Unit 2

Quantitative and qualitative research ●● Human behaviour. Much marketing research depends upon
Data collected through desk and field research can be either the responses of consumers who participate in the collection
quantitative or qualitative in nature. Qualitative research involves of primary data. While the responses of consumers may be
the collection of data about attitudes, beliefs and intentions. Focus honest and truthful at the time, it does not mean that they
groups and interviews are common methods used to collect will necessarily respond in the same manner in future. This is
qualitative data. An example of qualitative research could be because all human behaviour, including the act of consuming
face-to-face interviews with 100 purchasers of new Land Rover and purchasing goods, is to some extent unpredictable.
●● Sampling and bias. When carrying out market research,
Discoveries to find out why they prefer this product to similar
four-wheel drives sold by other car manufacturers. The information it is usual to base the research upon a sample of the total
collected through qualitative research is usually regarded as being population. This is because it would be impossible and costly
open to a high degree of interpretation. This means that there are to include every person when dealing with a large population.
often disagreements within businesses about the significance and It is possible, however, that results from the sample may be
importance of qualitative research data. different from those that would have been obtained if the
Quantitative research involves the collection of data that whole population had been questioned. This is known as a
can be measured. In practice this usually means the collection of sampling discrepancy. The greater the sampling discrepancy,
statistical data such as sales figures and market share. Surveys the less reliable the data obtained.
●● As mentioned earlier, questionnaires need to be carefully
and the use of government publications are common methods of
collecting quantitative research data. An example of quantitative constructed to avoid the problem of encouraging particular
research would be a survey of four-wheel drive owners in responses from consumers through the use of leading
West Derbyshire to establish their places of residence, ages, questions. Similarly, the behaviour of interviewers can affect
occupations, incomes and gender. The information collected the outcome of interviews.
through quantitative research is usually regarded as being open to Businesses must also be careful when using secondary data.
less interpretation than that collected through qualitative research. For example, businesses may use a government publication to
estimate the size of markets in which they might wish to operate.
Limitations of market research However, these market sizes may not always accurately match
If market research was totally dependable, businesses could use the product market being researched.
it when introducing or changing products and be completely
confident about how consumers would respond to them. This Use of ICT to support market research
would mean that all new products launched onto the market, Developments in information and communications technology
which had been researched in advance, would be a success. (ICT) have had an impact on the way businesses carry out
Similarly, no products would flop because businesses would market research. ICT can provide support in a number of ways.
receive advance warning from their research and take any
necessary measures. Company websites: These can be used to provide access
In reality, things can be different. It has been estimated that 90 to online surveys. These are similar to postal surveys except
per cent of all products fail after they have been initially launched. respondents may be directed to a questionnaire after receiving
Some of this may be put down to a lack of, or inadequate, market an email confirming an online transaction, for example. Online
research. However, a number of businesses that have conducted surveys may be more sophisticated because they are flexible
extensive research among consumers before committing a and can be tailored to the responses of individuals – for instance
product to the market place have launched products which have if someone responds ‘yes’ to a particular question the survey
failed. Given estimates which suggest that the minimum cost of can then take them to a further set of questions, and if ‘no’ it
launching a new product nationally is £1 million, this is a risky takes them to a different set of questions. They are cheap to
business. Famous examples of thoroughly researched products administer and can be made available to respondents 24/7.
which have turned out to be flops include the Sinclair C5, a cheap However, many people still ignore them.
vehicle with more stability than a moped and lower costs than a Some businesses have review systems on their websites.
car. In research, consumers enthused over this vehicle. In reality, These allow customers to write accounts of their experiences
it was almost impossible to sell. Similarly, when the Coca-Cola after buying or consuming a product or service. TripAdvisor, the
Company launched ‘New Coke’ with a new formula flavour onto online hotel booking site, offers such a facility. Not only can a
the market, research suggested it would be a huge success. In business collect information from their own customers, but they
practice, ‘New Coke’ was quickly withdrawn from the shops. can also look at the reviews of rivals’ customers.
Businesses want to be sure that the data they collect is A business can also carry out secondary research by
reliable. One way of checking the reliability of data is to pose gathering data from the websites of rivals. By analysing the
the question, ‘If this information was collected again would the websites of competitors a wide range of information can be
same or broadly similar results be obtained?’ Businesses acting gathered very easily and cheaply. For example, information
upon research data need to be sure that they can depend upon about prices charged, product ranges, delivery terms, payment
it. There is a great deal of debate among researchers about the terms, store locations, details of special offers and useful links
reliability of different research methods. There are a number of that might provide even more information. A business might also
reasons why primary research does not always provide reliable use comparison websites to identify the cheapest suppliers in
information for businesses. the market.
12
 Marketing and people

Social networking: Few businesses can afford to neglect Databases

the role social media can play in marketing. A very fast A database is really an electronic filing system. It allows a
growing number of businesses make use of social media great deal of data to be stored. Every business which uses
platforms such as Facebook, Twitter, YouTube, blogs and computers will compile and use databases. The information
coupon sites. Social media can provide a cost-effective and is set up so that it can be updated and recalled when
in-depth tool for gaining insights into a firm’s customers, needed. Table 2 shows part of a database of a finance
market, brand appearance and other important market company which gives details about their clients. The
research aspects. collection of common data is called a file. A file consists of
For example, most social media platforms offer numerous a set of related records. In Table 2 all the information on
ways to analyse trends and conduct market research. By Jane Brown, for example, is a record. The information on
simply searching the latest posts and popular terms, it is each record is listed under headings known as fields, e.g.
possible to gain insight into emerging trends and see what name, address, age, occupation, income each year. A good
customers are talking about in real-time. One example of this database will have the following facilities.
is conducting hashtag searches on Twitter. By setting up a few ●● User-definable record format, allowing the user to enter
searches with hashtags related to a specific brand, industry or any chosen field on the record.
product, instant notifications can be received when customers, ●● File-searching facility for finding specified information
clients or competitors use key terms. from a file, e.g. identifying all clients with an income
One of the biggest weaknesses to most marketing over £33,000. It is usually possible to search on more
research methods is that they are driven by questions. To than one criterion, e.g. all females with an income over
obtain the proper information, you must first know what £33,000.
to ask. At the same time, simply rewording a question ●● File sorting facility for rearranging data in another
can result in drastically different answers. This means that order, e.g. arranging the file in Table 2 in ascending
market research is only as good as the questions used. order of income.
With the broad scope and interactive nature of social media, ●● Calculations on fields within records for inclusion
information is gained through interaction and observation. in reports.
Instead of leading the discussions, businesses can simply In the world of business and commerce there is actually
observe or join in as an equal. This can result in a variety of a market for information held on databases. It is possible
answers and discoveries that might have remained hidden to buy banks of information from market researchers who
using other research methods. have compiled databases over the years. Names and
Table 1 summarises the advantages of using social media addresses of potential customers would be information well
for market research. worth purchasing if it were legally available. The storage
of personal data on a computer is subject to the Data
Table 1 The advantages of using social media for market Protection Act. Any company or institution wishing to store
research personal data on a computer system must register with the
Broad reach It can reach millions of people all around the world. Data Protection Office. Individuals have a right under the Act
to request details of information held on them.
Ability to Social media allows specific groups of people to be
target targeted. Table 2 An extract from a simple database
Free or The use of social media may be free for businesses and Surname First Address Town Age Occupation Income
low cost paid options are usually cheap. name p.a.
It allows communication on a personal basis with Adams John 14 Stanley St Bristol 39 Bricklayer £32,000
Personal individual customers and groups.
Appaswamy Krishen 2 Virginia St Cardiff 23 Welder £26,000
Information can be collected very quickly from large
Fast numbers of people. Atkins Robert 25 Liverpool Rd Cardiff 42 Teacher £32,000

High level IT skills and complex equipment are not Biddle Ron 34 Bedford Rd Bath 58 Civil servant £35,000
Easy needed.
Brown Jane 111 Bold St Newport 25 Solicitor £41,000

13
Market research Unit 2

Question 2
Some businesses use online surveys to gather data. This involves The sample of respondents may not be representative. This is
providing a link to a questionnaire on a company website and because online surveys are only presented to internet users. The
inviting people to complete it. An online questionnaire can views of others may not be taken into account even though they
be completed quickly and responses can often be analysed may be potential customers.
immediately. Survey costs are low because there are no printing Some businesses are keen to find out what customers think of
and postage charges. Online surveys can be interactive and may their websites. They might use an online survey similar to the one
be fun to complete. They can also be accessed 24/7 and be shown in Figure 3.
completed when it is convenient. However, there are problems.

Figure 3
An example of a website survey

Website survey How did you find our site? Please select all that apply.
❏ Recommended by others
Thank you for using our website. We'd like to ask you some questions about
your experience so that we can improve. ❏ Link from email our site sent you
❏ Link from another website
We would like your feeedback about the content on our site. How satisfied are
you with the content? ❏ Link from marketing leaflet
❍ Very dissatisfied ❍ Dissatisfied ❍ Neutral ❍ Satisfied ❏ Search engine results
❍ Very satisfied ❏ Other, please specify
Please tell us how our site compares with similar sites for each of the items How frequently do you visit our site?
below If you did not experience an item, please select “N/A”.
❍ First choice ❍ Daily ❍ A few times per week
Much Worse About Better Much N/A
worse the better
❍ A few times per month ❍ Once per month ❍ Less frequently than
once per month
same
Overall organisation/ ❍ ❍ ❍ ❍ ❍ ❍ The next questions will only be used to group your answers with others
navigation 1 2 3 4 5 – like yourself.
Please tell us how you access the internet. Check all that apply.
Home page content ❍ ❍ ❍ ❍ ❍ ❍
1 2 3 4 5 – ❏ Home ❏ Cafe
Product information ❍ ❍ ❍ ❍ ❍ ❍ ❏ Work ❏ Mobile phone
1 2 3 4 5 –
❏ College ❏ Computer tablet (eg iPad)
Ease of finding how to ❍ ❍ ❍ ❍ ❍ ❍ ❏ LIbrary ❏ Other, please specify
contact us 1 2 3 4 5 –

Downloading information ❍ ❍ ❍ ❍ ❍ ❍ How long do you spend on the internet each day? Select a choice.
1 2 3 4 5 –
❍ 1–2 hours ❍ 3–4 hours ❍ More than 8 hours
How likely are you to recommend our site to others?
Please indicate your gender
❍ Definitely not ❍ Unlikely ❍ Neutral ❍ May be likely
❍ Very likely ❍ Male ❍ Female
What prompted you to visit our site today? Please select all that apply. Please select the category that includes your age.

❏ Comparison shopping ❍ 18–30 ❍ 31–55 ❍ 56 or older

❏ Interested in purchasing products/services Which one of the following ranges includes your total yearly household
❏ Looking for contact information income before taxes?
❏ Looking for technical support ❍ up to £28,000 ❍ over £28,000
❏ Other, please specify ❍ Prefer not to answer
Submit Back

(a) Give one reason why it might be important to find out what people (c) Discuss the advantages and disadvantages of online surveys.
think of a business website.
(b) Explain whether an online survey would benefit a company selling
to: (i) customers in isolated areas (ii) less developed countries,
such as Ethiopia, Bhutan and Haiti.

14
 Marketing and people

Market segmentation more than other ethnic groups on leather goods, furniture,
Markets can be divided into different sections or market appliances and electronic equipment.
segments. Each segment is made up of consumers that have ●● Religion. Different religious groups can display different
similar needs. Businesses recognise this and target particular tastes. For example, Muslims do not eat pork or drink alcohol.
market segments with their products. In the US the market for kosher (Jewish) food is thought to be
●● Some businesses concentrate on producing one product for
worth $100 billion.
one particular segment, for example luxury cars targeted at a
very wealthy market segment in the car market. Table 3 Socio-economic groups
●● Some businesses produce a range of different products and % of UK
Social Social Head of household
target them at several different segments. population
grade status occupation
●● Some businesses aim their products at nearly all consumers.
(approx)
For example, large food manufacturers are likely to target Higher managerial, administrative
A Upper middle or professional – doctors, lawyers 4%
their brands at everyone. and company directors
However, by dividing markets into segments businesses can
Intermediate managerial,
more easily supply products that meet customers’ needs. B Middle class administrative or professional – 12%
teachers, nurses and managers
Geographic and demographic Supervisory or clerical and junior
segmentation C1 Lower middle managerial, administrative or 22%
class professional – shop assistants,
Geographic segmentation: Different customer groups are clerks and police constables
likely to have different needs depending on where they live. For Skilled manual workers –
example, groups living in hot climates, such as Australia or South Skilled
C2 working class carpenters, plumbers, cooks and 33%
Africa, will have different needs to groups living in temperate train drivers
climates such as the UK. There might also be differences between Semi-skilled and unskilled manual
groups living in different parts of the same country. For example, D Working class workers – fitters, window cleaners 19%
in India different regions have slightly different tastes in cuisine. and storekeepers
State pensioners or widows,
Demographic segmentation: It is common for businesses to E The poor casual or lower grade workers, or 10%
divide markets according to age, gender, income, social class, long-term unemployed
ethnicity or religion of the population.
●● Age. Infants, teenagers, young adults and the over 65s are all Psychographic segmentation
likely to have different needs because of their different ages. Geographic and demographic segmentation have limitations. For
Many products are targeted to different consumer groups on example, there is a wide variety of spending patterns among
the grounds of age. For example, clothes are produced in females aged 16–18 living in Manchester. Yet people in this
different styles for people in different age groups. consumer group share the same gender, age and location. An
●● Gender. Men and women are likely to be targeted by alternative way of grouping customers is through psychographic
businesses with different products. For example, producers segmentation. This groups customers according to their
of clothes, cars, magazines, toiletries and drinks target attitudes, opinions and lifestyles.
different products to different genders. ●● Sports products may be aimed at those who are interested in

●● Income. Incomes in most countries vary considerably. As a ‘extreme’ sports such as skiboarding.
result businesses target products at certain income groups. ●● Chocolate manufacturers have identified two categories of

For example, luxury watchmakers target products at very chocolate eaters. ‘Depressive’ chocolate lovers eat chocolate
high-income groups. In contrast, low-cost supermarket chains to unwind, predominantly during the evening. ‘Energetic’
target lower income groups. chocolate eaters eat chocolate as a fast food and live life at a
●● Social class. Businesses pay a lot of attention to different fast pace.
socio-economic groups. Such groups are usually based on ●● People’s attitudes to life may also be used to segment the

occupations. An example of a commonly used measure of market. Some pension funds are geared towards those who
social class is shown in Table 3. It is compiled by the Institute of only want investments in ‘ethical’ businesses.
Practitioners in Advertising (IPA) and divides social class into six ●● Clothes may be geared at those who are interested in ‘retro’

categories. These can be used by businesses to target products. fashions from earlier decades.
●● Ethnicity. Many countries in the world are becoming more ●● Travel companies target holidays at families with younger children.

cosmopolitan. This means that people from different ethnic ●● Certain newspapers are geared towards Labour voters, while

groups are likely to live in the same country. This is important others are geared towards Conservative voters.
for businesses because different ethnic groups are likely to One of the drawbacks of psychographic segmentation is that it
have different needs and tastes due to their different cultures. can be difficult for businesses to collect data about the beliefs,
For example, in Canada, where there are over 200 different attitudes and lifestyles of consumers. In order to do this they
ethnic groups, Chinese consumers are likely to spend may require the help of specialist businesses.

15
 Market research Unit 2

Behavioural segmentation Question 3

Behavioural segmentation attempts to segment markets
according to how consumers relate to a product. There are a In common with many airlines, Emirates offers three distinct
number of different methods of behavioural segmentation. services on most of their flights. For example, on 22nd June
2015, a flight from Manchester to Dubai was showing the
Usage rate: This is when consumers are categorised following services.
according to the quantity and frequency of their purchases. Economy class Price = £432.60
One example of this is British Airways, which established Business class Price = £2,349.60
an ‘Executive Club’ to encourage and develop the custom of First class Price = £3,237.60
regular business travellers.
(a) Describe the different customer groups targeted by Emirates in
this example.
Loyalty: Consumers can be categorised according to their
product loyalty. The Tesco Clubcard, for example, which offers (b) Discuss how Emirates might benefit from this method of market
discounts to regular customers of Tesco supermarkets, seeks to segmentation.
reward and encourage loyalty to Tesco and its products.

Time and date of consumption: Consumers often consume

particular products at particular times and dates. Businesses
Key terms
can take advantage of this in order to improve their marketing. Consumer panels – groups of customers are asked for
So, for example, manufacturers of breakfast cereals, while feedback about products over a period of time.
recognising that their product will be primarily consumed in the Database – an organised collection of data stored electronically
morning, encourage consumers also to consume their products with instant access, searching and sorting facilities.
in the evening. Similarly, many bars and clubs seek to encourage Focus groups – where a number of customers are invited to
different groups of consumers according to the night of the attend a discussion about a product led by market researchers.
week. For example, Thursday nights are often for older singles Market orientation – an approach to business which places
and Friday nights for younger consumers. the needs of consumers at the centre of the decision-making
Like other segmentation methods, a drawback of behavioural process.
segmentation is that on its own it may fail to adequately capture Market research – the collection, presentation and analysis
a target market for a business. For this reason, in many cases a of information relating to the marketing and consumption of
business might employ a variety of the segmentation methods goods and services.
explained above. So, for example, a manufacturer of luxury Market segment – part of a whole market where a particular
apartments may be interested in segments that included single customer group has similar characteristics.
Primary research or field research – the gathering of ‘new’
men or women with no children, in the 30–40 age range, with
information which does not already exist.
high incomes that fall into social class AB. Because of the likely
Product orientation – an approach to business which places
one-off nature of such a purchase, behavioural segmentation
the emphasis upon the production process and the product
would be less important in this instance. itself.
Qualitative research – the collection of data about attitudes,
Benefits of market segmentation beliefs and intentions.
Generally a business is more able to meet the needs of different
Quantitative research – the collection of data that can be
customer groups if the market is segmented. Some specific quantified.
advantages include the following. Respondent – a person or organisation that answers
●● Businesses that produce different products for different
questions in a survey.
market segments can increase revenue. For example, airlines Sample – a small group of people who must represent a
charge first class passengers many times more than they proportion of a total market when carrying out market research.
charge economy passengers for the same flight. This helps to Secondary research or desk research – the collection of
increase revenue from the flight. data that is already in existence.
●● Customers may be more loyal to a business that provides Socio-economic groups – division of people according to
products that are tailored specifically to them. social class.
●● Businesses can avoid wasting promotional resources by not

targeting products at customers that do not want them.

●● Some businesses can market a wider range of goods

to different customer groups. For example, many car

manufacturers have several different models, each of which is
targeted at a different segment.

16
 Marketing and people

Case study
MARKET RESEARCH ON
‘CLICK & COLLECT’ ORDERS
Mintel is the world’s leading market intelligence agency.
It provides a wide range of services in the field of market
research. For example, it carries out primary research,
analyses market data and market trends, and produces
specialist market research reports for its clients. Some of
Mintel’s reports can be purchased online and can cost up
to £2,500. The research data below about click & collect
orders was gathered by Mintel in 2014.
• Click & collect orders made up 15 per cent of all internet
retail sales of goods in 2014. The collection rate was
much higher for non-grocery orders than in groceries. • New click-and-collect fashion hubs are likely to drive up
online sales. In the survey, 80 per cent of consumers agreed
• In 2014, online retail sales were expected to contribute
that when shopping online it is difficult to tell if clothes will fit
to 11.6 per cent of all retail sales. This means, in turn,
– consumers aged under 35 see this as the main issue.
that click & collect orders would make up 1.7 per cent of
all retail sales in 2014. • 50 per cent of consumers (rising to 57 per cent of women)
said the hassle of returning goods through the post was
• The survey estimated that in 2015, 17 per cent of all
one of the main barriers to buying clothes online. 31 per
internet retail sales (or 2.2 per cent of all retail sales)
cent of consumers preferred to be able to return their online
would be collected by customers. In September 2014,
order to an actual store – and 23 per cent of UK consumers
Transport for London reported that it had processed
said that an option to deliver to a store to try on before
10,000 orders at its click & collect stations in the first
purchasing would encourage them to buy from one online
10 months of operation.
retailer over another.
• 35 per cent of UK consumers had used click & collect
Source: adapted from www.mintel.com
services in the previous year and 64 per cent said that
they shopped online more now because retailers offer
click & collect services. Furthermore, 58 per cent said (a) What is meant by primary research? (2 marks)
that click & collect encouraged them to visit stores
(b) Explain one benefit of using qualitative market research.
more frequently.
(4 marks)
• 60 per cent of UK consumers only used click & collect for
(c) Explain one way in which the data in the Mintel report
smaller items that were easy to carry, but 53 per cent said
might be used by retailers. (4 marks)
they would like drive-through points that offered click &
collect for a number of retailers – suggesting opportunities (d) Assess the usefulness of market research data, like the
to extend click & collect to heavier or bulkier items. above information, to retailers. (12 marks)

Knowledge check
1. How might market research reduce the risk in business? 7. Why might qualitative data be open to different
2. State two benefits that a market orientated business interpretations?
might enjoy. 8. How might a business use social media to conduct market
3. State three advantages of primary research. research?
4. What is meant by desk research? 9. Give three advantages of using online surveys.
5. State four sources of data for secondary research. 10. How might a business use databases for market research?
6. What is meant by quantitative market research? 11. What is meant by behavioural segmentation?
12. State two benefits of market segmentation.

17
 3 Market positioning 1.1.3
Theme 1

Key points
1. Market mapping.
2. Competitive advantage of a product or service.
3. The purpose of product differentiation.
4. Adding value to products and services.

Getting started those of competitors. For example, some shampoos claim to

The market for automobiles is very competitive. Consider the remove dandruff.
●● The attributes of the product. This is a common method
market for the cars below.
used to position products. For example, the slogan ‘M&Ms
melt in your mouth, not in your hand’ emphasises clearly an
attribute of this confectionery.
●● The origin of the product. In the market for cheese, the

names of many products are derived from where they were

originally manufactured. Examples might be Lancashire,
Munster, Gloucester, Wensleydale and Cheshire.
●● The classification of the product. The product name,

I Can’t Believe It’s Not Butter® may be a claim to position

margarine against butter, despite the fact that it is not butter.
As markets change in response to shifting consumer demand,
some businesses find they need to reposition their products.
This usually involves changing their target market, the features
of the product or the image of the product that distinguishes it
from those of rivals. For example, detergents originally designed
for washing babies’ nappies faced a sharp fall in demand when
To what extent are the two cars the same or different? What disposable nappies were introduced. However, some companies
might be the target markets for these two products? How might successfully repositioned their brand for a new use – being an
the manufacturers differentiate two products? How might one of ideal laundry detergent for tough stains.
the manufacturers try to gain a competitive edge over their rival?
Market mapping
The positioning of a brand is influenced by customer perceptions
Market positioning rather than by those of businesses. For example, a business
Market positioning is concerned with the perceptions may feel its brand is a high-quality, up-market product. But if
consumers have about products. To simplify the choice from a customers see it as low quality and down-market, it is their
vast array of products, consumers categorise them according views that will influence sales.
to a range of factors. Such factors include the quality, status So, if a business wants to find out where its brand is
and value for money of products. It is the categories into which positioned in the market, it might carry out market research. This
consumers place products that define their ‘position’. will help it to understand how customers see the brand in relation
Consumers often position a business’s products in relation to others in the market.
to those of its competitors. This can be in the form of ‘pecking A business may also wish to launch a new brand. Having
order’ or product ladder. Firms will plan marketing activities to decided the target market, market research might show
shape consumer perceptions and therefore achieve a desired what characteristics the brand must have to succeed in that
position. Some approaches that a business might use to position market. It could reveal the price that customers are prepared
its products are outlined below. to pay. It could also suggest what sort of promotional
●● The benefits offered by the product. For example, in the support will be needed. For example, will a national television
automobile market, some manufacturers emphasise safety, advertising campaign be used? Will promotion to retailers be
others the quality of work and style, and yet more value a better strategy?
for money. The results of market research can be displayed on
●● The unique selling point. The unique selling point or perceptual maps (sometimes also called market maps or
unique selling proposition (USP) of the product. This is the positioning maps). An example is shown in Figure 1. This
key aspect of the product or service that sets it apart from illustrates a perceptual map for a sample of motor cars.
18
 Marketing and people

Figure 1 Thinking bigger

A perceptual map for cars
From time to time there may be a need to reposition an entire company,
rather than just a product line. Reasons for repositioning an entire
company might be to deal with a tarnished image, to differentiate the
HIGHER PRICE
company from rivals, to clarify the company’s position, to create more
Bentley
Rolls Royce
Ferrari business opportunities or to increase the value of the company. In 2014,
Mercedes TVR many felt that Tesco would need to reposition itself in the market. This
BMW
Morgan followed a major corporate accounting issue when a whistle-blower
Jaguar Audi revealed that Tesco’s finance department had overstated the first half
TRADITIONAL SPORTY STYLE year’s profits by £250 million, a figure later adjusted to £263 million.
Ford Figure 2 also shows that Tesco may be perceived as a supermarket
Vauxhall Caterham without a well-defined position. It may be perceived as neither very
Fiat cheap nor very expensive, and neither high quality nor low quality.
Repositioning a company is an enormous task. It involves more than
LOWER PRICE a marketing challenge. It requires making hard decisions about how a
market is shifting and how a firm’s competitors will react. Often these
decisions must be made without the benefit of sufficient information.
The use of market maps can have its limitations. For example, Positioning is also difficult to measure because customer perception of a
perceptual maps are two dimensional, which means that only two product may not have been tested using quantitative techniques.
product attributes can be analysed on the same map. They can Source: adapted from the Financial Times, all rights reserved.
also be more relevant for individual brands, and less helpful for a
corporate brand image. The information needed to plot the maps
can be expensive to obtain, requiring the use of primary market Competitive advantage of a product
research. There may also be a difference between consumers’ or service
perception of the brand’s benefits and the actual benefits. A business is likely to be more successful if it can gain a
Finally, perceptual maps need not come from a detailed competitive advantage in the market place. Competitive
study. There are also intuitive maps (also called judgemental advantage is a set of unique features of a company and its
maps or consensus maps) that are created by marketers based products that are perceived by customers as significant and
on their understanding of their industry. Management uses its superior to the competition. For example, a product may save
best judgement. It is questionable how valuable this type of time, save money, make money, improve health, taste better, be
map is. Often they just give the appearance of credibility to more convenient or offer more comfort. A business can develop
management’s preconceptions. a competitive advantage in a number of ways.
●● Product design. If a firm can develop a product that has

Question 1 superior design, this might appeal to a significant proportion

of a market. A business may emphasise a specific design
Figure 2 shows a perceptual map for supermarket brands. feature to differentiate its product from those of its rivals and
(a) Explain how a French supermarket chain might use the map in gain a competitive advantage. It could stress the superior
Figure 2 if it was considering an entry into the UK market. functionality of the product – it might be ergonomically
(b) Explain one drawback to the French supermarket chain of using designed for example. Alternatively a design might focus on
the perceptual map in Figure 2. the aesthetics of a product. This approach may be used by
(c) Assess the position of Tesco compared to that of Aldi using the jewellery producers. Product design is discussed in Unit 9.
perceptual map in Figure 2. ●● Product quality. Offering high-quality products is a common

way of gaining a competitive edge in a market. The main

Figure 2 advantage of this approach is that a premium price can
A perceptual map for supermarket brands (as perceived be charged. However, costs may be higher if superior raw
by the author) materials are required along with higher standards of quality.
High price
Savile Row tailors in London, for instance, have a reputation
Marks & Spencer for high-quality hand-made suits.
●● Promotion. Effective promotion using creative advertising,
Waitrose
for example, might give a firm a competitive edge. The use of
Spar Sainsbury’s persuasive advertising may be capable of changing consumer
perceptions so that they are more inclined to buy the
Quality –ve Tesco Quality +ve product. For example, the use of TV adverts for products that
Morrisons Asda claim to reduce pain may be perceived as persuasive.
Aldi ●● Customer service. Some businesses pay less attention to
Lidl the product itself and rely on high-quality customer service
to gain a competitive edge. For example, Enterprise, the car
Low price hire firm, delivers and collects cars from a chosen customer
location (e.g. at home) to encourage sales.
19
Market positioning Unit 3

●● Delivery times. Some customers demand fast delivery of elaborate and expensive advertising campaigns to create a
products. Where speed of delivery is important, a prompt strong image for the perfume. Consumers may not realise that
service will be a way of gaining an advantage. An example production costs for perfumes are relatively low. As a result,
might be a components supplier in the car industry that can perfume manufacturers can often charge high prices.
guarantee to deliver just-in-time (see Unit 39).
●● Economies of scale. Firms that can produce efficiently at Recognition: One of the main purposes for product
low cost can afford to charge a lower price and therefore differentiation is to gain recognition in the market place.
gain a competitive advantage by being a cost leader in their Consumers often find products more appealing if they stand
market. Larger firms are likely to be better placed to exploit out from the pack. Confectionery products tend to be packaged
this advantage. in attractive and colourful wrappings so that consumers are
●● Flexibility. Some customers appreciate a flexible service. drawn to them. Also, some consumers ‘like to be different’ and
For example, firms that supply other businesses may will naturally be drawn to products that are explicitly different
win a bigger market share if they can change designs from those of rivals.
or specifications while production is in progress. Or if
they can speed up production to meet a more urgent Extend product range: If businesses can differentiate
delivery time. products they may be able to serve more than one market
●● Ethical stance. It might be possible to gain a competitive segment in the same industry. For example, cruise ships offer
edge by adopting a particular ethical stance. For example, different standards of cabin accommodation to consumers with
Fairtrade aims to deal ethically and fairly with the producers different levels of spending power. They also offer different
of the commodity being sold. A furniture-maker might attract destinations, different length cruises and different on-board
environmentally aware consumers if it ethically sources its facilities. In the biscuits market, producers supply a very wide
raw materials. It could do this by avoiding the use of wood range of different products in an effort to appeal to different
from trees that are threatened with extinction. tastes and to compete aggressively with rivals.
●● Focusing on a particular market segment. For example,
a gym could gain a competitive advantage by focusing on an Brand development: A business that can differentiate its
audience not typically catered for by gyms and fitness clubs product successfully for a sustained period of time can develop
such as the over-60s or parents with young children. a strong brand. The Coca-Cola Company, with its distinctive
formula, has built one of the strongest brands in the world as a
The purpose of product differentiation result of initial product differentiation. Over the years the brand
Product differentiation is used by businesses to gain a has been supported by constant advertising and other forms of
competitive edge over their rivals. In highly competitive markets, promotion to stay at the top. But it all started with successful
where lots of firms produce similar products, firms will try to product differentiation.
make their product unique in some way so that it stands out
from the pack. This involves supplying goods and services that Overcome competition: Generally, a business will differentiate
have different features or physical attributes. The differences its products to try and outcompete rivals. By creating real or
in products may be real – the products look different, or have perceived differences businesses can attract new customers and
different technical specifications or have different capabilities or win larger market shares. With an increase in scale a business
performance levels. Energizer, for example, claims that its AA might also be able to lower costs and raise profits.
lithium batteries have a longer life than any other AA batteries.
Or in contrast the differences may be perceived – consumers Adding value to products and services
believe there is a difference even if there is not one, or it is In highly competitive markets a business may try to add
not a significant one. Consumers attach a value to products value to its product. This means that the business provides
in their own minds based on information that they receive – ‘extra’ features for the customer that go beyond their standard
an elaborate persuasive advertising campaign, for example. expectations. For example, a car MOT centre may valet a
Attractive packaging might also be used to create a customer’s car as part of a £50 MOT inspection. It normally
perceived difference. costs £50 to have an MOT inspection, so the car valet is adding
The purpose of product differentiation may include value for the customer. Businesses can add value to their
the following. products and services in a number of ways. Some examples are
outlined below.
Flexible pricing: If a business can demonstrate clear
physical differences between their products and those of Bundling: A business might be able to add value by putting
rivals, it may be able to charge higher prices. In the case together a ‘package’ of benefits or services that make up
of perceived differences, consumers sometimes attach the whole product. For example, in the holiday industry tour
a value to a product that may be priced well above the operators may offer flights, accommodation, transfers, insurance,
costs of production. For example, perceived value is often childcare facilities and excursions all for one price. The product
used with perfumes. Perfumes are frequently associated may also be presented in such a way that suggests that some of
with a glamorous celebrity in order to create a mystique the services, such as insurance and excursions, are free in the
and perception of luxury. Or, they may be the subject of package. This will help to add value for consumers.
20
 Marketing and people

Customer service: Staff that come into direct contact with Question 2
customers can play a very big role in adding value. Well-
groomed, friendly, attentive and professional staff create a In common with most commercial banks, Lloyds Bank offers
good image and make customers feel at ease. Staff with free banking to customers. For example, customers can open
a sound knowledge of the products that they are selling, a current account and enjoy free cash withdrawals and access
coupled with the willingness to ‘go out of their way’ to help to account information from ATMs, free direct debits and free
customers are likely to be a source of added value. After- cheque books. However, in 2014 Lloyds Bank offered two other
sales service can also be an important feature of added ‘added value’ current accounts.
value. Customers may be happier buying from a business that
Silver account – £9.95 a month fee
operates a helpdesk, makes follow-up calls or offers a free
maintenance service. • European and UK travel insurance for customers and their
partners.
Speed of response to customers: This is linked to • Motor vehicle breakdown insurance with roadside assistance.
customer service. A lot of people do not like waiting – this
might include queuing at checkouts, waiting for appointments • Mobile phone insurance.
and waiting for deliveries. A business can add value by • £50 interest and fee-free planned overdraft, subject to
reducing waiting times or eliminating them completely. For application and approval.
example, airlines allow first class passengers to disembark
Platinum account – £17 a month fee
first. A customer might choose a particular dry-cleaning
service because it can return garments within four hours. • Worldwide and UK travel insurance with either family or
winter sports cover.
Packaging: The packaging of products can add value. • Motor vehicle breakdown insurance with roadside assistance,
Many businesses make an effort to present products in relay and home start.
attractive wrappings. For some products, such as jewellery
for example, a business might offer to gift-wrap a product. In • Mobile phone insurance.
agriculture many farms add value by packing produce, such as • £300 interest and fee-free planned overdraft, subject to
vegetables, in customised bags for supermarkets. application and approval.
Source: adapted from www.lloydsbank.com
Frequent buyer offers: It might be possible to add value
by rewarding customers for repeated purchases. Regular (a) Explain how Lloyds Bank has added value in this case.
customers are offered benefits such as a more valuable (b) Explain one benefit to Lloyds Bank of adding value to its products.
service, preferential pricing and free products. For example,
many regular travellers collect air miles, which can be
accumulated and used to get free flights.
Exam tip
When discussing a concept, such as added value in this unit, it is
Customisation: Customising products might involve not necessary to remember all of the different methods. You only
embedding a customer’s logo or brand in the product, or need to remember one or two. However, you must be able to
simply using customised wrapping to distinguish a product explain them in detail and perhaps give an example.
from those of competitors. It could also involve changing
or adapting product designs to suit the needs of individual
customers. ●● Adding value can be used to differentiate a product and gain
Adding value can generate a number of benefits for a competitive edge. For example, some customers may prefer
a business. to shop with retailers that offer high-quality customer service.
●● It may be possible for a business to charge a higher price. ●● Adding value may help a business protect itself from
However, businesses may want to disguise higher prices competitors charging lower prices in a bid to steal customers.
so that the value-added element appears to be free. Some ●● A business might focus more closely on its target market
tour operators do this by giving free holiday insurance segment by adding value, for example by meeting the needs
when a package is purchased. of customers more effectively.

21
Market positioning Unit 3

Case study
Tim Wade said that brand repositioning was a  ‘huge
project’, which should not be undertaken without thorough
BEST WESTERN HOTELS planning and research:  ‘You’ve got to make sure your
positioning is right and really get the people in the business
A few years ago the Best Western hotel chain felt that it behind what you’re doing. Once the repositioning strategy
had lost its identity in the market and was not effectively was devised, it was tested with consumers at focus groups
differentiating itself. The rise of independent boutique to establish whether the new position was really relevant
hotels in the UK suggested that customers prefer hotels and appealing to customers.’
with character. As a result the chain organised a re-launch David Clarke, CEO of Best Western, said ‘It has been a
campaign with the message ‘Hotels with personality’. highly successful campaign and ensured that Best Western
The campaign emphasised the individuality of each is a group that stands apart from our competitors.’ Sales
member hotel and targeted ‘independently minded’ have increased by nearly 30 per cent year-on-year, the
people in the market. most in the chain’s history, with corporate sales also up
The structure of the hotel chain meant that Best significantly. According to Tim Wade the repositioning
Western could do this because each hotel in the group is campaign has been a resounding success with
independently owned. Hotels range from 12th-century expectations being surpassed on several levels. Growth in
castles to modern, purpose-built venues; establishments the business can be traced back to the first TV advert that
that grow their own produce to those with deer parks launched the campaign.
and golf courses. This enabled them to emphasise the Source: adapted from www.startups.co.uk
independence and variety of hotels within the group with
a new market position and strapline. Tim Wade, head
of marketing, said, ‘Because every hotel is independent, (a) What is meant by market positioning? (2 marks)
every hotel has its own personality, and we had a real (b) Explain one reason why Best Western felt the need to
opportunity to stand out against the formulaic hotel chains reposition its hotel chain. (4 marks)
and say something very different about ourselves.’ Rather
than going for traditional demographic segmentation, (c) Explain one way in which Best Western has developed a
the new position targeted ‘independent-minded people, competitive edge. (4 marks)
who don’t want the same experience everywhere . . . We (d) Assess the importance to Best Western of product
already had the product; it was really about getting people differentiation in this case. (12 marks)
to take notice or look at it from a different perspective.’

Key terms Knowledge check

Added value – the extra features that may be offered by 1. State three ways a business might position its products.
a business when selling a product, such as high quality
2. Perceptual maps are two dimensional. What does this mean?
customer service, which helps to exceed customer
expectations. 3. State two benefits of using perceptual maps.
Competitive advantage – an advantage that enables a 4. State one key disadvantage of using perceptual maps.
business to perform better than its rivals in the market.
5. Why might a business choose to reposition the whole
Market maps or perceptual maps – typically a two-
dimensional diagram that shows two of the attributes or corporation?
characteristics of a brand and those of rival brands in the 6. State three ways a business might try to gain a competitive
market. advantage in the market.
Market positioning – the view consumers have about the 7. What is a USP?
quality, value for money and image of a product in relation to
those of competitors. 8. State two reasons why a business should differentiate
Product differentiation – an attempt by a business to its product.
distinguish its product from those of competitors. 9. What is meant by adding value?
Reposition – change the view consumers have about a
product by altering some of its characteristics.
10. State three ways a business might add value to products.
Unique selling point (or proposition) – the aspect or feature
of a product that clearly distinguishes it from its rivals.

22
 4 Demand 1.2.1
Theme 1

Key points
1. Factors leading to a change in demand:
●● changes in the prices of substitutes and complementary goods
●● changes in consumer incomes
●● fashions, tastes and preferences
●● advertising and branding
●● demographics
●● external shocks
●● seasonality.

Getting started curve as a movement along (up or down) the curve. In Figure 1,
a fall in price from £1.50 to £1, for example, will result in a
What might happen to sales of these products if there was a movement along the curve from point X to point Y.
recession in the economy? What might happen to sales of these This will result in a rise in the quantity demanded from
products if free Wi-Fi was introduced? What other factors might 60,000 to 80,000 kilos. The demand curve itself has not
encourage more people to buy these products? moved from its original position. Price changes only lead to an
extension (rise) or contraction (fall) in the quantity demanded.

Table 1 The demand schedule for button mushrooms

Price per kilo (£) Quantity demanded (000 kilos)
0.50 100
1.00 80
1.50 60
2.00 40
2.50 20

Figure 1
The demand curve for button mushrooms
Demand Price (£)
2.50
Demand is the amount of a product that consumers are willing
and able to purchase at any given price. Demand is concerned
2.00
with what consumers are actually able to buy (what they can
afford to and would buy), rather than what they would like to
1.50 X
buy. So, for example, we could say that the demand for cars
in the UK market at an average price of £9,000 might be
1.00 Y
130,000 a year.
Table 1 shows a demand schedule for button mushrooms.
These figures can be used to draw a demand curve as in 0.50 Demand
Figure 1. In practice, demand curves are not a straight line, but
are usually drawn in this way for simplicity. 0
20 40 60 80 100
The curve shows the quantity of a good or service that Quantity demanded of mushrooms (000 kilos)
will be demanded at any given price. As with nearly all such
curves, it slopes downwards from left to right. This is because
the quantity demanded is likely to be higher at lower prices Maths tip
and lower at higher prices – ceteris paribus (assuming no other When a demand curve slopes down from left to right,
things change). In Table 1 more button mushrooms are bought this reflects the inverse relationship between price and quantity
at a price of £0.50 than at a price of £2.50. demanded. When the price goes up, the quantity demanded goes
A change in the price of a good or service will lead to a down. When the price goes down, the quantity demanded goes up.
change in the quantity demanded. This is shown on the demand
23
 Demand Unit 4

Factors leading to a change in demand rise when income rises. Most goods in the economy are normal
The price of a product has a significant influence on its demand. goods; however, a minority are inferior goods. This means
For most goods and services higher prices will tend to reduce that demand for them will actually fall when incomes rise.
demand and lower prices will tend to raise demand. However, Supermarket ‘own-label’ brands or public transport can
there are several other factors that can lead to a change in be examples of inferior goods. For example, consumers
demand. Changes in these factors, which are outlined below, who generally buy Morrisons’ own-label canned beans may
will actually shift the demand curve. This is different from a price switch to a more expensive brand, such as Heinz, when their
change, which results in a movement along the demand curve. incomes rise. Therefore demand for the Morrisons’ own-label
brand will fall.
Prices of substitutes: Many goods sold by businesses have In Figure 2, if consumer incomes rise, the demand for skiing
substitutes. For example, a consumer buying a can of Coca-Cola holidays would also probably rise causing a shift in the demand
might have considered other brands such as Pepsi-Cola® or a curve from D to D1.
supermarket ‘own label’. Most consumers would consider these as
good substitutes. The price of substitutes will affect demand. If the Question 1
price of a substitute product falls, the quantity demanded of the
substitute rises. As a result the demand for the product would fall.
Figure 3
If a good has a lot of close substitutes then the prices of these
Monthly UK petrol prices August 2013–December 2014
will affect demand significantly. In Figure 2, the line labelled D
represents the demand for skiing holidays in the UK. A decrease Price (£)

in the price of a substitute, such as ‘winter sun holidays’, may 1.40

reduce the demand for skiing holidays. This would result in a shift 1.35
from D to D2 in Figure 2.
1.30

1.25
Figure 2
1.20
The demand for skiing holidays in the UK
1.15
Price
1.10

1.05

1
Aug
Sep
Oct
Nov
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Year
P
Source: adapted from petrolprices.com

D1 (a) What is meant by the term complementary goods?

D
D2 (b) Explain how the pattern of prices shown in Figure 3 might
0 Q2 Q Q1 Quantity demanded of influence the demand for (i) cars (ii) public transport.
skiing holidays

Prices of complements: Consumers sometimes purchase Fashions, tastes and preferences: Over a period of time,
certain goods together. This is because the two goods are used demand patterns change because of changes in consumer
together. For example, consumers of cornflakes will also buy milk tastes and fashion. For example, the growth in demand for
and people who buy cars will also buy car insurance. In these 4 wheel drive cars in the UK, not because an increasing
examples milk and cornflakes and cars and car insurance are number of people need to drive off-road but because increasing
complementary goods. Demand for such products is likely to numbers of drivers find them appealing. The clothes industry in
be affected by the price of complementary goods. For example, particular is influenced strongly by changes in fashion. In many
a reduction in the price of skiing accessories may encourage countries there are buying seasons for clothes – many clothes
more people to try skiing. This would be shown by a shift from items bought in one season would not be in demand in later
D to D1 in Figure 2. seasons because they will have gone out of fashion.
Since 2005 there has been a significant increase in the
Changes in consumer incomes: The amount of money demand for bicycles in the UK. This demand has been led by
that people earn will influence the amount and types of goods Bradley Wiggins’ road cycling success in the Tour de France and
that they buy. Generally, when income rises, demand for goods Olympic Games, and the success of the British Olympic track
will also rise. For example, if wages and salaries go up people cyclists. There has also been an improvement in the UK cycling
may decide to spend more money going out to restaurants, infrastructure, such as more bicycle-only lanes, to get people
they may take an extra holiday or they may buy a new car. back on their bikes. In 2013, 50 million journeys were made by
These are all normal goods – goods for which demand will bicycle, up 7 per cent on the previous year.

24
 Marketing and people

Advertising and branding: Businesses try to influence Also, there are likely to be changes in the size and structure
demand for their products through advertising and other forms of populations over time. For example, if the birth rate or
of promotion. If goods are heavily advertised demand for them immigration rises they will increase the size and structure
is likely to increase. This helps to explain the huge amounts of the population. Since 2005 there has been growth in the
of money that some businesses are prepared to spend on number of Eastern Europeans moving into the UK as more
advertising. For example, from figures widely available it was countries join the EU. As a consequence many specialist
possible to identify that Sky spent more on advertising than retail outlets have been established to serve this population,
any other company in the UK in 2013, with expenditure of such as Polish food shops.
over £264 million. This was £87 million more than Proctor & External shocks: Factors beyond the control of businesses
Gamble, reported as the second biggest UK advertiser. The can have an impact on the demand for products. Some key
range of expenditure of the top 10 advertisers in the UK in examples are outlined below.
2013 was widely reported from DFS at number 10 with over ●● Competition. If a strong new competitor enters the market
£75 million to Sky at number one with over £264 million. for the first time, demand is likely to fall for the original
Businesses also use branding to influence demand. By firm’s product. For example, it is possible that Sky may
giving products a name, term, symbol or any other sign, to be adversely affected following BT winning the right to
distinguish them from those of competitors, businesses can broadcast Barclays Premier League football for the first time
develop brand recognition and increase sales. They do this by in 2014.
investing heavily in positioning, promoting and advertising to ●● Government. A government can influence demand in a
make the brand strong. Branding is discussed in Unit 10. In number of ways. Raising taxes, for instance, could dampen
Figure 2, if businesses selling skiing holidays increase spending demand for many products because spending power would
on advertising and branding, demand will probably increase be curbed. New laws can affect demand. For example, legal
from D to D1. measures designed to increase competition in the market
for gas and electricity might result in a fall in demand for the
Demographics: As population grows there will be an increase existing operators in the market.
in demand for nearly all goods and services. However, demand ●● Economic climate. If the economy is growing, demand for
is also affected by the structure of the population as well as most goods and services will tend to rise. In contrast, during
its size. a recession, demand for non-essential goods such as skiing
●● The age distribution of a population is the numbers of holidays is likely to fall. This would be represented by a shift
people that fall into different age groups. For example, in from D to D2 in Figure 2.
many countries there has been growth in the number of ●● Social and environmental factors. Demand for some

people aged over 60. This will have an effect on demand goods might be affected by changes in society. For
patterns. For example, as the population ages there will be example, there has been a huge increase in demand
more demand for goods such as retirement homes, specialist for social media. New social websites have emerged as
holidays for the elderly and healthcare. In Figure 2, if there a major means of communication. This has helped to
was an increase in the 18 to 40 age group, there might be an increase the demand for mobile phones, apps, tablets,
increase in the demand for skiing holidays. This would shift smartphones and related services. Concerns about global
the demand curve from D to D1. warming have changed consumers’ attitudes towards
●● There are slightly more women than men overall in the UK
goods and services that raise carbon emissions. For
population. In the older age groups the number of women example, there has been a significant increase in demand
compared to men increases. Consequently, the gender for electric cars and hybrids (cars which run on both petrol
distribution of the population is likely to affect demand and electricity).
patterns. For example, there will be a greater demand for Seasonality: Some goods and services have seasonal
women’s clothes than men’s clothes. demand. This means that demand rises at particular times of
●● Geographical distribution can also affect demand. the year. For example, in the UK, demand for garden furniture
Increasingly, in most developed and developing countries rises in late spring when the weather starts to improve. Similarly,
more and more people live in urban areas. As a result demand demand for warm clothing, such as overcoats and woolly
for schools and hospitals in these areas, for example, will be jumpers, rises in the late autumn when the weather turns
higher than in rural areas. colder. Demand is also influenced by calendar events, such as
●● Other factors can affect the structure of the population, such Christmas, Easter, Mother’s Day, St Valentine’s Day
as the nature of households. For example, in some parts of and Halloween.
the world there has been a growth in the number of one-
person households. This trend increases the demand for
Exam tip
single accommodation. Many countries have ethnic groups
When drawing demand curves to help illustrate answers in
in their population structure. If these ethnic groups grow examinations, it is acceptable to draw straight lines. Remember the
in size there is also likely to be an increase in demand for price is always on the vertical axis and quantity on the horizontal axis.
products associated with their culture.

25
 Demand Unit 4

Case study
Figure 4
BARCHESTER UK population 1971 to 2031 (millions)

HEALTHCARE LTD 80

Population (millions)
Barchester Healthcare Ltd is one of the UK’s largest 70
providers of care homes. It employs over 17,000 staff 60
providing care for over 11,000 residents in over 200
locations. The profit-making company is currently 50
constructing a high-quality, purpose-built care home at a 40
picturesque site by a marina in Burton Waters, Lincolnshire. 1971 1981 1991 2001 2006 2011 2021* 2031*
The home will provide residential and nursing care, *Projected figures Year
including dementia care, to the elderly.
The home’s publicity states it will employ highly trained Source: adapted from Office for National Statistics,
www.ons.gov.uk
staff and provide facilities specifically designed to help
people with dementia, including memory boxes for each
person containing mementoes to help them to remember. Figure 5
Initiatives to help residents to partake in everyday
UK population (male and female over 75s) 1971 to 2016 (000s)
activities include adapted kitchen equipment and
sensory gardens. 5,000
Sources: adapted from www.barchester.com and
4,000
Population (000s)

www.carehome.co.uk
3,000

(a) Draw a diagram showing the likely effect on the demand 2,000
for Barchester Healthcare’s services in the future. 1,000
(4 marks)
0
(b) Assess how the information shown in Figures 4 and 5
1971 1981 1991 2001 2006 2011 2016* 2021* 2026*
might affect demand patterns in the UK. (8 marks) Year
*Projected figures Key
(c) Assess the impact that external factors might have on UK male population (over 75s)
the demand for services supplied by companies like UK female population (over 75s)
Barchester Healthcare. (12 marks)
Source: adapted from Office for National Statistics,
www.ons.gov.uk

Key Terms Knowledge check

Complementary goods – goods that are purchased 1. What is the relationship between price and the quantity
together because they are consumed together. demanded?
Demand – the quantity of a product bought at a given price 2. Give two examples of goods that are close substitutes.
over a given period of time.
Demand curve – a line drawn on a graph that shows how 3. If the price of a good rises what will happen to demand for a
much of a good will be bought at different prices. complementary good?
Inferior goods – goods for which demand will fall if income 4. What might happen to the demand for furniture if incomes fall?
rises or rise if income falls. 5. If a business increases its spending on advertising, how will
Normal goods – goods for which demand will rise if income this affect the position of the demand curve?
rises or fall if income falls.
6. How might demand be affected by a change in the structure
Substitute goods – goods that can be bought as an
of the population caused by an increase in immigration?
alternative to others, but perform the same function.
7. Give three examples of external shocks that might affect demand.
8. What might affect the demand for ice cream?

26
 5 Supply 1.2.2
Theme 1

Key points
1. Factors leading to a change in supply:
●● changes in the costs of production
●● introduction of new technology
●● indirect taxes
●● government subsidies
●● external shocks.

Getting started Figure 1

In 2014 it was widely reported that supplies of electricity The supply curve for button mushrooms
might be threatened during the winter in the UK. National Price (£)
Grid offered to pay businesses to reduce or shut down their 2.50 S
energy use during peak hours. The threat to supplies came
about from lack of investment in power generation this
century and from the loss of capacity due to breakdowns. 2.00
National Grid, which manages the UK’s energy infrastructure,
also announced plans to contract additional UK power stations 1.50
to be on standby, in preparation for high winter demand for
lights and heating.
1.00
What might happen to future supplies of electricity if the price
of oil and gas continues to fall? How might the government
0.50
affect the future supply of electricity? Will plans to construct
some new nuclear power stations avoid winter electricity
shortages? What other factors influence the supply of 0
20 40 60 80 100
electricity in the UK? Quantity supplied of button mushrooms (000 kilos)

Supply
Supply is the amount of a product which suppliers will offer to
the market at a given price. The higher the price of a particular Maths tip
good or service, the more that will be offered to the market. For Most supply curves slope up from left to right, like the
example, the amount of button mushrooms supplied to a market
one in Figure 1. This reflects the direct relationship that exists
in any given week may be as shown in Table 1.
between the price of the product and the quantity supplied. It
These figures have been plotted onto a graph in Figure 1,
shows that when price goes up, the quantity supplied also goes
which shows the supply curve for button mushrooms. The
up. When the price goes down, the quantity supplied
supply curve slopes up from left to right. This is because at
higher prices a greater quantity will be supplied to the market goes down.
and at lower prices less will be supplied.
A change in price will cause a movement either up or down
the supply curve. The curve will not change its position assuming Thinking bigger
that all other factors remain the same. There are a number of In some circumstances the supply of a product or service may be fixed.
other factors that may affect supply other than price. Changes in If this is the case the supply curve will be vertical. Supply will be fixed if
these factors will cause the whole supply curve to shift. it is impossible for sellers to increase supply even when prices rise. The
supply at venues such as cinemas, theatres and sports stadiums may
Table 1 The supply schedule for button mushrooms be fixed. For example, the Royal Albert Hall, a major music venue, can
Price per kilo (£) Quantity supplied (000 kilos) accommodate around 6,000 people for the Proms. Even if the price
0.50 20 of tickets were to rise, say, from £100 to £300 for a concert, no more
1.00 40 seats could be supplied (see Figure 2).
1.50 60
2.00 80
2.50 100

27
Supply Unit 5

The availability of resources will also affect supply. If there

Figure 2
is a shortage in some of the factors of production, such as
Fixed supply – the capacity of the Royal Albert Hall land, labour, raw materials or capital, it will make it difficult
Price (£) for producers to supply the market. For example, in the UK in
Supply 2013 and 2014, it was widely reported that there were labour
shortages. Kevin Green, chief executive of the Recruitment &
300 Employment Confederation (REC), suggested that there were
around 40 areas of skills shortage, compared to previous years
when it was reported as fewer than 10 areas. Engineering skills
were reported to be in short supply, including electrical, civil,
software and mechanical. IT skills were also reported to be in
short supply, including programmers, developers and coders.
A shortage of National Health Service nurses and doctors was
also reported, along with a need for around 20,000 further
teachers in the UK. It was reckoned by many that economic
100
growth would be hampered by the shortages of skilled labour
in the UK.

Figure 3
0 6,000
Quantity (accommodation for a prom concert)
Shifts in the supply curve

Price (£)
S2

Factors leading to a change in supply S

The main determinant of supply is price. For most goods S1

and services, when the market price rises suppliers are
willing to supply more. This is because they are likely to P
make more profit at higher prices. However, a number of
other factors can lead to a change in supply. Changes in
these factors, which are outlined below, will actually shift
the supply curve. This is different from a price change,
which results in a movement along the supply curve.

Changes in the costs of production: The supply of

any product is influenced by the costs of production, such 0 Q2 Q Q1 Quantity supplied
as wages, raw materials, energy, rent and machinery. If
production costs rise, sellers are likely to reduce supply.
This is because their profits will be reduced. For example, Introduction of new technology: As new technology
in 2013, Tata Chemicals shut its soda ash factory at becomes available many businesses will start to use it
Winnington in Northwich. This factory had supplied soda ash in their production processes. New technology is usually
for industries such as glass and soap-making since 1874. more efficient than older technology and will help to lower
The factory closed because it was being squeezed by rising production costs, encouraging firms to offer more for sale.
gas prices. For example, Britain’s manufacturers are using cutting-
A rise in costs will cause the supply curve to shift to the edge technology to improve products and processes in car
left. This is shown in Figure 3. When costs rise, the whole manufacturing and the aerospace industry. The strength of
supply curve will shift to the left, from S to S2. At a price of these two industries since 2008 has helped the revival in
P the quantity supplied in the market falls from Q to Q2. If manufacturing – a sector of the UK economy that had been
costs fall, supply will increase because production becomes declining in the previous 30 years.
more profitable. As a result the supply curve will shift to the The introduction of new technology will shift the supply
right. This shows that more is supplied at every price. In curve to the right, from S to S1 in Figure 3. The amount
Figure 3 the new supply curve would be S1 and the amount supplied in the market at price P will rise from Q to Q1.
supplied at P will rise from Q to Q1.

28
 Marketing and people

Question 1 right, from S to S1 in Figure 3. This is because costs are lower

and firms will be encouraged to supply more in the market.
Following the imposition of an indirect tax, the burden is
likely to be shared between the consumer and the producer.
The size of the price increase faced by consumers will depend
largely on the price elasticity of demand (this is discussed in
Unit 7). If an indirect tax is imposed and demand is relatively
inelastic, the consumer will bear a greater burden of the tax.
In January 2011 the UK government raised the rate of
VAT from 17.5 per cent to 20 per cent. Many argued that this
measure would prolong the recession as it acts as a disincentive
to producers.

Government subsidies: Sometimes the government may

give money to businesses in the form of a grant. This is called a
According to farmers and the government, farming might
subsidy. Subsidies may be given to firms to try and encourage
be changed by the increasing number of ‘farmbots’ used in them to produce a particular product. For example, in 2014
agriculture. The development of the machines aims to raise the UK government announced that it would give £300 million
efficiency and complete complex tasks that have not been subsidies to the renewable energies industry to encourage further
possible with the large-scale agricultural machinery of the developments in power generation using renewable power
past. For example, a ‘lettuce bot’ can hoe weeds away from sources. This was part of Britain’s plans to cut greenhouse gas
the base of young lettuce plants. A ‘wine bot’ (shown in the emissions by 80 per cent from 1990s levels by 2050. The extra
photograph) can prune vines, moving through the vineyards. subsidies will be awarded to low-carbon electricity projects, bid for
Other bots are under development to remotely check crops for at auctions and distributed on 15-year contracts.
their growth, moisture and signs of disease. Drone technology If the government grants a subsidy on a good the effect is
(use of remotely controlled aircraft) is also being adapted for use to increase its supply. This is because subsidies help to reduce
on farms. For example, in South America, drones are being used production costs. As a result the supply curve will shift to the
for the surveillance of herds and to monitor crops, and in Japan right, from S to S1 in Figure 3.
smaller models are programmed to spray pesticide on crops.
External shocks: Factors beyond the control of businesses
However, there are doubts about how likely it is that new robot can have an impact on the supply of products. Some examples
technology will take off. Emma Hockridge, head of policy at are outlined below.
the Soil Association, has said that: ‘The potential use of robots ●● World events. Global events can have an impact on the
on farms has been discussed for years, but we haven’t yet seen supply of some products. For example, in recent years the
anything practical close to reaching the market.’ political situation in the Middle East has been quite volatile.
While the prospect of replacing seasonal workers with robots may Consequently, when the situation becomes hostile, supplies
be attractive for farm bosses looking to consolidate into bigger of oil are threatened and the price rises. This is because a
units, farm workers may be less keen. Even enthusiasts for the significant proportion of the global oil supply comes from
technology think that it will probably be decades before farmbots this region.
are used commercially. The head of engineering at Harper Adams In 2008, the global financial crisis led to a ‘credit crunch’.
University, Professor Simon Blackmore, said that his vision was This meant that many firms were unable to borrow the money
for “farming with robots in 2050”, by which time he believes this they needed to trade and invest for the future. As a result
some businesses collapsed and others were unable to grow.
should be practical.
●● Weather. The supply of agricultural products in particular
Source: adapted from www.theguardian.com can be affected by the weather. Good growing conditions will
(a) Explain one impact that the introduction of farmbots might have result in high crop yields and increased supply. Conversely,
on agriculture. bad weather, such as a drought, can reduce crop yields
(b) Draw a diagram and analyse the effect that the introduction of
severely and cause shortages. In 2014, there were bumper
farmbots might have on the supply of food in the UK. crops of wheat in Europe and the Black Sea region due to
favourable growing conditions. The increase in the global
supply of wheat helped to reduce prices.
Indirect taxes: Indirect taxes are taxes imposed by the Bad weather, such as snow storms, can disrupt the supply
government on spending. VAT and excise duties, such as those of many goods in the short term, for instance by hampering
levied on petrol and tobacco, are examples of indirect taxes. the distribution of goods due to closed roads, railway lines
Such taxes have an effect on supply. When they are imposed or and airports.
increased, the supply curve will shift to the left, from S to S2 in ●● Government. Government economic policies can have
Figure 3. This is because indirect taxes represent a cost to firms. an impact on supply. For example, if the Bank of England
If indirect taxes are reduced, the supply curve will shift to the increased interest rates (in order to meet a government
29
Supply Unit 5 Marketing and people

inflation target), this could increase business costs for firms

Exam tip
with debt. Borrowing to invest might also be discouraged. When answering questions relating to the supply of goods and
Government legislation can have an impact on supply. For services, it can be helpful to consider the short term and long
example, if the government passes laws to make a particular term. For example, in the long term the supply of most goods
market more competitive, then supply in that market is likely and services can be increased. This is because firms can adapt
to changes in market conditions – by expanding production if
to increase as new entrants join the market.
necessary. However, in the short term firms may not be able to
●● Price of related goods. In some markets supply can be increase supply even if they wanted to. Farmers cannot increase
affected by price changes of related goods. For example, if supply until the following year because it takes time to grow
an arable farmer producing mainly potatoes sees that the produce. Manufacturers may be operating at full capacity and it
price of carrots and parsnips are rising in the market place, could take some time to build more plants. Making distinctions
their response might be to grow more carrots and parsnips between the short term and the long term is useful when showing
your skills in evaluation.
next season instead of potatoes. As a consequence the
supply of potatoes could fall.

Case study
Figure 4
THE SUPPLY OF NEW Private sector house build 2002/3 to 2012/13 (completions)

HOUSES IN THE UK 16,000

14,000
In 2007 house prices peaked in the UK. The average price 12,000
was over £180,000. Then the financial crisis of 2008 10,000
caused prices to fall sharply back down to around an 8,000
average of £150,000 in 2009. However, since then house
6,000
prices have risen again. As the population in the UK rises,
4,000
demand for housing increases. Unfortunately this has not
2,000
been matched by an equivalent increase in the supply.
Figure 4 shows the number of new houses built by the 0
2002/3

2003/4

2004/5

2005/6

2006/7

2007/8

2008/9

2009/10

2010/11

2011/12

2012/13
private sector over the last 10 years. Some new houses
have been built by the public sector but the numbers are
very small in comparison.
Source: adapted from www.shelter.org.uk

(c) Explain the impact that higher land prices would have on
the supply of houses. (4 marks)
(d) Assess the possible factors that have reduced the supply of
new houses in the private sector in recent years. (12 marks)

Knowledge check
(a) What is meant by supply? (2 marks) 1. Describe the relationship between price and the quantity
supplied in a market.
(b) Explain one effect on the supply of housing if 2. What is meant by fixed supply?
construction companies were given a government 3. What might happen to the supply of laptop computers if
subsidy. (4 marks) wages of assembly workers rose significantly?
4. How might a fall in gold prices affect the supply of gold
wedding rings?
Key terms 5. What impact does the introduction of new technology have
on the supply of goods and services?
Subsidy – a grant given to producers, usually to encourage 6. What would happen to the supply curve for gardening
production of a certain good. services if VAT was increased?
Supply – the amount of a product that suppliers make available 7. Why is the supply of a good or service likely to increase if the
to the market at any given price in a given period of time. government grants producers a subsidy?
Supply curve – a line drawn on a graph that shows how much 8. How can government legislation affect supply?
of a good sellers are willing to supply at different prices. 9. State two external shocks that might affect the global supply of oil.

30
 6 Markets 1.2.3
Theme 1
Key points
1. The interaction of supply and demand.
2. The drawing and interpretation of supply and demand diagrams to show the causes and consequences
of price changes.

Getting started Figure 1

The prices of some goods change slowly over time; others are The demand for and supply of button mushrooms
more volatile. For example, it was widely reported that the Price (£)
global price of oil was around $90 per barrel in October 2014. 2.50 S
By the end of December the price had fallen to around $55.
The price of flowers can increase greatly in the few days leading 2.00
up to Mother’s Day. On Christmas Day and New Year’s Eve it is
1.50
common for taxi drivers to double their prices. In general, prices
are determined by the interaction of supply and demand. 1.00
What market factor do you think has the most influence on the
0.50 D
price of oil? Why does the price of flowers rise by so much in
the run up to Mother’s Day? Why can’t taxi drivers double their 0
prices all year round? 20 40 60 80 100
Quantity of button mushrooms
demanded and supplied (000 kilos)

The interaction of supply and demand

In any market the price is set where the wishes of consumers are
matched exactly with those of producers. This price, called the Question 1
equilibrium price, is where supply and demand are equal. The
During the summer months, livestock, such as cows and
way in which the forces of supply and demand determine prices
horses, are left to roam in fields and eat grass. However, in the
in a market can be shown graphically. Figure 1 shows the supply
winter many of them are housed under cover and need to be fed
and demand curves for button mushrooms. Here the equilibrium
on hay. The market for large, round hay bales is represented by
price is £1.50. At this price consumers want to buy 60,000 kilos
the supply and demand curves shown in Figure 2.
and producers want to sell 60,000 kilos. There is no other price
where this happens. For example, if the price were £2, sellers
Figure 2
would want to supply 80,000 kilos. However, at this price,
buyers only demand 40,000 kilos because the price is too high. The market for large, round hay bales
The equilibrium price is also known as the market clearing Price (£)
40
price. This is because the amount supplied in the market is Supply
completely bought up by consumers. There are no buyers left 35
without goods and there are no sellers left with unsold stock. 30
The market is cleared.
25
Figure 1 also shows the total revenue or total expenditure
at the equilibrium price. Total revenue is the amount of money 20

generated from the sale of output. It is calculated by multiplying 15

price and quantity. 10
Demand
Total revenue (TR) = Price (P) × Quantity (Q) 5

In Figure 1, total revenue at the equilibrium price of £1.50 is: 0

100 200 300 400 500 600 700 800 900 1000 1100 1200
TR = P × Q = £1.50 × 60,000 = £90,000 Bales (000s)

There are many different factors that can cause a change in (a) State the equilibrium price and quantity.
supply or demand. When such changes occur the supply and (b) Using this diagram, explain what is meant by equilibrium price.
demand curves will shift. As a result there will be a change in (c) What is the value of total revenue at the equilibrium price?
the equilibrium price.

31
Markets Unit 6

Changes in demand Question 2

If demand increases, price will rise. This is because producers
react to rising consumer demand by putting up their prices. In 2014, the UK enjoyed one of the warmest and sunniest
They can do this because customers are wanting the product summers on record. Demand for a number of summer-related
in higher numbers. In Figure 3(a), an increase in demand for a products soared. One example was gas-fired BBQs. Figure 4
product is shown by a shift in the demand curve to the right, shows the market for such a product.
from D to D1. This changes the equilibrium price because supply
and demand are now equal at a different point. The price is Figure 4
forced up from P to P1 and the amount sold in the market has The market for gas-fired BBQs
gone up from Q to Q1. Price (£)
400
If demand were to fall, the opposite would happen. This is
because producers are forced to lower their prices. Otherwise 350
S
they would be left with too much unsold stock. They are forced 300

to do this because customers are wanting much less of the 250

product. The demand curve would shift to the left from D to D2
200
and the price would fall to P2. The amount traded in the market
would fall from Q to Q2. 150

100
D1

50
D
Figure 3
0
100 200 300 400 500 600 700 800
The effect on equilibrium price of a change in demand
Number of BBQs (000s)
and supply
Price (a)
(a) Explain one reason for the shift in the demand curve from D to D1.
S
(b) What has happened to the equilibrium price and quantity as a
result of the shift in demand?

P1 Changes in supply
P A change in supply will also affect equilibrium price. For
P2 example, if supply increases the price will fall. In Figure 3(b),
an increase in supply for the product is shown by a shift in the
D1
D Worked example
D2
0 Q2 Q Q1 Quantity demanded
and supplied
Figure 5 shows the market for accommodation in a UK city.
The equilibrium price per room is currently £60. What might
Price (b) happen to the price of rooms if some new hotels open up?
S2
S The arrival of new hotels in the city would increase the supply
S1
of rooms available. This would shift the supply curve to the right
P2
from S to S1. As a result the equilibrium price per room is forced
P
down from £60 to £40. The equilibrium number of rooms let
P1
rises from 20,000 to 25,000.

Figure 5
The market for accommodation in a UK city
D
Price per room (£)
160

0 Q2 Q Q1 Quantity demanded 140 S

and supplied S1
120

100

80

60

40

20
D

0
5 10 15 20 25 30 35 40
Number of rooms (000s)

32
 Marketing and people

supply curve to the right, from S to S1. This changes equilibrium

price because supply and demand are now equal at a different Figure 7
point. The price is forced down from P to P1 and the amount The excess demand for and excess supply of button mushrooms
sold on the market has gone up from Q to Q1. If supply were to Price (£) Excess supply
fall, the opposite would happen. The supply curve would shift 2.50 S
to the left from S to S2, price would rise from P to P2 and the
2.00
amount traded in the market would fall from Q to Q2.
1.50
Changes in supply and demand together
1.00
It is possible for both supply and demand to change at the same
time in a market. For example, demand might increase and 0.50 D
supply decrease at the same time. This is shown in Figure 6. Excess demand
0
The original equilibrium price is P where S = D. The increase in 20 40 60 80 100
demand is represented by a shift to the right from D to D1. The Quantity of mushrooms demanded
decrease in supply is represented by a shift to the left from S to and supplied (000 kilos)

S1. The new equilibrium price, where D1 = S1, is P1. The price is
higher and the amount sold in the market has fallen from Q to Q1.
Excess supply: If the price charged is set above the
equilibrium price, again, supply and demand are not equal. In
Figure 6 Figure 7, if the price is set higher, say at £2.50, demand is only
A change in supply and demand 20,000 kilos while supply is 100,000 kilos. This time there is
Price excess supply, which means that goods would remain unsold.
In this case, the quantity of unsold goods is 80,000 kilos
S1 S (100,000–20,000).

P1
Thinking bigger
Every year the FA Cup Final is played at Wembley Stadium. Unfortunately,
P there are never enough tickets for all the supporters that would like to go;
there is always a shortage. The English FA are aware of this, but don’t set
D1
the price very high as they say that they would prefer to keep the tickets
‘reasonably priced’ so that genuine football supporters can afford to go
D
to the match. Evidence of ticket shortages is shown by the price of tickets
on the ‘black market’ (an illegal market where touts sell tickets above
face value). In some years a ticket with a face value of £60 might be sold
0
Q1 Q Quantity for £500 or more. Figure 8 is an illustration of what is happening in the
market. Note that the supply curve is vertical because supply is fixed. The
capacity of Wembley Stadium is 90,000.
Note that it would be possible to redraw the diagram to show
that, although the price will be higher, the quantity sold could Figure 8
also be higher. To do this it would be necessary to make the The market for FA Cup Final tickets
increase in demand greater than the decrease in supply. When Price per seat (£)
there is a change in both supply and demand, it is not possible 160
S
to show exactly what will happen to price and quantity unless it
140
is known precisely by how much supply and demand shift.
120
Disequilibrium in the market 100
If the price in a particular market is not set at the point where
supply and demand are equal, there will be disequilibrium in 80

the market. Two situations might occur. 60

Excess demand D

Excess demand: If the price charged in a market is below the 40

equilibrium price, supply and demand will not be equal. In 20

Figure 7 the equilibrium price for button mushrooms is £1.50. 0

At this price, supply and demand are both 60,000 kilos. 20 40 60 80 100 120 140 160
Number of seats (000)
However, if the price is set lower, say at 50p a kilo, the market is
not in equilibrium. At this lower price demand is 100,000 kilos
and supply is only 20,000 kilos. There is excess demand, which In Figure 8, the average price of tickets is set at £60 per ticket. At this price
there is excess demand of 50,000. This is because the price is set below
means there is a shortage of goods in the market. In this case the equilibrium, which in this example is £100 per ticket.
there is a shortage of 80,000 kilos (100,000–20,000).
33
Markets Unit 6

Case study
THE MARKET FOR READY
MIXED CONCRETE
The construction industry has suffered badly since the
financial crisis of 2008 and the subsequent recession.
Output in the construction sector fell faster than the
economy as a whole in 2008. 2009 saw the sector recover
faster than the economy as a whole, but during 2010 and
2011 growth was flat. There was another contraction
in 2012 but the sector grew through 2013. In 2014 the
industry was still 11.6 per cent down on the 2007 level.
Many of the companies operating in the sector have
struggled to remain profitable. Some of the marginal
(a) Explain one factor that might cause excess supply of ready
operators have left the market. One important part of the
mixed cement. (4 marks)
supply chain in the construction industry is the contribution
made by suppliers of ready mixed concrete. This is concrete (b) Using a supply and demand diagram, illustrate the impact
that can be transported to building sites and pumped on the market for ready mixed concrete of the decline in the
directly to where it is needed. When the construction construction industry. (4 marks)
industry declined, demand for ready mixed concrete (c) Using a supply and demand diagram, illustrate the impact
naturally fell. The price of ready mixed concrete can vary on the market for ready mixed concrete if a number of
depending on how much is purchased, but a builder can suppliers are forced out of business. (4 marks)
expect to pay around £100 per cubic metre.
(d) Assess the impact on the price of ready mixed concrete of
Sources: adapted from Parliament briefing papers: The both a decline in the construction industry and the collapse
construction industry: statistics and policy, House of Commons of several suppliers. (8 marks)
and www.singletrackworld.com

Key terms Knowledge check

Equilibrium price or market clearing price – the price 1. Explain how the prices of goods and services are determined.
where supply and demand are equal. 2. What is meant by the equilibrium price?
Excess demand – the position where demand is greater than
supply at a given price and there are shortages in the market. 3. What will happen to the equilibrium price if there is a fall in
Excess supply – the position where supply is greater than demand?
demand at a given price and there are unsold goods in 4. What will happen to the equilibrium price if there is a fall in
the market. supply?
Total revenue or total expenditure – the amount of revenue
5. What is meant by fixed supply?
generated from the sale of goods calculated by multiplying
price by quantity in a given period of time. 6. What would cause excess demand in a market?
7. What will happen to the equilibrium price if there is both an
increase in demand and a fall in supply?
Exam tip
When drawing supply and demand curves you need to remember
that demand curves always slope down from left to right and
supply curves slope up from left to right (unless supply is fixed).
You also need to remember to label the axes correctly. Marks may
be awarded in examinations for labelling axes correctly and
showing clearly the units measured.

34
 7 Price elasticity of demand 1.2.4
Theme 1

Key points
1. Calculation of price elasticity of demand.
2. Interpretation of numerical values of price elasticity of demand.
3. The factors influencing price elasticity of demand.
4. The significance of price elasticity of demand to businesses in terms of implications for pricing.
5. Calculation and interpretation of the relationship between price elasticity of demand and
total revenue.

Getting started Figure 1

Albert Rogers owns a milk round in Dorset. He delivers milk to The effect of a price change on the demand for products
over 300 homes in the town. However, 30 years ago his business A and B
used to deliver to over 1,000 homes. The business has been hit Price (£)
hard by competition from retailers, particularly supermarkets, 16
selling cheap milk. In 2013 he decided that he would need to 14
generate more revenue. He raised the price of a pint of fresh milk
12
(delivered to the doorstep) from 50p to 60p. As a result sales fell
10
from 16,000 bottles to 12,000 bottles a month.
8
Calculate the total revenue the business earned (price x quantity
sold) before the increase in price. Now calculate the revenue it 6
DB
earned after it increased price. Was the price increase a wise 4
move for the business? Do you think the same would happen to 2
DA
any business that raised its price by 20 per cent?
0
20 40 60 80 100 120 140 160 180 200 220 240
Quantity (units)
What is price elasticity of demand?
For some goods a price change will result in a large change
in demand and for others a smaller change. Figure 1 helps to
illustrate this. Two demand curves (DA and DB) are shown with Price elastic demand
different slopes representing two different products: A and In Figure 1, for product B, the price change resulted in a
B. The demand curve for product A is steep and the demand more than proportionate change in demand. This means that
curve for product B is flatter. At a price of £10, demand for the change in demand was greater than the change in price.
both products is Price fell by 40 per cent (from £10 to £6) while demand
100 units. However, when the price falls to £6 demand increased by 100 per cent (from 100 units to 200 units).
increases by different amounts for each product. Demand When this happens economists say that the good has price
for product A only increases slightly to 120 units. But for elastic demand or that demand is price elastic. Goods with
product B demand increases a lot more to 200 units. Demand elastic demand are more responsive to price changes. Most
for product B is more responsive to the price change. This goods have price elastic demand.
relationship that exists between the responsiveness of demand
and a change in price is called price elastic demand.
Calculation of price elasticity of
demand
Price inelastic demand It is possible to calculate the price elasticity of demand of a
In Figure 1, for product A, the price change resulted in a less good using the formula shown below.
than proportionate change in demand. This means that the
change in demand was not as big as the change in price. Percentage change in quantity demanded
Price fell by 40 per cent (from £10 to £6) but demand only Price elasticity =
of demand Percentage change in price
increased by 20 per cent (from 100 units to 120 units). When
this happens economists say that the good has price inelastic
demand or that demand is price inelastic. A minority of goods,
such as petrol, have price inelastic demand.

35
Price elasticity of demand Unit 7

Maths tip The factors influencing price elasticity

In the formula for elasticity calculation you need to work of demand
out percentage changes. The method below can be used. The value of price elasticity of demand for a product is mainly
Difference between the two numbers determined by the ease with which customers can switch to
Percentage change = ––––––––––––––––––––––––––– × 100 other similar substitute products. A number of factors is likely
Original number to determine this.
The percentage change in the quantity demanded for product A is: ●● Time. Price elasticity of demand tends to fall the longer

the time period. This is mainly because consumers and

(120 – 100) × 100 20 × 100
Percentage change = ––––––––––––––– = ––––––– = 20% businesses are more likely to turn to substitutes in the long
100 100 term. For example, the demand for fuel oil is highly price
inelastic in the short term. If the price of petrol goes up 20
Worked example per cent in a week, the fall in quantity demanded is likely
to be only a few per cent. This is because car owners have
For product A in Figure 1, the price elasticity of demand would be: to use their cars to get to work or to go shopping. But
20% over a ten-year period, car owners will tend to buy more
= ––––– = – 0.5 fuel-efficient cars. Businesses with boilers using oil may
– 40%
replace these with gas boilers. Homeowners with oil-fired
For product B in Figure 1, the price elasticity of demand central heating systems might install more insulation in
would be: their houses to cut running costs or change to gas boilers.
100% As a result, demand for oil in the long run is likely to be
= ––––– = – 2.5 price elastic.
– 40% ●● Competition for the same product. Some businesses

face highly price elastic demand for their products. This is

Maths tip because they are in very competitive markets, where their
product is either identical (i.e. are perfect substitutes) or
There is a minus number in the calculation above little different from those produced by other businesses.
because the price fell by 40 per cent (from £10 to £6). Since Farmers, for example, when selling wheat or potatoes are
the price change was negative a minus sign must be shown. in this position. If they push their prices above the market
Whenever price or demand falls in the calculation, it is proper, price, they won’t be able to sell their crop. Customers will
and may be helpful, to show the minus sign. simply buy elsewhere at the lower market price.
●● Branding. Some products are branded. The stronger the

branding, the less substitutes are acceptable to customers.

Interpretation of numerical values of For example, many buyers of Kellogg’s corn flakes do not
price elasticity of demand see own-label brands, such as Tesco or Asda cornflakes,
The values calculated above show whether demand is price as good substitutes for Kellogg’s. They will often pay 50
elastic or price inelastic. per cent more to buy Kellogg’s rather than another brand.
●● If the value of price elasticity is less than 1 (i.e. a fraction Successful branding therefore reduces the price elasticity
or a decimal), demand is said to be price inelastic. Demand of demand for the product.
for product A in Figure 1 is price inelastic because price ●● The proportion of income spent on a product.

elasticity is - 0.5. For inexpensive products, where the proportion of a

●● If the value of price elasticity is greater than 1, demand is consumer’s income spent on the transaction is very small,
said to be price elastic. Demand for product B in Figure 1 is demand is likely to be price inelastic. For example, if the
price elastic because price elasticity is - 2.5. price of a box of matches rises by 20 per cent from 10p
●● Note that the minus sign is not used to determine whether to 12p, the fall in demand is likely to be a lot less than
goods are price elastic or price inelastic. It is enough to focus 20 per cent because the amounts of money involved
on the numerical value. are ‘trivial’. In contrast, the demand for products where
the proporttion of a consumer’s income spent on the
Question 1 transaction is much larger is likely to be price elastic. For
example, if the price of a car rises by 20 per cent from
Coolpop Ltd sells fizzy citrus drinks in the very competitive soft
£20,000 to £24,000, there is likely to be a more than
drinks market. In 2013, the company sold 2,000,000 cans of
proportionate fall in demand (i.e. greater than 20 per cent).
Lemon Coolpop at a price of 50p. In 2014, the company decided to
This is because the increase in price of £4,000 is likely to
reduce the price of Lemon Coolpop to try and win a bigger market
deter a significant number of consumers from purchasing
share. The price was reduced to 40p and sales rose to 2,600,000. the product. £4,000 will represent a sizable proportion of
(a) Calculate the price elasticity of demand for Coolpop. many consumer’s incomes.
(b) State whether demand is price elastic or price inelastic.

36
 Marketing and people

●● Product types vs the product of an individual

business. Most products are made and sold by a number Figure 2
of different businesses. Petrol, for example, is processed UK gas and electricity prices 2007 to 2013
and sold by companies such as Shell, Esso and Total.
The major supermarkets also sell petrol which they have 400
bought from independent refiners. The demand for petrol
is price inelastic in the short term. But the demand for

Price index
300
Shell petrol or Esso petrol is price elastic. This is because
petrol has no real substitutes in the short term. But Esso
200
petrol is a very good substitute for Shell petrol. In general,
a product category like petrol, carpets or haircuts has a
100
much lower price elasticity of demand than products within
2007 2008 2009 2010 2011 2012 2013
that category made by individual businesses.
Year
However strong the branding and however little the Key
competition that an individual product faces, it is still likely Consumer price index (electricity)
that a business will sell at a price where demand is price Consumer price index (gas)
elastic. To understand why, consider a product which has
price inelastic demand. As explained above, raising the price
of the product would increase sales revenue. It would also will rise by a larger proportion than the price cut. This might
reduce sales and costs of production would fall. So profits help to explain the success of low-cost supermarkets, such as
would rise. A profit-maximising firm should therefore continue Aldi and Lidl. Their sales have risen significantly, probably due
raising price until demand is price elastic. to charging lower prices in a highly competitive market.
If demand is price elastic, raising price leads to a fall in sales
revenue, but also a fall in costs because less is sold. At the Price elasticity of demand and total
profit-maximising point, any further increase in price would see revenue
the fall in sales revenue being greater than the fall in costs. When a business changes its price there will be a change
This would suggest that even strongly branded goods, such in demand and therefore a change in total revenue. It would
as Coca-Cola or McDonald’s meals, have a price elasticity of be useful for a business to know what effect a particular
demand greater than one at the price at which they are sold. It price change might have on total revenue. The value of price
also suggests that luxury brands, such as Chanel or Gucci, also elasticity can help here. In Figure 1, the demand for product A
have price elastic demand at their current price. is price inelastic and the demand for product B is price elastic.
At the price of £10 the demand for both products is 100 units.
Price elasticity of demand and pricing However, when the price falls demand for product A rises to
A business may consider price elasticity of demand when
120 units while the demand for B rises to 200 units.
setting the prices of its products. For a minority of products
The different effects on total revenue for each product
demand is price inelastic. This means that if a business
are outlined below.
raises its price there will be a less than proportionate fall in
demand. For example, if a business (selling a product that
For product A: When the price falls from £10 to £6 there is
is price inelastic) raises price by 10 per cent, demand might
an increase in demand from 100 units to 120 units. This means
fall by, say, 7 per cent. This suggests that raising price
that total revenue will change. This is shown by the following
when selling products with inelastic demand would be a
calculations.
good strategy.
Since 2007 in the UK, energy companies selling gas and
When P = £10 TR = £10 × 100 = £1,000
electricity have increased their prices substantially. Figure 2
When P = £6 TR = £6 × 120 = £720
shows that the price of gas, for example, has almost doubled
between 2007 and 2013. However, there is no evidence that
The price reduction from £10 to £6 has resulted in a £280
demand has fallen by any significant amount (if at all). This
fall in total revenue (£1,000 - £720). This shows that when
suggests that demand for gas and electricity is price inelastic
demand is inelastic, a price cut will cause total revenue to fall.
and energy companies can increase price without suffering
The opposite will happen if the price is increased. If demand is
any significant fall in demand.
inelastic, a price increase will cause total revenue to rise.
If goods have price elastic demand, a price change will
result in a more than proportionate change in demand. For
For product B: When the price falls from £10 to £6, demand
example, if a business selling a product that is price elastic
rises from 100 units to 200 units. The effect on total revenue is
raises the price by 10 per cent, demand might fall by, say,
calculated below.
18 per cent. This suggests that raising the price when selling
products with price elastic demand would not be a good When P = £10 TR = £10 × 100 = £1,000
strategy. However, if the business lowers the price, demand When P = £6 TR = £6 × 200 = £1,200

37
Price elasticity of demand Unit 7

Exam tip
This time, for product B, the price reduction has resulted in a A common mistake made by students in examinations relates to
£200 increase in revenue from £1,000 to £1,200. This shows products with inelastic demand. Sometimes students say ‘demand
that when demand is price elastic, a price cut will result in an for product x is inelastic. This means that a business can raise the
increase in total revenue. The opposite will happen if the price is price and there will be no change in demand’. This is not the case.
increased. If demand is price elastic, a price increase will cause Even when demand is price inelastic, a price change will still cause
total revenue to fall. The effect of price changes on total revenue a change in demand. It is just that the percentage change in
demand is smaller than the percentage change in price.
for different price elasticities is summarised in Table 1.

Table 1 The effect of price changes on total revenue when Thinking bigger
demand is elastic and inelastic When using price elasticity of demand to help make pricing decisions,
businesses need to be aware of some possible drawbacks with the
Price Value of Price Effect on TR concept. The main problem is the origin of elasticity values. A business
elasticity elasticity change
might estimate the value of price elasticity by measuring the effect on
Inelastic <1 Decrease Fall sales of previous price changes. For example, if a business cut the price
Inelastic <1 Increase Rise by 12 per cent four years ago and demand rose by 18 per cent, price
elasticity would be –1.5. However, this data is historic; what happened
Elastic >1 Decrease Rise four years ago may not happen again in the future.
Elastic >1 Increase Fall Another way of estimating elasticity values is to carry out market
research to find out how consumers will react to price changes in the
To conclude, if businesses know the value of price elasticity future. This would give more up-to-date values, but there could be
for their products, they can predict the effect on total revenue problems with the accuracy of the data collected by market researchers.
For example, the sample may not be representative or consumers might
of any price changes they make. They will know, for example,
not behave in the way they said they would. Consequently the data
that if demand for their product is elastic, a price reduction would be flawed. Businesses need to be aware, therefore, that elasticity
will increase total revenue. This might help to explain why values may not be entirely accurate.
many rail companies charge lower prices for off-peak rail
travel. By lowering the price more travellers are attracted and
revenue rises. Demand during the off-peak period must be Knowledge check
price elastic. 1. What is meant by price elasticity of demand?
2. Give two examples of products that might have inelastic
demand.
Question 2
3. What is the formula for calculating price elasticity
Cheryl Newman runs a pizza takeaway restaurant called of demand?
GrandPizza in a large town in Cornwall. The market for pizzas is
4. The price of a product is increased by 8 per cent; as a result
competitive and she faces very stiff competition from Domino’s
demand falls by 12 per cent. Calculate price elasticity of
Pizza in particular. However, she has traded profitably for nearly
demand.
five years. She provides excellent customer service and uses a
combination of flour and semolina to make the pizza bases, 5. The price elasticity of demand for a product is –0.67. What
which gives them a distinctive taste. will happen to total revenue if price is reduced?
In 2013, she wondered if she could increase her sales by 6. The price elasticity of demand for a product is –2.7. What
undercutting her rivals. For example, a large cheese and tomato will happen to total revenue if price is raised?
pizza from Domino’s Pizza costs just under £12. Cheryl currently 7. State two factors that affect the price elasticity of demand for
charges £10 for an equivalent product. She is considering a price a product.
cut to £8 to make the price difference more significant. Cheryl
has done some research and reckons that the price elasticity of
demand for her pizzas is about –2. In 2013 Cheryl sold 10,000 Key terms
cheese and tomato pizzas.
Price elastic demand – a change in price results in a greater
(a) Calculate the number of pizzas Cheryl would expect to sell in
change in demand.
2014 if she cut the price to £8.
Price elasticity of demand – the responsiveness of demand
(b) Calculate the change in total revenue resulting from the price
to a change in price.
change above.
Price inelastic demand – a change in price results in a
(c) Assess whether Cheryl’s decision to cut the price might be
proportionately smaller change in demand.
successful.

38
 Marketing and people

Case study
THOMPSON ENGINEERING LTD

Thompson Engineering Ltd is a family business based in

Chesterfield. The company makes three components for the (a) What is meant by the term ‘price elastic demand’?
engines that power microlights. The work undertaken by the (2 marks)
company is quite specialised and it was thought that few rivals
operated in the same market. At the end of 2013 the company (b) Explain one factor that might affect the price elasticity of
had to make some modifications to two of the components, A demand. (4 marks)
and C. This was to comply with some new health and safety (c) Calculate the expected change in revenue generated by
specifications. As a result the directors decided to raise the price product A in 2014 if the price is increased by 20 per cent.
of these two components by 20 per cent in 2014. Some financial (4 marks)
information for the three components is shown in Table 2. (d) Calculate the expected change in revenue generated by
Table 2 Financial information and price elasticity of product C in 2014 if the price is increased by 20 per cent.
demand (PED) for three products (2013) (4 marks)
  Price Sales PED (e) Assess the possible impact on Thompson Engineering Ltd of
Component A £10 100,000 -0.8 the price changes. (12 marks)
Component B £7 150,000 -1.1
Component C £5 300,000 -1.2

39
 8 Income elasticity 1.2.5
Theme 1

Key points of demand

1. Calculation of income elasticity of demand.
2. Interpretation of numerical values of income elasticity of demand.
3. The factors influencing income elasticity of demand.
4. The significance of income elasticity of demand to businesses.

Getting started Calculation of income elasticity of demand

It is possible to calculate the income elasticity of demand for a
The demand for some products can be affected by changes in good using the formula:
income. However, for some other products changes in income Percentage change in quantity demanded
will have very little impact on demand. Income elasticity =
of demand Percentage change in income
Look at the two photographs below.

Worked example
For product A in the earlier example, income elasticity of
demand would be:
25%
–––– = 2.5
10%
For product B in the earlier example, income elasticity of
demand would be:
How do you think changes in income will affect demand for 5%
–––– = 0.5
the two products? What would you expect to happen to the 10%
demand for luxury goods in the next 20 years? Can you think of
any goods for which demand might actually fall if incomes rose?
What might account for this fall in demand?
Interpretation of the numerical values of
income elasticity of demand
The values calculated above show whether demand is income
What is income elasticity of demand? elastic or income inelastic.
One of the main factors that can change the demand for
●● If the value of income elasticity is greater than 1, demand is
products is the amount of income consumers have to spend.
said to be income elastic. Demand for product A is income
Income elasticity of demand measures the responsiveness of
elastic because income elasticity is 2.5. This means that the
demand to a change in income.
change in demand is proportionately greater than the change
Consider two products: A and B. If incomes rise by 10 per
in income.
cent and demand for product A rises by 25 per cent, the change
●● If the value of income elasticity of demand is less than 1,
in demand is proportionately greater than the change in income.
demand is said to be income inelastic. Demand for product B
Economists would say that demand for product A is income
is income inelastic because income elasticity is 0.5. This
elastic. Demand for many goods and services is income elastic.
means that the change in demand is proportionately less than
Examples might include cars, fashion accessories, entertainment,
the change in income.
holidays and a wide range of luxury goods.
The value of income elasticity can also show whether goods are
In contrast, if demand for product B only rose by 5 per cent,
normal goods or inferior goods. For normal goods, where
economists would say that demand for product B is income
an increase in income results in an increase in demand, the
inelastic. This is because the percentage increase (or change) in
value of income elasticity will be positive (+). Products A and
demand is proportionately less than the percentage increase (or
B above are both normal goods because income elasticity is
change) in income. Demand for some goods and services may
positive in both cases. For inferior goods, where, for example,
be income inelastic. Examples are likely to be essential goods,
an increase in income results in a decrease in demand, the
such as milk, food in general and heating fuel.
value of income elasticity will be negative (–). Some examples
are shown in Table 1.

40
 Marketing and people

Table 1 Some examples of goods with different income elasticities of demand

Good Income elasticity Elastic or inelastic Type of good The effect of a 10% increase in income
Product W 0.6 Inelastic Normal Demand would increase by 6%
Product X -2.4 Elastic Inferior Demand would fall by 24%
Product Y 1.9 Elastic Normal Demand would rise by 19%
Product Z -0.8 Inelastic Inferior Demand would fall by 8%

Maths tip The significance of income elasticity of

Always show the positive (+) and negative (–) signs demand to businesses
when performing elasticity calculations. If you leave a negative Businesses may be interested in income elasticity of demand
sign out, you could end up getting a wrong answer. The signs because changes in income in the economy can affect the
also tell you whether the good is normal or inferior. demand for their products.

Businesses selling goods with high income elasticity:

Question 1 The demand for goods that are very sensitive to changes in
income (i.e. highly income elastic) is often cyclical. This means
Healy Ltd is a paper merchant. The company sells that when the economy is growing, demand for these types of
standard A4 paper to a wide variety of stationers, other retailers goods, such as air travel, restaurants and luxury goods, is also
and office equipment suppliers. In 2014, incomes rose by two growing. But when the economy falls into recession, demand
per cent; as a result, demand for paper rose from 2,000,000 also falls. This can cause difficulties for such businesses. During
reams to 2,030,000 reams. a recession they may lay off workers and postpone or cancel
investment projects. Forecasting demand for goods that are
(a) Calculate the income elasticity of demand for paper in this case.
influenced by the business cycle can be quite difficult. The
(b) Explain whether (i) demand for paper in this case is income
business cycle is discussed in Unit 41.
elastic or income inelastic and (ii) whether paper is a normal
good or an inferior good.
Businesses selling goods with low income elasticity:
Demand for goods that are income inelastic tends to be more
stable during the different phases in the business cycle. For
The factors influencing income elasticity example, farmers are much less affected by income changes
of demand because demand for many food products is fairly stable. This
The main factor affecting income elasticity of demand is whether makes production planning and investment decisions a little
or not goods are necessities or luxuries. easier. In countries where economic growth is steady, over
●● Necessities are basic goods that consumers need to buy. a period of time the demand for inferior goods and normal
Examples include food in general, electricity and water. necessities tends to decline. It could be argued that businesses
Demand for these types of goods will be income inelastic. operating in these sectors should attempt to diversify into goods
Another example of a good which has income inelastic with higher income elasticity of demand in the long run.
demand is cigarettes. A study in Ukraine a number of years
ago found that the income elasticity of demand for cigarettes Production planning: If businesses know the income
was 0.06. It could be argued that cigarettes are a necessity elasticity of demand for their products they can respond to
once people become addicted to them. predicted changes in incomes. Businesses that produce goods
●● Luxuries are goods that consumers like to buy if they can that have income elastic demand will expect changes in income
afford them. Spending on these types of goods is discretionary, to affect demand. So if incomes are expected to rise in the
which means that it does not have to be undertaken. Demand future they can plan ahead, making sure they have enough
for these goods is income elastic. Examples include air travel, capacity, for example. On the other hand, if a recession is
satellite television, fashion accessories, and many goods and expected, these businesses would plan to cut output. This is
services in the leisure and tourism industry. It is also argued because incomes are likely to fall during a recession. In 2008,
that the demand for imported goods is income elastic. It has as a result of the global recession, car manufacturers started to
been found that as developing nations become better off, their cut their output. For example, it was widely reported that Honda,
demand for imports rises significantly. the Japanese car manufacturer, halted production at their UK
●● The price of a product relative to incomes can also influence Swindon factory for four months between February and March
income elasticity. Demand for products that are relatively 2009. On the other hand, producers of inferior goods might
cheap, such as pencils, will tend to be income inelastic. start to build capacity if they believed a recession was coming.
However, demand for expensive items, such as houses, will When incomes fall, demand for inferior goods, such as those
be income elastic. sold by low-cost ‘no-frills’ supermarkets, starts to rise.
41
Income elasticity of demand Unit 8

Product switching: Some manufacturers have flexible Exam tip

resources and can switch from the production of one good It is important not to confuse income elasticity of demand and
to another. For example, a manufacturer of plastic moulded price elasticity of demand. Both changes in income and changes in
products may be able to switch from the production of plastic price can affect demand but when calculating and discussing
household goods to plastic toys. A predicted rise in incomes elasticity, you need to remain focused and not get them mixed up.
may encourage such a business to make more plastic toys if The formulae are very similar.
demand for them was income elastic. • Percentage change in demand is the numerator in both cases.
• For income elasticity, percentage change in income is obviously
the denominator.
• For price elasticity, percentage change in price is the denominator.

Case study
FRESHBAKE LTD
Figure 1
UK gross domestic product (GDP) per capita (average individual income) between 2004 and 2014

40,500 40,500

40,000 40,000

39,500 39,500

39,000 39,000

38,500 38,500

38,000 38,000

37,500 37,500

37,000 37,000
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
GDP per capita in US dollars at constant prices since 2004

Source: adapted from www.tradingeconomics.com

Freshbake Ltd is a large baker in the West Midlands.

It delivers to independent retailers and small supermarkets (a) What is meant by the term income inelastic demand?
in the region. Up until 2003, 80 per cent of its sales were (2 marks)
bread, bread rolls and other bread-related products.
(b) Assuming average income fell by 7 per cent, calculate
In 2003 it started to focus more on the market for cakes –
the percentage change in demand for Freshbake’s cakes
fresh cream cakes in particular. The switch in emphasis paid
between 2008 and 2010. (4 marks)
off. By 2008, slightly more than 40 per cent of Freshbake’s
revenue was from the sale of cakes – while sales of bread (c) Explain one reason why demand for Freshbake’s cakes
products remained stable. changed between 2008 and 2010. (4 marks)
Unfortunately, between 2008 and 2010, sales of cakes fell (d) Assess how useful income elasticity is for a business like
sharply. This caused the business difficulties. It had built up Freshbake Ltd. (12 marks)
cake-baking capacity since 2003 and the fall in demand
from 2008 meant that staff had to be laid off and some
investment in new machinery cancelled. It was estimated
by the business that income elasticity of demand for bread
and cakes was 0.6 and 3.9 respectively. Figure 1 shows UK
GDP per capita (average individual income) between 2004
and 2014.

42
 Marketing and people

Key terms Knowledge check

Discretionary expenditure – non-essential spending or 1. What does it mean when it is said that a good is ‘income
spending that is not automatic. elastic’?
Income elastic demand – the percentage change in
2. Give two examples of goods that might be income inelastic.
demand for a product is proportionately greater than the
percentage change in income. 3. What is the formula for calculating income elasticity of
Income elasticity of demand – the responsiveness of demand?
demand to a change in income. 4. If incomes rise by 12 per cent and demand rises by
Income inelastic demand – where the percentage change 20 per cent, what is income elasticity of demand?
in demand is proportionately less than the percentage
change in income. 5. A good has income elasticity of –0.9. Is this good normal or
inferior?
6. State two factors that might affect income elasticity of
demand.
7. Why are imports believed to be income elastic?
8. State two implications of income elasticity for businesses.

43
 9 Product/service design 1.3.1
Theme 1

Key points
1. Design mix: function, aesthetics and cost.
2. Changes in elements of the design mix to reflect social trends, such as:
●● concern over resource depletion
●● designing for waste minimisation, re-use and recycling
●● ethical sourcing.

Getting started Design mix

When designing any product or service a number of key features
have to be considered. These features may be referred to as the
design mix and are summarised in Figure 1.

Figure 1
The design mix Function

Look at the product in the image. Do you like the design?

Explain your reasons. State three factors that might be
important when designing a product like this. How might the
design be affected by changes in social trends, such as health Cost Aesthetics
and safety issues, resource depletion and waste minimisation?

Product/service design Function: A product or service must be fit for purpose, which
Many businesses are keen to bring new products and services means that it must be capable of doing the job that it is sold
to the market. New products and services help to generate more to do. For example, a waterproof jacket must not let in rain.
revenue and ensure that businesses remain competitive. The It must also be reliable and work every time the customer
process of creating a new product or service is called product uses it. For example, an internet service provider must
design. It involves the generation and development of ideas provide a reliable and safe connection. The manufacturers of
through a process that leads to new products/services. many consumer durables offer long warranties to show that
Once a business has identified a need for a product, a design they have confidence in the reliability and durability of their
brief can be written. This will contain features about a product products. Products that are not fit for purpose are also likely to
that the designers can use. For example, a business aiming to be returned, which will add to business costs.
produce a new travel iron may write a design brief such as ‘a Products and services should also be convenient and
new travel iron that is compact and possesses all the features easy for the customer to use. People will get frustrated if
of a full-sized model’. Designers can work from this design brief. they cannot download an app quickly or understand how
When designing the new travel iron they may take into account: to assemble flat-pack furniture from a set of instructions.
●● the shape and appearance of the iron Technical products and machinery often need maintenance,
●● whether it fits the intended need so these products should be designed so that maintenance
●● how easily and cost-effectively it can be produced from can be carried out easily. However, if there is adequate
the design competition in the market this might not be an issue.
●● the dimensions and preferred materials to be used Consumers can find another supplier if they are unhappy with
●● the image it gives when displayed the level of convenience offered by a particular business.
●● whether the design should create a ‘corporate identity’, saying Some products are ergonomically designed. This means
something about the image of the company. that they are designed so that people can interact with them

44
 Marketing and people

safely and without using unnecessary effort. Figure 2 shows the design mix. Product and service design has changed
how a workstation might be ergonomically designed to ensure dramatically in recent years, as computers, vehicles, mobile
that a person at work is entirely comfortable. phones and music players have become more compact and
If a business can design a product or service with superior more powerful. Many consumers prefer smaller and more
functionality, it may be used as a unique selling point, or USP. portable products that are more user-friendly.
Most people recognise that Volvo emphasise the safety of their
cars. This is their USP. Cost: A well-designed product or service is more likely to
Designers must also ensure that new products or services be economically viable. This means that a business should
are safe. Safety is particularly important if children, the elderly or be able to produce and sell the product or service at a
pregnant women use the products. Safety issues could include profit. Therefore designers will need to select materials and
ensuring that products do not contain poisons or dangerous processes that minimise costs. For example, it was reported
materials, such as toxic paint. If potentially dangerous features that Apple wanted to use curved glass for early iPhones.
are necessary, such as a sharp edge on a power tool, then it is However, the prototypes were too expensive to manufacture,
important to design the product to provide adequate protection. so they were shelved. In the airline industry, new routes must
be cost-effective if they are to be introduced. Businesses often
have to reach a compromise between design and cost. If costs
Question 1 are high, products or services may be dropped altogether.
An office supplies company has produced a new ergonomically
designed computer workstation. Figure 2 shows how it has Question 2
taken into account the needs of users.

Figure 2 Figure 3
An ergonomically designed computer workstation The design mix – positions 1 to 5 represent different
products
Viewing distance Lamp
Function
18–30 inches
2
Display angle Document
5°–20° holder
1

Back support
Keyboard slope
5°–20°
Wrist rest 4 3 5
Table adjustable
Cost Aesthetics
for keyboard
Adjustable
height and (a) Match the following products with the positions shown on the
chair height
terminal height triangle which best represent the design mix in Figure 3. Each of
Foot rest
the positions suggests which aspect of the mix may be relatively
more important for particular products. (i) designer high heeled
(a) Explain what is meant by an ergonomically designed product. shoes, (ii) a sports car, (iii) a life assurance policy, (iv) a dining
(b) Explain the possible benefits to a business of using room table, (v) a smartphone.
ergonomically designed workstations. (b) Explain how cost might affect the design of a package holiday.

Aesthetics: Products and services should provide a sensory

stimulation in addition to performing a function. This is the
product or service’s aesthetic appeal. Designers must consider Exam tip
The design of individual products may require emphasis on a
elements of a product, such as its size, appearance, shape,
particular element in the design mix. When answering questions, it
smell or taste, or the presentation of a service, because it has an will be helpful to give examples of products where a particular
impact on the choices that consumers make. For example, some element is important. Functionality is important for products like
companies choose designs that use more expensive materials hiking boots, tools, central heating systems and exercise bikes.
to add to the aesthetic appeal of a product, because a product Aesthetic appeal is important for products like fashion
that appeals to the senses may sell better. Someone may buy accessories, sunglasses, carpets and luxury goods. Cost is
a luxury car because they like the smell of leather seats or the important for consumer durables, public transport and financial
services such as house and car insurance. This may help you to
appearance of wooden panelling, and the atmosphere that these
demonstrate that you understand the nature of the design mix and
features create, rather than because of its fuel economy or can apply your knowledge.
speed.
As the cost of resources and manufacturing comes down
over time, aesthetics is likely to become more important in

45
Product/service design Unit 9

The design mix and social trends ●● Businesses could be encouraged to design packaging which
People have become increasingly aware about the effects can be re-used. In the past, fizzy drinks and beer were sold
their lifestyles have on the environment. Worries about global in returnable bottles. Customers would return their ‘empties’
warming, resource depletion and pollution have encouraged and get a refund. The empty bottles would then be returned
many to adopt more environmentally friendly lifestyles. to the supplier, washed and re-used. Many countries
Businesses have also responded to pressure from the around the world, such as Holland and Germany, still give
government, media and consumer groups by taking into customers money for returning their empty bottles.
account environmental issues in the design of their products. ●● Another approach is to design products so that components
For example, their designs may now attempt to reduce can be easily re-used. For example, Philips designed a new
waste and facilitate the re-use and recycling of products light bulb that was easier to dismantle than previous light
and packaging. bulbs, so that the component parts could be re-used.
●● In the theatre industry, sets and props could be designed so
Design for waste minimisation: Firms are under increasing that they could be adapted and re-used for different plays.
pressure to design products that minimise waste. Waste
minimisation can take place in a number of ways. Design for recycling: Businesses are making increasing use
●● Products that use a lot of energy and other resources in
of recycled materials in their designs.
manufacturing should be designed to be more durable by ●● Some businesses are adapting their production methods
designing products that might last a lifetime. This could be so that newly designed products can be produced using
achieved by including components in a design that can be recycled materials. For example, carpet manufacturers are
replaced, or better still, repaired. For example, the Apple developing ways of using their old carpets in the production
iPhone 6 included new design features that enabled the of new ones. Glass manufacturers have long used recycled
handset to be opened and repaired more easily than glass in the production of new glass.
●● Some businesses specialise in the sole use of recycled
earlier models.
●● Products could be designed to be smaller and lighter. This
materials in their manufacture. For example, the Reefer
will help to save the amount of material used in production. Sail Company makes its products from recycled materials,
Resources used in handling, packaging and transport will including boat and windsurf sails and kites, as well as from
also be reduced. Examples of this include laptops, tablet sail-makers’ roll ends and offcuts. Its product range includes
computers, smartphones, digital cameras, music systems and deck chairs, cushions, buckets, bags and children’s toys.
●● Some firms make use of waste discarded by other
flat-screen televisions.
●● Designers could be discouraged from designing disposable
businesses in their designs. For example, Yübe is a modular
products. Products such as disposable razors, plastic cutlery, storage system built with reconstituted sugar cane waste
cardboard plates and paper cups can be replaced with fibre panels. The Yübe frames, which allow for multiple
durable equivalents. There is probably a lot more scope here stacking configurations, are made of a combination of sugar
for businesses to make improvements. At the moment, the cane fibre, recycled plastic and bamboo.
●● In the media, it may be possible to recycle material to save
amount of packaging used by businesses and discarded by
customers is considerable. time and effort. For example, the same news stories might
●● In the restaurant industry, dishes and menus could be
be adapted and used in several different formats. They might
designed to reduce food waste, such as meat off-cuts. appear in print, online, as television broadcasts, as radio
Although there are clear benefits of designing products that broadcasts and as podcasts.
reduce waste, many businesses have not embraced the idea.
For example, many products are discarded because they are Question 3
considered ‘out of date’. In the fashion industry, for example,
Jaguar Land Rover is developing a recycling process to increase
clothes and accessories are often worn for a limited period
the use of recycled aluminium in their vehicles. Working with the
of time only. They are discarded even though they are still
REAL CAR initiative, they have developed a technique to produce
functional. This is because fashions change and businesses can
a sheet metal alloy using scrap aluminium. They have also
make money by selling consumers ‘new season’ collections.
At the moment this is unlikely to change. There would need developed a recycling system at their production centre, reducing
to be a radical change in social trends for people to change transport emissions by using materials recycled in the UK instead
their behaviour. of importing them from overseas suppliers. Jaguar Land Rover
aim to reduce aluminium waste by increasing the amount of
Design for re-use: Resources can be saved if products are recycled aluminium used in vehicle manufacturing to up to
designed so that they can be re-used. For example, mobile 75 per cent where possible.
phones are designed to last for years but are thought to have (a) Explain how Jaguar is designing a method to reduce waste.
an average first use of around 18 months, so it is important that
(b) Explain how Jaguar’s approach reflects social trends.
their component parts can be re-used to prevent waste.

46
 Marketing and people

Ethical sourcing: In order to reflect social trends, some ●● Some businesses use their design features as a USP. This
businesses use ethically sourced resources in their designs. will help to market their products more effectively. For
Ethical sourcing means that businesses only use materials, example, Ecover produces household cleaners made from
components and services from suppliers that respect the plant and mineral materials. Avoiding the use of chemicals
environment, treat their workforce well by paying them a fair is environmentally friendly, and it is also their USP.
wage and providing a safe working environment, and generally ●● Businesses that adopt some of the emerging design
trade with integrity. For example, a clothes designer might features relating to social trends are more likely to be
insist that their collections are not manufactured by overseas viewed as good corporate citizens. Many businesses
businesses that use child labour in their factories. attempt to emphasise corporate social responsibility in
In 2007, British supermarket Sainsbury’s made the decision their marketing strategy. By doing this they aim to raise
to sell only Fairtrade bananas. Fairtrade banana growers get a sales revenue and profit. They may also avoid criticism for
fair price for their crop, as well as a premium that is used to fund trading unethically.
projects in their local communities. In addition, Fairtrade growers
are required to use environmentally friendly techniques, so this
decision also has a positive environmental impact.
Although some businesses try to adopt an ethical stance
when supplying products, it could be argued that the majority
are still focused on lowering costs. For example, the cheap
‘value brands’ in supermarkets are still very popular. Perhaps this
is because people are more concerned with getting products
for the lowest possible price. They may have little regard for
ethically sourced products.

Benefits of adapting product designs to

changes in social trends
Although businesses may have to make an effort to reflect social
trends in their designs, which could possibly increase costs,
there are likely to be some lucrative benefits.
●● If businesses can reduce waste they will use fewer resources.

This will result in lower costs and higher profits.

●● If designs reflect social trends, products are likely to be more

popular and sell in larger quantities. This will raise revenue

and improve profits.

Key terms Knowledge check

Consumer durables – goods that can be used repeatedly 1. State two examples of products where aesthetics is
over a period of time, such as cars and household particularly important in the design mix.
appliances.
2. State two examples of products where functionality is of
Design mix – the range of features that are important when
prime importance in the design mix.
designing a product.
Ergonomics – the study of how people interact with their 3. Explain one way in which the government might affect the
environment and the equipment they use – often in the design of products.
workplace. 4. State three examples of products that are likely to be
Ethical sourcing – using materials, components and ergonomically designed.
services from suppliers that respect the environment, treat
their workforce well and generally trade with integrity. 5. State two benefits to consumers of designs that reflect
Product design – the process of creating a new product or changes in social trends.
service. 6. State two benefits to businesses of designs that reflect
Recycling – making use of materials that have been changes in social trends.
discarded as waste.
7. How might ethical sourcing affect the design of clothing?
Resource depletion – the using up of natural resources.
Waste minimisation – reducing the quantity of resources
that are discarded in the production process.

47
Product/service design Unit 9

Case study
with a tiny proportion sent to landfill. Keeping the amount
of waste to these levels requires more employees to actively
STANLEY MODULAR work on waste management, as the factory environment
has to be strictly controlled to ensure that waste is kept to
The construction sector generates millions of tonnes a minimum.
of waste every year in the UK. This includes building
materials, such as insulation, nails, electrical wiring, steel Waste is minimised in a wide range of areas.
reinforcement and waste from site preparation such • Transportation. A Stanley Modular house can be
as dredging materials, tree stumps and rubble. Some transported to site on a single truck, with flat-pack panels
construction waste can be dangerous, as it can contain lead, on the front, roofing on the back and a 4-metre trailer
asbestos or other hazardous substances, and this sort of containing the bathroom modules. More complex parts of
waste needs to be disposed of carefully. the building process require more trips, but far fewer than
Construction companies have come under increasing pressure would be required on a traditional building site.
to reduce this waste. A construction firm in New Zealand, • Materials. In a typical build, 1,200 kg of timber is
Stanley Modular, is committed to reducing waste and has wasted – Stanley Modular only waste around
come up with some effective designs. Stanley constructs 10 per cent of this. Reductions in waste have been
modular buildings supplied as prefinished panels for schools found when all gun nails use galvanised nail strips, which
and homes in New Zealand. Wall, ceiling and floor panels are prevents operators from mixing up nail types, resulting
constructed in a factory and then transported to the building in rework. The use of computer numerical control (CNC)
site. Almost all of the work is done in the factory, with just a machinery maximises the usable material from sheets
small proportion done on site. and planks.
• Time wastage. Stanley Modular save a lot of time in
their operations. They estimate that modular building is
up to a third faster than traditional construction. The use
of CNC machinery is also 50 per cent faster than manually
controlled machinery.
Stanley Modular continually explore ways to decrease the
impact of construction on the environment. Their projects
show how a well-designed prefabricated building system
can minimise waste, improve productivity and speed up
construction projects.
Source: adapted from www.branz.co.nz/REBRI

Constructing the panels in a factory cuts down the amount (a) Explain how designs that reduce waste benefit Stanley
of waste on site, and the management of waste and Modular. (4 marks)
materials becomes easier as they are all in one place, (b) Explain the aspects of the traditional design mix that
making it easier to collect and sort the waste. might be important to Stanley Modular. (8 marks)
Almost all the materials used by Stanley Modular end up (c) Evaluate the benefits to Stanley Modular of adapting its
in their completed buildings, because the parts of each designs to reflect changes in social trends. (12 marks)
building are created to fit the exact size of the finished
structure. The small amount of excess is mostly recycled,

48
 10 Branding and promotion 1.3.2
Theme 1

Key points
1. Types of promotion.
2. Types of branding.
3. The benefits of strong branding: added value, ability to charge premium prices and reduced price
elasticity of demand.
4. Ways to build a brand: unique selling points (USPs)/differentiation, advertising, sponsorship and the use
of social media.
5. Changes in branding and promotion to reflect social trends: viral marketing, social media and
emotional branding.

Getting started
What is promotion?
In 2014 the total amount of money spent by businesses An important element in the marketing mix is promotion.
worldwide on advertising was around $537 billion. Internet This involves businesses drawing attention to their products,
advertising accounted for nearly one-quarter of that, at around services or companies. Generally, businesses use promotion to
$121 billion, according to forecasts by ZenithOptimedia, an obtain and retain customers. However, promotion is also likely
industry specialist. Figure 1 shows the share of global advertising to be used to achieve some specific aims.
by medium in 2013 and 2016*. ●● Tell consumers about a new product.

●● Remind customers about an existing product.

Figure 1 ●● Reach a widely dispersed target audience.
The share of global advertising by medium in 2013 ●● Reassure customers about products.
and 2016* 2013 ●● Show consumers that rival products are not as good.

6.9% 0.5% ●● Improve or develop the image of the business.

7.0%

7.9%
Above-the-line promotion
40.1% Above-the-line promotion involves advertising in the media.
Businesses pay television companies or newspapers, for
example, to have their adverts broadcast or printed. Advertising
16.9%
may be placed into different categories.
●● Informative advertising. This means that the adverts are
2.7%
18.1%
designed to increase consumer awareness of products.
They may give clear information about the features of a
2016
product, for example. The classified advertisements in
6.3% 0.6% Key
6.8% newspapers are examples of informative advertising.
Television
●● Persuasive advertising. Some advertising is designed to
6.4% Desktop internet
39.2% put pressure on consumers to buy a product. Persuasive
Mobile internet
Newspapers
advertisements often try to convince consumers to buy a
13.7%
Magazines
particular brand rather than that of a competitor. They are
Outdoor
often designed to appeal to people’s emotions, such as fear
Radio and pity. Persuasive adverts may also appeal to people’s
7.6%
Cinema respect for authority and fascination with celebrity. A lot of
19.5% television and cinema adverts are persuasive.
●● Reassuring advertising. This advertising is aimed at
*Predicted
existing customers. It is designed to be comforting and
Source: adapted from: www.zenithoptimedia.com suggest to consumers that they were ‘right’ to buy a
Why do businesses spend so much on advertising? What might particular product and that they should continue to do so.
account for the changes in spending by businesses on newspaper Businesses selling financial services may use this approach
and mobile internet advertising between 2013 and 2016* to reassure people that their money is ‘safe’.
as shown in Figure 1? What other methods might a business use
to promote its products?

49
Branding and promotion Unit 10
Table 1 shows the advantages and disadvantages of the main media.
Table 1 The advantages and disadvantages of selected advertising media
Media Advantages Disadvantages
Television Huge audiences can be reached Very expensive
  The use of products can be demonstrated Message may be short-lived
Sound and movement can be used Some viewers avoid TV ads
Scope for targeting groups with digital TV Delay between seeing ads and shopping
Newspapers and National and local coverage No movement or sound
magazines Reader can refer back Individual ads may be lost in a ‘sea of ads’
Ads can be linked to articles and features
Vouchers and coupons can be used
Scope for targeting with specialist magazines
Relatively cheap
Cinema Big impact with a big screen Limited audience
Can be used for local and national advertising Message may only be seen once
Specific age groups can be targeted Message is short-lived
Sound and movement can be used
Radio Sound can be used Not visual
Minority audiences allow targeting May be ignored
Cheap production May lack impact
Can target youngsters Can be intrusive when listening
Posters and billboards Can produce national campaigns Posters can get damaged by vandals
Seen repeatedly Only limited information can be shown
Good for short sharp messages Difficult to evaluate effectiveness
Large posters can have big impact
Internet Can be updated regularly Some ads such as pop-up ads are irritating
Can be targeted Possible technical problems
Hits and response can be measured
Can be sent to mobile devices
For goods available online, there is no delay between seeing
ads and shopping for the product online

Question 1
This advertisement has been used by the
RSPCA as part of a poster campaign to raise
money for the charity.
(a) What is meant by above-the-line promotion?
(b) Explain one advantage of using posters as an
advertising media.
(c) Assess to what extent this advert is meant
to be persuasive.

50
 Marketing and people

Below-the-line promotion was sponsored by Ford. The main advantage of sports

Below-the-line promotion refers to any form of promotion that sponsorship is that brand names are projected globally
does not involve advertising. It can take many forms. on the television without having to pay the owners of
television companies.
●● Donations. Donations to charities and the local community
Sales promotions: Incentives used to encourage people to buy
products are called sales promotions. They are used to boost might be used by businesses to improve their image. A
sales in the hope that if new customers are attracted they will large donation from a business is likely to be reported in the
continue to buy the product. They might be used to break into a media, which is good publicity.
new market. They may also be used to reward loyal customers The main advantage of PR to businesses is that it is often a cheap
and allow businesses to measure the impact of promotion, by method of promotion. Some businesses have been known to
counting the number of returned coupons, for example. deliberately seek bad publicity by being controversial. This can
●● Free gifts. Businesses might give free gifts to customers
raise the profile of a business very quickly, sometimes at no cost.
when they buy the product; for example, computer
companies often give away free software. Question 2
●● Coupons. Money-off vouchers can be used by businesses to
Sport has attracted funding from sponsors for many years. High-
attract customers. They may be attached to products, appear profile sporting events, such as the FIFA World Cup, the Wimbledon
in newspaper adverts, or pushed through letterboxes. Tennis Championships, the Open Golf Championship and many
●● Loyalty cards. Some businesses reward customers according
others, raise considerable sums from a wide variety of different
to how much they spend. Points are collected and then
sponsors. In 2013, around $50 billion was reported to have been
exchanged for cash, vouchers or free goods. Loyalty cards are
spent on sponsorship worldwide, most of which went on sport.
popular with supermarkets, credit card companies and stores.
●● Competitions. People may be allowed free entry into a Rolex, the luxury watchmaker, spends a lot of money on
competition when they buy a particular product. An attractive promoting its products. In 2013, it was reported to have spent
prize is offered to the winners. $61.48 million on advertising. It is also reported to be the most
●● BOGOF offers. BOGOF stands for ‘Buy One, Get One Free’. active sports sponsor. Sponsors like Rolex benefit from having
These offers are popular with many businesses, such as their name and logo ‘splashed’ everywhere at an event. For
supermarkets, transport services and restaurants. example, Rolex were one of the official partners of the US Open
●● Money-off deals. Businesses may offer customers discounts Golf Championship, which was broadcast around the world – this
such as ‘30 per cent off’ or ‘an extra 20 per cent free’. These represents a massive potential audience.
are similar to BOGOF deals and are used by a range of
Source: www.statista.com
suppliers.
(a) What is meant by sponsorship?
Public relations: Some businesses communicate with (b) Explain the advantages of sponsorship to a company like Rolex.
stakeholders using public relations (PR). The main purpose of
PR is to increase sales by improving the image of the business.
A number of approaches might be used by businesses to Merchandising and packaging: Some businesses
attract publicity. may arrange the point of sale so that it is interesting and
●● Press releases. Some information about the business may eye-catching, and likely to encourage sales. This is called
be presented to the media. This might be used to write an merchandising. Some examples are outlined below.
article or feature in a television programme. For example, a ●● Product layout. The layout of products in a store is often

business might announce that it is to create 2,000 new jobs. planned very carefully to encourage shoppers to follow
Such positive news would be of interest to the media and particular routes and look at certain products. Products that
they might want full details. stores want you to buy are placed at prominent locations, such
●● Press conferences. This is where representatives meet with as at the end of aisles and at eye level.
the media and present information verbally. This allows for ●● Display material. Posters, leaflets and other materials may

questioning and other feedback. The press might be invited be used to display certain products with the aim of persuading
to a product launch, for example. customers to buy. Lighting and other special effects can improve
●● Sponsorship. Sponsorship is when businesses attract the shopping environment. Window displays are considered
publicity by linking their brands with events, particularly important by retailers as they can draw in customers.
sporting events, TV programmes and films. For example, ●● Stock. Businesses must keep shelves well stocked because

Pepsi, Vodafone and Yes Bank were some of the companies empty shelves create a bad impression. Also, if items are out
making financial contributions to the Indian Premier League of stock customers may shop elsewhere.
in return for publicity at events in 2014. They were the
sponsors. The sponsoring of TV programmes is also popular. Direct mailing: This is where businesses mail out leaflets or
For example, in 2015, ITV’s Coronation Street was sponsored letters to households. Sometimes personal letters are used. They
by comparethemarket.com and Sky’s Goals on Sunday may contain information about new products or details of price

51
Branding and promotion Unit 10

changes, for example. Increasingly, email and text messages ●● Legal factors. In many countries legislation designed
(often called spam) are being used to contact consumers to protect consumers can affect the method and style of
rather than the postal system. The development of ICT and promotion. For example, in the EU tobacco products cannot
use of customer databases has resulted in more use of be advertised on television.
personalised marketing.
Types of branding
Direct selling or personal selling: This might involve a The aim of many businesses is to build a powerful brand. Branding
‘sales rep’ calling at households or businesses hoping to sell involves giving a product a name, sign, symbol or logo, design
products. It could also be a telephone call from a call centre or any feature that allows consumers to instantly recognise the
where a battery of sales staff is employed to sell over the product and differentiate it from those of competitors.
telephone. One advantage of this approach is that the features of
Brands can come in a number of forms.
the product can be discussed. However, people are often irritated
●● Manufacturer brands. Manufacturer brands are brands
by this approach because the callers have not been invited.
created by the producers of goods and services. The goods
or services bear the producer’s name. Examples might be
Exhibitions and trade fairs: Some businesses attend trade
Kellogg’s Corn Flakes®, Gillette razors or Dell computers. The
fairs or exhibitions to promote their products. Businesses set
manufacturers are involved in the production, distribution,
up a stand and promote their products face-to-face. Trade fairs
promotion and pricing decisions of these products.
can be attended by commercial buyers or consumers, or both.
●● Own-label brands. Own-label brands (also known
In the UK some popular exhibitions are the Motor Show, the
as distributor or private brands) are products which
Ideal Homes Exhibition and the Boat Show. There are certain
are manufactured for wholesalers or retailers by other
advantages of this method of promotion.
businesses. But the wholesalers and retailers sell the
●● Products can be tested out on consumers before a full launch.
products under their own name. One example of a product
●● Some exhibitions are overseas and can be used to break into
containing the retailer’s name is Tesco® Baked Beans.
foreign markets.
Sometimes the retailer will create its own brand name, for
●● Products can be physically demonstrated and questions
example F&F clothes sold at Tesco. These products allow a
answered.
retailer to buy from the cheapest manufacturer, reducing its
●● Exhibitions often attract the media.
cost. It will hope to promote its own products effectively to
●● Customers can speak to business owners or senior personnel
shoppers in its outlets.
face-to-face.
●● Generic brands. Some generic brands are products that

Choosing methods of promotion only contain the name of the actual product category rather
Many businesses use a range of different promotional methods. than the company or product name. Examples are aluminium
However, these must be co-ordinated so that they support each foil, carrots or aspirin. These products are usually sold at
other. Small businesses often have limited budgets so careful lower prices than branded products. They tend to account for
consideration is needed when choosing a method of promotion. a small percentage of all sales.

What affects the choice of promotion?

The benefits of strong branding
If a business can establish a strong brand it will enjoy a number
●● Cost. Not all businesses can afford to advertise on television
of benefits.
and in national newspapers so they have to find other more
cost-effective, and often more appropriate, means. Added value: A strong brand may add value to a product in
●● Market type. Local businesses often rely on adverts in local
the eyes of customers. For example, if a business can capture a
newspapers and the Yellow Pages. In contrast, businesses desirable image that is reflected in the brand, it is likely to have a
aiming their products at mass markets are more likely to use competitive edge. It could be argued that perfume manufacturers
television and national newspapers, or specialist magazines. are able to do this. They may use powerful television adverts
●● Product type. Certain products are better suited to certain
that feature celebrities using the product. Some adverts suggest
methods of promotion. For example, a car manufacturer is that if you buy a particular brand you will belong to a group of
not likely to use sales promotions such as coupons, BOGOF elegant and sophisticated consumers, similar to those featured in
deals or loyalty cards, preferring TV and cinema advertising, adverts. Such adverts may offer consumers glamour, confidence
and billboards. Similarly, supermarkets are unlikely to use and style. This approach can add value for some consumers.
personal selling.
●● Stage in the product life cycle. It is common for Ability to charge premium prices: Products with strong
promotional methods to change as a product gets older. For brands can be priced higher than those of competitors. This is
example, PR is often used at the launch of a product, but because of the customer loyalty that has been built up over a
when the product matures other methods will be used. period of time. People are less likely to switch to cheaper brands
●● Competitors’ promotions. It is common for businesses to if they have developed the habit of buying a ‘favourite’ brand.
copy successful methods of promotion used by rivals. Once Heinz, the food processing company, generally charges higher
one business comes up with a successful promotion, others prices for its canned and bottled products because they are
soon bring out their own versions. perceived to be ‘superior’ to those of rival brands.
52
 Marketing and people

Reduced price elasticity of demand: The strength of a Sponsorship: Some companies favour the use of
brand may be reflected in the price elasticity of demand for a sponsorship to help build their brands. Many argue that
product (price elasticity of demand is explained in Unit 7). sponsorship is a cheaper method of promotion than
Firms would prefer their brands to have a lower price advertising – although many companies use both. The
elasticity of demand. This means that a price increase will have majority of sponsorship spending is in sport. Companies
less impact on demand. For example, if a product has price sponsor both national and international sporting events.
elasticity of demand of –1.5, a 10 per cent increase in price will For example, Barclays Bank sponsors the English Premier
result in a 15 per cent decrease in demand. However, if price League. Sponsorship helps to:
elasticity is lower at –0.9, a 10 per cent increase in price will ●● raise brand awareness, create preference and develop

reduce demand by just 9 per cent. Consequently, with a strong brand loyalty
brand and lower price elasticity, price increases are more viable. ●● create positive PR and raise corporate awareness

●● build brand positioning by linking the product to

Ways to build a brand attractive images at events
Different companies may use different methods in an effort to ●● support other promotional campaigns
build a brand. ●● create emotional commitment to the brand

●● promote good relations with customers because

Exploiting a unique selling point: One of the best ways sponsors often provide corporate hospitality at events.
to build a brand is to develop a unique selling point (USP) for
a product. If a product has a USP it is much easier to differentiate Using social media: An increasing number of
the brand and make it ‘stand out from the pack’. Some companies businesses are switching marketing resources into
develop USPs by incorporating special features in their designs. social media. Social media can be used in more
Another approach is to make promises to customers. For than one way. For example, a business can place its
example, some companies offer to give customers their money adverts in strategic places on sites such as Facebook,
back if they are not satisfied. Producers of luxury goods, such as Twitter, Instagram and Google+. The use of social
Prada or Gucci, use exclusivity as their USP. media often allows businesses to focus more easily on
particular customer groups. Social media also helps
Advertising: Advertising may be used in different ways. A businesses to get to know their customers better
business might use advertising to introduce a new brand. If the and enables them to communicate with them more
brand becomes popular and established, advertising is likely effectively. Social media may help to increase trust in
to continue in order to remind consumers that ‘it is still out a business or brand. Seeing that a particular business
there’. Advertising spreads the word about a brand, and the is active on social media helps customers to develop
more people who are familiar with the brand the greater the trust. A social media presence may suggest that a
firm’s market power. Advertising also reassures customers. An business cares about its customers. For example, if
important element of advertising is pride. Advertising may be a anything goes wrong customers will feel more secure
source of pride for customers who have chosen the brand. The if they know that it is easy for them to make contact
importance of advertising to help build brands is reflected in the and raise their issues.
amount of money spent by businesses on advertising. In 2013, A large and increasing number of businesses use
over $500 billion was spent worldwide. Table 2 shows the top social media to help build their brands. For example,
10 global advertisers in 2013. Kentucky Fried Chicken (KFC) used a social media
campaign to attract more young female customers.
Table 2 Top 10 global advertisers in (2013) It used a viral ad featuring the comedian Jenny Bede
Company Ad spend ($ billion) suggesting reasons for eating unhealthy food.

1 Procter & Gamble 11.47 Building a brand is an ongoing process. Even companies
with extremely strong brands, continually invest in
2 Unilever 7.91
advertising and promotional campaigns to support and
3 L’Oréal 5.93 reinforce their brands.
4 Toyota 3.44
5 General Motors 3.35
6 Volkswagen 3.23
7 Nestlé 3.12
8 Coca-Cola 2.9
9 McDonald’s 2.86
10 Pepsi 2.74
Source: adapted from www.statista.com

53
Branding and promotion Unit 10

Changes in branding and promotion to Using social media, such as Facebook and Twitter, to help
build a brand is important but many businesses go further. An
reflect social trends increasing number are developing their own social networks,
Businesses are under constant pressure to keep up to date with
which are linked to the main platforms. Some analysts
trends, patterns, fashions and new technology. This pressure
suggest that, while Facebook is a good platform to use to find
extends to the methods they use to promote and brand their
customers and raise brand awareness, most people who ‘like’
products. For example, since the rise of the internet, most
a brand page on Facebook never visit it again. In comparison,
firms have set up their own business websites. These are used
some companies create their own social networks. Virgin
to provide information, promote products and in some cases
Atlantic is one example of a business that has developed its
to sell goods directly to customers. Some other very recent
own social hub. This is discussed in Question 3 on the
developments are outlined below.
next page.
Viral marketing: Communication using the internet has
provided the opportunity for viral marketing. This involves Figure 2
any strategy that encourages people to pass on messages to Mean percentage of marketing budget spent on social media
others about a product or a business electronically. It creates
the potential for exponential growth in the exposure of a
25%
message. Like a virus, these strategies exploit the process of 22.4%
rapid multiplication that results from people sending messages 20%
to family, friends and colleagues, who then send them on again.
Not only can people send text relating to a marketing message, 13.5%
15%
but they also can send images, such as photographs and video 9.9%
clips. One example of a successful viral marketing campaign 10%
was produced by Volvo. It featured a video clip of Jean-Claude
5%
Van Damme doing the splits between two Volvo trucks as
they were being driven along a road. The clip was used to 0%
demonstrate the stability and precision of Volvo’s steering Current levels Over next 12 months In 5 years
system. The video had been viewed over 76 million times at the
time of writing. Key
% of marketing budget (2015)

Source: The CMO Survey – Highlights and Insights Report,

Figure 5.1, February 2015

Emotional branding: Emotional branding refers

to the practice of using the emotions of a consumer to
build a brand. It is designed to appeal to a customer’s
emotion, human need, or a perceived aspiration. The
aim of emotional marketing is to develop a love affair
between a consumer and a brand. Businesses try to instil
in their customers the emotional attachment that football
supporters have with their chosen clubs. The overwhelming
majority of football supporters all over the world could not
switch their support to another club even when theirs is
performing badly – the bond is just too strong. Emotional
branding is also based on the idea that people’s actions are
driven more by emotion than reason.
One example of a business that has used emotional
branding effectively is Apple. Apple has found a way to
connect with its customers and create with them a powerful
bond. They achieved this by connecting with younger
people in particular and creating a ‘cool’ product image.
The Apple brand has aligned itself with design innovation;
the release of a new Apple product is an event and people
Social media: A survey of marketing leaders in 2013 showed will queue for hours. They have created an emotional
they devoted around 9.4 per cent of their marketing budgets to attachment with their customers, one which is not defined
social media – a figure that continues to rise (see Figure 2). by commerce.

54
 Marketing and people

Question 3 Key terms

Virgin Atlantic, Above-the-line promotion – placing adverts using the
the London-based airline, has used social media to help media.
promote its business for several years. In 2010, Virgin Atlantic Advertising – communication between a business and
had over 200,000 Facebook fans, 115,000 Twitter followers its customers where images are placed in the media to
and 1.2 million followers on its Virgin Google+ page. However, encourage the purchase of products.
the amount of traffic driven from these to where bookings Below-the-line promotion – any promotion that does not
are made was considered inadequate. Virgin realised that it involve using the media.
needed its own social platform so it created the Virgin Atlantic Emotional branding – the practice of using the emotions of
Blog. When the blog was launched it had four specific aims. a consumer to build a brand.
Generic brands – products that only contain the name of the
1 To become an authority on travel. They did this by employing
product category rather than the company or product name.
writers to provide useful ‘insider’ information about different
Manufacturer brands – brands created by the producers of
destinations – some of which coincided with
goods or services.
Virgin Atlantic routes. Marketing mix – the elements of a business’s marketing
2 Create a central hub for their social media outreach. This had that are designed to meet the needs of customers. The
links to Facebook, Twitter, Instagram and Pinterest, which four elements are often called the ‘4Ps’ – product, price,
meant that people could be directed from these platforms to promotion and place.
Virgin’s own hub where blogs were posted. Merchandising – a promotion specifically at the point of sale
3 Add reach, depth and longevity to their marketing of a product.
campaigns. Major ad and marketing campaigns are, by Own-label, distributor or private brands – products that
necessity, short, but the blog gives Virgin a more in-depth are manufactured for wholesalers or retailers by other
opportunity to tell a campaign’s story, whether it’s businesses.
Point of sale – any point where a consumer buys a product.
interviewing the chefs behind a new meal programme or
Promotion – an attempt to obtain and retain customers by
getting to know the pilots, flight attendants and other staff
drawing their attention to a firm or its products.
who make the airline run.
Public relations – an organisation’s attempt to communicate
4 Boost sales. The best way to encourage customers to shop with interested parties.
is to provide relevant links in the right places. For example, Sales promotions – methods of promoting products in the
creating interest in a Virgin holiday or a new service, then short term to boost sales.
providing the chance to click through and book. Sponsorship – making a financial contribution to an event in
As a result of creating their own social hub, Virgin Atlantic return for publicity.
enjoyed three key benefits: Viral marketing – any strategy that encourages people to
pass on messages to others about a product or a business
• a 12 per cent increase in search traffic after six months
electronically.
• customers referred from their blog spent an extra 20 per cent.
• first-time buyers referred from the blog rose by 40 per cent.
Source: Copyright © 2013 Lithium Technologies, Inc. All rights Knowledge check
reserved.
1. State six examples of advertising media.
(a) Explain one way in which Virgin Atlantic is responding to social
2. What is meant by below-the-line media?
changes with its promotion.
(b) Explain one aim of Virgin’s social media hub. 3. What is direct mailing?
(c) Assess the benefits to Virgin Atlantic of setting up its own social 4. State four aims of promotion.
media hub.
5. Identify four different methods of sales promotion.
6. State three different types of branding.
7. State two benefits of sponsorship.
8. Why can strong brands charge premium prices?
9. How might a business use social media as a promotional aid?
10. Why are businesses spending more money on social media to
promote products?
11. What is meant by emotional branding?
12. Why might viral marketing benefit a business?

55
Branding and promotion Unit 10

Case study
PREMIER INN

Premier Inn is the UK’s largest budget hotel chain with over Finally, a poster ad featuring Lenny Henry went viral
600 hotels in 2015. It plans to increase its number of rooms in April 2014. The billboard showing Lenny Henry in a
to over 85,000 (from 59,138). Premier Inn saw total sales Premier Inn bed appeared just after William Henwood,
grow by 4 per cent to £531 million in 2014, with room a UK Independence Party (UKIP) candidate, suggested
occupancy at 78.8%. per cent. that Lenny Henry should emigrate to a ‘black country’
The company operates a guarantee system to help after the comedian’s comment about the lack of black and
differentiate its service from those of competitors. Premier ethnic minority people working in the creative industries.
Inn claims to have thought of everything that is needed to However, it was revealed that Premier Inn did not
have a great night’s sleep. They provide guests with super produce the image. This was a great example of ‘real-time
comfy, king size Hypnos beds with a choice of firm or soft marketing’. Even though the ad was a spoof, Premier Inn
pillows. The company is so confident that guests will have a benefited from a great deal of free exposure as the image
great night’s sleep that they will return their money if they was sent repeatedly around the world.
do not. This is called their Good Night Guarantee.
To help the company grow and develop its brand, Premier Inn
is committed to advertising. In 2014 it launched its biggest (a) What is meant by viral marketing? (2 marks)
to date advertising campaign – starring comedian Lenny
Henry who has featured in Premier Inn ads since 2008. The (b) Explain one way in which Premier Inn might have
aim of the campaign is to encourage potential customers to benefited from the spoof poster ad. (4 marks)
consider the various reasons for staying at a Premier Inn. In (c) Explain one way in which Premier Inn has differentiated
the television advert, Henry is shown sleeping in a Premier Inn its brand. (4 marks)
bed in a range of places, including a beach, a railway station (d) Assess the benefits to Premier Inn of having a strong
and a wedding reception. brand. (12 marks)

56
 11 Pricing strategies 1.3.3
Theme 1

Key points
1. Types of pricing strategy: cost plus (calculating mark-up on unit costs), price skimming, penetration,
predatory, competitive and psychological.
2. Factors that determine the most appropriate pricing strategy for a particular situation: number of USPs/
amount of differentiation, price elasticity of demand, level of competition in the business environment,
strength of brand, stage in the product life cycle, costs and the need to make a profit.
3. Changes in pricing to reflect social trends: online sales and price comparison sites.

Getting started ●● Some strategies may be more suitable for existing

products.
Hambleton Farm
Ruth and Carl Fletcher run Hambleton Farm, a dairy farm Cost plus pricing
in Warwickshire. In most of 2014 they sold their milk to a Businesses have to set prices that generate a profit. One
wholesaler for around 32p per litre. Ruth and Carl are ‘price method that ensures that all costs are covered is cost plus
takers’, they have no control over the price of their output. pricing. It involves adding a mark-up to unit costs. The
During the year Hambleton Farm made a very small profit – mark-up is usually a percentage of the unit cost. This method
total costs were £1,560,500 and total revenue was £1,561,000. is common with retailers. However, one of the drawbacks of
this method is that it ignores market conditions. For example,
Virgin Media
the mark-up used by a business may be far too high in
In 2014 Virgin Media launched a new TV, home phone and
relation to the prices of rival products. This might result in low
broadband bundle, the ‘Essential Family Sports Collection’. This
sales. Another problem is that it may be difficult to identify
allowed subscribers access to some sports channels so they could precisely all the costs associated with the production of a
watch all 154 Barclays Premier League games shown live on TV. particular product – particularly for multi-product businesses.
New customers were offered the package for just £46.75 per
month plus line rental. After six months, the price rose to £66.25
per month. Worked example
What would happen if Ruth and Carl tried to increase the price of The unit cost to a manufacturer of making a fibreglass canoe is
their output to 35p per litre? Why is Virgin Media offering its new £80. The manufacturer adds a mark-up of 25 per cent to get the
package £19.50 cheaper than the long-term price? How might price. Therefore the price of the canoe is:
price elasticity of demand influence the price set by a business? Price = unit cost + (mark-up x unit cost)
£80 + (25% x £80) = £80 + £20 = £100

Pricing strategies Question 1

A strategy is a set of plans designed to meet objectives. Pricing
strategy is part of the marketing strategy of the business. Other Harvey Milton Ltd is a family butcher with a busy shop in
strategies such as product and distribution strategy also make Harrogate. The shop sells a wide variety of game, poultry and
up a marketing strategy. Marketing strategy is then part of the meat, and a number of homemade pies. His three best-selling
corporate strategy of the business. Other strategies include pies and their unit production costs are:
production and financial strategy. • game pie – £3.80
Pricing strategy is therefore a set of plans about pricing which • chicken and leek pie – £2.90
help a business to achieve its marketing and corporate objectives.
• steak and kidney pie – £3.20.
For example, a corporate objective might be to double in size
over the next five years. A marketing objective to achieve this Harvey uses cost plus pricing to set the price of his pies. He adds
might be to take the products of the business ‘up-market’. The a 50 per cent mark-up. Harvey believes that this gives him a
pricing strategy developed from this could be to increase the satisfactory profit margin on the pies.
average price of the products made by the business. (a) Calculate the price of the three best-selling pies.
●● Some pricing strategies can be used for new products, such
(b) Explain one disadvantage of using cost plus pricing to a
as market skimming or penetration pricing (these strategies
business such as Harvey Milton Ltd.
will be discussed on the next page).

57
Pricing strategies Unit 11

Maths tip Businesses using this strategy are better placed if they
have a relatively low cost base. They must also resist the
It may be necessary to calculate the percentage mark-up. temptation of extending such offers for too long. If consumers
This is the difference between unit cost and price, expressed become accustomed to low prices they may be lost when the
as a percentage of the unit cost. For example, if unit cost is introductory offer expires as they are not prepared to pay the
£40 and price is £70, the percentage mark-up is 75 per cent higher price.
(£70 – £40 = £30, 30/40 x 100 = 75%). Penetration pricing is used by a variety of industries. For
example, sports clubs to attract members, online gaming sites
to attract customers, satellite broadcasters to attract subscribers
Price skimming and driving schools to attract learners.
Some businesses may launch a product into a market charging
a high price for a limited time period. This is called skimming Question 2
or creaming. The aim of this strategy is to generate high levels
of revenue with a new product before competitors arrive, and Sony launched PlayStation® 3 at a price of $599 (60 GB Model)
exploit the popularity of a new product while it is unique. in 2006 but eventually dropped the price to $299 in 2009. This
This method is common with technical products. For pricing strategy is common with technological goods, such as
example, when laptop computers were first introduced into gaming machines. When Sony launched PlayStation 4 it was
the UK market they were over £1,000. However, they can now priced at $399 and near the end of the first year it had sold
be purchased for less than £200. Pharmaceutical companies around 14 million units worldwide. Many gaming enthusiasts
also use this method. They sell new drugs for high prices when were waiting for the price to fall before buying their own.
they are first launched. However, when a patent (a licence However, it was reported in November 2014 that a price cut was
that prevents competition for a number of years) runs out, not imminent.
competition emerges and prices fall. Charging a high price
initially helps such companies recover high development costs. (a) Explain the pricing strategy used by Sony in this case.
An advantage of skimming is that high prices are charged (b) Assess the advantages and disadvantages of the pricing strategy
in a market where there are people who are prepared to used by businesses like Sony.
pay them. This helps to maximise revenue. As the price is
lowered, other customer groups are drawn into the market.
The higher, initial revenues help a business to recover the cost Predatory pricing
of research and development. The higher price also helps to Predatory pricing or destroyer pricing aims to eliminate
elevate the image of a product. However, skimming can only be competitors from the market. It involves charging a very low
used if demand is price inelastic. Skimming might also attract price for a period of time until one or more rivals leave the
competitors into the market. market. Some forms of predatory pricing are illegal in the UK
and the EU. This is when a business is selling a product below
Penetration pricing the cost of production with the deliberate aim of forcing a
Sometimes a business will introduce a new product and charge competitor out of the market. This practice is outlawed because
a low price for a limited period. This is called penetration in the long term it can lead to a lack of competition in a market.
pricing. The aim of this strategy is to get a foothold in the As a result, if all firms have left the market except for the
market. Businesses using this strategy hope that customers are predator, the price is likely to be raised beyond the initial level.
attracted by the low price, and then carry on buying it when Such low-price strategies are allowed if low-cost businesses
the price rises. One approach is to offer products at a very are prepared to endure low profit margins for extended periods
cheap rate for a trial period – sometimes as low as half price of time. They can also be used to sell stocks that would otherwise
or even free. Another is to offer the first one or few items free, remain unsold or as a means of breaking into a new market.
or at a low price, such as driving lessons. Such a strategy is In 2013, Esso and Shell were accused of localised predatory
sometimes called an introductory offer. Penetration pricing has pricing. The RMI Petroleum Retailers Association (PRA) made
a number of benefits. a submission to the Office of Fair Trading. According to the
●● It is particularly beneficial when products are targeted at Sunday Telegraph, this said: ‘From evidence submitted, certain oil
middle- or low-income consumer groups. This is because companies, notably Esso and Shell, appear to indulge in localised
such groups are more likely to be responsive to low-price predatory pricing whereby franchised dealers have to buy their
introductory offers. branded fuels at wholesale prices higher than the retail prices on
●● It can grow sales of new product lines very quickly. Usually, sites owned and operated by the same oil company.’
the lower the introductory offer the faster the growth in sales.
●● Fast growth in sales may allow a business to lower Competitive pricing
production costs by exploiting economies of scale. Some businesses take a very close look at what their rivals
●● This strategy can put pressure on rivals. They may have are charging when setting their prices. This approach is called
to lower their prices or make an effort to differentiate their competitive pricing and is likely to be used by businesses
products. Either way financial pressure is applied. operating in a fiercely competitive market. One approach is

58
 Marketing and people

to charge the same price as competitors. The advantage of Factors that determine the most
this strategy is that a price war is likely to be avoided. It is
considered to be a safe pricing strategy. Another approach is for
appropriate pricing strategy for a
the market leader to set the price and all others follow. This is particular situation
called price leadership. Price leaders are usually the dominant Setting the right price is an important marketing decision for
firms in the market. They may have developed their dominance businesses. A number of factors have to be taken into account
through being a low-cost operator or perhaps by building a before the price is set.
strong brand over a period of time.
Differentiation and USP: A business can generally charge a
Psychological pricing higher price if its product has a USP or is sufficiently differentiated
One common pricing strategy is to set the price slightly below a from those of its rivals. This is because many consumers are
round figure – charging £99.99 instead of £100. This is called prepared to pay more for products with some individuality or
psychological pricing. Consumers are ‘tricked’ into thinking that additional features. For example, restaurants can differentiate their
£99.99 is significantly cheaper than £100. Of course it is not service if they offer innovative dishes, in a uniquely interesting and
but this psychological effect often works for businesses. This comfortable environment with warm and friendly customer service.
approach targets consumers who are looking for bargains. It is As a result they may be able to charge higher prices.
not likely to be used by businesses selling ‘up-market’ products. Price elasticity of demand: If the demand for a firm’s
products is price inelastic, there will be scope for price increases.
Question 3 For example, if price elasticity was –0.8, a business could
raise its price by 10 per cent and demand would only fall by
8 per cent. As a result, total revenue would rise. Some utility
companies, such as those supplying gas, electricity and water,
have been able to raise prices quite significantly in recent years
without any serious negative impact on demand. This is because
demand for these services is price inelastic. In contrast, if a
firm’s product is price elastic, it may benefit from price cuts. For
example, if price elasticity was –2.7, a 10 per cent reduction
in price would result in a 27 per cent increase in demand. This
would increase total revenue. Some of the low-cost supermarkets
in the UK have benefited from this strategy. See Unit 7 for
detailed information about price elasticity of demand.

Amount of competition: The amount of competition in a

market will have a big influence on pricing. If there is very little
competition in the market, a business can charge much higher
prices because consumers cannot switch to a rival. For example,
a grocery shop in an isolated village in the Scottish Highlands may
be able to charge much higher prices because there is no other
shop in the vicinity. In contrast, in highly competitive markets, firms
are not generally able to charge higher prices. In some cases, firms
might be price takers. This means they have to charge the market
price. This is often the case for farmers who sell their produce in
national or international commodity markets.
In competitive markets, businesses are likely to use
competition-based pricing strategies. Many will prefer to charge
(a) Explain the pricing strategy used in this case. the ‘going rate’ price, i.e. the same or very similar price to those of
(b) Explain one reason why such a pricing strategy might be so competitors. This will help to avoid price wars. If a firm has some
popular with businesses such as petrol stations. power in a competitive market it may become the price leader. In
this situation all other firms are likely to be content just copying or
following the leader.
Exam tip
You should avoid confusing penetration pricing with predatory Strength of the brand: A business with a strong brand
pricing. Both of these pricing strategies involve charging a low can generally charge a higher price than those with weaker
price. However, penetration pricing involves charging a low price brands. One of the reasons why companies like Coca Cola and
for a short time in order to break into a new market. Predatory
Unilever spend so much money on supporting their brands, with
pricing involves trying to eliminate rivals in the market. Penetration
pricing is legal, but predatory pricing may be illegal. This is likely to
advertising for example, is so they are able to charge higher
be the case if a business is selling a product below cost price for prices. Companies with strong brands are in a better position to
a period of time with the deliberate aim of driving out a rival. use price skimming when introducing new products. They might
also consider predatory pricing to deter entry into the market.
59
Pricing strategies Unit 11

Stage in the product life cycle: Products pass through a ●● Auction sites. Gumtree, Avabid and eBay, for instance,
number of stages over their lifetime. Life for a product begins sell goods to the highest bidder. This allows sellers to get
with their development and, for many products, ends when the best possible price for goods. However, the seller has
they are withdrawn from the market. The level of sales that can to pay a fee for the use of the site. One other advantage
be expected in each stage over this time period is called the of this method of pricing is that online auction platforms
product life cycle. This is discussed in detail in Unit 13. create a sense of urgency. Consumers fear losing out
As a product passes through the different stages of this on a bargain if they wait too long. This helps to induce
cycle, a business may adjust the price charged. For example, more sales.
when a product is first launched a business might use ●● Personalised pricing. Involves the use of data relating
penetration pricing to try and get established in the market. to a specific online shopper, such as purchase history,
Later, when sales start to grow, the price can be increased. As browsing history, demographic data, hardware and
the product matures, prices might be reduced a little in order operating system used, to set a unique price for that
to remain competitive. Alternatively, a business may use price shopper. This data could come from a retailer’s own
skimming when the product is launched. This approach might be database, be enhanced by a third party or be offered up
used if the product is new and has few, if any, rivals. Later, when by the user’s own computer, tablet or mobile phone. The
rivals copy the product or bring out versions of their own, prices advantage of this method to businesses is that they can
are likely to gradually decrease. charge higher prices to those customers who are prepared
to pay more. It has been reported that Amazon has tried
Costs and the need to make a profit: In the long term, this method of pricing.
price must cover all the costs of production and generate a ●● Subscription pricing. Usually involves charging
profit. This might explain why many businesses use cost plus customers a regular monthly fee for the use of a service
pricing. Once the unit cost of a product has been calculated, or access to a specific product range. This is not a new
a business knows that if it adds mark-up a profit will be made. concept, but it lends itself well to online shopping. Online
However, customers do not care about costs, they care about magazines and newspapers; software providers, such as
value for money. It is possible to under-price a product and not Adobe Systems; audio streaming services such as Spotify;
maximise potential revenue using this approach. Businesses gaming sites, such as PlayStation Plus; fashion retailers,
need to consider the value of their products in addition to costs such as ASOS Premier; and TV and film providers, such as
if they are to extract the most from consumers. Netflix, are examples of businesses that use subscription
pricing. The main advantage is that customers are tied
Changes in pricing to reflect social into long-term agreements with businesses. Although
trends customers have the right to cancel subscriptions, many do
It is possible for social trends to have an impact on pricing not. This is an attractive proposition. It helps to improve
strategies. For example, it could be argued that today’s cash flow and removes some of the uncertainty about
consumers are more aware and better informed than ever future sales levels.
before. As a result they may challenge the prices charged by
businesses. They may haggle or spend more time searching Price comparison sites: Many online shoppers make
for bargains. They may also be less tied to particular brands use of comparison websites. The sites simply compare the
and consider instead the views and experiences of friends and prices of goods and services from a range of suppliers. Some
colleagues posted on social media sites. sites are general, but an increasing number are specialists.
For example, trivago provides a comparison of hotel prices,
Online sales: Businesses are having to adapt to selling goods KAYAK the prices of flights, Carrentals the prices of car hire,
online. Many businesses use traditional pricing strategies, such uSwitch energy prices and Mobile Checker for mobile phone
as cost plus pricing. However, for others, selling goods online prices. Comparison sites are useful for consumers because
has provided opportunities for new pricing strategies. they may be able to identify the cheapest deals available.
●● Dynamic pricing. Often used in the travel industry. For These sites might also be used by people who prefer not to
example, in the airline industry prices are flexible and shop online. They may check out prices online and then go to
different passengers can pay different fares depending on the store that is offering the best deal.
the day of the week, time of day, and number of days before Consumers should understand that no two price-
the flight. For airlines, there are dynamic pricing factors comparison websites are likely to yield exactly the same
in different components, such as how many seats a flight results – even if you provide them with identical information.
has, departure time, and average cancellations on similar This is because they may provide quotations from different
flights. Dynamic pricing is also used in the hotel industry, providers, depending on which companies they have
entertainment and retail. The aim of dynamic pricing is to access to. 
maximise revenue and profits by filling capacity such as
stadiums, flights or sales quotas.

60
 Marketing and people

® (registered trademark).
Case study

ADOBE
Adobe Systems is a multinational software provider based of Adobe’s software. It also provided an online storage system
in California, USA, and is probably best known for creating and project management tools. The cost for UK customers to
Photoshop®, Acrobat®, InDesign® and Dreamweaver®. In access all programs in the Creative Cloud was £47 a month, if
2013, Adobe announced that subscription pricing would they agreed this payment for at least a year.
be introduced. Before the new pricing system, customers Some Adobe customers preferred the company’s traditional
paid a single fee for Adobe’s Creative Suite® (many of its sales approach. However, it was widely reported that by the
applications integrated to one product) and had perpetual end of 2014 there were over 3 million subscribers to Creative
access. However, from June 2013, a monthly fee was Cloud, and feedback that the satisfaction level was high.
required to continue to access programs individually or
as a suite of programs through Adobe’s Creative Cloud®. In 2011, Microsoft introduced Office 365, a subscription
Although Creative Suite standalone products were still version of Office applications plus other productivity programs.
available, there were no further upgrades. outside Adobe’s introduction of a subscription pricing strategy in 2013
Creative Cloud. reflected a growing trend for large software firms to adopt a
subscription pricing strategy. Feedback on customer satisfaction
The announcements from Adobe stated that improvements indicated that more customers were comfortable, as part of
to Creative Cloud from June 2013 would be released on a this trend, in paying for an online service.
regular basis as features rolled out. The subscription system
would no longer be constrained by a traditional upgrade
cycle that meant that customers waited for new features. (a) What is meant by subscription pricing? (2 marks)
Development of Creative Suite was frozen at version 6, (b) Explain one reason why Adobe switched to subscription
with no new enhancements or features, though bug fixes pricing. (4 marks)
were available. Before June 2013, it cost over £1500 for the
standalone version of Creative Suite 6, where 16 programs (c) Assess the success of Adobe’s subscription pricing strategy.
including Dreamweaver, Photoshop, Illustrator®, Adobe (8 marks)
Premiere® and Adobe Audition® were bundled together. (d) Evaluate the factors that might influence the prices set by a
Customers were only able to access updates and changes business like Adobe. (20 marks)
to Creative Suite applications by subscription to Adobe’s
Creative Cloud®, a web-based system that gave access to all

Knowledge check
1. In competitive markets some firms are price takers. 6. State two advantages of skimming.
What does this mean? 7. How can firms avoid a price war in a highly competitive
2. What is the main disadvantage of cost plus pricing? market?
3. If a product costs £500 and sells for £600, what is the 8. What is the aim of predatory pricing?
percentage mark-up? 9. How might price comparison sites benefit consumers?
4. When is a business likely to use penetration pricing? 10. What is meant by dynamic pricing?
5. What is likely to happen to price as a product nears the end of
its life in the product life cycle?

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Pricing strategies Unit 11

Key terms
Competitive pricing – pricing strategies based on the prices Pricing strategy – the pricing policies or methods used by a
charged by rivals. business when deciding what to charge for its products.
Cost plus pricing – adding a percentage (the mark-up) to the Product life cycle – shows the different stages in the life of a
costs of producing a product to get the price. product and the sales that can be expected at each stage.
Mark-up – the percentage added to unit cost that makes a Psychological pricing – setting the price slightly below a
profit for a business when setting the price. round figure.
Penetration pricing – setting a low price when launching a Skimming or creaming – setting a high price initially and then
new product in order to get established in the market. lowering it later.
Predatory or destroyer pricing – setting a low price forcing Unit costs – the same as average cost (total cost divided
rivals out of business. by output).

62
 12 Distribution 1.3.4
Theme 1

Key points
1. Distribution channels.
2. Changes in distribution to reflect social trends – online distribution and changing from product
to service.

Getting started
Distribution
Cadbury is a well-known confectionery manufacturer. It is owned One important marketing activity is the distribution of
by Mondele-z International and is famous for its brands, including products, which refers to the location where consumers
the Cadbury’s Creme Egg®, Cadbury’s Roses®, Cadbury’s Flake® can buy products from. If businesses cannot get products
and Cadbury Dairy Milk®. Cadbury sells its products in as many in the right place at the right time they are not likely to
outlets as possible, for instance newsagents, sweet shops, be successful. If products are not available in convenient
supermarkets, petrol stations, bars, cinemas, sports venues and locations consumers may not have the time to search for
vending machines. them. For example, if motorway service stations were located
two or three miles from the motorway, they might struggle to
Love4Bags is a family-owned business selling handbags, purses, survive. Food producers in the UK would have limited sales if
accessories and jewellery. It is based in Yorkshire, with a shop they did not make groceries available in supermarkets.
in Otley. It also has a website, which can be used by online
shoppers. However, Love4Bags specialises in shopping parties Distribution channels
as a way to generate sales. This is where a person invites friends The route taken by a product from the producer to the
and family to a party, usually at a home location, and Love4Bags customer is called a distribution channel. Businesses can
supplies a small range of stock for display, which partygoers are choose from a number of different distribution channels.
encouraged to buy. The party host receives a generous discount Some of the main channels used for consumer goods are
or free gift. shown in Figure 1. One approach is to sell goods directly to
consumers, but others involve using intermediaries, such as
In what ways do these businesses sell their products to
retailers and wholesalers. These are businesses that provide
customers? Do you think Cadbury sells to online shoppers via a links between producers and consumers. The diagram shows
website? Give a reason for your answer. What are the advantages that some producers may use more than one channel
to Love4Bags of using shopping parties to sell goods? of distribution.

Figure 1
Distribution channels for consumer goods
MANUFACTURER

consumers

retailers consumers

wholesalers retailers consumers

agents/brokers wholesalers retailers consumers

63
Distribution Unit 12

Direct selling to shops. The main drawback is that with some methods
Some producers market their products directly to consumers. people cannot physically see the products until they have been
For example, many services are sold directly – banks, purchased. Also, some people object to direct mail, door-to-door
solicitors, hairdressers, dentists, plumbers, restaurants and salespeople and unwanted telephone calls.
taxis, for instance, do not normally use intermediaries. Some
manufacturers may use direct selling as well. This can take
Retailing
Figure 1 showed that most distribution channels use retailers.
a number of forms; for example, Avon uses door-to-door agents
These are businesses that buy goods and sell them straight to
to sell its cosmetic products. Other methods include
consumers. They provide a number of services.
the following.
●● They buy large quantities from manufacturers and
●● The internet. A rapidly growing number of retailers sell
wholesalers, and sell small quantities to customers. This is
their products online. Some manufacturers also have their
called breaking-bulk.
own websites. Online distribution is discussed in more
●● They sell in locations that are convenient to consumers. Most
detail later in the unit.
supermarkets, for example, are conveniently located and have
●● Direct mail. This is where suppliers send promotions
ample parking space.
through the post direct to customers inviting them to buy
●● They may add value to products by providing other services.
products. The utilities industry, for example, spent
These might include help with packing or delivery, repair
£11.9 million on direct mail in 2010, while almost 25 per cent
services, information about products, warranties and gift-
of all direct mail is sent by financial services companies.
wrapping. Table 1 summarises the main forms of retail outlet
●● Door-to-door selling. This is where salespeople visit
used in the UK.
households directly on spec, inviting people to buy products
or services. Energy providers have used this method to try Table 1 Common types of retail outlet in the UK
and persuade customers to change their supplier. However,
Retailer Description
after complaints about the tactics used by some of the door-
to-door sellers, and the growth of comparison websites, Mainly small shops, though some can be quite large, such
Independents as newsagents, grocers and specialists (e.g. jewellers).
the practice has been stopped by most energy providers.
Supermarkets Large
Arguably, this method of distribution is in decline. chain stores selling up to 20,000 lines, including food
and non-food products.
●● Mail order catalogues. This is where catalogues are

distributed to customers who may buy the products Department Large stores divided into separate departments, such as
stores menswear, lingerie, electricals and cosmetics.
illustrated – sometimes on credit. Traditionally people
would fill in an order form and post it back to the company. Chains of stores selling common goods, e.g. Next, WHSmith,
Multiples Boots, H.Samuel and Jaeger.
However, most businesses using this method, such as Next,
Littlewoods and Freemans, now also offer online ordering. Online Wide-ranging, from giants such as Amazon selling many
retailers goods, to small independents.
●● Direct response adverts. Some businesses place adverts

in newspapers, magazines or on television inviting people to Sometimes called hypermarkets – very large stores selling a
Superstores wide variety of goods, often very cheaply.
buy goods and services. For example, local service providers,
such as cleaners, gardeners, tutors, builders, childminders Kiosks/street Small outlets, usually specialists, selling limited ranges in
vendors airports, stations, malls, etc.
and many other traders offer their services in this way.
●● Shopping parties. Representatives organise parties and
Market Usually sole traders selling from market stalls in streets,
traders squares and market halls – can be temporary or permanent.
invite people to attend for an enjoyable social occasion while
having the opportunity to buy products such as jewellery, The UK grocery market was worth £174.5 billion in 2014, with
cosmetics, Tupperware, fashion accessories and lingerie. around 55p in every £1 being spent on groceries. By 2019 it
●● Telephone selling. Although many people do not is expected to have grown to £203 billion. Figure 2 shows the
welcome telephone calls from businesses trying to sell distribution methods used in the grocery industry in the UK in 2014.
them goods and services, the practice is still widespread.
Suppliers of insurance, home improvements, legal services Figure 2
(to help you make claims from the mis-selling of financial
Distribution channels used in the grocery market
products, for example), energy-saving improvements and
£9.4bn
energy providers are often associated with this method of £7.7bn
distribution. A development in telephone selling (sometimes £10.8bn £73.7bn Key
called telemarketing) is the use of ‘robocalls’. This is where Hypermarkets and superstores
an automated telephone call produced by a computerised Small supermarkets
autodialer delivers a message. The message usually invites Convenience stores
people to press a number on the phone to continue £37.4bn Discounters
the conversation. Online
The main advantage of direct selling is that intermediaries Other retailers
are not required, so producers are able to make more profit.
£35.5bn Source: IGD copyright 2014
Producers can also reach customers who do not like going

64
 Marketing and people

Question 1 Question 2
The use of agents when selling goods overseas is common.
Agents are people who know the foreign market and can
introduce a business to overseas customers. They are paid a
commission for any sales made, ranging between 2.5 per cent
and 15 per cent. When a business exports for the first time it
may lack the experience and confidence to ‘go it alone’. For
example, a UK company trying to penetrate the Chinese market
is likely to face a number of obstacles. The use of an agent may
reduce the risk of exporting and provide a number of specific
advantages.
• The costs of recruiting, training and paying specialist staff for
sales overseas are avoided.
• An agent is likely to have a network of contacts that can be
Shetland Blankets Ltd manufactures blankets made from
Shetland wool. The company has a limited product line, but exploited immediately. Such contacts would take time to
has been trading for 80 years. The company is profitable, but a develop when ‘going it alone’.
new managing director wants to grow the business. Most of the • Agents may be preferred to distributors because the seller
blankets are distributed to independent retailers in Scotland. then has more control over matters such as prices, display and
However, the company has a contract to supply a small multiple brand image.
in the north of England. The new managing director wants to • Agents have the experience and knowledge needed to sell in
widen the distribution network. She thinks that contracts with places where culture, trading practices, commercial laws and
department stores and one or two larger multiples would be other customs are different from the UK.
a good short-term target. In the future the company could
Despite the advantages of using agents when selling overseas
look into online selling, but at the moment the product line is
there may be some drawbacks. For example, shipping and
too small to justify the investment needed to set up an online
other related costs may not be met by an agent. After-sales
selling operation.
service may be difficult to provide and the amount of control
(a) What is the difference between a department store and over marketing and brand image will be less than it would be if
a multiple? selling abroad independently.
(b) Explain one reason why distribution through multiples might be
more profitable than independent retailers.
Source: adapted from www.nibusinessinfo.co.uk
(a) Explain one motive for using an agent when selling overseas.
(b) Assess the advantages of using agents when trying to penetrate
Wholesaling overseas markets.

Some producers use wholesalers to help distribute goods.

Wholesalers usually buy from manufacturers and sell to
retailers. Wholesalers may break bulk, repack goods, Choosing the appropriate distribution
redistribute smaller quantities, store goods and provide channel
delivery services. A wholesaler stocks goods produced by The channels of distribution chosen by a business will depend
many manufacturers. Therefore retailers get to select from a on a number of factors. It should also be noted that many
wide range of merchandise. businesses use a combination of different channels. This will
help to widen the distribution network and reach a larger
Agents or brokers number of potential customers.
The role of agents or brokers is to link buyers and sellers.
They are used in a variety of markets. For example, travel
The nature of the product: Different types of products
agents sell holidays and flights for holiday companies, airlines
may require different distribution channels. Some examples are
and tour operators. Estate agents sell properties on behalf of
given below.
vendors. Agents are also used to sell insurance, life insurance
●● Most services are sold directly to consumers. It might not be
and other financial products. Manufacturers may also use
appropriate for window cleaners, gardeners and hairdressers,
agents when exporting. Agents can reduce the risk of selling
for example, to use intermediaries. This is because unlike
overseas because they have knowledge of the country and
goods, services cannot be held in stock.
the market.
●● Fast-moving consumer goods like breakfast cereals,

confectionery, crisps and toilet paper cannot be sold directly

65
Distribution Unit 12

by manufacturers to consumers. This is because such goods ●● Business to consumers (B2C). This is the selling of goods
could not be sold effectively by manufacturers in single units. and services by businesses directly to consumers. Most
Wholesalers and retailers are used because they break bulk. e-tailing involves ordering goods online and taking delivery
●● Businesses producing high-quality ‘exclusive’ products, at home or work. However, new ‘click & collect’ services are
such as perfume and designer clothes, will choose their being developed where people order goods online and then
outlets very carefully. The image of their products is important, pick them up from a store or a central hub. In London, tube
so they are not likely to use supermarkets, for example. stations are being used as sites for hubs. Amazon has a well-
●● Products that need explanation or demonstration, such developed network of pick-up points in the UK where they
as technical products or complex financial products might utilise lockers and post offices. Most large retailers now have
need to be sold by expert salespeople or specialists. online services. Other examples of B2C e-commerce include:
o tickets for air, rail and coach travel
Cost: Businesses will normally choose the cheapest distribution o tickets for sports fixtures, cinemas, theatres and attractions
channels. They also prefer direct channels. This is because if o holidays, weekend breaks and hotel rooms
intermediaries are used they will take a share of the profit. Large o access to online audio and film broadcasts
supermarkets will try to buy direct from manufacturers as they o a wide range of goods on eBay and other auction sites.
can bulk buy and get lower prices. Independents are more likely ●● Business to business (B2B). This involves businesses selling
to buy from wholesalers and will have to charge higher prices as to other businesses online. Businesses can also use specialist
a result. Many producers now sell direct to consumers from their software to purchase resources. The software helps to find
websites. This helps to keep costs down. the cheapest supplier and carries out all the paperwork. The
benefits to consumers and businesses of online distribution are
The market: Producers selling to mass markets are likely to summarised in Tables 2 and 3 respectively.
use intermediaries. In contrast, businesses targeting smaller
markets are more likely to target customers directly. For example, Table 2 Benefits to consumers of online distribution
a building contractor in a small town will deal directly with
• It is cheaper because online retailers often have lower costs
customers. Producers selling in overseas markets are likely to use
agents because they know the market better. Businesses selling • Consumers can shop 24/7
goods to other businesses are likely to use more direct channels. • There is generally a huge amount of choice
• People can shop from anywhere if they have access to the internet
Control: For some producers it is important to have complete
control over distribution. For example, producers of exclusive
products do not want to see them being sold in ‘downmarket’ Table 3 Benefits to businesses of online distribution
outlets as this might damage their image. Some products, • E-tailers may not have to meet the costs of operating stores
such as heating systems, require expert installation and need • Lower start-up costs – both fixed and variable costs are lower
to comply with health and safety legislation. Producers of such
• Lower costs when processing transactions – many systems are automated
products might prefer to handle installation themselves and deal
directly with customers. They can then ensure safe installation • Less paper is needed for documents, such as invoices and receipts
more easily. • Payments can be made and received online using credit cards or PayPal
• B2C businesses can offer goods to a much wider market – e.g. global
Changes in distribution to reflect social • Businesses can serve their customers 24/7
trends • Businesses have more choice of where to locate their operations
The way in which goods and services are sold is subject to
change. Many of these changes reflect social trends. Here are
some examples. Despite the advantages to both consumers and businesses of
●● A huge growth in online shopping (this is discussed below). online distribution, there are some drawbacks for businesses.
●● Building of large US-style shopping malls. They face increasing competition, since selling online is a
●● Sellers using call centres to sell products, such as relatively cheap method of distribution. As it can be organised
financial services. from any location in the world, at any time of the day, businesses
●● Supermarkets extending their product ranges and will face more competition from overseas. There is also a lack of
opening hours. human contact, which might not suit some customers, and there
●● Shopping becoming more of a leisure activity for many people. is heavy reliance on delivery services where e-tailers often lack
●● A growth in the use of TV shopping channels. control on the quality of delivery. There may also be technical
●● The flourishing of charity shops on the high street. problems online. For example, websites can crash or be
attacked by viruses, and internet connections can be unreliable.
Online distribution: The most important new trend is Finally, there is also a security risk as computer hackers might
probably the development of online distribution. It is often called gain access to sensitive information.
e-commerce because it involves the use of electronic systems Additional drawbacks for consumers include not being
to sell goods and services. There are two main types. able to physically inspect goods before purchase, the risk of a

66
 Marketing and people

poor after-sales service, and the exclusion of customers without Changing from product to service: In most Western
internet access or credit cards. In addition, bogus traders may be economies the size of the tertiary (service) sector has
more difficult to identify online and people may have problems grown at the expense of the primary (agriculture and mining)
taking delivery of goods, for instance if they are at work all day. and secondary (manufacturing and construction) sectors.
Consequently, businesses have had to focus more on the
Question 3 distribution of services. Most services are sold directly to
consumers, so businesses have to consider more carefully the
Figure 3 range of direct distribution channels that are available.
UK online spending 2011–2014
In some cases businesses that once sold products (goods)
are now selling services and have to consider how this impacts
Billion £ on their distribution. Businesses have had to adapt to changes
120 in technology and consumer buying habits. Here are some
107
100
examples.
91
●● People used to buy music on CDs, which may have been sold
80 78
68 by a retailer or wholesaler. However, people now listen to
60 music by streaming or downloading via the internet direct to
40 computers, tablets and mobile phones. Consumers are able
20 to access vast databases of music from a variety of different
locations.
0
2011 2012 2013 2014* ●● To watch a film, people could buy a DVD sold in a retail
Year
outlet. Now there are film channels that stream films that
*Estimate
Source: www.statista.com can be viewed on a computer, mobile phone or television
via the internet.
(a) Calculate the percentage change in online retail spending ●● Instead of buying a newspaper from a local shop, some

between 2011 and 2014. businesses provide a subscription service which allows
(b) Explain the advantages to businesses of online distribution. consumers to view news online.
(c) Assess what might account for the change in online spending.

67
Distribution Unit 12

Case study
Isolated or remote areas without the infrastructure of
UNILEVER more developed regions are difficult to penetrate. Unilever
is therefore encouraging small retailers in such areas to
undertake door-to-door selling. People receive practical
Unilever is an Anglo-Dutch multinational company help in the form of marketing, accounting and sales
selling a huge range of fast-moving consumer goods. training, access to credit and even the provision of
Examples include food, beverages, cleaning agents and bicycles to help them get around. This initiative provides
personal care products. Its 400 or more brands include employment and the opportunity for people to become
well-known names such as Knorr®, Hellmann’s®, PG part of Unilever’s large sales network in countries such as
Tips® and Surf®. Unilever distributes its products to Sri Lanka, Pakistan and Bangladesh. In India, for instance,
over 190 countries using a network of outlets, from Unilever’s door-to-door selling operation is called Shakti
multinational retailers, wholesalers and distributors and it employs 65,000 women in some of the country’s
to small independent shops. Large national and poorest rural areas.
international retailers, including Metro, Walmart,
Carrefour and Tesco, play an important role in developed (a) What is meant by wholesaling? (2 marks)
markets, such as the US and Europe.
(b) Explain one reason why Unilever uses door-to-door
Unilever also sells products through a diverse group selling in emerging economies, such as India. (4 marks)
of distributors, wholesalers and millions of small
independent outlets and kiosks, particularly in developing (c) Explain one reason why online selling might be an
countries. This diversified distribution network supports unsuitable distribution channel for Unilever. (4 marks)
the incomes of millions of small-scale businesses and (d) Assess the factors that might influence a business like
individual sellers around the world. Unilever when choosing distribution channels. (12 marks)

Key terms Knowledge check

Agent or broker – an intermediary that brings together 1. Explain why it is important for a business to have goods
buyers and sellers. available for sale (a) at the right place (b) at the right time.
Breaking-bulk – dividing a large quantity of goods received 2. Give three examples of direct selling.
from a supplier before selling them on in smaller quantities 3. What is one main disadvantage of telephone selling?
to customers.
4. State three functions undertaken by retailers.
Direct selling – producers selling their products directly
to consumers. 5. Explain the difference between a supermarket and a
Distribution – the delivery of goods from the producer to department store.
the consumer. 6. State two types of business that might use an agent to
Distribution channel – the route taken by a product from distribute goods.
the producer to the customer. 7. Explain why a cereal farmer is unlikely to use retailers to
E-commerce – the use of electronic systems to sell goods distribute goods.
and services. 8. What are three advantages to consumers of online
Intermediaries – links between the producer and the distribution?
consumer.
9. Give three examples of recent developments in distribution.
Retailer – a business that buys goods from manufacturers
and wholesalers, and sells them in small quantities to
10. How is car insurance most likely to be distributed?
consumers.
Wholesaler – a business that buys goods from
manufacturers and sells them in smaller quantities
to retailers.

68
 13 Marketing strategy 1.3.5
Theme 1

Key points
1. The product life cycle.
2. Extension strategies: product and promotion.
3. Boston Matrix and the product portfolio.
4. Marketing strategies for different types of market: mass markets, niche markets, business to
business (B2B) and business to consumer (B2C) marketing.
5. Consumer behaviour – how businesses develop customer loyalty.

Getting started
Development: During the development stage the product
Some products have long product life cycles. This means that is being researched and designed. Suitable ideas must be
they are on the market for many years. One example is Bisto investigated, developed and tested. If an idea is considered
gravy powder, which was first introduced in 1908. It can still worth pursuing then a prototype or model of the product might
be bought in shops today. Other products have shorter life be produced. A decision will then be made about whether or
cycles. They are introduced and marketed for a while, but then not to launch the product. A large number of new products
withdrawn. For example, the Sony Walkman® (a portable never progress beyond this stage and will fail. This is because
compact cassette player) was on the market for about 30 years businesses are often reluctant to take risks associated with
before being withdrawn in 2009. Some products have very short new products. During the development stage it is likely that the
lives indeed. They are sometimes called ‘fads’. Certain children’s business will spend to develop the product and costs will be
high. As there will be no sales at this stage, the business will
toys are a good example.
initially be spending but receiving no revenue.
Describe some possible marketing activities that Bisto’s
manufacturer might have used to keep the product ‘alive’ in the Introduction: At the start of this stage the product will be
market. Why did the Sony Walkman disappear from the market launched. As the product is new to the market, sales initially
in 2009? How might the marketing of a product or service are often slow. Costs are incurred when the product is launched.
change over its lifespan? It may be necessary to build a new production line or plant,
and the firm will have to meet promotion and distribution costs.
A business is also likely to spend on promotion to make
consumers aware of the new product. Therefore, it is likely that
The product life cycle the product will still not be profitable. Prices may be set high
Product is one part of the marketing mix. For marketing to be to cover promotion costs. But they may also be set low in order
effective, a business must be aware of its product life cycle. to break into the market. Few outlets may stock products at
The product life cycle shows the different stages that a product this stage. The length of this stage will vary according to the
passes through over time and the sales that can be expected product. With brand-new technical products, for example, the
at each stage. By considering product life cycles, businesses introduction stage can be quite long. It takes time for consumers
can plan for the future. Most products pass through six stages to become confident that such products ‘work’. At first the
- development, introduction, growth, maturity/saturation and price of such products may be quite high. On the other hand,
decline. These are illustrated in Figure 1. a product can be an instant hit resulting in very rapid sales
growth. Fashion products and some fast-moving consumer
Figure 1 goods may enjoy this type of start to their life.
The product life cycle
Growth: Once the product is established and consumers are
Sales aware of it, sales may begin to grow rapidly, new customers buy
Sales the product and there are repeat purchases. Unit costs may fall
as production increases. The product then becomes profitable.
If it is a new product and there is a rapid growth in sales,
0 competitors may launch their own versions. This can lead to a
Time slowdown of the rise in sales. Businesses may need to consider
Product
development Introduction Growth Maturity Decline their prices and promotion. For example, a high price charged
initially may need to be lowered, or promotion may need to
increase to encourage brand loyalty.

69
Marketing strategy Unit 13

Maturity and saturation: At some stage the growth in Promotion: Some businesses prefer to leave the product
sales will level off. The product has become established with unchanged but give a boost to flagging sales by investing in
a stable market share at this point. Sales will have peaked and promotion campaigns.
competitors will have entered the market to take advantage of ●● One approach is to find new uses for a product. For example,
profits. As more firms enter the market, it will become saturated. WD-40 was first developed in 1953 to repel water and
Some businesses will be forced out of the market, as there are prevent corrosion. Today it has multiple advertised uses,
too many firms competing for consumers. During the maturity such as removing dirt and residue, loosening screws and
and saturation stages of the product life cycle, many businesses displacing moisture in car engines.
use extension strategies to extend the life of their products. ●● Some businesses try to find new markets for their products.
These are discussed below. For example, a local business might start to serve a larger
region. A regional business might try to market its products
Decline: For the majority of products, sales will eventually nationally. A business with a national market might begin
decline. This is usually due to changing consumer tastes, new to export its products. Some UK retailers, such as Tesco
technology or the introduction of new products. The product will and Marks & Spencer, have tried this approach with
lose its appeal to customers. At some stage it will be withdrawn mixed success.
or sold to another business. It may still be possible to make ●● Investment in a sizeable advertising campaign can sometimes
a profit if a high price can be charged and little is spent on rejuvenate sales. A big advertising campaign on television, for
promotion or other costs. example, can get people interested in a product again.
●● Another approach is to encourage more frequent use of the
Extension strategies product. An example of this might be cereal manufacturers
Extension strategies, ways to prolong the life of a product persuading people to eat cereals for supper as well as for
before it starts to decline, are popular with businesses. This breakfast.
is because the costs of product development are high and The effect that an extension strategy can have on a product life
extension strategies help a product to generate more cash. cycle is shown in Figure 2. As the market becomes saturated
Two general approaches are often used. One is to make some and sales begin to fall, the decline in sales is delayed by the use
adjustments to the product; the second is to invest in promotion. of an extension strategy. It would be sensible for a business to
extend the life of a mature product before sales start to decline.
Product adjustments: Many companies try to prolong the life Firms that can predict falling sales from market forecasts may
of the product by ‘freshening’ it up. This might involve making attempt to use extension strategies before the decline takes
improvements, updating the product, repackaging the product or place – that is at the maturity stage.
extending the range.
●● Updating is quite a common approach for technical products

and certain types of consumer durables. For example, in the Figure 2

car industry firms are keen to bring out updated versions of Extension strategies
their successful models. An example is shown in Question 1
Sales
on the next page.
●● Some businesses add value to their products by making

improvements. For example, computer manufacturers bring

out new machines that are faster, have more memory, look
Extension
more stylish and have more functions than previous versions.
strategies
In the service industry, banks offer new accounts with extra
services, such as travel insurance, breakdown cover and 1 2
mobile phone insurance.
●● Another common approach is to extend the product range.

Crisp manufacturers have used this method in the past by

bringing out new flavours. In 2014, Walkers launched ‘pulled Sales without
extension
pork in a sticky BBQ sauce’ flavoured crisps after inviting strategies
consumers to vote for their favourite from a list of proposed
new flavours submitted by members of the public. 0 Time
●● Some businesses give the impression that the product has

been modified by changing the packaging. For example,

many soft drinks manufacturers sell their brands in cans,
glass bottles and different-sized plastic bottles. In the music
industry, record companies often release compilations of
hits from a number of previously released albums. The new
compilation is supported with a new cover.

70
 Marketing and people

Question 1 declining, another is growing and further launches are planned.

At point (i), as sales of product X are growing, product Y has
The Golf GTI is produced by Volkswagen (VW), the German- just been launched. This means that at point (ii), when sales
based multinational car manufacturer. The Mk l GTI was of product X have started to decline, sales of product Y are
unveiled at the Frankfurt Motor Show in 1975. The powerful growing and product Z has just been launched.
hatchback could reach 60 mph in nine seconds. Designed with This simple example shows a ‘snapshot’ of three products
the emphasis on fun, it had a tartan trim and an iconic golf ball only. In practice, a business may have many products. It would
hope that existing products remain in ‘maturity’ for a long
gearshift. To extend the life of the model a further six versions
period. The profit from these mature products would be used to
were introduced, as outlined below.
‘subsidise’ the launch of new products. New products would be
• 1984 The Mk II GTI was launched with a new chassis costly at first, and would make no profit for the business.
structure, a 1,781 cc engine and new styling to appeal to a Examples of businesses that have successfully managed their
new generation of drivers. product portfolios are sweet manufacturers. Companies such
• 1987 The Mk III GTI had a new 2.0-litre eight-valve engine as Nestlé produce a wide range of products, including KitKat,
and improved aerodynamics. This reduced the 0–60 mph time Milkybar and Yorkie, and constantly look to launch new products.
to 8.3 seconds.
• 1998 The Mk IV GTI had improved refinement and safety. In
Figure 3
2002 the fastest and most powerful GTI produced to date was
released for the 25th Anniversary Edition. Managing the product portfolio
• 2004 Launched at the Paris Motor Show, the Mk V GTI was Sales
the most powerful GTI yet produced. The vehicle had new
springs, dampers and anti-roll bars.
• 2009 Mk VI GTI won the ‘Best Hot Hatch’ award at the Auto
Express Awards. Testers complimented the sharp handling, Product X Product Y Product Z
impressive refinement and excellent comfort, and called it the
best Golf to date.
• 2012 The Golf GTI Mk VII was launched with a lighter but
stronger platform. This was the most fuel-efficient GTI to date,
and was capable of 0–62mph in 6.5 seconds.
Source: adapted from www.volkswagen.co.uk
(a) What is meant by an extension strategy?
(b) Explain one way in which VW extended the life of the 0 (i) (ii) (iii) Time
Golf GTI.
(c) Explain one advantage to VW of using an extension strategy.
The Boston Matrix: One problem for firms when planning
their product portfolios is that it is very difficult in practice to
tell what stage of the life cycle a product is at. Also, there is
Boston Matrix and the product portfolio no standard lifetime for products. For example, young people’s
Product life cycle analysis shows businesses that sales of fashion clothing has life cycles which can be predicted with
products eventually decline. A well-organised business with one some certainty. Other products are less reliable. Who, for
or more products will attempt to phase out old products and example, could have predicted the lengthy life cycles of products
introduce new ones. This is known as managing the product such as Heinz baked beans and the VW Beetle, or the short life
portfolio or product mix. cycle of products such as the Sinclair C5 - a sort of ‘mini-car’
introduced in the 1980s?
The product portfolio: The product portfolio will be made up A useful technique for allowing firms to analyse their product
of product lines. A product line is a group of products which are portfolios is the Product Portfolio Matrix developed by the Boston
similar. For example, televisions are a product line including flat Consulting Group. It is sometimes called the Boston Matrix or the
screen, HD widescreen and portable televisions. With a constant Growth Share Matrix. This is shown in Figure 4 on the next page.
launch of new products, a business can make sure a ‘vacuum’ is Products are categorized according to two criteria.
not created as products reach the end of their life. ●● Market growth. How fast is the market for the product

Figure 3 shows how a business can manage its product growing? The market may be declining or it may be
portfolio. Say that a business over a particular time period aims expanding. Sales of a product in a fast expanding market
to launch three products. By organising their launch at regular have a better chance of growing than a product in a stagnant
intervals, there is never a gap in the market. As one product is or declining market.

71
Marketing strategy Unit 13

●● Relative market share. How strong is the product within its flow. Money coming into the business from profits will not be
market? Is it a market leader that other products follow? Is it taken out via investment.
a product that is twelfth in terms of sales? To measure this
the market share of a product is compared with the strongest Question marks: Question marks, sometimes known as
rival product. For example, if Product X had a market share problem children or wildcats, are products with a relatively low
of 10 per cent and the market leader had 40 per cent, then market share in a fast-growing market. This can be a problem
the relative market share of Product X is 0.25 (10 per cent for a business because it is unclear what should be done with
÷ 40 per cent). If Product Y is a market leader with 50 per these products. If a product is performing weakly it is unlikely
cent market share and the next most important product had to be profitable. But as it is in a fast-growing market, there
a market share of 25 per cent, the relative market share of is potential to turn it into a star. Net cash flow is likely to be
product Y is 2.0 (50 per cent ÷ 25 per cent). zero or negative. Weak relative market share means that it will
Using these criteria the products of a business can be placed not be profitable. But investment will be needed to cope with
into one of four categories on the Boston Matrix. expanding sales in a fast-growing market.

Figure 4 Dogs: These are products with a relatively low market share
in a market with low growth. Dogs have poor prospects for
The Boston Matrix
future sales and profits. They may generate some positive net
cash flow because they will need little investment but may
earn some profit. But if they make little or no profit, net cash
flow may be zero or even negative.
HIGH

Businesses can make use of the Boston Matrix to manage their

Market growth rate (%)

product portfolios.
Stars Question marks
Balancing product lines: Businesses must ensure that their
product portfolios do not contain too many items within each
£ category. Naturally, they do not want lots of ‘Dogs’, but they
LOW

should also avoid having too many ‘Stars’ and ‘Question marks’.
Products on the top of the Boston Matrix are in the early stages
of the product life cycle and are in growing markets. But the
Cash cows Dogs cost of developing and promoting them will not yet have been
recovered. This will drain resources. Balancing these with ‘Cash
HIGH LOW
cows’ will mean that the positive net cash flow from the ‘Cash
Relative market share
cows’ can be used to support products in a growing market.
Source: adapted from The BCG Portfolio Matrix from the Product The development cost of ‘Cash cows’ is likely to have already
Portfolio Matrix, © 1970, The Boston Consulting Group (BCG) been recovered and promotional costs should be low relative to
sales. This does not mean though that a business would want
Stars: A star is a product with a high market growth and a lots of ‘Cash cows’ and few ‘Question marks’ and ‘Stars’. This is
relatively high market share. Stars are valuable to businesses. because many of the ‘Stars’ and perhaps some ‘Question marks’
The product will be in a strong position in its market as it has might become the ‘Cash cows’ of the future.
a high market share and the business can take advantage of a
fast-growing market. A star is already likely to be profitable as Taking appropriate decisions: Products in different
it has a relatively high market share. But a business will need categories in the Matrix may require different approaches.
to invest in the product to cope with a growing market and ●● Stars have great future potential. They are future cash cows.

growing sales. This could mean investing in new production A business will need to build the brand of these products so
facilities or promotion to fend off competition. Net cash flow that sales increase and competition is fought off successfully.
may be nearly zero. This is because although profits will be high, ●● Cash cows might be milked for cash, which can then be

bringing money in, investment spending will also be high, leading used to develop other products. Or the business may decide
to outflows. to spend just enough on promotion and development to
maintain sales and market share, known as holding.
Cash cows: A cash cow is a product with a relatively high ●● For question marks a business has choices. It can build

market share. It is therefore well positioned in the market and the brand, hoping to turn it into a star, harvest the product
likely to be profitable. But the market it is in will have weak by raising price and cutting promotion so that profits are
growth. So there will be little chance of increasing sales and increased, or divest itself of the product, withdrawing it or
profits in future. There will be little need for investment. selling it because it is not making a profit.
With slow growth in sales there should be little need for new ●● Dogs may be divested if they are not making a profit or in

premises, for example. Cash cows have strong positive net cash some cases harvested.

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 Marketing and people

Question 2 markets are usually very competitive because the rewards for
success can be significant. A wide range of different marketing
CheezyBix Ltd manufactures a range of cheesy snacks. The strategies can be used in a mass market, but some general
business currently has four products in its portfolio. They are similarities are as follows.
shown in Figure 5. CheezyBix, a product first launched in 1987, ●● Product. In a mass market there will be many products

earns about 65 per cent of the company’s revenue. It has a high vying for customer attention. Most of these products will be
market share and it is still growing. very close substitutes for each other. The most successful
businesses are likely to be those that can differentiate their
Figure 5 product in some way. Developing a USP will help a business’s
CheezyBix Ltd product portfolio product ‘stand out from the pack’. If a business is unable to
differentiate its product it will have to rely on other elements
in the marketing mix to compensate.
●● Price. The prices charged by businesses in a mass market

are likely to be very similar. All businesses in the market are

HIGH

CheezyBix Cheesy Snaps likely to fear a price war because they usually reduce revenue
for every competitor. This helps to explain why businesses
Market growth rate (%)

are happy to charge the ‘going rate’ in the market. Price

leadership is common in mass markets where the dominant
business, perhaps the one with the lowest unit costs, sets the
price and everyone else follows.
●● Promotion. In the absence of price competition, firms look to
LOW

Crackles Frappers non-price competition to help gain an edge. This means they
are prepared to invest heavily in advertising and promotion
because it is such an important part of the marketing mix in
mass markets. An overwhelming majority of TV adverts are
placed by businesses selling into mass markets. Perhaps
HIGH LOW
less than five per cent of those that see the adverts will buy
Relative market share
the product. However, five per cent of several million is a
significant number.
(a) Explain how you would categorise the position of Crackles in the
●● Place. Businesses serving mass markets will often use
Boston Matrix using Figure 5.
multiple channels to distribute their goods. Businesses
(b) Explain one way in which CheezyBix Ltd might use the selling fast-moving consumer goods will target supermarkets,
information in Figure 5.
wholesalers, independents and any other outlet that is
suited to their particular product. Some manufacturers pay
supermarkets to display their goods in prominent places – at
eye level or at the end of aisles, for example. The internet is
Marketing strategies used increasingly by businesses to sell goods and services
A marketing strategy is a set of plans that aim to achieve a in mass markets. All banks, for instance, offer online bank
specific marketing objective. For example, a local car rental accounts and an increasing number of supermarkets offer
company might aim to become the market leader in the region. online shopping and delivery or ‘click & collect’ services.
Its strategy to achieve this objective might be to: The internet has allowed small businesses and other
●● improve the quality of customer service by delivering cars to independents to have access to mass markets. For example,
people’s homes a small glove manufacturer based in, say, Dumbarton in
●● contact all previous customers offering them a half-price deal Scotland, could distribute its products to individual customers
●● offer a three-day weekend rental for the price of two days anywhere in the world.
●● invest £500 in a local newspaper advert

●● donate a vehicle to a local community group to get some PR Strategies for niche markets: Customers in niche markets
●● set up a website to promote the business and take online have very particular needs, which are sometimes neglected by
bookings. larger firms. Consequently, there is a gap in the market for a
This strategy involves all aspects of the marketing mix and a business that is prepared to tailor goods or services to this
number of different promotional methods. small customer group. Businesses selling to niche markets
will use different marketing strategies from those selling into
Strategies for mass markets: Some businesses sell mass markets.
products into mass markets. Such markets are huge, often ●● Product. In a niche market the product is likely to have quite

global, and can have millions of potential customers. Procter significant differences from its rivals. For example, in the
& Gamble, Heinz, Kellogg’s, Coca-Cola and General Motors dining out market there are around 420,000 restaurants in
are examples of businesses that sell into mass markets. Mass the UK. However, only four of these have been awarded three

73
Marketing strategy Unit 13

Michelin stars (the highest award possible for food quality some drawbacks using this approach. People are increasingly
and service). These four restaurants serve stunning food of ignoring adverts. How many do people remember? Also, many
the highest possible quality – very different from that served people object to cold calling and other intrusive methods.
in the overwhelming majority of other restaurants. They Persistence in the use of these could damage a brand’s
cater for a particular niche – people who want to experience reputation. Many of the leads obtained using these methods
the very best dining, perhaps just as a one-off, and are are poor quality, ‘fizzling out’ and wasting resources. It has also
prepared to pay for it. In niche markets products will be been reported that outbound leads cost significantly more to
designed carefully in order to meet the very specific needs acquire than inbound leads.
of the customer group. Product will be a key element in the
marketing mix. Inbound marketing strategies: This involves attracting
●● Price. Businesses selling in niche markets have more potential customers to websites when they are looking for
flexibility in their pricing. There is less competition in niche suppliers or solutions to problems. Some of the common
markets so higher prices can be charged without losing inbound marketing techniques are summarised in Table 1.
significant market share to rivals. Also, customers may be
prepared to pay higher prices if their specific needs are Table 1 Common inbound marketing techniques
being met effectively. For example, the prices charged by Method Description
restaurants with three Michelin stars can be over £100 per Provide content on company blogs to help draw
Blogging
person (without wine). in potential customers
●● Promotion. In niche markets promotion and advertising Develop a following on social media, such as
Social media marketing
will tend to be more targeted. Since niche markets are Twitter, LinkedIn and Facebook
smaller there is less need to use national media when
Search engine optimisation Increase website traffic by getting a
advertising. Businesses need to identify their customer profile high-ranking placement in searches
very accurately to ensure that advertising and promotion Offer useful, in-depth information for website
Free e-books
expenditure is not wasted. Adverts are likely to be placed in visitors to download
specialised publications. For example, yachts and chandlery Produce short and informative video clips for
Video marketing
(boat equipment and accessories) are likely to be advertised website visitors
in magazines such as Yachting Monthly and Boating World. Send personalised emails targeted to people –
Some manufacturers of golf clubs and golf accessories Targeted email marketing for example, those who who have downloaded a
advertise on TV, but only use specialised channels, such as free e-book
Sky Sports.
●● Place. Businesses selling into niche markets are often more The use of inbound methods also has challenges. For
selective when choosing distribution channels. They are more example, it requires effort and resources to build up enough
likely to use exclusive distributors or to handle distribution useful content on websites to change visitors into leads.
privately. They will also use the internet if it is practical. One Recruitment of experienced inbound marketers can be difficult,
example is Blue Mountain coffee. This is a high-quality coffee and it can be tricky to keep the strategy up-to-date with
grown mainly in Jamaica, which can only be purchased from rapidly emerging trends.
selected stores in the UK, and online. It is marketed at around
£24 for 227g compared to around £3.50 for rival beans, Hybrid strategies: This involves a combination of both
which might be sold in supermarkets, for example. outbound and inbound methods. It is reckoned that inbound
strategies take at least six months to generate results, so some
Strategies for business-to-business (B2B) outbound methods can be employed in the short term. Once
and business-to-consumer (B2C) markets inbound methods start to generate meaningful leads some of the
Many businesses supply goods and services to other less effective outbound methods can be dropped. This will help to
businesses. For example, JCB produces a wide range of reduce costs and create sustainable growth in market share.
machinery for use in the construction industry. It sells most of its
products to construction companies and plant hire companies Exam tip
all over the world. The marketing strategies used by companies You need to understand that marketing strategies can vary hugely.
that sell to other businesses (B2B) are likely to be different from They depend on a wide range of factors, such as the nature of the
product, the resources available to a company, the aim of the
those discussed above, that sell to consumers (B2C). In B2B
strategy, the size and nature of the market, corporate strategy
marketing, one approach is to distinguish between outbound and the creativity of employees. You would expect very different
and inbound marketing strategies. products to be marketed differently; for instance, the way
healthcare and confectionery are marketed is likely to be very
Outbound marketing strategies: This involves directing different. However, businesses in the same industry can also have
marketing material at potential customers whether they different marketing strategies. Small businesses will use different
are expecting it or not. This could include sending direct approaches to multinationals because they have fewer resources.
Some businesses may have similarities in their marketing
mail, email, telemarketing, sponsorship, targeted adverts in
strategies, but rarely will they be identical.
specialist publications or trade shows. However, there are

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 Marketing and people

Developing customer loyalty Question 3

A business is likely to be more successful if it can persuade
customers to keep returning. How can businesses develop
customer loyalty?
●● Communication. A business must keep customers informed.

In a mass market this might involve using national advertising

campaigns to tell customers about new products. Some
businesses may use reassuring adverts. These help to
convince customers that they have made the right purchase.
Some firms send out regular newsletters, usually by email,
to keep customers up to date with company events. Regular
communication helps to build a relationship between a
business and a customer. If a bond can be formed customers
are more likely to return.
●● Customer service. Customers are more likely to return to

a business if they receive high-quality customer service.

Employees who come into contact with customers must
be professional, consistent and conduct themselves with
integrity. Customer service can often be improved by dealing
with matters more promptly, providing a more effective
after-sales service or making the ‘purchasing experience’
a pleasant one. Some businesses provide customers with
refreshments while they are conducting a transaction.
A number of banks offer their customers ‘cashback deals’ when
●● Customer incentives. Many businesses reward their
using credit cards. This means that a credit card user can receive
customers if they keep returning. Some supermarkets use
loyalty cards. In 2014, Morrisons launched its Match & an amount of cash depending on how much is spent on the card.
More loyalty card. Under the scheme, Morrisons’ prices are For example, American Express offered customers 5 per cent
checked against a database of thousands of products at cashback if they spent up to £2,000 in the first three months
other retailers. Consumers are awarded points if a product of a platinum card membership. After the initial three months
they have bought from Morrisons is sold more cheaply by a customers could earn up to 1.25 per cent cashback, depending
rival. For example, if a rival’s product is 50 pence cheaper on how much they spent each month. If customers spent:
than Morrisons, then 500 points are added to a customer’s • between £0 and £3,500, they got 0.5 per cent cashback
Match & More account. Points are also awarded on hundreds
• between £3,500 and £7,500, they got 1 per cent cashback
of the store’s products. Customers are rewarded with a £5
voucher for every 5,000 points they collect. Such schemes • over £7,501, they got 1.25 per cent cashback.
encourage people to keep returning to the same provider in Provided customers spent a minimum of £3,000 in a year,
order to accumulate enough points for the reward. almost every pound spent using the card qualified for cashback.
●● Personalisation. Some businesses try to deal with
There was no annual fee charged on this level of membership
customers on a personal level. They may address individual
(the Platinum Cashback Everyday Credit Card).
customers by their name – perhaps in person or in mail
shots. Some firms send customers birthday cards and (a) Calculate the amount of cashback a customer would be
Christmas cards to help build relationships. However, dealing entitled to if £5,000 is spent on the card in the ninth month of
with a customer at a personal level is a lot easier for a ownership.
smaller business than, say, a multinational. (b) Explain one way in which cashback cards might help to develop
●● Preferential treatment. Many people like the idea of customer loyalty.
receiving preferential treatment from a business. For example,
some nightclubs offer VIP areas reserved exclusively for
selected customers – this treatment is usually for customers
that spend a lot of money. Many airlines have VIP lounges
at airports where first class, business class, or other select
passengers can relax away from the ‘hustle and bustle’
of normal airport business. The lounges usually offer free
refreshments, free access to Wi-Fi, satellite television,
comfortable seating and showers. The principle behind all this
is that if a business can provide customers with preferential
treatment they may return for more.

75
Marketing strategy Unit 13

Case study
WATER FUSION try the product. It was reported that television advertising
involving celebrities would be used at a later date. The
retail price of Water Fusion was set at the same level as
In 2012 Water-First launched Water Fusion, a brand other leading brands.
extension of its best-selling soft drink. It contained less Figure 6 shows the amount of money Water-First spent on
sugar and fewer calories than most leading brands of soft advertising between 2009 and 2013.
drinks. It was launched as part of a summer promotion,
associated with government and industry efforts to tackle
obesity. The mass appeal marketing campaign targeted Figure 6
young professionals, emphasising the lower sugar content Water-First spending on advertising 2009–2013 ($ billion)
and lower calories. It highlighted the blend of water and Billion £
natural fruit juices, and used attractive yellow packaging. 3.4
The launch of Water Fusion was supported by a multi- 3.2
million-pound media campaign. Features of the marketing
strategy included the following. 3.0

• Raising awareness of the new yellow packaging, using print 2.8

and digital methods to encourage consumers to try the drink 2.6
at a special summer discount price.
• Driving awareness through shopper marketing activity 2.4
2009 2010 2011 2012 2013
and a presence at key summer events in major cities. Year
• Product sampling in major retailers.
• Advertising on public transport using outdoor posters,
alongside digital screens, Facebook and Twitter. Water (a) Explain Water-First’s distribution policy in this case.
Fusion used over 4,000 sites, including significant (4 marks)
locations on major routes for rail, underground, bus and
commuter traffic. (b) Explain how Water-First is using an extension strategy in this
case. (4 marks)
The whole marketing strategy was designed to establish the
product features, raise awareness of the benefits of lower (c) Evaluate the importance of marketing to Water-First.
calories with natural sweetness, and encourage people to (20 marks)

Key terms Knowledge check

Boston Matrix – a 2x2 matrix model that analyses a product 1. Explain the first stage in the product life cycle.
portfolio according to the growth rate of the market and the 2. What pricing strategy might be used in the launch stage of
relative market share of products within the market. the product life cycle?
Extension strategies – methods used to prolong the life of 3. What happens to sales in the maturity stage of the product
a product. life cycle?
Marketing strategy – a set of plans that aim to achieve a 4. Why might some products decline very quickly?
specific marketing objective. 5. Give three examples of possible extension strategies.
Product lines – a group of products that are very similar. 6. What is the difference between a product portfolio and a
Product portfolio – the collection of products a business is product line?
currently marketing. 7. What is meant by a ‘Question mark’ in the Boston Matrix?
8. How might businesses distribute their products in a mass
market?
9. Why are prices likely to be higher in niche markets?
10. What is the difference between outbound and inbound
B2B marketing?
11. Give three examples of inbound B2B marketing.
12. State three ways in which a business might develop
customer loyalty.

76
 14 Approaches to staffing 1.4.1
Theme 1

Key points
1. Staff as an asset and staff as a cost.
2. Flexible workforce: multi-skilling, part-time and temporary, flexible hours and home working,
outsourcing.
3. Distinction between dismissal and redundancy.
4. Employer/employee relationships: individual approach and collective bargaining.

Getting started ●● a safe and comfortable working environment

Agueda Bega runs a gym in Brighton. She employs nine staff, ●● training, so that staff can develop skills and carry out work
six of whom are part-time. Most of the part-time staff work tasks competently and safely
evenings and weekends when the gym is busy. Agueda has ●● job security and opportunities to interact with colleagues

a very good relationship with her employees. Every month ●● recognition and professional relationships

●● clear and effective leadership

she takes all of her staff out for a meal. She encourages her
●● chances for promotion
employees to work as a team and sees the monthly meal out as
●● opportunities to solve problems, work in teams and
an opportunity to bond team members and discuss work issues.
She also encourages staff to come up with new ideas for the be creative.
If employers treat staff as assets, they will also make an effort
business in the future.
to retain them. They know employees want to be challenged,
What is an advantage to Agueda of employing part-time staff? acknowledged and rewarded. These employers know that
What might be the benefits to the business of having a good while money may not be the motivator for all employees, it
relationship with employees? Agueda thinks she treats staff as is still important and they may well provide above-average
an asset. What does this mean? What are the advantages of wages. This approach is likely to help recruit, retain and
organising staff as a team? motivate high-quality staff.
In 1991 the UK government set up an organisation,
Investors in People (IIP). Its purpose was to help employers
Approaches to staffing to maximise the potential of employees. IIP encourages
businesses and other organisations to improve the
In some businesses the owner is the only person working in the
management and development of their employees. It does this
organisation. However, as a business grows there is usually a
by giving accreditation to businesses that can demonstrate
need to employ people to share the workload. Businesses can
very high standards of practice in people management and
be defined according to the number of people they employ. For
development. IIP uses ten performance indicators, such as
example, using the definition of size of a business in the UK:
empowerment, continuous improvement and leadership,
●● small businesses employ between 1 and 49 people
when assessing an organisation’s commitment to its people.
●● medium-sized businesses employ between 50 and 249 people
Businesses also have to meet 39 accreditation requirements to
●● large businesses employ 250 people or more.
gain the IIP award.
Tesco was one of the largest business employers in the UK in
2015, with its website referring to around 310,000 staff.
Different businesses have different approaches to their
Staff as a cost: If employers view their staff as a cost, their
focus is likely to be different. Like any other cost, they will try
staff. Some view staff as assets, while others view them as
to minimise it wherever possible. This might involve:
costs. These approaches might have implications for levels of
●● paying just the legal national minimum wage
productivity.
●● using zero-hours contracts

●● neglecting investment in training

Staff as an asset: Employers who view their staff as assets
●● using financial incentives to raise productivity
will value their employees and have concern for their welfare.
●● providing the minimum legal ‘employee rights’ in relation to
Staff will be valued because employers recognise that their
sick leave, holiday pay and working conditions
efforts will help the business to perform more effectively. Such
●● having penalties for employees who are late, break rules,
employers will therefore try to meet the needs of employees.
etc. that incur costs for the business
This might involve providing:
●● using cheap and inferior recruitment methods.
●● acceptable remuneration

●● reasonable holidays, sick leave, maternity/paternity leave

and pensions

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Approaches to staffing Unit 14
This approach might lower employment costs, but it may also be
Exam tip
a ‘false economy’. This is because productivity might be lower The word ‘asset’ is perhaps more commonly used in finance. In
due to poor motivation. Staff turnover and absenteeism may also finance it is used to describe a tangible resource that is used
be higher and there may be more conflict between staff and repeatedly over a period of time, such as a machine, computer,
management. Treating staff as costs may leave workers feeling vehicle or item of equipment. These are all assets that belong to a
exploited, neglected, stressed and unhappy in their work. business. However, the word asset can also relate to people and
the qualities they have and can impart to the business. The word is
used in a very positive and complimentary sense. If people are
Question 1 assets they are valued.
W. L.Gore & Associates is an innovative, technology-driven
business that makes medical devices and Gore-Tex fabrics. It is a flexible workforce might be able to make more use of temporary
privately owned company, with sales of more than $3 billion. Its workers. Businesses can increase the flexibility of their
UK operations are run from Scotland where around 400 of the workforce using a number of methods.
company’s total 10,000 workforce are employed.
Multi-skilling: Multi-skilling is a term used to describe the
In 2014, Gore earned a spot on the World’s Best Multinational process of enhancing the skills of employees. It is argued that
Workplaces list by the Great Place to Work® Institute. The ranking giving individuals the skills and responsibilities to deal with
is the world’s largest annual study of workplace excellence and a greater variety of issues will allow a business to respond
identifies the top 25 best multinational companies in terms of more quickly and effectively to problems. So for example, a
workplace culture. For the 18th consecutive year, Gore also earned receptionist might have been trained to pass on calls to other
a position on the FORTUNE 100 Best Companies to Work For®, people in a business. Multi-skilling this job could mean that
ranking 17th overall in 2015. In relationship to the 2014 awards, the the receptionist now deals with more straightforward enquiries
following factors were considered of high value by employees. Gore him/herself. This would result in a quicker response to the
calls its staff ‘associates’ and more than 80 per cent of employees customer’s enquiry. It would also free up time for other people
have been with the business for at least five years. This includes 167 to work on more demanding activities.
people who have been with the company for over 15 years. Voluntary Certain motivation theories suggest that giving individuals
staff turnover is around 3 per cent (the national average for staff more skills and responsibilities can improve their work
turnover is around 15 per cent) with less than 20 per cent saying performance. A criticism of multi-skilling is that individuals are
they would consider leaving if offered a job elsewhere. only given more skills so that they are expected to work harder
without any extra pay. Problems may also result if workers are
Gore organises its workers into teams, but still encourages
not trained adequately for their new roles.
personal initiative. Although clearly operating as a business,
associates in 2014 valued the following factors. There are no job
Part-time and temporary staff: Part-time workers are
titles and pay is negotiated on an individual level. Provided that
defined in the Economic and Labour Market Review as people
associates fulfil their work commitments there are no set hours who normally work for not more than around 30 hours a week
of work. Employees are in complete control of their own working except where it’s stated otherwise. Some people prefer to work
day and week (apart from a small number who are required for part-time because it suits their lifestyle. For example, many
specific time-dependent tasks). students take part-time jobs to help support themselves while
Further factors valued by associates in the context of the 2014 at college. However, in 2014, it was widely reported that over
awards included receiving profit-related pay, free private one million of the UK’s part-time employees would prefer full-
healthcare and a contributory pension into which the business time employment. The use of part-time staff provides flexibility
puts 15 per cent of employees’ pay. In a survey 84 per cent of for businesses. Part-time staff can be employed during weekend
staff found their job good for personal development, 81 per peak hours in restaurants, for example.
cent said they have no time to be bored, 75 per cent said that Temporary workers are those employed for a limited period
company deadlines were realistic and 83 per cent said that their only. For example, during the 2012 London Olympics it was
health was not adversely affected by their work. reported that more than 100,000 temporary jobs were created.
Many businesses need temporary workers from time to time.
Sources: adapted from www.gore.com and www.b.co.uk
For example, farmers need workers to help out during the busy
(a) Describe one piece of evidence that could suggest that harvest period and the Royal Mail takes on temporary staff to
W. L.Gore & Associates treats its staff as assets. help deal with a greater volume of post at Christmas.
(b) Explain one advantage to W. L.Gore & Associates of treating The use of part-time and temporary workers has grown
their staff in this way. significantly. In the UK the working population is over 30 million
people, but it has been reported that nearly half of these do
not work full-time. Those not engaged in full-time employment
Flexible workforce were widely reported in 2014 to include around 4.1 million
Most businesses prefer to employ a flexible workforce. This people who are self-employed, 1.6 million temporary workers,
helps a business to adapt to change more easily. For example, 6.7 million part-time workers, 1 million unpaid people on
if output needs to be increased quickly a business with a apprenticeships or work schemes, the 1.5 million people acting
as unpaid carers and 1.1 million workers with second jobs.
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 Marketing and people

Flexible hours and home working: The workforce is more – especially if specialists are employed. However, major
flexible if staff work flexible hours. However, there are different drawbacks are the loss of control and the reliance that
ways of arranging this. For example, staff might have to work a businesses place on suppliers. For example, if suppliers fail
number of hours in a particular time period, say one week, but to deliver on time the whole production process can be held
have the choice as to when they work during that week. Or they up. Employees may also resent outsourcing because their jobs
might work a reduced number of days, but longer hours each might be threatened.
day. Some people might be asked to undertake shift work. For Both large and small businesses are happy to outsource
example, a factory that wants to operate 24 hours a day is likely work. It was widely reported in 2014 that companies were
to operate three eight-hour shifts. One of the main advantages increasingly outsourcing work to the developing world, with a
to businesses of flexible hours is that they can often remain growth in the number of businesses using offshore services.
open for longer. It was thought that the trend would continue. Computer
One example of a business that offers their employees programming, other IT services and marketing were popular
flexible working hours is BMW. A range of options for full-time targets for outsourcing.
employees is available. For example, workers can take days
off using a flexitime system. They can also take sabbaticals The advantages and disadvantages of a
of between one and six months. Another scheme offers full- flexible workforce
time employees the chance to take up to 20 extra days of There are a number of advantages of a flexible workforce for
unpaid holiday each year (subject to conditions). There are also a business.
schemes for part-time workers that help staff when planning ●● A flexible workforce allows a business to expand and
their childcare arrangements. contract quickly in response to changes in demand
Some businesses in the UK have started to offer their for its products. In contrast, a workforce made up of
workers zero-hours contracts. This means that workers are permanent staff is difficult to slim down quickly because
only employed when employers need them and often at short of the cost and because of the time it takes to fulfil legal
notice. This arrangement provides businesses with a great deal requirements. Businesses may also be reluctant to take on
of flexibility. However, such contracts are unpopular with many new permanent staff in case demand falls again and they
employees. This is because they do not offer enough financial are left with too many staff.
security. Figures from the Office for National Statistics (ONS), ●● Some specialist jobs need to be done but it would be
based on a survey of workers, found 700,000 people were on wasteful to employ a permanent worker to do them.
zero-hours contracts. That represents about 2.3 per cent of For example, most small businesses employ external
the UK workforce. Examples of businesses that employ a high accountants to manage their accounts. It is far cheaper to
proportion of its workforce using zero-hours contracts include do this than to employ an accountant within the business
Sports Direct and pub chain JD Wetherspoon. because the amount of work needed is relatively small.
A wide range of people working in the UK might be classified ●● In some cases, temporary staff or subcontractors are
as home workers. They include farmers, shop owners, writers, cheaper to employ than permanent staff. For example, a
musicians, telesales people, hotel owners and software business may not offer certain benefits to certain staff,
designers. They may be full-time or part-time and may also be although it must be careful not to infringe legislation.
self-employed. Some people prefer to work at home because If the temporary staff are treated as self-employed or
it suits their lifestyle. It also reduces travelling time to and subcontractors, the business may also be able to save
from work. Businesses benefit from home working because on National Insurance contributions. It isn’t always
certain costs, such as office space, equipment, heating and cheaper to employ temporary staff and in some cases it
lighting might be reduced. There will also be fewer problems may be more expensive because temporary staff or their
with absenteeism and less disruption due to bad weather agencies are able to secure higher pay. But temporary
and transport delays. However, there may be communication staff can be laid off almost immediately when they are
problems if staff cannot be contacted and it is more difficult to not needed, with little cost, which is not the case for
monitor the quality and quantity of work undertaken. Figures permanent staff.
from the ONS state that of the 30.2 million people in work in ●● Employers are responsible for training their permanent
January to March 2014, 4.2 million were home workers. workers. By outsourcing work or employing temporary
workers, businesses may be able to pass that cost onto
Outsourcing: Another way of introducing flexibility into an subcontractors or whoever has paid for the training of a
organisation is to outsource work. This involves getting other temporary worker.
people or businesses to carry out tasks that were originally ●● Employing workers who can job share or work flexible
carried out by people employed by the business. Outsourcing hours may allow a business to operate more efficiently. For
allows a business to focus on its core capabilities and lets example, a business may be able to employ an employee
others carry out peripheral work. For example, a business in the day and another in the evening to respond to clients’
manufacturing aircraft components may outsource payroll, needs over a longer period. A restaurant may be able to
marketing or IT work. The key advantages of outsourcing react to increased orders by asking staff to work longer
are that costs are lower and capacity can be increased. The hours at certain times of the week than others.
work outsourced may also be undertaken more effectively
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Approaches to staffing Unit 14

However, using peripheral workers has its disadvantages. Distinction between dismissal and
●● Peripheral workers may have less loyalty to the business

where they work temporarily. They may be motivated mainly

redundancy
Most people leave a job because they are moving on to another
by financial gain.
job or because they are retiring. However, some people are
●● Some businesses have found that their outsourced work
forced out of work. They may be dismissed or made redundant.
has been of poor quality, damaging their reputation with
customers. The peripheral workers move on and don’t have
to take responsibility for the poor work. But the business may
Dismissal: Employees may be dismissed for a number of
reasons. These may be for unfair reasons, such as joining
have lost customers as a result.
a trade union. If an employment tribunal finds that a person
●● Communication can be a problem. Peripheral workers are
has been dismissed unfairly, it has the power to reinstate the
not necessarily available when the business would like to
employee. There are lawful reasons, however, for dismissing
communicate with them, although IT and the mobile phone
an employee. These may include misconduct or because an
has to some extent solved this problem.
employee is incapable of doing a job. A period of notice is
●● Employing peripheral workers can be a costly process. For
required, but the length will vary depending on how long the
example, a business may put a piece of work out to tender to
employee has worked for the business.
a subcontractor. It might get the lowest price as a result, but
the efficiency gains from putting it out to tender rather than
hiring core permanent staff to do the job might be more than
Redundancy: Another lawful method of dismissing an
employee is on grounds of redundancy. This is where there is
outweighed by the costs of the tender process itself.
no work or insufficient work for the employee to do. Employees
●● Temporary staff can be excellent, well qualified and highly
are entitled to redundancy or severance payments by law. They
motivated. But equally, some temporary staff are simply workers
also need to meet other criteria. For example, they must have
who have found it difficult to hold down a permanent job. When
a contract of employment (i.e. not be self-employed). Some
employing temporary staff, there is no guarantee that they will
people, such as members of the armed forces, The House of
perform their job as well as a permanent member of staff.
Commons and the House of Lords are not covered by the Act.
●● Too many peripheral workers employed alongside core
Neither are people who are retiring over the age of 60/65 or
workers can cause demotivation amongst the core workers.
who are coming to the end of a contract or an apprenticeship.
Core workers may want to be part of a stable team to form
Workers are most likely to be made redundant during a
relationships and fulfil some of their higher order needs.
recession or when a business is struggling due to external
Constant turnover of peripheral workers may lead to core
factors. For example, in 2014 BP announced that it would spend
workers feeling disorientated.

Question 2
Many large multi-national businesses use zero-hours contracts. In addition:
It has been argued that these work arrangements have created a • 39 per cent of zero-hours workers earn less than the qualifying
more flexible workforce and helped to keep unemployment down threshold for statutory sick pay (£111 a week) compared to
in the UK. They also allow individuals more say over when, where 8 per cent of permanent employees
and how much they work.
• only 25 per cent of zero-hours workers work a full week
Some employers like zero-hour contracts because they help compared to 66 per cent of other employees
provide a flexible workforce and are a cheaper alternative to
• a third of zero-hours workers report having no regular amount
employing agency staff. For example, a pub landlord may need
of income
extra workers to help out at busy weekends. Other businesses use
zero-contract workers to cover temporary staff shortages. The main • on average, women on zero-hours contracts earn £32 a week
advantage to workers is the opportunity to gain work experience less than men on zero-hours contracts.
and skills without the requirement to accept full-time contracts. An TUC General Secretary Frances O’Grady suggested that the growth
ONS survey of people on zero-hour contracts found that around of zero-hours contracts is one of the main reasons why working
66 per cent did not want more hours of work. people have seen living standards worsen significantly in recent
In contrast, a recent Trades Union Congress (TUC) report said zero- years, along with other precarious forms of employment.
hours workers: Sources: adapted from www.ons.gov.uk and www.tuc.org.uk
• on average, earn nearly £300 a week less than permanent (a) What are zero-hours contracts?
employees (b) Explain one reason why zero-hours contracts provide
• get weekly average earnings of just £188, compared to £479 businesses with flexibility.
for permanent workers (c) Explain one reason why zero-hours contracts might be
• are five times more likely not to qualify for statutory sick pay unpopular with employees.
than permanent workers.

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about $1 billion laying off hundreds of workers as a result of This approach means that individuals will negotiate wages,
falling oil prices. It was reported that a number of back-office holiday and other entitlements, hours of work and other terms
jobs were no longer needed because BP had 50 per cent of employment, directly with the employer. If an employee has
fewer offshore fields and pipelines and 30 per cent fewer a work-related grievance, it also has to be raised and discussed
wells. This was as a result of paying costs resulting from the with their employer. For example, if an employee feels that more
Deepwater Horizon rig explosion in the Gulf of Mexico. training is required, they would have to make a case and present
it individually.
Employer/employee relationships With an individual approach, pay and other conditions may
When someone gets a job a relationship begins between the vary between employees. Those individuals with good bargaining
employee and the employer. The quality of this relationship skills may get a ‘better deal’. This might be a source of conflict
is important because it has an impact on the welfare of the in itself. Many would argue that individual bargaining in this way
employee and the performance of a business. If the relationship favours the employer. In a large firm the bargaining skills of most
flourishes employees will be relatively happy in their work, individuals would not be much of a match when pitched against
motivated and productive. As a result the business should those of an experienced and trained human resources manager.
enjoy an adaptable and co-operative workforce, and high levels Many employees would prefer to be represented by an equally
of skill and output. However, relationships between employees skilled and trained body – perhaps collectively.
and employers can be difficult. This is because the objectives
of the two groups are sometimes in conflict, for instance over Collective bargaining: The alternative to individual bargaining
the following. is collective bargaining. This involves determining wages,
●● Rates of pay. Employers often attempt to keep wages conditions of work and other terms of employment through
suppressed to help control their costs and remain a negotiation process between employers and employee
competitive. In contrast, employees want higher wages to representatives, such as trade unions representatives. Trade
keep up with rises in the cost of living and hopefully raise unions represent the views of their members and try to negotiate
their living standards. in their interests. One individual in a large company employing,
●● The introduction of technology. Employers are often say, 10,000 staff, would have little or no influence in determining
keen to use new technology because it helps to increase wages and conditions. A representative body, such as a trade
efficiency in the business. However, employees may resist union, however, would have more strength and influence to
the introduction of technology because they are anxious negotiate for its membership. Without such a bargaining process,
about learning new production techniques or may fear employers and managers would be able to set wages and
losing their jobs as work processes are taken over by conditions without taking into account the interests of employees.
machines. For collective bargaining to take place:
●● Flexible working. Employers prefer to employ a flexible ●● employees must be free to join representative bodies, such
workforce because it helps to manage production more as trade unions
effectively and keeps costs down. However, some of the ●● employers must recognise such bodies as the legal
methods used to develop more flexibility, such as zero- representatives of workers and agree to negotiate with them
hours contracts, can be unpopular with employees. ●● such bodies must be independent of employers and the state
●● Work conditions. Employees may want better conditions or ●● bodies should negotiate in good faith, in their members’
facilities from employers, such as the provision of a crèche interests
for workers’ children. However, employers may consider ●● employers and employees should accept negotiated
such things inappropriate or too expensive. agreements without having to use the law to enforce them.
The relationship that exists between employers and employees Bargaining between employers and employee representatives
can be shaped using two approaches. They are both often has often led to conflict in the past. A failure to reach agreement
concerned with finding resolutions to the areas of conflict may result in industrial action. The worst that can happen is that
outlined above. workers go on strike. In April 2014, strikes disrupted London
Underground services. The RMT, Britain’s largest transport
Individual approach: An increasing number of employers union, was in dispute with Transport for London, the tube
develop relationships with employees at an individual level. operator, over job losses caused largely by the closure of ticket
This means that terms of employment and disagreements are offices in tube stations. Strikes can damage both employers
settled through negotiation between an individual employee and employees. In this case, Transport for London lost revenue
and a representative of the employer. In a small business the because trains were cancelled, and striking employees lost
employer representative is likely to be the owner. In a large wages because they do not get paid when they withdraw their
business it could be a manager – perhaps from the human labour. Table 1 on the next page summarises the possible
resources department. advantages and disadvantages of collective bargaining.

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Approaches to staffing Unit 14

Table 1 The possible advantages and disadvantages of Question 3

collective bargaining
In October 2013, workers at the Grangemouth oil refinery
Advantages and petrochemical plant in Scotland threatened to go
• Agreements are transparent and binding on a 48-hour strike. The Unite union, which represented
• May be more cost-effective to have just one set of negotiations Grangemouth’s workers, said that a walkout would be
• Rules and terms are more likely to be respected by both parties organised for 20 October beginning at 7.00 a.m. The union
• More equitable because power between both sides is equalised was in dispute with Ineos, the owners of the plant, over the
• Favouritism and victimisation might be reduced at work company’s investigation into the alleged misconduct of a
• Employee representatives are democratically elected trade union official. It also accused the company of planning
Disadvantages job losses, an end to the final salary pension scheme and the
• Negotiations can result in more bureaucracy and take longer withdrawal of collective bargaining.
• The views of individuals are not always reflected by unions As the dispute escalated, Ineos threatened to shut the
• Negotiation costs can be high and are usually met by businesses Grangemouth plant with the loss of 800 jobs. In the end talks
• A failure to agree can have serious consequences, e.g. strike action succeeded and a rescue deal was agreed. It was reported that
• Owners may feel their freedom to manage is compromised the dispute cost the Scottish economy around £65 million in
lost output.
Thinking bigger (a) Explain one factor that led to the breakdown in the employer/
employee relationship in this case.
(b) Discuss the possible disadvantages to Ineos of collective
bargaining.

Key terms
Collective bargaining – a method of determining conditions
of work and terms of employment through negotiations
between employers and employee representatives.
Flexible workforce – a workforce that can respond, in
quantity and type, to changes in market demand.
Home workers – people who undertake their regular work
from home.
Industrial action – disruptive measures taken by workers
Trade unions are organisations of workers who join together to further to apply pressure on employers when disagreements cannot
their own interests in the workplace. There are over 150 trade unions
in the UK. They tend to represent groups of workers with different skills
be resolved.
and needs. It is important for employees to have their voice heard at Outsourcing – getting other people or businesses to
work – they need representation – because individual workers find it undertake work that was originally done in-house.
difficult to stand up for themselves. When trying to exert their rights Multi-skilling – the process of increasing the skills
against a large multinational, for example, they need a more powerful of employees.
authority to represent them. Trade unions can provide this authority. Trade unions – organisations of workers that exist to
If workers join a trade union they will have to pay an annual promote the interests of their members.
membership fee. In return they get a number of benefits. Trade unions: Zero-hours contract – a contract that does not guarantee
• represent workers by negotiating with employers on their behalf. any particular number of hours’ work.
They employ skilled negotiators to get the best possible deal for
workers. They press for higher pay, better working conditions,
improved health and safety, and they fight against redundancies
• have a legal network that will represent individual members in
cases such as discrimination and unfair dismissal. The cost to workers
of legal representation would be huge without their support
• act as a pressure group to influence business decision-making
in general
• provide other benefits such as access to cheap insurance, discounts on
mortgages and travel, social facilities and support when times are hard
• play a key role in industrial relations at work. For example, they
communicate the views of workers when big changes are about to
take place, such as the introduction of new technology.

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Case study
After making small losses for three years between 2009
BLACKBIRD POWER and 2012, the directors decided that some changes were
needed to make the business more competitive. It was
TOOLS LTD felt that the workforce needed to be more flexible. The
proposals included the following.
• Training production staff in all aspects of production
so that they could be moved from one workstation to
another easily.
• Introducing flexible working hours in the office so that the
business could answer customer calls from 7.00 a.m. to
8.00 p.m.
• Employing more temporary staff to help deal with high
levels of demand in the spring and summer months.
Temporary staff also give more flexibility if there is
another downturn in demand.
• Outsourcing the production of some components to a
Chinese supplier to save £1.3 million per year. This would
result in the loss of 12 more jobs.
The directors expected a negative reaction from the
workforce when the proposals were announced. Therefore
it was agreed that wages would have to be increased by the
CPI (cost of living) plus 1 per cent for the next three years.

Blackbird Power Tools Ltd makes a range of power tools

for the construction industry and DIY enthusiasts. It has (a) What is meant by redundancy? (2 marks)
a reputation for high-quality durable products and good (b) Explain one advantage to workers at Blackbird Power
after-sales service. Its products are distributed from large Tools Ltd of multi-skilling. (4 marks)
DIY stores, independents and, increasingly, online. In 2009, (c) Explain one possible drawback to Blackbird Power Tools
Blackbird Power Tools Ltd was hit hard by the recession. Ltd of outsourcing the production of some components.
Demand for its products fell sharply as the construction (4 marks)
industry went into decline and people spent less on DIY. As
a result the business had to make 20 of its production and (d) Evaluate the impact on Blackbird Power Tools Ltd of
back-room office staff redundant. introducing more flexibility in the workforce. (20 marks)

Knowledge check
1. State three employee needs. 6. Explain one motive for outsourcing jobs.
2. What is the main disadvantage of treating staff like costs? 7. What is the difference between dismissal and redundancy?
3. State two advantages of multi-skilling to a business. 8. State two advantages of collective bargaining to a business.
4. What is the difference between part-time and temporary 9. Why might employees prefer not to negotiate their pay and
staff ? conditions individually?
5. What are the advantages to a business of using more 10. What are the benefits of a positive relationship between
home workers? employees and employers?

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 15 Recruitment, selection 1.4.2
Theme 1
and training
Key points
1. Recruitment and selection process: internal versus external recruitment.
2. Costs of recruitment, selection and training.
3. Types of training: induction, on-the-job and off-the-job.

Getting started Figure 1

Stella Hammond has just landed a £45,000 a year job at a Stages in the recruitment process
major marketing agency in London. Her job title will be Head
Identify the type and number of staff needed
of Creative Design. She saw the job advertised online and was
invited to an interview within two weeks. Part of her job when
she starts is to recruit three up-and-coming creative designers.
She will also be responsible for providing them with on-the-job Prepare job description and person specification
training.
Why might the marketing agency use the internet to recruit staff
like Stella? What costs might the business have incurred when Advertise the job using appropriate media

recruiting Stella? Explain how Stella might recruit three new

creative designers. What do you think is meant by on-the-job
training? Evaluate applicants and select a shortlist for interview

Recruitment Carry out interviews

When businesses hire new employees they need to attract
and appoint the best people – those with the right skills and
appropriate experience. This is called recruitment and selection.
In a very small business recruitment might be undertaken Evaluate interviews and make appointment
informally – a chat between a business owner and someone
who is searching for a job. In a large business, the human
resources department is likely to be responsible for employing Provide feedback for unsuccessful candidates
staff, following a lengthy, formal recruitment process, as
explained below.
A business may need new staff because: ●● The right people are more likely to be selected if a job
●● the business is expanding and more labour is needed description and person specification are drawn up. These
●● people are leaving and they need to be replaced are explained on the next page.
●● positions have become vacant due to promotion ●● Advertising costs money, so businesses must place job
●● people are required for a given period to cover temporary advertisements in media where they are likely to attract
staff absence, due to maternity or paternity leave, sufficient interest from the ‘right’ sort of applicants. For
for example. example, a hospital would not use a national newspaper to
advertise jobs for porters; a local newspaper or a jobcentre
Stages in the recruitment and selection would be more suitable. On the other hand, a vacancy for
process a senior manager is an important position and a business
The recruitment process may be broken down into a number of would want to attract interest from a wide area. Therefore a
stages, as shown in Figure 1. national newspaper would be appropriate.
●● The first stage is to identify the number and type of staff ●● Job applications can be made on standard forms sent out
that need to be recruited. The overall business plan will to applicants who respond to an advert. Some applicants
help provide this information. For example, if the business is might write letters and include a curriculum vitae (CV). This
planning to expand, larger numbers of applicants will need to is a document that contains personal details, qualifications,
be attracted. A business may also need to choose between experience, names of referees, hobbies and reasons why
full-time, part-time, temporary and permanent workers. the person is suitable for the job. A business must sort

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 Marketing and people

through all the applications and might draw up a longlist Job description
and a shortlist. This is because it is not normally possible to A job description states the title of a job and outlines the tasks,
interview every single applicant. Also, some applicants will duties and responsibilities associated with that job. If a new
be unsuitable. job is created, a new job description may have to be prepared.
●● Shortlisted applicants may then be invited for an interview. This
If a business is replacing someone who is leaving, the job
is where interviewers can find out more about the applicants description may be the same. However, when someone leaves a
by asking questions. It also gives candidates the opportunity post the job description may be updated.
to provide more detailed information and ask questions The main purpose of a job description is to show clearly
about the job and the business. Interviewing is often best what is expected of an employee. Extracts from it are likely to
done by people who are experienced or have been trained in be used in a job advert. It might also be used during appraisal
interviewing. For many jobs interviews are carried out by more to see how well an employee has performed in relation to what
than one person. This provides an opportunity for a discussion was expected of them. Figure 2 shows an example of a job
about the performance of candidates in their interviews. description.
●● After the interviews the interviewers must decide who to

appoint. In many cases, interviewees are told the outcome Person specification
of the interview by post at a later date. This gives the A person specification provides details of the qualifications,
business more time to evaluate the performance of the experience, skills, attitudes and any other characteristics that
candidates. A business might also check references before would be expected of a person appointed to do a particular
making a final decision. job. It is used to ‘screen’ applicants when sorting through
●● The recruitment process ends when a job offer has been the applications. Applications that do not match the person
made and accepted. It is also courteous to provide feedback specification can be ignored. It is common to state on the
to the unsuccessful candidates. specification whether a particular requirement is ‘essential’
An increasing number of businesses are using online recruitment or ‘desirable’. An example of a person specification is shown
methods. People can submit application forms online and in in Figure 3. The style of both job descriptions and person
some cases might be asked to complete an online test. For specifications is likely to vary between different businesses
example, the retailer Next uses online testing (a focus in the according to their specific needs.
case study at the end of this unit). The main advantage of online
recruitment is that people can apply for jobs at any time and
their application details can be stored by a business until they
are needed. Online recruitment is also a cheap alternative to Figure 3
traditional methods. A person specification for an administrative assistant in an
engineering plant

Figure 2
A job description for a cabin crew assistant for an airline Essential/Desirable
Aptitudes/skills/abilities
Able to take a flexible approach to working conditions
Job title E
Cabin crew member. and a changing working environment
Fun ctio n reasonably
es that the company may Self-motivated and enthusiastic
Perform ground and air duti of wor k con nec ted to aircraft E
ly to any area
require. Ground duties app Ability to work on own initiative
D
operational requirements. y, are voluntary.
rdroom functions and publicit Work effectively as part of a team
Other duties, including boa D
Cabin crew must also: cedures
with company policy and pro
• be familiar and comply ervi ce a nd p erfo rm their Qualifications/knowledge and experience
of cab in s
• provide a high standard
times
duties conscientiously at all company or 4 GCSEs grade 4 or above
n
ot b eha ve i n an y w ay t hat reflects badly upon the E
• Computer literate in Word and Excel
harms its reputation. E
Pay and exp enses Good written and verbal communication skills
annum. E
Salary will be £17,000 per the
in arrears, paid directly into Able to solve problems effectively
Payment will be one month E
employee’s bank account. Planning and organisational skills
out in the current contract. D
Expenses will be paid as set
you will be entitled to a reporting Experience of working in a manufacturing environmen
If flights are cancelled, t D
curr contract.
ent
allowance as set out in the
Work time period.
days in every 28-day roster
You are required to work 20 the com pan y’s req uirements.
ording to
Days and hours will vary acc are set out in the
flight time limitations
Details of rest periods and
staff manual.

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Recruitment, selection and training Unit 15

Question 1 aren’t seeking promotion, internal recruitment suggests

that the employer is looking after existing staff.
Figure 4
External recruitment is when someone is appointed from
Job description for an accounts clerk outside the business. External recruitment has two main
advantages over internal recruitment.
●● The employer may want someone with new and different

ideas to those already working in the business. Bringing in

experience of working in different organisations can often
be helpful in keeping a business competitive.
●● External recruitment might attract a larger number of

applicants than internal recruitment. The employer then

has more choice of whom to appoint.
External recruitment requires the employer to communicate
with potential employees. Ideally, every person who is
suitable and who might consider the job should apply.
That way, the employer will have the maximum number of
candidates from which to choose. There are a number of
ways in which an employer can do this.

Word of mouth: A common method of hearing about a

job is through word of mouth. This means a person hearing
about a job from someone else, often someone who works in
the place of employment. For example, a person might hear
about a vacancy for a hospital porter from their next-door
neighbour who works as a nurse in a local hospital.

Direct application: Many jobseekers send their details

to employers for whom they would like to work on the off-
(a) Explain what is meant by a job description, illustrating your chance that they have a vacancy. An employer might then use
answer with examples from Figure 4. these to recruit if a vacancy arises.

Advertising: The employer may place advertisements

in local or national newspapers, and specialist magazines
Internal and external recruitment and journals. The internet is another medium for job
Internal recruitment is recruitment from within the business. advertisements. Advertisements may appear on a company
An employee may be chosen to be offered a post. Or the website. The largest sector covered by internet advertising
business may advertise internally, asking employees to apply for is jobs in IT. Advertisements on a board or window on the
the vacancy. The advertisement may be sent round via email and employer’s premises can also be successful. Advertisements
posted on a noticeboard. Larger organisations may have regular are sometimes costly. But they can reach a wide number of
newsletters devoted to internal vacancies, or notices may be put potential applicants. People wanting to change their job are
in the company magazine or on the company website. Internal likely to seek out advertisements.
recruitment has a number of advantages compared to external
recruitment. Private employment agencies: The business may employ
●● It is often cheaper because no adverts have to be placed and a private employment agency to find candidates. Private
paid for at commercial rates. employment agencies are probably best known for finding
●● Internal recruits might already be familiar with the temporary workers (temps). However, many also specialise in
procedures and working environment of the business. They finding permanent staff. At the top end of the range, private
may, therefore, need less induction training and be more employment agencies tend to call themselves executive
productive in their first year of employment. agencies. They specialise in recruiting company executives
●● The qualities, abilities and potential of the candidates should and finding jobs for executives seeking a change or who have
be better known to the employer. It is often difficult to foresee been made redundant. Using an employment agency should
exactly how an external recruit will perform in a particular take much of the work out of the recruitment process for
work environment. the employer. But it can be costly because the employment
●● Regular internal recruiting can motivate staff. They might see agency charges a fee. Private employment agencies have
a career progression with their employer. Even for those who a website where specialist workers can look for jobs or
advertise their services.

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 Marketing and people

Headhunting: For some posts, such as chief executive Question 2

of a company, it may be possible to headhunt a candidate.
This is where the agency draws up a list of people they think The advertisement below is an example of external recruitment
would be suitable for a job. Having cleared the list with the that might appear in a local newspaper.
organisation making the appointment, the agency will approach
those on the list and discuss the possibility of them taking the Figure 5
job. Some will say no. Others will indicate that, if the terms Recruitment advertisement from a local newspaper
were right, they might take the job. A final selection is then
made and one person is offered the job. Nobody has formally
applied or been interviewed. Headhunting works best where
there is only a limited number of people who potentially could
take on the post and where the agency knows about most of
those people.

Jobcentres: Businesses can advertise vacancies through

jobcentres run by the government. Jobcentres are often used
by the unemployed and vacancies tend to pay less than
the average wage. So a cleaner’s post is more likely to be
advertised in a jobcentre than a chief executive’s post. For a
business, this is a relatively cheap way of advertising, but it is
not suitable for many vacancies.

Government funded training schemes: Some businesses

take on trainees from government funded training schemes.
For example, for the period 2015–2016, an apprenticeship
grant was made available to employers through the Skills
Funding Agency, sponsored by the Department for Business,
Innovation and Skills. This grant was set up to fund businesses
that could not otherwise afford to employ apprentices,
targeting those aged 16–24. (a) Explain one benefit of using external recruitment for The
Ferns Health Club.
(b) Discuss the suitability of using a local newspaper to
advertise the job shown above.
Thinking bigger
Both large and small businesses make use of online recruitment. A
number of online tools can be used by businesses, such as internet job
boards, applicant tracking systems, CV databases, and online testing and Costs of recruitment, selection and
assessments. Such tools can be used to identify and filter applicants,
assess personalities and screen applicants to see if qualified candidates
training
match the company’s values and culture. Some recruitment software
At each stage in the recruitment process shown in Figure 1, a
providers combine all of these technologies into a simple-to-use business will incur costs. These costs can be significant and
package. Software can also be adapted to meet the needs of underline the importance of employing an effective recruitment
individual businesses. process to attract and retain high-quality staff. According to a
One of the main advantages of online recruitment is that applicants report carried out by Oxford Economics, the cost of replacing a
can be drawn from a much wider area – global if necessary, twenty- single member of staff can be as much as £30,614. There are
four hours a day. Specialists may be attracted by positions with niche two elements to this cost – lost output while a replacement is
industries that are targeted by some online job boards. Employers may found and inducted, and the process costs of recruiting and
also post job advertisements on the websites of many professional selecting a new worker. Generally, recruitment costs will tend
associations. This can attract candidates who may not actively be looking to rise directly in relation to the seniority of the post. Some of
for employment, as well as attracting candidates with specific skills.
the main costs incurred are outlined below.
The cost of using the internet to recruit staff is very low compared with
other methods. It has been reported that the costs of posting jobs and/ Recruitment and selection costs: Costs are incurred
or searching for candidates online can be up to 90 per cent lower than
the costs of using conventional methods. Recruiting online reaches a
throughout the whole recruitment and selection process.
broad audience with reduced human interaction. It also reduces cost and ●● The human resources department will incur costs when
time through the use of automated selection tools, electronic recording identifying the number and type of staff required. For
of files, and less demand on storage. The pressure on employee time for a single post the cost might be quite small, but if, for
maintaining and administering selection procedures is also reduced. example, a chain store is opening a new branch, and

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Recruitment, selection and training Unit 15

requires, say, 80 new recruits, the task is significant and ●● Loss of output. If workers are involved in off-the-job training
will require more time and planning. If a manufacturer is they will not be producing anything. This will result in lower
expanding production in a new plant and requires 1,500 new output levels. Even if workers are trained on the job, there
staff, then the task is even more burdensome, financially and may be a loss of output due to mistakes and slow work
logistically. associated with the fact people are learning.
●● Some administrative costs will be incurred when checking ●● Employees leaving. Businesses are likely to get very
and updating job descriptions and person specifications. frustrated if employees leave and join a rival company after
These costs will be higher if the nature of the jobs have they have invested in training them. Some businesses actually
changed or if the jobs are freshly created. prefer to recruit workers that have already been trained by
●● Jobs will have to be advertised. If internal recruitment is others to avoid such losses.
being used, such costs will be quite modest since internal
communication systems will be used. However, if external Training
recruitment is being used there will be a cost. Training is the process of increasing the knowledge and skills
●● Time will be spent handling and sorting applications. Some of workers so that they are better able to perform their jobs.
adverts can attract thousands of applications – particularly The objectives of training differ from business to business but
when unemployment is high. This cost can be miminised they include:
by designing a job advert that attracts a small number ●● making workers more productive by teaching them more

of perfectly suitable candidates and actively discourages effective ways of working

unsuitable ones. However, this can be a challenging task. ●● familiarising workers with new equipment or technology

The aim of this sorting process is to compile a shortlist being introduced

of candidates to interview. Further costs are incurred if ●● educating workers in new methods of working, such as

interviewees are contacted by post or phone. shifting from production line methods to cell methods
●● The interviewing process can also be expensive for a ●● making workers more flexible so that they are able to do

business. It is likely to involve some highly paid senior staff. more than one job
While these people are involved in the interview process, ●● preparing workers to move into a different job within the

they are not undertaking their normal tasks; this can have business, which could be a new job at a similar level or
a financial impact. Some businesses use two or even three a promotion
rounds of interviews when selecting staff. Interviews can ●● improving standards of work in order to improve quality

require candidates to sit tests or undertake personality ●● implementing health and safety at work policies

profiling – these activities will also incur costs. Documents ●● increasing job satisfaction and motivation, because training

need to be photocopied and circulated, rooms booked, should help workers feel more confident in what they are
interviewees welcomed and briefed, refreshments provided doing and they should gain self-esteem
and interview staff co-ordinated. ●● assisting in recruiting and retaining high-quality staff,

●● After the interviews have taken place the performance of attracted by the quality of training offered.
interviewees will have to be evaluated. The more people Sometimes, individual employees request training or undertake
involved in the interview process, the higher the cost. Finally, training without the financial or time support of their employers.
the selection is made, unsuccessful candidates are given For example, a manager may take an MBA (Masters of Business
feedback and the successful candidate receives a formal job Administration) university course in her own time. More
offer. There may be some legal formalities to complete, which frequently, training is provided by the employer. The need for
might also add to the cost. training is sometimes identified in the appraisal process.
Sometimes the new person recruited will negotiate a higher
Induction training
●●

salary or better benefits than the outgoing person they are

replacing, again adding to the business’s costs. Many businesses put on training for people starting a job. This
is known as induction training. It is designed to help new
Training costs: Costs can be so high that businesses can employees settle quickly into the business and their jobs. Exactly
be reluctant to invest heavily in training. Some training costs what is offered differs from business to business and job to job.
are essential and have to be met by a business. For example, For example, a small business might simply allocate another
employees often have to be trained in health and safety by law. worker to look after the new employee for a day to ‘show them
Examples of training costs are outlined below. the ropes’. A young person just out of university might have a
●● Training courses and other resources. Businesses will
year-long induction programme to a large company. They might
have to pay training providers if they use external training. spend time in a number of departments, as well as being given
Even internal training can be expensive if specialist training more general training about the business. But most induction
staff and equipment is needed. training attempts to introduce workers to the nature of the
business and work practices, including health and safety issues.

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 Marketing and people

On-the-job training Off-the-job training can provide courses which a business

On-the-job training is training given in the workplace by the internally would be unable to provide. But it can be expensive,
employer. There are many ways in which this could happen. particularly if the business is paying not just for the course but
also a salary for the time the employee is attending the course.
Learning from other workers: An employee might simply
work next to another worker, watch that worker do a task and Table 2 Advantages and disadvantages of off-the-job
with their help repeat it. training
Advantages
Mentoring: This is where a more experienced employee is • Output is not affected if mistakes are made
asked to provide advice and help to a less experienced worker. • Workers’ learning cannot be distracted by work
The less experienced worker can turn for help and advice to • Training could take place outside work hours if necessary
another more experienced worker at any time. • Customers and others are not put at risk
Disadvantages
Job rotation: This is where a worker spends a period of time
• No output because employees do not contribute to work
doing one job, then another period of time doing another job,
and so on. Eventually they have received the broad experience • Some off-the-job training is expensive if provided by specialists
needed to do a more specialist job. • Some aspects of work cannot be taught off the job
• Trainees may feel that some of the training is not relevant to them
Traditional apprenticeships: In the past, workers in • It may take time to organise
traditional skilled trades, such as carpentry or engineering,
would undertake training over, say, three–five years in an Benefits of training
apprenticeship. This would involve a mix of training methods. Although it is expensive, a number of stakeholders will benefit
When the business decided they had ‘qualified’ they would be from training.
employed as a full-time worker. Many of these schemes died out ●● Managers. Managers will benefit because workers may be

due to the cost for the business, the decline in traditional trades, better motivated and more satisfied. This makes them more
mechanisation and the need for more flexible work practices. co-operative and easier to work with. They will be better at
doing their job. Workers may also be more flexible which will
Graduate training: Medium- to large-sized businesses may help managers in their organisation. Providing training may
offer graduate training programmes. They are typically designed also improve the image of the business and make it easier to
to offer those with university degrees either professional attract and retain high-quality staff.
training, such as in accountancy or law, or managerial training. ●● Owners. Businesses will benefit from training if productivity

is higher. This means that costs will be lower and the

Table 1 Advantages and disadvantages of on-the-job business might gain a competitive edge in the market. This
training should improve the financial performance of the business,
with higher profits and higher rewards for the owners.
Advantages
●● Employees. If workers have been trained they will be
• Output is being produced
able to do their jobs more effectively. This should reduce
• Relevant because trainees learn by actually doing the job anxieties about their work and provide more job satisfaction.
• Cheaper than other forms of training Employees will feel valued if their employer is paying for their
• Can be easy to organise training. They may also feel better motivated, less stressed
Disadvantages out and enjoy more job satisfaction. They are likely to develop
• Output may be lost if workers make mistakes a range of skills that they can use in the future – to gain
• May be stressful for the worker – particularly if working with others promotion or get a better job.
• Trainers may get frustrated if they are ‘unpaid’ trainers ●● Customers. If training improves quality and skills, then

• Could be a danger to others, e.g. surgeon or train driver customers will benefit from better quality products. Customers
will benefit from improvements in customer service following
training, such as a better outcome when making complaints.
Off-the-job training One example of a business that recognises the benefits of
Off-the-job training is training which takes place outside the training is the retailer and owner of Waitrose, John Lewis
business by an external training provider like a local college or Partnership (JLP). It offers their employees, who are addressed
university. For example, 16–25 year olds might go to college as partners, a wide range of training opportunities. For example,
one day a week to do a catering course or an engineering JLP have two apprentice training programmes – Retail Apprentice
course. A trainee accountant might have an intensive course at Scheme (Level 2) and Advanced Retail Apprentice Scheme
an accountancy college or attend night classes before taking (Level 3). Both schemes use a combination of on-the-job and
professional exams. A graduate manager might do an MBA off-the-job training methods. JLP also use online recruitment
course at a business school in the evenings and at weekends. methods to help in their selection process.

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Recruitment, selection and training Unit 15

Question 3 Key terms

Curriculum vitae – a document that lists personal details,
qualifications, work experience, referees and other
information about the jobseeker.
External recruitment – appointing workers from outside
the business.
Induction training – training given to new employees when
they first start a job.
Internal recruitment – appointing workers from inside
the business.
Job description – a document that shows clearly the tasks,
duties and responsibilities expected of a worker for a
particular job.
Off-the-job training – training that takes place away from
the work area.
On-the-job training – training that takes place while doing
the job.
Person specification – a personal profile of the type of
person needed to do a particular job.
Training – a process that involves increasing the knowledge
and skills of a worker to enable them to do their jobs more
GymTec makes workout machines and apparatus for gyms. It has effectively.
some high-profile customers and is benefiting from an export
drive that was launched in 2013. To keep up with fast-moving
technology it has recently invested in some new computerised Knowledge check
shaping machinery. However, the introduction of the new 1. State three reasons why a business might need to recruit
technology has not been without problems. The conversation new staff.
below took place between the production manager (PM) and 2. Outline the different stages in the recruitment process.
the managing director (MD) of GymTec.
3. What is the difference between internal and external
MD: Another £100,000 on training is too much. It is double the recruitment?
annual training budget. 4. Explain one advantage of internal recruitment.
PM: But without the training it will take at least another six 5. Explain one drawback of external recruitment.
months before the new system is up and running. 6. Give three examples of external recruitment.
MD: I know that training is necessary but it’s so expensive. Plus, 7. State three specific costs of recruitment and selection.
what happens when the trained workers leave, and go and work 8. What is the purpose of induction training?
for someone else? 9. State two disadvantages of on-the-job training.
PM: I appreciate that, but we often get workers that have been 10. Explain the possible benefits of training employees to be
trained elsewhere. shareholders in a plc.
MD: How many need to be trained?
PM: About 15 – but if we trained all 30 staff we get more
flexibility and won’t have to spend on training again for quite
a while.
MD: Look – here’s the deal. You can have £60,000 for
on-the-job training. I don’t want workers going off on one
of these ‘training holidays’ for two weeks. We lose too much
production and I would rather staff were trained on our system
– not some simulator.
(a) Explain one reason why training is needed at GymTec.
(b) Explain one reason why GymTec might be reluctant to spend
on training.
(c) Assess the advantages and disadvantages of on-the-job
training to GymTec.

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 Marketing and people

Case study

AMY’S WARDROBE

Amy’s Wardrobe is a large multinational retailer selling Many companies have their own training programme
clothing and footwear. It has more than 200 stores for graduates. The training and development provided
worldwide with around 100 in the UK. In 2014 the is revered across the industry and is often tailored to the
business generated a turnover of £1.54 billion and company’s needs. Training at Amy’s Wardrobe starts
made a profit after tax of £204.3 million. The company with an introduction to the whole of the business, so that
employs over 20,000 people worldwide and uses online recruits understand the overall objective of the business
recruitment to attract some of its staff. Graduates can before delving into the detail of their specific business
apply online for jobs in buying, merchandising and design. area. Recruits are paired up with more experienced staff
The online recruitment process used by Amy’s Wardrobe members so that they have all the support they need. By
can be rigorous, and can take several months to complete. offering numerous training opportunities and encouraging
There are usually three key stages, beginning with an their recruits to learn from colleagues, Amy’s Wardrobe
online application. encourages promotion in less than two years.
1. Candidates have to complete an application form
online. These are then reviewed and successful (a) Explain one reason why recruitment is such an important
candidates are invited to complete a short test, which activity for Amy’s Wardrobe. (4 marks)
is also online. (b) Explain how Amy’s Wardrobe attempts to overcome the
2. If candidates do well on the test they are then invited problem of recruiting sufficiently high-quality staff.
to participate in a video interview, normally held (4 marks)
via Skype. These consist of a set of questions that all
applicants are asked and often are competency-based (c) Assess the benefits of online recruitment to Amy’s
questions. So, candidates might be asked to describe Wardrobe. (8 marks)
a time when they dealt with a difficult customer, for (d) Evaluate the importance of training to a business like
example. These interviews last around an hour and Amy’s Wardrobe. (20 marks)
are conducted by a Manager.
3. Once the interviews are over, candidates are then
moved to the ‘offline’ stage of the process. Candidates
will be invited to group interviews at local stores where
they will be assessed by at least two people. Activities
such as role plays are used to assess suitability.

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 16 Organisational design 1.4.3
Theme 1

Key points
1. Structure: hierarchy, chain of command, span of control, and centralised and decentralised control.
2. Types of structure: tall, flat, matrix.
3. Impact of different structures on business efficiency and motivation.

Getting started
Organisational structures
The Theatre Grand is a large theatre in Northern Ireland Each business has its own organisational structure or business
owned by a private consortium. It employees 26 staff and structure. The structure is the way in which positions within
is divided into four departments organised as follows (the the business are arranged. It is often know as the internal
figures in brackets represent the number of additional staff in structure or formal organisation of the business.
each department). The organisational structure of the business defines
●● the workforce roles of employees and their job titles
General manager (2) Emma is in charge of the whole
●● the route through which decisions are made
operation. She meets every day with the departmental heads
●● who is responsible and who is accountable to whom, and for
and is the figurehead of the organisation. She spends a lot
what activities
of her time trying to raise funds – from the Arts Council,
●● the relationship between positions in a business
for example.
●● how employees communicate with each other and how
Booking and administration (5) Adnan is head of this information is passed on.
department, which handles all the ticketing and booking Different businesses tend to have different objectives,
arrangements. It also keeps financial records and works closely relationships and ways in which decisions are made. So they
with the external accountant. may have different structures. But there may also be some
similarities. For example, small businesses are likely to have
Theatre maintenance (8) Francesca is responsible for ensuring
simple structures. Larger businesses are often divided into
that the theatre is cleaned after every performance and
departments with managers.
maintaining what is an old building requiring significant repair
Structure is important to all businesses. It helps them to divide
and refurbishment.
work and co-ordinate activities to achieve objectives. But it may be
Production liaison (4) Leroy and his small team are more important for larger businesses. For example, a two-person
responsible for working with the groups of actors and production plumbing business is likely to have fewer problems deciding ‘who
teams that put on plays and other events. does what’ than a business operating in many countries.
Marketing (2) Carl is in charge of promoting the theatre and One method of organising a business is where managers
put people together to work effectively based on their skills and
its productions.
abilities. The structure is ‘built up’ or it ‘develops’ as a result of
the employees of the business. In contrast a structure could
Figure 1 be created first, with all appropriate workforce roles outlined,
Organisational chart for the Theatre Grand and then people employed to fill them. It has been suggested
that the entrepreneur Richard Branson worked out a complete
General manager organisation structure for his Virgin Atlantic airline before setting
up the company, and then recruited the 102 people needed to
fill all the positions.
Booking and
administration
Theatre
maintenance
Production
liaison
Marketing Hierarchy
Some businesses produce organisational charts. These
illustrate the structure of the business and the workforce roles of
Who is control of the Theatre Grand? Describe briefly how people employed in the business. Organisational charts show:
staff are organised at the theatre. What is Celia’s role in the ●● how the business is split into divisions or departments

organisation? To whom is Leroy accountable? What might be ●● the roles of employees and their job titles

an advantage of drawing a chart to represent people in an ●● who has responsibility

organisation? ●● to whom people are accountable

●● communication channels

●● the relationships between different positions in the business.

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 Marketing and people

Figure 2
A formal organisational chart for Able Engineering

Chairperson

Managing
director

Sales Finance and Production Personnel

director administration director director director

Sales Financial Administration Production Quality control Product Personnel Personnel

managers accountants officers supervisors engineers designers officer (wages) officer (welfare)

Salespeople Finance Administrative Test Draughtspeople Personnel

assistants assistants Technicians inspectors assistants

Accounting Ancillary Machine

clerks staff operators

Apprentices

An organisation chart for Able Engineering, an engineering have departmental managers, such as the marketing, human
company, is shown in Figure 2. It is a traditional organisational resources, finance and production manager. There may also
chart and the person in charge, at the top of the hierarchy, is the be regional managers, organising the business in areas of a
chairperson, accountable to the shareholders. The hierarchical country, or branch managers, organising particular branches
nature of the structure shows that employees have different or stores.
levels of authority and responsibility. The chairperson at the
top of the hierarchy has the most, while the apprentices, at the Team leaders: Team leaders are members of a team whose
very bottom, have the least. The roles played by the different role is to resolve issues between team members and co-ordinate
employees in an organisation are outlined below. team efforts so that the team works effectively. A team leader
may be part of a permanent cell production team or a team set
Exam tip up for a particular job, such as investigating staff morale. A team
Remember not to get authority and responsibility mixed up. They leader may also take responsibility for representing the views of
do not mean the same thing. Someone with responsibility is a team to the next higher reporting level, for example to report
accountable for the work of others. A person with authority has the findings of a market research team.
the right to carry out a particular task or duties.
Supervisors: Supervisors monitor and regulate the work in
their assigned or delegated area, for example stock supervisor
Employee roles in the organisational or payroll supervisor. Supervisors may be given some of the
hierarchy roles of managers, but at a lower level. Their roles in this case
The positions in an organisation will have particular workloads may be to hire, discipline, promote, punish or reward.
and jobs allocated to them.
Professionals: These are positions for staff with high levels of
Directors: Directors are appointed to run the business in the qualifications and experience. The job roles are likely to involve
interest of its owners. In smaller businesses, owners may also be a degree of decision making and responsibility for ensuring that
directors. But in larger businesses owned by shareholders, for tasks are carried out effectively to a high standard. Examples
example, they may be different. Directors are in overall charge might include doctors, architects, stockbrokers, product
of activities in an organisation. They meet, as the board of designers, chefs and accountants.
directors, to make major decisions that will affect the owners.
Some directors, known as executive directors, will be involved Operatives: These are positions for skilled workers who are
in the running of a business. Non-executive directors may play involved in the production process or service provision. They
little part in its running. The managing director (MD) will have carry out the instructions of managers or supervisors. In their
overall responsibility for the organisation and have authority over own area of activity they may have to ensure targets are met
specific directors, such as the finance or marketing director. and tasks are carried out effectively. Examples of operatives in
business might include staff in:
Managers: Managers are responsible for controlling or ●● production, for example assembling a car or manufacturing

organising within the business. They often make day-to-day furniture

decisions about the running of the business. The sales manager, ●● warehousing, for example checking invoices against goods

for example, would have responsibility for sales in the business and ensuring effective deliveries
and be responsible to the marketing director. Businesses often ●● IT, for example giving technical support for machinery.

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Organisational design Unit 16

General staff: There are a variety of positions in business Authority, on the other hand, is the ability to carry out the task.
which are carried out by staff with non-specific skills. They follow For example, it would make no sense asking an office worker
instructions given by superiors to carry out particular tasks to pay company debts if she did not have the authority to sign
and are an essential part of the production process or service cheques. Employees at lower levels of the hierarchy have less
provision. Examples might include checkout staff and shelf responsibility and authority than those further up. However,
stackers in supermarkets, cleaners and receptionists in offices. it may be possible for a superior to delegate (pass down)
They might also include general jobs on a farm or building site, authority to a subordinate, e.g. a manager to an office worker,
such as cleaning out. but retain responsibility. Increasingly, businesses are realising
the benefits of delegating both authority and responsibility.
Although there may be similar generic job roles, there will be
differences between organisations in the precise nature of these Question 1
roles, relationships between various job roles, how they are
managed and how decisions are made.

Chain of command
The hierarchy in a business is the levels of management in
a business, from the lowest to the highest rank. It shows the
chain of command within the organisation – the way authority
is organised. Orders pass down the levels and information
passes up. Businesses must also consider the number of links
or levels in the chain of command. R. Townsend, in his book Up
the Organisation, estimated that each extra level of management
in the hierarchy reduced the effectiveness of communication by
about 25 per cent. No rules are laid down on the most effective
number of links in the chain. However, businesses generally try
to keep chains as short as possible.
Idris Textiles Ltd produces a range of clothing. Its factory has
Span of control three production lines, where machinists are employed to make
The number of people, or subordinates, a person directly the clothes. Figure 3 shows part of the organisational chart.
controls in a business is called the span of control. For example,
Figure 3
if a production manager has ten subordinates, their span of
control is ten. If a business has a wide span of control it means Extract from the organisational chart of Idris Textiles Ltd
that a person controls relatively more subordinates. Someone
Chairperson
with a narrow span of control controls fewer subordinates. If
the span of control is greater than six, difficulties may arise.
Henri Fayol, who developed a general theory of business Managing
director
administration in his 2001 work Critical Evaluations in Business
Management, argued that the span of control should be between Production
three and six because: manager
●● there should be tight managerial control from the top of

the business
●● there are physical and mental limitations to any single
Line A manager Line B manager Line C manager
manager’s ability to control people and activities.
The implications of wide and narrow spans of control are
discussed in more detail below. Line A supervisors (2) Line B supervisors (3) Line C supervisors (1)

Authority and responsibility Machinists (12) Machinists (15) Machinists (4)

Employees in the hierarchy will have responsibility and authority.
However, as we mentioned earlier these terms do not mean the
same thing. Responsibility involves being accountable or being (a) What is the span of control for the manager of Line B?
required to justify an action. So, for example, managers who (b) Using Figure 3, describe the chain of command at Idris
are responsible for a department may be asked to justify poor Textiles, from the chairperson to the machinists working on
performance to the board of directors. The human resources all lines.
department may be responsible for employing workers. If a new
(c) Explain one reason why the business might produce an
worker was unable to do a particular job, they would be asked
to explain why. organisational chart.

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 Marketing and people

Centralisation and decentralisation Question 2

Centralisation and decentralisation refer to the extent to which
authority is delegated in a business. If there was complete In 2006, Dewhurst, the chain of butchers, went into
centralisation, subordinates would have no authority at all. administration. High street butchers had lost out to
Complete decentralisation would mean subordinates would have supermarkets and there was a lack of trust in the meat trade.
all the authority to take decisions. Some delegation may always Consumers went to supermarkets because they trusted their
be necessary in all firms because of the limits to the amount of brands. However, a revival for high street butchers began in
work senior managers can carry out. Tasks that might be delegated the early 2000s, when celebrity chefs such as Jamie Oliver
include staff selection, quality control, customer relations, and and Nigella Lawson started to influence consumers. Lawson
purchasing and stock control. Even if authority is delegated to a suggested, following the crisis of confidence from the BSE scare,
subordinate, it is usual for the manager to retain responsibility. that it was essential to go to a trusted butcher for good meat, as
In pyramid structures, subordinates often have little with the butcher she used who sourced beef from organic herds.
authority, with most decisions being taken at the top of the
Harry Enkleman, the owner of Enkleman’s Butchers, a chain
organisation. Open systems thinking would suggest that this
based in Nottingham, decided that he must make some changes
form of organisation may not suit the various markets that
in his organisation. Purchase of all meat for his shops had been
a growing and competitive business could face. Individuals
close to consumers might be better placed to make decisions.
made by the head office in Nottingham. Centralised purchasing
Hence regional, divisional, or in some cases for multinational ensured standard quality and discounts for bulk-buying.
companies, national operations may become a ‘business unit’ About 40 per cent of the meat purchased for his 36 shops was
with its own cost and profit centre. However, it would still remain imported from Poland. He decided that meat should in future
accountable to the head office. The advantages of centralisation be purchased from local suppliers by the shop managers. He
and decentralisation are shown in Table 1. thought that it was important to meet the expectations of local
customers and ‘cash in’ on the revival of high street butchers.
Table 1 Advantages of centralisation and decentralisation
Source: adapted from the Financial Times, 04.04.2014. All
Advantages of centralisation
rights reserved.
• Senior management has more control of the business, e.g. budgets.
• Procedures, such as ordering and purchasing, can be standardised (a) Assess the possible impact on Enkleman’s Butchers of the
throughout the organisation, leading to economies of scale and lower costs. switch to decentralised purchasing.
• Senior managers can make decisions from the point of view of the business
as a whole. Subordinates would tend to make decisions from the point of
view of their department or section. This allows senior managers to maintain
a balance between departments or sections. For example, if a company
has only a limited amount of funds available to spend over the next few
years, centralised management would be able to share the funds out
Types of organisational structure
between production, marketing, research and development, and fixed asset Organisational structures can vary between different businesses.
purchases in different departments, etc. This is because different businesses have different needs and
• Senior managers should be more experienced and skilful in making possibly have different views about the way staff should be
decisions. In theory, centralised decisions by senior people should be of better organised and controlled. Organisational structures may be flat,
quality than decentralised decisions made by others less experienced. tall or matrix. Examples are shown in Figure 4 on the next page.
• In times of crisis, a business may need strong leadership by a central group
of senior managers.
Tall structures: Figure 4a shows a tall structure. Here there
• Communication may improve if there are fewer decision makers.
is a long chain of command, but a narrow span of control. In
Advantages of decentralisation this chart there are five levels in the hierarchy. Some advise
• It empowers and motivates workers. that the number of levels should not exceed eight, the point at
• It reduces the stress and burdens of senior management. It also frees time which the disadvantages of tall structures begin to outweigh
for managers to concentrate on more important tasks. the advantages.
• It provides subordinates with greater job satisfaction by giving them more
say in decision making, which affects their work, as explained by McGregor’s
Theory Y. Flat structures: A flat structure means there are fewer layers
• Subordinates may have a better knowledge of ‘local’ conditions affecting in the hierarchy. In Figure 4b the flat structure only has three
their area of work. This should allow them to make more informed, layers in the hierarchy. The chain of command is short but
well-judged choices. For example, salespeople may have more detailed the span of control is wide. This type of structure means that
knowledge of their customers and be able to advise them on purchases. employees are free from strict, close control in the workplace.
• Delegation should allow greater flexibility and a quicker response to They have more freedom and responsibility.
changes. If problems do not have to be referred to senior managers,
decision making will be quicker. Since decisions are quicker, they are easier
to change in the light of unforeseen circumstances which may arise. Matrix structures: Matrix structures allow businesses to
• By allowing delegated authority, management at middle and junior levels connect people with particular specialist skills, as shown in
are groomed to take over higher positions. They are given the experience of Figure 4c. They involve getting people together from different
decision making when carrying out delegated tasks. Delegation is therefore areas in the business to form a project team. Individuals within
important for management development.
the team each have their own responsibility. Teams are fluid,

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Organisational design Unit 16

and can be made, altered or dissolved to suit the business Implications of different organisational
need at the time. Matrix structures are often used to solve
problems in a business – particularly problems which require
structures
The different structures used by businesses to organise
multi-disciplinary solutions.
their workforces have advantages and disadvantages. The
implications of each type are outlined below.
Figure 4
Tall, flat and matrix organisational structures Tall structures: With tall structures the span of control can
be small. This means that managers have a tighter control
over their subordinates. As a result employees can be more
closely supervised. There is a clear management structure and
a clear route for promotion. This might help to motivate staff.
(a) Tall structure However, management costs will be higher since there are more
managers. Communication through the whole structure can be
poor because there is a long chain of command. Messages may
get distorted as they get passed down through the different
layers in the hierarchy. It might also slow down the decision-
making process as approval may be needed at each level of
management. Finally, close-quarters control may be resented by
some staff and they could become demotivated.

Flat structures: With flat structures, communication is

A long chain of command and a narrow span of control. A production
better because the chain of command is generally shorter.
department may look like this. One manager is helped by a few assistant
Communication can be quicker and there is less scope for
managers, each responsible for supervisors. These supervisors are
message distortion. Management costs are lower because
responsible for skilled workers, who are in charge of a group of semi-skilled
there are fewer layers of management. Decision making may
workers. Close supervision is needed to make sure quality is maintained.
be quicker because approval from several managerial layers is
This is sometimes referred to as a tall organisational structure.
not required. Also, employees may be better motivated because
they are less closely controlled. Indeed, in many flat structures
employees are empowered. They have more responsibility for
organising their work and may be allowed to solve their own
(b) Flat structure
problems. This can help to make their work more interesting.
However, managers may lose control of the workforce because
the span of control is too wide. As a result discipline may be
lacking, which could have a negative impact on productivity.
There could also be co-ordination problems if managers are
A short chain of command and a wide span of control. A higher or further responsible for too many subordinates. As a result they may
education department may look like this, with a ‘head’ of department, become over-burdened.
a few senior staff and many lecturing staff. Staff will want a degree of
independence. This is sometimes referred to as a flat organisational Matrix structures: Managers often argue that this is the best
structure. way of organising people. This is because it is based on the
expertise and skills of employees, and gives scope for people
lower down the organisation to use their talents effectively.
For example, a product manager looking into the possibility
(c) Matrix structure of developing a new product may draw on the expertise of
employees with skills in design, research and development,
Production Marketing Human resources Accounting
marketing, costing, etc. In this way, a matrix structure can also
Project operate within a business that has a bureaucratic structure.
X manager
The matrix model fits with some of the motivational theories
discussed in Unit 17, which view employees in a very positive
Project
Y manager light. It is suggested that this structure improves flexibility and
the motivation of employees. However, the method often
The matrix structure here shows two specific business projects, X and Y, needs expensive support systems, such as extra secretarial
drawing people from four different departments – production, marketing, and office staff. There may also be problems with co-ordinating
human resources and accounting. a team drawn from different departments and with the speed
of decision making.

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 Marketing and people

Thinking bigger
Delayering also involves a business reducing its staff. The cuts are advantage of delayering is the savings made from laying off expensive
directed at particular levels of a business, such as managerial posts. Many managers. It may also lead to better communication and a better
traditional organisational charts are hierarchical, with many layers of motivated staff if they are empowered and allowed to make their
management. Delayering involves removing some of these layers. This own decisions.
gives a flatter structure. In the late 1980s, the average number of layers in However, remaining managers may become demoralised after delayering.
a typical organisational structure was 7, although some were as high as Also staff may become over-burdened as they have to do more work.
14. By the early 2000s this was reduced to less than five. The main Fewer layers may also mean less chance of promotion.

Key terms Knowledge check

Authority – the 1. Why do some businesses need a formal organisation?
right to command and make decisions. 2. State three benefits of drawing an organisational chart.
Centralisation – a type of business organisation where 3. What is the advantage of a short chain of command?
major decisions are made at the centre or core of the
4. What is the advantage of having a small span of control?
organisation and then passed down the chain of command.
Chain of command – the way authority and power is 5. State two advantages of a centralised organisation.
organised in an organisation. 6. State two benefits of decentralisation.
Decentralisation – a type of business organisation where 7. Explain one disadvantage of a tall organisational structure.
decision making is pushed down the chain of command and 8. Explain the benefits of using a matrix organisational
away from the centre of the organisation. structure.
Delayering – removing layers of management from the 9. How might motivation be affected by employing a flatter
hierarchy of an organisation. organisational structure?
Delegation – authority to pass down from superior
10. How might communication be less effective in a tall
to subordinate.
organisational structure?
Formal organisation – the internal structure of a business
as shown by an organisational chart.
Hierarchy – the order or levels of responsibility in an
organisation, from the lowest to the highest.
Organisational chart – a diagram that shows the different
job roles in a business and how they relate to each other.
Responsibility – the duty to complete a task.
Span of control – the number of people a person is directly
responsible for in a business.
Subordinates – people in the hierarchy who work under the
control of a senior worker.

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Organisational design Unit 16

Case study
MORRISONS its supermarkets, looking to offer displaced colleagues an
opportunity to work in the growing businesses. An official
from the union representing the workers, Usdaw, reported
that they would do all they could to support those members
affected by the restructure. They planned to look in detail at
the company’s business case during the consultation period
and safeguard as many jobs as possible.
Figures 5 and 6 show Morrisons’ turnover and profit
after tax.

Figure 5
Morrisons’ turnover 2010–2014 (£ million)
£ million
18,500
18,000
17,500
17,000
16,500
16,000
15,500
15,000
Morrisons is a national supermarket chain with 14,500
headquarters in Bradford. It operates more than 600 14,000
2010 2011 2012 2013 2014
stores and employs over 120,000 people. Like other big Year
supermarket chains in the UK, the business has been feeling
the effects of stiff competition from low-price supermarkets
such as Aldi and Lidl, and the ‘up-market chain’ Waitrose. Figure 6
In 2014, it was reported that Morrisons was going to cut Morrisons’ profit 2010–2014 (£ million)
2,600 jobs as a result of changing its management structure.
The plan was to remove layers of management in stores, 800
leading to a flatter organisational structure. Some stores 600
had as many as seven layers between the shop floor and
400
the store manager. Dalton Philips, Morrisons’ chief executive
at the time of the restructure, suggested that it was the right 200
time to modernise the management of the stores, and that 0
changes would improve the focus on customers and lead to -200
smarter and simpler ways of working.
-400
2010 2011 2012 2013 2014*
Morrisons planned to increase the responsibility of duty
managers in the stores. The new structure would merge *Includes an exceptional non-recurring cost of £903 million
department managers and supervisors into a single and
smaller tier of team managers. The new arrangement Source: adapted from the Financial Times, 23.06.2015. All rights
reserved.
would promote 1,000 from this group into new duty
manager roles. This was designed to strengthen the senior
management team in each store. Morrisons also planned to
provide more resources for customer-facing jobs on the shop
floor. The new system was trialled and found to improve (a) What is meant by a flat organisational structure?
performance and also led to clearer lines of responsibility. (2 marks)
Morrisons also pledged to create 1,000 new jobs in its (b) Evaluate the possible impact on Morrisons of using a
M Local convenience stores and a further 3,000 positions in flatter organisational structure. (20 marks)

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 17 Motivation in theory 1.4.4
Theme 1
and practice
Key points
1. The importance of employee motivation to a business.
2. Motivation theories: Taylor (scientific management), Mayo (human relations theory), Maslow (hierarchy
of needs), Herzberg (two-factor theory).
3. Financial incentives to improve employee performance: piecework, commission, bonus, profit sharing,
performance-related pay.
4. Non-financial techniques to improve employee performance: delegation, consultation, empowerment,
teamworking, flexible working, job enrichment, job rotation, job enlargement.

Getting started
Taylor’s theory of scientific management
Panna Alam works for a financial services business selling private Frederick W. Taylor set out a theory of scientific management in
pensions. She is in charge of a small team of six sales staff. She his book The Principles of Scientific Management in 1911. Many
receives a basic pay of £12,000 a year, but gets 2 per cent per of the ideas of today’s ‘scientific management school’ come from
month commission based on the team’s monthly sales. Last the work of Taylor.
month the team sold £120,000 worth of policies. Panna enjoys The turn of the 20th century in the USA was a time of rapid
her job and is well motivated. She can choose her hours of work expansion. Compared to today, the organisation of work on the
and gets up to eight weeks holiday a year. shop floor was left much more in the hands of workers and
foremen. Workers often brought their own tools and decisions
Calculate the amount of money that Panna earned last month.
about the speed of machines were left to operators. There were
How do you think her employer motivates sales staff in this
few training programmes to teach workers their jobs, and skills
case? What do you think would motivate you? What are the
were gained simply by watching more experienced colleagues.
advantages to a business of teamworking? Decisions about selection, rest periods and layoffs were
frequently made by foremen.
Taylor suggested that such arrangements were haphazard
The importance of motivation and inefficient. Management did not understand the shop floor
Why is it important for a business to find out what satisfies and allowed wasteful work practices to continue. Workers, on
the needs of its employees? It is argued that if an individual’s the other hand, left to their own devices, would do as little as
needs are not satisfied, then that worker will not be motivated possible. ‘Soldiering’ would also take place (working more slowly
to work. Businesses have found that even if employees are together so that management did not realise workers’ potential)
satisfied with pay and conditions at work, they complain and workers would carry out tasks in ways they were used to
that their employer does not do a good job in motivating rather than the most efficient way.
them. This applies to all levels, from the shop floor to the Taylor’s scientific principles were designed to reduce
boardroom. It appears in many companies that employers are inefficiency of workers and managers. This was to be achieved
not getting the full potential from their employees because by ‘objective laws’ that management and workers could agree
they are not satisfying all of their employees’ needs. on, reducing conflict between them. Neither party could argue
It is important for a business to motivate its employees. against a system of work that was based on ‘science’. Taylor
In the short run a lack of motivation may lead to reduced believed his principles would create a partnership between
effort and lack of commitment. If employees are watched manager and worker, based on an understanding of how jobs
closely, fear of wage cuts or redundancy may force them to should be done and how workers are motivated.
maintain their effort even though they are not motivated. This
is negative motivation. Taylor’s approach: How did Taylor discover what the ‘best
In the long term, a lack of motivation may result in way’ was of carrying out a task? Table 1 on the next page
high levels of absenteeism, industrial disputes, and falling shows an illustration of Taylor’s method. Taylor had a very
productivity and profit for a business. So it is argued that simple view of what motivated people at work – money. He
well-motivated employees will be productive, which should felt that workers should receive a ‘fair day’s pay for a fair day’s
lead to greater efficiency and profits. work’, and pay should be linked to output through piece rates.
There are a number of motivational theories used A worker who did not produce a ‘fair day’s work’ would face a
in business. loss of earnings; exceeding the target would lead to a bonus.

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Motivation in theory and practice Unit 17

In 1899 Taylor’s methods were used at the Bethlehem Steel The Hawthorne studies: Many of the ideas which are today
Works in the USA, where they were responsible for raising pig known as the ‘human relations school’ grew out of experiments
iron production by almost 400 per cent per man per day. Taylor between 1927 and 1932 at the Hawthorne Plant of the Western
found the ‘best way to do each job’ and designed incentives to Electric company in Chicago. Initially these were based on
motivate workers. ‘scientific management’ – the belief that workers’ productivity
Taylor’s message for business is simple – allow workers to was affected by work conditions, the skills of workers and
work and managers to manage based on scientific principles financial incentives. Over the five-year period, changes were
of work study. Many firms today still attempt to use Taylor’s made in incentive schemes, rest periods, hours of work, lighting
principles. In the 1990s, for example, some businesses and heating, and the effect on workers’ productivity was
introduced business process reengineering (BPR). This is a measured. One example was a group of six women assembling
management approach where organisations look at their business telephone relays. It was found that whatever changes were
processes from a ‘clean slate’ perspective and determine how made, including a return to the original conditions, output rose.
they can best construct these processes to improve how they This came to be known as the Hawthorne effect.
conduct business. Taylor’s approach is similar in that it advocates The study concluded that changes in conditions and
businesses finding the best way of doing something to add value financial rewards had little or no effect on productivity.
to the business. Increases in output were mainly due to the greater cohesion
and communication which workers in groups developed as
Table 1 Taylor’s method, designed to find out the ‘best they interacted and were motivated to work together. Workers
way’ to carry out a task at work were also motivated by the interest shown in their work by the
• Pick a dozen skilled workers. researchers. This result was confirmed by further investigations
• Observe them at work and note down the elements and sequences adopted
in the Bank Wiring Observation where 14 men with different
in their tasks. tasks were studied.
• Time each element with a stop watch. The work of Elton Mayo (and Roethlisberger and Dickson)
• Eliminate any factors which appear to add nothing to the completion of in the 1930s, who reported on the Hawthorne Studies, has led
the task. to what is known today as the human relations school.
• Choose the quickest method discovered and fit them in their sequence. A business aiming to maximise productivity must make sure that
• Teach the worker this sequence; do not allow any change from the the ‘personal satisfactions’ of workers are met for workers to be
set procedure. motivated. Management must also work and communicate with
• Include time for rest and the result will be the ‘quickest and best’ method informal work groups, making sure that their goals fit in with
for the task. Because it is the best way, all workers selected to perform the the goals of the business. One way to do this is to allow such
task must adopt it and meet the time allowed.
groups to be part of decision making. Workers are likely to be
• Supervise workers to ensure that these methods are carried out during the
working day. more committed to tasks that they have had some say in.
There are examples of these ideas being used in business.
Problems with Taylor’s approach: There are a number The Volvo plant in Uddevalla, opened in 1989, was designed to
of problems with Taylor’s ideas. The notion of a ‘quickest and allow workers to work in teams of eight to ten. Each team built
best way’ for all workers does not take into account individual a complete car and made decisions about production. Volvo
differences. There is no guarantee that the ‘best way’ will found that absenteeism rates at Uddevalla averaged 8 per cent,
suit everyone. compared to 25 per cent in their Gothenburg plant which used a
Taylor also viewed people at work more as machines, with production line system. Other examples have been:
●● Honda’s plant in Swindon where ‘teamwork’ has been
financial needs, than as humans in a social setting. There is no
doubt that money is an important motivator. Taylor overlooked emphasised – there were no workers or directors,
that people also work for reasons other than money. only ‘associates’
●● McDonald’s picnics, parties and McBingo for their employees
A survey in America by Robb and Myatt in 2004, for example,
found that of the top ten factors motivating workers, the first where they were made to feel part of the company
●● Mary Kay’s seminars in the USA, which were presented like
three categories were a sense of achievement, having that
achievement recognised, and positive working relationships. the American Academy awards for company employees.
This suggests there may be needs that must be met at work,
which Taylor ignored, but were recognised in Maslow’s ideas Problems: There are a number of criticisms of the human
which came later. relations school.
●● It assumes workers and management share the same goals.

Mayo’s theory of human relations This idea of workplace ‘consensus’ may not always exist. For
Taylor’s scientific management ideas may have seemed example, in the 1980s Rover tried to introduce a programme
appealing at first glance to business. Some tried to introduce his called ‘Working with Pride’. It was an attempt to raise quality
ideas in the 1920s and 1930s, which led to industrial unrest. by gaining employee commitment. This would be achieved
Others found that financial incentives did motivate workers, and by greater communication with employees. The programme
still do today. However, what was becoming clear was that there was not accepted throughout the company. As one manager
were other factors which may affect workers’ motivation. stated: ‘We’ve tried the face-to-face communications

100
 Marketing and people

approach. It works to a degree, but we are not too good at of the pyramid are basic needs. They are concerned with
the supervisory level ... enthusiasm for the Working with Pride survival. These needs must be satisfied before a person can
programme is proportionate to the level in the hierarchy. For move to the next level. For example, people are likely to be
supervisors it’s often just seen as a gimmick ...’ more concerned with basic needs, such as food, than anything
●● It is assumed that communication between workers and else. At work an employee is unlikely to be concerned about
management will break down ‘barriers’. It could be argued, acceptance from colleagues if he has not eaten for six hours.
however, that the knowledge of directors’ salaries or Once each level is satisfied, the needs at this level become less
redundancies may lead to even more ‘barriers’ and unrest. important. The exception is the top level of self-actualisation.
●● It is biased towards management. Workers are manipulated This is the need to fulfil your potential. Maslow argued that
into being productive by managers. It may also be seen as a although everyone is capable of this, in practice very few reach
way of reducing trade union power. this level.
Each level of needs is dependent on the levels below. Say an
Maslow’s hierarchy of needs employee has been motivated at work by the opportunity to take
The first comprehensive attempt to classify needs was by responsibility, but finds he may lose his job. The whole system
Abraham Maslow in his book Motivation and Personality, collapses, as the need to feed and provide for himself and his
published in 1954. Maslow’s hierarchy of needs theory dependants again becomes the most important need.
consisted of two parts. The first concerned classification of Maslow’s ideas have great appeal for business. The message
needs. The second concerned how these classes are related to is clear – find out which level each individual is at and decide
each other. Maslow suggested that ‘classes’ of needs could be on suitable rewards. Unfortunately the theory has problems
placed into a hierarchy. The hierarchy is normally presented as a when used in practice. Some levels do not appear to exist
‘pyramid’, with each level consisting of a certain class of needs. for certain individuals, while some rewards appear to fit into
This is shown in Figure 1. The classes of needs were: more than one class. Money, for example, needs to be used to
●● physiological needs, e.g. wages high enough to meet weekly purchase ‘essentials’ such as food, but it can also be seen as a
bills, good working conditions status symbol or an indicator of personal worth. There is also a
●● safety needs, e.g. job security, safe working conditions problem in deciding when a level has actually been ‘satisfied’.
●● love and belonging, e.g. working with colleagues that support There will always be exceptions to the rules Maslow outlined.
you at work, teamwork, communicating A well-motivated designer may spend many hours on a creative
●● esteem needs, e.g. being given recognition for doing a design despite lack of sleep or food.
job well
●● self-actualisation, e.g. being promoted and given more Herzberg’s two-factor theory
responsibility, scope to develop and introduce new ideas, and In 1966 Fredrick Herzberg attempted to find out what motivated
take on challenging new job assignments. people at work. He asked a group of professional engineers and
Figure 1 can also be used to show the relationship between accountants to describe incidents in their jobs which gave them
the different classes. Maslow argued that needs at the bottom strong feelings of satisfaction or dissatisfaction. He then asked
them to describe the causes in each case.

Figure 1 Results: Herzberg divided the causes into two categories or

Maslow’s hierarchy of needs factors. These are shown in Figure 2 on the next page.
●● Motivators. These are the factors which give workers job

SELF-ACTUALISATION satisfaction, such as recognition for their effort. Increasing

• Realising your full potential these motivators is needed to give job satisfaction. This,
it could be argued, will make workers more productive.
ESTEEM NEEDS A business that rewards its workforce for, say, achieving
• Gaining the esteem and respect of others
• Gaining self-esteem and self-respect a target is likely to motivate them to be more productive.
• Feeling competent
However, this is not guaranteed, as other factors can also
affect productivity.
LOVE AND BELONGING ●● Hygiene or maintenance factors. These are factors that
• Receiving and giving love, affection, trust and acceptance
• Affiliating with or being part of a group can lead to workers being dissatisfied, such as pay or
conditions. Improving hygiene factors should remove
dissatisfaction. For example, better canteen facilities may
SAFETY NEEDS make workers less dissatisfied about their environment. An
• Protection from dangerous objects or situations
• Protection from physical and psychological threats improvement in hygiene factors alone is not likely to motivate
• The importance of routine and familiarity an individual. But if they are not met, there could be a fall in
productivity.
There is some similarity between Herzberg’s and Maslow’s
PHYSIOLOGICAL NEEDS
• Obtaining food, drink, air, rest and activity ideas. They both point to needs that have to be satisfied for the
employee to be motivated. Herzberg argues that only the higher
levels of Maslow’s hierarchy motivate workers.
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Motivation in theory and practice Unit 17

Figure 2
Herzberg’s two-factor theory

Sense of achievement
Chance of promotion
Motivators Factors which Chance of improvement
motivate Recognition of effort
Responsibility
Nature of the job itself
WORK
Pay
Conditions
Factors which Company policy
Hygiene need to be met to Relationships with higher levels of
factors prevent dissatisfaction. the hierarchy, such as management
Will not motivate Treatment at work
in themselves Inability to develop
Feelings of inadequacy

Herzberg’s ideas are often linked with job enrichment. Question 1

This is where workers have their jobs ‘expanded’, so that they
can experience more of the production process. This allows Cambridge-based Bard is a pharmaceuticals company that
the workers to be more involved and motivated, and have a employs over 400 people. In 2014 the company came
greater sense of achievement. Herzberg used his ideas in the nineteenth in a national survey carried out by the Sunday Times
development of clerical work. He selected a group of workers to find the best employers in the UK. The survey showed that
in a large corporation. Performance and job attitudes were low. the majority of staff were happy working for Bard. Indeed, the
Herzberg redesigned these jobs so that they were given more staff turnover rate was only 4 per cent (the national average is
responsibility and recognition. around 15 per cent).

Problems: Herzberg’s theory does seem to have some Colm Moody, director of production and supply chain, says the
merits. Improving pay or conditions, for example, may remove leadership style is all about trusting employees. ‘I tell people
dissatisfaction at first. Often, however, these things become what I expect,’ he says, ‘and I do not need to hear from them
taken for granted. It is likely that better conditions will be asked again unless something goes wrong. I also insist my managers
for in following years. Evidence of this can be seen in wage know their team members as individuals. Do they know who
claims which aim to be above the rate of inflation in some might need an arm around the shoulder to perform better?’
businesses every year. Job enrichment may also be expensive Some of the notable results taken from the survey included:
for many firms. In addition, it is likely that any benefits from
• 78 per cent said they loved what they did
job improvements will not be seen for a long time and that
businesses will not be able to continue with such a policy in • 84 per cent said they felt proud to work for the organisation
periods of recession. • 82 per cent said they believed they could make a valuable
Surveys that have tried to reproduce Herzberg’s results contribution to the success of the organisation
have often failed. This may have been because different groups
• 80 per cent regarded the business as fun and said that
of workers have been examined and different techniques used.
colleagues went out of their way to help one another
Also, there is a problem in relying too much on what people
say they find satisfying or dissatisfying at work, as this is • 83 per cent were happy with the pay and benefits they receive.
subjective. For example, if things go wrong at work individuals Sources: adapted from www.bardpharmaceuticals.co.uk and
have a tendency to blame it on others or factors outside of www.b.co.uk
their control. On the other hand, if individuals feel happy and
(a) Explain one reason why motivation is important to a business
satisfied when they are at work then they tend to see it as their
like Bard Pharmaceuticals.
own doing.
(b) Identify two of Herzberg’s hygiene factors at Bard
Pharmaceuticals.
(c) Explain one factor that will help to motivate staff at Bard
Pharmaceuticals, according to Herzberg.

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 Marketing and people

Financial incentives to improve staff Commission: Commission is a payment system mainly used
with white collar workers. Commission, like piece rates, is a
performance payment for achieving a target. For example, car salespeople
A number of theories have tried to explain the factors that
may get a commission of £100 for each car they sell. Some
motivate people at work. Some of these theories stress that
white collar workers are paid entirely on commission.
money is the most important factor. The scientific approach,
A salesperson, for example, may be paid entirely on the
in particular, argues that workers respond to financial rewards.
basis of their sales record. Alternatively, a worker may be
It is argued that such rewards are necessary to motivate a
paid a basic salary and then receive commission on top.
reluctant workforce. Employees see work as a means to an end.
Commission-based pay systems are intended to ‘incentivise’
As a result they are far more likely to be interested in financial
workers by tying in pay with output.
rewards. In contrast, the human relations view argues that
workers are motivated by a variety of factors. An employee
Bonus: Some firms make bonus payments to workers.
working in a car assembly plant, for example, may be highly
Bonuses are paid in addition to the basic wage or salary.
motivated by working as part of a team.
They are usually paid if targets are met. For example,
machinists may be paid a bonus if they reach a weekly
Piecework: Piece rates are payments for each unit produced.
production target. Bonuses can also be paid to groups of
They are an example of payment by results. For example, a
workers. For example, a sales team may get a bonus if the
worker might be paid £0.50 per parcel delivered or £1.00 per
whole team meets a sales target.
kilo of strawberries picked. Piece rates were recommended by
The main advantage to businesses of bonus payments
Frederick Taylor, founder of the scientific management school.
is that they are only paid if targets are met. This means that
He thought they were an ideal way to motivate workers. Workers
money is only paid if it has been earned. Bonus payments
who produced more were more highly paid. However, piece
may help to motivate workers as they strive to reach a target
rates are only suitable for jobs where it is easy to identify the
to earn their bonus. Finally, some businesses pay their staff
contribution of an individual worker. It would be difficult to
loyalty bonuses. These are usually paid annually, often
devise a piece rate system for, say, secretaries or managers.
at Christmas. Such bonuses are not necessarily linked to
Piece rates have been criticised on health and safety grounds.
productivity. They are designed to reward workers for staying
They might encourage workers to take dangerous short cuts in
with the company.
a bid to reduce the amount of time taken for each item. Rushing
production might also affect the quality of the product.
Profit sharing: Some businesses have profit sharing
schemes. In a company, profits would normally be distributed
Question 2 to shareholders. Profit sharing occurs when some of
the profits made are distributed to workers as well as
Paying workers according to what they produce is common in a shareholders.
number of industries. One such industry is textiles. For example, Profit sharing can motivate workers to achieve the
people employed on machines to make garments are likely to be objectives of the business. Shareholders want higher profits.
paid according to how many units they produce in a shift. So too do workers if they are to receive a share of them.
Profit sharing therefore unites the goals of both owners and
workers for extra money. Profit sharing can also be a way of
showing staff that they are appreciated. In Maslow’s hierarchy
of needs, it may help satisfy the need for love and belonging.
However, most individual workers will have little or no
control over how much profit their company makes. If they
make extra effort to raise sales or reduce costs, the benefit of
that extra effort will be shared between all the other workers.
There is no link between individual effort and individual
reward in profit sharing. Profit sharing is also unlikely to
motivate financially if the amount received is fairly small.
A UK business which uses profit sharing is the John
Lewis Partnership, which owns the John Lewis department
stores and the supermarket chain Waitrose. The John Lewis
Partnership is owned in trust for its workers. So all the profits
(a) Explain the payment system used in this case. after tax and retentions are distributed to its workers. The
(b) Explain which motivational theory this payment system might amount given varies according to the salary of the worker.
be based on. In a good year, Waitrose workers will receive a profit share
(c) Explain one possible disadvantage of this method as a handout of more than 20 per cent of their salary. This is a
means of motivating machinists.
substantial sum. Whether it motivates John Lewis Partnership
workers to work harder is debatable.

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Motivation in theory and practice Unit 17

Performance-related pay: Performance-related pay (PRP) is Non-financial techniques to improve

a pay system designed specifically to motivate staff. Introduced
in the 1980s and 1990s, it is now used widely in the UK among
staff performance
Financial rewards have often been used in the past by firms
white collar workers, especially in the financial services industry,
in an attempt to motivate employees to improve productivity.
such as banking, and in the public sector.
However, increasingly businesses have realised that:
PRP gives workers extra pay for achieving targets. The
●● the chance to earn more money may not be an
extra pay may be a lump sum such as £1,000 or it could be
effective motivator
a percentage of salary. Some PRP systems make distinctions
●● financial incentive schemes are difficult to operate
between levels of achievement. For example, one worker may
●● individual reward schemes may no longer be effective as
be rated ‘excellent’ and receive a 10 per cent bonus, another
production has become organised into group tasks
‘good’ and receive a 5 per cent bonus, another ‘satisfactory’ and
●● other factors may be more important in motivating
receive no bonus.
employees.
The targets are likely to be set through a system of
If other factors are more important than pay in motivating
appraisal. This is where the performance of individual staff is
workers, it is important for firms to identify them. Only then can
reviewed against a set of criteria. These criteria could include
a business make sure its workforce is motivated.
factors such as arriving for work on time, ability to get on with
other workers, improving skills through training or achieving
Delegation: In some situations a manager may hand a more
a particular task within the job. Staff are likely to have a
complex task to a subordinate. This is called delegation. The
performance appraisal interview where someone more senior,
manager will still have responsibility, but authority is passed
such as their line manager, conducts the appraisal.
down the hierarchy. However, time can be saved if a subordinate
PRP is widely used because it directly links performance
completes the task. Sometimes delegation can motivate workers.
with pay. According to the scientific management school, it
This is because they feel they are being trusted to carry
should motivate workers to achieve the goals set for them by
out more difficult work. Delegation is most likely to improve
the organisation.
motivation if managers:
However, PRP and performance appraisal have been widely
●● only delegate when they are overloaded, otherwise
criticised for a number of reasons.
subordinates may feel resentful
●● The bonus may be too low to give workers an incentive to
●● take time to explain the tasks carefully and be sure
achieve their targets.
subordinates have the skills to complete them
●● Achieving the targets may have far more to do with the
●● give subordinates complete authority to carry out the task
smooth running of machinery or technological systems, or
and that colleagues are aware of the delegation
how a group of workers perform than the performance of an
●● do not interfere with delegated tasks
individual. For example, a worker may set a goal of increasing
●● provide the support and resources that are needed to carry
forms processed by 5 per cent. But the number of forms
out the delegated task.
she receives may depend on how many are processed by
other members of her team or whether the printing machines
Consultation: Staff often complain when changes are
are working smoothly. Where teamworking is an important
made and they are not consulted. For example, if a business
management tool, it is likely to be better to give bonuses
introduced flexible working hours so that it could remain open
based on the output of a team rather than an individual.
seven days a week without consulting staff, it is likely that
●● Targets may be difficult or even impossible to achieve in the
the workforce would feel resentful. If staff are consulted by
eyes of workers. If this is the case, then they are unlikely to
employers when changes are proposed they are more likely to
make any effort to achieve them.
feel that their views are valued. This can improve motivation.
●● Few staff see appraisal as an independent objective
Consultation has other advantages. Changes are less likely
procedure. Staff are quite likely to put their failure to
to be resisted if staff are consulted. It is also possible that
achieve a grade in an appraisal interview down to the
employees may have ideas of their own that could benefit
unfairness of the interviewer. This is particularly true when
the business. Such ideas can only be expressed if there is a
there are already problems in the relationship between,
proper consultation process. However, some might argue that
say, a worker and his or her boss. Staff who do achieve
consultation takes too long and slows down the process of
highly in appraisal interviews may be seen by others as
change. Also, some see consultation as a ‘cosmetic’ process
‘favourites’ of the interviewer.
where the views of workers are heard but then ignored.
Failure to receive a high enough grade in the appraisal process
may act as a demotivator of staff. Instead of staff wanting to
Empowerment: Delegated decision-making can be more
improve their performance, they may simply give up attempting
successful if employees are empowered. Empowerment of
to change their behaviour and attitudes. Failure to receive a
employees involves a number of aspects.
PRP bonus could challenge the physiological needs of staff in
●● Recognising that employees are capable of doing more than
Maslow’s hierarchy of needs because it deprives them of money.
they have in the past.
It could also make them feel less ‘loved’ by the organisation,
●● Making employees feel trusted, so that they can carry out
challenging their need for love and belonging. It will almost
their jobs without constant checking.
certainly knock their self-esteem.
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 Marketing and people

●● Giving employees control of decision making. However, in practice teamwork does not always produce the
●● Giving employees self-confidence. desired results. Part of the problem may lie in the way teams are
●● Recognising employees’ achievements. organised. Members may fail to work well together for several
●● Developing a work environment where employees are reasons, from lack of a sense of humour to clashing goals.
motivated and interested in their work. Studies of teams in the US have shown a number of problems
Many businesses now recognise the need to empower with teamwork.
employees. There are a number of advantages of this for a ●● Too much emphasis on harmony. Teams probably work

business and for employees. best when there is room for disagreement. Papering
●● Employees may feel more motivated. They feel trusted and over differences sometimes leads to vague or bland
feel that businesses recognise their talents. This should recommendations.
improve productivity and benefit the business in the long ●● Too much discord. Tension can destroy team effectiveness.

term, for example by reducing absenteeism. ●● Poor preparation. It is important that team members prepare

●● Employees may find less stress in their work as they have for meetings by focusing on the facts. Members should have
greater control over their working lives. This could reduce a detailed knowledge of the issues at hand and all work with
illness and absenteeism. the same information.
●● Decisions may be made by those most suited to make them. ●● Too much emphasis on individualism. For example, teams

Also, employees may feel less frustrated that senior staff who may fail to deliver results if the emphasis of the company is
are less equipped to make decisions are making them. placed on individualism.
●● There may be greater employee skills and personal ●● A feeling of powerlessness. To work well, teams must be able

development. to influence decisions.

●● Businesses may be able to streamline their organisations and ●● The failure of senior management to work well together. This

delegate decision making. creates problems because team members may walk into
●● Workers may feel less frustrated by more senior staff making meetings with different priorities.
decisions which they feel may be incorrect. ●● Meeting-itis. Teams should not try to do everything together.

However, empowerment is sometimes criticised as simply a means Too many meetings waste the team’s time.
of cutting costs and removing layers from the business. Passing ●● Seeing teams as the solution for all problems. Some tasks are

decision making down the hierarchy might allow a company to better accomplished by individuals, rather than groups.
make managers redundant. Employees are given more work to
do, but for the same pay. Some businesses argue that they want Flexible working: Employing a flexible workforce has a
to empower workers, but in practice they are unable or unwilling number of benefits for a business. For example, it can cope with
to do this. For example, a manager may feel insecure about fluctuations in demand more easily and extend opening hours.
subordinates making decisions that might affect his position in the However, flexible working may also help to motivate workers.
business. Feeling that they may ‘make the wrong decision’ might This is most likely if staff can choose their hours of work, work
lead to constant interruptions which are counter-productive. A from home or take lengthy periods of leave, for example. Flexible
further problem is the cost involved to the business, such as the working is discussed in detail in Unit 14.
cost of training employees or changing the workplace.
Job enrichment: The idea of job enrichment came from
Teamworking: The Swedish car firm Volvo is a well- Herzberg’s two-factor theory. Job enrichment attempts to give
quoted example of a company that has effectively introduced employees greater responsibility by ‘vertically’ extending their
‘teamwork’. In both its plants at Kalmar and Uddevalla, it set role in the production process. An employee, for example, may
up production in teams of eight to ten highly skilled workers. be given responsibility for planning a task, quality control, work
The teams decided between themselves how work was to be supervision, ordering materials and maintenance.
distributed and how to solve problems that arise. It is arguable Job enrichment gives employees a ‘challenge’, which will
whether these practices led to an increase in productivity, but develop their ‘unused’ skills and encourage them to be more
the company firmly believed that this method of organisation productive. The aim is to make workers feel they have been
was better than an assembly line system. A similar system rewarded for their contribution to the company. Employees will
has been used at Honda UK. Teamworking has a number also be provided with varied tasks, which may possibly lead to
of benefits. future promotion. It is not, however, without problems. Workers
●● Productivity may be greater because of pooled talents. who feel that they are unable to carry out the ‘extra work’, or
●● People can specialise and draw on the skills and knowledge who consider that they are forced into it, may not respond to
of others in the team. incentives. In addition, it is unlikely that all workers will react
●● Increasingly businesses are finding that the abilities of teams the same to job enrichment. Trade unions sometimes argue
are needed to solve difficult business problems. that such practices are an attempt to reduce the labour force,
●● Responsibility is shared. People may be more prepared to and disputes about the payment for extra responsibilities may
take risks. arise. In practice, job enrichment has been found to be most
●● Ideas may be created by brainstorming. successful in administrative and technical positions.
●● It allows flexible working.

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Motivation in theory and practice Unit 17

Question 3 Job rotation: Job rotation involves an employee changing

jobs or tasks from time to time. This could mean, for
Kwik Fit Insurance Services (KFIS), owned by Ageas, provides example, a move to a different part of the production line
general insurance services from its call centre near Glasgow. to carry out a different task. Alternatively, an employee
In 2014, the company employed around 950 people. When the may be moved from the human resources to the marketing
company was Kwik Fit Financial Services (KFFS) in around 2010, department where they have skills which are common to
it decided to make some key changes in its organisation. KFFS both. From an employee’s point of view this should reduce
wanted to create a working environment that empowered and boredom and enable a variety of skills and experience to be
involved people. It wanted to reduce levels of staff turnover, gained. An employer might also benefit from a more widely
raise morale, attract and recruit employees and increase trained workforce.
financial performance. Although job rotation may motivate a worker, it is
possible that any gains in productivity may be offset by a
Kwik Fit began by consulting the workforce. It invited all 650 fall in output as workers learn new jobs and take time
workers (at the time) to attend a one-day workshop. The event to ‘settle in’. Worker motivation is not guaranteed if the
was designed to generate ideas for improvements to the employee is simply switched from one boring job to another.
working environment. The outcome of the day was a total of In fact some workers do not like the uncertainty that job
6,500 proposals. Some of the important ones were as follows. changes lead to and may become dissatisfied. Although
• A flexible benefits scheme for staff. This was developed by an used by firms such as Volkswagen in the past, where
empowered and autonomous staff project team. employees carried out a variety of production tasks, job
rotation has declined in popularity.
• The provision of proper career paths to dismiss the view that
you could not develop a career in a call centre. KFFS produced Job enlargement: Job enlargement involves giving an
coaching programmes for managers to help them advise and employee more work to do of a similar nature. For example,
guide staff along their career paths. instead of an employee putting wheels onto a bicycle
• A culture of employee recognition, with internal call quality he could be allowed to put the entire product together.
competitions and ‘Going the Extra Mile’ awards. It is argued that this variety prevents boredom with one
repetitive task and encourages employees’ satisfaction in
• The appointment of a ‘Ministry of Fun’ to help staff engage in
their work, as they are completing the entire process. Job
social networking.
enlargement is more efficient if workers are organised in
• Community involvement schemes, with purpose and meaning groups. Each worker can be trained to do all jobs in the
for staff. group and job rotation can take place. Other forms of job
By fostering an involvement culture, KFFS reduced staff turnover enlargement include job rotation and job loading.
to 34 per cent, increased sales per hour in the next two years by Critics of this method argue that it is simply giving a
worker ‘more of the same’. It is often called the problem of
15 per cent and 23 per cent respectively, and reduced customer
horizontal loading – instead of turning five screws the
complaints by a half. Customer retention rates were also the
worker turns ten. In many businesses today such tasks are
highest for four years.
carried out more effectively by machines, where repetitive
Sources: adapted from www.theworkfoundation.com and tasks can be completed quickly and efficiently without
www.xperthr.co.uk strain, boredom or dissatisfaction. It could even be argued
(a) Explain one reason why consultation was important in the that allowing employees to complete the entire process will
process used by KFFS. reduce efficiency. This is because the fall in productivity from
carrying out many tasks more than offsets any productivity
(b) Explain how staff were empowered at KFFS.
gains from increased worker satisfaction.
(c) Assess the benefits to a business like KFFS of empowerment.

Exam tip
Do not confuse job enlargement with job enrichment. They are
similar, but not the same. Remember that job enrichment ‘vertically’
extends the job by giving an employee greater responsibility. Job
enlargement expands the job ‘horizontally’ by giving an employee
‘more of the same’.

106
 Marketing and people

Case study
PENINSULA BUSINESS The survey found that:
• 91 per cent of staff said that their job did not adversely
SERVICES affect their health
• 86 per cent said that their jobs did not interfere with
Peninsula Business Services provides employment law their home responsibilities
and health and safety services for businesses. Based in • 86 per cent said that they loved their jobs and that their
Manchester, the company employs around 1,000 people in jobs were fun.
the UK, Ireland and Australia. It was established in 1983 Peninsula is also committed to the personal development
and since then has worked with over 28,000 businesses. In of staff. Mentoring and knowledge sharing are
2014 the business generated around £65 million in revenue emphasised. Staff have the opportunity to attend the
and made a profit of around £14.5 million. It also came company’s leadership and development course in the
third in a national survey carried out by the Sunday Times to Lake District. Their career prospects are good, with a high
find the best employers in the UK for 2014. percentage of internal promotions to senior managers.
The survey revealed a number of good employment Some 87 per cent of employees said that the experience
practices used by the business. Every Monday morning and training they are gaining will help to develop their
staff get a free breakfast, which is popular and very much future careers.
appreciated. Also, the survey found that most people in the Sources: adapted from www.peninsulagrouplimited.com
organisation were paid between £15,000 and £35,000 and www.b.co.uk
a year and that 77 per cent of staff were happy with their
remuneration and benefits, despite a pay freeze. Employees
receive incentives, such as trips abroad and bonuses for (a) What is meant by profit-related pay? (2 marks)
attracting new clients. They also get some profit-related (b) Explain one possible drawback of profit-related pay.
earnings. The company pays for monthly social events and a (4 marks)
weekly keep-fit session for staff.
(c) Explain one way in which the use of flexible working
Peninsula Business Services makes use of flexible working at Peninsula Business Services helps to motivate staff.
in its organisation. For example, it offers term-time only (4 marks)
contracts, compressed hours contracts and sabbaticals. It has
also shortened the hours of its telemarketers and human (d) Evaluate the extent to which Peninsula Business Services
resource advisers. meets the needs of employees, as identified by Maslow.
(20 marks)

107
Motivation in theory and practice Unit 17

Key terms Knowledge check

Bonus – a payment in addition to the basic wage for 1. State three reasons why it is important for a business to
reaching targets or in recognition for service. motivate staff.
Commission – percentage payment on a sale made to the 2. What method of pay might Taylor recommend to help
salesperson. motivate staff?
Consultation – listening to the views of employees before
3. What helps to motivate people at work according to Mayo?
making key decisions that affect them.
Delegation – the passing of authority further down the 4. What is meant by self-actualisation needs in Maslow’s
managerial hierarchy. hierarchy of needs?
Empowerment – giving official authority to employees to 5. How might a business meet its workers’ esteem needs?
make decisions and control their own work activities. 6. What is the difference between piece rates and
Hawthorne effect – the idea that workers are motivated by performance-related pay?
recognition given to them as a group. 7. How might profit sharing motivate workers?
Hygiene or maintenance factors (Herzberg’s) – things at 8. State two advantages of flexible working to employees.
work that result in dissatisfaction.
9. Give two advantages of delegation as a means of
Job enlargement – giving an employee more work to do of
motivating staff.
a similar nature; ‘horizontally’ extending their work role.
Job enrichment – giving employees greater responsibility 10. What is the difference between job enrichment and
and recognition by ‘vertically’ extending their work role. job enlargement?
Job rotation – the periodic changing of jobs or tasks. 11. How might job rotation help to motivate staff?
Maslow’s hierarchy of needs – the order of people’s needs 12. State two advantages of job enrichment to a business.
starting with basic human requirements.
Motivated – the desire to take action to achieve a goal.
Motivators (Herzberg’s) – things at work that result
in satisfaction.
Payment by results – payment methods that reward workers
for the quantity and quality of work they produce.
Performance-related pay (PRP) – a payment system
designed for non-manual workers where pay increases are
given if performance targets are met.
Piece rates – a payment system where employees are paid
an agreed rate for every item produced.
Profit sharing – where workers are given a share of the
profits, usually as part of their pay.
Scientific management – a theory that suggests there is a
‘best way’ to perform work tasks.
Self-actualisation – a level in Maslow’s hierarchy where
people realise their full potential.
Teamworking – organising people into working groups that
have a common aim.

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 18 Leadership 1.4.5
Theme 1

Key points
1. The distinction between management and leadership.
2. Types of leadership style: autocratic, paternalistic, democratic and laissez-faire.

Getting started ●● Leaders are often excellent at motivating those around

Pauline Allen worked for a toy manufacturer helping to make them, allowing them to perform at their best. They are
teddy bears and other soft toys. She disliked her job and spent particularly good at motivating others to change both
at least ten hours every week searching for another. The main themselves and the organisation.
problem was her boss. The managing director of the company It could be argued that, in large businesses, leaders devise
was unpopular with everyone. He was rarely to be seen and strategies whilst managers are responsible for implementing
did not know the names of the 21 staff that worked for him. them. However, sometimes leaders do get involved in
In the last 15 weeks Pauline had spoken to him twice. On implementation because they appreciate that it is just as
both occasions he called her Paula and failed to listen to her important to implement change as it is to devise strategies. In
small businesses, leaders often have the skills to both devise
answer after asking a question. All decisions were made by the
and carry out a strategy.
managing director without consultation. Staff turnover at the
company was 86 per cent and the working atmosphere was The characteristics of leaders
oppressive and negative. One approach to finding out what makes good leaders is to
Describe the approach to leadership used by the managing identify the qualities, characteristics or traits that they should
director in this case. Explain why this approach may not be have (see Figure 1). A number of characteristics have been
working. What characteristics might it be useful for leaders to suggested.
have? Does every person have the potential to lead? ●● Effective leaders have a positive self-image, backed up with a

genuine ability and realistic aspirations. This is shown in the

confidence they have. An example in UK industry might be
The distinction between management Richard Branson, in his various pioneering business activities.
and leadership Leaders also appreciate their own strengths and weaknesses.
Management has a number of functions. For example, managers, It is argued that many managers fail to lead because they
according to the management theorist Henri Fayol, should often get bogged down in short-term activity.
predict what will happen in the future, plan to achieve their ●● Leaders need to be able to get to the ‘core’ of a problem and

objectives, organise resources, exercise command over staff have the vision and commitment to suggest radical solutions.
lower down the hierarchy, co-ordinate day-to-day tasks and For example, after working at Apple for a period of time,
monitor how well objectives are being achieved. Peter Drucker, Steve Jobs left in 1985. However, he returned in 1996 to
writing 40 years later, The Practice of Management added to this help recover the company’s successful position. Steve Jobs
list motivating and communicating with staff, and giving them cut the number of Apple development projects from 350 to
training opportunities. 10. He was then responsible for launching the iMac, the iPod,
Some writers make no distinction between management and iTunes and the iPhone. Jobs helped Apple’s shares to rise by
leadership in an organisation. Managers are leaders because of 9,000 per cent.
the roles they play. Others, however, suggest that leaders are
not necessarily the same as managers. Leaders may perform the
same functions as managers. But in addition, they may do some Figure 1
or all of the following. Leadership traits
●● Leaders can be visionaries, understanding where an

organisation is at today and seeing the direction in which an ability to motivate others sense of responsibility and personal integrity
organisation has to change to survive and flourish. change direction when required focus on completing a job
●● Leaders tend to be good at carrying through the process of
solve problems accept responsibility
change. Because they understand the starting point and the
self-confident act decisively
end point, they can chart a route from one to the other. Where
others may see only chaos and think the organisation is taking self-motivated vision
the wrong road, the leader has the ability to see through the
details and small setbacks which are a part of any change.

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Leadership Unit 18

●● Studies of leaders in business suggest that they are experts Autocratic leadership may be needed in certain
in particular fields and well read in everything else. They tend circumstances. For example, in the armed forces there
to be ‘out of the ordinary’, intelligent and articulate. Examples may be a need to move troops quickly and for orders to be
might be Anita Roddick, the founder of Body Shop, or Bill obeyed instantly.
Gates, the founder of Microsoft.
●● Leaders are often creative and innovative. They tend to seek Paternalistic leadership: Paternalistic leaders are
new solutions to problems, make sure that important things similar to autocratic leaders. They make all the decisions
are done and try to improve standards. and expect subordinates to obey these decisions. However,
●● Leaders often have the ability to sense change and can whereas an autocratic leader may be uninterested in the
respond to it. This is dealt with later in this unit. well-being of subordinates, a paternalistic leader places a
great deal of importance on their welfare. In the past there
Leadership styles have been a number of paternalistic leaders, such as Joseph
Successful businesses often have very good leaders. However, Rowntree and George Cadbury. Examples of their concern
the style of leadership adopted by individual leaders may be for employees included the building of new houses which
very different. Some of the most common leadership styles are they could rent at low rates. As with autocratic leaders,
outlined below. paternalistic leaders do not give subordinates control over
decision making.
Autocratic leadership: An autocratic leadership style is one
where the manager sets objectives, allocates tasks and insists Democratic leadership: A democratic leadership style
on obedience. Therefore the group become dependent on him encourages participation in decision making. Democratic
or her. The result of this style is that members of the group are leadership styles can be persuasive or consultative.
often dissatisfied with the leader. This results in little cohesion, ●● Persuasive. This is where a leader has already made a
the need for high levels of supervision, and poor levels of decision, but takes the time to persuade others that it is
motivation amongst employees. a good idea. For example, the owner of a business may

Question 1
Helen Beaumont was appointed CEO of Keymex airlines in guidelines regarding air safety the government grounded all
2008. The airline company was suffering difficulties given the flights. Beaumont felt that the closure was maintained for
success of competitors who were quicker at adapting to market too long and started flying planes before the ban had been
trends. When Helen Beaumont was appointed she identified fully lifted, with no problems. The ban was lifted after this
that slow decision-making was a key reason why this problem and Beaumont proved herself a strong leader, willing to risk
kept occurring. She felt that there were too many levels of her personal reputation.
management and too many people had to discuss and approve
decisions before change could happen. To stop this being an issue, Figure 2
Beaumont took swift action and made 50 people redundant,
Keymex trends for growth 2009 to 2013
removing an entire management layer and placing herself closer
to key people in the organisation’s structure. £ million
Beaumont could be described as an autocratic leader. She 6,000
makes all the key decisions and when she passes these down to 5,000
her management team, she expects them to be implemented
4,000
without any question. Beaumont has many of the traits of a
successful leader – she is ambitious and assertive, and decisive 3,000
and dominant. Furthermore, she is a dynamic leader and is 2,000
popular with her shareholders, if not always with the staff 1,000
members below her. Her popularity with shareholders might be
0
due to how her decisiveness affects the revenue of the company. 2009 2010 2011 2012 2013
Year
Figure 2 shows the substantial increase in revenue growth
trends under Beaumont’s leadership.
In 2011 a cloud of volcanic ash from an erupting volcano (a) Assess the advantages and disadvantages to Keymex of
was heading towards the airline flightpaths. Following employing an autocratic leader.

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 Marketing and people

decide to employ outside staff for certain jobs and persuade Laissez-faire leadership: A laissez-faire leadership style
existing staff that this may ease their work load. is more of a ‘hands-off’ approach to leadership. A laissez-faire
●● Consultative. This is where a leader consults others about leader provides others with the proper tools and resources
their views before making a decision. The decision will take needed, and then backs off. The leader gives little guidance and
into account these views. For example, the views of the direction, and allows others the freedom to make decisions. This
marketing department about whether to launch a new range leadership style can be effective when the group members are
of products may be considered. highly skilled, experienced, motivated and capable of working
Democratic leadership styles need good communication skills. on their own. However, it is not ideal in many situations. This is
The leaders must be able to explain ideas clearly to employees particularly the case if others lack the experience or knowledge
and understand any feedback they receive. It may mean, needed to complete the tasks or make decisions. Also, some
however, that decisions take a long time to be reached as people are not capable at setting their own deadlines or
lengthy consultation can take place. managing their own projects. Some people in the group may
It has been suggested that a democratic style of leadership also lack the motivation needed to get certain tasks done on
can be more effective in business for a number of reasons. time. Such people usually need an ‘extra push’ from the leader.
●● There has been increased public participation in social and As a result deadlines may be missed, which could cost a
political life. Democratic management reflects this trend. business money.
●● Increasing income and educational standards means that

people now expect greater freedom and a better quality of

Exam tip
working life.
You need to show that you appreciate that business leaders may
●● Research suggests that this style is generally more effective.
not necessarily adopt just one of the particular leadership styles
Managers are able to ‘tap into’ the ideas of people with described. Some leaders may have styles that are a mixture or
knowledge and experience. This can lead to better decisions combination of two or more of the styles. For example, it was
being made. often argued that Sir Alex Ferguson (ex Manchester United
●● People involved in the decision-making process are likely manager) was an autocratic leader. However, he demonstrated
to be more committed and motivated, to accept decisions paternalistic tendencies when protecting some of his younger
players from the press, for example.
reached with their help, to trust managers who make the
decisions, and to volunteer new and creative ideas.

Question 2
Warren Buffett is one of the wealthiest individuals in the world. Some people argue that a laissez-faire style of leadership results
In 1964 he was appointed CEO of Berkshire Hathaway, now a US in low levels of productivity. However, in the case of Berkshire
multinational holding company. The company owns businesses Hathaway it was widely reported to have worked well. This might
in a wide range of industrial sectors, such as confectionery, retail, be because Warren Buffett was effective in hiring talented and
railways, home furnishings, vacuum cleaners, jewellery and well-motivated people to run the various businesses. He also gave
newspaper publishing, as well as several regional electric and them complete autonomy and enough resources to enable them
gas utilities. In 2014, the business was worth around $350 billion to meet company objectives. However, if these employees needed
with the share price reaching $200,000 for the first time in guidance or support, Warren was available for consultation. It
August 2014. was also widely reported that laissez-faire leadership worked
Warren Buffett is known internationally as an investment guru well because each business had its own culture, and each person
as a result of his success in buying businesses and watching appointed by Warren understood the way that each particular
them grow. His leadership style is widely reported as laissez- business worked.
faire. He allows subsidiary heads lots of freedom. In his 2009 Source: adapted from www.berkshirehathaway.com
letter to shareholders he said, ‘We tend to let our many (a) Explain the style of leadership used by Warren Buffett.
subsidiaries operate on their own, without our supervising and
(b) Explain one reason why this style of leadership has been
monitoring them to any degree’, and that most managers ‘use
successful at Berkshire Hathaway.
the independence we grant them magnificently, rewarding our
confidence by maintaining an owner-oriented attitude that is (c) Assess the possible benefits to Berkshire Hathaway of this
seldom found in huge organisations.’ style of leadership.

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Leadership Unit 18

Thinking bigger Key terms

The media often suggests that ‘heroic’ leaders are vital to making a
successful business. Such leaders make things happen. They are heroes
Autocratic leadership – a leadership style where a
because they alone have the vision, personality and capability to bring manager makes all the decisions without consultation.
things about in the business, either by themselves or through others. Democratic leadership – a leadership style where
Although not denying that leaders have special qualities, it could be managers allow others to participate in decision making.
argued that focusing too much on leadership can create problems. For Laissez-faire leadership – a leadership style where
example, this approach may lead to the conclusion that a business employees are encouraged to make their own decisions,
without a heroic leader may not be able to function properly. Or it within certain limits.
might suggest that the heroic leader is the most important thing to Paternalistic leadership – a leadership style where the
organisational effectiveness. It also perhaps devalues the role and leader makes decisions but takes into account the welfare
importance of other employees. of employees.
There is evidence to suggest that effective businesses are those which are
more concerned with the creativity of their products and organisational
structures that enable those products to be produced and sold than those Knowledge check
that rely heavily on leadership. It could be argued that the ability to 1. What are the main differences between a leader and
teamwork, delegate and manage others effectively is more important in a manager?
the daily workings of creative organisations than the attributes of heroic
leadership, such as vision, command and personality. 2. State three different leadership traits.
3. Under what circumstances might an autocratic leadership
Mainstream approaches to leadership also take consensus in organisations
for granted, i.e. that employees are generally happy to be at work and style be particularly appropriate?
that leadership is about providing them with the direction to get the 4. Some people argue that Sir Alex Ferguson (ex-manager of
most out of them. Where there is conflict, this is often seen as being Manchester United) had an autocratic leadership style.
related to problems with an individual or about resistance to change. To what extent do you agree with this?
The possibility that there might be underlying conflicts associated with 5. State two disadvantages for a business of an autocratic
inequalities of wealth, status or power between leaders and subordinates leadership style.
is not considered. Critics argue that although businesses may appear to
be consensual, this is because leaders occupy positions in the hierarchy 6. What is the difference between an autocratic leader and a
that enable them to suppress conflict or because subordinates have an paternalistic leader?
understanding that compliance or consent is in their own ‘best’ interests. 7. What is the difference between persuasive and
In other words, the absence of conflict is a consequence of dependence consultative democratic leadership?
- subordinates depend on managers for terms and conditions, including 8. State two disadvantages of democratic leadership.
retaining their jobs, promotion, future employment and references.
9. State the main advantage of laissez-faire leadership.

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 Marketing and people

Case study
ISLIP TRAVEL amounted to £3,300 each for the 50 staff employed by
the company.
After a slow start the fortunes of the company started to
change. Figure 3 shows the profit made from 2007 to 2014.
Ellen led the company with confidence and verve. She had
charm, was well liked by staff and led by example. All key
decisions made by the business were ‘thrashed out’ at
management meetings. In the early days of the ‘buy-out’
some of these meetings were hard work and lasted for
several hours – sometimes a whole day. At the end of the
meetings the four senior managers and Ellen would vote
on new company policies. Most of the votes were carried
unanimously. Ellen also consulted staff and held voluntary
meetings in work time to get their views and ideas. The
Islip Travel organises specialist holidays for the 55+ age new pay system introduced for sales staff was the idea of a
group. The company was the subject of a management sales assistant.
buy-out in 2009 after the previous owners decided to In 2014 the company made a record profit. The new
‘ditch’ the business because of poor financial performance. website was starting to attract an increasing amount of
The management team, led by Ellen Bridges, bought the traffic and bookings made via the website doubled in two
indebted company for £1. It had debts of £1.2 million and years. The marketing agency was also producing good
was struggling due to the economic recession. The previous results – it was expert at placing ads that the target market
owners had run the business very badly. However, the new would see. Finally, as the economy started to grow in 2014,
management team believed that they could manage the consumer confidence improved and the holiday industry in
company much better. They aimed to counter earlier poor general picked up. Demographics were also working in the
marketing decisions, weak leadership and to raise workforce company’s favour. The proportion of people aged over 55 in
motivation levels. the UK is a fast-growing sector.
The management team raised £500,000 privately and
persuaded a venture capitalist to invest a further
£1.5 million for 49 per cent of the company. Ellen Bridges Figure 3
was appointed CEO and some key changes were made. Islip Travel profit after tax 2007 to 2014
The company: £ million
• redesigned its website. It was made more attractive and 1.4
easier to navigate. The site also introduced a review 1.2
system so that clients could describe their experiences and 1.0
0.8
rate the company’s performance 0.6
• carried out some market research to find out which types 0.4
0.2
of holiday were most popular with the 55+ age group 0
and which particular features were most important -0.2
to them -0.4
2007 2008 2009 2010 2011 2012 2013 2014
Year
• outsourced marketing to an agency with particular
experience in the holiday industry
• introduced a new pay system to help motivate sales
staff. The system organised sales people into three teams (a) Explain the style of leadership used by Ellen Bridges.
of eight and awarded a monthly team bonus linked (4 marks)
to monthly sales. If teams performed well, each team
member could earn up to an extra £1,000 per month on (b) Explain one benefit to Islip Travel of this style of
top of their basic pay of £15,000 per annum. leadership. (4 marks)
• introduced an annual profit-related bonus for all staff, (c) Assess the extent to which Ellen’s leadership style
which was paid just before Christmas. In 2014 this contributed to the recovery of Islip Travel. (12 marks)

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 19 Role of an entrepreneur 1.5.1
Theme 1

Key points
1. Creating and setting up a business.
2. Running and expanding/developing a business.
3. Innovation within a business (intrapreneurship).
4. Barriers to entrepreneurship.
5. Anticipating risk and uncertainty in the business environment.

Entrepreneurs are risk takers. This is because they risk losing

Getting started ●●

any money they put into the business if it fails. However, if the
Sophie Helston worked for a large US film producer for ten business is successful they will be rewarded with profit. The
years as a make-up artist. In 2011 she moved to England and risks faced by entrepreneurs are discussed below.
immediately wanted to set up her own business. She considered
Risks and rewards for entrepreneurs: In 2013 over
starting a health farm, but thought that such an enterprise would
500,000 businesses were set up. However, less than half of
cost too much to set up. After doing some market research,
these were predicted to survive beyond five years. Starting
talking to a number of business people, and undertaking a great up a new business offers the potential for high rewards. Some
deal of planning, Sophie opened an ‘up-market’ beauty parlour entrepreneurs, like Richard Branson, have become rich through
in Manchester. She invested £20,000 of her own money and developing their own businesses. Starting a new business also
provided services such as facials, waxing, skin treatments, hair- offers a chance for many people to do something different.
styling, make-up and pedicures. The business was a success and If nothing else, it means working for yourself rather than for
by 2014 she employed 16 staff. The business was turning over someone else.
£1.8 million per annum. Sophie now plans to develop a chain of However, being an entrepreneur is risky. The downside of
beauty parlours in the north west of England. success is business failure. If the business fails, it may leave
State four tasks that Sophie might have carried out before debts to be paid off. The entrepreneur might have borrowed
setting up her business. What resources might Sophie money to start the business or to finance growth. Getting
have needed before setting up her business? What role do back into a normal job may also be difficult, especially if the
entrepreneurs like Sophie play in their businesses? How might entrepreneur left a well-paid job in the first place. The risk of
failure is a major motivator for entrepreneurs to carry on and
Sophie’s role change if she starts to develop a chain of parlours?
make a success of their enterprise even when the going is tough.
Success and failure have an opportunity cost. The
Creating and setting up a business opportunity cost of an activity is the benefits lost from the next
best alternative. For example, an entrepreneur who has just
The role of entrepreneurs: Entrepreneurs are people who started up a business might have left a job earning £40,000
have a business idea and want to make money working for a year. Part of the opportunity cost of setting up the business
themselves. They are the owners of a business and without would then be the benefits gained from earning £40,000
them the business would not exist. The roles played by a year. They would only be part of the opportunity cost
entrepreneurs in business are summarised below. because the job would probably have had other benefits too,
●● Entrepreneurs are innovators because they try to make
including the satisfaction from doing the job. For a successful
money out of a business idea. Such ideas might come from entrepreneur, the opportunity cost of being an entrepreneur is
spotting a gap in the market, a new invention or market likely to be lower than the benefits of owning a business. For
research. However, many people set up a business by an unsuccessful entrepreneur, the opportunity cost is likely to
copying or adapting what another business does. Business be higher. This is why the unsuccessful entrepreneur is likely to
ideas are discussed below. close the business and move on to something else.
●● Entrepreneurs are responsible for organising other factors

of production. They buy or hire resources, such as materials, Entrepreneurs and business ideas: Each year, hundreds
labour and equipment. These resources are used to make of thousands of people set themselves up in business. Instead
or deliver products. Organising involves giving instructions, of working for someone else, they become the owner. Or, they
making arrangements and setting up systems. move from owning one business to owning another business. If
●● Since entrepreneurs are the owners they have to make all they are successful, they may start to own and set up a string of
the key decisions. They may make decisions on how to raise businesses. But how do most would-be entrepreneurs (those
finance, product design, choice of production method, prices, who risk their own capital in setting up and running a business)
recruitment and wages. find a business idea? There are a number of ways.

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 Marketing and people

Business experience. For most people starting a small

business, the business idea comes from their existing job.
Figure 1
A plumber might work for a plumbing company and decide Stages in setting up a business
to set up on her own. A marketing consultant working for an
advertising agency sets up his own marketing agency. This IDEA
is likely to be the most risk-free way of setting up a business
because the would-be entrepreneur already has knowledge of RESEARCH
the market.
PLANNING

Personal experience. Some people draw on their personal FINANCING

experience outside of work to find a business idea. Some
turn a hobby into a job. An amateur cyclist might buy a cycle LOCATION
shop. A keen gardener might set up a nursery. Some use their
customer experience to spot a gap in the market. A mother RESOURCES
might find it difficult to find a baby product and so set up a
business to provide it. LAUNCH

Skills. Some entrepreneurs draw on their broad skills base

to start a business. A person with an administration job might
judge that they have good ‘people skills’ and decide to set ●● Location. The location an entrepreneur chooses will depend on
up a business in selling. A plumber might judge that in his the nature of the business. Some people, such as tradespeople
area electricians can charge more for their work. So he or tutors, offer services to the local area. Others work from
gets training as an electrician and sets himself up as a self- home and yet offer services nationally, such as website
employed electrician. designers. Restaurants and shops may be located close to their
target-market customers. Manufacturers will have to decide
Lifestyle choices. Some business areas attract people who whether their factories will be close to business customers and
want to make a lifestyle change. They might want to move to suppliers, or whether they will transport their products. Certain
the country and invest in a small holding. They might always types of business activity may need planning permission. For
have wanted to run a pub and so buy a pub. Or they might be example, to change the use of a building from a computer
retiring from a full-time job but still want to carry on working repair shop to a fast-food takeaway is likely to need planning
on their own. So they invest in a seasonal bed and breakfast permission. This could take many months to obtain.
(B&B) business. ●● Resources. The business plan will contain a list of the
resources needed to set up and run the business. For
Stages in setting up a business: The way an entrepreneur example, a dentist will need suitable premises, furniture,
goes about setting up a business is important. It needs to be specialist dental equipment, a computer, uniforms, protective
carried out in a methodical way and carefully planned. The gear, and so on. Adverts might have to be placed to attract
future success of a business might depend on the quality of workers. Entrepreneurs will also have to find suppliers of
work undertaken during the setting-up process. One approach materials, utilities and other day-to-day resources.
to setting up a business is summarised in Figure 1. ●● Launch. This is an exciting time for an entrepreneur. It is when
●● Idea. A business cannot start without an entrepreneur the business first starts trading. Some entrepreneurs organise
having a business idea. The sources of ideas are discussed an opening event. For example, a new restaurant might have a
above. special opening night where guests are invited for a free meal.
●● Research. The viability of a business idea has to be Special launches like this are designed to create good public
researched. This might involve carrying out market research relations (PR) with customers, so that people become aware of
and analysing the competition to decide whether the idea is the new enterprise. Some entrepreneurs ‘ease’ themselves into
likely to work. Other research might involve meeting people, their new business life by retaining their jobs for a while until
such as bankers and business people, to get advice on the business gets established.
setting up and running a business. It may also be possible
to attend a course designed for new entrepreneurs. Although the information above suggests that setting up a
●● Planning. Planning is a very important stage in setting up a business in an organised and methodical way will help to reduce
business. Business planning is discussed in Unit 29. the risk of failure, some entrepreneurs may bypass many of
●● Financing. Entrepreneurs will provide some of the money these stages and set up anyway. Such people, driven by an
needed to set up a business. Finance may also be needed entrepreneurial spirit, just cannot wait to try out their business
when the business is ‘up and running’. Entrepreneurs have idea. They run their businesses in an instinctive and responsive
to decide how much finance they will need and which way, some may say by ‘flying by the seat of their pants’. It is
sources they will use to obtain this. Sources of finance are possible that they might succeed – and many do. However, others
discussed in Units 26 and 27. would argue that ‘failing to plan is planning to fail’.

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Role of an entrepreneur Unit 19

Running and expanding/developing a health and safety issues in the factory, and ensure that
production levels match orders.
business It is clear that once the hard work of setting up a business
After the launch, entrepreneurs become immersed in the day- has been done, it does not get any easier. The pressure on
to-day running of the business. For many this involves working entrepreneurs can be considerable, and because their livelihoods
in production or delivering a particular service. For example, depend on its success, running a business can be stressful. It is
someone opening a hair salon will be cutting customers’ hair, and reckoned that more than half of new businesses fail within five
someone setting up a microbrewery will be busy brewing beer. years. However, some businesses survive and become established.
However, running a business requires owners to undertake a range If entrepreneurs develop and expand their businesses, their role is
of other tasks that are crucial to the success of the business. As likely to change. They are less likely to be involved in production
the business expands and develops, more and more time will be and spend more of their time addressing issues related to
spent attending to these ‘functional’ business activities. marketing, finance, administration, and so on. Eventually, when
●● Financial management. The business needs enough money
it becomes cost-effective, an entrepreneur is likely to organise
to fund its operations. This might require producing cash-flow the business into departments and employ specialists to handle
forecasts, arranging loans and overdrafts, making payments, marketing, finance, human resources, etc. The business owner will
chasing debts and monitoring cash movements into and out probably take on the role of leader in the organisation. This change
of the business. in role from entrepreneur to leader is discussed in Unit 25.
●● Administration. This usually involves accurate record

keeping. For example, a business must record all of its

transactions so that profit and tax liabilities can be calculated.
It may be necessary to send out invoices, keep stock records,
process wage slips, deal with the tax authorities and comply
with legislation. If an entrepreneur sets up a limited company
there will be other administrative duties to perform.
●● Marketing. Initially, depending on the nature of the business,

marketing might involve obtaining a Yellow Pages or online

business listing, developing an attractive website, using an
email campaign, distributing leaflets, placing advertisements
in a newspaper, organising promotions or giving special
offers. It will also involve developing relationships with
customers. However, as the business develops there may be
a need to carry out more market research, investigate new
distribution channels, raise the profile of the business by using
social media and invest in some sophisticated promotions.
Investment in marketing may be necessary to retain market
share, launch new products and penetrate new markets.
●● Purchasing. Businesses will have to buy resources all the

time. They may also have to buy in commercial services, such

as cleaning, printing and accountancy. Entrepreneurs need to
get the best quality resources at the lowest possible price.
Many business owners will develop relationships with their
suppliers. However, it will also be important to explore new
opportunities in the supply chain. Purchasing may require
entrepreneurs to develop negotiating skills so that they can One example of a new business that expanded and developed
reduce their costs. successfully is OneMinuteLondon.com. This business was
●● Managing people. Some entrepreneurs run their businesses launched in 2013 by Nelson Sivalingam, a film and video
independently without the help of others. However, if a production specialist. It provides an online guide to eating and
business is successful it will probably need staff to help out. drinking in London. Before making a booking, or prior to turning
This will involve spending time on recruitment, selection up at a venue, people can watch a one-minute video clip of
and training. Entrepreneurs may need to develop skills in places under their consideration using their mobile phones or
managing people and motivating staff. other internet devices. Some high-profile venues, such as Buddha
●● Production. In manufacturing and construction, the Bar, Hix, Hyatt Group and Be At One, signed up to the platform
production process is an important business function. For and saw it as a way of converting visitors into bookings. The
example, an entrepreneur setting up a small factory to make site was generating over 1,500 bookings a month in 2013/14.
soft drinks will need to organise the various manufacturing OneMinuteLondon.com attracted attention from The Guardian and
processes, from mixing raw materials to bottling and the Evening Standard which generated some positive publicity.
packaging products for distribution. The entrepreneur will The business planned to raise more finance, diversify into hotels
need to monitor product quality and consistency, consider and experiences, and expand into two other major cities.

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 Marketing and people

Question 1 Intrapreneurship
Entrepreneurs are business owners and risk their own
Right Formula is a London-based sports marketing agency. personal finances when developing a business idea.
It deals with clients who want their businesses and products Intrapreneurs are employees, usually in large businesses,
associated with Formula One racing. They organise promotions, who use entrepreneurial skills to find and develop initiatives
hospitality and events, and business-to-business opportunities that will have financial benefits for their companies. These
for customers who have included Hilton, BlackBerry and might be new products, services or systems. However, unlike
Sky Sports. For example, Right Formula might organise an entrepreneurs, intrapreneurs carry no financial risk. If their
exclusive, intimate VIP hospitality event as part of a grandstand initiatives fail, the employer shoulders the financial burden.
programme for a client. A package might include catering, Some businesses encourage the spirit of
grandstand seating, VIP transportation, arranging driver entrepreneurship through the whole of the organisation. It
appearances, access to show-cars and simulators, driving is embedded in their culture. Examples of businesses that
experiences and the organisation of merchandise and gifts. adopt this approach include Google, Apple and Zappos.
Such companies believe that entrepreneurial spirit helps a
The business was set up in 2009 by Robin Fenwick. Since then
company to grow and evolve rather than become stale
Right Formula has grown quickly and in 2013 turnover was
and stagnate.
£5.7 million with 20 staff employed. In 2014 the business Intrapreneurs are usually employed in product
featured in the Sunday Times Virgin Fast Track 100 companies development. The advantages of employing intrapreneurial
as the sixth fastest-growing company in the UK. Before setting staff include the following.
up Right Formula, Fenwick was employed by Sky Sports, ●● Intrapreneurs can drive innovation in a business and
marketing agency Octagon, McLaren and then Hilton Hotels, uncover new commercial opportunities. This can help a
where he was in charge of sports marketing. A few years later business gain a competitive edge and increase profits
Hilton was bought out and Fenwick decided to set up his own significantly. In some cases the discoveries and inventions
business, with Hilton immediately prepared to become his made by intrapreneurs can have a huge positive impact
first client. on a business.
●● It is a means of satisfying the self-actualisation needs
The business went from strength to strength. In an interview
in 2013 Fenwick reported a really busy year where they had of employees. Self-actualisation is the highest level of
to increase the number of staff quite quickly but still maintain need, according to Maslow’s hierarchy of needs. If staff
quality. Fenwick suggested it was a challenge that a lot of small adopt this role they are being given the opportunity to
be creative and reach their full potential. This will help to
businesses go through when they grow quite quickly. They need
motivate staff and hopefully raise their productivity.
to manage the growth effectively, especially in an industry like
●● A number of awards can be won by businesses if
Formula One where reputation is everything. He couldn’t take
they develop unique or ground-breaking products.
on too much and then let down the clients already on their
For example, the Queen’s Award for Enterprise, which
books. Despite the glamorous image of Formula 1, Fenwick has three categories, including one for innovation, is
acknowledged that long working hours were required to be awarded each year for outstanding achievements by UK
successful in business. businesses. These awards are prestigious and can help
Source: adapted from www.rightformula.com to enhance the image of a business. Receiving one of
these awards can also attract free PR which will help to
(a) Explain the role of an entrepreneur using examples from
promote the business.
this case.
●● Individuals benefit by getting the opportunity to
(b) Explain one way in which Robin’s role might have changed experiment and be creative without having to meet the
between 2009 and 2014. cost of failure. This should improve their job satisfaction
and help them develop entrepreneurial skills which they
might use in the future – perhaps by setting up their
Exam tip own business.
Becoming an entrepreneur is very challenging. It requires a person
to take a financial risk and the chances of success may not be Barriers to entrepreneurship
good. Entrepreneurs also have to be multi-talented and work very Many would argue that it is important for an economy to
hard indeed. The majority of people may not be ‘cut out’ to set encourage entrepreneurship. This is because businesses
up and run businesses. However, entrepreneurs perform a very
are the main source of income, employment and wealth
important role in the economy and consequently should be
encouraged. These are important factors to consider when
for a country. However, despite this, a number of barriers
evaluating the impact on entrepreneurs of running their own exist that discourage many would-be-entrepreneurs from
business, for example. getting started.

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Role of an entrepreneur Unit 19

Question 2 Lack of finance: Some people with a good business idea do

not start trading because they cannot attract the necessary
finance. The main problem is that the providers of capital and
loans may be reluctant to lend money to entrepreneurs. This is
because the failure rate can be high for new businesses and
financial institutions cannot afford to lose money. In 2012 around
400,000 new businesses were set up but 20 per cent failed in
the first year. A further 50 per cent were not expected to survive
for three years. The inability to get finance is one of the main
barriers to entrepreneurship.

Lack of entrepreneurial capacity: To be successful in

business people have to be equipped with the necessary
entrepreneurial skills and characteristics. Running a business
requires a multitude of talents and skills, and needs considerable
energy and commitment. These are discussed in Unit 20. Many
people lack the entrepreneurial capacity needed and therefore
fewer businesses are set up. However, this may not prevent
some people trying. Although some make a success of it,
perhaps by learning from their mistakes, they may be a very
small minority.

Becoming an employer: Employing a person for the first time

Richard Branson’s business, Virgin, is an example of a business is quite a big step in the development of a business. Employers
that employs intrapreneurs. Branson suggests that the growth have responsibilities to their employees. For example:
of a business requires a number of intrapreneurs who drive new ●● employees have to be paid a regular wage
projects and explore new and unexpected directions for business ●● employees may be entitled to sick pay and other benefits
development. Virgin would never have grown into a diverse ●● health and safety issues have to be considered
group of over 200 companies without employing intrapreneurs. ●● employers have to pay National Insurance contributions

For example, Branson reports that when Virgin Atlantic could ●● new employees may have to be trained, which is

not find a supplier able to meet the design specifications for a expensive.
seat in its upper class cabins, a young in-house designer, Joe It is these responsibilities that often discourage employment and
Ferry, volunteered to take on the project. He came up with the therefore prevent business development. Employees may also
designs for the herringbone-configured private sleeper suites. turn out to be unreliable and possibly damage the reputation
This inspired piece of creativity gave Virgin a competitive of the business. Becoming an employer may be an unattractive
advantage in the market and improved the comfort of millions proposition for some entrepreneurs.
of passengers.
Legal barriers (red tape): Bureaucratic ‘red tape’ can
When Virgin ventures into new markets, it has a policy of discourage potential entrepreneurs. Legislation and other
recruiting the best managers possible and giving them the regulations can be demanding – complying with legislation
freedom to set up their own ventures within the Virgin Group. relating to employment, the environment, consumers, corporate
Examples include Tom Alexander in the UK and Andrew Black governance, health and safety, taxation, property rights and
in Canada. Their appointment and subsequent freedom of competition costs money and diverts an entrepreneur’s focus
operation has led Virgin companies in new and unexpected away from what is important to them – i.e. running the business
directions. Branson suggests that the greatest thing about this and ‘making money’. This can be a big barrier to entrepreneurship.
form of enabled intrapreneurship is that everyone can become
so immersed in what they’re doing that they don’t feel like they Lack of ideas: Some people would like to run their own
are working for someone else as employees. They feel like they business, but do not have any original ideas. A lot of markets
own their companies. are saturated or so competitive that the potential for profit is
limited. It is possible to take out a franchise or reflect the ideas
(a) What is the difference between an entrepreneur and an
of others. However, for many people this does not reflect the
intrapreneur?
‘spirit’ of enterprise.
(b) Explain one advantage to a company like Virgin of employing
intrapreneurs. Fear of failure: The failure rate for business start-ups can be
high. Many new entrepreneurs may not realise that statistically
their chances of success may be quite low. However, many do

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 Marketing and people

recognise that failure is a possibility and a fear of failure stops Finally, entrepreneurs usually know that if they take more
them from starting an enterprise. In many cultures failure has risk, the rewards could be greater – however, so could the
very negative associations and is best avoided if possible. losses. For example, a business might decide to export
products. In overseas markets where these products might
Aversion to risk: Entrepreneurs have to take risk. But many be completely new, sales, revenues and profits could be very
people are risk averse and are not inclined to undertake high. However, different countries have different cultures,
activities where the outcome is uncertain. This is a psychological tastes and preferences. As a result, a product that was
barrier to enterprise and one that is difficult to overcome. It is successful in the domestic market may be a ‘flop’ overseas.
hard to encourage a person to ‘take a gamble’ if they are not Such a failed venture could be very expensive.
that way inclined.
Anticipating uncertainty: Dealing with uncertainty is
Corrupt and unsupportive environment: Some countries more of a problem for entrepreneurs as they have no control
may have an unsupportive business environment. This might be over the nature or timing of some events. For example, the
because they are politically unstable, have contract and property outcome of an election might lead to uncertainty about future
laws that may be unclear, enforce regulations inconsistently or policies, such as the status of the UK’s membership of the
may be impacted by corruption and bribery. In these countries, EU. Many businesses feel that not belonging to the EU could
some regulators and inspectors might act as predators. This be a disaster, and that any uncertainty of status with the EU
means that entrepreneurs might have to develop friendly ties could cause businesses to postpone investment in projects.
with government officials and bureaucrats to ‘smooth the way’ There is nothing that businesses can do to prevent
for their businesses to operate. uncertain events from happening, but they may be able to
make some preparations to deal with their consequences,
Anticipating risk and uncertainty in the should they occur. For example, they may set aside
business environment contingency funds to deal with unexpected events.
In Unit 1 it was explained that businesses have to deal with Entrepreneurs might also use methods such as PESTLE
both risk and uncertainty. The key difference between the two analysis, SWOT analysis, risk assessment and scenario
is that entrepreneurs have some control over risk. They make planning to help reduce uncertainty, prepare for unexpected
a conscious decision to take a risk and to a certain extent they events and improve the quality of decision making.
can choose the levels of risk they take. In contrast, although it
is known that uncertain events might occur, their timing is often
impossible to predict. For example, no one can predict when an Key terms
earthquake might occur. Also, the impact on businesses of some Entrepreneurs – individuals who, typically, set up and run a
uncertain events can be devastating. Arguably, dealing with business and take the risks associated with this.
uncertainty is more challenging than dealing with risk. Intrapreneurs – employees who use entrepreneurial skills,
without having to risk their own money, to find and develop
Anticipating risk: Entrepreneurs understand the nature of initiatives that will have financial benefits for their employer.
risk right from the point when they first set up a business. For
example, a significant number of entrepreneurs have probably
sacrificed secure employment with a regular income to start
Knowledge check
their businesses. Also, most of them will have used some of their
own money for start-up capital. Entrepreneurs know that if their 1. Entrepreneurs are innovators. What does this mean?
business fails, they could lose their investment and they may 2. What risks might an entrepreneur take in addition to putting
not find another job easily. Even if entrepreneurs are successful, personal money into a business start-up?
they are likely to take further risks in the future. For example, a 3. Describe the possible stages that need to be completed
business may grant trade credit to a new customer for a highly when setting up a business.
lucrative order. However, there is a risk that the customer might
4. How important is the planning stage when starting a
not pay once the order has been delivered.
Entrepreneurs can take measures to reduce the amount
new business?
of risk they take. For example, before launching a brand new 5. What is meant by financial management?
product nationally, they could test it out in a smaller market. In 6. State three benefits to a business of employing
the above example, before granting trade credit a business can intrapreneurs.
undertake a credit search to check the creditworthiness of a 7. What is meant by risk aversion?
new customer. Entrepreneurs can also deal with risk by using 8. State three other possible barriers to entrepreneurship.
quantitative techniques, such as decision trees, when making
important decisions. Using quantitative techniques often helps
to quantify the possible outcomes of actions, which makes them
easier to evaluate.

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Role of an entrepreneur Unit 19

Case study
Piotr Santos

Piotr Santos came to the UK from Poland in 2006. He was a the searching. Eventually he found some suitable premises
qualified chef and wanted to open his own Polish restaurant in a part of the city popular with the Polish community.
in Liverpool city centre. He had recently spent four months in It was also on a bus route popular with Polish people
his spare time researching the business idea. Two important going into town. He left his full-time job and spent two
pieces of information had come to light. There were around months preparing for his restaurant launch. He employed
10,000 Poles living in Merseyside and there was no an assistant chef to help him out in the kitchen, a general
uniquely Polish restaurant currently operating in Liverpool. kitchen assistant and two waiting staff. On the opening
This suggested that there was a chance his business idea night he invited 100 people who paid £5 each for a
was viable. After collecting questionnaires from 250 people five-course meal (drinks not included). It was a resounding
the results were encouraging. However, there was a snag. success. After 12 months of trading Piotr had made
The cost of setting up the restaurant was going to be far £48,000 profit. What surprised Piotr most of all was
more than he had imagined. Piotr had saved up £12,000 the number of non-Polish customers that used the
but needed a total of £20,000 to fund the start-up. restaurant regularly.
Piotr was not discouraged. He wrote a detailed business In 2013 he opened a second restaurant in Manchester
plan, attended a local business course funded by the and started to dream of a restaurant chain – ‘PIOTR’.
Liverpool and Sefton Chambers of Commerce and made This was also a success and in 2014 he opened two
appointments with four different banks to discuss funding. more restaurants, another in Manchester and one in
Unfortunately his meetings with banks were fruitless. Leeds. By the end of 2014 Piotr was spending most of his
None of them was interested in lending him the £8,000 time on financial management, marketing and business
he needed to start a business. He approached the Polish development. Each of his four restaurants had their own
community to see if anyone would be interested in making manager and three more openings were in the ‘pipeline’.
a private loan. He had one offer of £5,000 but the person
wanted a 50 per cent share of the business and also insisted
that Piotr employed two of his daughters in the restaurant. (a) Explain one risk that Piotr has taken in this case.
Piotr could not accept these terms and was on the verge (4 marks)
of ‘throwing in the towel’ when a friend mentioned (b) Explain one factor that could have affected where Piotr
peer-to-peer funding. This involves getting a loan from decided to locate the restaurant when setting up his
unrelated individuals online via a specialist website. If business. (4 marks)
people are interested they can lend money in return for (c) Explain one barrier to entrepreneurship that almost
interest. Within two months of making the application prevented Piotr from setting up his business. (4 marks)
Piotr had raised the money needed.
(d) Assess the impact on Piotr’s role in the business as it
Piotr spent a lot of time finding a suitable location for the started to expand. (12 marks)
restaurant. He felt it was vital to find exactly the right place.
He contacted 12 estate agents and got them to help with

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 20 Entrepreneurial motives 1.5.2
Theme 1
and characteristics
Key points
1. Characteristics and skills required.
2. Reasons why people set up in businesses: financial motives like profit maximisation and profit satisficing.
3. Reasons why people set up in businesses: non-financial motives like ethical stance, social
entrepreneurship, independence and home working.

Getting started They can influence those events and turn them into something
Suzi Trebowic left the hospital where she worked because she which will benefit their business.
felt overworked and unappreciated. She was employed as a
radiographer for 22 years. She now wants a complete change Being a self-starter: Many people work best when being
and plans to start her own business. Her passion is health food. told what to do. But to be a successful entrepreneur, you
She enjoys cooking exciting meals on a very small budget. She have to be a self-starter. Entrepreneurs are able to work
plans to set up a website showing how people can eat well and independently and can take decisions. They have their own
lose weight on a very small budget. She believes that if she ideas about how things should be done and they are able to
develop those ideas.
can generate enough website traffic she can earn revenue from
selling advertising space. At work Suzi was quiet, conscientious,
Judgement: The business environment is changing all the
and good at following instructions. However, although she was a
time. A successful entrepreneur is one who is taking in
proficient radiographer, she lacked drive and self-confidence, and
information and listening to advice. At the same time, they are
did not seek promotion like most of her colleagues. able to see where the business might go in the future and
State three skills that might be needed to run an online what they want out of the business. This helps them to make
business. State three characteristics that might be needed to judgements and decisions.
be a successful entrepreneur. Do you think Suzi might be a
successful entrepreneur? What might be Suzi’s motive for Commitment: Many people think when starting up a business
setting up a business? that it is going to be easier than working for someone else.
All the evidence shows that entrepreneurs work longer hours
than those with a normal job. Running your own business can
Characteristics of entrepreneurs sometimes be more stressful because of the risks that are
Starting your own business is very common. Hundreds of always present. So successful entrepreneurs are ones who are
thousands of small businesses are started each year. People committed to what they do.
give up their jobs to work for themselves or they start a new
business alongside a normal full-time job. Not everyone is suited Perseverance: All businesses have successes and failures.
to becoming an entrepreneur, either because they lack the There is always an element of risk that their business could
skills needed or because they don’t want to cope with the risk perform poorly or even fail. Therefore, successful entrepreneurs
involved in setting up a business. Business Link, a government have to show perseverance. They have to be able to get through
agency that encouraged business start-ups, identified seven the bad times and the setbacks.
characteristics of successful entrepreneurs.
Initiative: Successful entrepreneurs are able to take the
Self-confidence: Successful entrepreneurs are people who initiative in situations. They don’t allow events to overwhelm
believe that they are going to succeed. They think they have them by doing nothing. They are able to change and
a winning formula for their business. They can persuade be proactive.
other people, for example, to buy the product or help finance
the business. Not every successful entrepreneur has all of these
characteristics. Few entrepreneurs are strong in every area. But
Self-determination: Successful entrepreneurs are ones who people who run their own businesses tend to show different
think they can take control of events going on around them. characteristics from people who work for someone else.

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Entrepreneurial motives and characteristics Unit 20

One example of an entrepreneur is 26-year-old Pippa

Question 1
Murray. In 2014, she set up a business called Pip & Nut, which
produces a range of nut butters that are sold in capsules. Grant Travers left school at the age of 16. He obtained C grades
Flavours include peanut, almond, and almond and coconut. in 3 GCSEs – Maths, English and French. However, he did not
The idea came to her as a result of her interest in running. really enjoy school because the education system, he felt, did not
She saw the potential of products which were high in protein. meet his needs and he was never really interested in schoolwork.
Grant was very sporty, creative and enjoyed organising events,
such as discos and sports tournaments. When he turned 16 he
started organising transport from Plymouth, his home town,
to Plymouth Argyle away football fixtures. He booked a coach
with a local coach company and sold tickets to friends at school
and others near where he lived. He organised 11 trips between
December and May. His main motive for this venture was to
provide affordable transport to away matches for him and
his friends. However, he made an average profit of £100 per
trip. Grant is now in the process of setting up his own travel
company. His final school reference, written by the Head of Year,
is shown in Figure 1 (written in May before exam results were
published in August).

Figure 1
She started out in her kitchen and spent the whole of 2013
Grant Travers – school reference
experimenting with different flavours and testing them at
Maltby Market in London. Pippa then started production in a
commercial kitchen in London’s Royal Park, which provides
facilities for new businesses in the food industry. Most of her Grant Travers
start-up capital came from small loans from family and friends, Grant is a charming young man. He is loyal, honest, open and friendly. However,
with a further contribution from a government-backed scheme his five years spent at The Plymouth Academy have been somewhat wasted –
for business start-ups. although he will probably ‘scrape through’ with C grades in Maths and English.
Grant had plenty of ability but was not motivated to reach his full academic
Like many entrepreneurs, Pippa took a risk by leaving paid potential. It is regretful that he has chosen to leave and not enrol on one of the
employment to start the business. She worked as a producer academy’s vocational courses, to which he might be better suited.
at the Science Museum. However, she won a competition
To his credit, outside the classroom Grant excelled. He was the captain of the
called ‘Escape The City’, which helped people to leave jobs
school football team for five consecutive years and led his team to win the
they found unfulfilling. To help save money for the business South West Schools Cup in his final year. He also organised discos and other
she moved into a shed. This was to be her home for a few events, working alongside academy staff. He was well liked by everyone.
months while she launched Pip & Nut. Pippa said in a report He is full of self-confidence, shows initiative and when interested can be
extremely determined.
in The Telegraph, ‘Escape The City enabled me to quit my day
job… I needed it to pay my rent but I really wanted to give the I’m not sure what will become of Grant. He says that he is going to start his
business more time. Now, I sleep in the shed and there’s a own business. A little ambitious perhaps for a sixteen-year-old – but it wouldn’t
surprise me at all if he made a great success of it.
desk space in their Battersea headquarters.’ Pippa’s products
went on sale in Selfridges. Good luck, Grant!

Skills required by entrepreneurs

Not only do entrepreneurs need to possess a number of
important characteristics to be successful, they also need
to use a wide range of different skills. To begin with it helps Elizabeth Welland (Head of Year)
if entrepreneurs are capable to some extent in their chosen
line of business. For example, an entrepreneur setting up a
flying school will need aviation experience and an instructor’s (a) Discuss whether Grant has the characteristics to become an
certificate. Someone starting a commercial radio station may entrepreneur.
need some broadcasting, transmitting and programming
experience.
However, it is possible to set up a business in unfamiliar experience. For example, Sir Stelios Haji-Ioannou set up easyJet
fields. For example, the skills needed in retailing, window after being involved in his father’s shipping business. It is
cleaning and running an online sales operation can be learnt possible to do this by employing experts in the chosen field right
fairly quickly. There are also examples of entrepreneurs from the start. Other important entrepreneurial skills are outlined
entering quite diversified lines of business without any relevant on the next page.

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 Marketing and people

Organising: Entrepreneurs play an important organisational Negotiating: Inevitably entrepreneurs will spend some of
role. They have to project manage the setting up and running their time negotiating. This often means agreeing the terms of a
of their business ventures. This involves organising and contract, such as agreeing a price for undertaking some work or
co-ordinating a wide range of resources in order to get completing an order for a customer. However, negotiation might
the business up and running. In this organisational role, also be needed when dealing with suppliers and employees.
entrepreneurs will be planning, scheduling, giving instructions, Entrepreneurs need to be able to get their points across in a
prioritising, setting up systems, monitoring, time managing calm and assertive manner, develop arguments with reasoning,
and meeting deadlines. If things go wrong, entrepreneurs will know when to compromise, and try to arrive at a settlement that
sometimes be ‘fire-fighting’, that is resolving conflict, dealing is agreeable to both parties.
with business issues and sorting out problems.
IT skills: Entrepreneurs will be able to run their business more
Financial management: This is a very important skill and efficiently if they have good IT skills. For example, they might
if it is neglected can lead to the demise of the business. The need to:
main aim of financial management is to make sure that the ●● set up filing systems for business documents and other

business has enough money whenever it is needed. This information

might involve budgeting, cash-flow forecasting, chasing debts, ●● communicate with stakeholders using email or conference

keeping up-to-date financial records, arranging loans and calling

overdrafts, and analysing financial information (in business ●● use spreadsheets to prepare budgets and cash-flow forecasts

accounts, for example). ●● design documents, such as invoices, order forms, job

descriptions, expense claim forms, flyers and newsletters

Communication: Entrepreneurs will need to interact with ●● set up a business website and provide a system for online

a wide range of different stakeholders. These might include purchases

customers, employees, suppliers, the local community and the ●● use social media to help raise the profile of the business and

authorities. Entrepreneurs will need to develop effective face-to- direct potential customers to the business website
face communication skills to deal directly with people. Charm, ●● use computer software to give presentations

courtesy, assertiveness, professionalism and a convincing ●● use specialist software, for designing products, for example.

manner are all useful entrepreneurial attributes. Entrepreneurs

might also be required to write letters, memos and reports, fill in Exam tip
forms and design documents for both internal and external use. Be careful not to confuse the characteristics of an entrepreneur
Presentational skills might also be needed – when making a sales with the skills required to be an entrepreneur. Most of the
pitch, for example. If entrepreneurs have good communication characteristics may be inherent – ‘you either have them or you
skills, their businesses are likely to perform better. don’t’, although some might argue that they could be acquired
over time. In contrast, most of the skills needed can be learned
either by experience – ‘learning by doing’ – or through education
Managing people: As a business grows there will be a need and training. It is possible, for instance, to attend specialist
to take on more staff. It is often said that managing people training courses where many skills required by entrepreneurs can
is one of the most difficult tasks when running a business. be learned and practised. For example, most local councils provide
Individuals are all different and may require different approaches courses for people who want to set up and run a business.
to motivation. Entrepreneurs need to recruit the ‘right people’
in the first place and then show clear leadership and direction.
People should be easier to manage if their needs are met, and if Reasons why people set up businesses
they are treated with respect and valued. People set up businesses for a wide range of reasons. For
example, they may not want to work for an employer any more,
Decision making: Running a business will require a lot of they may want to develop a personal interest into a business
decision making. The level of decisions however will differ. Most or they may have been made redundant and want to start
decisions are about low-level, day-to-day issues such as what afresh. These motives, and others, fall into one of two different
materials or stock to order, which tools to use and where to categories: financial and non-financial.
advertise for a new operative. In contrast, a small number of
decisions are strategic. These are important and can have Financial motives: Many people set up a business because
long-term effects on the business. An example might be whether they want to make money. They often think that they could earn
to move premises to a new location. Entrepreneurs will also far more if they worked for themselves. Profit is the driving force
have to solve problems when they occur. Decision making and behind many entrepreneurs and most businesses would not
problem solving require entrepreneurs to process, analyse and exist if it wasn’t for the likelihood of making a profit.
evaluate information.

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Entrepreneurial motives and characteristics Unit 20

Two approaches to the pursuit of profit can be identified. income through trade or donations. Fairtrade is an example
●● Profit maximisation. Some entrepreneurs try to make as of a social enterprise. It markets products produced by small-
much profit as they possibly can in a given time period. scale farmers and workers who are marginalised from trade
This is called profit maximisation. These entrepreneurs are in a variety of ways. Fairtrade ensures that these people
motivated by money and their key focus is the financial return get a better price for their produce, such as coffee. Social
on their efforts. It might be argued that entrepreneurs that enterprises are discussed in Unit 22.
try to maximise profits are likely to take bigger risks. This ●● Independence. A lot of people want to be ‘their own boss’.
is because there is usually a direct relationship between This is an important non-financial motive for setting up a
risk and reward. For example, a small manufacturer might business. These entrepreneurs are driven by the desire to be
decide to replace some workers with a computer numerically independent. The freedom to make all the decisions when
controlled (CNC) machine costing £250,000. However, running a business is very appealing. Some people often
if production levels cannot be raised sufficiently to cover resent being told what to do at work. Being able to make
the cost of the machine, the financial burden might cause your own decisions is often regarded as the main key benefit
extreme cash-flow difficulties. It might also be argued that of being an entrepreneur. Nearly 90 per cent of respondents
entrepreneurs that aim to maximise profits are more likely to to a poll by Startups.co.uk said this was very important.
marginalise the needs of other stakeholders. For example, However, in practice this independence may be limited. Work
an entrepreneur might enforce zero hours contracts and only has to be done. Taxes have to be paid. Those financing the
pay the legal minimum wage. business, like a bank giving a loan, have to be kept satisfied
●● Profit satisficing. Some entrepreneurs might take a different that the business is doing OK. But those who own their own
approach to profit. For example, they may aim to make business, in general, do have more independence than those
enough profit to maintain their interest in the business. This is who work for an employer.
called profit satisficing. One reason why some entrepreneurs ●● Home working. Quite a number of entrepreneurs set up
do not seek to maximise profits is because they do not their businesses from home. They may be tradespeople such
want to take on the extra responsibility of expanding their as plumbers, decorators or electricians that use their home
business – which is often required to make more profit. Also, as a base for their business. Or, increasingly, they may work
some entrepreneurs run ‘lifestyle’ businesses. This means a from a room or an office at home. Examples include writers,
business that generates enough profit to provide the flexibility accountants, software designers, app developers, artists,
needed to sustain a particular lifestyle. This type of business tutors and financial analysts. There are two key benefits for
allows owners to spend more time pursuing other interests home workers. The time and expense spent travelling to and
or with family. For example, a couple running a bed and from work is eliminated. They also enjoy more flexibility. For
breakfast business might shut down for four months in the example, they can take meals and breaks whenever they
winter so that they can visit family in Australia. want and a parent may be able to fit work around the needs
of their children.
Non-financial motives: For some people, other motives for
setting up a business might be as important or more important Key terms
than making money. They will obviously need to make enough
profit in order for the business to continue in operation, but the Profit maximisation – an attempt to make as much profit as
main driving force is non-financial. A number of non-financial possible in a given time period.
motives exist. Profit satisficing – making enough profit to satisfy the needs
●● Ethical stance. A minority of people set up a business of the business owner(s).
in support of a moral belief they possess. For example, a
vegetarian who believes that it is wrong to kill animals for
meat may open up a vegetarian restaurant. By encouraging Knowledge check
more people to use the restaurant, particularly if non-
1. State three characteristics of an entrepreneur.
vegetarians can be attracted, fewer animals would be
slaughtered. Another example might be setting up a business 2. What is meant by financial management?
to generate ‘clean’ electricity. A keen environmentalist might 3. State two communication skills that an entrepreneur
feel that setting up a solar farm could contribute towards the might need.
reduction of carbon emissions. 4. Why will an entrepreneur need negotiating skills?
●● Social enterprise. These are organisations that trade 5. What IT skills might an entrepreneur need?
with the aim of improving human and environmental well- 6. What is meant by profit satisficing?
being. They are sometimes referred to as not-for-profit
7. State two non-financial motives for becoming an
organisations. Generally, social enterprises have a clear social
entrepreneur.
and/or environmental mission and generate most of their

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 Marketing and people

Case study
PICALOULOU

Shireen Cunliffe is an entrepreneur who set up Picaloulou, Shireen does not believe in throwaway fashion. Picaloulou’s
an online retailer of natural and sustainable children’s knitwear is all designed and made in Britain using 100 per
knitwear, in 2011. Its target market is an affluent, eco- cent natural yarns such as Merino wool, cotton and cashmere.
aware internet customer base. Shireen set up the business Picaloulou develops a small collection each autumn and has
when she was unable to find quality British-made children’s started to expand beyond children’s styles into teenage and
knitwear that was stylish and used natural fibres. She began adult fashion. Shireen does not appear to be driven by profit,
by designing a hand-knitted range using naturally dyed loving the fact that Picaloulou supports British wool growers
British wools. She then found a team of home working and mills, and is helping to keep the craft of hand knitting alive.
knitters to make them. Sources: adapted from www.picaloulou.com
As a mum, Shireen needed a flexible business arrangement.
She combined working on Picaloulou with looking after her
young children and helping on the administrative side of her (a) Explain why Shireen might be profit satisficing in this
husband’s business. This often meant burning the midnight case. (4 marks)
oil on her Picaloulou work. The business used a spare (b) Explain one benefit to Picaloulou from being a
bedroom in the family home in Cornwall. This served as a home-based business. (4 marks)
storeroom, packaging and distribution centre, show room (c) Explain two entrepreneurial skills that Shireen has used to
and studio. help make Picaloulou successful. (4 marks)
Shireen used high speed internet, email, social networking (d) Assess whether Shireen’s motives for setting up Picaloulou
and hosting services to keep in touch with her freelancers were mainly financial or non-financial. (10 marks)
and home working knitters across the country.

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 21 Business objectives 1.5.3
Theme 1

Key points
1. Survival.
2. Profit maximisation.
3. Other objectives: sales maximisation, market share, cost efficiency, employee welfare, customer
satisfaction, social objectives.

Getting started It is easier to assess the performance of a business if the

Solomon Cohen is a social media enthusiast. He wanted to set objectives set are SMART. This means that they should be
up an organisation advising small businesses on how to raise ●● Specific – stating clearly what is trying to be achieved

their profile and generate sales using social media. He wrote ●● Measurable – capable of numeric measurement

a comprehensive business plan, invested £50,000 of his own ●● Agreed – have the approval of everyone involved

●● Realistic – able to be achieved given the resources available

money in the start-up and began designing his own website. The
●● Time-specific – have a stated time by which they should
plan detailed three important business objectives.
be achieved.
• Break-even by the end of the first year. An example of a SMART objective might be for a business to
• Generate £100,000 sales by the end of the second year. increase turnover by 8 per cent in the next 12 months. If the
• Make customer satisfaction a business priority. objectives are achieved it could be argued that the business has
State two advantages of setting business objectives. Do you performed well.
think Solomon’s business objectives are realistic? What other
business objectives might you have if you set up in business? Survival
All businesses will consider survival to be important. However,
from time to time survival can become the most important
objective. For example, when a business first starts trading it
Business objectives may be vulnerable. It often takes time for people to recognise
The aims of a business are what the business wants to achieve the existence of a new business. Entrepreneurs may lack
in the long term. Aims tend to be general and examples might experience and there may be a shortage of resources.
be to be the ‘best’ in the market or the ‘market leader’. The Therefore, a target for a new business may be simply to survive
objectives of a business are the goals or targets that need to be in the first 12 months. A business might also struggle to
met in order to achieve an aim. For example, a business might survive if new competitors enter the market. If the new entrants
aim to grow and set annual sales targets as objectives to help have better or cheaper products, or more financial resources,
achieve it. Businesses are more likely to be successful if they entrepreneurs may need to focus on survival in the changed
set clear objectives. Businesses need to have objectives for the business environment at the expense of other objectives.
following reasons. The survival of a business might also be threatened when
●● Employees need something to work towards. Objectives trading conditions become difficult. During the recession in the UK
help to motivate people. For example, sales staff might get between 2008 and 2013, a large number of businesses started
bonuses if they reach certain sales targets. to struggle for survival. One such business was the British airline
●● Without objectives owners might not have the motivation carrier British Airways (BA). In 2009, it was widely reported that
needed to keep the business going. Owners might lose BA’s 40,000 staff were told that the business was struggling as
grip and allow their business to ‘drift’. This could result in the whole industry was trying to come to terms with the global
business failure. downturn. BA had lost £401 million in the previous year. It was
●● Objectives help owners decide where to take a business reported that Willie Walsh, BA’s CEO, told his employees that he
and what steps are necessary to get there. For example, would work for nothing in the month of July. Walsh, who went
if a business aims to grow by 10 per cent, it might decide without £61,000 as a result, wrote to the airline’s employees
that launching products overseas would be the best way to asking them to volunteer for either unpaid leave or even to work
achieve this. for nothing for up to a month. Walsh suggested that the trading
environment was the toughest it had ever been with no evidence
of improvement, and that it was probably the most difficult period
in the history of the industry. BA did survive and returned to profit.
It was reported as making £631 million in 2013.

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 Marketing and people

Question 1 alienate other stakeholders, such as employees and customers.

Higher profits often mean lower wages for employees and
Sears, one of North America’s highest profile retailers, announced higher prices for customers.
in 2014 that it would be closing a number of stores and taking
out loans from the billionaire chairman and CEO, Eddie Lampert. Other objectives
Sears had seen its revenue fall for eight consecutive years. It Although survival and profit maximisation are two important
had made losses for the last four of those years. The struggling business objectives, there are others.
superstore, which also owns Kmart, lost $548 million in the
quarter up to November 2014. The reasons for the decline of Sales maximisation: Some entrepreneurs might try to
Sears were reported as two-fold. The slow economic recovery increase sales as an objective. This is called sales maximisation.
from a deep recession hit the store hard because its target market It involves a business selling as much as it possibly can in
a particular period of time. Sales levels are an important
was middle- and low-income consumers, who may have been
performance indicator and generally growing sales is a healthy
most affected by the recession. Also, stiff competition was reported
sign for a business. Most businesses can raise profits by selling
from ‘leaner’ operators such as Walmart, Home Depot and
more output.
Amazon. It was reported that Eddie Lampert thought that many
Sales maximisation might be used by an entrepreneur to win
of the Sears stores were too large and in the wrong locations. a larger market share. This could be important when trading first
In an effort to revive the company the following measures begins. Also, as a business grows, specialist sales staff might
were announced. be employed. If the pay of sales staff is linked to physical sales
• More stores would be closed. Sears once owned 3,523 stores. levels, a business is likely to pursue sales maximisation as sales
staff try to maximise their earnings.
This figure reduced to fewer than 2,000 by 2015.
• $400 million would be borrowed from a hedge fund owned
Thinking bigger
by Eddie Lampert.
There is a difference between physical sales levels and sales revenue.
• Between 200 and 300 buildings would be sold and leased Maximising physical sales levels is likely to benefit a business. However,
back to improve liquidity. it might be more appropriate to focus on sales revenue as an objective,
i.e. the money generated by physical sales. It may be possible to sell
(a) Using an example from this case, explain one reason why more units by lowering the price. However, this might actually reduce
Sears might have pursued survival as a business objective. sales revenue. The impact on revenue of reducing price to increase sales
(b) Discuss whether the measures Sears has taken to survive are depends on price elasticity of demand. This is discussed in Unit 7.
likely to be successful. Consider this example. An entrepreneur currently sells 6,000 units a
month at £5 per unit. This generates sales revenue of £30,000. In an
effort to sell more, the entrepreneur lowers price to £4. As a result sales
rise to 7,000. However, sales revenue drops to £28,000. This is likely
Profit maximisation to have a negative impact on profit. This example shows that an effort
Without profit most businesses would not exist. However, some to maximise physical sales levels has actually resulted in lower levels of
sales revenue.
businesses focus on profit more aggressively, usually because
the owners want to make as much profit as they possibly can.
This is called profit maximisation. This might be more likely if Market share: Most businesses would prefer a large market
businesses are owned by institutional shareholders, such as share than a small one. Consequently, trying to increase market
pension funds and investment funds. These owners need to share is a common business objective. If a business can get a
maximise the returns on their investments to meet the needs of larger market share this should help to increase revenue and
their clients. Many entrepreneurs are unlikely to pursue profit raise the profile of the business in the market. If a business can
maximisation, they are more likely to pursue profit satisficing. build a bigger market share than its rivals, it may be able to
This is discussed in Unit 20. dominate the market. This might mean that it has more control
If entrepreneurs want to maximise profit, they will focus on over price. A larger market share also means that output levels
keeping costs as low as possible while raising prices as high will be higher so a business might be able to lower its costs.
as they can before customer loyalty is damaged. Skim pricing This will increase profit margins and generate more profit for
is often used by profit maximisers. This strategy is usually used the owners.
in the luxury goods market, for instance jewellery and designer
clothes. The prices are set unnaturally high, as customers for Cost efficiency: From time to time businesses may consider
these goods are wealthy and not price sensitive so don’t object how to reduce their costs. It is an objective that might be
to such inflated values. pursued when trading conditions become difficult due to
One criticism of this approach is that it is too short-termist. more competition or an economic downturn. However, some
By focusing aggressively on maximising short-term profits, businesses look to cut costs all of the time. If costs are lower,
it is possible that more lucrative long-term opportunities are profit margins will be higher. Businesses with lower costs might
overlooked. Profit maximisation as an objective might also also gain a competitive edge in the market.

127
Business objectives Unit 21

A business can use a variety of methods to cut costs. It might: Question 2

●● lay off staff to cut labour costs

●● find new suppliers to get cheaper resources Brad Jones runs FancyThat,
●● increase the usage of recycled materials a manufacturing company
●● develop new working practices that use fewer resources based in Bradford that
●● develop ways of saving energy. makes fancy dress costumes
One of the drawbacks of cutting costs is that product quality or and accessories for shops
customer service might suffer. For example, if a pub cuts down and other outlets around
on bar staff to reduce costs, customers might get fed up waiting the country. After a quiet
to get served and go somewhere else. start in 2010 the business
Employee welfare: In recent years a number of businesses is now booming. Interest in
have realised the benefits of meeting the needs of employees fancy dress costumes has
more effectively. If employee welfare is improved workers will be escalated in recent years.
happier, better motivated, more productive, more co-operative, Brad got the idea after
more flexible and less likely to leave. Therefore another objective going to sporting and social
might be to improve employee welfare. A number of measures events, and talking to some
can be taken to achieve this, including: people who had dressed up
●● improving the working environment by making it cleaner, less for the day. Brad could not
noisy and less crowded believe what people were
●● ensuring that staff are given proper breaks and somewhere prepared to pay for fancy
comfortable to interact with colleagues during those breaks dress costumes. Also, there
●● ensuring that staff are equipped with the necessary tools and were whole groups of people in the crowd dressed in identical
equipment, providing ergonomically designed chairs for call costumes. Brad saw a business opportunity.
centre workers, for example
●● maintaining high standards of courtesy between all staff members
When Brad first started he just wanted to survive in the first year.
●● encouraging regular exercise by organising fitness sessions or
However, he was ambitious and by 2013 he was still in business
providing a staff gym, for example. and wanted to grow turnover to £200,000. He succeeded;
Improving employee welfare is also likely to reduce staff however he has noticed recently that costs are rising sharply. His
absenteeism through sickness, enhance the image of the objective now is to cut fixed costs by 20 per cent and variable
business, help to comply with health and safety legislation, and costs by 25 per cent, both by the end of the year.
make it easier to recruit and retain good quality people. (a) Explain what is meant by a SMART objective.
Customer satisfaction: Most businesses will try to meet the (b) Explain how Brad might cut costs in his business.
needs of customers. The benefits are clear. If customers are
satisfied they are more likely to return. Loyal customers are valuable ●● demonstrating responsibility to the environment by
to a business. In order to win their loyalty, some businesses aim to minimising pollution
exceed customer expectations. How might they do this? ●● providing employment for local people
●● Ensure that all customer-facing staff are trained to a very high
●● maintaining open channels of communication between the
level in communication. Their conduct must be courteous, business and the local community so that issues can be
professional and friendly 100 per cent of the time. raised and discussed
●● Provide a platform for customer feedback – an online review
●● making contributions to community life, such as visiting local
system, for example. schools, sponsoring local events or making donations to
●● Interact with customers using social media – encourage a
local charities.
two-way flow of information. It is not in the interests of a business to upset the local
●● Deal with customer complaints promptly and effectively – to
community. This is because collectively, the local population may
the evident satisfaction of the customer. be a formidable force should they lodge any form of objection.
●● Monitor customer service regularly – using mystery shoppers,
A business has a duty to be considerate and respectful when
for example. operating in a residential area, for example.
In order to have effective customer service, businesses must
know what customers want, provide them with it on a consistent Exam tip
basis and receive feedback on how the business is doing. You need to appreciate that a business may pursue more than one
business objective. For example, an established business might be
Social objectives: A business that sets social objectives is one trying to increase its market share, cut costs and improve
that shows concern for the local area. A business should aim to employee welfare all at the same time. Also, the objectives of a
promote prosperity and develop a strong relationship with the local business are likely to change over time. For example, when a
community so it can co-exist harmoniously. This might involve: business is first set up the main objective might be to survive the
●● keeping noise levels down
first two years. The next objective might be to build market share,
and then further on in time, to maximise profits.
●● maintaining sensible opening hours

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 Marketing and people

Case study
THE HAWKSHEAD Hawkshead Relish is all about preserving in the traditional
way and using locally sourced products and local people to

RELISH COMPANY make everything by hand without any artificial ingredients.

In 2005 they received the Speciality Producer of the Year
award from the Guild of Fine Food, and have since gone on
to win over 50 Great Taste awards for the products. Things
got even better in 2011 when Mark and Maria received
joint MBEs from Her Majesty the Queen for services to the
food industry in South Lakeland.
In 2007 the business moved production a short distance
into a sixteenth-century restored barn. This has helped to
ensure long-term employment for the small but dedicated
workforce. Supporting the local economy and community
is very high on the company’s list of priorities. It employs
between 18 to 24 local and highly valued staff.
Hawkshead Relish now supplies around 500 stores in the
UK and exports to over 30 countries. Over the next five
years Mark and Maria aim to build Hawkshead Relish so
that it is widely recognised around the UK as a high-quality
handmade brand. The company will continue to grow its
Maria and Mark Whitehead run the Hawkshead Relish Company sales and look at new markets, while retaining its base in
based in the Lake District. It makes handmade relishes, pickles South Lakeland, ‘where our hearts belong,’ said Mark.
and preserves in small batches using locally sourced ingredients.
Sources: adapted from www.hawksheadrelish.com,
The company started to take off in 2001. Prior to that, the
www.countrylife.co.uk and Invest in South Lakeland
couple’s café business was devastated by the outbreak of Foot
and Mouth where Mark and Maria nearly lost everything.
However, they then started to manufacture the relishes, pickles (a) Explain one reason why survival may have been an
and preserves they had made at home for the café, on a larger objective for the Hawkshead Relish Company when it was
scale. The business developed when local retailers agreed to stock set up in 2001. (4 marks)
their products, and it has been growing ever since. (b) Explain one benefit to a business like the Hawkshead
All the products are handmade in small batches with no Relish Company of pursuing social objectives. (4 marks)
colourings, preservatives, artificial flavourings or padding (c) Assess the importance of sales maximisation in helping
out. According to Mark, who is the creative influence in the the Hawkshead Relish Company achieve its aim of
partnership, ‘If it doesn’t add flavour it doesn’t get added … establishing the brand over the next five years. (12 marks)
Allowing the great quality of the ingredients to speak
for themselves is the key to creating a product that bursts
with flavour.’

Key terms Knowledge check

Aims – what a business tries to achieve in the long term. 1. State two situations where survival is likely to be an
Objectives – the goals or targets set by a business to help important business objective.
achieve its long-term purpose. 2. What is meant by profit maximisation?
Sales maximisation – an attempt to sell as much as possible 3. Explain one benefit of increasing market share as a
in a given time period (or an attempt to generate as much business objective.
sales revenue as possible in a given time period).
4. State three ways a business can cut costs.
5. Why might a business aim to improve employee welfare?
6. State three ways a business can improve employee welfare.
7. How important is customer satisfaction as a business objective?
8. What is meant by the social objectives of a business?

129
 22 Forms of business 1 1.5.4
Theme 1

Key points
1. Sole trader, partnership and private limited company.
2. Franchising, social enterprise, lifestyle businesses and online businesses.

Getting started Table 1 Advantages and disadvantages of sole traders

There are many kinds of business organisation. Some examples Advantages Disadvantages
include your local hairdresser, Amazon, EasyJet, a window The owner keeps all the profit. The owner has unlimited liability.
cleaner, Nissan and Oxfam. The business is independent and the The owner may struggle to raise finance,
owner has complete control. as lenders may consider them too risky
Who might own these businesses? How are these businesses to offer credit.
different? What might be the advantages to a business like The business is simple to set up, with no Independence may be a burden, for
Amazon of operating an online business? Do all of these legal requirements. example if an owner is ill.
businesses aim to make a profit? The business can be flexible and can The owner and any employees are likely
adapt to change quickly. to work very hard, with long hours.
The business can offer a personal service The business is usually too small to
Sole traders because it is small. exploit economies of scale.
In January 2014, there were around 5 million businesses in the The business may qualify for government The business will have no continuity if the
UK. They vary in their size, ownership and legal structure. help. owner passes away.
A sole trader or sole proprietor is the simplest form of business
organisation. It has one owner, but can employ any number of Partnerships
people. Sole traders can be involved in a wide range of business A partnership is defined in The Partnership Act, 1890 as the
activity. In the primary sector, they may be farmers or fishermen. ‘relation which subsists between persons carrying on business
In the secondary sector, they may be small building or with common view to profit’. Put simply, a partnership has more
manufacturing businesses. However, most sole traders will be than one owner. The ‘joint’ owners will share responsibility for
found in the tertiary sector. Many of these are retailers running running the business and also share the profits. Partnerships
small shops. Others may offer services such as web design, are often found in professions such as accountants, doctors,
tutoring, hairdressing, taxi driving and garden maintenance. Setting estate agents, solicitors and veterinary surgeons. After sole
up as a sole trader is easy, as there are no legal formalities. traders, partnerships are the most common type of business
However, sole traders do have some legal responsibilities. organisation. It is usual for partners to specialise. A firm of
●● They may have to pay income tax and National Insurance
chartered accountants with five partners might be organised so
contributions. that each partner specialises in one aspect of finance, such as
●● Once their turnover reaches a certain level, they must register
tax law, investments or VAT returns.
for value added tax (VAT). However, some sole traders choose There are no legal formalities to complete when a
to register because they can claim back VAT that they have partnership is formed. However, partners may draw up a Deed
paid, even though they do not charge VAT. of Partnership. This is a legal document which states partners’
●● They may need a licence to trade if they are involved in
rights in the event of a dispute. It covers issues such as:
activities such as selling alcohol or supplying a taxi service or ●● how much capital each partner will contribute
public transport. ●● how profits (and losses) will be shared amongst the partners
●● They may need planning permission – for example, a person
●● the procedure for ending the partnership
may have to apply to the local authority for planning permission ●● how much control each partner has
to convert a warehouse into a nightclub. ●● rules for taking on new partners.
●● They must comply with legislation aimed at business practice
If no Deed of Partnership is drawn up the arrangements
– for example, they are legally required to provide safe working between partners will be subject to the Partnership Act. For
conditions for their employees. example, if there is a dispute regarding the share of profits, the
All sole traders have unlimited liability. This means that if Act states that profits are shared equally among the partners.
the business fails, a sole trader can lose more money than The advantages and disadvantages of partnerships are
was originally invested. This is because a sole trader can be shown in Table 2 on the next page.
forced to use personal wealth to pay off business debts.
The advantages and disadvantages of operating as a sole
trader are summarised in Table 1.
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 Marketing and people

Table 2 Advantages and disadvantages of partnerships unlimited liability. The Act also allows this type of partnership to
Advantages Disadvantages have more than 20 partners.
The partnership is easy to set up and Partners have unlimited liability. The Limited Liability Partnership Act, 2000 allows the setting
run, with no legal formalities. up of a limited liability partnership. All partners in this type of
Partners can specialise in their area of Partners have to share the profit. partnership have limited liability. To set up as a limited liability
expertise. partnership, the business has to agree to comply with a number
Partners share the burden of running the Partners may disagree and fall out with of regulations, such as filing annual reports with the Registrar of
business. one another. Companies.
More owners can raise more capital. One partner’s decision is legally binding
on all other partners. Limited companies
The partnership does not have to publish Partnerships have limited growth A limited company has a separate legal identity from its owners.
financial information. potential. The company can own assets, form contracts, employ people,
sue people and be sued.
Limited partnerships Certain features are common to limited companies.
The Limited Partnerships Act 1907 allows a business to become ●● Capital is raised by selling shares. Each shareholder owns a
a limited partnership, although this is rare. This is where some number of these shares and is a joint owner of the company.
partners provide capital but take no part in the management They are entitled to vote on important business decisions,
of the business. Such a partner will have limited liability – the such as a choice of who should run the company. They also
partner can only lose the original amount of money invested. get dividends paid from profits. Shareholders with more
A partner with limited liability cannot be made to sell personal shares will have more control and get more dividends.
possessions to meet any other business debts. This type ●● Unlike sole traders or partnerships, the owners
of partner is called a sleeping partner. Even with a limited (shareholders) have limited liability. If a limited company has
partnership there must always be at least one partner with debts, the owners can only lose the money they originally
invested. They cannot be forced to use their own money to
pay any debts that have been run up by the business.
Question 1 ●● Limited companies are run by directors who are elected

Jones, Thomas and Wilson is a firm of chartered accountants by the shareholders. The board of directors, headed by
based in Aylesbury. The partnership was formed in 2009, when a chairperson, is accountable to shareholders. The board
each of the partners contributed £50,000 in capital. A Deed of runs the company as the shareholders wish. If the company
Partnership was drawn up and it was agreed that the profits performs badly, directors can be voted out at an annual
from the business would be shared 40 per cent, 40 per cent and general meeting (AGM).
●● Unlike sole traders and partnerships, who pay income tax on
20 per cent between Jones, Thomas and Wilson respectively.
Wilson’s share was lower because he was a newly qualified profits, limited companies pay corporation tax.
accountant and therefore had less experience than the others. Forming a limited company: To form a limited company, it
One of the business’s strengths is that each partner is a specialist is necessary to follow a legal procedure. This involves sending
in a particular field of accountancy. Jones is a tax specialist, some important documents to the Registrar of Companies:
Thomas is an investment analyst and Wilson is in charge of these are the Memorandum of Association and the Articles of
external audits. This helped the business to serve a range of Association. These are shown in Figures 1 (below) and 2 (on
customers with different financial needs. the next page) .
In 2011, the partners decided to expand. They needed to
raise £100,000 to obtain more office space and upgrade their Figure 1
computer systems. The partners considered inviting a sleeping
Memorandum of Association
partner to contribute some capital. However, in the end, they
borrowed the money from a bank.
sets out the
(a) (i) Why do you think Jones, Thomas and Wilson drew up a The Memorandum of Association
give s deta ils abo ut the company.
Deed of Partnership? constitution and
ded:
The following details must be inclu
(ii) In 2013, the partnership made a profit of £240,000. In pan y
• name of the com
y’s registered office
the absence of a Deed of Partnership, how much profit would • name and address of the compan
the nature of
Wilson be entitled to? • objectives of the company and
(b) Explain two advantages of a partnership illustrated by its activities
the number of
this case. • amount of capital to be raised and
shares to be issued.
(c) Discuss two possible reasons why Jones, Thomas and Wilson
decided against inviting a sleeping partner into the business.

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Forms of business 1 Unit 22

Figure 2 Question 2
Articles of Association Ilene Bracken owns VegPack, a food processing business in Wigan.
The business supplies small retail outlets in the north-west region
rnal running of the of the UK with pre-packed vegetables. She buys vegetables in
This document deals with the inte bulk from local farmers and then washes, trims and packs them
tion include details
company. The Articles of Associa
attractively before dispatching them to customers. She set up as
such as:
on the type of share a sole trader in 2006, but the growth of the business has taken
• rights of shareholders depending
they hold her by surprise. The success is down to a ‘sale-or-return’ policy
s
• procedures for appointing director that customers like. This results in some waste, but her premium
ctor s sho uld serv e before re-election pricing helps to compensate for any losses.
• length of time dire
y meetings
• timing and frequency of compan In order to meet the demands of rapid growth and to help
pany accounts.
• arrangements for auditing com expand into new markets, Ilene needs to raise £400,000. She
has approached a number of banks, but has found that they are
reluctant to lend to her. Her accountant has suggested forming
a private limited company to raise money by issuing some
If the documents in Figures 1 and 2 are acceptable, the shares to members of her family and two key employees of the
company gets a Certificate of Incorporation. This allows it to business.
trade as a limited company. The shareholders have a legal
(a) Explain two advantages of becoming a shareholder in VegPack.
right to attend the AGM and must be told of the date and
venue in writing. (b) Explain who runs a private limited company.
A limited company can be set up online, and a number of (c) Assess the likely impact on Ilene of VegPack becoming a
websites offer such services. Such websites provide templates private limited company.
for the Memorandum of Association and the Articles of
Association, which makes the whole process easier.

Private limited companies Franchising

Most private limited companies are small or medium-sized Starting up your own business carries a lot of risk. Most new
businesses, though some are large businesses, similar in size to start-ups have ceased to exist after five years of trading. One way
public limited companies. Private limited companies share the of possibly reducing this risk is to buy a franchise. The franchisor
following features. is a company which owns the franchise. It has a track record
●● Their business name ends in Limited or Ltd. of running a successful business operation. It allows another
●● Shares can only be transferred privately, from one individual business, the franchisee, to use its business ideas and methods
to another. All shareholders must agree on the transfer and in return for a variety of fees. In the UK, there are a large number
they cannot be advertised for sale. of franchise operations including Dairy Crest, Domino’s Pizza,
●● They are often family businesses owned by family members Dyno-Rod, McDonald’s, SUBWAY and Tumble Tots.
or close friends. The franchisor provides a variety of services to its franchisees.
●● The directors of private limited companies tend to be ●● It gives the franchisee a licence to make a product which is

shareholders and are involved in running the business. already tried and tested in the market place. This could be a
The advantage and disadvantages of private limited companies physical product but is far more likely to be a service.
are outlined in Table 3. ●● The franchisor provides a recognised brand name which

customers should recognise and trust. This helps generate

Table 3 Advantages and disadvantages of private limited sales from the moment the franchise starts trading.
companies ●● The franchisor will provide a start-up package. This will

Advantages Disadvantages include help and advice about setting up the business. The
franchisor might provide the equipment to start the business.
Shareholders have limited liability. Private limited companies have to publish
their financial information. It might help find a bank which will lend money. It will provide
training for the new franchisee.
More capital can be raised by issuing Setting-up costs have to be met.
shares. ●● Many franchises provide materials to use to make the

Control over the business cannot be lost Profits are shared between more
product. A company like McDonald’s, for example, sells food
to outsiders. members. ingredients to its franchisees. If the franchisor doesn’t directly
The owners have tax advantages. Owners It takes time to transfer shares to new sell to the franchisee, it might organise bulk-buy deals with
may pay less tax, for example. owners. suppliers to cut costs for all its franchise operation.
●● It is likely to provide marketing support. For example, it might
Private limited companies are considered Private limited companies cannot raise
to have a higher status than some other large amounts of money like public have national advertising campaigns. It may provide marketing
types of business organisations, such as limited companies. materials like posters to place in business premises, or
a sole trader. leaflets to circulate to customers.
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 Marketing and people

●● There should be ongoing training. This will be linked to issues Table 5 Advantages and disadvantages to franchisors
such as maintaining standards, sales and new products. of franchising
●● There is likely to be a range of business services available Advantages to the franchisor Disadvantages to the
at competitive prices. For example, the franchisor might franchisor
negotiate good deals on business insurance or vehicle Franchising is a fast method of growth. Potential profit is shared with
leasing with suppliers. franchisees.
●● Many franchises operate exclusive area contracts. This Franchising is a cheaper method of Poor franchisees may damage the
is where one franchisee is guaranteed that no franchise growth because franchisees take some of brand’s reputation.
deal will be signed with another franchisee to operate in the financial risk.
a particular geographical area. This prevents competition Franchisees take some of the risk on Franchisees may get their merchandise
behalf of the franchisor. from elsewhere.
between franchisees and so helps sales.
Franchisees are more motivated than The cost of supporting franchisees may
●● Over time, the brand should be developed by the franchisor. employees. be high.
For example, new products should be developed to appeal to
customers.
Question 3
In return for these services, the franchisee has to pay a variety The Soya Bean is an international franchise operation selling
of fees. vegetarian snacks. Their outlets offer a fresh, healthy alternative
●● There will be an initial start-up fee. Part of this will cover to fast-food restaurants. The success of the UK-based franchise is
the costs of the franchisor in giving advice or perhaps due partly to the support that it offers to its franchisees:
providing equipment. Part of it will be a payment to use the
• Brand recognition: The Soya Bean brand is recognised
franchise name.
internationally and franchisees are encouraged to get
●● Most franchisors charge a percentage of sales for ongoing
involved in its marketing.
management services and the ongoing right to use the
brand name. • Training: Franchisees attend yearly training ‘camps’ to ensure
●● Franchisors will also make profit on the supplies they sell
they are aware of all new developments and to learn from
directly to their franchisors. other franchisees.
●● There may also be one-off fees charged for management • Open communication: Franchisees are encouraged to share
services such as training. best practice with each other and their service providers and
There are advantages and disadvantages of franchising. Table develop new ideas collaboratively.
4 shows some general advantages and disadvantages for the • Supportive decision-making: The Soya Bean encourages
franchisee. Although one of the advantages is that the franchisor collaboration and tries to include franchisees in their
provides national advertising, some of it can be quite poor. Also, decision making .
like any other business enterprise they can prosper or they can
• Centralised purchasing: The Soya Bean operates an online
fail. For example, when buying a franchise, it is important for
ordering system so that the same supplier is used for all food,
the franchisee to be vigilant when assessing the opportunities
packaging, equipment and services to franchisees.
that the franchisor is offering. It is worth remembering that
often ‘you get what you pay for’. If someone who is not suited
to running a business buys a franchise, the prospect of failure is Figure 3
still relatively high. Some of the advantages and disadvantages
Growth in The Soya Bean franchise outlets between 2008
to franchisors of franchising are summarised in Table 5.
and 2012
30,000
Table 4 Advantages and disadvantages to franchisees
25,000
of franchising
Number of outlets

20,000 Key
Advantages to the franchisee Disadvantages to the
15,000 UK
franchisee International
Franchises are lower risk, as they use A franchisee’s profit is shared with the 10,000
an idea that has already been tried and franchisor. 5,000
tested.
0
Franchisees get support from the Franchisees have to sign contracts 2008 2009 2010 2011 2012
franchisor. with franchisors, which can reduce Years
independence.
The set-up costs of a franchise are Setting up a franchise can be an
predictable. expensive way to start a business. (a) Explain the difference between a franchisor and a franchisee.
Franchisees can benefit from national Franchisees lack independence and must (b) Discuss the key benefits to franchisees of taking out a franchise
marketing campaigns organised by the abide by strict operating rules. of The Soya Bean.
franchisor.
(c) How does the data in Figure 3 illustrate one of the key
advantages to the franchisor of franchising?

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 Forms of business 1 Unit 22

Social enterprises lifestyle. The business should be lucrative enough to support

Some businesses operate as social enterprises. These the desired lifestyle without having to sacrifice time for the
organisations trade with the aim of improving human and entrepreneur’s personal life. Typical examples might include
environmental well-being, rather than making profit for external tradespeople such as plumbers and electricians, consultants
owners. They are sometimes referred to as not-for-profit in a variety of industries, florists, and people who run small
organisations. Generally, social enterprises: retail stores, bed and breakfasts and small lifestyle farms. Many
online businesses, such as web design, coaching, advisory or
●● have a clear social and/or environmental mission marketing services, also operate as lifestyle businesses. Some
●● generate most of their income through trade or donations features of lifestyle businesses are as follows.
●● reinvest most of their profits ●● The business will often be small and is likely to have just

●● are not connected to the government one owner.

●● are majority controlled in the interests of the social mission ●● The personal interests of the entrepreneur are likely to

●● are accountable and transparent. influence the nature of the business, so that time spent
working is enjoyable.
Social enterprises may take a variety of forms. ●● An owner may undertake a variety of different ventures. For

example, a musician may generate income by playing live

Co-operatives: Most modern co-operatives operate as in a band, teaching people to play an instrument, busking,
consumer or retail co-operatives. They are owned and controlled teaching part-time in a college and writing music for adverts.
by their members. Members can purchase shares that entitle ●● Running the business is likely to be much less stressful than
them to a vote at annual general meetings (AGMs). The other forms of business.
members elect a board of directors to make overall business ●● The business is likely to be home-based.
decisions and appoint managers to run day-to-day business. ●● They are likely to have similar advantages and disadvantages
Co-operatives are run in the interests of their members. Any to those of sole traders.
surplus made by the co-operative is distributed to members as a ●● Lifestyle businesses are sometimes considered an alternative
dividend according to levels of spending. to retirement.
Lifestyle businesses are sometimes contrasted with start-up
Worker co-operatives: These are businesses jointly owned
businesses, which are intended to grow and create increasing
by their employees. Examples might be a wine growing
amounts of profit. Because growth in revenue and profit is
co-operative or a co-operative of farmers producing milk. In a
not a key objective to lifestyle businesses, owners of lifestyle
worker co-operative, employees are likely to:
businesses usually have to provide all the funding themselves.
●● contribute to production and be involved in decision making
Not many external investors will fund businesses that do not aim
●● share in the profit (usually on an equal basis)
to maximise profits. However, there are exceptions. For example,
●● provide some capital when buying a share in the business.
Tim Ferriss runs a large lifestyle business in the US. He is an
Mutual organisations: Most building societies in the UK are author, business advisor and angel investor, and in 2014 he was
mutual organisations. They are owned by their customers – or ranked sixth in the Top 20 Angel Investor rankings.
members, as they are known – rather than by shareholders. They
offer a wide range of financial services such as mortgages and Online businesses
savings products. Profits are returned to members in the form Amazon.com, MoneySuperMarket.com, Confused.com, eBay
of better and cheaper products. Friendly societies (also mutual and Facebook are examples of large and well-known online
organisations) began in the 18th and 19th centuries to support businesses. However, there are many thousands of much
the working classes. Today, they offer a wide range of affordable smaller examples including retailers, consultants, gaming
financial services. These include savings schemes, insurance companies, bloggers, share dealers, teachers, web designers
plans and protection against the loss of income or death. and information providers. Despite being very different
companies, they all use the internet to trade and are likely to
Charities: These exist to raise money for various causes and have the following features in common.
draw attention to the needs of disadvantaged groups in society. ●● Customers access the business via the internet. All online

For example, Age UK is a charity that raises money on behalf of businesses have a website which gives information about
older people. They also raise awareness of issues that relate to their products, their prices and general information about
older people, such as the winter fuel payment. Other examples the company.
of charities include the British Red Cross, Save the Children ●● Online businesses collect payment for goods and services

Fund and Mencap. Charities rely on donations for their revenue. electronically. Credit cards, debit cards and PayPal are the
They may also organise fundraising events such as jumble sales, most common methods used.
sponsored activities and raffles. A number of charities also run ●● There are no formal procedures to follow or legal

business ventures such as charity shops. requirements when starting an online business. However,
traders must have secure websites with adequate protection
Lifestyle businesses against technical breakdowns and fraud.
A person running a lifestyle business aims to make enough ●● Online businesses have low set-up costs. A trader could build

money and provide the flexibility needed to sustain a particular their own website for a few hundred pounds. Alternatively,
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 Marketing and people

for a higher set-up cost, a new online trader could purchase

a complete set-up package, including web design, domain Case study
name registration and arranging the hosting of the website
by an internet service provider. Many online businesses
are also run from home, which eliminates the need to find
business premises.
KHAN ACADEMY
●● For many online businesses, paid-for or sponsored

advertising is their main source of revenue. For example,

most people use Facebook’s social media services free of
charge. However, in 2013, most of the $7.87 billion revenue
was generated from advertising on the site.
The majority of businesses have websites that give information
about company history, products, services, company aims and
contact details. Also, many retailers, such as supermarkets, chain
stores and even independent retailers, have an online sales
operation.
The internet has fundamentally changed the way products
and services are sold. It has also revolutionised the development,
design, production and distribution of products and services.
Thanks to the internet, even small businesses have access to Khan Academy is an example of both a social enterprise
global markets, international suppliers and foreign employees. and an online business. It is a not-for-profit business that
Table 6 shows that global internet usage is growing rapidly, from aims to change education for the better by providing a free
1,562 million in 2008 to 2,712 million in 2013. It also shows that world-class education for anyone anywhere. In 2014, the
in the UK, the growth in internet usage is slowing down. This is organisation employed around 80 people and had around
probably because most people in the UK are now internet users. 10 million users each month. All of the site’s resources
There is not much scope left for future growth. The value of are available to anyone who has an internet connection –
ecommerce sales rose from £334.6 billion in 2008 to £556.6 there are no subscription fees or other charges. Its services
billion in 2013. This is still a rapid rate of growth. are aimed at students of all ages, teachers and parents.
Table 6 Growth in global and UK internet users, and total • The website offers support such as practice exercises and
UK ecommerce sales instructional videos. It also provides some teacher aids
and is designed to let learners work at their own speed.
  2008 2009 2010 2011 2012 2013
• Resources are adjusted to meet individual needs. They
Global internet users
(million) 1,562 1,752 2,034 2,272 2,511 2,712 offer personalised advice about the order of learning
UK internet users and help to motivate learners.
(million) 48.0 51.6 52.8 54.2 54.6 55.5 • Many are from the US but students from countries like
UK ecommerce sales India, Brazil, Mexico, South Africa and beyond also use
(£ billion)* 334.6 375.1 418.9 494.1 479.4 556.6 the site. Video lessons have been translated into almost
*Value of total sales derived from ecommerce sales 40 languages to meet the needs of these international
Sources: adapted from www.ons.gov.uk and students.
www.internetlivestats.com
• Learning programmes address many subjects such
Maths tip as maths, physics, biology, economics, art history and
computer science.
When analysing data like that shown in Table 6, it may
be useful to describe changes over time in percentage terms. • Most revenue is raised from donations. For example, in
For example, total UK ecommerce spending rose from November 2011, Khan Academy received a grant of
£334.6 billion in 2008 to £556.6 billion in 2013. The $5 million from the O’Sullivan Foundation.
percentage increase is calculated as follows: Source: adapted from www.khanacademy.org.
Difference × 100 =
Original number
(a) What is meant by a social enterprise? (2 marks)
£556.6 bn – £334.6 bn × 100 = £222.0bn × 100 = 66.3% (b) Explain one benefit to Khan Academy of operating an
£334.6 bn £334.6 bn online business. (4 marks)
Therefore, you can say that the value of sales derived from (c) Assess the importance of growth in internet usage on an
ecommerce sales in the UK rose by 66.3% between 2008 online business like Khan Academy. (12 marks)
and 2013.
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Forms of business 1 Unit 22

Key terms Knowledge check

Articles of Association – a document that provides details 1. State three advantages and three disadvantages of being a
of the internal running of a limited company. sole trader.
Certificate of Incorporation – a document that declares a 2. What is the advantage of a Deed of Partnership?
business is allowed to trade as a limited company.
Co-operative – a business organisation owned by its 3. State three advantages and three disadvantages of
members, who have equal voting rights. partnerships.
Deed of Partnership – a binding legal document that states 4. What is meant by a sleeping partner?
the formal rights of partners.
5. What is the role of directors in limited companies?
Franchise – a business model in which a business (the
franchisor) allows another operator (the franchisee) to trade 6. What is the difference between the Memorandum of
under their name. Association and the Articles of Association?
Lifestyle business – a business that aims to make enough 7. State two disadvantages of private limited companies.
money and provide the flexibility needed to support a
particular lifestyle for the owner. 8. Give two examples of a social enterprise.
Limited company – a business organisation that has a 9. State three features of a lifestyle business.
separate legal entity from that of its owners.
10. State two advantages of online businesses.
Limited liability – a legal status which means that a
business owner is only liable for the original amount of
money invested in the business.
Limited partnership – a partnership where some members
contribute capital and enjoy a share of profit, but do not
participate in the running of the business. At least one
partner must have unlimited liability.
Memorandum of Association – a document that sets out
the constitution and states key external details about a
limited company.
Mutual organisation – a business owned by its members,
who are customers not shareholders.
Online business – a business that uses the global
communications infrastructure of the internet as a trading base.
Partnership – a business organisation that is usually owned
by between 2–20 people.
Primary sector – production involving the extraction of raw
materials from the earth.
Secondary sector – production involving the conversion of
raw materials into finished and semi-finished goods.
Sleeping partner – a partner that contributes capital and
enjoys a share of the profit but takes no active role in
running the business.
Social enterprise – a business that trades with the objective
of improving human or environmental well-being – charities
and workers’ co-operatives, for example.
Sole trader or sole proprietor – a business organisation
which has a single owner.
Tertiary sector – the production of services in the economy.
Unlimited liability – a legal status which means that the
owner of a business is personally liable for all business debts.

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 23 Forms of business 2 1.5.4
Theme 1

Key points
1. The growth of business to public limited company (plc).
2. Stock market flotation.

Getting started Question 1

J D Wetherspoon plc is a British pub chain. Tim Martin set up the Sainsbury’s was set up in 1869 when John James Sainsbury and
business in 1979 when he opened his first pub in London. Since his wife Mary Ann formed a partnership and opened a small
then, the company has expanded into a huge chain. After floating grocery shop in London. The company was owned wholly by the
on the stock market in 1992, the company’s share price rose by Sainsbury family until it went public as J Sainsbury plc in 1973.
around 1,500 per cent over a 20-year period. It was the largest ever flotation on the London Stock Exchange at
Who now owns J D Wetherspoon plc? Why do you think the the time. The Sainsbury family retained 85 per cent of the firm’s
company’s share price rose by 1,500 per cent? What motivates shares. The company’s progressive image was strengthened by
owners to grow their businesses? How might Tim Martin expand the excitement of the press reports surrounding the flotation.
his business further?

The growth of businesses

Most owners want their businesses to grow. This is usually
because larger businesses enjoy a higher profile in the market In 2014, Sainsbury’s generated a turnover of £23.9 billion,
place, larger revenues, lower unit costs due to economies of scale up slightly from £23.3 billion in 2013. This represented about
and higher profits. Larger businesses also feel more secure and 16 per cent of the market. In 2014 it had 1,200 outlets and
find it easier to raise money. Many entrepreneurs may dream of employed 161,000 people. The Sainsbury family had also sold
owning a huge business that they built from scratch. many of its shares.
Many of the large businesses that dominate markets today
started out as small sole traders or partnerships. They may have Figure 1
traded as private limited companies for a period of time in order
J Sainsbury plc share price from 1988 to 2014
to raise more capital. Finally they decided to ‘go public’ and (September closing price in pence)
operate as public limited companies. For example, Greggs plc is
the UK’s leading bakery retailer, specialising in sandwiches and 600
baked savouries. John Gregg opened his first bakery in Newcastle
500
upon Tyne in 1951. Since then it has expanded from one shop
with a small bakery at the rear into a major UK chain, and in 400
2015 it had nearly 1,700 shops and 20,000 employees. Its 2013
300
turnover was £762.4 million.
200
Public limited companies
100
A public limited company is owned by shareholders and the name
of the company ends in plc. Like a private limited company, it is 0
run by a board of directors under the supervision of a chairperson
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014

who is accountable to the shareholders. There are just over one

million registered limited companies in the UK, but only around
one per cent of them are public limited companies. However, they (a) What is meant by a public limited company?
contribute significantly to national output and employment. The (b) How might a new investor buy shares in J Sainsbury plc?
shares of public limited companies can be bought and sold on (c) Explain what might account for the change in the Sainsbury
the stock market. This is a market for second-hand shares and share price between 1988 and 2014.
is accessible to anyone. It is possible to buy shares in any public
limited company by using an online share-dealing site.

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Forms of business 2 Unit 23

Stock market flotation Question 2

A stock market flotation occurs when a company ‘goes public’.
The process is also called an initial public offering (IPO), which Sometimes an established business may decide to sell off part of
means that a company’s shares are offered to the public for its operations. This may be called a divestment. One way to do
the first time. The process is time-consuming and expensive. this is to organise an IPO. In 2014, Lloyds Bank did this when it
A great deal of administration is necessary and it is common was ordered by the European Commission to sell TSB, following
for a specialist such as an investment bank to be awarded the its £20 billion taxpayer bailout.
task. One of the first jobs when undertaking an IPO is to publish At the point of the IPO, TSB provided retail banking services via
a prospectus. This is a detailed document that advertises the
a network of 631 branches in the UK, employing 8,600 staff. The
company to potential investors and invites them to buy shares
initial price of TSB shares was 260p. However, at the end of the
before the day of the flotation.
first day’s trading TSB shares rose by 30p to 290p. This meant
The prospectus is likely to contain the following.
●● A brief history of the business.
that some private investors were £231 better off by the end of
●● A list of the directors and other key personnel.
that first day.
●● A description of its operations.

●● An outline of how the money raised will be spent.

●● The company’s future strategy.

●● Some financial details such as historic accounts.

●● Details of any pending legal action.

●● Details of possible risks to investors.

●● Clear information about how to buy shares – including key

dates for example.

●● An application form to buy shares.

‘Going public’ is expensive. This is because:

The offer was in high demand, with 60,000 applications from
●● the company needs lawyers to ensure that the prospectus is

‘legally’ correct private investors. They ended up with 30 per cent of the shares
●● a large number of ‘glossy’ publications have to be made available
on offer. Those retaining the shares for 12 months had terms of a
●● the company is likely to pay an investment bank to process
free bonus share of one for every 20 shares held. Each member
share applications of TSB’s 8,600 staff was given £100 worth of free shares as part
●● the share issue has to be underwritten (which means that the of the flotation. The idea was to make employees ‘TSB Partners’
company must insure against the possibility of some shares and help with staff motivation.
remaining unsold) and a fee is paid to an underwriter who (a) What is meant by an IPO?
must buy any unsold shares
(b) Explain the reasons why a flotation such as an IPO is expensive.
●● the company will have advertising and administrative expenses

●● the company must have a minimum of £50,000 share capital.

(c) Explain how giving free shares to TSB staff might impact on
the company.
A public limited company cannot begin trading until it has
completed these tasks and has received payment of at least
25 per cent for the value of shares. It will then receive a Trading
Certificate and can begin operating, and the shares will be quoted Advantages of public limited companies
on the stock exchange or the Alternative Investment Market (AIM). Some of the advantages of public limited companies are
A full stock exchange listing means that the company must the same as those of private limited companies (see page
comply with the rules and regulations laid down by the stock 132). For example, all members have limited liability, the firm
exchange. Many of these rules are to protect shareholders from continues to trade if one of the owners dies, and more power
fraud. The AIM is designed for companies that want to avoid is enjoyed due to the larger size of the plc. Other advantages
some of the high costs of a full listing. However, shareholders of public limited companies are as follows.
with shares quoted on the AIM do not have the same protection ●● Huge amounts of money can be raised from the sale of

as those with ‘fully’ quoted shares. shares to the public. For example, when Alibaba went public
An example of a successful flotation is the Chinese internet in 2014, around $20 billion was raised for the company.
giant Alibaba that was floated on the New York Stock Exchange, ●● Production costs may be lower as firms may gain

as widely reported in September 2014. It controlled 80 per cent of economies of scale. Public limited companies are expected
online commerce in China. Shares initially priced at $68 reached a to grow and as they get bigger unit costs are likely to fall.
high of $100 at one point before settling back to $93.89 by the end This will improve their competitiveness and help to generate
of the day, up 38 per cent. This valued the company at $231 billion. more profit.
High-profile flotations attract a lot of media attention. The ●● Because of their size, public limited companies can often

shares are traded for the first time ever and investors who fail dominate the market. Most plcs aim to grow and may
to buy shares initially have the chance to buy them on the open eventually exercise some control in the market. For example,
market. If the initial public offering is heavily oversubscribed, the they may be able to create barriers to entry, preventing
share price can rise very sharply. competition.
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 Marketing and people

●● It becomes easier to raise finance, as financial institutions which means that they have international markets and production
are more willing to lend to public limited companies. A plc operations in a number of different countries. For example, the
with substantial assets can provide the collateral needed by UK oil giant BP employs about 84,000 people around the world
financial institutions to protect loans. Larger plcs also have a in over 80 different countries. In 2014, it operated over 17,200
wider range of capital sources to choose from. petrol outlets and had 18 operational oil wells. In 2013 its annual
●● Pressures from the media and financial analysts, as well profit was $13.4 billion, down from $17.1 in 2012. Multinationals
as the danger that the public limited company might be are discussed in Unit 79 and Unit 81.
taken over by another company, encourages executives and
managers to perform well and make profits. These pressures
do not exist for private limited companies.
Question 3
Founded in 2010, Versarien is an advanced materials manufacturer.
Disadvantages of public limited Its products include a heat transfer material made from porous
companies copper (VersarienCu) for use in cooling systems in computing and
Setting up as a public limited company can also have disadvantages. power conditioning equipment. It has already gained considerable
●● The setting-up costs for public limited companies can be very industry recognition and received a number of awards, including:
expensive – running into millions of pounds in some cases. • 2013 Racecar Engineering Magazine’s Most Innovative
The various costs of ‘going public’ are listed under ‘Stock Product Award
market flotation’ on the previous page.
• 2012 MWP Advanced Manufacturing Award for Research
●● As anyone can buy their shares, it is possible for an ‘outsider’
and Development.
to exert control on the company. They might even take
complete control of a company if they buy enough shares. In 2013, Versarien floated on the Alternative Investment Market
For example, in 2012 Kraft was able to take over Cadbury for (AIM). It was reported that the company raised £3 million before
£11.5 billion. flotation expenses. Following this, the company acquired Total
●● Members of the public can inspect all of the company’s Carbide, a leading manufacturer of tungsten carbide products,
accounts. Competitors may be able to use some of this for £2.28 million. This provided extra capacity to meet growing
information to their advantage. Public limited companies have customer demand.
to publish more information than private limited companies. Source adapted from www.versarien.com
●● Because of their size it is more difficult to deal with

customers at a personal level. Some customers do not like (a) What is meant by AIM?
dealing with giant ‘faceless’ corporations. They may prefer (b) Explain what advantages there are for Versarien of trading as
the personal service of a much smaller enterprise, perhaps a public limited company.
even dealing directly with the owner. (c) Explain how the funds raised by the flotation benefited
●● The way they operate is controlled by various Company Acts,
Versarien.
which aim to protect shareholders. Compliance with company
legislation will use up company resources. Public limited
companies often employ a company secretary to deal solely Thinking bigger
with compliance issues. Sometimes a business operating as a public limited company is taken
back into private ownership. This may be called ‘exiting the stock
●● There may be a divorce of ownership and control. This
market’. Why does it happen?
means that the shareholders may not be able to exert
• The people responsible for running the business might no longer be
enough pressure on those that end up running the company, willing to tolerate interference from the external shareholders. For
such as senior managers. As a result the senior managers example, shareholders such as financial institutions may demand
might pursue their own objectives, possibly at the expense higher dividends when the senior managers would prefer to reinvest
of shareholders. This may happen if the shares are spread profits to generate more growth.
between a very large number of small shareholders. For • Sometimes businesses lose favour with the stock market. This may
example, Fred Goodwin, who was CEO of RBS from 2001 happen when city analysts publish unhelpful or negative reports
to 2009, was criticised for the £350 million spent on a new about companies failing to reach profit targets, for example. Such
publicity often has the effect of lowering the share price very sharply.
head office in Gogarburn. It had deep pile carpets and the
walls were covered with expensive works of art. Some also • One growing trend is for plcs to be bought by private equity
companies. These are businesses that borrow money from a variety
criticised the amount of money paid to sponsors such as of sources and then use it to buy other businesses. They often aim to
Jackie Stewart and Jack Nicklaus. Some shareholders may not increase the value of the business and then sell it about five years later. For
have been very supportive of such expenditure. example, office2office plc, a major supplier of office supplies, was bought
●● It is argued that some very large public limited companies are by the private equity firm Endless LLP for around £19 million in 2014.
inflexible due to their size. The above information can be useful if you are asked to evaluate the
Some public limited companies are very large indeed. They have impact on a company of going public. Although there are numerous
millions of shareholders and a wide variety of business interests advantages, history tells us that some plcs return into private ownership
for the reasons given.
situated all over the world. They are known as multinationals,

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Forms of business 2 Unit 23

Case study
ALEXIS PARKER It was reported that Alexis Parker expected to make around
£25 million of profit in 2014, on sales of £150 million. It
had favourable operating profit margins of around 9 per
cent. The flotation raised about £100 million. Alexis Parker’s
In 2014, the luxury shoe brand Alexis Parker floated just
CEO, Andrew Wright, and the company’s Creative Director,
over 20 per cent of the business on the stock market. The
Carol Anderson, retained small stakes in the company and
brand, with over 90 stores, planned to open about 5–10
the flotation enabled them to be rewarded in shares if they
further stores a year between 2014 and 2016. The brand
improve the company’s performance and share price. The
was popularised after being featured in a Hollywood
share price closed at 162p after the first day’s trading, 1p
movie, and its growing popularity in Europe saw it featured
higher than the initial flotation price of 161p.
on the cover of a leading magazine.
In its prospectus,Alexis Parker promised investors an
annual sales growth of more than 7 per cent. The company (a) What is a company prospectus? (2 marks)
particularly planned to grow its presence in Europe. The (b) Explain one possible motive for the Alexis Parker IPO.
IPO valued Alexis Parker at £272.8 million. (4 marks)
The prospectus also acknowledged that Alexis Parker’s (c) Assess the drawbacks to Alexis Parker of going public.
success could be negatively affected by downturns in the (10 marks)
economy or consumer confidence. The business environment
(d) Assess whether you think the flotation will be successful.
for luxury goods became more challenging in 2014, with
(12 marks)
flagging demand from shoppers. It was reported that the
luxury goods market in 2014 had slowed by an estimated
2 per cent on 2013 figures.

Exam tip Knowledge check

If you are assessing the impact of going public on a particular
company, you will need to demonstrate your ability to evaluate. It 1. State two possible reasons why owners want their
will be helpful to build your answer around any information given businesses to grow.
that is specific to the company, to show your skills in application. 2. What are the main legal differences between private and
When you have analysed the advantages and disadvantages of
public limited companies?
going public you will need to make a judgement. This will depend
on the information in the case. However, one approach might be to 3. State four financial costs incurred when forming a public
suggest that some stakeholders will benefit, such as shareholders, limited company.
and others might lose out, such as customers. Some people argue 4. State four pieces of information that are likely to be included
that this happened in the UK when some of the ‘old’ nationalised
in a company prospectus.
industries went public. For example, the price of shares in
privatised water companies has grown well since their initial 5. State three advantages of public limited companies.
flotation, which is good for shareholders, but customers have not 6. State three disadvantages of public limited companies.
always seen an equivalent decrease in their water bills. 7. What might happen to the share price of a new public
limited company if the share issue is oversubscribed?
Key terms 8. What is a private equity company?
Private equity company – a business usually owned by
private individuals backed by financial institutions.
Public limited company – a company owned by shareholders
where the shares can be traded openly on the stock market.
Stock market – a market for second-hand shares.
Stock market flotation or initial public offering (IPO) –
the process of a company ‘going public’ – making shares
available to the public for the first time.

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 24 Business choices 1.5.5
Theme 1

Key points
1. Opportunity cost.
2. Choices faced by businesses.
3. Potential trade-offs made by businesses.

Getting started next best alternative is called the opportunity cost of the choice.
Imagine that your employer has given you an unexpected In this example, it would be the benefit lost by not retraining the
Christmas bonus of £100. Make a list of all the things you would workforce. When making such choices, individuals, businesses
like to buy with the money. Now arrange that list in order of and governments can identify and face the opportunity cost once
preference. The item on the top will be the one you decide to their preferred spending choice has been made.
spend the money on.
Question 1
What have you foregone by choosing the preferred item at the
top of the list? How often in life are you faced with decisions like A commercial bank operates 600 branches. The bank is
this? Why do such decisions arise? Do businesses face similar expanding rapidly but is short of funds to meet all of its
situations? If so, give some possible examples. spending plans. It has £100 million to spend and the bank has
drawn up a list of spending options in order of preference. All of
the projects will cost around £100 million.
Opportunity cost 1. Open 50 new branches.
Entrepreneurs and other business decision-makers are frequently
2. Buy an insurance company.
faced with choices. There are often a number of alternative ways
3. Renew all ATMs.
of using resources. As a result businesses have to make a choice
4. Retrain all staff in customer service.
about which way to use them. Such choices are common in life
and are faced by individuals, businesses and the government.
●● Individuals have to choose how to spend their limited

budgets. For example, a university student, after all living

costs have been met, may have £50 left at the end of the
week. This student would like to buy some new books (£20),
get the train home for the weekend (£30), go out for a meal
with friends (£30) or buy a new pair of designer jeans (£50).
Clearly, a choice has to be made because all of these goods
together would cost £130.
●● Businesses may have to choose between spending £100,000

on an advertising campaign, retraining its workforce,

redecorating the reception area or buying new vehicles for
sales staff.
●● A government may have to decide whether to spend

£5 billion on increasing disability benefits, building new

hospitals, providing better care for the mentally ill or building
a new motorway.
(a) Using this case as an example, explain what is meant by
Assume that a business placed its spending desires in the order
opportunity cost.
of preference below.
1 Advertising campaign.
2 Retrain workforce.
3 Redecorate reception area.
Non-monetary opportunity cost
Opportunity costs can quite often be measured in monetary
4 Buy new vehicles for sales staff.
terms. In the above example, the opportunity cost of investing in
In this example, the advertising campaign is the preferred choice. the advertising campaign is the benefit forgone from retraining
Therefore the £100,000 will be allocated to this project. The other the workforce. The business might be able to calculate the value
three options are foregone or given up. The benefit lost from the of the extra output generated by the workers after retraining.

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Business choices Unit 24

However, there may also be some non-monetary or intangible One very important trade-off is that between risk and reward,
benefits of staff retraining. For example, many workers may feel as shown in Figure 1. It is often necessary to take bigger risks
more confident in their work and as a result they may be happier in order to reap higher rewards. However, with high risk there is
and more contented. This may improve productivity further. the danger of large losses. For example, it was reported in the
However, such improvements, although real, would be very media that before 2008, banks granted mortgages to high-risk
difficult to measure in monetary terms. Opportunity cost may borrowers. The potential returns were high, but unfortunately
also be difficult to quantify because such costs are incurred in when the property market collapsed many borrowers could not
the future and the future is so difficult to predict. repay their loans. As a result some banks also collapsed.
Opportunity cost can sometimes be personal. For example,
an entrepreneur might decide to reinvest profits in the business Figure 1
at the expense of a family holiday. The opportunity cost of this
The relationship between risk and reward
decision might be over-work and disappointed children, which
High
might be felt by the whole family. Clearly, increased happiness
and a greater sense of well-being are additional factors that may
contribute to opportunity costs.

Level of reward (profit or loss)

Thinking bigger
In 2001 Arsenal FC won approval to build a new stadium, increasing
capacity from about 38,000 to over 60,000. The club invested about
£400 million in the construction of the Emirates Stadium. The Arsenal
manager, Arsène Wenger, was reported as describing it as the biggest
decision in Arsenal’s history since Herbert Chapman was appointed
as chairman by the board. The Emirates opened in 2006 and up until
2014, when Arsenal won the FA Cup, the club failed to win a single
trophy. For many of the club’s supporters, this eight-year period of
underachievement on the pitch was an important part of the opportunity Risk Risk
averse taker
cost of the decision to build a new stadium as during this period the
Low Risk High
club appeared to have only limited resources to invest in new players
and improve the quality of the playing staff. However, the true value of
the opportunity cost is very difficult to quantify. How can you measure Initially, one important decision for an entrepreneur is whether to
supporters’ emotional disappointment at not winning any trophies?
Also, if Arsenal had won some trophies their revenue would have been
set up a business in the first place. The benefits of running your
higher, but by how much? This example helps to highlight the difficulties own business may include:
in measuring the precise value of opportunity cost. You could use this ●● independence, as owners are in complete control and are free

example, or ones like it, when discussing the opportunity costs of to make all decisions
business decisions. ●● flexibility, as owners can choose a life balance between work

and leisure that suits them

●● the chance to make more money than might be earned in

employment
●● job satisfaction and a sense of achievement in building

something from scratch

●● the chance of becoming rich – some entrepreneurs become

millionaires!

However, there is a trade-off. Many entrepreneurs leave their

jobs to set up a business. They give up financial security that a
regular salary from employment often affords. Employment may
also offer health insurance, employee pensions, holiday pay and
sick leave. Running a business is also very challenging, for the
following reasons.
●● Owners of small businesses are responsible for all day-to-day

Business choices and trade-offs operations. Unless they have a reliable and trustworthy assistant,
Businesses have to make countless decisions, and decision- they have to be available whenever the business is open.
makers are frequently faced with trade-offs. This means that ●● The demands of running a business may result in a lack of

opting for one choice involves compromising another. For free time. Also, if working from home the boundaries between
example, a company that prides itself on attention to detail must work time and personal time may become blurred. Owners
often sacrifice the speed of production. If a business wants to may spend too much time in ‘work-mode’.
accumulate stock, it must sacrifice cash. There are many such ●● Business owners need a variety of skills to be successful.

examples in business. Advertising, marketing, interviewing, hiring, management,

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 Marketing and people

stock control and accounting are all part of an entrepreneur’s Weighing up trade-offs
responsibilities. This will be a lot more demanding than When businesses are faced with trade-offs similar to the ones
working in a specialised area as an employee. shown in Table 1, the following actions might help to find the
●● If owners operate as a sole trader, they have unlimited right balance.
liability. This means that personal assets are unprotected if ●● Obtain information. One approach would be to list the
the business starts to run up debts. advantages and disadvantages of each choice and try to
determine which carries the heaviest weight.
Potential entrepreneurs would have to give this trade-off serious ●● Balance short term with long term. Try to determine what
consideration before taking the risk. Some examples of common might be given up in the long run for some important short-
trade-offs in business are outlined in Table 1. term gain – and vice versa.
●● Gauge support. When weighing up alternatives, it might be
Table 1 Examples of common business trade-offs
appropriate for the decision-maker to think about which key
1. Firms often have to consider the trade-off between holding liquid assets staff will support a particular idea and who will oppose it. The
and investing more in productive assets such as machinery. By reducing
the amount of liquid assets held, there is a risk of cash-flow problems. views of others can be a powerful influence.
However, investing more in productive assets may increase profitability.
2. Directors of public limited companies have to find the right balance when
distributing corporate profits. They can re-invest profits and hopefully
increase future profitability. However, shareholders may prefer higher
current dividend payments and less re-investment.
3. Firms might choose to take a more ethical stance in their operations.
However, this is likely to come at a cost, as investment in cleaner
technology might be required, for example.
4. A common trade-off is that between higher profit margins or higher
turnover. Some businesses can often sell more and raise turnover, but
this may come at the expense of lower prices and reduced profit margins.

Question 2
In 2013, a Boeing Dreamliner® caught fire at Boston Airport
and all Dreamliners were grounded due to safety concerns. It
was widely reported that the aircraft had experienced a variety
of incidents up to that point, and that some felt there was
an element of risk in Boeing’s manufacture and operations
decisions. The company chose to have the jet designed and
built mostly by other companies. Although Boeing had a record
number of orders, the process of designing and manufacturing
the jet was problematic.
• The original delivery date of 2008 was significantly delayed,
and the first Dreamliner was delivered in 2011.
• Many of the components used in the fuselage failed to conform
to Boeing’s specifications. This was expensive and caused delays.
• The first Dreamliner to arrive at the company’s factory for
assembly was missing thousands of parts.
• In January 2013 the entire fleet of 50 Dreamliner planes
was grounded after planes had problems with the lithium-ion
batteries. One company made the original batteries that were
approved but the batteries that were later installed in the
Dreamliner were made by another company.
Was Boeing right to outsource the design and production of the Exam tip
Dreamliner? Or did the company save money but at a risk that When businesses are making decisions in any aspect of their
was too high and a cost that was too great? operations, there is likely to be an opportunity cost resulting from
that decision. When answering questions, there may be a wide
Source: adapted frowm the Financial Times 11.01.2013. All rights range of situations where you can apply the concept of
reserved. opportunity cost. For example, in a question about pricing, you
could discuss the opportunity costs of a price cut for the
(a) What is meant by the trade-off between risk and reward?
business. The use of opportunity cost is likely to provide a
(b) Assess the possible costs incurred by Boeing as a result of counterbalance in an argument and may help you show skills of
outsourcing its design and production of the Dreamliner. evaluation.

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Business choices Unit 24

Case study
natural forms of farming such as biological pest control
and crop rotation. Using ladybirds which eat aphids is
BENSON FARMS LTD one example where a natural process replaces a chemical
pesticide. However, organic farming is less efficient and so
George and Marion Benson run Benson Farms Ltd, a large output is more expensive. The demand for organic produce
arable farm in Suffolk. The farm produces cereal crops, mainly is increasing in the UK but people may return to non-organic
barley for the brewing industry. The business is successful produce if incomes fall. George and Marion hope to meet
and in 2012 it made a profit of £120,000. However, George a consultant to consider the switch. Some of the general
and Marion couldn’t agree on how to use the profit. Marion advantages and disadvantages of organic farming are
was keen to plough it back into the business to increase outlined in Table 2.
future profitability. However, in contrast, George wanted to
buy a holiday home in Andalucia. This could be rented out Table 2 General advantages and disadvantages of
to generate an income and provide a second home in one of organic farming
their favourite holiday destinations. The options in order of Advantages of organic Disadvantages of organic
preference are listed below. farming farming
1. Develop a campsite on the farm. • Natural habitats are protected. • Yields may be lower due to crop
2. Buy a holiday home in Andalucia. damage by pests.
• Soil condition is improved
3. Set up a farm shop. because manure is used. • The crop yield has been reported
as around 19 per cent lower on
4. Buy a new tractor. • Healthier food is likely to be organic farms.
produced.
George and Marion have become increasingly concerned • Weed control is very time-
about the use of pesticides and fertilisers in agriculture. They • Fewer chemicals means more consuming and labour intensive.
wildlife.
currently use both on their farm but have recently had their • Some organic pesticides, such as
attention drawn to a report by the European Environment • Organic farming is worth over copper, can be harmful.
£1 billion a year.
Agency (EEA) European waters – assessment of status and • Some organic farming methods
pressures. In this assessment, the agency reports that use more water, which can be
48 per cent of streams and lakes in the EU will fail to meet costly.
good ecological status by 2015. One problem is the growth
of algae that chokes off oxygen to fish and plant life in
waterways. However, the fight against pollution clashes
head-on with concern about food security. There is growing (a) Explain what is meant by a trade-off when making a
global pressure for farmers to increase food supplies to help business decision. (2 marks)
combat rising prices and rising population growth. The trade- (b) Explain the opportunity cost to Benson Farms Ltd of
off between higher yields (using pesticides and fertilisers) and developing the campsite. (4 marks)
environmentally friendly farming methods (using less or no
(c) Explain one way in which the business might find the ‘right
fertiliser and pesticides) is well known.
balance’ when weighing up a trade-off. (4 marks)
As a result of their concern George and Marion have been
(d) Assess the costs to Benson Farms Ltd of switching to organic
considering a switch to organic farming. This method does
production. (12 marks)
not use chemical fertilisers or pesticides. It relies upon more

Key terms Knowledge check

Choices – in business, deciding between alternative uses of 1. What might be the opportunity cost of a business giving
resources. workers a six per cent pay increase?
Opportunity cost – when choosing between different
2. Give two possible examples of non-monetary opportunity costs.
alternatives, the opportunity cost is the benefit lost from the
next best alternative to the one that has been chosen. 3. What might be the consequences of a business investing too
Trade-offs – in business, where a decision-maker faces a heavily in productive assets like machinery?
compromise between two different alternatives; for example, 4. Give two examples of possible trade-offs in business.
between paying dividends to shareholders and re-investing
profits in the business 5. What might be sacrificed by an entrepreneur starting a new
business?

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 25 Moving from entrepreneur 1.5.6
Theme 1
to leader
Key points
1. The difficulties in developing from an entrepreneur to a leader.

Getting started Moving from entrepreneur to leader

If an entrepreneur sets up a business and it becomes
successful, the role of the entrepreneur is likely to change as
the business expands. Running a sole trader business with two
employees and a turnover of £250,000 is different from the
challenge of running a large plc with 59,000 employees and
a turnover of £3.6 billion. The change in role stems from the
need to deal with growth. For example, there is likely to be a
growth in the:
●● number of employees

●● number and size of financial transactions

●● number and size of customers

●● amount of regulation

●● quantity of resources used

●● level and range of communication needed.

Jennifer Compton is a successful entrepreneur. She owns a

The transition from entrepreneur to leader is likely to require
large children’s retail chain worth £80 million called Under 10s.
a number of changes in the way the business is run. This
She first demonstrated her entrepreneurial skills when running
usually means that entrepreneurs have to adapt and perform
a baby-sitting agency whilst studying for her A levels at sixth
different functions.
form college. Then after working in a small store making and
selling children’s clothes in Preston she started buying very cheap
housing in the Preston area. She used the properties to provide
The need for formality: Small businesses can be run on
an informal basis. This means that communication takes place
student accommodation in Preston. After four years she sold her
without the need for regular structured meetings, detailed
property business for £2.7 million.
documentation or official communication channels. They
Jenny then saw that the small store that she worked in earlier employ just a few employees and communication between
was for sale. She bought it and began building her chain – Under them can be ongoing as they are likely to be working in
10s. The store had been run down and needed a number of close proximity to each other. Decisions can be made swiftly
key changes to become profitable. She sourced a new and because the entrepreneur is always at hand. However, in a large
exciting product range from a number of countries in SE Asia organisation, where the entrepreneur becomes a leader, there
to complement her tailor-made clothes. She also employed is a need for formality. Communication between thousands
young and flexible staff who she motivated with her warm and of employees requires systems and formal structures. The
enthusiastic brand of leadership. Jenny worked very hard opening business is likely to be split up into departments or divisions.
six new shops per year for five years in the north west and then There will have to be formal communication channels that are
12 shops a year for 10 years nationally. She is now a respected recognised and approved by all staff. There will be a need for
business person, the CEO of Under 10s and has a reputation a formal organisational structure so that the business can be
for retail development. She has recently started a consultancy controlled and employees brought to account. The entrepreneur
business to help young people develop their stores. in a small business may become a chairperson or a senior
Jennifer Compton is both an entrepreneur and a leader. What executive in a large business.
changes do you think have occurred in her business role over
the years? Do you think that entrepreneurs and leaders need The need for shared ownership: When businesses grow
different skills? If so, describe them. What particular leadership they need capital to fund expansion. To obtain funding it is
qualities did Jennifer demonstrate when she developed the Under sometimes necessary to invite new owners to contribute
10s brand? What difficulties might Jennifer have faced when capital. For very large corporations this usually means selling
making the transition to corporate leader? shares and operating as a plc. Entrepreneurs begin their
business life as sole owners, but often end up having to share

145
Moving from entrepreneur to leader Unit 25

ownership with others. Ownership is likely to be shared with Stress: Running a business is stressful. The livelihood of
financial institutions, such as pension funds and insurance entrepreneurs and their families are dependent upon the
companies, as well as an army of very small investors. success of the business. There is the constant worry that the
business ‘won’t provide’ and what will happen if the business
Greater responsibility to others: An entrepreneur running collapses?
a small business is only likely to have responsibility for a small One major cause of stress is the worry that debtors will fail
number of employees. However, when a business grows into a to pay what they owe. However, if the business grows it is likely
corporation the number of people employed could be tens of that it is being successful. But with growth comes more stress,
thousands or more. The livelihoods of these people will often as there is more at stake. The business may have borrowed
rest on the decisions made by the leader. This is an enormous money that must be repaid. There are more staff and more
responsibility. A leader may also have responsibility to other responsibilities, with an increased scope for conflict because
stakeholders, such as shareholders, and a far larger number of more people are involved.
suppliers and customers. Conflict is a common cause of stress in larger organisations.
Some stakeholders have different needs that might cause
The need for motivation and inspiration: As the size conflict. For example, workers may want a wage increase but
of the business grows there is a need to focus more on the customers want stable or lower prices. The threat of a strike
workforce. This is because there are a lot more people to would cause stress in such cases.
manage. As entrepreneurs develop into leaders, there is a
greater need for motivational skills. Some people are self- Sharing ownership and control: Some entrepreneurs may
motivated but most people need encouragement and well- struggle with a loss of control when the business expands.
defined goals, which leaders have to provide. Workers are likely Inviting partners, business angels or shareholders to contribute
to look to the leader for support and inspiration. Leaders also capital means that business ownership is shared. It also means
have to develop the talents of others. that future profits have to be shared.
Some entrepreneurs may also find it difficult to share control
The need for strategy and vision: In a small business the and resent others influencing the shape and direction of a
owner is likely to be involved in production and other business business that they set up from scratch. They may feel that their
functions such as marketing, finance and administration. leadership is being undermined, which may cause conflict.
However, as the business expands, specialists undertake most
of these tasks. The leader becomes more concerned with Trust: As entrepreneurs develop as leaders, they may have
designing business strategies and providing a vision for the problems trusting people. As the business grows there is a
future direction of the company. However, there are exceptions need to delegate and employ specialists. Some leaders find it
to this. For example, TV chef Jamie Oliver is the leader of a difficult to delegate and may become suspicious of new senior
sizable catering and restaurant business but is still involved in staff. Where specialists are appointed, the leader may feel that
cooking in various kitchens in his organisation. the specialists know more than them. The leader may feel
Some of the people who have made a success of the threatened and concerned that they are being kept in the dark
transition from entrepreneur to leader include Richard Branson or manipulated. If leaders cannot trust the new owners and
(the Virgin brand), Michelle Mone (founder of Ultimo), Lord Sugar staff there may be problems because employees may question
(computers), Deborah Meaden (holiday business), Mike Ashley whether or not the leader trusts them.
(Sports Direct and Newcastle Utd FC) and Hilary Devey (logisitics).
They all began their careers with modest business start-ups and Lack of leadership qualities: As entrepreneurs take on
developed into successful leaders of large corporations. more leadership duties there may be concern that they lack the
necessary leadership skills and qualities. These might include
The difficulties in developing from an management, communication, problem solving, decision making
entrepreneur to a leader and organisational skills. It is true that entrepreneurs also need
When dealing with the changes required in the transition from these skills to be successful. However, once the business
entrepreneur to leader, inevitably there will be difficulties. grows, these skills have to be applied on a different scale. The
problems are likely to be larger, decisions more important and
Adapting the mindset: Entrepreneurs usually have a desire communication more complex. For example, in communication,
for greater control over their life, career and destiny. They want entrepreneurs may have to give instructions to employees,
more autonomy and to do things in their own way. However, a discuss specifications with a customer and meet the accountant
different mindset is needed when the business expands. Leaders to finalise a tax return. A high-profile business leader may meet
have to relinquish some control and learn to delegate and focus with other leaders and politicians in Germany, speak in more
on different things. They have to believe that specialists will do than one language, write reports for shareholders and give
a better job in certain fields and that they cannot do everything presentations to the media. Such demands may cause problems
themselves. For some people this is very difficult. They may for some entrepreneurs as they develop into leaders.
have doubts, fears and a lack of trust that could create a barrier
to development.

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 Marketing and people

Overcoming difficulties Figure 1

The changes required in the transition from entrepreneur to
Measures that might help to reduce stress
business leader are substantial. It is easy to see why many
business owners are happy to remain small traders, maybe
preferring a lifestyle business. However, despite the difficulties Having a balanced diet
outlined above, some people do make the transition successfully.
They learn to adapt and overcome the difficulties. They might
use a number of methods, including those listed below.
Sharing feelings Taking regular exercise

Delegation and trust: A successful business leader must

be comfortable with delegation. The delegation of tasks to
specialists and experts will improve the performance of the Maintaining a sense Reducing stress Resting
business. A good leader will surround themselves with talented, of humour
honest and trustworthy people. Leaders can reduce the risk in
recruitment if they employ a thorough and effective recruitment
process. The ability to delegate and trust will reduce stress. Avoiding alcohol, Having a balanced
drugs and tobacco work/leisure lifestyle
Earn respect: Many of the difficulties outlined on the previous
page can be overcome if a leader can earn respect from all
stakeholders. People will be more trustworthy, effective and
flexible if they are treated well. This means meeting their
needs at work, praising them when they excel, being fair but
tough, open and honest. Respect might also be earned if the
organisational culture is open, positive and accepted.

Maturity and experience: Some people are born leaders.

They find leadership natural and have the charisma and
leadership qualities needed to be successful. However, others
may develop into good leaders. Through maturity, experience,
drive and learning from mistakes, they can overcome any
difficulties they may encounter. The transition from entrepreneur
to corporate leader may be a lengthy one.

Education: Some of the leadership skills can be learnt by

attending specialist courses. There are countless courses
designed to help business people improve management,
negotiation, communication and decision-making skills. Additional
languages can be taught, as can report writing and IT skills.

Reduce stress: Calm leaders are more likely to succeed than

stressed leaders. Figure 1 summarises some of the measures
that might be used to reduce stress. Knowledge check
1. State three ways in which the role of an entrepreneur might
Exam tip change as a business grows.
You can use your learning from this unit in many ways, because
entrepreneurship and leadership are central to business 2. Why is there a need to introduce formality in businesses
development in an economy. For example, the information might be when they grow?
used when specifically explaining the difficulties in moving from an
3. Why might an entrepreneur have difficulty delegating tasks?
entrepreneur to a leader. Some of the information might also be
used in discussions about the problems with business growth, 4. Why might a leader lack confidence?
reasons that account for the performance of a business, the 5. How might entrepreneurs have to adapt their mindset when
importance of good leaders and risk taking, the characteristics of
entrepreneurs and leaders, stakeholder conflict, motivation and
developing into a leader?
business management. This unit links particularly well with Unit 18
on leadership, Unit 19 on the role of an entrepreneur and Unit 20
on entrepreneurial motives and characteristics.

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Moving from entrepreneur to leader Unit 25

Case study
In 1986, Microsoft was floated on the stock exchange. The
company was valued at $520 million of which Gates owned
BILL GATES 45 per cent. As the company grew rapidly, the share price
soared. At one point, Gates’ share was worth over $100
billion. In 2000, the Bill & Melinda Gates Foundation was set
up to support philanthropic initiatives, with Gates devoting a
lot of his time to working with, and funding, a wide range of
charities.
The story about Bill Gates
Bill Gates was known for his passion for computer programming
from a young age and while at college. During his early years
at Microsoft, he reportedly oversaw the business detail, yet
personally reviewed every line of code and often rewrote parts
of it if he felt it was needed. Gates was appointed as president
of Microsoft in 1981. He met regularly with senior and program
managers, with a management style that some may have
found intimidating. He was passionate about the quality and
performance of Microsoft products and was reported as rigorous
with his employees in ensuring robust business strategies, to
Bill Gates is the founder of the Microsoft® Corporation, a protect the company from long-term risk. It was reported that
worldwide leader in software, services and solutions that Gates expected his employees to share his drive and dedication,
helps people and businesses realise their full potential. Bill and that he challenged their ideas as part of the creative process,
Gates formed Microsoft in 1975, dropping out of Harvard testing out whether they were convincing. His competitive spirit
University, which might have been considered a risk at the drove Microsoft’s success and the company’s strength was used
time, to devote his energies to software development. His to reinforce its dominance in the market place.
original vision was reported as ‘A computer on every desk Bill Gates stepped down as chairman of Microsoft in 2014 and
and in every home’, running Microsoft software. Bill was a was the richest person in the world in 2015, with a net worth
visionary person and worked hard to achieve this vision. In of $78.3 billion. His philanthropic work, reported as totalling
1980, Gates made a deal with IBM to provide the MS-DOS grants from the Foundation of $21.8 billion in 2015, and to
operating system on the new IBM PC for a fee of $50,000. involve diplomacy and persuasion, has won many awards. He is
However, he stipulated that he and Microsoft held onto the known as one of the most influential people of the 20th century.
copyright of the software. When the PC market took off,
Microsoft also sold MS-DOS to other PC manufacturers. Source: adapted from the Financial Times, 01.11.2013
Not long after, Microsoft operating systems dominated
the world.
(a) When Microsoft went public in 1986, Bill Gates owned
In 1985, Gates released the Microsoft Windows® operating 45 per cent of the company. Calculate the value of his
system, similar to one introduced by Apple® in 1984, taking holding. (4 marks)
what some might consider another risk. Originally, some
thought that the Apple version was better than Microsoft (b) Explain how a risk taken by Bill Gates in 1985 might have
Windows. However, the Apple operating system only ran affected Microsoft. (4 marks)
on Apple machines, whereas Microsoft Windows could run (c) Explain one way in which the role of an entrepreneur, such as
on a variety of PC-compatible machines. Microsoft won the Bill Gates, might change as the business develops. (4 marks)
operating system market and was soon installed on nearly (d) Assess the difficulties that Bill Gates might have encountered
90 per cent of the world’s personal computers. Gates went when moving from entrepreneur to the leader of Microsoft.
on to introduce further products such as Windows Office® (12 marks)
programs like Word® and Excel®.

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 26 Internal finance 2.1.1
Theme 2

Key points
1. Owner’s capital: personal savings.
2. Retained profit.
3. Sale of assets.

Getting started The need for finance

Firms need money to get started. They might need to buy
equipment, raw materials and obtain premises, for example.
Once this initial expenditure has been met, the business
can get under way. If successful, it will earn money from
sales. However, business is a continuous activity and money
flowing in may be used to buy more raw materials and settle
other trading debts. If the owner wants to expand, extra
money may be needed over and above that from sales.
Expansion may mean larger premises, more equipment and
extra workers. A business will need to find a way of raising
this finance.
The items of expenditure above fall into two categories
– capital expenditure or revenue expenditure. Capital
expenditure is spending on items that may be used over
and over again. A company vehicle, a cutting machine and a
new factory all fall into this category. Revenue expenditure
refers to payments for goods and services that have either
already been consumed or will be very soon. Wages, raw
materials and fuel are all examples of this category. Revenue
expenditure also includes the maintenance and repair of
buildings and machines.

Owner’s capital
Capital is the money provided by the owners in a business.
It is an example of internal finance. Internal finance is money
generated by the business or the current owners. In most
cases, a business cannot start unless the owners provide
capital of their own. Providing capital is part of the risk taken
by entrepreneurs when setting up a business.
Ahana Chaudhary started her own business after she was
Owners provide capital from their own personal resources.
made redundant from her local hospital. She used her £6,000
A common source is personal savings. Some entrepreneurs
redundancy money and a further £4,000 from her savings to have deliberately saved up over a period of time so that they
start a business, providing a home care service for the elderly in can start their own business. Sometimes, people who have
Brighton. The business was profitable from the start and five years lost their jobs may decide to go into business using their
later she recruited two full-time staff. Eventually, the demand redundancy payments. These sources are personal and can
was so great that she decided to operate a care agency, providing be used by sole traders and partnerships. Owners of limited
staff to deal with the wide-ranging needs of the elderly. She used companies also provide their own capital. They have to find
£25,000 profit from the business to buy an office for the agency. money to buy shares. Finally, owners can introduce fresh
Why do entrepreneurs need finance to start a business? What capital in the future if there is a need. Owner’s capital is not
sources of finance did Ahana use to start her care business? How did just provided at the start-up stage.
she fund the expansion of the business into an agency? What might
be the advantages and disadvantages of using this source of finance?

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Internal finance Unit 26

Retained profit sold its farms business to the Wellcome Trust in 2014 for £249
Retained profit is profit after tax that is put back into million to help reduce its debt.
business and not returned to the owners. It is the single Another option is to raise money through a sale and
most important source of finance for a business. Much of leaseback agreement. This involves selling an asset, such as
all business funding comes from retained profit. It is the property or machinery that the business still actually needs. The
cheapest source of finance, with no financial charges such as sale is made to a specialist company that leases the asset back
interest and administration. However, there is an opportunity to the seller. This is an increasingly popular source of finance.
cost. If retained profit is used by the business it cannot be With such agreements instant cash is generated for the seller and
returned to the owners. For a small business this might mean the responsibility for the maintenance and upkeep of the asset
that owners and their families have less money to fund their passes to the new owner.
lifestyle. For limited companies it means that shareholders In 2014 it was reported that the entrepreneur Duncan
receive lower dividends. In the case of a public limited Bannatyne agreed a sale and leaseback deal with M&G
company this may lead to conflict if the shareholders see that Investments. He sold 39 health clubs for £92 million and then
dividend payments have been frozen because the directors leased them back. The money was used to help clear some
have used the profit in the business. business debts.
Retained profit is a flexible source of finance. It does not
have to be used immediately. It can be accumulated by a
Advantages and disadvantages of
business and retained in a bank account where it will earn internal finance
interest. A business can then use the retained profit at a later There are a number of advantages when using internal finance
date. If a business doesn’t make a profit, retained profit is not to fund business activity, though despite the attractive nature of
possible as a source of finance. internal finance, there may also be some drawbacks.
Table 1 summarises the advantages and disadvantages of
Sale of assets using internal finance.
An established business may be able to sell some unwanted
assets to raise finance. For example, machinery, obsolete Table 1 Advantages and disadvantages of internal finance
stock, land and buildings that are no longer required could Advantages
be sold off for cash. Large companies can sell parts of their
organisation to raise finance. The capital is available immediately – there is no time delay between
identifying a need for finance and obtaining it. For instance, retained profit
will be in a bank account ready and waiting. Assets can be sold quickly if the
price is competitive.
Internal finance is cheap – there are no interest payments, which means that
costs will be lower and profit higher. Also, there are no administration costs.
The business will not be subject to credit checks. External finance often
requires investigations into credit history of the borrowers.
There is no need to involve third parties.

Disadvantages
Internal finance can be limited – a business may not be sufficiently profitable
to use retained profit or may not have unwanted assets to sell. Also, the
current owners may not have any personal resources to contribute.
Internal sources of finance are not tax-deductible. If external finance is used,
the interest paid on a loan or leasing charges for assets, for example, can be
treated as a business cost and offset against tax.
Internal finance can be inflexible compared to external sources of finance.
There are a wide variety of funding options for external finance, which can
give the business flexibility.
There are no inflationary benefits with internal finance. Inflation can reduce
Standard Life, the financial services provider, sold its the value of debt if external sources are used.
Canadian arm in 2014 for £2.2 billion. The money was used
to reward shareholders and allow the business to focus on Opportunity cost of using internal sources of finance can be high. For
its UK activities. example, a plc considering the use of retained profits for funding will have to
Sometimes a business might be pressured into selling consider the reactions of shareholders if dividends are frozen or cut. Some
shareholders may have a very short-term view and demand higher dividends
assets when quite large amounts of money are needed to
now. This could result in conflict between shareholders and directors.
overcome a problem. For example, The Co-operative Group

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 Managing business activities

Question 1

The Priory Group is a leading provider in healthcare and famous

for treating various celebrities. It specialises in conditions ranging
from addiction to Alzheimer’s disease. The Priory Group sold some
property in 2014 in a leaseback deal. It was reported that Priory
sold six sites for a total of £223 million, in Altrincham, Bristol,
Chelmsford, North London, Roehampton and Woking. The deal
with M&G Investments, a property development company, involved
a lease agreement for 30 years with Priory. Priory planned to
use the proceeds, along with other cash reserves, to pay off part
of its debt. It was reported that service users and commissioning
arrangements at the hospitals were unaffected by this deal.
(a) What is meant by sale and leaseback?
(b) How did The Priory Group plan to use the proceeds from the
sale of its properties?
(c) Explain two advantages of the sale and leaseback method of
finance for The Priory Group.

Case study
Figure 1
CROMWELL AND JONES Cromwell and Jones profit, 2008–2014
Profit (£)
Lisa Jones and Tom Cromwell run their decoration and interior 60,000
design business as a partnership. They each invested £10,000
50,000
into the business start-up in 2008. Although many businesses
were facing financial problems in that year, they decided to 40,000
go ahead anyway. The first few years were difficult, but they
30,000
worked very well together as a small team. Lisa was a creative
interior designer and Tom was a highly skilled painter and 20,000
decorator. After four years the couple had earned a reputation
10,000
in the Cheshire area for producing high-quality interior designs
and installation. They specialised in bedroom design and 0
started to win some large and lucrative jobs from Premier 2008 2009 2010 2011 2012 2013 2014
League footballers living in the Wilmslow area. Year

In late 2014, they won a £200,000 contract to design and

refurbish five bedrooms in a large house. However, they
accepted the contract knowing that they would have to (a) What is meant by internal finance? (2 marks)
outlay £40,000 in equipment and some specialist imported
raw materials. They were absolutely committed to raising (b) Explain one method of internal finance that Tom and Lisa
the finance internally even if it meant selling one of the two might have used to raise the initial capital to start the
vehicles owned by the business. Tom and Lisa did not want business in 2008. (4 marks)
the business to go into debt, owing money to people outside (c) Explain one opportunity cost to Cromwell and Jones of using
the business. They wanted the business to be self-financing. retained profit for financing business activity. (4 marks)
Figure 1 shows the profit made by the business between (d) Evaluate Tom and Lisa’s decision to use internal finance to
2008 and 2014. fund the new contract in this case. (12 marks)

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Internal finance Unit 26

Exam tip Knowledge check

When answering a question on internal sources of finance,
remember to consider carefully the financial circumstances of the 1. What is the difference between revenue expenditure and
case in the question. The sources and methods of finance used by capital expenditure?
a business will depend significantly on the nature of the business
and its financial position. For example, smaller businesses may be
2. Give three examples of capital expenditure a farmer
forced to use internal sources because they present too much of might undertake.
a risk to external providers. In contrast, plcs have a much wider 3. What is meant by capital?
range to choose from because they are more secure and may have
large quantities of collateral, which they can use to support a loan. 4. State one advantage of using retained profit as a source
Paying close attention to the business circumstances in the of finance.
question will help you to show your skills in application.
5. State two advantages of using the sale of assets to
raise finance.
Key terms 6. State two disadvantages of using internal finance.
Capital – the money provided by the owners in a business.
Capital expenditure – spending on business resources that
can be used repeatedly over a period of time.
Internal finance – money generated by the business or its
current owners.
Retained profit – profit after tax that is ‘ploughed back’ into
the business.
Revenue expenditure – spending on business resources
that have already been consumed or will be very shortly.
Sale and leaseback – the practice of selling assets, such as
property or machinery, and leasing them back from the buyer.

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 27 External finance 2.1.2
Theme 2

Key points
1. Sources of finance: family and friends, banks and peer-to-peer funding, business angels, crowd funding
and other businesses.
2. Methods of finance: loans, share capital and venture capital, overdrafts, leasing, trade credit and grants.

Getting started Banks: Commercial banks such as Barclays, NatWest, Lloyds and
HSBC provide a range of different external funding arrangements
Ellerman Construction Ltd is a medium-sized building contractor. for businesses. These include loans, overdrafts and mortgages.
It has recently undertaken a lot of sub-contract work for large Most commercial banks have specialist departments or staff
construction companies involved in the building of Crossrail, the that deal exclusively with businesses. Banks will be involved in
new underground rail link in London. The business carries out a business start-up because businesses need a bank account to
concreting work and uses trade credit to buy its raw materials facilitate financial transactions with customers and suppliers. Banks
from suppliers. It gets 90 days to pay back the credit. The might also offer advisory services to businesses. These are often
business has a 25-year mortgage on its premises and owes free. A formal application is required to get finance from banks and
£5,000 on a two-year bank loan. It owns about half of its it will probably be necessary to provide a business plan.
plant and machinery, but the other half is leased. Ellerman
Construction Ltd is a family-owned business with four members Peer-to-peer lending: Peer-to-peer lending (P2PL) involves
of the family having equal shares. people lending money to unrelated individuals or ‘peers’ and
therefore avoiding the use of a bank. Transactions are undertaken
What is meant by external sources of finance? Suggest the ways
online and are organised by specialists such as Zopa, Funding
in which Ellerman Construction Ltd funds its business. Can you
Circle, Lending Works and RateSetter. Although this source
think of any other methods of business finance? How might the of finance can be used by a business, it is not exclusive to
business raise £500,000 to buy an expensive machine? businesses. Anyone can apply for a peer-to-peer loan. The key
features of peer-to-peer lending include the following.
External finance ●● All loans are unsecured which means there is no protection

Few businesses can rely entirely on internal financing (see for lenders. Therefore, lenders might lose their money if a
Unit 26) to fund all business activity. Initially, external finance, borrower defaults.
which is finance from sources outside the business, may not be ●● The whole financial arrangement is conducted for profit.

available. This is because business start-ups have no trading ●● All transactions take place online.

record and present too much risk for many lenders. However, ●● No previous knowledge or relationship between lenders and

once a business has survived the initial ‘uncertain’ stages of borrowers is needed.
business development, external sources of finance are likely to ●● Lenders may choose which borrower to lend to.

become a realistic option. ●● Peer-to-peer sites make a charge – typically about one per cent.

Sources of finance The main attraction of P2PL is that interest rates are better for both
There is quite a wide range of external sources that businesses borrowers and lenders than those offered by a bank. P2PL is also
can choose from. very convenient because it can be completed online fairly quickly.
However, the main disadvantage is that the Financial Services
Family and friends: A common source of finance, particularly Compensation Scheme, which guarantees savings up to the value
for small businesses, is family members or close friends. This of £85,000, does not cover participants. Also, if you are a lender,
may be a cheap source because if the money is a loan, interest access to cash may not be instant – each operator has different
charges may be low, or possibly zero. In some cases money rules, but money might be locked away for months or longer.
might be gifted to an entrepreneur. For example, a parent
or grandparent might give their child or grandchild a sum of Business angels: Business angels are individuals who typically
money as a present to help them get started. Another possible may invest between £10,000 and £100,000+, often in exchange
advantage of finance from friends or family is that they may not for a stake in a business. An angel might make one or two
want a stake in the business. Consequently, they will not be able investments in a three-year period, either individually or together
to interfere in the running of the business. However, serious with a small group of friends, relatives or business associates.
problems could arise if a loan cannot be repaid or the terms Most investments are in business start-ups or in early stages
of the arrangement lack clarity. This could lead to the loss of of expansion. There are several reasons why people become
friendship or a breakdown in family relations. business angels. Many like the excitement of the risk involved,
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External finance Unit 27

or being part of a new or developing business. Others are building a school or setting up a community project. The
attracted by the tax relief offered by the government. Some are lenders or investors will be large numbers of individuals who
looking for investment opportunities for their unused income. collectively represent ‘the crowd’. Transactions are conducted
A problem with this source of finance for businesses is online. They are administered by a crowd funding specialist
finding a suitable ‘angel’. As angels normally take a stake in such as Crowdcube, Kickstarter and Crowdfunder. These
the business, the angel and the current business owners must websites allow those seeking finance to publish details of
have shared interests and a common view about the future their business idea or project, including how much cash
direction of the firm. For example, some owners might look for they need, how they will use it and how investors stand to
an angel with business experience hoping that they can provide profit (if at all) in future. Some of the sites carry out checks
some useful input into the running of the business. In contrast, on the fundraisers but not all of them. In most cases the
many owners might want angels to keep their distance and investors, who can usually subscribe as little as £10 per
just maintain a financial interest in the business. Also, business venture, are offered shares in the business. In 2013, PixelPin,
angels may be demanding individuals with considerable a tech-company which helps customers reduce fraud, raised
pressures on their time. They may be overwhelmed by business £150,000 using the crowd funding platform Seedrs.
propositions and spend a lot of time selecting suitable targets
for investment.
Thinking bigger
Business owners must present a compelling business
There has been a huge growth in the number of sites offering P2PL
proposition concisely and succinctly. They must highlight the and crowd funding since 2008. This is mainly because interest rates
positive aspects of the venture, but with due regard to the risks have been low for many years, so savers have been desperate to seek
involved. Business owners also have to be comfortable with alternative ways of using their money to gain a good return. There has
sharing profits with the angel for as long as they are involved. One also been a ‘credit crunch’ since 2008, which has resulted in a reduction
example of a business that used business angels to raise finance in the number of loans granted by traditional business lenders such as
is Turbo Drinks, a Leeds-based soft drinks producer. It raised banks. Further, a string of financial scandals has led to a loss of trust in
£200,000 in 2011 from three angels who also brought with them Britain’s banks. In the future, if there is strong growth in these sources
of finance, it may become easier for businesses to raise external finance.
a wealth of business experience and financial knowledge. The market might become more competitive and business funding could
get cheaper and more accessible.
Question 1 You could use this information on sources of external funding in a
Usman Ahmad Khalid runs Khalid SportsGear Ltd, a sports variety of ways. It will be of use when answering questions on business
finance. It might also be useful when discussing changes in technology,
equipment manufacturing business in Carlisle. After a successful competition and business, business and the economy, business efficiency
start, Usman saw that the market was expanding and that an and the causes and effects of change.
opportunity existed for growing the business. However, his current
factory was too small and access was poor. Usman had found a new
location but £75,000 was needed to complete the move and meet Other businesses: Another external source of finance might
refurbishing costs. He met with a bank manager and it was agreed be provided by other businesses. For example, a business
that a good way forward would be to attract a business angel. might set up a fully-funded subsidiary. This might occur when a
Usman was introduced to Kyle Barton, a wealthy retired manufacturer sets up a business to supply it with components.
businessman. He agreed to put £75,000 in the business for a Some businesses set up joint ventures, where the businesses
20 per cent stake. Kyle advised Usman that he would be looking share the finance, costs and profits of a specific venture. Some
to ‘cash-in’ his investment in five years. In 2013, Usman said plcs buy shares in other companies. This might be to earn an
about the business angel: ‘Throughout the last four years Kyle income, if they have surplus cash for example. Alternatively, plcs
attended monthly meetings, making valuable contributions. With might buy shares in other companies to build a controlling stake,
his prudent advice he guided the business through a recession perhaps with a view to taking it over in the future.
and helped it to double in size. He had a number of useful
contacts and was particularly helpful on the marketing side. I will
Methods of finance
Businesses can use a variety of different methods to raise finance.
miss him when he moves on next year.’
(a) What is meant by the term ‘business angel’? Loans: A loan is an arrangement where the amount borrowed
(b) Explain two possible disadvantages of using business angels must be repaid over a clearly stated period of time, in regular
as an external source of finance. instalments. Loans tend to be rigid and interest will be added to
(c) Assess the impact Kyle has had on Usman’s business. the total. There are different sorts of loan capital.
●● Bank loans are probably the most common type of loan.

They may be unsecured loans. This means that the lender

Crowd funding: Crowd funding is similar to peer-to-peer has no protection if the borrower fails to repay the money
funding in that banks are excluded and individuals can lend owed. They can be used for long-term or short-term
money to others without previous knowledge of them. However, purposes depending on the needs of the business. However,
the fundraisers tend to be businesses or groups who are the use of unsecured bank loans has probably diminished in
involved in a particular venture such as staging a production, recent years due to the high risk they carry for banks.
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 Managing business activities

●● Mortgages are secured loans where the borrower has The shares of public limited companies are sold in a special
to provide some assets as collateral to support the loan. share market called the stock market or stock exchange.
This means that if the borrower defaults, the lender is Shares in private limited companies are transferred privately.
entitled to sell the assets and use the proceeds to repay the Shareholders, because they are part owners of the business,
outstanding amount. Mortgages are long-term loans and are entitled to a vote. One vote is allowed for each share
are typically for 25 years or more. They might be used by a owned. Voting takes place annually and shareholders vote either
business to fund the purchase of premises or a large item to re-elect the existing board of directors or replace them.
of capital equipment. Mortgages are usually cheaper than Different types of shares can be issued.
unsecured loans because there is less risk for the lender. ●● Ordinary shares. These are also called equities and are

●● Debentures are a specialised method of loan finance. The the most common type of share issued. They are also the
holder of a debenture is a creditor (someone to whom riskiest type of share since there is no guaranteed dividend.
the business owes money) of a company, not an owner. The size of the dividend depends on how much profit is
Debenture holders are entitled to a fixed rate of return, made and how much the directors decide to retain in the
but have no voting rights. They must also be repaid on business. All ordinary shareholders have voting rights. When
a set date – when the debenture matures. Public limited a share is first sold it has a nominal value shown on it – its
companies use this long-term source of finance. original value. Share prices will change as they are bought
and sold again and again.
●● Preference shares. The owners of these shares receive a
Maths tip
fixed rate of return when a dividend is declared. They carry
If a business takes out a four-year bank loan for £50,000 less risk because shareholders are entitled to their dividend
with an interest rate of 10 per cent per annum, what will be the before the holders of ordinary shares. Preference shareholders
monthly repayments (including interest)? are not strictly owners of the company. If the company is sold,
their rights to dividends and capital repayments are limited
Total interest = 10% × £50,000 × 4 = £5000 × 4 = £20,000.
to fixed amounts. Some preference shares are cumulative,
Monthly £50,000 + £20,000 £70,000 £1,458.33 entitling the holder to dividend arrears from years when
= = =
repayments 4 × 12 48 per month dividends were not declared. Some are also redeemable,
which means that they can be bought back by the company.
●● Deferred shares. These are not used often. They are

usually held by the founders of the company. Deferred

Question 2 shareholders only receive a dividend after the ordinary
Siobhan Daley runs a haulage company in Bristol. She shareholders have been paid a minimum amount.
owns five lorries and has a contract with a supermarket chain.
Venture capital: Venture capitalists are specialists in the
She distributes grocery products from suppliers to a network of
provision of funds for small and medium-sized businesses.
supermarkets in the south-west region. In 2013, she needed
Typically they invest in businesses after the initial start-up and
£60,000 to replace one of the older lorries. Siobhan considered
often prefer technology companies with high growth potential.
a number of sources but decided to take out a five-year bank They prefer to take a stake in the company, which means they
loan. The interest rate was 7.5 per cent per annum. have some control and are entitled to a share in the profit.
(a) What is meant by a bank loan? Venture capitalists raise their funds from institutional investors
(b) Calculate the total interest charge on the five-year loan. such as pension funds, insurance companies and wealthy
individuals. They are also likely to exit after about five years.
(c) Calculate the monthly repayments on the loan.
Examples of venture capitalists include MMC Ventures, Index
Ventures and AXM Venture Capital. Businesses may turn to
venture capitalists for funding when they have been refused by
Share capital: For a limited company share capital is likely other sources.
to be the most important source of finance. The sale of shares
can raise very large amounts of money. Issued share capital Bank overdraft: This is an important source of finance for
is the money raised from the sale of shares. Authorised share a large number of businesses. A bank overdraft means that a
capital is the maximum amount shareholders want to raise. business can spend more money than it has in its account. In
Share capital is often referred to as permanent capital. This other words they go ‘overdrawn’. The bank and the business will
is because it is not normally redeemed, i.e. it is not repaid agree on an overdraft limit and interest is only charged when
by the business. Once the share has been sold, the buyer is the account is overdrawn. The amount by which a business
entitled to a share in the profit of the company, i.e. a dividend. goes overdrawn depends on its needs at the time. This means
Dividends are not always declared. Sometimes a business that bank overdrafts provide a flexible source of funding to
makes a loss or needs to retain profit to help fund future businesses. However, a bank has the legal right to call in the
business activities. A shareholder can make a capital gain money owed at any point in time. This will happen if the bank
by selling the share at a higher price than it was originally suspects that the business is struggling and unlikely to repay
bought for. Shares are not normally sold back to the business. what is owed.
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External finance Unit 27

Leasing: A lease is a contract in which a business acquires Question 3

the use of resources such as property, machinery or
equipment, in return for regular payments. In this type of Andres Fonseca, co-founder of app company Virtually Free,
finance, the ownership never passes to the business that is received a grant of £50,000 from Nominet Trust, the UK’s largest
using the resource. With a finance lease, the arrangement is ‘tech-for-good’ funder. The grant enables tech entrepreneurs with
often for three years or longer and, at the end of the period, a social mission to develop a particular venture. For example,
the business is given the option of then buying the resource. projects that tackle issues such as health (like the Virtually Free
app), education, social care and environment.
There are some advantages of leasing. To get the grant, Virtually Free had to fill in some application
●● No large sums of money are needed to buy the use of
forms. There were three forms in total and success at each
equipment. stage brought on a more detailed form to complete. They had
●● Maintenance and repair costs are not the responsibility of
to provide information about different aspects of the business,
the user. from financial to technical to academic. The business had to
●● Hire companies can offer the most up-to-date equipment.
meet a number of conditions to qualify for the grant. They had
●● Leasing is useful when equipment is only required
to have a specific ‘social tech’ project to spend the money on and
occasionally. demonstrate the social impact of their project.
●● A leasing agreement is generally easier for a new company

to obtain than other forms of loan finance. This is because Virtually Free spent the grant on creating an app to treat
the assets remain the property of the leasing company. agoraphobia. This is a condition that may prevent individuals
However: affected from seeking help as it traps them at home and makes
●● over a long period of time leasing is more expensive than
it impossible for them to seek help outside. Virtually Free’s digital
the outright purchase of plant and machinery tool replicates the two parts that make up traditional treatment,
●● loans cannot be secured on assets which are leased.
namely education and training. Combined with exposure
therapy, these techniques are delivered to users via their phones
Trade credit: It is common for businesses to buy raw or tablets. One of the benefits of the tool is that it reduces, or
materials, components and fuel, and pay for them at a later even eliminates, the need for support staff or therapists. The
date, usually within 30–90 days. Paying for goods and grant helped Virtually Free to create what they consider to be
services using trade credit seems to be an interest-free way their first clinical application.
of raising finance. It is particularly profitable during periods of Source: adapted from: www.smallbusiness.co.uk
inflation. However, many companies encourage early payment
by offering discounts. The cost of goods is often higher if the (a) Explain one advantage for Virtually Free of getting a grant.
firm does not pay early. Delaying the payment of bills can also (b) What measures did Virtually Free have to take in order to
result in poor business relations with suppliers. qualify for its £50,000 grant?

Grants: Some businesses might qualify for financial support

in the form of a grant. Both central and local government back
a wide range of schemes. A list of grants available can be Knowledge check
accessed using the government’s ‘business finance support 1. What is meant by external finance?
finder’ tool. This allows firms to select specific funding options
2. What is the difference between crowd funding and peer-to-
and search for grants by business location, size and type of
peer lending?
business activity.
There are also other organisations, such as trusts and 3. State two reasons why a business angel would invest in a
industry specialists, which provide funding. For example, business.
the Building Enhancement Programme gives grants to 4. Bank overdrafts are flexible. What does this mean?
Swansea city-centre businesses to help build new shop fronts 5. What is the main advantage of an unsecured bank loan for a
or improve their facades. Fuse Fund provides grants for
business, when raising finance?
investment projects that will stimulate growth and create jobs
in Lancashire, including machinery acquisition and property 6. What is the difference between an ordinary share and a
improvements. preference share?
Grants are usually available to small businesses providing 7. What is meant by a capital gain?
they meet certain criteria. Most grants do not have to be 8. State two advantages of leasing as a method of finance.
repaid, so this is a significant advantage of this type of external
9. How might a business use trade credit as a method of finance?
finance.
10. What sort of businesses might venture capitalists look to
invest in?

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 Managing business activities

Case study
Figure 1
PRINCE HOSPITALITY Profit and retained profit for Prince Hospitality 2008–2014
£
Oxford-based Prince Hospitality provides corporate hospitality in
70,000
the south-east region. They organise trips, visits and events for
companies that want to entertain clients. Examples are taking 60,000

guests to high-profile sporting events such as race meetings and 50,000

international cricket, football and rugby matches. In the last five 40,000
Annual profit
years a lot of business has been generated organising hospitality Retained profit
30,000
at Premier League football stadiums, particularly for Champions
League matches. The market is growing very strongly and Jennifer 20,000

Prince, the owner of the business, has always been able to get 10,000
plenty of custom. 0
The business was started in a warehouse office in Abingdon.
-10,000
However, there is now a need to relocate to more salubrious 2008 2009 2010 2011 2012 2013 2014
offices in order to project a more ‘up-market’ image. There
are other investment needs. In total the business requires
£200,000 to: The method of funding preferred by Jennifer is the unsecured
bank loan. She does not really want to risk any personal
• relocate to a refurbished office in Hinksey
wealth by using her house as security for a mortgage.
• redesign and upgrade the website
Also, although her father could easily provide much of the
• set up a ticketing agency, ‘TicketPrince’, to buy and sell
finance in a share issue, she is a little worried that he might
tickets for sporting events.
try and interfere too much. She thinks the involvement of a
Jennifer is planning to use external funding for the business. business angel might be OK but wonders whether the right
Internal funding is not really an option because there are sort of investor could be found.
no assets to sell and Jenny has spent most of her profit on
developing her home in Woodstock. Figure 1 shows the profit
and retained profit for the business between 2008 and 2014. (a) What is meant by an unsecured bank loan? (2 marks)
After a meeting with her accountant, the following funding (b) Explain one disadvantage to Prince Hospitality of issuing
options have been identified. share capital. (4 marks)
• A mortgage, using Jennifer’s own house as security. (c) Explain one possible reason why Jennifer preferred external
• An unsecured bank loan. funding in this case. (4 marks)
• Set up a private limited company and sell shares to
members of the family. (d) Assess which method of finance Prince Hospitality is likely to
• Attract a business angel to invest in the company. use in this case. (12 marks)

Key terms
Authorised share capital – the maximum amount that can be Lease – a contract to acquire the use of resources such as
legally raised. property or equipment.
Bank overdraft – an agreement between a business and a bank Peer-to-peer lending (P2PL) – where individuals lend to other
that means a business can spend more money than it has in its individuals without prior knowledge of them, on the internet.
account (going ‘overdrawn’). The overdraft limit is agreed and Permanent capital – share capital that is never repaid by the
interest is only charged when the business goes overdrawn. company.
Capital gain – the profit made from selling a share for more Secured loans – a loan where the lender requires security, such
than it was bought. as property, to provide protection in case the borrower defaults.
Crowd funding – where a large number of individuals (the Share capital – money introduced into the business through
crowd) invest in a business or project on the internet, avoiding the sale of shares.
the use of a bank. Unsecured loans – where the lender has no protection if the
Debenture – a long-term loan to a business. borrower fails to repay the money owed.
Equities – another name for an ordinary share. Venture capitalism – providers of funds for small or medium-
External finance – money raised from outside the business. sized companies that may be considered too risky for other
Issued share capital – amount of current share capital arising investors.
from the sale of shares.

157
 28 Liability 2.1.3
Theme 2

Key points
1. Implications of limited and unlimited liability.
2. Finance appropriate for unlimited liability businesses.
3. Finance appropriate for limited liability businesses.

Getting started ●● Limited liability businesses. A limited liability business

has a legal identity separate from its owners. In other words,
Collette and Nyran own and run a service station on the A82 in the business (as opposed to the owners) can be sued,
Scotland in partnership. They have unlimited liability. Last year taken over or liquidated. These firms are sometimes called
the business lost £23,000, mainly because of road closures due incorporated businesses. The owners of these businesses
to bad weather and ongoing road works. They hope to relaunch will have limited liability.
the business by opening a café adjacent to the service station.
To convert an unused building at the site for this purpose will Figure 1 shows the different types of businesses, their legal
cost £60,000. status, their ownership and the owner’s liability.
What is meant by the term unlimited liability? How might
Collette and Nyran raise the £60,000 needed for the
Implications of unlimited liability
Business owners with unlimited liability are exposed financially
conversion? Under what circumstances might Collette and Nyran
to the failure of their businesses. If their business collapses while
be able to obtain a bank loan?
owing money to external parties, such as banks, suppliers and
the tax authorities, the owners will have to meet these debts
from their personal resources. This means that if owners do not
Limited liability and unlimited liability have the money to pay off these debts they can be forced to
businesses sell private assets to raise the necessary cash. For example, a
Whether business owners have limited liability or unlimited sole trader can be legally required to sell a house to raise funds
liability depends on the legal status of their businesses. This to meet a demand from the tax authorities. This is regardless of
may take one of two different forms. the hardship this might inflict on the owner and their family. This
●● Unlimited liability businesses. These are businesses highlights the risk taken by entrepreneurs when setting up an
where there is no legal difference between the owners and unincorporated business.
the business. They are sometimes called unincorporated Owners of businesses with unlimited liability are also
businesses. Everything is carried out in the name of the liable for any unlawful acts committed by the owners or the
owner or owners. These firms tend to be small, owned employees. For example, if an employee wrote something
either by one person or a few partners. The owners of these libellous about someone, that person might be able to claim
businesses will have unlimited liability. compensation from the business owner. If the business does not

Figure 1
Businesses with unlimited and limited liability

Private sector business organisations

Unlimited liability businesses Limited liability businesses

Private limited Public limited

Partnership
Sole trader company company
(owned by
(one owner) (owned by a few (owned by many
partners)
shareholders) shareholders)

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 Managing business activities

have enough money to pay, the owner would again have to use private wealth of the business’s shareholders if the business
private funds. The owners may also be financially liable if sued cannot pay the compensation. However, there are exceptions to
successfully by other stakeholders, such as customers, employees this rule. Courts may decide that individuals are liable if a crime
or suppliers. This all arises because there is no separation of legal has been committed or if the company has failed to maintain
identity between the business and the owners. adequate records and accounts, hold annual general meetings
Businesses with unlimited liability sometimes find it easier or file annual reports. This might be more likely to happen with
raising finance. This is because lenders will be reimbursed if a private limited companies.
business defaults. Unlimited liability businesses are often also Because shareholders’ private assets are protected, limited
seen as more credible. This is because owners are encouraged companies may find it easier to raise larger amounts of money
to be more cautious since their personal assets are at risk. from investors. As a result investors are more willing to buy
shares in limited companies because they know precisely
Question 1 the extent of their liability – it is limited to the size of their
investment. However, in some cases the owners of small limited
Candy McDougal runs a sandwich bar in Glasgow city centre. companies, who are frequently also shareholders, are required
She is a sole trader and the business has unlimited liability. The to give personal guarantees of the company’s debts to those
rent she pays on her high street shop is high, but she reckons it lending to the company. They will then be liable for those debts
is worthwhile because the passing trade is so good. Her rent is in the event that the company cannot pay, although the other
£3,000 per month which she pays six months in advance and shareholders will not be.
she has signed a five-year lease.
Unfortunately, three of her customers fell ill as a result of
Choosing appropriate finance
The wide range of sources and methods of finance was
eating contaminated food from her sandwich bar. One customer
discussed in Units 26 and 27. However, not all of these sources
threatened to take her to court, but eventually settled out of
can be accessed by all businesses. The method of finance
court accepting an £8,000 payout. Candy had to use her own
chosen by a business can be influenced by a number of factors.
savings to meet this payment because the business bank account
only contained £2,300. Whether short-term or long-term finance is needed:
If a business needs to borrow money for a lengthy period of
time, say ten years or more, certain types of funding are more
suitable than others. For example, mortgages can be taken out
for 25 years. Unsecured bank loans may be granted for one to
five years. Debentures can be issued for up to 30 years. Share
capital – money raised from the sale of shares – is permanent
capital and never repaid. This is the most long-term method
of finance. A business is not likely to use trade credit, bank
overdrafts or leasing for long-term funding. These are more
suitable for short-term borrowing.

The financial position of the business: The financial

situation of businesses is constantly changing. When a
business is in a poor financial situation, it finds that lenders are
(a) What is meant by a business with unlimited liability? more reluctant to offer finance. At the same time, the cost of
(b) Explain two implications of running a business with unlimited borrowing rises. Financial institutions are more willing to lend to
liability. secure businesses, which have a large amount of collateral.

The type of expenditure for which the money

Implications of limited liability is needed: When a company undertakes heavy capital
The owners of businesses with limited liability are shareholders. expenditure, it is usually funded by a long-term source of finance.
The main advantage of this is that shareholders’ financial liability For example, the building of a new factory might be financed by
is limited to the amount of money they invested in the business. a share issue or a mortgage. Revenue expenditure tends to be
It is a fixed sum and equal to the amount of money they paid for financed by short-term sources. For example, the purchase of raw
their shares. If a limited company collapses, the owners’ private materials might be funded by trade credit or a bank overdraft.
assets are fully protected. Shareholders cannot be legally forced
to sell personal assets to meet the business’s debts. Cost: Businesses will prefer sources and methods that are less
Shareholders also have protection from legal claims on the expensive, both in terms of interest payments and administration
business. This is because the owners and the business have costs. For example, share issues can carry high administration
separate legal identities. For example, if a customer sues a costs, while the interest payments on bank overdrafts tend to be
limited company for damages, there can be no claim on the relatively low.

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Liability Unit 28

The legal status of the business: This will depend on For example, the owners of unlimited liability businesses have to
whether a business has limited or unlimited liability. This is meet business debts from their own resources, so lenders might
discussed in more detail below. be reimbursed if a business collapses.

Finance appropriate for unlimited Finance appropriate for limited liability

liability businesses businesses
Unlimited liability businesses, such as sole traders and Generally, limited liability businesses, particularly plcs, have a
partnerships, have fewer sources and methods of finance to much wider range of funding opportunities. Some methods of
choose from. They are most likely to include some of the following. finance, such as shares and debentures, for example, are only
●● Personal savings. Most small-business owners with available to limited companies. The main advantage for limited
unlimited liability are likely to use their own money to set up a liability businesses is that they tend to be larger than unlimited
business. It is an important source of finance. liability businesses and have more resources to support loans.
●● Retained profit. This source can only be used if the Consequently, they are less risky for lenders and other investors.
business survives and becomes established. As the business Appropriate sources of finance for limited liability businesses
develops it must generate enough profit to support both the include the following.
owner and future business investment. However, for many ●● Share capital. The sale of shares allows limited companies

unlimited liability businesses, the scope for using retained to raise very large amounts of capital. Share capital is
profit is restricted. provided by the owners of the business from their own
●● Mortgage. It is common for unlimited liability businesses to resources. Once shares are purchased, the money raised is
use the owner’s house as collateral for a business loan. This not normally repaid to shareholders, so the capital remains
provides a source of long-term finance. However, the owners in the business for as long as it is trading. Also, a business
are at increased risk. If the business goes into heavy debt might raise more money in the future by selling more
and fails, the owners can suffer serious financial hardship, shares. They may use a rights issue, for example. This is
such as losing the house. where existing shareholders are given the ‘right’ to buy
●● Unsecured bank loans. On occasion, banks might advance new shares at a discounted price. This is cheap and simple
unsecured loans to established and successful businesses. This and creates free publicity. Share allocations are based on
might depend on the financial climate at the time of request. For current holdings; for example, a one-for-five issue means that
example, banks may have tighter criteria for unsecured bank shareholders can buy one new share for every five that they
loans if there is a credit crunch. Owners must be prepared to currently own. Rights issues are also normally regarded as a
produce detailed business plans to obtain bank loans. cost-effective way of raising fresh capital.
●● Peer-to-peer lending. Small business owners can raise ●● Debentures. Public limited companies can raise large

finance through dedicated websites from people interested in amounts of money by selling debentures. This loan
lending money to their enterprise, thus avoiding the need for capital can be very long term – up to 30 years. One key
a bank. However, some peer-to-peer funding is not available advantage of this method to the business is that, unlike
to businesses. The owners will have to check with individual shareholders, debenture holders do not have any control
P2PL sites to see whether businesses can borrow. over the business.
●● Crowd funding. Crowd funding can provide long-term ●● Retained profit. Around half of all business finance comes

finance for businesses. Once this new concept has had time from retained profit. Limited liability businesses are no
to develop and prove to be reliable, it could well become a exception. Some very large companies have hundreds of
very popular source for unlimited liability businesses. millions of pounds in cash reserves, which have accumulated
●● Bank overdraft. Most businesses will have access to a bank over the years. Some of this is likely to be used by the
overdraft. However, the size of the overdraft limit will vary business in the future.
considerably. Established and profitable businesses will have ●● Venture capitalists. The majority of finance provided by

access to much larger overdrafts than those that are not. venture capitalists finds its way into limited companies. One
●● Grants. These can provide a ‘free’ source of finance to reason is because they usually take a share in the business,
unlimited liability businesses. However, businesses have to thereby having some control over the key decisions. Venture
prove that they qualify for grants and some owners might be capitalists also like to invest larger amounts of money
put off by the lengthy application process. than business angels – several million pounds sometimes.
However, they are also prepared to invest in small and
All of the finance sources outlined above are appropriate for medium-sized enterprises.
unlimited businesses because they are accessible to small ●● Business angels. Business angels may provide funds for

businesses. Businesses with unlimited liability tend to be small both limited and unlimited liability businesses. They will
and often struggle to raise finance. Such businesses have access normally take a share in the business, but this does not
to fewer sources because they have fewer assets that can be mean they will avoid sole traders and partnerships. They
used as collateral. Also, they may be new start-ups with no are also more inclined to invest at an earlier stage than
trading record, which can often discourage lenders. However, it venture capitalists. One problem with business angels is
must be remembered that there are exceptions to these rules. that they are often difficult to find. This sometimes means

160
 Managing business activities

that entrepreneurs spend too long searching for suitable

Exam tip
angels when their time could be better spent focusing on the When answering a question on the suitability of different finance
development of the business. sources for a business, it is important to pay close attention to
●● Other sources. Businesses with limited liability are all likely the financial circumstances of the particular business. Theoretically,
to use bank overdrafts, trade credit, leasing, unsecured bank most sources are available to all businesses (depending on their
loans, mortgages and grants in some combination or other. legal status), but in reality the current financial position of the
Larger limited companies are much less likely to use sources business will be crucial. Generally, businesses will struggle to raise
finance from any source if they are losing money, have cash-flow
such as crowd funding and P2PL.
problems, are encountering trading difficulties, already owe money
to other lenders, or have few assets.
All the finance sources outlined above are appropriate for
limited liability businesses. One reason for this is due to their
legal status. For example, only limited companies can issue
shares to raise finance. Other sources, such as business angels Key terms
and venture capitalists, are likely to be appropriate because they Collateral – an
prefer to invest in, or lend to, larger businesses which tend to asset that might be sold to pay a lender when a loan cannot
be limited companies. be repaid.
Incorporated business – a business model in which the
business and the owner(s) have separate legal identities.
Maths tip Limited liability – a legal status that means shareholders
It was widely reported that RSA, a large insurance can only lose the original amount they invested in a
company, planned to raise £748 million in a rights issue. It business.
Long-term finance – money borrowed for more than one year.
proposed to offer shareholders three new shares for every eight
Rights issue – issuing new shares to existing shareholders
held at the heavily discounted price of 56p.
at a discount.
If a shareholder owned 240,000 shares, how many new shares Short-term borrowing – money borrowed for 12 months
would that holder be entitled to buy and how much would they or less.
cost them? Undercapitalised – a business not raising enough capital
Share entitlement = 3/8 x 240,000 = 90,000 shares when setting up.
Unincorporated businesses – a business model in which
Cost of share purchase = 90,000 x 56p = £50,400 there is no legal difference between the owner(s) and the
business.
Unlimited liability – a legal status which means that
Thinking bigger business owners are liable for all business debts
It has been argued that many businesses in the UK are
undercapitalised. This means that they did not raise enough capital
when setting up. This is particularly true for small and medium-sized
businesses. Knowledge check
Most business start-ups are funded by personal finance, family, friends 1. What is the difference between limited and unlimited
and house re-mortgaging. This is often the case when availability of
liability?
capital for new businesses is very low. Companies at early stages of
setting up have low or zero revenues but high expenditure, and are 2. State two implications of limited liability for a business.
often in need of additional funding to develop.
3. Why might a business with unlimited liability sometimes find
However, bank loans and overdrafts, historically the only available it easier to raise finance than one with limited liability?
sources of external finance, are unsuitable for new firms. This is because
the cost of servicing the debt comes at a time when cash is short. Also, 4. How is a limited liability business most likely to raise capital?
the lending terms from banks are often demanding and subject to
change at any time, which is not good for a new start-up. The advantage
5. What is a rights issue?
of capital finance is that it is permanent. It cannot be withdrawn 6. Which sort of business is likely to issue debentures?
(although it can be lost) and does not drain cash.
7. What is undercapitalisation?
Perhaps the development of crowd funding, where lots of individuals are
invited to invest small sums of cash in start-up or early stage companies,
will help deal with this problem of undercapitalisation.
Source: adapted from www.support-finance.co.uk

161
Liability Unit 28

Case study
Mothercare plc

ILGA SKUJA AND In 2014 Mothercare, the retailer of parent and children’s
products, raised £100 million in a rights issue. The company
MOTHERCARE PLC offered nine new shares at a price of 125p for every ten
shares currently held by shareholders. Mothercare said in a
statement that it planned to use the proceeds to modernise
Ilga Skuja
and revitalise the group’s retail chain and reduce debt.
Ilga Skuja, a talented IT expert, arrived in the UK from It planned to close 75 stores, improve the company’s IT
Latvia in 2006. For two years she worked for a major UK systems and transform the property-heavy business into a
software company. In 2008 she started her own unlimited digitally led business. Mothercare’s share price was 173p on
liability business, investing £10,000 of her savings in an 5 November 2014.
online marketing service. She produced online promotional
Source: adapted from the Financial Times 27.10.14,
materials for rock bands and celebrities. The business grew
all rights reserved.
quickly and was profitable for four years. However, in 2013
competitors entered the market and offered better services
– making particular use of apps for mobile phones. To
maintain her market share, she needed to retrain and invest
in new technology. The business also suffered from cash-
flow problems as it was owed a total of £7,800 from clients.
The business is now £3,000 overdrawn (it has an overdraft
limit of £3,500) and Ilga needs a total of £12,000 to get
the business back on its feet. The business has no collateral.
Ilga owns a house worth £150,000, but has £110,000
outstanding on the mortgage. The profit made by the
business between 2008 and 2014 is shown in Figure 2.

Figure 2
Profit made by Ilga Skuja’s business 2008–2014
£

40,000
(a) (i) Calculate the cost to a shareholder of taking up the
35,000 whole entitlement if 2,000,000 shares are currently held.
30,000
(4 marks)
(ii) Calculate the profit made by the shareholder if
Profit

25,000 500,000 of the new shares were sold on 5 November

20,000
2014. (4 marks)
(b) Explain one implication for Ilga Skuja of unlimited liability.
15,000
(4 marks)
10,000
(c) Explain how raising capital using a rights issue might
5,000 benefit Mothercare. (4 marks)
2008 2009 2010 2011 2012 2013 2014*
(d) Assess the possible funding options available to Ilga Skuja.
Year * Estimated
(12 marks)

162
 29 Planning 2.1.4
Theme 2
Key points
1. The relevance of a business plan in obtaining finance.
2. Interpretation of a simple cash-flow forecast and calculations based on changes in cash-flow variables.
3. The use and limitations of a cash-flow forecast.

Getting started unless the owners can provide a clear, concise vision of future
CoolCo Ltd makes children’s clothes. It is a fairly new brand on progress and profitability. In particular, investors will want to
the market and the manufacturer is beginning to receive interest know how their money is going to be spent and when and
how they are going to benefit from their investment. Also,
from high street retailers. However, the board of CoolCo Ltd
when a company plans to raise money by floating on the stock
has agreed that it needs to increase capacity, as it cannot meet
market, it must publish a prospectus. This is a document that
large orders from its existing factory. CoolCo Ltd needs to raise
contains important elements of the business plan and other
£200,000 to upgrade its manufacturing facilities. It would like
information for investors. This will help potential investors have
to attract a business angel or a venture capitalist to invest in the confidence that the company is going to be a success before
business. The first stage in this process is to draw up a business they commit to buying shares.
plan, incorporating a comprehensive cash-flow forecast. A thorough and well-written business plan is likely to:
●● force owners to take an objective, critical and unemotional

look at the whole business idea

●● provide a ‘road map’ that shows a clear direction for the

development of the business

●● provide an action plan that identifies key tasks that must

be undertaken and goals that must be met to improve the

chances of success
●● flag up potential problems in advance so that investors are

aware and solutions can be found

●● help show lenders and investors that the owner is cautious,

responsible, serious and credible.

The contents of a business plan

The outline of a business plan can be obtained from any of
Why is it necessary for CoolCo Ltd to draw up a business plan? the major banks in leaflets they produce on starting up a
What information might be contained in a business plan? What business. They give a very detailed list of points which must
is a cash-flow forecast? How might a cash-flow forecast help be addressed in the plan. These include the following.
CoolCo to obtain finance? ●● An executive summary – an overview of the business

start-up. It describes briefly the business opportunity to be

exploited, the marketing and sales strategy, operations and
The relevance of a business plan then finance.
For many people, setting up a business is a life-changing ●● The business opportunity – a description of the product

decision and will have far-reaching consequences. It is or range of products to be made, the quantity to be sold
important, therefore, to carefully plan the whole process. and the estimated price.
Indeed, research has shown that start-up businesses that ●● Buying and production – where the business will buy

have prepared a business plan are more likely to succeed its supplies, production methods to be used, the cost of
than those that have not. The business plan shows how the production.
business will develop over a period of time. ●● Financial forecasts – a variety of financial forecasts

A business plan is also needed to support applications for need to be included, such as a sales forecast, a cash-
finance, both at the start-up stage and in the future. Lenders flow forecast, a profit and loss forecast and a break-even
and other investors are not likely to put money into a business analysis.

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Planning Unit 29

●● The business and its objectives – the name of the Cash-flow forecasts
business, its address, its legal structure and its aims and Without cash a business cannot trade. Experts suggest that
objectives. about 20 per cent of business failures are due to poor cash
●● The market – the size of the potential market and a flow. Even when trading conditions are good, businesses
description of the potential customers, the nature of the can fail. A business must ensure that it has enough cash to
competition, marketing priorities. pay staff wages and bills when they are due. One way for
●● Personnel – who will run the business, how many a business to help control its cash flow is to plan ahead by
employees, if any, there will be, the skills, qualifications and producing accurate cash-flow forecasts. Such forecasts also
experience of those in the business. form an important part of business plans.
●● Premises and equipment – the premises to be used,
equipment which needs to be obtained and financed. Interpreting cash-flow forecasts
●● Finance – where the finance to start up and run the A cash-flow forecast lists all the likely receipts (cash inflows)
business will come from. and payments (cash outflows) over a future period of time.
All the entries in the forecast are estimated because they
have not occurred yet. The forecast shows the planned cash
Question 1 flow of the business month by month. Table 1 on the next
page shows a twelve-month cash-flow forecast statement for
Cherry Watson is a retired teacher of modern languages. She Fishan’s Ltd, a grocery wholesaler located in Ipswich.
lives in London and wants to set up a tutoring agency. She thinks What is predicted to happen to cash flow at Fishan’s over
there is a demand for private lessons in French and Spanish from the twelve-month period?
students studying modern language GCSEs and A-levels. She
also thinks that money could be made setting up short language January: The company will have an opening cash balance
courses for people wanting to learn English, for instance new of £11,000 in January. In January receipts are expected to
arrivals from Eastern Europe. be £451,000 and payments £365,000. This means that an
extra £86,000 (£451,000 – £365,000) will be added in this
month – a positive net cash flow. The closing balance should
be £97,000 (£11,000 + £86,000).

February: In February expected payments (£406,000) are

greater than expected receipts (£360,000). This means that
there will be a negative net cash flow of £46,000 in February.
However, the opening balance of £97,000 will cover this and
the business will not have a cash-flow problem. It ends the
month with a positive closing balance of £51,000 (£97,000 –
£46,000).

March: In March payments again will be greater than

receipts, giving a negative net cash flow of £92,000.
However, this is now greater than the opening balance of
£51,000. This means that the business faces a negative
closing balance of £41,000 and will have a cash-flow
problem. It would have to find some way to finance this,
perhaps by borrowing from a bank.

March to May: The business will have cash-flow problems

Cherry has discussed the idea with friends and spoken to some in March and April, when it faces negative closing balances,
other language teachers who have expressed an interest in using even though in April receipts are greater than payments (a
the agency to get work. She has also met with a bank manager positive net cash flow). In May, however, the negative opening
to discuss funding for such a business. Cherry calculated that she balance of £26,000 is outweighed by the positive net cash
would need £15,000 to get started. A lot of this money would flow of £113,000. The business will have a positive closing
be used to market the business at the launch stage. However, balance of £87,000 and no cash-flow problem.
the bank manager has said that to have any chance of getting
funding she will need to write a business plan. June to December: In June and August, but not July, the
business would have cash flow problems. From September
(a) What is meant by a business plan?
onwards, when there will be positive closing balances every
(b) Explain how Cherry might benefit from writing a business month, there appear to be no cash-flow problems. This is
plan. because the owners plan to introduce £300,000 into the
business in September.

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 Managing business activities

Table 1 Cash-flow forecast for Fishan’s Ltd

(£000s)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Receipts
Cash sales 451 360 399 410 490 464 452 340 450 390 480 680
Capital introduced 300
Total receipts 451 360 399 410 490 464 452 340 750 390 480 680
Payments
Goods for resale 150 180 150 180 150 180 150 180 150 180 220 250
Leasing charges 20 20 20 20 20 20 20 20 20 20 20 20
Motor expenses 40 40 40 40 40 40 40 40 40 40 40 40
Wages 100 100 100 100 100 100 100 105 105 105 125 125
VAT 126 189 187 187 198
Loan repayments 35 35 35 35 35 35 35 35 35 35 35 35
Telephone 11 12 12 14
Miscellaneous 20 20 20 20 20 20 20 20 20 20 20 20
Total payments 365 406 491 395 377 584 552 412 557 400 474 688
Net cash flow 86 (46) (92) 15 113 (120) 87 (72) 193 (10) 6 (8)
Opening balance 11 97 51 (41) (26) 87 (33) 54 (18) 175 165 171
Closing balance 97 51 (41) (26) 87 (33) 54 (18) 175 165 171 163
Brackets show minus figures.

Question 2
Frank Fullerton owns a bookshop near the University of Table 2 Cash-flow forecast for Frank Fullerton’s
Hull. He sells educational books to students, but also has a bookshop (£)
large stock of fiction books. Unfortunately the business has   Jan Feb Mar
been struggling in recent months. He thinks that students are Cash inflows  
sharing books and therefore his sales are suffering. Table 2 Book sales 3,000 3,500 3,100
shows a cash-flow forecast for the bookshop at the beginning Fresh capital 2,000
of 2014. It is incomplete. Interest 150  
Total cash inflows 3,000 3,650 5,100
Cash outflows  
Stock 1,700 1,790 1,900
Casual labour 500 500 500
Rent 1,000 1,000 1,000
Other expenses 230 240 230
Total cash outflows ? ? ?
Net cash flow ? ? ?
Opening balance 230 ? ?
Closing balance ? ? ?

(a) Using examples from this case, explain the difference

between cash inflows and cash outflows.
(b) Complete the cash-flow forecast for Frank Fullerton’s
bookshop to show:
(i) the total cash outflows for each month
(ii) the closing balance for each month
(iii) the opening balance for February and March.
(c) Assess, using information from the table, whether the
business is struggling.

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Planning Unit 29

Changes in cash-flow variables In August Mr Patel had to buy computer equipment to help
Once a cash-flow forecast has been prepared, it can be in the repair of newer cars. This cost £1,200. He also had to
adjusted to show the effect on net cash flows of changes in employ more casual labour to help out in the shop. As a result,
some of the variables. wages paid to casual labourers rose to £1,100 per month from
Table 3 shows a six-month cash-flow forecast for Patel August onwards. Finally, Mr Patel received a £400 unexpected
Motors, a small garage and car service business in Bromsgrove. payment from a customer in September for work carried out
Mr Patel opened a shop inside his garage in May and hopes two years ago. He had previously written off the debt, that is
that this will help to boost his cash flow. declared the money lost.
The forecast shows that by the end of the six-month period The effects of changes to variables are shown in Table 4.
the cash position of the business is expected to improve. The There will be a negative impact on the cash balance of the
closing cash balance is forecast to rise from £1,900 in June to business at the end of the six months. The closing cash balance
£3,550 in November. is now expected to fall from £1,900 in June to £1,550 in
However, after a couple of months it became evident November.
that some of the figures in the forecast needed amending.

Table 3 Cash-flow forecast for Patel Motors

  June July August September October November
Cash inflows  
Petrol and repairs 6,700 6,600 7,200 6,800 7,100 7,600
Shop and other sales 2,250 2,750 2,300 3,300 3,850 4,350
Total cash inflows 8,950 9,350 9,500 10,100 10,950 11,950
Cash outflows  
Casual labour 800 800 800 800 800 800
Petrol and parts 4,250 4,300 4,700 4,500 4,500 5,000
Stock and other expenses 2,450 2,500 4,500 5,000 5,600 5,600
Total cash outflows 7,500 7,600 10,000 10,300 10,900 11,400
Net cash flow 1,450 1,750 (500) (200) 50 550
Opening balance 450 1,900 3,650 3,150 2,950 3,000
Closing balance 1,900 3,650 3,150 2,950 3,000 3,550

Table 4 Amended cash-flow forecast for Patel Motors

  June July August September October November
Cash inflows  
Petrol and repairs 6,700 6,600 7,200 6,800 7,100 7,600
Shop and other sales 2,250 2,750 2,300 3,300 3,850 4,350
Debt repayment 400  
Total cash inflows 8,950 9,350 9,500 10,500 10,950 11,950
Cash outflows  
Casual labour 800 800 1,100 1,100 1,100 1,100
Petrol and parts 4,250 4,300 4,700 4,500 4,500 5,000
Stock and other expenses 2,450 2,500 4,500 5,000 5,600 5,600
Computer equipment 1,200  
Total cash outflows 7500 7600 11500 10600 11200 11700
Net cash flow 1,450 1,750 (2,000) (100) (250) 250
Opening balance 450 1,900 3,650 1,650 1,550 1,300
Closing balance 1,900 3,650 1,650 1,550 1,300 1,550

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 Managing business activities

Worked example the reader to identify when a bank overdraft will be needed.
For example, Table 1 showed that Fishan’s would need to
The effect of a change in one single variable in a cash- borrow money in March, April, June and August. In addition,
flow forecast has a multiplied effect on the rest of the forecast. if a large cash surplus is identified in a particular month, this
The simple cash-flow forecast for a retailer is shown in Table 5. might provide an opportunity; for example, to buy some new
The effect of an increase in stock purchases from £69,000 to equipment. A business should try to avoid being overdrawn at
£72,000 in June is shown in Table 6. The changes are shown in the bank because interest is charged. If certain payments can
green. Note that the increase in the value of stock purchases has be delayed until cash is available, this will avoid unnecessary
an impact on five other values – even in this very simple forecast. borrowing.
Cash-flow forecasts are particularly helpful for businesses
Table 5 Simple cash-flow forecast
that have seasonal demand. This is because cash inflows will be
  JUN JUL irregular, i.e. high during peak season and low at off-peak times.
Cash inflow   It will be important to delay some payments during periods
Sales revenue 98,000 107,000 where cash inflows are expected to be low.
Cash outflow  
Supporting applications for finance: When trying to raise
Wages 25,000 25,000
finance, lenders often insist that businesses support their
Stock 69,000 74,000 applications with documents showing business performance,
Total cash outflow 94,000 99,000 outlook and solvency. A cash-flow forecast will help to indicate
Net cash flow 4,000 8,000 the future outlook for the business. It is also common practice to
Opening balance 10,000 14,000 produce a cash-flow forecast statement in the planning stages of
setting up a business. It is unlikely that any potential investor or
Closing balance 14,000 22,000
lender will finance a business without a thorough business plan
supported by a cash-flow forecast.
Table 6 The effect of changes in one variable
(shown in light green) Enhancing the planning process: Careful planning in
  JUN JUL business is crucial. It helps to clarify aims and improve
Cash inflow   performance. Producing a cash-flow forecast is a key part of
Sales revenue 98,000 107,000 the planning process because it is a document concerned with
the future. If business owners try to run a business without any
Cash outflow  
forward planning, mistakes are more likely to be made and it is
Wages 25,000 25,000 difficult to identify problems in advance. A lack of planning is
Stock 72,000 74,000 likely to result in poor business performance.
Total cash outflow 97,000 99,000
Net cash flow 1,000 8,000 Monitoring cash flow: During and at the end of the
financial year, a business should make comparisons between
Opening balance 10,000 11,000
the predicted figures in the cash-flow forecast and those that
Closing balance 11,000 19,000 actually occurred. This will help identify where problems have
arisen. The business can then try to identify possible reasons for
any significant differences between the two sets of figures. For
Maths tip example, it might be that an overpayment was made. Constant
monitoring in this way should allow a business to control its cash
Cash-flow forecasts can be produced on spreadsheets.
flow effectively.
This means that the effect of changes in some of the variables,
such as in the examples above, can be shown very easily. Once The limitations of cash-flow forecasts
the new figures are entered in the spreadsheet, the new totals Although cash-flow forecasts are extremely useful in helping to
and balances are calculated automatically. manage a business, it is important to recognise their limitations.
●● Some of the financial information used in forecasts will

be based on estimates. For example, even under normal

The use of cash-flow forecasts trading conditions it is very difficult to predict sales revenue
Businesses draw up cash-flow forecast statements to help for a future time period – it has to be estimated. It is also
control and monitor cash flow in the business. There are certain difficult to estimate future costs – particularly variable costs.
advantages in using forecasts to control cash flow. These will be dependent on future sales that are uncertain.
Fixed costs, such as rent, rates and insurance are more
Identifying the timing of cash shortages and surpluses: predictable. Consequently, if the figures for cash inflows and
A forecast can help to identify in advance when a business cash outflows are not accurate, then the net cash flows and
might wish to borrow cash. At the bottom of the statement closing balances will be unreliable.
the monthly closing balances are shown clearly. This will help
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Planning Unit 29

●● Business activity is subject to external forces that are beyond ●● A cash-flow forecast only focuses on one important
the control of owners and managers. Changes in factors such as business variable – cash. Other variables are also
interest rates, the state of the economy, government legislation, important, such as profit, profit margins and productivity.
exchange rates, competition and consumer tastes can have an The cash-flow forecast is a one-dimensional tool and
impact on business costs and revenues. As a result, there will cannot be used on its own to evaluate the performance
be an impact on a cash-flow forecast. For example, the cash- of a business.
flow forecast for a wheat farm would be affected negatively if
poor weather conditions reduced crop yields.
●● A business uses resources in preparing a cash-flow forecast. Exam tip
A business owner or employee will spend time gathering When answering a question on the usefulness of cash-flow
the information and assembling the forecast. It will also have forecasting to a business, remember to analyse both the
advantages and the disadvantages. You will need to apply your
to be regularly updated so that the monitoring process is answer to the case material provided and make a judgement at the
meaningful. There might be a danger, for instance, that an end. The judgement might require you to say whether cash-flow
owner spends too much time focusing on the cash-flow forecasting is beneficial overall to the business in your case.
forecast at the expense of meeting customer needs.

Case study
At the end of January the firm’s financial director notified
the board that the forecast had to be amended to take into
CHARLTON PLASTICS LTD account the following changes.
• Wages would have to rise to £57,000 from February
Charlton Plastics Ltd manufactures polythene materials onwards.
for the packaging industry. The family-run business is
committed to the use of recycled materials and produces a • Due to favourable market conditions, material prices would
range of plastic bags, sacks and sheets. In 2011 the business fall to £71,000, £75,000 and £81,000 in February, March
started to export its products and recently overseas sales and April respectively.
have grown healthily. • A payment of £11,500 to the tax authorities would have to
In December 2013, Charlton’s financial director produced a be paid in February to compensate for an underpayment in
cash-flow forecast for the following year. Table 7 shows part the previous tax year.
of that forecast, from January to April 2014.
Table 7 Cash-flow forecast for Charlton Plastics Ltd
JAN FEB MAR APR
(a) Explain one reason why a cash-flow forecast is an
Cash inflows important part of a business plan. (4 marks)
Home sales 124,000 124,000 125,000 128,000
(b) Calculate the closing balances in the cash-flow forecast
Export sales 62,000 63,000 66,000 72,000 resulting from the changes above. (4 marks)
Interest 3,000 3,000 3,000 3,000
(c) Assess the impact of the changes in the cash-flow forecast
Total cash inflows 189,000 190,000 194,000 203,000 on Charlton Plastics Ltd. (8 marks)
Cash outflows (d) Evaluate the use of cash-flow forecasts by Charlton Plastics
Wages 55,000 55,000 55,000 55,000 Ltd. (20 marks)
Materials 76,000 78,000 81,000 87,000
Insurance 4,000 4,000 4,000 4,000
Drawings 21,000 21,000 21,000 21,000
Other overheads 24,000 27,000 28,000 30,000
Total cash outflows 180,000 185,000 189,000 197,000
Net cash flow 9,000 5,000 5,000 6,000
Opening balance 12,300 21,300 26,300 31,300
Closing balance 21,300 26,300 31,300 37,300

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 Managing business activities

Key terms Knowledge check

Business plan – a plan for the development of a 1. State five pieces of information that are likely to appear in a
business, giving details such as the products to be made, business plan.
resources needed, and forecasts such as costs, revenues
2. Give two examples of cash inflows in a cash-flow forecast.
and cash flow.
Cash-flow forecast – the prediction of all expected receipts 3. Give two examples of cash outflows in a cash-flow forecast.
and expenses of a business over a future time period which 4. How is the net cash flow calculated in a cash-flow forecast?
shows the expected cash balance at the end of each month.
Cash inflows – the flow of money into a business. 5. How is the closing cash balance calculated in a cash-flow
Cash outflows – the flow of money out of a business. forecast?
Net cash flow – the difference between the cash flowing 6. State three benefits of using a cash-flow forecast.
in and the cash flowing out of a business in a given 7. How is a cash-flow forecast used as a planning tool?
time period.
Solvency – the degree to which a business is able to meet 8. State three limitations of using a cash-flow forecast.
its debts when they fall due.

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 30 Sales forecasting 2.2.1
Theme 2

Key points
1. Purpose of sales forecasts.
2. Factors affecting sales forecasts: consumer trends, economic variables and the actions of competitors.
3. Difficulties of sales forecasting.

Getting started predictions of sales, these questions are impossible to answer.

Businesses are keen to know about what might happen in the
All business organisations, from the smallest of sole traders to the future. Anything a business can predict accurately will reduce
largest multinational, must try to forecast future sales. Important uncertainty and enable it to plan more effectively.
decisions within the business will be based on these forecasts. Given the importance of sales forecasting, the next step is
to understand how to produce forecasts that will be useful to
any business.
Forecasting is a business process, assessing the probable
outcome using assumptions about the future. Forecasts may be
based on a variety of data, for instance current information
provided by managers. Most forecasts are based on data
gathered from a variety of market research techniques. The
accuracy of forecasts will depend on the reliability of the data.
What might a business like to predict with accuracy?
Examples include:
●● future sales of products

●● the effect of promotion on sales

●● possible changes in the size of the market in the future

●● the way sales fluctuate at different times of the year.

Time series analysis: A variety of techniques can be used

Marco Frederick owns and runs an ice-cream manufacturer that to predict future trends. One of the most popular is time
produces high-quality ice cream. Marco was sitting in his office series analysis. This involves predicting future levels from past
late one evening preparing orders from his suppliers for the data. The data used are known as time series data – a set of
following three months. He was deciding how much of his key figures arranged in order, based on the time they occurred. For
example, a business may predict future sales by analysing sales
raw materials he needed to buy. Milk, sugar and ingredients
data over the last ten years.
such as vanilla and clotted cream are expensive and are an
important cost for his business. But how much of each should Table 1 Yearly sales of a garden furniture manufacturer
he order? If he ordered too much the result would be waste. If Year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
he ordered too little he would not be able to meet demand and Sales 125 130 130 150 140 155 180 190 210 230
lose potential profit. He turned to the sales forecasts he had (£ 000)
prepared before working out his order.
The business is assuming that past figures are a useful indicator
Why is it important for a business like this to have an idea of what of what will happen in the future. This is likely to be the case if
its sales will be next month, next year or in three years? What trading conditions are stable or if the business needs to forecast
problems might the business face if Marco did not attempt to trends in the short term. Consider Table 1. Based on the trend
forecast future sales? If we accept that this type of prediction is of sales during preceding years, the business might reasonably
important, how might a business construct its forecasts? forecast that sales will rise in 2016. But precisely what sales might
the business expect? This forecast is important because it will
determine orders of raw materials and component parts, which
Purpose of sales forecasts may need to be placed well in advance. In terms of capacity, if
Sales forecasting is one of the most important tasks for a the forecast for 2016 is sales of £250,000, the business will
business, and one that will directly affect its efficiency and need to consider whether it has the physical capacity to produce
success. Imagine a business that did not carry out any sales this volume, and whether it has the staffing required to produce
forecasting. How much stock would it buy and hold? What this. These considerations may require the business to look for
would its staffing levels be? How would it know if it had enough additional production capacity, or to recruit more staff. In short, the
funding? What would its marketing strategy be? Without some sales forecast will trigger other decisions within the business.

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 Managing business activities

Time series analysis does not try to explain data, only to The benefits of sales forecasting
describe what is happening to it or predict what will happen to it. Using sales forecasts has some real advantages for businesses. In
There are likely to be four components that a business wants general it will help the business to plan ahead and avoid surprises.
to identify in time series data. Having a clear idea of what sales will be in the next financial
●● The trend. ‘Raw’ data can provide figures for many different period will:
things and it may not always be easy to see exactly what is ●● inform cash-flow forecasts and give the business a clear idea of
happening from these figures. Consequently businesses often what cash inflows will be, so that finances can be managed
try to identify a trend. This shows the pattern that is indicated ●● allow the business to plan orders of supplies and components.
from the figures. For example, there may be a trend for the For some businesses, suppliers will need notice of large orders.
sales of a new product to rise sharply in a short period as it Sales forecasts help build relationships with suppliers
becomes very popular. Statistical techniques for calculating ●● enable the business to ensure it has the correct staffing levels
trends and using this information are covered in Unit 52. for the projected sales. From Table 1, if the business had a
●● Seasonal fluctuations. Over a year a business is unlikely to forecast for 2016 of £250,000, this might mean that it needs
have a constant level of sales. Seasonal variations are very to recruit more staff to meet these higher sales levels
important to certain businesses, such as ice-cream producers ●● enable the business to ensure that it has the capacity to meet the
or greeting card manufacturers, where there may be large projected orders. If forecasts are for higher sales, the business
sales at some times but not at others. may need to buy additional equipment or rent/buy premises.
●● Cyclical fluctuations. For many businesses there may be a
cycle of ‘highs and lows’ in their sales figures over a number Factors affecting sales forecasting
of years. These can be the result of the recession-boom- Sales forecasting is extremely important for a business, but it can
recession of the trade cycle in the economy. In a recession, for be an extremely difficult process to complete. Past data is useful
example, people have less money to spend and so the turnover in helping to predict future outcomes, but this is not an exact
of a business may fall in that period. science. Unexpected things happen and there are other factors that
●● Random fluctuations. At times there will be ‘freak’ figures need to be taken into account when trying to forecast future sales.
that stand out from any trend that is taking place. An example Three crucial factors are consumer trends, economic variables and
might be the sudden boost in sales of umbrellas in unusually actions of competitors.
wet summer months, or the impact on consumer spending of a 1 Consumer trends
one-off event, such as a summer music festival. Businesses aim to meet the needs of consumers by providing
products and services. In a market economy successful businesses
Maths tip anticipate and meet the needs of consumers by supplying goods and
services that are in demand at a point in time. Consumer tastes and
Sales forecasting necessarily involves statistics. It can be preferences can and do change over time. Sometimes these changes
useful to show percentage changes in business statistics data. can occur quickly. Consumer trends are the habits and behaviours of
consumers around the products they buy and how they use them.
Example Today, the most popular use of a smartphone is not the
2012 sales = £400, 000 2013 sales = £450,000 ‘phone’ at all; it is to access the internet, either through the
sales have increased by 12.5% between 2012 and 2013. phone’s browser, or through apps. In the late 1980s, when the
first mobile phones became widely available, this could not easily
This is found by: Change in sales × 100% be predicted. Consumer behaviour has changed. This affects the
Original decisions and marketing of smartphone producers. This is an
£50,000 × 100% = 12.5% example of a long-term trend in consumer spending behaviour.
£400,000 Many changes in consumer behaviour are more short term, and in
response to factors such as seasonal variations and fashion.
Seasonal variations. Some products are seasonal in that they are
purchased in smaller or greater quantities at different times of the
Question 1 year. Some businesses that are affected by seasonal factors are
obvious: coastal hotels and guest houses see a rise in sales during
Drawing on the data in Table 1, Table 2 shows seasonal spring and summer months; power companies see a rise in sales
fluctuations in the sales of garden furniture. of gas and electricity during the winter. Knowledge of the seasonal
Table 2 Quarterly sales of a garden furniture variation in sales is vital when constructing sales forecasts. This is
manufacturer important for the management of a business, for example when
2013 2014 2015 looking at cash-flow. Businesses affected by seasonal factors
use sales forecasts to inform cash-flow forecasts and from these
Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
forecasts will recognise when lower sales will occur and therefore
75 30 25 65 80 40 30 65 95 40
expect lower cash-flow during certain times of the year. Knowing
(a) Use the data from Table 2 to explain one reason why sales for this is very useful. Businesses can put in place strategies to
this business are higher in Q3 than in Q1. manage the periods when cash-flow will be less strong.
(b) Explain why sales forecasting will be useful for this business in Time series data is used by businesses to identify seasonal
terms of: (i)staffing (ii)buying supplies. variations. For example, gas companies know that in the winter
months they need to have available larger quantities of gas to cope
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Sales forecasting Unit 30

Table 3 UK gas and electricity consumption (domestic): 2012–14 (Gwh*)

2012 2013 2013 2013 2013 2014 2014 2014 2014
Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4
Gas 121,540 154,453 63,606 25,616 100,827 120,654 45,556 24,381 96,411
Electricity 32,799 34,234 25,521 22,755 30,943 31,438 23,992 22,188 29,572
Source: adapted from www.gov.uk
*Gwh: Gigawatt hour – a measure of a unit of energy. Specifically, the production or consumption of a thousand million watts for one hour.

Question 2 Figure 1
(a) Use the data from Table 3 to explain the meaning of ‘seasonal Electric car sales 2010–2014
variations’. Sales
55,000
(b) Calculate the percentage change in consumption of gas and
electricity between: 50,000
45,000
(i) 2013 Quarter 1 and Quarter 3
40,000
(ii) 2013 Quarter 4 and 2014 Quarter 4.
35,000
(c) Assess two possible impacts on energy companies of the 30,000
seasonal variations shown in Table 3. 25,000
20,000
15,000
with the higher levels of demand from domestic and business
10,000
consumers.
5,000
Energy providers, such as British Gas and npower, are
0
very aware of this type of data. These seasonal variations in 2010 2011 2012 2013 2014
consumption of energy – gas and electricity – have important Key Year
implications for sales and cash flow. Petrol/electric hybrid
Diesel/electric hybrid
Fashion. Consumer tastes and preferences change and can Other electric (plug-in hybrid/range extender)
be highly unpredictable. Fashion – particularly in the area of Pure electric
clothing – changes constantly. This can make accurate sales
www.smmt.co.uk
forecasting very difficult. Any change in fashion will lead to
businesses modifying their sales forecasts. Unpredictability is a
feature of sales in some industries.
Figure 2
Long-term trends. Whereas fashions can change in the short Total number of new passenger cars registered in the UK
term, and with little notice, other changes to consumer behaviour between 2003 and 2014
are more long term. For example, the trend for consumers today Newly registered cars
to watch film and TV on demand, and using mobile devices, has 3,000,000
led to a growth of media platforms such as Netflix and Amazon
Prime, and the demise of operators such as Blockbuster. 2,500,000
Long-term changes affect sales forecasts, and business strategic
responses based on investment and strategic planning. Consider 2,000,000
the motor car market. In recent years it has witnessed a rise in
demand for electric cars that do not solely rely on petrol or diesel. 1,500,000
There are environmental and cost reasons why consumers may
switch their preferences. 1,000,000
The kind of information given in Figure 1 and Figure 2 will be
used by car manufacturers when constructing sales forecasts, and 500,000
also when deciding on corporate strategy. This might influence
decisions on what to produce and where. Consumer trends have 0
2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

changed over recent years to favour low-emission cars. This

change is due in part to the cost advantage for motorists, and Year
in part to the environmentally friendly aspect. These factors led Source: www.statista.com
car-manufacturer Nissan to invest in its Sunderland factory and to
produce its European electric car – the Nissan Leaf. This decision
was taken due to sales forecast information which showed that 2 Economic variables
customers’ preferences were changing. In 2014 the 100,000th What happens in the wider economy has some important
Nissan Leaf was produced in Sunderland. Nissan forecast that implications for business sales forecasting. The economy
sales of electric cars would rise. is comprised of consumers (households), businesses and

172
 Managing business activities

Question 3 a new car, the chances are this will be purchased using a
bank loan. When interest rates are rising, sales forecasts
Read the following headlines, Extract A and Extract B, and may be adjusted downwards. Businesses might expect that
answer the questions that follow. demand for their product will fall. In contrast, when interest
rates fall the cost of loans also falls. This means they are more
Figure 3 attractive for consumers. Sales forecasts may be adjusted
Bennet’s Lark
upwards in response to such a change in interest rates.
● Inflation. The general rise in consumer prices over time.
Extract A When inflation is rising this indicates that prices in the
economy are rising also. In such periods consumers and
New model car to be businesses often choose to spend less. Sales forecasts are
built in Cumbria reduced at these times.
● Unemployment. The number of people who are out of
The British car industry received work. During a recession, unemployment rises. During the
a boost on Wednesday when economic crisis that started in 2008, UK unemployment rose
car-maker Bennets annouced to almost 3 million. As a result, spending in the economy fell
that it will build the Lark, its and this had a huge impact on business sales and orders. At
six-seater electric car, in Cumbria. such times, sales forecasts are reduced.
● Exchange rates. These reflect the value of one currency
in terms of another. An exchange of £1 = US$1.45 means
that £1 will buy $1.45. If this exchange rate rises, say to
Extract B £1 = $1.60, it is cheaper for UK consumers to buy goods
and services from the US. As a result, UK businesses might find
50,000th Bennets that sales fall due to the increased price competitiveness of the
Lark to hit the road US. The impact on sales forecasts would be to cause them
to fall, as consumers are shifting their spending to US goods
The electric revolution has reached and services. In addition, UK goods become more expensive
a milestone with news that the for US consumers; something that used to cost $1.45 now
50,000th
100,00th Bennets Lark has
Nissan Leaf has hit
hit costs $1.60. Demand will tend to fall in such situations.
the roads.
Table 4 Effect of economic variables
Change in economic Impact on business sales forecasts
(a) What is meant by consumer trends? variable Higher sales forecast Lower sales forecast
(b) Explain how Bennets might have used the idea of sales Strong economic growth X
forecasting when deciding to build the Lark at its Cumbrian plant. Slower GDP growth X
Rising inflation X
Falling inflation/deflation X
government. Economic variables are measurements of different
Rising unemployment X
aspects of an economy that give an indication of how that
Falling unemployment X
economy is performing. Economic performance has some
Rising interest rates X
important implications for businesses generally, and sales
Falling interest rates X
forecasting in particular. Important economic variables are as
follows: Higher exchange rate X
● Economic growth. Economic growth is judged using Gross
Falling exchange rate X
Domestic Product (GDP). This is a measure of the total The analysis of economic variables in Table 4 assumes that
output of an economy. When economic growth is rising, sales businesses enjoy ‘normal’ patterns of demand. When incomes
for many – but not all – businesses tend to increase. One rise consumers tend to buy more of the product. This applies to
reason for this is that consumer incomes generally increase a large majority of products. For example, the demand for new
during periods of economic growth, and this translates into cars rises when unemployment falls and incomes rise. So does
higher spending. In a period of strong economic growth, the demand for theatre tickets, books and magazines, fresh food,
sales forecasts will often be increased. A slowdown in wine, clothing, and so on. These products are likely to have a
economic growth leads to lower sales. In this scenario, sales positive income elasticity of demand. This means that as incomes
forecasts are often reduced. Many businesses expect to sell rise, demand also rises. For such businesses the impact on sales
less in times of economic downturn. This will affect sales forecasts will be for them to increase.
forecasts. However, for some businesses the opposite is true. When
● Interest rates. These are charged by banks and other incomes rise some businesses expect their sales to fall. Value
financial institutions for borrowing money. When interest rates supermarkets, such as Aldi and Lidl, tend to grow in popularity
are high, the cost of loans increases and the demand for when incomes are falling, for example during a recession. When
loans falls. Loans are used by consumers and businesses to incomes start to rise, consumers begin to shift to more expensive
fund purchases. For example, when a household buys providers. The result for such businesses is that sales forecasts

173
Sales forecasting Unit 30

actually fall when consumer incomes are rising. However, this is Question 4
a simplistic interpretation of the current position of supermarkets
in the UK. It does not necessarily follow that value supermarkets, In 2014 German discount supermarket Lidl announced that it
such as Aldi and Lidl, will simply accept that customers will planned to spend £20 million on opening 20 new stores in the
shift their allegiance as soon as incomes begin to rise. In fact, UK. This was seen as a threat to other supermarkets who were
these businesses have been very proactive in not only trying under pressure from Lidl’s low price strategy.
to attract customers away from their original supermarket, but
In response to Lidl’s growth and success, in 2014 Morrisons
also in trying to keep their custom. This is a competitive market
launched a new loyalty scheme. Its ‘Match & More’ scheme
and rivals are keen to capture and retain custom. There is some
evidence that more affluent customers are now sticking with promised to match the prices charged by other supermarkets,
retailers that would previously have been regarded as perhaps including discount retailers such as Aldi and Lidl. Morrisons
lower in quality. planned that this scheme would help to protect sales at a time
when competition was increasing.
3 Actions of competitors (a) Explain one impact on Morrisons’ sales forecast in response to
The actions of competitors can have a real impact on a business Lidl’s expansion plan.
in many ways, from pricing to promotion. Sales forecasting is
(b) Why might time series data from Morrisons – details of sales in
another area that can be affected by the actions of competitors.
previous years – be less reliable following the announcement
Where competitors use a strategy to capture market share from
from Lidl?
a rival, sales forecasts may need to be adjusted downwards.
The size of the impact on sales forecasts will depend on the
type of strategy used by the competing business. A short-term Thinking bigger
promotion might affect sales for a short period of time only, Sales forecasting is extremely important for businesses. Whether they do it
and not lead to a change to next year’s sales forecast. A rival formally, using statistical trend analysis and modelling, or less formally, using
restaurant opening next door to an existing restaurant is likely to estimates based loosely on sales from previous series or informed by ‘gut
have a greater, more long-term effect. instinct’, all businesses aim to forecast what sales will be in the next period.
Any significant action by a competitor will affect the reliability There are lots of opportunities for questions requiring analysis and
of time series data, such as past sales. Effectively, the conditions evaluation in this topic. The statistical element of sales data means that
within the market have been changed. analytical considerations can be made.
How the business responds to the actions of competitors A key thing to consider in this topic is the difficulty of forecasting in different
is important. If a competing business opened a new branch industries. Whereas time series data may be useful for businesses in some
close to a business, it might realistically be expected that sales sectors, such as energy or greeting cards, this is less useful for others. For
at the existing business would fall. Sales forecasts would need example, industries where many new competitors enter the market, such as
new technology businesses, may struggle.
to reflect this. However, the dynamic nature of business means
that a company does not ignore the actions of competitors. The Another consideration when analysing business cash flow is the nature of
response will influence sales forecasts. A response that aims the business. Rising incomes in the economy would ordinarily lead a business
to expect higher sales and to therefore reflect this expectation in their sales
to counter the action of the competitors may mean that sales
forecast. However, for businesses that sell at the lower end of quality goods,
projections remain unchanged. the opposite may be true. This is an important consideration when analysing
The effect of the actions of competitors cannot truly be known business sales forecasting due to changing economic variables.
until some point in the future. Consider the example below.

Table 5 Yearly sales of a coffee shop The difficulties of sales forecasting

Competitor enters market 2013 Predicting the future is not easy. This uncertainty applies in all
spheres of life. What will the weather be like next week? How
Year 2010 2011 2012 2013 2014 2015
↓ (forecast) will my football team perform next season? Will the value of my
house rise or fall over the next 12 months? This affects many
Sales (£ 000) 78 86 84 79 62 65
aspects of life, but especially business.
In this Unit we have explored how businesses can use
The data in Table 5 shows that sales from previous years are
techniques to help minimise this uncertainty, by using statistical
fairly stable, and these can be used by the business to forecast
methods and time series analysis to help predict with more
sales. The entry into the market of a competitor clearly had
certainty what might happen to sales in the future. These
some impact on the business. Sales in 2014 fell sharply from
quantitative methods will be explained more fully in Unit 52. In
the previous year and below the trend. In consequence, the
fact, some of the factors we have explored in this unit give rise
sales forecast for 2015, based on the time series data, reflects
to the very difficulties involved in sales forecasting.
the fact that sales are lower due to the entry into the market of
a rival.
Volatile consumer tastes and preferences: We have
seen how a business can use past sales data to identify future
sales. This is called extrapolation. This is often a good starting
point and a reasonable basis on which to base forecasts.
However, extrapolation is not a perfect method to base future

174
 Managing business activities

predictions. If Chelsea wins the Premiership for two consecutive <v_983521_ph_148> [photo – airport]<v_983521_ph_148>
years, does this mean they will win a third time? Possibly, but Case study
[photo – airport]
this is not guaranteed. Crocs produce rubber shoes that were
once very fashionable. Inaccurate sales forecasts from 2008
onwards nearly caused the collapse of the business. Sales
from 2004–2007 were increasing steeply and it was therefore
ROLLS-ROYCE
reasonable, based on extrapolation of this data, to forecast Rolls-Royce is a British aeroplane engine manufacturer
strong growth in subsequent years. Capacity and production producing jet engines for major aeroplane producers, such as
were increased. Unfortunately, these decisions by the business Boeing and Airbus. Rolls-Royce received an order in 2015 to
coincided with changing consumer tastes. The perception supply 50 Emirates airline A380 ‘superjumbo’ planes with
of Crocs changed from trendy ‘must have’ to very off trend. their engines.
Range of data: There is a lot of data available to consumers,
business and government. Which data is most important for In 2015 Emirates, based in Dubai, was the seventh largest
a business to use? In addition to its own sales data, what airline company in the world. It had experienced strong
about wider economic data, such as unemployment, average growth in previous years and was looking to expand its fleet
income growth, commodity prices, exchange rates and so of aircraft. The order of 50 new A380 planes was in response
on? This extensive range of data can be difficult enough for a to growing demand in the Middle East. The airline believed
large multinational business to make sense of, let alone a small that strengthening economic growth and rising incomes in the
business. A real difficulty of accurate sales forecasting lies in the region would lead to greater demand for air travel.
sheer amount of data that exists which might inform the forecast. The order for Rolls-Royce was worth £6.1 billion and was
Subjective expert opinion: However statistical and a new order for the company. Engines for the A380 were
quantitative time series data might be, the final decisions around previously supplied by Rolls-Royce’s main competitor –
sales forecasts are often left to business experts, such as sales Engine Alliance.
analysts. Experts will base their judgements in part on their
own opinion and knowledge of the market and wider economic The deal has secured the jobs of Rolls-Royce workers for
variables. These opinions are necessarily subjective and can be some years. Its sales forecasts for future years will include the
wrong. Crocs almost collapsed because of the well-intentioned Emirates order.
but ultimately inaccurate sales forecasts of its marketing team. Source: adapted from the Financial Times, 16.04.2015. All rights reserved.

Exam tip (a) What is meant by sales forecast? (2 marks)

Think about the type of business in any exam question. Context is
important. When questions refer to particular businesses or (b) Explain how the order might affect future sales forecasts
industries, it is important that your answers are in the correct for Rolls-Royce. (4 marks)
context. Apply your knowledge to the specific business and avoid
‘general’ answers that could apply to any business. (c) Assess the extent to which consumer trends are affecting
You will be asked questions with the command word ‘assess’, for sales forecasting at Rolls-Royce. (10 marks)
example, ‘Assess the importance of X to a business’. In this type of
question, it is possible to introduce the idea of sales forecasting as
a balancing item (evaluation). For example, if the question asked you
to assess the importance of budgeting for the success of a
business, it would clearly be appropriate to consider that other
Key terms
factors, such as sales forecasting, were even more important. When Consumer income – the amount of income remaining after
concluding questions such as this, the ‘it depends’ rule can be used.
taxes and expenses have been deducted from wages.
This involves consideration of the type of industry involved.
Consumer trends – the habits or behaviours of consumers
that determine the goods and services they buy.
Economic growth – the rise in output of an economy as
Knowledge check measured by the growth in Gross Domestic Product (GDP),
1. Why might a business want to predict future sales? usually as a percentage.
Economic variables – measures within the economy which
2. State three advantages to a business of using sales forecasts. have effects on business and consumers. Examples include
3. What is time series data? unemployment, inflation and exchange rates.
Extrapolation – forecasting future trends based on past data.
4. What is meant by ‘trend’? Forecasting – a business process, assessing the probable
5. State three economic variables that might affect the sales outcome using assumptions about the future.
forecasts of a business. Sales forecast – projection of future sales revenue, often
based on previous sales data.
6. Give three reasons why consumer trends might change.
Time series data – a method that allows a business to
7. State three difficulties in accurately forecasting sales. predict future levels from past figures.

175
 31 Sales, revenue and costs 2.2.2
Theme 2
Key points
1. Calculating sales volume and sales revenue.
2. Calculating fixed and variable costs.

Getting started Sales volume

The output produced by businesses is eventually sold.
OzzyTrek organises specialised adventure holidays in Australia
Businesses measure and monitor sales levels. One approach
where customers can enjoy a range of outdoor pursuits, such as
is to measure the sales volume. This is the number of units
canoeing, hiking, camping and kangaroo watching. The target
sold by a business. However, depending on the nature of the
market is young adults in the UK. In 2011, OzzyTrek lowered business, sales volume can be measured in different ways. Some
the price of its trips by 20 per cent to try to boost sales. Figures 1 examples are illustrated in Table 1.
and 2 show sales volume and sales revenue for the business
between 2005 and 2014. Table 1 Measuring sales volume
Figure 1 Type of business How sales volume is measured
Sales volume for OzzyTrek 2005 to 2014 Cereal farmer Tonnes of wheat sold
Number of
trips sold
Car manufacturer Number of cars sold
400
365 370 370 380 Airline Number of passengers carried
350 360 360
350 Oil company Barrels of oil sold
305
300 275
250
Haulage business Number of miles travelled
250
Hotel Number of rooms let
200
150
Driving instructor Number of hourly lessons given
100 Insurance company Number of policies sold
50 Music tutor Number of hourly lessons given
0 Dairy farmer Litres of milk sold
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Year
Power generator Megawatt hours sold
When a business sells clearly identifiable units of output, such as
Figure 2
the examples shown in Table 1, measuring or calculating sales
Sales revenue for OzzyTrek 2005 to 2014 volume is straightforward. However, in some cases it is difficult
£ million to identify single units of output. For example, how might you
2.0
measure the sales volume of a supermarket that sells thousands
1.8 1.75 1.80 1.80
of different products each day? Or how would you measure
1.6 1.525
1.46 1.48 1.48 1.52 the annual sales volume of a construction company that builds
1.4 1.375
1.25 25 semi-detached houses, 5 apartment blocks, 2 warehouses,
1.2 2 office blocks, 2 tunnels, 5 different-sized factories and a
1.0 bridge? In these cases the units sold are different – they are not
0.8 standard. To overcome this problem it may be easier, and more
0.6 meaningful, to calculate the sales revenue.
0.4
0.2 Sales revenue
0 Sales revenue is the value of output sold by a business. It may
2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Year be calculated for a specific time period, such as a day, week,

month or year. It can also be calculated for individual products
What is the difference between sales revenue and sales volume? when a business has a wide product range. Sales revenue,
What price was charged between 2005 and 2010? What price which is often called total revenue, is calculated using the
was charged after 2010? What impact did the price change in following formula:
2011 have on sales volume and sales revenue? What types of
business costs might be incurred by OzzyTrek? Sales revenue = Price × Quantity of output

176
 Managing business activities

Worked example Business costs

A business needs accurate and reliable cost information to make
In 2014, Gartex Mining Ltd sold 1,433,400 tonnes of decisions. For example, a firm that is aiming to expand production
limestone to customers. The price per tonne was £12.60. or deliver more services to meet rising demand must know how
What is the sales revenue for 2014? much that extra production or services delivery will cost. In the
Sales revenue = £12.60 × 1,433,400 = £18,060,840 same way that you are familiar with your own personal costs –
these are the regular expenses you have, such as travel to school
All businesses have to calculate the value of their sales revenue
or college – so businesses will know what their expenses are.
each year. Sales revenue can be used as a measure of business These might include wages, raw materials, insurance and rent.
performance. Most businesses would want to see their sales It is important to understand how the costs of a business
revenue grow each year. change in the short run and the long run.
● The short run is the period of time when at least one factor of

production is fixed. For example, in the short run, a firm might

want to expand production in its factory. It can acquire more
Question 1 labour and buy more raw materials, but it has a fixed amount of
space in the factory and a limited number of machines.
Manchester United is one of the richest football clubs in ● In the long run, all factors can vary. The firm can buy another

the world. In the 2012/13 season the total revenue generated factory and add to the number of machines. This will increase
by the club, as reported in the media, was £350-360 million. capacity (the maximum amount that can be produced) and
Figure 3 shows the key sources of this revenue. However, the begin another short-run period. In the service industry, an
pie chart does not reflect accurately the wide range of revenue airline, for example, can buy or lease another plane in the long
sources enjoyed by the football club. For example, on a match run to increase capacity. In the short run it may be able to fly
day revenues are likely to be generated from the sale of match more passengers by using its fleet of planes more frequently.
tickets, match programmes, food and beverages, hospitality
boxes, special functions and concessions (revenue from vendors
Fixed costs
Costs which stay the same at all levels of output in the short
given the right to trade in or around the stadium). Sources
run are called fixed costs. Examples might be rent, insurance,
of commercial revenues are also diverse. Examples might
heating bills, depreciation and business rates, as well as capital
be the sale of merchandising, such as replica shirts, clothes
costs such as factories and machinery. These costs remain
and virtually anything using the MUFC logo; sponsorship; the same whether a business produces nothing or is working
advertising; travel packages to overseas fixtures; weddings; at full capacity. For example, rent must still be paid even if a
business meetings and other functions held at the stadium; factory is shut for a two-week holiday when nothing is produced.
stadium tours and revenue from providing hospitality for Old Importantly, ‘fixed’ here means costs do not change as a result of
Trafford International cricket matches. a change in output in the short run. But they may increase due
to, say, inflation. Figure 4 shows what happens to fixed costs as
Figure 3 a firm increases production. The line on the graph is horizontal
Manchester United revenue by source 2012/13 (€) which shows that fixed costs are £400,000 no matter how much
is produced. The firm is a doll manufacturer.
What happens over a longer period? Figure 5 on the next
Match day page illustrates ‘stepped’ fixed costs. If a firm is at full capacity,
Commercial €127.3m
€177.9m but needs to raise production, it might decide to invest in more
equipment. The new machines raise overall fixed costs as well as
capacity. The rise in fixed costs is shown by a ‘step’ in the graph.
This illustrates how fixed costs can change in the long run.

Figure 4
Fixed costs of a doll manufacturer
Broadcasting €118.6m
(£000)
1,200
Source: adapted from www.statista.com
800
(a) Why might Manchester United find it difficult to calculate sales
volume? Fixed costs
400
(b) If Manchester United play 19 Premier League fixtures at home in
a season, calculate the total revenue from programme sales if an
average of 26,200 programmes are sold at each match for £3. 0 100 200 300 400 500 600
Output (000)

177
Sales, revenue and costs Unit 31

Figure 5 Thinking bigger

Stepped fixed costs of a doll manufacturer Some production costs do not fit neatly into our definitions of fixed and
variable costs. This is because they are not entirely fixed or variable costs.
(£000)
Labour is a good example. If a firm employs a member of staff on a
1,200 permanent basis, no matter what level of output, then this is a fixed cost. If
this member of staff is asked to work overtime at nights and weekends to
800 'Stepped' cope with extra production levels, then the extra cost is variable. Such labour
fixed costs
costs are said to be semi-variable costs. Another example could be the
400 cost of telephone charges. This often consists of a fixed or ‘standing charge’
plus an extra rate which varies according to the number of calls made.

0 100 200 300 400 500 600 Total cost

Output (000) If fixed and variable costs are added together they show the
total cost of a business. The total cost of production is the cost
of producing any given level of output. As output increases total
Exam tip
When discussing or calculating fixed costs, it is important to
costs will rise. This is shown in Figure 7, which again shows the
remember that fixed costs will be incurred even if the business production of dolls. We can say:
shuts down for a period of time. For example, if a sole trader Total cost (TC) = Fixed cost (FC) + Variable cost (VC)
operating a restaurant shuts down for three weeks in January when
trade is low, fixed costs such as rent, insurance, interest on loans The business has fixed costs of £400,000 and variable costs
and business rates still have to be paid. of £2 per doll. When output is 0, total costs are £400,000. When
output has risen to 300,000 dolls, total costs are £1,000,000,
made up of fixed costs of £400,000 and variable costs of
Variable costs £600,000 (£2 × 300,000). When output is 600,000, total
Costs of production which increase directly as output rises are costs are £1,600,000, made up of fixed costs of £400,000 and
called variable costs. For example, a baker will require more variable costs of £1,200,000 (£2 × 600,000). Figure 7 shows
flour if more loaves are to be produced. Raw materials are the way that total costs increase as output increases. Notice that
just one example of variable costs. Others might include fuel, as output increases fixed costs become a smaller proportion of
packaging and wages. If the firm does not produce anything total costs.
then variable costs will be zero.
Figure 6 shows the variable costs of the doll manufacturer Figure 7
mentioned above. Variable costs are £2 per doll. If the firm Total cost of a doll manufacturer
produces 100,000 dolls it will have variable costs of £200,000 (£000)

}
(£2 × 100,000). 1,800
Producing 600,000 dolls will incur variable costs of Total cost
1,600
£1,200,000 (£2 × 600,000). Joining these points together
shows the firm’s variable costs at any level of output. As output 1,400

increases, so do variable costs. Notice that the graph is linear. 1,200

This means that it is a straight line. Variable
1,000 costs

800
Figure 6 600
Variable costs of a doll manufacturer

}
400
(£000)
200 Fixed costs
1,200 Variable
costs
1,000 0 100 200 300 400 500 600
Output (000)
800

600
Thinking bigger
Costs can also be divided into direct and indirect costs. Direct costs are costs
400 which can be identified with a particular product or process. Examples of
direct costs are raw materials, packaging and direct labour. Indirect costs
200 or overheads result from the whole business. It is not possible to associate
these costs directly with particular products or processes. Examples are rent,
0 insurance, the salaries of office staff and audit fees. Indirect costs are usually
100 200 300 400 500 600 fixed costs and direct costs variable costs, although in theory both direct and
Output (000)
indirect costs can be fixed or variable.

178
 Managing business activities

Average cost or unit cost Knowledge check

The average cost is the cost per unit of production, also known
as the unit cost. To calculate average cost, the total cost of 1. What is the difference between sales volume and sales
production should be divided by the number of units produced, revenue?
or output. 2. How is sales revenue calculated?
Total cost 3. What is the difference between the short run and the long
Average cost =
Output run in business?

Worked example 4. Give two examples of fixed costs for a taxi driver.
5. Give two examples of variable costs for an online retailer.
Take the example of the doll manufacturer with fixed
costs of £400,000 and variable costs of £2 per unit. 6. What is meant by a semi-variable cost?
If output was 100,000 units: 7. How is profit calculated?
£400,000 + (£2 × 100,000)
Average cost = –––––––––––––––––––––
100,000
£600,000 Key terms
= –––––––– = £6
100,000 Average cost or unit cost – the cost of producing one unit,
The importance of average cost is discussed in more detail in calculated by dividing the total cost by the output.
Unit 37. Fixed cost – a cost that does not change as a result of a
change in output in the short run.
Long run – the time period where all factors of production
Profit and loss are variable.
One of the main reasons why firms calculate their costs and Profit – the difference between total costs and total revenue.
revenue is to enable them to work out their profit or loss. It can be negative.
Profit is the difference between revenue and costs. Sales revenue – the value of output sold in a particular time
period. It is calculated by price × quantity of output.
Profit = total revenue – total costs
Sales volume – the quantity of output sold in a particular
For example, if the doll manufacturer produces and sells time period.
300,000 dolls, they sell for £5, fixed costs are £400,000 and Semi-variable cost – a cost that consists of both fixed and
variable costs are £2 per unit, then: variable elements.
Profit = £5 × 300,000 – (£400,000 + [£2 x 300,000]) Short run – the time period where at least one factor of
= £1,500,000 – (£400,000 + [£600,000]) production is fixed.
= £1,500,000 – £1,000,000 Total cost – the entire cost of producing a given level of
= £500,000 output.
Total revenue – the amount of money the business receives
It is possible to calculate the profit for a business at any level of from selling output.
output using this method. Variable cost – a cost that rises as output rises.
If the variable costs were £4 per unit, the business would
make a loss.
Loss = £5 x 300,000 – (£400,000 + [£4 × 300,000])
= £1,500,000 – (£400,000 + £1,200,000)
= £1,500,000 – £1,600,000
= – £100,000

179
Sales, revenue and costs Unit 31

Case study
Table 2 Financial information for Razia Malik’s
business training courses (£)
RAZIA MALIK   2013 2014
Razia Malik operates as a sole trader. She offers one-day Car lease per annum 5,000 5,000
courses in business start-ups for Urdu-speaking people in the Insurance per annum 1,000 1,200
Midlands. The courses cover all aspects of business start-ups, Other fixed costs per annum 2,000 2,800
such as writing a business plan, market research, financial Special promotion 0 3,000
management, negotiation skills and legal issues. Most of her    
work comes from local authorities. Room hire fees per course 150 200
Refreshment costs per course 150 180
The business charges £600 for a one-day course and can
Training materials per course 50 50
enrol up to 20 entrepreneurs. Razia rents function rooms in
small hotels for £150 per day to run the courses. The course Other variable costs per course 50 70
   
fee also includes refreshments.
Price per course 600 800
In 2013 the business provided a total of 200 courses and
made a reasonable profit. However, Razia felt that she could
improve the sales revenue of the business by marketing the (a) What is meant by fixed costs? (2 marks)
business more aggressively in the Birmingham area. Her (b) What is meant by sales volume? (2 marks)
aim was to raise profit by 10 per cent. She thought that
she could charge more and also reduce the amount of time (c) (i) Calculate the sales revenue in 2013. (4 marks)
travelling around the region. She spent £3,000 advertising (ii) Calculate the variable costs in 2013. (4 marks)
on specialist Urdu websites and raised the price of the (iii) Calculate the total costs in 2013. (4 marks)
courses to £800. As a result, the number of courses sold (iv) Calculate the profit made in 2013. (4 marks)
fell to 150 in 2014. Details of the costs incurred by Razia’s (d) Assess the extent to which Razia achieved her objective
business are shown in Table 2. by raising the price of the courses from £600 to £800.
(12 marks)

180
 32 Break-even 2.2.3
Theme 2

Key points
1. Calculating contribution (selling price – variable cost per unit).
2. Break-even point (total fixed costs + total variable costs = total revenue).
3. Using contribution to calculate break-even point.
4. Margin of safety.
5. Interpretation of break-even charts.
6. Limitations of break-even analysis.

Getting started
Total contribution: When more than one unit is sold the total
Anna Powell runs a company that provides a 24-hour taxi contribution can be calculated. For example, a textile company
service from Huddersfield to Manchester Airport. Fixed costs receives an order for 1,000 pairs of trousers. The variable costs
each month are usually £3,000 and variable costs are £10 per are £7.50 a pair and they will be sold for £9.00 a pair. The total
trip. Anna charges £40 per trip. In the summer months (June to contribution made by the order is:
September) the business can make 250 trips a month.
Total contribution = Total revenue – Total variable cost
Calculate the total cost of 250 trips to the airport in June (total = (£9.00 × 1,000) – (£7.50 × 1,000)
cost = fixed costs + variable costs). Calculate the total revenue = £9,000 – £7,500
from 250 trips to the airport. How much profit is made from = £1,500
250 trips? How many trips would be needed in a month for the
business to break-even? The £1,500 in this example will contribute to the textile
company’s fixed costs and profit. The total contribution can also
be calculated by multiplying the unit contribution by the number
Contribution of units sold.
Craig Eckert sells second-hand cars. His last sale was £990 Total contribution = Unit contribution × Number of units sold
for a Golf GTI. He bought the Golf at a car auction for £890. = (£9.00 – £7.50) × 1,000
The difference between what he paid for the car and the price = £1.50 × 1,000
he sold it for is £100 (£990 – £890). This difference is called = £1,500
the contribution. It is not profit because Craig has fixed costs
to pay such as rent, insurance and administration expenses. Exam tip
Contribution is the difference between selling price and variable Contribution can be used to calculate the profit made by a
costs. In this case the selling price was £990 and the variable business. The formula needed is:
cost was £890. The £100 will contribute to the total fixed
Profit = Total contribution – Fixed costs
costs of the business and the profit.

Contribution per unit and total Question 1

contribution
A business might calculate the contribution on the sale of a Westwood Holdings is a manufacturer of camping trailers.
single unit, or the sale of a larger quantity, such as a whole The factory is located near Dover and nearly 70 per cent of the
year’s output. company’s output is exported to France, Italy and Spain. The
fixed costs are £200,000 per annum and the variable costs are
Unit contribution: In the above example the unit contribution £500 per trailer. The trailers are sold for £800.
was calculated. It was the contribution on the sale of one unit, a
(a) What is meant by the term contribution?
single car. The formula for calculating the unit contribution is:
(b) Calculate the contribution made by each trailer.
Contribution per unit = Selling price – Variable cost (c) Calculate the profit made by Westwood Holdings if 2,000
= £990 – £890 trailers are made and sold in a year.
= £100 (d) Due to a new entrant in the market, Westwood Holdings is
forced to lower its price to £650 in the coming year. Calculate
the impact the price cut will have on annual profit.

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Break-even Unit 32

Break-even point Question 2

Businesses, particularly those that are just starting up, often like
to know how much they need to produce and sell to break-even. Karen Ficenec assembles presentational gift packs that
If a business has information about fixed costs and variable she sells online. She operates from a small warehouse in
costs and knows what price it is going to charge, it can calculate Swindon that she rents for £400 per month. She incurs other
how many units it needs to sell to cover all of its costs. The fixed costs of £100 per month and sells the gift packs for £10
point where total costs (fixed costs + variable costs) are exactly each (including postage and packaging). She employs two part-
the same as total revenue is called the break-even point. The time staff and variable costs are £8 per gift pack.
level of output a business needs to produce so that total costs
(a) Calculate the monthly break-even output for Karen Ficenec’s
are exactly the same as total revenue is called the break-even business.
output. It makes neither a profit nor a loss. For many businesses
(b) Calculate the total cost and total revenue at the break-even level
the break-even point is a sort of ‘performance milestone’. It of output.
shows the level of output where all costs have been covered and
(c) Calculate the profit made by the business if 2,000 gift packs are
that all future sales will generate a profit for the business.
sold in a month.
Worked example
A business produces 1,000 units and sells them for £50 Break-even chart
each. Total fixed costs are £10,000. Variable costs are £40 per The use of graphs is often helpful in break-even analysis.
unit. So total variable costs are £40 × 1,000 = £40,000. It is possible to identify the break-even point and break-even
Therefore: output by plotting the total cost and total revenue equations
Total costs = £10,000 + £40,000 = £50,000 on a graph. This graph is called a break-even chart. Figure 1
Total revenue = £50 × 1,000 = £50,000 on the next page shows the break-even chart for Jack
Cadwallader’s business.
Total revenue and total costs are exactly the same at £50,000. Output is measured on the horizontal axis and revenue,
Therefore the business will break even at this level of output. costs and profit are measured on the vertical axis. What does
So the break-even output is 1,000 units. the break-even chart show?
●● The value of total cost over a range of output. For

Calculating break-even using contribution example, when Jack produces 1,500 benches total costs
are £120,000.
It is possible to calculate the break-even output if a firm knows
●● The value of total revenue over a range of output.
the value of its fixed costs, variable costs and the price it will
charge. The simplest way to calculate the break-even output is For example, when Jack produces 1,500 benches total
to use contribution. The following formula can be used. revenue is £150,000.
●● Break-even charts can show the level of fixed costs
Fixed costs
Break-even output = over a range of output. For example, the fixed costs for
Contribution
Jack’s business are £60,000.
●● The level of output needed to break-even. The break-
Worked example
even point is where total costs equal total revenue of
Jack Cadwallader makes wrought-iron park benches. £100,000. This is when 1,000 benches are produced. So
His fixed costs (FC) are £60,000 and variable costs (VC) £40 the break-even output is 1,000 benches.
per bench. He sells the benches to local authorities across the ●● The profit at a particular level of output. If Jack
country for £100 each. Therefore contribution is given by: produces 1,500 benches, profit is shown by the vertical
gap between the total cost and total revenue equations.
Contribution = Selling price − Variable cost
It is £30,000.
Contribution = £100 − £40
●● At levels of output below the break-even output,
Contribution = £60
losses are made. This is because total costs exceed total
Once the contribution has been calculated, the number of revenue. At an output of 500, a £30,000 loss is made.
benches Jack needs to sell to break-even can then be determined. ●● At levels of output above the break-even output, a

Fixed costs profit is made. This profit gets larger as output rises. At
Break-even output = an output of 1,500 a profit of £30,000 is made.
Contribution
●● The relationship between fixed costs and variable

£60,000 costs as output rises. At low levels of output, fixed costs

=
£60 represent a large proportion of total costs. As output rises,
fixed costs become a smaller proportion of total costs.
= 1,000 benches
Jack Cadwallader’s business will break even when 1,000
park benches are sold.

182
 Managing business activities

Figure 1 Using break-even analysis

Break-even analysis is used in business as a tool to make
Break-even chart for Jack Cadwallader
decisions about the future. It helps answer ‘what if’ questions.
Cost, revenue, profit (£000) For instance:
180 ●● if the price went up, what would happen to the break-even point?
170 Total
160 ●● if the business introduced a new product line, how many
revenue
150 would the new product have to sell to at least break-even?
140 Profit
130 ●● if the business is just starting up, what has to be the level of
Total
120 cost output to prevent a loss being incurred?
110 Break-even point ●● what will happen to the break-even point if costs are forecast
100 Variable
90
cost
to rise?
80 ●● would the break-even point be lower if components were
70
60 Fixed bought in from outside suppliers rather than being made
50 cost in-house?
40 Loss
30
20 Break-even analysis is also found in business plans. Banks often
10 ask for business plans when deciding whether or not to give
0
a loan. So break-even analysis can be vital in gaining finance,
0 100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500 1,600
(Benches) especially when starting up a business.

Limitations of break-even analysis

Margin of safety Break-even analysis does have some limitations. It is often
What if a business is producing more than the break-even regarded as too simplistic and some of its assumptions
output? It might be useful to know by how much sales could are unrealistic.
fall before a loss is made. This is called the margin of safety.
It refers to the range of output over which a profit can be made. Output and stocks: It assumes that all output is sold, so that
The margin of safety can be identified on the break-even chart output equals sales, and no stocks are held. Many businesses
by measuring the distance between the break-even level of hold stocks of finished goods to cope with changes in demand.
output and the current (profitable) level of output. For example, There are also times when firms cannot sell what they produce
Figure 2 shows the break-even chart for Jack Cadwallader. If Jack and choose to stockpile their output to avoid laying off staff.
produces 1,200 benches the margin of safety is 200 benches.
This means that output can fall by 200 before a loss is made. If Unchanging conditions: The break-even chart is drawn for a
Jack sells 1,200 benches the chart shows that total revenue is given set of conditions. It cannot cope with a sudden increase in
£120,000, total cost is £108,000 and profit is £12,000. wages and prices or changes in technology.
Businesses prefer to operate with a large margin of safety.
Accuracy of data: The effectiveness of break-even analysis
This means that if sales drop they still might make some profit.
depends on the quality and accuracy of the data used to
With a small margin of safety there is a risk that the business is
construct cost and revenue functions. If the data is poor and
more likely to make losses if sales fall.
inaccurate, the conclusions drawn on the basis of the data are
flawed. For example, if fixed costs are underestimated, the level
Figure 2 of output required to break-even will be higher than suggested
Break-even chart showing the margin of safety for Jack by the break-even chart.
Cadwallader’s business
Cost, revenue, profit (£000) Non-linear relationships: It is assumed that the total revenue
180 and total cost lines are linear or straight. This may not always be
170
160 Total the case. For example, a business may have to offer discounts
150 revenue
140 on large orders, so total revenues fall at high outputs. In this
130 Total case the total revenue line would rise and then fall, and be
120 cost
110 curved. A business can lower costs by buying in bulk. So costs
100 may fall at high outputs and the costs function will be curved.
90
80
70
60 Margin Multi-product businesses: Many businesses produce more
50 of than one single product. It is likely that each product will have
40 safety
30 different variable costs and different prices. The problem is how
20 to allocate the fixed costs of the multi-product business to each
10
0 individual product. There are a number of ways, but none is
0 100 200 300 400 500 600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500 1,600 perfect. Therefore, if the fixed costs incurred by each product
(Benches)
are inaccurate, break-even analysis is less useful.

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Break-even Unit 32

Stepped fixed costs: Some fixed costs are stepped. For Maths tip
example, in order to increase output a manufacturer may need
to acquire more capacity. This may result in rent increases and A break-even chart can be used to work out the price
thus fixed costs will rise sharply. Under these circumstances it charged and the variable cost per unit. To calculate the price
is difficult to use break-even analysis. charged, look at the total revenue at the break-even level of
output and divide this by the break-even output. To calculate the
variable cost you need to look at the total cost at the break-even
level of output, subtract fixed costs and then divide the answer
by the break-even level of output.

Case study
Figure 3

GOWDA CHANDA LTD Break-even chart for Gowda Chanda Ltd

£000
70
Gowda Chanda runs a plastics recycling plant. The business Total revenue
incurs quite high monthly fixed costs, which include leasing 60
charges for premises and machinery. He also employs five
staff. Figure 3 shows a monthly break-even chart for the 50
Total cost
business in November. The planned output of pellets for
40
the month is 1,000 tonnes and the margin of safety is also
shown on the chart. 30

Margin of safety
Unfortunately there was a machinery breakdown on
20
12 November and the monthly output was only 700 tonnes.
Essential repairs had to be carried out which stopped 10
production for several days.
0
0 2 4 6 8 10 12 14
Tonnes 00s

(d) Explain the impact on Gowda Chanda Ltd of the machinery

(a) What is meant by the margin of safety? (2 marks) breakdown. (4 marks)
(b) Calculate the price charged for pellets per tonne. (4 marks) (e) Assess the usefulness of break-even analysis to Gowda
(c) Calculate the variable cost per tonne of pellets. (4 marks) Chanda Ltd. (12 marks)

Key terms Knowledge check

Break-even – when a business generates just enough 1. A product sells for £10 and the variable costs are £8.50.
revenue to cover its total costs What is the contribution per unit?
Break-even chart – a graph containing the total cost and 2. A clothes retailer buys 240 jumpers for £27 each. The
total revenue lines, illustrating the break-even output. jumpers are sold for £39 each. What is the total contribution
Break-even output – the output a business needs to made by the jumpers?
produce so that its total revenue and total costs are the 3. If total contribution is £120,000 and fixed costs are £96,000,
same.
what is the profit?
Break-even point – the point at which total revenue and
4. If total variable costs are £450,000 and contribution is
total costs are the same.
£225,000, what is the total revenue?
Contribution – the amount of money left over after variable
costs have been subtracted from revenue. The money 5. How can the contribution be used to calculate the break-even
contributes towards fixed costs and profit. level of output?
Margin of safety – the range of output between the break- 6. How can the break-even level of output calculation be checked?
even level and the current level of output, over which a profit 7. What effect will a price increase have on the margin of safety?
is made. 8. What effect will a fall in fixed costs have on the margin of safety?
9. State three uses of break-even analysis.
10. State three limitations of break-even analysis.

184
 33 Budgets 2.2.4
Theme 2

Key points
1. Purpose of budgets.
2. Types of budget – historical figures and zero-based budgets.
3. Variance analysis.
4. Difficulties of budgeting.

Getting started results with the budget. Any reasons for failing to achieve the
budget can then be analysed and appropriate action taken. For more
Lizzy Bennett runs a hair salon. She likes to keep control of effective control it is helpful to monitor budgets continually. Some
business costs and uses budgets to help her. Table 1 shows the businesses produce weekly budgets to allow for swift intervention.
cost budget for a six-month period.
Planning: Budgeting forces management to think ahead. Without
Table 1 A cost budget for Lizzy Bennett’s hair salon budgeting, managers might work on a day-by-day basis, only dealing
  JUL AUG SEP OCT NOV DEC Total with opportunities and problems as they arise. Budgeting, however,
Wages 4,200 4,200 4,200 4,200 4,400 5,000 26,200 plans for the future. It anticipates problems and their solutions.
Rent 1,400 1,400 1,400 1,400 1,400 1,400 8,400 Co-ordination: Larger businesses are often complex
Materials 450 450 460 460 470 520 2810 organisations. There may be many departments and different
Electricity 100 100 110 130 180 200 820 operating sites – for instance for production and administration.
Advertising 500 500 500 500 500 500 3000 A multinational company will have sites and workers spread
Other across the world. Budgeting is one way in which managers can
overheads 300 300 300 310 310 330 1850 co-ordinate and control activities of the many areas of business.
   
Total 6,950 6,950 6,970 7,000 7,260 7,950 43,080 Communication: Planning allows the objectives of the business
to be communicated to the workforce. By keeping to a budget,
What is the total expected cost of running the business for the managers and workers have a clear framework within which to
six-month period? What is happening to planned costs over the operate. So budgeting removes an element of uncertainty within
time period? Why might costs be so high in December? How decision-making throughout the business. Budgeting also shows
might this cost budget help Lizzy? the priorities of the business and highlights costs that need to be
kept under control.
Purpose of budgets Efficiency: In a business with many workers, it becomes
A budget is a financial plan that is agreed in advance. It important for management to empower staff by delegating
must be a plan and not a forecast – a forecast is a prediction decision-making. In a medium to large business, senior
of what might happen in the future, whereas a budget is a management cannot efficiently make every decision on behalf of
planned outcome that the firm hopes to achieve. A budget will every employee, department or site. Budgeting gives financial
show the money needed for spending and how this might be control to lower levels of management who are best able to make
financed. Budgets are based on the objectives of businesses. decisions at their point within the organisation.
They force managers to think ahead and improve co-ordination.
Most budgets are set for twelve months to coincide with the Motivation: Budgeting should act as a motivator to the
accounting period, but there are exceptions. workforce. It provides workers with targets and standards.
Budgets are likely to be used by both large and small Improving on the budget position is an indication of success for a
businesses. Small business owners often underestimate the department or group of workers. Fear of failing to reach budgeted
importance of financial control when running their businesses targets can be an incentive to the workforce.
and budgeting is a method of control that could easily be
employed. This might help avoid problems in the future. Types of budget
Budgets fulfil the following specific purposes. Businesses might use a wide range of different budget types.
However, some budgets are more frequently used than others. Two
Control and monitoring: Budgeting allows management to key types are the sales budget and the production cost budget.
control the business. It does this by setting objectives and targets. Budgets are often prepared using historical figures. This means
These are then translated into budgets for a particular period; that the data used to prepare the budgets is based on data that the
say, the coming year. How successful the business has been in business has gathered in the past. Obviously adjustments will be
achieving those targets can be found by comparing the actual made to take into account future known events, such as planned

185
Budgets Unit 33

changes in production or changes in costs or prices. Examples of

Production budget
budgets that make use of historical figures are shown in Table 2.
Emerald Artwork’s production costs include materials, direct
Table 2 Types of budgets – some examples
labour, indirect labour and overheads. Table 5 shows the
Budget Description production cost budget for Emerald Artwork. The budget
Sales volume A key budget – shows planned sales levels shows that total production costs are planned to rise over the
Uses sales volume budget and prices to show planned time period.
Sales revenue revenue
Table 5 Production cost budget for Emerald Artwork
Production Based on sales volume budget and shows all planned
cost production costs (£)
Shows all planned indirect costs, such as insurance, rent FEB MAR APR MAY
Overheads and office wages Cost of materials 660 780 810 900
Total cost Shows all planned business costs (£3 per unit) (3 × 220) (3 × 260) (3 × 270) (3 × 300)
Marketing Shows planned spending on, for example, research,
advertising, promotion and sales Direct labour costs 880 1,040 1,080 1,200
R&D Shows planned expenditure in research and development (£4 per unit) (4 × 220) (4 × 260) (4 × 270) (4 × 300)
Profit Shows planned revenue, costs and profit Indirect labour costs 440 520 540 600
Cash Shows planned cash inflows and outflows and cash balances (£2 per unit) (2 × 220) (2 × 260) (2 × 270) (2 × 300)
Shows a summary of all budgets – including cost, revenue
Master and profit Production overheads
(10% of direct 1,320 × 10% 1,560 × 10% 1,620 × 10% 1,800 × 10%
& indirect costs) = 132 = 156 = 162 = 180
Worked examples Total 2,112 2,496 2,592 2,880
Sales volume budget
Table 3 shows a sales volume budget for Emerald Artwork. The
company produces four products: AD23, AD24, AE12 and AE13.
Question 1
Table 3 Sales volume budget for Emerald Artwork
Feb Mar Apr May FibreCraft Ltd produces three types of canoe for the UK
market – the Kayak, the Explorer and the Twin-seater. The
AD23 100 100 100 100
products sell for £200, £220 and £280 respectively. The financial
AD24 50 80 80 100
director produces six-monthly budgets to help control the
AE12 40 50 40 50
business. Table 6 shows the sales volume budget for January to
AE13 30 30 50 50
June 2014.
Sales revenue budget
Table 6 Sales volume budget for FibreCraft Ltd January–June
The sales revenue budget for Emerald Artwork is shown in 2014
Table 4. The planned sales revenue for each month is calculated   JAN FEB MAR APR MAY JUN
by multiplying the planned sales volume by the prices of each Kayak 210 210 210 230 250 300
product. The prices for AD23, AD24, AE12 and AE13 are £12,
Explorer 100 100 110 110 120 130
£20, £25 and £30 respectively.
Twin-seater 30 35 35 40 40 50
Table 4 Sales revenue budget for Emerald Artwork (a) Prepare the sales revenue budget for FibreCraft Ltd.
(£) (b) Use the sales volume budget to calculate total revenue for each
Feb Mar Apr May month and for the whole six-month budget period.
AD23 1,200 1,200 1,200 1,200 (c) What does the budget show over the time period?
(12 × 100) (12 × 100) (12 × 100) (12 × 100)

AD24 1,000 1,600 1,600 2,000

(20 × 50) (20 × 80) (20 × 80) (20 × 100) Zero-based budget: The financial information used in most
budgets is based on historical data. For example, the cost
AE12 1,000 1,250 1,000 1,250 of materials in this year’s production budget may be based
(25 × 40) (25 × 50) (25 × 40) (25 × 50)
on last year’s figure, with perhaps an allowance for inflation.
AE13 900 900 1,500 1,500 Production and manufacturing costs, such as labour, raw
(30 × 30) (30 × 30) (30 × 50) (30 × 50) materials and overheads, are relatively easy to value and tend
to be controlled using methods such as standard costing.
Total 4,100 4,950 5,300 5,950

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 Managing business activities

However, in some areas of business it is not so easy to quantify has been divided up into smaller control periods – usually four
costs. Examples might be certain marketing, administration or weeks or one calendar month. It is common to prepare a budget
computer services costs. Where costs cannot be justified then no for each control period. At the end of the period the actual
money is allocated in the budget for those costs. This is known as results can then be compared with targets set in the budget.
zero-based budgeting (ZBB) or zero budgeting. A manager must
show that a particular item of spending generates an adequate Analysis of variances: This is the most important stage
amount of benefit in relation to the general objectives of the in the control process. Variance analysis involves trying to
business in order for money to be allocated in a budget. find reasons for the differences between actual and expected
This approach is different to the common practice of financial outcomes. Variances are explained in the next
extrapolating from past costs. It encourages the regular evaluation section. A variance might be the result of some external factor
of costs and helps to minimise unnecessary purchases. The influencing the business. In this case the business may need to
concept of opportunity cost is linked to ZBB. Opportunity cost change its business plans and adjust the next budget.
is the cost of the next best alternative. When choices are made,
businesses try to minimise the opportunity cost. ZBB also involves Figure 1
a cautious approach to spending, so that costs are minimised.
Stages in budgetary control
Both approaches include an element of ‘value for money’.
The main advantages of ZBB are that: Preparation
●● the allocation of resources should be improved
of plans

●● a questioning attitude is developed which will help to reduce

unnecessary costs and eliminate inefficient practices

●● staff motivation might improve because evaluation skills are

practised and a greater knowledge of the firm’s operations Comparison of

Analysis of
might develop variances
plans with
●● it encourages managers to look for alternatives.
actual results

ZBB also has some disadvantages.

●● It is time-consuming because the budgeting process involves

the collection and analysis of quite detailed information so Variances

that spending decisions can be made. A variance in budgeting is the difference between the figure
●● Skilful decision-making is required. Such skills may not be
that the business has budgeted for and the actual figure.
available in the organisation. In addition, decisions may be Variances are usually calculated at the end of the budget
influenced by subjective opinions. period, as that is when the actual figure will be known.
●● It threatens the status quo. This might adversely affect motivation.
Variances can be favourable (F) or adverse (A).
●● Managers may not be prepared to justify spending on certain
Favourable variances occur when the actual figures are ‘better’
costs. Money, therefore, may not be allocated to spending than the budgeted figures.
●● If the sales revenue for a month was budgeted at £25,000,
which could benefit the business.
To deal with these possible problems, a business might but turned out to be £29,000, there would be a £4,000
give each department a ‘base’ budget of, say, 50 per cent. favourable variance (£29,000 – £25,000) as sales revenue
Departments could then be invited to bid for increased was higher than planned.
●● If costs were planned to be £20,000 and turned out to
expenditure on a ZBB basis.
be £18,000, this would also be a favourable variance of
Using budgets £2,000, as actual costs were lower than planned.
Budgetary control or budgeting involves a business using Adverse variances are when the actual figures are worse
budgets to look into the future, stating what it wants to happen, than the budgeted figures. Actual sales revenues may be lower
and then deciding how to achieve these aims. The control than planned, or actual costs may be higher than planned.
process is shown in Figure 1 and explained below. Managers will examine variances and try to identify reasons
why they have occurred. By doing this they might be able to
Preparation of plans: All businesses have objectives. If the improve the performance of the business in the future.
sales department increases sales by 10 per cent, how does it
know whether or not this is satisfactory? Targets are usually set Types of variance
which allow a business to determine whether its objectives have Variances can be calculated for a wide range of financial
been met. The results it achieves can then be compared with the outcomes. Most budgets are set for expenditure (costs) and
targets it sets. income (sales revenue). Consequently, variances will also
focus on a firm’s expenditure and income. This suggests that
Comparisons of plans with actual results: Control will variance analysis provides a very good way of monitoring
be effective if information is available as quickly as possible. business costs. Examples of variances could be wages,
Managers need budgetary data as soon as it is available. Recent materials, overheads and sales revenue. Variances can also be
developments in information technology have helped to speed calculated for volumes. For example, it is possible to calculate
up the supply of data. For budgeting purposes the financial year a sales variance or a labour hours variance. One of the most

187
Budgets Unit 33

important variances of all is the profit variance. The profit Worked example
variance is influenced by all other variances. A change in any
variance will affect profit. This is because all variances relate Table 9 calculates the profit variances for Wishart Ltd.
to either the costs or the revenue of a business, both of which Over the six-month period the variance is adverse – mainly
affect profit levels. The number of possible variances is equal because costs have been higher than planned.
to the number of factors which can influence business costs
Table 9 Budgeted profit, actual profit and profit variances for
and revenue.
Wishart Ltd
(£)
Worked example Jan Feb Mar Apr May Jun Total
Table 7 calculates the income variances for Wishart Ltd, Budgeted 5,100 5,100 5,000 5,000 5,000 5,000 30,200
profit
a bamboo and wicker furniture manufacturer. Most of the
variances are favourable (F) and might be the result of: Actual profit 5,100 5,800 5,200 4,200 4,300 5,200 29,800
Profit
• the ability to charge higher prices 0 700F 200F 800A 700A 200F 400A
variances
• an increase in demand due to a marketing campaign
• improvements in the quality of the product
• an increase in consumer incomes Question 2
• a change in consumers’ tastes in favour of bamboo and
wicker furniture. Gerrard & Co repairs, maintains and services agricultural
machinery for farmers in the Norfolk area. The business has
Table 7 Income budget, actual income and income variances
a workshop in Swaffham but also does ‘call-out’ work to fix
for Wishart Ltd
tractors, combine harvesters and other farm machinery on
(£) location. Table 10 shows the income (sales revenue) budget and
Jan Feb Mar Apr May Jun Total actual income for the business between January and June 2014.
Budgeted 16,500 17,000 17,500 18,000 19,000 20,000 108,000 Table 10 Income budget and actual income for Gerrard & Co
income
January–June 2014
Actual 16,600 17,400 17,900 17,700 18,500 20,800 108,900   JAN FEB MAR APR MAY JUN
income
Variance 100F 400F 400F 300A 500A 800F 900F Budgeted
income (£) 100,000 110,000 120,000 125,000 140,000 175,000
Actual
income (£) 90,000 110,000 128,000 129,000 152,000 197,000
Worked example (a) Calculate the sales revenue variances for each month and the
total sales revenue variance for the whole budget period.
Table 8 calculates the expenditure or cost variances for (b) Explain the variance in February.
Wishart Ltd. Most of these variances are adverse (A) – possibly (c) Explain two possible reasons for the pattern of variances over
because: the six-month time period.
• costs might be higher due to production being higher
• suppliers may have raised prices
• there may be some inefficiencies in production Using variances for decision making
The final stage in budgetary control is the analysis of variances. It
• wages may have been higher due to wage demands by workers.
is important to identify the reasons why variances have occurred.
Table 8 Budgeted expenditure, actual expenditure and If variances are adverse it will be necessary to take action to
expenditure variances for Wishart Ltd ensure that adverse variances are avoided in future. If variances are
(£) favourable the business can learn from understanding the reasons
Jan Feb Mar Apr May Jun Total why this has occurred and can introduce strategies and systems to
Budgeted 11,400 11,900 12,500 13,000 14,000 15,000 77,800 help sustain performance improvements in the future.
expenditure When making decisions about how the business should be
Actual run, information about the causes of variances will be very helpful.
expenditure 11,500 11,600 12,700 13,500 14,200 15,600 79,100 For example, if a business has an adverse cost variance, it might
Expenditure 100A 300F 200A 500A 200A 600A 1,300A discover that the cause was higher prices charged by suppliers.
variances The business might then decide to look for new suppliers. A
favourable sales revenue variance might be the result of an
effective advertising campaign. The business might decide to make
more use of the same or similar campaigns in the future. Variance
analysis can help business decision-makers because of the
information it provides about financial outcomes and their causes.
188
 Managing business activities

●● Sometimes businesses set over-ambitious objectives. When

Exam tip
When you have calculated a profit variance, you need to appreciate this happens, the budgeting process is pointless because
that if it is a favourable profit variance of £450,000 it could be budgets are being drawn up for targets that are unachievable.
made up of a favourable cost variance of £560,000 and an The budget then ceases to become a benchmark with which
adverse income variance of £110,000. In this case the business to compare the outcome.
would need to investigate why the income variance was adverse.
This could help to improve performance further. Motivation: In some businesses, workers are left out of the
planning process. If workers are not consulted about the budget,
it could be difficult to use that budget to motivate them. Budgets
Difficulties of budgeting that are unrealistic can also fail to motivate staff.
Businesses may encounter problems when setting budgets
and using them as tools for financial management. Manipulation: Budgets can be manipulated by managers. For
example, a departmental manager might have great influence
over those co-ordinating and setting budgets. The manager may
be able to set a budget that is easy to achieve and consequently
makes the department look successful, but ultimately that
budget might not help the business achieve its objectives.

Rigidity: Budgets can sometimes constrain business activities.

For instance, departments within a business may have different
views about when to replace delivery vehicles. The more often
vehicles are replaced, the higher the cost. However, the newer
the vehicle, the lower the maintenance cost and the less likely
it will be off the road for repairs. The budget may be set so that
older vehicles have to be kept rather than replaced. But this
may lead to customer dissatisfaction and lost orders because
deliveries are unreliable.

Short-termism: Some managers might be too focused on the

current budget. They might take actions that undermine the future
performance of the business just to meet current budget targets.
For example, to keep labour costs down in the current budget
period, the manager of a supermarket might reduce staffing on
customer service. This may well save costs now, but it could lead
to customers drifting away due to poor service. Consequently the
long-term performance of the business would suffer.

Key terms
Budget – a quantitative economic plan prepared and agreed
Setting budgets: in advance.
●● Problems may arise because figures in budgets are not
Budgetary control – a business system that involves making
actual figures. The figures are plans based on historical data,
future plans, comparing the actual results with the planned
forecasts or human judgement. A business might simply take
results and then investigating the causes of any differences.
historical data and add an arbitrary percentage to arrive at
Historical figures – quantitative information based on past
the budgeted value.
trading records.
●● The most important data in the preparation of nearly all
Production cost budget – a firm’s planned production costs
budgets is sales data. If sales data are inaccurate, many of
for a future period of time.
the firm’s budgets will be inexact.
Sales budget – a firm’s planned sales for a future period of
●● The setting of budgets may lead to conflict between
time – can be measured in terms of volume or revenue.
departments or staff. A business may only have limited funds
Variance – the difference between actual financial outcomes
and departments compete against each other for those
and those budgeted.
funds. For instance, the marketing department may want to
Variance analysis – the process of calculating variances and
promote a product, but new machinery may be needed in the
attempting to identify their causes.
R&D department.
Zero-based budgeting or zero budgeting – a system
●● The time spent setting budgets could have been spent on
of budgeting where no money is allocated for costs or
other tasks. For example, sales managers could be securing
spending unless they can be justified by the fund holder
new customers and increasing revenue for the business
(they are given a zero value).
instead of drawing up this year’s budget.

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Budgets Unit 33

Knowledge check
Case study
1. How might a budget improve managerial accountability?
2. Why is the sales budget such an important budget?
3. How might budgets motivate staff?
BUYAMOTORJON.COM 4. Give examples of three types of budget.
5. Why might a business use zero-based budgeting?
The website buyamotorjon.com is an online business that 6. Describe the three steps in budgetary control.
brings together buyers and sellers of second-hand cars. 7. How is a variance calculated?
The business charges car owners a fixed price to list their 8. What is meant by an adverse variance?
cars for sale on the site for two weeks. Anyone searching 9. State two possible causes of a favourable sales revenue
to buy a car can use the site free of charge. The business variance.
also earns a growing stream of income from selling
10. State two possible causes of an adverse cost variance.
advertising space on the site.
11. State four benefits of using budgets.
In 2012 the directors took a decision to incorporate and
develop a comparison site for second-hand cars. However,
the decision was not unanimous because two of the
directors thought that the level of expenditure needed
to develop and launch the site was too high. They also
thought that competition would be tough. Table 11
shows the budgeted expenditure, revenue and profit for
2012–2016 and the actual figures for 2012–2014.
Table 11 Budgeted expenditure, costs and profit, and actual
figures 2012–2014 (£ million)

  2012 2013 2014 2015 2016

Budgeted income 2.14 2.2 2.6 3 3.8
Actual income 2.13 2.14 2.22  
   
Budgeted expenditure 1.99 2.11 2.01 2.01 2.1
Actual expenditure 2.01 2.21 2.3
   
Budgeted profit 0.15 0.09 0.59 0.99 1.7
Actual profit 0.12 –0.07 –0.08    

(a) What is meant by a variance? (2 marks)

(b) Calculate the income, expenditure and profit variances
for 2012, 2013 and 2014 for buyamotorjon.com.
(6 marks)
(c) Explain the possible impact of the new comparison site
on buyamotorjon.com. (8 marks)
(d) Assess the usefulness to buyamotorjon.com of using
variance analysis. (12 marks)

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 34 Profit 2.3.1
Theme 2

Key points
1. Calculation of gross profit, operating profit and profit for the year (net profit).
2. Statement of comprehensive income (profit and loss account).
3. Measuring profitability – calculation of gross profit margin, operating profit margin and profit for the year
(net profit) margin.
4. Ways to improve profitability.
5. Distinction between profit and cash.

Gross profit is calculated by:

Getting started
Halfords is the UK’s leading retailer of automotive and cycling Gross profit = Revenue – Cost of sales
products. It is also the main operator in garage servicing and auto Operating profit: Operating profit is the difference between
repair in the UK. In 2014 it was reported that the business made gross profit and business overheads. Overheads are indirect
a profit after tax of £55.5 million on a turnover/revenue of £939.7 costs, such as selling and administrative expenses. Operating
million. This was an increase on 2013 when turnover was £871.3 profit is calculated by:
million and profit after tax was £52.7 million. The sales of cycles
did particularly well during the year, rising by 21 per cent. Operating profit = Gross profit – Operating expenses
Source: adapted from www.halfordscompany.com Profit for the year (net profit): Net profit or profit for the
Calculate the percentage change in turnover between 2013 and 2014. year is the profit made by the business for the year. It is the
Calculate the percentage change in profit between 2013 and 2014. difference between operating profit and interest and any other
What might account for the differences in these percentages? What exceptional costs. Net profit may be calculated before or after
measures might Halfords take to improve its profitability in the future? the subtraction of taxation. It is calculated by:

Profit for the year (net profit) = Operating profit – Interest (and
Exam tip exceptional costs)
The accounting ratios in the Edexcel specification use the term
‘profit for the year (net profit)’. In business, you might see the Sometimes net interest is shown in the statement of
terms ‘profit for the year (net profit)’ or ‘net profit’ used comprehensive income. This is the difference between any interest
interchangeably. The accounting ratios in the Edexcel specification
paid by a business (on loans and overdrafts, for example) and any
use the term ‘revenue’. In business, you might see the terms
‘revenue’ or ‘turnover’ used interchangeably.
interest received by the business (from money placed in deposit
accounts, for example).

Profit Worked example

As explained in Unit 31, if total costs are subtracted from total
revenue you arrive at a business’s profit. This is the money left HLD plc is a large paper manufacturer. In 2014 its
over after all costs have been met, and belongs to the owners turnover was £46 million. Its cost of sales was £23.5 million,
of the business. Accountants calculate and define profit in a operating expenses £12.4 million and interest paid £2.1 million.
number of ways. What was the gross profit, operating profit and net profit?

Gross profit: Gross profit is the difference between revenue/ Gross profit = Revenue/turnover − Cost of sales
turnover and cost of sales. = £46 million − £23.5 million
●● Turnover, also called revenue or sales revenue, can be
= £22.5 million
calculated as price × quantity of sales.
●● Cost of sales are the direct costs of a business.
Operating profit = Gross profit − Operating expenses
●● Gross profit is the profit made by a business after direct costs
= £22.5 million − £12.4 million
have been met. = £10.1 million

For a retailer or wholesaler the cost of sales is the cost of buying Profit for the year = Operating profit − Interest (and any
in stock to re-sell. For a manufacturer the cost of sales is any (net profit) exceptional items)
costs associated directly with production, such as raw materials, = £10.1 million − £2.1 million
factory wages and other direct costs. For a supplier of services it = £8 million
is any direct costs, such as direct labour.
191
Profit Unit 34

Question 1 Question 2
Weston Manor Hotel is an established and successful four- AppGame Ltd is a new, but growing, company. It designs
star hotel in Somerset. It has 43 rooms, employs 42 staff and children’s game apps on mobile phones. During 2014 the
its restaurant has a reputation for fine dining. Some financial company had some staff shortages and invested in an expensive
information for the hotel for 2014 and 2013 is shown in Table 1. recruitment campaign. Selected information from the statement
Table 1 Financial information for Weston Manor Hotel of comprehensive income for AppGame Ltd is shown in Table 3
(three figures are missing).
  2014 2013
Revenue/turnover £2,341,700 £2,600,700 Table 3 Selected information from the statement of
comprehensive income for AppGame Ltd, year ending
Cost of sales £1,090,000 £980,500
31.12.14
Administration expenses £399,100 £388,900
2014 2013
Interest £21,000 £19,300 (£m) (£m)
(a) Calculate: (i) gross profit, (ii) operating profit, (iii) profit for the Revenue/turnover 6.444 5.871
year (net profit) for 2014 and 2013. Cost of sales 4.191 3.713
(b) Calculate the percentage change in net profit between 2013 Gross profit ? 2.158
and 2014. Selling expenses 1.223 1.112
Admin expenses ? 0.211
Statement of comprehensive income Operating profit 0.796 0.835
(profit and loss account) Interest ? 0.216
At the end of the trading year, businesses produce documents Profit for the year (net profit) 0.595 0.619
that show key information relating to the financial performance Taxation 0.120 0.121
of the business. One of these documents is the statement of Profit for the year (net profit) after taxation 0.475 0.498
comprehensive income. This shows the income and expenses (a) What is meant by a statement of comprehensive income?
of a business during the financial year. It is used to calculate (b) Calculate the missing figures in the statement for AppGame Ltd.
gross profit, operating profit and profit for the year (net profit).
(c) Assess the possible impact on AppGame Ltd of the staff
The layout of the statement is important. The financial shortages in 2014.
information must be presented in a standard way. An example
from a statement for Forest Way Autotraders Ltd, a second-hand
car dealership, is shown in Table 2. Measuring profitability
The information contained in the statement of comprehensive
Table 2 Selected information from the statement of income can show how well a business is performing. As
comprehensive income for Forest Way Autotraders Ltd for mentioned earlier, in Table 2 the statement for Forest Way
the year ending 31.1.14 Autotraders Ltd shows that net profit for the year has increased
2014 2013 from £14,100 to £40,100. This is a significant increase.
  (£) (£) However, it is possible to measure the profitability of a business
Revenue/turnover 561,000 498,200 in a more meaningful way. This can be done by calculating profit
margins, which measure the size of profit in relation to revenue/
Cost of sales 331,000 322,100
turnover. Three profit margins can be calculated.
Gross profit 230,000 176,100
Selling expenses 45,300 38,200 Gross profit margin: The gross profit margin shows the
gross profit made on sales turnover/revenue. It is calculated using
Admin expenses 122,500 102,800
the formula:
Operating profit 62,200 35,100
Interest 22,100 21,000
Gross profit margin = Gross profit × 100%
Revenue
Profit for the year (net profit) 40,100 14,100
Taxation 8,000 2,800 Higher gross margins are usually preferable to lower ones
because it means that more gross profit is being made per £1 of
Profit for the year (net profit)after tax 32,100 11,300
sales. The gross profit margin:
The statement always shows the figures for the current ●● may be increased by raising revenue/turnover relative to the

trading year and the previous year. This allows a comparison cost of sales, by increasing price
to be made. In this case, the statement shows that net profit ●● may be increased by cutting the cost of sales; this might be

before tax has increased from £14,100 to £40,100. This is a achieved by finding cheaper suppliers of key materials
significant increase, probably because turnover has increased ●● will vary between different industries. As a rule, the quicker the

quite sharply. The statement in Table 2 also shows the taxation turnover of inventory, the lower the gross margin that is needed.
paid by the business and the net profit after tax. Statements of So, for example, a supermarket with a fast stock turnover is
comprehensive income are discussed in more detail in Unit 60. likely to have a lower gross margin than a car retailer with a
192
 Managing business activities

much slower stock (inventory) turnover. Some supermarkets Again, higher margins are usually better than lower ones. The
are therefore very successful with relatively low gross profit profit for the year (net profit) margin focuses on the profit left
margins because of the regular and fast turnover of inventory. after all deductions have been made.

Operating profit margin: The operating profit margin

shows the operating profit made on sales revenue/turnover. Question 3
Operating margin is used to measure a company’s pricing
strategy and operating efficiency. It gives an idea of how much
a company makes (before interest and taxes) on each pound of
sales. It is calculated using the formula:
Operating profit margin = Operating profit × 100%
Revenue
A high or increasing operating margin is preferred. This is
because more money is made on each £1 of sales. If the
operating margin is increasing, the company is earning more per
pound of sales. Operating margin shows the profitability of sales
resulting from regular business. Operating income results from
ordinary business operations and excludes other revenue
or losses, exceptional items, interest and income taxes.

Profit for the year (net profit) margin: The net profit
margin takes into account all business costs, including interest,
other non-operating costs and exceptional items. It is usually
calculated before tax has been deducted.
Chapperton Ltd develops wearable technology. UK shoppers
The profit for the year (net profit) margin can be calculated by: spent around £105 million on wearable tech devices during
Profit for the year (net profit) margin = Net profit before tax × 100% the Christmas shopping period in 2014, a massive increase
Revenue of 182 per cent compared to the previous year. Fitness and
activity trackers are the most popular wearable devices,
Worked example accounting for over £29 million, followed by smart watches at
£25 million, healthcare wearable devices at £22 million, and
On the previous page, Table 2 shows the income statement the remainder on other wearable devices. Table 5 shows the
for Forest Way Autotraders Ltd. The profit margins for 2014 can be company’s statement of comprehensive income at 31 March
calculated as follows. 2014.
Gross Gross Profit × 100% = £230,000 × 100% = 41% Table 5 Selected information from the statement of
profit margin = ––––––––– ––––––––
comprehensive income for Chapperton Ltd 31.03.14
Revenue £561,000
2014 2013
Operating Operating profit × 100% = £62,200 = 11.1% £000s £000s
profit margin = –––––––––––– ––––––– Revenue/turnover 7,800 5,700
Revenue £561,000
Cost of sales 3,780 2,100
Profit for the Net profit (before tax) × 100% = £40,100 = 7.1% Gross profit 4,020 3,600
year (net = –––––––––––––––– ––––––– Admin expenses 1,560 1,800
profit) margin Revenue £561,000
Operating profit 2,460 1,800
Table 4 provides a summary of the profit margins for both 2014 Interest 70 45
and 2013. Over the two years there is a clear improvement in Profit for the year (net profit) 2,390 1,755
all of the profit margins. This suggests that the business has Taxation 580 450
performed well – improving efficiency and possibly raising prices.
Profit for the year (net profit) after tax 1,810 1,305
Table 4 Profit margins for Forest Way Autotraders Ltd
(a) Explain the difference between the gross profit margin and the
2014 and 2013 profit for the year (net profit) margin.
  2014 2013 (b) Calculate the gross, operating and profit for the year (net
Gross profit margin 41% 35.3% profit) margins for 2013 and 2014. Present the information in
Operating profit margin 11.1% 7% a table.

Profit for the year (net profit) margin 7.1% 2.8% (c) Assess the financial performance of Chapperton Ltd in 2014.

193
Profit Unit 34

Exam tip guarantee supply. Moving abroad to take advantage of cheap

Calculating the different profit margins is fairly straightforward. It labour may be disruptive. It may also damage the image of
is important, though, to interpret the answers correctly. You need the company if it lays off large numbers of staff in the UK.
to know that the gross margin will always be the highest and the Consequently, when looking to acquire cheaper resources, a
profit for the year (net profit) margin the lowest. You also need to business must be cautious and understand the pitfalls.
know that higher margins are better and that an increase in ●● Using existing resources more efficiently. Making better
margins over time shows an improvement.
use of current resources will improve efficiency and lower
Profit margins can be used to make comparisons between costs. A business might do this by introducing new working
businesses in the same industry, but only if the businesses being practices or training staff. This would help to raise labour
compared have similar trading activities. For example, using the
productivity. It could upgrade its machinery by acquiring
gross margin to compare the performance of Sainsbury’s and
Marks & Spencer (M&S) may not be appropriate because many of newer, more efficient models. This would raise capital
their product lines and the proportions of types of retail product productivity. A business might be able to reduce waste by
are different (M&S sell more clothes than Sainsbury’s, for instance). recycling materials, for example. Some of these measures
You need to understand that profit margins are likely to vary might also have drawbacks. For example, the workers might
considerably across different industries. resist new working practices and new technology often has
teething problems. This could disrupt the business.

Ways to improve profitability Distinction between cash and profit

All businesses will want to improve their performance. An It is important for businesses to recognise the difference
improved performance is likely to benefit all stakeholders. The between cash and profit. At the end of a trading year it is
returns on capital can be increased by making more profit with unlikely that the value of profit will be the same as the cash
the same level of investment. This might be achieved by growth balance. Differences between cash and profit can arise for a
funded externally. This means the business increases sales number of reasons.
using fresh capital. ●● During the trading year a business might sell £200,000

Increasing profit margins will also improve performance. If worth of goods with total costs of £160,000. Its profit would
profit margins can be raised, the business will make more profit be £40,000. However, if some goods had been sold on
at the existing level of sales. The profit margins can be improved credit, payment by certain customers may not yet have been
in two ways. received. If £12,000 was still owing, the amount of cash the
business had would be £28,000 (£40,000 – £12,000).
Raising prices: If a business raises its price it will get more Thus, profit is greater than cash.
revenue for every unit sold. If costs remain the same then ●● A business may receive cash at the beginning of the trading

profitability should improve. However, raising price might have year from sales made in the previous year. This would
an impact on the level of sales. Generally, when price is raised increase the cash balance, but would not affect profit. In
demand will fall. However, if demand is not too responsive addition, the business may buy resources from suppliers and
to changes in price, the increase in price will generate more not pay for them until the next trading year. As a result its
revenue even though fewer units are sold. Raising price is always trading costs will not be the same as cash paid out.
risky because it is never certain how competitors will react. ●● Sometimes the owners might introduce more cash into the

business. This will increase the cash balance, but will have
Lowering costs: A business can also raise profit margins by no effect on the profit made. This is because the introduction
lowering its costs. It can do this by buying cheaper resources or of capital is not treated as business revenue in the profit
using the existing resources more effectively. and loss account. The effect will be the same if a business
●● Buying cheaper resources. It might be possible to buy borrows money from a bank.
raw materials and components from new suppliers that ●● Purchases of fixed assets will reduce cash balances, but

offer better prices. It may also be possible to find new will have no effect on the profit a company makes. This is
providers of essential services such as telecommunications, because the purchase of assets is not treated as a business
electricity, insurance and IT support. For example, there has cost in the profit and loss account.
been increased competition recently in the supply of gas, ●● Sales of fixed assets will increase cash balances but will have

electricity and telecommunications. Another option might no effect on profit unless a profit or loss is made on disposal
be to find ways of using cheaper labour. For example, some of the asset. This is because the cash from the sale of a fixed
businesses have moved overseas to take advantage of cheap asset is not included in business turnover.
labour in places like China and eastern Europe. However, ●● The amount of cash at the end of the year will be different

these measures may have drawbacks. When taking on new from profit because at the beginning of the year the cash
suppliers the possibility that they are cheaper because they balance is unlikely to be zero. If, at the beginning of the year,
are not as good should be considered. The quality of raw the cash balance for a business is £23,000, then the amount
materials might be inferior, they may be unreliable and supply of cash a business has at the end of the year will exceed
might not be guaranteed. For example, a number of new, profit by £23,000.
and cheaper, broadband providers have not been able to

194
 Managing business activities

Case study
Table 6 Salwell plc – extract from statement of
comprehensive income for 2014
SALWELL   2014 2013
(£m) (£m)
Leeds-based Salwell plc is a world leader in reinforced Revenue/turnover 650.3 670.7
polymer technology. It employs over 5,000 people and Cost of sales 443.1 442.8
serves markets all over the world. Since 2007 the company Gross profit 207.2 227.9
has grown its revenue by around 57 per cent. However, in
Distribution costs 51.0 51.3
2014 revenue actually fell a little. This may have been due to
slower than expected economic growth in emerging markets, Admin expenses 89.2 79.7
such as China and India. Operating profit* 67.0 96.9
Net interest** 13.9 15.1
In 2015, Salwell plc experienced a further reduction in
turnover and profits. This was due mainly to a slowdown in Profit for the year (net profit) 53.1 81.8
demand for one of the components that they produce that Taxation 14.8 20.8
is normally one of their biggest sellers. As a result, factory Profit for the year (net profit) after taxation 38.3 61.0
staff were put on a shorter working week for much of the
year. In 2015, Salwell’s chief executive officer suggested that Operating profit* – after amortisation of costs resulting
the weakness in the mining market, caused by political and from acquisitions
economic uncertainties, might undermine the strength and Net interest** = Interest paid – Interest received
resilience of their businesses. Table 6 shows an extract from
the statement of comprehensive income for Salwell plc.

(a) Calculate the gross profit margin for Salwell plc in 2014 (c) Assess the impact on Salwell plc of difficult global trading
and 2013. (4 marks) conditions. (8 marks)
(b) Calculate the profit for the year (net profit) margin for (d) Assess the measures a company like Salwell plc might take
Salwell plc in 2014 and 2013. (4 marks) to improve profitability. (12 marks)

Key terms Knowledge check

Amortisation – the writing off of an intangible asset. 1. How is gross profit calculated?
Cost of sales – the direct costs of a business.
2. If operating profit is £32 million and interest is £670,000,
Exceptional costs – a one-off cost, such as a large bad debt.
what is the profit for the year (net profit)?
Gross profit – the difference between revenue/turnover and
cost of sales. 3. What is meant by the ‘bottom line’?
Gross profit margin – gross profit expressed as a 4. What does a statement of comprehensive income show?
percentage of revenue/turnover.
Operating profit – the difference between gross profit 5. What does the operating profit margin measure?
and business overheads, such as selling and administrative 6. What is the profit for the year (net profit) margin if revenue is
expenses. £128,000 and profit for the year (net profit) is £18,000?
Operating profit margin – operating profit expressed as a
percentage of revenue/turnover. 7. State two ways a business might increase its gross profit
Profit for the year (net profit) or net profit – the difference margin.
between operating profit and interest and exceptional items. 8. State two ways a business might lower its costs.
Profit for the year (net profit) margin or net profit margin –
9. Describe briefly the difference between cash and profit.
net profit before tax, expressed as a percentage of revenue/
turnover. 10. State two reasons why profit may be higher than cash.
Statement of comprehensive income – a financial
document showing a company’s income and expenditure
over a particular time period, usually one year.
Revenue or turnover – the total income of a business
resulting from sales of goods or services.

195
 35 Liquidity 2.3.2
Theme 2

Key points
1. Statement of financial position (balance sheet):
●● measuring liquidity – calculating current ratio and acid test ratio

●● ways to improve liquidity.

2. Working capital and its management: the importance of cash.

Getting started In a statement of financial position, the value of assets (what

a business uses or owns) will equal the value of liabilities and
To run a business effectively it must have enough money to capital (what the business owes). This is because all resources
pay its day-to-day bills, such as wages, raw materials, fuel and purchased by a business have to be financed from either capital
overheads. This money is called working capital. In 2014 a or liabilities. Therefore:
shortage of working capital resulted in the closure of Tyneside
Autobuy Ltd with the loss of 48 jobs. According to media sources, Assets = Capital + Liabilities
the Creditors Report stated that the shortage of working capital So, if a business has capital of £5 million and liabilities of £2.6
was caused by poor cost controls and excessive overheads. The million, the value of assets must be £7.6 million (£5 million +
Gosforth-based used-car supermarket was also reported by £2.6 million).
administrators to have been making losses since 2010, despite
turnover/revenue of nearly £23 million in 2014. Prior to its
Question 1
closure in July, the company had struggled to make payments
to a supplier. In June, corporate finance specialists were brought
in to prepare a short-term cash-flow forecast for the business
and found that a substantial working capital investment was
needed to continue. Unable to raise this, the firm was put up for
sale. However, prospective buyers failed to make a deal with the
landlords of Autobuy’s premises, Autoparc, and the business went
into administration.
Source: adapted from www.chroniclelive.co.uk
Why do businesses need working capital? What might be the
consequences of not having enough working capital? Why did
Tyneside Autobuy Ltd have insufficient working capital? What
measures might have avoided the closure of Tyneside Autobuy Ltd?

Statement of financial position

(balance sheet)
Many businesses produce a statement of financial position at
the end of the financial year. This document can also be called a
balance sheet. It is like a photograph of the financial position of
a business at a particular point in time. It provides a summary of
its assets, liabilities and capital. Britvic is the second largest soft drinks producer in the United
●● Assets. The resources owned by a business. Examples include
Kingdom. Although most of its operations are concentrated in the
buildings, machinery, equipment, vehicles, stock and cash. UK and Ireland, the company’s international arm is expanding and
Businesses use assets to make products or provide services. it now exports to over 50 countries. In 2013 the value of its assets
●● Liabilities. The debts of the business, in other words what
was £1,062.8 million and its total liabilities were £1,021.9 million.
it owes to others. Liabilities are a source of funds for a
business. They might be short term, such as an overdraft, or (a) Give two examples of assets that Britvic might own.
long term, such as a mortgage. (b) Explain the difference between liabilities and capital.
●● Capital. The money put into the business by the owners. (c) Calculate the value of capital for Britvic in 2013.
Along with other sources of finance it is used to buy assets.

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 Managing business activities

The presentation of the statement of Table 1 Statement of financial position for Kingham plc
2014
financial position (balance sheet) 2014 2013
The presentation of these statements varies between different
businesses. For example, the statement of financial position for (£m) (£m)
a limited company is likely to be slightly different from that of Non-current assets
a sole trader. Table 1 shows a statement of financial position Property and equipment 176.5 189.3
for Kingham plc, a chain store selling clothes and fashion Intangible assets 45.2 41.6
accessories. The structure of this statement is fairly typical. 221.7 230.9
Information is presented in a vertical fashion, with assets at the Current assets
top and liabilities and equity at the bottom. Inventories 32.1 28.3
Trade and other receivables 7.3 6.8
Non-current assets: Non-current assets are long-term Cash and cash equivalents 3.1 6.2
resources that will be used repeatedly by the business over 42.5 41.3
a period of time. They may be called fixed assets. Common Total assets 264.2 272.2
examples include land, property, plant, equipment, tools, Current liabilities
vehicles, and fixtures and fittings. Intangible assets are also
Trade and other payables 25.6 24.9
included in this category. These are non-physical assets, such
Current tax liabilities 11.1 10.5
as customer lists, franchising agreements and brand names.
36.7 35.4
These are discussed in more detail in Unit 60.
Non-current liabilities
Current assets: Current assets are assets that will be changed Loans 24.5 26.1
into cash within 12 months. They are liquid assets. The liquidity Pensions 7.8 6.7
of an asset is how easily it can be converted into cash. Common 32.3 32.8
examples include: Total liabilities 69.0 68.2
●● inventories, such as stocks of raw materials, components Net assets 195.2 204.0
and finished goods Shareholders’ equity
●● trade and other receivables, which relate to money that Share capital 25.0 25.0
is owed to the business. Examples might be debtors (the Retained earnings 170.2 179.0
money owed by customers) and prepayments (where a Total equity 195.2 204.0
business has paid in advance for a resource, such as an
insurance premium) Shareholders’ equity: The final section of the balance sheet
●● cash or cash equivalents, which usually refers to cash on the is the shareholders’ equity. This provides a summary of what is
business premises and money held in bank accounts. owed to the owners of the business. Share capital and retained
earnings (retained profit) are common examples.
Current liabilities: Any money owed by a business that The statement of financial position can be used in a number
must be repaid within one year is called a current liability. of ways, which is discussed in more detail in Unit 60.
Examples include:
●● loans and other borrowings, which include short-term bank Maths tip
loans and bank overdrafts
●● trade and other payables, which refer to money owed by In some financial statements figures may be shown in
the business to suppliers of raw materials, components, brackets. This just means that they are negative or should
business services and utilities. These are sometimes called be subtracted.
trade creditors
●● current tax liabilities. A business is likely to owe money to the

tax authorities. This might include employees’ income tax,

Measuring liquidity
Information contained in the balance sheet can be used to
VAT and corporation tax. Tax must be paid within one year.
measure the liquidity of a business. It is important that a business
is able to meet its short-term debts. This means a business must
Non-current liabilities: Non-current liabilities relate to
have enough liquid resources to pay its immediate bills. Failure to
long-term loans and any other money owed by the business that
do so could result in the financial collapse of the business. Two
does not have to be repaid for at least one year. Long-term bank
financial ratios can be used to measure liquidity.
loans, mortgages and company pension funds are examples.

Net assets: net assets are calculated by subtracting the Current ratio: The current ratio is a liquidity ratio and focuses
on the current assets and current liabilities of a business. It can
value of total liabilities from total assets. This will be equal to
be calculated using the formula:
shareholders’ equity at the bottom of the balance sheet.
Current assets
Current ratio = ––––––––––––––
Current liabilities
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Liquidity Unit 35

A business is generally regarded as having sufficient liquid Question 2

resources if the current ratio is between 1.5:1 and 2:1. If the current
ratio is below 1.5 it could be argued that the business does not Simpsons Ltd is a family business based in Coventry. It
have enough working capital. This might mean that a business is produces components for the car industry. It has been struggling
over-borrowing or overtrading. However, some businesses, such as to control inventories. Simpsons’ customers insist that they
retailers, often have very low current ratios, perhaps 1:1 or below. supply products just-in-time (at very short notice) and as a
This is because they hold fast-selling stocks and generate cash from result the burden of storage lies with Simpsons. Some financial
sales. In contrast, operating above a ratio of 2:1 may suggest that information for Simpsons Ltd is shown in Table 3.
too much money is tied up unproductively. Money tied up in stocks,
for example, does not earn any return.
Table 3 Financial information for Simpsons Ltd
2014 2013 2012
Acid test ratio: The acid test ratio is a more severe test of   (£m) (£m) (£m)
liquidity. This is because inventories (stocks) are not treated as Inventories 34.2 28.3 27.8
liquid resources. There is no guarantee that stocks can be sold Trade and other receivables 12.4 11.2 13.8
and they may become obsolete or deteriorate. They are therefore
Cash and cash equivalents 5.7 3.1 4.9
excluded from current assets when calculating the ratio. The acid
test ratio can be calculated using the formula: Loans and other borrowings 14.2 16.2 13.1
Trade and other payables 11.9 13.1 10.7
Current assets – Inventories Current tax liabilities 4.1 5.2 4.2
Acid test ratio =
Current liabilities
(a) Calculate the current ratios and acid test ratios for Simpsons Ltd
If a business has an acid test ratio of less than 1:1 it means that between 2012 and 2014.
its current assets minus stocks do not cover its current liabilities. (b) Assess whether Simpsons Ltd has enough liquid assets.
This could indicate a potential problem. However, as with the
current ratio, there is considerable variation between the typical
acid test ratios of businesses in different industries. Again, What is working capital?
retailers with strong cash flows may operate comfortably with an Working capital, sometimes called circulating capital, is the
acid test ratio of less than 1. amount of money needed to pay for the day-to-day trading
of a business. A business needs working capital to pay
Worked example expenses such as wages, electricity and gas charges, and to
Current and acid test ratios can be used to measure the buy components to make products. The working capital of a
liquidity of Kingham plc. The information needed is contained in business is the amount left over after all current debts have
the balance sheet in Table 1 for 2014. been paid. It is:
●● the relatively liquid assets of a business that can easily be
Current assets £42.5 m
Current ratio = –––––––––––––– = ––––––– = 1.16 turned into cash (cash itself, inventories, the money owing
Current liabilities £36.7 m from debtors who have bought goods or services); minus
●● the money owed by a business which needs to be paid in
Current assets – Inventories the short term (to the bank, to creditors who have supplied
Acid test = –––––––––––––––––––––
ratio Current liabilities goods or services, to government in the form of tax or
shareholders’ dividends payable within the year).
£42.5 m – £32.1 m £10.4 m In the balance sheet of a company, working capital is
= ––––––––––––––– = ––––––– = 0.28 calculated by subtracting current liabilities from current assets:
36.7 m £36.7 m
Table 2 provides a summary of the liquidity ratios for Kingham plc. Working capital = Current assets – Current liabilities
It could be argued that in 2014 both ratios are on the low side. The
current ratio is below 1.5 and the acid test ratio is well below 1. The amount of working capital a business has is an important
This could mean that the business is short of liquid resources. The issue. It can reflect how well a business is performing.
position has also worsened over the two years. The acid test ratio For example, a business that is struggling and threatened
in particular has fallen significantly. However, Kingham plc is a chain with closure is likely to have low levels of working capital.
store selling clothes. Most of its sales will be for cash so it may well Consequently, if a balance sheet shows a low level of working
be able to operate with much lower liquidity ratios. capital, this should act as a signal that the business may be
in trouble.
Table 2 Liquidity ratios for Kingham plc 2013 and 2014
  2014 2013
Current ratio 1.16 1.17
Acid test ratio 0.28 0.37

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 Managing business activities

Managing working capital expensive because money tied up in stock could be used to
Different businesses have different working capital needs. reduce borrowing and so save interest for the business.
●● Too much cash is also a problem because the cash is
Size of business. Sales typically generate a need for stocks, unlikely to be earning very high rates of interest. It could
trade credit and cash. Hence the larger the business, the larger the be used, perhaps, to pay back debts or to invest in higher
amount of working capital there is likely to be. Equally, expanding interest long-term investments.
businesses are likely to need growing amounts of working capital.
Stock levels. Businesses in different industries have different The importance of cash
Cash is the most liquid of all business assets. A business’s
needs for stocks. A window cleaning business is unlikely to
cash is the notes and coins it keeps on the premises and any
carry much stock. A retailer is likely to carry considerable
money it has in the bank, for example. Cash is part of, but not
amounts of stock. Businesses which are able to adopt just-in-
the same as, working capital. Working capital includes other
time techniques will carry lower stocks than other businesses.
current assets, such as debtors; however this cannot be used
The more stocks a business needs, the higher will be its working
to pay bills.
capital, all other things being equal.
Cash is vital to a business. Without cash, the business
would cease to exist. There are a number of reasons why firms
Debtors and creditors. The time between buying stock
fail, but according to a Confederation of British Industry (CBI)
financed by trade credit and selling finished products can influence
survey, 21 per cent of business failures are due to poor cash
levels of working capital. For example, a builder may need high
flow or a lack of working capital. Even when trading conditions
levels of working capital because the time between starting a
are good, businesses can fail. Many of these businesses
project and receiving payment from the client may be long.
may offer good products for which there is some demand.
At the other extreme, large supermarket chains can often
They have the potential to be profitable and yet still collapse.
operate with negative working capital (i.e. the current assets
Probably the most likely cause of this is that they run out of
are less than their current liabilities). This happens because they
cash. Business failure is discussed in more detail in Unit 36.
buy in stock from suppliers and do not pay them for at least
30 days. The stock though is sold quickly on supermarket
shelves, often within days of delivery from suppliers. Customers
Ways to improve liquidity
Liquidity problems can be prevented by keeping a tight
pay cash. So large supermarket chains can operate safely owing control on financial resources. The use of budgets and cash-
suppliers large amounts, but having very few debtors. The result flow forecasts will improve the financial management of the
is negative working capital. business. Inevitably, though, there will be occasions when
Few businesses are fortunate enough to be able to operate firms run short of cash. When this does happen the firm’s
with negative working capital. The textbook rule is that the main aim will be survival rather than profit. If a business is
typical business needs around twice the amount of current experiencing liquidity problems it must raise current assets
assets as current liabilities to operate safely. This means that or reduce current liabilities, or both. The following measures
its current ratio is between 1.5:1 and 2:1. This is how we can might be used to either generate cash or save it.
measure whether the business is performing effectively with
regard to working capital. Use of overdraft facilities: Most businesses have an
overdraft facility with their banks. A business can increase
Maintaining adequate levels of working capital: its cash by borrowing more money on its overdraft. For
Businesses need to keep adequate levels of working capital. If they example, it might have an overdraft limit of £5,000. If it is
keep too little (i.e. current assets are too low and current liabilities currently borrowing £3,000 it could borrow up to £2,000
are too high) they will start to encounter trading problems. extra. However, there may be a problem if it is already up to
●● If a business does not carry enough stocks of raw materials, its overdraft limit. Then it has to negotiate with its bank to
it could find that production is halted when items run out of increase its overdraft limit. There is no guarantee that the bank
stock. If it does not carry enough finished stock, it might be will do this. A business experiencing cash-flow problems could
unable to fulfil orders on time. well be a business in difficulties. The bank will not want to
●● If there is not enough cash in the business, it might not be increase lending to a business that could cease trading in the
able to pay its bills on time. immediate future.
●● If it has borrowed too much through trade credit, so it owes

too much to creditors, it might be unable to pay invoices Negotiate additional short-term or long-term loans:
when they are due. A business may be able to obtain a short-term loan from a
On the other hand, a business does not want too much working bank to inject some extra cash. If a business feels that extra
capital (i.e current assets are too high and current liabilities are money will be needed for a longer period of time, a long-term
too low). loan might be considered. A business could pay back smaller
●● Stocks are costly to keep. The more stock, the higher the instalments over a longer period of time to help cash flow.
cost of physically storing and handling it. The stock will need However, once it is known that a business is short of cash,
to be insured while it may be liable to shrinkage (a business banks and other moneylenders may be reluctant to provide
term for theft, usually by employees). Stock is also financially cash for fear of the business collapsing.

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Liquidity Unit 35

Encourage cash sales and sell off stocks: Extend credit with selected suppliers: A business
Many businesses, retailers for example, can generate can save cash if it delays paying suppliers for goods and
cash by offering large discounts for customers who pay in services that have already been bought. It may be able to
cash. Sometimes it may be possible to sell stocks of raw extend its credit payment period from 30 to 60 days, for
materials, components or semi-finished goods for cash. To example. However, delaying for too long could mean that
generate cash quickly they can be sold cheaply in a sale or suppliers withdraw their credit facilities or refuse to deliver
below cost if necessary. A business might simply reduce goods in the future.
the amount of stocks it holds. Stocks cost money to hold.
So fewer stocks can increase cash in the business. The Reduce personal drawings from the business:
danger is that stocks will not be available to make products Owners that regularly take cash from the business for their
that are required for sale. own personal use could attempt to take less. Obviously
some cash might be needed for living expenses, but a
Sale and leaseback: Assets including property and reduction in drawings is a quick way to stop cash leaving
machinery can be sold to specialists in the market such as the business.
Arnold Clark. The assets are then leased back to the seller.
This means that cash can be raised and the business can Introduce fresh capital: Owners may be able to provide
continue to use the assets. However, it may take a while to some new capital to improve cash flow. For example, small
set up such agreements and can be an expensive way to fund businesses may be able to use savings or take out loans
assets in the long term. If assets are no longer needed it may using personal possessions as security. A small business
be possible to sell them for cash. may be able to persuade friends or relatives to invest in the
firm – new partners might be taken on for example. Larger
Only make essential purchases: It obviously makes sense companies may be able to sell shares to raise fresh capital.
during a cash crisis to postpone or cancel all unnecessary However, attracting fresh capital might be very difficult if the
spending. A business should only buy resources for cash business is struggling. It is likely to be down to the current
when it absolutely has to. Also, a business may simply delay owners to provide more capital.
payments. It then keeps this cash in the business for a longer
period of time. It will only make payments when it is put under
pressure to do so by creditors.

Question 3
In 2014, it was widely reported that Euro Disney, operating
company of Disneyland Paris, Europe’s largest tourist attraction
by visitor numbers, needed an injection of finance to pay off debts
and provide extra cash. A plan was announced that The Walt
Disney Company, the theme park’s main shareholder, would back
a €420 million rights issue and convert a further €600 million of
loans into equity.
One of Euro Disney’s main problems since it opened has been
the servicing of its debt. This was about €1.75 billion before the
recapitalisation of the business. It had always been a financial
pressure on the company. It was reported that the planned
injection of fresh capital would help to boost cash flow by around
€800 million for a period of ten years
Source: adapted from the Financial Times 11.10.2014, all rights
reserved
(a) Explain the main cause of Euro Disney’s liquidity problems.
(b) Explain how Euro Disney might benefit from its plans to
improve liquidity.

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 Managing business activities

Thinking bigger
Some people might incorrectly assume that working capital problems is preserved. But improving cash flow in this way leaves the amount
are the same as cash-flow problems. Although cash flow and working of working capital the same. On the balance sheet the value of stocks
capital are interlinked, and many working capital problems are cash- falls whilst the value of cash rises. Equally, one way of dealing with a
flow problems as well, they are not the same. For example, one way of cash-flow problem is to delay paying bills. This increases the amount
dealing with a cash-flow problem is to get an overdraft or a short-term of cash in the business, but it also increases the amount of creditors.
bank loan. Borrowing more in the short term will lead to an increase There is no change in overall working capital. However, a business with
in cash, a current asset. So it could solve a cash-flow problem. But it persistent cash-flow problems is likely to have a shortage of working
will not increase working capital. This is because such borrowing also capital. The most likely solution to both problems is to increase the
increases current liabilities. The money borrowed is, in theory, repayable equity in the business or to borrow more in the long term. You may need
within 12 months. Another way in which a business can solve a cash-flow to think about this when answering questions such as (d) and (e) in the
problem is to run down its stocks. Not reordering stock means that cash case study.

Case study
Falcon has is the amount of trade credit they have to offer
buyers to secure sales. Most buyers want at least 120 days
FALCON TOYS PLC credit. This has increased from 60 days in 2011.
Another problem Falcon Toys encounters is in the build up
to Christmas. Production levels are higher during the late
summer and autumn months as they accumulate stocks
ready for the very busy buying period. This puts an even
greater strain on liquid resources. Working capital is actually
high during this period but a large proportion is held in
stocks. This does not show up in the statement of financial
position because the accounts are produced at the end of the
tax year (April) when most of the stocks have been sold. This
seasonal demand creates quite a challenge for the financial
manager of Falcon. Table 4 shows some information from
Falcon Toys plc’s statement of financial position 2011–2014.

Table 4 Extracts from Falcon Toys plc’s statement of

financial position 2011–2014
  2014 2013 2012 2011
  (£m) (£m) (£m) (£m)
Non-current assets 131.6 126.5 118.2 104.2
Current assets 34.2 30.9 28.3 23.4
Current liabilities 28.1 23.1 16.5 11.6
Non-current liabilities 44.8 41.6 38.5 37.7
Share capital 50 50 50 50
Retained earnings 42.9 42.7 41.5 28.3

(a) What is meant by working capital? (2 marks)

(b) Calculate the value of working capital for Falcon Toys plc
Falcon Toys plc manufactures a range of toys for the between 2011 and 2014. (4 marks)
UK market. Most of its products are plastic-based and (c) Calculate the current ratio for Falcon Toys plc between
targeted at the 4–6 age group. Examples include dolls, 2011 and 2014. (4 marks)
planes, trains, cars, creative games, discovery toys, (d) Explain how reducing debtors may not lead to an increase
farms and animals. Like many toy manufacturers Falcon in the value of working capital for Falcon Toys plc. (4 marks)
attends toy fairs at the beginning of the year to display
new designs and take orders from large buyers for the (e) Assess the measures that Falcon Toys plc might use to deal
Christmas period. However, one of the problems that with its problems. (12 marks)

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Liquidity Unit 35

Key terms Knowledge check

Acid test ratio – similar to the current ratio but excludes 1. What does a statement of financial position (balance sheet)
stocks from current assets. A more severe test of liquidity. show?
Assets – resources that belong to a business. 2. What is the difference between current assets and current
Capital – money put into the business by the owners. liabilities?
Current assets – liquid assets, i.e. those assets that will be
converted into cash within one year. 3. Where will retained earnings appear in a balance sheet?
Current liabilities – money owed by the business that must 4. Give two examples of non-current assets.
be repaid within one year.
5. How is the value of working capital calculated?
Current ratio – assesses whether or not a business has
enough resources to meet any debts that arise in the next 6. What is the difference between the current ratio and the acid
12 months. It is found by dividing current liabilities into test ratio?
current assets. 7. What might be the ‘ideal’ value for the acid test ratio?
Intangible assets – non-physical assets, such as brand
names, patents and customer lists. 8. What sort of businesses may operate with a relatively low
Inventories – stocks, such as raw materials and finished current ratio?
goods held by a business. 9. State four measures a business can take to improve liquidity.
Liabilities – money owed by the business to banks and
10. Can a business have too much working capital? Explain.
suppliers, for example.
Liquidity – the ease with which assets can be converted
into cash.
Net assets – total assets – total liabilities.
Non-current assets – long-term resources that will be used
by the business repeatedly over a period of time.
Non-current liabilities – money owed by the business for
more than one year, sometimes called long-term liabilities.
Shareholders’ equity – the amount of money owed by the
business to the shareholders.
Statement of financial position (balance sheet) – a
summary at a particular point in time of the value of a firm’s
assets, liabilities and capital.
Trade and other payables – money owed by the business
to suppliers and utilities, for example. Sometimes called
trade creditors.
Trade and other receivables – money owed to the business
by customers and any prepayments made by the business.
Working capital – the funds left over to meet day-to-day
expenses after current debts have been paid. It is calculated
by subtracting current liabilities from current assets.

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 36 Business failure 2.3.3
Theme 2

Key points
1. Internal causes of business failure.
2. External causes of business failure.
3. Failure due to financial factors.
4. Failure due to non-financial factors.

Getting started was around 24,000 and predicted to remain roughly at that level
until 2016. In 2013 there were 4.9 million businesses in the UK.
In 2014 Albemarle & Bond, one of the largest pawnbrokers in If around 23,000 fail in a given year it is not a large proportion;
the UK, went into administration. The economic downturn however, most business start-ups, possibly in excess of 90
after 2011 meant that pawnbrokers became more popular. This per cent, cease to trade after five years. What is the cause of
encouraged some companies, including Albermarle & Bond, to business failure?
expand rapidly. But the fall in gold prices in 2013 and the reported
overexpansion produced cash-flow problems, turning profit into Internal causes of business failure
loss for the company. The company attempted to restructure, to Businesses fail for a wide variety of reasons. In some cases the
cause of failure comes from within the business, for example
merge with another company – Better Capital, and sought further
through ineffective management. Some of the common internal
bank loans, but it came to nothing. The only option was to file a
factors that cause business failure are outlined below.
notice of administration, after its main creditors (banks) withdrew
their support.
Lack of planning: The failure of new businesses in particular
In April, Promethean Investments bought 128 of the 187 outlets. may be caused by a lack of planning. At the start-up stage
Out of a workforce of 809, this saved 628 jobs. entrepreneurs can be prone to overlook the importance of
Source: adapted from www.retailresearch.org planning. A thorough business plan is needed to provide a clear
vision for the future so that owners can take an objective and
What caused Albemarle & Bond to collapse? Which factors critical look at the whole business idea. A plan will provide a
that caused the collapse were outside the business (external roadmap that shows a clear direction for the development of the
factors)? How can overexpansion cause a business to fail? business and help to identify potential problems in advance so
that the business is better prepared to deal with them.
Financial planning is crucial. Entrepreneurs need to ensure
Business failure in the UK that the business is sufficiently funded to cope with weak cash
Every year thousands of new businesses are set up in the flow in the initial stages. Business plans clarify the relationships
UK, but at the same time, unfortunately, thousands of existing between operating expenses, prices and profits – all essential
businesses collapse. Between 2003 and the end of 2007 information for an entrepreneur. Small businesses may fail
failures were below 20,000 per annum. However, after they because owners do not put enough time and research into a
peaked in 2009 at around 26,000, the annual rate of failure comprehensive business plan.

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Business failure Unit 36

Part of the planning process should involve seeking to spend cash when it is not definitely there. The control of
advice from relevant business people, potential investors cash flow will be improved if owners and managers produce
and specialists. A range of courses are also available to help regular cash-flow forecasts, keep up-to-date financial records
entrepreneurs in the setting up of a business. Attending such and operate an efficient credit control system.
courses will help entrepreneurs to appreciate the importance of The Northern Echo reported in 2014 that Apex Electrical
planning and hopefully reduce the risk of failure. Solutions, an electrical wholesaler in Gateshead, collapsed due
to severe cash-flow problems. The cash shortage apparently
Cash-flow problems: Many businesses fail because they run resulted from the collapse of a big customer and a subsequent
out of cash. In some cases entrepreneurs focus too much on bad debt of £100,000. The company recorded £190,000 losses
profit and neglect the importance of cash. There are a number in its last yearly results, owed over £580,000 to RBS Invoice
of reasons why a business might run short of cash. Finance and was also £11,000 in arrears on staff wages.
● Overtrading. Young and rapidly growing businesses are

particularly prone to overtrading. This occurs when a

Exam tip
business is attempting to fund a large volume of production It is important to remember that it is possible for a profitable
with inadequate cash. Established companies trying to business to collapse if it runs out of cash. One likely scenario is
expand can also face this problem. that a business is overtrading. If a business grows too quickly it
● Investing too much in fixed assets. In the initial stages of uses up liquid resources to fund the growth. Profitable businesses
a business, funds are limited. Spending large amounts at the can also fail if they get a large bad debt, if they are faced with a
outset on equipment, vehicles and other capital items drains large and unexpected payment or if they offer trade credit that is
resources. It may be better to lease some of these fixed too generous. You can use this information to answer questions
such as (b) in Question 1.
assets, leaving sufficient cash funds.
● Allowing too much credit. A great deal of business is

done on credit. One of the dangers is that businesses allow

their customers too long for payment. This means that they Question 1
are waiting for money and may actually be forced to borrow
In 2014 Astec, a specialist in the design, supply and installation
during this period. Failure to control debtors may also lead to
of external building envelopes, collapsed owing money to
bad debts.
more than 300 suppliers and subcontractors. It was reported
● Over-borrowing. Businesses may borrow to finance growth.
that up to 2012, the business had grown to £30 million sales
As more loans are taken out interest costs rise. Over-
and was trading profitably. The directors decided to grow the
borrowing not only threatens a firm’s cash position, but also
the overall control of the business. It is important to fund business further after several contract opportunities arose, and
growth in a balanced way, perhaps by raising some capital during 2013 recorded sales of £45 million. One reason for its
from share issues. difficulties could have been that the company was growing too
● Seasonal factors. Sometimes trade fluctuates for seasonal
quickly and resources had become strained – it was unable to
reasons. In agriculture, for instance, cereal farmers have a fund the additional working capital requirements of the enlarged
large cash inflow when their harvest is sold, but for much of business. This resulted in catastrophic cash-flow problems. The
the year they have to pay expenses without any cash flowing failure of the business resulted in the redundancy of 85 staff and
in. This situation requires careful management, although it is debts of around £12 million.
possible to predict these fluctuations. (a) What is meant by overtrading?
● Unforeseen expenditure. Businesses need to be prepared
(b) Explain how it is possible for a profitable business, like Astec,
for any unforeseen expenditure. Equipment breakdowns,
to fail.
tax demands, strikes and bad debts are common examples
of this type of emergency expense. In the early stages of
business development, owners are often hit by unforeseen Lack of funds: Some businesses fail because they cannot
expenditure. This can be because they lack experience or attract funding. A lack of funding can affect both established
have not undertaken sufficient planning. businesses and new businesses. Established businesses may
● External factors. Sometimes events that are outside the fail to attract funding because their track record is not as good
control of the business cause cash-flow problems. Examples as it needs to be. As a result they present too much of a risk for
include changes in consumer tastes, changes in legislation investors and other lenders. New businesses often struggle to
or a downturn in the economy. These are discussed in more attract funding because they do not have a trading history, and
detail later in this unit. again, they are too risky for investors. Some business owners
● Poor financial management. Inexperience in managing think they can survive with limited amounts of capital by being
cash or a poor understanding of the way cash flows into cautious. However, if a business is undercapitalised it is
and out of a business may lead to cash-flow problems. For likely to fail. A lot of businesses failed during the ‘credit
example, if a business plans to spend heavily just before it crunch’ just after the global financial crisis in 2008. Lenders
receives large amounts of cash from customers that have became extremely cautious and businesses were starved of
bought on credit, it is likely to face problems. It is not prudent essential funding.

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 Managing business activities

Relying on a narrow customer base: Some businesses experience at the beginning of the development and that the
fail because their customer base is too narrow. This means venture had not been a very nice experience. He said that it
they rely too heavily on a small number of large customers. was something that he wouldn’t do again, adding that he had
Obviously if they lose these large customers, sales will fall lost a lot of money.
dramatically and survival becomes difficult. In recent years
many farmers have gone out of business because they relied Poor leadership: Senior managers and business leaders may
too heavily on contracts with large supermarkets. When terms bring down companies almost singlehandedly. Such failures
for new contracts could not be agreed, farmers were left with are often reported as the result of poor decision-making and
an inadequate customer base. not making urgent changes. Kodak, the camera business,
Blockbuster, the DVD retailer and Nokia, the mobile phone
Marketing problems: A range of marketing problems could maker are all examples where senior managers have been
be the cause of business failure. Businesses that launch new criticised for failing to implement crucial strategies needed to
products that fail to meet customer needs are likely to stumble. protect their business from changes in the market place and
The use of inappropriate pricing strategies could mean that save the companies from collapse. Some leaders have come
prices are too high or too low. A business may invest too unstuck when merging or taking over other businesses. For
heavily in extravagant or inappropriate promotional campaigns. example, some have blamed the near collapse of the Co-
Correct positioning in the market is also vital. For operative Bank on its takeover of the Britannia Building Society,
example, Jane Norman, the women’s fashion chain, went into and the failure of RBS was attributed to poor leadership from
administration in 2014. It was reported as being neither cheap Fred Goodwin and his decision to take over ABN Amro.
nor upmarket, so strategically ‘stuck in the middle’. In a tough
retail environment, the 24-store chain in Britain and Ireland External causes of business failure
had been making losses. Eventually its owner, Edinburgh Failed business owners may often try to cite external
Woollen Mill, was unable to continue to fund the losses and factors for their demise, as this deflects blame away from
put the chain into administration. It was also reported that the themselves. However, some commentators argue that only
positioning of the brand might move forward online. about 20 per cent of business failure is due to external
forces. The most likely external factors to cause business
Failure to innovate: In some cases businesses have failed failure are outlined below.
because they have resisted the need to innovate and not
changed with the times. One common reason is that they may Competition: The strength and success of business rivals
have been reluctant to adopt new technology. For example, can push others out of business. Competitors might bring out
the main reason for camera company Kodak’s demise was its superior products or read market conditions more effectively.
failure to recognise the importance of digital photography. It They may charge lower prices because their costs are lower.
was said that Kodak’s top management never fully grasped They may be a larger, more powerful company and use
how the world around them was changing. Kodak was destroyer pricing to drive smaller rivals out of the market.
reported as thinking that people would prefer hard-copy prints In recent years many manufacturers in the West have been
because they valued film-based photos for their high quality. outcompeted by low-cost producers from China and other
In the end, digital cameras came to dominate because people emerging nations.
no longer felt the need to have high-quality prints.
Changes in legislation: Sometimes changes in
Lack of business skills: Inevitably some small businesses government legislation can lead to business failure. For
fail because their owners may not be fully competent in the example, a number of failing pubs and bars blamed the
required skills. Running a business is challenging and requires legislation that banned smoking from public places for their
a multitude of skills. Entrepreneurs have to be creative, demise. In 2014 a number of lenders withdrew from the
numerate, motivational and good decision-makers. They market after the government passed legislation to control the
also need skills in communication, IT, marketing, negotiating, supply of so-called ‘payday loans’. In April 2014 the West
financial management and more. It is perhaps not surprising Cornwall Pasty Company, a supplier and retailer of pasties
that entrepreneurs may sometimes lack the skills required to and snacks, went into administration citing the government’s
be successful in a business context. so-called ‘pasty tax’ (tax on items sold hot) as one reason.
In 2014, Variety Shopping Ltd, a store owned by Lewis’s The company ran 45 retail outlets plus facilities in 20 railway
Southport Ltd, failed after just a few months of trading. The stations and employed 350 people. However, the company
local press reported that the owner said he had limited retail was taken over shortly afterwards and survived.

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Business failure Unit 36

Changes in consumer tastes: Consumer tastes are not

constant. They are likely to change over time and businesses
Figure 1
that cannot adapt to such changes are more likely to fail. Crude oil prices in 2014 ($ per barrel)
For example, in 2014 two Northern Ireland fashion chains, 110.00
NV and All Gino Casuals (womenswear and menswear
105.00
respectively), closed 15 stores after the parent company
100.00
went into liquidation. A retail analyst was reported as saying
that they had fallen victim to the changing patterns and 95.00
trends in consumer behaviour in the fashion industry, and 90.00
that others in a similar position needed to learn lessons 85.00
from this failure. 80.00
75.00
Economic conditions: The general state of the economy,
both domestic and global, can have an impact on the success 70.00
Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
of businesses. It was widely reported that the level of
business failures rose after the financial crisis in 2008. After Source: www.barchart.com
this crisis many countries in the world went into recession
and thousands of businesses in the UK collapsed as a result.
A government’s economic policies can also contribute to
Question 2
business failure. For example, in the last five years there have In April 2014 Paul Simon, the Barking-based furniture, curtains
been cuts in the public sector, which have resulted in job and carpets retailer, went into administration. This resulted
losses, wages in the public sector have been frozen and some in the closure of some of their 51 stores, based mainly in
taxes have increased. This has led to a drop in disposable retail parks in the south east of England, and the loss of jobs.
income for many people in the UK, which results in lower Poor trading conditions caused by the uncertain economic
demand, particularly for non-essential products and services. environment and online competitors adversely affected the
Businesses that produce these are likely to feel the effects of business. Also, bad weather and floods in 2013/2014 restricted
an economic downturn more severely. customers’ access to stores and led to a further decline in sales.
Other important economic variables include interest rates
and exchange rates. Interest rates dropped after 2008, Source: adapted from www.retailresearch.org
making borrowing cheaper. However, a sharp increase in (a) Explain two external factors that have resulted in the collapse of
interest rates could cause difficulties for some businesses. Paul Simon.
Those with large debts would be at risk, as would businesses (b) Assess whether it is possible for a business like Paul Simon to
that depend on consumers using credit to fund their protect itself from the effect of external factors.
purchasing. Businesses that import and export are also
affected by changes in the exchange rate. For example, a
business that relies heavily on the export market will suffer if Financial and non-financial causes of
the exchange rate rises sharply. Higher exchange rates mean business failure
that overseas customers have to pay more for UK goods and The reasons for business failure can be classified as financial or
services. This can reduce demand and force marginal firms non-financial.
into administration.
Financial factors: Many businesses fail for financial reasons.
Changes in market prices: Some businesses have very They either become bankrupt (where they are taken to court by
little control over the prices they charge. In certain industries creditors) or they become insolvent (where they cease trading
firms are ‘price takers’. For example, oil producers have to sell of their own accord). The most common reason for this failure is
their output at the global market price. Consequently, when the shortage of cash – the inability to pay immediate debts.
these prices fall, marginal producers will leave the market. For A number of things can cause cash shortages, as outlined earlier
example, in late 2014 the price of oil fell from around $103 in this unit. The importance of effective cash-flow management
a barrel in June to around $74 in November. This is shown in in business cannot be overemphasised.
Figure 1. For some oil producers $73 per barrel is the break-
even price. If the price were to fall below this for a long period Non-financial factors: In some cases business failure results
of time these producers might not survive. Many farmers in from factors such as a lack of planning, a lack of business skills,
the UK are also ‘price takers’. In 2014 the livelihoods of many inability to compete effectively, failure to meet customer needs,
dairy farmers were threatened because the price of milk reluctance to change and adverse economic conditions. These
dropped in the market to about 27p per litre. It was reported may be classified as non-financial factors as they are not linked
that this was below the break-even price of around 30p per directly to money issues. However, even these factors are likely to
litre for many farmers. result in financial failure if they are not addressed by a business.

206
 Managing business activities

Case study
attracted trade away from the Jacksons end of the shopping
district. However, Jacksons battled on, relying heavily on
JACKSONS OF READING being a supplier of school uniforms. It also opened a bowls
department to help it compete with online retailers. Thomas
Some consumers value tradition and authenticity highly. Macey, the company archivist, was reported as saying that
Jacksons was a traditional department store in Reading if Jacksons changed with the times, it would lose its appeal.
town centre. Its fittings included glass counters set before Despite this confidence, its appeal did fade away.
wooden shelves. It used a system of pneumatic tubes to Other problems encountered by Jacksons included care of
transport money from customers to a central cash office its old multi-level labyrinthine building, which was hard
and its receipts were hand-written. The Jacksons shopping to manage, along with its old-fashioned labour-intensive
experience reminded people of the 1970s TV series Are approach to customer service. The final straw for Jacksons
You Being Served?, a sitcom that mocked traditional was probably the news that the shop roof was rotting and
retailing. However, on Christmas Eve 2013 the store closed needed to be replaced at a cost of £60,000.
and its 60 employees were laid off. In general, stand-alone department stores have declined
since the 1970s. Customers have been attracted by shopping
malls with their specialist and stylish shops. However,
some are surviving. For example, Jarrold in Norwich attract
customers through events, including Gok Wan, the celebrity
fashion stylist, who signed cookery books and prepared a
dish in the store’s demonstration kitchen. In Trowbridge, the
traditional department store H J Knee, established in 1879,
teamed up with Euronics to sell electronics. These shops have
combined their traditional pedigrees and local roots with
ways of adapting to meet changing patterns in demand.
Source: adapted from www.retailresearch.org

(a) What is meant by the non-financial causes of business

It was reported that competition and failure to innovate failure? (2 marks)
may have been a reason for the closure. The Oracle, a (b) Evaluate the extent to which internal factors contributed to
shopping mall that opened in Reading in 1999, gradually the failure of Jacksons. (20 marks)

Key terms Knowledge check

Administration – a failing business appoints a specialist to 1. Explain the internal and external factors that cause
rescue the business or wind it up. business failure.
External factors – factors beyond the control of businesses
2. Why has the business failure rate in the UK risen since 2008?
cause it to collapse.
Internal factors – factors that businesses are able to control 3. What happens when a business goes into administration?
cause it to collapse. 4. Explain why the management of cash is so important to the
Overtrading – the situation where a business does not have survival of a business.
enough cash to support its production and sales, usually
because it is growing too fast. 5. Give four possible causes of cash-flow problems for a business.
6. State two ways that poor marketing could result in
business failure.
7. How can business failure be caused by poor leadership?
8. State two ways in which competitors might cause business
failure.
9. How might a change in interest rates result in business failure?
10. State two non-financial reasons why businesses fail.

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 37 Production, productivity 2.4.1
Theme 2

Key points
and efficiency
1. Methods of production – job, batch, flow and cell.
2. Productivity – output per unit of input per time period.
3. Factors influencing productivity.
4. The link between productivity and competitiveness.
5. Efficiency – production at minimum average cost.
6. Factors influencing efficiency.
7. Distinction between labour intensive production and capital intensive production.

Getting started What is production?

Production takes place when resources, such as raw materials
or components, are changed into ‘products’. Land, labour,
capital and enterprise, the factors of production, are used in
the production process. The use of land and a tractor to grow
cabbages is an example of production in primary industry.
An example of secondary industry would be the use
of wood, plastic, glue, screws, labour, drilling and cutting
equipment to manufacture furniture.
Today production is often referred to more generally as
those activities that ‘bring a product into being’. Activities which
are part of tertiary industry, such as services, would be
included in this definition. A bank might talk about providing a
‘product’ in the same way as a carpet manufacturer. Examples
of products in a bank’s product portfolio might include
mortgages, current accounts, house insurance and foreign
currency. Direct services from the producer to the consumer,
such as car repairs or decorating, can also be regarded as
production in this sense.

Job production
Job production involves the production of a single product
at a time. It is used when orders for products are small, such
as ‘one-offs’. Production is organised so that one ‘job’ is
completed at a time. There are a wide variety of goods and
services which are produced or provided using this method of
production. Small-scale examples include the baking of a child’s
birthday cake, a dentist’s treatment session or the construction
of an extension to a house. On a large scale, examples could
include the building of a ship, the construction of the Crossrail
link in London or the manufacture of specialised machinery.
Job production is found in both manufacturing and the service
industries. Because the numbers of units produced is small,
the production process tends to be labour intensive. The
workforce is usually made up of skilled workers or specialists
Describe the two different methods of production used above. and the possibility of using labour-saving machinery is limited.
Why are different methods necessary? Which do you think is Many businesses adopt this method of production when they
the most efficient method of production? What might be the are ‘starting up’. The advantages and disadvantages of job
advantages of each method of production? production are shown in Table 1 on the next page.

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 Managing business activities

Table 1 The advantages and disadvantages of job Larger production runs tend to lower the unit or average cost
production of production. New technology is increasingly being introduced
Advantages Disadvantages to make batch production more efficient. The advantages and
disadvantages of batch production are shown in Table 3.
Quality is high because workers are High labour costs due to skilled
skilled workers Table 2 Operations involved in the production of a batch
Workers are well motivated because Production may be slow – long lead of bread
work is varied times
1. Blend ingredients in a mixing container until a dough is formed.
Products can be custom made A wide range of specialist tools may
be needed 2. Knead the dough for a period of time.
Production is easy to organise Generally an expensive method of 3. Leave the dough to rise for a period of time.
production 4. Divide the dough into suitable units (loaves) for baking.
5. Bake the loaves.
Question 1 6. Allow loaves to cool.

Harrods Christmas displays have become a traditional spot to Table 3 The advantages and disadvantages of batch
visit in London during the holiday season. The window displays production
are a real attraction for both children and adults. In 2014, each Advantages Disadvantages
window display for ‘the land of magic’, including Christmas mice
Workers are likely to specialise in More complex machinery may be
and Father Christmas, had an element of mechanism, with the one process needed
most amount of movement ever. Unit costs are lower because output Careful planning and co-ordination
Millington Associates was involved in the production of the is higher is needed
window displays. Millington Associates is an internationally Production is flexible since different Less motivation because workers
established business offering design, prototyping, project orders can be met specialise
management, build, logistics and installation. It has a proven More use of machinery is made If batches are small, costs will still
track record of delivering outstanding work for retail windows, be high
interiors, travel retail, exhibitions and events.   Money may be tied up in work-in-
progress
Source: adapted from All about London
(a) What is meant by job production?
Question 2
(b) Explain one advantage of job production for a company like
Millington Associates. Radford Textiles Ltd makes workwear, leisurewear and
(c) Explain one reason why job production might motivate promotional clothing for UK customers. In 2013, the company
employees at Millington Associates. moved to a new factory in Rochdale. The company has an
excellent reputation in the industry. This is because it:
Batch production • provides a wide choice of quality clothing at low prices
Batch production may be used when demand for a firm’s • provides excellent customer service
product or service is regular rather than a ‘one-off’. An example • is flexible and can meet orders quickly.
might be a furniture factory, where a batch of armchairs is made Like most companies in the clothes industry, Radford Textiles
to a particular design. Production is divided into a number of Ltd uses batch production. The company can meet a wide range
operations. A particular operation is carried out on all products of different orders due to the flexibility of their machinery and
in a batch. The batch then moves to the next operation. A baker multi-skilled workforce.
uses batch production when baking bread. The operations in the
baking process are broken down in Table 2. (a) What is meant by batch production?
These operations would be performed on every batch of (b) Explain why batch production is common in the clothes industry.
bread. There is some standardisation because each loaf in the (c) Explain one way in which Radford Textiles Ltd might have
batch will be the same. However, it may be possible to vary overcome some of the typical problems associated with batch
each batch. The ingredients could be changed to produce brown production.
bread or the style of baking tin could be changed for different-
shaped loaves.
A great number of products are produced using this Flow production
method, particularly in manufacturing, such as the production Most people will have some idea of flow production from
of components and food processing. For example, in a canning pictures of motor car factories. Production is organised so that
plant, a firm may can several different batches of soup, each different operations can be carried out, one after the other, in a
batch being a different recipe. Products can be produced in very continuous sequence. Vehicles move from one operation to the
large or very small batches, depending on the level of demand. next, often on a conveyer belt.

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Production, productivity and efficiency Unit 37

The main features of flow production are: or shaping by routing would be carried out at workstations. The
●● the production of large quantities part would then be assembled and passed on to stock. The cell
●● a simplified or standardised product may also be responsible for tasks such as designing, schedule
●● a semi-skilled workforce, specialising in one operation only planning, maintenance and problem solving, as well as the
●● large amounts of machinery and equipment manufacturing tasks which are shared by the team.
●● large stocks of raw materials and components. Here are some advantages of cellular manufacturing.
●● Floor space is released because cells use less space than a

Flow production is used in the manufacture of products as linear production line.

varied as newspapers, food and cement. It is sometimes called ●● Product flexibility is improved.

mass production, as it tends to be used for the production of ●● Lead times are cut.

large numbers of standard products, such as cars or breakfast ●● Movement of resources and handling time is reduced.

cereals. Certain types of flow production are known as continual ●● There is less work-in-progress.

flow production, because products such as clothing material ●● Teamworking is encouraged.

pass continually through a series of processes. Repetitive flow ●● There may be a safer working environment and more efficient

production is the manufacture of large numbers of the same maintenance.

product, such as plastic toy parts or metal cans.
The advantages and disadvantages of flow production are Productivity
shown in Table 4. In the 1990s flow production processes were Output can be increased if productivity is raised. Productivity is
changed in an attempt to solve some of the problems. Japanese the amount of output that can be produced with a given input of
manufacturers setting up businesses in the UK introduced resources. It is common to measure the productivity of specific
methods to improve efficiency. Just-in-time manufacturing, for resources in a period of time. A business may measure labour
example, helped to reduce the cost of holding stocks. Some productivity – this is output per worker per period of time. For
vehicle manufacturers attempted to introduce an element of job example, a factory producing standard mobile homes employed
production into flow processes by customising products for 40 workers in 2014. During the year a total of 1,200 mobile
clients. For example, a range of different cars was produced on homes were produced. Therefore labour productivity was 30
the same production line. Cars in the same model range differed homes per worker (1,200/40).
in colour, engine size, trim and interior design. This ratio is a useful measure of labour productivity, but there
are some problems that need to be recognised. For example,
Table 4 The advantages and disadvantages of flow which workers should be counted? Should maintenance crew,
production management and clerical staff be counted, or should the ratio
Advantages Disadvantages concentrate on direct labour only, i.e. shop floor workers? How
Very low unit costs due to Products may be too standardised should part-time workers and the long-term sick be treated?
economies of scale How can the ratio accommodate a multi-product plant, where
Output can be produced very quickly Huge set-up costs before the efforts of an employee might contribute to the production of
production can begin more than one product?
Modern plant and machines can Worker motivation can be very low – A business may be interested in the productivity of its capital.
allow some flexibility repetitive tasks This is becoming increasingly the case as more firms become
Production speed can vary Breaks in production can be very capital intensive. A capital productivity ratio can be calculated
according to demand expensive by dividing output by the amount of capital employed in a given
period. For example, if a factory used 10 sewing machines and
Cell production a total of 900 garments were sewn in a day, the productivity of
Flow production involves mass producing a standard product on capital would be 90 garments per machine each day.
a production line. The product undergoes a series of operations
in sequence on a continuous basis until a finished product rolls Exam tip
off the ‘end of the line’. You need to be careful not to confuse production with
Cellular manufacturing or cell production adopts a different productivity. Remember that production involves transforming
approach and involves dividing the workplace into ‘cells’. Each resources into useful goods and services that meet customer
cell occupies an area on the factory floor and focuses on the needs – it refers to the level of output produced. Productivity
production of a ‘product family’. A ‘product family’ is a group of is the rate of production. It is the amount of output that can be
produced with a given quantity of resources in a period of time.
products which requires a sequence of similar operations. For
Productivity will increase if more output can be made with the
example, the metal body part of a machine might require the same amount of resources.
operations cut, punch, fold, spot weld, dispatch. This could all
be carried out in one cell. Inside a cell, machines are grouped
together and a team of workers sees the production of a good Factors influencing productivity
from start to finish. Over time a business wants to improve productivity if possible.
Take the example of a furniture manufacturer making parts This is because costs will be lower and profit will be higher.
for a kitchen range in a cell. The raw material, such as wood, Some of the key factors that can be used to influence
would be brought into the cell. Tasks such as turning on a lathe productivity are outlined below.
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 Managing business activities

Specialisation and the division of labour: One feature rivals. This makes businesses more competitive in the market
of modern business is specialisation. This is the production of place. As a result they are likely to win more customers, increase
a limited range of goods by an individual, business, region or market share and possibly threaten the survival of their rivals.
nation. For example, Coca-Cola specialises in soft drinks, Toyota If UK businesses can be more productive then they may
makes cars and Emirates provides air travel. Specialisation inside become more competitive in overseas markets. This will help
a business is also common. Departments specialise in different to boost the nation’s exports and improve the performance of
activities, such as marketing, production, finance, personnel the UK economy. This could help increase the standard of living
and purchasing. Workers will also specialise in certain tasks in the UK. However, improving productivity may not be enough
and skills. This is called the division of labour. It allows people to outcompete overseas rivals. Other factors have to be taken
to concentrate on a limited range of tasks. For example, in into account. For example, the price of exports is influenced by
construction an architect will draw up plans, a bricklayer will exchange rates. If the exchange rate improves for the UK the
build walls, a roofer will lay the roof, and so on. price of exports will rise. This will reduce the competitiveness of
UK goods sold abroad.
Education and training: The government can help improve
the quality of labour by investing in education. This might involve Efficiency
providing more equipment for schools or improving the quality Efficiency is about making the best possible use of all a
of teaching. Firms can also improve the productivity of their business’s resources. A business will want to use its materials,
workers by providing their own training. labour and capital as effectively as possible. Businesses often
use costs as an indicator of efficiency. Production is said to be
Motivation of workers: If people are motivated at work they efficient if average costs are minimised. Figure 1 shows the
will be more productive. Firms might use financial incentives, average cost curve for a business. The diagram shows that
such as piece rates. Workers who are not motivated by money average costs fall at first, reach a minimum and then rise again.
may respond to other incentives. For example, job rotation might In this example the business will minimise its average cost
be introduced. This involves an employee changing jobs from when output is 500 units. At this level of output average cost is
time to time. If people are trained to do different jobs, their time £20 per unit and efficiency cannot be improved. All resources
at work may be more interesting because there is more variety. are being used as effectively as possible. If the business was
producing just 200 units of output, efficiency is not being
Working practices: The way labour is organised and managed maximised because average cost is higher at £30.
can affect productivity. Working practices are the methods and
systems that employees adopt when working. For example, Figure 1
productivity might be increased by changing the factory
The average cost curve for a business
layout – repositioning workstations or reorganising the flow of
(£)
production. Such changes may improve productivity because
60
workers do not have to move around as much, for example.
50
Labour flexibility: Labour can be more flexible if workers
40
are trained to do different jobs and can switch from one to the
other at short notice. For example, some supermarkets train most 30
of their staff to operate checkouts. Then, during a busy period,
20
workers can be switched from other jobs to operate checkouts to
prevent long queues from forming. Some businesses use flexitime 10
where workers can choose their own hours of work (within limits).
0
For example, a call centre can be kept open from 7.00 a.m. to 0 100 200 300 400 500 600 700 800 900 1000
8.00 p.m. if individual workers choose to work at different times of Units
the day. Shift work can be used to keep factories running for 24
hours a day. For example, many factories operate three daily shifts
– 08.00 to 16.00, 16.00 to 00.00 and 00.00 to 08.00. Factors influencing efficiency
The efficiency of businesses can be influenced by a very
Capital productivity: Productivity usually increases when new wide range of factors. If a business can reduce average costs,
technology is introduced. This is because new technology is more efficiency will improve. Some of the measures that a business
efficient. Productivity is also likely to increase if production becomes might use to reduce costs are outlined below.
more capital intensive. The benefits of more capital intensive
production are summarised in Table 5 at the end of this unit. Introducing standardisation: Standardisation involves using
uniform resources and activities or producing a uniform product.
Productivity and competitiveness It can be applied to tools, components, equipment, procedures
If businesses can raise productivity they will be able to produce and documents. For example, a construction company building
more output with the same level of resources. This will mean an apartment block would benefit if all the flats were fitted with
that costs will be lower and they can charge lower prices than the same kitchen and bathroom units. Bulk purchases can be
211
Production, productivity and efficiency Unit 37

made, the same tools and procedures could be used for fitting, Lean production: Lean production is an approach developed
and training time could be reduced. In general, efficiency will by Toyota, the Japanese car manufacturer. Its aim is to use fewer
improve if there are standard components, such as nuts, screws, resources in production. Lean producers use less of everything.
bolts, pipes and wire, and standard measurements terminology, This includes factory space, materials, stocks, suppliers, labour,
procedures and equipment. However, standardisation is capital and time. As a result, lean production:
somewhat inflexible because it makes customisation more ●● raises productivity
difficult and design more challenging. ●● reduces costs and cuts lead times

●● reduces the number of defective products

Outsourcing: It may be possible to improve efficiency by ●● improves reliability and speeds up product design.
outsourcing specific business activities. This means that work Lean production involves using a range of practices designed
currently done by a business is given to specialists outside the to reduce waste and improve productivity and quality. Examples
business that can do the same work at a lower cost or more include Kaizen, just-in-time production, cell production,
flexibly. For example, a call centre might outsource its staff empowerment and teamworking.
catering facilities to a specialist catering company that can
operate more effectively and at a cheaper rate. Kaizen: There is a strong link between Kaizen and lean
production. Kaizen is a Japanese word that means continuous
Relocating: Moving the entire business to a new site is improvement. There is a belief in Japan that everything can be
a drastic measure, but can result in much lower costs. By improved. This means that workers are always coming up with
relocating, businesses might enjoy lower rents, lower wages ideas to improve quality, reduce waste or increase efficiency. The
and better transport links. Many businesses have relocated improvements may be very small, but over a long period of time
their operations overseas to countries such as China, they can have a huge impact.
Thailand and India, where labour costs in particular are
Just-in-time production (JIT): This involves minimising or
substantially lower.
eliminating the amount of stock held by a business. It reduces all
of the costs associated with stock holding.
Downsizing: Downsizing involves reducing capacity, i.e. laying
off workers and closing unprofitable divisions. The advantages
of this for businesses can include: Question 3
●● cost savings and increased profit
For several years, it was widely reported that HSBC, one of
●● a leaner, more competitive operation
the world’s leading banks, was downsizing its operations.
●● removal of unprofitable or inefficient parts of a business
In 2013 it planned to lay off up to 14,000 staff globally in
●● profitable businesses no longer subsidising unprofitable ones.
a cost-cutting move, planning to include redundancies
However, downsizing can have drawbacks. For example, laying among the bank’s back-office IT employees. HSBC outlined the
off workers means that businesses lose skills, experience and plan in its three-year strategy. The bank said it aimed to save
knowledge. In some cases businesses have been forced to $2-3 billion in annual costs, on top of the $4 billion it had
hire back redundant staff as expensive consultants. Downsizing already saved. The move planned to reduce the total headcount
might also have an adverse effect on the morale of workers. to 240,000 by 2016, bringing the total number of
redundancies to 55,000 since 2010. These losses formed part
Delayering: Delayering also involves reducing staff. Cuts are of a plan to streamline HSBC’s global operations: providing
directed at particular levels of a business, such as managerial more control to their London head office and to try to avoid
posts. Many traditional organisational charts are hierarchical, overlaps in job roles and to remove inefficiencies in processes.
with several layers of management. Delayering involves They were also looking to move away from their traditional
removing some of these layers to give a flatter structure. In in-house software development. Though still aiming to remain
the late 1980s, the average number of layers in a typical an international bank HSBC planned to focus on 22 countries,
organisational structure was 7, although some were as high as despite their presence in 80 countries around the world.
14. By 2000 this had been reduced to less than five. The main
advantage of delayering is the savings made from laying off Source: adapted from the Financial Times, 17.3.13, 23.4.13,
expensive managers. It may also lead to better communication 15.5.13. All rights reserved
and better-motivated staff if they are empowered and allowed (a) What is meant by downsizing?
to make their own decisions. (b) Explain (i) one benefit and (ii) one drawback to HSBC of downsizing.

Investing in new technology: New technology can often

improve efficiency. New machinery may be quicker, more
accurate, be capable of more tasks, and carry out work in Distinction between labour and capital
more extreme conditions than older equipment or labour. Many intensive production
machines are controlled by computers and can undertake very One of the most important production decisions which operations
complex tasks. The use of information and communications managers have to make is what combination of capital and
technology has helped most businesses improve efficiency. labour to use. Labour intensive production techniques involve

212
 Managing business activities

using a larger proportion of labour than capital. Capital intensive

production techniques involve employing more machinery relative
to labour. For example, chemical production is capital intensive,
with only a relatively small workforce to oversee the process. The
postal service is labour intensive, with a considerable amount of
sorting and delivery done by hand.
The optimal resource mix between labour and capital
depends on a number of factors.
●● The nature of the product. Everyday products with high

demand, like newspapers, are mass produced in huge plants

using large quantities of machinery. However, in modern
economies like the UK an increasing number of the products
supplied by businesses are services. Generally, the provision
of services is labour intensive.
●● The relative prices of the two factors. If labour costs are

rising then it may be worth the company employing more

capital instead. In countries like China and India where labour
is relatively cheap, labour intensive production methods
are preferred. However, in most developed economies
like the UK, labour is more expensive and a great deal of
manufacturing is capital intensive.
●● The size of the firm. As a firm grows and the scale of

production increases, it tends to employ more capital relative

to labour. For example, in the UK, Morgan cars, a small
sports car manufacturer, uses a labour intensive approach to
production. In contrast, Honda, which has a huge car factory
in Derby, uses capital intensive production.

Table 5 The benefits and drawbacks of capital and labour

intensive strategies
Capital intensive strategies Knowledge check
Benefits
1. State two disadvantages of job production.
• Generally more cost-effective if large quantities are produced
2. Explain why batch production is a flexible method of
• Machinery is often more precise and consistent
production.
• Machinery can operate 24/7
3. Give two examples of industries where process production is
• Machinery is easier to manage than people
likely to be used.
Drawbacks
4. What is the difference between production and productivity?
• Huge set-up costs
• Huge delays and costs if machinery breaks down 5. State two ways in which labour productivity might be
• Can be inflexible – much machinery is highly specialised
improved.
• Often poses a threat to the workforce and could reduce morale 6. What is the difference between downsizing and delayering?
Labour intensive strategies 7. How will specialisation improve efficiency?
Benefits 8. Give two advantages of outsourcing.
• Generally more flexible than capital – can be retrained for example 9. What is meant by cell production?
• Cheaper for small-scale production
10. What is the aim of Kaizen?
• Cheaper for large-scale production in countries like China and India
11. Explain why the provision of services is often labour
• People are creative and can therefore solve problems and make improvements
intensive.
Drawbacks
12. Give two examples of businesses that are likely to be
• People are more difficult to manage than machines. They have feelings
and react capital intensive.
• People can be unreliable. They may be sick or leave suddenly
• People cannot work without breaks and holidays
• People sometimes need to be motivated to improve performance

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Production, productivity and efficiency Unit 37

Case study
JAGUAR LAND ROVER • moved to 24-hour production at Halewood on Merseyside
to meet demand for the Range Rover Evoque
In 2012 it was reported that Jaguar Land Rover (JLR), the • opened a new state-of-the-art manufacturing facility
luxury car maker owned by Tata, had invested £370 million at Solihull.
to increase productivity and upgrade its UK manufacturing To create a lean production strategy, Jaguar also
facilities. This was to help prepare for the launch of the streamlined its production methods, operations and
new Range Rover in 170 countries. JLR installed a new processes. This enabled it to compete globally and retain
aluminium body shop at the company’s Solihull plant as part quality, yet drive down costs. For example, ‘just in time’
of the investment package. It upgraded paint-applications was introduced to improve efficiency, reshaping workshops
technologies, trim assembly, warehousing and JLR’s first where many parts had been in stock. Workers could then
customer handover centre. The company also invested heavily call for additional spares when needed, rather than having
in all-aluminium production processes at Land Rover’s Solihull parts on hand if required. To assist with the change to
plant, where more than 6,800 workers were employed. just-in-time ordering and ensure that lean production
A spokesman for Jaguar said that news of the investment ideas were implemented smoothly with suppliers and cut
was good for the thousands of JLR workers, the UK costs, the firm introduced dedicated Customer Relationship
automotive industry and the wider economy. He commented Management (CRM) software.
that the wave of investments from global automotive Sources: adapted from www.smmt.co.uk
companies demonstrated the growing strength and
competitiveness of the manufacturing sector. It showed
what could happen when industry and government worked
together to build a better business environment. As part of (a) What is meant by flow production? (2 marks)
its expansion, Jaguar Land Rover: (b) Assess the benefits to Jaguar of using flow production.
• created 1,100 new jobs at Jaguar’s Castle (8 marks)
Bromwich plant (c) Evaluate the importance to Jaguar of continual investment
• began work on a £355 million engine factory near in new technology. (20 marks)
Wolverhampton

Key terms
Batch production – a method that involves completing one Job production – a method of production that involves
operation at a time on all units before performing the next. employing all factors to complete one unit of output at a time.
Capital intensive – production methods that make more use Kaizen – a Japanese term that means continuous improvement.
of machinery relative to labour. Labour intensive – production methods that make more use
Capital productivity – the amount of output each unit of of labour relative to machinery.
capital (e.g. one machine) produces. Labour productivity – the amount of output each unit of
Cell production – involves producing a family of products in a labour (e.g. one worker) produces.
small self-contained unit (a cell) within a factory. Lean production – an approach to operations that focuses on
Division of labour – specialisation in specific tasks or skills by the reduction of resource use.
an individual. Outsourcing – giving work to sub-contractors to reduce costs.
Downsizing – the process of reducing capacity, usually by Production – the transformation of resources into goods or
laying off staff. services.
Efficiency – producing a level of output where average cost is Productivity – the output per unit of input per time period.
minimised. Specialisation – in business, the production of a limited range
Flow production – large-scale production of a standard of goods.
product, where each operation on a unit is performed Standardisation – using uniform resources and activities or
continuously one after the other, usually on a production line. producing a uniform product.

214
 38 Capacity utilisation 2.4.2
Theme 2

Key points
1. Calculating capacity utilisation: current output (divided by) maximum possible output (×100)
2. Implications of under-utilisation and over-utilisation of capacity.
3. Ways of improving capacity utilisation.

Getting started The formula for capacity utilisation is:

Ruta and Gatis Dukurs run the Mansion Hotel in Bournemouth. Current output
Capacity utilisation = ––––––––––––––––––––– × 100
The hotel has 30 rooms and the average occupancy per night Maximum possible output
each month for 2014 is shown in Figure 1. The business only
made a very small profit in 2014 and the owners are keen to
Worked example
raise occupancy rates during the next year.
A printing operation is capable of printing 10,000
Figure 1 leaflets in a particular time period but only prints 9,000.
Mansion Hotel occupancy for 2014 Capacity utilisation would be:
Rooms 9,000
Capacity utilisation = –––––– × 100 = 90 per cent
30 10,000
25 25 Here the printing operation has 10 per cent unused capacity.
20 20
18
16
12 12 12
10 10 10 9 10 Worked example
0 Alternatively, consider a printing operation that is able to
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec operate for ten hours, six days a week, using shifts. If last week
it only had sufficient work to operate for 48 hours, the capacity
How well is the business using its resources in this case? What utilisation would be:
problems are encountered when a business does not operate at 48
Capacity utilisation = ––––– × 100 = 80 per cent
full capacity? What measures might the hotel take to improve (10 x 6)
room occupancy? In this case the operation has spare capacity of 20 per cent.

Capacity utilisation Implications of under-utilisation

Capacity utilisation is about the use that a business makes of its A business might be under-utilising capacity if it has experienced
resources. If a business is not able to increase output, it is said a drop in demand, due for example to increased competition in
to be running at full capacity. Its capacity utilisation is 100 per the market. Some businesses have to deal with seasonal demand
cent. If a London to Edinburgh coach with 52 seats had only where at certain times of the year demand is expected to be low.
30 passengers it would be operating at less than full capacity For example, toy manufacturers expect most of their sales to fall in
and would have spare, excess, surplus or unused capacity. the run-up to Christmas. Just after Christmas such manufacturers
Businesses do not always operate at full capacity. It may not are likely to operate below capacity.
be possible to keep all resources and machinery fully employed
all the time. However, most businesses would wish to be Drawbacks: If a business is working with under-utilised
operating at close to full capacity, say 90 per cent. In some cases capacity it will not be making the most of its resources. It
businesses choose to operate at less than full capacity to be may be operating inefficiently because its unit costs are not
flexible. For example, they might want to have spare capacity to minimised. Table 1 shows capacity utilisation, output, variable
cope with increased orders from regular customers. Without this, cost, fixed cost, total cost and average cost (unit cost) for a
a business might let down its customers and risk losing them. component manufacturer. When capacity utilisation is raised
from 60 per cent to 80 per cent, for example, unit cost falls
Measuring capacity utilisation from £2.42 to £2.31. This is because the fixed costs of
Capacity utilisation can be measured by comparing actual or £50,000 are spread over more units of output. This explains
current output with the potential output at full capacity. why firms will always be keen to raise capacity utilisation.
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Capacity utilisation Unit 38

Table 1 Capacity utilisation, output, variable cost, fixed with opportunities to increase their earnings by doing overtime.
cost, total cost and unit cost for a component manufacturer Finally, a busy operation can improve the company’s image. As a
Actual output (units) 120,000 160,000 result customers might be more confident when placing orders.
Maximum possible output (units) 200,000 200,000
Capacity utilisation 60% 80% Question 1
Variable costs (£2 per unit) £240,000 £320,000 Hardwick Ltd is a bottling company and has contracts with
Fixed costs £50,000 £50,000 a number of independent brewers in the UK. It has benefited
Total cost £290,000 £370,000 from a growth in the home consumption of bottled beer. Table 2
Unit cost £2.42 £2.31 shows the capacity and actual output of Hardwick Ltd for 2013
and 2014.
Operating with too much spare capacity may also affect the
morale of workers. They may feel that the business is struggling Table 2 Capacity and actual production for Hardwick
to generate orders. This might mean that workers feel insecure Ltd 2013 and 2014
in their jobs. Also, if workers become accustomed to a ‘light’   2013 2014
workload, they may resent working harder if the business Production capacity (bottles) 42m 42m
suddenly gets more orders.
Actual output (bottles) 34m 40m
Benefits: It could be argued that operating at below capacity (a) Calculate capacity utilisation in 2013 and 2014.
does have some benefits. For example, a business would be (b) Explain one reason that could account for the change in capacity
able to cope more easily with sudden increases in demand. A utilisation between 2013 and 2014.
business that is not able to meet immediate customer needs may (c) Explain one benefit of operating close to full capacity for a
lose out in the long term. Customers might go to rivals that are business like Hardwick Ltd.
able to deal with demand fluctuations. Also, when working below
full capacity there is likely to be less work-related stress. Both
workers and managers will be more relaxed and comfortable
with their workloads. This can reduce sickness and absenteeism.
Ways of improving capacity utilisation
Reduce capacity: A business might decide to cut capacity, for
Implications of over-utilisation instance by rationalising. This involves reducing excess capacity
Many businesses would prefer to operate at close to full capacity by getting rid of resources that the business can do without.
because average costs are lower. However, if a business is A business could take a number of measures.
running at full capacity it might be over-utilising its resources. ●● Reduce staff by making people redundant, employing more

This means that resources will be stretched uncomfortably. For part-time and temporary staff, and offering early retirement.
example, over-utilisation might occur if people are being asked ●● Sell off unused fixed assets, such as machinery, vehicles,

to work long periods of overtime without a reasonable break for office space, warehouses and factory space.
rest. There are both drawbacks and benefits of over-utilisation. ●● Review leasing capacity. For example, Debenhams has leased

unused floor space in its stores to other retailers. Parts of

Drawbacks: The pressure of constantly working at full capacity a factory could also be leased to another manufacturer.
can put a strain on some of the resources. As well as causing The advantage of this is that the space may be reclaimed if
stress and tiredness to the workforce, possibly increasing the demand picks up again.
risk of accidents or absence, machines may also be overworked ●● Move to smaller premises where costs are lower.

to breaking point. If a business is using flow production ●● Mothball some resources. This means that fixed assets, such

techniques, breakdowns on a production line can be hugely as machinery, are left unused, but maintained, so that they
expensive – especially if production is stopped completely for can be brought back into use if necessary.
a period of time. Another problem is that a business may not
be able to respond to an increase in demand. For example, the Increase sales: If a business sells more of its output, it will
business might lose lucrative orders from new customers. Finally, have to produce more. Therefore capacity utilisation will rise. A
there may be insufficient time for staff training and important business might need to spend on promotion to increase sales,
maintenance work. This might save money in the short term, but for example. However, if these costs are not covered by the
in the long term staff may be lacking in vital skills and machinery extra revenue generated, raising capacity utilisation in this way
may break down. may not be viable.

Benefits: Average costs will be lower because fixed costs Increase usage: A problem that many businesses face is
will be spread across more units of output. This will help to dealing with peak demand. Train operators can find that capacity
improve competitiveness and raise profits. Also, staff motivation utilisation is close to 100 per cent during the ‘rush hour’, but
might be good if workers feel secure in their jobs. People in perhaps as low as 10 per cent late at night. Such businesses
the organisation may also be happier if there is lots of work would like to increase capacity utilisation during off-peak hours.

216
 Managing business activities

Incentives might include discounts for off-peak travel. For Key terms
example, many rail companies offer some of their customers
railcards to travel cheaply on off-peak trains. Capacity utilisation – the use that a business makes of its
resources.
Outsourcing: Capacity utilisation can vary considerably within Excess or surplus capacity – when a business has too many
a business. Where capital equipment has low utilisation rates, resources, such as labour and capital, to produce its desired
it might be more efficient for the business to sub-contract or level of output.
outsource the work. This means hiring or contracting another Full capacity – the point where a business cannot produce
business to do work which was previously done in-house. For any more output.
example, a business might run a small fleet of delivery vans, Mothballing – leaving machines, equipment or building
which on average are on the road for four hours per day. It is space unused, but maintained, so they could be brought
likely that it would be cheaper for the business to sell the vans back into use if necessary.
and employ a company to make the deliveries. The delivery Over-utilisation – the position where a business is running
company will be more efficient because it will be running its at full capacity and ‘straining’ resources.
vans for much longer during the day. There may also be cost Rationalisation – reducing the number of resources,
savings in terms of staff. If the business employed full-time particularly labour and capital, put into the production
drivers for the vans, they would have been under-utilised for four process, usually undertaken because a business has excess
hours per day. capacity.
Outsourcing can also lead to other cost advantages. The Under-utilisation – the position where a business is
delivery business will be a specialist business. It should operate producing at less than full capacity.
its delivery service more efficiently than a business with a few
vans and little knowledge of the industry. If nothing else, it
should have greater buying power. It might be able, for instance, Knowledge check
to negotiate lower prices for its vans because it is buying several
at a time. If it is a very small business, its hourly wages may be 1. What is meant by spare capacity?
less than, say, a union negotiated rate at a larger business. 2. If a train carries an average of 340 passengers between
An alternative outsourcing strategy is to take on outsourcing London and Glasgow, what is capacity utilisation if the
contracts for other businesses. For example, a major manufacturer train’s capacity is 500?
of soap could accept contracts from rival soap manufacturers
3. State two drawbacks of operating well below full capacity.
to improve its capacity utilisation. Outsourcing then becomes a
strategy for increasing demand for the business. 4. State two drawbacks of operating at full capacity.
5. How might a large retailer use outsourcing to improve
Redeployment: If a business has too many resources in capacity utilisation?
one part of the business, it may be possible to deploy them
in another part. For example, a bank may ask some of its 6. How will rationalisation improve capacity utilisation?
employees to work in another branch for a short period. 7. What sort of resources can be effectively mothballed?

Exam tip
When answering a question on capacity utilisation where a
business has under-utilised capacity or is over-utilising capacity,
you need to assess whether a business has long-term or
short-term problems. For example, a business with seasonal
demand, where under-utilisation is not permanent, will address
problems slightly differently. Drawing distinctions between the
long term and the short term in business will help show your
skills for evaluation.

Maths tip
If you know both the capacity of a business and the
capacity utilisation, it is possible to calculate the current output
of a business. For example, if the capacity of a manufacturer is
120,000 units per month and capacity utilisation is at
91 per cent, current output is 109,200 units (120,000 × 91/100).

217
Capacity utilisation Unit 38

Case study
ENFIELD SHIPPING LTD

Enfield Shipping Ltd is a small shipping company and owns We need to carry 9,000 containers per trip to break-even.
just a single container ship. The capacity of the ship is We’re close to collapse unless we do something to improve
16,000 containers. The company ships containers between capacity utilisation.’ Table 3 shows the average number
the UK and the Middle East. It offers a full range of shipping of containers shipped by Enfield Shipping Ltd per trip
services that includes: between 2011 and 2014.
• competitive deep sea rates to ports throughout the
Table 3 The average number of containers shipped by
Middle East
Enfield Shipping Ltd per trip 2011 to 2014
• customs clearance services   2011 2012 2013 2014
• a choice of receiving shipping containers delivered on to the Average number of
ground in the UK for safer, more convenient loading containers per trip 14,500 13,600 12,000 9,500
• project loads
• full import and export services.
(a) What is meant by capacity utilisation? (2 marks)
Due to the political difficulties in the Middle East a number
of Enfield’s regular customers have stopped exporting (b) Calculate the capacity utilisation for Enfield Shipping Ltd
to the region. Consequently, the average number of between 2011 and 2014. (4 marks)
containers carried per trip has fallen since 2011. The (c) Assess the importance to Enfield Shipping Ltd of
managing director of the company says, ‘The situation is increasing capacity utilisation. (8 marks)
worsening almost by the month. I get far more phone calls
(d) Assess the measures that Enfield Shipping Ltd might take
from customers who say they’ve decided to quit than those
to increase capacity utilisation. (12 marks)
that are interested in exporting to the Middle East.

218
 39 Stock control 2.4.3
Theme 2

Key points
1. Interpretation of stock control diagram.
2. Buffer stocks.
3. Implications of poor stock control.
4. Just-in-time (JIT) management of stock.
5. Waste minimisation.
6. Competitive advantage from lean production.

Getting started sudden rise in demand, a firm can meet urgent orders by
supplying customers from stock holdings. This avoids the
need to step up production rates quickly.

Stock control
One of the most important tasks in stock control is to maintain
the right level of stocks. This involves keeping stock levels as
low as possible, so that the costs of holding them are minimised.
At the same time stocks must not be allowed to run out, which
can result in production being halted and customers being let
down. A number of factors influence stock levels.
●● Demand. Sufficient stocks need to be kept to satisfy normal

demand. Firms must also carry enough stock to cover growth

in sales and unexpected demand. The term buffer stock
is used to describe stock held to cover unforeseen rises in
demand or breaks in supply. This is discussed later in this unit.
Why do you think the business in the photograph holds such
●● Stockpile goods. Toy manufacturers, for example, build
large amounts of stock? What might be the opportunity cost of
up stocks in the few months up to December ready for the
holding stock? What other costs might be incurred when storing
Christmas period. Coal-fired power stations build up stocks of
stock like this?
fuel in the summer when demand for electricity is low so less
coal is needed and the price of coal is lower. This means they
What is stock? have stocks ready for higher demand in the winter, and they
Businesses purchase raw materials, semi-finished goods and have made savings on the cost.
components. A washing machine manufacturer, for example, may ●● The costs of stock holding. If stock is expensive to hold

buy electric motors, circuit boards, rubber drive belts, nuts, bolts, then only a small quantity will be kept. Furniture retailers may
sheet metal, and a variety of metal and plastic components. These keep low stock levels because the cost is high and sales
stocks, also called inventories, are used to make products, which levels are uncertain.
are then sold to customers. Some businesses also hold stocks ●● The amount of working capital available. A business that

of their finished goods before they are delivered to customers. In is short of working capital may not be able to purchase more
practice a variety of stocks are held, for different reasons. stock, even if it is needed.
●● The type of stock. Businesses can only hold small stocks

●● Raw materials and components. These are purchased from of perishable products. The stock levels of food items and
suppliers before production. They are stored by firms to cope fresh ingredients will be very small. Almost the entire stock
with changes in production levels. Delays in production can of finished goods is often sold in one day. The ‘life’ of stock,
be avoided if materials and components can be supplied from however, does not solely depend on its perishability. Stocks
stores rather than waiting for a new delivery to arrive. Also, if can become out of date when they are replaced by new
a company is let down by suppliers it can use stocks to carry models, for example.
on production. ●● Lead time. This is the amount of time it takes for a stock

●● Work-in-progress. These are partly finished goods. In a purchase to be ordered, received, inspected and made ready
TV assembly plant, work-in-progress would be TVs on the for use. The longer the lead time, the higher the minimum
assembly line which are only partly built. level of stock needed.
●● Finished goods. The main reason for keeping finished ●● External factors. Fear of future shortages may prompt firms

goods is to cope with changes in demand. If there is a to hold higher levels of raw materials in stock as a precaution.

219
Stock control Unit 39

Interpretation of a stock control diagram Question 1

The flow of stocks in a business can be illustrated using a stock
control diagram like the one shown in Figure 1. The diagram MelCo Electronics assembles control panels for computer
focuses on the re-order quantity (the amount of stock ordered games. The company imports a number of components from
when a new order is placed) and the re-order level (the level of around the world – mainly China. One supplier in Shanghai
stock currently held when an order is placed). ships a particular circuit board to the company. This is a new
supplier and was given the contract to supply circuit boards
Figure 1 because they were 19 per cent cheaper than the original
supplier. The change in supplier occurred 12 months ago.
Stock control diagram
Figure 2 shows stock movements of this component over an
80 eight-month period.
Maximum
stock level
70
Re-order Figure 2
60 quantity
Stocks of circuit boards at MelCo Electronics
Stock level (000)

50 Stock level (000s)

Re-order
level 500
40

30 400
Minimum
stock level
20 300

10 Lead
time 200
Re-order
level
0 1 2 3 4 5 6 7 Time (Months) 100

0
The stock control diagram shown in Figure 1 assumes that: 0 1 2 3 4 5 6 7 8
●● 50,000 units are used every two months (25,000 Time (months)
each month)
●● the maximum stock level, above which stocks never rise, (a) Calculate the (i) minimum stock level, (ii) re-order level,
is 70,000 units (iii) re-order quantity, (iv) lead time for the circuit boards.
●● the minimum stock level, below which stocks should never (b) Explain one reason for the change in stock level after the
fall, is 20,000 units, so there is a buffer against delays sixth month.
in delivery (c) Discuss the possible consequences of the change in stock level
●● stock is re-ordered when it reaches a level of 40,000 units after the sixth month for MelCo Electronics.
(the re-order level)
●● the re-order quantity is 50,000 units – the same quantity

is used up every two months in demand it will miss out on sales opportunities. There is also
●● the lead time is just under one month. This is the time the fear of losing regular customers, which is a serious long-
between the order being placed and the date it arrives term problem. Businesses that need to hold buffer stocks of
in stock. finished goods are those that experience sharp fluctuations
This is a hypothetical model, which would be the ideal for a in demand.
business. In practice deliveries are sometimes late, so there Some businesses need to hold buffer stocks of important
is a delay in stocks arriving. Firms may need to use their raw materials or components. This is to protect themselves
buffer stocks in this case. It is likely that re-order quantities from a break in supply, which can lead to a halt in production.
will need to be reviewed from time to time. Suppliers might With some production processes this could be catastrophic.
offer discounts for ordering larger quantities. The quantities of For example, if there was a break in the supply of soda ash for
stocks used in each time period are unlikely to be constant, sheet glass production, this could involve halting an enormous
for instance because production levels fluctuate according plant with hundreds of millions of pounds worth of labour
to demand. and capital resources being made idle. Some coal-powered
electricity generators keep large buffer stocks of coal so
Buffer stocks that they can deal with surges in demand for electricity – if
Some businesses keep buffer stocks. This is an emergency there is a ‘cold snap’ in the winter, for example. Finally, some
stock held in case there is a stock shortage. A business might businesses may keep buffer stocks to give them a competitive
hold buffer stocks of finished goods in case there is a sudden edge – if they can respond to customer orders quickly, they
increase in demand. If a business is not able to meet a surge may get more custom.

220
 Managing business activities

Implications of poor stock control needed. This reduced the need for high levels of working capital
Businesses need to hold the ‘right’ amount of stock. Holding too and improved the financial performance of the business. JIT
much stock or too little stock can both have a negative impact on was extended to every stage of production. For example, raw
the business. materials were delivered JIT to be made into parts, parts were
delivered JIT to be made into goods and goods were produced
Holding too much stock: If too much stock is held a business and delivered JIT to be sold.
will incur unnecessary costs. JIT was introduced in other Japanese industries, such as the
●● Storage. Stocks of raw materials, components and finished car industry, and then spread to other parts of the world, such
goods occupy space in buildings. A firm may also have to pay as the USA and Europe. JCB has used JIT in its Rochester plant.
heating, lighting and labour costs if, for example, a security When JCB excavators are manufactured, every machine on the
guard is employed to safeguard stores when the business production line has already been sold. Supplies of components,
is closed. Some products require very special storage such as engines from Perkins, and raw materials, such as steel
conditions. Food items may need expensive refrigerated plate, arrive on the day they are needed. JIT manufacturing
storage facilities. A firm may have to insure against fire, theft requires high levels of organisational skills and reliable suppliers.
and other damages. Table 1 shows the advantages and disadvantages of JIT
●● Opportunity cost. Capital tied up in stocks earns no
manufacturing.
rewards. The money used to purchase stocks could have
Table 1 Advantages and disadvantages of JIT
been put to other uses, such as new machinery. This might
have earned the business money. Advantages Disadvantages
●● Spoilage costs. The quality of some stock may deteriorate • It improves cash flow since money • A lot of faith is placed in the
over time, for example perishable goods. In addition, if some is not tied up in stocks reliability and flexibility of
finished goods are held too long they may become outdated suppliers
and difficult to sell. • The system reduces waste, • Increased ordering and
obsolete and damaged stock administration costs
●● Administrative and financial costs. These include the cost

of placing and processing orders, handling costs and the • More factory space is made • Advantages of bulk buying may
available for productive use be lost
costs of failing to anticipate price increases.
• The costs of stockholding are • Vulnerable to a break in supply
●● Unsold stock. If there is an unexpected reduction in demand,
reduced significantly and machinery breakdowns
the firm may be left with stocks that it cannot sell. • Links with and the control of • Difficult to cope with sharp
●● Shrinkage. Very large stocks might result in an increase in suppliers are improved increases in demand
theft by employees. They may feel the business would not • The supplier base is reduced • Possible loss of reputation if
miss a small amount of stock relative to the total stock. significantly customers are let down by late
deliveries
Too little stock: To reduce the costs of holding too much stock • More scope for integration within
a business may fall into the trap of holding too little. There are the factory’s computer system
several problems with holding too little stock. • The motivation of workers is
●● The business may not be able to cope with unexpected
improved. They are given more
responsibility and encouraged to
increases in demand. This might result in lost customers if work in teams
they are let down too often.
●● If stock deliveries are delayed, the firm may run out of stock

and have to halt production. This can lead to idle labour and
machinery while the firm waits for delivery. Thinking bigger
●● The firm is less able to cope with unexpected shortages of Many firms using JIT stock control make use of Kanban systems. Kanban
materials. Again, this could result in lost production. is a Japanese term that means signboards or cards. The kanban system
is a method used to control the transfer of materials between different
●● A firm which holds very low stocks may have to place more
stages of production. The kanban might be a solid plastic marker or
orders. This will raise total ordering costs. It might also miss coloured ping-pong ball used to, for instance:
out on discounts from bulk buying.
• inform employees in the previous stage of production that a particular
part must be taken from stocks and sent to a specific destination
Just-in-time (JIT) management of stock (conveyance kanbans)
Just-in-time (JIT) manufacturing is an important part of lean
• tell employees involved in a particular operation that they can begin
production and the Kaizen approach. It was developed in the production and add their output to stock (production kanbans)
Japanese shipbuilding industry in the 1950s and 1960s. The
• instruct external suppliers to send parts to a destination (vendor kanbans).
industry recognised that a great deal of money was tied up in
stocks. Traditionally, one month’s supply of steel was held by Kanbans are used to trigger the movement or production of resources.
Used properly, they will be the only means of authorising movement.
a shipyard. However, as the industry became more competitive, Kanbans are an important part of JIT manufacturing as they prevent the
shipbuilders insisted that steel suppliers deliver orders build-up of stock or parts in a factory.
‘just in time’, i.e. a few hours or less before the steel was

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Stock control Unit 39

Question 2 fresh produce, such as fruit, vegetables, meat, cakes and

flowers, ready-mix concrete, airline meals and some medical
products, like stored blood, vaccines and biological medicines.
Stock can also be wasted if it has a limited life span and
becomes obsolete after a certain amount of time. Examples
might include newspapers and magazines, seasonal goods,
such as Valentine’s Day cards, and merchandising produced
for specific events like a concert or sports fixture. It is
important for businesses that produce these types of goods
to control stock levels very carefully indeed. They may adopt
some of the methods outlined below to minimise waste.
●● If goods are perishable they must be stored in refrigerated

units. Refrigeration can prolong the life of perishable goods

– particularly in warm weather.
●● Businesses have to be diligent when forecasting demand

patterns for perishable goods. If they overestimate

demand they could be left with a lot of unsold stock. Some
businesses use complex quantitative techniques to predict
the demand of perishable goods. Such techniques use
historic data relating to demand, the shelf life of products,
lead times and storage costs.
●● A suitable stock rotation method should be adopted. With

perishable goods the FIFO method (first in first out) is

used. This means that the stocks that were delivered first
must be issued first. Using this method ensures that older
stock is used up first.
●● Many businesses use computers to manage stock

control. Computerised systems are programmed to

Like many construction companies, Balfour Beatty is making automatically order stock when the re-order level is
increased use of off-site modularisation. This is where the reached. In supermarkets, computerised checkout systems
record every item of stock purchased by customers and
individual modules of a building are constructed in a factory and
automatically subtract items from total stock levels. Most
then transported to the site on specially designed trailers. Once
very large businesses use computerised stock control.
on site, the modules are fixed together.
●● Some businesses might be able to use adjustable pricing
In 2013, Balfour Beatty won a contract from the developer strategies to help minimise waste. For example, if stocks
Ballymore Group to build its 43-storey Providence Tower remain high as the ‘sell-by date’ approaches, prices might
residential skyscraper in London Docklands, the tallest building be reduced to encourage purchases.
constructed by Balfour Beatty in the UK to date. Balfour Beatty ●● Perishable goods need to be transported rapidly. If

won the job with its plan to use modularised mechanical and transportation can be speeded up then goods will reach
electrical services. These would be constructed off site and the market place more quickly and be available for sale in
delivered just in time, to reduce vehicle movements to and from the best condition. Some perishable goods, such as food
the site, and reduce timescales for site construction. and flowers, are flown to customers to increase the speed
of delivery.
Source: adapted from www.balfourbeattycsuk.com
●● To minimise waste, a business might find creative methods

(a) What stocks might a company like Balfour Beatty hold on a in the disposal of goods that have passed their sell-by date.
construction site? For example, food products might be given to charities or
(b) Assess the costs and benefits to Balfour Beatty of using a just- sold as animal feed. Newspapers and magazines are likely
in-time approach to construction. to be recycled.

Competitive advantage from lean

production
Waste minimisation The use of just-in-time stock control is often an important
A failure to control stock adequately can result in wasted stock. element if a business is adopting lean production. Lean
This is most likely to happen if stocks are perishable. Perishable production aims to use fewer resources in production. A range
stocks or goods are those which physically deteriorate after of production techniques, such as Kaizen, cell production,
a certain amount of time and therefore cannot be used. flexible manufacturing, teamworking, empowerment and
Consequently they have to be thrown away. Examples include multi-skilling, are used to minimise waste. Lean producers

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 Managing business activities

use less time, less stock, fewer materials, less labour, less
Thinking bigger
space and fewer suppliers. Lean producers are likely to have
Stock control has been improved by the use of computers. Many
a competitive advantage because the reduction in waste businesses hold details of their entire stock on computer databases. All
and resource use will lower production costs. Specifically, additions to and issues from stocks are recorded and up-to-date stock
competitiveness will be improved because lean production: levels can be found instantly. Actual levels of stock should be the same
●● raises productivity as shown in the computer printout. A prudent firm will carry out regular
●● reduces costs and cuts lead times stock checks to identify differences. Some systems are programmed to
●● lowers the number of defective products automatically order stock when the re-order level is reached. Access to
●● improves reliability and speeds up design time.
stock levels is useful when manufacturers are dealing with large orders.
The firm might need to find out whether there are enough materials in
With these improvements businesses will be able to charge
stock to complete an order. If this information is available, then the firm
lower prices, offer better quality and reliability, and fight off can give a more accurate delivery date.
rivals in the global market place.
Knowledge check
1. Why do businesses prefer to minimise stock holdings?
Key terms
2. What is meant by work-in-progress?
Buffer stocks – stocks held as a precaution to cope with 3. State four costs of holding stocks.
unforeseen demand.
4. Why are buffer stocks held by firms?
Kanban – a card or an object that acts as a signal to move
or provide resources in a factory. 5. State two drawbacks of holding too little stock.
Lead time – the time between placing the order and the 6. State two possible disadvantages of just-in-time stock
delivery of goods. management.
Re-order level – the level of current stock when new orders 7. What types of stocks are most likely to be wasted?
are placed.
Re-order quantity – the amount of stock ordered when an 8. What method of stock rotation is most suitable for
order is placed. perishable goods?
Stock rotation – the flow of stock into and out of storage. 9. State two ways of minimising waste stock.
Work-in-progress – partly finished goods. 10. How might lean production improve competitiveness?

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Stock control Unit 39

Case study
3. The assembly line must replace the parts used by
retrieving the same number of parts from the parts-
TOYOTA producing process (the preceding process).
4. The preceding process must be stocked with small
Toyota, the Japanese car manufacturer, has developed a numbers of all types of parts. Also, they should only
production system that aims to completely eliminate waste. produce what was taken by an operator from the
The Toyota Production System (TPS) is based on just-in-time next process.
production, but also uses other lean production methods, TPS has helped Toyota to keep improving the way it
such as Kaizen, in an attempt to completely eliminate seven manufactures vehicles. It has also developed a corporate
sources of waste: culture where employees have to constantly grapple with
1. over production (largest waste) challenges and problems, and must come up with fresh
2. time on hand (waiting) ideas. TPS has been so successful over the years that Toyota
3. transportation has gained a competitive advantage in the car industry.
Indeed, many other manufacturers have adopted TPS or
4. processing itself
adapted it to meet their own needs.
5. stock at hand
Reproduced with permission from Toyota (GB) PLC.
6. movement
7. making defective products.
(a) What is meant by just-in-time stock management?
Building on the just-in-time method of production, Toyota
(2 marks)
has produced an efficient system that reduces waste and
demands on the production line, meaning that the vehicle (b) Explain one reason why Toyota does not hold buffer
can be built in the shortest period of time possible. The stocks. (4 marks)
following principles help Toyota to achieve its aims. (c) Assess the importance to Toyota of minimising waste.
1. When a vehicle order is received, a production (8 marks)
instruction must be issued to the beginning of the (d) Assess the extent to which lean production has helped
vehicle production line. Toyota to gain a competitive edge. (12 marks)
2. The assembly line must be stocked with the required
number of all needed parts so that any type of ordered
vehicle can be assembled.

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 40 Quality management 2.4.4
Theme 2

Key points
1. Quality control, quality assurance and quality circles.
2. Total quality management (TQM).
3. Continuous improvement (Kaizen).
4. Competitive advantage from quality management.

Getting started What is quality?

Consumers, faced with many goods or services at similar
prices, are likely to consider quality when making choices.
Quality could be described as those features of a product
or service that allow it to satisfy customers’ wants. Take an
example of a family buying a television. They may consider:
●● physical appearance – they may want a certain style

●● reliability and durability – will it last for 10 years?

●● special features – does it have stereo sound?

●● suitability – they may want a portable television

●● parts – are spare parts available?

●● repairs – does the shop carry out maintenance?

●● after-sales service – how prompt is delivery?

They may also consider features which they perceive as

important, such as:
●● image – is the manufacturer’s name widely recognised?

●● reputation – what do other consumers think of the business

or product?
The importance of quality has grown in recent years. Consumers
are more aware. They get information through magazines
such as Which? that contain reports on the quality of certain
products. They also have more disposable income and higher
expectations than ever before. Legislation and competition have
also forced firms to improve the quality of their products.
Businesses, faced with competition, are also concerned
about the quality of their:
●● design – the ideas and plans for the product or service

●● production processes – the methods used to manufacture

Michelin stars are awarded to restaurants for the excellence the goods or provide the services.
Poor designs may lead to problems with the materials and the
of their food and service. In the UK only four restaurants have
functions of the finished good or service. It costs time and
been awarded three Michelin stars (the highest award). One
money to redesign poor products. Clients are unlikely to use
of these is The Fat Duck, Bray, owned by the well-known chef,
businesses with poor designs again. Problems also occur with
Heston Blumenthal. In 2015, a meal for two at The Fat Duck
poor-quality production processes. Faulty products are costly for
could cost up to £440 (without wine). a business. Machinery that breaks down or constantly needs to
What is meant by quality to a customer in this business? be repaired will also be expensive. Late delivery and ineffective
Why would the award of a Michelin star be coveted by a chef productivity that results in poor quality can harm a business’s
or restaurant owner? What are the advantages of selling reputation.
quality products? Why might quality be increasingly important
to businesses? Quality control
Traditionally, in manufacturing, production departments have
been responsible for ensuring quality.

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Quality management Unit 40

Their objectives might have been to make sure that products: Question 1
●● satisfied consumers’ needs

●● worked under conditions they were likely to face The Quality Assurance Agency (QAA) is an independent
●● operated in the way they should body entrusted with monitoring and advising on standards
●● could be produced cost-effectively and quality in UK higher education. The agency is responsible
●● could be repaired easily for ensuring that the UK’s three million higher education
●● conformed to safety standards set down by legislation and students get the experience they are entitled to expect. The
independent bodies. QAA is independent of both the government and of the higher
At Kellogg’s, for example, samples of breakfast cereal have, education providers. It acts in the public interest, for the benefit
in the past, been taken from the production line every half of students. Its work involves matters such as:
hour and tested. The testing took place in a food review room
• publishing and maintaining the UK Quality Code for
twice a day and was undertaken by a small group of staff.
Each sample, about 50 in total, was compared with a ‘perfect’ Higher Education
Kellogg’s sample and given a grade between 1 and 10. 10 • conducting external reviews of higher education providers and
was perfect but between 9.8 and 7, although noticeable to publishing their reports
the trained eye, was acceptable to the customer. Below 7 the • investigating concerns about academic quality and standards
consumer would notice the reduction in quality. The cereals
• conducting research and sharing information about good
were tested for appearance, texture, colour, taste, etc. More
practice to improve quality
sophisticated tests were carried out in a laboratory where the
nutritional value of a sample, for example, was measured. • providing training and events to help higher education
Quality control in UK organisations, in the past, often providers develop and improve their own quality assurance
meant quality controllers or quality inspectors checking processes.
other people’s work and the product itself after production had (a) Explain one example in higher education where quality would be
taken place. By today’s standards this is not quality control, of concern to students.
but a method of finding a poor-quality product (or a problem) (b) Explain one way in which the QAA might gather information
before it is sold to the consumer. relating to the quality of higher education.

Quality assurance
Today businesses are less concerned about ‘Has the job been
done properly?’ than ‘Are we able to do the job properly?’ In
other words inspection is carried out during the production
Quality circles
Quality control circles or quality circles are small groups of
process. This means that problems and poor-quality products workers (about 5–20) in the same area of production who
can be prevented before final production. meet regularly to study and solve production problems. In
Such a preventative approach has been used by Japanese addition, such groups are intended to motivate and involve
businesses and is known as total quality management (TQM). workers on the shopfloor. They allow the workforce directly
It is now being adopted by many companies in the UK. It to improve the nature of the work they are doing.
involves all employees in a business contributing to and being Quality control circles started in America, where it was
responsible for ensuring quality at all stages in the production felt workers could be motivated by being involved in decision
process. Quality assurance is a commitment by a business making. The idea gained in popularity in Japan and was
to maintain quality throughout the organisation. The aim is taken up by Western businesses. Examples of their use can
to stop problems before they occur rather than finding them be found in Japanese companies setting up plants in the UK
after they occur. in the 1990s. For example, Honda at Swindon had 52 teams
Quality assurance also takes into account customers’ views of six people looking at improvements that could be made in
when planning the production process. For example, customers areas allocated to the groups, such as, safety.
may be consulted about their views through market research Quality control circles are only likely to work if they
before a product is manufactured or a service provided. They have the support of both management and employees.
may also be part of a consultation group involved at the design Businesses have to want worker participation and
and manufacturing stage. involvement in decision making, and set up a structure that
supports this. Workers and their representatives also need
Exam tip to support the scheme. Employees must feel that their views
You need to avoid confusion between quality assurance and quality within the circle are valued and must make a contribution
control. Remember that quality assurance aims to prevent defects to decisions.
with a focus on the processes used to make the product. It is a
proactive quality task. Quality control aims to identify (and
correct) defects in the finished product. Quality control, therefore,
is a reactive task.

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Quality chains: Great stress is placed on the operation of quality

Question 2
chains. In any business a series of suppliers and customers
exists. For example, a secretary is a supplier to a manager, who
is the customer. The secretarial duties must be carried out to the
satisfaction of the manager. The chain also includes customers
and suppliers outside the business. The chain remains intact if
the supplier satisfies the customer. It is broken if a person or item
of equipment does not satisfy the needs of the customer. Failure
to meet the requirements in any part of the quality chain creates
problems, such as delays in the next stage of production.

Company policy, accountability and empowerment: There

will only be improvements in quality if there is a company-wide
quality policy. TQM must start from the top with the most senior
executive and spread throughout the business to every employee.
People must be totally committed and take a ‘pride in the job’.
This might be considered as an example of job enrichment. Lack
of commitment, particularly at the top, causes problems. For
example, if the managing director lacks commitment, employees
Winnebago is a well-known producer of recreational vehicles lower down are unlikely to commit themselves. TQM stresses the
(RVs). It has a reputation among motorhome enthusiasts for role of the individual and aims to make everyone accountable for
high quality and innovation, dating back to its founding in 1958. their own performance. For example, a machine operator may be
Every Winnebago motorhome integrates superior construction, accountable to a workshop supervisor for their work. They may
design and comfort. In its effort to maintain very high quality also be empowered to make decisions.
standards, Winnebago has used quality circles for many years.
Indeed, the company has won the Recreational Vehicle Dealers Control: Consumers’ needs will only be satisfied if the business
Association’s prestigious Quality Circle Award every year since its has control of the factors that affect a product’s quality. These
inception in 1996. may be human, administrative or technical factors, shown in
Figure 1 on the next page. The process is only under control if
Winnebago designs and manufactures components to high materials, equipment and tasks are used in the same way every
specifications. It has been able to deliver high quality at time. Take an example of a firm making biscuits. Only by cooking
competitive prices. Higher quality is also the result of ongoing in the same way can the quality be consistent every time.
testing. Winnebago has a state-of-the-art, 40,000-square-foot These methods can be documented and used to assess
testing facility. The computerised road simulator (nicknamed operations. Regular audits must be carried out by the firm to check
‘The Shaker’) and the half-mile test track can simulate the effects quality. Information is then fed back from the customer to the
of years of normal driving in just a few days. Components are ‘operator’ or producer, and from the operator to the supplier of
checked under hot, cold, wet and dry conditions, and every inputs, such as raw materials. For example, a retailer may return
Winnebago RV goes through a high-pressure water tunnel and is a batch of vehicles to the manufacturer because the gears were
checked for leaks before shipping. faulty. The manufacturer might then identify the person responsible
for fitting the gears. An investigation might reveal that the faulty
(a) What is meant by quality circles?
gears were the responsibility of a component supplier. The
(b) Assess the importance of quality circles to Winnebago. supplier can then be contacted and the problem resolved. Quality
audits and reviews may lead to suggestions for improvements – a
different material, perhaps, or a new piece of equipment.

Monitoring the process: TQM relies on monitoring the

Total quality management (TQM) business process to find possible improvements. Methods have
Errors are costly for business. It is estimated that about been developed to help achieve this. Statistical process control
one-third of all the effort of British businesses is wasted in (SPC) involves collecting data relating to the performance of a
correcting errors. There are benefits if something is done right process. Data is presented in diagrams, charts and graphs. The
the first time. Total quality management (TQM) is a method information is then passed to all those concerned.
designed to prevent errors, such as the creation of poor-quality SPC can be used to reduce variability, which is the cause of
products, from happening. The business is organised so that most quality problems. Variations in products, delivery times,
the manufacturing process is investigated at every stage. It is methods, materials, people’s attitudes and staff performance
argued that the success of Japanese companies is based on their often occur. For example, statistical data may show that worker
superior organisation. Every department, activity and individual is attitudes may have led to variations in output late on Friday
organised to take into account quality at all times. What are the afternoon. Discussion might result in a change in the ‘clocking
features of TQM? on’ and ‘clocking off’ times to solve the problem.
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Quality management Unit 40

Teamwork: TQM stresses that teamwork is the most effective There are, however, some problems.
way of solving problems. The main advantages are: ●● There will be training and development costs of the new system.
●● a greater range of skills, knowledge and experience can be ●● TQM will only work if there is commitment from the entire

used to solve the problem business.

●● employee morale is often improved ●● There will be a great deal of bureaucracy and documents,

●● problems across departments are better dealt with and regular audits will be needed. This may be a problem for
●● a greater variety of problems can be tackled small firms.
●● team ‘ideas’ are more likely to be used than individual ones. ●● Stress is placed on the process and not the product.

TQM strongly favours teamwork throughout the business.

It builds trust and morale, improves communications and
Figure 1
co-operation, and develops interdependence. Many UK firms
in the past have suffered due to lack of sharing of information The systematic approach to quality management
and ideas. Such approaches have often led to division between Good Consistent Consistent Consistent Satisfactory
sections of the workforce. design method equipment materials instructions

Consumer views: Firms using TQM must be committed to their

customers. They must be responsive to changes in people’s needs
and expectations. To do this, information must be gathered on a
Operation
regular basis and there must be clear communication channels for and control
customers to express their views. Consumers are often influential of process
in setting quality standards. For example, holiday companies issue
questionnaires to their customers on the way back from a package
holiday. The information can be used to identify the strengths and Consistently
satisfied
weaknesses of their operations. Such information can be used to customer
monitor and upgrade quality standards.
Feedback channel
Zero defects: Many business quality systems have a zero defect
policy. This aims to ensure that every product that is manufactured
is free from defects. A business that is able to guarantee zero Kaizen
defects in customers’ orders is likely to gain a good reputation. Kaizen is perhaps the most important concept in Japanese
This could lead to new clients and improved sales. management. It means continuous improvement. Every
aspect of life, including social life, working life and home life,
Quality circles: TQM stresses the importance of teamwork in a is constantly improved. Everyone in the business is involved.
business. Many businesses have introduced quality circles into Kaizen is said to be an ‘umbrella concept’. A wide range of
their operations. In order for quality circles to be successful certain different production techniques and working practices must
conditions must exist. be carried out for it to be effective. Figure 2 on the next page
●● A steering committee should be set up to oversee the whole shows examples of the techniques, principles and practices.
quality circle programme. They should result in ongoing improvements. This approach
●● A senior manager should ideally chair the committee. argues that a day should not pass without some kind of
Managers must show commitment to the principle of improvement being made somewhere in the business.
quality circles. There are a number of features of Kaizen which affect
●● At least one person on the committee should be accountable a business.
for the programme.
●● Team leaders should be properly trained. Continuous improvement: Kaizen has been the main
difference between the Japanese and the Western
Using TQM: TQM helps companies to: approaches to management in the past. The attempts of
●● focus clearly on the needs of customers and relationships Western businesses to improve efficiency and quality have
between suppliers and customers tended to be ‘one-offs’. In Figure 3 on the next page the solid
●● achieve quality in all aspects of business, not just product or line illustrates the Western approach. Productivity remains
service quality the same for long periods of time, then suddenly rises. The
●● critically analyse all processes to remove waste and inefficiencies increase is followed by another period of stability, before
●● find improvements and develop measures of performance another rise. Increases in productivity may result from new
●● develop a team approach to problem solving working practices or new technology. The dotted line shows
●● develop effective procedures for communication and the Japanese approach. Improvements are continuous. They
acknowledgement of work result from changes in production techniques which are
●● continually review the processes to develop a strategy of introduced gradually.
constant improvement.

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 Managing business activities

Eliminating waste: The elimination of waste (called muda in Figure 2

Japan) in business practices is an important part of Kaizen.
Waste is any activity which raises costs without adding value to a The Kaizen umbrella
product. Examples may be:
●● time wasted while staff wait around before starting tasks, such

as waiting for materials to arrive

●● time wasted when workers move unnecessarily in the

workplace, such as walking to a central point in the factory to

Customer orientation Just in time
get tools Total Quality Management (TQM) Zero defects
●● the irregular use of a machine, such as a machine which is Quality control circles Cooperative staff–
Suggestion system management relations
only used once a month for a special order Kanban
Robotics Automation
●● excessive demands upon machines or workers, such as staff Quality improvement
Discipline in the workplace
working overtime seven days a week which causes them to TPM (Total Productive Productivity improvement
Maintenance) Small group activities
be tired and work poorly. New product development
Firms that adopt the Kaizen approach train and reward workers
to continually search for waste and to suggest how it might be
eliminated.
Implementing continuous improvement: It is often difficult
for workers in a business to look for continuous improvement
all the time. Japanese businesses tried to solve this problem by Figure 3
introducing the PDCA (Plan, Do, Check, Action) cycle. It is a
The Western and Japanese approaches to improvement
series of activities that lead to improvement.
Continuous
●● Plan. Businesses must identify where improvement is needed.
improvements
Data must be gathered and used to develop a plan which will

Output per worker

result in improvement.

(productivity)
●● Do. Once the plan has been finalised it must be carried One-off
out. The plan is likely to be implemented by workers, on the improvements
production line perhaps.
●● Check. The next stage in the cycle is to check whether or not

there has been an improvement. This task may be carried out

by inspectors.
●● Action. If the plan has been successful, it must be introduced

in all parts of the business. 0

Time

Question 3
Sylvie Bennet, based in Yorkshire, produces high-quality children’s improved. This included additional staff training so staff members
clothing and the family-owned company has been trading for could take on different tasks, to better purchasing negotiations
over 100 years. Their total commitment to quality and innovative with their material suppliers. They even looked at the way the
design has seen the company produce products that are often product was sold. They identified that users on their website were
featured in magazines and even sometimes purchased by not completing their purchases and investigated reasons why. They
celebrities for their children to wear. realised that their ‘checkout’ button was not very clear and resolved
As a company that is always looking to improve processes, the the issue, pushing online sales up 10 per cent.
managing director, Julia Humphrey, decided to introduce Kaizen. Humphrey thinks that their productivity will continue to grow and
She’d read about how the car industry used Kaizen to improve estimates that they can increase it by at least another 5 per cent.
their productivity and felt that their product could be treated the By increasing the number of garments made at each stage, they
same in many respects as each product was made from the same will make the company more profitable as the costs per item of
basic body shape. She also wanted to look at how the company manufacture will decrease.
could gain profit at each step. In the year after introducing Kaizen
(a) Explain one way in which Kaizen can help a business improve
productivity rose 5 per cent, which helped them increase their productivity.
profit by 10 per cent as well.
(b) Explain one way in which Sylvie Bennet has benefited from the
To make Kaizen work for their business Humphrey looked at introduction of Kaizen.
each point of the production chain and identified ways it could be

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Quality management Unit 40

Competitive advantage from quality Thinking bigger

management Despite the benefits from improving quality, it is important to recognise
Supplying high-quality goods and services can have a huge the costs.
positive impact on businesses. The main one is that product
• Designing and setting up a quality control system. This might
quality should be improved, which should help to increase sales.
include the time used to ‘think through’ a system and the training of
Also, business costs may be cut if faults in products are identified staff to use it.
before the product reaches the market. The costs of failure once
• Lost production. When a business introduces a major new system
the product has reached the market are likely to be much higher there can be some serious disruption while the new system is bedded-
than those during manufacture. in. This could lead to a loss of output and damage to customer
Some businesses use quality as a means of developing a USP. relations if orders are not met.
If a business can differentiate its product on grounds of quality • Improving the actual quality. This may be the cost of better
and persuade the customer that their product is superior to its materials, superior methods, new machinery or training staff in new
rivals, it may enjoy some benefits, particularly the ability to charge working practices. If the whole quality system fails, there may be costs
a higher price. This gives a business more flexibility in pricing. in setting it up again. Time may be needed to rethink or adjust the
Inevitably a business that can deliver quality will develop a system. Retraining might also be necessary.
competitive advantage. This will allow firms to win customers • Training. Quality initiatives will only be successful if the people involved
from rivals, increase market share, raise revenue and improve in their implementation are properly trained. This can prove very costly.
profitability. A number of British firms have been successful in For example, if TQM is introduced the entire workforce will have to be
overseas markets due to the competitive edge they have gained trained. This may involve sending all staff on specialist training courses
as a result of marketing quality products. Examples include or outsourcing training to an expert in TQM.
Rolls-Royce, Burberry, Jaguar Land Rover (owned by Tata), British It has been suggested that 10–20 per cent of the revenue of a business
Airways and Jimmy Choo. is accounted for by quality-related costs. The vast majority of these costs
are related to appraisal and failure, which add very little to the quality
Key terms of the product. Eliminating such failure would help to reduce these costs,
saving UK businesses billions of pounds.
Quality – features of a product that allow it to satisfy customers’
needs. It may refer to some standard of excellence.
Quality assurance – a method of working for businesses
that takes into account customers’ wants when standardising Knowledge check
quality. It often involves guaranteeing that quality standards
are met. 1. What is meant by the quality of a product?
Quality chains – when employees form a series of links 2. Explain the difference between actual and perceived quality.
between customers and suppliers in business, both internally
3. Explain the difference between quality control and quality
and externally.
Quality circles – groups of workers meeting regularly to
assurance.
solve problems and discuss work issues. 4. What is the main purpose of using quality circles?
Quality control – making sure that the quality of a product 5. State five implications of TQM for a business.
meets specified quality performance criteria.
Statistical process control – the collection of data about the 6. Why is teamwork so important in TQM?
performance of a particular process in a business. 7. What is meant by the Kaizen umbrella?
Total quality management (TQM) – a managerial
approach that focuses on quality and aims to improve the 8. Explain the purpose of the PDCA cycle.
effectiveness, flexibility and competitiveness of the business. 9. What are the costs and benefits of ensuring quality?

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 Managing business activities

Case study
After several emergency board meetings the directors
decided that some drastic action was necessary. They decided
THE POWARTH GROUP to invest in total quality management (TQM) to try and
improve the quality of the hotel service. In 2013, they took
The Powarth Group owns a small chain of 23 hotels the following measures to introduce TQM at a total cost of
in Europe. Up until 2010 the group’s performance had €5.6 million.
been lacklustre with flat sales for five consecutive years. • Organised an outside agency to train all staff in TQM.
However, in 2010 the group signed a deal with an online
booking company in the hope that sales would soar, raising • Employed another agency to train staff in customer service.
occupancy rates above the current 52 per cent. This turned • Set up a suggestions box to encourage staff ideas.
out to be a disaster. The booking site also has a customer €1,000 was given to a member of staff if their idea was
review system where people can give feedback about their implemented by management.
experience. The review below is typical of the many posted • Organised the staff into teams.
on the site relating to Powarth Group hotels.
• Kept records of all guest complaints and followed every
single one up with a personal letter from the manager.
The Globe – Milan
The group also invested €4.3 million in the refurbishment
This is one of the worst hotels my husband and I have of half of the hotels – pledging another €5 million in
ever stayed in. The main problem was the staff – they investment in three years’ time for refurbishing the
were totally disinterested and as guests we felt that we remainder. The group also upgraded their website, changed
were an inconvenience. When we arrived there was a the mission statement to emphasise the quality of their
queue to check in and only one youngster on duty
service and purchased a smart new hotel uniform. All staff
who could not speak English. The whole process took
55 minutes and the receptionist tried to charge us again
were consulted on the uniform design and the wording of the
even though we had paid in advance. There was quite mission statement.
a heated dispute and communication was difficult – the At the end of 2014 profits rose from €120,000 to
hotel manager, who could speak English, was on a break €1.67 million, guest complaints fell by 82 per cent, staff
and could not be contacted. morale improved and hotel occupancy rates had increased
Things did not get better. Our room was dark, musty and to 74 per cent.
in a very poor decorative state. There were no coat-
hangers, the towels did not look clean, the furniture was
(a) What is meant by total quality management? (2 marks)
old and the television did not work. I could go on but the
next day my husband and I checked out even though we (b) Explain how the use of teamworking might improve the
had paid for two nights in advance. quality of service at the Powarth Group hotels. (4 marks)
(c) Assess the possible benefits to the Powarth Group of total
Mrs T. Ellington
quality management. (8 marks)
(d) Assess the extent to which the introduction of total
quality management at the Powarth Group was a success.
(12 marks)

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 41 Economic influences 2.5.1
Theme 2

Key points
The effect on businesses of changes in economic influences:
1. Inflation (the rate of inflation and consumer price index).
2. Exchange rates (appreciation and depreciation).
3. Interest rates.
4. Taxation and government spending.
5. The business cycle.
6. The effect of economic uncertainty on the business environment.

Getting started Economic influences, such as inflation, exchange rates,

interest rates, taxation, government expenditure and the
Dunelm is a well-known homewares retailer. It has over business cycle can have many effects on a business. The
120 stores and sells household goods, such as bedding, blinds, government is responsible for the management of the
curtains, cushions, décor, lights, mirrors, some electrical goods and economy. The aim of many governments is to keep prices
kitchenware. The company has performed well, increasing revenue stable, keep unemployment down, keep borrowing down and
from £423.8 million in 2009 to £677.2 million in 2013. help the economy grow. The measures a government might
use to achieve these aims can have an impact on businesses.
Give four examples of economic influences that might affect the
performance of Dunelm. How might a cut in income tax affect Inflation
Dunelm? How might Dunelm react to people having less to A government will want to keep prices stable in the country’s
spend or other businesses closing down? Would Dunelm benefit economy. This means that inflation must be kept under
from higher interest rates? control. Inflation is when the general price level is rising. For
example, if a basket of goods cost £100 on 1.1.2013, and
the same basket cost £103 on 1.1.2014, prices have gone up
External influences by three per cent. This means that the inflation rate is three
Business activity is influenced by a number of external per cent. If inflation is too high it can harm the economy.
influences. These are factors beyond the control of businesses. Figure 2 shows inflation rates in the UK between 2004 and
In some cases they constrain a business’s decisions and may 2014. The graph shows that the rate of inflation has been
prevent its growth and development. Examples of these external quite low, fluctuating between one and five per cent. Inflation
influences are summarised in Figure 1. rates at these levels are not really troublesome. However, in
the 1970s, inflation reached levels of 25 per cent, which was
a serious threat to businesses and the economy.
Figure 1
External influences on businesses Figure 2
UK inflation rates between 2004 and 2014
Government % %
6 6
Legislation and
World events
regulation 5 5

4 4
Environmental External Consumer tastes
factors influences
3 3

Social factors Economic climate 2 2

1 1
Changes in Jan/04 Jan/06 Jan/08 Jan/10 Jan/12 Jan/14
Pressure groups
population
Sources: www.tradingeconomics.com/Office for National Statistics

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 Managing business activities

How is inflation measured? Uncertainty: With high and fluctuating inflation, businesses don’t
A common approach to measuring inflation is to calculate know what prices will be in three or six months’ time, let alone in
changes in the consumer price index (CPI). This involves one or five years. But decisions have to be made now which will
gathering information about the prices of goods and services affect the business in the long term. For example, businesses need
in the economy. Each month the government records price to invest to survive. But how much should they invest? The price
changes of about 600 goods and services. From these records of a new machine, a shop or a new computer system will probably
an average price change is calculated and converted into an be higher in six months than today. But are they worth buying if
index number. The month’s figures can then be compared with interest rates are at very high levels? What if the new machine
the previous month’s, or that of 12 months ago, to calculate the is bought, financed by very high cost borrowing and there is a
percentage change in prices (i.e. the inflation rate) over the time recession, where demand for goods and services falls?
period. The inflation rates shown in Figure 2 use the CPI. Another problem with uncertainty is linked to entering long-
term contracts. A customer might approach a business wanting to
buy products on a regular monthly basis for the next two years.
Maths tip How can the supplier put a price on this contract if it doesn’t know
The use of index numbers is common in business and what the inflation rate will be over the next 24 months?
economics. An index number is an indication of change in a
series of figures where one figure is given a value of 100 and Borrowing and lending: Borrowing and lending becomes
others are adjusted in proportion to it. It is often used as an an opportunity and a problem for businesses. On the one hand,
average of a number of figures like when measuring the CPI. the real value of debts incurred in the past can become quickly
eroded by inflation. If inflation is 100 per cent per annum, the
real value of money borrowed a year ago is halved in one year.
Inflation initially benefits borrowers and harms lenders.
How does inflation affect businesses? But in an inflationary environment, interest rates rise to match
Inflation rates between one and five per cent, like those in the
inflation. If there is prolonged inflation, interest rates are likely to
UK between 2004 and 2014 in Figure 2, are not likely to have
become index linked – linked to the index of prices. So interest
a big impact on businesses. However, once the CPI gets into
might be charged at the rate of inflation plus 5 per cent or plus
double figures and beyond, inflation can have some damaging
10 per cent.
effects on businesses.
High and particularly fluctuating inflation is likely to be Consumer reactions: Consumers react to inflation as well as
damaging to businesses for a number of reasons. businesses. Prolonged inflation tends to lead to more saving.
Inflation unsettles consumers. They become less willing to
Increased costs: High or fluctuating inflation imposes a variety borrow money, not knowing what will happen in the future. The
of costs on businesses. value of savings tends to fall as inflation erodes their real value.
●● With suppliers’ prices rising all the time, but at different rates, So people react by saving more to make up savings to their
time must be spent researching the market for the best deals. previous real value. Increased saving means less spending and
Equally, more time has to be spent tracking the prices of so businesses will sell less.
competitors to decide when and by how much to increase If inflation is very high, consumers will adopt different
your own prices. These costs are called shoe leather costs, spending patterns which may affect businesses. For example,
because before the age of the telephone and the internet, if there is hyperinflation, prices will be changing by the day.
businesses would have to send their employees round on Consumers will then tend to spend wages or interest as soon
foot to gather this information. as they receive them. On ‘pay day’ there can be huge activity in
●● Raising prices costs money. Customers have to be informed shops. Supermarkets have to be geared up to selling most of the
of the new prices. Brochures might have to be reprinted weekly or monthly turnover in just a few hours. Suppliers of fresh
and sent out. Websites might have to be updated. The sales produce to supermarkets have to be geared to delivering most of
force has to be made familiar with new prices. These costs their goods on one day a week.
are called menu costs because, for a restaurant, increasing
prices means that it has to reprint its menus. International competitiveness: High inflation can have an
●● Management is likely to have to spend more time dealing with impact on businesses that import or export goods and services.
workers’ pay claims. Instead of being able to sign a two- or For example, if the UK has higher inflation rates than its trading
three-year deal, annual pay negotiations are likely to be the partners, UK businesses will become uncompetitive. As a result,
norm. If there is hyperinflation, where inflation is running they are likely to lose sales and shares in overseas markets.
into 100 per cent per annum or over, pay negotiations may Also, UK businesses facing competition from overseas will lose
have to take place each month. There is also a much larger out because imports become relatively cheaper. For example,
risk of strikes because workers and managers will probably consumers in the UK may buy foreign goods instead of UK
have different views of future inflation rates. Workers will be goods because their prices are rising less quickly than those
worried that any deal they make will leave them worse off in the UK. The impact of changes in the price of imports and
after inflation. So they might be more willing to take industrial exports are discussed in more detail later in this unit.
action to get high pay settlements.
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Economic influences Unit 41

Deflation The impact of an appreciation in the

Some countries in the world have experienced deflation. This exchange rate on imports and exports
is where the general price level starts to fall and can also be a The exchange rate is the price of one currency in terms of
problem for businesses. This is mainly because deflation is usually another. Like all prices the exchange rate can change. This is
associated with a fall in demand. When prices are falling consumers because prices are determined by market forces, and supply
may delay spending because they think they can make purchases and demand conditions can change at any time. For example,
in the future at lower prices. As a result businesses postpone if the demand for UK exports rises, there will be an increase
investment and may lay off workers due to the need to cut in the demand for pounds. This is because foreigners need
production. Businesses may also have to lower their prices, which pounds to pay for exports. The increase in demand for pounds
can reduce their profits. In 2014, there were some deflationary will raise the exchange rate (i.e. raise the value of the currency,
pressures in the EU when the oil price fell sharply, inflation was the pound, against that of another currency). When it rises, the
very low and a number of countries were in recession. However, if exchange rate has appreciated.
deflation is the result of falling import prices or falls in the prices of Changes in the exchange rate can have an impact on the
commodities, such as oil, the effects could be positive. For example, demand for exports and imports. This is because, when the
a fall in UK import prices could be the result of a strong pound. This exchange rate changes, the prices of exports and imports
means that imported goods will be cheaper and will put downward also change.
pressure on the CPI. This may not have a negative impact on the
UK economy. Also, if commodity prices (such as oil) fall, this might Worked example
reduce the cost of inputs for many businesses. As a result they may
What happens when the exchange rate rises (i.e. the
respond by actually increasing production.
value of the pound rises) from, say, £1 = US$1.50 to £1 = US$2?
Exchange rates Impact on exports: If a UK business sells goods worth
Different countries in the world have their own currencies. For £2 million to a US customer, the dollar price at the original
example, the USA uses the dollar, Japan uses the yen, many exchange rate is $3 million (£2 million × 1.50). When the
EU countries use the euro and the UK has the pound. When exchange rate rises the dollar price of the goods also rises to $4
countries use different currencies transactions between people million (£2 million × 2). This means that demand for UK exports
and businesses are affected. For example, an Indian visitor to is likely to fall because they are now dearer.
the UK cannot use rupees, they would have to buy some British
pounds. How many pounds would the Indian visitor get for
Impact on imports: If another UK firm buys goods worth
150,000 rupees? This depends on the exchange rate between $600,000 from a US supplier, the price in pounds at the original
the pound and the rupee. If it were £1 = ₹100 the visitor would exchange rate is £400,000 ($600,000 ÷ 1.50). When the
get £1,500 (₹150,000 ÷ ₹100). The exchange rate shows the exchange rate rises the sterling price to the importer falls to
price of pounds in terms of rupees. When businesses buy goods £300,000 ($600,000 ÷ 2). This means that demand for imports
and services from other countries, payments are usually made in is likely to rise, because they are cheaper.
the supplier’s currency. Some examples are given below.
The impact of a depreciation in the
Worked example exchange rate on imports and exports
1. How much will it cost a French business to buy When the exchange rate falls it has depreciated. The impact on
the demand for imports and exports is the opposite.
goods from a British business which cost £400,000 if
£1 = €1.25? The cost to the French business in euros is:
Worked example
£400,000 × 1.25 = €500,000
What happens when the exchange rate falls (i.e. the value
2. How many US dollars will it cost a British business of the pound falls) from, say, £1 = US$1.50 to £1 = US$1.20?
buying £55,000 of goods from an American business if
£1 = US$1.50? The cost to the British business in US dollars is: Impact on exports: If a UK business sells goods worth
£2 million to a US customer, the dollar price at the original
£55,000 × 1.50 = $82,500 exchange rate is $3 million (£2 million × 1.50). When the
3. How much will it cost a British business in pounds to buy exchange falls the dollar price of the goods also falls to
$300,000 of goods from a US business if £1 = US$1.50? $2.4 million (£2 million × 1.20). This means that demand for UK
The cost in pounds is: exports is likely to rise because they are now cheaper.
$300,000 ÷ 1.50 = £200,000 Impact on imports: If another UK business buys goods worth
$600,000 from a US supplier, the price in pounds at the
4. How many pounds can a Japanese business person buy with
original exchange rate is £400,000 ($600,000 ÷ 1.50). When
¥100,000 when visiting London if £1 = ¥190?
the exchange rate falls the sterling price to the importer rises
The quantity of pounds that can be bought is:
to £500,000 ($600,000 ÷ 1.20). This means that demand for
¥100,000 ÷ 190 = £526.32 imports is likely to fall because they are dearer.

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 Managing business activities

The effects of changes in the exchange rate on the demand for The impact of low interest rates on businesses has been
exports and imports are summarised in Table 1. generally helpful. Figure 3 shows the level of interest rates in
the UK between 1984 and 2014. Since 2008 the base rate has
Table 1 Summary of the effects of changing exchange rates been 0.5 per cent. However, previously to this in the late 1980s,
Exchange Price of Demand for Price of Demand rates were much higher, reaching a peak of 15 per cent. Rates
rate exports exports imports for imports this high can have damaging effects on businesses, as outlined
below.
Falls Falls Rises Rises Falls
Finally, the use of interest rates to help control the economy is
Rises Rises Falls Falls Rises called monetary policy. For example, a government might raise
interest rates to dampen demand in the economy if they thought
How are businesses affected by that inflation was being caused by demand rising too quickly.
exchange rates?
The examples on the previous page show what happens to the Figure 3
prices of imports and exports when exchange rates appreciate
UK interest rates 1984–2014
and depreciate. Sometimes these changes will benefit a business,
other times they will not. For example, if the value of the rupee % %

falls, Indian exporters will benefit because the price of exports 16 16

falls and demand should increase. However, Indian importers will
14 14
lose out because their purchases will be more expensive.
Fluctuating exchange rates cause uncertainty. Businesses 12 12
do not know what is going to happen to exchange rates in 10 10
the future. This means that it is difficult to predict demand
for exports and the cost of imports. This makes planning and 8 8
budgeting more difficult. Another problem is that it costs money 6 6
to switch from one currency to another. There is usually a
commission charge of around two per cent. This represents a 4 4
cost to importers and therefore reduces profit. 2 2

0 0
Question 1 84 Jan/86 Jan/92 Jan/98 Jan/04 Jan/10 Jan/14
Burberry Group plc is a British luxury fashion house, distributing Source: www.tradingeconomics.com/Bank of England
clothing, fashion accessories, fragrances, sunglasses and
cosmetics. Burberry is most famous for its trench coat with
its distinctive tartan pattern, which was designed by founder Effect of interest rates on costs
Thomas Burberry. The company has branded stores and Changes in interest rates are likely to affect the overheads of a
franchises around the world, and also sells through concessions business. Interest charges are part of overhead costs. If interest
in third-party stores. Burberry has several shops in Japan rates rise, businesses are likely to have to pay higher interest
including five in Tokyo. payments on their borrowing. For example, a business might
borrow £10,000 on overdraft. The annual payments on this
(a) Explain why exchange rates are necessary.
would rise from £600 to £700 if the rate of interest rose from
(b) One of Burberry’s products is the Sandringham Short Heritage 6 to 7 per cent a year.
Trench Coat. If this sells for £995 in the UK, calculate how much
Not all borrowing is at variable rates of interest. Variable rates
it would cost a Japanese shopper in Tokyo if £1 = ¥190.
mean that banks or other lenders are free to change the rate of
(c) Assess the possible impact on Burberry if the exchange rate interest on any money borrowed. Many loans to businesses are
changed to £1 = ¥150.
at fixed rates of interest. This is where the bank cannot change
the rate of interest over the agreed term (the time over which
the loan will be paid off) of the loan. A rise in interest rates in
Interest rates the economy won’t affect the overheads of a business with only
If a business or an individual borrows money, they usually have fixed term loans. But, if a business wanted to take out new loans,
to pay interest on the loan. Equally, if they put their savings into it would have to pay the higher rates of interest the bank or
a bank or building society, they expect to receive interest. other lender was now charging. So overhead costs would rise.
The interest rate is the price of borrowing or saving money.
For example, if a small business borrows £10,000 from a bank for Effect of interest rates on investment
one year, and the interest rate is 7 per cent, it has to pay £700 in Changes in the rate of interest affect the amount that businesses
interest. Equally, if a business has £1 million in the bank for a year invest, for example in new buildings, plant and machinery. There
which it uses as working capital, and the rate of interest the bank are four main reasons for this.
offers is 3 per cent, it will earn £30,000 in interest.

235
Economic influences Unit 41

The cost of loans: Investment projects are often financed Domestic investment: As explained above, businesses are
through loans. A rise in interest rates increases the cost of likely to cut back plans for new investment if interest rates rise.
borrowing money. So projects financed this way will find that Investment goods, like new buildings or machines, are made by
the total costs have risen, reducing profitability. This might be businesses. So these businesses will see a fall in their demand.
enough to persuade some businesses to shelve their investment
plans. Total investment in the economy will then fall. Stocks: Businesses keep stocks of raw materials and finished
goods. Stocks cost money to keep, because a fall in stock
Attractiveness of saving: Businesses have the alternative of levels could be used to finance a fall in borrowing and interest
putting their funds into savings schemes rather than investing payments. So a rise in interest rates will increase the cost of
in machinery or buildings, for example. A rise in interest rates keeping stock. This will encourage businesses to destock, i.e.
makes putting money into financial assets relatively more reduce their stock levels. This will be especially true if the rise in
attractive. For example, if interest rates rise from 5 to 8 per cent, interest rates has hit demand in the economy. With fewer sales,
a business might decide to shelve an investment project and less needs to be produced. So less stock needs to be kept.
save the funds instead. But cutting stock reduces orders for businesses further up the
chain of production. For example, a retailer cutting stocks affects
Paying off existing loans: A rise in interest rates will demand from its suppliers. Destocking due to higher interest rates
increase the cost of existing variable rate borrowing. A business will therefore cause a fall in demand throughout much of industry.
could choose to pay off existing loans rather than increase its
investment. This will reduce its costs. It also reduces the risk Exports and imports: A rise in interest rates tends to lead
associated with borrowing. to a rise in the value of one currency against others. A rise in
the pound, for example, will make it harder for UK businesses
A fall in demand: A rise in interest rates is likely to reduce to export profitably. At the same time, foreign firms will find it
total spending in the economy, as explained below. This might easier to gain sales in the UK domestic market because they will
affect the profitability of many investment projects. For example, be able to reduce their prices. The result is likely to be a fall in
a business might forecast that an investment project would be exports and a loss of sales to importers in the domestic market.
profitable with 20,000 sales a year. But if sales were projected Both will reduce demand and hit UK businesses.
to be only 15,000 a year because of a downturn in demand,
then the investment project could be unprofitable and might not Question 2
go ahead.
In 1990, restaurateur Ernie Carter was declared bankrupt. His
Effect of interest rates on demand restaurant business went into liquidation when he failed to
The level of interest rates affects aggregate demand (i.e. total pay interest owing on a mortgage. The interest payments on
demand) for goods and services in the economy. A rise in his £155,000 mortgage were £2,400 a month. The mortgage,
interest rates will tend to push down aggregate demand. A fall in taken out on his private residence, had been used to help fund
interest rates will tend to increase demand. the restaurant. However, the restaurant struggled and was
Businesses are directly affected by changes in demand. not generating enough revenue to meet the high mortgage
When demand falls, their sales go down because less is being
payments. Ernie lost everything. He borrowed £2,000 from
bought. If demand rises, businesses receive more orders and
his father and went to New Zealand. Fifteen years later,
more sales.
after working as a chef in various hotels in Wellington and
There are many different ways in which changes in interest
Queenstown, he returned to England with £30,000 of savings.
rates lead to changes in the sales of businesses.
Ernie invested £20,000 setting up a new catering venture
Domestic consumption: Consumers will be hit by a rise specialising in the provision of food for weddings, business
in interest rates. The cost of loans will rise. This will deter functions and parties. The business went very well and even
consumers from buying goods bought on credit, such as cars, grew during the recession in the UK between 2008 and 2012.
furniture and electrical equipment. These goods are known In 2013, Ernie decided to expand his business and invest some
as consumer durables because they are ‘used up’ over a retained profit in an outdoor catering operation. His idea was to
long period. provide ‘instant party facilities’. This included a marquee, music
In the UK, people who have a mortgage (a loan to buy a system, bar, spit-roasting and full buffet service. The idea worked
house) are also likely to see their monthly repayments rise very well indeed. He took on four more employees and since
because many mortgages are variable rate loans. Existing interest rates were at ‘rock bottom’ decided to borrow £10,000
mortgage holders will then have less to spend on other goods to double the size of his outdoor catering operation.
and services. Some potential new home buyers will be put off
because they can’t afford the repayments, directly hitting the (a) Explain one effect that high interest rates can have on
new housing market. If unemployment begins to rise because businesses.
of less spending, consumer confidence will fall. This will make (b) Explain why a business like Ernie’s is likely to invest more when
consumers even less willing to take out loans and spend. interest rates are low.

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 Managing business activities

Taxation Business spending and investment: Increases in costs and

Governments can affect business decision-making using fiscal reduced profits mean that businesses have less retained profit.
policy. This involves changing taxation and government This can affect the ability of the business to pay its debts, buy
expenditure to influence the economy. Taxes vary from country stocks and meet other expenses. It can also affect whether it
to country but are paid by both businesses and individuals. The invests in new factories or machinery.
main taxes levied in the UK are shown in Table 2.
Shares: Changes in capital gains tax and stamp duty might
Table 2 The main taxes levied in the UK affect shareholding. For example, an increase in capital gains tax
might deter shareholders or delay sales of shares.
Direct taxes (taxes on income)
Income tax Paid on personal income and that from paid and Importing and exporting: Increases in customs duties can
self-employment
affect businesses. For example, if the UK raised customs duties
National Insurance Paid by businesses and individuals on on imported products a UK business might benefit because
contributions employee’s earnings imports against which it competed would then have a higher
Corporation tax Paid by companies based on how much profit price. However, UK businesses buying imported supplies would
they make
have to pay higher prices.
Capital gains tax Paid on the capital gain (profit) made when selling
an asset Business operations and employees: Increases in National
Inheritance tax Paid on money transferred to another individual, Insurance contributions of employers might deter employers
usually after death from recruiting extra workers. Changes in taxation on company
Indirect taxes (taxes on spending) cars or mileage allowances might also change how a business
Value Added Tax (VAT) Paid mainly when buying goods and services offers these benefits to employees.
(except food)
Excise duties Paid when buying certain goods such as petrol Other effects: Certain types of business might be affected
and tobacco by changes in tax. For example, an increase in landfill tax might
Customs duties Paid when buying certain goods from abroad encourage businesses to recycle. A rise in passenger duty could
Council tax Paid by residents to the council to help fund discourage holiday makers and reduce the demand for holidays.
local services
Business rates Paid by businesses to the council to help fund Tax avoidance and evasion: Increases in taxation often
local services lead businesses to try to avoid paying the tax. For example,
they might not hire workers to avoid higher National Insurance
The effect on businesses of changes contributions or switch from buying imports to avoid customs
duties. In some cases they might even try to evade the law,
in taxation for example dumping waste in the countryside to avoid landfill
How might changes in taxation affect businesses in the UK?
taxes, which is illegal.
Consumer spending: Changes in certain types of taxation are Government expenditure
likely to increase the income consumers have left after tax. These The government is responsible for spending in the public sector.
include reductions in income tax rates, increases in personal It provides a range of services, such as education, defence,
allowances and an increase in the limits on which inheritance tax welfare benefits, transport and healthcare. In 2014, the UK
is paid or a reduction in the rate of inheritance tax. If consumers government spent £732 billion. Figure 4 shows the categories
have more income left they might increase spending on the of planned expenditure for 2014 in the UK.
products of businesses. Increases in income tax, National Insurance
contributions and council taxes are all likely to leave consumers
Figure 4
with less income and could reduce spending on products.
Government expenditure planned for 2014
Prices: An increase in VAT or excise duty will raise the costs Transport: £23 billion
Industry, agriculture and employment: £17 billion

of a business. Businesses often pass this on to customers by Housing and enviroment: £25 billion
Personal social services: £31 billion
raising the price of goods. An increase in customs duty will Social protection:
Public order and safety: £32 billion
increase the price of goods being imported into a country. £222 billion
Defence: £38 billion

Business costs, revenue and profits: Increases in some Other: £53 billion
taxes might raise the costs of business. For example, VAT will
raise costs. A business might try to raise prices to cover this and Debt interest: £53 billion
maintain profit. However, higher prices can reduce sales and so
Health: £140 billion
profit could still be affected if revenue falls. Rises in corporation Education: £98 billion
tax, business rates, employers’ National Insurance contributions
Source: Office for Budget Responsibility, 2014-2015, estimate.
and landfill tax will all tend to reduce business profits. Reductions Allocations to function are based on HM Treasury analysis
in taxes are likely to increase the profits of a business.

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Economic influences Unit 41

The effect of changes in government The business cycle

expenditure on businesses Over a period of time gross domestic product (GDP) (output in
Levels of government expenditure can influence business the economy) is expected to grow. However, the rate of growth
activity. If the government increases spending to more than is rarely smooth; there are likely to be some fluctuations. It is also
it raises in taxes, total spending in the economy will rise. The possible for GDP to fall. These fluctuations are often referred to
exact impact of such a measure is complex. Although many as the economic, trade or business cycle. Figure 5 shows these
businesses may benefit from higher spending levels in the fluctuations and identifies four different phases in the cycle.
economy, too much spending can lead to other problems,
such as inflation and higher interest rates. Figure 5
In recent years the UK government has tried to cut The economic, trade or business cycle
spending in some departments to reduce government
borrowing. The pie chart in Figure 4 on the previous Upswing
Boom
page shows that the amount of debt interest paid by the
government in 2014 is planned to be £53 billion. This
is a huge amount of money and could be used for other
departments, such as healthcare or education, if government

GDP
Downturn Recession
debt was eliminated. The government has tried to reduce
the annual deficit (the difference between spending and
government income) for nearly five years, but it is proving to
be a difficult objective. However, the government has made
cuts in expenditure. For example, it has frozen most public
sector pay since 2010. This, along with other government Time
measures, has led to a drop in disposable income for many,
which has affected some businesses adversely. For example,
quite a few retailers have experienced a drop in demand and Boom: The peak of the cycle is called a boom. During a boom
some have collapsed. However, the impact on businesses of GDP is growing fast because the economy is performing well.
changes in government spending depends upon the industry Existing firms will be expanding and new firms will be entering the
in which they operate. market. Demand will be rising, jobs will be created, wages will be
rising and the profits made by firms will be rising. However, prices
Question 3 may also be rising. For example, in the UK, the price of houses rose
sharply when GDP was growing rapidly in the 1990s and 2000s.
Carillion is a British multinational facilities management
and construction services company with headquarters in Downturn: A boom will be followed by a downturn. The
Wolverhampton. It undertakes a range of construction projects economy is still growing, but at a slower rate. Demand for goods
including roads and hospitals. Most of its business is in the United and services will flatten out or begin to fall, unemployment will
Kingdom, but it also operates in several other regions, such as start to rise and wage increases will slow down. Many firms will
Canada, the Middle East and the Caribbean. In 2014 it was stop expanding, profits may fall and some firms will leave the
reported to have been awarded the contract to redevelop Anfield, market. Prices will rise more slowly.
Liverpool FC’s stadium.
Recession or depression: At the bottom of the business cycle
Despite efforts by the government since 2009 to cut its
GDP may be flat. If GDP starts to fall, the bottom of the cycle
expenditure, at the end of 2014 it was announced that it would may be referred to as a slump or depression. Such a period is
be spending £15 billion on more than 80 new road schemes. This often associated with hardship. Demand will start to fall for many
included a long-awaited plan to tunnel under Stonehenge. The £15 goods and services – particularly non-essentials. Unemployment
billion initiative, which covers investment lasting up to 2021, was rises sharply, business confidence is very low, bankruptcies rise
set out in the government’s first road investment strategy, which and prices become flat. The prices of some things may even fall.
also included improvements to junctions on the M25, to the A27 in A less severe version of a depression is a recession.
Sussex, to approaches to Liverpool, and to the A1 in the north-east Recovery or upswing: When GDP starts to rise again there is a
of England. It comes as a report from the RAC Foundation predicts recovery or an upswing in the economy. Businesses and consumers
there could be an additional 7 million road users in England and regain their confidence and economic activity is on the increase.
Wales – taking the total to 43 million – by 2034. Demand starts to rise, unemployment begins to fall and prices start
to rise again.
(a) Explain one way in which businesses are likely to be affected by
cuts in government expenditure.
The impact of the business cycle on
(b) Assess the extent to which a company like Carillion will benefit
from the government’s announcement to spend £15 billion on business
road improvements. The uneven pattern of growth, shown by the business cycle, can
have an impact on businesses. However, the size of the impact

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 Managing business activities

will depend on the financial position of the business and what decision-making more difficult, reduces business confidence
it produces. and presents businesses with some unexpected events which
●● Output. During a boom, businesses increase output they have to deal with.
to meet rising demand. Some will increase capacity.
Businesses providing non-essential products and luxury Decision making: The uncertainty which results from the
items will benefit more than those that produce necessities. unpredictable behaviour of economic variables can have an
Businesses operating in the holiday, restaurant, air impact on some of the strategic decisions made by a business.
transport, jewellery and fashion industries are likely to For example, when evaluating an investment project which is
benefit most. In contrast, during a recession or a depression expected to yield a 20-year return, a business would have to
output will fall. Businesses respond by reducing output and consider the possible effects of higher or lower inflation, higher
cutting capacity. Businesses that trade in essential items, or lower interest rates, stronger or weaker exchange rates,
such as supermarkets, will avoid the worst of the downturn. changes in the levels and pattern of government expenditure,
●● Profit. During a boom business profits are likely to rise. and what might happen to economic growth. This is very
This is because demand is rising and it is easier to raise difficult indeed. The level of uncertainty will increase some
prices. However, when national income starts to decline, it of the risks that businesses take when making long-term
is harder to make a profit. Businesses may cut their costs to decisions. Consequently, marginal investment projects, for
maintain profit levels. Many will have to tolerate lower profits example, are not likely to be undertaken.
and some will make losses.
●● Business confidence and investment. During an Unexpected events: The behaviour of some economic
economic recovery and into a boom, business confidence is variables can be volatile. This means that they can fluctuate,
high. Business owners are optimistic about the future and sometimes alarmingly. For example, in 1992, on a day which
are prepared to take more risks. For example, they are more became ‘Black Wednesday’, the Chancellor of the Exchequer
inclined to launch new products, enter new markets and increased interest rates from 10 per cent to 15 per cent. This
expand. In contrast, during a recession business confidence means that a business with a £50 million loan would see its
is low and business owners are pessimistic, cautious annual interest charges rise from £5 million to £7.5 million.
and anxious about the future. Consequently, they are not The effect of such volatility can have a very unsettling effect
likely to take risks and are more inclined to contract their on business. More recently, the financial crisis in 2008, which
businesses. Investment is likely to fall. For example, instead plunged many Western economies into recession, happened
of replacing outdated machinery they will make do with very suddenly and unexpectedly. Even in 2015, the UK, and
what they have. the Eurozone in particular, were struggling to recover from
●● Employment. During a boom unemployment falls because its effects.
businesses are taking on more workers to cope with rising
demand. Sometimes firms might struggle to recruit the quantity Business confidence: The economist John Maynard Keynes
and quality of staff that they need as there are fewer people suggested that business confidence can affect investment
seeking work. However, during a recession the opposite decisions. His suggestion was that if business people were
happens. Businesses lay off workers and unemployment rises. optimistic about the future, they are far more likely to take
●● Business start-ups and closures. In a boom more people the risk and invest in new projects. In contrast, those with a
are prepared to set up a new business. This is because pessimistic outlook would be less inclined to invest. This is
demand is rising and it is easier to make a profit. Business important because there is probably a link between uncertainty
confidence will be high so new entrepreneurs will be more and business confidence. If levels of uncertainty are high,
enthusiastic. However, a recession is not a good time to business decision-makers are more likely to be pessimistic and
start a new business. Business closures will be rising and lack the confidence to invest. This means that high levels of
inefficient businesses, those with cash-flow problems and economic uncertainty will result in low levels of investment and
those producing non-essential products, are most at risk. business development.
All businesses are faced with the problem of economic
The effect of economic uncertainty on uncertainty. Business owners and senior managers would
the business environment hope that the government’s economic policies are as business-
One big problem for businesses in relation to economic friendly as the current economic climate permits. Ideally, a
influences is the uncertainty which results from their behaviour. business would want stable prices, low interest rates, stable
The pattern of economic variables such as inflation, exchange exchange rates, and steady and sustainable economic growth.
rates, interest rates, taxation, government expenditure and the
business cycle cannot be predicted with any accuracy. For Finally, a business might use methods such as PESTLE
example, few people would have predicted that interest rates in analysis, SWOT analysis, risk assessment and scenario planning
the UK would have been so low for so long. In 2015 they had to help reduce uncertainty, prepare for unexpected economic
been stuck at 0.5 per cent for six years. Uncertainty makes events and improve the quality of decision-making.

239
Economic influences Unit 41

Exam tip Key terms

When answering questions about the impact of events on a
business, it may be useful to distinguish between whether they are Appreciation of a currency – a rise in the value of a currency.
internal or external. Credit may be given to answers which Base rate – the rate of interest around which a bank
distinguish clearly between influences that a business can control structures other interest rates. If the Bank of England raises
and those that it cannot. For example, if a business is performing the base rate, all other borrowing and savings rates are likely
well it might be because it is being well managed. However, it to move in the same direction and vice versa.
might also be because a key rival has left the market. Evaluation Boom – the peak of the economic cycle where GDP is
marks may be awarded for answers that recognise this distinction. growing at its fastest.
Consumer price index (CPI) – a common measure of price
changes used in the EU.
Deflation – a fall in the general price level. Also used to
Knowledge check describe a situation where economic growth is falling or
1. What is meant by an external influence on business? negative when inflation is falling.
Depreciation (of a currency) – a fall in the value of a currency.
2. How is inflation measured? Downturn – a period in the economic cycle where GDP
3. State three drawbacks of inflation for businesses. grows, but more slowly.
Economic, trade or business cycle – regular fluctuations in
4. How might deflation affect a business?
the level of output in the economy.
5. Why does the government impose taxes on individuals and Exchange rate – the price of one currency in terms of another.
businesses? Fiscal policy – using changes in taxation and government
6. What is the difference between direct and indirect taxes? expenditure to manage the economy.
Government expenditure – the amount spent by the
7. State four examples of direct taxes. government in its provision of public services.
8. What might be the impact on businesses of a fall in Gross domestic product (GDP) – a common measure of
corporation tax? national income, output or employment.
Index linked – the linking of certain payments, such as
9. Explain the link between business investment and the
benefits, to the rate of inflation.
interest rate. Inflation – a general rise in prices.
10. How will a business be affected by a depreciating exchange Monetary policy – using changes in the interest rate and
rate if it exports 80 per cent of its output? money supply to manage the economy.
11. If £1 = AU$1.85, how much will a British tourist pay Recession – a less severe form of depression.
in pounds for a meal in a Sydney restaurant that cost Recover or upswing – a period where economic growth
AU$245.00? begins to increase again after a recession.
Slump or depression – the bottom of the economic cycle
12. What is meant by a boom in the economy? where GDP starts to fall with significant increases in
unemployment.
Taxation – the charges made by government on the
activities, earnings and income of businesses and individuals.

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 Managing business activities

Case study
Figure 7
UpFLY profit 2009–2013
UpFLY £ million

450
401
UpFLY, a budget airline with bases in leading airports, is the 400
largest airline in the UK by the number of passengers carried. 350
In 2015 it had 500 routes, 160 aircraft, 20 bases and carried 320
50.7 million passengers. The airline serves over 35 countries. 300

Like other low-cost airlines in the European market, UpFly 250

223
performs better than long-haul operators because it keeps 200 172
its planes in the air for as long as possible every day. It also
150
charges passengers for add-ons, such as baggage check-in,
food and hotel hire. Costs are kept low by buying fuel- 100
50
efficient aircraft in bulk with aggressive discounts, reducing 50
baggage-handling costs by charging passengers for check-
0
in luggage and operating a younger, more efficient fleet
2009 2010 2011 2012 2013
of aircraft. Similar airlines in the US have fleets with an
Some airlines in the world made a loss in 2009, affected by the
average age of around 12 years. The average age of an economic slump
UpFly plane is just over five years. Finally, UpFly has a good
record for their flights being on time and they have easy-to-
use web and mobile sites, which attract over a million visits Figure 8
each day. Some operating information is shown in Figures UpFLY passengers by country (2014)
6, 7 and 8. Figure 9 shows some economic data. 9%
4% Key
4% UK
(a) What is meant by a slump? (2 marks) France
44%
(b) Explain one reason why a business like UpFLY might be 10%
Italy
affected by a cut in income tax. (4 marks) Switzerland

(c) Explain whether UpFly was affected by the UK slump. Germany

(8 marks) 14% Spain
Other
(d) Assess the possible impact on UpFly of an appreciation in
the exchange rate. (12 marks) 15%

Figure 9
Growth in GDP 2006–2014
% %
Figure 6
1.5 1.5
UpFLY number of passengers carried 2009–2013
1.0 1.0
Millions
0.5 0.5
59.7
60
54.5 0 0
47.8
50 -0.5 -0.5
40.2
40 35.6 -1.0 -1.0

30 -1.5 -1.5

-2.0 -2.0
20
-2.5 -2.5
10 2006 2008 2010 2012 2014

0 Source: adapted from Office of National Statistics and

2009 2010 2011 2012 2013 www.tradingeconomics.com

241
 42 Legislation 2.5.2
Theme 2

Key points
1. The effects on businesses of: consumer protection, employee protection, environmental protection,
competition policy, and health and safety.

Getting started Figure 1

In 2014, two Northamptonshire firms were fined after a safety Consumer issues affected by legislation
inspection unearthed serious asbestos-related breaches. Lifting
Systems Ltd (fined £14,000 plus £523 in costs) had contracted
Product
Durasteel Services Ltd (fined £10,000 plus £523 in costs) to quality
refurbish an asbestos cement roof at one of its sites. When
inspectors carried out a check, they found asbestos insulation Trading
board had been removed and stored on the premises. They also and age Product
restrictions safety
found that debris had been placed in waste skips around the
site. As a result the Health and Safety Exective (HSE) served a Consumer
Prohibition Notice to stop work immediately. The two companies issues
were in breach of health and safety regulations since neither had influenced by
a licence to remove asbestos. legislation
Promotion Prices and
Source: adapted from www.press.hse.gov.uk and payment
advertising methods
How have the businesses in this case been affected by
government legislation? What is the purpose of legislation in Consumer
this case? State two other areas where these businesses might rights
be affected by government legislation. How might complying
with government legislation benefit these businesses?

The need for legislation in business How does consumer legislation affect
Without legislation it is possible that some businesses could businesses?
neglect the needs of certain stakeholders. For example, workers The UK has lot of consumer legislation compared with some
might be paid low wages or forced to work in an uncomfortable other countries. There is also a body of EU legislation that affects
or even dangerous environment. One of the roles of the UK businesses. Businesses have to ensure that their products,
government is to provide a legal framework in which businesses marketing and other activities comply with this legislation.
can operate and ensure that vulnerable groups are protected. The increase in the number of consumer laws and the
It is important for the government to find the ‘right balance’. concern about protecting consumers has a number of possible
Too much legislation will discourage enterprise and deter implications for firms.
foreign investment in the UK. This might stifle growth in national ●● Increases in costs. Improving the safety of a good or
income, reduce job creation, decrease tax revenues and reduce ensuring that measuring equipment is more accurate can
consumer choice. Too little, and some stakeholders’ best increase the costs of a firm. For example, an electrical firm
interests might be neglected. producing table lamps may find that its product contravened
legislation. The firm would have to change or improve the
Consumer protection components used to make the lamps or re-design the lamp
Consumers want to buy good-quality products at fair prices
itself. Such changes would be likely to raise the firm’s costs.
and receive good customer service. They also want clear and
●● Quality control. Many firms have needed to improve their
accurate information about products. They do not want to buy
quality control procedures as a result of legislation. For
goods that may be dangerous, overpriced or sold to them on
example, firms involved in bagging or packaging goods
false grounds. Without government legislation some firms would
must ensure that the correct quantities are weighed out.
exploit consumers. Some of the consumer issues affected
Failure to do so could result in prosecution. In addition,
by government legislation are summarised in Figure 1. Some
businesses must be careful not to sell substandard or
examples of legislation introduced by the government to protect
damaged products.
consumers is summarised in Table 2 at the end of the unit.
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 Managing
Magaging business activities

●● Dealing with customer complaints. Many businesses now (drivers losing their driving licence, for example), are made
have a customer service or customer complaints department redundant or for any other substantial reason, such as giving
to deal with customers. These allow firms to deal with false details on an application form. However, if employees feel
problems quickly and efficiently, and to ‘nip problems in the that they have been unfairly dismissed they can take their case
bud’ – dealing with any problems before the customer turns to an employment tribunal. If the tribunal finds in favour of
to the legal system. the employee, it has the power to reinstate that worker. Some
●● Changes in business practice. Attempts to ensure examples of legislation designed to protect people at work are
that customers are treated fairly by a business may place summarised in Table 2 at the end of the unit.
pressure on it to become more market-orientated. The firm
would attempt to ensure that it is actually meeting the needs Equal pay: Historically, in many professions and occupations
of those people it is attempting to serve. Such a change, for women have not received the same pay as men. To address this
example, may lead to greater use of market research. issue the government introduced the Equal Pay Act 1970. This
stated that an employee (whatever their gender) doing the same
Employee protection or ‘broadly similar’ work as a member of staff of the opposite
Employers have a responsibility towards their employees, but sex is entitled to equal rates of pay and conditions. The Act
legislation is necessary to ensure that minimum standards are aimed to eliminate discrimination in wages and other conditions
applied. Without legislative protection some businesses could of work, such as holidays, overtime, hours and duties. The Act
exploit their workers. For example, they might pay low wages, make was updated in 1983 to allow female workers to claim for work
them work long hours, deny them employment rights, discriminate of ‘equal value’ to that done by a man.
against certain groups and dismiss them unfairly. Businesses
have a number of legal obligations when employing people. How does employment legislation affect
Employment contract: Workers are entitled to a contract
businesses?
Businesses often complain about the burden of employment
of employment. This is a legally binding agreement between legislation. Many say that the legislation discourages them from
the employer and the employee. It is likely to contain details taking on staff. Some of the negative effects of employment
including the start date, term of employment, job title and duties, legislation are outlined below.
place and hours of work, pay and holiday entitlement, pension
and sickness absence, termination conditions and details relating Compliance costs: The expenses incurred by a business in
to disciplinary, dismissal and grievance procedures. meeting the requirements of employment and related legislation
can be significant.
Discrimination: Businesses have to make a choice when ●● When taking on a new employee a business must check
recruiting staff or selecting employees for promotion or that the person is entitled to work in the UK. This involves
training. Businesses will evaluate candidates in order to checking a passport, or any other means of identification,
choose which one to employ or promote. It usual to choose which shows that a person is a national of an EU country.
the person that is most experienced or better qualified; this is If the person was born in the UK then documents, such
legal discrimination. However, it is illegal in most countries as their birth certificate, and tax forms, such as a P60 and
to discriminate on grounds of gender, race, disability, sexual a P45, must be inspected and their National Insurance
orientation or age. This is unfair discrimination. When number provided. A business must also check that the
employing and promoting people, employers must base their documents belong to the applicant. If a business only
decisions on the ability of candidates, and not for example, checks the documents of people whom they suspect
whether they are male or female. There have been a number might not be entitled to work in the UK, they may face a
of acts addressing discrimination in the UK. One example is claim for discrimination. Copies of the documents must
the Equality Act 2010 – which replaced the Sex Discrimination also be made.
Act 1975 – the original legislation that made it unlawful to ●● Employers are responsible for the well-being of employees
discriminate either directly or indirectly against someone on the at work. They must take out the necessary insurance policies
grounds of their gender or marital status. and guard against discrimination or harassment. They may
also have to deal with matters such as health and safety,
Unfair dismissal: The Employment Relations Act, 1999, states discipline and grievances, discrimination in the workplace,
that employees who have worked for an employer for a year bullying, annual leave and redundancy.
have the right not to be unfairly dismissed. Employees may ●● Businesses must also deal with the tax authorities. For
have grounds to claim unfair dismissal if they were dismissed example, they must tell Her Majesty’s Revenue and
because they: Customs (HMRC) whenever someone is employed, deduct
●● were trying to join a trade union
tax and National Insurance contributions (NICs) from
●● became pregnant
earnings, provide employees with a P60 tax form every
●● refused to work on a Sunday
year and a P45 if they leave the business’s employment.
●● were made redundant without a proper procedure.
They also have to provide HMRC with an annual return for
Employees can be dismissed fairly if they are incapable of doing every employee.
their job, found guilty of misconduct, become ineligible to work
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Legislation Unit 42

These are just a few of the legal requirements when employing worker motivation and employee welfare, which will help raise
someone. These tasks and responsibilities take time and money productivity, reduce absenteeism and cut staff turnover. It might
to manage. Large businesses have specialists employed in this also help to foster a more positive and friendly culture within
field to deal with compliance and the necessary administration. organisations. This can improve the image of businesses and make
Costs will also be incurred if a business gets involved in a it easier to recruit and retain high-quality staff.
dispute with an employee. For example, a business might need
to employ a legal team for representation.
Question 1
Higher labour costs: Some employment legislation has A ruling by the employment appeal tribunal in 2014 stated
resulted in certain businesses having to meet higher labour that employees’ holiday pay should reflect the pay levels that
costs. For example, the national minimum wage was introduced employees actually receive while working. This meant that
in the UK in 1999 to boost the pay of very low-paid workers – overtime and other supplementary payments would be included
taking some people out of poverty. The legal minimum wage is in holiday pay. According to the European Court of Justice
reviewed and updated each year. This usually means that it goes (ECJ) the change was necessary so that workers would not be
up. As a result, businesses paying the minimum wage rate to discouraged from taking holiday (for health and safety reasons).
employees have to meet this increase by law. This ruling was not welcomed by businesses. For example, John
Cridland, Director-General of the CBI, suggested that it would
Changing working practices: As a business employs more be hard for UK businesses, who faced the prospect of costs
people it will have to introduce systems to deal with compliance
potentially running into billions of pounds, and might result in
and human resource management. It will also have to ensure that
business closures and significant job losses. Cridland suggested
job advertisements do not discriminate on the basis of gender or
marital status. For example, job titles should be gender neutral, that the uncertainty created by the cases would impact on
as in ‘cashier’ or ‘salesperson’. There will be a greater need for investment and resourcing decisions.
job descriptions and person specifications. For example, generally As a result of the new rulings, businesses faced higher labour
speaking, a person specification must not restrict the job to men costs, with an increase in wages and National Insurance costs.
or women, although there are exceptions. It is possible to offer It was suggested that the impact was greatest on smaller
a job to someone of a particular sex if the work is exempt from businesses because they often paid lower basic salaries, but used
gender discrimination legislation. This could include teaching commission and performance-based pay to ‘top-up’ staff wages.
in single-sex schools, jobs in welfare services, e.g. the right to It was also reckoned that about a third of small businesses paid
employ a female in a women’s refuge, and acting roles. Interviews their workers overtime and the extra costs were a negative
must be carried out in a structured way to help limit any prejudice impact on small businesses. Also, the impact on costs from the
that an interviewer might have. Selection procedures must not time managers spent reviewing their employment contracts and
discriminate against certain groups. For example, a test style must working practices would be an extra burden for small businesses
not be used if it is alien to a particular ethnic culture.
without a specialist human resources department.
Loss of flexibility: Some businesses argue that sections of (a) Explain one reason for the ruling relating to holiday pay.
the legislation make it more difficult to run a business because (b) Explain one possible impact on a small business of the ruling.
the laws are too rigid. For example, employees can ask for
flexible working arrangements that suit them if they have worked
continuously for 26 weeks or if they have a child under the age
of six (or a disabled child under the age of 18). Reasons for Environmental protection
refusing an employee flexible working must be set out in writing Without regulation, business activity can have an adverse effect
and be legally justified. on the environment. For example, governments are becoming
concerned about global warming and consequent changes in
Penalties: If businesses fail to comply with the laws outlined weather patterns and climates. Some of the greenhouse gases
above there may be penalties. For example, fines can be that contribute to global warming come from businesses, such
imposed and the image or reputation of a business might be as power generators. As business activity increases there is
damaged. Businesses might also be forced to backdate claims more gas emission. Also, economic development means that
from employees where ‘wrongdoing’ is proven. This can be car ownership and air travel increases. The emissions from cars
very expensive. and aircraft also add to global warming. Some specific problems
include the following.
Employment legislation can also have a positive effect on
businesses. For example, legislation creates a ‘level playing field’ ●● Pollution. There are different types of pollution. Water
when employing people. This means that unscrupulous businesses pollution may be caused by businesses dumping waste
that want to exploit workers to lower costs so that they can gain into rivers, streams, canals, lakes and the sea. An example
a competitive edge in the market are prevented from doing so. would be warm water or chemicals being leaked into rivers.
Complying with employment legislation is also likely to improve Air pollution may be caused by businesses discharging

244
 Magaging business activities

particulate waste or gases into the air. Noise pollution can Marketing: Environmental issues can be a highly effective
also be a problem. Noise from factory machinery, loud music marketing tool for some businesses. Some companies, such
from pubs and night clubs, and low flying aircraft by airports as IKEA, which uses sustainable forestry techniques when
are examples. sourcing wood for its products, and Johnson & Johnson,
●● Destruction of wildlife habitats. Some business which uses mainly solar energy in its production processes,
development destroys wildlife habitats and spoils the natural have made a particular point of pursuing environmentally
environment. For example, around half of the forests that friendly policies, and feature these on their websites. Many
once covered the planet are now gone. Forests are vital for businesses claim on their packaging to be environmentally
the ecological balance of the planet. It is also reckoned that friendly in some way. However, some businesses have
more than half of the world’s primates will become extinct found that environmental issues pose a marketing threat. Oil
due to habitat destruction. Many other species are under companies, for example, are frequently accused by pressure
threat from human activity, such as tigers, pandas, and myriad groups, such as Greenpeace, of harming the environment.
plant and insect species. Shell has been heavily criticised for its oil exploration projects
●● Traffic congestion. Extra traffic caused by commercial in the Arctic and it was widely reported that partly as a result
vehicles or workers travelling to and from work can cause of pressure from Greenpeace, Lego ended its co-promotion
congestion resulting in delays and accidents. Traffic in London with Shell after a 50 years’ association. Such examples show
got so bad that a congestion charge was introduced in 2003 that businesses must take quick and positive action when an
to discourage vehicles from entering the centre of London environmental issue suddenly arises. It also shows that some
during the week. businesses have to work constantly to protect and improve
●● Resource depletion. Non-renewable resources, such as their environmental image.
oil, coal, gas and minerals, cannot be replaced. Therefore,
as business development gathers pace these resources are Finance: In some cases, responding to environmental
depleted. Once they have run out, future generations will have concerns or new laws and regulations can have a positive
to do without. Fertile soil, which is needed to grow food, is also financial impact on a business. Energy-saving measures, for
being lost. Around 40 per cent of the world’s agricultural land example, can lead to a business having lower costs than
is seriously degraded. This is due to poor farming practices, before because of previous inefficiencies. In most cases,
overgrazing, urban sprawl and land pollution. Also, some though, taking environmental action is likely to lead to higher
businesses waste resources. For example, many argue that costs. If all businesses in the industry also face these higher
some of the packaging used by businesses is unnecessary and costs, prices are likely to rise to reflect the higher costs. Profits
that not enough use is made of recycled materials. would then be largely unaffected. But if higher costs fall more
heavily on one business than another, then some will gain
One approach used by many governments to minimise the damage a competitive advantage and others lose it. This in turn will
done by businesses to the environment is to pass new laws. Much have different impacts on profitability. Installing expensive new
of the pressure for environmental legislation has emerged due to equipment will also have a negative impact on cash flow. In
the growing concerns about global warming. If businesses fail to the nuclear power industry and the car industry, businesses
comply with environmental laws they may be fined or forced to must also make investment decisions knowing that there will
close until the problem is resolved. Examples of environmental be heavy costs at the end of a product’s life. In the case of the
legislation are shown in Table 2 at the end of the unit. nuclear power industry, this is in terms of decommissioning
plant. For motor manufacturers, they have to take back old
How does environmental legislation cars for recycling. This will affect the outcomes of appraisal
affect businesses? methods like the payback method and discounted cash flow.
Environmental issues offer both threats and opportunities to
businesses. Businesses which stand to gain the most from growing Operations management: Pollution controls and other
environmental regulation are those selling pro-environmental and environmental measures could have an impact on how a
anti-pollution products. These businesses range from engineering product is made. This could range from changes in the type
companies selling equipment designed to reduce emissions, to of materials used, to production methods, to storage and
service companies which advise other businesses on how they after-sales service. For example, asbestos was widely used
can comply with regulations, to businesses selling environmentally in industry years ago but its use today is severely restricted.
friendly products, such as managed wood. Industries such as electricity generation and chemicals have
Those which stand to lose the most are companies which are had to introduce much cleaner production methods to reduce
high polluters and who face competition from other businesses emissions. The landfill tax encourages businesses to reduce
which don’t face similar problems. For example, a specialist the amount of waste they produce.
chemicals company may cease trading because there are many
good substitutes to its products which have only a fraction of Human resources: Environmental concerns and policies
the environmental impact in production. Or a heavily regulated have human resource implications. Staff will need to be
UK company may face competition from a Third World producer recruited and trained to deal with ever increasing government
whose government places little restriction on its activity. regulations concerning the environment. Some businesses

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Legislation Unit 42

may choose to outsource the guidance they need. Larger Competition policy
businesses are likely to put environmental policies in There is a need to monitor the activities of monopolies and
place. This could include an environmental audit where markets that are dominated by a small number of large
key measures relating to the impact of the business on the businesses. Without government regulation some businesses
environment are audited each year and the results are made would exploit consumers by using anti-competitive practices
public. Implementing policies means that staff throughout the or restrictive practices to reduce competition in the market.
organisation are aware of the policies and what they must Such practices might include the following.
do to comply with the policies. As with any policy, unless ●● Increasing prices. Raising prices to levels above what
there are good procedures and training in place to ensure they would be in a competitive market. For example, some
compliance, staff will tend to interpret the policies as they manufacturers supply goods to retailers and insist that they
see fit. Effective communication up and down the hierarchy are retailed at a fixed price.
is therefore essential. The very small minority of businesses ●● Restricting consumer choice. A manufacturer might refuse
which make environmental concerns an important business to supply a retailer if that retailer stocks rival products. This
objective can use this as a way of motivating staff. Over will reduce choice for the consumer.
time, it will tend to attract employees who are interested ●● Raise barriers to entry. By spending huge amounts of
in this aspect of business. However, a tension between money on advertising, for example, a dominant firm can
meeting financial targets such as profit targets and meeting squeeze others out of the market. It might also lower its
environmental targets is likely to arise. For a business to price for a temporary period. This would make it difficult for
survive, it must at least break-even. In this sense, financial a new business to get established in the market. Once the
targets tend to be more important than environmental targets. new business disappears the price would go up again.
This tension between targets could demotivate staff who ●● Market sharing. This might occur if there is collusion.
want to see environmental targets as the most important for When a market is shared out between the dominant firms,
the business. choice is restricted and prices rise.
In the UK, the Competition and Markets Authority (CMA)
Question 2 is responsible for serving the interests of consumers and
protecting them from restrictive practices. This body was
CMI Demolition Ltd is a waste management business based formed in 2014 and replaced the Office of Fair Trading (OFT)
in Glasgow. In 2014 the company was reported as being in and the Competition Commission. Its responsibilities are
breach of the Environmental Protection Act 1990 and fined summarised in Table 1.
£16,000 (reduced from an original £24,000 fine because of
the company’s acceptance of responsibility and subsequent Table 1 Responsibilities of the Competition and Markets
co-operation). According to the report, CMI Demolition Ltd Authority for protecting consumers from restrictive
used an unlicensed company to transport and dispose of waste practices
materials from its transfer station. This occurred between March
• Investigating mergers which could restrict competition
and June 2011. According to the Act, waste management
companies must ensure that any carriers of waste are licensed • Conducting market studies and investigations in markets where there may
by the Scottish Environment Protection Agency (SEPA). The Act be competition and consumer problems
also states that companies must produce Waste Transfer Notes • Investigating where there may be breaches of UK or EU prohibitions
to show what waste is being transported, when and where it against anti-competitive agreements and abuses of dominant positions
is going, and who is carrying it. This is to discourage the illegal
• Bringing criminal proceedings against individuals who commit the cartel
dumping of waste materials. offence
A SEPA officer said, ‘It’s critically important that waste
• Enforcing consumer protection legislation to tackle practices and market
management companies ensure their contractors are fully conditions that make it difficult for consumers to exercise choice
licensed and credible operators to transport their waste
materials. Providing business to unlicensed groups or individuals • Co-operating with sector regulators and encouraging them to use their
competition powers
is not only illegal, it undercuts legitimate waste carriers and
impacts on the wider industry as a whole.’ • Considering regulatory references and appeals
Source: adapted from www.media.sepa.org.uk Source: www.gov.uk
(a) Explain one way in which CMI Demolition is affected by
environmental legislation.
(b) Give one reason why such legislation is required.

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 Magaging business activities

How does competition policy affect Sometimes, after an investigation, a merger or takeover
might be permitted, but with provisos. For example, in 2014
businesses? a merger between two large cement producers, Lafarge and
It might be argued that competition policy will have both a
Holcim, was approved by the European Union. However, the
positive and a negative impact on businesses.
EU directed Lafarge to sell all of its German and Romanian
business activities, and instructed Holcim to unload all of its
Positive: Businesses might get frustrated if their restrictive Slovak business and most of its activities in France.
practices are deemed illegal and are forced to comply
with the law. This is because such practices are often very Health and safety
lucrative. However, since competition policy is designed to Figure 2 shows that work can be a dangerous environment.
promote competition, many firms will actually benefit from it. Because of the danger to employees, governments aim to
For example, if dominant firms erect barriers to entry, this will protect workers by passing legislation that forces businesses
make it very difficult for smaller firms to break into the market. to provide a safe and healthy workplace. This might involve:
Thus, if such barriers are outlawed then it is easier for new ●● providing and maintaining adequate safety equipment and
firms to break into the market. This will give opportunities to protective clothing, such as fire extinguishers, protective
more businesses. overalls, hard hats, ear plugs and safety goggles
A more competitive business environment will benefit ●● ensuring workers have enough space to do their jobs
the economy. Competition will encourage innovation and ●● guaranteeing a hygienic environment with adequate toilet
improve efficiency as businesses try to survive in the market. and washing facilities
As a result, UK businesses are more likely to develop new ●● maintaining workplace temperatures and reasonable
products, reduce costs and make progress in overseas noise levels
markets. This will help businesses to generate more revenue ●● providing protection from hazardous substances
and profit from exports. It will also raise income and ●● providing protection from violence, bullying, threats and
employment in the UK. stress in the workplace
●● providing adequate breaks for rest.
Negative: Some businesses might argue that competition In the UK, laws to protect employees have existed for over
policy acts as a constraint on their activities. For example, if a 100 years. There are also many regulations concerning
proposed merger or takeover is investigated by the CMA, this health and safety at work that are regularly updated. In
might slow down the whole process. This could cause delays addition, businesses may follow codes of practice designed
and cost the businesses involved a lot of money. In 2014, a to protect workers. Finally, UK regulations are influenced by
proposed merger between soft drinks companies, Britvic and EU directives relating to health and safety at work. Some
AG Barr, was investigated by the authorities. The decision was examples of health and safety legislation are given in
delayed for about four months. Table 2 on the next page.

Figure 2
Standardised incidence rates (per 100,000 workers) of fatal injuries at work in GB/UK

Incidence rate of fatal injury

(per 100,000 workers)
4

0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Year
Source: www.hse.gov.uk

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Legislation Unit 42

Table 2 Examples of legislation directed at businesses

Legislation Date Brief description and example
Sale of Goods Act Products must be of a merchantable quality and fit for purpose
(Consumer legislation) 1979 Example: a garment sold as ‘waterproof’ must not let in the rain
Food Safety Act Food should be fit for human consumption and comply with safety standards
(Consumer legislation) 1990 Example: food should not be sold if decaying or contaminated
Equal Pay Act Pay and conditions must be the same for all people doing the same or ‘broadly similar’ work
(Employment legislation) 1970 Example: male and female bus drivers must be paid the same rates
National Minimum Wage Act It is unlawful to pay a worker a wage rate below the set minimum wage rate
(Employment legislation) 1998 Example: in 2014 a wage of £6.00 per hr would be illegal (£6.50 was the minimum wage)
Environment Act Set up the Environment Agency to monitor and control pollution
(Environmental legislation) 1995 Example: it is unlawful to discharge emissions into the air (above certain levels)
Environmental Protection Act Controls pollution caused by the disposal of waste into land, water and air
(Environmental legislation) 1990 Example: an unlicensed carrier of waste can be fined
Competition Act Prohibits agreements, cartels or practices that restrict or prevent competition
(Competition policy) 1998 Example: it is illegal for a group of businesses to charge an agreed price
Enterprise Act Established the Office of Fair Trading (OFT)* as an independent body
(Competition policy) 2002 Example: the OFT can refer investigations to the Competition Commission**
Health and Safety at Work Act Aimed to raise the standard of health and safety at work
(Health and safety) 1974 Example: employers must provide a written statement of policy on health and safety
Working Time Regulations Act Clarifies hours of work and break entitlements for workers
(Health and safety) 1998 Example: 48 hours is the maximum working week
* The Office of Fair Trading was replaced by the Competition and Market Authority in 2014
** The Competition Commission was replaced by the Competition and Market Authority in 2014

How does health and safety legislation on a conveyor belt when the main power was switched on.
As a result the whole line, including the belt, reactivated and
affect businesses? the worker fell, breaking ribs on both sides of his body. An
investigation by the Health and Safety Executive (HSE) found
Costs: The Health and Safety at Work Act 1974 requires the electricity source for the conveyor belt had not been isolated.
businesses to prepare a written statement of their general policy
on health and safety. Businesses also have to give training,
Benefits: Although complying with health and safety legislation
information, instruction and supervision to ensure the health and
imposes costs on businesses, there are some considerable
safety of workers. Many businesses also follow codes of practice
benefits that result from it. For example, a good health and
to meet health and safety standards at work. Meeting these
safety record will help to improve the image of a business.
requirements will raise business costs. Many large businesses,
This will make it easier to attract and retain high-quality staff –
for example, employ a health and safety officer whose sole
especially in industries with ‘hostile’ working conditions where
responsibility is ensuring that health and safety issues are
health and safety issues are of the utmost importance. Also,
addressed in accordance with the law. Smaller firms are likely
if businesses are genuinely committed to maintaining high
to attach health and safety duties to the job description of a
standards of health and safety, workers will feel protected and
senior member of staff, to ensure compliance. Finally, health and
more secure. As a result they may be better motivated and more
safety inspectors have the right to enter business premises to
loyal. This will benefit the business as workers will be more
ensure that health and safety measures are being carried out by
productive. Absence through injuries at work will be reduced, as
businesses.
might staff turnover.
Penalties: Failure to comply with the law can be serious. At Exam tip
worst, employees’ safety might be compromised, which could It is not necessary to learn all the legislative Acts that relate to
lead to accidents – in some cases fatal. Businesses can also be the protection of consumers, employees and the environment.
fined if they fail to comply with legislation. For example, in 2014, However, it might be useful if you can remember, generally, the
issues that are addressed by the Acts. You do need to be fully
Lincolnshire-based BW Biddle, a well-established metal recycling
aware of the impact that the legislation has on businesses. Also,
business, was fined £70,000 and ordered to pay £18,000 in remember that the legislation can have both positive and negative
costs for breaching Section 2(1) of the Health and Safety at effects on business.
Work Act 1974. An employee was carrying out maintenance

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 Magaging business activities

Case study
‘This pay increase is very bad for us. We try to be efficient
here at Padwell, we keep our costs low, we aim to be the
PADWELL ELECTRONICS PLC cheapest in the industry – it’s what keeps us going. The
government is always creating new demands. Just last month
we had to spend £100,000 on a new toilet block for staff.
Padwell Electronics manufacture diodes, resistors, capacitors There was nothing wrong with the old block until the HSE
and transistors to standard sizes and standard electrical [Health and Safety Executive] got involved.’
specifications. The Walsall-based company employs 4,800 Sally also mentioned the proposed merger with Deptford
people in a large factory on an industrial estate. Most of the Electricals as an example of government intervention
components are sold to the manufacturers of mobile phones. that’s ‘gone too far’. When the merger was proposed the
Padwell Electronics has a reputation in the industry for being authorities said that an investigation may be necessary
one of the cheapest producers. However, its image in the because the two businesses together would dominate the
local area is not very positive. Although it is a large employer, market. The two companies were still waiting for an official
people often see jobs at Padwell Electronics as a ‘last resort’. announcement from the authorities seven months after the
This is mainly because the pay is low, the work is very boring initial proposal.
and working conditions are harsh. The factory is said to be
noisy, cold and poorly lit. Staff turnover is 39 per cent. Sources: adapted from www.gov.uk and www.hse.gov.uk
In October 2014, the national legal minimum wage rate in
the UK was increased by 3 per cent from £6.31 to £6.50. At (a) Calculate the increase in the weekly wage bill as a result of
Padwell Electronics, 90 per cent of employees are paid the the increase in the minimum wage. (4 marks)
national minimum wage for a standard 36-hour week (four (b) Explain the main impact of the national minimum wage on
shifts of nine hours). After the increase, Business Secretary Padwell Electronics. (4 marks)
Vince Cable said, ‘The National Minimum Wage provides a
vital safety net for the lowest paid, ensuring they get a fair (c) Explain one way in which the proposed merger with
wage whilst not costing jobs. This year’s rise will mean that Deptford Electricals might be affected by competition policy.
they will enjoy the biggest cash increase in their take-home (4 marks)
pay since the banking crisis, benefiting over one million (d) Assess the extent to which the costs of complying with
people in total.’ However, Sally Castle, the CEO at Padwell legislation outweigh the benefits to a business like Padwell
Electronics, had this to say when talking to the local press: Electronics plc. (12 marks)

Key terms Knowledge check

Anti-competitive or restrictive practices – attempts by firms 1. State four consumer issues covered by consumer legislation.
to prevent or restrict competition.
2. How might a food producer be affected by consumer
Barriers to entry – obstacles that make it difficult for new
legislation?
firms to enter a market.
Collusion – two (or more) businesses agreeing to a 3. How might business adverts be affected by consumer
restrictive practice, such as price fixing. legislation?
Contract of employment – a written agreement between 4. What is the main purpose of the Sale of Goods Act?
an employer and an employee in which each has certain
obligations. 5. What is a contract of employment?
Discrimination – favouring one person over another. For 6. How might an employee claim unfair dismissal?
example, in the EU it is unlawful to discriminate on grounds 7. State two restrictive practices that a business might try to
of race, gender, age and disability.
engage in.
Employment tribunal – a court that deals with cases
involving disputes between employers and employees. 8. State three responsibilities of the CMA.
National minimum wage – a wage rate set by the 9. Why do businesses often regard legislation as a burden?
government below which it is illegal to pay people at work.
Unfair dismissal – the illegal dismissal of a worker by a
10. State two benefits to a business of complying with health and
business. safety legislation.

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 43 The competitive 2.5.3
Theme 2

Key points environment

1. Competition and market size.

Getting started ●● department or variety stores, such as Marks & Spencer,

During 2013 the price of motor insurance in the UK fell. Matalan, Primark, TK Maxx, Debenhams and John Lewis,
According to commentators this was the result of fierce which sell clothes along with other items, such as make-up,
competition. However, despite the intense competition, esure, leisure goods, fashion accessories, sportswear, groceries,
the insurance company behind the Sheilas’ Wheels brand, saw soft furnishings, household goods and bedding
its pre-tax profits rise by 2.5 per cent to £118.4 million. It also ●● independents, which are often quite specialised, and cater for
reported a 4 per cent increase in gross insurance premiums particular market niches; for example, an independent store
(total revenue). might specialise in clothes for toddlers or wealthy shoppers
looking for exclusivity
●● supermarkets, such as Tesco and Asda, which have branched
out into non-food goods including clothes
●● online retailers, the numbers of which have grown very
quickly since the introduction of the internet. Many online
suppliers belong to the stores mentioned above. However,
there are a growing number of online retailers that sell solely
from a website. Examples of these are the two global giants
Amazon and Alibaba.

In a minority of markets there is very little competition. For

example, in the UK the supply of water is organised on a
regional basis. In each region there is usually only one supplier,
such as Wessex Water, the sole supplier for Dorset, Somerset,
Bristol, most of Wiltshire, and parts of Gloucestershire and
Hampshire. The company, which is owned by the Malaysian
company YTL Power International, serves a total of 2.7 million
customers. People in this region cannot obtain a domestic water
Source: adapted from www.esuregroup.com supply from any other provider, so Wessex Water operates as a
monopoly. This arrangement is typical for the supply of water
What is meant by a ‘fiercely competitive market’? Suggest how in the UK.
esure was able to increase both profit and revenue in such a
competitive market. How might a business reduce competition Determinants of competitiveness
in a market? Not all markets are the same. Different markets have different
features and characteristics. The features and characteristics
of markets are known as market structures. It is these market
The competitive environment structures that largely determine how competitive a market is.
One of the most important external influences faced by
a business is the threat posed by competitors. This was The number and relative size of businesses in the
mentioned first in Unit 1. The majority of markets are competitive market: In some markets, such as farming, a large number of
and some are extremely competitive. For example, the UK businesses compete with each other. None of these businesses
market for clothes, which was worth about £26 billion in 2014, are particularly large compared to other businesses in the
is highly competitive. There are many thousands of businesses market. So the market share of any single business is small.
competing to sell a wide range of clothes to the UK population. In other markets, a few businesses dominate the market,
These include: even though there might be a large number of other small firms.
●● specialist clothes chains, such as Next, River Island, Dorothy In some markets, there is only one business, a monopolist. For
Perkins, Warehouse, Jaeger, Miss Selfridge, Monsoon, example, on some railway routes in the UK, there is only one
Topshop, Prada, Gucci and Wallis train company operating a service.

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 Managing business activities

The extent of barriers to entry: In some markets, it is easy Degree of interrelationship: In some markets, the
for a new business to set up. Many people each year set up actions of one business have no effect on another business.
small shops selling everything from groceries to clothes to toys. Businesses are independent of one another. In farming, the
This is because the barriers to entry are low. It doesn’t cost decision by one farmer to plant a field with carrots has no
much to open a shop. The amount of knowledge of the industry impact on a nearby farm in terms of the price it will receive or
required is fairly little. In most cases, there are no special how much it produces.
licences or other legal obstacles in the way. In certain markets, In other markets, such as car production, increased sales
barriers to entry are high. In the rail transport industry or mobile by one business will mean reduced sales by another business
telephone industry, the government gives licences to a limited if the size of the market remains the same. Businesses are then
number of businesses to operate. In the drug industry, newer interdependent.
drugs are protected by patent. This prevents other businesses
from copying them. Legal factors: Competition between businesses is generally
In other markets, the costs of starting up a business are seen as being in the best interests of customers. They can
large. Car manufacturing, aeroplane production or oil refining are shop around between businesses offering the same or similar
examples. In the perfume industry, the main companies devote a products for the best deal. This means that businesses have to
large proportion of their costs to marketing. Any new entrant then offer what the customer wants or face closing down through
has to be able to afford to spend millions of pounds launching its lack of customers.
new product. In contrast, monopoly is usually argued to be bad for
Where barriers to entry are high, competition tends to customers. They are forced to buy from one supplier whatever
be lower. One consequence of this is that businesses often the quality of the product and whatever the prices. The
compete on issues other than price. This means that they tend to monopolist has enormous power over customers and acts to
emphasise the non-price elements of the marketing mix, such as maximise the benefits to itself.
promotion and place. Monopolies, therefore, tend to be controlled by governments.
In the USA, they are illegal. In the UK and the rest of the
The extent to which products can be differentiated: In European Union they are regulated. A monopolist exists where
some markets, products are homogeneous. This means that they there is only one firm in a market. However, firms in a market can
are the same whichever business produces them. Typically, there act as if they were a monopoly by colluding. This means they
are standards to which products conform. So nine carat gold is get together, usually to fix prices and output in a market. They
the same quality whatever business produces it. Homogeneous, then have formed a cartel. For example, a group of firms making
products are often found in raw materials markets and in basic vitamins may fix a high price between themselves at which they
manufacturing, such as steel. Where products are homogenous, will sell vitamins to customers. Then they have to restrict output
competition tends to be largely based upon price with this between themselves to sustain those high prices.
element of the marketing mix emphasised.
In other markets, products differ according to which business Impact on businesses of a competitive
makes them. A McDonald’s meal is different from a Burger King environment
meal. Ford cars differ from Volkswagen cars. Heineken lager is Operating in a competitive market is likely to have a number of
different from Budweiser lager. Individual products or product implications for a business. Businesses will be challenged and
ranges can then be branded. The stronger the perceived forced to monitor the activities of rivals in order to minimise the
difference, the stronger the brand. Where product differentiation threat they pose. Some specific implications are outlined below.
is strong the non-price elements of the marketing mix such as
promotion tend to be emphasised by businesses. Price: In a highly competitive market, businesses have less
control over the prices they charge. Prices are likely to be forced
The knowledge that buyers and sellers possess: In some down. A business that charges a price that is significantly higher
markets, buyers and sellers have access to all the information than those of rivals risks losing sales because consumers can
they need to make rational decisions. Buyers, for instance, would switch easily from one supplier to another. If a business can
be able to find out the best price in the market. Sellers would effectively differentiate its product there may be some scope for
have open access to the most efficient methods of production. price increases. For example, in the fashion industry, businesses
This is known as having perfect knowledge. Where knowledge is such as Burberry, Prada and Gucci can charge higher prices
perfect, price is strongly emphasised in the marketing mix. than rivals because the quality of their products is perceived to
In other markets, knowledge is not available to all. One be superior.
business might not be able to find out how much a rival
business is charging for its products. A consumer might not Profit: The profit available in a highly competitive market has to
know which of 20 cars will be most environmentally friendly. be shared between a greater number of players. Profit margins
If there is imperfect information in the market, this can give a are likely to be squeezed because prices will be forced down.
competitive advantage to some businesses over others. Where However, businesses that can operate more efficiently and
knowledge is imperfect, businesses will tend to place a great reduce their costs may be able to enjoy higher profits than rivals
deal of importance upon non-price elements of the marketing that operate with a higher cost base.
mix such as the product and promotion.
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The competitive environment Unit 43

Communication with customers: Businesses will be product, or a story about a product, is sent globally across
under pressure to meet customer needs. Those businesses the internet by people who have seen and enjoyed the clip.
that meet customer needs effectively are more likely to There are many examples where the adverts of
survive in the market. This competitive pressure may mean businesses in the same industry have similar features. For
that businesses make more of an effort to communicate with example, many TV adverts for perfumes feature celebrities
their customers. They may carry out more market research, or models wearing expensive clothes and jewellery in
for example. They may also use social media to keep in touch glamorous surroundings. Many TV adverts for cars show
with consumer sentiment. them being driven in stunning scenic locations. One of the
For example, comments relating to what people think reasons for the similarity of marketing campaigns in certain
about products can be picked up on Twitter accounts. industries is the fear that a business will get left behind if it
On Twitter, O2 used social media to address customer fails to match the campaigns of rivals.
complaints with a friendly, personal approach. This helped
O2 to win back their customers. Competition and market size
An important part of good customer service is effective The size of a market refers to the number of customers and
communication with customers. It is reckoned by some businesses that buy and sell a particular product or product
commentators that customer engagement is set to overtake group. Market size may be measured in terms of value, and
productivity as a key driver of profitable growth. can vary considerably.

Innovation: In highly competitive markets, innovation will Global markets: These are obviously the largest markets
be encouraged. This is because if a business can design new in which a business can compete. Due to the process of
products, they may be of more interest to consumers and globalisation an increasing number of worldwide markets
allow a business to gain a competitive edge in the market. have opened up for businesses. Even small businesses can
The development of a USP can go a long way towards aiding now access global markets because they can market their
survival in a competitive market. Many people prefer to buy products online. One example of a rapidly growing global
products that are differentiated from those of rivals. market is for cars. In 2010 the market was worth $728.3
For example, Durham-based Orsto Ltd produces a billion, with predictions of growth to $904 billion by 2015.
smartwatch called the Orsto X3. The wearable technology
market is in its infancy, but it is likely to be dominated by National markets: These are markets confined to national
huge companies like Apple, Google, IBM and Samsung. borders. In 2012 the value of the new car market in the
However, the Orsto X3 has a USP. It is British designed UK was about £32 billion. The new car market is highly
and offers a suite of specifications that are unique. For competitive in the UK because manufacturers from all over
example, it does not rely on a smartphone connection for the world compete in the market.
functionality.
Regional markets: Some businesses serve regional
Product range: The range of products sold by a business markets. For example, Merseyrail provides train services in
is likely to be strongly influenced by competitors. If a business the Merseyside region. It operates trains between Liverpool
extends its range with a new product, this usually puts pressure and Southport, Liverpool and Chester, and Liverpool and
on rivals to do the same. Ormskirk. Merseyrail has the monopoly on rail transport in
For example, following the success of Magners cider in the region.
the early 2000s, other beverage producers, such as Carling
(owned by Molson Coors) and Stella Artois (owned by Inbev), Local markets: By their very nature, local markets are much
launched their own brands of cider – Carling British Cider and smaller. Businesses in these markets serve limited areas
Stella Artois Cidre respectively. The failure to match a rival’s such as villages, small towns and specific residential areas. In
extensive product range might result in lost customers. some cases there may only be one business serving a local
market. For example, many rural villages are served by just
Marketing: In highly competitive markets the quality one shop or one pub. However, this does not mean that they
of marketing, and the amount of money invested in do not face any competition. Most people in rural areas have
marketing strategies, is very important. Businesses will cars and can travel to other shops and pubs.
be heavily influenced by the marketing methods used by The size of a market in which a business competes can
rivals. If a business enjoys a fruitful advertising campaign, influence the way it operates. For example, businesses
rivals are put under pressure to match that success. It is operating in small markets are not likely to undertake large-
quite common for businesses to imitate or replicate the scale production in an effort to exploit economies of scale.
campaigns of rivals. Also, large markets are likely to be more competitive than
For example, a wide range of businesses in many small ones. For instance, a grocery shop in a Scottish
different markets are all trying to exploit social media in Highland village is not likely to face the same competition as
their marketing strategies. One growing trend is the use of a branch of Sainsbury’s in a large town.
viral marketing. This is where a short video clip relating to a

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 Managing business activities

Operating in large markets

National and global markets are likely to be more
challenging for businesses. Even in large markets that
are dominated by just a few producers, competition can
be still be severe. For example, the UK grocery industry
is dominated by a small number of very large operators.
These comprise mainly large supermarket chains, such
as Asda, Morrisons, Sainsbury’s, Tesco, Aldi, Lidl and
Waitrose. Since 2009, competition has intensified, with the
low-cost operators, including Aldi and Lidl, gaining market
share at the expense of the other large chains. This intense
pressure has caused some operators, such as Tesco,
to review their operations. For example, in 2014 Tesco
responded to the competition by implementing a loyalty
scheme shake-up, improving its online delivery service and
refreshing some of its stores.
In large competitive markets it is vital for businesses
to monitor the activities of rivals. A business needs to be
aware of the pricing strategies that rivals use, changes
in their product ranges, the promotional and production
methods used, and any other information that might have
an impact in the market. Close monitoring often results in
businesses copying their rivals. They might copy product
designs, packaging, pricing strategies and promotions.
Copying rivals is common practice in many industries.

Operating in small markets Key terms

One of the main problems when operating in small
Barriers to entry – factors which make it difficult or
markets is whether the volume of sales will be sufficient to
impossible for businesses to enter a market and compete
generate the desired rate of return. Small markets might
with existing producers.
be attractive because they may lack competition. However,
Cartel – a group of businesses (or countries) which join
if the market is too small then trying to serve it might be
together to agree on pricing and output in a market in an
a mistake. In 2015, the US aircraft manufacturer Boeing
attempt to gain higher profits at the expense of customers.
said that it would not make any more Boeing 757s as the
Colluding – in business, where several businesses (or
market was not large enough.
countries) make agreements among themselves which
In South Australia, the market for kangaroo meat
benefit them at the expense of either rival businesses or
reduced and some businesses left the industry or extended
customers.
their product range to include some value added meat
Market structures – the characteristics of a market, such as
products.
the size of the barriers to entry to the market, the number of
Another problem operating in a small market is the fear
businesses in the market or whether they produce identical
that a larger, stronger rival will enter the market and take
products, which determine the behaviour of businesses
away all the custom. Small independents often find it difficult
within the market.
to compete with a large corporation if they decide to compete
directly. A large corporation has much greater resources. For
example, they can afford to spend more on advertising and Knowledge check
other forms of promotion. Also, their costs are likely to be
lower because larger firms canexploit economies of scale. 1. Give two examples of highly competitive markets.
This means they can charge lower prices. 2. Give two examples of markets that might lack competition.
3. How might consumers benefit from competition in a market?
Exam tip
4. Describe two determinants of competition in a market.
Remember that in a minority of large markets there may be a lack
of competition. For example, the energy markets in the UK are 5. Explain why global markets are likely to be highly competitive.
huge. However, there is a lack of proper competition and it has
been alleged that many of the operators in the industry are 6. Outline two implications of operating in a relatively
exploiting consumers. small market.

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The competitive environment Unit 43

Case study
• Focus sharply on game design. As freemium games
become the norm, the quality of new games will have to
MOBILE GAMING MARKET be extremely high to enjoy any sort of success. Freemium
pricing is where a basic version of a game is provided
free to all users. However, any special features or superior
levels come with a fee. Designers will need to be inventive
to retain customers. They will also have to meet the high
performance expectations of users. For example, since
gaming enthusiasts are using a wider range of devices to
play games, simpler games, such as Flappy Bird, are likely to
perform better.
• Invest in a mobile APM tool. To make apps competitive
it is important to keep up to date with technology. An
application performance monitoring (APM) tool will help to
improve the performance of games, particularly those that
are media and animation heavy.

Figure 1
Total and mobile global gaming market ($ billion)

$ billion
The global mobile gaming industry is not only large, but also 120
95.2 102.9
growing. In early 2014 Newzoo, a games research agency, 100 88.4
75.5 81.4
predicted that the market would grow by about 8 per cent a 80 70.4
year for at least three years, this growth being driven by the 60
rising popularity of mobile gaming and increasing incomes 35.4
40 30.7
in Asia. The firm increased this forecast slightly in the course 12.7 17.6 21.8 26.3
20
of 2014. Figure 1 shows the total and mobile global gaming
market between 2012 and 2017. 0
2012 2013 2014 2015 2016 2017
Game designers have responded to this rapid growth. Key Year
A survey by the Game Developers Conference showed Total global gaming market ($bn)
that 52 per cent of developers design games specifically for Mobile global gaming market ($bn)
mobile devices, such as tablets and smartphones. However, Source: www.newzoo.com
according to a report by New Relic Mobile, developers need
to be aware of the possible pitfalls in this highly competitive
market. This is because designs for mobile games apps often Source: adapted from www.newzoo.com
include features that slow down performance. For example,
they integrate media-rich and animation-heavy content.
(a) Calculate the percentage growth in the mobile global, and
Also, users can easily delete games and download other
the total global gaming markets, between 2012 and 2017,
ones from the enormous choice available. The report offered
to determine which is the fastest growing. (4 marks)
three pieces of advice to game developers.
(b) Evaluate the implications for businesses of operating in
• Monitor current industry trends. In this industry it is
a large and highly competitive market, like the mobile
vital that new games do not lag behind those of rivals.
gaming market. (20 marks)
However, it is also bad practice to replicate a game that
already exists (although many designers do blatantly copy
those of rivals). Some of the key trends in 2014 included
big-screen functionality, free-to-play models, 3D gaming
and growing interest from emerging markets.

254
 Preparing for your
AS Level Paper 1 exam
Advance planning Section B questions
1. Draw up a timetable for your revision and try to keep to it. In Section B you will be given Extract B as a stimulus and you
Spread your timetable over a number of weeks, and aim to will need to answer Question 2, a–f. The parts of Question 2
cover a chosen number of topics each week. require a range of depths in your responses.
2. Spend longer on topics that you have found difficult, and Section C questions
revise them several times. In Section C you will be given Extract C as a stimulus. You will
3. Do not try to limit your revision by attempting to ‘question need to answer Question 3, which is not broken down into parts.
spot’. Revise so that you are confident about all aspects of You will be expected to give an extended answer. This means
your work. that you will need to write more.
Paper 1 overview
You should familiarise yourself with the layout of the paper by
AS Paper 1: Marketing and people: 1 hour 30 minutes looking at the examples published by Edexcel. The questions
Section A, Theme 1 , Question 1 2 × 2 mark questions within each section are followed by lined spaces where you
2 × 4 mark questions should write your answer. Use the mark allocation as a guide to
1 × 8 mark question how much time to spend on each question.
1 × 10 mark question
Skills required when answering questions
Total marks for Section A 30 marks
If you are entered for the AS Level qualification you will be
required to sit two examinations. You should be aware of the
Section B, Theme 1, Question 2 2 × 2 mark questions
skills that you need to demonstrate when answering questions.
2 × 4 mark questions
1 × 8 mark question You will need to demonstrate four different skills referred to as
1 × 10 mark question assessment objectives (AOs).
Total marks for Section B 30 marks AO1 – Knowledge: this means you have to show that you:
• recognise and understand business terms, concepts and
Section C, Theme 1 and Theme 2, 1 × 20 mark question
theories
Question 3
• understand how individuals and organisations are affected by
Total marks for Section C 20 marks
and respond to business issues.

Total marks = 80 marks All questions will test knowledge to some extent. A minority of
questions will test knowledge alone. These can be recognised
Paper 1 will assess your knowledge and understanding of by the mark allocation. They will tend to carry just two or four
Theme 1 – Marketing and people. It is a written examination marks.
and the paper is divided into three sections. The duration of
Paper 1 will be 1 hour and 30 minutes. You have to answer ALL AO2 – Application: this means that you have to apply
questions. There is no choice. However, this can be an advantage knowledge and understanding to various contexts to show how
because it means you do not have to waste time deciding which individuals and organisations are affected by and respond to
questions to answer. issues. This might involve:
• using a business formula in appropriate circumstances, for
Section A questions
example calculating the price elasticity of demand for a
In Section A you will be given Extract A as a stimulus (probably
product
some information about a business) and you will need to answer
• using a theory to show why a business has chosen a particular
Question 1, a–f. The parts of Question 1 require a range of depths
course of action
in your responses.
• using a theory to show the impact on a business of choosing a
particular course of action.

255
AS Level Paper 1

Most questions in the examination will require you to Questions that carry more than four marks will require analysis
demonstrate application. This means that you have to ensure that in the answer. Some questions that carry four marks may also
your answers relate directly to the context given in the question. require you to demonstrate some analytical skills.
You must discuss the implications of issues to the particular
AO4 – Evaluation: evaluation involves making a judgement.
business or industry in the context you are given.
You will need to evaluate both qualitative and quantitative
AO3 – Analysis: this means you have to show that you can evidence to make informed judgements and propose evidence-
break down information and understand the implications of the based solutions to business issues. This might involve:
information presented in the question. You will need to show an
• showing judgement when weighing up the relative importance
understanding of the impact on individuals and organisations of
of different points or sides of an argument in order to reach a
external and internal influences. This might involve:
conclusion
• explaining causes and effects and interrelationships, for • drawing conclusions from the evidence that you present
example by recognising from a graph that sales are falling and • assessing the relative importance of particular issues to a
could be the result of new competition in the market business
• breaking down information to identify specific causes or • suggesting a course of action for a business, supported by
problems, for example by realising that a business is suffering plausible motives or evidence.
from inefficiency because staff motivation has fallen as a
When evaluating, it is often possible to draw a number of
result of a pay cut
different conclusions. Very often in business studies there is no
• using appropriate techniques to analyse data, for example by
‘right’ answer, so examiners are likely to be more interested in
calculating the net profit ratio.
whether your judgement is plausible and in the quality of your
You will often be required to construct an argument, for example argument in support of that judgement. Questions that carry eight
by explaining the possible reasons for events or discussing the marks or more are likely to test evaluation.
advantages or disadvantages of particular courses of action.

256
Preparing for your AS exams
Sample answer with comments
Paper 1: Marketing and people
These questions will help you prepare for your AS Business Paper 1 examination. Some sample answers and comments are provided
for you to review and you will have the opportunity to answer some questions yourself.

Section A, Question 1
In Section A, Question 1, you will need to read Extract A before answering Question 1 a–f (no example is provided in
this section).
Section B, Question 2
Read Extract B before answering Question 2.

Extract B
Brainwave
In 2014, Richard Baister launched Brainwave, a world-fi rst soft drink designed
to keep the mind healthy. It may reduce the risk of Alzheimer’s and other forms
of cognitive decline. Brainwave does not contain any added sugar, preservatives
or colourings and uses only natural fruit fl avourings. It was developed with the
help of Newcastle Science City. Brainwave delivers the key ingredients the
body needs to help maintain brain health and cognitive performance.
There is likely to be increasing demand for a product that can reduce the risk
of Alzheimer’s and dementia as people live longer and the proportion of older
people in the global population gets larger. However, although the drink is
targeted at ‘everyone with a brain’, Baister said that early adopting young
professionals greatly interest Brainwave, as they ask a lot of their brains every
day. The total market size for soft drinks in the UK was about £15.6 billion
in 2013.
At launch in 2014, a pack of 8 × 330 ml of Brainwave was available online
for £16. That retail price of around £2.00 per pack was planned to be refl ected
as the brand rolled out to more stockists. The business donates 10 per cent of
profi ts to funding research into Alzheimer’s and dementia.
Source: adapted from www.brainwavedrinks.com

2 (a) What is meant by market size? (2 marks)

Question 2 (a), student answer

The total size of a market can be estimated or calculated by the market, or by value, which is the amount spent by consumers
the total sales of all businesses in the market. Market size can in the market. In this case the size of the UK soft drinks market
be measured by volume, which is the number of units sold in is measured by value. It is worth about £15.6 billion.

Comment, Question 2 (a)

Questions like this require you to demonstrate knowledge. One It is always helpful to give an example if there is one available –
mark might be awarded for defi ning market size and another for in this case you are told that the size of the soft drinks market is
showing that you recognise that it can be calculated in two ways. £15.6 billion.

257
AS Level Paper 1

2 (b) Explain one advantage of online retailing to Brainwave. (4 marks)

Question 2 (b), student answer

One of the biggest changes to occur in the marketing of There are a number of advantages of selling products online.
products in recent years has been the development of One of the main ones is that costs will be lower. Brainwave
online retailing. This is a popular branch of e-commerce that will avoid selling costs such as sales staff, display units, rent,
has emerged along with the development of the internet. It rates, lighting and heating, and other store overheads. The
involves shoppers ordering goods online and taking delivery savings might be enormous and allow Brainwave to charge
at home. In this case, Brainwave is sold online. For example, an lower prices. This might help Brainwave to break into the soft
8-pack of Brainwave can be purchased online for £16. drinks market.

Comment, Question 2 (b)

Questions like this require you to demonstrate knowledge, analysis. In this case, explaining that lower costs will allow
application and possibly analysis. One or two marks might be Brainwave to charge lower prices and break into the market is
awarded for showing that you understand what online retailing an example of analysis. Note that the answer is always about
means. Another one or two marks might be awarded for Brainwave. This shows application, for which marks will be
identifying one advantage. Finally, credit may be given for awarded.

2 (c) What is meant by supply? (2 marks)

No sample answer has been provided for question 2 (c) so that you can answer it yourself, for exam practice.
2 (d) Explain one reason why Richard Baister may have set up his business. (4 marks)
No sample answer has been provided for question 2 (d) so that you can answer it yourself, for exam practice.
2 (e) Assess two possible impacts on Brainwave of employing more staff if the business starts to expand rapidly. (8 marks)
No sample answer has been provided for question 2 (e) so that you can answer it yourself, for exam practice.
2 (f) Assess the factors that might infl uence the demand for Brainwave in the future. (10 marks)

Question 2 (f), student answer

One of the reasons why Brainwave was developed was rise, then demand for Brainwave might also rise. However,
to help combat Alzheimer’s and other cognitive diseases. many elderly people have to live on fixed incomes and price
Brainwave delivers key ingredients the body needs to may be a consideration for purchase. Over time, incomes
help maintain brain health and cognitive performance. in the UK would be expected to rise so the drink might
Older members of the population are more prone to such become more affordable. However, since 2009 real incomes
diseases so Brainwave may be an appealing product for for many people have stayed pretty much the same, or even
this target group. In the future the size of this market is declined, due to the recession and the austerity measures
likely to grow because globally the population is aging. of the government.
Consequently demand for Brainwave is also likely Finally, the effectiveness of Brainwave’s marketing strategy
to grow. could have a big impact on future demand. If the business
Brainwave is priced at £16.00 a pack for 8 drinks. That invests in clever marketing strategies and builds a strong
is £2.00 per drink, and price has a big influence on the brand, then demand is likely to rise in the future. However, if
demand for a product. Brainwave must ensure that the the Brainwave brand does become successful, rivals might
price is ‘right’. Brainwave may have carried out some bring out their own versions of the product. If a company like
research to determine what customers are prepared to Coca-Cola were to launch such a brand, Brainwave might find
pay for the product. In the future Brainwave must keep it difficult to compete. To conclude, it is difficult to predict
in touch with consumer sentiment and be prepared to what might happen to demand for Brainwave in the future.
change the price if market conditions change. If the price If its health benefits are proven, then it could become ‘big’.
is too high, then demand may fall in the future. I think future demand will depend largely on whether rivals
enter the market, and if they do, whether Brainwave can deal
Future demand might also depend on the incomes of with the increased competition.
potential customers. If the incomes of the target group

258
 Preparing for your exams

Comment, Question 2 (f)

Questions like this require you to demonstrate knowledge, i.e. the health-related benefi ts to the elderly. Three marks might be
application, analysis and evaluation. Two marks might be awarded awarded for evaluation. An example of evaluation in this answer
for demonstrating knowledge, such as identifying two factors that is the attempt to determine what might happen to future demand
might affect future demand, for instance aging population, price, for Brainwave. This is diffi cult to predict because there are so
incomes or the effectiveness of marketing. Two marks might be many variables to consider. However, by acknowledging this,
awarded for application. The whole of this answer is embedded in and exploring, for example, what could happen if a strong rival
the soft drinks industry, Brainwave’s product and closely related enters the market, a plausible conclusion is drawn. In this answer,
issues. Three marks might be awarded for analysis. An example counterbalance arguments are raised more than once. For example,
of analysis in this answer is the explanation of how future the effects on demand of rising incomes in the future and the recent
demand for Brainwave is dependent upon the growth of the decline in incomes have both been recognised. Evaluation marks
aging population and the product’s link with the target market, are likely to be awarded for this inclusion.

Section C, Question 3
Read Extract C before answering Question 3.

Extract C
Working in social media
ChitChat is an online social networking service. It allows users to communicate with each other by sending short messages.
ChitChat, which is based in Manchester, employs about 2000 people globally.
Many employees think that ChitChat is a good place to work. They get free meals at onsite cafés; they have access to a gym that
offers group exercise and yoga classes, personal fi tness instructors and massage therapists; they have games rooms and very fl exible
working hours; and they have access to company-subsidised childcare.
Staff work together in small teams, but they are regularly allowed to work on projects of their choice. If they come up with good ideas
they are given awards. There is also evidence to suggest that staff feel empowered by this workplace environment. For example, in
a recent survey, over 80 per cent of workers agreed that they felt like they had a high level of responsibility, while about 75 per cent
agreed that they could complete their work without interference from the senior leadership team.
3 Evaluate the importance of non-fi nancial methods of employee motivation to a business such as ChitChat. (20 marks)

Question 3, student answer

Businesses will gain a lot if their workforce is motivated. to carry out their responsibilities without management
Generally, people will be happier, easier to manage, more interference. The main benefit to a business like ChitChat
productive, more co-operative and less resistant to change. of empowering its workforce is that workers will be better
One notable advantage is a low staff turnover. If workers motivated. They will feel trusted and that the business
are well-motivated they are less likely to leave the company. recognises their talents. Workers will also have a greater
Having a low staff turnover can save a business with large control over their working day and this could reduce illness
numbers of employees, such as ChitChat, a lot of money in and absenteeism. Employees might develop new skills that
recruitment, selection and training costs. It will also provide a will help their personal development. Empowerment will also
more stable environment for workers. help to generate more ideas and different ways of solving
problems. At ChitChat, staff are allowed to work regularly on
One non-financial method that can be used to motivate staff is
any project of their choice. If they come up with good ideas
empowerment. This involves giving employees control to make
they are given awards.
decisions, giving them more self-confidence and recognising
their achievements. There is evidence to suggest that staff However, empowerment is sometimes criticised as simply
at ChitChat are empowered. For example, over 80 per cent a means of cutting costs and removing layers of management
of workers claim that they carry a lot of responsibility in the from the business. Employees may also resent being given
business. Also, around 75 per cent say that they are allowed more responsibility if they are not paid more. Sometimes
managers resent giving power away because it undermines

259
AS Level Paper 1

their importance. In the case of ChitChat though, foster relationships with their work colleagues. This will help
empowerment seems to have worked well – there is no them to develop a sense of belonging. ChitChat might also
evidence of resentment. enjoy other benefits from teamwork. For example, productivity
might be higher because of pooled talents, more ideas might
ChitChat seems to have created a good working environment,
be created, problems are often more easily solved by teams
offering staff a number of ‘perks’ so their time at work will
and responsibility can be shared around. ChitChat also allows
be more tolerable – perhaps even enjoyable. For example,
flexible working. However, team working may have some
employees get free meals at onsite cafés; they have access
drawbacks. For example, there may be conflict between team
to a gym that offers group exercise and yoga classes,
members, which might result in wasted resources as time is
personal fitness instructors and massage therapists; they
spent on resolving differences of opinion.
have games rooms and very flexible working hours. According
to Herzberg these non-financial benefits should help to To conclude, many businesses favour the use of non-financial
remove dissatisfaction amongst workers. Although such methods when motivating staff. In industries where it is
benefits may not be motivators, they will help to develop a difficult to measure the output of workers, the use of financial
satisfied workforce. methods of motivation, such as piece rates or commission,
are not really suitable. In the case of ChitChat, where many
According to Maslow, workers have needs and employers
employees are involved in research and project work, and
can meet some of these needs at work. For example, one
most employees are highly skilled professionals, the use
level that Maslow identified in his hierarchy of needs was love
of non-financial methods of motivation are likely to be very
and belonging. ChitChat seems to understand this notion
important. ChitChat’s approach seems to be working because
and organises its workers into small teams. If employees are
it is regarded by many as a good place to work.
allowed to work in groups they will have the opportunity to

Comment, Question 3
Questions like this require you to demonstrate knowledge, non-motivational factors can benefi t businesses such as ChitChat.
application, analysis and evaluation. Four marks might be Six marks might be awarded for evaluation. An example of
awarded for demonstrating knowledge, such as understanding the evaluation in this answer is how the importance of non-fi nancial
meaning of non-fi nancial motivational factors and defi ning terms awards is shown to be important to businesses like ChitChat.
like ‘empowerment’ in this case, and identifying its benefi ts. A judgement is made and supported with an argument. For
Four marks might be awarded for application. The whole of this example, one of the reasons why non-fi nancial methods are
answer focuses on non-fi nancial motivational factors, ChitChat’s important is because fi nancial methods of motivation in this
use of such methods and closely related issues. Two motivational case may not be appropriate. They are not suited to industries
theories (Herzberg and Maslow) are also applied to the case. where it is diffi cult to measure a worker’s output. The answer
Six marks might be awarded for analysis. An example of also considers potential counterbalances, the drawbacks of
analysis in the fi rst part of this answer is the explanation of how empowerment and team working, for example.

260
 Preparing for your exams

Practice question – AS Level, Paper 1: Marketing and people

The more you practise for your examination, the more confident you will feel. The following question provides practice for Section B,
Question 2.

Section B, Question 2
Read Extract B before answering Question 2.

Extract B
Fit Britches
Fit Britches supplies a range of garments designed to help
slimmers lose inches, reduce signs of cellulite and aid skin
elasticity in just 30 days. It was founded by entrepreneur Farnaz
Khan. She developed the products after she struggled to lose
weight after childbirth. Farnaz found a link between weight-loss
and heat after experimenting with enormous underpants and
clingfilm. Eventually, Farnaz developed a special shapewear
garment made from using a combination of advanced knitting
technology, intelligent fibres and compression which can help
stimulate blood circulation. By bringing the blood flow back into
the areas it causes the matabolism rates to rise through release
of the body’s own nitric oxide. This in turn improves blood flow
and oxygen supply at the skin level, causing the fat layers that
make up cellulite to be melted down, leaving the wearer with
smoother and firmer skin.
A study was carried out independently following scientific protocols in a double blind, paired and controlled experiments using a
total of 90 subjects. They wore the pants for 6 hours a day over 30 days. The study found that participants agreed improvements of
smoother skin, improvement in the appearance of cellulite and agreed their blood flow had improved in the area covered by the fabric
in less than 4 weeks.
Farnaz launched her business in 2013. The main products, which are manufactured in Italy and can be bought online, are called
Skinny Knickers, Skinny Top, Skinny Shorts and Skinny Leggings. Fit Britches uses psychological pricing. For example, a Skinny
Top is priced at £49.99. By 2014 the business was doing very well and planned to launch into the US market.
Source: adapted from www.fitbritches.com

2 (a) What is meant by psychological pricing? (2 marks)

(b) What is meant by an entrepreneur? (2 marks)
(c) Calculate the percentage mark-up if a Skinny Top cost £30 to make. (4 marks)
(d) Explain one aspect of the design mix that might be important to Fit Britches. (4 marks)
(e) Assess two possible reasons why Farnaz set up Fit Britches. (8 marks)
(f) Assess the possible business objectives of Fit Britches. (10 marks)

261
 Preparing for your
AS Level Paper 2 exam
Advance planning Section C questions
1. Draw up a timetable for your revision and try to keep to it. In Section C you will be given Extract E as a stimulus. You will
Spread your timetable over a number of weeks, and aim to need to answer Question 3, which is not broken down into parts.
cover a chosen number of topics each week. You will be expected to give an extended answer. This means
2. S
pend longer on topics that you have found difficult, and that you will need to write more.
revise them several times.
You should familiarise yourself with the layout of the paper by
3. Do not try to limit your revision by attempting to ‘question
looking at the examples published by Edexcel. The questions
spot’. Revise so that you are confident about all aspects of
within each section are followed by lined spaces where you
your work.
should write your answer. Use the mark allocation as a guide to
Paper 2 overview how much time to spend on each question.
AS Paper 2: Managing business activities: 1 hour 30 minutes
Skills required when answering questions
Section A, Theme 2, Question 1 2 × 2 mark questions
If you are entered for the AS Level qualification you will be
2 × 4 mark questions
required to sit two examinations. You should be aware of the
1 × 8 mark question
skills that you need to demonstrate when answering questions.
1 × 10 mark question
Total marks for Section A 30 marks You will need to demonstrate four different skills referred to as
assessment objectives (AOs).
Section B, Theme 2, Question 2 2 × 2 mark questions
AO1 – Knowledge: this means you have to show that you:
2 × 4 mark questions
1 × 8 mark question • recognise and understand business terms, concepts and
1 × 10 mark question theories
• understand how individuals and organisations are affected by
Total marks for Section B 30 marks
and respond to business issues.
Section C, Theme 1 and Theme 2, 1 × 20 mark question
All questions will test knowledge to some extent. A minority of
Question 3
questions will test knowledge alone. These can be recognised
Total marks for Section C 20 marks by the mark allocation. They will tend to carry just two or four
Total marks = 80 marks marks.

Paper 2 will assess your knowledge and understanding of Theme 2 AO2 – Application: this means that you have to apply
– Managing business activities. It is a written examination and knowledge and understanding to various contexts to show how
the paper is divided into three sections. The duration of Paper individuals and organisations are affected by and respond to
1 will be 1 hour and 30 minutes. You have to answer ALL issues. This might involve:
questions. There is no choice. However, this can be an advantage • using a business formula in appropriate circumstances, for
because it means you do not have to waste time deciding which example calculating the break-even point for a product
questions to answer. • using a theory to show why a business has chosen a particular
course of action
Section A questions
• using a theory to show the impact on a business of choosing a
In Section A you will be given Extracts A–C as a stimulus and particular course of action.
you will need to answer Question 1, a–f. The parts of Question 1
require a range of depths in your responses. Most questions in the examination will require you to
Section B questions demonstrate application. This means that you have to ensure that
your answers relate directly to the context given in the question.
In Section B you will be given Extract D as a stimulus and you
You must discuss the implications of issues to the particular
will need to answer Question 2, a–f. The parts of Question 2
business or industry in the context you are given.
require a range of depths in your responses.
262
 Preparing for your exams

AO3 – Analysis: this means you have to show that you can AO4 – Evaluation: evaluation involves making a judgement.
break down information and understand the implications of the You will need to evaluate both qualitative and quantitative
information presented in the question. You will need to show an evidence to make informed judgements and propose evidence-
understanding of the impact on individuals and organisations of based solutions to business issues. This might involve:
external and internal influences. This might involve:
• showing judgement when weighing up the relative importance
• explaining causes and effects and interrelationships, for of different points or sides of an argument in order to reach a
example by recognising from a graph that sales are falling and conclusion
could be the result of new competition in the market • drawing conclusions from the evidence that you present
• breaking down information to identify specific causes or • assessing the relative importance of particular issues to a
problems, for example by realising that quality has improved business
as a result of introducing continuous improvement • suggesting a course of action for a business, supported by
• using appropriate techniques to analyse data, for example by plausible motives or evidence.
calculating the return on capital employed (ROCE).
When evaluating, it is often possible to draw a number of
You will often be required to construct an argument, for example different conclusions. Very often in business studies there is no
by explaining the possible reasons for events or discussing the ‘right’ answer, so examiners are likely to be more interested in
advantages or disadvantages of particular courses of action. whether your judgement is plausible and in the quality of your
Questions that carry more than four marks will require analysis argument in support of that judgement. Questions that carry eight
in the answer. Some questions that carry four marks may also marks or more are likely to test evaluation.
require you to demonstrate some analytical skills.

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Preparing for your AS exams
Sample answer with comments
Paper 2: Managing business activities
These questions will help you prepare for your AS Business Paper 2 examination. Some sample answers and comments are provided
for you to review and you will have the opportunity to answer some questions yourself.

Section A, Question 1
Read the following extracts (A–C) before answering Question 1.

Extract A
JLR balance sheet
An extract from the statement of financial position (balance sheet) for Jaguar Land Rover 2013/14

2014
£ million
Non-current assets 8,359
Current assets 7,230
Non-current liabilities 3,591
Current liabilities 6,134
Source: www.jaguarlandrover.com

Extract B
Production at JLR
Jaguar Land Rover (JLR) uses state-of-the-art technology and
modern production methods in its factories. It also uses methods
such as continuous improvement and lean production. At its
plant in Halewood, JLR has its Lean Learning Academy training
centre. It provides a range of courses for its own employees, but
also attracts learners from a broader range of manufacturers.
In 2013 Jaguar Land Rover recorded sales in over 170 countries.
It exports around 80 per cent of production from its UK
factories. In 2014 pre-tax profits were £2.5 billion as it sold
434,311 vehicles bringing in £19.4 billion. With the introduction
of the fourth generation Range Rover, which is being produced
in Solihull, it is on course to improve its financial performance.
Source: adapted from www.jaguarlandrover.com

Extract C
A strengthening pound
The pound has strengthened against a number of global currencies since the beginning of 2013. For example, in March 2013
£1 = €1.17 but in March 2015 £1 = €1.41. The pound has also strengthened against the Australian dollar. In March 2013
£1 = AUS$1.40 but by March 2015 £1 = AUS$1.95.

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 Preparing for your exams

1 (a) What is meant by lean production? (2 marks)

Question 1 (a), student answer

Lean production aims to use fewer resources in production. Lean producers, such as Jaguar Land Rover, use less time,
A range of production techniques, such as continuous less stock, fewer materials, less labour, less space and fewer
improvement, flexible manufacturing, team working, suppliers. Lean producers are likely to have a competitive
empowerment and multi-skilling, are used to minimise waste. advantage because the reduction in waste and resource use
will lower production costs.

Comment, Question 1 (a)

Questions with a small mark allocation require you to understand that it involves using a range of different production
demonstrate knowledge. One mark might be awarded for techniques, such as continuous improvement.
defi ning lean production and another for showing that you

1 (b) What is meant by continuous improvement? (2 marks)

No sample answer has been provided for question 1 (b) so that you can answer it yourself, for exam practice.
1 (c) Using Extract A, calculate the current ratio for Jaguar Land Rover in 2014. (4 marks)

Question 1 (c), student answer

The current ratio is a liquidity ratio and is given by:
Current ratio = Current assets = £7,230m = 1.18
Current liabilities £6,134m

Comment, Question 1 (c)

There is always likely to be a question requiring a calculation working out. Even if you make a mistake in the calculation
in Paper 1, or Paper 2, or both. For this question you will need you might pick up some marks for using the correct formula
to remember the formula for calculating the current ratio. It is and identifying some appropriate fi nancial information in your
important to write down the formula and show all of your working out.

1 (d) Explain one way a business like JLR might improve its liquidity. (4 marks)
No sample answer has been provided for question 1 (d) so that you can answer it yourself, for exam practice.
1 (e) Assess two implications for JLR of using modern production techniques in its operations. (8 marks)
No sample answer has been provided for question 1 (e) so that you can answer it yourself, for exam practice.
1 (f) Assess the possible impact of the stronger pound on Jaguar Land Rover. (10 marks)

Question 1 (f), student answer

Jaguar Land Rover exports a significant amount of its appreciated against the Australian dollar – by almost
output. For example, in 2013 around 80 per cent of the 40 per cent. This is an even bigger price increase.
vehicles produced in its UK factories were sold overseas. However, although JLR’s products will be dearer to buy for
Consequently, movements in the exchange rate could have an some overseas customers, it does not necessarily mean
impact on the prices of JLR’s vehicles when sold overseas. that demand will fall. To some extent it will depend on the
When the domestic exchange rate appreciates, exports price elasticity of demand for JLR’s products in these
become dearer. Information in Extract C shows that the value markets. If demand is price inelastic, the fall in demand will
of the pound against the euro has increased from £1 = €1.17 be proportionately less than the increase in price. JLR has a
in 2013 to £1 = €1.41 in 2015. This is an increase of around good reputation overseas for high-quality products and its
21 per cent. This means that the price of JLR vehicles will brand is strong. Consequently current demand levels might
be 21 per cent more expensive for European customers. be sustained even if prices rise.
This could lead to a fall in demand in the European market
because a 21 per cent increase in price is significant. If JLR JLR might compensate for the appreciation in the exchange
sells cars to Australia from its UK factories there may be a rate by lowering prices slightly to remain competitive. However,
similar problem for Australian customers. The pound has also this is likely to lower revenues and have a negative impact on

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AS Level Paper 2

profits. Alternatively, JLR might invest some more money in trading results are favourable. In 2014 pre-tax profits were
marketing to try and drive overseas sales up. £2.5 billion as it sold 434,311 vehicles that pushed revenues
to £19.4 billion. With the introduction of the fourth generation
Finally, JLR may actually derive some direct benefit from
Range Rover, which is being produced in Solihull, it is on
the strong pound. This is because when the exchange
course to improve its financial performance. Also, although
rate appreciates the price of imports will fall. Therefore, if
the pound was quite strong at the time of writing the
JLR imports any raw materials or components, they will be
extracts, future movements in the exchange rate could be in
cheaper. This will help to lower production costs and have a
the opposite direction. Exchange rates are quite volatile and
positive effect on profits. However, there is no information in
JLR may have taken some protection against their fluctuation.
the extracts about the source of JLR’s inputs.
At the moment, the impact of the strong pound does not
To conclude, it is difficult to predict the impact of a stronger seem to be overwhelming.
pound on JLR because more information is needed. However,

Comment, Question 1 (f)

This is another question that requires you to demonstrate Three marks might be awarded for analysis. An example of
knowledge, application, analysis and evaluation. Two marks analysis in this answer is the explanation of exactly how stronger
might be awarded for demonstrating knowledge, for instance exchange rates might reduce demand for exports, and as a result,
identifying two possible effects of a strong pound on JLR, such reduce the profi t made by JLR. Three marks might be awarded
as higher export prices and lower import prices. Two marks for evaluation. In this answer, evidence of evaluation is the way
might be awarded for application. All of this answer is directed the different impacts of a strong pound on JLR are weighed up.
at the effect of changes in the exchange rate on JLR. Some of the There are both positive and negative effects. The conclusion
fi nancial information in the extracts (actual exchange rates and suggests that the fi nal impact of a strong pound may not be too
profi t fi gures for JLR) is also used to support arguments. dramatic.

Section B, Question 2
In Section B, Question 2, you will need to read stimulus Extract D before answering Question 2 a–f (no example is provided in
this section).
Section C, Question 3
Read Extract E before answering Question 3.

Extract E
AutoTrader
In 2015, private equity company Apax Partners planned to sell
off between 35 and 50 per cent of its used-car sales website,
AutoTrader. The company, valued at around £2.5 billion, was
being fl oated on the London Stock Exchange. The shares were
expected to be priced between 200p and 250p each.
Source: adapted from the Financial Times 9.3.2015. All rights reserved.
3 Evaluate the possible benefi ts to AutoTrader of operating as a plc. (20 marks)

Question 3, student answer

A public limited company is owned by shareholders and Operating as a plc, AutoTrader might enjoy some possible
the name of the company ends in plc. Like a private limited benefits. For example, the owners or shareholders have
company it is run by a board of directors under the limited liability. This means that if the business collapses
supervision of a chairperson who is accountable to the investors can only lose the money that they used to
shareholders. However, shares in a public limited company purchase the shares. Investors cannot be forced to
can be purchased by anyone on the open market. In this contribute more money if the company is seriously in debt. As
case, AutoTrader was set to become a plc in 2015. Prior to a result, plcs like AutoTrader are able to raise large amounts
flotation on the London stock market it was owned by Apax of capital from issuing more shares. People are happier to
Partners, a private equity company. invest when they know exactly the extent of their possible

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 Preparing for your exams

losses if things go wrong. Also, in the future AutoTrader must insure against the possibility of some shares remaining
may find it easier to raise finance as financial institutions are unsold) and a fee is paid to an underwriter who must buy any
more willing to lend to plcs. A plc with substantial assets unsold shares.
can provide the collateral needed by financial institutions to
Another potential problem is that anyone can buy
protect loans. Larger plcs also have a wider range of financial
AutoTrader’s shares. It is therefore possible, at least in
sources from which to choose.
theory, for an outsider to buy sufficient shares to be able to
Another benefit is that plcs tend to be large companies. exert control over the company, or worse take control of the
Therefore, AutoTrader’s operating costs may be lower as it company. Also, AutoTrader’s accounts can be inspected by
may benefit from economies of scale. Plcs are expected to members of the public. Competitors may be able to use some
grow and as they get bigger unit costs are likely to fall. This of this information to their advantage. AutoTrader will also be
will improve their competitiveness and hopefully generate influenced by various Company Acts, which aim to protect
more profit. shareholders. Compliance with company legislation will use
up company resources. For example, plcs often employ a
Because of their size, plcs can often dominate the market.
company secretary to deal solely with compliance issues.
Most plcs aim to grow and may eventually exercise some
control in the market. For example, they may be able to There may also be operational problems. For example,
create barriers to entry preventing competition. In this case, because of the company’s size it is more difficult to deal with
AutoTrader may be able to invest large amounts of money in customers at a personal level. Some customers do not like
advertising to strengthen its brand. Finally, pressures from dealing with giant ‘faceless’ corporations. They may prefer
the media and financial analysts, as well as the danger that the personal service of a much smaller enterprise – dealing
the plc might be taken over by another company, encourages directly with the owner perhaps.
executives and managers to perform well and make profits.
In this case, AutoTrader may avoid some of the possible
These pressures do not exist for private limited companies.
drawbacks. For example, only between 35 and 50 per cent of
However, despite these advantages there may be some the company is being sold. Consequently, it will be difficult for
drawbacks when operating as a plc. The setting up costs an outsider to exert much control. AutoTrader may also avoid
can be high. The various costs of ‘going public’ include the operational problems because it is an online business
lawyers’ fees to ensure that the prospectus is ‘legally’ and does not really interact with its customers. To conclude,
correct, the printing and distribution of prospectuses to AutoTrader may flourish as a plc. The benefits are likely to
potential investors, and the fees paid to an investment bank outweigh the drawbacks. For example, it will have easier
to process all the share applications. Also, the share issue access to greater funding, expand and enjoy economies of
has to be underwritten (which means that the company scale, strengthen its brand and enjoy greater profitability.

Comment, Question 3
This question requires an extended answer and you need to drawbacks of operating as a plc in each case will impact on
demonstrate knowledge, application, analysis and evaluation. AutoTrader and its performance. Six marks might be awarded for
Four marks might be awarded for demonstrating knowledge evaluation. In this case, there is a need to weigh up the benefi ts
such as understanding the implications of operating as a plc and possible drawbacks and make a fi nal judgement as to
and identifying some benefi ts and possible drawbacks. Four whether the fl otation is the right thing for AutoTrader.
marks might be awarded for application. This answer recognises Another approach could have been to rank the benefi ts and
that the sale of AutoTrader is only a partial sale and that it is decide which was the most important to AutoTrader. There are
an online business. Specifi c references to AutoTrader’s unique often a number of ways in which judgements can be made in
circumstances are referred to throughout. answers. Examiners do not expect all students to make exactly
Six marks might be awarded for analysis. Examples of analysis the same judgements.
in this answer are the explanation of how the benefi ts and

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AS Level Paper 2

Practice question – AS Level, Paper 2: Managing business activities

The more you practise for your examination, the more confident you will feel. The following question provides practice for Section C,
Question 3.

Section C, Question 3
Read Extract E before answering Question 3.

Extract E
The oil industry
As a result of the falling oil price in 2014/15, BP announced that
it would cut investment from around $24 billion to $20 billion by
reducing exploration expenditure and postponing or cancelling
marginal projects.
In his 2015 budget, George Osborne, the Chancellor of the
Exchequer, announced that the oil industry would receive tax
cuts of £1.3 billion.
Source: adapted from the Financial Times 3.2.2015, 8.4.2015.
All rights reserved.

3 Evaluate the possible impact on companies like BP of the cut

in taxes in the oil industry announced by the Chancellor of the
Exchequer. (20 marks)

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 44 Corporate objectives 3.1.1
Theme 3

Key points
1. Development of corporate objectives from mission statement/corporate aims.
2. Critical appraisal of mission statements/corporate aims.

There are two reasons why a business may form

Getting started
and share a mission statement. The first is to make a
An objective is something that a business intends to achieve. commitment to its customers. A mission statement forms
The nature and purpose of business objectives is explored in a promise to customers on what they can expect the
Unit 21. This unit explores the role of corporate aims and corporate business to strive for. Secondly, a mission statement can
objectives in shaping the strategy that a business follows. be used to bring a company’s workforce together with a
shared purpose. Many successful businesses have a mission
Look at the following two statements.
statement that their employees believe in. This is why a
R&F Fitness Centre corporate aim mission statement is important in forming a strong corporate
To encourage targeted activity to improve levels of fitness. culture (see Unit 57).
A&L Entertainment Group corporate objective (one of Some mission statements are short and succinct, while
several) others are lengthy and relatively detailed.
●● R&F Fitness Centre: ‘We improve levels of fitness by
To establish two new attractions every new season.
providing individual plans for people of all ages and
The first is an aim and the second an objective. What is the helping them to achieve their aims’.
difference between an aim and an objective? How do the two ●● R&B furniture maker: ‘To help create practical and
work together? beautiful homes for our customers.’
●● 18EC, energy company: To achieve sustainable energy

that delivers shareholder value by:

Business aims o researching and innovating new products and
All businesses have aims, the things the business intends services that meets the needs of our customers
to do in the long term – its purpose or reason for being. o maintaining a safe end efficient working environment
Ultimately its aims are what the business is striving to o achieving technical and operational excellence
achieve. The aim of a business will be less specific than its o creating a team of flexible and adaptive individuals
objectives and could be expressed as a vision. A business who strive for sustainable energy solutions and
will often communicate its aim through a mission statement. continually offer value to customers.
●● Amnesty International, NGO: ‘To undertake research and
Mission statements action focused on preventing and ending grave abuses of
A mission statement declares the business’s overriding
human rights.’
purpose, but may also reflect its goals and values. It
●● DHC coffee shop: ‘To offer a comfortable environment
describes in general terms what it considers to be the
and excellent range of coffee to refresh our customers in
company’s core activities and may also reference such
body, mind and spirit.’
information as the markets in which it operates, what its
key commercial objectives are, in what way it values its
stakeholders, or what its ethics involve. A good mission Question 1
statement should help guide the decision making of the Choose one of the industries listed below and devise a mission
firm. Running a business can be extremely complicated and
statement for a business in that sector. Use some of the
it is very easy to get lost in the finer details of business
examples above for inspiration, but try to link your mission
decision-making. When all else fails a good mission
statement to the context of the industry. Present your mission
statement can clarify the direction a business should take
statement and explain your thinking behind it. How does it
by reminding the owners and directors of the reason why
the business exists. Many people would argue that the sole convey the vision and aims of the business you have chosen?
purpose of a business is to generate a profit for its owners. 1. Airline industry
However, most people would like to believe that they go 2. Soft drinks industry
to work to achieve something more than this – a mission 3. Container shipping industry
statement makes this point.

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Corporate objectives Unit 44

Development of corporate objectives The objectives hierarchy

Corporate objectives are objectives set by senior managers
and directors for a company. They should be specific to the Figure 1
company, its particular history and vision of the future, and sit Objectives hierarchy
well with its mission statement. They should focus mainly on
desired performance and results of the business over time, and
may include such goals as market share, profit levels, creation Aims
of new products or processes, resource usage and scale
economies, management of people and ethical behaviours.
To be of any real use to a business in achieving its aims, Mission statement
corporate objectives must be Specific, Measurable, Agreed,
Realistic and Time specific. These criteria are known as
SMART criteria.
Corporate objectives
●● Specific means that the objective sets out clearly what the

business is aiming to achieve and should refer to a particular

aspect or function of the business. Functional objectives
●● Measurable involves evidence to demonstrate whether Finance Marketing Operations People
or not the objectives have actually been achieved. For this
reason most corporate objectives will have a financial or An objective will ultimately flow from the firm’s overall aim
and be effective if it contributes to achieving the level above.
quantifiable element because this makes it easier to measure
the success of that objective.
●● Agreed implies that everyone responsible for achieving the

objective has agreed with the objective and understands

what it means for them. Without an objective being
The difference between small and
agreed by all those involved there will be no motivation or large firms
commitment to achieve it. Unit 1 explored the possible objectives that may drive a
●● Realistic ensures that the objective can be met within the
business. Usually, a business aims to make a profit. However,
resources available and the prevailing market conditions. businesses may have other goals as well, such as maximising
If an objective is unrealistic people will soon ignore it, and sales, sales revenue or market share; achieving efficiencies
failing to achieve the objective is likely to have a negative in cost; looking after its employees or ensuring its customers
impact on the business. are satisfied. It may even aim to achieve a social purpose. An
●● Time specific gives the stated time frame within which
objective is a desired outcome that allows a business to achieve
the objectives are to be achieved. All objectives must have its stated aims. While some objectives are general, others can be
an end point to ensure urgency and a point at which the very specific, including the quantification or precise statement of
objective can be assessed. a particular goal for a department or functional area.
Small businesses may have a wide variety of objectives, such
Departmental and functional objectives as the following.
From general objectives that flow from the mission statement ●● To ensure that the company breaks even at the end of the tax

come more specific corporate objectives that detail specifically year (see Unit 32).
what the firm does. Following this hierarchy come the even ●● To improve the firm’s liquidity in the next six months (see

more specific departmental and functional objectives, which Unit 35).

set the day-to-day goals and may include human resources, ●● To increase sales by 10 per cent over the next three years

finance, operations, logistics and marketing. These all refer (see Unit 30).
back up the hierarchy to the corporate objectives and mission ●● To increase pre-tax profits by 5 per cent over the next

statement, so that the goals and activities of the business 12 months (see Unit 34).
are consistent. In this way, functional objectives will directly ●● To hire five new staff with skills in sales and marketing, and

support the corporate objectives. As all business functions are build a strong marketing department over the next year.
guided by the corporate objectives they should all be aligned ●● To reduce energy consumption by 2 per cent and cut use of

with one another. For example, if the operations department non-recyclable packaging over the next three years.
sets a departmental objective to reduce waste by 25 per cent By contrast, the objectives of large firms and multinationals
within the next year, it is likely that this will have to feed into tend to be mostly financial. This is because they have many
the objectives set by the human resources (HR) department. stakeholders to satisfy, the foremost being the shareholders.
For instance, HR will need to ensure all production workers Financial objectives are more objective and quantifiable, and
complete a specific training programme focusing on quality therefore easier to communicate to a wide variety of interested
management (see Unit 40). parties. For example, a supermarket chain such as Lidl might

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 Business decisions and strategy

state an objective that covers its entire operation: ‘To increase Question 3
market share by 5 per cent over the next two years.’
1. RWDC, technology company: RWDC innovates and creates
Question 2 cutting edge mobile technology and software. It is a leader
in games and music technology and its focus is on increasing
Tesco states that its core purpose and values is a clear and
shared experiences and customer fun.
simple statement of what it does and what it stands for: ‘Serving
Britain’s shoppers a little better every day’. It explains that: 2. PM Camping, active guides company: ‘PM Camping unites
a community of campers, suppliers and advertisers online,
‘Our Core Purpose needs to reflect how much society has changed
in-print and on-site, sharing experiences in a spirit of trust
in recent years – more scepticism about corporations, more desire
and co-operation.’
to see business demonstrate it has a purpose beyond profit,
a sense that large companies should be contributing more to 3. Thomas Therapeutics and Pharmacy: ‘To research, develop,
tackling some of the big challenges. The world has changed from a monitor and deliver complementary therapy that eases
culture of “more is better” to “making what matters better”. patients’ symptoms and helps to overcome cancer’.
That’s why we’ve changed our Core Purpose – this profound (a) What is the purpose of each of the statements?
shift in society must be reflected in the way we think and behave (b) Who are the intended audiences?
as a business. Today, our brand must be about more than simply
function. It’s about the way we work, the values we live by, the
legacy we leave. ‘ Key terms
As part of this, Tesco has a commitment to the local communities
Corporate objectives – the objectives of a medium to
in which it operates and has clear policies to maintain a socially large-sized business as a whole.
responsible ethos. One of Tesco’s corporate objectives is to: ‘support Departmental and functional objectives – the
the well-being of the community and to protect the environment’. objectives of a department within a business.
Source: www.tescoplc.com Mission statement – a brief statement, written by the
business, describing its purpose and objectives, designed
(a) Explain how the functional objectives of Tesco’s marketing
to encapsulate its present operations.
department could support this corporate objective.
Objective (or goal) – a target of or outcome for a business
(b) Explain how the functional objectives of Tesco’s operations
that allows it to achieve its aims.
department could support this corporate objective.
SMART – acronym for the attributes of a good objective:
Specific, Measurable, Agreed, Realistic and Time specific.
Critical appraisal of mission statements
and corporate aims
Mission statements must be constantly assessed to ensure they Knowledge check
have continued relevance for the business. Sometimes they 1. Explain the difference between a functional objective and a
are not appropriate. For example, a company with a mission corporate objective.
statement that includes respect and integrity would not align if
fraud were to be reported. Many organisations may put in place 2. Why should objectives be SMART?
a mission statement that is appealing to its customers, but if it is 3. Why might corporate objectives mainly be expressed as
not believed and followed by employees then the customers may financial objectives?
soon lose faith in the business. On any corporate website you will
4. What is the purpose of a mission statement?
find objectives relating to corporate social responsibility, ethical
practices and sustainable business growth. However, businesses 5. State three areas of business activity that corporate objectives
may need to consider the balance of the appeal of some of these might refer to.
objectives to their customers if the organisation is not achieving a
profit for shareholders.
A critical re-assessment should involve an appraisal of
the following.
●● What is the purpose of the mission statement?

●● Who is its intended audience?

●● How does the strategy followed by the business fit with its

stated mission?
●● Are the aims and objectives realistic and achievable?

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Corporate objectives Unit 44

Thinking bigger
Most large businesses identify various corporate objectives that cover a
range of issues and facets of the business. These range from objectives
centred on profitability to ones that guide corporate social responsibility.
For example, see the list of corporate objectives below for LPW Car
Rental company.
Customer loyalty
We conduct business in an honorable and transparent way that develops
customer loyalty and respect.
Growth
We target new opportunities and ideas to encourage and extend
high performance.
Profit
We deliver high returns for our shareholders through achieving
our objectives.
Market leadership
We provide excellent service and trusted products, continually innovating
to lead provision for changing customer needs.
Commitment to employees
We are committed to open and supportive teamwork, providing honest
feedback and rewarding employer achievement.
Leadership capability
We encourage leadership qualities at all levels, developing career
opportunities for those who achieve business results and enhancing It is common for a business to have a number of objectives
individual potential to lead to growth and profitability. that cover a number of areas. As a result, these objectives
Sustainability may sometimes conflict with each other. In other words, the
achievement of one objective can hinder a business achieving
We research, adopt and promote best working practices that help protect another. For example, it could be theorised that providing rewards
the environment and to contribute to local and global environmental for staff performance could detract from financial profit. The same
sustainability as part of our charitable giving. could be said for environmental objectives. Although it’s attractive
Most large businesses state their corporate objectives on their websites. to promote a company as an ethical business, the development of
How SMART would you say the above objectives are? Why might objectives, technologies and strategies to ensure environmental compliance
as shown on a company website, be more general than those discussed could lead to the company not achieving its financial objectives.
around the boardroom table?

Exam tip
When analysing a case study, always try to identify the business’s
objectives. If a business achieves its objectives then it is a
successful business. Remember that not all objectives are as
important as one another. Therefore by prioritising an objective
with a clear justification you can provide the basis for a
recommendation when answering a question. For example, if you
can justify that the objective to ‘develop leaders at all levels’ is
the most important, then this helps you justify, for instance, a
decision to invest in a new employee training programme.
Evaluation is about picking out the key issues facing a business.
Therefore, if you can argue that a certain course of action will
support a business in achieving its objectives then you have a
strong point of evaluation.

272
 Business decisions and strategy

Case study
LEGO® CORPORATE OBJECTIVES
LEGO® is the world’s largest toy manufacturer and a highly The LEGO® Group believes in transparency and always tries
popular toy with children. LEGO®’s mission is ‘to inspire to provide a very honest assessment of its performance
and develop the builders of tomorrow’. In Danish the word against specific targets. The 2014 report highlighted a
LEGO® is an abbreviation meaning ‘play well’, and this number of targets related to its corporate objectives.
unique value is at the core of what the company does to Table 1 LEGO® Group targets linked to corporate objectives
change the way people understand learning and the huge
Objective Target Actual
value play has in helping children learn essential skills for life
in the twenty-first century. 1 Zero product recalls 0
2 Score of +10 for employee satisfaction +14
In 2013 LEGO® assessed the needs and attitudes of its and motivation
stakeholders through an online survey of more than 1,500 3 101 million children educated 95.4 million
respondents. They interviewed almost 1,500 additional
4 +10 per cent improvement in energy +9%
participants from their most significant stakeholder groups efficiency by 2016
and industry associates. LEGO® found that the following
5 90 per cent waste recycled 91%
three issues were the most important:
• the safety and quality of their products LEGO® now plans to expand overseas with the opening of
• supporting children’s right to develop offices in Malaysia and China. LEGO® still has a relatively small
market share of the toy market in Asia compared to Europe and
• communication with children.
North America, but as these countries become wealthier so will
In 2014 a letter to the company employees from the consumers’ willingness and ability to purchase LEGO® products.
Chief Executive Officer, Jørgen Vig Knudstorp, said that Source: adapted from www.lego.com
LEGO® should continue to strive to be the best, and that
while 2014 was a good year there was also room for All information in this case study is collected and interpreted
improvement.’ As part of the LEGO® Group Responsibility by its authors and does not represent the opinion of the
Report 2014, the company analysed its performance against LEGO® Group.
a set of corporate objectives that were defined in 2009.
These were: (a) What is meant by corporate objective? (2 marks)
1. Zero product recalls – always. (b) Explain why LEGO® might set an objective to achieve 100
2. To be ranked in the Top 10 companies for employee safety per cent renewable energy by 2020. (4 marks)
by 2015.
(c) Explain why LEGO® has a mission statement. (4 marks)
3. To support learning for 101 million children by 2015.
4. To use 100 per cent renewable energy by 2020. (d) Assess which of the LEGO® Group’s corporate objectives
is the most important for the long-term success of the
5. Adopt a zero-waste mindset.
business. (12 marks)

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 45 Theories of corporate 3.1.2
Theme 3

Key points
strategy
1. Development of corporate strategy:
Ansoff’s Matrix
●●

Porter’s Strategic Matrix.

●●

2. Aim of portfolio analysis.

3. Achieving competitive advantage through distinctive capabilities.
4. Effect of strategic and tactical decisions on human, physical and financial resources.

Getting started Development of corporate strategy

Developing an effective corporate strategy requires a significant
The Restaurant Group (TRG) operates over 400 restaurants amount of time and research. The process of strategic planning
and pubs, including Frankie & Benny’s, Chiquito, Garfunkel’s involves key members of management looking critically at what
and Coast to Coast. TRG’s competitive advantage comes the business has done before and what it may need to do in the
from their choice of locations, differentiation and culture. future in order to achieve its corporate objectives. This is a very
Rather than try to compete on the high street – and pay big task but there are numerous tools to help managers during
the high rents for space, TRG locates on leisure parks the planning process, including value chain analysis, Ansoff’s
and in airports, and two thirds of their Frankie & Benny’s Matrix, Porter’s Strategic Matrix and portfolio analysis.
restaurants are near cinemas. Its customers do not have
to contend with parking issues and can come out of the Ansoff’s Matrix
cinema or bowling alley and walk next door into one of Igor Ansoff was an applied mathematician and influential business
its eateries. The restaurants are differentiated to attract strategist. He developed Ansoff’s Matrix as a strategic tool to help
different customers and their tastes. For instance, Frankie & a business achieve growth. Figure 1 illustrates both existing and
Benny’s caters to families while Coast to Coast targets adults new products within existing and new markets. Ansoff’s Matrix is
a useful decision-making tool because it allows the owners of a
on a night out. In the future, TRG plans to continue to grow
business to consider a number of factors that will determine its
organically, rather than acquire new brands or take over
corporate strategy:
competing firms.
●● the level of investment in existing and new products
Source: adapted from www.ft.com ●● the exploitation of different markets

●● the growth strategy for the business

What is TRG’s competitive advantage and how does it
●● the level of risk the business is willing to accept.
inform its strategy? Do you think that its strategy will change
in the future? Ansoff’s Matrix reveals four possible strategies that a
business might adopt. The key issue is that risk becomes greater
the further a firm strays from its core of existing products and
consumers, i.e. the further it gets from the top left-hand corner
Business strategy of the matrix.
Businesses have aims that they hope to achieve through
their stated objectives. However, this requires a considerable
amount of planning. Such planning to achieve corporate Figure 1
objectives is known as strategy. The first part of the process Ansoff’s Matrix
involves using analytical tools to understand where the
business currently sits in the market and then evaluating PRODUCT
where it wants to be. A firm might begin this analytical
Existing New
process with a SWOT analysis (see Unit 46), followed by a
Five Forces Analysis (see Unit 47). The corporate strategy Market Product
Existing
derived from this process is the long-term plan to achieve penetration development
the aims of the entire business. A successful strategy will MARKET
Market
give the firm an advantage in the competitive market place New
development
Diversification
and fulfil stakeholder expectations.

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 Business decisions and strategy

Market penetration: As suggested by Ansoff’s Matrix, Even where market development is appropriate and successful,
the purpose of market penetration is to achieve growth in it is often necessary to make slight modifications to suit the new
existing markets with existing products. There are several ways market, even if this is simply changing the name to be more
a business can achieve this. acceptable or accessible in a different language, or labelling the
●● Increase the brand loyalty of customers so that they use product differently to meet international laws.
substitute brands less frequently, for instance by adopting a
loyalty scheme such as Costa Coffee’s reward card. Diversification: Diversification occurs when new products
●● Encourage consumers to use the product more regularly. are developed for new markets. It enables a business to move
An example might be encouraging people to eat breakfast away from reliance upon existing markets and products, thus
cereal as a night-time snack. allowing the company to spread risk and increase safety. If
●● Encourage consumers to use more of the product. one product faces difficulties or fails, a successful product
An example might be a crisps manufacturer producing in another market may prevent the business overall facing
maxi-sized crisp packets rather than standard-sized problems. However, diversification will take a business outside
crisp packets. its area of expertise, and for this reason it is the strategy with
If it has a successful product and believes that it can generate the highest risk. This might mean that its performance in new
more revenue from it, a business might adopt a market markets is relatively poor compared with more experienced
penetration strategy. This is the strategy with the lowest risk operators.
because it involves the lowest level of investment. In addition The move by Mercedes Benz into the market for small,
the business will have a good understanding of the product and high-volume cars, and the diversification by Virgin into financial
how the market might respond. services and the air passenger business, are examples of this
marketing strategy. Diversification is generally adopted by large
Product development: Product development is concerned corporations and conglomerates that have extensive business
with marketing new or modified products in existing markets. networks, considerable capital and strong corporate brands.
This might be an appropriate strategy to adopt where the Virgin is one such business where the brand has allowed it
product life cycle is traditionally short, or where trends to diversify into a range of industries. A consideration with
or technology change quickly. This strategy is associated diversification is that there may be significant barriers to
with product innovation and continuous development. The entering a new industry (see Porter’s Five Forces in Unit 47).
confectionery market is famous for product development.
Take for example Cadbury’s Dairy Milk. The brand has been Question 1
around for over 100 years, but new extensions of the product
are continuously launched, for example Dairy Milk Marvellous Tough Mudder is an extreme events company founded in the
Creations, with Oreos and with jelly, popping candy and USA by Will Dean. It is the UK market leader for endurance
candy shells. Some businesses have gained a reputation for events. The company runs extreme obstacle events across the
continuous product development and used this strategy to country where participants pay up to £125 to take part. Teams
stay ahead of the competition. Apple has achieved this through of competitors face obstacles, such as ‘Arctic Enema’ (swimming
the iPhone, iPad and Apple Watch. A strategy of product through a skip full of ice), ‘Everest’ (climbing a quarter pike
development requires significant investment in research and slicked with mud) and ‘Electroshock Therapy’ (running through
development, and there may be a high level of risk in developing a field of hanging electric wires). In 2013 there were 35 Tough
new products – it may be that only one in five product launches Mudder events across the globe; this number grew to over
succeed. For those that succeed, heavy investment in promotion 50 events in 2015. Tough Mudder also uses a number of
may be required. tactics to encourage customers to return to their events in the
future, including different-coloured headbands representing the
Market development: Market development involves the number of times a competitor has completed the course and
marketing of existing products in new markets. The most basic
exclusive obstacles for returning ‘mudders’.
form of the strategy is entering geographically new markets. This is
not always simple as customers from different regions of the same (a) With reference to Ansoff’s Matrix, assess the strategies Tough
country, let alone a different country, may have different tastes and Mudder uses to fuel growth.
preferences. Although Tesco is an extremely successful company
in the UK, the success was not matched when it opened stores
in France in the 1990s. A market development strategy relies Porter’s Strategic Matrix
heavily on understanding local habits, tastes and needs. Enterprise Porter’s Strategic Matrix was developed by Michael Porter, a
Rent-A-Car is one example of a business that has adopted a professor at Harvard Business School, to identify the sources
very successful strategy of market development. The car leasing of competitive advantage that a business might achieve in a
company’s model was very successful, but the business achieved market. Porter stated that any business that does not adopt one
exponential growth when it started to locate its branches at of these generic strategies is ‘stuck in the middle’ and unlikely
airport locations. This move opened the company up to an entirely to succeed.
different profile of customer and by 2005 Enterprise had over 200
airport branches worldwide.
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Theories of corporate strategy Unit 45

to niche marketing (Unit 77). It tends to be used by small or

Figure 2
very specialist firms. As a business is focusing on a very narrow
Porter’s Strategic Matrix segment of the market, it is able to gain an advantage by
Focus Cost understanding its customers very well and delivering products
(cost focus and leadership
differentiation focus)
and services that are very specific to their needs. As a result,
this can create a high level of customer satisfaction and loyalty.
Furthermore, by definition a focus strategy will result in less
competition and higher profit margins. On the other hand, as the
market is very small, a firm adopting this strategy tends to have
low bargaining power with suppliers. A focus strategy can take
one of two forms.
●● Cost focus – emphasising cost-minimisation within a focused

or niche market. Aldi is a good example of this strategy.

Differentiation Although it does not operate as the cost leader in the market, it
is able to offer a focused range of products at very low prices.
●● Differentiation focus – pursuing different strategies within
Cost leadership: This involves striving to be the lowest-cost
provider in the market. This does not necessarily mean that the a focused market. Ferrari is an example of this strategy
business will offer the lowest price, although this may be an as its high performance cars are targeted at a very small
option. Generally speaking, the firm that is able to operate as percentage of the population.
the lowest-cost provider in a market will compete in two ways.
1. Increase profits, while still charging market level prices. Question 2
2. Increase market share, while charging lower prices (still The BBC iPlayer service has been in operation since 2007. Since
making a profit since costs are reduced). then, there has been a significant change in the competitive
landscape of online programme and film providers. Many other
Cost leadership is generally held by one business in the UK channels have also launched online sites. Netflix joined the
market as it requires having a significant market share in order
UK market in 2012, reaching one million users in July of that
to achieve the lowest costs. A firm will achieve the lowest
year. Amazon also launched an online programming system with
costs by operating on a large scale and therefore leveraging
their Amazon Prime subscription. All of these providers can be
economies of scale. The business will also have a clear focus
viewed as competition to BBC iPlayer.
on reducing costs through negotiation with suppliers, efficiency
and streamlining operations. A cost leader will also offer a ‘no- Source: adapted from the Financial Times, 14.05.2015. All rights
frills’ product in order to minimise costs and limit the options for reserved.
adding value. The level of service and variation in the product (a) Explain how the BBC might adapt its strategy to compete with
will be minimal and the scale associated with mass production. other online programme providers.

Differentiation: This involves a business operating in a mass

market but adopting a unique position instead of the lowest-cost Achieving competitive advantage
position. Unlike cost leadership, a differentiation strategy may through distinctive capabilities
be adopted by any business providing it can deliver a defensible Unit 3 looked at how a business is likely to be more successful
way of differentiating itself from the competition. A business if it can gain a competitive advantage in the market place.
adopting differentiation will do so through adding value to their Competitive advantage is a set of unique features of a company
products in a unique way. This might include quality, design, and its products that are perceived by customers as significant
brand identity or customer service. The advantage of operating and superior to the competition. These features will allow a
under a differentiation strategy is that the business may be business to perform better than its competitors in the market.
able to charge a premium price if customers value their unique A business can develop a competitive advantage in many
selling point. However, it is difficult to guarantee that the rewards ways, such as through superior quality or design, by using
of differentiation will justify the additional costs. For example, creative advertising to promote the product, or by offering very
differentiation will require good research and development as good after-sales care and service. It could also achieve scale
well as effective marketing to highlight the uniqueness to the economies and thereby be able to charge a lower price,
customer. Comparatively, differentiation is much easier to copy provide greater flexibility in delivery times or product attributes.
than cost leadership unless the differentiation is sustainable A business might also be able to create an advantage through its
and defensible. For example, a business may be able to acquire reputation or ethical stance.
a patent on a design or register a logo as a trademark so that A distinctive capability is a form of competitive advantage
competitors cannot copy it. that is difficult for competitors to understand, let alone imitate.
The importance of a distinctive capability is that, because
Focus: This strategy involves targeting a narrow range of it cannot be easily reproduced, it can be the source of a
customers in one of two ways. A focus strategy is closely aligned sustainable competitive advantage.

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 Business decisions and strategy

In his bestseller The Foundations of Corporate Success (1995), 3. Question marks are products with low market shares in high-
John Kay argues that the source of competitive advantage is the growth markets. They consume a lot of cash, but give little return.
exploitation of distinctive capabilities. Kay identified three types of However, they have the potential to turn into stars. Keeping these
distinctive capability. lines requires a belief that there is a potential for growth.
1. Architecture – refers to the contracts and relationships 4. Dogs are products with low market share in low-growth markets.
within and around an organisation. These include the They may break-even, but nevertheless take up time and effort with
relationships between the business and its employees, and little prospect of future growth. They should be sold or divested.
the collaborative relationships it has with partners, suppliers
and customers. Some firms build and manage relationships Figure 3
extremely well. These effective relationships allow a business
The Boston Matrix
to add value by being more efficient through easy and open
transfer of knowledge and information. The value of this
architecture is often intangible and is closely linked to the
culture within an organisation.

HIGH
2. Reputation – closely linked to brand image and takes time
for a business to build. Reputation refers to the positive

Market growth rate (%)

associations a business builds around issues such as quality,
reliability, service, prestige and honesty. The organisational Stars Question marks
characteristics cannot be built overnight, and any negative
publicity or deterioration of the brand can have a lasting
impact on a firm’s reputation.
3. Innovation – often a sustainable competitive advantage will
£

LOW
arise when a business is able to innovate by developing a
new product or process in the production of a product. For
successful innovation to take place, considerable investment Cash cows Dogs
in research and development, and in no small part the
presence of luck, is often required. Sometimes innovation HIGH LOW
will not only give a business a distinctive capability, but on Source: adapted from The BCG Portfolio Matrix from the Product
occasion it might also create a whole new market or industry. Portfolio Matrix, © 1970, The Boston Consulting Group (BCG)

Aim of portfolio analysis The Boston Matrix may be used to assist a business in identifying
Portfolio analysis is a method of categorising all of the products which strategy to adopt. For example, if a firm believes that it
and services of a firm (its ‘portfolio’) so as to decide where each has a ‘Star’ it may decide to adopt a market penetration strategy
fits within the strategic plans. The products are then evaluated to increase sales revenue and maximise market share while the
according to their competitive position and potential growth product is competitive. Similarly, a firm may choose to move a
rates. This involves a two-step process. product out of a low-growth market and target a market with
●● Step 1: Give a full and detailed overview of all of the products high-growth prospects. On the other hand, the matrix could be
and services in the current business portfolio. used to identify those ‘Dogs’ that need to be discontinued in
●● Step 2: Look at the performance of each of these products order to cut costs and follow its strategy of cost leadership.
and services by examining:
o current and projected sales Question 3
o current and projected costs
o competitor activity and future competition De Vere is a British car manufacturer owned by a Chinese
o risks that may affect performance. company called MXJ. Since MXJ bought De Vere in 2009 it
The Boston Consulting Group (BCG) has created an has invested heavily in product development, building on De
advanced tool for portfolio analysis. First, a business gathers Vere’s reputation for luxury sport and executive saloon cars.
market-share and growth-rate data on all of its products. Next, Since 2009, De Vere has launched four new models across these
the Boston Consulting Group Matrix (or ‘Boston Matrix’ / Growth vehicle categories.
Share Matrix) categorises these products into one of four Table 1 De Vere product range and sales figures
different areas based upon their current and potential market Models Sales – Feb 2012 Sales – Feb 2013 Year on year
share or market growth. change (%)
1. Stars are high-growth products that are strong compared to P4 2,033 2,784 36.94
those of competitors. Stars require investment, but the hope P6 473 337 –28.75
is that they will become cash cows.
P7 – 79 –
2. Cash cows are low-growth products with high market shares.
They generate more cash than they consume, and so can P901 943 1,201 27.36
provide a return for investors and can fund investment in (a) Using the information in Table 1 and the BCG Matrix, analyse
other areas. De Vere’s product portfolio.

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Theories of corporate strategy Unit 45

Strategies and tactics Thinking bigger

Strategies set out the long-term direction that a firm will take There are a range of concepts and theories surrounding the
to achieve its objectives. In contrast, tactics are short-term development of corporate strategies and this can sometimes make
responses to an opportunity or threat in the market. Most the concept a confusing one. The reality is that corporate strategy
day-to-day decisions in business are tactical and involve and what actually makes one business successful while another
decision making responding to the current business conditions. might miserably fail is not straightforward. There are just too
For example, a business might put on an impromptu sale in many variables and external factors for anyone to be able to write
a definitive formula for success. Nevertheless, theoretical models
order to disrupt a competitor who has similar plans. A tactical
help businesses simplify reality in order to understand it better. It is
decision might be to buy an exceptionally large order of stock perhaps useful to consider how the three main models within this
because the opportunity arises to buy it at a low price, even unit fit together and see more clearly how they are each separate but
if the stock is not necessarily needed. Although tactics should still related to one another.
ideally support the corporate strategy, tactical decisions are For example, Ansoff’s Matrix is a useful tool for a business to identify
often made in isolation of the ‘bigger picture’ and are more its current position and choose an appropriate direction for the
responsive in nature. While strategy is often based on a set company – the ‘what and where tool’. Whereas Porter’s Strategic
of principles or guidelines set down by the CEO and board Matrix presents three strategies that a business might use to compete
of directors, tactical decisions happen at managerial or even in its market – the ‘how tool’. Finally, Kay’s theory of distinctive
supervisory level. capabilities will help a business decide whether its strategy is
sustainable, defensible and has longevity.
By nature, tactical decisions have to be made quickly and
without significant research or planning. For this reason tactical Similarly, using the BCG Matrix can help you categorise a firm’s
decisions can backfire if they are made poorly. For example, a products and make informed recommendations on how it should use
them for future growth. Business models are not just useful tools for
business might exaggerate the benefits of a product through
business, they are also useful tools to help guide your analysis and
an advert, which then comes under scrutiny from a social evaluation in examinations.
media campaign against the company. Although this decision
was made to try and boost sales, it might have been against
the corporate social responsibility policy outlined by the board
and may have a lasting impact on the firm’s reputation.

Case study

BUSINESS TACTICS:
TIES.COM, ZARA, JCB AND IKEA
Ties.com Zara
Ties.com was founded in 1998 as an online company Zara is an international clothing company and part of
specialising in men’s neckties, bow ties, cufflinks and a the Inditex Group. Zara is a recognised high street name
range of related men’s accessories. The company carries in the UK with branches in most towns and cities. It has
popular brands, such as Tommy Hilfiger and Jerry Garcia, also penetrated many international markets, including
but a highly talented team at its head office in California China where it has opened over 200 very successful
designs most of their products. The company prides itself stores. The Inditex Group also owns a range of highly
on having the widest range of neckties anywhere and automated factories and a huge team of fashion
guarantees 100 per cent customer satisfaction. Ties. designers. This vertical integration of the business has
com believes in the personal touch and tries to build allowed Zara and Inditex’s other brands to deliver
relationships with its customers. For example, Ties. exceptionally fast lead times on all of their products.
com has the tactic of only using real people to answer Zara realised that women wanted clothes that reflected
their phone lines, no automated menus, and makes current trends and Zara’s ability to design and deliver
sure that every package sent to the customer includes a new clothing lines to their stores in a few weeks allows
personalised note inside. The company also runs a blog it to meet this demand. Zara’s ability to respond quickly
entitled TheGentleManual, where customers and experts to emerging trends can help it to stay one step ahead of
discuss all matter of men’s fashion and grooming. its competitors.

278
 Business decisions and strategy

JCB IKEA
JCB is a British manufacturing company that specialises The Swedish furniture retailer IKEA revolutionised
in construction machinery and vehicles, with a 12 per the furniture industry by offering affordable but stylish
cent share of the global market. JCB dominates in a furniture. The company is known for its modern
number of international markets, including Britain, India architectural designs for various types of appliances and
and Brazil. JCB’s leading product is a digger known furniture, and its interior design is often associated with
as a backhoe loader, which is a staple feature of most an eco-friendly simplicity. IKEA maintains its competitive
construction sites around the world. JCB has focused prices by careful sourcing of products to selected
on producing smaller vehicles rather than some other countries and offering a service that is consistent
segments of the market, such as large-scale construction with affordability. IKEA does not assemble or deliver
vehicles used for mining and drilling, which is dominated furniture; customers must collect the furniture in the
by US firm and market leader, Caterpillar. JCB is warehouse and assemble it at home themselves. During
renowned for innovation and exceptional quality. JCB a ten-year period of global expansion, IKEA has been
realised that their customers valued speed and efficiency, able to further reduce its prices on average by two to
as a digger is at the centre of most construction sites three per cent.
and any breakdown will inevitably result in the build
grinding to a halt.

(c) Discuss how IKEA’s corporate strategy compares to that of

(a) What is meant by business tactic? (2 marks) JCB. (8 marks)
(b) Explain one reason why Ties.com is a successful business. (d) Assess the competitive advantages of each business and
(4 marks) which might be most sustainable. (12 marks)

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Theories of corporate strategy Unit 45

Key terms Knowledge check

Corporate strategy – the plans and policies developed 1. Explain the connection between corporate strategy and
to meet a company’s objectives. It is concerned with what business aims.
range of activities the business needs to undertake in order
2. Why is a long-term decision to move into a new market an
to achieve its goals. It is also concerned with whether
example of corporate strategy?
the size of the business organisation makes it capable of
achieving the objectives set. 3. What are the four strategies outlined by Ansoff’s Matrix?
Distinctive capability – a form of competitive advantage that 4. Which of Porter’s strategies is focused on achieving the lowest costs
is sustainable because it cannot easily be replicated by a of production?
competitor.
Diversification – developing new products in new markets. 5. What is a distinctive capability?
Market development – the marketing of existing products in 6. Explain what is meant by a sustainable competitive advantage.
new markets.
7. How might a business use the BCG Matrix to make strategic
Penetration – using tactics such as the marketing mix to
decisions?
increase the growth of existing products in an existing market.
Portfolio analysis – a method of categorising all the 8. What is the difference between a long-term strategy and a tactic?
products and services of a firm (its portfolio) to decide
where each fits within the strategic plans.
Product development – marketing new or modified products
in existing markets.

Exam tip
In your examination it is important to understand a range of
theoretical models that explain corporate strategy and the issues
surrounding each distinguishable strategy. By understanding
theories of corporate strategy you can categorise any business
that features in the case study and they can help you trigger
points of analysis in your answers. For example, being able to
identify a firm as adopting a market penetration strategy will allow
you to discuss the following issues and relate them to the firm.
• It is a comparatively low-risk strategy.
• It might require heavy investment in marketing.
• Success relies on building loyal relationships with customers.
• There is a danger of falling behind competitors who innovate.

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 46 SWOT analysis 3.1.3
Theme 3

Key points
1. SWOT analysis:
●● internal considerations: strengths and weaknesses
●● external considerations: opportunities and threats.

Getting started The internal audit: An internal audit is an analysis of the

business itself and how it operates. It attempts to identify the
strengths and weaknesses of its operations. It might cover areas
such as:
●● products and their costs, quality and development

●● finance, including profit, assets and cash flow

●● production, including capacity, quality, efficiency and stock

management
●● internal organisation, including divisional and departmental

structures
●● human resources, including skills, training and recruitment.

In a large business, the internal audit might be conducted

by outside management consultants. This could help to
produce a more independent-minded analysis of the
business’s situation.

Glympton Enterprises Ltd operates three businesses. One is a The external audit: An external audit is an analysis of the
roofing specialist, another is a household maintenance business environment in which the business operates and over which it
and the third is a solar heating provider. The solar heating has little or no control. This audit may address three key areas:
business is fairly new and has encountered one or two problems the market; competition; and the political, economic, social,
since its inception. It has been a drain on cash resources and has technological, legal and environmental issues relevant to the
forced the group to borrow a lot of money. However, sales are business.
growing fast and the future looks bright, although the CEO is The audit should analyse the market or markets in which the
worried about overtrading. business operates. For example, it should analyse:
The roofing business is established and has an excellent reputation ●● the size and growth potential of the market

for reliability in the local area. It has high profit margins and ●● the characteristics of the customers in the market

currently generates 75 per cent of the group’s profits. The housing ●● the products on offer

maintenance business struggled a little during the recession, but ●● the pricing structure

is starting to recover as homeowners increase spending on home ●● how products are distributed

improvements. The business offers a 24-hour call-out service, ●● how products are promoted

which none of its competitors can match. However, it has had ●● industry practices, such as whether there is a trade

difficulties attracting staff, and existing workers are pushing hard association or government regulation.
for a seven per cent pay increase, which will hit margins if granted. The audit should also analyse the competition in the market.
Identify the strengths of Glympton Enterprises. Identify the The nature and strength of competitors will be an important
weaknesses of Glympton Enterprises. Why might it be important for influence on the development of a strategy. For example, it
Glympton Enterprises to understand the strengths and weaknesses should analyse:
●● the structure of the industry, including the number and size
of its operations? Suggest some possible external factors that might
threaten the performance of the business in the future. of competitors, their production capacity and marketing
methods, the likelihood of new entrants to the market or
businesses leaving the industry
●● finance, including profits of competitors, their investment
Gathering information to help develop programmes, costs, revenues, cash and assets.
a strategy PESTLE analysis is an analysis of the political (P), economic (E),
When making plans or developing a business strategy it is social (S), technological (T), legal (L) and environmental (E)
important to gather appropriate information. A business can use issues relevant to the business. It is discussed in more detail in
a variety of methods to do this. Unit 47.
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SWOT analysis Unit 46

What is SWOT analysis? SWOT analysis is often carried out in mind-mapping or ‘blue
It is helpful if the information gathered can then be summarised skies thinking’ sessions before being documented. It can be a
and presented in a meaningful way. One approach is to use powerful way of summarising and building upon the results of
SWOT analysis. This involves looking at the internal strengths (S) internal and external audits. Clearly, it will be a useful tool when
and weaknesses (W) of a business and the external developing a corporate strategy, but it may have other uses. For
opportunities (O) and threats (T) that it faces. example, it might be used to:
●● make a decision about which new product to launch

●● help design a new marketing strategy

Strengths: These are the positive aspects of a business that
●● help decide whether to outsource a specific business task or
may be identified from the internal audit. Strengths are what the
business is good at – they are what help make the business a activity, such as IT
●● prepare for a completely new business venture
success. Examples might include:
●● help prepare for a restructuring of the business.
●● a respected, intelligent, inspirational and visionary leader

●● a highly motivated and loyal workforce

Finally, by identifying clearly the strengths, weaknesses,
●● a product with a unique selling point
opportunities and threats, it may be possible to improve the
●● ‘state of the art’ production facilities
performance of a business. However, this will depend on the
●● a loyal customer base
action it takes after carrying out the analysis. For example,
●● an innovative marketing department.
only if a business takes measures to eliminate weaknesses will
performance improve.
Weaknesses: These are the negative aspects of a business
that may be identified from the internal audit. Weaknesses are
An example of a SWOT analysis
Thorntons is a well-established and well-known confectionery
what the business lacks or does poorly, for example in relation
business. It has been trading for over 100 years and now has
to its competitors. They are the characteristics that undermine
around 250 shops located in prominent positions around the
the performance of a business – perhaps even preventing it
UK. In 2014 the business made a pre-tax profit of £7.5 million,
from growing. They are also areas for improvement. Examples
but a profits warning in December 2014 suggested that this
might include:
might be difficult to match. In the years running up to 2014 the
●● a poorly motivated workforce with a high staff turnover
business had focused on improving profitability. It had closed
●● an organisational structure that has too many layers of
down marginal stores and tried to increase sales using other
management
outlets. Figure 1 shows a SWOT analysis for Thorntons.
●● a product range that is getting out of date

●● poor cash flow and growing debt

●● outdated tools and machinery

Figure 1
●● a poorly presented and out-of-date website. SWOT analysis for Thorntons

STRENGTHS WEAKNESSES
Opportunities: The external audit should show up what
• Progress is being made • Profits declining
opportunities are available to the business. These are the developing wholesale and • Still too much reliance on
options or openings that the business might be able to exploit third-party sales high street shops (250 in
– resulting in improvements, such as higher revenues or lower • Market research suggests 2014)
that the business is • Falling sales, partly caused
costs. Examples might include: increasing its market share by operational difficulties
●● a new overseas market opening up following a political • Online sales have increased at a depot in Derbyshire
significantly – albeit from a
change low base
●● a fall in the cost of an essential raw material, such as oil • The historic brand is widely
●● low interest rates, which provide cheap finance for investment recognised
●● a fall in the exchange rate, which will make exports cheaper

●● the abolition of some burdensome regulations

SWOT ANALYSIS
●● the collapse of a major rival in the market.

Threats: The external audit should show up what threats face OPPORTUNITIES THREATS
the business. Threats are the possible hazards or perils that • Overseas markets offer • Profit margins could suffer
considerable potential for as a result of supermarket
have the potential to damage the performance of the business. growth only 3 per cent of price wars
Examples might include: sales are currently from • Emerging competition from
●● a new entrant in the market
exports gift-selling rivals, such as
• The business is working Hotel Chocolat and Moonpig
●● a rival appointing a new and highly successful CEO hard to get its products on • The cost of raw materials,
●● a looming recession the shelves of other retailers such as sugar and cocoa, is
• A number of new products subject to volatility
●● new legislation aimed at improving the rights of employees
could help lift sales, revenue
●● mounting pressure from environmentalists and market share
●● a change in social attitudes towards the business’s key

product. Source: adapted from www.thorntons.co.uk

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 Business decisions and strategy

Case study
BHP BILLITON
The company and its products
BHP Billiton is a large Anglo-Australian mining company. In
2014 it employed over 120,000 people and had operations
in 130 locations in 21 different countries. The company’s
revenue was US$67.2 billion. This was generated from the
sale of minerals and petroleum products including iron ore,
coal, copper, oil and gas. 2014 and there were rumours of a possible merger between
them. Mergers of competitor companies could have a negative
BHP Billiton’s portfolio of assets, operations and interests are impact on BHP. Also, reports from Australia suggested that the
separated into just four business units, which creates a simple mining boom in the country was under threat from increased
organisation for a company of its scale. This helps to keep international competition. One report showed that the minerals
costs down. The company holds a dominant position in some sector was losing out to increased competition from other
of the world’s richest resource basins. minerals-exporting regions, such as Brazil and West Africa.
BHP Billiton is the largest exporter of seaborne metallurgical
coal, a global top three producer of iron ore, a global top Markets
four producer of copper and the largest overseas investor China has been the driving force behind the mining industry
in onshore US shale oil and gas. It is also the developer since the 1990s. This has been due to its insatiable demand for
of the world’s best undeveloped potash resource – in commodities needed for the development of its infrastructure.
Saskatchewan, Canada. However, in the 2014 financial year However, economic growth in China has slowed down.
about half of its earnings was generated from iron ore. Also, some of the Chinese steel plants have purchased their
own mining operations, which is likely to impact on BHP.
In the 2014 financial year, the company delivered a strong Economic recovery in the US, Japan and the UK should help to
financial performance. It had a strong balance sheet and compensate a little for the fall in demand from China. However,
maintained a solid ‘A’ credit rating. BHP Billiton reported the European market was weak in 2014.
a profit of US$13.8 billion and a net operating cash flow of
US$25.4 billion. Costs
Iron-ore prices In 2014, BHP Billiton and Rio Tinto reported their average
production cost in Pilbara, where most of Australia’s iron-
Iron-ore prices have come under considerable pressure ore production is located, was around $25 a tonne. So
since 2012. Figure 2 shows that the price fell by nearly 50 even at low prices ($60 per tonne), these producers were
per cent from $135 to $69 between December 2013 and still profitable. Smaller mining companies might struggle to
December 2014. Also, the combination of a further increase survive if prices continue to fall. However, rising wages in
in global iron ore supply in 2014 and only subdued demand Australia could also erode profit margins. BHP is striving to
growth suggested that prices would continue to drift lower. reduce costs and improve efficiency. New production records
Competition were set at a number of BHP operations. Investment in up-
BHP Billiton does have some sizable rivals in the market. to-date technology and improved working practices ensured
Glencore and Rio Tinto were two of its closest competitors in that BHP was ahead of rivals in cutting costs.
The decline in the Australian dollar could have an impact on
Figure 2 BHP. For example, it was suggested that the company would
The price of iron ore in US dollars (per dry metric tonne) find it difficult to cut capital expenditure costs. Between 2012
and 2015 the Australian dollar fell around 26 per cent, from
US$/dry metric tonne
70.4p/AUS$1 to 52.0p/AUS$1.
150
Source: adapted from www.bhpbilliton.com

100
(a) Explain how an internal audit might play a role in SWOT
50
analysis. (4 marks)
(b) Explain how an external audit might play a role in SWOT
0
analysis. (4 marks)
Dec-13
Jan-14
Feb-14
Mar-14

May-14
Jun-14
Jul-14
Aug-14

Dec-14
Apr-14

Sep-14
Oct-14
Nov-14

(c) Assess the position of BHP Billiton by carrying out a SWOT

analysis. (12 marks)
Month

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SWOT analysis Unit 46

Links
A business may use SWOT analysis to help make decisions.
Therefore, you could link information in this unit to any answer
where decision making is being discussed. For example, a
business might be deciding whether or not to penetrate an
overseas market, which is discussed in Unit 72. You could
explain that a business might carry out a SWOT analysis to
help decide whether such a move would be desirable given the
company’s current situation. Other examples of units to which
SWOT analysis might be linked include Market positioning
(Unit 3), Pricing strategies (Unit 11), Marketing strategy (Unit
13), Business choices (Unit 24), Corporate objectives (Unit 45),
Mergers and takeovers (Unit 49), Investment appraisal (Unit 53)
and Key factors in change (Unit 64).

Exam tip Knowledge check

You need to remember that strengths and weaknesses are internal
factors and opportunities and threats are external factors. It is 1. Give three examples of information that an internal audit
important not to get them mixed up. might find.
2. Give three examples of information that an external audit
might find.
Key terms
3. Why might SWOT analysis help a business to make decisions?
External audit – an audit of the external environment in
which a business finds itself, such as the market within 4. Give three possible examples of uses for SWOT analysis.
which it operates or government restrictions on its 5. How might SWOT analysis help to improve the performance
operations. of a business?
Internal audit – an analysis of the business itself and how it
operates.
SWOT analysis – an analysis of the internal strengths and
weaknesses of the business and the opportunities and
threats presented by its external environment.
Trade association – an organisation whose members are
all involved in the same industry or trade. The organisation
pursues the interests of these businesses.

284
 47 Impact of external 3.1.4
Theme 3

Key points
influences
1. PESTLE (political, economic, social, technological, legal and environmental).
2. The changing competitive environment.
3. Porter’s Five Forces.

Getting started goods, such as cars and houses, which are often funded by
borrowing, will fall.
Consequently, it will be helpful to businesses if they can
monitor and analyse the likely impact of external influences
in some way. One approach is to use PESTLE analysis. This
involves identifying the political (P), economic (E), social (S),
technological (T), legal (L) and environmental (E) factors that
might influence business activity and performance.

Political: Some parts of the world are politically volatile and

special attention has to be paid if businesses venture into
politically unstable countries. However, political factors can also
influence businesses in stable, democratic countries. The activities
of pressure groups can play a role in influencing business activity.
In 2014, it was widely reported that the daily newspaper Some examples of political factors include the following.
market was falling at a rate of 8 per cent a year. The Sunday ●● Members joining or leaving the EU. This could disrupt
newspaper market was said to be falling at an even faster financial markets and create a great deal of uncertainty in the
rate of 9 per cent. Some newspapers were struggling more Eurozone. For example, in 2015, some felt that Greece might
than others. For example, one of the national newspapers leave the EU.
saw its sales drop by around 13 per cent. ●● The issue of national security has become a priority for many

governments. If measures designed to improve national

In 2013, the main newspaper companies included the
security restrict the movement of goods, people and capital,
Telegraph Media Group, News Corporation, Daily Mail and
this could have a negative impact on businesses.
General Trust, and Johnston Press. The top four businesses in
●● Pressure groups, such as ASH (Action on Smoking and
the UK newspaper market were reported to account for around Health), which aims to eliminate the harm done by smoking,
50% of industry revenue in 2012–2013, with a medium level can affect businesses. For example, ASH might persuade
of market share concentration. The future potential for the government to increase the tax on tobacco, which would
newspaper industry could be seen as uncertain, and affected by clearly affect the tobacco industry.
many factors. ●● Changes in government. For example, a new government

Identify possible external factors that might account for the might be elected which is very pro-business.
decline in the newspaper industry. Do you think that there is a
Economic: The general state of the economy can have a huge
lot of competition in the newspaper industry? Explain whether impact on business activity. Since the financial crisis in 2008, a
you think that new newspaper businesses are likely to enter the number of countries have suffered a recession, which has made
market for newspapers in the near future. trading conditions very difficult for many businesses. However,
some specific examples include the following.
●● Falling unemployment might help to increase demand for

many businesses.
●● Stable prices would create more certainty, which should
PESTLE analysis encourage businesses to invest for the future.
The impact of external influences on business can be ●● A strengthening exchange rate could make exporting more
enormous and can be both positive and negative. For example, difficult. However, in contrast, imports become cheaper.
if interest rates fall, the costs of repayment of loans for a ●● Lower interest rates would make borrowing cheaper and
business will fall and profits could rise. Businesses may also encourage more investment.
be encouraged to invest more. In contrast, if interest rates rise, ●● Some businesses may suffer badly during a recession.
interest charges will rise and profits will fall. Also, demand for Those which produce goods and services that are income
285
Impact of external influences Unit 47

elastic will tend to have the most problems. For example, Environmental: People are increasingly protective of the
car producers, housebuilders, holiday companies, computer environment, for instance because of the threats posed by
games and ‘white goods’ such as freezers, cookers and global warming. People are also concerned about the
washing machines, are likely to get hit the hardest. This is threats to wildlife and natural habitats that businesses
because people can postpone purchases of these items until sometimes pose.
incomes pick up again. ●● People are more inclined to buy ‘green’ goods. This provides

opportunities for businesses that specialise in such products.

Social: Over time there are likely to be changes in the way ●● New ways of generating power using renewable sources
society operates. Although social and cultural changes tend to rather than by burning hydrocarbons are providing new
be gradual, they can still have an impact. opportunities.
●● In the UK, greater numbers of people are going to university. ●● The trend towards recycling is gathering pace in the UK. By
This could increase the quality of human resources, which using recycled resources, businesses can cut their costs.
would benefit businesses.
●● The population in many countries is ageing. This could affect
Question 1
demand patterns and create new opportunities for some
businesses. Royal Mail provides a universal postal service in the UK.
●● Increasing migration might increase the size of the potential It delivers mail to anywhere in the country using a ‘one-price-
workforce, making recruitment easier. It might also provide a goes-anywhere’ capability. After a turbulent period of trading,
boost to demand. the business was privatised (sold to shareholders by the state) in
●● People appear to be becoming more health conscious. This
2013. It then started to transform its business in response to the
might create opportunities for certain businesses, such as continuing decline in letter volumes caused by the increased use
those selling healthy foods or running fitness centres. of email and the rise in demand for parcel delivery as a result of
more online shopping.
Technological: The rate of technological change seems
to gather pace all the time. Businesses usually welcome One of the reasons why Royal Mail was privatised was so that
technological developments because they often provide new it could attract private sector investment – investment that the
product opportunities or help to improve efficiency. public sector could no longer afford. The money was needed
●● Changes in technology can shorten product life cycles. This is for a strategy to transform the business and maintain efficient
because new products are quickly developed to replace ones operations. With the ‘pick-up’ in the economy, low interest rates
that use older technology. and higher future growth predictions, Royal Mail could see its
●● Developments in technology often mean that businesses can performance improve.
replace labour with capital. This is welcomed because human
(a) Explain the purpose of PESTLE analysis.
resources are often said to be the most expensive and
difficult to manage. New technology also lowers unit costs. (b) Assess the political, economic and technological factors that
have affected Royal Mail in this case.
●● The development of social media has helped to improve

communications between businesses and customers.

This allows businesses to keep abreast of changing
consumer needs. The structure of markets
Competition is the rivalry that exists between firms when trying
Legal: The government provides the legal framework in which to sell goods in a particular market. In some markets there
businesses operate. However, it also directs legislation at is a lot of competition. For example, the restaurant market in
businesses to protect vulnerable groups that might otherwise get London is very competitive, with more than 5,500 restaurants
exploited. UK businesses are also affected by EU regulations. competing for customers. However, in other markets there is
●● EU legislation can affect tax laws. In 2015, for example, rules very little competition. Thames Water, for example, is the sole
changed so that EU VAT would be charged in the country supplier of tap water in London. No other firm competes with
where products were bought as opposed to the country Thames Water.
where they were sold. The legislation only applied to digital
products, such as e-books, online courses or downloads. Competitive markets: In a competitive market there is
●● There have been calls to ban the advertising of alcohol likely to be a large number of buyers and sellers, and the
on television. If introduced, such legislation might have a products sold by each business are close substitutes for each
negative impact on the beverages industry. other. Barriers to entry in competitive markets will be low and
●● Businesses in the food industry are currently under pressure businesses have very little control over the price charged. For
to reduce the amount of sugar and salt they add to products. example, if a firm tries to charge more than its rivals it is likely
●● The government in the UK often states that it wants to reduce to lose nearly all of its business. Finally, there will be a free
the amount of ‘red tape’ in business. This might benefit a flow of information about the nature of products, availability at
wide range of businesses. different outlets, prices, methods of production and the cost and
availability of production factors.

286
 Business decisions and strategy

Uncompetitive markets: Some markets are dominated ●● There has been a significant consolidation in the global airline
by a single producer or just a few large businesses. In industry. For example, in 2005 there were 11 US airlines
a small number of markets such as rail travel and water sharing 96 per cent of the domestic market. In 2014 this had
supply, a monopoly exists. This means that just one fallen to just 6 airlines sharing 94 per cent of the market. In
business supplies the entire market. For example, if you Europe, there were mergers between national airlines. BA
want to get a train from Glasgow to Edinburgh there is only and Iberian Airlines merged to become IAG, now one of the
one operator – ScotRail. A monopoly might also exist in a biggest carriers in the world. Air France and KLM have also
local market where a village shop, for example, serves the merged, as have Swiss Air and Lufthansa.
whole community without any competition. Monopolies may ●● The number of businesses in the mobile telephone industry is
attempt to exploit consumers by charging higher prices and falling. For example, in 2015 Hutchison Whampoa bought O2
preventing competition – by erecting barriers to entry, for for £10.25 billion. This reduced the number of operators in
example. As a consequence the UK from four to three.
the government is obliged to monitor the activities of
monopolies closely. The impact on businesses of a changing
A market that is dominated by a few very large producers competitive environment
is called an oligopoly. For example, there might be 2,000 Many markets are dynamic and businesses need to be aware
businesses in a market, but if three of those businesses share of the changes that are taking place. They may have to react to
70 per cent of the market between them, an oligopoly is said certain changes when they occur.
to exist. One of the key features of an oligopolistic market
is interdependence. This means the actions of one business New entrants: When competition gets stronger, as a result of
will affect other businesses. For example, if one business new entrants in the market, existing businesses have to consider
gains an extra 4 per cent of the market, others must have lost their position. For example, the growth in online shopping has
4 per cent between them. There are usually high barriers to forced many retailers to offer their own online shopping services.
entry in oligopolistic markets and the larger firms can exploit In some cases, failure to compete online has resulted in the
economies of scale. Also, because of interdependence, prices collapse of retailers. In the first half of 2014, 16 shops a day in
tend to remain stable for long periods of time. This is because the UK were closing down, although this was a slight fall from the
all firms in the market are afraid of a price war. In an oligopoly first half of 2013 when it was 18 per day. Some of the casualties
businesses are more likely to engage in non-price competition, include building societies, video rental shops, pawnbrokers,
such as advertising and promotion. The car industry, mobile phone shops and fashion retailers. Not all of these
confectionery industry and the potato crisp industry are good closures are due to online shopping, but retailers that fail to offer
examples of oligopolies in the UK. an online service in the future may find it difficult to survive.

The changing competitive environment New products: When a new product appears in the market,
Over time, the structure of markets is likely to change. In businesses may be forced to make changes of their own. They
some markets competition intensifies as new businesses enter might adapt their own products, lower the price of existing
the market. A new entrant might be a business with a novel products or invest in an aggressive marketing campaign. In
product. Alternatively, the newcomer might be an established the banking industry a number of new entrants have appeared
business that wants to diversify into a different business area. offering peer-to-peer (P2P) lending. This has obviously been
Since 1980, UK governments have tried to make markets more noticed by the traditional banks and some have started to make
competitive by reducing the amount of regulation. For example, a move. The majority have looked to joining with portals that are
at one time only local councils were permitted to operate bus already up and running, but the Royal Bank of Scotland plans to
services. However, today anyone can obtain a licence and pilot a new P2P platform of its own.
provide bus services on any route they choose. In contrast, in
some markets there has been some consolidation. This means Consolidation: When consolidation occurs in markets the
that there are now fewer businesses in the market. This might number of businesses in the market falls, but some of the
result from takeover or merger activity when two or more firms existing businesses get bigger. These bigger organisations are
join together. Some examples of changes in the competitive likely to pose more of a threat to the others. They may be able to
environment are outlined below. lower their costs and they will have a larger market share. Other
●● The supermarket industry has become more competitive businesses in the market might respond by organising mergers
since 2010. For example, in the last four months of 2014, or takeovers of their own. Alternatively they may look to develop
Tesco, Sainsbury’s, Asda and Morrisons all lost market share their products, diversify, or cut their costs in some way. As a last
to Aldi, Lidl and Waitrose. resort they may continue to operate in much the same way, but
●● Retailing in general has become more competitive due to accept lower profit margins.
the increasing use made by consumers of online shopping Failure to respond effectively to the changing competitive
facilities. For example, people can buy products from all environment could adversely affect the performance of a business.
over the world when shopping online. At worst, certain changes may threaten the business’s survival.

287
Impact of external influences Unit 47

Question 2 adopt to achieve this. It can grow vertically (backward vertical

integration, see Unit 49), either acquiring a supplier or setting
Many consumers have complained about rising energy prices up its own business by growing organically upwards. It can
in the UK. Between 2003 and 2015, gas prices, for example, seek out new suppliers to create more competition amongst
increased by nearly 200 per cent. As a result, a household with a suppliers. It might be able to engage in technical research to
gas bill of £300 in 2003 would be paying around £900 in 2015. find substitutes for a particular input to broaden the supply
One possible reason for these significant price increases is the base. It may also minimise the information provided to
lack of competition in energy markets. At the end of the 1990s suppliers in order to prevent the supplier realising its power
there were 14 regional monopolies supplying the UK. In 2015 over the customer.
there were just six big companies: British Gas, npower, SSE,
E.ON UK, EDF Energy and Scottish Power.
Bargaining power of buyers: Just as suppliers want to
charge maximum prices to customers, so buyers want to
However, since the market consolidated, a number of new, obtain supplies for the lowest price. If buyers or customers
smaller firms started to emerge. The competitive landscape have considerable market power, they will be able to beat
could change in the future and prices might start to fall. Some of down prices offered by suppliers. For example, the major
the entrants to the market, such as GnERGY, FlowEnergy, First car manufacturers have succeeded in forcing down the price
Utility, extraenergy, ecotricity and green energy, are keen, agile of components from component suppliers because of their
and offer innovative services. For example, many provide smart enormous buying power and the relatively few number of
meters, new technology, a commitment to energy efficiency and major car manufacturers in the world. One way a business can
green energy, and a range of different contracts. Some also claim improve its competitive position viz-a-viz buyers is to extend
that their pricing strategies are much easier to understand. into the buyers’ market through forward vertical integration.
A car manufacturer might set up its own dealership, for
When people complain about energy price increases the
example. It could encourage other businesses to set up in its
government often responds by saying that consumers have the
customers’ market to reduce the power of existing customers.
freedom to switch suppliers. Many of the new suppliers offer It could also try to make it expensive for customers to switch
lower prices, but only between 15 and 17 per cent of customers to another supplier. For example, one way in which games
per year have switched. In 2015, these entrants had only captured console manufacturers keep up the price of computer games
between 2 and 3 per cent of the total market. However, with more for their machines on which they receive a royalty is by making
awareness and possibly more government intervention, the energy them technically incompatible with other machines.
market might become more competitive in the future.
Sources: adapted from the Office for National Statistics and Threat of new entrants: If businesses can easily come into
www.ofgem.gov.uk an industry and leave it again if profits are low, it becomes
difficult for existing businesses in the industry to charge
(a) Assess the possible impact on the existing energy providers of
high prices and make high profits. Existing businesses are
the growing number of new entrants.
constantly under threat that if their profits rise too much, this
will attract new suppliers into the market who will undercut
their prices. Businesses can counter this by erecting barriers
Porter’s Five Forces to entry to the industry. For example, a business may apply
Another way of looking at the competitive environment is for patents and copyright to protect its intellectual property
to consider a model put forward by Michael Porter in his and prevent other businesses using it. It can attempt to create
book, Competitive advantage: creating and sustaining superior strong brands which will attract customer loyalty and make
performance (1985). In the book, he outlines five forces or customers less price sensitive. Large amounts of advertising
factors which determine the profitability of an industry. He can be a deterrent because it represents a large cost to a new
argues that the ultimate aim of competitive strategy is to cope entrant which might have to match the spending to grow some
with and ideally change those rules in favour of the business. market share. Large sunk costs, costs which have to paid at
Where the collective strength of those five forces is favourable, the start but are difficult to recoup if the business leaves the
a business will be able to earn above-average rates of return industry, can deter new entrants.
on capital. Where they are unfavourable, a business will be
locked into low returns or wildly fluctuating returns. The five Substitutes: The more substitutes there are for a particular
forces, shown in Figure 1 on the next page, are as follows. product, the fiercer the competitive pressure on a business
making the product. Equally, a business making a product with
The bargaining power of suppliers: Suppliers, like few or no substitutes is likely to be able to charge high prices
any business, want to maximise the profit they make from and make high profits. A business can reduce the number of
their customers. The more power a supplier has over its potential substitutes through research and development, and
customers, the higher the prices it can charge and the more it then patenting the substitutes itself. Sometimes, a business will
can re-allocate profit from the customer to itself. Limiting the buy the patent for a new invention from a third party and do
power of its supplier, therefore, will improve the competitive nothing with it simply to prevent the product coming to market.
position of a business. It has a variety of strategies it can Businesses can also use marketing tactics to stop the spread of
288
 Business decisions and strategy

substitute products. A local newspaper, for example, might use Key terms
predatory pricing if a new competitor comes into its market to
drive it out again. Monopoly – a market dominated by a single business.
Oligopoly – a market dominated by a few large businesses.
Rivalry among existing firms: The degree of rivalry PESTLE analysis – analysis of the external political,
among existing firms in an industry will also determine prices economic, social, technological, legal and environmental
and profits for any single firm. If rivalry is fierce, businesses factors affecting a business.
can reduce that rivalry by forming cartels or engaging in
a broad range of anti-competitive practices. In UK and EU
law this is illegal but it is not uncommon. Businesses can
also reduce competition by buying up their rivals (horizontal Links
integration, see Unit 49). Again, competition law may intervene External influences can have an impact on a wide range
to prevent this happening but most horizontal mergers are of business activities. It is a topic area that allows you to
allowed to proceed. In industries where there are relatively demonstrate your synoptic skills. For example, you might need to
few businesses, often businesses don’t compete on price. answer a question explaining the impact on a particular business
This allows them to maintain high profitability. Instead they of economic growth. Or you might need to explain the impact of
tend to compete by bringing out new products and through higher interest rates on a business that is planning to increase
advertising, thus creating strong brands. As a result their investment. Examples of other units that could be linked to
costs are higher than they might otherwise be, but they can external influences include: Marketing strategy (Unit 13),
also charge higher prices than in a more competitive market, Business failure (Unit 36), Theories of corporate strategy
creating high profits. (Unit 45), Marketing (Unit 76), Cultural/social factors (Unit 78),
Global competitiveness (Unit 75), Ethics (Unit 80) and Controlling
Figure 1 MNCs (Unit 81). There are many others.
The five competitive forces that determine industry profitability

Potential
entrants
Knowledge check
1. Give two examples of political factors that might affect the
Threat of food industry.
new entrants
2. Give two examples of economic factors that might affect the
Bargaining Industry Bargaining holiday industry.
power competitors power
of suppliers of buyers 3. Give two examples of technological factors that might affect
Suppliers Buyers the motor industry.
Rivalry among
existing firms 4. Give two examples of environmental factors that might affect
the chemical-processing industry.
Threat of 5. How does PESTLE analysis help a business?
substitute products
or services 6. What is meant by an oligopoly?
7. State two possible effects on a business of a strong new
Substitutes
entrant in a market.
8. How might the degree of rivalry in a market affect prices and
profits?
Exam tip 9. What action might businesses take to deal with the threat of
When answering a question about factors that might influence potential entrants?
business performance or any of its activities, it is good
practice to distinguish between internal and external factors.
This may provide a useful opportunity to demonstrate your
evaluation skills.

289
Impact of external influences Unit 47

Case study
On the supply side, fewer houses are being built as shown in
THE HOUSING MARKET Figure 3 on the next page. Possible reasons for this are
as follows:
• Smaller builders have been hit hard by the recession and
In 2007, construction companies Taylor Woodrow and a lack of bank finance, meaning they have found it difficult
George Wimpey, joined together in a merger to form Taylor to buy land and deal with the often costly and time-
Wimpey to become the largest housebuilder in the UK. This consuming planning system.
was an example of the consolidation that has been taking • Resources in the construction industry are being stretched.
place in the housebuilding market since the 1980s. In 1988 Other projects, such as roads, schools, hospitals and railways,
the 25 largest housebuilders shared about 37 per cent of the are competing for resources. Some construction companies
market. By 1999 this had risen to about 55 per cent. In 2015 have found it difficult to recruit skilled workers, for example.
the top 10 companies had about 60 per cent of the market • Some of the big housebuilders are being very cautious,
and Persimmon, Barratt and Taylor Wimpey dominated following the financial crisis and the recession in the UK.
about 25 per cent. Just after the Taylor Wimpey merger They are planning a more measured growth strategy and
the Office of Fair Trading carried out an investigation into are returning money to shareholders.
the industry but found ‘little evidence’ of anti-competitive
behaviour by housebuilders and ‘no evidence’ of monopolies. The housing shortage has prompted a small measure of action
However, Rob Perrins, managing director of upmarket builder from the government. A ‘Help to buy’ equity loan scheme
Berkeley, says of the big companies: ‘They’re too powerful… was introduced, with the first phase starting in April 2013 in
They haven’t wanted to be that dominant, but small England. This saw the government offering a 20 per cent equity
builders are just not there at the moment.’ In contrast to the loan to buyers of newly built properties. These buyers must
strengthening of big housebuilders, the number of small and offer a 5 per cent deposit. The government also sought to help
medium-sized developers has dwindled. In 1988 two-thirds smaller developers by launching the £500 million Builders’
of all new homes were built by developers with an annual Finance Fund, which provides loans to small housebuilders.
output of fewer than 500 units. By 2012 that was down to
less than a third.
There is currently a housing shortage in the UK. This is
reflected in the price increases shown in Figure 2. However,
the graph shows that the price increases are not evenly
distributed around the country. Demand for housing
outstrips supply. There are several reasons for the rise in
demand.
• The UK population is growing – it is around 64 million
at the moment, but is forecast to grow to around
70 million by 2030. Some of the population growth is
due to migration from parts of Eastern Europe as more
countries join the EU.
• A significant number of houses are being bought up by
property dealers in the ‘buy-to-let’ market. This means
there are fewer properties left for other buyers.
• People are delaying marriage, which means that there
are more single people looking for property.
• The population is aging so more properties are needed
because people are living for longer and people are living
in their houses for longer.
• Foreign investors have stepped up their demand for
property – particularly at the high end of the market, and
especially in London.

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 Business decisions and strategy

In 2015, interest rates in the UK economy were still at an

historic low and there were signs that the government would Figure 2
continue to encourage more house building. For example, it All dwellings annual house price rates of change 2014
announced the development of a new eco-town in Bicester,
UK
Oxfordshire, which would provide around 6,000 sustainable
England
new houses. The first phase of this development would see
Wales
the construction of energy-efficient, zero-carbon homes, Scotland
creating the UK’s first true zero-carbon community. The Northern Ireland
plan is to keep the environment at the core of the project, North East
adopting cutting-edge technology and ensuring that the North West
provision of green space in the community is key. Yorks & The
Humber
East Midlands
Builders in the construction industry have also seen signs
West Midlands
of recovery with reports in indicating that builders in
East
the FTSE 350 saw their highest revenues for five years
London
in 2014. However, it still faced difficulties. The industry South East
is the biggest producer of waste in the economy and is South West
closely regulated. In 2013 there were 42 fatal injuries in 0 2 4 6 8 10 12 14 16 18
construction and around 5,000 injuries, which showed Change (%)
that the health and safety issues were still a concern. Source: Office for National Statistics
Suitable land was difficult to obtain and there was
increasing regulation relating to the UK’s commitment to
build zero-carbon homes. Figure 3
Source: adapted from the Financial Times 28.07.14, Housebuilding trends in the UK from 2003/04 to 2014/15
27.01.15. All rights reserved. 12-month rolling totals
60,000
Key
(a) Explain what is meant by the changing competitive 50,000 Completions
environment in the housebuilding market. (4 marks)
Starts
(b) Assess how Porter’s Five Forces analysis might be used 40,000
by one of the major suppliers in the housebuilding
market. (8 marks) 30,000

(c) Assess the possible political, economic, social,

20,000
technological, legal and environmental factors affecting
the housing market. (12 marks)
10,000

0
2003–04

2004–05

2005–06

2006–07

2007–08

2008–09

2009–10

2010–11

2011–12

2012–13

2013–14

2014–15

Year
Source: www.gov.uk

291
 48 Growth 3.2.1
Theme 3

Key points
1. Objectives of growth:
to achieve economies of scale (internal and external)
●●

increased market power over customers and suppliers

●●

●● increased market share and brand recognition

●● increased profitability.

2. Problems arising from growth:

●● diseconomies of scale

●● internal communication

●● overtrading.

Getting started Growth

Most businesses start small and then grow. For example,
Salford-based online retailer Missguided was set up in 2009
by Nitin Passi. The fashion retailer offers catwalk looks and
celebrity-inspired fashion to women aged between 16 and 35.
Two years after the company was founded sales were
£2.1 million. However, since 2011 the annual growth rate was
191 per cent and in 2014 sales were £51 million. Businesses
like to grow because the benefits can be very attractive. For
example, revenues will be higher, unit costs are likely to be lower
and the business will have a higher profile with a larger market
share. The specific objectives that a business might have when
growing, such as economies of scale and increased market
power, are outlined below.

Economies of scale
The size of a business has a major impact on average costs
of production. Typically, there is a range of output over
which average costs fall as output rises. Over this range,
The Cambridge Satchel Company was founded in 2008 by larger businesses have a competitive advantage over smaller
Julie Deane, OBE, and her mother Freda Thomas. Investing businesses. They enjoy economies of scale. In the long run, a
just £600 to get the idea off the ground, the company is now a business can build another factory or purchase more machinery.
Made-in-Britain worldwide phenomenon, employing more than This can cause the average cost of production to fall.
140 people and selling to over 120 countries across the globe. In Figure 1 a firm is currently producing in a small plant and
Turning over £15,000 in the first year, the company made its short-run costs are SRAC1. When it produces an output equal
£10 million turnover in 2014 following an appearance in a to Q1 its average cost will be AC1. If it raises production to Q2,
Google Chrome ad and collaborations with the likes of Vivienne average costs will rise to AC2. This is the result of the law of
Westwood and Comme des Garcons. diminishing returns.
In 2014 it was the seventh fastest growing company in the UK If the firm expands the scale of its operations (which it can
according to the Sunday Times Fast Track 100. The brand sells do in the long run) the same level of output can be produced
from its global website as well as the flagship store in London's more efficiently. With a bigger plant, represented by SRAC2,
Covent Garden, a store in Cambridge, a 'Pop Up' store in Q2 can be produced at an average cost of just AC3. Long-run
Glasgow and a dedicated Men's Store in London's Seven Dials. average costs fall due to economies of scale and will continue
Source: adapted from www.cambridgesatchel.com to do so until the firm has built a plant which minimises long-run
average costs. In the diagram this occurs when a plant shown by
Calculate the percentage growth in the turnover between the SRAC3 is built. This is sometimes called the minimum efficient
first year and 2014. State the possible benefits to the Cambridge scale of plant. When output reaches Q* in this plant, long-run
Satchel Company of growing the business. Explain possible average costs cannot be reduced any further through expansion.
problems arising from the growth of the business. Do you think this The business is said to be productively efficient at this point.
business will continue to grow? Explain reasons for your answer.

292
 Business decisions and strategy

At any output level higher or lower than Q*, the business is As the scale of operations expands the firm may switch
productively inefficient because average costs could be lower. to mass production techniques. Flow production, which
For example, if the firm continues to grow it will experience involves breaking down the production process into a very
rising average costs due to diseconomies of scale, as in SRAC4 large number of small operations, allows greater use of highly
in Figure 1. This is dealt with later in the unit. specialised machinery. This results in large improvements in
efficiency as labour is replaced by capital.
Figure 1 Businesses often employ a variety of machines which
The long-run average cost curve and the effect of economies have different capacities. A slow machine may increase
of scale production time. As the firm expands and produces more
output, it can employ more of the slower machines in order
Average
cost SRAC 1 LRAC to match the capacity of the faster machines. This is called
the law of multiples. It involves firms finding a balanced
AC 2 team of machines so that when they operate together they
AC 1 SRAC 2 SRAC 4 are all running at full capacity.

AC 3 SRAC 3
Specialisation and managerial economies: As the
firm grows it can afford to employ specialist managers. In
a small business one general manager may be responsible
for finance, marketing, production and human resources.
Economies of scale Diseconomies of scale The manager may find her role demanding. If a business
employs specialists in these fields, efficiency may improve
0 Q1 Q2 Q* Output and average costs fall. If specialists were employed in a
small firm they would be an indivisibility.

Internal economies of scale Financial economies: Large firms have advantages when
What are the different economies of scale a firm can gain? they try to raise finance. They will have a wider variety of
internal economies of sale are the benefits of growth that arise sources from which to choose. For example, sole traders
within the firm. They occur for a number of reasons. cannot sell more shares to raise extra funds but large public
limited companies can. Very large firms will often find it
Purchasing and marketing economies: Large firms easier to persuade institutions to lend them money since they
are likely to get better rates when buying raw materials and will have large assets to offer as security. Finally, large firms
components in bulk. In addition, the administration costs borrowing very large amounts of money can often gain better
involved do not rise in proportion to the size of the order. The interest rates. In the past the government has recognised the
cost of processing an order for 10,000 tonnes of coal does not problems facing small firms. A number of schemes have been
treble when 30,000 tonnes are ordered. designed to help small firms raise funds.
A number of marketing economies exist. A large company may
find it cost-effective to acquire its own fleet of vans and lorries, for Risk-bearing economies: As a firm grows it may well
example. The cost to the sales force of selling 30 product lines is diversify to reduce risk. For example, breweries have
not double that of selling 15 lines. Again, the administration costs diversified into the provision of food and other forms of
of selling do not rise in proportion to the size of the sale. entertainment in their public houses. Large businesses can
also reduce risk by carrying out research and development.
Technical economies: Technical economies arise because The development of new products can help firms gain a
larger plants are often more efficient. The capital costs and the competitive edge over smaller rivals.
running costs of plants do not rise in proportion to their size.
For example, the capital cost of a double decker bus will not be External economies of scale
twice that of a single decker bus. This is because the main cost External economies of sale are the reductions in cost which
(engine and chassis) does not double when the capacity of the any business in an industry might enjoy as the industry
bus doubles. Increased size may mean a doubling of output but grows. External economies are more likely to arise if the
not cost. The average cost will therefore fall. This is sometimes industry is concentrated in a particular region.
called the principle of increased dimensions. In addition, the
cost of the crew and fuel will not increase in proportion to its size. Labour: The concentration of firms may lead to the
Another technical economy is that of indivisibility. Many build-up of a labour force equipped with the skills required
firms need a particular item of equipment or machinery, but by the industry. Training costs may be reduced if workers
fail to make full use of it. A small business may pay £400 for a have gained skills at another firm in the same industry.
laptop computer. The cost will be the same whether it is used Local schools and colleges, or even local government, may
twice a week by a part-time clerical worker or every day. As offer training courses which are aimed at the needs of the
the business expands, more use will be made of it and so the local industry.
average cost of the machine will fall.
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Growth Unit 48

Ancillary and commercial services: An established Question 1

industry, particularly if it is growing, tends to attract smaller
There is some evidence in the dairy industry that larger herds
firms trying to serve its needs. A wide range of commercial
and support services can be offered. Specialist banking,
result in higher yields and lower costs. For example, Table 1
insurance, marketing, waste disposal, maintenance, cleaning, shows that when the herd size rises from 85 cows to 339 cows,
components and distribution services are just some examples. the average milk yield per cow rises from 6,247 litres per year to
8,135 litres per year. Figure 2 shows the impact of larger herds
Co-operation: Firms in the same industry are more likely to on revenue, costs and profit margins.
co-operate if they are concentrated in the same region. They Table 1 The impact of larger herds on milk production
might join forces to fund a research and development centre and yields
for the industry. An industry journal might be published, so that Summary of Quartile 1 Quartile 2 Quartile 3 Quartile 4
information can be shared. milk production (small) (small/ (medium/ (large)
quartiles medium) large)
Disintegration: Disintegration occurs when production is Average annual 531,000 1,033,000 1,535,000 2,758,000
broken up so that more specialisation can take place. When milk production
an industry is concentrated in an area, firms might specialise (litres)
Herd size 85 157 205 339
in the production of one component and then transport it to a (number cows)
main assembly car plant. In the West Midlands a few large car
Average yield 6,247 6,580 7,488 8,135
assembly plants exist, while there are many supporting firms. (1/cow/year)

Exam tip Figure 2 shows that costs ppl (pence per litre) fall as herd size
You need to remember that economies of scale are a long-run gets bigger. There are at least two reasons for this. A farmer with
phenomenon. This means that average costs will fall when a business a larger herd will need larger quantities of inputs – cattle feed,
increases the scale of its operations. This involves changing fixed
for example. Suppliers might offer farmers discounts for buying
factors of production, such as machinery or premises.
larger amounts. It is also possible that farmers can make better
use of technology with larger herds. For example, automatic
milking units are likely to become cost-effective with larger herds.
Increased market power
As businesses get bigger they become more dominant. As There is evidence of different farms at any herd size on the scale
a result rivals are left with a smaller market share and some achieving positive margins. However, it is notable that the lowest
weaker businesses may be forced to close down. If a business herd margins are all among the smaller sized sized herds.
is large enough it may be able to dominate two particular
stakeholders. Figure 2
●● Customers. A dominant business may be able to charge
The impact of larger herds on costs, revenue and profit
higher prices if competition in the market is limited. In the
margins
absence of choice, customers are forced to pay higher
prices. Also, if there is a lack of competitive pressure in pence per litre
the market there is less need to develop new products. 40
This means that a dominant firm will not have to meet the 35
costs of expensive and risky innovation. As a result, product 30
choice may remain limited for consumers. 25
20
●● Suppliers. Sometimes a business can dominate its
15
suppliers. For example, it may be able to force the costs 10
of materials and commercial services down if it buys 5
large quantities from relatively small suppliers. Dominant 0
businesses will be in a particularly good position if their -5
-10
suppliers rely heavily upon them for their custom. For Q1 Q2 Q3 Q4
example, if a small supplier sells all of its output to just one Key Herd size quartiles
large business, it is in a vulnerable position and may have to Revenue Cost of production Net margin
accept the prices that the customer is prepared to pay.
However, if a business becomes too dominant it might attract
the attention of the authorities. If it is felt that the dominant Source: adapted from www.dairy.ahdb.org.uk
business is exploiting consumers or suppliers there may be an (a) Explain what is meant by economies of scale in the case of the
investigation into the industry. In 2014, energy companies were dairy industry.
criticised for charging high prices and some supermarkets were
(b) Explain one internal economy that might account for lower unit
accused of ‘bullying suppliers’. costs when larger herds are used in the dairy industry.

294
 Business decisions and strategy

Increased market share and brand Question 2

recognition RTR Ltd was originally set up as a satellite TV company in
As businesses grow, their share of the market is also likely to
grow. This will give them more power and they may be able to 1991. Originally most famous for its sports channels it has
enjoy the benefits outlined above. However, they will also benefit since branched out into a range of different services, including
from having a greater brand recognition. As a business gets a broadband and telephony.
larger and larger share of the market, customers become more In 2008 RTR’s revenue was £5,200 million. By 2013 it had
aware of the brand name because they see the brand advertised grown to £7,691 million.
and for sale in stores or online. As the brand becomes stronger,
a business may be able to: Figure 3
●● charge higher prices
RTR profit after tax 2008–2013
●● differentiate the product from those of rivals

●● create customer loyalty £ million

●● enhance product recognition 1200
●● develop an image 1000
800
●● launch new products more easily.
600
A business with a larger market share is also more likely to 400
attract media attention, which helps to promote the company. 200
0
Increased profitability -200
2008 2009 2010 2011 2012 2013
One of the main objectives of growth is to make more profit. Year
Larger businesses tend to make bigger profits than smaller
ones. As profits grow, returns to the owners will also grow. For
example, Whitbread, which owns brands including Premier Inn, Figure 4
Costa Coffee, Beefeater Grill and Brewers Fayre, grew its revenue
from £1,599.6 million in 2010–11 to £2,294.3 million in 2013–14 RTR dividends per share 2008–2013
Pence
– a 43.4 per cent increase. During the same time period profit
40
before tax grew by 44 per cent from £287.1 million to £411.8
million. The benefit to shareholders of this growth was significant. 30
Whitbread increased its dividend payment to shareholders from 20
44.5p in 2010–11 to 68.8p in 2013–14. In addition to this, when 10
a company grows, shareholders are likely to see the price of their
shares rise. The Whitbread share price rose by around 300 per 0
2008 2009 2010 2011 2012 2013
cent in five years to just over £53 in April 2015. Year
If a business grows and increases its profitability, it will
have more profit for investment and innovation. This will allow (a) Calculate the percentage increase in dividend payments between
the business to develop and launch new products and make 2008 and 2013.
acquisitions. If these investments are successful the business is (b) Explain one benefit of growth to the shareholders of RTR.
likely to grow even further.

Problems arising from growth

A business that aims to grow must ensure that the growth is Internal diseconomies of scale: Most internal diseconomies
sustainable. It is possible for a business to encounter problems if are caused by the problem of managing large businesses.
it grows too big or too fast. ●● Communication becomes more complicated and co-ordination

more difficult because a large firm is divided into departments.

Diseconomies of scale ●● The control and co-ordination of large businesses is also

If a business expands the scale of its operations beyond the demanding. Thousands of employees, billions of pounds and
minimum efficient scale, diseconomies of scale may result. This dozens of plants all mean added responsibility and more
is where average costs rise as output rises. There are a variety supervision.
of sources of diseconomies of scale. As shown in Figure 1, ●● Motivation may suffer as individual workers become a minor

long-run average costs start to rise once the output of a part of the total workforce. This can cause poor relations
business passes Q* on the diagram. between management and the workforce.

295
Growth Unit 48

●● Technical diseconomies also arise. In the chemical industry, Question 3

construction problems often mean that two smaller plants
are more cost-effective than one very large one. Also, if a In 2014, the large mining company, BHP Billiton, announced
business employs one huge plant and a breakdown occurs, that it would sell off about £15 billion of non-core assets. This
production will stop. With two smaller plants, production was the company’s response to its dwindling productivity. For
can continue even if one breaks down. many years prior to this announcement the whole mining
industry had been increasing the scale of its operations in the
External diseconomies of scale: These may occur from belief that ‘bigger was better’, i.e. that costs would continue to
overcrowding in industrial areas. The price of land, labour, fall as individual mines grew.
services and materials might rise as firms compete for a
limited amount. Congestion might lead to inefficiency, as However, Andrew Mackenzie, chief executive at BHP Billiton,
travelling workers and deliveries are delayed. said that he was worried about diseconomies of scale at
the company. Also, according to a report by consultant EY,
Internal communication individual mining operations were sometimes getting too large
Internal communication is the exchange of messages and the to manage effectively, thereby resulting in lower productivity.
flow of information inside a business – between individual ‘The industry thought that bigger was always going to be
workers or between departments, for example. If a business better and it hasn’t always worked out that way.’ Paul Mitchell,
grows too big there could be a problem with internal global mining and metals advisory leader at EY, observed, ‘It is
communication. The number of layers in the management bad enough [managing a mine] with 100 people on site – with
structure is likely to grow and as a result channels of 1,000 it becomes much more complex.’
communication get longer and the scope for error in the The rapid growth in the size of mines has resulted in several
transmission of messages increases. Distortions to information problems. The cost of resources, such as labour and materials,
may occur is it is passed through the managerial hierarchy. has risen sharply increasing average costs. The EY report
At worst this could lead to misunderstandings and disputes
identified the increased complexity of running larger mines.
between workers and managers. Such disputes are a drain on
It said that very high staff turnover in the industry meant
resources and any cost resulting from a misunderstanding or
that mines were being run by inexperienced managers who
dispute will reduce productivity.
were not being given the resources needed to deal with the
With the rapid development in information and
increased complexity. Executives in the industry said that
communication technology (ICT) some of these problems
communication across departments was poor and that a ‘silo
may have been reduced. For example, any number of people
can be copied into an email so that important messages
mentality’ had developed in some quarters.
can be transmitted instantly to 10,000s of people all over Source: adapted from the Financial Times 20.10.14, all rights
the world. The use of video conferencing might also help reserved
internal communication, where members of staff in different
(a) Explain what is meant by diseconomies of scale and, using the
geographical locations can communicate face to face. example of BHP Billiton, explain why they occur.
However, it might also be argued that IT has also brought
(b) Explain one way in which BHP Billiton has dealt with the problem
a whole new set of communication problems. For example,
of diseconomies of scale.
communications can be seriously hampered when IT
systems fail.
Sometimes resources might be wasted due to a lack Overtrading
of effective communication. One problem that might occur If a business grows too fast there is a danger that it might suffer
is the duplication of resources. This is where two or more from overtrading. This is more likely to happen to young, rapidly
identical activities or projects are being pursued in the same growing businesses. Overtrading occurs when a business tries to
organisation at the same time. For example, the division fund a large volume of new business without sufficient resources.
of a company in the UK may be writing a new grievance As a result it runs out of cash, and at worst, it can collapse.
procedure policy. If another division, say the Australian Overtrading is most likely to occur if a business:
division, is doing exactly the same, resources will be ●● does not have enough capital. It is not uncommon for a new

wasted. Better communication would ensure that only one business to be undercapitalised. This means that it has started
new grievance procedure policy is produced. trading with insufficient capital. It does not have enough cash to
If communication is poor between different departments, buy the resources needed to meet the growing orders
competition between them may have negative effects. As ●● offers too much trade credit to customers. It may be tempting

different departments compete for company resources for a new business to allow its customers 90 or 120 days trade
they may adopt a ‘silo mentality’. This is where individual credit. However, this means that the business has to wait that
departments become reluctant to share information with length of time, or more, to be paid. During this time it will be
others in the organisation. Such behaviour could result in short of cash to buy the resources needed to meet new orders
conflict between departments, stifle development and result ●● is operating with slim profit margins. In order to make an

in missed opportunities and higher costs. impact in the market, a new business may offer its products at
lower prices. However, with lower prices and subsequent lower
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 Business decisions and strategy

profit margins, it may not generate enough profit to fund the Whatever the cause, if a business is overtrading it can run out of
growing volume of business. cash and this threatens its survival. Therefore, growth has to be
managed carefully.

Links
You can demonstrate synoptic skills by linking information on business growth also has important links to the development of multinational
growth to a number of other areas in the specification. For example, companies (Unit 79), corporate strategies (Unit 45), business
you could link business growth to the effects it might have on the objectives (Unit 21), decision making (Unit 54), business ethics
environment or human resources. It is often said that very large (Unit 59), human resources (Unit 62), causes and effects of change
businesses can have a negative impact on the environment. Business (Unit 63), and international trade and business growth (Unit 67).

Case study
ANESCO Some of the funding for the business came from venture
capitalists. One such company is CBPE Capital. It is a leading
In 2010, Adrian Pike and Tim Payne founded Anesco, an private equity firm with eight funds raised over 30 years. CBPE
energy and efficiencies solutions company. Anesco advises likes to invest in companies seeking growth or development
homeowners, businesses – including Whitbread, and local capital, with an enterprise value of up to £150 million. Ian
authorities on renewable energy and energy efficiency Moore, partner at CBPE Capital, said ‘Anesco’s management
products and services. The company provides equipment and team has built a fantastic business and have an unrivalled
financing as well as offering operation and maintenance. knowledge of the sector, as well as a genuine passion for
delivering energy-efficient solutions to their customers. We are
By growing at a rate of 374.3 per cent over three years,
very excited to be working with them to facilitate Anesco’s
Anesco saw its revenue rise from £1 million in 2011 to
growth plans over the coming years.’
£106.7 million in 2014. It was the fastest growing company
in the UK, according to the Sunday Times Fast Track 100 Anesco plans further growth in the future. It expects much
league table. Anesco’s revenue comes from a range of of this growth to come from developing new markets and
business streams covering energy efficiency measures products that will benefit the UK.
including biomass, LED lighting, insulation, battery storage Sources: adapted from www.anesco.co.uk
solutions and domestic and commercial solar installations.
The business was responsible for the installation and
maintenance of one of Britain’s largest solar farms. In 2014 (a) Explain one way in which Anesco might benefit from
this plant generated enough electricity to power 2,000 exploiting financial economies of scale. (4 marks)
homes. Investors in such schemes can get tax breaks and (b) Explain one danger that a rapidly growing company like
subsidies from the government.
Anesco might need to be aware of. (4 marks)
Anesco was the first UK business in the energy efficiency
(c) Evaluate the possible growth objectives of Anesco.
sector to combine different technologies to help meet
customers’ needs. The company understood the (20 marks)
government’s incentive schemes, utility obligations and the
importance of tackling climate change.

Key terms Knowledge check

Diseconomies of scale – rising long-run average costs as a 1. What is the difference between internal and external
business expands beyond its minimum efficient scale. economies of scale?
Economies of scale – the reductions in average costs 2. Explain what is meant by technical economies of scale.
enjoyed by a business as output increases. 3. Explain how a supermarket chain would benefit from
External economies of scale – the cost reductions available purchasing economies.
to all businesses as the industry grows. 4. What is meant by risk-bearing economies?
internal economies of scale – the cost reductions enjoyed 5. Give two possible examples of external economies of scale.
by a single business as it grows. 6. What is meant by the minimum efficient scale of plant?
Minimum efficient scale – the output that minimises long- 7. Give one reason why average costs might start to rise when
run average costs. output is pushed beyond the minimum efficient scale.
8. How can a business enjoy market power over its suppliers?
9. How might internal communication be affected if a business
grows too quickly?
10. What is meant by overtrading?

297
 49 Mergers and takeovers 3.2.2
Theme 3

Key points
1. Reasons for mergers and takeovers.
2. Distinction between mergers and takeovers.
3. Horizontal and vertical integration.
4. Financial risks and rewards.
5. Problems of rapid growth.

●● Buying a business is often cheaper than growing internally.

Getting started A business may calculate that the cost of internal growth is
In 2014, Swedish-based Spotify, the on-demand music £80 million. However, it might be possible to buy another
streaming service, bought The Echo Nest, a Massachusetts- company for £55 million on the stock market. The process
based music data firm. Spotify bought The Echo Nest for its of buying the company might inflate its price, but it could still
technology. The Echo Nest’s core product is a database that work out much cheaper.
stores the characteristics of millions of songs. The data held by ●● Some businesses have cash available which they want to use.
Buying another business is one way of doing this.
The Echo Nest can be used to do things such as recognise and
●● Mergers take place for defensive reasons. A business might
name songs by listening to them, make music recommendations
buy another to consolidate its position in the market. Also, if a
and generate playlists. Spotify hoped to use this technology to
firm can increase its size through merging, it may avoid being
drive its music discovery features and help its partners to build
the victim of a takeover itself.
new music experiences. The purchase was widely reported, with
●● Businesses respond to economic changes. For example,
Daniel Ek, founder of Spotify, commenting that they had been some businesses may have merged before the introduction of
fans of The Echo Nest for a long time and were honoured to the euro in 1999 in certain European countries or before the
have their talented team joining Spotify. expansion of the EU in 2004.
Source: adapted from the Financial Times 06.03.2014. All rights ●● Merging with a business in a different country is one way
reserved. in which a business can gain entry into foreign markets. It
may also avoid restrictions that prevent it from locating in a
What do you think is meant by a takeover? Why has Spotify
country or avoid paying tariffs on goods sold in that country.
bought The Echo Nest? Are there any alternatives to taking
●● The globalisation of markets has encouraged mergers
over another business in order to grow? What problems might
between foreign businesses. This could allow a company to
businesses encounter when taking over another company? operate and sell worldwide, rather than in particular countries
or regions.
●● A business may want to gain economies of scale. Firms can
Reasons for mergers and takeovers often lower their costs by joining with another firm.
Mergers and takeovers take place when firms join together and ●● Some firms are asset strippers. They buy a company, sell
operate as one organisation. Why do some businesses act in off profitable parts, close down unprofitable sections and
this way? perhaps integrate other activities into the existing business.
●● One of the main motives for integration is to exploit the Some private equity companies have been accused of asset
synergies that might exist following a merger or takeover. stripping in recent years.
This means that two businesses joined together form an ●● Management may want to increase the size of the company.
organisation that is more powerful and efficient than the This is because the growth of the business is their main
two companies operating on their own. Synergy occurs objective.
when the ‘the whole is greater than the sum of the parts’,
for example when 2 + 2 = 5. Synergies may arise from Distinction between mergers and
economies of scale, the potential for asset stripping, the takeovers
reduction of risk through diversification or the potential for Both mergers and takeovers are corporate strategies that aim
gains by management. to improve the performance of a business. However, there is a
●● It is a quick and easy way to expand the business. For clear distinction between the two.
example, if a supermarket chain wanted to open another
twenty stores in the UK, it could find sites and build new Merger: A merger is where two (or more) businesses join
premises. A quicker way could be to buy a company that together and operate as one. Mergers are usually conducted
already owns some stores and convert them. with the agreement of both businesses. They are generally
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 Business decisions and strategy

‘friendly’ in nature. The name of the new business is often Once it is known that a takeover is likely, investors scramble
formed out of the names of the two original businesses. For to buy shares, anticipating a quick price rise. Sometimes more
example, one of the biggest mergers that was approved in than one firm might attempt to take over a company. This can
2014 was between Swiss-based cement producer Holcim result in very sharp increases in the share price as the two
Ltd and French cement company Lafarge SA, forming buyers bid up the price.
LafargeHolcim. It was widely reported that the new company An example of a takeover in the UK in 2015 was the
would be the world’s largest cement producer with annual purchase of mobile operator O2 by another mobile operator,
sales over $40 billion. The main reason for this merger was Three. It was reported that the cost of the takeover would be
to help cut costs and cope better with overcapacity and £10.5 billion. The deal would make Three the biggest mobile
weak demand. operator in the UK with around 32 million customers.
Figure 1 shows the number and value of mergers and
Takeover: A takeover, sometimes called an acquisition, acquisitions in the UK from 1988 to 2013. For example, since
occurs when one business buys another. Takeovers among 2003 the value of mergers and acquisitions rose sharply up
public limited companies can occur because their shares are until 2007 and then fell sharply just after. The financial crisis
traded openly and anyone can buy them. One business can followed by the recession was probably responsible for the
acquire another by buying 51 per cent of the shares. Some of rapid decline.
these can be bought on the stock market and others might be
bought directly from existing shareholders. When a takeover Thinking bigger
is complete, the company that has been ‘bought’ loses its
Takeovers can be hostile or friendly. A hostile takeover means that
identity and becomes part of the predator company. Private the victim tries to resist the bid. Resistance is usually co-ordinated by
limited companies, however, cannot be taken over unless the the board of directors. They attempt to persuade the shareholders that
majority shareholders ‘invite’ others to buy their shares. their interests would be best protected if the company remains under
In practice, a firm can take control of another company the control of the existing board of directors. Shareholders then have
by buying less than 51 per cent of the shares. This may to weigh up the advantages and disadvantages of a new ‘owner’. It
happen when share ownership is widely spread and little was reported in 2014 that a hostile takeover bid was made by the
pharmaceuticals company Pfizer for its UK rival AstraZeneca. The bid,
communication takes place between shareholders. In
reported to be worth around £70 billion, was eventually rejected by
some cases a predator can take control of a company by AstraZeneca. The board felt that AstraZeneca could get better returns
purchasing as little as 15 per cent of the total share issue. for the shareholders by remaining an independent company.
Once a company has bought 3 per cent of another company
A takeover may be invited. A firm might be struggling because it has
it must make a declaration to the stock market. This is a legal cash-flow problems, for example. It might want the current business
requirement designed to ensure that the existing shareholders activity to continue, but under the control of another, stronger company.
are aware of the situation. The new company would inject some cash in exchange for control. Such
Takeovers of public limited companies often result in a a company is sometimes referred to as a ‘white knight’.
sudden increase in their share price. This is due to the volume Source: adapted from www.ft.com/indepth
of buying by the predator and also speculation by investors.

Figure 1
Announced mergers and acquisitions in the UK 1988–2013

Number of transactions Value of transactions (in billions, USD)

6,000 1,000
Key 900
5,000 800
Number
700
4,000 Value
600
3,000 500
400
2,000 300
200
1,000
100
0 0
1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Source: www.imaa-institute.org Year

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Mergers and takeovers Unit 49

Question 1 manufacturer might merge with a retail outlet selling bikes. Again
this eliminates the profit margin expected by the firm in the next
In 2015 a communications giant was formed when telecoms stage of production. It also gives manufacturers guaranteed
group BT confirmed that it would buy mobile operator EE for outlets for their output.
£12.5 billion. This takeover would create a company offering
a range of telecommunications services, such as broadband, Question 2
fixed telephony and pay-TV services. BT planned to sell these
In contrast to some other supermarket chains in the industry,
services to those EE customers who did not currently subscribe
Morrisons employs a different approach to its supply chain. It
to BT. It also hoped to speed up the sale of other services to its
has a history of owning suppliers of fresh produce dating back
existing customers. The takeover was subject to approval by BT
to 1970, but recently, through a series of acquisitions, Morrisons
shareholders and scrutiny from the Competition and Markets
has expanded its supply operation. In 2010, it announced that
Authority, and was planned to finalise in up to a year.
it would invest £200 million over three years to grow its supply
The takeover was to result in estimated savings to BT of about chain. In 2011 it bought Derby-based horticulture supplier
£360 million a year in operating and capital costs after four Flower World – which had sales of £34 million in 2010. This was
years. Combining the two businesses could also result in the followed by the acquisition of Vion UK’s meat-processing plant
generation of an extra £1.6 billion a year. However, BT would in Cheshire. Just after that Morrisons bought an empty seafood-
have to raise about £1 billion by selling some fresh shares. BT processing factory in Grimsby. The store also planned several
chief executive Gavin Patterson said, ‘This is a major milestone other acquisitions in the fresh produce industry.
for BT as it will allow us to accelerate our mobility plans and
A spokesperson explained that owning suppliers gave Morrisons
increase our investment in them.’
more control over quality and cost. Morrisons was trying to get
Source: adapted from the Financial Times 05.02.2015. All rights a competitive edge over its rivals by having the freshest produce
reserved. available. The approach also helped to reduce waste in the
(a) Explain what is meant by a takeover, using the communications supply chain. It was possible that Morrisons would adopt this
industry as an example. approach in non-food products. For example, Morrisons’ clothing
(b) Explain one reason why BT has taken over EE. director, Tim Bettley, said that the retailer may consider acquiring
a clothing manufacturer to support its new Nutmeg brand.
The key advantages of Morrisons’ approach are summarised
Horizontal and vertical integration below.
Integration is when businesses join together to form one. It
can be classified in a number of ways, although not all mergers • Higher profit margins by owning the product from source to
and acquisitions fit neatly into these categories. customer.
Horizontal integration occurs when two firms that are • Greater control over price and product quality.
in exactly the same line of business and the same stage of • Less waste.
production join together. The merger described above between • Faster lead-time.
the two cement producers, Lafarge SA and Holcim Ltd, is • New opportunities for product development.
an example of a horizontal merger. The benefits of mergers • Improves its image in its support for British farmers.
between such firms include:
However, some of the possible drawbacks of the policy might be
●● a common knowledge of the markets in which they operate
as follows.
●● less likelihood of failure than merging two different areas of

business • High capital outlays for acquisitions and research.

●● similar skills of employees • More difficult to manage businesses that are in different
●● less disruption. stages of production.
Vertical integration occurs when firms in different stages • Loss of flexibility, for example Morrisons cannot switch
of production join together. Forward vertical integration is suppliers if needed like rivals can.
where a business joins with another that is in the next stage of • Increased pressure on company resources as Morrisons is
production whereas backward vertical integration is where a also committed to developing online business and opening
business joins with another in the previous stage of production. convenience stores.
Consider a business that manufactures and assembles Source: adapted from www.retailtimes.co.uk
mountain bikes. If it bought a supplier of tyres for the bikes, this
would be an example of backward vertical integration. The two (a) Explain what is meant by vertical integration, using the
firms are at different stages of production. The main motives for supermarket industry as an example.
such a merger would be to guarantee and control the supply of (b) Explain one advantage to Morrisons of vertical integration in this
components and raw materials, and to remove the profit margin case.
the supplier would demand. Forward vertical integration involves (c) Explain one possible drawback to Morrisons of vertical
merging with a firm that is in the next stage of production integration in this case.
rather than the previous stage. For example, the mountain bike
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 Business decisions and strategy

Financial risks and rewards Despite these financial risks, companies are happy to pursue
Mergers and takeovers are common corporate strategies. They takeovers and mergers if the conditions are deemed right. This
allow businesses to grow quickly and may create benefits for a is probably because the rewards are potentially high.
range of stakeholders. However, they can sometimes go wrong
and may have a negative long-term impact on a business. Some Speedy growth: Businesses can grow far more quickly
of the key financial risks are outlined below. through mergers and takeovers than growing internally. This
means that the benefits of growth, such as larger market share,
Regulatory intervention: Mergers and takeovers in the UK lower costs resulting from economies of scale, more market
may attract the attention of the Competition and Markets Authority power and higher profitability, can be enjoyed more immediately.
(CMA). If they think that a merger or takeover acts against the This might benefit a range of stakeholders.
interests of the consumer, they have the power to order an
investigation. This takes time and may cause delays. After the Higher remuneration for senior staff: After a merger or a
investigation, the CMA has the power to recommend that the takeover it is likely that executives’ salaries will rise because they
merger be blocked. Alternatively, they may allow a merger or are now responsible for running a much bigger business. There
takeover to go ahead, but with certain conditions. The Lafarge may also be bonus- or performance-related payments if part of
Holcim merger was only permitted after the companies agreed to the remuneration package is linked to growth rates.
sell off assets around the world. The EU directed Lafarge to sell
all of its German and Romanian business activities and instructed Rewards to previous owners: Quite often the owners of
Holcim to unload all of its Slovak business and most of its activities the business that is taken over get significant financial rewards
in France. Delays in proceedings and undertakings, such as the when the business is sold. For example, in 2014 Synergy Health,
sale of assets, take time and cost money. a British outsourcing company, was taken over by US company,
Steris Corporation. Just before a bid was made, shares in Synergy
Resistance from employees: In some cases, mergers Health were trading at £14. Steris said they would pay £19.50 per
and takeovers result in job losses. This is because when two share to take over the company. Consequently, shareholders make
companies join together certain resources are likely to be an immediate 39 per cent gain on completion of the takeover.
duplicated. For example, after a merger the single company will
probably not require two head offices. Therefore one can be Increased profitability: If a merger or takeover is
closed down, which will result in job losses. If job losses are on successful, future revenues will be higher because market share
a large scale, employees are likely to react. They might disrupt will be higher. In addition, costs will be lower if economies of
proceedings, for example by going on strike. scale can be exploited. As a result, in the long-term profits
should rise. If the merger or takeover results in a significantly
Integration costs: After a merger or takeover has been agreed, larger business, it may be able to dominate the market and
the next step is to physically integrate the two organisations. This generate even bigger profits.
can be a very complex, expensive and time-consuming process,
the effects of which may be felt for many years. Some of the costs
Problems of rapid growth
Businesses that use external growth strategies are usually trying
incurred result from the organisational and personnel changes,
to grow rapidly. Unfortunately, there is risk associated with this
severance pay for dismissed workers, technical changes, systems
and some mergers and takeovers actually fail. In this case failure
changes, training and many others. It is not uncommon for
probably means that outcomes did not match expectations.
businesses to underestimate these costs and encounter problems
However, occasionally failures can be quite spectacular. For
when carrying out the consolidation process. For example,
example, some have argued that the merger of the Britannia
merging two different cultures can be particularly problematic.
Building Society and the Co-operative Bank in 2009 should
never have happened, given that it almost led to the collapse of
Bidding wars: In a minority of cases it is possible that one
the Co-op Bank. A report by Sir Christopher Kelly said that both
business attracts more than one potential buyer. If this happens
the Co-op Bank and Britannia had problems at the time of the
the price of the acquisition will start to rise, as it would do
merger.
in an auction. This makes the takeover more expensive. One
Companies that pursue growth through mergers and
example of this in 2014 was the takeover of the American
takeovers have to be cautious. In some cases, if growth is too
food company Hillshire Brands Co. by Tyson Foods Inc. Earlier,
rapid serious problems might be encountered. Some examples
another company, poultry producer Pilgrim’s Pride, had made an
are outlined below.
offer of $6.4 billion for Hillshire. However, within 48 hours Tyson
offered $6.8 billion. Pilgrim then raised its bid to $7.7 billion,
but this was outstripped by Tyson’s further bid of $8.55 billion,
Drain on resources: Mergers and takeovers can cost a lot
of money. For example, Three spent £10.5 billion buying O2 in
which was finally accepted by Hillshire. This case helps to show
2015. In the US in 2012 Google paid $12.5 billion for Motorola
how the cost of a takeover can escalate when more than one
and in 2014/15, Actavis, the Ireland-based drug-maker, bought
business is interested in a target. The overall price rose from
Allergan, the maker of botox, for a huge $66 billion. These are
$6.4 billion to $8.55 billion, an increase of 33.6 per cent.
clearly very large amounts of money and companies that spend

301
Mergers and takeovers Unit 49

such sums on mergers and takeovers have to be very well

resourced. If a company grows too rapidly by embarking on an
aggressive acquisition trail, it may stretch financial resources and
impair other aspects of the business.

Coping with change: When businesses merge, the integration

process can be challenging because lots of changes have to
be made. One of the main difficulties is merging two different
cultures. It can be very difficult to impose a new culture on a
business and there may be resistance. If changes are forced
through too quickly, without proper consultation for example,
this resistance is likely to be stronger. Such problems are
likely to be more intense if growth is too rapid and firms are
combining two different cultures too quickly.

The alienation of customers: Companies that are growing

too fast might lose touch with their customers. Too much
attention and resources get focused on the process of growth.
As a consequence the needs of customers can be overlooked.
For example, after a takeover or merger the name of a business
may change; some consumers may be confused by this,
Key terms
wondering what the new name stands for and what values might Backward vertical integration – joining with a business in
be attached to it. Ultimately this could damage the image of the the previous stage of production.
company and result in the loss of customers. Forward vertical integration – joining with a business in the
next stage of production.
Loss of control: If growth is too rapid the company might get Horizontal integration – the joining of businesses that are in
too big too fast. This can result in a loss of control by the senior exactly the same line of business.
executives. With a bigger organisation come extra layers of Integration – the joining together of two businesses as a
management. This may lengthen communication channels and result of a merger or takeover.
impact negatively on the chain of command. As a result costs Merger – occurs when two (or more) businesses join
may start to rise as diseconomies of scale set in. together and operate as one.
Shortages of resources: A rapidly growing business will be Synergy – the combining of two or more activities or
thirsty for resources. As a result demand for these resources businesses creating a better outcome than the sum of the
may drive up prices. This may happen when there is a shortage individual parts.
of skilled labour and wages are driven up, for example. Takeover – the process of one business buying another.
Vertical integration – the joining of two businesses at
Exam tip
different stages of production.
When answering questions on mergers and takeovers it is
important not to get too carried away with the potential benefits.
You must provide a balanced answer and remember that there are Knowledge check
some significant problems with this strategy. Try to remember that
according to the KPMG report in 2013, 90 per cent of mergers 1. Give three reasons why two businesses might choose to join
and takeovers actually fail. What failure means may be open to together.
debate, but it is an important issue. 2. Give two examples of horizontal integration.
3. Give an example of forward vertical integration in the car
Links industry.
Many businesses pursue growth through mergers and takeovers. To 4. Give an example of backward vertical integration in the
demonstrate your synoptic skills you could link answers on this topic airline industry.
to a range of other areas covered by the specification. For example, 5. Briefly explain how an acquisition is carried out.
when discussing multinational businesses you might add to your 6. Give an example of a problem that a business might
discussion the role played by mergers and takeovers in becoming encounter when integrating two organisations.
a multinational. You may connect this unit with others in the book
such as Marketing strategy (Unit 13), Business failure (Unit 36), 7. Explain one financial reward of a merger or takeover.
Production, productivity and efficiency (Unit 37), Legislation (Unit 8. Why might job losses result from a takeover or merger?
42), Corporate objectives (Unit 44), Theories of corporate strategy 9. Explain one financial risk of a merger or takeover.
(Unit 45), Growth (Unit 48), Business ethics (Unit 59) and Reasons 10. Outline two problems of rapid growth.
for global mergers or joint ventures (Unit 74).

302
 Business decisions and strategy

Case study
to take commissions from supermarkets or music services for
DIXONS CARPHONE pre-installing their apps on smartphones. Dixons Carphone
wanted to develop an end-to-end service, from sales to set-
up advice, service, insurance, repairs and recycling.

In 2014, it was reported that Dixons Retail, owner of The deal was also put together as a means of competing
Currys and PC World, would merge with the mobile phone with rapidly growing online rivals, such as Amazon and
retailer, Carphone Warehouse. The new company would AO.com. Electrical retailers are in danger of following the
be called Dixons Carphone and the £3.8 billion deal would declining sales of physical book and music stores. Comet was
be shared equally between the two sets of shareholders. recently pushed into receivership, while Carphone’s short-
The combined group would own around 1,300 stores in lived attempt to sell electrical products with Best Buy ended
the UK and almost 3,000 worldwide with potential annual in failure.
revenues of over £10 billion. It was reported that the merger would generate annual
The newly formed company planned to branch out into savings of around £80 million after three years. The effect
domestic heating, lighting and security services – all on jobs was reported to be positive with an increase overall.
controlled by mobile phone. It was also felt that the Dixons Carphone said it would cut about 800 of its combined
combined force would benefit from greater buying power workforce in a rationalisation process to reduce costs.
and a wider range of growth options. For example, it hoped However, it said it would add 1,600 jobs to exploit growth
to sell the combined broadband, pay TV and phone services opportunities.
offered by operators such as BT and Virgin. It also planned Some saw the merger as one step closer to a connected
world, while others felt there were still too many stores in
the UK trying to sell phones and fridges. David Alexander,
consultant at Conlumino, said: ‘Although there are plenty of
reasons to view the merger in a positive light, the history of
mergers and acquisitions is littered with the corpses of failed
unions . . . Carphone Warehouse itself is no stranger to this,
having seen its partnership with US electronics giant Best
Buy in 2008 peter out three years later in the face of intense
competition from Dixons.’ Another analyst, Louise Cooper,
said there would be ‘much scepticism’ about the idea that the
merger would produce better growth.
Shares in both companies fell after the announcement.
Dixons’ share price closed down 10.3 per cent after the news
and Carphone Warehouse’s dropped 8 per cent.
Source: adapted from the Financial Times, 15.05.2014. All
rights reserved.

(a) Explain one reason for the merger between Dixons Retail
and Carphone Warehouse. (4 marks)
(b) Evaluate the possible financial risks and rewards of the
Dixons Carphone merger. (20 marks)

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 50 Organic growth 3.2.3
Theme 3

Key points
1. Distinction between inorganic and organic growth.
2. Methods of growing organically.
3. Advantages and disadvantages of organic growth.

Getting started is normally much slower. It takes time to develop and grow a
business using its own resources.
Co-wheels is a national car club that operates as a social Another difference is the potential risk involved in the two
enterprise. It provides a network of community car clubs different strategies. It could be argued that organic growth is
across the UK. Members can access cars on a ‘pay by the hour’ a safer strategy because owners expand their businesses by
basis without any of the costs or inconveniences of owning a car. developing their current expertise. They may be growing by
After joining the club members are issued with a smartcard that ‘doing more of the same’. There is not much risk involved in this
allows them to book cars online or by phone. strategy. In contrast, growing through mergers or acquisitions
has risk attached because when two organisations are brought
Co-wheels has grown organically (without mergers or takeovers)
together the integration process can create problems. For
and in 2015 had over 350 vehicles and a turnover of £2 million.
example, there may be a clash of cultures, which could result in
2014 saw a big expansion both in service provision and in staff, conflict, delays and instability.
bringing car clubs to new locations and increasing the fleet size. In the early stages of business development, after the initial
Co-wheels plans to develop the club further across more areas. launch and ‘settling down’ period, most owners pursue organic
It has already developed an electric bike hire operation and growth strategies. Entrepreneurs are likely to be cautious
offers wheelchair accessible vehicles for the social care sector. It and grow their businesses gradually, perhaps by selling more
also plans to launch the world's first fully hydrogen powered car products to existing customers or by trying to attract new
club vehicles in Aberdeen. customers. However, once business owners have built up their
Source: adapted from Co-wheels car club Community Interest confidence and generated some cash, they may be tempted to
Company, www.co-wheels.org.uk speed up growth by making acquisitions.
What might be two possible advantages to a business like
Co-wheels of growing without mergers and takeovers? What
Methods of growing organically
Organic growth usually involves a business growing by building
might be the disadvantages of this approach to growth?
on its strengths to increase sales. However, there are several
different approaches to growing organically.
Distinction between inorganic and
organic growth New customers: Perhaps the easiest approach is to rely
Unit 49 looked at how businesses can grow using mergers on driving sales from existing activities. For example, a food
and takeovers. This type of growth is called external growth or processing company supplying local shops may gradually
inorganic growth. It involves businesses joining together so that step up production to supply more and more customers. If
theoretically they might double in size overnight. For example, the factory reaches full capacity, the business can carry on
when the Finsbury Food Group took over Fletchers Group, the growing organically by building an extension or moving to
fresh and frozen bakery supplier, for £56 million in 2014, it was larger premises. It may be possible to find new customers
expected to nearly double sales from £175 million to £300 million. by exploiting new distribution channels. For example, the
In contrast, internal growth or organic growth occurs food processor above may start selling to supermarkets. This
when a business grows naturally by selling more of its output approach to growth may need investment in marketing to
using its own resources. For example, Fog Creek Software is increase the customer base.
a US company owned by its employees. It develops project
management tools and has been growing organically since it New products: Some businesses grow by developing new
was set up in 2000. It has built itself gradually by gaining more products. They may be very innovative and committed to
customers and consultancy work. In 2014 it employed over research and development. For example, a business that designs
40 people and generated a substantial income. software for computer games can grow by designing new
One of the key differences between the two growth games. Alternatively, a business might identify customers with
strategies is speed. Inorganic growth is much faster. As the slightly different needs. This could require adapting or modifying
example above shows, it is possible to instantly double in size existing products to meet these needs. A business might need
as a result of joining with another business. Organic growth to invest some of its profit into product development.
304
 Business decisions and strategy

New markets: Some businesses grow organically by finding Advantages of organic growth
new markets for their products. For example, a hairdresser The benefits of organic growth are numerous. Entrepreneurs
could open another salon in a different location. The assets, should know their business ‘inside out’ and grow their company
systems and working practices used in the original salon can be by exploiting its own strengths and expertise. They can move
replicated in another location. New premises can be adapted and quickly, for example by adapting to changes in the market.
refurbished in the style that has already been successful. Some Entrepreneurs can experience the satisfaction of seeing their
businesses may look to overseas markets to grow. However, business develop and flourish. They can also choose the pace of
this approach carries more risk because of the unfamiliarity of growth – a rate that is comfortable for their own personal needs.
markets abroad. Growing by selling in new areas is sometimes Eventually, owners may choose to sell the business and cash in
called geographic expansion. For example, it was reported that on their investment and hard work. Some specific advantages
in 2014 the UK fashion retailer, New Look, planned to expand are outlined below.
to China. Opening with two stores intially, it then hoped to have ● Organic growth might be less risky than other growth
between 15 and 20 stores in Beijing and Shanghai. strategies. Growth can be achieved by extending practices
that are well known and understood. This can prevent errors,
New business model: It is possible to grow organically by as the culture, norms and practices of the business are
using a new business model. Developments in technology or already established and effective. Organic growth can also
social change may give rise to such a step. For example, a avoid the complications that might arise when integrating with
retailer selling children’s toys may start an online operation. This another organisation.
approach could see the business grow very quickly because the ● Growing organically might be relatively cheaper than using
size of the potential market opened up could be considerable – other methods. Organic growth can be financed from retained
possibly global. profit, which is likely to be the cheapest of all sources of
finance. There will be an opportunity cost, but the financial
Franchising: To speed up organic growth a business might cost can be zero. Businesses that grow inorganically often
set up a franchising operation. This approach allows other have to borrow money or raise fresh capital. This will add to
entrepreneurs to trade under the name of the original business. the costs of growth. Organic growth also avoids the premium
The fast-food outlet SUBWAY is an example of a business that prices that can be paid when buying other businesses.
has used this method to grow. Franchising is discussed in detail
in Unit 22.

Question 1

Figure 1
Sales revenue for APPicon 2010–2014

£
300,000
250,000
200,000
150,000
100,000
50,000
0
2010 2011 2012 2013 2014
Year

Rufus Storm owns a business called APPicon, which designs icons to increase revenue. In the future Rufus wants to carry on
for apps. He set up APPicon after graduating from art school in growing the business organically. The success of the business
2010. He worked alone at home for two years, but after early is reflected by the sales data shown in Figure 1.
successes he opened up an office in Cambridge. Since then he has
(a) Explain what is meant by organic growth, using APPicon as
taken on four staff. He has designed 25,000 icons that might be an example.
used for apps. However, now that the business is established he
(b) Explain two ways in which Rufus might continue to grow his
is getting enquiries from app developers that want tailor-made business organically in the future.
designs for their icons. This work is more lucrative and is helping

305
Organic growth Unit 50

● A business will retain more control when growing organically. ● As a business grows it may be able to exploit economies of
Owners, or the senior management team, will have complete scale. However, if a business is growing organically it may take
control of the growth process because there are no outsiders some time before such economies are fully exploited. This
with any controlling interest. For example, if a retail chain is could mean that a business is having to operate with higher
growing by opening a new store in a new location every six costs for longer periods of time. This could lower profit margins
months, the business is likely to have a team of employees and make it less competitive. Also, some lines of business, such
who are experienced at opening new stores. They can go in, as shipbuilding, require investment in large-scale production
recruit and train new staff, and ensure that the store is run before trading can begin. Businesses that grow organically may
in the way that has proved a success in the past, then move be prevented from entering such industries.
on to the next. This approach means that the business has ● If a particular market is growing rapidly, organic growth may
full control and is much easier to organise. If growth were not be appropriate. For example, when mobile telephones
achieved by joining with another business, some control were first introduced, the market expanded very quickly.
would be lost because the other organisation will probably Businesses making the best progress were those that were
want to retain some control of its own. growing through mergers or acquisitions. The three firms
● The financial position of a business might be better protected now remaining in the UK market are all the result of multiple
with organic growth. Since growth is gradual, there is less takeovers and mergers.
strain on financial resources. As a result, cash flow is stronger
and the business will retain more liquidity. Inorganic growth Exam tip
often requires huge outlays of money. For example, the You need to remember that companies may use organic and
inorganic growth strategies together to increase the size of their
purchase of O2 by Three was reported to have cost
businesses. It does not have to be a straight choice between one
£10.5 billion. Such high expenditure can put financial pressure or the other. For example, a supermarket chain may grow
on the business. organically by opening brand new stores in new locations, and
● A business that grows organically is less likely to encounter inorganically at the same time by acquiring another chain.
diseconomies of scale. Sharp increases in unit costs are not
likely to occur if growth is steady and measured. It may be
easier for a business growing organically to spot in advance Links
possible difficulties resulting from scale increases. This will Organic growth is an example of a growth strategy. The information
help to keep costs under control. in this unit could be used when discussing issues in exam questions
such as Business objectives (Unit 21), Corporate objectives (Unit 44),
Disadvantages of organic growth Theories of corporate strategy (Unit 45), Growth (Unit 48), Causes
Although there are advantages of organic growth, there is the and effects of change (Unit 63), Key factors in change (Unit 64) and
argument that it prevents a business from reaching its full potential. International trade and business growth (Unit 67). For example, in a
It may miss out on lucrative opportunities and get left behind in the question on choosing an appropriate corporate strategy for a business,
market. Some specific disadvantages are outlined below. organic growth might be one of the options. Or, in a question on key
● The pace of organic growth may be too slow for some factors in change, a decision to grow organically might be a reason
stakeholders. For example, shareholders in a plc may want why changes are necessary. In a question on business objectives,
the business to provide quicker returns on their investments organic growth might feature as a possible option.
than organic growth can deliver. If shareholders are unhappy
with the current pace of growth they may sell their shares. As
Key terms
a result the share price can fall, possibly making the company
vulnerable to a takeover. Inorganic growth – a business growth strategy that involves
● Organic growth may prevent the business from ‘tapping into’ two (or more) businesses joining together to form one much
the resources owned by other businesses. As a result it might larger one.
miss out on some profitable developments. For example, a Organic growth – a business growth strategy that involves a
construction firm might want to develop expertise in energy- business growing gradually using its own resources.
saving technology so it can build more houses with solar
panels. It could do both of these by gradually developing Knowledge check
its own expertise. However, it might be better for it to buy
a company that already has a proven track record in these 1. What is the difference between organic and inorganic growth?
fields rather than trying to acquire this expertise from scratch. 2. Why are businesses likely to grow organically in their early
Such companies will be specialists and can provide the stages of development?
knowledge and experience required by the housebuilder. 3. Outline two methods of growing organically.
● Growing slowly may mean that a business gets left behind
4. Why is organic growth likely to be slower than inorganic growth?
in the market. If competitors are growing through mergers
5. Why is organic growth less risky than inorganic growth?
and acquisitions, the business may end up feeling small in
comparison. As a result it may lose its ability to compete 6. Why might a business growing inorganically experience
effectively. For example, it may not be able to match the higher costs than some of its rivals in the market?
advertising budgets of its larger rivals. 7. How might shareholders in a plc feel about organic growth?
306
 Business decisions and strategy

Case study
Their continual growth and commitment has been
THE CAR FINANCE supported by industry recognition and multiple awards,
including the Consumer Credit Team of the Year at the
COMPANY ICM British Credit Awards. Also, as a testament to its
commitment to customer care, it has one of the highest
According to the Sunday Times Fast Track 100, The Car customer renewal rates in the industry.
Finance Company was the second fastest growing company in A combination of being attractive to consumers, technology
the UK in 2013. Founded in 2007, The Car Finance Company deployment and leading underwriting and customer
has grown to become Europe’s leading alternative lender by services allow The Car Finance Company to have the
serving a sector of the community ordinarily excluded from highest approval to deal conversion rates. The Car Finance
mainstream financing. Company has become the preferred partner by providing
What makes The Car Finance Company the preferred choice consistent, predictable and fast credit decisions along with
in the market is their approach to customers, treating them tailored and flexible funding options which enable access to
fairly and putting their needs first. The Car Finance Company the large sector of the population ordinarily excluded from
considers every application, no matter what the customer’s mainstream financing.
credit history, and accept more than 50% of all applicants. In 2015, the company planned to explore further
This unique approach allows partners to sell more cars. opportunities within the market, with a view to continuing
The Car Finance Company has provided loans to over to grow its market share.
30,000 customers who have been denied access to Source: adapted from www.thecarfinancecompany.co.uk
mainstream credit. They finance nearly 2,000 customers
every month which is set to rise to 3,000 by December
2015. The business also helped customers rebuild their
credit rating and get back on track after financial difficulties. (a) Explain the main method used by The Car Finance
Customers are referred to The Car Finance Company Company to grow. (4 marks)
by partners such as car dealers and finance brokers or (b) Evaluate the advantages to The Car Finance Company if it
customers apply directly via the company website continued to grow organically. (20 marks)
www.thecarfinancecompany.co.uk.

307
 51 Reasons for staying small 3.2.4
Theme 3

Key points
1. Small business survival in competitive markets:
●● product differentiation and USPs
●● flexibility in responding to customer needs
●● customer services
●● e-commerce.

Getting started Reasons for staying small

Despite the advantages of large-scale production, many firms
choose to remain small. Also, small firms sometimes have
advantages over larger ones.
●● Personal service. As a firm expands it becomes increasingly

difficult to deal with individuals, rather than departments

or automated systems. Many people prefer to do business
with the owner of the company directly and are prepared
to pay higher prices for the privilege. For example, people
may prefer to deal directly with one of the partners in an
accountancy practice. This is discussed in more detail later.
Many businesses serve niche markets. It is usually easier for a
business to deliver a personal service in such circumstances.
For example, Rolls-Royce cars are sold to a select number
of exclusive buyers. It was widely reported that in 2014 they
sold 4,063 cars worldwide (this was the highest number in
its 111-year history). In addition to the high quality of their
vehicles, Rolls-Royce emphasises the quality of their personal
service. A record number of customers spent personal one-
on-one time with Rolls-Royce bespoke design consultants in
2014, commissioning their personalised vehicles.
●● Owner’s preference. Some entrepreneurs may be content

with the current level of profits, for instance remaining below

the VAT threshold to avoid the administrative burden of
increased correspondence with HMRC. Some will want to
The brewing industry in the UK is dominated by a few very avoid the added responsibilities that growth brings.
●● Flexibility and efficiency. Small firms are more often flexible
large producers. 170 new breweries started up in the UK in
2013/14. There were 1,285 breweries operating in Britain in and innovative. They may be able to react more quickly to
changes in market conditions or technology. Management
2014. One of these small brewers is Smith's Brewery, a family-
can make decisions quickly, without following lengthy
run business, which brews traditional, handcrafted quality
procedures. This is discussed in more detail later.
beers and supplies local pubs and retail outlets. The brewery
●● Lower costs. In some cases, small firms might have lower
also supplies individuals. It is possible to ring the brewery and costs than larger producers in the same market. For example,
place an order with the owner. The brewery will deliver it to large firms often have to pay their employees nationally
a customer’s home or venue. Upon arrival the deliverer will agreed wage rates. A small firm may be able to pay lower
set up the barrel, give advice on storage and dispensing, and wages to non-union workers.
answer any questions. When the barrel is finished the brewery ●● Low barriers to entry. In some types of business activity,
will collect it. such as grocery, gardening services, window cleaning and
Explain how a small brewer like Smith’s Brewery can survive many online businesses, the set-up costs are relatively low.
alongside a multinational company like Heineken. How does There is little to stop competitors setting up in business.
●● Small firms can be monopolists. Many small firms survive
Smith’s Brewery offer a personal service? Do you think this
because they supply a service to members of the local
small brewery will survive in the future? Give reasons for
community that no other business does. People often use
your answer.
their local shop, for instance, because it provides a convenient,
nearby service, saving them the trouble of travelling.
308
 Business decisions and strategy

small firm may be able to bring a new product to the market

Product differentiation and USPs more quickly because there will be fewer people involved
Even in competitive markets that might be dominated by large
in its creation. A larger company will involve many people,
businesses, it is still possible to flourish operating as a small
departments and processes in product development. This
business. One way to survive in this situation is to differentiate the
slows down the process. A large corporation may have to
product or develop a USP. If a small business can offer customers
gather, analyse and evaluate information, consider multiple
something that their larger rivals do not, survival is possible.
options and gain multiple approvals before the process is
People often prefer to buy products that are different from the
complete. By which time the advantage of ‘first mover’ may
majority of others on the market – products that ‘stand out from
be lost. This can be important in a world where the pace of
the crowd’. Some examples from 2015 are outlined below.
change seems to accelerate all of the time.
●● The banking industry in the UK is dominated by a few very
●● Sometimes a customer may have a special request. Small
large banks, including HSBC, NatWest, Lloyds, RBS and
businesses are often able to cater for such requests because
Barclays. However, a number of small businesses have
they do not have rigid systems. For example, a large car
entered the market by offering peer-to-peer lending. These
dealership may have a rigid car finance agreement that
small businesses allow individuals to lend money to other
requires customers to repay what they owe in fixed monthly
individuals using an online site. Lenders get higher interest
instalments over a fixed period of time. A small dealer may
rates than banks offer and borrowers can often get loans
accept variable payments or allow customers to pay off what
when they have been refused by banks.
is owed before the agreed time period is up.
●● In the confectionery industry, which is dominated by some

huge companies, such as Cadbury, Mars and Nestlé, small Customer service
firms co-exist by developing a USP. Starting in the US, a Offering high-quality customer service is a way of adding value
business called Mast Brothers flourishes by selling hand- to products. It can also give firms a competitive edge in a market
crafted chocolate. They make every bar themselves including and allow smaller firms to survive in markets dominated by large
the packaging. Rick and Michael Mast also travel to source corporations.
their own cacao, and then ship the beans back. This may ●● It is a lot easier for a small business than for a giant
seem an unusual approach but the story of their commitment corporation to offer customers a personal service. This
to craft is a USP. can sometimes give a small business a competitive edge.
●● In retailing, small specialists may be able to offer more Because customers attach value to dealing directly with the
product choice than larger rivals. For example, a small toy owner of a business, the business can charge a premium for
shop specialising in the sale of working model aircraft, this. A simple, friendly greeting with a handshake from the
helicopters, cars, trains and boats could offer a huge range of owner of an independent restaurant upon arrival is something
different makes and models. It may also offer a wide range of that a large restaurant chain can rarely match.
related accessories, such as engines, spare parts, lubricants, ●● Small retailers may have a geographical advantage over their
batteries and chargers. A large toy chain store is not likely larger rivals. For example, a local grocer offers convenience
to offer such a wide choice in this product range, so the for customers – they do not have to travel far for their
specialist has an advantage. shopping. Local businesses also get to know their customers.
They may carry stock lines to cater for individual needs or
Flexibility in responding to customer help carry shopping to the customer’s car. An out-of-town
needs superstore is not likely to offer this level of customer service.
Small firms can survive alongside larger ones by offering customers ●● Communications in smaller organisations may be more

flexibility. Small and nimble businesses are often quick in identifying effective than those in giant corporations. For example,
new opportunities and meeting the changing needs of customers. customers trying to contact someone in a position of authority
Large corporations are often hampered by a complex organisational in a large corporation will often be met with an automated
structure where approval for a business decision can take days, or answering machine. Such systems often lack flexibility
even longer. Smaller firms are not constrained in this way – in this and have a habit of directing customers into a labyrinth of
case their size can be their strength. recorded messages where it is seemingly impossible to get
●● Smaller businesses can often make changes to customer access to someone who has the expertise and authority to
orders even though a start has been made on production. deal with a specific problem. In a small business it might be
For example, a small housebuilder may be able to change possible to get straight through to the owner of the business,
the design and specifications on a new house as it is being where an issue can be addressed and resolved immediately.
built. The customer may decide that triple-glazed windows are ●● It is often said that customer care is about building

preferred to double-glazed and that a swimming pool is now relationships with customers. It is a lot easier for small
required in the back garden. A large housebuilding corporation businesses to do this because they are usually closer to their
committed to building, say, 50 houses on a particular site may customers. Also, with the use of social media, businesses
not be able to accommodate such changes. can get instant customer feedback. What is more important,
●● A small business can often respond to changes in external though, is responding positively to that feedback. Small
factors, such as shifts in customer needs, exchange rates businesses may be able to do this more effectively because
or legislation, more quickly than larger rivals. For example, a they are closer to their customers.
309
Reasons for staying small Unit 51

Question 1 E-commerce
Developments in technology mean that it is not difficult to set
up an online business. It could be argued that e-commerce
helps smaller firms to compete more easily with larger firms.
If a website is attractive and professionally presented, it may not
be possible to distinguish whether the trader is large or small.
Barriers to entry are small, with it being possible to set up a site
for little cost. Many online businesses are initially run from home,
which eliminates the need to find business premises. For around
£2,000 new online traders can buy a package that includes web
design, domain name registration and arranging hosting of the
website by an internet service provider.
●● Online shops. In this simple model, small online retailers

can compete alongside larger businesses quite effectively.

For example, Naked Wines is an online wine retailer. It was
founded in 2008 and has been able to compete effectively
with the retail giants. It is reckoned that 38 per cent of
people in the UK buy their online wine from just three stores
– Tesco, Sainsbury’s and Asda.
●● Social media consultants. There are a growing number of

these businesses delivering online services. Large companies

can often afford to employ their own staff to operate their
Helen and David Watson run their own nursery business in Facebook and Twitter accounts. However, smaller businesses
Banbury, Oxfordshire. The couple met when they were at college might need the help of a specialist, such as Carvill Creative.
fifteen years ago. Since then they have both worked with children This business helps those starting out with social media who
in the NHS and have got married and had three children of might need support with set-up and social network creation.
their own. The nursery is profitable and both Helen and David There are even websites that can help set up a business as a
enjoy looking after people’s children while they are at work. The social media consultant, such as Shawn Christenson’s ‘More
business serves the local area and employs three other staff. Than a Webmaster’ site. Social media is now very important
The Watsons have no ambition to expand their business at the to businesses. The Pew Internet Social Networking study
moment. They earn enough money to support their lifestyle. found that in January of 2014, 76 percent of women and
They can also spend more time with their own children and do 72 per cent of men who use the internet also use social media.
not want the extra work and responsibility that expanding a ●● Information and advice sites. Some small online

business would bring. businesses make money by providing information and advice
or bringing people together who have common interests.
Last year a leading national provider of nursery care opened
Some people run businesses by setting up blogging sites.
up a centre just 500 yards from their business. However, the To generate revenue from sites like these it is necessary to
impact was virtually zero. Helen and David are well known and build up high volumes of traffic. Once this is achieved money
trusted in the area. They do not advertise and their business is can be earned from selling banner advertising, using AdSense,
generated through ‘word of mouth’. They offer a very personal affiliating to large sites such as Amazon or eBay, and offering
service. For example, they will collect children and return them if premium services that people are willing to pay for.
parents occasionally have transport difficulties, they are on first ●● Tutoring, training or mentoring. These types of
name terms with all their customers and will sometimes look businesses could teach a foreign language, offer marketing
after children at weekends. training, help to improve writing skills or help deliver
(a) Explain one reason why this business is likely to remain small. academic courses. One approach is to offer a free service
now and build a ‘freemium’ model (offer free accounts with
(b) Explain one reason why Helen and David’s business was not
limited features, then charge for upgrades) for the future, in
affected when a larger rival set up close by.
order to generate cash.

310
 Business decisions and strategy

Thinking bigger • Increasing numbers of people over the age of 65 have gone into self-
Since the 1990s there has been a growth in the number of small employment. Between 2008 and 2014 this number doubled. One
businesses in the UK. This growth has accelerated since 2000 and reason for this may be the desire to keep economically active after
self-employment in particular has grown rapidly. In 2014 there were retirement.
4.6 million self-employed people in the UK. Most of these people did • More women have opted for self-employment. Between 2008 and
not employ other workers in their business activities. Figure 1 shows that 2011 women accounted for an unprecedented 80 per cent of the newly
the number of single-person businesses in the UK rose by 68 per cent self-employed (Labour Force Survey, Office of National Statistics 2013).
from 2.355 million in 2000 to 3.965 million in 2014. What factors led In 2014 there were almost 1.5 million self-employed women, an
to these trends? increase of around 300,000 since the start of the economic downturn.
• High unemployment between 2007 and 2014 had an important • Changes in the structure of the economy. The expansion of the
impact. The number of jobs being created by existing businesses fell tertiary sector has contributed to the growth in small businesses.
during this time. As a result many people saw self-employment as Many services can be undertaken more effectively on a small scale.
the only means of support. Also, some people had the capital to set
• The development of e-commerce has also had a large impact. By
up a business from their redundancy pay-outs.
using the internet, a wide range of business opportunities have
• Government and local authorities introduced a number of measures opened up. For example, some types of business activity, such as
to encourage the development of small businesses. Business start-up online tutoring, can be delivered from anywhere in the world by using
schemes provided funds for small businesses for an initial period. an online business model.
Government helpline Business Link (replaced in 2012 by Gov.UK)
Sources: adapted from www.gov.uk, www.ons.gov.uk,
gave advice on running businesses and obtaining finance. European
Labour Force Survey, Office of National Statistics 2013
initiatives included loans from the European Investment Fund and
finance for training from the European Social Fund.

Figure 1
The growth in the number of single-person businesses in the UK 2000 to 2014

Businesses (millions)
4.5

4.0

3.5

3.0

2.5

2.0

1.5
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: www.gov.uk Year

Exam tip Links

When answering exam questions in general it is important to
remember that small businesses play a big role in the economy.
One way of demonstrating synoptic skills here is to link the role
When giving examples to support your arguments it is easy to played by small firms in niche marketing, which is discussed in
remember the names of big companies. However, do not neglect Units 1 and 13. There are many examples of small businesses
the importance of small businesses. Remember that at the that have learnt how to co-exist with large corporations by
beginning of 2014, 99.4 per cent of the 5.2 million businesses in carving out a niche for themselves. Also, when answering a
the UK were classified as small, according to government
question on flexibility in business you could link this to how
statistics.
small businesses can offer flexibility as discussed in this unit. The
survival of small firms in competitive markets can also be linked
to the development of online businesses in Unit 22, and the use
of USPs and product differentiation in Units 10 and 13. There
are also links between this unit on small businesses and units
relating to entrepreneurs, such as Units 19, 20 and 22. As stated
in the exam tip, there will be many opportunities where the role
of small businesses will be relevant.

311
Reasons for staying small Unit 51

Case study
ENCLOTHED Both of the founders have experience in business. Levi was
head of sales at a branding and marketing firm, and is now
in charge of the sales and marketing team at Enclothed. Dana
Enclothed is an online retailer founded by Levi Young and began her career with a first degree in fashion and masters in
Dana Zingher in 2013. The business focuses specifically on the Business and Management, followed by work in the City as a
needs of fashion-conscious, time-starved men, or men who technology consultant. She is now in charge of the styling and
simply lack the motivation to shop on the high street. The technology department. In February 2015, the pair presented
service provided by Enclothed is hassle-free and very customer- their business to the Dragon’s Den team on BBC television.
orientated. Men can sign up for the service online. They give They impressed and succeeded in raising £70,000 from
information about their size, style and any price or clothing Dragon investors Kelly Hoppen and Piers Linny.
preferences they may have. This information is processed
by clever software which produces a profile of the customer. Sources: adapted from www.startups.co.uk and
Stylists, or personal shoppers employed by Enclothed, then www.enclothed.co.uk
handpick a collection of clothing and outfits that match the
customer’s profile. The items are packed into attractive boxes (a) Explain one way in which Enclothed differentiates its product
and despatched. Clients can then try on the outfits in the from those of larger online clothes retailers. (4 marks)
comfort of their own homes, decide which items to buy and
return those that are unwanted. The client doesn’t even have (b) Evaluate the possible methods a small business like
to bother with the hassle of repackaging and posting the Enclothed might use to survive in competitive markets.
unwanted items as the Enclothed service includes collection. (20 marks)

Knowledge check
1. State two reasons why the owners of a successful small 4. State two ways a business can offer a more personal service
business might choose not to grow. than a much larger rival.
2. Give an example of how a small newsagent might offer some 5. Explain one reason why online businesses are popular with
flexibility to its customers. small enterprises.
3. How might a small publisher differentiate its product? 6. State three reasons why the popularity of small businesses
has grown.

312
 52 Quantitative sales 3.3.1
Theme 3

Key points
forecasting
1. Calculation of time-series analysis:
●● moving averages (three period/four quarter).
2. Interpretation of scatter graphs and line of best fit – extrapolation of past data to future.
3. Limitations of quantitative sales forecasting techniques.

Getting started
Unit 30 showed how sales forecasting is vitally important to business
and that this process informs key decisions of business. In Theme 3 the
aim is to explore and develop an understanding of some of the key
statistical tools that are used to make this forecasting as accurate and
robust as possible.
Marco, in deciding on his sales forecasts for the coming months and
years, has produced a range of time series data that records previous
sales and includes a trend analysis. A breakdown of sales, and
predictions for coming months, is shown in Table 1.
Table 1 Sales breakdown and predictions by quarter
2014 2014 2014 2014 Total 2015 2015 2015 2015 Total
Q1 Q2 Q3 Q4 2014 Q1 Q2 Q3 Q4 2015
Sales 17 19 34 16 86 18 21 33 16 88
(thousands)
What will Marco’s sales forecast be for the first three months of 2016?
What is the trend of his sales? Is there any evidence that sales are
generally increasing? To what extent is the business affected by
seasonal factors?

Calculating time series data

The four main components that a business wants to identify in
time series data are:
●● trend

●● seasonal fluctuations

●● cyclical fluctuations

●● random fluctuations.

This unit is concerned with identifying the trend.

Identifying the trend

An analysis of figures will tell a business whether there is an
upward, downward or constant trend. Identifying the trend
allows the business to predict what is likely to happen in
future. The first step is to smooth out the raw data. Take the
example of the garden furniture manufacturer from Unit 30,
whose yearly sales over ten years are shown in Table 2 on the
next page.

313
Quantitative sales forecasting Unit 52

Table 2 Yearly sales of a garden furniture manufacturer

Year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Sales (£ 000) 125 130 130 150 140 155 180 190 210 230

It is possible to calculate a trend by using a moving average. Table 5 Calculating a four-year moving average for a
The average can be taken for any period the business wants, garden furniture manufacturer
such as a year, a month or a quarter. For now we will assume Year Sales Four-year Eight-year Trend
the garden furniture manufacturer uses a three-year average. moving total moving
total (Four-year centred
The average of sales in the first three years was: moving average = Eight-
year moving total / 8)
125 + 130 + 130 = 385 = 128.3
2006 125
3 3
2007 130
535
To calculate the moving average, the first year’s sales drop out 2008 130 1,085 135.63
and the next year’s sales (2009) are added. The average for the 2009 150 1,125 140.63
next three years was: 2010 140 1,200 150
550
2011 155 575 1,290 161.25
130 + 130 + 150 = 410 = 136.7 2012 180 625 1,400 175
3 3 2013 190 665 1,535 193.13
If the business continues to do this, the results will be as shown 2014 210 735
in Table 3. Notice that the moving average is placed at the 2015 230 810
centre of the three years (i.e. the average for 2006–2008 is
plotted next to 2007).

Table 3 Three-year moving average for sales of a garden Figure 1

furniture manufacturer Annual sales of a garden furniture manufacturer
Sales
Year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 (£000)
Sales 125 130 130 150 140 155 180 190 210 230
230
(£000)
128.3 136.7 140 148.3 158.3 175 193.3 210 220

What if the firm had used a four-year period instead of three 210

years? No one year is the centre point and simply placing the 200
figure in between two years may result in misleading predictions
in future. The solution is to use centring. This uses a four- and 190
eight-year moving total to find a mid-point, as shown in Table 4. 180

Table 4 Centring 170

Year 2006 2007 2008 2009 2010 160

Sales (£ 000) 125 130 130 150 140 150

535 + 550 = 1085 140

(Four-year moving totals) (Eight-year moving total) 130

Here, the mid-point is 2008. The trend or four-period centred 120

moving average can be found by dividing the eight-year moving 110
total by 8, the number of years, as shown in Table 5.
Plotting the four-period centred moving average figures onto 100
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
a graph (as shown in Figure 1) shows the trend in the figures. Year
It is clear to see that sales appear to be rising over the period. Key
The trend line is ‘smoother’ than the line showing the actual Sales
sales figures. It eliminates any fluctuations in sales each year Trend

and gives a more obvious picture of the trend that has been
taking place.

314
 Business decisions and strategy

Question 1 Figure 2
A business has recently gathered data on its sales revenue as Annual sales of a toy manufacturer
shown in Table 6, and wants to calculate a three- and four-
period moving average.
Table 6 Sales revenue
(£000)
Period 1 2 3 4 5 6 7 8 9 10

Sales revenue 100 130 160 175 180 190 190 180 220 250
3-period
moving average 130 155
4-period
moving average 151.3
(a) Calculate the three- and four-period moving averages for as
many years as you can to complete the table.
(b) Plot the sales figures and both trend lines onto a graph on graph
paper and explain the relationship between the trend and the
actual sales revenue figures.
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Predicting the line of best fit from

the trend Secondly, the sales figures are predicted by drawing a line
Having identified a trend that is taking place, it is possible for a through the trend figures and extending it to the year 2016. The
business to now predict what may happen in future. Consider broken line through the trend in Figure 2 is called the line of
the business represented in Table 7. best fit. It is the best line that can be drawn that matches the
general slope of all points in the trend. The line is an average,
Table 7 Four-year moving average and trend for a toy where points in the trend on one side of the line are balanced
manufacturer with those on the other. In other words, it is a line that ‘best fits’
Year Sales Four-year Eight-year Trend all points in the trend.
moving total moving total It is possible to draw the line of best fit by plotting the trend
(Four-year centred
moving average = figures on graph paper accurately and then adding the line of
Eight-year-moving best fit ‘by eye’, so that points fit equally either side of the line.
total / 8) Extending the line carefully should give a reasonable prediction.
2006 300 To help draw the line, it should pass through the coordinates
2007 500 (X,Y) where X is the average of the years and Y is the average
2008 600 1,950 sales. These coordinates can be calculated using the figures in
4,200 525.00 Table 7.
2009 550 2,250 4,750 593.75
2010 600 2,500 5,250 656.25 – ΣX (the total years) 2006+2007+2008+2009+2010+2011 12,051
X = ——————–––— = —————————————————— = ——— = 2008.5
2011 750 2,750 6,050 756.25 N (the number 6 6
2012 850 3,300 6,800 850 of years)
2013 1,100 3,500 7,350 918.75
– ΣY (the total sales in the trend)
2014 800 3,850 Y = —————–————————
N (the number of years)
2015 1,100
£525,000 + £593,750 + £656,250 + £756,250 + £850,000 + £918,750 £4,300,000
Consider the sales of this business during the period 2006–2015. = ———————————————————————————————— = —————
These data have been used to calculate four-year moving averages 6 6
and this information used to calculate the trend. Extrapolation = £716,667
involves the use of past sales data to forecast future sales.
Figure 2 shows that sales of the toy manufacturer’s goods may This point is shown on Figure 2. The actual predicted figure for
reach about £1,160,000. the year 2016 is £1,162,550. This can be found by a method
The business has made certain assumptions when predicting known as ‘the sum of least squares’. Computer software can be
this figure. Firstly, no other factors were likely to have changed used by businesses to calculate the line of best fit and to predict
to affect the trend. If other factors changed, resulting in different from the trend.
sales figures, then the prediction is likely to be inaccurate.
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Quantitative sales forecasting Unit 52

Variations from the trend Table 9 Seasonal variations

How accurate is the prediction of around £1,160,000 sales
(£000)
of toys by the year 2016? Even allowing for the assumptions
Year Quarter Sales Four-quarter Variation
on the previous page, the prediction may not be accurate moving average
because it is taken from the trend, and the trend ‘smoothed out’
2012 3 460
variations in sales figures. To make an accurate prediction, the
4 218
business will have to find the average variation over the period
and take this into account. We can find how much variation there 2013 1 205 328.5 –123.5
is from the trend by calculating: 2 388 346.0 +42.0
3 546 358.25 –187.75
Actual sales – trend 4 272 369.125 –97.125
2014 1 249 383.625 –134.625
So, for example, the cyclical variation in Table 7 would be
2 431 396.625 +34.375
as shown in Table 8. The average of the variations over the
period 2006–2015 is (in £000): 3 619 404.0 +215.0
4 303 420.5 –117.5
+75 -43.75 –56.25 -6.25 +/-0 +181.25 = +150 = +25 (or +£25,000)
—–––––—–––––––—–––––––—––––––– –––– 2015 1 277
6 6
2 535
If the predicted value based on the trend was £1,160,000,
then adding £25,000 may give a more accurate predicted
figure of £1,185,000. Question 2
Table 10 shows the yearly sales figures of a furniture
Table 8 Cyclical variations
manufacturer over a period of ten years.
(£000)
Table 10
Year Sales Trend Variation in
(four-year centred each year (£000)
moving average) Period 1 2 3 4 5 6 7 8 9 10
2006 300 Sales 5,000 5,200 5,800 6,000 5,800 7,000 8,200 7,400 7,600 8,400
2007 500 (a) Calculate a four-yearly moving average from the figures to show
2008 600 525.00 +75.00 the trend taking place.
2009 550 593.75 –43.75 (b) Plot the trend onto a graph on graph paper and predict the likely
output in year 11.
2010 600 656.25 –56.25
(c) Calculate:
2011 750 756.25 –6.25
(i) the cyclical variation for each year
2012 850 850.00 +/– 0
(ii) the average cyclical variation over the period.
2013 1,100 918.75 +181.25
2014 800
2015 1,100 The limitations of quantitative sales
forecasts
Seasonal variations Quantitative sales forecasts are powerful tools for businesses
It is possible to predict from a trend and use seasonal variations and are used to inform key decisions. The fact that they
to make a more accurate prediction. Table 9 shows sales of a are often produced using advanced computer models and
different business over a three-year period, including sales in algorithms, and managed by expert sales analysts, does not
each quarter. A four-quarter moving average has been calculated mean such methods are infallible – what has gone before is not
and also the variation in each quarter. always the best predictor of what is to come.
Carrying on the trend to predict the sales for the fourth Sales forecasts are likely to be more reliable when:
quarter of the year 2015 might give a figure of £470,000. (It ●● the forecast is for a short period of time in the future, such as

would be possible to find this by drawing and extending a line six months, rather than a long time, such as five years
of best fit through the trend.) As we know, this is a ‘smoothed ●● they are revised frequently to take account of new data and

out’ figure. A more accurate prediction might be to calculate the other information
average seasonal variation in the fourth quarter, for example ●● the market is slow changing

(in £000): ●● market research data, including test marketing data, is available

●● those preparing the forecast have a good understanding of

–97.125 –117.5 = –214.625 = –107.313
––––––––––––– ––––––– how to use data to produce a forecast
2 2 ●● those preparing the forecast have a good ‘feel’ for the market

By subtracting £107,313 from the total of £470,000, this and can adjust the forecast to take account of their hunches
gives a more accurate prediction of £362,687. and guesses about the future.
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 Business decisions and strategy

No forecaster is accurate all the time. Even in slow-moving

markets, sales can change by a few per cent for no apparent Figure 3
reason. One way to take this into account is to produce a Advertising and sales data
forecast range. Forecasters might, for example, prepare three
sets of figures – an optimistic forecast, a pessimistic forecast
and a central forecast. The two outlying forecasts would have
low probabilities of occurring, but would indicate a best and
worst case scenarios. The central forecast would be the forecast
that had the highest probability of occurring. Supplying these
forecasts to other departments, such as production, would
give them an indication of the possible variations they might
have to face. They could then prepare their own plans for these
eventualities. In a very sophisticated forecast there would be
a whole range of possible outcomes, each with a probability
attached to its occurring.
Even though forecasts are rarely 100 per cent accurate, they
do provide an indication of likely future trends. As such, they are
important tools for any planning or budgeting.

Causal modelling and line of best fit

Time series analysis only describes what is happening to
information. Causal modelling tries to explain data, usually by Looking at the graph, there appears to be a positive correlation
finding a link between one set of data and another. For example, between the two variables. The more that is spent on
a business may want to find whether there is a link between the advertising, the higher the level of sales. The line of best fit is
amount that it spends on advertising and its sales. drawn through the data to show this relationship better. It is also
Table 11 shows data that have been collected about possible to calculate the extent of the relationship by means of a
advertising and sales by a business at different times. The data correlation coefficient, using the formula:
in the table are plotted onto a scatter graph in Figure 3. ΣXY
Advertising (the independent variable) is shown on the r= ——————
horizontal (X) axis. Sales (the dependent variable) are shown (ΣX2) (ΣY2)
on the vertical (Y) axis. The figure shows, for example, that in
one period (E) the business had advertising spending of £1,500 Using the data in Table 11, the correlation coefficient for
and sales of 1,800 units. In another period (G) the business had advertising and sales can be calculated as follows.
advertising spending of £3,500 and sales of 5,800 units. £102.28m
r = ————————–—
Table 11 Advertising and sales data £81.93m × 173.18m
Period Advertising Sales (£million) (million) (£million)
expenditure (000) £102.28m
r = ———––—
(£000) £119.117m
X Y X2 Y2 XY r = + 0.86
A 1.0 3.2 1.0 10.24 3.2
B 2.0 4.5 4.0 20.25 9.0 ●● A correlation coefficient of +1 means that there is an absolute
positive relationship between the two variables. All points in
C 3.0 1.8 9.0 3.24 5.4
the scatter graph fall on the line of best fit and the line slopes
D 4.0 3.0 16 9.0 12.0 upwards from left to right. As the values of the independent
E 1.5 1.8 2.25 3.24 2.7 variable increase, so do the dependent variable values.
F 2.5 1.6 6.25 2.56 4.0 ●● A correlation coefficient of 0 means that there is no
G 3.5 5.8 12.25 33.64 20.3 relationship between the variables.
●● A correlation coefficient of –1 means that there is an absolute
H 1.2 4.7 1.44 22.09 5.64
negative relationship between the two variables. All points
I 2.7 5.9 7.29 34.81 15.93 in the scatter graph fall on the line of best fit and the line
J 3.0 3.5 9.0 12.25 10.5 slopes downwards from left to right. As the values of the
K 3.6 3.1 12.96 9.61 11.16 independent variable increase, the values of the dependent
L 7.0 3.5 0.49 12.25 2.45 variable fall.
ΣX2 =81.93 ΣY2=173.18 ΣXY=102.28

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Quantitative sales forecasting Unit 52

The formula itself does not show positive and negative values. Question 3
However, it is easy to see whether the relationship is positive or
negative from the graph. A positive coefficient of 0.86 suggests Denten Limited is a manufacturer of bins and other storage
a strong correlation between the spending on advertising and equipment. It exports a large amount of its products abroad. It
the level of sales. As advertising increases, so do sales. This makes use of direct sales to customers and also employs some
information could help a business in future when making decisions overseas agents. The managing director has asked the marketing
about its marketing. It is suggested that if the figure falls below 0.7 department to examine the relationship between the number
it becomes difficult to see any correlation from the scatter graph. of agents it employs and sales of three of its most popular
An example of a negative correlation might be the relationship products, and make recommendations. The research found the
between prices and customer demand. As prices rise, demand following information.
falls. Examples of different correlations are shown in Figure 4.
Businesses must be careful when basing decisions on Product 1 ΣY2 = 5,360 ΣXY = 2,720
such calculations. Product 2 ΣY2 = 17,360 ΣXY = 3,200
●● A large quantity of sales in any period may be due to factors
Product 3 ΣY2 = 25,080 ΣXY = 3,240
other than advertising, such as other forms of promotion. Agents ΣX2 = 1,400
●● There are sometimes examples of ‘nonsense correlations’. (a) Calculate the correlation coefficients to show the relationship
These are correlation coefficients that appear to show a between spending on overseas agents and products 1, 2 and 3.
strong relationship between two variables, when in fact the (b) Explain the relationship between the variables in each case.
relationship between the figures is pure coincidence. (c) Evaluate the performance of the overseas agents in terms of the
sales of the three products.
Qualitative forecasting
Qualitative forecasting uses people’s opinions or judgements
rather than numerical data. A business could base its
predictions on the views of so-called experts, or on the opinions
of experienced managers in the marketing or production
department. Such methods are usually used by businesses:
●● where there is insufficient numerical data

●● where figures date quickly because the market is changing rapidly.

Figure 4
A weak positive correlation, a strong negative correlation and little or no correlation

Marketing expenditure Unemployment (Millions) Quantity of baked beans (Millions)

£70,000 3.5 10.4
£60,000 3.0 10.3
10.2
£50,000 2.5
10.1
£40,000 2.0 10.0
£30,000 1.5 9.9
£20,000 1.0 9.8
9.7
£10,000 0.5 9.6
0 0 9.5
0 5 10 15 20 25 0 5 10 15 20 25 0 5 10 15 20 25
Quantity of sofas sold (000) Quantity of sofas sold (000) Quantity of sofas sold (000)

Exam tip
There are lots of opportunities for exam questions requiring analysis information before jumping to this conclusion. Considerations
and evaluation in this topic. The statistical element of quantitative might include the following.
sales data means that analytical considerations can be made. Imagine • What were sales before 2014? Is 2015 a blip?
data being presented from which a question is asked regarding the • What market does the business operate within? Might there be
likely sales in the next period where sales in previous years have some reason why sales in 2015 were so high?
been shown to be growing. • Are sales of this business cyclical?
Table 12 Sales • What is the seasonal breakdown throughout the year?

2014 2015 The ‘it depends’ rule is a useful tool when faced with exam
questions. Sales might increase further in 2016; the evidence
Sales (£ ‘000) 50 60
available – and there is not much of it – points to this conclusion.
It might appear reasonable to suggest that sales in the following However, it depends on other factors. This is an important
year will increase. However, it is important to take account of other consideration and can be used to help prompt further questions.

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 Business decisions and strategy

Case study
PROSPER-i

In 2011 Prosper-i, a global electronics company and The sales performance led Prosper-i to lower its 2013 sales
developer of toys and games, launched the latest version of forecast by 70 per cent from 900,000 units to 280,000.
its popular robot toy. Called the i-do, the new robot offered The reported actual sales for 2013 are shown below.
new features such as the ability to be controlled by a smart
phone app, and programmed to play music and video. Table 14 i-do sales 2013
The new features were designed to appeal to new market 2013 Q1 2013 Q2 2013 Q3 2013 Q4
segments including adults. It was also designed to compete Sales (thousands) 31 51 61 1.91
with two main competitors – ChiBot and Pal-i.
i-do was initially well-received by consumers and by In 2014, Prosper-i reported that sales of i-do were running
reviewers. In the US the entire stock of over 40,000 units ahead of its sales forecast.
was sold in the first three months of release. Over 300,000
units were sold in 2011. Table 13 summarises sales in 2012. (a) What is meant by a sales forecast? (2 marks)
Table 13 i-do sales 2012 (b) Using the information in the case study, explain the
2012 Q1 2012 Q2 2012 Q3 2012 Q4 extent to which sales of i-do could be described as being
influenced by seasonal factors. (4 marks)
Sales (thousands) 39 16 30 1.95
(c) Assess the extent to which quantitative sales forecasting is
From March to June 2012, i-do sold approximately 16,000 useful to Prosper-i. (10 marks)
units, which was down 51 per cent on the previous three
months. Some retailers were considering whether to
continue to stock i-do.

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Quantitative sales forecasting Unit 52

Key terms Thinking bigger

Centring – a method used in the calculation of a moving Quantitative sales forecasting is an important technique for
businesses, but it is not without contention. Even with the most
average where the average is plotted or calculated in relation powerful statistical models and forecasts, at some point the
to the central figure. judgement needs to be made by someone within a business about
Correlation – the relationship between two sets of variables. what the forecast will be. From this forecast decisions will be made
Correlation coefficient – a measure of the extent of the concerning staffing, ordering of materials, marketing, and so on.
relationship between two sets of variables. Importantly, ultimate decisions are subjective in the sense that they
Moving average – a succession of averages derived are judgements made by individuals or departments. Individuals
from successive segments (typically of constant size and may be driven by competing motives. The sales manager may be
motivated to have forecasts that paint a positive picture.
overlapping) of a series of values.
Scatter graph – a graph showing the performance of one This lack of certainty is a good opportunity for the development
variable against another independent variable on a variety of balanced arguments in any written response to a question. The
statistically produced trend may well point to a particular level of sales.
of occasions. It is used to show whether a correlation exists
However, wider economic factors might make this forecast unlikely. A
between the variables. rise in average incomes in an economy, combined with a weakening
Time series analysis – a method that allows a business to exchange rate, for instance, may mean that the forecast is an under-
predict future levels from past figures. prediction. The topic lends itself to an evaluative approach. In essence,
avoid basing forecasts on a very small range of factors. Time series
analysis is a useful tool for business, but it is risky to rely heavily on what
has gone before.
Knowledge check
1. Why might a business want to predict the future?
2. What are the four components of time series data that a
business will take into account?
3. What does a trend show?
4. How might a business use the calculation of a trend?
5. What does a scatter graph show?
6. What is meant by causal modelling?
7. State two difficulties with quantitative sales forecasting.
8. How would a line of best fit be useful for a business when
looking to forecast sales?

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 53 Investment appraisal 3.3.2
Theme 3

Key points
1. Simple payback.
2. Average (accounting) rate of return.
3. Discounted cash flow (net present value only).
4. Calculations and interpretations of figures generated by these techniques.
5. Limitations of these techniques.

Getting started
Clifton recycling is a recycling plant owned by the Anderson family The investment would create 20 new jobs at the plant.
in Essex. In 2014 the business invested £1.2 million in a new However, some local residents were worried about the
plant designed to convert plastic bottles into plastic flakes and noise the new plant might make and were meeting with the
pellets. Table 1 shows the net cash flow the business hoped to local council about their concerns.
receive over the life of the investment (expected to be 10 years). Calculate the expected cash flow from the investment over the
Once the plant was constructed in 2015 at a cost of £50 million, time period. Investment is often said to be risky. Can you account
revenue flows were due to begin in 2016. James Anderson, the for this view using this investment as an example? What non-
managing director, commented that the growth in the recycling of financial factors might Clifton recycling have taken into account
plastic bottles was around 45 per cent and looked to grow in the when deciding whether to build the new plant?
future and, if so, it would be a profitable investment.

Table 1 Expected net cash flow from the new plant

  2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Net cash flow (£000s) -50 10 110 180 230 300 340 370 400 390 370

Investment appraisal Simple payback

Investment refers to the purchase of capital goods. Capital The payback period refers to the amount of time it takes
goods are used in the production of other goods. For example, a for a project to recover or pay back the initial outlay. For
building contractor who buys a cement mixer, some scaffolding, example, an engineer may invest £500,000 in new cutting
a lorry, a computer, some office furniture and five shovels has machinery and estimate that it will lead to a net cash flow
invested. These goods will be used repeatedly by the business over the next five years, as in the Table 2 on the next page.
over a period of time. Here the payback period is four years. If we add together
Investment might also refer to expenditure by a business that the net cash flows from the project in the first four years
is likely to yield a return in the future. For example, a business it amounts to £500,000 (i.e. £100,000 + £125,000 +
might spend £20 million on research and development into a £125,000 + £150,000).
new product or invest £10 million in a promotion campaign. In The payback period can also be found by calculating the
each case, money is being spent on projects now in the hope cumulative net cash flow. This is the net cash flow each
that a greater amount of money will be generated in the future year taking into account the initial cost of the machine.
as a result of that expenditure. When the machine is first bought, in year 0, there is negative
Investment appraisal describes how a business might cash flow of minus £500,000, the cost of the machine.
objectively evaluate an investment project to determine whether Next year the net cash flow minus operating costs is
or not it is likely to be profitable. It also allows businesses to £100,000. So the cumulative net cash flow is -£500,000
make comparisons between different investment projects. There + £100,000 = -£400,000. In year 4 it is zero, so all costs
are several quantitative methods that a business might use when have been covered.
evaluating projects. However, they all involve comparing the
capital cost of the project with the net cash flow.
●● The capital cost is the amount of money spent when setting

up a new venture.
●● Net cash flow is cash inflows minus cash outflows.

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Investment appraisal Unit 53

Table 2 Expected net cash flow from some new cutting Question 1
machinery
£000 Delrose Associates is a full service digital marketing
agency. The company offers a blend of consultancy and
Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5
creativity, resulting in fully managed, highly successful
Net cash flow (500) 100 125 125 150 150
online marketing campaigns. Delrose has clients in a variety
Cumulative net (500) (400) (275) (150) 0 150 of sectors including consumer, corporate, commercial, retail
cash flow and not-for-profit. Their main work is developing targeted
campaigns to drive quality traffic to websites using highly
Worked example cost-effective methods.
When using the payback method to choose between In 2015 the managing director of the company recognised
projects, you are looking for the project with the shortest the need for a new computer system. She carried out some
payback period. Assume a business is appraising three research into three new systems and put together the financial
investment projects, all of which cost £70,000. The net cash flow information shown in Table 4.
expected from each project is shown in Table 3. (a) Explain what is meant by ‘expected net cash flow’.
Table 3 Expected net cash flow from three projects (b) Calculate the payback period for each system and state which
£000 system Delrose Associates should select.
Yr 0 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Total net Payback (c) Explain one reason why Delrose used the payback method of
cash flow period investment appraisal in this case.
A Net cash flow (70) 10 10 20 20 30 40 60 4 yrs 4 mths Table 4 Capital costs and expected net cash flows from
A Cumulative cash flow (70) (60) (50) (30) (10) 20 60 three new computer systems
B Net cash flow (70) 20 20 20 20 20 20 50 3 yrs 6 mths Computer Capital 2015 2016 2017 2018 2019 2020 Total
B Cumulative cash flow (70) (50) (30) (10) 10 30 50 system cost
C Net cash flow (70) 30 30 20 10 10 10 40 2 yrs 6 mths System A 24,000 6,000 6,000 6,000 6,000 6,000 6,000 36,000
C Cumulative cash flow (70) (40) (10) 10 20 30 40 System B 37,000 8,000 8,000 9,000 9,000 6,000 6,000 46,000
System C 12,000 4,000 4,000 4,000 2,000 1,000 1,000 16,000
In this example Project C would be chosen because it has
the shortest payback time: 2 years and 6 months. How is
this calculated? In years 1 and 2 the net cash flow is
£30,000 + £30,000 = £60,000. To pay for an investment of Average (Accounting) Rate of Return (ARR)
£70,000 the remaining £10,000 (£70,000 – £60,000) comes The average rate of return or the accounting rate of return
from year 3’s net cash flow. This is £20,000, which is more. method measures the net return each year as a percentage of
So the number of months in year 3 it takes to pay the £10,000 the capital cost of the investment.
can be calculated as: Average Rate
Net return (profit) per annum
Amount required £10,000 of Return (ARR) (%) = –––––––––––––––––––––––– × 100
–––––––––––––––– × 12 = ––––––– × 12 = 6 months Capital outlay (cost)
Net cash flow in year £20,000
Project A’s payback is 4 years 4 months and Project B’s is
3 years and 6 months. Note that total cash flow is not taken Worked example
into account in this method. In fact Project C has the lowest total
return over the six years. The capital cost and expected net cash flow from three
investment projects is shown in Table 5.
Advantages of the payback method Table 5 The capital cost and net cash flow from three
There are certain advantages to a business of the use of the payback investment projects
method to appraise the potential success of an investment. Project X Project Y Project Z
●● This method is useful when technology changes rapidly, Capital cost £50,000 £40,000 £90,000
as it is important to recover the cost of investment before Return Yr 1 £10,000 £10,000 £20,000
a new model or equipment is designed. This is true of the
Yr 2 £10,000 £10,000 £20,000
agriculture industry where new farm machinery is designed
and introduced into the market regularly. Yr 3 £15,000 £10,000 £30,000
●● It is simple to use. Yr 4 £15,000 £15,000 £30,000
●● Firms might adopt this method if they have cash-flow Yr 5 £20,000 £15,000 £30,000
problems. This is because the project chosen will ‘payback’ Total net cash flows £70,000 £60,000 £130,000
the investment more quickly than others.

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 Business decisions and strategy

A business would first calculate the net cash flow from each Discounted cash flow (net present value
project by subtracting its capital cost from the total net cash flow or NPV)
of the project, i.e. £70,000 - £50,000 = £20,000 for Project X. When making an investment decision a business might take into
The next step is to calculate the profit per annum by dividing account what cash flow or profit earned in the future is worth
the profit by the number of years the project runs for, i.e. at the present value. Look at Table 8. This shows that £100
£20,000 ÷ 5 = £4,000 for X. Finally, the ARR is calculated by invested today at a compound interest rate of 10 per cent would
using the above formula, i.e.: be worth £161 in five years’ time.
●● In one year’s time, the investment would be worth £110.
£4,000 Of this, £10 would be the interest and £100 would be the
ARR (Project X) = ––––––– × 100 = 8%
£50,000 initial investment.
●● In two years’ time, it would be worth £121. With compound
The results for all three projects are shown in Table 6. Project Y
interest, the interest is based not on the initial investment but
would be chosen because it gives a higher ARR (10 per cent) than
on the investment at the end of the first year. So interest is
the other two.
10 per cent of £110, making £11. Then this has to be added
Table 6 The ARR calculated for three investment projects to the £110 value at the end of the first year to make a total of
Project X Project Y Project Z £121 for the second year.
This carries on until the value after five years is £161.
Capital cost £50,000 £40,000 £90,000
Total net profit £20,000 £20,000 £40,000 Table 8 Value of £100 invested over five years at 10 per
(net cash flow – cent per annum compound interest
capital cost) Year 1 2 3 4 5
Net profit p.a. £4,000 £4,000 £8,000 Value of £100 £110 £121 £133 £146 £161
(profit ÷ 5)
ARR 8% 10% 8.9% If £100 today is worth £161 in five years’ time, it must be
true that £161 in five years’ time is worth just £100 today. This
is an example of an important insight of discounted cash-flow
Advantages of the ARR method techniques. Money in the future is worth less than the same
The advantage of this method is that it shows clearly the amount now (the present value). This is because money available
profitability of an investment project. Not only does it allow a today could be invested and it could earn interest.
range of projects to be compared, the overall rate of return Note that this is a completely different idea to the fact that
can be compared to other uses for investment funds. In the money in the future can also become devalued due to the effects
example in Table 6, if a company can gain 12 per cent by of inflation. Inflation does indeed affect future values of money. So
placing its funds in a bank account, it might choose to postpone there are two effects on the value of future money. Discounted
the investment project until interest rates fall. It is also easier to cash-flow techniques just deal with one of these, the effect of
identify the opportunity cost of investment. interest rates.

Question 2
Hastings Group focuses on the development, production, installation The capital cost and expected cash flows for the investment
and support of electrical, electronic and mechanical components for projects are shown in Table 7.
aircraft, helicopters, missiles and targeting systems. The company
(a) (i) Calculate the average rate of return for each project.
has a leading position in the field of aircraft and helicopter services,
(ii) Explain which project should be selected.
customisation and modification. Hastings’ employees are engineers
(b) Explain the advantages to Hastings Group of using this method of
and skilled workers. In 2015 the directors identified three investment
appraisal.
projects that would benefit the company:
• research and development (R & D)
• marketing campaign
• some new CNC machinery.
Table 7 Capital cost and net cash flow for three investment projects
£000
Investment project Capital cost 2015 2016 2017 2018 2019 2020 Total
R&D 9,600 0 0 2,500 4,600 5,000 5,500 17,600
Marketing campaign 9,000 5,000 4,000 3,000 2,000 1,000 1,000 16,000
New CNC machinery 7,800 2,000 2,000 2,000 2,000 2,000 2,000 12,000

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Investment appraisal Unit 53

Discount tables can be used to show by how much a future Table 9 Discount table
value must be multiplied to calculate its present value. Table 9 shows Rate of discount
a discount table with five different rates of interest. If an investment
Year 5% 10% 15% 20% 25%
project was predicted to give a net cash flow of £10,000 in three
years’ time, and the discount rate was 10 per cent, then reading off 0 1.00 1.00 1.00 1.00 1.00
the table, the £10,000 would need to be multiplied by 0.75. 1 0.95 0.91 0.87 0.83 0.80
To arrive at its present value the calculation would be: 2 0.91 0.83 0.76 0.69 0.64
£10,000 × 0.75 = £7,500 3 0.86 0.75 0.66 0.58 0.51
4 0.82 0.68 0.57 0.48 0.41
Cash flow or profit of £15,000 from a project received in five
years’ time, at a discount rate of 20 per cent, would be worth 5 0.78 0.62 0.50 0.40 0.33
£6,000 in the present (£15,000 × 0.40). 6 0.75 0.56 0.43 0.33 0.26
The discount table shown in Table 9 also shows two features 7 0.71 0.51 0.38 0.28 0.21
of discounting. 8 0.68 0.47 0.33 0.23 0.17
●● The higher the rate of discount, the less the present value
9 0.64 0.42 0.28 0.19 0.13
of cash flow in future. This is the reverse of saying that the
higher the rate of interest, the greater will be the value of an 10 0.61 0.39 0.25 0.16 0.11
investment in the future.
●● The further into the future the cash flow or earnings from an Calculating NPV: The net present value method makes use
investment project, the less is their present value. So £1,000 of discounted cash flow. It calculates the rate of return on an
earned in five years’ time is worth less than £1,000 earned investment project taking into account the effects of interest
in one year’s time. Again this is simply the opposite way of rates and time. Using discount tables, it is possible to calculate
saying that £1,000 invested today at a fixed rate of interest the net present value of an investment project.
will be worth more in five years’ time than in one year’s time.

Worked example
Table 10 shows three investment projects. The initial cost that each investment project is profitable. However, if the
of each investment project is £50,000, shown in the Year 0 row. net cash flow is discounted using a discount rate of 20 per cent, the
In years 1 to 10, each produces a stream of net cash flow. When picture is very different.
added up, these exceed the initial £50,000. So it might appear
Table 10 Net present value of three investment projects discounted at 20 per cent
Project A Project B Project C
Year Net cash Present Net cash Present Net cash Present Discount table
flow £ value £ flow £ value £ flow £ value £ Rate of
discount at
20%
0 (50,000) (50,000) (50,000) (50,000) (50,000) (50,000) 1.00
1 10,000 8,300 5,000 4,150 20,000 16,600 0.83
2 10,000 6,900 8,000 5,520 16,000 11,040 0.69
3 10,000 5,800 10,000 5,800 14,000 8,120 0.58
4 10,000 4,800 12,000 5,760 12,000 5,760 0.48
5 10,000 4,000 12,000 4,800 12,000 4,800 0.40
6 10,000 3,300 12,000 3,960 12,000 3,960 0.33
7 10,000 2,800 12,000 3,360 12,000 3,360 0.28
8 10,000 2,300 14,000 3,220 10,000 2,300 0.23
9 10,000 1,900 16,000 3,040 8,000 1,520 0.19
10 10,000 1,600 20,000 3,200 5,000 800 0.16
Total net cash flow before 50,000 71,000 71,000
discounting
Present values years 1–10 41,700 42,810 £58.260
Net present value (NPV) (8,300) (7,190) +8,260

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 Business decisions and strategy

• Project A. The sum of the present values in years 1–10 for towards later years. The net present value of this project is
Project A is just £41,700. The net cash flow each year is constant £42,810 - £50,000 = -£7,190. Again, Project B is unprofitable
at £10,000, but the present value of each of those £10,000 falls according to discounted cash-flow techniques.
the further away it is received. By year 10, the present value • Project C. The total net cash flow before discounting is the
of £10,000 discounted at 20 per cent is just £1,600. The net same as with Project B. Indeed, the pattern of net cash flow is
present value can be calculated simply by totalling the present an exact reverse of those of Project B. Here, the higher net
value figures in years 0–10, including subtracting the initial cost. cash-flow figures are concentrated at the start and fall off
Or it can be calculated using the formula: towards the end. This means that the total present value
Net present value = present values - initial cost = is much higher than with Project B. The net present value
£41,700 - £50,000 = -£8,300 of Project C is £58,260 - £50,000 = £8,260. This is the
So Project A is unprofitable according to discounted cash-flow discounted profit that the business will make on this project.
techniques. The net present value method would suggest that a business should
• Project B. The total net cash flow before discounting is higher go ahead with any investment projects that have a positive net
than for Project A: £71,000 compared to £50,000. But once present value. If a business has to make a choice between investment
discounted, there is little difference in the sum of the present projects for whatever reason, it should go for those with the highest
values. This is because net cash flow in Project B is weighted net present value. So in this case it would choose Project C.

Advantages of the discounted cash-flow Question 3

method Gethings is a garment manufacturer in London. It is
●● The discounted cash-flow method, unlike the payback
considering making an investment in one of two machines,
method and the average rate of return, correctly accounts for
A and B. The projected net cash flows for each machine are
the value of future earnings by calculating present values.
shown in Table 12.
●● The discount rate used can be changed as risk and
conditions in financial markets change. For example, in the Table 12 Expected net cash flow from two investment
1990s, the cost of bank borrowing for many businesses fell projects
from over 15 per cent to 7–8 per cent. Investment projects £000
therefore did not need to make such a high rate of return to
be profitable and so the rate of discount could be lowered. Year 0 1 2 3 4 5 6
Since 2008 rates have been even lower. Initial cost
Machine A
Exam tip Net cash flow (600) 100 150 200 300 200 100
Remember that discounted cash flow is used to take into account
Discounted
the effect that interest rates have on investment decisions. It cash flow
does not take into account the effects of inflation. This is a
common error made by students. Machine B
Net cash flow (600) 200 300 200 150 100 100
Discounted
Limitations of these techniques cash flow
Each of the three methods of investment appraisal outlined (a) Calculate the discounted cash flow for each machine and each year using a
above has some limitations. These are summarised in Table 11. discount rate of 15 per cent from the discount table on the previous page,
Table 9.
Table 11 Limitations of the methods of investment
(b) Calculate the net present value for each machine.
Appraisal method Limitations
(c) Explain why Gethings might buy Machine B if it uses the net present value
Simple payback Cash earned after the payback period is ignored method of decision making.
  The profitability of the method is overlooked
Average rate of return The effects of time on the value of money are ignored
Discounted cash flow The calculation is more complex than the other
methods
 
The rate of discount is critical – if it is high, fewer
projects will be profitable

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Investment appraisal Unit 53

Thinking bigger Key terms

A number of qualitative factors should also be taken into account
Average rate of return or accounting rate of return (ARR)
when appraising investment opportunities. These are non-financial
considerations. – a method of investment appraisal that measures the net
return per annum as a percentage of the initial spending.
Human relations: Some investment projects can have a huge impact
Capital cost – the amount of money spent when setting up a
on the staff in an organisation. For example, investment in plant
automation might lead to mass redundancies. A business might decide new venture.
to postpone plans to automate their plant if it thought the damage to Discounted cash flow (DCF) – a method of investment
human relations in the organisation would be too severe. appraisal that takes interest rates into account by calculating
Ethical considerations: Along with many other business decisions, the present value of future income.
managers are taking more of an ethical stance when choosing courses Investment – the purchase of capital goods.
of action. For example, a chemicals producer might decide to build a Investment appraisal – the evaluation of an investment
new plant in a location that does not minimise financial costs, but does project to determine whether or not it is likely to be
reduce environmental damage. Such a decision might help to enhance worthwhile.
the image of a company. Companies are increasingly keen to be seen as Net cash flow – cash inflows minus cash outflows.
‘good corporate citizens’.
Net present value (NPV) – the present value of future
Risk: The financial position in which a business finds itself is one factor income from an investment project, minus the cost.
in assessing the risk of an investment project. Others include the state Payback period – the amount of time it takes to recover the
of the economy and the markets into which a business sells. Investment
cost of an investment project.
projects that have long payback periods are also riskier than ones with
shorter payback periods. Present value – the value today of a sum of money available
in the future.
Availability of funds: Some investment projects fail to get started
because businesses are unable to raise the money needed to fund the
project. A significant proportion of these will be small businesses that
have difficulty in persuading investors and lenders to provide finance.
Business confidence: Entrepreneurs, managers and businesses tend to
Knowledge check
have different attitudes and cultures from each other. One aspect of this is 1. What is meant by the term ‘investment in business’?
confidence or optimism. Some decision makers tend to be very cautious,
seeing all the problems that might arise if things go wrong. Others are 2. Explain briefly how a business would appraise investment
confident and optimistic. They see the future as much better and brighter using the payback period.
than the average. This has a crucial impact on investment. The cautious,
unconfident entrepreneur or manager may delay or abandon possible 3. What are the advantages of the payback method of
investment projects. In the same circumstances with the same investment investment appraisal?
projects, confident and optimistic managers will tend to go ahead and 4. What is the formula for calculating ARR?
authorise the expenditure. So the deeply held attitudes of decision makers
have an important influence on investment decision-making. 5. What does the average or accounting rate of return method
of investment appraisal aim to measure?
6. Give one advantage of the ARR method of investment
Links
appraisal.
One way you can demonstrate synoptic skills here is to link
investment appraisal with a possible decision to locate a 7. What is the formula for calculating NPV?
production operation abroad. For example, a business might face 8. Why is the discounted cash flow/NPV method of appraisal
a choice between several different overseas locations. It might used in business?
use one of the investment appraisal techniques discussed in 9. Give one limitation of the payback method of investment
this unit to help decide which location might generate the best appraisal.
returns. Choosing an overseas location is discussed in Unit 73.
In general, investment appraisal might be used to help make 10. Suggest how environmental considerations may affect an
decisions when the costs and expected net cash flows from investment decision.
different options can be clearly identified or estimated – when 11. Give two other qualitative factors that might influence an
choosing between different corporate strategies, for example. investment decision.

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 Business decisions and strategy

Case study
growing season by up to 25 per cent. The other involves
introducing total quality management (TQM) right across
FLORIpori LTD the organisation. The capital cost of the two projects and
the expected cash flows are shown in Table 13. The present
value of £1 receivable at the end of 5 years at 5 per cent is
shown in Table 14.
The new owners of the company are very optimistic about
its future direction. However, the workforce does not
share their enthusiasm. Many of them are worried about
the proposed investment plans. The age profile of the
workforce is high. More than 50 per cent of the workers
are over 55 and have never worked anywhere else. Many
of them joined the company when they left school and
undertook horticulture apprenticeships. If FLORIpori select
the greenhouse project about 40 staff may lose their jobs
because of the improved efficiency of the new system. Also,
an employee representative said, ‘The introduction of TQM
will create pressure and stress for many of the folk here . . .
Some of them just aren’t up to it.’
Table 13 Capital cost and expected cash flows for
FLORIpori Ltd investment projects
Investment project Cost Year 1 Year 2 Year 3 Year 4 Year 5 Total
Greenhouses (£m) 5 2.3 2.6 2.8 3.3 3.2 14.2
The management team of FLORIpori Ltd, a large but poorly Introduce TQM (£m) 4.4 2.1 2.1 2.3 2.4 2.5 11.4
performing flower grower, has recently bought the company
for £100,000. The company employs 112 staff and operates Table 14 The present value of £1 receivable at the end
from a farm in Devon. It grows a range of cut flowers, pot of five years at 5 per cent
plants, herbs and shrubs. After 0 yr 1 yr 2 yrs 3 yrs 4 yrs 5 yrs
The new management team believes it can transform the Present value of £1 £1.00 £0.95 £0.90 £0.86 £0.82 £0.78
business into a profit-making concern. In the previous year
the company lost £260,000 on sales of £1,256,000. The
team believes that the old management were not prepared
to take risks. Consequently they have failed to invest in new
technology and working methods, and fallen behind their (a) Calculate the average rate of return of each investment
competitors. project. (4 marks)
Dave Williams, the new managing director, has already (b) Calculate the net present value of each investment project.
earmarked £5 million for investment. Initially four (4 marks)
investment projects were identified, but two were (c) Explain one advantage of the net present value method
eliminated at a preliminary stage using the payback method of investment appraisal to FLORIpori Ltd. (4 marks)
of appraisal. The two remaining projects are now being
appraised. One of these projects involves constructing (d) Assess which investment project FLORIpori should select.
some giant ‘state-of-the-art’ greenhouses to extend the (12 marks)

327
 54 Decision trees 3.3.3
Theme 3

Key points
1. Construct and interpret simple decision tree diagrams.
2. Calculations and interpretations of figures generated by these techniques.
3. Limitations of using decision trees.

Getting started What are decision trees?

A decision tree is a method of tracing the alternative outcomes
When making a business decision it is helpful to use a of any decision. The likely results can then be compared so
quantitative decision-making technique, if possible. This involves that the business can find the most profitable alternative. For
the application of numerical values, which can be compared example, a business may be faced with two alternatives – to
easily. For example, Latika Naidu runs a successful import launch a new product in Europe or in the USA. A decision tree
business, Gujurat Craftwork, based in Coventry, buying craft may show that launching a new product in Europe is likely to be
products from India. The company sells the items to a network more successful than launching a new product in the USA.
of retailers in the UK. Latika wants to expand the business and It is argued by some that decision making is more effective
has identified two clear options. if a quantitative approach is taken. This is where information
1. Begin importing products from the Middle East to expand on which decisions are based, and the outcomes of decisions,
the product range. are expressed as numbers. In a decision tree, numerical
values are given to such information. The decision tree also
2. Set up an online operation to sell more widely. provides a pictorial approach to decision making because
Latika paid a business consultant £500 to help make the a diagram is used which resembles the branches of a tree.
decision. This was quite helpful. The consultant said the The diagram maps out different courses of action, possible
probability of success for the first option was 0.5, or 50 per cent. outcomes of decisions and points where decisions have to be
In contrast, the probability of success for the second option was made. Calculations based on the decision tree can be used to
0.72, or 72 per cent. The cost of both options is very similar, but determine the ‘best’ likely outcome for the business and hence
Latika will only choose one option. the most suitable decision.

Which option do you think Latika should choose? Explain Features of decision trees
your answer. Why might using a quantitative decision-making Decision trees have a number of features. These can be seen
approach improve the quality of decision making? What might in Figure 1 which shows the decision tree for a business that
be the drawbacks of using such an approach? has to decide whether to launch a new advertising campaign or
retain an old one.

Making decisions Figure 1

Every day, businesses make decisions. Most, if not all, involve
A simple decision tree based on a decision whether to retain
some risk. This could be because the business has limited
an existing advertising campaign or begin a new one
information on which to base the decision. Furthermore, the Profit
outcome of the decision may be uncertain. Launching a new or loss
Success
product in a market abroad can be risky because a firm may not £15m
have experience of selling in that market. It may also be unsure 0.2
about how consumers will react. Launch new campaign
When faced with a number of different decisions a business B
will want to choose the course of action which gives the most
Failure
return. What if a printing company had to decide whether to –£2m
0.8
invest £750,000 in a new printing press now or wait a few A
Success
years? If it bought now and a more efficient machine became £7m
0.4
available next year then it might have been more profitable to
wait. Alternatively, if it waits it may find the old machine has C
Retain old campaign
problems and costs increase.
When the outcome is uncertain, decision trees can be used Failure
–£1m
to help a business reach a decision which could minimise risk 0.6
and gain the greatest return.

328
 Business decisions and strategy

Decision points: Points where decisions have to be made in a From these figures the firm should continue with the existing
decision tree are represented by squares and are called decision campaign because the expected value is higher.
points. The decision maker has to choose between certain
courses of action. In this example, the decision is whether to Numerous outcomes
launch a new campaign or retain the old one. It is possible to have more than two outcomes at a chance node.
For example, at point ‘B’ in Figure 1 there might have been three
Outcomes: Points where there are different possible outcomes outcomes.
in a decision tree are represented by circles and are called ●● The probability of great success may be 0.2 with a profit of
chance nodes. At these chance nodes it can be shown that a £15 million.
particular course of action might result in a number of outcomes. ●● The probability of average success may be 0.4 with a profit
In this example, at ‘B’ there is a chance of failure or success of of £6 million.
the new campaign. ●● The probability of failure may be 0.4 with a loss of

–£2 million.
Probability or chance: The likelihood of possible outcomes
The expected value is now:
happening is represented by probabilities in decision trees. The
= (0.2 × £15m) + (0.4 x £6m) + (0.4 × –£2m)
chance of a particular outcome occurring is given a value. If
= £3m + £2.4m – £0.8m
the outcome is certain then the probability is 1. Alternatively, if
= £4.6m
there is no chance at all of a particular outcome occurring, the
probability will be 0. In practice the value will lie between 0 and 1.
In Figure 1, at ‘B’ the chance of success for the new campaign is Question 1
0.2 and the chance of failure is 0.8.
BGS Holdings owns a chain of 32 pubs and bars in the north
It is possible to estimate the probability of events occurring
of England. Due to intense competition, revenue has fallen
provided information about these events can be found. There are
in the last couple of years. As a means of boosting revenue
two sources of information which can be used to help estimate
probabilities. One source is backdata. For example, if a business
it has been suggested that the chain, in line with many
has opened 10 new stores in recent years, and 9 of them have other competitors, should use ‘happy hours’ to attract more
been successful, it might be reasonable to assume that the customers. Traditionally a ‘happy hour’ is a period of time (not
chances of another new store being successful are 9/10 or 0.9. always an hour) where drinks are sold at reduced prices. The
Another source is research data. For example, a business might problem though is choosing the right ‘hour’ when prices should
carry out market research to find out how customers would react be reduced. It is thought not to be a good idea to choose a
to a new product design. 80 per cent of people surveyed may period of time which is already popular. This is because sales
like the product and 20 per cent may dislike it. of drinks would already be very high and to cut prices during
this time would reduce margins significantly. In order to help
Expected monetary values: This is the financial outcome of a make the decision an investigation was carried out in a sample
decision. It is based on the predicted profit or loss of an outcome of four pubs. The data gathered during the investigation is
and the probability of that outcome occurring. The profit or loss shown in Table 1.
of any decision is shown on the right-hand side of Figure 1. For
example, if the launch of a new campaign is a success, a £15 Table 1 Happy hour data gathered by BGS Holdings
million profit is expected. If it fails a loss of £2 million is expected.
Happy Probability Estimated Probability Estimated Expected
Calculating expected monetary values hour
period
of success effect on of failure effect on monetary
profit profit value
(EMV) 3–4pm 0.5 +£1,300 ? –£200 ?
What should the firm decide? It has to work out the expected
values of each decision, taking into account the expected profit 4–5pm 0.5 +£1,700 ? –£400 ?
or loss and the probabilities. So, for example, the expected value
5–6pm 0.7 +£400 ? –£1,200 ?
of a new campaign is:
6–7pm 0.6 +£1,000 ? –£800 ?
Success Failure
Expected value = 0.2 × £15m + 0.8 × (–£2m) 7–8pm 0.6 +£1,100 ? –£400 ?
(probability) (expected profit) (probability) (expected loss)
(a) Complete Table 1.
= £3m – £1.6m
= 1.4m (b) On financial grounds, when should the ‘happy hour’ be arranged?

The expected value of retaining the current campaign is:

Success Failure
Expected value = 0.4 × £7m + 0.6 × (–£1m)
= £2.8m – £0.6m
= 2.2m
329
Decision trees Unit 54

Decisions, outcomes and costs to be 0.4, while the probability of getting a low price, i.e. £6
In practice businesses face many alternative decisions and million, is 0.6. The farmer could also develop the land himself at
possible outcomes. Take a farmer who has inherited some land, a cost of £5 million. The probability of selling the developed land
but does not wish to use it with his existing farming business. at a good price, i.e. £25 million, is estimated to be 0.3 while
There are three possible decisions that the farmer could make. the likelihood of getting a low price, i.e. £10 million, is 0.7. The
●● Sell the land. The market is depressed and this will earn
information about probability and earnings is shown in Figure 2.
£0.6 million.
●● Wait for one year and hope that the market price improves.

A land agent has told the farmer that the chance of an

upturn in the market is 0.3, while the probabilities of it
staying the same or worsening are 0.5 and 0.2 respectively.
The likely proceeds from a sale in each of the circumstances
are £1 million, £0.6 million and £0.5 million.
●● Seek planning permission to develop the land. The legal

and administration fees would be £0.5 million and the

probability of being refused permission would be 0.8,
which means the likelihood of obtaining permission is 0.2.
If refused, the farmer would be left with the same set of
circumstances described in the second option.

If planning permission is granted the farmer has to make

a decision (at node E). If the farmer decides to sell, the
probability of getting a good price, i.e. £10 million, is estimated

Figure 2
The decisions faced by a farmer in the disposal of land
Profit or loss
Sell immediately at the current market price
£0.6m

Improve
£1m
0.3

Wait for one year Unchanged

A B £0.6m
0.5
Worsen
£0.5m
0.2
Improve
£1m
Refused planning 0.3
permission Unchanged
Seek D 0.5
£0.6m
planning 0.8
permission Worsen
£0.5m
0.2
C
–£0.5m Good price
£10m
Sell 0.4
F
Low price
Obtained planning £6m
permission 0.6
E
0.2 Good price
£25m
Develop and sell 0.3
G
–£5m Low price
£10m
0.7

330
 Business decisions and strategy

What decision should the farmer make? The sale of the land Question 2
immediately will earn £0.6 million.
The expected monetary value of the second option, waiting a Colin Andrews is the owner of Slade Farm near Spalding. He
year, is: specialises in vegetable crops and allocates about 400 acres of
land each year to the production of potatoes and swedes. He
Expected monetary value decides what crops to plant in October each year.
= 0.3 × £1m + 0.5 × £0.6m + 0.2 × £0.5m
If Colin plants potatoes he estimates that the probability of a good
= £0.3m + £0.3m + £0.1m
crop is 0.3, which will generate £50,000 profit. The probability
= £0.7m
of an average crop is 0.3, which would result in £30,000 profit.
Since this earns more than the first option, it would be a better The probability of a poor crop is 0.4, which would result in only
choice. We could show this in Figure 4 (on the next page) by £10,000 profit.
crossing the ‘selling immediately’ path with a //, indicating that If swedes are planted, either a good crop or a bad crop will result.
the first option will not be taken up. The expected value of the He estimates that the probability in each case is 0.5. A good crop
second option (£0.7 million) is shown in the diagram at node B. will generate a profit of £40,000 and a poor crop only £10,000.
A rollback technique can then be used to work out the Figure 3 is a decision tree which shows this information.
expected value of the third option, seeking planning permission.
This means working from right to left, calculating the expected Figure 3
values at each node in the diagram. The expected value at node The alternative courses of action faced by Colin Andrews
D is:
Profit
Expected value = 0.3 × £1m + 0.5 × £0.6m + 0.2 × £0.5m Good crop
= £0.7m £50,000
0.3
Plant potatoes Average crop
The expected monetary value at node F is: £30,000
B
0.3

Expected value = 0.4 × £10m + 0.6 × £6m Poor crop

£10,000
0.4
= £4m + £3.6m A
Good crop
= £7.6m £40,000
0.5

The expected value at node G is: C

Plant swedes

Expected monetary value = 0.3 × £25m + 0.7 x £10m Poor crop

£10,000
= £7.5m + £7m 0.5

= £14.5m
(a) What is happening at points B and C in the decision tree?
At node E, a decision node, the farmer would choose to develop (b) Calculate the expected values of each course of action and
the land before selling it. This would yield an expected return decide, on financial grounds, which course Colin should take.
of £9.5 million (£14.5 million – £5 million) which is higher
than £7.6 million, i.e. the expected return from selling the land Maths tip
undeveloped. Thus, in Figure 4 the path representing this option
can be crossed. The expected value at node C is now: Probability can be expressed as a decimal, a fraction or
a percentage. For example, the probability of an event might
Expected monetary value = 0.2 × £9.5m + 0.8 × £0.7m be 0.8, 45 or 80 per cent. They all mean the same. However,
= £1.9m + £0.56m when using decision trees it is common to use decimals to
= £2.46m represent probability.

Finally, by subtracting the extra cost of seeking planning

Exam tip
permission (£0.5 million), the expected value of the final option
It is important to recognise that once a particular course of action
can be found. It is £1.96 million. Since this is the highest value, has been chosen, the profit or revenue generated by that choice
this would be the best option for the farmer. This means a // can .
is not the same as the expected value. In the first example shown
be placed on the line to node B as £0.7 million is lower than by the decision tree in Figure 1, the expected value of the best
£1.96 million. All of the expected values are shown in Figure 4 option (retain the old campaign) was £4.6 million. However, the
on the next page. profit resulting from the decision will be either £7 million, or a loss
of £1 million – it depends on the success of the campaign. But it is
Figure 4 shows profit or loss (taking into account costs) and
not £4.6 million, which is the expected value. Expected values are
then the extra costs of planning permission are subtracted in used to make the choice but they do not represent the actual
the calculation. However, a decision tree may show revenue on amount of money made.

331
Decision trees Unit 54

Figure 4
The final solution
to the farmer’s decision problem (all expected values and unused routes are shown)

Sell immediately at the current market price Profit or loss

£0.6m

Improve
£1m
0.3

Wait for one year Unchanged

A B £0.6m
0.5
£0.7m Worsen
£0.5m
0.2
£1.96m Improve
£1m
Refused planning 0.3
permission Unchanged
Seek D 0.5
£0.6m
planning 0.8
permission £0.7m Worsen
£0.5m
0.2
C
–£0.5m Good price
£10m
£2.46m Sell 0.4
F
Low price
Obtained planning £6m
permission £7.6m 0.6
E
0.2 Good price
£25m
£9.5m Develop and sell 0.3
G
–£0.5m Low price
£10m
£14.5m 0.7

the right side instead of profit, and all costs indicated on the probabilities. They often involve people and are influenced
diagram must be subtracted. Whichever is shown, the method of by legal constraints or people’s opinions, for example.
calculation is the same. These factors cannot always be shown by numerical values.
Qualitatitive data may also be important.
Advantages of decision trees ●● Time lags often occur in decision making. By the time a
Decision trees can be applied to much more complicated decision is finally made, some of the numerical information
problems. They have some major advantages. may be out of date.
●● Constructing the tree diagram may show possible courses of ●● The process can be quite time-consuming, using up valuable
action not previously considered. business resources. However, computerised decision-making
●● They involve placing numerical values on decisions. This models can be used to analyse decision trees which can save
tends to improve results. some time.
●● They force management to take account of the risks ●● It is argued that decision makers, in an attempt to
involved in decisions and help to separate important from encourage a particular course of action, may manipulate
unimportant risks. the data. For example, a manager might be ‘biased’ when
attaching probabilities to certain outcomes. This will distort
Limitations of decision trees the final results.
The technique also has some limitations. ●● Decision trees are not able to take into account the dynamic
●● The information which the technique ‘throws out’ is not exact.
nature of business. For example, a sudden change in the
Much of it is based on probabilities which are often estimated. economic climate might render a decision based on a
●● Decisions are not always concerned with quantities and
decision tree obsolete.

332
 Business decisions and strategy

Question 3 Links
Trumed plc is a medical company that carries out research into Decision trees are quite a versatile decision-making technique.
new treatments for colds and influenza. It has won a contract They can be used in a variety of circumstances. Consequently,
from a large pharmaceuticals corporation to carry out research it will be easier to demonstrate synoptic skills when discussing
into new treatments. Trumed has identified three distinct decision trees. For example, a business might use decision trees
research programmes to develop a vaccination to combat the to help determine which course of action to take when deciding
strain. The code names for each programme are VAC1, VAC2 upon a price change, or which marketing strategy to select. Links
and VAC3. The cost of the programmes, the expected returns can be made to a range of different areas in the specification
and the probabilities of success and failure are illustrated in the – wherever a business might need to make a decision. Some
decision tree in Figure 5. examples of links between this unit and others include Pricing
strategies (Unit 11), Marketing strategy (Unit 13), Business
Figure 5 choices (Unit 24), Internal finance (Unit 26), External finance
The costs, revenues and probabilities of success and (Unit 27), Theories of corporate strategy (Unit 45), Investment
failure of each research programme for Trumed plc appraisal (Unit 53) and Assessment of a country as a production
Revenue
location (Unit 73).
Success
£20m
0.3 Key terms
VAC 1
B Decision tree – a technique which shows all possible
-£2m
outcomes of a decision. The name comes from the similarity
Failure
0.7
£2m of the diagrams to the branches of trees.
Success
£17m
0.4

A
VAC 2
C
Knowledge check
-£2.6m
1. Why are decision trees useful when a business has to make
Failure important decisions?
£4m
0.6
Success 2. What is meant by a quantitative approach to decision making?
£9m
0.5
3. What is meant by probability in a decision tree?
VAC 3
D 4. What is the difference between chance nodes and decision nodes?
-£1.4m

Failure
5. How is the expected value of a course of action calculated?
£6m
0.5 6. What are the advantages and disadvantages of using
decision trees?
(a) Calculate the expected values of each research programme and 7. State three possible situations where a business might make
advise Trumed which is the best option. use of a decision tree.

Case study
OPAL MEDIA
Opal Media publishes a number of consumer magazines in McMahon, head of marketing, believed that the fall in sales was
the UK. It specialises in magazines for people involved in due mainly to the decline in the popularity of the sport. Twenty
sports such as canoeing, snow boarding, surfing, paragliding, years ago, Squash Monthly, was one of the company’s ‘stars’.
bowling, archery, skydiving and water-skiing. Opal Media It was now regarded as a ‘dog’ by many in the department and
currently owns 18 publications. In 2014, the company was was barely breaking even.
concerned that one of its magazines, Squash Monthly, was The board at Opal Media asked Pat to look into the situation
not performing well enough. Its circulation figures had and make a recommendation. Pat identified a number of options
dwindled slowly but consistently over the last ten years. Pat open to the company. These are outlined on the next page.

333
Decision trees Unit 54

Withdraw Squash Monthly from the market and The costs, revenues and probabilities of success and failure of
replace it with a new magazine Opal Media's options are shown in Figure 6.
The marketing department believes there might be a gap in
the market for a magazine devoted entirely to the World Cup Figure 6
2018. Obviously this would have a short life cycle because
The costs, revenues and probabilities of success and
once the event is over sales would fall to zero. However, the failure of the options open to Opal Media
amount of publicity that the event would get suggests that the REVENUE
potential for high sales levels for a short period of time could Success
Thorough £3.5m
be enormous. It was also felt that competitors would not be 0.5
development Moderate success
interested in a magazine with such a short life cycle. £400,000
D
0.3
£1.8m
Failure
• With a thorough development programme the new £0.9m
0.2
Withdraw
magazine, called World Cup ‘18, could be launched in B
Success
September 2016. The cost of thorough product development Rapid £2.8m
0.6
would be £400,000 and once launched net revenue of development
E
Moderate success
£1.2m
£100,000 0.2
£3.5 million would be generated if the magazine was a Failure
complete success. The chances of this were estimated to be £0.5m
0.2
0.5. If the magazine flopped, sales would only be £900,000.
The chances of this were thought to be 0.2. If the magazine
Success
enjoyed moderate success (0.3 chance) sales of £1.8 million £3.9m
Retain 0.4
would be generated. A F
− £500,000 Failure
£0.7m
• If the product was launched with a rapid development 0.6

programme it could come out in December 2015. This

would cost £100,000. However, with a short development
Success
programme the quality would not be as good and as a result £3m
Relaunch 0.5
advertising revenue would be lower. If the launch was a − £300,000
G
Failure
complete success (0.6 chance) sales revenue of £2.8 million £0.6m
Retain 0.5
C Success
would be generated. If the magazine flopped (0.2 chance) £8m
New markets 0.3
revenue would be £500,000. With moderate success H
− £600,000 Failure
(0.2 chance) revenue would be £1.2 million. £0.8m
0.7

Retain Squash Monthly in its existing form and

invest £500,000 in an above-the-line promotion
This strategy would generate £3.9 million if successful and
the chances of success are 0.4. If the investment fails to be a (a) Calculate the expected values for each option and
success only £700,000 will be generated. determine on financial grounds which option Opal Media
should select. (10 marks)
Retain Squash Monthly and develop some extension
strategies (b) Just before the final decision was made by Opal, it was
brought to the attention of the marketing department that
Two alternative extension strategies were identified by the
future exchange rate forecasts would have an impact on the
marketing department.
revenues earned in Canada and the USA. It was estimated
• Relaunch the magazine with new features, articles and some that the pound would rise against the dollar over the next
below-the-line promotion. The cost of this strategy would few years and the revenues earned could fall to £6.5m and
be £300,000 and if successful would generate revenue of £0.6m (depending on the success of the launch). How might
£3 million. The probability of this was estimated at 0.5. this affect the decision? (4 marks)
If the strategy was unsuccessful only £600,000 would be
(c) Evaluate the limitations to Opal Media of using decision
generated.
trees to make a decision about the future of Squash
• Launch Squash Monthly in Canada and America. This would Monthly. (20 marks)
be risky and more expensive but the rewards potentially
higher at £8 million if completely successful. The costs
would be £600,000 and the chance of complete success is
estimated to be 0.3. If the magazine flopped in the new
markets the revenue would only amount to £800,000.

334
 55 Critical path analysis 3.3.4
Theme 3

Key points
1. Nature and purpose of critical path analysis.
2. Complete and interpret simple networks to identify the critical path.
3. Calculate: earliest start time, latest finish time and total float.
4. Limitations of using critical path analysis.

time needed to complete a project. It can also identify possible

Getting started
delays, which could have a crucial effect on its completion
Sometimes business activity involves project management. A
date. CPA has a number of uses and can be used in a range of
project could be planning a product launch, refurbishing some
industries. It is a helpful tool when managing large projects that
premises, installing some new machinery, moving to a new may take many days, weeks, months or even years to complete.
location or constructing a factory. These projects are ‘big jobs’. If such projects have hundreds or thousands of tasks, CPA can
They involve lots of different tasks and might use a wide range aid planning, organisation and resource management. It is used
of business resources. It is important to calculate how much time commonly in the construction industry, engineering, product
it will take to complete such a project and whether or not the development, software design, plant maintenance, aerospace
completion time will be extended if a particular task is held up. and defence industries.
Look at the example below.
Scotnect+ provides a connection service for the supply of Efficiency: Producing a network diagram can help a business
electricity. It currently has a job connecting a new hotel to the to operate efficiently. For example, a network shows those
national grid in a remote part of Scotland. The tasks required in tasks that can be carried out at the same time. This can help
the connection, and the order in which they should be completed, save production or installation time and the use of resources.
are as follows. Highlighting exactly which delays are crucial to the timing of the
project can help a business to meet deadlines. Inability to meet
• Task A Clear land (3 days) a deadline can be costly for a business. Orders may be lost if
• Task B Erect ten pylons (6 days) goods are not produced on time. In the construction industry,
• Task C Fit cabling (4 days) clients sometimes have penalty clauses in contracts. These are
• Task D Fit fuse box, junction and meter (2 days) costs payable by the building company if it does not meet its
• Task E Safety testing (1 day) deadlines. Sometimes building firms earn bonuses for coming in
In this project Task C and Task D can be done at the same time. ‘on time’ or beating deadlines.

What is meant by project management? How many days will it Decision making: The use of business models, such as
take Scotnect+ to complete the project? If Task D were delayed network analysis, is argued to be a more scientific and objective
by 1 day what impact would this have on the completion time? method of making decisions. It is suggested that estimating
Why is it important to know how long a project will take to the length of time a project will take based on past information
complete before starting? and an analysis of the tasks involved should lead to deadlines
being met more effectively, as the implications of delays can be
assessed, identified and prevented.
Nature and purposes of critical path
analysis Time-based management: Some businesses operate time-
In business there is a well-known saying that ‘time is money’. based management systems. These are techniques to minimise
What exactly does this mean? One interpretation is that if tasks the length of time spent in business processes. Identifying tasks
are completed more quickly, the business will benefit financially. that have to be done in order, tasks that can be done together
For example, if a company completes an order in five weeks and tasks that may delay the whole project if not completed
instead of six weeks there will be some real benefits. Once on time will all help to ensure that the least time is taken to
the order is completed resources are available for other tasks, complete an operation.
the customer will get the order more quickly and the business
can ask for payment earlier. Completing tasks more quickly will Working capital control: Identifying when resources will be
improve efficiency and profitability. One established method required in projects can help a business to manage its working
used to improve the management of time and other resources capital cycle. Network diagrams allow a business to identify
is critical path analysis (CPA). The technique, which makes use exactly when materials and equipment will be used in a project.
of network diagrams, can be used to calculate the minimum For instance, materials can be purchased when required, rather
335
Critical path analysis Unit 55

Maths tip Question 1

The arithmetic needed for critical path analysis is very An airline company is considering improvements to its
basic – just adding and subtracting. However, to avoid mistakes turnaround time for planes from the moment a plane arrives
it is important that your network diagram is big enough to at the airport terminal to the time it leaves. Figure 3 shows a
contain all the information needed and is also clearly labelled. network diagram for the turnaround.
Try to draw all arrows with straight lines. It might also be helpful
to use more than one colour. Figure 3
Turnaround time for a passenger aircraft
than holding costly stocks. This is especially important if a Refuel plane
business operates a ‘just-in-time’ system of stock control. If a 16 minutes
Passengers board
business has to borrow to purchase materials then charges Passengers leave
Clean plane plane
plane
or interest costs may be reduced if materials are only bought
12 minutes 20 minutes 15 minutes
when required. If delays are identified and taken into account
then resources can be allocated to other operations until they Change crew

are needed. 12 minutes

Networks (a) What is the minimum amount of time it takes for the turnaround
Many of the operations carried out by businesses are made up of the aeroplane?
of a number of tasks. The operation is only complete when all of (b) If the company could cut the time it takes to clean a plane from
the tasks have taken place. For example, the tasks involved in 20 minutes to 14 minutes, would that affect the time change?
changing a set of strings on a guitar for an instrument repairer
might include:
prepare, which is longer than any of the other ingredients.
●  slackening the strings ●  attaching new strings
So the whole operation must take 30 minutes (5 minutes +
●  removing the strings ●  retuning the strings.
10 minutes + 15 minutes). This assumes tasks A, B and C can
●  cleaning the fretboard
be carried out at the same time.
These tasks must be carried out in order for the operation
to take place. Each task will take a certain amount of time. Network analysis
The operation is shown in Figure 1 on a network diagram. The Businesses often have to complete large projects, which involve
operation takes 20 minutes to carry out (1 minute + 1 minute a series of complicated tasks or activities which must be carried
+ 5 minutes + 10 minutes + 3 minutes). out in a certain order. The use of networks helps a business to
Some operations are less simple, with many tasks involved. manage these projects effectively.
Figure 2 shows a network diagram for an operation carried out It is vital that a business knows the minimum length of time
by a cake manufacturer to make cakes for a wedding reception. a project will take to complete. It is also important to know
In this operation some of the tasks can be carried out at the whether a delay in completing individual tasks in an operation
same time. So, for example, some of the ingredients can be will delay the whole project. Network analysis allows a business
prepared at the same time. Ingredient A takes 10 minutes to to find the sequence or ‘path’ of tasks which are critical to the
project and which, if delayed, will cause delays in the entire
Figure 1 operation. In practice, businesses may use computers to manage
A simple network large projects, such as the construction of a road system or
Slacken Remove Clean Attach Retune hospital, or the manufacture of a large urgent overseas order for
the the the new the
strings strings fretboard strings strings new machinery.
Before any project starts, it is important that networks are
planned. This involves identifying the tasks that are to take place,
1 1 5 10 3 how long each will take and the order in which they will take
minute minute minutes minutes minutes
place. This information may be based on previous experience of
projects or from research carried out by the business.
Figure 2 Figure 4 on the next page shows a network for a
A more complex network construction company which is renovating a cottage. There are
Prepare ingredient A certain features to note about the network.
10 minutes ●  Arrows and lines show the tasks or activities to be carried

Collect and order out to complete the project. For example, Task B involves
ingredients Prepare ingredient B Bake cakes
removing and replacing brickwork and flooring in the cottage.
5 minutes 5 minutes 15 minutes
●  Some tasks can be carried out together, at the same time.
Prepare For example, Tasks B and C can take place together but only
ingredient C
3 minutes
after Task A has been completed.
●  Arrows and lines cannot cross.

336
 Business decisions and strategy

●  Each task takes a certain amount of time. For example, the start until after 5 days (4 days + 1 day). This is placed in the
business plans to take four days to complete Task B, removing EST in Node 3.
and replacing the brickwork and flooring in the cottage. Node 4: Task C takes 8 days to complete. Together with the 1 day
●  Tasks must be completed in a certain order. Certain tasks are to complete Task A, this means that Task F can’t start until after 9
dependent on others being completed. For example, Task D, days (8 days + 1 day). This is placed in the EST in Node 4.
fitting new windows, and Task E, rewiring, cannot begin until Node 5: What will be the earliest start time for Task G which
Task B, removing and replacing brickwork and flooring, has begins at Node 5?
taken place. ●  Tasks A, B and D take 7 days to complete

●  Circles on the diagram, called nodes, show the start and (1 day + 4 days + 2 days)
finish of a task or activity. For example, Task A, preparing and ●  Tasks A, C and F take 17 days to complete

organising materials, starts at Node 1 and ends at Node 2. (1 day + 8 days + 8 days)
●  There is always a node at the start and end of the project. ●  Tasks A, B and E take 19 days to complete

●  Nodes contain information about the timing involved in (1 day + 4 days + 14 days).
the project. Task G can only begin when all preceding tasks are completed.
It is dependent on earlier tasks. The longest time to complete
Figure 4 these tasks is 19 days. So the EST in Node 5 is 19 days and
Network for a cottage renovation Task G can’t start until after 19 days. This highlights an important
rule when calculating earliest start times. Always choose the
TASK I
TASK B
Remove and TASK D TASK H Lay new paths longest amount of time when placing the ESTs in nodes.
replace brickwork
and flooring
Fit new
windows
Clear site of and tidy
garden
Node 8: Another example of this can be found when calculating
materials
4 days
3
2 days 1 day
7
2 days the final node, Node 8. Tasks up to Node 6 have taken 22 days
TASK A to complete. So Tasks H and J can only begin after 22 days.
Prepare and TASK E TASK G
organise Rewire the Install TASK J The time taken to complete Task J is 6 days. This is longer than
materials house fittings Paint and decorate
1 2 5 6 8 the time taken to complete Tasks H and I, which is 3 days
1 day 14 days 3 days 6 days
(2 days + 1 day). So the EST placed in Node 8 is
TASK C
Install new TASK F 22 days + 6 days = 28 days.
plumbing Replaster
4 As Node 8 is the final node, then 28 days is the time taken
8 days 8 days
to complete the entire project.

Calculating the earliest start times Question 2

The first stage in determining the critical path in the network is to
An advertising agency is working on a campaign for a large
calculate the earliest time at which each of the tasks or activities
client for the launch of a new product. It has constructed a
can start, called the earliest start time (EST). These are shown
in the top right of the nodes. Figure 5 shows the earliest start network showing the earliest start times for the different phases
times for all tasks in the renovation of the cottage. of the campaign.
Node 1: Task A can begin immediately. So 0 is placed in the Figure 6
EST in Node 1.
Node 2: Task A takes 1 day to complete. Tasks B and C, which Network for an advertising campaign
CreateTV Film TV Edit TV
can be carried out at the same time, can only begin after Task A campaign ? commercial ? commercial
3 4
is completed. So they can only begin after 1 day. This is placed 6 months 4 months 1 month

in the EST in Node 2.

Node 3: Task B takes 4 days to complete. Together with the Plan Plan newspaper and Co-ordinate
campaign magazine campaign Photo shoots launch
1 day to complete Task A, this means that Tasks D and E can’t 1
0
2
?
5
?
6
?
7
?

1 month 5 months 2 months 1 month

Figure 5
Create PR
Network showing the earliest start times for the cottage campaign

renovation 2 months
Earliest start time

TASK B 5 TASK D TASK H 23 TASK I (a) Copy out the network in Figure 6 and fill in the earliest start
3 7
4 days 2 days 1 day 2 days times marked by ‘?’.
(b) What is the minimum amount of time the campaign will take
TASK A
to complete?
0 1 TASK E 19 TASK G 22 TASK J 28
1 2 5 6 8 (c) In the one month taken to plan the campaign at the start, the
1 day 14 days 3 days 6 days
advertising agency revises its estimate of the time taken to plan
the newspaper and magazine campaign to 10 months. How will
TASK C 9 TASK F this affect (i) the earliest starting times and (ii) the overall time
4
8 days 8 days
taken to complete the campaign?

337
Critical path analysis Unit 55

Calculating the latest finish times Calculating the float

The next step involves calculating the latest times that each task A business can use the information in the network to calculate
can finish without causing the project to be delayed. The latest the float time in the project. This is the amount of time by which
finish times (LFTs) of the project to renovate a cottage are a task can be delayed without causing the project to be delayed.
shown in Figure 7. They appear at the bottom right of the nodes. For example, Task I takes 2 days to complete. However, as it
Calculating the latest finish times begins at the final node, does not lie on the critical path, it is possible that some delay can
Node 8. It has already been calculated that the project will take take place in this task without delaying the whole project. A delay
28 days. This is placed in the LFT of Node 8. To calculate the of 1 day, for instance, would not lead to the project taking longer
LFTs of earlier nodes, use the formula: than 28 days.
How much delay can there be in tasks which do not lie on
LFT at node – time taken to complete previous task the critical path?

So the LFT at Node 7, for Task H, is 28 days – 2 days = 26 days. Total float: The total float is the amount of time by which
To calculate the LFT for Task G, to be placed in Node 6, a task can be delayed without affecting the project. It can be
again use the tasks which take the longest amount of time. calculated as:
Task J takes 6 days and Tasks H and I only 3 days (2 days + 1 day).
So the LFT at Node 6 is 28 – 6 days = 22 days. LFT of activity – EST of activity – duration

So for Task B in Figure 8, for example, it would be:

5 days – 1 day – 4 days = 0 days

Figure 7
Network showing latest finishing times for the cottage Activities which lie on the critical path will always have a zero
renovation total float value.
Task B 5 Task D Task H 23 Task I
4 days
3 5 2 days 1 day
7 26
2 days For Task C, which does not lie on the critical path, the total
float is:
Task J
11 days – 1 day – 8 days = 2 days
0 Task A 1 Task E 19 Task G 22 28
1 0
2 5 6 22
8 28
1 day 1 14 days 19 3 days 6 days
Table 1 shows the total float for all tasks.

Task C
4
9
11
Task F Latest finish time
Free float: The free float is the amount of time by which a
8 days 8 days
task can be delayed without affecting the following task. It can
be calculated by:

Identifying the critical path EST start of EST start of

It is now possible to identify the critical path through the next task – this task – duration
network. This shows the tasks which, if delayed, will lead to a So for Task C it would be:
delay in the project. The critical path on any network is where
the earliest start times and the latest finish times in the nodes 9 – 1 – 8 = 0 days
are the same. But it must also be the route through the nodes
which takes the longest time. Table 1 Float
Figure 8 shows the critical path and the tasks which can’t be
(days)
delayed if the renovation of the cottage is to be completed on time.
These are tasks A, B, E, G and J. The critical path can be indicated Task/activity LFT EST Duration Total EST EST Duration Free
by a broken line or crossed lines, or by some other method, such float next this float
as highlighting the line in colour, by pen or on computer. Other A 1 0 1 0 1 0 1 0
tasks in the network do not lie on the critical path.
B 5 1 4 0 5 1 4 0
C 11 1 8 2 9 1 8 0
Figure 8
Critical path for the cottage renovation D 19 5 2 12 19 5 2 12

Task B 5 Task D Task H 23 Task I E 19 5 14 0 19 5 14 0

3 7 26
5 2 days 1 day 2 days
4 days F 19 9 8 2 19 9 8 2
0
Task A 1 Task E 19
Task G
22
Task J
28 G 22 19 3 0 22 19 3 0
1 0
2 1
5 19
6 22
8 28
1 day 14 days 3 days 6 days
H 26 22 1 3 23 22 1 0
Task C
4
9 Task F I 28 23 2 3 28 23 2 3
8 days 11 8 days
J 28 22 6 0 28 22 6 0

338
 Business decisions and strategy

Question 3
Hurford’s is a specialist zinc galvanising business, coating steel
components with zinc to prevent them from rusting. A network
for one of its processes is shown in Figure 9.

Figure 9
Network for a zinc galvanising business
Job B Job C Job D Job I Job J
3 4 8
2 mins 5 mins 2 mins 1 min 3 mins

Job A Job E Job H

1 2 6 7 10
3 mins 1 min 10 mins

Job F Job G
5 Job K Job L
1 min 4 mins 9
2 mins 3 mins

(a) Copy out Figure 9 and fill in the earliest start times for each job on your diagram.
(b) Fill in the latest finishing times on the diagram.
(c) Show the critical path on the diagram.

Limitations of critical path analysis Links

Although critical path analysis is clearly of value, a business
To demonstrate your synoptic skills when discussing critical
must not assume that simply because it produces a network path analysis in an exam you could make relevant links to a
its project will be completed without delay. There are some number of areas in the specification. For example, critical path
limitations that businesses need to be aware of when using analysis is used to improve efficiency and reduce waste in a
this technique. business. Therefore it could be linked to Production, productivity
●  Information used to estimate times in the network may be and efficiency (Unit 37), Capacity utilisation (Unit 38) and lean
incorrect. For example, management might have estimated production in Stock control (Unit 39). Remember also that critical
times based on past performance, but a new project could path analysis can be used to manage a wide range of projects in
have special requirements that take longer. business, such as planning marketing strategy, planning a product
●  Changes sometimes occur during the life of the project. For launch or relocating premises, for example.
example, construction companies may need contingency
plans to deal with unforeseen events, such as bad weather
delaying operations. These need to be taken into account Key terms
when producing a network. Earliest start time – how soon a task in a project can begin.
●  Although critical path analysis identifies times when It is influenced by the length of time taken by tasks which
resources might be used somewhere else in the business, must be completed before it can begin.
these resources may be inflexible. For example, a giant Critical path – the tasks involved in a project which, if
crane may be identified as being available for a few days. delayed, could delay the project.
However, if it takes several days to dismantle the crane, Critical path analysis (CPA)/network analysis – a method of
move it and reassemble it, it may not be feasible to use it at calculating the minimum time required to complete a project,
another location. identifying delays which could be critical to its completion.
●  With very large projects, such as building a skyscraper, Free float – the time by which a task can be delayed without
network analysis can become complex with hundreds of affecting the following task.
thousands of tasks to take into account. However, the use Latest finish time – the latest time that a task in a project
of a computer may simplify the whole approach. can finish.
Network diagram – a chart showing the order of the tasks
Exam tip involved in completing a project, containing information
Drawing network diagrams, calculating ESTs, LFTs and floats may about the times taken to complete the tasks.
be challenging. However, with practice it becomes a lot easier. It is Nodes – positions in a network diagram which indicate the
also important not to neglect your understanding of the nature, start and finish times of a task.
purpose and limitations of critical path analysis. It is possible for Total float – the time by which a task can be delayed
exam questions to focus on this and/or calculations. without affecting the project.

339
Critical path analysis Unit 55

Case study
NEWPORT HOLDINGS

Newport Holdings manufactures electronic components for

Figure 10
domestic appliances. The company has received some large orders
recently after a successful sales drive. However, to increase capacity Network diagram for the installation of new technology at
Newport Holdings
and improve productivity it must replace the entire assembly line B
15
with up-to-date technology. The directors are keen to go ahead
with the investment, but are worried about the disruption that
will be caused. During the construction of the new assembly line A C F G H I
1 2 4 5 6 7 8
3 2 3 11 3 2
production will be zero. The company can hold up to 30 days of
stocks so the new line must be up and running within one month. If 2 D E 2

the new line isn’t ready, Newport Holdings will lose approximately 3
£200,000 per day. This will be unacceptable to the directors.
Figure 10 shows the network diagram for the installation of Table 2 The tasks, task order and task times required to
the new technology and Table 2 shows the tasks, task order construct the new assembly line
and task times required to construct the new assembly line. Task Description Order/dependency Duration
A Dismantle old line Must be done first 3 days
B Retrain staff Must follow A 15 days
(a) For the activities required to install the new technology, C Position lifting gear Must follow A 2 days
calculate the earliest start times (ESTs). (4 marks) D Remove roof panels Must follow A 2 days
(b) For the activities required to install the new technology, E Lower in new plant Must follow D 2 days
calculate the latest finish times (LFTs). (4 marks) F Replace roof panels Must follow C and E 3 days
(c) Identify the critical path on the network diagram and hence, G Install new plant Must follow F 11 days
state the minimum amount of time in which the project can H Test run Must follow B and G 3 days
be completed. (4 marks) I Safety checks Must follow H 2 days
(d) How will the construction time be affected if Task B is (e) Assess the advantages and disadvantages to Newport
delayed by 4 days? (4 marks) Holdings of using critical path analysis. (12 marks)

Knowledge check
1. Why is network analysis also known as ‘critical path analysis’? 4. Why can network analysis help improve the efficiency of
2. What is shown by a node on a network diagram? a business?
3. Explain the difference between (a) the earliest start time and 5. What are the implications of network analysis for working
the latest finish time; (b) the total float and the free float. capital control?

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 56 Corporate influences 3.4.1
Theme 3

Key points
1. Corporate timescales: short-termism versus long-termism.
2. Evidence-based versus subjective decision making.

Getting started Corporate influences: Most businesses have a set

strategy which has long-term objectives and short-term goals.
Sometimes, in an attempt to boost profits they might make short-
term decisions which do not fit into the long-term strategy. As a
result they may decide, for example, to limit wage increases to
just 1 per cent for three years. This might help to boost profits
in the short term, but could adversely affect the long-term
performance of the business if worker motivation declines.
Another corporate influence is whether business decisions
are based on evidence or the subjective views of key decision
makers. Subjective decision making is likely to carry more risk.
These corporate influences are discussed in more detail below.

Corporate culture: The culture of an organisation can

influence decision making. For example, if the culture is open,
Vincenzo Cicotti is the well-liked but ‘maverick’ leader of creative, flexible and innovative, a business is more likely to
LiftWithPower, a manufacturer of forklift trucks. In 2014, a make decisions that involve change. If a culture is more resistant
fierce rival made an offer for LiftWithPower that looked quite to change, decisions are likely to be more cautious and involve
generous to shareholders. However, Vincenzo, who makes all less risk. This might result in less innovation and a loss of
the key decisions at the company, turned it down flat. He said: competitive edge. The effect of corporate culture on decision
making is discussed in Unit 57.
‘They’ll change the name of the company. It’s been in the family
for years and I want to keep it the same.’ However, at least one
Stakeholder perspective: Some corporations take a
angry shareholder said that Vincenzo should have made a more
‘shareholder approach’ when making business decisions. This
informed decision. ‘Why not get all the facts together, analyse
means that the views of shareholders influence decision making,
them and then get back to them’, was a view held by several while those of other stakeholders are marginalised. For example,
others. Since Vincenzo had a history of making good business large shareholders, such as institutional investors like pension
decisions the bid was soon forgotten. Also, Vincenzo wanted to funds, may have an impact on the amount of risk taken by a
build a business for the future and believed that his workforce of company. In contrast, some corporations take a ‘stakeholder
3,200 would deliver results for the owners. approach’. This means that the views and needs of a wider
In the above case, Vincenzo made a subjective decision. What range of stakeholders, such as customers, employees, suppliers
do you think this means? What approach to decision making and the environment, are considered when making strategic
did some of the shareholders recommend? Does Vincenzo take decisions. This is discussed in Unit 58.
a short-term or long-term view when running LiftWithPower?
Explain your answer. Business ethics: Corporations with a strong ethical stance
are likely to make different decisions from those that have little
regard for ethics. For example, businesses with a strong sense
Influences on business decisions of corporate social responsibility are not likely to choose a
One of the main functions of the senior management team in a course of action that may threaten the environment, damage
corporation is to make strategic decisions. These are important, relations with local communities or upset the workforce. In
far-reaching decisions that can have a long-term impact on a contrast, a corporation that is not concerned with ethical issues
business. For example, if a business decides to build a new may decide to invest cash reserves in, for example, a weapons
factory in an overseas location, this is not a decision that can manufacturer. However, even those who do not have a strong
be easily reversed. As a result the impact of the decision on ethical stance or who would not make ethical decisions out of
the finances of the business, employees and operations will be choice will still be influenced by these issues or potential bad
felt for a long time. For large corporations, important business publicity. The effect of ethical issues on decision making is
decisions are likely to be influenced by a number of key factors. discussed in Unit 59.

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Corporate influences Unit 56

Corporate timescales ●● Pursue external growth rather than organic growth.

The outcome of decisions can have both a short-term and Organic growth may be considered too slow for companies
a long-term impact on a company. The long-term decisions with a short-termist approach. Growth through mergers and
are those that affect the vision, mission and objectives of the acquisitions is much faster and may generate swifter returns,
company. They could have an impact on the business in five if successful.
or even ten years’ time, for example. Short-term decisions are
more operational in nature and are designed to achieve goals in,
Drawbacks of short-termism: Here are some of the specific
drawbacks of short-termism.
say, 12 months’ time. Companies recognise this and therefore
●● The long-term profitability of a business might be threatened
have to decide which is most important to them.
by focusing too much on the short term. It is possible
Short-termism that some very lucrative long-term opportunities might be
Some companies appear to be more short-termist than others. overlooked. For example, a failure to invest in R&D might
If this is the case they are likely to choose certain courses of mean that the chance to discover a potentially lucrative
action when making a decision. For example, they are more innovation is lost forever.
●● Companies may lose their competitive edge in overseas
likely to do the following.
●● Maximise short-term profits. Most companies that pursue
markets. The ability to compete internationally may be
short-term objectives aim to increase shareholder value. They hampered if the long-term performance of business is
are likely to do this by trying to maximise short-term profits. ignored. If businesses fail to invest in the future by developing
There are several ways they can do this. For example, they new products and new technology to reduce costs, they will
might try to maximise revenue by charging higher prices or eventually lose their market shares. As a result, there will be
investing heavily in persuasive advertising. They may also try to less job and wealth creation, and the economy will suffer.
●● One of the features of short-termism is the need for
cut costs by investing less in research and development, which
is discussed below, using cheaper resources (perhaps at the companies to make quarterly financial reports. It is argued
expense of quality) and switching suppliers on a regular basis. that these are required in order to force companies to be
●● Invest less money in research and development (R&D).
disciplined. However, others say that it is a dangerous waste
This is because research and development can be a big drain of time. For example, if two quarterly reports were eliminated,
on cash reserves. A company will prefer to use this to help fund an extra two weeks of time would be created for CEOs and
short-term objectives. Investment in R&D is also risky. Returns other key staff in a corporation. This extra time could be
could be negative if R&D projects are fruitless. Even if R&D is used productively. There is also the risk that senior managers
successful, the financial returns can take many years to reap. are likely to make the wrong long-term decisions if they are
●● Invest less in training. Training staff is also expensive and
wholly focused on reaching short-term quarterly forecasts.
●● Over-reliance on short-term contracts may be inappropriate.
the returns are not immediate. The returns from training are
likely to be positive because workers will be better motivated, In some cases the cost of resources when acquired on
better equipped to do their job and staff turnover will be a temporary basis can be higher than when sourced for
lower. However, it will take time for the benefits to materialise. longer time periods. For example, the wages paid to agency
●● Return cash to shareholders. A business with large cash
staff are often higher than the equivalent full-time rate for a
reserves may pay special dividends to shareholders instead of permanently employed worker. A commitment to short-
investing for the long term. For example, in 2014 Rexam, the term contracts is likely to send out the ‘wrong message’.
beverage can-maker, returned £450 million to shareholders by For example, it may be difficult to recruit high-quality staff
paying them 57p per share. This was after the sale of the bulk and find good-quality and reliable suppliers.
of its healthcare business for £490 million.
●● Engage in asset stripping. Asset stripping is where a
Long-termism
Long-termism is clearly the opposite of short-termism.
business buys another business, often in financial difficulty,
Therefore, businesses with a long-term outlook would not
and breaks it up. The profitable parts are sold for cash and
suffer the drawbacks that are associated with short-termism.
the loss-making sections are closed down. This practice is
For example, businesses are less likely to overlook lucrative
often considered unethical because there is no regard for
opportunities that yield long-term profits. They are more
the future of the company and its stakeholders. However,
likely to invest in R&D, new-product development and other
in the short term it can generate a quick cash return for
innovations. This will help them gain a competitive edge. They
shareholders of the predator.
will attach much less importance to quarterly reports and
●● Arrange more short-term contracts. Companies with
emphasise the importance of the long-term outlook. They will
short-term objectives may rely more heavily on short-term
be more interested in recruiting high-quality staff, training them,
contracts, for example with suppliers. They may also employ
building loyalty and retaining them. Finally, they are likely to
more agency and temporary staff, and favour short-term
be more interested in long-term contracts with suppliers and
leases for machinery and other essential assets. Entering
other agents, in order to develop meaningful and profitable
short-term contracts obviously does not really commit a
relationships.
business to any long-term objectives.

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 Business decisions and strategy

Thinking bigger Figure 1

It has been suggested that many companies are too short-termist in An evidence-based approach to decision making
their approach to business. This corporate focus on short-term objectives
might be the result of the way senior managers are remunerated. For
example, the performance of senior managers in corporations is focused Setting/identifying
on short-term share prices rather than long-term value creation. Also, objectives
there is a lot of pressure from institutional investors who want to make
a quick return for the investment funds they manage, and who have
little concern for a company’s long-term prosperity. It is suggested that
the average holding period for shares bought on the New York Stock
Exchange has fallen from six years to just six months. Gathering ideas
In a report written for the Labour Party in 2013 by the former Institute of and data
Directors boss, Sir George Cox, it was suggested that short-termism was
becoming an entrenched feature in British business. Sir George suggested
that short-termism curtailed ambition, inhibited long-term thinking and
provided a disincentive to invest in research, new capabilities, products,
training, recruitment and skills. Analysing ideas
Source: adapted from Overcoming short-termism, Labour Party, 2013 and data

Evidence-based versus subjective

decision making Making a decision
When making important strategic decisions, businesses are
likely to gather a range of information before choosing a
course of action. This information will be used to make an
evidence-based decision.
●● Evidence-based decision making requires a systematic Implementing the
and rational approach to researching and analysing all the decision
available information before a conclusion is reached.
●● Subjective decision making is where the personal opinions

of the key decision maker strongly influence the course of

action chosen.
Monitoring and
Evidence-based decision making evaluation
Many would argue that the best way to make an informed
decision is to use an evidence-based approach. For complex
and strategic decisions there is likely to be more data available;
consequently there needs to be a scientific approach to making Collecting information and ideas: People need information
a decision. One such approach is summarised in Figure 1. It is and ideas to make decisions. The amount and nature of the
based on a number of stages. information needed will depend on the decision. For example,
the decision whether or not to launch a new product might
Identifying objectives: The first stage in the process is require some information about possible sales levels and
to identify the objective a business wants to achieve. The consumer reactions, costs of production and reactions of
objective might be a corporate objective, such as growth or competitors. It could take several months to collect all this
survival in a poor trading period. These decisions are likely to information. Other decisions could perhaps be made from
be complex and might be taken by the board of directors. information which the business already has. A decision whether
For lower-level objectives, such as filling a part-time or not to dismiss an employee might be made on the basis of
vacancy, decisions may be taken by junior managers. A information from the human resources department.
business’s objectives might be different at different stages in Where does the business get its ideas? It might set up a
its growth. Business activities controlled by local government working party to collect information and ideas from within the
may have different objectives from public limited companies. firm. The working party would then produce a report or make a
The business also needs to develop criteria to measure presentation to the decision makers. Alternatively, individuals or
whether it has achieved its objectives. Quite often the objective departments might submit ideas and information. Another way of
is to solve a problem. This might be planning for an uncertain obtaining information and ideas is to hold discussions amongst
future or dealing with a low level of profitability. staff in the firm.

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Corporate influences Unit 56

Analysing information and ideas: The next stage in the

Thinking bigger
process is to analyse information to look for alternative courses
The use of models or simulations is widespread in business. Models
of action. Possible courses of action may be based on previous
are replicas or copies of problem areas in business. They are theories,
ideas or completely new ideas. The aim is to identify which laws or equations, stating things about a problem and helping in our
course of action will best achieve the business’s objective or understanding of it. There are a number of common features to models.
solve the problem. It may be possible to test the alternatives • They reflect the key characteristics or behaviour of an area of concern.
before the one that is chosen is carried out. • They tend to be simplified versions of areas of concern.
• They simulate the actions and processes that operate in the
Making a decision: Next the decision has to be made. problem area.
This is the most important stage in the process. Decision • They provide an aid to problem solving or decision making.
makers have to commit themselves to one course of action. • Models often make use of formulae to express concepts.
It is difficult to change the decision, so getting it right is vital.
Some models can be carried out using computer software. This allows
For example, once production begins following the decision decisions to be made quickly and many variables affecting decisions can
to launch a new product, it is difficult for the firm to change be included.
its mind. If the product does not sell, this can lead to a loss
Management science and operations research are areas which often
of money. Some decisions can be reversed. For example, if make use of decision-making models. For example, linear programming
the owner of a shop decides to close on Tuesday afternoons, provides a model which allows decision makers to determine optimal
but then finds the loss of sales is intolerable, the owner can solutions to a wide range of business problems. It has been used to
easily reopen again. Sometimes the decision makers feel that make decisions such as:
they cannot reach a decision. They may have to obtain more • how to minimise waste in production
information and complete the previous two stages in the • how to allocate resources between two competing tasks
process again. • how to find the least cost mix of ingredients for a product.
Another example in the area of marketing is the use of Ansoff’s Matrix.
Communication: Once a decision has been made, personnel This model is used to help consider the relationship between the
are informed and the decision is carried out. Quite often the strategic direction of the business and its marketing strategy.
people making the decisions are not those that carry them A simulation involves trying to mimic what might happen in reality. It
out. Instructions may be passed by the decision makers to allows a business to test ideas and make decisions without bearing the
someone else, probably a manager, explaining what action consequences of ‘real action’ if things go wrong. Imagine a business
should be taken. For example, if the directors decide to begin has a problem. A simulation can be carried out several times, quickly
selling their products in a new country, instructions must and cheaply, in order to test alternative decisions. There is no risk and
be sent to the marketing manager. In smaller firms, decision resources are not used up. Simulations are often used to deal with
makers are more likely to carry out their own decisions. problems such as queues in business.

Outcome: Once a decision has been carried out it will take Subjective decision making
time before the results are known. Sometimes this can be Making a subjective decision involves choosing a course
quite a long time. For example, the companies which decided of action that you ‘feel’ is right. For example, it might be
to build the Channel Tunnel will not know for several decades necessary to make such a decision when driving to an unfamiliar
whether or not it will be a commercial success. destination. If you come to a fork in the road and there is no
signpost, which way do you go? The route you take is the one
Evaluate the results: Finally, decision makers need you ‘feel’ is right. This is not an evidence-based decision. Some
to evaluate the outcome of their decisions. This is often might argue that subjective decision making is too risky when
presented as a report. It may be necessary to modify the making strategic decisions. This is because subjective decisions
course of action on the basis of the report. For example, it may be based purely on the opinions and emotions of perhaps
might be necessary to revise the objectives or collect some just one person. However, there are times when such an
more information, as shown in Figure 1 on the previous page. approach might be appropriate.
There may be problems in following such an approach. ●● If there is a lack of current, accurate and meaningful
Objectives may be difficult to identify or unrealistic. Information information relating to a decision, decision makers may be
may be limited, incorrect or misleading. People making forced to take a subjective approach. For example, a business
decisions in the process may have different views and this may may be contemplating selling £5 million of goods to a large,
lead to differences of opinion about what is the best course of but new customer. If the customer does not have a trading
action, for example. history but promises to pay in 90 days, place regular large
orders and meet a range of other contractual obligations, in
the absence of ‘hard information’ the decision to sell to the
new customer might be subjective.

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 Business decisions and strategy

●● Some corporations are dominated by a powerful and

persuasive leader. There may be occasions where such a
Links
leader makes strategic decisions singled-handedly, without When evaluating in answers to exam questions it is often
consultation and perhaps with only a limited range of helpful to distinguish between the short term and the
information. This can be acceptable, particularly if the leader long term. Consequently you may get an opportunity to
is experienced, has a good track record with decisions and demonstrate your synoptic skills by linking your answer to
there is a culture of trust in the organisation. issues on corporate timescales discussed in this unit. Corporate
●● In some industries subjective decision making may be quite influences on decision making might also be linked to other
normal. For example, in the fashion industry people may units on decision making such as Decision trees (Unit 54),
have to make decisions, for instance, about which collection SWOT analysis (Unit 46) and Shareholders versus stakeholders
of designs to purchase, based purely on what they feel. (Unit 58).
People in businesses that make subjective decisions like this
are often successful because they have good instincts for
what will be a hit.
●● There are times when some decisions have to be made very
Key terms
quickly indeed. There may not be enough time to follow Asset stripping – the practice of buying businesses and
the scientific approach outlined earlier. Consequently, such breaking them up. The profitable parts are sold for cash and
decisions are more likely to be subjective. Where speed the rest are closed down.
is of the essence it may be preferable to make a quick Evidence-based decision making – an approach to decision
decision based on ‘gut feeling’ rather than wait to gather making that involves gathering information and using a
and analyse information. Opportunities can often be lost if a systematic and rational approach to reach a conclusion.
quick decision is not made. Long term – the time period where decisions have an
The level of reliance on subjective decision making might be impact on the vision, mission and objectives of a business –
surprising. In 2014 a study on business decision making typically longer than five years.
was carried out by the global creative agency gyro and the Short term – the time period where decisions only have an
Fortune Knowledge Group. The study resulted in findings impact on the operational activities of a business – typically
that showed that factors such as emotion played a big role less than five years.
in business decision making. The report, called Only Human: Strategic decisions – decisions concerning policy that can
The Emotional Logic of Business Decisions, gathered feedback have a long-term impact on a business. Can be risky.
from 720 US senior executives. It found that many executives Subjective decision making – an approach to decision
believed that subjective factors, such as corporate culture and making where the personal opinions of the key decision
corporate values, had an impact on decision making. It also maker strongly influence the course of action chosen.
found that factors such as trust, reputation and ‘gut instinct’
were influential.
The success of subjective decisions is variable as they
can involve more risk. For example, some put forward that the Knowledge check
decision made by Kodak not to exploit digital cameras – 1. State two possible influences on corporate decision making.
a technology that Kodak actually developed, may have been
subjective, when they placed confidence in the long-term 2. Explain the importance of strategic decisions.
future of film. 3. State three activities that a company with a short-term
outlook might engage in.
4. State three possible drawbacks of short-termism.
5. What is meant by evidence-based decision making?
6. Outline the different stages that might be used in an
evidence-based decision making process.
7. Give two examples of circumstances where subjective
decision making might be appropriate.
8. Explain why subjective decision making might be more risky
than evidence-based decision making.

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Corporate influences Unit 56

Case study
buildings that were built in the 1940s. RR wants to invest
in its Civil Aerospace division at Sinfin and eventually create

ROLLS-ROYCE an aerospace campus similar to those it owns in Bristol, the

US and Singapore. A spokesman for RR said: ‘We need to
modernise our facilities to help us continue to be competitive
and continue to meet the needs of our customers . . . This is a
long-term programme. Our wider plans for a campus are at
an early stage in their development and, as they evolve, we’ll
share more details.’
In 2014, RR spent £819 million on research and
development (R&D). According to the chairman, R&D and
innovation are crucial to the development of the company.
He said: ‘A key characteristic of RR is that it is a long-term
business with technologies that take years to develop. This
creates the necessity of a long-term view and for long-term
investment, together with a commensurate attitude and
mind-set for risk.’ One example of this commitment to R&D
is provided by the development of the Trent XWB engine,
which is now the most efficient large civil aero engine in
the world. Development on this new product started back
in 2006. Another product that has taken a lot of time and
money to develop is the liquefied natural gas (LNG) power
system. This system allows ships to reduce their carbon
dioxide emissions by 40 per cent and has almost wiped out
emissions of sulphur and nitrogen oxides.
However, the chairman emphasised in his 2013 report that
Rolls-Royce (RR) is a well-known global brand. The company RR is committed to both the short-term performance and
provides products for the aerospace, power systems, marine long-term health of the business. He said: ‘It is a matter
energy and defence industries. It is well established, has a of “both-and”, not “either-or”. In my experience the most
reputation for quality and aims to deliver ‘better power for successful, most enduring organisations invest equivalent
a changing world’. In 2014, its revenue was £14.588 billion resource and imagination in the long-term health of
and its profit was £1.617 billion. The value of Rolls-Royce’s their business as they do in their short- to medium-term
order book rose from £71.6 billion in 2013 to £73.7 billion performance.’
in 2014. Evidence of RR’s short-term commitment came in 2014
It could be argued that RR has benefited from its when it announced a £1 billion share buyback programme.
commitment to the long term. Some of its key staff have (This benefits shareholders because the share price rises
been with the company for many years. For example, until quickly.) This came after the company sold one of its
his resignation in 2014, Mark Morris, the Chief Finance businesses to Siemens.
Officer (CFO), had been with RR for 27 years. In 2014 Colin Sources: adapted from www.rolls-royce.com,
Smith, Director of Engineering and Technology, had been www.derbytelegraph.co.uk and the Financial Times 
with the company for 40 years and James M. Guyette, 19.06.2014, all rights reserved
President and CEO of US operations, 17 years. These
employees have a wealth of experience and demonstrate
that RR has a long-term view. (a) Explain one reason why a business like Rolls-Royce might
use evidence-based decision making. (4 marks)
Further evidence of its commitment to the long term
was provided by an announcement in 2015 that it would (b) Evaluate the importance of timescale to Rolls-Royce in its
be modernising its facilities in Derby by replacing some approach to decision making. (20 marks)

346
 57 Corporate culture 3.4.2
Theme 3

Key points
1. Strong and weak cultures.
2. Classification of company cultures: power, role, task, person.
3. How corporate culture is formed.
4. Difficulties in changing an established culture.

Getting started ●● It acts as a control device for management. This can help
when setting company strategy.
In 2015, investor Warren Buffett, aged 84, was displaying
few signs of slowing down. Buffett is the CEO and chairman In comparison to a strong culture, a weak culture exists where it is
of Berkshire Hathaway, a multinational conglomerate that difficult to identify the factors that form the culture or where a wide
has stakes in many famous brands, such as Heinz, American range of sub-cultures exists, making the culture difficult to define.
Express and Coca-Cola, since 1970. In 2015, he was personally There are certain factors that are likely to determine whether
worth $58.5 billion. A known philanthropist, Buffet devotes a a business has a strong or weak culture.
large portion of this vast fortune to good deeds. In July 2013 Surface manifestations: These include:
he bestowed $2 billion of his company’s stock on the Bill and ●● artefacts, such as furniture, clothes or tools – wearing a
Melinda Gates Foundation. uniform would be an example
Source: adapted from www.berkshirehathaway.com ●● ceremonials, such as award-giving ceremonies or the singing
of the company song at the start of work
Having held the position of CEO for over 40 years, what long-
●● courses, such as induction courses, or ongoing training
term influence will Warren Buffett have on his company? courses for workers used to instil the organisational culture
●● heroes of the business, living or dead, such as Bill Gates,
Strong and weak corporate cultures Richard Branson or Walt Disney, whose way of working
Every place of work has a slightly different atmosphere. Some are provides a role model within the business
busy, some are friendly, some are disorganised and some are ●● language used in a business-specific way, such as referring to
challenging. This reflects the organisational culture (sometimes workers as ‘colleagues’ or calling workers ‘crew members’
also called the organisation, corporate or business culture) of ●● mottoes, which are short statements that never change,
a business. The organisational culture is the values, attitudes, expressing the values of an organisation
beliefs, meanings and norms that are shared by people and ●● stories, which tell of some important event that exemplifies the
groups within an organisation. values of the business, such as the history and role of the founders
myths, which are frequently told stories within a business
Advantages of a strong corporate culture
●●

about itself, but are not necessarily literally true

A strong culture is one that is deeply embedded into the ways ●● norms, which are the ways in which most workers behave,
a business or organisation does things. It is argued that there such as worrying if you turn up for work late, always being
are certain advantages to a business of establishing a strong prepared to cover for workers who are off sick, or not using
corporate culture. the company’s telephone to make personal calls
●● It provides a sense of identity for employees. They feel part
●● physical layout of premises, such as open plan offices, ‘hot
of the business. This may lead workers to be flexible when desking’, or allocating the size of an office according to a
the company needs to change or is having difficulties. manager’s place in the hierarchy
●● Workers identify with other employees. This may help with
●● rituals, which are regular events that reinforce the culture of
aspects of the business such as teamwork. an organisation, such as always supporting Red Nose Day
●● It increases the commitment of employees to the company.
(we are a caring organisation), having a weekly ‘dress down
This may prevent problems such as high labour turnover or day’ (we are a relaxed organisation), or holding an annual
industrial relations problems. Christmas party (we are a sociable organisation).
●● It motivates workers in their jobs. This may lead to increased

productivity. Core organisational values: Core values are located below

●● It helps employees understand what is going on around the surface manifestations of organisational culture. They are
them. This can prevent misunderstanding in operations or consciously thought-out and expressed in words and policies.
instructions passed to them. The values expressed in a mission statement would be an
●● It helps to reinforce the values of the organisation and senior example. Often these are the values that have come from the
management. top of an organisation. They may have come from the original

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Corporate culture Unit 57

founder of the business, or the current senior management, still very much in control, could typically have
which has attempted to impose a culture on the business. power cultures.
Core organisational values can reflect the actual culture of a
business, but, equally, they might not. Workers at the bottom Role culture: In a role culture, decisions are made through
of the hierarchy might have very different values from the well-established rules and procedures. Power is associated
ones that senior management want them to possess. For with a role, such as marketing director or supervisor, rather
example, workers who face a very difficult environment where than with individuals. In contrast to a power culture, influence
customers often complain might not share the views of the and control lies with the roles that individuals play rather than
CEO that the customer is always right and at the heart of with the individuals themselves. An organisation with a role
the business. culture will have a tall – or flat – hierarchy with a long chain of
command. Role cultures could be described as bureaucratic
Basic assumptions: Basic assumptions are the unsaid cultures. The Civil Service is an example of a role culture.
beliefs and ways of working; they form the general attitude
of the workforce and represent the totality of individuals’ Task culture: In a task culture, power is given to those who
beliefs and how they then behave. They are ‘invisible’ and can accomplish tasks. Power therefore lies with those with
below the surface, and therefore often difficult to see, expertise rather than a particular role, as in a role culture. In
understand and change. a task culture, teamworking is common, with teams made up
In practice, there may be discrepancies between the of the experts needed to get a job done. Teams are created
three levels of surface manifestations, core organisational and then dissolved as the work changes. Adaptability and
values and basic assumptions. For example, a company dynamism are important in this culture.
might organise regular social events for employees (a
surface manifestation). It might say in documents that it is Person culture: A person culture is one where there are a
a ‘friendly and caring employer’ (its organisational values). number of individuals in the business who have expertise, but
Yet, throughout the organisation there might be a culture who don’t necessarily work together particularly closely. The
of competitiveness that tends to make people ‘look out for purpose of the organisation is to support those individuals.
themselves’ and distrustful of everyone else. In this situation, The business will be full of people with a similar background,
the actual organisational culture is different from the surface skills set and training. Examples of person cultures could be
manifestation and the organisational values. In contrast, firms of accountants, lawyers, doctors or architects.
another organisation might call its employees ‘partners’ (the
surface manifestation). Its mission statement may say that it is
committed to ‘rewarding employees as well as shareholders’ Question 1
(its organisational values). It may then, year after year, pay Each year The Sunday Times conducts a survey to establish which
employees above the average for the industry and give regular are the best UK businesses to work for. Companies sign up to enter
annual bonuses based upon how much profit the business the survey and in 2015 more than 1,000 businesses registered to
has made during the year (the organisational culture). Here take part. All of the data is based on employee opinions through
the underlying organisational culture fits with the stated values a questionnaire. The questionnaire is updated each year to reflect
and the surface manifestation. There is a culture of rewarding
current workplace concerns. Below is the top ten of the ‘25 Best
employees because they are stakeholders, for instance the
Big Companies’ to work for from the 2015 list:
John Lewis Partnership.
1. TGI Friday’s
Classification of company cultures 2. Sytner Group
There are many ways of classifying organisational culture. 3. American Express
One attempt was made by Charles Handy in Understanding 4. Marriott Hotels International
Organisations (1993). He argued that there were four main 5. Admiral Group
types of organisational culture. 6. Nationwide Building Society
7. Bourne Leisure
Power culture: A power culture is one where there is a 8. Inchcape UK
central source of power responsible for decision making. 9. McDonald’s Restaurants
There are few rules and procedures within the business and 10. Iceland Foods
these are overridden by the individuals who hold power
Source: adapted from www.features.thesundaytimes.co.uk
when it suits them. There is a competitive atmosphere
amongst employees. Among other things, they compete (a) Discuss the cultural factors that may have led to these
companies being voted into the top ten ‘25 Best Big Companies’
to gain power because this allows them to achieve their
to work for. You could pick two companies and carry out your
own objectives. This creates a political atmosphere within
own research.
the business. Relatively young, small- to medium-sized
businesses, where a single owner founded the firm and is

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Thinking bigger Effects of organisational culture

In the 1970s and 1980s, Dutch psychologist Professor Geert Hofstede Organisational culture affects a business in a wide variety
conducted one of the most thorough pieces of research into how culture of ways. Three of these ways are motivation, organisational
differs between organisations across international barriers. (Geert structures and change (for example, new management and
Hofstede, Comparing Values, Behaviors, Insititutions and Organizations mergers and takeovers).
Across Nations, Second Edition, 2003) He examined these cultural
dimensions by studying work-related values and identified five key
variables, or dimensions, that vary across businesses in different countries.
Motivation: Organisational culture affects the motivation of
These variables impact organisational culture and how the business may staff. It can have a direct effect because the way in which staff
react in certain circumstances. treat each other impacts on motivation. For example, motivation
Power distance is likely to be greater if the culture of the organisation respects
This is the distance between managers and subordinates. A high power individual workers and their achievements. A highly competitive
distance suggests that managers will have significantly more power and culture might motivate some workers and demotivate others.
privileges than their subordinates. They probably will not socialise and Organisational culture can also indirectly affect motivation. An
communication is generally top down. A lower power distance culture
organisational culture which leads to a successful business is
has greater collaboration and discussion between employees of different
rank. Chinese companies tend to have a very high power distance, while likely in itself to motivate staff because they feel part of the
Scandinavian countries have a low power distance. successful business.
Individualism
This is how people see themselves within their organisation. Where Organisational structures: Organisational culture can
individualism is high, people tend to focus on their own success above affect the organisational structure of a business. In a person
that of the organisation or their team. The level of individualism versus culture, for example, the hierarchy is likely to be fairly flat. So
collectivism within a culture can determine organisational structure,
in a doctors’ practice, for instance, there are unlikely to be
motivation and internal competition.
many layers of management. This is because a number of
Masculinity
The management style in a masculine organisation is competitive and key workers share the senior management roles. In contrast
assertive. A more feminine approach is considered to be caring and there are likely to be more layers of management in a large
co-operative. This may determine how people respond to targets and multinational business that might require regional and divisional
goals, and relate to one another in the business. managers and multiple product teams. The larger the business,
Uncertainty avoidance the more layers in the hierarchy there are likely to be as
This is the level at which an organisation will accept risk. A high level of specialist roles are assigned.
uncertainty avoidance suggests a business will want evidence, security
and proof before acting. By contrast a business with a low uncertainty
avoidance might take ‘a long shot’ if it believes the rewards are New management: One way for a business to change
worthwhile. Organisations with low uncertainty avoidance are more is for new management to be appointed. The greater the
entrepreneurial and agile in their decision making. change needed, the more likely it is that the new management
Long-term versus short-term orientation will have to confront the existing organisational culture. The
This addresses a culture’s ‘time horizon’ and the basis on which decisions organisational culture is likely to be part of the problem that
are made. A high score indicates business decisions are made to achieve needs addressing if the business is to be turned around.
success in the long term. A low score suggests an organisation makes
decisions to achieve short-term rewards and immediate gratification in
terms of shareholder value. UK businesses have been criticised in the Mergers and takeovers: When two businesses merge
past for their short-termism. or one takes over another, each business is likely to have
a different organisational culture. The process of creating a
Hofstede’s cultural dimensions go beyond simply identifying behavioural
differences – they present a useful framework for understanding the single business out of the two organisations will therefore
cultural setting of a business. This is particularly useful when analysing involve changing organisational culture. In a takeover, one
businesses across borders and interpreting how international businesses simple way of making that change quickly is for the senior
might react and interact in different circumstances, such as international management in the company being taken over to be made
trade, partnerships, mergers and takeovers.

Question 2
In March 2015, Chinese company Fosun International bought a Thomas Cook and Fosun will work together to capitalise on the
5 per cent stake in Thomas Cook, the British tour operator. It paid Chinese domestic and international tourism market, which is
almost £92 million for the stake, which formed part of a larger expanding rapidly as the middle classes in the world’s second-
expansion into the European travel and tourism sector. It also largest economy swell. The two companies also plan to jointly
expressed its intention to raise its stake in the future, to about develop a hotel portfolio designed for Chinese travellers.
10 per cent. Source: adapted from the Financial Times 06.03.2015. All rights
The chief executive of Thomas Cook said Fosun’s portfolio of travel reserved.
investments would allow his company to exploit new opportunities (a) Assess the factors that Thomas Cook and Fosun may have to
for growth abroad. consider to ensure their cultural differences impact in a successful
way on their partnership.

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Corporate culture Unit 57

redundant. Without powerful advocates at the top of the

organisation, those lower down will find it difficult to resist the Figure 1
change that will be imposed upon them. However, motivation Factors that affect the culture of an organisation
and morale is often low in a company that has been taken Business A
over for the first year or so because they are being forced
to change.
Nationality
In the same way that you might identify a patent on an
invention or an established brand as an asset, culture too can Environment
Policies /
be a distinctive and sustainable competitive advantage. Unit Rules
45 discussed distinctive capabilities as a route to achieving Beliefs
competitive advantage for a business. John Kay (1993) referred
to ‘architecture’ as one of the types of distinctive capability that Leader
could lead to competitive advantage. Architecture refers to the
relationships and networks within an organisation and those
that it develops with its external stakeholders – corporate History
culture would fall into this category. Whenever discussing Values
corporate culture, it is worth considering it in terms of an asset Structures
that can be used to add value and compete in the market.
However, it is also worth remembering that culture is very Norms
difficult to manipulate and shape in order to meet the changing
needs of the business.

How corporate culture is formed Business B

Many factors contribute to the formation of organisational
culture. These include the role of the founding members of Nationality
the organisation, their personalities and beliefs. Often a strong
leader’s attitudes will permeate the organisation. For example,
Jan Koum, the CEO of WhatsApp, has refused to let advertisers
Beliefs
buy space on the WhatsApp application. His belief has
influenced the strategy and values of the company. Norms
Other factors that are likely to have a significant impact on Values
the formation of a firm’s culture are the environmental factors Environment
that the business was born into. For example, the history or
heritage of a business may determine certain values and norms
because they form part of what employees ‘buy into’. However, Structures
such a factor may not play a part in a new company such as Leader
Pinterest, which was set up in 2010. Similarly, the success
History
of a company will play a big part in setting the values and
Policies /
expectations of staff. Pinterest was the most rapidly growing Rules
social network site in 2012 and 2013, and was named one of
the most innovative companies, all of which will contribute to
the motivation and belief of its workforce.
The type of product is another factor in creating culture.
For example, the technological complexity of a product may Difficulties in changing an established
determine the skill and expertise of the workforce (perhaps culture
contributing to a role culture) and the pace of change or need Unit 63 explores the causes and effects of change on a
for innovation. business. From time to time it might be desirable for a
Figure 1 shows the overlapping factors that form the business to change its culture to one that is stronger and more
culture of an organisation. These factors play a part in forming productive. A firm’s culture can provide it with a competitive
the culture in every business. However, each business is advantage over its rivals. The problem with organisational culture
unique and the factors will have varying levels of influence and is that although it may be easy to describe, identifying the
connection. As you can see, the leader in Business A has a factors that contribute towards that culture and their significance
big influence on the formation of the overall culture. However, is very difficult. Even changing one of these factors may not
in Business B it is the well-established values that play a have a significant influence on shifting the culture. Furthermore,
significant role in shaping the culture. most organisations have sub-cultures within specific teams or
functions. Some aspects of organisational culture might also
be easier to change than others. For example, it might be easy

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 Business decisions and strategy

to change the policies, rules and working practices within a

Exam tip
firm – these are tangible factors. However, it is much harder to When reading through a case study there may be indications of a
manipulate people’s attitudes and beliefs. firm’s culture, or at least signs that it is a weak culture or a strong
Overall, culture can be changed if the right factors are culture. These signs may be surface manifestations, values or
influenced and the leaders within the organisation are strong, beliefs. You might also be able to identify the culture by the
but changing culture is not easy and can be a long process. influence of the CEO (power culture), the nationality of the
Many factors contribute to the formation of corporate culture. It business, or different dimensions and structures.
is important for the directors of a company to understand these
factors and the role they play before they can hope to manage
cultural change.

Case study

MOSAIC to become a member of the ‘Mosicians’ – a company

social and sports club that builds a sense of belonging and
networking within the organisation.
Mosaic is continually flexible with its corporate culture.
Since 1995, Mosaic has grown from two to over 25,000 Each week, alongside working on allocated projects, half
employees. Mosaic Ltd has an organisational culture a day is devoted to new ideas on existing products, and
that encourages employees to be creative and loyal. research and development of new projects, reflecting
It encourages innovation, and as a result has created individual interests. Dominic Moore suggests that this
some leading products, including an advanced Mosaic creates key opportunities for innovation and is also
search engine, a leading smartphone and a music- motivating for employees. Every other month there is a
streaming service. meeting between employees and the executive team,
The founders of Mosaic, Dominic Moore and Rita Singh, where new ideas and concepts can be put forward
brought flexible and hard-working approaches to Mosaic, and discussed.
and these qualities have survived as the business has Mosaic has an informal motto created by a young
grown. There has been a purposeful emphasis within the employee – ‘Live to give’. Alongside the business decisions
company on developing a corporate culture that is open that are focused on strong revenue growth, the company
and creative. philosophy is to work creatively to build success and to
At Mosaic’s head office, known as ‘Mosaic Towers’, develop products that enhance people’s lives.
employees are encouraged to keep fit and healthy through
heavily subsidised membership of the next-door gym.
A free healthy breakfast is also provided for all employees,
(a) Explain one reason why Mosaic’s corporate culture could
and on-site childcare facilities are part of a supportive
be referred to as a ‘strong culture’. (4 marks)
package for parents. These benefits are designed to build a
happy and healthy company where employees can focus on (b) Assess the benefits for Mosaic of fostering a creative
productivity and innovation. culture. (10 marks)
Dominic Moore places an emphasis on ability and (c) Evaluate the extent to which a strong corporate culture is
creativity when the company appoints new employees, important to the long-term success of Mosaic. (20 marks)
not only on experience. All new employees are invited

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Key terms Knowledge check

Cultural dimensions – a set of characteristics that form 1. Explain the difference between surface manifestations,
the international context of business culture. organisational values and basic assumptions of corporate
Organisational, organisation, corporate or business culture.
culture – the values, attitudes, beliefs, meanings and
2. Explain the differences between power culture, role culture,
norms that are shared by people and groups within an
task culture and person culture.
organisation.
Strong culture – a culture where the values, beliefs 3. How can an organisational culture give a business a
and ways of working are deeply embedded within the competitive advantage?
business and its employees. 4. How might Hofstede’s cultural dimensions influence the culture
of international businesses?
5. Outline the possible impact of organisational culture on
(a) staff motivation and (b) the organisational structure
of a business.
6. State five advantages of a strong organisational culture.
7. Can an organisation’s culture be changed?

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 58 Shareholders versus 3.4.3
Theme 3
Key points stakeholders
1. Internal and external stakeholders.
2. Stakeholder objectives.
3. Stakeholder influences: that the business considers all of its stakeholders in its business decisions/
objectives.
4. Shareholder influences: that the business should focus purely on shareholder returns (increasing share
price and dividends) in its business decisions/objectives.
5. The potential for conflict between profit-based (shareholder) and wider (stakeholder) objectives.

Getting started
Identify the two groups of people in the
photograph who have an interest in this
business. Identify another group that might
have an interest in this business. What
might be the objectives of the groups that
you have identified? Do you think these
groups have all the same objectives? If they
differ, why? To what extent might each of
these groups influence decision making in
the business?

Internal and external stakeholders investment banks and insurance companies. Their interests
A stakeholder is a person, group or organisation who are discussed later. However, in most large plcs some of
can affect or be affected by the organisation’s actions, the senior managers and members of the board are likely
objectives and policies. Stakeholders can be directors, to own shares. One reason for this is because part of their
employees, owners, suppliers, unions and customers. The remuneration often consists of shares. Finally, in some
interest each stakeholder has will vary according to the companies employees may own a small number of shares.
nature of their stake; for example, whether they are inside For example, about one third of all BT workers are signed
or outside the business. up to a ‘saveshare’ scheme. They make a contribution to the
scheme from their monthly salary and get the right to buy
Internal stakeholders shares at a discount when the scheme matures. It was widely
Some groups of people inside the business have a direct reported that in August 2014, around 23,000 BT workers
interest in its survival and well-being. These may be received an average of £42,000 when one of the schemes
referred to as internal stakeholders. matured. If employees own shares in the company they work
for, then they are also part-owners of that company.
Business owners: A business is the property of the
owners. Owners are stakeholders because they stand to gain, Employees: Employees are internal stakeholders
or lose, financially from the performance of the business. If because they work for businesses. Employees depend
the business does well they will enjoy a share of the profit. on businesses for their livelihood. Most employees have
They will also benefit if the value of business increases. no other sources of income and rely on wages to live
However, if the business fails owners may lose the money on. Some employees are represented at work by trade
they invested in the business. With larger companies, such unions. If this is the case, then trade unions also become
as large plcs, the shareholders may be internal and external. stakeholders. The needs of employees are often in conflict
Most are likely to be external since the majority of large plcs with those of other stakeholders, such as owners and
are owned by financial institutions, such as pension funds, managers. This is discussed later in the unit.

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Shareholders versus stakeholders Unit 58

Managers and directors: In small businesses managerial payments to be met and their money returned at the end
tasks, such as organising, decision making, planning and of the loan period. They will also want clear communication
control, are undertaken by the entrepreneur themselves. links with the business.
However, in large businesses, the key decisions relating
to company policy and strategy are made by the board of Suppliers: Businesses that provide raw materials,
directors. It is then the responsibility of managers to ensure components, commercial services and utilities to other
that the policies and strategies are implemented. Large businesses are called suppliers. Relations between
businesses employ specialists in managerial positions. For businesses and their suppliers need to be good because they
example, managers are often employed to run the different rely on each other. Businesses want good-quality resources
departments in businesses, such as marketing, production, at reasonable prices. They also want prompt delivery, trade
finance and human resources. They are responsible for the credit (buy now pay later) and flexibility. In return, suppliers
work carried out in their departments and for the people require prompt payment and regular orders. As with
employed to do the work. customers and businesses, there is a mutual dependence
Managers have to show leadership, solve problems, make between suppliers and businesses.
decisions, settle disputes and motivate workers. Managers
are likely to help plan the direction of the business with The local community: Most businesses are likely to have
owners. They also have to control resources, such as finance, an impact on the local community.
equipment, time and people. Managers are also accountable. ●● Positive impact. A business may employ people locally

This means they are responsible for their actions and the and if the business does well the community may
actions of their subordinates. Managers are accountable to prosper. There may be more jobs, more overtime and
senior managers in the managerial hierarchy. The board of possibly higher pay. This will have a knock-on effect in the
directors is accountable to the shareholders. community. For example, shops, restaurants and cinemas
may benefit from extra spending.
External stakeholders ●● Negative impact. A business may be criticised by
A range of groups outside a business may have an interest in the local community. For example, if a factory is noisy,
its activities. Such groups are called external stakeholders. polluting or works at night there may be complaints from
local residents. If a business that employed a lot of local
Shareholders: Most shareholders in large companies are people closes down, the impact on the community can
not involved in the day-to-day running of the business. They be devastating. In the 1980s when many coal mines were
are investors and have a purely financial interest. External closed in the UK, the mining communities suffered badly
shareholders, who might be individuals, or more likely, large due to very high unemployment.
financial institutions, invest their money to get a financial
return. Shareholders are also entitled to a vote at the AGM of The government: The government has an interest in all
a plc. They can vote to re-elect or dismiss the current board businesses. Generally the government will want businesses
of directors. However, many external shareholders do not take to be successful. They provide employment, generate wealth
up this entitlement. If they are not happy with the way the and pay taxes. Taxes from businesses and their employees
company is being run, or the return they get is inadequate, are used to fund government expenditure. It helps to pay for
external shareholders can sell their shares and invest their benefits, the NHS, schools and other services. If businesses
money elsewhere. fail, the government loses tax revenue and has to pay
benefits to the unemployed. However, the government will
Customers: Customers buy the goods and services that also require businesses to comply with the law. A significant
businesses sell. Through their purchases they provide the amount of legislation exists to protect those who might be
revenue and profit that businesses need to survive. However, exploited by businesses if they were too powerful.
customers need businesses because they provide the goods
and services they require and want. Most customers are The environment: Business activity can have an impact
consumers (individuals and families) who use or ‘consume’ on the environment. For example, if a business releases
products. However, some may be other businesses. For toxic waste into the waterway system, wildlife and its
example, JCB manufactures a range of construction machinery habitats could be destroyed. Thus, representatives of the
that it sells to other businesses. environment have an interest in business activity. These
representatives may be individuals or environmental groups,
Creditors: Creditors lend money to a business. They may be such as Friends of the Earth and Greenpeace. An increasing
banks, but could also be individuals, such as family members, number of people are concerned about environmental issues;
or private investors, such as venture capitalists. Clearly these consequently environmental groups are becoming more
stakeholders have a financial interest in a business and will influential in business decision making.
be keen for it to do well. Creditors will expect their interest

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 Business decisions and strategy

Question 1 valued, personal development, fair and honest treatment, and

opportunities for promotion. Safety at work is also important, as
are issues to do with equal opportunities. Generally, employees
will want to maximise their financial rewards and welfare.

Managerial objectives: Managers and directors are likely

to have similar needs to those of employees. Many managers
(and employees) have part of their remuneration linked to
the performance of the business and will therefore want the
business to perform well. Managers may also press for other
benefits, for instance bonus payments if they perform well,
expense allowances when travelling on company business,
and benefits such as a company car, free health insurance
and more flexibility. Some senior executives may see power
as an objective; they like ‘empire building’. As a result, the
In 2015 it was announced that data centre providers, shareholders may lose the ability to influence key decisions in
TelecityGroup and Interxion, were going to merge. The new the organisation.
group would give Telecity shareholders 55 per cent of the shares
and Interxion shareholders 45 per cent. The boards of directors Customer objectives: Customers want good-quality products
of both companies felt that customers would be better served at a fair price. They also want clear and accurate information
by the combined group. It would be stronger and able to supply about products and high-quality customer service. They may
customers with a greater range of products. The company hoped also want choice, innovative products and flexibility. For some
to expand into markets in Africa, Asia and Eastern Europe. products, such as machinery, electrical goods and children’s
John Hughes, chairman of the merged group, suggested that products, safety is an important issue. If these needs are not
the combination of TelecityGroup and Interxion would represent met, customers will spend their money elsewhere. Customers
an extremely compelling combination for all stakeholders in have a powerful influence on businesses. They are also more
both groups. aware today about the range of products available and about
their rights as consumers. In competitive markets only those
Source: adapted from the Financial Times 11.02.2015, all rights businesses that meet customer needs are likely to survive.
reserved
(a) What is the difference between internal and external Supplier objectives: Suppliers want to be treated fairly by
stakeholders? Use examples from this case. businesses. They would prefer to have long-term contracts and
regular orders. They will also want a fair price for their goods or
(b) Explain how the two groups of stakeholders might benefit from
this merger. services and to be paid in reasonable time. In 2013/14 it was
suggested in the media that some businesses might ‘bully’ suppliers.
For example, some stores might put pressure on suppliers and
Stakeholder objectives demand price cuts because of falls in commodity prices. They might
Many stakeholders have common objectives. For example, most threaten to withdraw products if suppliers refuse to comply. In cases
stakeholders will want a business to survive and be successful. such as these, an investigation might take place by the Groceries
However, each group of stakeholders is likely to have some of Code Adjudicator, for example.
their own specific objectives.
Government objectives: The government will want businesses
to grow and make more profit. They will also want them to comply
Shareholders: The majority of shareholders will want the with legislation and not exploit vulnerable groups.
business to maximise shareholder value. This is a measure
of company performance that takes into account the size of Environmental objectives: Environmental groups will
dividends (share in profits) and the share price. Over time want businesses to avoid having any negative impact on the
shareholders want this to grow. If the growth in shareholder environment. For example, they will demand that business
value is not to the satisfaction of external investors they may sell activity does not damage wildlife and its habitats, pollute the
their shares. This could result in a fall in the share price, which atmosphere or waste resources.
might make the company vulnerable to a takeover.
Local community objectives: Local communities will want
Employee objectives: Employees want the business that businesses to contribute to the prosperity of the community and
they work for to prosper. If a business is growing and profitable, be good corporate citizens. Communities would probably want
employees are likely to get higher wages, more perks and businesses to create employment and, depending on their size,
perhaps a bonus. They will also feel more secure in their jobs. It nature of business and capabilities, build links with schools and
could be argued that, according to Herzberg, employees expect charities, maintain open communications, and avoid or minimise
good pay and comfortable working conditions. However, they congestion and pollution in the area.
will also want responsibility, interaction with colleagues, to be
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Shareholders versus stakeholders Unit 58

Stakeholder influences – stakeholder Thinking bigger

approach In the UK, adopting a ‘stakeholder approach’ means giving less
Some corporations take into account the objectives of a wider importance to the interests of owners and more importance to other
group of stakeholders in addition to shareholders when making stakeholders than the typical business. The costs and benefits to
business decisions. According to the Clarkson Principles businesses of adopting such an approach tend to be measured in terms
of their impact on profits, sales, revenues and accounting costs. The
(www.cauxroundtable.org), this means that corporations should: advantages include the following.
●● recognise the interests of other stakeholders and take their views
• Having good employment policies will tend to attract better
into account when running the business and making decisions
applicants for posts, and help motivate and retain existing staff.
●● maintain open communication channels with other stakeholders
Improved motivation and retention should lead to increased profits.
and consult with them before making radical changes • Effective customer care policies should lead to higher sales and hence
●● recognise the interdependence that exists between different higher profits.
stakeholders, ensuring that the benefits of enterprise are • Working well with suppliers should enable the purchaser to get value for
distributed fairly after taking into account the level of effort money. It should be much easier to sort out problems of late deliveries
and risk each group contributes or defective work with suppliers with whom there is a good relationship.
●● minimise or eliminate the adverse effects of business activity. • Putting something into the community, such as giving to local charities,
If such effects cannot be avoided then those affected should taking on workers or backing training projects should give the business
good public relations. This might help sell products or attract good
be adequately compensated.
applicants for jobs.
Some businesses might claim to have adopted this stakeholder • Being environmentally friendly could lead to lower overall costs.
approach. Part of the reason for this is that corporations are For example, recycling heat in a boiler might cost money for new
coming under increasing pressure from stakeholders, the media equipment but quickly save money because of the lower fuel inputs
and the wider public to be more socially responsible. It might needed. Being seen as environmentally friendly may help sales of
be argued that some businesses like to give the impression products and thus increase profit.
that they consider the needs of a wider range of stakeholders, • For some high-profile companies, becoming more socially responsible
but in reality they are still more focused on shareholder needs. can deflect the criticisms of pressure groups. For example, Foxconn, an
electronics company that reportedly used child labour in some of its
For example, a business might claim to adopt an ethical stance
factories, said it would take action against any of its plants if violations
purely to increase sales, revenue and profit. Corporate social are discovered. Foxconn carries out work for companies such as Apple
responsibility is discussed in Unit 59. and Samsung, and considers attention to social responsibility an
important part of its business context..
Stakeholder influences – shareholder The main disadvantage of the stakeholder approach is that, in practice,
approach it tends to add to costs and thus lower profits for most businesses. If this
weren’t the case, every employer would increase the benefits given to
Traditionally, many corporations have focused on growth or profit
workers, or give money to local charities, or devote resources to pursuing
when making important business decisions. The objectives of environmentally friendly policies. Only some businesses benefit from a
shareholders have had more influence on decision making than ‘stakeholder approach’.
those of other stakeholders. This approach was based on the
idea that directors and managers are employed by shareholders employee welfare comes at a cost. If the needs of employees
and should therefore serve their interests. This meant that are met in full there is likely to be a negative impact on profit
they should make as much money as possible for the owners and dividends. Conflict will arise if shareholders insist that
of the business provided they comply with the law. Some the rewards to employees should not come at the expense of
businesses still adopt this approach and their main objective is to dividends. Employees may try to put pressure on the business
maximise shareholder returns by raising both dividends paid to to ensure their objectives are met by threatening industrial
shareholders and the share price. action. However, if this action is too disruptive it may jeopardise
the survival of the business. Employees have to be careful not
The potential for conflict between to push their claims too far. In 2014, workers at Jaguar Land
shareholders and other stakeholders Rover (JLR) in the Midlands were given an ‘inflation-busting’
Problems are likely to arise between shareholders and other pay rise after threatening strike action. Staff had turned down
stakeholders when their objectives are in direct conflict. Some an earlier offer saying it failed to reflect the contribution made
examples of this conflict are outlined below. by workers to the company’s turnaround. The Unite trade union
recommended that workers should accept JLR’s new offer of
Shareholders and employees: Meeting the objectives 4.5% and a £825 lump sum in the first year of a two-year deal,
of employees in terms of higher wages, better conditions, followed by RPI inflation plus 0.5% in the second year or 3%,
more perks and bonuses, providing training and improving whichever is higher.

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 Business decisions and strategy

Shareholders and customers: Conflict between shareholders Question 2

and customers is most likely to arise if a business charges prices
that are too high. Higher prices will help to boost shareholder In 2014 the number of customer complaints about energy
returns but reduce the purchasing power of customers. In 2014, providers in the UK doubled during the first half of the year.
many customers complained about the rising prices of gas and It was reported that the largest number of complaints were
electricity. For example, gas bills rose 3.5 per cent between April about npower, which received 1.48 million complaints in 2014.
and June 2014. At the same time the cost of gas paid by suppliers This represented 28 per cent of all npower’s customers and
fell by 21 per cent. Many customers were annoyed by this. an increase from 25.1 per cent in 2013. In fact, npower had
Customers might also come into conflict with businesses if levels been the subject of complaints for several years. In 2011, it was
of customer service are poor or if businesses fail to invest in fined £2 million by Ofgem (the industry regulator) for failing to
research and development and bring out new products. However, deal with customer complaints adequately. In December 2013
if businesses can cut back on research and development npower acknowledged that it had problems with its billing
expenditure they can pay shareholders higher dividends. system (the source of many complaints) and agreed a recovery
plan with the regulator. The company had installed a new
Shareholders and directors and managers: Senior computer system and as a result around 300,000 bills were
managers and directors are employed to further the interests
sent out late. In recognition of this the company made a public
of shareholders. However, conflict might arise if they start to
apology and gave a £1 million donation to charity. It also agreed
prioritise their own objectives, such as maximising remuneration,
to pay $3.5 million in compensation to customers that had been
expenses, perks and other benefits. If these are too high,
mis-sold some energy services.
profit and dividends may suffer. This is most likely to happen
if shareholders lose some of their control over the business. In October 2013, npower increased its dual-fuel prices by 10.4
There may be a ‘divorce of ownership and control’. This can per cent (much in line with other providers). Table 1 shows the
happen if shares are held by a very large number of different price increases required of customers by npower between 2011
shareholders where no single shareholder has any significant and 2013. In 2013, npower made a profit of £390 million. This
control. A common conflict between shareholders and directors was an increase of 25 per cent on the previous year. This attitude
is the balance between paying dividends and retaining profit for to making profit was criticised by Labour MP John Robertson,
investment. Shareholders may prefer to have higher dividends who sits on the Commons energy select committee.
while the directors may prefer to retain more profit for investment.
Table 1 Increases in the price of gas and electricity to npower
customers
Shareholders and the environment: In an effort to
maximise profit, a business might neglect its responsibilities   Jan-11 Oct-11 Feb-12 Nov-12 Dec-13
towards the environment. For example, in 2011 it was widely Gas 5.1% 15.7% –5% 8.8% 7.7%
reported that some of the UK’s water companies were accused Electricity 5.1% 7.2% 0 9.1% 9.3%
of draining rivers that were at risk of completely drying up. As
a result some wildlife was destroyed and there was a build- Source: adapted from the Financial Times 20.06.2014. All rights
up of chemicals, which threatened some fragile ecosystems. reserved.
The report suggested that companies were extracting water (a) What are likely to be the main objectives for customers as
from these sources because they were the cheapest. Activities stakeholders in the market for energy?
such as these may attract the attention of the media and
(b) Discuss the conflict between stakeholders that has occurred in
environmental groups, resulting in conflict between the company this case.
and environmentalists.

Shareholders and the government: Conflict between

shareholders and the government is likely if businesses break the Links
law. However, the judicial system should resolve such conflicts. The experiences of stakeholders could be linked to most topics
In 2013 and 2014 there was evidence of uneasiness between in the specification. This is because stakeholders are at the
the government and large corporations. It came to light that heart of business activity. Any decision made by a business
some big corporations were avoiding the payment of tax in the is likely to have an impact on at least one stakeholder. For
UK. For example, it was widely reported that Amazon only paid example, pricing decisions affect customers and shareholders.
£4.2 million of tax in 2013 on sales in the UK of £4.3 billion. If Location decisions affect communities and employees.
corporations can reduce the amount of tax they pay then the Marketing decisions will affect customers and employees.
shareholders will enjoy bigger profits. However, if businesses Wage negotiations will have an impact on employees,
are able to avoid paying taxes the government is likely to be shareholders and managers. It is not difficult to identify links.
criticised. In the future, governments might have to pursue such And do not forget, decisions are also made by stakeholders.
businesses for the payment of taxes or risk losing their political
support.

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Shareholders versus stakeholders Unit 58

Case study
Halfords is committed to local communities and the

HALFORDS environment. It recognises that there are gains to be made

from acting responsibly and meeting the needs of a wider
range of stakeholders. For example, it has taken measures to
Redditch-based Halfords is a leading retailer in leisure and
reduce carbon emissions by using larger trailers to distribute
car products. It is also the UK’s top seller of bicycles with
stock around the country so that fewer miles are travelled. It
sales of around one million a year. The business operates
also uses ‘smart meters’ to control water consumption and
over 460 stores and employs more than 11,000 people. It is
tries to increase the amount of recycling from its autocentres.
a customer-orientated business and prides itself on the help
that staff give to customers. For example, Halfords offers free
summer and winter checks to customers at its stores. Halfords Figure 1
grew revenues from £809.5 million to £871.3 million Dividend payments to shareholders 2009–2013
between 2009 and 2013. Figure 1 shows the dividend
Pence
payments to shareholders in that period.
25
In 2015, Halfords was ranked 18th in the Sunday Times 20
25 Best Big Companies to Work For, having been ranked
15
25th in 2014. Employees say that they enjoy working in
teams at Halfords, they are happy to help each other out, 10
that it is fun working with each other and that there is a 5
strong sense of family in the organisation. Managers at 0
Halfords listen to their staff. Regular meetings are held to 2009 2010 2011 2012 2013
Year
find out how employees feel about working for the company
and what ideas they might have. For example, as a result of
Source: adapted from www.halfords.com
some meetings with trainees, a new induction programme
was introduced. Some 78 per cent of staff say that managers
are open and honest, while 73 per cent of employees say (a) Assess the possible benefits to a business like Halfords
that managers are happy to share important information. of adopting a stakeholder approach to decision making.
During the school holidays Halfords organises Kids’ Clubs. (10 marks)
Up to 2015 these have attracted over 24,000 children. Staff (b) Evaluate the extent to which Halfords has adopted a
give advice on bike maintenance and demonstrate how to stakeholder approach to business. (20 marks)
mend a puncture. The retailer also offers free bike workshops
aimed at women and GEAR UP! which teaches school
children the basics of bike maintenance.

Knowledge check Key terms

1. Give two examples of internal stakeholders in a business. External stakeholders – groups outside a business with an
interest in its activities.
2. Give two examples of external stakeholders in a business.
Internal stakeholders – groups inside a business with an
3. Explain how employees might also be shareholders. interest in its activities.
4. What are the objectives of suppliers as stakeholders? Shareholder value – a measure of company performance
that combines the size of dividends with the share price.
5. What are the objectives of the government as a stakeholder?
Stakeholders – those with an interest in the activities of a
6. Explain the difference between the ‘shareholder approach’ business.
and the ‘stakeholder approach’ when running a company.
7. How might the objectives of shareholders and employees
Exam tip
come into conflict? Do not confuse stakeholders with shareholders. When you write
8. How might the objectives of shareholders and the local the word shareholders, make sure that you mean shareholders,
community come into conflict? that is the owners of the business who hold shares in it.

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 59 Business ethics
58 3.4.4
Theme 3
Key points
1. Ethics of strategic decisions:
●●trade-offs between profit and ethics..
2. Pay and rewards.
3. Corporate Social Responsibility (CSR).

not face such an ethical dilemma. Despite these differences, in

Getting started many situations most people often take the same ethical stance
In August 2013 it was widely reported that Tesco would close and are anyway required to operate within the business code
its distribution centre at Harlow in Essex. The depot employed of conduct and mission statements. For example, most would
800 workers. Tesco offered many of these workers positions in agree that a company should not use employees’ money in a
Dagenham, its next closest depot. pension fund to bail it out if it is making a loss.

Many people objected to the closure, and were concerned Ethics of strategic decisions
about the changes in pay and terms and conditions. A local MP Strategic decisions are those that affect how a business
commented on the impact on some workers of reduced pay operates in the long term. All businesses have to make ethical
and increased travel costs. The MP also commented that the decisions as part of their corporate strategy and these are
Dagenham depot employed agency workers on lower wages. usually the responsibility of senior management. These decisions
In response, Tesco commented that it had one of the best pay then affect the direction of the business, with medium-term
and benefits packages in the industry, and paid the same rate tactical decisions usually the responsibility of middle managers.
Should a finance manager delay payments if the business has
whether the colleagues are British or from the EU.
cash-flow difficulties? Should a self-employed plumber charge
What is most important for a business – looking after its stakeholders a senior citizen extra when a job takes longer than estimated?
or looking after its shareholders? Do you think a business has done Over the past 20 years, a number of issues have arisen for large
anything wrong if it relocates, with an impact on some of its workers? corporations that require strategic decisions based on ethics.
To what extent should a business take into account the views of local
stakeholders when making strategic decisions? The environment: In countries such as the UK or the USA,
the law limits the amount of pollution or environmental damage
a business can do. However, businesses must decide whether to
Ethics adopt even more stringent measures to protect the environment.
Ethics, in the context of business ethics, considers the moral For example, should a business recycle materials, especially if
‘rights and wrongs’ of a decision, focusing more on a strategic this will lower profits? Multinational businesses often face lower
level, rather than the decisions made by, for example, individual environmental standards in developing countries. Should they
employees. All businesses have to make many ethical decisions. lower their own environmental standards in such locations to
Some are affected by the law. For example, it is illegal for take advantage of this?
businesses to dump waste by the roadside or send their drivers
out on the road in unroadworthy vehicles. However, many Animal rights: Some companies, such as pharmaceutical
ethical decisions have to be made without the help of the law. companies or cosmetics manufacturers, might use animals to
For example, should an employer allow a worker to take a day test products. Animal rights groups argue this is unethical. Other
off work to look after a sick child and still be paid? Should a companies, particularly food manufacturers or oil businesses,
company stop buying goods from a factory in the Far East where can destroy habitats and endanger animals. Wildlife conservation
it knows that work conditions are poor and wages are very low? groups argue against farming activities that destroy forests
Every business should have a stated code of conduct or other habitats and oil installations that can pollute the
within which employees operate in respect of ethical business environment, leading to the destruction of animal and plant life.
decisions, although at a senior level and on a personal level
some employees might have differences of opinion. For example, Workers in developing countries: A number of companies
some individuals may argue that it is wrong for businesses to have been criticised for exploiting workers in developing
manufacture toy guns to sell to children. Others may suggest countries. Companies manufacture in countries with emerging
that they do no real harm. Some restaurant owners might face economies because production costs are much lower. However,
a dilemma about whether to sell alcoholic drink because of there is an ethical question about the extent to which low costs
religious beliefs about alcohol. Other restaurant owners might should be at the expense of workers.

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Business ethics Unit 59

Corruption: In some industries bribes might be used to Question 1

persuade customers to sign contracts. It has been suggested
that this takes place in certain emerging economies, where
civil servants or government ministers want money from big
business deals, for instance arms deals. The ethical question is
whether it is right to use bribes even if a business knows that
its competitors do, and whether such involvement in arms with
unstable political areas is ethical.

New technologies: Most new products, such as mobile

phones or a new chocolate bar, do not cause ethical problems.
But some technological developments seem always to be
controversial. Nuclear power generation, for instance, has
been an issue since the 1950s. More recently, genetically
modified (GM) crops have hit the headlines. In the future, other
biological processes, such as cloning, could arouse strong
ethical reactions.

Product availability: If a person cannot afford an expensive

car or some other luxury goods, most would not see this as
an ethical issue. But if someone is HIV positive in South Africa Chiquita is an American producer and distributor of bananas and
and cannot afford drugs for treatment because pharmaceutical other fruit. Its distinctive blue brand logo is a familiar adornment
businesses charge such a high price, many would argue that it to bananas found in UK supermarkets.
is an ethical issue. The direction of research is also important.
Companies might research new drugs for complaints suffered In the past, Chiquita faced criticism for its ethical decisions having
by only a few in the industrialised world. Or they might research been reportedly accused of having a poor record in terms of
illnesses such as malaria, which kill millions each year in many its environmental responsibility and with workers’ rights. In
developing counties. The choice that businesses make is an response to this criticism, Chiquita has attempted to improve
ethical issue. its record by having a large push to promote Corporate Social
Responsibility (CSR).
Trading issues: Some countries have been condemned • After a campaign by the pressure group ForestEthics, the
internationally for the policies pursued by their governments. business agreed to stop using fuel produced from Canada’s
They may even have had sanctions or trade embargoes placed tar sands. This fuel is extremely polluting and is a large
upon them. Companies must decide whether to trade with or producer of carbon dioxide.
invest in these countries.
• In 2012 Chiquita signed an agreement with local and
Codes of practice international trade unions that committed the business to
In recent years, some large businesses have adopted ethical paying fair rates of pay and promised to promote more
codes of practice. These lay down how employees in the women within the organisation.
business should respond in situations where ethical issues arise. • Chiquita formed working relationships with environmental
Ethical codes will differ from one business and one industry to groups, such as Rainforest Alliance, and gained certification
another. However, they may contain statements about: from this group, which served to improve its environmental
●● environmental responsibility
performance.
●● dealing with customers and suppliers in a fair and honest

manner However, not everyone was happy with Chiquita’s strategy.

●● competing fairly and not engaging in practices such as
The decision to stop using tar sands oil was unpopular in
collusion or destroyer pricing Canada, which relies on its oil exports.
●● the workforce and responding fairly to their needs. Time will tell how Chiquita benefits from this stance. As of early
2015, the business had not out-performed such rivals as Dole
Ethical objectives and Fresh Del Monte.
Ethical codes of practice may develop from ethical objectives of
businesses. Ethical objectives may be explicit. For example, a Source: adapted from the Financial Times 15.11.2011.
large business may have as its stated objectives that: All rights reserved.
●● it will not test its products on animals (a) Explain what is meant by an ‘ethical stance’.
●● it will deal with suppliers fairly
(b) How might a pressure group encourage a business to
●● it will not accept bribes from customers. become more ethical? Use examples from the text to support
your answer.

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 Business decisions and strategy

Explicit objectives will have been carefully thought out. The communities in which the business operates:
Partly this is because the business could get bad publicity if What impact does the business have on the life of the
it went against its stated ethical objectives. communities in which it operates? For example, how much
However, most businesses have implicit ethical does it give to charities? How much is spent on local schools,
objectives. Most businesses aim to deal fairly with hospitals and housing?
customers, for example. However, implicit ethical objectives
are not written down. Instead, they form part of the Business integrity and ethics: How ethical is the
corporate culture of the organisation. They are part of business in its activities? For example, has the company
the unwritten rules about how the business deals with its been involved in any cases of trading that break legislation?
stakeholders, such as customers, suppliers and workers. Did the company make political contributions and to whom?
Was the company involved in cases associated with unfair
Corporate Social Responsibility (CSR) competition?
Some large businesses have responded to concerns about
Corporate Social Responsibility, their responsibility not just Product responsibility: What was the social impact of
to their shareholders, but to all stakeholders, by auditing the products sold by the business? For example, were there
relevant activities. These audits may then be made available health and safety issues? Was after-sales service adequate?
to the public in a Corporate Responsibility Report, in the Was advertising true and fair? Did the company manage its
same way that the financial accounts of the company are information on customers and suppliers in such a way as to
published. Auditing involves inspecting evidence against preserve their privacy?
established standards. Auditors can then say that the
evidence presented by the business is ‘true and fair’. The environment: These indicators can form a separate
In accounting, standards for accounting audits are set by environmental audit. Some businesses may only compile an
accounting bodies, such as the Accounting Standards Board. environmental audit and not include any of the other social
In contrast, social and environmental auditing is voluntary indicators described above. Indicators might include the
and there is no body that draws up rules about how audits amount of energy or other raw materials, such as water or
should take place. At present, companies are free to choose pesticides, used by the business; how much waste or effluent
what standards they should be measured against and who was produced; the levels of greenhouse gases or ozone-
the auditors will be. Indeed, the vast majority of businesses depleting emissions; what percentage of materials used
do not undertake any social or environmental accounting. were recycled; the company’s impact on bio-diversity; what
Businesses that do compile social and environmental impact it had on protected and sensitive areas; how many
audits use a wide range of measures, which differ from times it was fined during the period for failure to comply with
business to business. An oil company, for example, may environmental regulations and the total level of fines.
measure the number of oil spills for which it is responsible. Some of these measures are financial, i.e. they are
This would not be appropriate for a drinks company, which measured in monetary terms. Many, however, are non-
might use other indicators such as levels of air pollution financial. For this reason, it is difficult to get a quick and easy
created by its breweries and distilleries. Social and overall measure of how well a business is doing from its
environmental audits might include some of the following. social and environmental audit. In contrast to a financial audit,
like a set of financial accounts, where it is possible to look
Employment indicators: How well does the business at the profit and loss account and say that the business has
treat its staff? This might include indicators about pensions, performed better or worse in terms of revenues, costs and
healthcare benefits, union representation, training and profit, the data from social audits are more difficult to assess
education, number of accidents involving staff, payment of and compare from year to year.
minimum wages, equal opportunities and the level of women
in higher management or director positions. Pay and rewards
An important issue in the area of business ethics relates to
Human rights indicators: How well does the company pay and rewards. Remuneration is the reward from work, in
perform on human rights issues? For example, does it the form of pay, wages or salary. Businesses use pay and
encourage its workers to join trade unions and give those rewards for different purposes.
trade unions negotiating rights with the company? Does ●● To attract employees with the right skills, experience
it have works councils? Does it or its suppliers use child and knowledge. Where jobs are less skilled the available
labour? Does the company operate in, buy supplies from number of workers is very high, which means pay can be
or sell products to countries that have a poor human rights relatively low. Where skills are extremely rare, for example
record? Does it discriminate on grounds of race, gender or with top Premier League footballers, pay rates need to be
age when recruiting or promoting staff? very high to attract the best.

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Business ethics Unit 59

Question 2 Table 1 UK National Minimum Wage – from October 2015

Adult rate (21+) £6.70 per hour
Lucent Technologies was a US manufacturer of
18–20 year olds £5.30 per hour
telecommunications equipment. It was created by a demerger
16–17 year olds £3.87 per hour
with AT&T, a large US telecommunications company, in
1996. In 2006, Lucent merged with Alcatel, the French Apprentice rate £3.30 per hour
telecommunications equipment company. Source: www.gov.uk

Whilst still an independent company, Lucent was pursuing a This type of government-imposed regulation effectively forces
strategy of selling into the Chinese telecommunications market. businesses to pay their workers a fair rate of pay. It is a legal limit
As part of its marketing effort, it invited Chinese officials to the on what can be paid and means that businesses cannot pay very
USA. The US Department of Justice in an investigation found low wages.
that the company spent more than $10 million (£5 million) on Some argue the National Minimum Wage is not high enough
about 315 trips for 1,000 Chinese government officials and to provide an adequate standard of living. As in the example of
telecoms executives. The problem was that they ‘spent little or no supermarkets above, workers on low pay often qualify for Tax
time’ touring Lucent’s production facilities. Instead, they enjoyed Credits, paid by the government to workers who earn below a
sightseeing in Hawaii, Las Vegas, the Grand Canyon, Niagara certain amount of money. Effectively, the government is making
Falls, Disneyland and Universal Studies. Despite paying for travel, up the difference between the wages paid by a business and the
hotels and meals, Lucent also gave some Chinese officials a daily amount needed for a person to live on. The Living Wage Foundation
cash allowance of $500 to $1,000. As for relatives or associates is an independent organisation that campaigns for fair pay. The
of the invited Chinese officials, they were offered ‘educational Foundation has developed the idea of a living wage, which is
opportunities’ both in the USA and back in China. The total cost of set higher than the National Minimum Wage and covers the basic
cost of living. The 2015 rate is £7.85 per hour (£9.15 in London),
these ‘educational opportunities’ to Lucent was over $100,000.
compared to that for the adult National Minimum Wage of £6.70.
Lucent was fined $2.5 million by the US Department of Justice Remuneration is extremely important for a business. The extent
under the Foreign Corrupt Practices Act for attempting to bribe to which decisions on pay are an ethical matter depends on which
Chinese officials to place orders with the company. perspective this is being viewed from. Free market proponents
Source: adapted from The Financial Times 06.03.2008. All would argue that decisions on pay should be left to businesses
rights reserved. to decide. The aim of business is to maximise profits and returns
for owners/shareholders. If, to achieve this, a business needs to
(a) Explain why Lucent was fined $2.5 million. pay millions to attract the most highly skilled staff, then this is their
(b Assess whether European and US businesses should be decision. In 2014 Wayne Rooney, striker for Manchester United,
allowed by their governments to use bribery to win contracts in earned a reported £14.4 million. Is it ‘right’ that one person can
emerging markets such as China and India. earn so much money, while others have to make do with the
minimum wage? From a business point of view it makes sense
●● To reward and motivate existing staff. The ultimate aim of to pay the highest salaries to the most highly skilled people. If
businesses is to make profit. Rather than pay the lowest Manchester United did not buy the best players, it would not be
possible rates of pay, to keep costs down and profit margins able to compete for league titles and other trophies.
high, businesses need to ensure that their pay rates ensure
that staff are motivated to work to the best of their ability. Question 3
●● Maximise productivity levels. Pay is an important motivator
Ocado is an online UK supermarket that has grown over time.
and highly motivated staff are more productive.
In 2015 it was widely reported that the business would not
commit to paying all of its workers the living wage. At an Annual
In 2015 a widely publicised report by the pressure
Shareholder Meeting, it was widely reported that the Chairman
group Citizens UK found that some UK employers, including
put forward that a majority of Ocado employees were already
supermarkets and other companies, pay their workers at a low
paid above the living wage. He also put forward that it was
rate, resulting in the government spending around £11 billion
necessary to balance off what can be afforded and what is right
per year topping up their pay through benefits such as Tax
to do.
Credits. Some businesses such as supermarkets often take
on a number of apprenticeships, which is a positive thing, He stated that the vast majority of businesses want to do
although it can involve significant public subsidy. Businesses the right thing on employee pay, but have a responsibility to
are organisations that need to make a profit if they are to shareholders to only do what they can afford to do.
survive. Although higher profits can be achieved by reducing (a) Explain what is meant by the ‘living wage’.
the pay of employees within legal limits, is this ethical? (b) Assess the case for paying the living wage from the point of
Generally it is the role of individual businesses to decide on view of:
rates of pay. An exception to this relates to low pay. In the UK
(i) Ocado shareholders
there exists a National Minimum Wage. Details are shown in
(ii) Ocado employees.
Table 1.
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 Business decisions and strategy

Trade-offs between profit and ethics drawing in customers who are attracted by this. But
As with social responsibility, there can exist a conflict adopting an ethical stance is no guarantee of success.
between ethical objectives and profitability. A trade-off In Question 1, Chiquita’s more ethical approach has not
exists when the selection of one choice results in the loss yet appeared to result in higher sales or profits. Many
of another. This applies at all levels, from individuals through high street coffee shops stress their ethical credentials.
to the largest corporation and even governments. If I choose Starbucks stated in 2015 that 99 per cent of its coffee was
to buy a new car the trade-off might be that I cannot have a ethically sourced through a partnership with Conservation
holiday. The trade-off of a government decision to increase International. Costa, in its Corporate Responsibility Report,
the income tax personal allowance might be that it cannot states that it only uses Forest Stewardship Council (FSC)
afford to spend more money on a high-speed rail upgrade. certified wood for furniture in its stores. However, Harris
Similarly for businesses, trade-offs exist with any decision. + Hoole, an artisan coffee shop brand launched in 2012
Investing in a new production facility may mean that a new which emphasised its ethical credentials, closed a number
fleet of vans cannot be purchased. The idea of such trade- of its London stores in 2014.
offs is particularly apparent when considering ethics. Is the ●● For most companies that have taken Corporate Social
cost of acting ethically an acceptance of lower profit? Responsibility seriously, informed by ethics, it can also
For businesses, acting ethically when not required to act as the equivalent of an insurance policy. Businesses
do so by the law can have a negative impact on profit in a don’t want to be seen to be behaving unethically and face
number of ways. The result can be a trade-off. serious penalties for breaking the law, or see sales fall as
●● It can raise costs. For example, paying higher wages than customers protest against this behaviour. In 2002, two
is necessary to overseas workers increases costs. Having major companies paid the price for reported unethical
to find other ways than animal experiments to test a new behaviour. Enron, a large US energy trading company,
drug might add to costs. Adopting an ethical code of collapsed. It was found to have manipulated its accounts
practice can raise costs. Staff have to be made aware of to inflate its profits. Senior management was reported
the code and trained to implement it. It takes management as acting unethically by hiding this from shareholders
time to prepare a code of practice. Paying workers more and government. This also led to the collapse of one of
than a legal minimum directly increases costs. the world’s top five accounting firms, Arthur Andersen. It
●● It can reduce revenues. A business might lose a contract had audited Enron’s accounts and was accused of hiding
if it refuses to give a bribe. Selling medicines to emerging the irregularities. As a result, it began to lose its major
economies at low prices might increase sales, but total customers and decided to close down.
revenue is likely to be lower. Refusing to develop GM
crops might mean a competitor getting into the market Large companies need to take seriously the consequences
first and becoming the market leader. Acting ethically of their behaviour and decision making. Customers and society
might even mean the destruction of the company. For have become less tolerant of businesses that behave in a way
example, a cigarette manufacturer that took full account of they regard as unethical. However, most companies tend to
the costs it causes to customers would probably decide to follow trends and adopt ethical policies that will prevent them
cease trading. from coming to harm in the market place or by law. A few have
adopted an aggressive ethical stance, which sometimes has
However, adopting an ethical stance can produce benefits. led to them gaining more customers. Often, small to medium-
●● Some companies have used their ethical stance for sized businesses do not have management time or resources
marketing purposes. In the UK, for example, the to draw up an ethical code of practice. Their ethical stance and
Co-operative Bank and The Body Shop have both behaviour is more organic, and influenced by the society in
increased sales by having a strong ethical stance and which they operate.

Exam tip
Exam questions on this topic offer opportunities for analysis and In short, when asked if a business decision is an ethical one, the
evaluation. When asked to consider the extent to which a business answer will almost certainly be, ‘it depends’. It depends on the type
decision is the right one, it is possible to consider this from of business, the market it operates in, economic conditions, staff
different angles. For a typical question in this area there will not be recruitment and retention, and so on. Using this ‘it depends’
a right or a wrong answer, and marks will be based on the strength approach is useful when tackling questions around ethics. Having this
of your arguments. in mind when considering an exam scenario will help you to focus on
the need for evaluation and give some structure to a response.

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Business ethics Unit 59

Thinking bigger
The question of business ethics is loaded with contention and controversy. have implications for prices and thus competitiveness. It may mean that
What factors does a business need to consider when weighing up being a business loses market position due to its ethical stance. Conversely,
‘good’ and being profitable as part of its decision-making processes? Is being ethical can have positive implications for a business. Lush is a soap
this a zero sum game, or can one improve the other? What considerations and cosmetics manufacturer that refuses to test on animals. It supports
influence decision making? For example, is the priority to drive down costs various campaign organisations, such as the Hunt Saboteurs Association
or to encourage professional development to upskill a workforce? and Plane Stupid, which campaigns against the expansion of the airline
It is worth actually thinking through your own beliefs in this area. These industry. It tries to use only natural ingredients and most things are made
views can be used in constructing arguments one way or the other. On the in the UK. In 2014 the business saw a large increase in sales and profits,
one hand, being ethical can increase the costs of a business. This might part of which it attributed to its ethical stance.

Table 2 Factors that businesses may consider in the context of decision-making processes, weighing up being ‘good’
and being profitable
Good Profitable
• Businesses have responsibilities to a wide range of stakeholders, not • Unprofitable businesses do not survive. An ethical stance is a luxury that
only shareholders. While profits may satisfy shareholders, employees can be indulged when a business is established and successful.
may be less happy if they are paid low wages.
• A trade-off can exist between being ethical and being profitable. For
• A business that treats its workers well, be it with pay or opportunities in example, paying the living wage will increase the costs of a business
the workplace, is more likely to retain its employees. This is extremely that would otherwise have paid the minimum wage. If the market is
important for businesses as recruiting and training new staff is very competitive these higher costs may lead to uncompetitive prices.
costly.
• Profitable businesses are more able to invest and innovate products
• Being good actually increases the chance of being profitable. An ethical that improve society. Pharmaceutical companies make vast profits.
stance can bring reputational benefits. Many consumers today are These are used, in part, to develop new drugs, such as those designed
conscious about ethical matters and are increasingly prepared to spend to treat cancer. Car manufacturers use profits to develop technologies
money on products that are more ethically based. such as fuel cell power units that reduce reliance on fossil fuels. These
developments and advancements would not happen without profits.

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 Business decisions and strategy

Case study

DIRECTORS’ PAY Some directors may put forward that the pay system is fair
as the main increases are in the performance-related area
of pay. Basic salaries, although high compared to most
employees, have not increased greatly. But bonuses and
share awards, both based on how the company performs,
In 2014, the High Pay Centre, a UK non-party think have increased when the businesses have performed well.
tank, reported that the directors of the top 100 listed UK Source: adapted from www.highpaycentre.org
companies now earned 130 times the average sum earned
by their employees. This difference between directors and
employees is growing. In 1998 the difference was 47 times. (a) Calculate the CEO/average employee pay multiple for:
It is estimated that pay received by the average FTSE top i) Next (2 marks)
100 CEO increased from £4.1 million to £4.7 million in ii) Unilever (2 marks)
2013, roughly 174 times that of the average UK worker. (b) Explain one reason why directors’ pay is significantly
Table 3 shows the pay ratios of some of the top directors of higher than that of employees. (4 marks)
UK companies compared to employees. (c) Assess the extent to which the difference in pay between
The highest paid director earned 780 times more than the top directors and employees might be considered an
average employee of the business. ethical issue. (12 marks)

Table 3 The 10 highest pay ratios at FTSE 100 companies

Average employee CEO/average employee
Company name CEO CEO Pay/£* pay/£ pay multiple
WPP Martin Sorrell 29.8m 38265 780
Next Lord Simon Wolfson 4.6m** 10125 ?
Compass Richard Cousins 5.5m 13248 418
Whitbread Andy Harrison 6.4m 15362 415
TUI Travel Peter Long 10.1m 26874 377
SAB Miller Alan Clark 6.5m 17698 365
Associated British Foods George Weston 5.3m 14558 361
Unilever  Paul Polman 6.4m 23920 ?
G4S Ashley Almanza 2m 7415 266
Anglo-American Mark Cutifani/Cynthia Carroll 6.8m*** 27346 247

The disclosure of the historic data used to calculate these ratios is inconsistent and therefore figures are estimated.
*CEO pay figures rounded to 1dp
**Wolfson donated annual bonus element of his pay package to staff
***Cumulative total paid for CEO role

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Business ethics Unit 59

Key terms Knowledge check

Corporate Social Responsibility (CSR) – a business 1. Give two examples of ethical decisions an oil production
assessing and taking responsibility for its effects on the company might have to make.
environment and its impact on social welfare. It involves
2. What is meant by a trade-off?
the idea that businesses bear a responsibility that stretches
beyond their shareholders. 3. Explain which types of companies might be particularly
Ethical codes of practice – statements about how affected by ethical issues relating to: (a) the environment;
employees in a business should behave in particular (b) animal rights issues; (c) workers in developing countries;
circumstances where ethical issues arise. (d) bribery; (e) new technologies; (f) access to products;
Ethics – in the context of business ethics, consideration (g) trading with politically unstable countries.
of the moral ‘rights and wrongs’ of a decision at an often 4. What might be contained in an ethical code of practice?
strategic level, in accordance with the law, and a business’s
code of conduct in relationship to Corporate Social 5. How are the National Minimum Wage and the ‘living wage’
Responsibility. different?
Living wage – an hourly rate of pay based on the basic 6. To what extent can businesses increase profits by becoming
cost of living, set independently of government and updated more ethical?
annually.
National Minimum Wage – the minimum pay per hour all 7. ‘Businesses should not be expected to act ethically.’ Explain
workers are entitled to by law. the two sides to this argument.
Remuneration – the reward for work in the form of pay, 8. To whom might a business have social responsibilities?
salary or wages, including allowances and benefits, such as
company cars, health insurance, pension, bonuses and non-
cash incentives.
Sanctions or Trade embargoes – sanctions are restrictions
imposed on trade or investment with the aim of influencing
a policy change in another country. Trade embargoes can
be included in sanctions, where commercial shipments
are banned in and out of a particular country, or where an
embargo is placed on a particular product.

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 58 Interpretation of financial
60 3.5.1
Theme 3

Key points
statements
1. Statement of comprehensive income (profit and loss account): key information and stakeholder interest.
2. Statement of financial position (balance sheet): key information and stakeholder interest.

Getting started then shows other items of comprehensive income, such as

Marks & Spencer (M&S) is an established retailer with nearly 800 gains made on currency transactions.
stores in the UK. It has around 34 million customers and is the Sole traders and partnerships also produce financial statements.
market leader in womenswear, lingerie and menswear. However, They tend to be less complex than those of companies and may
in 2014 around 55 per cent of its turnover was generated by food be presented in a slightly different style. However, the majority of
sales. Tables 1 and 2 show some financial information for M&S. small businesses produce a balance sheet and a profit and loss
Table 1 Extracts from M&S statement of comprehensive account (or an income and expenditure account). In this unit the
income 2014 focus is on the statement of financial position (balance sheet)
2014 2013 and the income statement (profit and loss account).
  (£m) (£m)
Revenue 10,309.70 10,026.80 The statement of comprehensive income
Cost of sales 6,439.00 6,230.30 For most plcs the statement of comprehensive income is used
to show the income and expenditure of the business for a period
Gross profit 3,870.70 3,796.50
of time (usually one year) and calculate the profit made by the
Selling and admin expenses 3,224.30 3,110.00 business. The financial information has to be presented in a
Operating profit 694.50 753.00 standard way. An example for a limited company, WellFed Ltd, is
Profit before tax 622.90 648.10 shown in Table 3 on the next page. WellFed Ltd supplies cattle
and sheep feed to farmers in the UK.
Table 2 Extracts from M&S statement of financial
position 2014 Key information
2014 2013 The statement of comprehensive income contains the following
  (£m) (£m) information.
Non-current assets 6,534.50 6,342.80 ●● Revenue. This is the money the business receives from

Current assets 1,368.50 1,267.90 selling goods and services. It is sometimes called turnover.
Current liabilities 2,349.30 2,238.30 Revenue must not include VAT. This is because VAT does not
Non-current liabilities 2,847.00 2,852.90 belong to the business. The revenue for WellFed Ltd in 2014
was £25.4 million.
Share capital 408.10 403.40
●● Cost of sales. This refers to the production costs of a
Retained earnings 6,325.10 6,150.30 business. More specifically it relates to direct costs, such
Source: adapted from Companies House, www.gov.uk as raw materials and labour. In the case of WellFed Ltd the
cost of sales would be the cost of grain, nutrients, electricity,
What is the key information in the above extracts? Comment on the
wages to factory workers and any sales taxes paid such as
performance of the business between 2013 and 2014. Why might
VAT. For a retailer it will be the cost of buying in stock to
shareholders be interested in this information?
re-sell and direct labour. For a service provider it will include
the direct costs of providing a service, such as labour. In
Financial statements 2014 the cost of sales for WellFed was £12.3 million.
Companies are required by law to produce financial statements at ●● Gross profit. This is the cost of sales subtracted from the

the end of the financial year – although many plcs produce them revenue. It is the profit made before the deduction of general
on a quarterly basis. According to the International Accounting overheads. The gross profit made by WellFed in 2014 was
Standards Board, the body responsible for developing and £13.1 million (£25.4 million – £12.3 million).
approving International Financial Reporting Standards since ●● Selling expenses. A business is likely to incur a range

1 January 2015, the following statements are required. of expenses that are directly related to the selling of its
1. Statement of financial position (balance sheet), which products. Examples might include sales commissions,
shows the assets, liabilities and capital of the business. advertising, distribution and promotional costs. In 2014
2. Statement of comprehensive income (profit and loss WellFed Ltd spent £3.2 million on selling expenses.
account), which starts with the profit or loss for the year and

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Interpretation of financial statements Unit 60

Table 3 Extract from the statement of comprehensive Stakeholder interest

income for WellFed Ltd, year ending 31.12.14 The statement of comprehensive income can be used to help
2014 2013 evaluate the performance of a business. Consequently, it is likely
  (£m) (£m) to be of interest to a range of stakeholders.
Revenue 25.4 21.2
Cost of sales 12.3 11.7
Shareholders: Naturally the owners of a business will be
interested in its performance. Shareholders are likely to be
Gross profit 13.1 9.5 interested in the profit made by the business – particularly the
Selling expenses 3.2 2.3 profit for the year (net profit) after tax. This is an effective guide
Admin expenses 6.4 5.2 to the performance of a business, but by no means the only
guide. Rising profits are an indication of improving performance.
Operating profit 3.5 2.0
It is possible for shareholders, or their representatives, to calculate
Finance costs 0.4 0.4 profit for the year (net profit) and gross profit margins using
Profit for the year (net profit) 3.1 1.6 information from the statement of comprehensive income to
assess performance more rigorously. This is discussed in Unit 34.
Taxation 0.6 0.3 It is also possible to gauge the growth of the business
Profit for the year (net profit) after taxation 2.5 1.3 by looking at the statement of comprehensive income. If the
revenue is rising this suggests that the business is growing. In
●● Administrative expenses. These are the general overheads the WellFed Ltd statement, revenue rises from £21.2 million in
or indirect costs of the business. Examples might include 2013 to £25.4 million in 2014. This is an increase of 19.8 per
office salaries, expenses claimed by senior staff, stationery cent and indicates a growth rate of nearly one fifth.
supplies, IT expenses, accountancy fees and telephone bills.
WellFed Ltd incurred £6.4 million of administrative expenses Managers and directors: Since managers and directors
in 2014. are responsible for running the business, they are likely to use
●● Operating profit. If the selling and administrative costs key information in the statement of comprehensive income to
are subtracted from gross profit we get the operating profit. monitor progress. For example, they might be setting annual
The operating profit is the profit generated from the firm’s targets for growth in revenue or profit for the year (net profit).
core activities. It does not include any income from financial Changes in the revenue, for example, will show how fast a
investments made by the business. WellFed Ltd made an company has grown and whether targets have been met.
operating profit of £3.5 million in 2014.
●● Finance costs. If a business borrows money it will have to
Employees: If employees, or their representatives, are seeking
a wage increase, it may be helpful to have access to some of
pay interest to the lender. The amount paid will be entered in
the information in the statement of comprehensive income when
the statement of comprehensive income as a finance cost.
presenting a claim. For example, if WellFed Ltd employees wanted
However, a business may also receive interest if it has money
a 5 per cent wage increase, they might point to the 92 per cent
in deposit accounts. This will appear as finance income in the
increase in profit for the year (net profit)(from £1.3 million in
accounts. In 2014 WellFed Ltd paid £400,000 in interest.
2013 to £2.5 million in 2014) as an argument that the company
●● Profit for the year (net profit). If the cost of finance is
could afford it.
subtracted from the operating profit the net profit for the year
is determined. This is the profit before taxation. WellFed Ltd Suppliers: Before a supplier accepts an order from a new
made a profit for the year (net profit) of £3.1 million in 2014. customer on trade credit, it is prudent to carry out a check
●● Profit for the year (net profit) after tax. This is the amount on their creditworthiness. One way to do this is to look at the
of money that is left over after all expenses, including taxation, trading history of the customer. If the customer can provide
have been deducted from revenue. It is often referred to as several years of authenticated accounts, this might help to show
the ‘bottom line’. The money belongs to the owners of the whether the customer is able to pay what is owed at the end
business. In the case of a limited company it belongs to the of the credit period. If the statement of comprehensive income
shareholders. However, it may not necessarily be distributed show that a customer is consistently profitable, this might be
to the shareholders. Some of it may be retained. This is enough proof for the supplier.
discussed later in the unit. WellFed Ltd made a profit for the
year (net profit) after tax of £2.5 million in 2014. The government: Companies have to produce a statement
of comprehensive income by law. It is needed by the tax
The extract from the statement of comprehensive income for authorities to help assess how much tax a business has to pay.
WellFed Ltd in Table 3 shows figures for both 2014 and the HMRC collects taxes on behalf of the government and requires
previous year. This is standard practice and helps to make all business owners to provide documentary evidence of the
comparisons over time. For example, the performance of profits or losses made by the business every year. Also, the ONS
WellFed Ltd has improved over the two years. Its profit for the (Office for National Statistics), a government agency, may have
year (net profit) after tax (the ‘bottom line’) has nearly doubled an interest in business accounts because it collects economic
from £1.3 million in 2013 to £2.5 million in 2014. data, which is collated and presented for public consumption.

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 Business decisions and strategy

Question 1 ●● Liabilities. Liabilities are the debts of the business, that is,
what it owes to other businesses, individuals and institutions.
Moosewear Ltd is an online shopping site. It sells mainly Liabilities are a source of funds for a business. They might
winter clothing imported from Alaska and Canada. The majority be short term, such as an overdraft, or long term, such as
of its products are made from fake fur. In 2013 it launched a a mortgage. In the balance sheet liabilities are divided into
range of furry ‘onesies’, which sold very well. An extract from current liabilities and non-current liabilities.
the statement of comprehensive income for Moosewear Ltd is ●● Capital. This is the money introduced by the owners of the
shown in Table 4. business, for example when they buy shares. It is another
source of funds and can be used to purchase assets.

In all balance sheets the value of assets (what a business uses

or owns) will equal the value of liabilities and capital (what the
<v_983521_ph_072> business owes). This is because any increase in total assets
must be funded by an equal increase in capital or liabilities. A
business wanting to buy extra machinery (an asset) may need
to obtain a bank loan (a liability), for example. Alternatively,
a reduction in credit from suppliers (a liability) may mean a
reduction in stocks that can be bought (an asset). So:

Assets = capital + liabilities

Table 4 Extract from the statement of comprehensive Worked example

income for Moosewear Ltd, 31.12.14
2014 2013 A business has assets of £437.6 million, its capital is
  (£000) (£000) £250.1 million, therefore its liabilities must be £187.5 million
Revenue 3,450 2,980 (£437.6 – £250.1).
Cost of sales 1,210 990 If this business took out a £15 million mortgage to pay for
Gross profit 2,240 1,990 a new building, liabilities would rise by £15 million and the
value of assets would also rise by £15 million. As a result the
Selling expenses 760 560
business’s assets would be £452.6 million and its liabilities
Admin expenses 780 870 would be £202.5 million. Capital and liabilities added
Operating profit 700 560 together would be £452.6 million, that is, exactly the same as
Finance costs 80 70 total assets.
Profit for the year (net profit) 620 490

Taxation 120 110 Key information

Profit for the year (net profit) after taxation 500 380 The key information that is likely to be listed in a statement of
financial position is shown in Table 5 on the next page. It shows
(a) What is meant by cost of sales? Use examples from this case to the assets, liabilities and capital of WellFed Ltd, the cattle feed
illustrate your answer. producer mentioned earlier.
(b) Calculate the percentage increase in (i) revenue and (ii) profit
for the year (net profit) after tax for Moosewear Ltd from 2013
to 2014.
(c) Discuss whether shareholders are likely to be happy with the
performance of Moosewear Ltd in 2014.

Statement of financial position

The statement of financial position (balance sheet) provides
a summary of a firm’s assets, liabilities and capital. It is like a
photograph of the financial position of a business at a particular
point in time.
●● Assets. Assets are the resources that a business owns and

uses. Assets are usually divided into current assets and

non-current assets. Current assets are used up in production,
such as stocks of raw materials. They can also be money
owed to the business by debtors. Non-current assets, such
as machinery, are used again and again over a period of time.
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Interpretation of financial statements Unit 60

Table 5 Statement of financial position for WellFed Ltd, as ●● Investments. These are the financial assets owned by
at 31.12.14 the company. An example might be shares held in other
2014 2013 companies. If investments are listed under non-current assets
(£m) (£m) it means that they are not expected to be sold for at least
Non-current assets 12 months. If investments are likely to be sold within
Goodwill 30.5 27.8 12 months they should be listed under current assets.
Other intangible assets 15.2 11.6 According to the balance sheet in Table 5, WellFed Ltd does
Property, plant & equipment 97.7 94.1 not own any investments.
143.4 133.5
Current assets Current assets: Current assets are the liquid assets that
Inventories 8.6 6.7 belong to the business. These assets are either cash, or are
Trade and other receivables 3.4 3.1 expected to be converted into cash within 12 months.
Cash and cash equivalents 3.1 2.7 ●● Inventories. This refers to stocks of raw materials and
15.1 12.5 components, stocks of finished goods and work in progress.
Total assets 158.5 146.0 For WellFed Ltd examples might be grain, such as barley
and wheat, nutrients and packaging. The value of WellFed’s
Current liabilities
inventories in 2014 was £8.6 m.
Trade and other payables 5.5 5.1
●● Trade and other receivables. These are trade debtors,
Dividends payable 1.2 0.8
prepayments and any other amounts owed to the business
Current tax liabilities 6.7 5.7
13.4 11.6 that are likely to be repaid within 12 months. If WellFed
Ltd gives its customers trade credit, the money owed by
Non-current liabilities customers would be an example. In 2014 WellFed Ltd was
Borrowings 24.5 26.1 owed a total of £3.4 million by debtors.
Provisions 4.1 3.4 ●● Cash at bank and in hand. This is the money held by a

Pensions 7.8 6.7 business on the premises or in bank accounts. WellFed Ltd
36.4 36.2 had £3.1 million of cash or cash equivalents in 2014. Also,
Total liabilities 49.8 47.8 WellFed’s current assets totaled £15.1 million and the value of
total assets for the business was £158.5 million.
Net assets 108.7 98.2
Current liabilities: Any money owed by the business that
Shareholders’ equity is expected to be repaid within 12 months is called a current
Share capital 30.0 30.0 liability. Some examples are outlined below.
Other reserves 17.7 9.7 ●● Borrowings. Any short-term loans or bank overdrafts taken
Retained earnings 61.0 58.5
out by the business. In this case WellFed does not have any
short-term loans.
Total equity 108.7 98.2
●● Trade and other payables. Trade creditors and other

amounts owed by the business to suppliers of goods,

Non-current assets: Non-current assets are any assets that are services and utilities, for example. Table 5 shows that WellFed
not expected to be sold within 12 months. They are the long-term owed £5.5 million to its suppliers in 2014.
resources of the business. A number of entries are likely to be ●● Dividends payable. When the balance sheet is prepared (at
found in this section of the balance sheet. the end of the financial year perhaps) it is possible that the
●● Goodwill. This is an example of an intangible asset. This is a company has decided how much it will pay to the shareholders
non-physical asset of a business (i.e. it is not a visible asset). in dividends. However, the money has not yet been paid so it
It is the amount the business is worth above the value of appears in the balance sheet as dividends payable. WellFed Ltd
net assets. Goodwill exists if a company has built up a good owed £1.2 million dividends to shareholders on 31.12.14.
reputation and its customers are likely to return. The goodwill ●● Current tax liabilities. Corporation tax, employees’ income
for WellFed Ltd in 2014 was valued at £30.5 million. tax and any other tax owed by the business that must be
●● Other intangible assets. These may appear in some plc repaid within 12 months. WellFed Ltd owed £6.7 million to
balance sheets. Examples include brand names, copyrights, the tax authorities on 31.12.14. The total value of WellFed’s
trademarks and patents. The value of other intangible assets current liabilities in 2014 was £13.4 million.
for WellFed Ltd in 2014 was £15.2 million.
●● Property, plant and equipment. These are the tangible Non-current liabilities: These are the long-term liabilities of
assets that the business owns. Tangible assets are the physical a business. Any amount of money owed for more than one year
assets of a business (i.e. they are visible). Examples for WellFed will appear in this section of the balance sheet.
Ltd might be a factory, and the machines and equipment used to ●● Other loans and borrowings. Money owed by the company
process cattle feed from raw materials. In 2014, WellFed Ltd had that does not have to be repaid for at least 12 months.
£97.7 million of tangible assets. The total for non-current assets Examples would be long-term bank loans and mortgages.
is also shown in the balance sheet – it was £143.4 million. Table 5 shows that WellFed Ltd owed £24.5 million in 2014.
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 Business decisions and strategy

●● Retirement pension obligations. Companies need to show Question 2

any money owed to past employees in the form of pension
obligations. In 2014 WellFed Ltd had £7.8 million of pension Steepwell Ltd makes cakes and biscuits for supermarkets
commitments. and large retailers. Table 6 shows the statement of financial
●● Provisions. Provisions have to be made if a company is likely position for the company as at 31.12.14.
to incur expenditure in the future. Such expenditure might
arise as a result of agreements in contracts or warranties. An
example for WellFed Ltd might be a possible bad debt that it
may incur. If these provisions are short term they will appear
under current liabilities. In 2014 WellFed Ltd had £4.1 million
of provisions. The total value of its non-current liabilities was
£36.4 million. Its total liabilities were £49.8 million.

Net assets: Net assets is simply the value of all assets

minus the value of all liabilities. It will be the same value as
shareholders’ equity at the bottom of the balance sheet. The
value of WellFed’s net assets in 2014 was £108.7 million. The Table 6 Statement of financial position for Steepwell
net assets provide a guide to the value of a business. Ltd, as at 31.12.14
2014 2013
Equity: The bottom section of the balance sheet shows the (£000) (£000)
amounts of money owed to the shareholders. It will contain
details of share capital and reserves. Non-current assets
Intangible assets 8,667 8,009
●● Share capital. The amount of money paid by shareholders
Property and equipment 11,987 12,134
for their shares when they were originally issued. It does
20,654 20,143
not represent the current value of those shares on the stock
market. Share capital is not usually repaid to the shareholders
Current assets
in the lifetime of a company. The value of WellFed’s issued Inventories 4,501 4,511
share capital in 2014 was £30 million. Trade and other receivables 3,444 4,100
●● Share premium account. This shows the difference
Cash and cash equivalents 1,200 1,300
between the value of new shares issued by the company 9,145 9,911
and their nominal value. For example, the nominal value of a Total assets 29,799 30,054
share may have been £1. The company may decide to issue
2 million new shares. If the company sold them for £3, each Current liabilities
new share is now worth £2 more than the nominal price. In Trade and other payables 4,888 4,976
total this would be £4 million (£2 x 2 million). This £4 million Current tax liabilities ????? 2,009
would be entered on the share premium account in the 6,009 6,985
balance sheet. WellFed Ltd does not have any share premium. Non-current liabilities
●● Other reserves. Refers to any amounts owing to the Borrowings 4,222 4,777
shareholders not covered by the other entries under equity. Pensions 1,233 1,341
WellFed Ltd had £17.7 million of other reserves in 2014. 5,455 6,118
●● Retained earnings. The same as retained profit. It is the Total liabilities 11,464 13,103
amount of profit retained by the business to be used in the
future, for example to fund investment projects. WellFed Ltd Net assets ?????? 16,951
had £61 million of retained profit in 2014.
The total value of shareholders’ equity, £108.7 million in the Shareholders’ equity
case of WellFed Ltd, is the same as net assets. This will always Share capital 10,000 10,000
Retained earnings 8,335 6,951
be the case and explains why the statement of financial position
is sometimes called the balance sheet. Company law requires
Total equity 18,335 16,951
companies to show both this year’s and last year’s figures in
published accounts. This allows comparisons to be made. (a) Complete the balance sheet by calculating the missing values for
(i) net assets and (ii) current tax liabilities.
Exam tip (b) Give two possible examples of trade and other payables for
Remember that retained profit in the balance sheet is not cash. It Steepwell Ltd.
is the amount owed to shareholders that has accumulated over the
years of trading. The amount of cash a business has is shown in (c) Explain the difference between current liabilities and non-current
current assets. Some of the retained profit may have been used liabilities.
to buy more assets. Only if the company was liquidated would (d) What has happened to the value of Steepwell Ltd between 2013
retained profit be returned to shareholders. and 2014?

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Interpretation of financial statements Unit 60

Stakeholder interest Managers and directors: The balance sheet might be used
The statement of financial position can also be used to help evaluate by the management of a business. For example, it is important
the performance of a business. It shows different information from for senior managers to be aware of the firm’s financial position
that of the statement of comprehensive income, and stakeholders at any given point in time. It will need to monitor working capital
are likely to be interested in both statements together. levels to ensure that the business does not overspend. Also, if the
business is considering raising some more finance, it will have to
Shareholders: Shareholders might use the balance sheet to consider the current capital structure before choosing a suitable
analyse the asset structure of the business. This shows how the source. For example, it might want to avoid borrowing more
funds raised by the business have been put to use. For example, money if the business is already in debt. Raising fresh capital
shareholders in WellFed Ltd in Table 5 can see that more than might be a better option.
60 per cent of the assets (£97.7 million) are tied up in property,
plant and equipment. The balance sheet also shows the capital Suppliers and creditors: Suppliers will be most interested in
structure of the business, i.e. the different sources of funds used the solvency of the business. Suppliers are not likely to offer trade
by the business. For WellFed Ltd nearly 67 per cent of the firm’s credit to a business that only has a limited amount of working
funding comes from the shareholders. capital. WellFed Ltd only has a small amount of working capital;
The balance sheet can also be used to assess the solvency of as a result it might struggle to get generous trade credit terms.
the business. A business is solvent if it has enough liquid assets However, this will also depend on WellFed’s trading history and its
to pay its bills. The value of working capital will help to assess past credit record. Banks and other lenders will be interested in
solvency. The working capital of a business can be calculated by the balance sheet for the same reasons.
subtracting current liabilities from current assets. For WellFed Others: It is possible that employees might use the balance sheet
the value of working capital is £1.7 million (£15.1 million – to assess whether a business can afford a pay rise or whether their
£13.4 million). This might be regarded as inadequate because the jobs are secure. The Office for National Statistics might also extract
value of current liabilities is only just covered by current assets. information from the balance sheet to compile national statistics.
Worked example
Links
Gallagher & Sons Ltd is a manufacturer of sweets and Information in this unit could be used in a range of answers.
desserts. It supplies supermarkets and other large retailers. For example, if you are discussing sources of finance for a
Table 7 shows some financial information taken from the business you could explain how the capital structure of the
statement of financial position. business might influence the decision. Businesses that already
Table 7 Extract from Gallagher & Sons Ltd, statement have a large quantity of borrowings might be better to raise
of financial position, 2014 fresh capital, for example. This unit could also be linked with
2014 Internal finance (Unit 26), External finance (Unit 27), Planning
£ million (Unit 29), Break-even (Unit 32), Profit (Unit 34), Liquidity
Current assets
(Unit 35), SWOT analysis (Unit 46), Decision trees (Unit 54),
Inventories 34.9
Ratio analysis (Unit 61) and Global competitiveness (Unit 75).
Trade and receivables 28.6
Cash and equivalents 31.8
Current liabilities Knowledge check
Trade and other payables 25.1
Borrowings 32.1 1. How is gross profit calculated in a statement of
Other tax liabilities 11.9 comprehensive income?
2. How is operating profit calculated in a statement of
The working capital for Gallagher & Sons Ltd is given by: comprehensive income?
Working capital = current assets – current liabilities 3. Give three examples of selling expenses for a business.
= £95,300,000 – £69,100,000 4. What is meant by finance costs in a statement of
= £26,200,000 comprehensive income?
In this example, Gallagher & Sons Ltd has £26,200,000 of 5. What is the difference between non-current assets and
working capital. This may be an adequate amount of working current assets?
capital for the business because current assets exceed current 6. Give two examples of intangible assets.
liabilities by about 1.5 times. Working capital is discussed in 7. What information is needed from the balance sheet to
more detail in Unit 35. calculate working capital?
8. Give two examples of non-current liabilities.
The value of a business is roughly equivalent to the value of 9. What is meant by ‘retained earnings’?
net assets in the business. This means that shareholders can
10. Give two reasons why shareholders might be interested in
use the balance sheet to see if their investment is growing.
company accounts.
Between 2013 and 2014 the value of WellFed Ltd grew from
11. Why might the government be interested in company accounts?
£98.2 million to £108.7 million.
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 Business decisions and strategy

Case study
Table 9 Statement of financial position for Swanpool

SWANPOOL MARINE PARK Marine Park as at 31.12.14

2014 2013
Swanpool Marine Park, Cornwall, has experienced difficult (£000) (£000)
trading conditions since 2011. The business has also come under Non-current assets
fire from pressure groups representing animal rights. Although Intangible assets 1,100 900
the marine park has a good reputation for the care of its dolphins, Property and equipment 8,556 7,986
seals, sharks and other sea creatures, negative publicity relating 9,656 8,886
to the captive environment in which the animals are kept has Current assets
hit the park’s popularity. However, in 2014 the good weather in Inventories 1,200 1,170
Trade and other receivables 780 750
the UK saw a return to profit for the park as visitor numbers rose
Cash and cash equivalents 600 200
sharply. The marine park hopes to improve its image in the future
2,580 2,120
by emphasising the work it does protecting the environment and Total assets 12,236 11,006
saving rare marine species. An extract from the statement of
comprehensive income and statement of financial position for the Current liabilities
business are shown in Tables 8 and 9 respectively. Trade and other payables 1,091 1,136
Borrowings 1,400 1,750
Current tax liabilities 60 76
2,551 2,962
Non-current liabilities
Borrowings 2,050 2,160
Pensions 833 841
2,883 3,001
Total liabilities 5,434 5,963

Net assets 6,802 5,043

Shareholders’ equity
Share capital 3,000 3,000
Other reserves 2,348 1,039
Table 8 Extract from statement of comprehensive income
Retained earnings 1,454 1,004
for Swanpool Marine Park, year ending 31.12.14
  2014 2013 Total equity 6,802 5,043
(£000) (£000)
Revenue 6,110 4,180
Cost of sales 4,210 2,990
Gross profit 1,900 1,190
(a) Explain one reason why suppliers might want access to the
statement of financial position for Swanpool Marine Park.
Selling expenses 460 470
Admin expenses 380 480 (4 marks)
Operating profit 1,060 240 (b) Explain one reason why managers and directors might
want access to the statement of comprehensive income for
Finance costs 500 600 Swanpool Marine Park. (4 marks)
Profit/loss for the year (net profit/loss) 560 (360)
(c) Evaluate the performance of Swanpool Marine Park
Taxation 110 0 between 2013 and 2014. (20 marks)
Profit for the year (net profit) after tax 450 (360)

Key terms
Finance cost – interest paid by a business on any borrowed
money.
Finance income – interest received by a business on any
money held in deposit accounts.

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 61 Ratio analysis 3.5.2
Theme 3

Key points
1. Calculate gearing ratio and return on capital employed (ROCE).
2. Interpret ratios to make business decisions.
3. The limitations of ratio analysis.

Getting started Worked example

Businesses need to know what returns they are getting on the Table 1 Selective financial information for
money invested in the business and whether the business is on a Washytree Holdings 2013–2014
strong financial footing. They also like to make comparisons with 2014 2013
their rivals. For example, Jones Ltd, a small property developer, (£000) (£000)
made a profit of £340,500 while a much larger rival, Acorn
Properties, made £78.5 million. But which of these companies Operating profit 6,570 5,430
has performed the best? Clearly one has made more profit than
the other, but it does not necessarily mean it has performed Non-current assets 21,900 20,100
the best. Current assets 5,430 4,300
Current liabilities 3,333 3,100
What other information might be needed to determine the best
Non-current liabilities 6,900 5,490
performing company in the above example? Explain your answer.
If Jones Ltd has borrowed 25 per cent of its finance while Acorn
Properties borrowed a much larger 86 per cent, to which business Washytree Holdings is a farm machinery repair and
is a bank most likely to lend more money? Explain your answer. maintenance company based in Northumberland. Using the
information in Table 1, the gearing ratio for the business is given by:

Gearing ratio = Non-current liabilities × 100%

Financial ratios –––––––––––––––––
It is possible to extract key information from the income Capital employed
statement and the statement of financial position to help assess
For 2014 = £6,900,000 × 100%
the performance of a business. This approach was used in
(£21,900,000 + £5,430,000) – £3,333,000
Unit 60. However, a more rigorous approach is to use ratio
analysis. Financial ratios can be calculated and used to analyse
the performance of businesses more precisely. A financial ratio = £6,900,000 × 100%
is one number divided by another or one number expressed as £27,330,000 – £3,333,000
a percentage of another. There are different types of ratio, which
address different aspects of financial performance. = £6,900,000 × 100%
£23,997,000
Gearing ratios
Gearing ratios show the long-term financial position of the = 28.8%
business. They can be used to show the relationship between
loans on which interest is paid, and shareholders’ equity on For 2013 = £5,490,000 × 100%
which dividends might be paid. There are several different (£20,100,000 + £4,300,000) – £3,100,000
versions of the gearing ratio. One relates the non-current
liabilities (total long-term loans) to the capital employed. If = £5,490,000 × 100%
not stated clearly, the capital employed can be determined by £24,400,000 – £3,100,000
subtracting current liabilities from total assets. The formula is:
Gearing ratio = Non-current liabilities × 100% = £5,490,000 × 100%
–––––––––––––––––
Capital employed £21,300,000
= 25.8%

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 Business decisions and strategy

Interpret the gearing ratio profit as operating profit (net profit before tax and interest).
Creditors are likely to be concerned about a firm’s gearing. This is sometimes described as earnings before interest
Loans, for example, have interest charges that must be paid. and tax (EBIT). Tax is ignored because it is determined by
Dividends do not have to be paid to ordinary shareholders. the government and is therefore outside the control of the
As a business becomes more highly geared (loans are high company. Interest is excluded because it does not relate to
relative to share capital) it is considered more risky by creditors. the business’s ordinary trading activities. The capital
The owners of a business might prefer to raise extra funds by employed, if not stated clearly, can be determined by
borrowing. They might not want to issue more shares and share subtracting current liabilities from total assets. ROCE can be
control of the business. calculated using the formula:
Gearing ratios can be used to analyse the capital structure
of a business. They compare the amount of capital raised from ROCE = Operating profit × 100%
ordinary shareholders with that raised in loans. This is important ––––––––––––––
Capital employed
because the interest on loans is a fixed commitment, whereas
the dividends for ordinary shareholders are not. Gearing ratios
can assess whether or not a business is burdened by its loans.
This is because highly geared companies must still pay their Question 1
interest even when trading becomes difficult. Edinburgh-based Cairn Energy is an oil exploration
company. It owns oil wells in a range of locations including the
Maths tip Atlantic margin, Asia, the Mediterranean, the UK and Norway.
You need to be careful when calculating ratios to ensure In 2011 it sold a 40 per cent shareholding in Cairn India to
that the correct units are used. For example, financial information Vedanta Resources, a global mining company, for $5.5 billion.
might be measured in 100s, 1000s, 100,000s, millions or
billions. You need to make sure that decimal points are in the
right place, otherwise you might end up with miscalculations.
As a result you might draw some inaccurate conclusions from
your calculations, which might have an adverse impact on
your answer.

The gearing ratio for Washytree Holdings has risen slightly

from 25.8 per cent in 2013 to 28.8 per cent in 2014. Most
would regard this as a relatively low gearing ratio. It is not
until the gearing ratio reaches 50 per cent that concerns are
raised. A gearing ratio of around 25 per cent means that the
business is not overburdened with long-term debt. Higher
gearing ratios mean that a much larger proportion of business
finance is borrowed. With low-geared companies more finance
is provided by shareholders (the owners).

Profitability ratios
Profitability or performance ratios help to show how well Table 2 Selective financial information for Cairn Energy
a business is doing. They tend to focus on profit, capital 2012–2013
employed and revenue. The profit figure alone is not a useful
  2013 2012
performance indicator. It is necessary to look at the value   ($m) ($m)
of profit in relation to the value of revenue or the amount of    
money that has been invested in the business. Non-current assets 2,054 2,602
Current assets 1,551 1,726
Return on capital employed (ROCE) Current liabilities 268 153
One of the most important ratios used to measure the Non-current liabilities 150 533
profitability of a business is the return on capital employed
(ROCE). This is sometimes referred to as the primary ratio. Source: adapted from www.ft.com
It compares the profit, i.e. return, made by the business with (a) Calculate the gearing ratio for Cairn Energy in 2013 and 2012.
the amount of money invested, i.e. its capital. The advantage
(b) Assess the extent to which Cairn Energy is low geared.
of this ratio is that it relates profit to the size of the business.
When calculating ROCE, it is standard practice to define

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Ratio analysis Unit 61

Worked example Question 2

For Washytree Holdings the return on capital employed Debenhams is a multinational retailer. In 2014 it had
is given by: around 240 department stores in 27 different countries.
For 2014 = £6,570,000 × 100% It also runs an online operation, which delivers to 66
(£21,900,000 + £5,430,000) – £3,333,000 different countries. Debenhams has a top-four market share in
womenswear and menswear, and leads the market in premium
= £6,570,000 × 100% health and beauty. It employs nearly 29,000 people and sells
£27,330,000 – £3,333,000 clothes, fashion accessories, household items and furniture.
Table 3 Selective financial information for Debenhams
= £6,570,000 × 100% 2013–2014
£23,997,000 2014 2013
(£m) (£m)
= 27.4%
Revenue 2,313 2,282
For 2013 = £5,430,000 × 100%
(£20,100,000 + £4,300,000) – £3,100,000 Operating profit 106 139
Non-current assets 1,662 1,662
= £5,430,000 × 100% Current assets 486 471
£24,400,000 – £3,100,000 Current liabilities 758 742
Non-current liabilities 623 646
= £5,430,000 × 100% Source: adapted from www.ft.com
£21,300,000
(a) Calculate the return on capital employed (ROCE) for Debenhams
for 2014 and 2013.
= 25.5%
(b) Discuss the performance of Debenhams between 2013 and 2014.

Interpret ROCE
The return on capital employed will vary between industries.
However, the higher the ratio the better. Over the two years Equally, some companies remain the same size over time.
Washytree Holdings has seen its ROCE increase from 25.5 Others grow rapidly or shrink quickly. Such factors can
per cent to 27.4 per cent. This appears to be an impressive affect the way in which ratios can be used as a measure of
performance. However, to decide whether Washytree Holdings performance. For example, the measures of performance of a
has performed well, this would have to be compared with another small company that starts off in the defence sector and grows
business in the same industry. An investor might also compare rapidly to become a leading telecommunications equipment
the ROCE with the possible return if the capital was invested manufacturer, will change over time. The value of a particular
elsewhere. For example, if £23,977,000 was placed in a bank ratio that is appropriate for the company will therefore change.
account in 2014 it might have earned a 3 per cent return. So the This must be taken into account when comparing ratios.
27.4 per cent ROCE in 2014 seems very impressive. However, ●● Inter-firm comparisons. Caution must also be used when
an investor in the company will also want to be rewarded for comparing ratios between companies at a point in time.
the risk involved. The £23,977,000 invested by shareholders Comparing the ratios of two companies that make broadly the
in Washytree Holdings is at risk if the business fails. So, for the same products is likely to say something about their relative
investment to be worthwhile, the ROCE must be far greater than performance. But comparing the ratios of a supermarket
the return that could be earned in a ‘safe’ investment. chain with those of a cement manufacturer is unlikely to be
helpful. For example, the two companies will have different
Limitations to ratio analysis working capital needs and different profit margins. Even
Unfortunately, ratio analysis is not without its problems, so it companies operating in the same industry can have subtle
must be used with caution. Some of the key limitations are differences. For example, Tesco and Waitrose are both
outlined here. supermarket chains. However, Tesco is selling more and
more non-food products, such as electrical goods, clothing
The basis for comparison: A great deal of care must be taken and kitchen equipment. This makes a direct comparison less
when making comparisons using ratios. It is very important to meaningful because, for instance, the profit margins on non-
compare ‘like with like’. food items might be different from those on groceries.
●● Comparisons over time. Care must be taken when ●● Other differences. Even when companies are well matched
comparing ratios from the same company over time. Many in their activities and operating circumstances, there may be
companies remain broadly in the same industrial sector other differences between them that must be observed. For
over time, but others can diversify and change very rapidly. example, two similar companies may use different accounting

376
 Business decisions and strategy

techniques, different methods to calculate depreciation or ●● Managers of companies might want to put as good a
different stock valuation methods. If the same accounting financial picture forward as possible for shareholders and
conventions have not been used, comparisons may be potential shareholders. Good financial results will attract
misleading. Companies can also have different year ends. praise and perhaps rewards. They might also prevent
For example, if one company ended its financial year on criticism from shareholders and the financial press.
31 December and the other on 31 July, although their ●● If a business wants to raise new capital from investors, then
accounts would nominally be for the same year they would it will want its financial accounts to look as good as possible.
actually be presenting financial information about two quite ●● Where a business has experienced severe difficulties during
different time periods. In this case only six months of the year the accounting period, it may decide to take action that will
would be truly comparable. make the financial position look even worse now, but which
will improve figures in the future.
The quality of final accounts: Ratios are based on financial ●● Making the financial picture look worse may be a way of
accounts, such as balance sheets and income statements. lowering the amount of tax that is paid.
Consequently ratio analysis is only useful if the accounts are ●● If the owners of a business want to sell it, the better the
accurate. One factor that can affect the quality of accounting financial position shown on the accounts, the higher the price
information is the change in monetary values caused by inflation. they are likely to get.
Rising prices can distort comparisons made between different
time periods. For example, in times of high inflation, asset values There are several ways of window dressing accounts. For
and revenue might rise rapidly in monetary terms. However, example, a business may manipulate its sales by increasing
when the figures are adjusted for inflation, there might be no the level of revenue recorded in the income statement. This
increase in real terms. There is also the possibility that the will increase profit in that accounting period. It may be able to
accounts have been window dressed. This is discussed in more suppress costs by changing its accounting policies or choosing
detail below. when to ‘write off’ unprofitable activities. It can also ‘write off’
bad debts, revalue property, boost liquidity through the sale and
Limitations of the balance sheet: Because the balance leaseback of assets, and manipulate current assets and current
sheet is a ‘snapshot’ of the business at the end of the liabilities. The methods required to conduct these transactions
financial year, it might not be representative of the business’s are beyond the scope of this book, but you should be aware
circumstances throughout the whole of the year. If, for example, such methods exist.
a business experiences its peak trading activity in the summer,
and it has its year end in January when trade is slow, figures for Exam tip
stock and debtors will be unrepresentative. When using ratio analysis you must understand the importance of
interpreting your results. The calculation of financial ratios is
relatively straightforward and quite often more marks are
Qualitative information is ignored: Ratios only use awarded for understanding the implications of your results. For
quantitative information. However, some important qualitative example, you need to understand that if ROCE is 2.3 per cent,
factors may affect the performance of a business that are ignored this is not a very good return on capital. You might get more
by ratio analysis. For example, in the service industry the quality than this from a bank deposit.
of customer service may be an important performance indicator.
However, ratio analysis cannot isolate the impact that good
customer service might have on sales. Sales might be higher as a Links
result of good customer service but there might be other factors In addition to assessing the performance of a business,
that have helped to increase sales, such as advertising. ratio analysis might also be used when making decisions.
Consequently, you can demonstrate synoptic skills by linking
Window dressing: Accounts must represent a ‘true and fair ratio analysis to answers that involve making business
record’ of the financial affairs of a business. Legislation and decisions, such as whether to start exporting, investing in
financial reporting standards place limits on the different ways growth or launching a new product. Ratio analysis might be
in which a business can present financial information. These linked to Internal finance (Unit 26), External finance (Unit 27),
limits are designed to prevent fraud and misrepresentation in the Planning (Unit 29), Break-even (Unit 32), Profit (Unit 34),
compilation and presentation of accounts. However, businesses Liquidity (Unit 35), Theories of corporate strategy (Unit 45),
can manipulate their accounts legally to present different financial SWOT analysis (Unit 46), Decision trees (Unit 54) and Global
pictures. This is known as window dressing. Businesses may competitiveness (Unit 75).
want to window dress their accounts for a variety of reasons.

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Ratio analysis Unit 61

Case study
JD SPORTS
JD Sports was set up in 1981 as a single sports shop in Bury. It During 2014 the business made some operational changes to
is now a major retailer of branded and own-brand sportswear, the Blacks and Millets Outdoor business, with the relocation
fashionwear, outdoor clothing, footwear and equipment in the UK. of some offices and a warehouse to the group’s main facilities.
It operates over 800 stores across Europe under fascia such as JD, This resulted in some disruption, but with the aim of providing
Size?, Blacks, Millets, Scotts, Chausport, Sprinter, Tessuti and Bank, scope for future efficiency gains. Table 4 shows some selective
as well as JD Sports. It also has a large online operation. information for JD Sports taken from the income statement and
statement of financial position.
Table 4 Selective financial information for JD Sports
2013–2014
2014 2013
(£000) (£000)

Revenue 1,330,578 1,258,892

Operating profit 57,850   55,117
Non-current assets 269,706 245,693
Current assets 329,879 256,814
Current liabilities 285,651 212,749
Non-current liabilities 41,094 38,001

Source: adapted from www.jdplc.com

(a) Calculate the gearing ratios for 2013 and 2014. (4 marks)
(b) Calculate the return on capital employed for 2013 and
2014. (4 marks)
(c) Assess the performance of JD Sports over the two years.
(10 marks)
(d) Evaluate the usefulness of ratio analysis to a company like
JD Sports. (20 marks)

Key terms Knowledge check

Gearing ratios – exploration of the capital structure of the 1. What is the difference between liquidity ratios and gearing
business by comparing the proportions of capital raised by ratios?
debt and equity. 2. How can capital employed be calculated using information
Profitability or performance ratios – illustration of the from the balance sheet?
relative profitability of a business.
Ratio analysis – a numerical approach to investigating 3. What is meant by a highly geared company?
accounts by comparing two related figures. 4. A business has a gearing ratio of 76 per cent. Comment on this.
Return on capital employed (ROCE) – the profit of a 5. What is the formula for calculating return on capital employed?
business as a percentage of the total amount of money used
6. Why is the return on capital employed an important ratio?
to generate it.
Window dressing – the legal manipulation of accounts by a 7. When using ratios it is important to compare ‘like with like’.
business to present a financial picture that is to its benefit. What does this mean?
8. Why does ratio analysis ignore qualitative information?
9. What is meant by window dressing accounts?
10. Outline three reasons why a business would choose to
window dress its accounts.

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 62 Human resources
58 3.5.3
Theme 3
Key points
1. Calculate and interpret the following to help make business decisions:
●● labour productivity
●● labour turnover and retention
●● absenteeism.

2. Human resources strategies to increase productivity and retention, and to reduce turnover and
absenteeism:
●● financial rewards

●● employee share ownership

●● consultation strategies

●● empowerment strategies.

Getting started Labour productivity is an important measure of the efficiency of

a workforce. For example, if there are two teams of workers in
Nissan, the Japanese car producer, has a large production plant in
a factory, each with identical equipment and the same number
Sunderland. It was widely reported that productivity at the plant
of workers, then the team with the highest productivity could be
fell by 1.7 per cent in 2013. However, this was thought to be a
identified as the most effective team.
temporary downturn caused by the introduction of new models. Figures for labour productivity need to be used with caution.
One of these new models, the Nissan Qashqai, is built on Line For example, differences in labour productivity between factories
One, which has been operating for 24 hours a day since 2010. or plants may be accounted for by differences in equipment
The production of the new model means more jobs for local used rather than the efficiency of the workforce. A plant with
people and the total number employed by Nissan in its Wearside newer equipment is likely to have higher labour productivity
plant was reported to have topped 7,000 in 2014. Nissan than one with old equipment. Equally, productivity differs widely
produces around 500,000 cars a year in Sunderland. between processes within a business and between businesses
in different industries. A highly automated section of a factory
is likely to have much higher labour productivity than a labour-
intensive packing section in the same factory using little capital
equipment. The manufacturing industry may have a higher
average labour productivity than service industries simply
because more capital is used per employee in manufacturing.
Increasing labour productivity is generally assumed to
increase the competitiveness of a business. Higher labour
productivity should drive down costs, allowing a business either
to lower its prices and so gain higher sales, or to keep its prices
the same but increase its profit margins.
However, businesses sometimes find that they become less
competitive despite increasing their labour productivity. This may
occur for a number of reasons.
Source: adapted from the Financial Times 09.01.2014. All rights
●● Rival businesses may increase their productivity at an even
reserved.
faster rate.
How might productivity be measured at the Nissan factory? How ●● New rival businesses may set up which pay considerably
might productivity be improved using financial methods? Give an lower wages. Many UK manufacturing businesses have
example of a non-financial method to improve productivity. How become less competitive over the past ten years due to
might a business reduce absenteeism in its organisation? the emergence of competition from low-wage, low-cost
businesses in the Far East and eastern Europe.
Labour productivity ●● Other factors apart from cost may change adversely for a

Labour productivity is defined as output per worker. business. For example, a rival business may bring out a far
As a formula: better new product. However productive the workforce and
however low the cost, customers may prefer to buy the new
Labour productivity = Total output (per period of time) product rather than a cheaper old product.
Average number of employees
(per period of time)
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Human resources Unit 62

Worked example Labour turnover

Labour or staff turnover is another measure of personnel
Massamore Ltd operates a call centre in Glasgow where effectiveness. Labour turnover is the proportion of staff leaving
customer service is provided for a large energy company. One a business over a period of time. It is measured by the formula:
week in October 2014, a total of 157,500 calls were handled
by the centre’s 140 staff. Labour productivity at the call centre is Number of staff leaving
given by: Labour turnover = over time period × 100%
Total output Average number of staff
Labour productivity = in post during the period
Average number of employees
157,500 As with other measures of personnel performance, labour
=
140 turnover differs from department to department within a
business, from business to business within an industry and from
= 1,125 calls per employee
industry to industry within an economy. Relatively high labour
This means that during that week in October each employee turnover is caused by a number of factors.
took 1,125 calls (on average). ●● Relatively low pay leads to higher labour turnover as workers

leave to get better paid jobs.

●● Relatively few training and promotion opportunities will

encourage workers to leave their current jobs.

Question 1 ●● Poor working conditions, low job satisfaction, bullying and

Jengril Ltd manufactures and distributes household harassment in the workplace are other factors.
appliances. In one of its Asian factories it has a production line ●● Some businesses are relatively poor at selecting and

making kettles. Table 1 shows the total output of kettles, and recruiting the right candidates for posts. Where workers are
staffing levels on the production line, between 2010 and 2014. ill-suited to their jobs, there is more chance that they will
leave relatively quickly.
●● In a recession, labour turnover tends to fall as the number

of vacancies falls and workers become worried that if they

leave their job without having another one to go to, they
will become part of the long-term unemployed. In a boom,
when there might be labour shortages, there are far more
vacancies and so labour turnover tends to rise.

Relatively high labour turnover is usually seen as a problem for

businesses for a number of reasons.
●● Recruiting new staff can be costly.

●● It takes time for new staff to become familiar with their roles

and the way in which the business operates. High labour

turnover is likely to reduce the human process advantage of a
business.
●● Larger companies may put on induction programmes which

further adds to costs.

●● If the post is filled internally, there may be training needs for

the worker who gets the job.

However, some labour turnover is usually beneficial to a

Table 1 Total output and staffing levels on the kettle business.
production line ●● New staff can bring in fresh ideas and experience from their

  2010 2011 2012 2013 2014 work with other businesses.

Total output ●● Some workers may be ineffective and need to be encouraged

(number of kettles) 23,200 24,800 24,700 25,300 24,900 to leave. Getting rid of ineffective staff leads to labour
Average number of turnover.
employees 11 12 13 14 14 ●● If a business is shrinking in size, reducing the size of the

workforce will lead to higher labour turnover.

(a) Calculate the labour productivity on the kettle line at Jengril Ltd
●● Where a business pays low wages, or where conditions
for each year between 2010 and 2014.
of work are poor, it may be more profitable to have a
(b) Explain one possible reason for the pattern of labour productivity
constant turnover of staff rather than raise wages or improve
on the kettle production line between 2010 and 2014.
conditions of work.

380
 Business decisions and strategy

permanent staff have to work overtime and are paid at higher

Worked example
rates than their basic rate of pay.
During 2014, 60 staff left Massamore Ltd, the business ●● Output may suffer if workers are expected to cover for sick

in the above example. Therefore, labour turnover is given by: colleagues or if temporary staff are not as productive as the
absent workers.
Number of staff leaving
●● Prolonged absences can lead to major disruption if the
Labour turnover = (over a time period) × 100%
worker is key to a particular area of work or a new project.
Average number of staff in post
●● If production is delayed or there are problems with quality,
(in the time period) customers can be lost.
= 60 × 100 ●● Absenteeism can demotivate staff left to cope with problems.

140 ●● The higher the rate of absenteeism, the more likely it is

= 42.9% that workers will report ill. This is because a culture of

absenteeism will develop where it becomes acceptable for
This means that during the year, 42.9 per cent of staff left workers to take extra days holiday by reporting in sick.
Massamore Ltd. The rate of absenteeism, or absenteeism rate, or absentee
rate can be calculated by dividing the number of staff absent by
the total number of staff employed. The rate is expressed as a
Labour retention percentage. It can be calculated as a daily rate using the formula:
Labour retention and labour turnover are related. This is because
labour turnover looks at the rate at which employees leave a Number of staff absent on a day
× 100%
business, while labour retention looks at the rate at which they Total number of staff employed
stay with the business. Therefore, labour retention is the opposite
of labour turnover. It can be calculated using the following formula: Worked example
Number of staff staying On 24 October 2014, eight staff were absent from work
Labour retention = (over a time period) × 100% at Massamore Ltd, the business in the above examples.
Average number of staff in post Therefore, the rate of absenteeism is given by:
(in the time period) Absenteeism rate = Number of staff absent on a day × 100%
Total number of staff employed
The benefits to a business of a high retention rate are the
same as the advantages of a low staff turnover rate, such as = 8 × 100%
lower recruitment and selection costs, more continuity and a 140
stable workforce. = 5.7%
This means that on 24 October 2014, 5.7 per cent of
Worked example
Massamore staff were absent from work.
During 2014, the number of staff that left Massamore Ltd,
was 60. This means that 80 (140 – 60) staff remained.
Therefore, the retention rate is given by: Worked example
Retention rate = Number of staff staying (over a time period) × 100% During 2014 a total of 1,000 staff days were lost
Average number of staff in post through staff absence at Massamore Ltd. Each of the 140 staff
(in the time period) should have worked 240 days during the year. So the total
number of staff days that should have been worked was 33,600
= 80 × 100%
(140 x 240). Therefore the rate of absenteeism for the year is
140
given by:
= 57.1%
Total number of staff
This means that during the year, 57.1 per cent of staff stayed Annual absenteeism rate = absence days over the year × 100%
with Massamore Ltd. Total number of staff days that
should have been worked
= 1,000 × 100%
Absenteeism
Absenteeism is a problem for all businesses for a number of 33,600
reasons. = 3%
●● Staff who are absent often claim to be ill. The business then,
This means that the absenteeism rate throughout 2014 was 3 per
in most cases, has to pay sick pay.
cent. Note that this annual rate for Massamore Ltd is lower than the
●● If temporary staff are brought in to cover for absent staff,
absenteeism rate on 24 October 2014, when it was 5.7 per cent.
this leads to increased costs. Equally, costs will increase if
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Human resources Unit 62

Rates of absenteeism can be calculated for a business

as a whole and compared to industry averages or national
Question 2
averages. They can also be compared between one part of Hunter & Co runs an online gift business. It has a
a business and another, or compared over time. Differences warehouse in Staffordshire where orders are packed and
in rates of absenteeism occur for a number of reasons. dispatched. In 2012, a new warehouse manager was employed
●● Small businesses tend to have lower rates of who introduced some new working practices. However,
absenteeism than larger businesses. Arguably this is there was a three-month consultation process before the
because there is much more commitment and feeling of new arrangements were introduced. This gave all staff the
teamwork in a small business than in a large business. opportunity to express their views and preferences about the
Workers in large businesses can feel that no one will proposed arrangements. Table 2 shows the average number of
suffer if they take a day off work and so absenteeism
staff employed at the warehouse, the number of staff leaving
is acceptable.
each year, and the total number of days missed through absence
●● Health and safety is a factor. Businesses which have
between 2010 and 2014.
good health and safety procedures will tend to suffer
less illness-related absenteeism than those with poor Table 2 Staffing information for Hunter & Co’s
procedures. Equally, some jobs are inherently more warehouse 2010–2014
dangerous to health than others and so absenteeism is   2010 2011 2012 2013 2014
more likely. Average number of staff
●● The nature of the tasks given to workers is another employed 1,590 1,610 1,620 1,670 1,710
factor. Tasks which are fragmented and repetitive lead
Average number of staff
to low job satisfaction and demotivation. This leaving 410 440 500 410 310
encourages workers to report sick. Workers in jobs
Total number of staff
which are interesting and rewarding tend to have lower absences (in days) 5,760 5,890 6,180 5,200 4,200
absentee rates.
●● The culture of a workplace can cause absenteeism. NB According to a survey, the average staff turnover rate for the
Where workers are overworked, where there is a climate UK in 2011 was 15.6 per cent. Also, according to the Office for
of intimidation and bullying by superiors of subordinates, National Statistics (ONS), staff absence in the UK in 2011 was
and where the needs of workers are ignored, work- 1.8 per cent.
related stress becomes much more common. Workers
Source: www.ons.gov.uk
who are off through stress are a particular problem
because they often take months off work at a time. (a) Calculate the annual staff turnover at Hunter & Co’s warehouse
●● Stress-related illness is also more common where between 2010 and 2014.
workers are oversupervised and feel that they are not (b) Calculate the annual absenteeism rate at Hunter & Co’s
trusted by their superiors to accomplish tasks. warehouse between 2010 and 2014 (assume that each
●● Workers who feel that they are grossly underpaid employee can work 240 days per year).
are more likely to take time off work. They see it (c) Assess whether the decision to change working practices in
as compensation for the lack of monetary reward 2012 was a good one for Hunter & Co.
they receive. Low pay is also a demotivator and so
contributes to absenteeism.

Strategies to increase productivity Financial rewards

According to some theories of motivation, if financial rewards are
and retention, and to reduce turnover increased, employees will work harder and produce more. For
and absenteeism example, American engineer and pioneer business consultant,
If businesses can raise productivity and retention rates, and F. W. Taylor, in his theory of scientific management, suggested
reduce staff turnover and absenteeism, the benefits will be that once the best way to carry out a task had been identified,
significant. Here are a couple of reasons why. workers should be paid according to what they produce. He
●● If productivity rises, output per employee will be higher suggested that people should be paid a fair day’s pay for a
so there is more output to sell. This will raise revenue fair day’s work. He argued that people are motivated mainly
and profit. by money and would work harder to earn more. Therefore,
●● If staff turnover can be reduced, money will be saved on employees should be paid piece rates if it is possible. The main
recruitment, selection and training. This will help to cut benefit of piece rates for businesses is that it rewards productive
costs and again increase profit. workers. Workers who are lazy or slow will not earn as much as
A number of human resources strategies might be those who are conscientious and productive. This system helps
used to help achieve these aims. to motivate workers, and businesses are likely to get more out of
their employees.

382
 Business decisions and strategy

Other ways of improving the performance of workers The benefit to employers is that workers are likely to be
using financial rewards might be to adopt performance- better motivated and more loyal to the company if they own
related pay, bonus systems, profit-related pay or shares. They may work harder, take less time off sick and
commission systems. All of these methods reward are less likely to leave. For example, once staff have signed up
employees for their effort – both in terms of results and for a five-year sharesave scheme, they may be reluctant to leave
attendance. Also, if financial rewards are lucrative, it is half way through the term and miss out on possible gains.
unlikely that staff will want to leave a business so staff
turnover will be lower. For example, bonuses can be paid Consultation strategies
in addition to the basic wage or salary. Operatives may Employees are likely to be better motivated and more productive
be paid a bonus if they reach a weekly production target. if they are involved in decision making. Staff often complain when
The main advantage to businesses of bonus payments changes are made and they are not consulted. For example, if
is that they are only paid if targets are met. This means a business introduced new working practices to improve the
that money is only paid if it has been earned. Some level of customer service without consulting staff, they may feel
businesses pay their staff loyalty bonuses. These are resentful. If staff are consulted by employers when changes are
usually paid annually, often at Christmas. Such bonuses proposed they are more likely to see their views as being valued.
are not necessarily linked to productivity. They are Three different types of consultation can be identified.
designed to reward workers for their loyalty and to help
to reduce staff turnover. Pseudo-consultation: Pseudo-consultation is where
Finally, some businesses use financial rewards to management makes a decision and informs employees of that
reduce absenteeism rates. In 2013 in the UK, the cost to decision through their representatives. Employees have no
organisations of sickness absence was widely reported to power to influence these decisions. Some have suggested that it
be nearly £29 billion. Therefore it is perhaps not surprising would be more accurately described as information giving.
that some businesses try to reduce absenteeism by
offering money if attendance targets are met. A system Classical consultation: Classical consultation is a way
might involve paying an employee with a 100 per cent of involving employees, through their representatives, in
attendance record a bonus of £1,000 in, say, a six-month discussions on matters which affect them. This allows
period, or a £200 bonus for a 98 per cent attendance employees to have an influence on management decisions.
record. However, attendance systems should not penalise Unions may be involved, for example, in restructuring.
employees who take time off to which they are entitled.
Integrative consultation: Pseudo- and classical
Employee share ownership consultation do not directly involve employees in decisions
Some businesses reward employees by giving them which affect them. Integrative consultation is a more
company shares. Such schemes are particularly common democratic method of decision making. Arguably it is neither
when remunerating senior managers and executives consultation nor negotiation. Management and unions discuss
in plcs. The idea is that key employees will be paid a and explore matters which are of common concern, such as
‘tranche’ of shares (probably in addition to cash bonuses) ways of increasing productivity or methods of changing work
if the business reaches important performance targets, practices. The two groups come to a joint decision having
such as growth in turnover, profit or share price. used, in many cases, problem-solving techniques. An example
Some businesses offer shares to a wider range of of an integrative approach to consultation might be the use
employees. A common method of share distribution is of quality circles in a number of UK businesses and in foreign
to use a sharesave scheme, sometimes called a Savings firms setting up in the UK.
Related Share Option Scheme. These involve employees
putting aside part of their monthly pay for a fixed number In addition to improving motivation and worker productivity,
of years. At the end of the period employees get the consultation has other advantages. Changes are less likely to
chance to use the money saved to buy shares at a price be resisted if staff have been consulted and it is also possible
that was fixed at the outset, often at a discount. If the that employees have ideas of their own which might benefit
share price has increased over the time period, employees a business. Such ideas can only be expressed if there is a
can often make a capital gain. However, if the share proper consultation process. However, some might argue that
price has fallen to below the price that was fixed at the consultation takes too long and slows down the process of
outset, employees get their cash back, perhaps with a change. Also, some see consultation as a ‘cosmetic’ process
small cash bonus. Such schemes are considered to be a where the views of workers are heard, but then ignored.
‘safe bet’ and are therefore very popular with employees.
UK government statistics suggest that, in 2012–13, over Empowerment strategies
1,000 companies offered such sharesave schemes. Empowerment involves making better use of the knowledge,
Examples include BT, Ocado, Asda, Tesco and Whitbread. experience and creative talents of employees. It is achieved
by granting employees more authority in the workplace.
Empowering staff may be a way of creating a positive working
environment where employees are happy, motivated and
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Human resources Unit 62

productive, and therefore engaged. The following strategies Key terms

might be used to help empower employees.
●● Training. It is not really possible to empower staff
Labour productivity – output per worker in a given time
effectively without first equipping them with the skills period.
needed to take on more advanced tasks. A business needs Labour retention – the number of employees that remain in
to identify any ‘skills gap’. This is the difference between an a business over a period of time.
employee’s current skills and those required to undertake Labour turnover – the rate at which staff leave a business.
new tasks. This gap can be bridged by training. Rate of absenteeism – the number of staff who are absent
●● Provide the necessary resources. There is little point
as a percentage of the total workforce. It can be calculated
empowering staff if they are not given the resources and for different periods of time, e.g. daily or annually.
information needed to undertake more complex tasks.
For example, if an employee is tasked with leading a
small team to solve a problem, such as improving the Knowledge check
response time to customer complaints, they will need a
range of information and enough resources to make the 1. The factory output for a manufacturer in 2014 was
improvements. 2.4 million units. The business employed 1,200 people in the
●● Hand over authority. Once employees have been factory. Calculate the labour productivity.
empowered they must be confident that they have complete 2. How is labour turnover calculated?
authority to make decisions. The methods they choose and
approaches they take must not be questioned. If employees 3. Give three reasons why staff might be absent from work.
are challenged or asked to explain themselves each time 4. How is the daily absenteeism rate calculated?
they make a decision, empowerment is not likely to work.
5. Explain one way a business might reduce absenteeism.
●● Inspire confidence. If employees are being empowered

it is important that they feel confident about their new 6. What is meant by retention?
role. A lack of confidence can lead to anxiety, hesitancy 7. Explain one advantage of having a high retention rate.
and mistakes. Senior managers can help to inspire
confidence by emphasising the strengths that an individual 8. Give two financial methods that a business might use to raise
has, showing trust, and by recognising and praising productivity.
achievements. 9. Explain one advantage of giving employees shares.
●● Provide feedback. At an appropriate time it will be
10. Explain how empowerment might help improve productivity.
necessary to provide positive feedback to empowered
workers. Workers need to know how they have performed
in their new roles. Feedback will help to guide them in the
future and build more confidence.

Giving people more control over their own work role should
help to improve their motivation and productivity. They will
feel valued, more loyal and less likely to leave an organisation.
It may also help to reduce absenteeism because empowered
staff may have a greater sense of responsibility.

Links
To demonstrate your synoptic skills you could link information
in this unit to answers relating to global competitiveness, for
example. UK businesses trying to compete globally may try to
improve productivity and staff retention to gain a competitive
edge. Information in this unit might also be linked with issues
covered in Motivation in theory and practice (Unit 17), Business
objectives (Unit 21), Production, productivity and efficiency
(Unit 37) and Corporate culture (Unit 57).

384
 Business decisions and strategy

Case study

LINDUM GROUP
Lindum Group is a construction company that provides a
wide range of construction services such as design, building,
roofing, security and waste recycling. Between 55 and
60 per cent of its business is private sector work and its
clients include Morrisons, Perkins, Bombardier, Siemens and
Premier Foods. It also does public sector work for clients
in Lincolnshire, the East Midlands, East Anglia and the
Yorkshire/Humberside area.
Lindum Group has a reputation for caring for its 480 staff.
It believes that if the company looks after its staff, then
the staff will look after its customers. In 2014 the labour
turnover was 12 per cent, which is below the national
average of around 15 per cent. In a survey by the Sunday
Times, it was found that more than half of the firm’s staff
have worked for Lindum for more than five years. Also,
81 per cent of workers said they would not leave Lindum if
they were offered alternative employment elsewhere.
Financial rewards are used to help motivate staff and
encourage loyalty. For example, every year the company
shares 10 per cent of the profits equally between all
members of staff. The company also gives free shares to
its employees. The company believes that by giving shares
to employees they will have an interest in the company
performing well and will therefore take more care to
ensure that customer needs are met.
Lindum managers have very good relations with staff. The
views of workers are valued and people are encouraged
to share information and come up with ideas. For
example, one member of staff suggested that the waste
oil from company vehicles could be utilised. The company
responded by using the oil to fuel heaters. Everyone in the
organisation is on first-name terms, and managers and
directors operate an ‘open door policy’ where staff are
welcome at any time to express their concerns and views. (a) Calculate the number of people who left the Lindum
Between 2012 and 2013 group revenue rose from Group during the year. (4 marks)
£83 million to £93.7 million. However, its profit after (b) Explain one advantage of a low staff turnover to the
tax dipped slightly from £1.8 million to £1.7 million. The Lindum Group. (4 marks)
company’s success comes a lot from its reputation as a
customer-focused organisation. According to the chairman, (c) Explain one method used by the Lindum Group to help
David Chambers, ‘Our approach is to understand and forge improve productivity and retention. (4 marks)
a good working relationship with our customers.’ (d) Assess the extent to which Lindum’s human resources
Source: adapted from www.lindumgroup.com policies may have improved the competitiveness of the
business. (12 marks)

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 63 Causes and effects of change 3.6.1
Theme 3
Key points
1. Causes of change:
changes in organisational size
●●

poor business performance

●●

●● new ownership

●● transformational leadership

●● the market and other external factors (PESTLE).

2. Possible effects on:

●● competitiveness

●● productivity

●● financial performance

●● stakeholders.

Getting started Effects of changes in organisational size

In 2014, an American car manufacturer called Local Motors ●● Competitiveness. There are significant advantages
used 3D printing to manufacture a drivable car. The car took to growth in the form of economies of scale, brand
44 hours to print. In 2015, a company took an ultrasound image recognition and financial security. Many of these benefits
of an unborn baby and printed a 3D model of the little boy so were explored in Theme 2. Overall, a business will grow to
that his blind mother could touch and feel her child for the first achieve these benefits.
time. These are just some of the applications of the technology ●● Productivity. Firms are certainly more productive as
commonly known as 3D printing. Thanks to the advancements they grow in size. However, in order to capitalise on
in the technology it is becoming cheaper to print out physical size a business will have to alter the scale and methods
models and objects for a wide range of uses. of production. For some organisations this may require
investment in automated production facilities and the loss
How might businesses change as technologies like 3D printing of a highly skilled small workforce.
advance? ●● Financial performance. With growth comes the need to
invest. This investment could come from the reinvestment
of profits, but more often than not, a firm will need to
The causes of change in business finance growth through borrowing. A highly geared
Businesses today have to operate in rapidly changing markets business is a risky business. Nevertheless, growth will
and conditions. They can no longer rely on a constant often bring with it increased profit in real terms and this is
stream of customers, the same production process or selling likely to please shareholders.
the same product over a long period of time. They must ●● Stakeholders. Fortunately, growth brings with it new
constantly be aware of, and be prepared to respond to, opportunities for employees through bonuses and
organisational change in a number of areas. promotion prospects. It may also be necessary to recruit
new employees and this is another important change to
Changes in organisational size manage. Individual workers might be concerned that they
The size of an organisation will naturally change as it seeks to will no longer work with ‘friends’, or may be moved to a
grow. Growth is a key corporate objective as it allows a firm to job that they dislike. As a firm grows there is the danger
satisfy shareholders and create security for its stakeholders. One of losing connections with its customer base. Larger
of the most significant drivers of change as a business grows organisations sometimes find it more difficult to offer a
is the need to restructure and adopt policies and processes to personal service. Trying to maintain a personal service has
manage expansion. been the focus of many high street banks. For example,
Sometimes a business will look to grow externally by NatWest has looked at extending branch opening hours
merging or taking over another business. This can bring and, historically, HSBC’s strapline focused on being the
very sudden change to all aspects of the business. How an world’s local bank. The expansion of business can also
organisation manages growth can be the difference between create pressures for local communities. For example,
success and failure. Most businesses are unable to operate the increased traffic caused by a growing factory can
as they once did when they were a small business. There are cause negative externalities in the form of noise pollution,
particular advantages to being a small business, which can be damage to roads and congestion.
lost as companies grow.

386
 Business decisions and strategy

Poor business performance Question 1

The poor performance of an organisation will invariably
bring with it a period of change as the company strives KDDR Steel’s financial performance slowed in 2014–15, with the
to regain customers, sales, profit or reputation. Often the Chinese company announcing a $473 million annual net loss in
change after a period of poor performance will happen May 2015. The price of shares in the steelmaker fell throughout
quickly as the business leaders try to ‘turn the tide’ and the year 2014-15, and KDDR Steel’s European bases faced a
improve the fortunes of the company before failure and threat of strikes in May 2015.
possibly closure. For this reason, change will often be very The weak commodity price of steel along with some operational
quick and may focus on the corporate objectives (Unit 44) problems in a key plant in China led to this lowering in KDDR
or change in corporate strategy (Unit 45). Steel’s profitability throughout 2014–15. The fall in profitability
Sometimes when a large business has a period of poor was also linked to a lower demand for steel and a change in
performance, a change of higher management or the Chief some export and import patterns for steel.
Executive Officer (CEO) is made. New leadership usually In 2014, KDDR Steel’s operations in China accounted for
brings significant change as the new boss attempts to assert 26 per cent of its overall global revenue.
themselves and strike a new course for the business. In 2015
(a) Explain the impact that KDDR Steel’s performance may have on
Deutsche Bank, the world’s largest lender, appointed John
stakeholders.
Cryan as their new CEO following years of reported scandals.
(b) Assess the impact on KDDR Steel of a lower demand for steel.
His appointment had an immediate impact of raising share
prices by 8 per cent before he made any decisions.

Effects of change on business performance Change to the market and other external factors
●● Competitiveness. Poor performance will often go hand (PESTLE)
in hand with a loss of competitiveness. Unit 47 explores external influences on a business. These
●● Productivity. With poor performance comes a fall in include political, economic, social, technological, legal and
sales, productivity and profitability. A fall in production environmental – PESTLE). Companies will often be required
will leave the business with a low rate of capacity to adapt and change in line with these external influences, as
utilisation (Unit 38). The key question is how will the firm shown in the examples below.
manage its excess capacity and the threat of rising unit
●● Technological. The introduction of new technology can
costs? Businesses must take account of changes in their
affect a business in many ways. Advances in ever more
human resource planning. This could mean employing a
powerful computer components, telecommunications and the
more flexible workforce that could be changed quickly to
power of handheld devices change not only how businesses
meet the needs of the business, for example employing
communicate with their customers and suppliers, but also the
part-time workers, or introducing job sharing. It might
pace of innovation and business processes.
also mean employing workers in low-cost countries, such
●● Social. Businesses must be prepared for changes in the
as in call centres abroad.
tastes of consumers. Examples include the increasing demand
●● Financial performance. A firm going through a period
for environmentally friendly products, the desire for greater
of poor performance is likely to be subject to liquidity
knowledge about products or the need for more convenient
problems. A reduction in sales will result in a reduction
methods of shopping, such as purchasing via the internet.
in cash flow and this might lead to cost cutting. In times
Population changes will also affect the age and make-up
of financial difficulty it is important for a business to find
of the workforce. The ageing of the population in the UK in
ways of being leaner and more efficient.
the early part of the twenty-first century is likely to result
●● Stakeholders. Poor performance brings uncertainty and
in changing recruitment policies for businesses. A falling
this can have a negative impact on motivation within the
population is also likely to change how a business plans its
workforce. A firm can find itself managing low morale and
human resources.
giving reassurances. Nevertheless, poor performance
●● Legal. Government legislation can force changes in business
sometimes signals redundancies and this can be an
activity. Taxation of pollution, for instance, would affect the
extremely difficult process to manage. In 2015 UK retailer
production methods of many firms. Safety standards, such as
Boots announced the decision to cut 700 jobs at its
EU regulations, the minimum wage or the governance of zero
Head Office as part of its cost-cutting plans over the next
hour contracts are likely to determine how businesses operate.
few years, following a slump in profits. All corporations
●● Economic. It is argued that economies go through periods
are answerable to their shareholders and a poor
of boom and slump, recession and recovery. This is known as
performing company is likely to lose value on the stock
the business cycle. Income, spending, saving, investment and
market. Following the announcement of redundancies at
economic variables, such as unemployment and inflation, are all
Boots, the share price fell by 35%.
likely to be different at different stages in the cycle. Businesses
have to deal with these economic factors. For example, through
the financial crisis of 2008 many firms had to find ways of
becoming leaner and more efficient in order to survive.
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Causes and effects of change Unit 63

Effects of change to the market and other external are good for share prices and the announcement of
factors (PESTLE) an acquisition or merger can increase demand for the
●● Competitiveness. The impact on competitiveness of company’s stocks.
PESTLE factors is very much determined by how quickly a ●● Stakeholders. With a merger or acquisition comes the
business is able to respond to these changing forces. For danger of a clash between two corporate cultures. One of
example, if a business is the first to innovate or adopt a new the most famous merger failures occurred in 1998 when
technology, responds fastest to consumer needs or embeds Daimler and Chrysler attempted to merge. The merger
policies that adhere to new legislation, it might be able to was quoted as being like ‘trying to mix oil and water’. The
gain an advantage over its competitors. occurrence of a merger will always lead to restructuring of
●● Productivity. New technology can feed into the production the two companies (or at least one of them) and may also
processes of a business. Whether that be a manufacturer lead to redundancies.
or service provider, new technology brings with it the
opportunity to increase scale, productivity and efficiency. Question 2
As the economy goes through periods of boom and slump,
businesses will be required to adapt to changing demands Property website Zoopla bought the price comparison site
for their products and services. As productivity rises and uSwitch in a deal worth up to £190m, bringing together two
falls a business must change to cope with different levels of well-known UK consumer brands. Shares in Zoopla jumped
capacity utilisation. These can require fast expansion or the 16 per cent to 215p on news of the deal, but remained below
need to rationalise. the flotation price of 220p.
●● Financial performance. In most instances any change Zoopla, which gets an average of 44m visits a month from
in these external forces means an increase in costs for a consumers searching for properties, said bringing together the
business. From simply having to adapt its packaging to meet brands was a good fit, creating a single portal where consumers
new consumer legislation or the complete revamp of its can find their home and manage it once they have moved in.
product line to introduce new technology, these changes uSwitch is devoted to helping consumers to compare deals for
are not going to be cheap. However, it is likely that the costs energy, TV, broadband, phone and other services. In 2014, it
will have to be absorbed by the whole industry and not just
achieved revenues of £63m and adjusted profits of £16m.
one firm.
●● Stakeholders. The impact of change as a result of a Source: adapted from the Financial Times, 30.04.2015. All
business having to respond to external influences is likely rights reserved.
to be felt by all stakeholders. Any impact of rising costs (a) Explain why Zoopla believes buying uSwitch was a good fit for
through legal implications is likely to be passed on to its business.
consumers. New technology may require retraining or, in a (b) Assess the potential impact on Zoopla of the acquisition of
worse case scenario, could lead to parts of the workforce uSwitch.
becoming redundant.

Changes in ownership Change and effects of transformational leadership

The change in ownership of a business may come from internal Occasionally change occurs as a result of a change in
growth, the transition from a private limited company to a management or leadership. When a new CEO takes the helm
public limited company and flotation of a firm’s shares on the of a business it is often because the previous CEO has retired,
stock market. With the flotation of a business on the stock stepped down or has been replaced due to poor performance.
market comes the opportunity to raise fresh capital for further In these circumstances the new CEO will bring in their own
investment and expansion, again fuelling more change ahead. A ideas and changes to the company. This transformational
change in ownership may also become necessary as a business leadership might be in the form of a new vision or strategic
goes through the process of a merger or acquisition (Unit 74), direction for the business. If the new CEO has been brought
which can bring very sudden change to a company. in following a challenging period of performance, they might
have been chosen as a catalyst for change to bring in new
Effects of changes in ownership and fresh ideas. For example, at the start of 2015 McDonald’s
●● Competitiveness. The impact on competitiveness will very replaced its CEO, Don Thompson, with Steve Easterbrook,
much be determined by how the companies integrate and who was formerly the president of McDonald’s Europe.
complement one another. However, significant economies of Macdonald’s sales had dropped by just over 1 per cent at
scale may come from two firms merging. the end of 2014. This was attributed to a range of reasons
●● Productivity. Productivity may eventually rise as a result such as the McDonald’s brand image, the company’s market
of a merger, but in the short term it is likely that business positioning in emerging markets, and its menu choices. They
operations will be disrupted as the two firms work out how hoped that the introduction of a new CEO with new ideas
to get along and integrate all aspects of the business. would stimulate change and increase sales.
●● Financial performance. Acquisitions can be very
expensive, and should the venture fail it can lead to huge
losses being incurred by the buyer. However, acquisitions
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 Business decisions and strategy

Thinking bigger
Change is a topic that encapsulates all other issues in business and is not finance, operations and human resources, will all be affected. You
a standalone issue. Any change will naturally affect all other functions should consider change in one of two ways. Firstly, does it pose a
of a business. It is difficult to separate the topic of change from others, threat to the business? (The answer is often yes.) If so, what can the
such as leadership (Unit 18), Corporate culture (Unit 57) and Corporate business do to manage the threat and negate the impact? Secondly,
strategy (Unit 45). change may bring opportunities that the business can capitalise on.
Not only will change affect issues such as competitiveness and If so, how can the business lever these opportunities to create a
stakeholders, the functions within a business, for instance marketing, competitive advantage?

Case study

AIRBUS GROUP
In 2013 the European Aeronautic Defence and Space
Company (EADS) officially changed its name to Airbus Group,
the group’s most famous brand used on its commercial
aircraft.
The name change came with a restructuring of the company
into three distinctive divisions:
1 Airbus, maker of passenger jets
2 Airbus Defence and Space, created by combining existing
defence and space businesses
3 Airbus Helicopters, manufacturer of civil and military
helicopters.
The restructuring of the company allowed the various
subsidiaries of the business to come together under the
strong Airbus brand with the purpose of moving forward to
capture the global aviation market. Figure 1
It is anticipated that the global market for aviation will Airbus Group revenue by region in 2013
go through considerable growth in the future, driven by
North America 15%
developments in emerging markets. Airbus Group revenue
by region in 2013 is shown in Figure 1. Overall, air traffic
is expected to double in the next 15 years. Emerging
economies, such as China, India and Latin America, have
Europe 36%
a joint population of 6.2 billion people with anticipated
air travel growth of 6 per cent by 2033. Comparatively,
developed countries in Western Europe and North America,
whose citizens are currently the most frequent flyers, equate
to 1 billion people, with a growth forecast of 4.2 per cent.
These statistics are a significant indication of where much of
Airbus’s revenue growth is likely to occur in the future.
Over the past nine years, Airbus has captured a significant Asia-Pacific 33%
proportion of new aircraft contracts. For example, orders
in the category of passenger widebody planes, such as the
Airbus A350, have totalled 1,761.

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Causes and effects of change Unit 63

Figure 2 Figure 3
Market forecast 2014–2033 Forecast of Brent crude oil to 2030
Brent oil price (nominal US$ per barrel (bbl))
Fleet in service
History Forecast
40,000 37,500 180

35,000 160

um
nn
140
ra
30,000 pe
19,000 Growth
120
%

25,000
3.7

31,400
+

new 100
20,000 18,500
aircraft
80
15,000
12,400 Replacement 60
10,000
40
5,000 20
6,100 Stay in service
0 0
Beginning 2014 2033 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

Source: adapted from www.airbus.com

With over 31,000 new aircraft required globally by 2033

there are significant opportunities for Airbus to grow, as (a) Explain one factor that may have driven the decision for
shown in Figure 2. It may be challenging to keep up with Airbus Group to change its organisation structure. (4 marks)
the numbers required. There are also considerable pressures
(b) Assess the impact of changing market conditions on the
on the industry to produce ever more environmentally
stakeholders of Airbus Group. (12 marks)
efficient planes. This is driven by consumer expectations and
the long-term projection of fuel prices, as shown in Figure 3. (c) Evaluate the factors that may lead to change within the
Airbus Group over the next two decades. (20 marks)

Key terms Knowledge check

Organisational change – a process in which a large 1. State four factors that may cause change in a business.
company or organisation changes its working methods or 2. How might change affect:
aims, for example in order to develop and deal with new a) motivation of employees?
situations or markets.
b) financial performance of a business?
Transformational leadership – where new leadership such
as a new CEO brings about change with the purpose of 3. What changes might a business go through when merging
improving business performance. with another company?
4. What changes might a business face as it moves from being a
private limited company (Ltd) to a public limited company (plc)?
5. Why might a business replace its CEO?
6. How might poor performance affect a business?

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 58 Key factors in change
64 3.6.2
Theme 3
Key points
1. The key factors in managing change:
●● organisational culture
●● size of organisation
●● time/speed of change
●● managing resistance to change.

Getting started Managing change

Change management is the process of organising and introducing
‘The only thing that is constant is change.’ new methods of working in a business. These changes can be
The above quotation, associated with Heraclitus, an ancient driven from within the business or as a result of responding to
Greek philosopher who lived about 100 years before Plato, the external environment (as seen in Unit 63). The management
suggests that change is a fundamental aspect of our lives. of change in business is becoming increasingly important. Under
pressure from competitors, higher costs and tougher economic
How might this quotation relate to the management
conditions, many firms in the UK have developed company-wide
of business? change programmes. Some firms have made only minor changes
to their business operations and remained successful.

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Key factors in change Unit 64

The Morgan Motor Company, for instance, still retains many One of the most significant drivers for organisational change
of the original production methods and design features that have is external growth as a result of a merger or acquisition. In such
been part of its operation since the 1930s. It argues that it is cases two organisational cultures will come together and their
exactly these ‘original’ features that attract consumers. However, compatibility will often be the key factor that leads to success
many businesses need to change to stay successful in business. or failure.
Unit 63 explored some of the factors that cause change and
the impact of this change. This unit will look at some of the key Size of the organisation
issues in managing successful business change. Growth is a key objective for most businesses and organisational
change may come about as a result of mergers and acquisitions,
Organisational culture change in organisational structure, strategic direction or a
Organisational culture in its simplest form can be change in ownership. However, the size of a business may
described as ‘the way things are done around here’. This significantly affect its ability to manage successful change.
is a simplistic view of extremely powerful phenomena It is a fair generalisation that the larger the organisation the
that play a significant role in the success of a business. less adaptable and flexible it becomes. This might simply be
Resistance to change may often be found in the culture because there is more change to manage and on a larger scale,
of an organisation. Customs and practices are embedded but also because decision making takes longer in firms with a
in systems that reflect the norms, values and beliefs of longer chain of command and subdivisions. This might be due
the organisation. While this may give stability, it presents to the number of people it is necessary to be involved in the
problems of rigidity when a business needs to change. decision-making process, or the number of people necessary
Unit 57 describes how corporate culture is formed by to communicate with or train during the changes. In contrast,
a multitude of factors that can be significantly different smaller businesses are far more flexible because decisions can
from business to business. For example, an organisation’s be taken quickly and implemented without the involvement of a
culture may be personified by a strong leader, such as the large number of stakeholders.
company’s founder, or by a particular operational principle, As companies expand it is also necessary for them to
such as the John Lewis Partnership. Although a strong change the way decisions are made. Multinational, or even
culture may give a company a competitive advantage, it can regional, businesses may be required to adapt their approach to
also be its downfall. For example, Kodak pioneered digital suit the local context. For example, Starbucks is one company
technology. Yet the changes in the digital market moved that has adopted a ‘glocalised’ (coined with the phrase ‘think
quickly and some competitors had an organisational culture global, act local’) approach with a number of its franchise
that was reported to respond at a faster pace than Kodak stores. Instead of having a standardised format, it has adapted
to meet market demand. Despite its previous dominance in some of its franchises to meet local contexts to capture the feel
the market place, the changes resulted in Kodak filing for of a local coffee shop, which would otherwise be threatened
bankruptcy in 2012. by the existence of Starbucks in its vicinity. The decisions in

Question 1
In 2010 Kraft, the US food giant, made a successful takeover bid of Olympic campaign,’ he says. The 5 to 10 launches under the
Cadbury, the UK chocolate manufacturer. An article in the Financial Cadbury brand last year will be repeated this year.
Times, published in 2011, explored some of the issues surrounding ‘The culture of the two organisations is so similar it’s been
the changes that took place in both companies. easy to get Kraft and Cadbury to mingle and get together,’ says
At the height of the battle over the £11.7bn takeover – which Mike Clarke, Kraft’s head of Europe.
was agreed a year ago next week – there were fears that jobs But insiders retort that Kraft’s propensity for lengthy meetings,
and taxes would divert to Zurich, and that chocolate would and a desire to include top-level executives on every decision,
taste like plastic and the family culture fostered by the Quaker- made the new jobs less compelling in any case.
founded company would become a distant memory. ‘Put simply, Gorilla would never have got done under Kraft,’
But the real loser, according to some analysts, is Kraft. ‘Cadbury says one, referring to the ground-breaking TV ads (which
had a cutting edge understanding of the shopper and its retail featured a gorilla playing the drums to the Phil Collins hit, ‘In
customers,’ says one former Cadbury employee. ‘We spent The Air Tonight’).
years building that at Cadbury, and that’s been lost.’ Another says there is much grumbling about ‘the number of layers
Kraft disagrees. Trevor Bond, who ran Cadbury in the UK and and amount of people that have to be involved to make things
now has an expanded Europe-wide portfolio at Kraft, says happen … Forget the brand manager having a voice in anything.’
that Cadbury sales have gone ‘incredibly well’ in the UK, and Source: adapted from the Financial Times 14.01.2011,
promises many product launches under the Cadbury name. 12.08.2013, 22.07.2014. All rights reserved.
‘There have been a lot [of product launches] under Kraft,
(a) Explain the problems that Cadbury and Kraft have faced as a result
for example the Spots v Stripes Challenge Bar as part of the
of the Kraft takeover in 2010.

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 Business decisions and strategy

these areas are then decentralised to local store and regional ●● Individual workers might be concerned that they will
managers. Where it is necessary for a business to move from a no longer work with their preferred colleagues or may be
centralised decision-making approach (or ‘top down’ structure) moved to a job that they dislike.
to a decentralised strategy, change management may be more If change is to be carried out effectively, the business must
difficult to implement. make certain that these fears are taken into account. Only if
Culture is a key factor in any change process. However, it is employees feel they can cope with change will the business
also true that in large organisations it is easier for sub-cultures be able to operate to its optimum potential.
to develop. Multiple cultures are more difficult to manage
through any change than simply one. Owners: Owners of businesses may also be resistant to
change for similar reasons. They might fear operating in
Question 2 unknown markets and conditions. They might not want the
cost of any changes. They may also fear that they might
Jon Clemence opened his first restaurant on Edinburgh’s Royal not be able to adjust to new situations and be forced out
Mile in 2004. His business was called ‘Relish’ and specialised in of business.
selling traditional hamburgers to tourists. In its first two years
the company was extremely successful and began to make Customers and suppliers: These too may resist change.
a profit. They may be unwilling to change their own practices when
In 2006 Jon Clemence decided to open his second restaurant in the business they are dealing with changes. For example, a
Edinburgh city centre, but changed the name of his two outlets company may reorganise its sales force and decide that it
will no longer visit clients that give it less than £5,000 worth
to ‘Wannaburger’. He wanted to add more fun to his brand and
of orders per year. Instead, it will develop a website and
develop a system that allowed his restaurants to offer burgers
telesales operation to deal with small customers. Inevitably,
in a faster, slicker way, with a more enjoyable experience. Along
the company will lose some customers who are not prepared
with the opening of the new store came a wider product range
to place orders in this new way.
and a focus on simplified packaging.
(a) Discuss the benefits of managing change in a small business Generally speaking therefore, stakeholders in a business may
like Wannaburger. resist change for any of the following reasons.
●● Disagreement with the reasons for or necessity to change.

●● Fear of the impact.

Speed of change ●● Lack of understanding.
Size is just one factor that can determine the pace of change in ●● Disagreement with the process involved in delivering
a business. Other factors also play their part. For example, in the change.
some contexts change can take its time and happen organically. ●● Lack of involvement.
This might be the case where a business is successful and ●● General inertia – satisfaction with the current situation /
perhaps leading the market. The development of new products, way of working.
technology and processes can then evolve in the knowledge that Harvard Business School professor John Kotter proposed
the business is in a safe position. Over the past 10 years Apple in Leading Change (1996) that are eight steps necessary to
has been at the forefront of innovation in the personal computing manage successful change in a business. The first step is to
market through continual change at a steady, but regular pace. create a sense of urgency – getting people to actually see and
By contrast, other organisations have to go through change feel the need for change. Stakeholders must understand the
very rapidly. Fashion is one example of an industry that is forever need for change through effective communication if anger and
involved in product development and innovation. Similarly, crisis fear are to be overcome and the management of change has
can also lead to very fast change. For example, the financial any chance of succeeding.
crisis of 2008 led to many organisations having to change very
quickly to rationalise and improve efficiency in order to survive.
Finnish company Nokia is a classic example of this. In 1980 Exam tip
Change management needs to be approached with care in any
Nokia was a television manufacturer, but because of a recession
examination because it can incorporate all aspects and functions of
in Finland in the 1990s, it streamlined its business to focus on a business. It is therefore worth examining change and the
its most profitable products – mobile phones. management of change in a systematic way.
• What are the driving forces behind the change? Are these
Managing resistance to change internal or external?
Businesses are likely to face a certain amount of resistance to
• What is the likely impact of the change?
change from parts of the workforce for a number of reasons.
• What factors might determine its succes? Think about the
●● Fear of the unknown. People often feel safe with familiar
issues covered in this unit.
work practices, conditions and relationships.
• What are the key steps the business must take to ensure the
●● Employees and managers may fear that they will be unable to
change is successful? This will often come from the context of
carry out new tasks, may be made redundant or may face the business you are analysing.
a fall in earnings.

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Key factors in change Unit 64

Case study

ERNST & YOUNG

Ernst & Young Global Ltd (EY) is a global financial audit
firm with its headquarters in London. EY provides financial
services, such as auditing, tax and advice for companies.
In 2013 EY adopted a comprehensive flexible working
arrangement across the company. EY already supported
both informal and formal (reduced hours) flexible working
arrangements. But in 2013 the company aimed to make it
‘business as usual’ rather than the exception by giving its
people more opportunity to choose when, where and how
they worked – while ensuring clients still took priority.
EY set out its vision ‘to be the leaders in flexible working
in professional services. We trust our people to create a
sustainable, high performing environment for our clients,
our people and our firm through being empowered to
choose how, when and where they work.’
Robin Tye, Chief Executive Officer for the UK and
Ireland, said:
‘Flexibility isn’t about working less or working more, but
about having greater control over how to get your work • Investment in workspaces and in new technology
done more effectively. Our aim, therefore, is to support to support remote working, including new video
teams in “making it real”, so that flexibility is a part of our conferencing facilities, global messaging and
working culture, enabled by the right policies, technology collaboration tools.
tools and effective use of space across all of our offices. This The feedback EY have received from their employees since
is a really important issue for our business because having the introduction of flexible working shows that having
a mobile and flexible workforce means that we can operate the ability to choose how their work is delivered makes
more effectively across time zones and respond more employees feel more engaged.
quickly to client needs. And as individuals, it means that
you have autonomy to perform in the most effective way Already, flexible working has had an impact on the
that suits you best, whilst meeting the needs of your teams amount of time workers spend travelling, reducing costs
and your clients.’ by £0.5 million in 2014, in turn reducing EY’s carbon
footprint. Furthermore, empowered flexible workers are
In order to implement these flexible working practices, more productive, happy and healthy employees.
EY introduced a range of measures.
Source: adapted from www.ey.com
• A central team of change managers supported by the
leadership team, who are responsible for implementing
and monitoring flexible working practices. (a) Explain how the changes introduced at EY will impact
clients. (4 marks)
• Workforce training, which identifies the desired
behaviours required to be an effective flexible worker. (b) Assess the factors that are driving changes in working
This training has also become an integral part of practices at EY. (10 marks)
recruitment, induction and appraisal. (c) Evaluate the key factors that the managing partners of
• A dedicated intranet site with information and advice on EY will need to consider in order to ensure the flexible
how to achieve flexible working and a HR helpline. working practices are successful. (20 marks)

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Thinking bigger
This unit has examined some of the factors that can determine the It is also worth considering the nature of the industry when
success of change. However, does the level of success of a business discussing change. Are some industries simply more adaptable
influence the likely success of change? Can a very successful business because of their context and the nature of their product? Fashion
be complacent, and thus its satisfaction with the way things are and information technology are two industries that are in a
result in inertia, making change difficult? Can failure be a good continuous state of change. Change management must be an
thing? Businesses that have made mistakes build a certain resilience integral characteristic of any business that operates within industries
that makes them more prepared for the next round of change. For like these. Nevertheless, there is much to be said for the status quo.
example, Firestone tyres had a product recall in 2000. The company Change can bring about new opportunities, but long periods of
revised its approach with its ‘Making it right’ campaign and regained stability and consistency can help a business build efficiencies and get
the trust of consumers. good at what it does.

Key terms Knowledge check

Management of change – the process of organising and 1. State four factors that may have an impact on the success of
introducing new methods of working within a business. organisational change.
2. Explain why a large firm may find change more difficult to
manage than a small business.
3. How are culture and change management linked?
4. Why do people resist change?
5. How might a business implement effective change
management?

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 65 Scenario planning 3.6.3
Theme 3

Key points
1. Identifying key risks through risk assessment:
natural disasters
●●

IT systems failure
●●

●● loss of key staff.

2. Planning for risk mitigation:

●● business continuity

●● succession planning.

Getting started ●● teach managers how events may transpire, develop and
In October 2014 it was widely reported that Christophe de affect the business
Margerie, the CEO of Total, Europe’s third largest oil company, ●● understand the causes and effects of change in business
was killed in an air crash. The corporate jet in which he was and how to manage it.
travelling collided with a snowplough on a runway at Moscow
airport. This was a sad loss to the company. The French Prime There may be different approaches to scenario planning, but
Minister commented that France had lost an extraordinary there are a number of important steps in the process.
1. Identify possible trends and issues. This involves
business leader who had turned Total into a world giant.
scanning the internal and external environment in an
In December 2013 it was widely reported that NatWest bank effort to ‘spot’ any emerging threats that might impact
was subject to a cyberattack. The bank’s online service was on the business. PESTLE analysis might be used to help
interrupted after it was deliberately bombarded with heavy this process.
internet traffic. It was reported that customers could not access 2. Build possible scenarios. Businesses need to imagine
their accounts to transfer money and pay bills. Another systems a range of possible scenarios that might affect their
failure at NatWest in June 2013 saw payments go missing. operations. The background for these scenarios will be
Some customers did not get their wages, and home purchases provided by the information gathered in the previous
and holidays were interrupted for several weeks. This cost stage. These scenarios will vary between different
NatWest £175 million in compensation. businesses because different businesses are likely to
be presented with different threats. For example, a
Describe the possible impacts of these events on each of the
supermarket chain is not likely to develop a scenario for
businesses. Could these events have been predicted? What
people trapped in an aircraft taken over by terrorists.
possible measures might businesses take to prepare for 3. Plan response. This involves identifying as precisely as
such events? possible the impact scenarios will have on the business
and developing plans to deal with them. This is a lengthy
process because such impacts might be numerous
What is scenario planning? and complex.
Businesses may be subject to unforeseen events, which could 4. Identify the most likely scenarios. A business may
hamper their activities. Examples might be a fire that destroys identify a wide range of scenarios that could affect a
premises, a breakdown in the internal back-up system that business. However, the likelihood of different events
stores business information, or the sudden retirement of a CEO. occurring will have different probabilities. A business is
Many businesses undertake scenario planning in an effort to not likely to have enough resources to plan responses to
deal with these events. Scenario planning is not about trying to every single scenario. Therefore, it will be necessary to
predict future events. It is a strategic planning method designed prioritise, say, the five most likely and the business can
to explore uncertainties, work out how to protect the business plan thorough responses to each.
from their worst consequences and prepare how to exploit any 5. Capitalise on scenarios. This involves implementing the
opportunities that might present themselves. It is a disciplined planned responses when scenarios appear a likely reality.
approach to dealing with uncertainty in the future. Not all scenarios have negative outcomes. For example,
Scenario planning helps to: if the global economy goes into recession some firms
●● clarify some of the future uncertainties in business, identify can flourish by catering for new needs. Those that are
risks and opportunities, and prepare for their eventuality prepared for such a scenario may prosper.

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Risk assessment IT systems failure: Most businesses employ IT systems in

When a business attempts to identify the possible scenarios it their organisation. However, the extent to which businesses
might face in the future, it might use risk assessment. This involves depend on such systems will vary. Generally, the larger the
examining what might cause harm to people and identifying the business, the more investment it will have in IT. Consequently,
precautions that might be taken to protect them from harm. One of an IT systems failure, or worse still, a cyberattack, could be a
the main purposes of risk assessment is to help comply with health serious disaster. Many small businesses may have only modest
and safety legislation. Workers have a legal right to protection in the investments in IT systems. Perhaps computers are used for data
workplace. However, the use of risk assessment might be extended storage, email communication, research and website display.
to assess risks to the business in general. Therefore, it has a role However, even smaller businesses are increasing their reliance
to play in scenario planning. It can be used to help identify hazards, on IT. For example, many conduct transactions online. This
decide who might be harmed and estimate the probability of events makes them more vulnerable to breakdowns.
occurring. This will help in the first stage of scenario planning where In December 2014, it was widely reported that Nats, an
the possible trends and issues are identified. air traffic control company, experienced a serious systems
failure. The failure meant that air traffic controllers were not
Possible scenarios able to access all of the available data to the flight paths of
The range of possible scenarios facing a business is huge. individual aircraft. As a result the controllers had to find ways of
However, some are more likely than others. Three of the most reducing the traffic. This led to the cancellation of many flights.
likely scenarios are discussed below. Nats reassured people that the controllers had a clear radar
picture and that all communication channels with aircraft were
Natural disasters: The Earth is susceptible to natural disasters. open during the incident. It said that passengers travelling on
These are catastrophic events that usually occur suddenly and aircraft were never in any danger. However, the incident raised
are caused by environmental factors. Examples include floods, questions about what could happen in the future. Airports
hurricanes, volcanic eruptions, tsunamis, earthquakes, forest fires, around the UK had to cancel many flights and a number of
snowstorms and epidemics. Such events can have devastating planes were diverted, meaning that passengers ended up in
effects and may result in high levels of damage, death and destinations that they were not expecting.
disruption. Some UK firms are multinationals with operations all Businesses, and the public at large, are becoming
over the world where some of these events are perhaps more increasingly concerned about the threat of cyberattacks.
likely to occur. Thus, multinationals are likely to be more exposed A cyberattack is where computer hackers break into computer
to the risk of natural disasters. systems and steal data. For many, the consequence of such
One common example of a natural disaster that causes attacks is largely a mystery. However, as the number of attacks
difficulties for UK businesses is flooding. It is estimated that increase, awareness of their effects is gradually being raised. In
around £1 billion is spent every year repairing flood damage. 2014 it was widely reported that hackers breached security at
It has also been suggested that this could rise to £27 billion eBay, the online auction site. Hackers stole the names, emails,
a year by 2080. In 2014 some serious floods caused severe postal addresses, phone numbers and dates of birth of its 233
damage and disruption to the southwest. A storm, followed million users. eBay was criticised for not notifying its customers
by several weeks of heavy rain, destroyed the only rail link what had happened. So far the consequences of such attacks
to the southwest. This cut off the region for several months have been manageable. But in the future more serious
until the line was repaired. West Country leaders said that the consequences might materialise.
local economy had been devastated by the floods. Tourism
in particular had suffered badly. Farmers in low-lying areas in Loss of key staff: People leave businesses all of the time.
Somerset, many of whom were just recovering from devastation This may not be a problem because, as the saying goes, ‘no
caused by floods in 2012, were hit again. Farmers had spent one is indispensable’. However, losing key members of staff can
tens of thousands or even hundreds of thousands of pounds on cause difficulties – especially if preparations for this eventuality
repairing their farms after the 2012 floods. In 2013, some then have not been fully considered. It can also be a very serious
had to cope with almost all of their land being flooded again. problem in small businesses, which are often dominated by a
Although there are no volcanoes in the UK, some disruption single person. It was reported in 2013 by Scottish Widows that
was caused in the spring of 2010 when a volcano erupted in around 55 per cent of businesses would cease trading if they
Iceland. Eyjafjallajökull erupted sending millions of cubic feet lost one or more key people from the business. Unexpected
of ash billowing over Europe, including the UK. This posed a losses through illness, long-term incapacity or death are the
threat to aircraft so many airports in Europe were closed for a most likely causes of such an event. In a small business, where
period of time. Estimates suggested that the cost of grounded perhaps the owner employs only a few other people, the loss
flights to the global airline industry was over £1 billion. of the owner could result in the closure of the business. This
However, some businesses actually benefited from the closure is because the other employees may not have the resources
of European airspace. Airport hotels were full of stranded or the desire to take ownership of the company. Finding an
travellers; trains, buses and coaches were extremely busy; outside agent to take over the business might also be difficult.
Eurostar trains between London and Paris or Brussels were In 2012, it was widely reported that Intel, the microchip
sold out. manufacturer, lost its CEO Paul Otellini when he announced his

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Scenario planning Unit 65

retirement. The company did not have a successor lined up. Business continuity: When an incident occurs, a business will
Intel is widely regarded as a well-run and methodical company want to minimise disruption. After safeguarding human life, one
and changes of leadership are unusual. In its 44-year history of the most important priorities is to get the business ‘up and
only five CEOs had ever been employed and Mr Otellini had running’ again. Some firms produce business continuity plans.
been an Intel employee for 40 of those years – he was an These show how a business will operate after a serious incident
experienced and valuable employee. and how it expects to return to normal in the quickest time
possible. There may be four stages in such a plan.
1. Carry out a business impact analysis. This will identify
Thinking bigger
those functions and processes that are essential to the
Although scenario planning has some obvious benefits, since it forces
decision makers to consider the future and plan for possible changes, it running of the business. This involves gathering information
does have some drawbacks. It is time-consuming and expensive. As a so that appropriate recovery strategies can be designed. The
result there is a risk that a business may not devote sufficient resources process also involves identifying the financial consequences
to it and therefore fail to carry out the process effectively. Also, some of such incidents, like loss of revenue, customer defection,
people might argue that preparing for events that may never happen increased costs, penalties and disruption to business plans.
is a waste of money. Another problem might be finding people in the This information may be gathered by using questionnaires
business who have a deep enough understanding of possible scenarios. and workshop sessions with appropriate employees. Once the
Therefore, it might be necessary to invite external agents to participate,
information has been gathered it must be analysed, reviewed
which will add to the cost. Finally, only large corporations are likely
to have the resources to undertake full-scale scenario planning. Most and if necessary updated to reflect changing circumstances.
small businesses have much less to lose and would probably see the 2. Formulate recovery strategies. These are the actions taken
opportunity cost of scenario planning as too high. to restore the business to a minimum acceptable level after
an incident. This will involve identifying the resources needed,
such as people, facilities, equipment, utilities, IT and materials
to aid recovery. Examples of recovery strategies that might
Exam tip
be used include:
You need to remember that scenario planning can be used to
●● setting up agreements with another business to share
prepare for uncertain events that provide a business with
opportunities. It is not just about planning for disasters. For resources and support each other should either party
example, a surge in demand as the global population booms (it is encounter serious disruption
expected to double by 2050) can provide many opportunities for ●● planning to convert resources for new usages; for
businesses around the world. example, a canteen might be used as office space
●● contracting out work to third parties

●● prioritising production – perhaps according to customer value

Planning for risk mitigation ●● maintaining higher stock levels

Risk mitigation plans identify, assess and prioritise risks. They ●● placing restrictions on orders

also plan responses to deal with the impact of these risks to ●● shifting production from one plant to another.

the operation of the business. In general a business can use a 3. Plan development. This involves developing a detailed
number of mitigation strategies to reduce the damage caused by plan to ensure that the recovery strategies are carried out
serious disruptive events. For example, it can: in an organised way. A business is likely to appoint recovery
●● set up in a location that is not vulnerable to flooding, teams, develop relocation plans, and document recovery
earthquakes, bush fires and other potential natural hazards strategies and procedures so that key staff are aware of
●● ensure that premises are constructed according to building what is expected of them.
codes that are designed for safety and protection 4. Testing and training. Once the recovery plan has gained
●● take out adequate insurance policies to cover losses resulting approval it is necessary to design testing exercises and train
from disasters; for example, it may be possible to take out staff in their roles during the execution of the recovery plan.
‘business interruption cover’ The recovery teams will be the main focus of such training.
●● ensure that data stored on computers is as secure as After testing and training it may be necessary to update the
possible and that back-up systems are adequate business continuity plan to take into account any discoveries
●● organise back-up power, such as a generator, to ensure that made during this process. Finally, it may be necessary to
vital machinery and other equipment can still be used in the review and update the plan on a regular basis to take into
event of a power interruption account any changes that have occurred in the business,
●● ensure that valuable assets, such as expensive machinery such as key personnel, vital equipment or premises.
and tools, are protected as much as possible
●● ensure that there is access to emergency funding Succession planning: Part of risk mitigation involves identifying
●● ensure that adequate communication channels are set up to and developing current employees who have the potential to
deal with crises occupy key roles in the future. This is called succession planning.
●● produce a business continuity plan to deal with crises. This This is an important process because it will help a business deal
is discussed next. with the problem of losing key staff. However, succession planning
will also help to develop the staff needed to fill posts as the

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 Business decisions and strategy

business expands. Without succession planning a business might

end up promoting a person who is not equipped to do the job or Links
recruiting an unknown outsider at a far greater risk and expense. There may only be limited opportunities to demonstrate
Some research suggests that CEOs appointed from internal synoptic skills using information about scenario planning and
sources tend to outperform those from outside. Some key steps risk mitigation. This is because it is quite a specialised topic.
involved in a succession planning process are outlined below. However, chances might arise when you are writing answers
●● Identify the characteristics a successor should possess. about Demand (Unit 4), Business failure (Unit 36), Economic
This task can be undertaken by looking at the job description influences (Unit 41) and SWOT analysis (Unit 46). There may
and developing a person specification giving the characteristics be a particularly strong link with Unit 47, which is about the
of the person who currently occupies the key role and impact of external influences on a business.
identifying any new skills and traits that may be required.
●● Decide how the successor will be found. This might

involve scrutinising the credentials of every prospective

internal candidate. Alternatively, an outside agency might be Key terms
employed to ‘headhunt’ possible candidates from outside. To
Business continuity plan – shows how a business will
‘widen the net’ some businesses might use both approaches.
operate after a serious incident and how it expects to return
●● Undertake a rigorous selection process. Examine the
to normal in the quickest time possible.
strengths and weaknesses of all the candidates. It is important
Risk assessment – identifying and evaluating the potential
to involve several key personnel, and perhaps other specialists,
risks that may be involved in an activity that a business
in this process in order to gain a broad view of the candidates.
proposes to undertake, ensuring compliance with health and
●● Make the decision. The people tasked with this duty
safety legislation.
need to analyse and evaluate the performance of each
Risk mitigation plans – identify, assess and prioritise risks,
candidate. It is important to reach a conclusion and make
and plan responses to deal with the impact of these risks on
an appointment. Failure to do this might demoralise and
the operation of the business.
undermine internal candidates. They may think that they are
Scenario planning – a strategic planning method designed
not valued by the business.
to explore uncertainties, learn how to protect the business
●● Communicate the decision. It is important for everyone
from their worst consequences and prepare how to exploit
affected by the decision to be informed about the appointment.
any opportunities that might present themselves.
●● Implement a training and preparation plan. The person
Succession planning – identifying and developing people
appointed will need to be trained and prepared for the final
who have the potential to occupy key roles in a business in
transition into the post when needed. This may involve
the future.
‘shadowing’ the person who currently occupies the position
for a period of time. It might also involve going on specialist
courses to enhance the skills and knowledge needed.
Knowledge check
In 2014, it was reported that the UK regulators were not happy
1. Outline the important steps in a scenario plan.
with some of the succession planning undertaken by corporations.
The criticism came after Tesco reportedly left the post of financial 2. Give three specific benefits of scenario planning.
director vacant for several months, and at one stage had only one 3. Give three examples of natural disasters that could impact on
board member with retail experience. Succession planning should a business.
play a very important role in business.
4. What role might risk assessment play in scenario planning?
5. How might the loss of key staff impact a business?
6. Give three examples of problems that a breakdown in IT
systems might cause a business.
7. What is meant by risk mitigation planning?
8. Outline the four stages in a business continuity plan.
9. Give four examples of recovery strategies that a business
might employ.

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Scenario planning Unit 65

Case study

ROYAL DUTCH SHELL

Royal Dutch Shell is a large energy and petrochemicals
multinational. It employs around 92,000 people in over
70 countries. It has more than 30 refineries and chemical
plants, and in 2013 its revenue was $452.1 billion. It
made a profit of $16 billion and invested $44 billion in
capital expenditure.
Royal Dutch Shell is a business that is exposed to a wide
range of global uncertainties. Consequently, it is no surprise
that Shell has been using scenario planning for over
40 years. It helps the company to understand how external
influences might affect the business and the petrochemicals
industry as a whole. It could be argued that scenario
planning originally helped Shell to develop as the market
leader during the global gas shortage in 1973. Since then • By 2060 electricity will become carbon neutral.
scenario planning has helped Shell to anticipate and • By 2100 global social mobility will be thwarted as a result
prepare for: of interference in the free market.
• the world energy crisis in 1979
Oceans – describes a more prosperous and
volatile world
• the collapse of the energy market in 1986
• Power is devolved, competing interests accommodated.
• the break-up of the Soviet Union
• Economic reforms improve productivity, but there is less
• rising terrorism in the Middle East
social cohesion and more political instability. This results in
• global pressure for greater environmental and social government policies being too slow-moving and decision
responsibility.  making being driven by market forces.
In 2013, Shell published a report outlining two possible • Chinese GDP will reach $20,000 per capita by 2025 and
scenarios looking as far ahead as 2100, taking into account there will be a surge in the global demand for energy. This
the fact that by 2060 the global population will be around will bring strong social and political tensions.
9 billion, meaning that demand for energy will rise by about • Emerging economies will boom. The number of cars in
80 per cent. Shell’s scenarios look at what might happen to India will reach 500 million and air travel will increase
the global economy, energy provision and political situations five-fold. But the effects of carbon dioxide emissions will
up until 2100. Entitled ‘Oceans’ and ‘Mountains’ the main be neglected.
points of the scenarios are outlined briefly below. • Fossil fuels will be important to the energy mix but
Mountains – describes a more stable political renewables will grow, until in 2070 solar will be the
environment largest energy source.
• Governments hold the balance of power and are able to Source: adapted from Shell International B.V.
introduce firm and far-reaching policies.
• A switch from fossil fuels is anticipated and governments
design compact cities and overhaul transport systems. (a) Assess the importance to a business such as Shell of
For example, in Japan it is expected that 10 per cent of succession planning. (10 marks)
car travel will be electric powered. (b) Evaluate the usefulness of these scenario plans to Shell.
• By 2030 there is serious investment in carbon capture and (20 marks)
storage. Gas is the primary energy source.

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 58 Growing economies
66 4.1.1
Theme 4
Key points
1. Growth rate of the UK economy compared to 4. Indicators of growth:
emerging economies. ●● Gross Domestic Product (GDP) per capita

2. Growing economic power of countries within ●● literacy

Asia, Africa and other parts of the world. ●● health

3. Implications of economic growth for individuals ●● Human Development Index (HDI).

and businesses:
●● trade opportunities for businesses

●● employment patterns.

Getting started
James Martin runs a furniture-making business. It has been Looking at Figure 1, which countries would you advise James to
operating for ten years and grown from just a few people to a consider expanding into, bearing in mind the highest growth rates?
workforce of over five hundred. James started selling his products How do you think expanding into these countries might affect his
in France and Spain in the Euro Area in 2012, opening small business? What other details about each country do you think James
offices in both countries to deal with the distribution. James will need to consider?
wants to build the long-term plan for his business and plans to
expand internationally.

Figure 1 Growth rate of the UK economy

The emerging economies of the MINT countries (Mexico, compared to emerging economies
Indonesia, Nigeria and Turkey) Around 150 years ago, Britain was an industrial powerhouse,
Country name 2012 2013e 2014e 2015f 2016f 2017f producing manufactured goods that were exported all over the
(percent change from previous year, except world. In the modern era of emerging economies and increased
interest rates) competition, the Office for National Statistics (ONS) figures published
US 2.3 2.2 2.4 2.7 2.8 2.4 in 2014 showed that UK manufacturing output made recent
Japan 1.7 1.6 0.0 1.1 1.7 1.2 improvements, with an average of 2.8 per cent growth. UK products
Euro Area –0.7 –0.4 0.9 1.5 1.8 1.6 were reported as more competitive than at any time in the modern
era. Alongside this, however, the UK has a strong and growing
United Kingdom 0.7 1.7 2.8 2.6 2.6 2.2
service sector, and the world’s emerging economies produce most
Brazil 1.8 2.7 0.1 –1.3 1.1 2.0
of the manufactured goods that are globally consumed.
Russia 3.4 1.3 0.6 –2.7 0.7 2.5
India 6.0 5.6 5.0 4.7 5.5 5.5 Emerging economies and markets: An emerging market
China 7.7 7.7 7.4 7.1 7.0 6.9 may be thought of as one where there is rapid growth, but also
South Africa 2.5 1.9 1.5 2.0 2.1 2.4 a lot of risk. Investors like emerging markets since they are likely
Mexico 4.0 1.4 2.1 2.6 3.2 3.5 to grow more quickly than more mature markets. Therefore
a business should be able to increase profits and dividends.
Indonesia 6.0 5.6 5.0 4.7 5.5 5.5
Economists sometimes group emerging economies together, e.g.
Nigeria 4.3 5.4 6.2 4.5 5.0 5.5
BRICS: Brazil, Russia, India, China and South Africa, and MINT:
Turkey 2.1 4.2 2.9 3.0 3.9 3.7 Mexico, Indonesia, Nigeria and Turkey.
Notes: Where an emerging market is experiencing an increase
1 The table shows selected entries from the global outlook summary in
Global Economic Prospects, The Global Economy in Transition, A World
in average incomes, it is likely that the middle classes are
Bank Group Flagship Report, June 2015. expanding. Increasing income allows consumers to spend more,
2 PPP = purchasing power parity; e = estimate; f = forecast. on both imports and domestically produced goods and services.
3 Aggregate growth rates calculated using constant 2010 US dollars
GDP weights. Buying more domestic goods encourages the growth of domestic
4 Based on real GDP and the percent change from previous year, except firms, giving them increased market power and allowing them
interest rates. to compete internationally. Consumers may also buy more
5 World Bank forecasts are frequently updated based on new information
and changing (global) circumstances. Consequently, projections may imported goods and services from businesses in more developed
differ from those contained in other documents. economies, thereby increasing their profitability and making the
Key: MINT countries are shown in red emerging market more attractive to new entrants. Consequently,
Source: World Bank many economists assume that the growth rates of emerging

401
Growing economies Unit 66

market economies will exceed those of the more developed continue to encounter many risks that might seriously affect
economies, including the UK. It is worth remembering however, overall economic performance. Moreover, countries differ in
that this is a trend and not a certainty. Emerging markets will how vulnerable they are to certain risks
and how well they will be able to cope should such risks
Figure 2 become reality.
Economic growth, the increase in a country’s productive
The 12 largest economies in nominal GDP terms ($ trillion,
1997, 2007 and 2012)
capacity, is usually measured using Gross Domestic Product
(GDP). GDP for the UK is available from the ONS. Figure 2
$ trillions
18 illustrates the growth rates of the UK economy compared with
a selection of countries from emerging markets.
16

14
Growing economic power of Asian,
12
African and other countries
Most of the BRICS and MINT countries have experienced
10 strong growth over the past few years. This growth is
increasing the overall economic power of many of the
8
countries in Asia, Africa and other parts of the world. China,
6 according to some measures, had the largest economy in
the world in 2015. If so, it overtook the US, which has been
4
the global leader since the late 1800s. It frequently comes
2 at or near the top of the rankings as an exporter and as a
destination for foreign investment. Its growing economic
0
power means that it is also one of the world’s biggest
Korea

Mexico

Italy

France

UK

Brazil

Russia

Germany

Japan

India

China

US

investors in other countries.

Key Countries
In 1990, China produced less than three per cent of
1997
2007 global manufacturing output by value, but by early 2015
2012 this had risen to nearly a quarter. China’s industrial might
Source: Office for National Statistics impacts all across South East Asia, through supply chains
and outsourcing. In fact, China drives what has come to
be known as ‘Factory Asia’ for its dominance of global
Question 1 manufacturing. The strength of this regional trading bloc
(known as the ASEAN, see Unit 70) looks set to continue
Through its offices in the Netherlands, Japan and the US, Mark in the near future. First, China has very efficient clusters of
Lyndon Paper Enterprises makes money exporting paper and suppliers and excellent infrastructure, allowing for further
cardboard to be recycled, in a circular trade that demonstrates cost-effective growth. Second, it has access to lower-cost
many of the benefits of global markets. The business works as labour throughout South East Asia, including Myanmar
follows: a factory in China produces a good that is boxed, put into (Burma) and the Philippines. Finally, Chinese and other Asian
a container and shipped to the US and Europe, where a customer consumers are spending more each year, driving increases in
buys the product. Mark Lyndon Paper recovers the box and sends it demand and reinforcing local production and distribution.
back to China – probably in a similar shipping container to the one Other emerging markets, such as Central and South
that transported the original product. There the packaging is America and Africa, are creating big international companies
pulped and made into a new cardboard box, whereupon the cycle that increasingly are challenging the dominance of firms
begins again. from the developed regions. However, because of China’s
dominance in manufacturing, these other regions may be less
The value of the UK trade in goods in 2014 was around
likely to follow this route to development. They may have to
£24.6 billion, with exports including cars and jewellery, for
find new ways to grow and develop in the future.
example, and a trend for growth. Yet Mark Lyndon Paper
According to the World Bank, the largest economies in
illustrates some profound changes in the UK economy since the
the world include US, Japan, Germany and the UK. However,
turn of the 21st century. It is owned by a Chinese firm, and owes the order of leading economies may change many times in
its success to the fact that the UK, amongst others, imports many the future. Regardless, roughly 70 per cent of world GDP
goods made elsewhere and sends back empty cardboard boxes. growth is likely to come from emerging market economies,
(a) What is meant by circular trade? with China and India accounting for between 40–50 per cent
(b) Explain how Mark Lyndon Paper reflects the changing economic of this figure. It follows then that 20–30 per cent of future
relationship between the emerging economy of China and the global growth may come from the rest.
developed one in the UK.

402
 Global business

Question 2 The employment rate gives a snapshot of the numbers of

jobs that are being gained or lost across an economy. The level
Figure 3 indicates that the Gross Domestic Product (GDP) in of unemployment can reveal a lot about an economy, but not
China was worth US$9240.27 billion in 2014. The GDP value all of it straightforward. As noted above, the amount of money
of China represents 14.90 per cent of the world economy. GDP that consumers have in their pockets (disposable income)
in China averaged US$1252.79 billion from 1960 until 2014, indicates whether or not they may be able to buy goods in the
reaching an all-time high of US$9240.27 billion in 2014 and a future. When people are out of work, they do not have much
record low of US$46.50 billion in 1962. money to spend or save. Consequently, if there is a high level
of unemployment in a country, it may not be a good time to
Figure 3 consider exporting there. On the other hand, unemployed
individuals may be looking for jobs and so a firm could find
China’s expanding economy 2006–2014 (billions of US$)
a pool of labour to make goods that it could then export
Billions of US $ Billions of US $ elsewhere. In this case, directly investing in a country by building
10,000 10,000
a factory, for instance, might be a good idea to consider.
The unemployment rate in the UK in 2014 was 5.8 per cent
8,000 8,000 according to the Office for National Statistics, a big improvement
on 2009, when unemployment hit 8 per cent. The International
Labour Organization (ILO) supplies figures for other countries. The
6,000 6,000
European Union has had persistent unemployment, and as of 2014
the number of people out of work showed no signs of decreasing.
4,000 4,000 In 2014 Greece and Spain had unemployment rates at or above
25 per cent, which indicates weakness in their economies. By
contrast, according to the ILO China’s unemployment rate has
2,000 2,000 remained around 3 per cent (2.9 per cent in 2012).
2006 2007 2008 2009 2010 2011 2012 2013 2014
Year Future employment trends are also important. For example,
Sources: www.tradingeconomics.com and World Bank Group new technology may mean that fewer workers are required to
manufacture goods. As a consequence, having cheap labour
(a) What are the key factors that are likely to have led to growth in may no longer be as significant a comparative advantage for an
GDP in China? emerging economy as it once was.
(b) Discuss the advantages and disadvantages of high growth rates
for China. Question 3
In March 2015 unemployment in Ireland was at the lowest rate
since 2009, when the country began its bailout programme
Implications of economic growth for after the 2008 financial crisis.
individuals and businesses
As noted earlier, consumers in emerging markets may be buying Figure 4
more goods and services, both from domestic companies and Ireland unemployment rate 2014–2015
from those from more developed economies. This may make the
Percentage of labour force
emerging markets even more attractive to new entrants, create 12.0 12.0
trade opportunities and alter existing employment patterns.
11.5 11.5
Trade opportunities: Where an economy is growing,
consumption may also be growing, and this is good news for firms 11.0 11.0
looking to invest or sell their products and services. Thus with
growth, it is likely that disposable income is also rising. Individuals 10.5 10.5
may therefore have more money in their pockets to spend,
increasing the overall demand for goods and services. Demand is 10.0 10.0
likely to become income elastic, providing greater opportunities for
increased revenues and profit. These goods and services can be 9.5
Apr/14 Jul/14 Oct/14 Jan/15
9.5

produced domestically or imported from abroad. This creates many Month/Year

opportunities for trade. Sources: www.tradingeconomics.com and Central Statistics
Office, Ireland
Employment patterns: In addition to looking at growth rates,
(a) What are the main influences on employment patterns within an
a business might want to assess the employment patterns across
economy?
an economy. Employment is one of the most important indicators
(b) Explain why a declining rate of unemployment may indicate that
of the health of an economy. A firm might want information on
the Irish economy is improving and may be more attractive for
unemployment rates and trends, labour costs and productivity, as
businesses looking to invest.
well as the educational qualifications of potential employees.
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Growing economies Unit 66

Indicators of growth countries, as can be seen from data available from the IMF’s
In order to spot opportunities to trade or evaluate markets for World Economic Outlook or if the CIA World Factbook is
potential investment, a business needs to be able to recognise reviewed. According to the ONS and CIA Factbook the GDP of
where an economy is likely to grow. There are numerous the UK in 2014 was around $2.9 trillion based upon market
indicators of economic growth, including GDP per capita and the exchange rates. However, GDP was only around $2.4 trillion
Human Development Index (HDI). where based upon PPP. For India, the Ministry of Statistics
reports its GDP in market exchange rates as just over $2 trillion,
Gross Domestic Product (GDP) per capita: This is a yet this rises above $7 trillion in PPP terms.
measure of economic activity, including all of the goods and
services produced in a year, divided by the number of people Literacy: Just as important for a business as the level of
in the country. What a business looking to invest in a particular employment is the quality of those employees, both as workers
country may be most interested in, however, is the trend or and as potential consumers. A company looking to invest in a
direction in GDP per capita. For instance, China reported a very country will need to hire a workforce. They will want the most
high growth rate of 7.4 per cent in 2014, but this was actually productive employees they can find at the lowest possible
down from the figure of 7.7 reported in 2013. cost. Equally, a firm looking to export to a country will want
Finding and evaluating data on GDP: to consider the consumers to which it will sell. It will want to
Figures for the UK are compiled by the ONS and are rigorously understand its potential customers and how to market its goods
assessed and adjusted for errors. GDP for other countries or services to them.
is obtained from other sources, such as the World Bank, Literacy is one of the key indicators that firms will assess when
International Monetary Fund or some other non-governmental making strategic decisions. The literacy rate is the percentage
organisation. It is important to understand that data is only as of adults that can read and write. The UN provides data on the
good as the source it comes from and the methods used to literacy rate of most countries, and Table 1 gives an example of
collect it. Thus, data may not always be consistent, comparable the literacy attainment of a few countries. For assessing literacy,
or easy to verify. You should always give your sources and be someone above the age of 15 is considered to be an adult.
cautious about using data from different sources.
Sources of data need to be used with care and it is important Table 1 Literacy rates compared for different countries – 2010
to understand what the figures imply. GDP figures do indicate the Country Literacy rate Country Literacy rate
value of economic activity, but care must be taken as there are a (in 2010) (per cent) (in 2010) (per cent)
variety of GDP statistics. GDP can be calculated to show the value China 94 Russia 100
of all of the goods as either produced or sold or purchased in an South Korea 100 South Africa 89
economy. They may take account of price changes over time (real
Malaysia 93 Sierra Leone 42
GDP, which adjusts GDP figures for inflation, verses nominal GDP,
which does not). They may also be reported for the economy as a Mexico 93 Brazil 90
whole or for each resident (per capita GDP), as explained above. Nigeria 61
Moreover, the figures, even where they show the same thing,
may be hard to compare across countries, owing to the statistics Health: As with educational attainment, the state of a country’s
being reported in different currencies. GDP figures usually health is important for investors to consider. It is another
use market exchange rates, which are derived in the foreign key indicator of the level of development of an economy.
exchange markets. We know that foreign exchange markets by An assessment of the health of a population may include:
their nature are constantly changing, and so GDP figures derived ●● life expectancy at birth

using market rates may also change rapidly over time. It is ●● infant and maternal mortality

necessary to use figures over a period of time to draw any reliable ●● pollution exposure

conclusions. Also, goods and services tend to be more expensive ●● access to clean water.

in high-income countries, and as a result GDP figures for those

countries may overstate what people can actually buy there. The World Health Organization collects and evaluates statistics
For these reasons, statisticians prefer to use purchasing relating to a broad range of indicators that can be used to
power parity (PPP) exchange rates. PPP is the price of purchasing assess population health. These include the following.
a standardized basket of goods and services and allows you to 1. Life expectancy and mortality (see Table 2).
compare prices across economies. The PPP exchange rate is 2. Causes of death including communicable and non-
the rate at which one country’s currency must be exchanged for communicable causes and injury.
that of another country in order to buy the same basket of goods 3. Infectious diseases.
and services there. Using PPP estimates of GDP, an investor has 4. Risk factors, such as sanitation, access to clean water, rates
a good idea of what buyers in different countries can afford, and of breast-feeding.
what their overall welfare might be in real terms.  5. Health infrastructure and access to essential medicines.
GDP figures may not mean the same thing, and may 6. Other factors, such as overall health expenditure,
have very different implications for investment decisions.  immunisation rates, access to contraception and socio-
The difference is often greatest for lower income or developing economic factors.

404
 Global business

Table 2 Life expectancy at birth and infant mortality

Thinking bigger
statistics of a few select countries
The success of the UK TV and film industry between 2004–2014 was
Country Life expectancy at birth Infant mortality impressive. One of the attractions for Hollywood investing in the UK
(years) (probability of dying before was tax credits but the attraction was more than that. The UK has a
age 5 per 1,000 live births) talented TV and film workforce. The National Film and Television School
1990 2009 1990 2010 continually dominates global industry awards. The UK has led the way
Best* 79 83 6 2 in innovation such as CGI and some of the biggest box-office winners
UK 76 80 9 5 have been filmed in the UK. The HBO series Games of Thrones made
Northern Ireland its production home and big budget movies including
China 68 74 48 18 Star Wars are filmed in the UK. A UK Television Exports Survey in 2014
India 58 65 115 63 (www.pact.co.uk) reported that the film sector contributes £4.6 billion to
Mexico 71 76 49 17 GDP and supports 117,000 jobs. Annual revenues for television exceed
South Africa 63 55 60 57 £3 billion, with TV exports alone worth more than £1.28 billion.
* ‘Best’ describes either the longest average life span or the lowest You could use this information in a variety of ways. Obviously, it can be
probability of dying before age five. used when answering questions on UK exports. But it might also be
useful when discussing influences on inward investment, and the impact
Source: www.who.int of a skilled workforce on business and within an economy.
Human Development Index: The Human Development
Index (HDI) combines statistics on life expectancy, education and Links
income for any particular country into a single rankable value. The growth rates of certain countries, in areas such as Africa
Published by the United Nations Development Programme
and Asia, for example, can affect other parts of the world. They
(www.hdr.undp.org), the index attempts to assess a country’s
may contribute to the growth of globalisation (Unit 68). They
people and their skills, rather than simply the economic conditions.
●● Life expectancy is how many years a person can, on
are also an important factor in influencing the assessment of a
average, expect to live. It is an important indicator of the country as a market (Unit 72) and as a location for production
health of a nation as well as the quality of its health care and (Unit 73). Further rapid growth may be a contribution to the
social systems. Countries with the longest life expectancy growth of international trade (Unit 67) and an influence on
in 2014 include Japan (83.6 years), followed by Hong Kong possible mergers and joint ventures (Unit 74).
(83.4), Switzerland (82.4) and Italy (82.4). At the other end,
Sierra Leone had the lowest at only 45.6 years, followed by Key terms
Swaziland (49 years) and Lesotho (49.4 years).
●● Mean years of schooling help to assess the average amount Economic growth – an increase in a country’s productive
of education a 25-year-old person might have had, though capacity.
it does not consider the nature or quality of that education. Emerging economies – the economies of developing
Countries with the highest average number of years of countries where there is rapid growth, but also significant risk.
study include the US and Germany (12.9 years), followed by Human Development Index (HDI) – a collection of statistics
Australia (12.8 years), New Zealand/Israel (12.5 years) and that are combined into an index, ranking countries according
Lithuania (12.4 years). The lowest include Burkina Faso to their human development.
(1.3 years), Niger (1.4 years) and Chad (1.5 years). Literacy rate – the percentage of adults (over 15) that can
●● Gross National Income per capita (GNI) illustrates the read and write.
relative wealth of the population (as measured in PPP$). Purchasing Power Parity (PPP) – a measure of real growth that
Countries with a wealthy population include: Qatar (119,029); uses the price of purchasing a standardised basket of goods
Kuwait (85, 820); Liechtenstein (87,000) and Singapore and services in order to compare prices across economies.
(72,300). At the other end, the poorest populations include:
the Democratic Republic of the Congo (444); Central African
Republic (588); Malawi (715) and Burundi (749). Knowledge check
A business looking to expand might want to use the Human 1. List the countries associated with the acronyms BRICS
Development Index to investigate a potential market or location and MINT.
for investment. For example, a company that makes and sells 2. Explain why employment patterns are one of the most
products for the elderly would need to evaluate the life expectancy important indicators of the health of an economy.
in a target country, to assess how many people might want to 3. Why have many Asian economies experienced high levels
buy their products in the future. Were this same business to sell of growth?
products that came with a high price, it would also want to try and
4. Explain why a business may prefer PPP to GDP as a measure
match countries that have the longest life expectancy to those
of growth.
that have high levels of GNI, so as to ensure that their potential
customers could actually afford their products. The company may 5. What are the key factors that affect external investment in
also be looking to hire technicians and scientists to research and an economy?
develop its new products. By searching the tables for mean years 6. What does the Human Development Index (HDI) indicate
of schooling, it can highlight places where potential employees about an economy?
could be found and so target its recruitment there.
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Growing economies Unit 66

Case study

ASSESSING FUTURE So where might growth come from in the future? It

may come from existing areas where Britain has been
UK GROWTH consistently strong. For instance:
• luxury cars, such as Jaguar Land Rover and Rolls Royce
• jewellery
The UK was one of the world’s largest economies in
2015, by most measures of real GDP. The UK exported • high-value chemicals and medicines, such as those
more manufacturing than ever before in 2014, with produced by the pharmaceutical firm GlaxoSmithKline
manufacturing growth outpacing other elements of the UK • media and entertainment, such as newspapers, television
economy. The nature of its trade, however, has changed programmes, music and films
from predominantly exporting manufactured goods to also
• services, especially financial services, which for many years
providing competitive services. As the pound began to slide
have accounted for a larger share of Britain’s net exports
following the 2008 financial crisis, it looked as though the
than all of the other services combined.
UK might as a result experience a boom in the export of
manufactured goods. However, while it continued to attract
foreign investment, an export boom in manufactured goods
never occurred. This can be explained by several factors.
• The weakness of the global economy, and especially of
the UK’s major trading partners, Europe and America.
Europe and the US remained in recession, and as a
consequence their consumers had less money to spend on
British exports.
• The recession, coupled with the decline in energy sector
productivity, resulted in the UK exporting less oil and gas.
• The relative strength of the services sector, which
continued to attract more money and talented staff than
manufacturing.
Although the make-up of the British economy continues However, there are many threats to this future growth.
to change, it is nevertheless still growing. In fact, in 2014, Britain has a low level of investment in infrastructure, such
Britain grew faster than any other European economy. as transport, housing, broadband and energy. An aging
However, what this means for growth in the future is not and over-stretched infrastructure is likely to constrain future
straightforward. For instance, Britain is a good source of growth over the medium to long term. Also, the fastest-
low-cost workers, but these workers are not very productive, growing companies are very often small, yet they need to be
as Table 3 shows. The hourly wages of workers in the UK able to attract employees with the right skills. This is proving
is now sufficiently low compared to competing countries, increasingly difficult, and limits on immigration may make it
to make British workers more attractive to domestic harder still. Another threat might be if Britain were to exit
businesses as well as international firms looking to invest. from Europe. An increase in trade barriers might follow,
making Britain less attractive as an investment destination.
Table 3 Productivity of British workers in comparison Source: www.economist.com
to competitors, as measured in GDP per hour worked.
Country Britain Germany USA France Italy Japan
(a) Assess where UK growth might come from in the future.
GDP per hour (10 marks)
100 125 130 124 110 85
worked in 2013
(b) Evaluate the various threats facing the UK economy and
Source: Office for National Statistics (ONS)
how they might affect future growth. (20 marks)

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 67 International trade and
58 4.1.2
Theme 4

Key points
business growth
1. Exports and imports.
2. The link between business specialisation and competitive advantage.
3. Foreign direct investment (FDI) and link to business growth.

Getting started Imports: Imports are the goods and services that are brought
Cheese Cellar, a business owned by the fine foods company into one country from another. For example, a Brazilian firm
Harvey & Brockless, has been in business since 1970. The exports its cars and South Africa imports them. To do so, Brazil
company has used its knowledge of the cheese market to export imports the transportation services of a Liberian shipping firm
its products abroad and has seen sales grow by 30–35 per cent. to collect the cars and deliver them to South Africa.
It recognised a demand for high-end British food abroad and Many countries try to limit the importation of goods by
capitalised on this. placing trade barriers in the way. These barriers often involve
tariffs, which are taxes that are imposed on imports. Trade
By tailoring its products to different markets, Cheese Cellar
liberalisation, through hundreds of treaties as well as through
has been very successful in its chosen export countries of
monitoring by the World Trade Organization, has reduced the
Sri Lanka, France and the Caribbean. It used its existing use of tariffs or limited the levels of tariffs that can be levied.
relationships with top-end hotels to reach the same market However, non-tariff barriers (NTBs), are proving harder to
overseas and used its knowledge of airlines to expand into manage. These include practices such as giving subsidies to
that market. local firms, putting numerical limits (quotas) on imports and
Why do you think Cheese Cellar decided to start exporting? How creating rules about how much of a product must be made in
do you think it chose which countries to export to? What was the the country or in what way.
advantage to Cheese Cellar of using its existing relationships with A firm can export or import directly, whereby it distributes
top-end hotels? and sells its own products, usually by hiring someone to be
its local agent. However, it can also operate indirectly, getting
another person or firm to prepare the documents and take on
Exports and imports all of the responsibility for selling and distributing the products
Businesses that trade internationally export and import or services for them. Exporting is not only the easiest way for a
goods and services. Exports and imports generate revenue firm to internationalise, it is also the least risky. A firm can limit
for businesses in different countries and contribute to the amount of money it spends, and ‘test the water’ to see if
business growth. there is a good level of demand for its products.
This does not mean, however, that exporting and importing
Exports: Exporting is the most common route for a firm into are totally risk-free. For instance, if exchange rates move the
the international market as it is the easiest mode of entry. wrong way between the currency of the exporter and that of
A firm continues to produce in its home market but exports the importer, the consequences can be financially very serious.
some of what it makes to a foreign market. Exporting has Also, governments can impose barriers to imports that limit
become easier owing to trade liberalisation (see Unit 69), a firm’s access to the market. There may be conflicts with
which has reduced tariffs and quotas that may otherwise have agents or distributors that are difficult to resolve from outside
limited the imports into a country. the country.
Exporting often involves physical goods, but may also International trade consists of exporting (selling abroad)
include services or so-called ‘invisible’ exports. These include and importing (buying from abroad). Firms trade within and
anything other than manufacturing, mining and agriculture. between countries because they benefit from doing so, even
For example, the UK is very competitive in financial services, where it is sometimes difficult for them. Moreover, countries
particularly banking and insurance. Other types of services that generally benefit from trade and see it as a good thing, though
are frequently exported include tourism, transport, education, these benefits are sometimes indirect, complex or controversial,
entertainment, information and professional services from as shall be touched upon in the units that follow.
accountants and lawyers.

407
International trade and business growth Unit 67

Question 1 the head requires two or three distinct operations.’ By each

worker focusing on a particular operation, output could be
increased and many, many more pins be produced than if
each worker made the entire pin. Specialisation increases
the speed and skill with which a task can be done, and
also saves time, thereby improving efficiency. As the market
becomes larger, the opportunities for specialisation become
greater and narrower.
Comparative advantages: From a country’s perspective,
it is beneficial to specialise and engage in trade according
to each country’s comparative advantages. David Ricardo
illustrated this in 1817 when he showed, using the example of
wool (cloth manufacture) and wine, that England and Portugal
will always benefit from trade if they specialise and produce
according to what each does best. At the start, Portugal
requires fewer days than England to make both wine and
cloth. It has an absolute advantage in both products. However,
Ricardo showed that there would be a net gain to both
countries if Portugal switched all of its production to wine and
England switched all of its wine workers to cloth, and then the
two countries traded. Total output of both products goes up
and consumers in both countries are better off.
This theory of comparative advantage has many limitations,
The Herdy Company Ltd makes a wide range of products based not least of which is that it assumes that the world does not
around the Herdwick, a sheep breed from the English Lake change. Yet our modern, globalised world changes rapidly,
District, Cumbria. The company sells its products online and in and often unpredictably. Nevertheless, the theory provides
a few retail outlets. Its range is popular with tourists visiting the a good base for understanding why two countries, and their
area, many of whom are Japanese and adore the characters consumers, can benefit from specialisation and trade.
and books of Beatrix Potter. Noting this, and thinking that
Competitive advantages: Michael Porter (Competitive
Japanese consumers might also like their own lovable sheep
Advantage, 1990) extended the comparative advantage theory
creations, the owners, Spencer and Diane Hannah, decided to
to show that countries may gain a competitive advantage
look at selling their products in Japan. The first thing they did in international trade, and that this also holds true to a large
was contact UK Trade & Investment (UKTI) and accessed the extent for businesses engaged in international trade. Put
Passport to Export Programme. This programme gives advice simply, a business should specialise in what it does well and
and training for firms looking to export, and even provides adds value, and this competitive advantage can help it to make
some matching funding to help exporters find partners in their a profit abroad. Competitive advantages can take many forms
target markets. However, countries such as Japan may not be for a business when engaging in trading.
an easy market in which to do business and so the Hannahs ●● A business may have particular resources that it can use
needed local assistance in order to grow. The company now has wherever it goes, such as a business model, highly trained
a representative in Japan, who helps distribute their products as and specialised staff, or intellectual property.
well as manage publicity and promotion. ●● It may have acquired access to local markets, local

resources and materials.

(a) Using examples from this case, explain what is meant by exports. ●● It may be able to better organise and replace separate,
(b) Explain why countries such as Japan may not be an easy market cross-border trading enterprises (exporting and importing)
in which to do business. with one firm that does it all: organises, manages and
controls all trading activities.
Specialisation in production, whereby a business focuses
The link between business specialisation on a limited scope of products or services, results in greater
and competitive advantage efficiency, allowing for goods and services to be produced
At the core of the modern exchange economy, and thus at a lower cost per unit. This in turn allows for businesses to
of international trade, is the concept of the division of reduce prices or to increase profit margins, both of which can
labour whereby workers specialise in a productive activity. lead to business growth.
Economist Adam Smith (1776) famously used a well-known Firms may expand abroad in stages, beginning with
example involving the making of pins: ‘One man draws out exporting and gradually increasing their involvement in foreign
the wire, another straightens it, a third cuts it, a fourth points markets as they gain knowledge and experience. However,
it, a fifth grinds it at the top for receiving the head: to make exporting has its limitations and many companies need to find

408
 Global business

other ways to expand. For example, producing abroad can What is FDI?: Foreign direct investment (FDI) is the most
be less expensive, making moving of manufacturing to complicated and expensive form of involvement in a country;
a lower-cost country attractive. Or it may be that transporting it is also the most risky. Nevertheless, according to The
the goods or services is too expensive and so the firm needs Economist, ‘The point about FDI is that it is far more than mere
to locate closer to where it sells or hopes to sell in the future. “capital”: it is a uniquely potent bundle of capital, contacts, and
Moreover, governments may limit the importation of products managerial and technical knowledge. It is the cutting edge of
and services, making exporting unviable, so the firm may have globalisation.’
to find other avenues to get its products to markets in other Simply defined, foreign direct investment is investing
countries. Increasingly firms are skipping these stages and by setting up operations or buying assets in businesses in
taking quicker routes to the international market. For instance, another country. The United Nations considers FDI to occur
firms can enter a market by buying or merging with a firm that where a firm takes an equity stake of more than 10 per cent
is already operating there. Some firms, especially those trading in a foreign enterprise. It is not the same as a foreign portfolio
through the internet, may even be ‘born global’. investment, which refers to holding stocks or bonds but not
tangible assets such as buildings or machinery. The main
Foreign direct investment (FDI) and link identifying aspect of FDI, however, is control. Thus, a firm
to business growth might prefer FDI over exporting or licensing for many reasons,
Many businesses outgrow their home markets and in order including the following.
to grow need to expand into other markets. Others become ●● Managers want to keep tight control over operations in the

aware of opportunities for growth in new markets (see Unit other country or countries. The businesses may need to
65). When the potential competitive advantages listed above share a common culture or communications systems, or
(ownership of resources, locations and internal organisation) they may want to ensure that agreements are enforced.
combine, a firm can benefit from becoming a multinational ●● A firm wants to protect its intellectual property (such

company (MNC) and investing directly in other countries. Firms as patents, copyrights, trademarks and management
may choose to invest directly because the business: know-how).
●● has a high potential for making a profit if it invests in a ●● It needs to be close to its customers.

new location ●● Its products incur high transportation and logistics costs.

●● needs to maintain control over its subsidiaries in the new market ●● It faces trade barriers or political opposition.

●● is trying to acquire direct knowledge of the local market

●● is attempting to avoid barriers to the market.

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International trade and business growth Unit 67

Horizontal and vertical FDI: FDI can be horizontal or its appliances from elsewhere. However, there was another,
vertical. Horizontal refers to producing the same products or less obvious reason for the investment. At the time, China
services as is done at home. For example, the takeover of the was getting poor press for ‘stealing American jobs’, but by
British bank TSB by the Spanish bank Sabadell in April 2015 building its appliances in South Carolina it could put a ‘Made
was a horizontal merger of two firms in the same industry. in the USA’ sticker on these products.
Vertical FDI is where one firm is seeking to acquire materials Firms engaged in FDI used to come mainly from developed
or support for its own products or services. Put another way, the countries, but the number and size of multinational corporations
firm is moving into another part of the value chain, such as when coming from emerging market countries, such as China, Brazil,
a firm opens a call centre in another country to deliver customer Mexico and South Africa, is increasing.
or staffing support. This should help lower its costs, allowing
growth in revenue or profit. Question 2
Different forms of FDI: FDI can take many forms, which
involve either buying, building or collaborating.
●● A joint venture is a collaborative agreement between two
parties to invest in a business and share ownership and
control. (See Unit 73.)
●● Strategic alliances are collaborations created when firms
contract to share resources (often intellectual property in
the form of patents or copyrights) or certain skills (such
as cultural understanding or managerial expertise). For
example, Star Alliance – the largest airline alliance in the
world – operates by codeshare, whereby its member airlines’
operations and bookings are all done through a central hub
based in Frankfurt.
●● Buying through cross-border mergers and acquisitions
(M&A) is the main way that businesses undertake FDI. Most
M&A are actually acquisitions, with over 90 per cent of
cross-border ventures involving the purchase of the entire
target business. There are many reasons for buying other
firms, several of which are explored in Unit 73.

Founded in 1886, Coca-Cola creates, manufactures, distributes

and markets soft drinks, and has a very long history as an
international firm. It began exporting in 1897, and engaged in
direct investment for the first time in 1906. While Coca-Cola has
one of the world’s best-known brands, much of its global success
is down to its very flexible international operations.
Although it retains absolute control over the formula for Coke,
the company has created a variety of joint ventures or flexible
ownership structures to support its business. Thus, many of its
bottlers operate under franchise agreements. The franchises
bottle, sell, deliver and help to market all of Coca-Cola’s soft
drinks in a given area. However, in China, it has joint ventures
with a variety of bottling plants. In some countries, the firm has
opted to take full control, especially where it is just starting to
●● A firm may build ‘greenfield’ facilities if they are unable to trade or the local bottlers need financial help.
collaborate or to find another firm to buy, or where it is
too expensive for one reason or another. Also, many local The company will also acquire firms that have complementary
governments may prevent certain acquisitions in order product lines or form joint ventures with them, such as those
to protect competition. For example, the Chinese firm established with Nestlé for tea and Danone for water.
Haier is now one of the world’s largest appliance makers. Sources: adapted from: the Financial Times 18.02.2005,
It began testing the international markets by exporting 16.04.2013. All rights reserved.
small refrigerators, which filled a neglected niche in the
international market. It then began building manufacturing (a) Using Coca-Cola as an example, explain what is meant by foreign
facilities abroad, including India, Indonesia and Iran. In 2000, direct investment.
it built a factory in South Carolina, USA, in order to be closer (b) Explain how the use of foreign direct investment has allowed the
to American consumers and reduce the costs of transporting business to grow.

410
 Global business

Exam tip Links

One factor influencing the exports and imports of goods
and services is the rate of exchange between countries. The
exchange rate between two currencies is explained in Unit 72.
The role that FDI plays in business growth can be discussed
when considering growing economies (Unit 66). Further, any
question considering the role that MNCs play in world trade and
generating FDI (Unit 79) can be supported by information in
this unit.

Key terms
Comparative advantage – the theory that a country should
specialise in products and services that it can produce more
efficiently than other countries.
Competitive advantage – the idea that a business should
specialise in any area (products, services, management,
research, etc.) where it can perform better than its
competitors.
Division of labour – different workers specialising in
different productive activities.
Exports – goods or services that a firm produces in its
home market, but sells in a foreign market.
You should recognise that a country can export and import both Foreign direct investment – investing by setting up
goods and services. A useful tip to help you identify whether there operations or buying assets in businesses in another
has been an export or import is to think about the way the money country.
moves when it is paid. This is particularly useful in identifying Imports – goods and services that are bought into one
exports and imports of services. country from another.
Let’s look at the UK. International trade – exporting (selling abroad) and
• Exports – goods or services are sold abroad and money comes
into the UK.
importing (buying from abroad).
• Imports – goods or services are bought from abroad and Specialisation – a production strategy where a business
money leaves the UK. focuses on a limited scope of products or services. This
Some examples help to illustrate this. results in greater efficiency, allowing for goods and services
• Exports of goods – a UK manufacturer of racing cycles sells its to be produced at a lower cost per unit.
cycles to Italy. This is an export of goods from the UK and Tariffs – taxes that are imposed on imports.
money comes into the country. The UK business sells its
products to Italian customers or businesses.
• Exports of services – a German company uses the financial
services of a UK bank. This is the export of a service to a
Knowledge check
German business and money comes into the UK. The German 1. Why do some countries try to limit imports?
business pays the UK bank.
• Imports of goods – a UK manufacturer of toys buys parts for 2. What are the risks of being involved in exporting and
its toys from the USA. This is an import of goods to the UK importing?
and money leaves the UK. The UK business pays the USA
business for the parts. 3. What is meant by comparative advantage?
• Imports of services – UK tourists visit Australia for a holiday 4. How does specialisation lead to greater efficiency?
and book with an Australian travel agent. This is the import of a
service to the UK and money leaves the UK. UK tourists are 5. Explain what is meant by foreign direct investment.
spending their money abroad. 6. What are the different forms of foreign direct investment?

411
International trade and business growth Unit 67

Case study

ANGELBERRY The franchising model has helped the business expand into
warmer climates where frozen products sell well all year
round. The company now has deals in place for 80 stores
Many firms try their hand at exporting only when they are across the Gulf States by 2018, following second stores in
established. They want to find new markets for their product both UAE and in Johannesburg, South Africa in 2014, and
range. This is not always the case, however, as shown by a deal with a cinema chain to roll out a kiosk version. There
Ryan Pasco and James Taylor of Bristol when they founded are a number of potential deals in the pipeline, with further
AngelBerry in September 2011. expansion into Europe and Asia planned in 2015.
They came up with the idea of frozen yogurt from a AngelBerry also went to a trade show in Dubai where they
Californian road trip in July 2011, when Ryan noticed the pitched to potential franchisees and secured a major deal
popularity of self-service frozen yogurt stores. As a frozen with TriStar Corporation, planning to open 80 franchises
yogurt retailer, they established just two UK stores in Bristol. across the region. That led to the decision to expand
They then concentrated on establishing themselves in hot production and after perfecting their recipe they did a deal
climates and established six international stores across the with an Italian producer that could make enough frozen
UAE, Mauritius and South Africa. yogurt to order to meet their ambitions.
Their tips for those who want to export are simple. They
think it is essential to carry out thorough research before
starting exporting. This will prevent costly mistakes and
boost chances of choosing the right market. They used the
services of their local Chamber of Commerce, and James
was full of praise for the help the company has had from
UK Trade & Investment, which he said had helped with
market research and making contacts.
Sources: adapted from www.exportbritain.org.uk

(a) Assess the benefits of the services provided by the

Chamber of Commerce to a small business seeking to
export. (10 marks)
(b) Evaluate the reasons why AngelBerry has been a success.
(20 marks)

Thinking bigger
The case study on AngelBerry highlights the help received from a variety of geared up to provide advice. In the UK, firms should check with the local
sources. How should firms approach exporting? There are a number of ‘to trade association, which will provide data on exporting within the sector.
dos’, especially for smaller firms. There is a need to build a research checklist Firms might consider using an agency and it might be useful to commission
assessing the potential markets in each territory. When identifying possible research. In the end it is a judgement call as to whether there is a gap in the
markets, a firm must define where it may be able to sell its products or market for products and services.
services. It also needs to decide which markets should be considered. You could use this information in a variety of ways. Obviously, it can be
Competitor markets overseas need to be assessed and this is where UK used when answering questions on how firms can successfully export
Trade & Investment can help in providing contacts. Firms should visit each but it might also be useful when discussing influences on foreign direct
territory and get advice on local customs and culture, as well as planning investment.
how to sell. On visits, firms should check with the UK Embassy, which is

412
 58 Factors contributing to
68 4.1.3
Theme 4

Key points
increased globalisation
1. Reduction of international trade barriers/trade liberalisation.
2. Political change.
3. Reduced cost of transport and communication.
4. Increased significance of global (transnational) companies.
5. Increased investment flows (FDI).
6. Migration (within and between economies).
7. Growth of the global labour force.
8. Structural change.

Getting started What is globalisation?

Many markets today are global. This means that some firms
In 1991 Estonia broke its ties with the Soviet Union and became
expect to sell their products anywhere in the world. A firm
independent. Since then it has developed strong political and could have a head office in London, borrow money from a bank
economic links with the West. Estonia is located in the Baltic in Japan, manufacture products in China, deal with customers
Sea region, with a population in 2015 of 1.3 million. Since from a call centre in India and sell goods to countries all over
independence Estonia has embraced the market mechanism the world. Firms and people are behaving as though there
in its economic policies. For example, it has privatised state is just one market or one economy in the whole world. This
industries, deregulated a number of markets, and encouraged development is called globalisation. It is often defined as the
free trade by opening up its economy to foreign businesses. growing integration of the world’s economies.
Estonia has also emphasised the importance of technology Some of the key features of globalisation are outlined below.
and aims to be a world leader in the industry. For example, ●● Goods and services are traded throughout the world.
it is creating one of the world’s fastest broadband networks, This means that firms like GlaxoSmithKline, the UK
offering free wireless internet, encouraging technology start-ups pharmaceuticals company, can sell their products as easily,
and putting government services online. Estonia has attracted say, in Australia as in England.
substantial investment from overseas businesses. Figure 1 shows ●● Many people are able to live and work in a country of their

the origin of this investment. choice. This has resulted in more multicultural societies
where people from many different nations live and work
Figure 1 together, for example in the same city.
Foreign direct investment stock by countries 2012 ●● There is a high level of interdependence between countries.

Key
This means that events in one economy are likely to affect
24% other economies. For example, the financial crisis in the US in
27% Sweden
2008 had an impact on many economies all over the world.
Finland
●● Capital flows freely between different countries. This means,
Netherlands for instance, that a business or consumer in Australia can
2% Norway put their savings in a bank in the UK. This also means that
3% Russia investors can buy shares in foreign companies and businesses
5% Lithuania can buy companies that operate in other countries. For
5% US example, in 2014, a Chinese insurance company bought New
24% York’s glamorous Waldorf Astoria Hotel for $2 billion.
10% Other
●● There is an interchange of technology and intellectual

property across borders. Increasingly, for instance, patents

Source: adapted from www.estonianexport.ee
granted in the US are recognised in other countries.
How has political change influenced the development of business
It should be noted that the process of globalisation is not
in Estonia? Why are an increasing number of companies trying
complete. This is because restrictions still exist. Many countries,
to develop business in foreign countries? From which countries do
such as Australia and the US, restrict the number of immigrants
most business investments in Estonia originate? What reasons
entering the country. There are also some trade barriers, such
might there be for this? What contributions has new technology
as tariffs and quotas, which make it more difficult to sell goods
made to the spread of international business?
in certain countries. Trade barriers are discussed in Unit 69.

413
Factors contributing to increased globalisation Unit 68

Factors contributing to globalisation Question 1

Countries and businesses have been trading with each other
for centuries, and the world economy has been interdependent In 2014 China and Australia had almost finalised a free trade
for some time. However, modern globalisation probably started agreement (FTA). Negotiations relating to the agreement
in the 1980s and since then the pace of globalisation has first started in 2005. The terms of the agreement mean that
accelerated. There are a number of reasons for this trend. Australia will reduce the tariffs on all Chinese goods to zero. In
return, China will reduce the tariffs on most Australian goods
Reduction of international trade to zero. In the services sector a number of opening promises
barriers/trade liberalisation were made to liberalise trade. In the investment field, both sides
agreed to grant each other ‘most favoured nation’ status once
An increasing number of countries around the world have
opened up their economies. This means that they have allowed the FTA takes effect. Favourable agreements were also reached
trade to flow without any barriers. One reason for this is the relating to the flow of investment between the two nations.
influence of the World Trade Organization (WTO). The role Before this new agreement, Australia had seven other free trade
played by the WTO in the liberalisation of trade is discussed in agreements in place with New Zealand, Singapore, Thailand,
Unit 70. Here are some examples of trade agreements. USA, Chile, the Association of Southeast Asian Nations (ASEAN)
●● In 2012, Australia and Malaysia agreed to remove the and Malaysia.
majority of tariffs on each other’s exports. It was hoped that The benefits of free trade agreements, such as eliminating tariffs,
the new agreement would increase trade between the two stimulating economic growth and enabling countries to specialise
countries significantly from its current level of £8 billion. in what they do best, generally outweigh the drawbacks, such
●● The EU and Singapore signed a free trade agreement in
as exposure to foreign imports. Free trade agreements mean
2012. This was expected to help the export of cars and that consumers today have far greater access to products
financial services from the EU. The EU is already Singapore’s manufactured all over the world than ever before. Free trade and
second largest trading partner. In 2011, the EU had a trade globalisation means that consumers can buy goods from a huge
surplus of €8 billion. range of suppliers in global markets.
Free trade agreements help to encourage trade between
nations. As a result the volume of international trade increases Source: adapted from the Financial Times 17.11.2014.
and businesses can sell goods and services in new foreign All rights reserved.
markets without penalties. This increase in international trade (a) What is meant by a free trade agreement?
helps to maintain the process of globalisation. However, (b) Explain how free trade agreements, like the one between China
despite the numerous trade agreements that have already been and Australia, contribute to globalisation.
established, there is still a long way to go before the entire world
embraces complete free trade.

Political change
Some radical changes in the political regimes of certain nations
have helped to increase globalisation. Some examples of these
are outlined below.
●● In 1991 communist rule ended in the Soviet Union and the

dissolution of the old soviet bloc was complete. After years

of economic decline and the relative rise of prosperity in the
West, it was clear that the Soviet Union had to make some
changes. Mikhail Gorbachev was responsible for introducing
the two key policies of Glasnost and Perestroika in the
1980s. Glasnost was the vehicle of political reform, and
Perestroika was responsible for restructuring the economy.
Old soviet bloc countries, such as Latvia, Georgia, Lithuania,
Belarus, Estonia and Moldova, were given independence. As
a result these countries began to open up their economies
and develop trading ties with the rest of the world. Some
of them joined the EU and Russia also began to permit a
greater movement of goods, services and capital. In the
whole region the introduction of market forces helped to
liberalise trade.
●● In addition to the break-up of the Soviet Union, a number

of other countries in eastern Europe sought political and

economic reform as their ties with the old soviet bloc
were severed. For example, the Berlin wall was removed
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 Global business

which brought together West Germany and East Germany ●● Before the use of containers it cost $5.83 per tonne to load a
as a single nation. In Romania, communist leader Nicolae ship manually. The use of containers has reduced this to just
Ceausescu was removed from power in 1989 and executed. $0.16 per tonne.
Czechoslovakia was divided peacefully into the Czech ●● There has been a 50 per cent reduction in the amount of

Republic and Slovakia. Other eastern European countries, capital tied up in a tonne of stock in a journey from Hamburg
such as Poland, Hungary and Bulgaria, also enjoyed more to Sydney.
democracy. This helped initiate economic reform, which ●● The loss to theft has tumbled because containers are locked.

again encouraged the operation of market economies. This has in turn reduced insurance costs.
●● Economic changes in China first began in the 1970s ●● The speed of loading has increased drastically, cutting costs.

following the death of Chairman Mao in 1976. The strong Before containerisation labour could only load 1.7 tonnes per
communist grip on the nation was loosened and economic hour onto a ship. This has risen to 30 tonnes per hour with
reforms began with changes in agriculture, where efficiency containers. As a result ships have got bigger and spend less
was improved by handing over plots of land to farmers. They time in ports.
were allowed to keep the output after paying a share to the Containerisation revolutionised the transportation of goods and
state. Then, between the mid-1990s and 2005, a large-scale since it was so easy to distribute goods by lorry due to the
privatisation programme was organised by the government. flexibility of containers, the number of loading ports used in
Trade was gradually opened up and China became a Europe has fallen from 11 to just 3.
member of the WTO. China is now a booming economy
with a well-established manufacturing sector, heavy state
expenditure on infrastructure and rising prosperity among Question 2
the Chinese ‘middle-classes’ who have a thirst for Western Carol and Martin McDonald have run The Scourie Bay Guest
goods. However, China is seen as an economy that is at a House in Scotland for 30 years. However, in 2008 they
stage of newly advanced economic development, not yet expanded by purchasing the property next door and increasing
completely ‘open for business’. the number of rooms to let from 6 to 14. This decision was
taken after they advertised the guest house on their own
Reduced cost of transport and website and started to attract visitors from Europe, Japan and
communication Australia. The expansion cost a total of £300,000 and initially
International transport networks have improved considerably they were worried that they might struggle to fill the rooms
in recent years. In particular, the cost of flying has fallen during the quiet winter period. However, due to the global
and the number of flights and destinations has increased.
exposure of their business via their website, the clever use of
This means that people can travel to business meetings
social media, and the growing popularity of low-cost flights,
more easily and goods can be transported more cheaply.
business has boomed. In 2014 the business made a record profit
For example, a number of low-cost airlines have entered the
of £105,000. More than 55 per cent of guests during 2014
market and brought air travel to the masses. In the UK, easyJet,
Ryanair and Flybe offer flights to a wide range of European were from overseas.
destinations, which are affordable to the majority of the (a) Discuss the factors in this case that have contributed to
population. India has also begun to enjoy low-cost air travel. globalisation.
Airlines such as SpiceJet, GoAir and Jet Airways offer cheap
internal flights and some provide international services.
Modern technology allows firms to transfer complex data
instantly to any part of the world. It also means that more Increased significance of global
people can work at home, or any other location that they (transnational) companies
choose. Many people do not have to be office-based to do One of the reasons why globalisation has flourished in recent
their jobs. This makes it easier for firms to have operations all years is because a growing number of large firms have
over the world. The internet also allows consumers to gather developed significant business interests overseas. Some of
information and buy goods online from businesses located in these firms are very powerful. They sell goods and services into
different parts of the world. Further, businesses, both large global markets and have production plants and other operating
and small, can reach out to global markets by promoting their facilities all over the world. They are called transnational or
activities and products using the internet. multinational companies (MNCs). Multinational companies
Containerisation has also made a significant contribution play a large and growing role in the world economy. They make
to globalisation. Containers are uniform metal boxes that significant contributions to world GDP and represent about two
can be loaded and unloaded easily from ships, lorries and thirds of global exports. They also make huge global investments
trains. They provide a flexible means of transporting goods. in research and development. Figure 2 on the next page shows
But most importantly their use has reduced the cost of a list of the biggest MNCs in the world.
transportation significantly.

415
Factors contributing to increased globalisation Unit 68

Figure 2
Biggest MNCs – 2011

General Electric (US)

Royal Dutch Shell (Netherlands/Britain)
BP (Britain)
Exxon Mobil (US)
Toyota (Japan)
Total (France)
Key
GDF Suez (France)
Vodafone (Britain) Domestic
Enel (Italy) Foreign
Telefónica (Spain)

0 150 300 450 600 750

Source: www.economist.com $ Billion

The contribution made by MNCs to globalisation is likely to companies. The UK has attracted more FDI than any other
continue growing. This is because these corporations are under country in the world, except the US. Figure 3 shows the stock
pressure to increase returns to their owners. Consequently they of inward investment for a selection of countries in 2013. The
will expand their current activities and search for new business overwhelming majority of this investment comes from Europe and
opportunities anywhere in the world wherever it is cost-effective. the Americas.
The role played by MNCs is discussed in more detail in Unit 79. Some specific examples of FDI in the UK are outlined below.
●● In 2013 a Malaysian consortium paid £400 million for

Exam tip Battersea Power Station. The buyers plan a 15-year

You need to remember that it is not just large MNCs that development consisting of homes and offices. The investment
contribute to and benefit from globalisation. Small businesses also was expected to create around 13,000 jobs.
play their role. The Scottish guest house in Question 2 is one ●● In the UK car industry, BMW invested £500 million in its Oxford
example. Also, many small businesses play a role as suppliers to plant where Minis are produced. Nissan, the Japanese car
the multinationals. manufacturer, has decided to make Infiniti, its premium brand
car, at its plant in Sunderland. Jaguar Land Rover, owned by
Indian company Tata, has expanded production of the Range
Increased investment flows Rover in its West Midlands plant, creating a further 1,500 jobs.
Foreign direct investment (FDI) occurs when a company
makes an investment in a foreign country. This may involve, for The examples above show foreign investment flowing into the
example, the construction of a factory, distribution centre or UK. However, UK businesses also invest in projects overseas.
store, or the development of a mine or tea plantation. Another For example, in 2015 Marks & Spencer (M&S) announced plans
part of FDI is the purchase of shares in a foreign business to open 250 stores overseas, including 20 new food outlets in
(10 per cent or more). Most FDI is undertaken by multinational Paris. M&S already had a substantial number of overseas stores,

Figure 3
Stock of inward investment – 2013

Canada
Netherlands
Spain
Switzerland
Germany
China
France
Hong Kong
UK
US

0 1,000 2,000 3,000 4,000 5,000 6,000

$ billion
Source: 2014 World Investment Report, UNCTAD

416
 Global business

but saw expansion abroad as a means of raising the financial in these manufacturing ‘hotspots’ because land and labour are
performance of the business. cheap. As a result globalisation has been given a boost.
FDI is often helpful in contributing to the development of Although migration is helping to boost global wealth,
emerging nations. For example, in 2015 M&S also announced some countries are worried that migration might lead to social
plans to build 100 sites in India, creating jobs and helping instability. Sectors of the population might blame immigration
to boost local economic activity. China has made significant for a range of domestic problems, such as overcrowding and
investments in Africa. For example, in 2014 there were over unemployment. As a result, governments are under pressure
500 Chinese companies with operations in Zambia. to reduce flows of migrants into the country. In the UK, the
FDI spreads business activity, job creation and wealth all over UK Independence Party has won some support by making the
the globe. It makes a huge contribution to globalisation. FDI also reduction of immigration their main priority.
allows businesses to penetrate markets where trade barriers
exist. Countries are more likely to welcome a foreign business Growth of the global labour force
building a factory than one that just wants to sell products. The global labour force has grown substantially. In 1980 the total
number of people employed in the world was 1.7 billion. By 2010
Migration this had grown to 2.9 billion. A significant proportion of these extra
Migration is the movement of people who aim to set up workers are Chinese and Indian. Growth in the global labour market
permanent or temporary residence in a new location. It is might also be accounted for by an increase in global population
commonly associated with the movement of people between from 4.45 billion in 1980 to 6.85 billion in 2010, an increasing
different countries. In 2013/14 a total of 624,000 people number of women entering the market, and people living longer
moved to live in the UK. However, at the same time 327,000 and working longer, as well as the effects of migration.
people left the UK to go and live in another country. Therefore, This growth in the size of the global labour market has
net migration into the UK was 297,000. It is argued that contributed to globalisation for the following reasons.
3 per cent of the world’s population live outside their country ●● A bigger global labour market helps to drive global demand.

of birth. However, in some countries, such as Australia and This is because people in employment earn money which can
Switzerland, migrants make up around 23 per cent of the be spent on goods and services. Some of this extra demand
population. How does migration contribute to globalisation? will be directed at imports sold by MNCs and other exporters.
●● Migrants often import their cultures into their new In countries like China and India, where much larger numbers
environment. Along with this often comes the importation of people have moved into employment, millions of people
of goods from their home countries. For example, in the have been lifted out of poverty and are making significant
UK there are many specialist shops that cater for Polish contributions to global demand
immigrants. Much of the produce sold in these stores is ●● The rising numbers of people making themselves available

imported from Poland. for work has acted as a drag on labour costs, especially in
●● Migrants often provide a supply of low-cost labour to a developed countries. This is because the rising supply of
nation. As a result businesses can lower their costs and gain labour forces wages down. This has helped to keep costs
a competitive edge in overseas markets. This helps them to down and encouraged businesses to expand their activities
sell more overseas. more widely.
●● A significant proportion of the money earned by migrants is ●● Some of the people moving into the labour market will set up

sent back to their place of birth. This money is usually spent their own businesses once they have gained work experience.
by families and helps to generate demand in these countries. This will boost the number of businesses globally, some of
Transnationals are likely to benefit from this increase in which might grow and develop their activities around the
demand so economic activity is spread around the globe by world adding another lift to globalisation.
the migrants.
●● Some migrants, such as lawyers, doctors, teachers, Structural change
musicians, writers, academics and Premier League Over time the structure of economies is likely to change. For
footballers, are highly skilled people. They can help to example, in most Western economies the contribution made to
fill ‘skills gaps’ and therefore make big contributions to national income by the primary and secondary sectors has fallen.
businesses and national income. In these economies it is the huge growth in services (the tertiary
Migration can also take place within a country, where people sector) that has provided most of the income, employment and
move from one region to another. This has happened on a large wealth. It could also be argued that it is the movement away
scale in China. During the past thirty years workers have moved from these once traditional sectors and into services that allows
from inland regions to coastal cities within China. These people businesses and economies to flourish. This is because the returns
have moved in search of jobs and new opportunities that are on capital invested in many service industries are often higher.
not available in rural areas. Domestic Chinese migrants now It is the development of knowledge-based industries, such as
account for approximately one third of all domestic migrants biotechnology, information technology, research and development,
worldwide. This movement of people in China has been the education, software development, pharmaceuticals, care, finance,
result of international investment and the development of the aerospace and security, that has helped countries to improve the
manufacturing sector. A lot of overseas businesses have invested standard of living for their citizens.

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Factors contributing to increased globalisation Unit 68

These structural changes have contributed to

Knowledge check
globalisation because most of the industries mentioned
above are export-orientated. As a result, in addition to 1. State three features of globalisation.
selling these services abroad, these industries are likely 2. Describe briefly the role played by the WTO in globalisation.
to set up operations in a range of countries, recruit high-
quality staff from anywhere in the world and try to foster a 3. What is meant by a free trade agreement?
global presence. It might also be argued that the internet 4. How do free trade agreements help to foster globalisation?
and social media have helped to deliver services to global 5. How might political change contribute to globalisation?
markets. Both large and small businesses can use the
internet and social media to raise their profiles, communicate 6. Describe briefly the role played by lower transport costs in the
with potential customers and sell products. spread of globalisation.
Finally, many industries in the tertiary sector can locate 7. How has containerisation had an impact on globalisation?
anywhere, provided there is a market. They are not tied 8. Outline one way in which transnational companies contribute
to specific geographical locations or influenced by other to globalisation.
locational factors. For example, a chain store like M&S can
locate anywhere in the world, provided there are people 9. What impact can FDI have on globalisation?
within close proximity who want to go shopping. 10. How has migration had an impact on globalisation?
11. How has the growth in the global labour force contributed to
globalisation?
Links
Globalisation is an important business development.
You may get the opportunity to make links to the topic of Key terms
globalisation in a wide variety of answers. For example,
when discussing the importance of exporting, importing, Foreign direct investment (FDI) – business investment
exchange rates, overseas marketing or outsourcing undertaken by a firm in another country; building a factory
to a business, globalisation is clearly a related issue. for example.
Globalisation may be linked to many units but some Globalisation – the growing integration of the world’s
obvious examples include Impact of external influences economies.
(Unit 47), Causes and effects of change (Unit 63), Scenario Transnational or multinational companies – companies that
own or control production or service facilities outside the
planning (Unit 65), Trading blocs (Unit 70), Assessment of a
country in which they are based.
country as a market (Unit 72), The impact of MNCs
World Trade Organization (WTO) – an international
(Unit 79) and other units in Theme 4.
organisation that promotes free trade by persuading
countries to abolish tariffs and other barriers. It polices
free trade agreements, settles trade disputes between
governments and organises trade negotiations.

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 Global business

Case study
development of solutions for gastrointestinal conditions using
kiwi fruit. In 2013 it opened an extension to its milk production
NESTLÉ factory in the Dominican Republic. It also announced the
building of a new factory in Poland to make Purina pet food,
at a cost of CHF93 million (£65 million). This investment was
Nestlé is a large MNC based in Switzerland. It is the world planned to create 200 jobs.
leader in nutrition, health and wellness products. In 2014 its
The company also enjoys a number of business partnerships
revenue was CHF91.6 billion and net profit CHF14.5 billion
with foreign companies. For example, in 2011 it set up some
(approximately £63.9 billion and £10.1 billion respectively).
joint ventures with Chinese partners, including food company
Some of its globally recognised brands include KitKat, Nescafé,
Yinlu, which makes ready-to-drink peanut milk and canned rice
Perrier, Carnation, Nesquik and Purina.
porridge, and Hsu Fu Chi, a confectionery and snacks producer.
The company has more than 400 operations, including
In 2015, Nestlé launched the Nestlé Global Youth Initiative
factories, distribution centres, offices and laboratories in nearly
to help young people around the world develop the skills
200 countries around the world. It directly employs around
needed for employment. It aims to develop young talent for the
339,000 people. It also has connections with a huge army
company and help create work and training opportunities for
of suppliers. For example, the company relies on around five
youngsters in an effort to reduce global youth unemployment.
million farmers around the world to supply agricultural goods
In 2013, Nestlé had organised a similar initiative in Europe that
to make its high-quality food and beverage products.
aimed to create 20,000 jobs for European young people over
For many decades Nestlé has invested heavily in operations three years.
around the world. In some cases it has built brand new
Sources: adapted from www.nestle.com and www.statista.com
facilities, in others it has bought foreign businesses. For
example, in 2011 Nestlé Health Science S.A. acquired
Prometheus Laboratories Inc., a US-based company that (a) Explain the role played by foreign direct investment (FDI)
specialises in diagnostics, and treatments in gastroenterology in globalisation. (4 marks)
and oncology. It also acquired a minority stake in Vital Foods,
(b) Evaluate the extent to which companies like Nestlé
a New Zealand-based company that specialises in the
contribute to increased globalisation. (20 marks)

419
 58 Protectionism
69 4.1.4
Theme 4
Key points
1. Tariffs.
2. Import quotas.
3. Other trade barriers:
●● government legislation
●● domestic subsidies.

Getting started
domestic market. This is considered to be unfair competition
Australia produces some of the cheapest sugar in the world. for domestic producers.
However, Australian sugar producers face difficulties when ●● Raise revenue. A government can raise revenue if it
it comes to selling to many other countries because of trade imposes tariffs on imports. This money can be spent on
barriers. For example, sugar farmers are heavily subsidised in government services to improve living standards.
the US and there are also quotas and tariffs (import controls) ●● Prevent the entry of harmful or undesirable goods.
imposed on imports. Farmers in Europe are also heavily A government might be justified in protectionism if it is felt
supported and trade with the EU is challenging. Australian that overseas producers are trying to sell goods that are
Greg Beashel, chairman of the Global Sugar Alliance, suggested harmful or undesirable.
that Australia is one of the lowest cost producers of sugar in ●● Improve the balance of payments. A country might need
the world, but could not make the money it should because of to use trade barriers because it has a very large balance of
corruption in the global market. payments deficit (where the spending on imports exceeds
income on exports). A country has to pay its way in the world
Why is it hard for Australian sugar producers to sell in overseas and if the balance of payments deficit gets out of control, action
markets? Why do you think countries erect trade barriers like may be needed. A government might try to reduce imports and
those in the case above? What might be the benefits of lifting all increase exports at the same time to reduce the deficit.
trade barriers?
Tariffs
Governments can use a number of trade barriers to restrict
trade. One approach is to make imports more expensive. This
Protectionism will reduce demand for imports and increase demand for goods
Most economists would argue that free trade will benefit the produced at home. Imports can be made more expensive if
global economy. However, sometimes countries believe that it the government imposes a special tax on them. For example,
is in their interests to restrict trade. For example, governments if a government adds £50 to the price of an imported camera,
may think it is necessary to protect their domestic producers demand should switch from foreign cameras to home-produced
from overseas competition. Or they may give financial help cameras. Taxes on imports are called tariffs or customs duties.
to exporters. This approach is called protectionism. Unit In addition to reducing imports, tariffs also raise revenue for the
67 outlined the benefits of free trade. However, there are government. However, the imposition of a tariff may only have
reasons why governments feel that the use of trade barriers is limited impact if demand for the import is price inelastic. This is
sometimes justified. because demand will not fall in proportion to the price increase.
●● Protect jobs. They may be used if domestic industries The fall in demand will be proportionately less.
need protection from overseas competitors to save jobs. Even though the pace of globalisation is accelerating and an
Unemployment is undesirable and a government may be increasing number of countries are opening up their economies
criticised if jobs are being lost because of cheap imports. to foreign businesses, there are countless examples of countries
●● Protect infant industries. It is often argued that infant imposing tariffs on imports. Here is a selection.
industries need protecting from strong overseas rivals until ●● In 2015 Ecuador imposed tariffs of 21 per cent and 7 per cent
they can grow, become established and exploit economies of on imports from Columbia and Peru respectively. The main
scale. However, it is also argued that this approach may not purpose of these tariffs was to offset the effects of a stronger
be successful because governments have a poor record in US dollar. Columbian and Peruvian officials claimed that the
identifying these new industries with potential. tariffs were a protectionist move and that their imposition
●● Prevent dumping. A government may use trade barriers if it contravened the principles of the Andean Community (CAN),
feels that an overseas business is dumping goods. Dumping a customs union formed by Bolivia, Ecuador, Columbia
is where foreign producers sell goods below cost in a and Peru.

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 Global business

●● In 2014, the US imposed tariffs on solar products coming in Import quotas

from China and Taiwan. The anti-dumping duties on Chinese Another way of reducing imports is to place a physical limit on the
solar goods were 165 per cent, compared to 27 per cent amount allowed into the country. This is called an import quota.
on Taiwanese solar panels. A Chinese official suggested By restricting the quantity of imports, domestic producers face
that the tariff abused trade remedy measures, damaging less of a threat. They will have more of the market for themselves.
the legitimate rights of Chinese companies and violating the However, quotas will raise prices because fewer of the cheaper
United States’ duty to respect World Trade Organization rules. imports are available. An extreme form of quota is an embargo.
In 2015 the US lowered some of these tariffs. This is where imports are completely banned from a country.
●● In 2014, some African countries imposed higher tariffs on Most embargos are imposed for political reasons. For example, in
imported goods. Some staple goods such as beans, rice, 2015 an arms embargo was imposed on Libya to prevent military
flour, palm oil and sugar were exempt, but not fruit and goods being exported to the country. A number of embargos exist
vegetables from Europe and neighbouring countries. The between Russia and the EU as a result of Russia’s involvement in
duties were up to 50 per cent on many items. The trade the war between the Ukraine and Russian-speaking rebels.
barriers were designed to encourage domestic production. Placing physical limits on the flow of imports means that
some demand for those goods will be met by domestic
producers. This will help to protect or increase domestic
Question 1 employment. At the same time, quotas help to prevent domestic
or imported goods from overpowering the market. This improves
consumer choice. Some examples of countries using import
quotas are given below.
In 2014 Indonesia imposed a quota on wheat flour imports,
in an effort to protect the financial interests of local producers.
The total allowance of wheat flour imports between May and
the end of the year was limited to 441,141 tons, with the three
main importers of Turkey, Sri Lanka and Ukraine all being given
fixed quotas. The remainder of the quota was given to other
trading partners.
In 2014 China announced that it would retain its quota of
foreign films being imported. In 2012 the quota was set at a
maximum of 34 foreign films per year coming into the country.
China’s film industry is the second largest in the world after
the US, and was worth £2.1 billion in 2013. Film imports are
restricted because China fears that an open market would
The falling price of coal has prompted some protectionism from damage the domestic industry.
a number of countries. In 2014, it was widely reported that
China imposed tariffs of 6 per cent and 3 per cent on Australian Problems with trade barriers
thermal coal and coking coal respectively. The Australian coal Although there are several motives for restricting trade, some
industry said that the effects would be felt more harshly by barriers may not be effective. One problem is that countries may
Australia because Indonesian coal producers, who also export retaliate when barriers are imposed. For example, if one country
to China, would not be affected by the tariffs. This is because imposes a tariff on another country’s goods, that country may
China and Indonesia have a bilateral free trade agreement. The well impose tariffs of its own to block goods coming in. This
‘tit-for-tat’ behaviour could escalate into a trade war where trade
Minerals Council of Australia argued that the tariffs would raise
between countries eventually stops.
the price of energy in China and jeopardise ongoing trade talks
Tariffs might also be ineffective if demand for imports is
between China and Australia.
inelastic. For example, if tariffs increase the price of an import by
China’s decision to impose the tariffs was designed to protect the 20 per cent, demand will only fall by 2 per cent if price elasticity
domestic industry in the face of falling global prices. The price of demand is –0.1. Therefore, the imposition of the tariff will only
of coal fell from $136 in 2011 to $65 in 2015. China estimated have a very limited impact.
that 70 per cent of its coal mines were making a loss. However,
some analysts suggested that too much coal is being produced in
relation to demand. China’s growth has slowed and it is making Thinking bigger
some effort to use cleaner fuels. When considering trade barriers, countries seem to favour the use of
tariffs rather than import quotas. Typically, the tariff is seen as a more
Source: adapted from the Financial Times 10.10.2014. All rights efficient way to place limits on the inflow of international goods without
reserved. placing undue hardship on producers who import goods. For many,
tariffs represent the best approach to supporting the domestic economy,
(a) What is meant by a tariff? providing consumers with a wider choice, and promoting genuine
(b) Explain why China has imposed tariffs on Australian coal. competition between businesses.

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Protectionism Unit 69

Government legislation Exam tip

Some countries avoid the use of tariffs and quotas, but still If considering the possible effects of protectionism, it might
manage to reduce the amount of imports coming in. They do be helpful to distinguish between the short-term and the
this by insisting that imported goods meet strict regulations long-term effects. For example, in the short term protectionism
and specifications. In some cases legislation can be passed might reduce imports and help domestic industries. However, in
the long term it might stifle competition, protect ailing and
to prevent entry. For example, a shipment of toys might be
inefficient industries, provoke retaliation and possibly lead to a
returned if they fail to meet strict safety regulations that are trade war. Making a distinction like this is a way of demonstrating
imposed by legislation. evaluation skills.
Goods that fail to reach cultural or environmental standards
may also face administrative barriers. Some products cannot
be imported into the EU. For some other products there are Links
restrictions, or the Food Standards Agency has issued advice
You can demonstrate your synoptic skills by linking this topic to
saying that particular food products should not be eaten. The
answers relating to global competitiveness, assessing overseas
most common examples of legal import bans aim to protect
consumers from dangerous goods. For example, in 2011 a ban markets and assessing a country as a suitable production
was imposed on feed and food coming in from Japan because location. For example, businesses often choose a particular
there were fears of it being contaminated by radioactivity international location for a factory to avoid trade barriers. This
resulting from earthquake and tsunami damage to Japanese is because if an overseas business produces goods in another
nuclear power stations. country, the output is not classified as an import for that country.
Links might be made to other units, such as SWOT analysis
Subsidies (Unit 46), Impact of external influences (Unit 47), International
Quotas and tariffs aim to reduce imports. Another approach to trade and business growth (Unit 67) and Trading blocs (Unit 70).
protectionism is to give a subsidy to domestic producers. This
involves giving financial support, such as grants, interest-free
loans or tax breaks, to exporters or domestic producers that Key terms
face fierce competition from imports. If subsidies are given
to domestic producers, this will lower prices for consumers Administrative barriers – rules and regulations (such as
because subsidies reduce production costs and increase trading standards and strict specifications) that make it
supply. This forces equilibrium prices down. If subsidies are difficult for importers to penetrate an overseas market.
given to exporters it makes it easier for home businesses to Dumping – where an overseas firm sells large quantities of
break into foreign markets. a product below cost in the domestic market.
Although government subsidies to either domestic Embargo – a complete ban on international trade – usually
producers or exporters may contravene free trade agreements, for political reasons.
there are many examples of governments using subsidies to Import quota – a physical limit on the quantity of imports
influence the flow of exports and imports. A small sample is allowed into a country.
given below. Infant industries – new industries that have yet to establish
●● In 2012 the Indian government announced that it
themselves.
would re-introduce subsidies to help boost exports of Protectionism – an approach used by a government to
textiles and engineering goods. The Indian government protect domestic producers.
proposed to hand over around $375 million of subsidies Subsidy – financial support given to a domestic producer to
to producers. The purpose of the subsidies was to revive help compete with overseas firms.
India’s flagging export industry and to help reduce the Tariffs or customs duties – a tax on imports to make them
more expensive.
widening trade deficit.
Trade barriers – measures designed to restrict trade.
●● To reduce the nation’s reliance on rare-earth imports from

China, the Japanese government promised $65 million

subsidies in 2012 to domestic businesses, the funds to
be directed to businesses that support projects to reduce
Knowledge check
consumption of rare earths. 1. State three reasons why a country might impose trade barriers.
●● In the UK a number of businesses received subsidies from
2. Explain the impact of tariffs on domestic producers.
the government to support the development of fossil-fuel
projects overseas. For example, businesses involved in oil 3. What is the aim of dumping by businesses?
exploration projects with Petrobras in Brazil were handed 4. How do import quotas reduce imports?
£528 million, while Rolls-Royce was loaned £330 million to 5. Which type of trade restriction will help to raise revenue for a
work with Russia’s Gazprom on gas power initiatives. government?
6. What is meant by administrative barriers to trade?
7. How might subsidies be used as a form of protectionism?

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Case study
US TARIFFS ON FOREIGN STEEL PRODUCERS

In 2014 the US government announced that it would counter measures based on legal reviews and discussions
impose tariffs worth several hundred millions of dollars on with the local industry, when commenting on the measures
imports of steel. The US Commerce Department imposed introduced by the US. Officials also added that steel is a
tariffs of up to 16 per cent on imports from South Korea of tariff-free item in US–South Korean trade under the WTO
steel pipe and tubes used for oil drilling. The department multilateral regime. Options that South Korea could consider
claimed that these products were being dumped in US included making a request to the WTO to adjudicate on the
markets – being sold at unfair prices. matter or press charges in a US court.
It was hoped that the tariffs would help the US steel One of the dangers of imposing trade barriers is that an
industry by raising prices and protecting hundreds of jobs all-out trade war can break out between countries, where
that had been threatened by cheap imports. Steel workers one country retaliates to the imposition of trade barriers by
in the US had been holding rallies around the country to imposing some of its own. This can lead to an escalation
urge the government to do something about cheap imports. where more counter-actions are taken and trade between
However, some industry analysts said that the tariffs nations eventually comes to a standstill. This would obviously
would only have a short-term impact. This was because be detrimental to both parties. In this case, the dispute came
of the worldwide glut of steel products resulting from the just a couple of years after the US and South Korea signed a
slowdown in the Chinese economy and the ‘softening’ of the bilateral trade agreement in 2012.
US shale gas boom.
Just after the announcement by the US, South Korea said it (a) Explain how the dumping of steel products from overseas
would take action against the US in order to protect its might impact on US steel producers. (4 marks)
exports of steel products to the country. South Korean
officials claimed that US steel producers charged higher than (b) Evaluate the possible effects of the US imposing tariffs on
market prices for their products. The South Korean trade steel imports. (20 marks)
ministry suggested it would come up with appropriate

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 70 Trading blocs
58 4.1.5
Theme 4
Key points
1. Expansion of trading blocs:
EU and the single market
●●

ASEAN
●●

●● NAFTA.

2. Impact on businesses of trading blocs.

Getting started
and Trade (GATT) and later the World Trade Organization have
Ludvik Andel owns a large motor-parts firm in the Czech promoted a multilateral approach to encouraging the growth
Republic that produces very specialised items. His business has of global trade, regional agreements nevertheless remain
been in operation for twenty years. He has always exported his attractive. In fact, whereas big international trade agreements
goods internationally and works quite closely with automobile have foundered, regional trade agreements (RTAs) have grown
companies based in Germany. in number and scope. There are now over 300 RTAs, involving
Between 2004 and 2014, 13 countries joined the European countries all over the world.
RTAs are made between two or more countries within a
Union (EU), including the Czech Republic, Estonia, Poland
geographical region, and are designed to facilitate trade by
and Croatia. By joining the EU these countries were able to
bringing down barriers. These arrangements include several
participate in the EU’s single market. This meant they could
varieties of agreement as the level of integration increases.
enjoy the lack of tariff barriers and customs procedures between
RTAs create trading blocs. A trading bloc is a group of
member countries. By co-ordinating product regulations, trade countries that have signed a regional trade agreement to reduce
between countries is easier. Additionally, because of the EU or eliminate tariffs, quotas and other protectionist barriers
having a strong presence globally, trade to other countries between themselves. These countries play a very big role in
outside the EU is also easier. shaping patterns of business expansion. Trading blocs can take
a number of different forms.

Preferential trading areas: Preferential trading areas (PTAs)

allow certain types of products from participating countries
to receive a reduced tariff rate. This is the beginning of the
process of economic integration and a PTA may become a free
trade area over time. In fact, this increasing integration is one of
the goals of GATT. The Association of Southeast Asian Nations
(ASEAN) has a PTA with China, for example.

Free trade areas: A free trade area (FTA) exists where

member states remove all trade barriers, such as tariffs and
import quotas, between themselves, but each member state
keeps different barriers against non-member states. However,
What do you think the Czech Republic joining the EU meant for within FTAs, taxes and excise duties may be different. The North
Ludvik’s company? What do you think the benefits are for him now American Free Trade Agreement (NAFTA) is an example of an
of doing business with companies in Germany? Do you think there FTA. It is essentially a PTA, but with much greater depth and
are any benefits for the companies in Germany as well? scope in its tariff reductions.
In order to protect the region, countries may use a
system of allocating certificates, known as rules of origin,
The expansion of trading blocs whereby a defined amount of a product or service must be
Just as people generally prefer to shop close to where they certified as being created within that region. Consequently,
live, countries also prefer to trade within their geographical when a product enters Canada from the US, it must come
region. It is cheaper to transport goods shorter distances, so with a customs invoice that certifies where the product
logistics costs will generally be lower. Moreover, cultural ties came from. Free trade agreements may also impose
and familiarity with nearby markets reinforce regional trading additional qualifying rules for members, such as minimum
preferences. So even though the General Agreement on Tariffs content or value requirements.

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Customs unions: A customs union is similar to a free trade Single market: A common market is considered to be the
area, except that the members adopt a common set of barriers starting point for the creation of a single market, whereby
against non-members. This means that when a product is almost all trade barriers between members have been
shipped from outside the union to any of the member states, removed and common laws or policies work to make the
only one set of rules regarding customs duties and rules of movement of goods and services, labour and capital between
origin will apply. Moreover, the product can then be moved countries as easy as the movement within each country.
freely throughout the countries within the union. Borders, standards and taxes are harmonised as much as
An example of a customs union is CARICOM, or the possible, so as not to interfere with the commerce between
‘Caribbean Community’, which includes 15 nations and members. The EU is a single market, but it is also an economic
dependencies (colonies). It was created to co-ordinate economic and monetary union (see below).
policies and promote integration to encourage development, and
is trying to mirror the stages through which the EU developed. Economic unions: An economic union is a type of trade bloc
involving both a customs union and a common market. Its aim
Common markets: A common market is much more is normally closer economic, political and cultural ties between
integrated than free trade arrangements or customs unions member states. Where an economic union involves a common
since goods, labour and capital can move freely across the currency it is called an economic and monetary union. The
member states. Tariffs are generally removed and non-tariff EU is one of the few fully operating economic and monetary
barriers eliminated, or at least reduced. Workers can relocate unions, but there are ongoing attempts to create others, such
from one country to another without restriction. All of this as Mercosur and the Economic Community of West African
integration means that the members of a common market must States (ECOWAS).
work together on economic and political policies that affect the Table 1 distinguishes between the various forms of
market. Examples of common markets include ASEAN and the integration involved in the formation of trade blocs.
Southern Common Market (Mercosur) in South America.

Table 1 Integration and trading blocs

Integration Common external tariff No internal trade barriers Free movement of goods, Common currency
labour and capital
Preferential trading area (lower tariffs on certain
products)
Free trade area x
Customs union x x
Common or single market x x x
Economic and monetary union x x x x

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Trading blocs Unit 70

This unit focuses on the impact on businesses of three main trading blocs – the EU, ASEAN and NAFTA. Some information on each
of these is shown in Table 2 and Figure 1.

Table 2 Trading bloc data for the EU, ASEAN and NAFTA–2015
Region Group Member countries Date of Type of agreement
formation
Europe EU Austria, Belgium, Bulgaria, Croatia, Denmark, France, Finland, Germany, Greece, 1993 Economic union
Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, the UK, the
Czech Republic, Poland, Romania, Hungary, Slovenia, Slovakia, Estonia, Lithuania,
Latvia, Cyprus, Malta
Southeast Asia ASEAN Indonesia, Malaysia, Philippines, Singapore, Thailand, Brunei, Cambodia, Laos, 1967 Free trade area
Myanmar, Vietnam
North and Central America NAFTA Canada, Mexico, US 1994 Free trade area

Figure 1
A map showing the EU, NAFTA and ASEAN trade blocs

Key

NAFTA
EU
ASEAN

Question 1
Mercosur, or the Southern Common Market, is a customs union of production among member states, sets a common external
and trading bloc comprising Argentina, Brazil, Paraguay, Uruguay tariff and trade policy for non-member states, co-ordinates policies
and Venezuela, with Bolivia, Chile, Columbia, Ecuador and Peru as affecting competition between the member states (for example,
associate members, and Mexico and New Zealand as observers. taxes, trade, monetary systems, customs, transport, etc.) and a
Although Mercosur originated in 1991, its creation and operation has commitment to continuing integration.
not been straightforward, because of the political difficulties of many of Source: adapted from the Financial Times, 1.4.2014. All rights
its member countries. For instance, Paraguay was suspended in 2012 reserved.
after the ousting of its elected president and Venezuela’s political
and economic problems have raised concerns over its membership. (a) Explain what is meant by a trading bloc, using Mercosur as
an example.
However, the trading bloc has contributed to a substantial increase
(b) Explain one reason why a business operating in Brazil might want
in trade between most of the members, with Brazil and Argentina
to recruit workers from Argentina rather than the UK.
accounting for just under half of the total. The Southern Common
Market allows for free movement of goods, services and factors

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 Global business

The European Union and the ●● e-commerce

regional sourcing.
single market ●●

The AEC is a very ambitious plan. In early 2015 some

The European Union is the most powerful trading bloc in the
countries appeared ready to move to a fully integrated system,
world. Its first foundations date from 1993, and the trading bloc
including Singapore, Thailand, the Philippines, Malaysia,
has expanded from the six founding members to 28 countries
Indonesia and Brunei, while others, such as Cambodia,
today. The Single European Act of 1987 supported internal
Vietnam, Laos and Myanmar (Burma), lagged a little behind in
liberalisation, but barriers to cross-border trade continued to
eliminating tariffs.
exist, and deeply rooted national cultures slowed the process.
After gradual integration and consolidation, the European Union NAFTA
emerged with the Maastricht Treaty in 1992, although with it has The North American Free Trade Agreement (NAFTA) – see Figure
come a great deal of controversy. 1 – dates back to 1994 and pulls together Canada, Mexico and
The EU developed a single market. The single market the United States in a free trade zone. The agreement covers
guarantees the free movement of people, goods, services and trade and investment, labour, financial dealings and intellectual
capital throughout the member states, as well as harmonising property as well as common environmental issues. Members
laws, policies and regulations in key areas. A monetary union agree to eliminate tariffs on most manufactured goods and to
was completed in 2002, further integrating most of the treat investors from the other two countries as if they were
European economies. Consequently, businesses operating domestic investors.
in most European countries are able to move and compete However, as is normal with a free trade agreement, the
equally in all other countries, operating to similar standards members do not share a common external trade policy, nor do
and processes, and paying in a common currency, the euro. they have any provision for co-ordinating exchange rates. Thus
Once goods enter anywhere at an EU border, they cannot be the US, Mexico and Canada still negotiate independently with
subject to customs duties, taxes or import quotas as they are non-NAFTA countries, organisations and trading blocs over the
transported throughout the bloc. The same general principle rules that govern their trading relationships.
applies to the movement of people and the purchasing of As a free trade area, NAFTA does not aspire to the level
property (including shares in companies). of integration of the EU. Nevertheless, its operation elicits
However, this process has not been straightforward and is concerns over sovereignty. The United States, with a GDP ten
not yet fully complete. As at 2015, not all European countries times the other members, is clearly the dominant power, raising
belong to the union, including Iceland, Norway, Liechtenstein issues of dependency for Canada and Mexico. In an effort to
and Switzerland (see Figure 1). Nor did all sign up to a single address this, the members signed up to a dispute resolution
currency: the UK, Denmark and Sweden decided not to join the system designed to balance out the rights and obligations of
euro and have kept their own separate currencies. Moreover, each member. Nevertheless, this system has been criticised for
most European countries remain culturally distinct, having being weakly enforced.
separate languages, customs and religions, and integration into NAFTA has been beneficial to US and Canadian consumers
the EU does not appear to be changing this over time. through the lowering of prices for agricultural products. Sellers
in each country have benefited from the larger and more diverse
ASEAN free trade agreement markets on offer, and producers from the lower-cost locations
South East Asia is a very diverse region: economically, politically
closer to home.
and culturally. According to its charter, the Association of
However, some believe that the agreement has been bad for
Southeast Asian Nations (ASEAN) was established in 1967 to
Mexico, and especially its farmers. Since joining NAFTA, overall
promote growth, social progress and socio-cultural evolution
economic growth has not increased significantly, real wages
among its members. It also aims to promote regional peace and
have declined and unemployment has increased. Although
stability. The associated free trade area covers a population in
this economic weakness may be due to many factors beyond
excess of 500 million and continues to expand in a piecemeal
NAFTA’s influence, the flood of heavily subsidised corn from
fashion: it has also completed free trade agreements with China,
the US clearly caused problems for Mexican farmers. When
Korea, Japan, Australia, India and New Zealand.
the lower priced corn first entered the market, it was a boon
ASEAN has an agreement covering trade in goods as well
to Mexico’s consumers, who could buy cheaper flour for their
as one relating to customs, which are part of a drive to create
staple food, tortillas. However, the competition drove many
a common market to be known as the ASEAN Economic
poor, small farms out of business. The US government then
Community (AEC). As a common market, it will promote the
began to encourage the manufacturing of ethanol, a ‘green’ fuel,
free flow of goods and services, investment, labour and capital.
and corn was diverted to this new use. The supplies of corn to
Areas of co-operation include:
Mexico dried up and yet the farms that used to grow it no longer
●● macro-economic and financial policy
existed and so there was nothing to fill the resulting shortage.
●● labour policies, including education and professional
Consequently, the price of corn rocketed and the Mexican
qualifications
consumer suffered.
●● infrastructure and communications

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Trading blocs Unit 70

Factors to consider in trading blocs from a firm’s perspective, NAFTA allows it to conduct business
There are four key factors to consider in trading blocs. in the US, Mexico and Canada, so long as it meets certain rules
●● Where to produce. A company may be able to locate in
relating to content, labour standards, safety requirements and
a neighbouring country where the costs of land, labour or environmental regulation. Prior to NAFTA’s formation, many US
capital are most favourable to it, and then ship goods and and Canadian producers looked to South East Asia or China
services to other members. for lower-cost production sites for building a new factory. With
●● Where to sell. Companies may view a trading bloc as
the free trade agreement, Mexico’s lower-cost labour force and
one big market for their goods and services. This can proximity made it a viable alternative. Firms such as IBM and
present opportunities, but also threats. For example, Gap moved their production to Mexico, where manufacturing
with the creation of NAFTA, many Mexican retailers were costs were competitive and delivery faster.
driven out of business by big American and Canadian
firms, including Walmart. Drawbacks for business: On the other hand, existing
●● How to enter a market. The market entry strategy may
businesses within a trading bloc, or those seeking to locate
be adapted according to the opportunities presented by the in a country within the trading bloc, could face drawbacks
free trade areas or common market, and can range from and problems.
●● Trade blocs may actually harm overall trade because countries
new investments through to joint ventures and mergers.
●● Business strategy. A business may not have been able to
outside the region may be better placed to specialise or
export to a neighbouring country because of the existence develop a competitive advantage in a product or service, and
of trade barriers. Once these barriers are negotiated away yet they are closed out of the market. Thus, blocs may lead
as part of a trade agreement, they may be able to do so. For to trade diversion rather than trade creation. For example,
instance, once fully operating, the AEC should encourage Indonesia may produce a crop more cheaply than countries in
firms from Vietnam to increase trade with Malaysia. the EU, but the EU’s agricultural subsidies and abolition of tariffs
may make the price of the Europe-produced crop artificially low.
Impacts on businesses of trading blocs ●● Inefficient producers may be protected from competition,

Trading blocs are likely to create both opportunities and thereby diverting trade away from more efficient producers
drawbacks for businesses. and potentially harming consumers. For example, less
efficient producers within regions may lobby for protection,
Opportunities for business: Businesses may be able so that they do not have to reform and compete.
to benefit in a number of ways and there might be certain ●● The overall benefits may turn out to be small if an agreement

opportunities that result from operating within a trading bloc. limits the goods/services that are traded.
●● Freeing regional trade may allow individual members ●● Locally, some of the benefits may be distributed unequally,

to specialise in line with their country’s comparative causing political and social tensions within the region.
advantages. ●● Globally, the benefits accrued inside the bloc may lead to

●● The market for firms’ goods and services should tensions with other regions, leading to possible retaliation,
increase. Since trading blocs often do more than reduce further harming global trade.
tariffs – they also often improve capital flows, streamline ●● Members of RTAs, especially those in free trade agreements,

regulations and improve competition – they may actually may have differing levels of economic power, causing long-
improve the market for non-members as well, even if not term economic and political imbalance, and potential conflict.
by as much as for members. ●● For smaller organisations, opening up competition and the

●● As the volume of trade increases within the region, large market may result in more competitors. This can put
producers are able to benefit from economies of scale; this pressure on their pricing strategies, since larger producers
leads to lower costs for them and usually lower prices for may be able to produce at a lower cost in a better location.
consumers. Small firms often fear the consolidation of a trading bloc
●● Resources may be easier to source and labour easier to and the competitive changes in the market place that it
recruit, while production and transport costs may continue brings.
to fall.
●● As trade increases, it may result in greater competition and
Exam tip
thereby more efficiency in the market. Although you should be aware of the three main trading blocs (the
●● Trading blocs may also provide a counter-balance against EU, ASEAN and NAFTA), a detailed in-depth knowledge of each is
globalisation, protecting industries in an area against not required. However, you could be asked to explain and assess
predatory competitors from more economically powerful the opportunities and problems for (a) a business located within a
regions. Moreover, being part of an RTA may give regions trading bloc member country or (b) a business that aims to sell
into a trading bloc from a country that is not a member. The
the power to negotiate for better deals in the global market.
Eurasian Economic Union, in ‘Thinking bigger’ at the end of the unit,
Thus for large, well-placed firms, trade blocs offer new suggests certain benefits (free movement, co-ordinated policy
potential markets as well as the prospect of higher efficiency and improved ties and relations), but also possible drawbacks
and productivity through larger factories, lower overheads, (trade diversion from other countries) for businesses operating in
and faster and possibly less costly logistics. For example, the bloc.

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Question 2 Key terms

BWD Entertainment is a UK-based media company. Originally Common market – a market where goods, labour and
a magazine company, it has diversified into radio and trade capital can move freely across the member states; tariffs are
newspapers, and also runs a book publishing business. In the generally removed and non-tariff barriers eliminated, or at
2000s, it acquired stakes in magazine publishing companies in least reduced.
Spain, the Netherlands and Italy, and owns radio companies in Customs union – a union where member states remove all
both Germany and France. trade barriers between themselves and members adopt a
common set of barriers against non-members.
The directors of the company recently completed a strategic Economic and monetary union – an economic union that
review and decided to target Croatia as an entrant to the EU in uses a common currency.
2013. The directors felt the Croatian economy was likely to grow Economic union – a type of trade bloc involving both a
at a faster rate than the EU average over the next 10–20 years customs union and a common market.
and this should give scope for increasing sales over time. Free trade area (FTA) – a region where member states
One strategy would be to buy an established Croatian magazine remove all trade barriers between themselves, but each
company and use its editorial expertise and distribution system member state nevertheless keeps different barriers against
to push a number of new magazines based on ones which have non-member states.
proved popular in the UK, Spain and Italy. A different strategy Preferential trading area (PTA) – a type of trading bloc
would be to buy a Croatian magazine company which already where certain types of products from participating countries
had strong market share. By giving new finance, BWD would receive a reduced tariff rate.
allow the existing Croatian management greater opportunities Regional trade agreement (RTA) – agreement made
between two or more countries within a geographical region,
to launch new magazines aimed at the local market. A third
which is designed to facilitate trade by bringing down
possible strategy would be to set up a company from scratch,
barriers.
recruiting editors and other workers from established Croatian
Rules of origin – a system of allocating certificates whereby
magazine companies, but also putting in staff from existing
a defined amount of a product or service must be certified
BWD operations in other European countries. This would as being created within that region.
probably be the highest-risk strategy. Single market – a market where almost all trade barriers
(a) Explain why there might be greater scope for marketing between members have been removed and common laws or
magazines in Croatia than in, say, the UK or Italy over the next policies aim to make the movement of goods and services,
ten years. labour and capital between countries as easy as the
(b) By considering the possible advantages and disadvantages of movement within each country.
each of the three strategic options, discuss which is likely to be Trading bloc – a group of countries that has signed a
the most successful for BWD. In your answer, identify what other regional trade agreement to reduce or eliminate tariffs,
information would be needed to make an informed choice. quotas and other protectionist barriers between themselves.

Links Knowledge check

Trading blocs can have a great effect on the selling and trade 1. Name four trading blocs.
patterns or businesses that sell within countries that are
2. Briefly explain why there has been an expansion in
members, and also on businesses selling from a country that
trading blocs.
is not a member. You could use this to consider why businesses
have chosen to relocate operations globally (Unit 73) or enter 3. How important are preferential trading areas?
into mergers (Unit 74) and the effect on globalisation (Unit 68). 4. What impact do trading blocs have on business?
You could also consider how selling into countries that are part
5. What are the drawbacks of trading blocs on business?
of a trading bloc could affect a business’s view of that country
as a market (Unit 72). 6. What impact might EU enlargement have had on a) a farmer
in Norfolk and b) a shoe manufacturer in Northampton?
7. Explain how a UK manufacturer might be at a competitive
disadvantage because the UK does not use the single
currency.

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Case study

TOYOTA’S EUROPEAN facilities throughout Europe. This expansion strategy was

designed for the EU as a whole, rather than for individual
EXPANSION European countries. Thus, once Toyota decided to produce
in the EU, it could locate its operations in the lowest-cost
area. So rather than go to Germany, where labour cost
$40 per hour, it chose to go to Poland and the Czech
Toyota began selling cars in Europe in 1963, but through Republic, where the wages were much lower. Moreover, it
very limited distribution agreements. After the Second could continue its expansion through joint ventures with
World War, the Japanese government and the European European firms, so as to take advantage of existing supply
Community (EC, the EU’s predecessor) negotiated an and logistics networks.
annual quota as to how many cars could be shipped to the The best-selling Yaris, Corolla and Avensis models were
EC market. This protectionist arrangement was in place to all designed and built in Europe, at facilities located to
help support European car makers after the war and then take advantage of lower-cost wages or other efficiencies,
during the transition to a full economic union. It meant and the Avensis was even exported to Japan. The Prius,
that Japanese cars were relatively rare in the European an innovative and environmentally friendly hybrid, was
market, and expensive to market or to accurately price. European ‘Car of the Year’ in 2005. By 2006, with a net
Moreover, the difficulties in obtaining parts and servicing worldwide income of around $14 billion, Toyota had
meant that the cars were less attractive than they might become the second largest producer of cars in the world, as
otherwise have been to the average consumer. However, well as the most profitable. Although there was a need for
in 1999 the EU lifted the import quota and opened up a global recall in 2010, Toyota’s presence in the European
the market to allow Japanese auto companies to expand market has continued to grow, as have its profit margins.
distribution, invest in design and manufacturing facilities, Toyota has staked much of its future growth on hybrid
and spend more on marketing to specific European tastes. models, with sales growing by 20 per cent in 2014.
By 2002, while its competitors were struggling with Reproduced with permission from Toyota (GB) PLC.
restructuring or consolidation, Toyota had become
extremely competitive in the European market, and had
even more ambitious expansion plans for the future. In (a) Explain how the change in the EU trading arrangements
order to take advantage of economies of scale and to limit affected Toyota. (4 marks)
external currency risks, Toyota decided to move towards (b) Explain one reason why production costs may have
local procurement and production. Given the downturn fallen. (4 marks)
in the European economy, some saw Toyota’s strategy as
(c) Assess whether, without the changes in the system
over ambitious, but Toyota’s planning was for the long
surrounding import quotas, Toyota could have successfully
term, so as to be ready when the economic upturn came.
expanded into the European market. (12 marks)
In terms of strategy, rather than taking a limited export
approach, it established full design and manufacturing

Thinking bigger
On 1 January 2015 a new trading bloc ‘opened its doors’. Russia, free transit of goods, services, capital and workforce, and will result in a
Belarus and Kazakhstan signed a treaty in 2014 formally creating co-ordinated policy for key economic sectors.
the Eurasian Economic Union. Armenia and Kyrgyzstan followed, The trading bloc was devised as the cornerstone of what will become
officially becoming part of the bloc in early 2015. Whether this will the Eurasian Union and include more former Soviet states. Mr Putin
stand the test of time is a key question, especially as a trade war hopes the bigger bloc will one day stand on equal economic footing
seemed to emerge in April 2015 between Russia and Kazakhstan. with the US, the EU and China, and serve as a counterweight to what
Political observers have stated that the signing of the treaty, years in Russia sees as the West’s growing influence in former Soviet states.
the making, was part of a continuing effort by Mr Putin to create an
independent economic force led by Russia. Russia’s efforts to form the union have included pressure on its
neighbours to shun seeking economic integration with the EU instead,
The creation of the bloc, which has a combined $2.7 trillion economy most notably Ukraine. Kiev had been in talks for years to join the
and vast energy resources, deepens ties among the three countries that Eurasian Union, then opted for a trade pact with the EU instead.
began with the creation of a customs union in 2010. It guarantees the
Source: adapted from the Financial Times 08.01.2015. All rights reserved.

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 71 Conditions that prompt
58 4.2.1
Theme 4

Key points
trade
1. Push factors:
●● saturated markets
●● competition.
2. Pull factors:
●● economies of scale

●● risk spreading.

3. Possibility of off-shoring and outsourcing.

4. Extending the product life cycle by selling in multiple markets.

Getting started Conditions that prompt trade

International trade has been vital for the UK economy since
The rock crystals of pure, unadulterated salt, which formed in pre-historic times. As an island, the UK must import supplies
a saucepan 19 years ago in a family home near Anglesey, led of raw materials to use in making many products. But the UK
to the creation of a staple condiment in the kitchens of most has also exported them. For instance, thousands of years ago,
upmarket restaurants, and on the shelves of high-end stores Bronze Age miners were excavating copper from Great Orme
and supermarkets such as Harvey Nichols, Waitrose, Fortnum in Wales and objects made from the ore have been found at
& Mason and Marks & Spencer, and not just in the UK – it archaeological sites throughout the Mediterranean. The Anglo
is exported to more than 20 countries across the globe. It is Saxons were heavily involved in international trade. In the
claimed that US President Barack Obama is a fan. Halen Môn 8th century, glass was imported from Gaul, and iron as well
also seems to have the endorsement of many celebrity chefs in as cheese was exported to Flanders. However, the industrial
the country: from the Two Fat Ladies (the late Clarissa Dickson revolution acted as a catalyst, prompting an explosion in
Wright and the late Jennifer Patterson) in the late 1990s, to international trade that has continued to this day.
Delia Smith and Heston Blumenthal today. Innovation and the entrepreneurial spirit provided the
impetus to trade that led to the UK dominating the world
David and Alison Lea-Wilson started their business in 1996. economy throughout the 19th century. Britain exported pumps,
They make hand-harvested sea salt using water from the steamships, railway locomotives and textile equipment. It
Menai Straits. They dry the salt, season it and pack it. Forty per influenced the development of railway systems throughout
cent of all the salt they produce is exported. With the help of a the world, as well as the building of dams and canals. As a
Welsh Government grant they attended a trade fair in Ireland consequence, the UK also became a leader in international
where a US firm was impressed by the product. They now and domestic banking. It is no surprise that successive UK
sell to most of Europe and as far as Australia. One of the key governments after 1840 preached free trade and advocated no
factors has been the popularity of their salt with chefs. Halen tariffs or quotas. In 2013, the UK was the fifth largest national
Môn has also joined the ranks of champagne, parma ham and economy and second largest in Europe as measured by nominal
Melton Mowbray pork pies by being awarded protected food GDP. In recent years the UK has been the fourth largest exporter
name status by the European Commission. The owners feel in the world with exports of £334 billion, and remains one of
that Halen Môn’s success is due to the purity of the product the world’s most globalised economies. The financial services
and the simplicity in which it is refined. They don’t boil up sector is particularly important, with London being the world’s
the seawater on the cooker any more and there has been largest financial centre. The pharmaceutical industry is another
significant investment in carbon filters and heaters, but is still major exporter. Alongside this, the UK was also the fifth largest
hand-harvested and each packet has the harvester’s initial on. importer in 2013.
There are many conditions that promote trade. On one
The above example shows how it is possible to build a business level there are economic factors such as the impact of being a
from a kitchen to trading successfully around the world. Why do member of the European Union, but there are also the creative
you think David and Alison were successful? To ensure future and entrepreneurial drives to seek new markets that dominate
long-term growth, what do the Lee-Wilsons need to consider? the push for trade. These are facilitated by a skilled workforce
Explain your answer. that contributes by providing high-quality goods and services
that are in demand.

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Conditions that prompt trade Unit 71

Although the politics and economics of free trade will never Seph’s Gourmet Popcorn looked for a different market abroad. It
be straightforward, trade has continued to expand and many experimented with 30 classic British flavours and its own secret
consider that we have a ‘global consumer culture’ stretching production process. It found that flavours such as strawberries
around the planet. Regardless, businesses see expanding into and cream, and cheddar cheese were popular with foreign
international markets as an opportunity to find new resources consumers. In 2015 it sold in over 1,000 retailers in countries
and markets for their goods, as well as producing their goods including Australia, Qatar, Saudi Arabia and Switzerland.
and services at a lower cost, thereby making them more money
or extending the life of their products or services. Question 1
Firms may be motivated to go abroad for many reasons.
James Dyson designed and produced his first vacuum cleaner
One way this can be categorised is to divide them into ‘push’
in 1983. His appliances were double the price of existing
factors, where firms are seeking opportunities, or ‘pull’ factors,
where a market overseas holds a particular attraction. brands, but of innovative design and very high quality, and they
sold well. All production was done domestically, and Dyson
Push factors established a research and development centre in England in
Push factors are adverse factors in the existing market that 1993. Nevertheless, the Dyson company did not make enough
encourage an organisation to seek international opportunities. money. The reasons were many. UK employment costs were
They force a business to seek overseas markets in which to high relative to Dyson’s competitors; the pound was strong,
sell their products. A firm may be attempting to overcome making exporting expensive; logistical costs were high and
weaknesses in its existing markets or looking to lower its the factory was not large enough to optimise economies of
costs. Push factors include saturated markets and competition. scale. So when the company was refused planning permission
Competition may drive prices down due to lowered costs, to expand the factory, Dyson decided he had no choice but to
or there may be declining demand for a product, due to move production abroad.
changes in tastes, availability of substitutes or superseding
technologies.

Saturated markets: A saturated market is one where most

of the customers who would buy a particular product already
have it, or there is limited remaining opportunity for growth
in sales. For example, a cycle manufacturer may have limited
opportunities to sell in countries where cycling is very popular.
However, it may be able to find a new market in a country
where the sport is just taking off. For example, most people in
the UK own mobile phones, all of which have the same basic
functions. In order to increase sales, the firms in this saturated
market need to either differentiate their products within the
home market, or sell their product in a market where there is
still a demand for it.

Competition: A rise in competitors or a high level of

competition in the domestic market may force a business to
Dyson chose Malaysia as a location for a giant new factory, near
sell abroad. Competitors could be selling similar products
to where the majority of his suppliers were located, as well
at a lower price or a higher quality, which may make selling
as many of the new markets for Dyson’s products. Malaysia’s
the original product difficult or unprofitable. Taking the same
overall costs of production were also far lower than those of
example as above, the market for mobile phones is highly
competitive: Apple, Samsung, Nokia, HTC, Blackberry and
the UK, meaning the firm could lower costs and improve profit
Sony are just a few of the many providers. Where all of the margins. By 2015, these profits had allowed Dyson to begin
brands are able to compete in a market, the businesses expanding the research and development centre back in the
will be forced to differentiate their products or to move to a UK, invest £12m at Imperial College London for a school of
market where the competition is less fierce for reasons of engineering, and create new and innovative products.
price, quality or novelty. Sources: adapted from the Financial Times, 22.03.2015,
Faced with competition in its domestic market, a business 10.04.2015. All rights reserved.
may be forced to look at markets abroad. This may involve
changing the product to meet the tastes of those consumers. (a) Explain one push factor that affected Dyson’s decision to move
his production abroad.
For example, many people enjoy popcorn when at the cinema.
It is often sold as sweet or salted in cinemas in the UK. It is also (b) Assess Dyson’s decision to keep his research and development
sold in supermarkets. However, in 2010 UK manufacturer Joe & centre in the UK.

432
 Global business

Pull factors Possibility of off-shoring and outsourcing

Pull factors entice firms into new markets. They are the Put simply, off-shoring is shifting jobs to other countries, while
opportunities that businesses can take advantage of when outsourcing is shifting jobs to other organisations.
selling into overseas markets. There are many pull factors, and
those that are the most important to a firm depend upon the Off-shoring: Off-shoring involves moving manufacturing or
nature of the business and the current state of its home market. service industries to a location with lower costs. A classic
However, the following lists many common attractions. example is the relocation in the 1980s of many call centres from
●● New or bigger markets. the UK to India, where well-educated workers speaking good
●● Lower-cost or secure resources, such as minerals, land English were employed on a lower wage and for longer hours
or labour. than British workers. It follows, therefore, that a firm may off-
●● Lower cost of transportation. shore in order to:
●● Technological expertise, including research facilities. ●● reduce costs

●● Managerial or financial expertise. ●● hire workers with particular skills.

●● Organisational skills. Moving jobs to other countries can be controversial,

●● Assets, such as brands, patents or other intellectual property. especially where a lot of jobs are lost in the home country.
A firm may be enticed by these factors since they may help it This could potentially damage a firm’s reputation. Other risks
to achieve economies of scale or to spread its risks. may also emerge, such as complications caused by language
or cultural differences, as well as any political, economic,
Economies of scale: Economies of scale occur where technological or intellectual property risks associated with the
increasing the scale of production leads to a lower cost per unit of host country. Some firms, focused on reducing costs, don’t
output. Put simply, increasing size or speed increases efficiency realise that off-shoring can actually fail. The process may
and lowers costs. Unit 67 described Adam Smith’s pin production increase management costs, reduce efficiency or quality, expose
and how division of labour can lead to more units being produced firms to corruption and loss of intellectual property – and even
in a shorter period of time. Likewise, if a factory were to increase end up as too expensive to continue.
its size, many of its fixed costs would decline relative to output.
The firm could buy supplies in bulk, usually at a discount. It could Outsourcing: Outsourcing involves moving an entire business
apply relatively expensive technology to automate its processes function or project to a specialist external provider. For instance,
and train its workers in ever more specialist tasks. However, many large firms have outsourced their information technology
bigger is not always better. Beyond a certain size, unit costs can and payroll functions, while others have shifted human
rise and resources can be spread too thinly. resources, accounting, supply and logistics, and transportation.
As seen in Question 1, a push factor for Dyson’s decision to In general, a firm might outsource for similar reasons to off-
go abroad was the fact that the company was refused planning shoring, to:
permission to expand its production facility in England. This ●● reduce costs

meant that it could not achieve the scale efficiencies needed to ●● specialise areas of the business

compete against the increasing number of lower-cost foreign o to focus on the core competences of the business rather
competitors that it was facing in the UK. So a push factor was than the support functions
that it needed to find a place to build a big, new and highly o in order to improve speed, flexibility or quality
efficient factory. Malaysia offered such a location and its many ●● comply with rules or regulations.

attractions were a pull factor for Dyson. Shifting jobs to other organisations does have risks, but
is often less controversial than off-shoring. Reliance on third
Risk spreading: Risk and how to mitigate it were addressed in parties can leave a firm vulnerable through loss of expertise or
Unit 65 in the context of scenario planning. One way of defining knowledge. In addition, the parties’ interests may not remain
risk is the probability of a (bad) event happening multiplied by aligned, so that the efficiencies sought by shifting the jobs are
its (negative) impact. This can range across financial, strategic, not as great as expected. Poor communication issues can be
operational and hazard-related risks. Where they can be disruptive and indirectly expensive to the business.
recognised and quantified, risks can usually be insured against.
Where they cannot, they pose a threat to a firm’s strategy and Labour productivity: Firms often cite ‘cheaper’ labour as
need to be addressed. a pull factor, but this is not a good way to describe the quest
By expanding into other countries and markets, a firm may be for lower labour costs. For a business, it is not simply that a
able to limit the various risks that it faces. For instance, over- worker can be paid a lower wage, but rather that each worker
dependence upon one market may leave a firm vulnerable in the costs less per unit of output that they produce. This is known
short term if that market faces an economic challenge, such as as labour productivity. This is defined as the amount of goods
a recession, where growth slows and perhaps people lose their and services produced by one hour of labour. Many factors
jobs. Or, for example, in the long term, a region characterised may affect the productivity of a worker. These include skills and
by a rapidly aging population may not be a viable place for a qualifications, working conditions and technological support, as
business that sells mainly to the under-30s. Expanding abroad well as rules and regulations.
may help a firm to minimise the impact of such risks upon its
overall profitability.
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Conditions that prompt trade Unit 71

Question 2 to reduce costs, allowing the firm to increase margins. Or it could

explore selling to new markets. A product that is in a mature stage
in one market may be at an introductory stage elsewhere, and so a
firm can sell a product in the new market and extend its life cycle.
For example, the Apple iPod was launched in 2001 and
went through many changes to remain competitive with new
technologies, music streaming, fashion and changing tastes. By
2009 sales had begun to decline. By outsourcing production,
adding new uses and variations, Apple extended the life cycle of
the iPod, though in 2013 it ceased introducing new models.
When extending the product life cycle into international markets,
a firm has to make a decision as to whether to modify or adapt
the product for the new markets, or whether to standardise the
product for global use. Also, it is worth noting that the life cycles
of products can vary considerably. For example, fashion items or
highly innovative technologies may have very short life cycles, while
In 2013, the US Federal Aviation Administration grounded all of luxury goods and precision watches may have very long ones.
Boeing’s brand new 787 Dreamliners because of the possibility
that their lithium-ion batteries would overheat and catch fire. This Thinking bigger
was one of many problems plaguing the new plane and critics The product life cycle has been used by firms as an instrument of
attributed this to the fact that 30 per cent of its construction had competitive power and it remains as the hub of the marketing strategy
been outsourced, as opposed to 5 per cent of previous models. of many firms as they maximise product lines along the bell-shaped
The suspect lithium-ion batteries were made in Japan, and it was curves. Why then do some products ‘defeat’ the curve? Business writers
talk about repositioning products so that they are ‘rescued’. They add
not until after changes were made to the batteries to contain the new attributes, sell in multiple markets and can convince customers that
fire risk that the planes were again allowed to fly. However, the a new offering is different.
problems were more complex than just faulty parts. Because there It is useful to reflect on why a brand such as Kit Kat, introduced by
were so many components coming from different countries, it was Rowntree’s in York in 1911 and relaunched in 1935, is still the number
difficult to monitor all of them for quality or to correct flaws during one selling chocolate bar in many countries, including Japan. Reflect
the assembly process. Although outsourcing may or may not be also on The Simpsons, the animated show conceived by Matt Groening
to blame for the problems Boeing experienced, it did make the as a brand that in TV history is unique. The 27th season has started
production. The Simpsons’ positioning has had an important impact
process of quality assurance much more complex. on its progress along the life cycle. Most live-action sitcoms have a
Source: the Financial Times, 11.1.2013. All rights reserved compressed life cycle, in part because actors age. Friends exited after
a 10-year run when its stars, originally cast as 20-somethings, started
(a) Explain the difference between outsourcing and off-shoring. approaching 40. But cartoon characters are ageless (Bart Simpson
(b) Assess whether outsourcing is always in the interest of has been ten years old for a decade and a half). Just as Bugs Bunny
consumers and manufacturers. exploited the cartoon medium to stay fresh for 65 years, The Simpsons’
breakaway status has allowed the series to pause seemingly indefinitely
on the life cycle curve at a point at which live-action sitcoms usually head
into decline. The Simpsons is just as much a brand as Kit Kat. The UK has
Extending the product life cycle by some of the oldest iconic brands such as Twinings Tea (1706) and Lyle’s
selling in multiple markets Golden Syrup (1883). Why do they last?
The concept of the product life cycle was developed in the You could use this information in a variety of ways. Obviously, it can be
1960s to describe the stages in the life of a product, as used if answering questions on product life cycle and selling in multiple
explained in Unit 13. markets. It is also useful to think through why some products do last the
These stages again in brief are as follows: test of time and whether others can adopt their techniques.
●● Development. The product is researched and designed, and

a decision made about whether to launch the product. Knowledge check

●● Introduction. From the development of an original idea to
1. Outline the factors that can prompt trade.
the launch of the product on the market.
2. What are push factors?
●● Growth. When the product takes off and sales increase.
3. Explain how a market becomes saturated.
●● Maturity. When sales are near their highest but are slowing
4. What impact might competition in domestic markets have on
down.
business strategy?
●● Decline. When sales begin to fall.
5. How do pull factors entice firms into the market?
When a product has reached the decline stage, with falling
6. Describe the impact of economies of scale.
sales, market saturation and a decline in profits, a firm has to
7. Outline how exporting could limit risks.
decide whether to get out of the market for that product altogether,
8. Describe how the product life cycle can be extended by selling
or to attempt to extend the product life cycle in some way. The
in multiple markets.
firm could choose to move production to new markets in order
434
 Global business

Case study
Zara’s first foray was into the similar cultural environment

ZARA of Portugal. Between 1989 and 1996, Zara opened

stores in several European countries and Mexico, as well
as the key fashion centre of New York in 1989. The New
Founded in La Coruña in north-west Spain with its first store York expansion held risk, but also provided insight into
in 1975, Zara has become one of the largest clothing retailers competitor business models, such as Gap. After 1997, Zara
in the world. Zara is the successful brand of the multinational began a rapid phase of international expansion that has
clothing company, Inditex. Founder Amancio Ortega, one made it into a globally recognised brand. Inditex, Zara’s
of the wealthiest men in the world, has established over parent company, saw growth and then share prices soar
6000 stores since 1988 and profits exceed €2 billion a year. (see Figure 1) partly as a result of these strategies. In recent
It is unique in that it is a fashion house as well as producer years it has also moved into online trading as a new route
of most of the clothes sold in its shops. Between 1975 and
to growth – opening e-commerce operations in Russia and
1988, Zara concentrated on developing its home market. By
Canada, for example.
1988, facing a saturated market and limited growth in Spain,
Zara decided that it had to expand internationally if it was to
continue to grow. (a) Evaluate the importance of push and pull factors in Zara’s
Spain joined the European Union (EU) in 1986, and thus decision to expand in the EU. (20 marks)
gained barrier-free access to the huge European consumer (b) Evaluate the success of Zara’s expansion strategies.
market. Moreover, the 1980s were also a time of rapid (20 marks)
globalisation and converging fashion tastes. So Zara saw
many market opportunities, as well as a chance to gain
economies of scale and spread its risks.

Figure 1
Inditex, Zara’s parent company share price (2001–2014) Share price
€

20

10

0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Year
Source: adapted from www.markets.ft.com

Key terms
Economies of scale – increasing the scale of production leads are the opportunities that businesses can take advantage of
to a lower cost per unit of output. Increasing size or speed when selling into overseas markets.
increases efficiency and lowers costs. Push factors – factors in the existing market that encourage
Labour productivity – the amount of goods and services an organisation to seek international opportunities.
produced by one hour of labour. Risk – the probability of a (bad) event happening multiplied
Off-shoring – shifting jobs to other countries. by its (negative) impact.
Outsourcing – shifting jobs to other organisations. Saturation – the point when most of the customers who want
Product life cycle – the stages that many products go through: to buy a product already have it, or there is limited remaining
development; introduction; growth; maturity; decline. opportunity for growth in sales.
Pull factors – factors that entice firms into new markets and

Links
As we have touched on in this unit, extending the product life cycle this as an appropriate reason for trade. Other factors that might be
of a business can be one factor that prompts a business to trade. important are push factors such as competition (Unit 75) and pull
Unit 13 explains the stages of a product life cycle for products, and factors such as economies of scale (Unit 48).
information there can be used to help answer questions relating to

435
 72 Assessment of a country as
58 4.2.2
Theme 4

Key points
a market
Factors to consider:
1. Levels and growth of disposable income.
2. Ease of doing business.
3. Infrastructure.
4. Political stability.
5. Exchange rate.

Getting started
Factors to consider
Like China, its populous neighbour, India has long looked like Assessing a country as a market is never easy. To even begin to
an attractive market for business. With 1.2 billion people and make a decision as to whether a place is good for investment
growth in GDP (as shown in Table 1), this South East Asian requires a huge amount of research, as well as a full understanding
economy presents many opportunities for businesses wishing of the company’s competitive advantages and whether the
to invest. investment, if successful, will enhance these. Even then, many
companies make a wrong decision. There are however, some key
Table 1 India: growth in GDP as an annual percentage factors for initial consideration, and these are covered in this unit.
2011 2012 2013
India 6.6 5.1 6.9 Levels and growth of disposable income
Source: adapted from World Bank There may be many reasons a business might look to sell its goods
and services in other countries, as explored in Unit 71. However, if
However, unlike China, India has yet to fully convince an enterprise wants to sell to a customer, the customer must have
international investors that its considerable attractions can the money with which to buy that good or service. It is therefore
be offset against some aspects, still in development, that are important for a business to evaluate whether the consumers in
required for a good environment when carrying out business. a particular country currently have – and will have in the future –
When Narendra Modi became India’s prime minister in 2014 he sufficient disposable income.
promised that his government would improve the environment
for doing business. India had just been ranked 142 in the world
Disposable income: Disposable income, as briefly introduced
in Unit 4, is essentially the amount of money that a person has left
under the World Bank’s ‘Ease of doing business’ rankings and
over after they have paid their taxes, national insurance and other
this was attributed to a high level of corruption, red tape and
deductions. This remaining or ‘disposable’ income can then be
regulation that stifled investment. This was two places lower used for consumption or for saving.
than the previous year. When thinking about international trade, it is important to
India’s 2015/2016 Union Budget reforms were designed understand the average level of household disposable income in
to make India’s business environment more attractive to comparison to other countries. A business can find out about the
entrepreneurs and investors. The reforms included simplifying level of disposable income in the UK from the Office for National
regulations, streamlining infrastructure, speeding up procedures Statistics (ONS). Data for other countries may be found through
for the resolution of disputes, and instituting a single national sources such as the OECD, Euromonitor, the World Bank or the UN.
goods and services tax, to raise more revenue and help create A falling level of disposable income may mean that people
an internal market for India. Companies wishing to start a new with low incomes are struggling to pay for what they consider
business should be able to acquire land for development more a minimum standard of living, and those on higher incomes
easily and obtain all the permits for that development through a are reducing expenditure on luxuries or unnecessary items.
single portal covering all of the government departments. As a result, people will be consuming less, total expenditure
in markets may be falling and there is likely to be reduced savings.
Source: adapted from www.doingbusiness.org For example, from Table 2, we can see how the Greek consumer
Do you think these reforms and their impact might make the has suffered significant falls in disposable income every year
market more attractive to businesses looking to invest or sell between 2011 and 2014, due to Greece’s poor financial situation.
goods or services in India? What benefits to India do you think The Greek consumer now has less money to buy new cars and, as
there would be of more businesses moving into their market? Table 2 shows, is spending less money on food.

436
 Global business

Table 2 Greece’s disposable income and food expenditure Every year, the World Bank Group publishes a report
2011–2014* summarising its research into the regulatory burden that each
country places on its business. The higher the ranking, the
2011 2012 2013 2014
easier it is to start and operate a business in a country.
Annual disposable income 206,783 173,804 173,247 171,669 Table 4 shows that Singapore and New Zealand are
Consumer expenditure on 31,982 27,824 28,002 27,632 consistently at the top of the rankings, indicating that they are
food good locations for a company to consider with respect to the
*Figures in US dollars (millions) ease of doing business. On the other hand, Eritrea, South Sudan
Source: Euromonitor and Afghanistan are consistently near the bottom, making these
locations unattractive for creating and running businesses. As
By contrast, Table 3 shows the same data for the UK. noted in the ‘Getting started’ activity, India fell two places in the
The disposable income of UK consumers, already significantly World Bank’s Ease of doing business rankings for 2014, from
higher than that of Greek consumers in 2011, rose throughout 140 to 142.
the same time period. This meant that many British consumers
had more money to buy goods and services or to add to Table 4 Ease of doing business rankings 2014*
their savings.
Country Rank Starting a Dealing with
business construction permits
Table 3 Britain’s disposable income and food expenditure
2011–2014* Singapore 1 6 2

2011 2012 2013 2014 United States 7 46 41

Annual disposable 1,690,166 1,754,166 1,784,101 1,856,096 United Kingdom 8 45 17
income
Consumer 124,962 131,803 139,497 138,701 Australia 10 7 19
expenditure on food
Germany 14 114 8
*Figures in US dollars (millions)
Source: Euromonitor Malaysia 18 13 28
Mexico 39 67 108
A business looking to expand into a market wants to ensure
not only that consumers have sufficient disposable income to Greece 61 52 88
purchase its goods and services, but also that the country’s
Russian Federation 62 34 156
level of disposable income is at least steady and preferably
growing over time. If disposable income is steady or rising, and China 90 128 179
has been so for several years, it may mean that the consumers
India 142 158 184
will be able to buy a business’s products or services both
now and in the future, and may therefore make the market an Afghanistan 183 24 167
attractive one to expand into.
For example, because of the rising disposable incomes South Sudan 186 178 189
of the growing young professional class, India’s luxury goods Eritrea 189 183 189
market has been on the increase. This is not only for reasons
of fashion, because items such as jewellery and watches are Countries are ranked from 1 to 189.
*

also purchased as investments. According to Euromonitor, up Sources: adapted from World Bank and www.doingbusiness.org
to 2030 the number of Indian households with a disposable
income of between $10,000 and $25,000 will continue to There are ten indicators produced by the World Bank that
increase significantly, making India a growth market for the track the life cycle of the business from its creation to its
makers of many products and services. possible end. At each stage the potential problems that might
exist are indicated.
Ease of doing business
The ease with which a company can do business is an 1. Starting a business (number of procedures, time it takes,
important factor to consider when evaluating a country as cost and minimal capital requirements).
a potential market. If a business faces problems with its 2. Dealing with construction permits (number of procedures,
goods entering a country, setting up premises or dealing with time it takes, days and cost).
everyday trading activities in a particular country, it is likely to
3. Getting electricity (number of procedures, time it takes, days
look at alternative locations or markets. Such problems with
and cost).
the ease of doing business are likely to cause delays in sales,
increasing costs and potentially affect other parts of the 4. Registering property (number of procedures, time it takes,
business in the distribution chain. days and cost).

437
Assessment of a country as a market Unit 72

5. Getting credit (strength of legal rights, information required). Infrastructure

6. Protecting minority investors. The quality of a country’s infrastructure is an important factor
7. Paying taxes (payments per year, time, percentage of profit). in any decision to move into a new market. Customers may
have sufficient disposable income to purchase a business’s
8. Trading across borders (documents required, time to export/
goods and services. However, those goods and services must
import, cost to export/import).
still be made and delivered to the buyer, and this requires a
9. Enforcing contracts (number of procedures, time, cost as certain level of communication and adequate transportation
percentage of claim). links, for example. Many developing countries have
10. Resolving insolvency. underdeveloped and unreliable transportation infrastructure,
and this can add significantly to a company’s production
Question 1 and operating costs. For instance, there may be awkward or
inefficient entry points (airports, sea ports), few or unreliable
trains or shipping lanes, incomplete road networks or limited
warehousing facilities. A delay or failure to deliver due to poor
infrastructure can lead to lost sales and increased costs, which
can make a market less attractive to a business.
Communication infrastructure is equally important.
Many companies want to co-ordinate production, sales and
distribution, and this is best done electronically. However,
electricity shortages and limited internet coverage may mean
that such efficiencies are not practicable.
With huge oil reserves and a good location, Dubai has
used the proceeds from the sale of its oil to further develop its
infrastructure, including the following.
●● An artificial harbour for ships.

●● The Jebel Ali Free Trade Zone.

●● An information technology hub, called Dubai Internet City,

where businesses such as IBM pay no tax, have few currency

restrictions and limited regulation.
●● The ‘Dubai Ideas Oasis’ to encourage venture capital and

new business start-ups.

●● The ‘Dubai Knowledge Village’ to improve educational

In May 2014, two years after Argentina’s government seized its opportunities.
assets, Spanish energy firm Repsol left the Argentine market. It ●● Many hotels and residential complexes to make Dubai an

was reported that Repsol agreed to a settlement that was worth attractive destination for visitors.
only half of its original investment, but would nevertheless allow This infrastructure investment appears to be getting results.
it to end years of lawsuits and further uncertainty. Repsol once Dubai is one of the seven monarchies of the United Arab
owned 50 per cent of YPF, an Argentine oil and gas business, Emirates, so it is difficult to separate out its growth rate from the
but was reportedly accused of under-investing in oil production others using the World Bank statistics. Nevertheless, according
and draining the local business’s resources. YPF was originally to Dubai government statistics, foreign direct investment has
state-owned, but was privatised in 1993, allowing Repsol to significantly risen year on year since 2012.
acquire a majority stake. In 2011, oil and gas production had
fallen below the level of domestic demand, with the business and
Political stability
Political decisions and events can have a significant effect on
the government disagreeing as to the reasons why. Repsol, and a country’s business environment and can cost investors some
most market analysts, blamed government controls and red tape, or all of the value of their investment. A country with a calm
as well as price controls on domestic oil and gas that made such political climate can minimise uncertainty, which might make that
investments unprofitable. By contrast, the government reportedly country attractive as a potential market to businesses.
accused Repsol of using the money it had made in Argentina It is therefore important to evaluate the political climate
to finance expansion elsewhere in the world. Argentina re- of a country before investing and to critically assess the
nationalised YPF in 2012. potential risks. There are a few obvious issues to check for
Source: adapted from the Financial Times 07.05.2014. All rights the target market.
●● The nature of the government and its relationship with business.
reserved.
●● The nature of the government and its relationship with major
(a) Explain one reason why Repsol left the Argentinian market. international institutions, such as the United Nations, the
(b) Discuss how, when buying assets in a country, a PESTLE analysis World Trade Organization, the International Monetary Fund
could be used to identify threats to their investment. and the World Bank.

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 Global business

●● The government’s legal orientation and approach to a currency can fall in value – or depreciate – against other
regulation and taxation. currencies. In this case, if the pound was to depreciate against
●● The possible political risks that may emerge in the near the euro, it would be able to buy fewer euros. Appreciation and
future, such as elections, political vacuums, coups, terrorism, depreciation of currencies is explored further in Unit 74.
human rights issues, or protests. Changes in exchange rates can have a very large impact on a
There are also numerous risks that a business might need to business that is operating internationally. For instance, if a small
be aware of. business from the UK was planning to export its goods to Japan,
●● Instability during an election. it would want those goods to be purchased in pounds. However,
●● The emergence of political vacuums. if the pound was to appreciate against the yen, this would make
●● Increasing authoritarianism. the business’s goods more expensive to Japanese consumers and
●● Factions in government, such as when political parties split. might reduce its sales and profits. Or, if a large UK business was
●● Increasing levels of corruption. considering buying a Japanese business, it would want to buy yen
●● Threats from terrorism. to pay the Japanese shareholders for their shares. A strong pound
●● External threats (border conflicts, trade disputes, invasion) would lower the price that the UK business had to pay because it
that may cause internal power changes. would take fewer pounds to buy the required amount of yen.
It is often difficult for a business to gauge the level Consequently, a business looking to expand abroad would want
of corruption that it might face when entering a market.
Transparency International is a non-governmental organisation Worked example
established to combat corruption. Every year, it publishes
the global Corruption Perceptions Index, which measures the Assume that a car made in Sunderland costs £10,000 to
perceived levels of public sector corruption in countries and produce and sells for £12,000 in the British market.
territories around the world. It is a useful starting point for The exact same car, exported and sold in a European country,
understanding whether a country is perceived by others to be would be much more expensive in 2015 than it was in 2014
corrupt. Some examples of countries are shown in Table 5. (assuming no change in production costs).  

Table 5 Selected ranks from Transparency International’s • 2014: €12,000 × 1.2 = €14,400
Corruption Perceptions Index, 2014 • 2015: €12,000 × 1.4 = €16,800
Country Rank This may lead to a decrease in demand for the car and lower
(1=least corrupt) profit margins for the car maker. However, this will also depend
Denmark 1 on other factors, including the price elasticity of demand for the
Norway 5 model and the level of growth in the various markets where the
Singapore 7
car is sold. Moreover, it is very unlikely (as assumed above) that
production costs would remain the same. This is because some
United Kingdom 14
of the components for the car are likely to come from countries
Japan 15 that use the euro (e.g. many car engines are made in Germany
United States 17 and interior fixtures and fittings in Spain). The exchange rate
Chile 21 will therefore affect the cost of these components and thus the
South Korea 43 overall cost of making the car.
Malaysia 50 In this case, it could lower production costs – and the car company
Saudi Arabia 55 could possibly afford to lower the price of the car as a result.
South Africa 67
Brazil, Italy, Greece, 69 to think about the relationship between its home currency and
Swaziland, Romania the currency of the country or countries with which it is trading.
India 85 Furthermore, it would want to consider this relationship over
time, since currencies can fluctuate in the short run. That is, if
China 100
the pound was appreciating one week yet falling the next, the
Argentina, Indonesia, Djibouti 107 business may not be very concerned unless the overall trend
Russia, Nigeria, Lebanon, 136 was for the pound to get stronger.
Kyrgyzstan, Iran, Cameroon However, there is another side to this relationship. Suppose
Source: www.transparency.org that rather than export, a business wants to buy or build a
factory in another country. If the pound is tending to appreciate,
Exchange rate then the overall cost of the purchase or construction may
The exchange rate is the price of one currency against another. actually be lower over time and vice versa.
A currency can rise in value – or appreciate – against other To illustrate this, suppose that a UK business signs a contract
currencies. For instance, when the pound rises, or appreciates, with a Malaysian builder to erect a vacuum factory in Malaysia.
against the euro, one pound will buy more euros. Likewise, It will take two years to complete the build, but the business will

439
Assessment of a country as a market Unit 72

not pay for the factory until it is up and ready to start making Question 2
the appliances. The contract for the build states that the UK
business will pay the builder £10 million, converted to the During 2014, the pound appreciated against the euro meaning that
Malaysian currency at the 2014 average exchange rate. every pound bought more euros in 2014 than in 2013. While this was
Table 6 shows that, in 2014, it took on average 5.39 ringgits to good news for tourists heading for Spain’s or Greece’s beaches, it was
not good news for British manufacturers who export to Madrid or Athens.
buy one pound. If the cost of building the factory is £10 million,
the business will have to pay the Malaysian business 53.9
million ringgits at the end of two years. However, suppose the Figure 1
exchange rate moves against the UK business, and the ringgit £/euro exchange rate, 2013–2014
strengthens to 5 ringgits per pound. The contract says £10 GBP/per 1 euro
million, but £10 million will now only buy 50 million ringgits, so 1.05
the UK business needs to pay 3.9 million ringgits more.
Table 6 Average exchange rates of a range of currencies 0.95
against £ sterling (January 2014 to January 2015)
Country or region Currency Average of currency units needed 0.85
to buy one £
(January 2014 to January 2015)
European Union Euro 1.2 0.75
Australia Dollar 1.82
Brazil Real 3.86 0.65
India Rupee 100.64 2013 2014
Year
Malaysia Ringgit 5.39
Nigeria Naira 271.102 (a) Explain why a British manufacturer might not want the pound to
Russia Rouble 62.44 appreciate, while a British holidaymaker might.
South Korea Won 1733.92
USA Dollar 1.65
Thinking bigger
Sources: markets.ft.com and www.gov.uk The Walt Disney Company plans for massive success with its Shanghai,
China resort in 2016. Over $5 billion dollars have been spent in
constructing the largest theme park in the world. Disney expects
A business might want to protect itself from adverse movements in 25 million visitors in its first full year, drawn in by state-of-the-art
the price of currencies. It can do this in many ways, including: technology, new attractions, as well as a Toy Story themed hotel.
●● taking out insurance to protect it from financial loss Shanghai is no stranger to large crowds as the World Expo held in 2010
●● using financial instruments, such as hedging, to try and attracted 73 million people. This indicates that disposable income in
hedge against the financial risks. China is sufficient to lead to this significant investment. It also shows that
Shanghai is becoming a tourist destination with all the infrastructure
Exam tip that is needed in place.
The title of this unit is ‘Assessment of a country as a market’. The
command word ‘assess’ in an exam requires you to make a
judgement of some form. To assess you could weigh up different
arguments and then come to a conclusion or judgement, backed
up by evidence. So, for example, you could consider a variety of
factors that might influence a business to market its products to a
particular country and then judge which of these is likely to be the
most important. Alternatively, you might consider a variety of
factors and their benefits and drawbacks, and then judge whether
the country is worth exporting to or setting up a business in.

Links
Several factors can be taken into account when assessing
a country as a potential market. You can demonstrate your
synoptic skills by drawing on other areas of the specification to
support the arguments that you put forward in answers.
This could include information in, for example, Unit 4 (Demand), You could use this information in a variety of ways. Obviously, it can be
Unit 66 (Growing economies), Unit 69 (Protectionism), used if answering questions on assessment of a country as a market. It is
Unit 70 (Trading blocs), Unit 75 (Global competitiveness) also useful in evaluating how that market might develop in the future.
and Unit 80 (Ethics). Source: adapted from the Financial Times 22.05.2015. All rights reserved.

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 Global business

Case study
There were three main reasons reported for Brazil’s gloom.
China’s slowing economy had punctured the commodity price
BRAZIL boom, forcing Brazil, and other commodity countries in the
region, to tighten their belts. The prospect of higher US interest
rates had threatened to suck international liquidity out of the
In a world of near-zero interest rates in early 2015, how about country. Most of all, Brazil was paying the cost of Ms Rousseff’s
this? In spring 2015 Brazil’s central bank increased its main reportedly mistaken faith during her first term in so-called
interest rate to 13.25 per cent. The 50 basis-point rise was part ‘developmentalism’.
of Brazil’s efforts to put its house in order. The Brazilian economy This belief in state intervention included artificially low interest
was expected to shrink by 1 per cent in 2015, the deepest rates, fiscal expansionism, limited returns for private investment
recession in 25 years; unemployment had been rising; while in much-needed infrastructure, and petrol and electricity prices
inflation had been running at over 8 per cent – almost twice the fixed below cost. Such measures were supposed to boost growth.
official target, hence the rate rise. After years of fast growth and Instead they resulted in the collapse of business investment.
easy credit, in 2015 Brazil was on its back. In March 2015, industry confidence fell to its lowest level
In 2015, Latin America’s biggest economy was also reported since 1998.
as reeling from a corruption scandal at Petrobas. Release of Despite all these issues, there is one aspect that could help
the state-controlled energy company’s long-delayed results in Brazil grow in 2015: the exchange rate. If taking July 2011 as a
spring 2015 reportedly estimated losses, due to corruption, comparison base, the exchange rate of the Brazilian real versus
of more than $2bn – much of them due to political kickbacks. the US dollar has increased 105 per cent, but the accumulated
Dozens of politicians, senior business figures and middle- inflation in the country during this same period has only been
men were arrested. They were reportedly accused of running 26 per cent.
an elaborate scheme that benefited individuals, and also the
Source: adapted from the Financial Times 04.05.2015.
governing Workers’ Party, to the tune of hundreds of millions of
All rights reserved
dollars. Across Brazil tens of thousands of jobs were reportedly
lost as Petrobras and other big firms caught up in the scandal
laid off workers and delayed investments. Petrobras is not just (a) Explain why raising interest rates would be part of Brazil’s
a huge oil company. It is emblematic of Brazil, and a source efforts to put its house in order. (4 marks)
of great national pride. The scandal shocked the country and
(b) Explain why corruption might influence investment in
shook the government. Partnering with Petrobras is reported as
Brazil. (4 marks)
near essential and somewhat unavoidable if you are to make
good on any attempt to tap hydrocarbons in Brazil. So investors (c) Explain how changes in exchange rate could help the
were shocked to be confronted by the sight of the company Brazilian economy to grow. (4 marks)
reportedly mired in corruption allegations on an industrial scale. (d) Assess why developmentalism could lead to collapse in
The company’s crisis has had a negative impact on the economy, business investment. (12 marks)
delaying investments in infrastructure and the oil and gas sector.

Key terms Knowledge check

Disposable income – the amount of money that a person 1. What is disposable income?
has left over after they have paid their taxes, national 2. Why is disposable income important when a business
insurance and other deductions. considers investment?
Exchange rate – the price of one currency against another.
Infrastructure – the basic systems, facilities, services and
3. Explain how ease of doing business affects investment.
capital equipment required for a country’s economy to 4. Show how a country’s infrastructure is an important factor in
function, which might include its roads, communication investment.
systems and power services. 5. How might political stability affect investment?
6. What impact might exchange rate fluctuation have on
investment decisions?

441
 73 Assessment of a country as
58 4.2.3
Theme 4

Key points
a production location
Factors to consider:
1. Costs of production.
2. Skills and availability of labour force.
3. Infrastructure.
4. Location in a trade bloc.
5. Government incentives.
6. Ease of doing business.
7. Political stability.
8. Natural resources.
9. Likely return on investment.

Getting started According to a 2014 report by global real estate firm

Cushman & Wakefield, the most popular location for
manufacturing is Malaysia. The report took into account a wide
range of location factors when compiling the list shown in Table 1.
However, these factors were placed into three key areas and
given different weights.
●● Costs (40%) such as labour, land and energy.

●● Risks (20%) such as natural disasters, energy and economic.

●● Conditions (40%) such as labour quality, sustainability and

access to markets.

Table 1 shows that Asia is the preferred region for locating

production facilities, with the top five positions being occupied by
In 2014, Jaguar Land Rover (JLR) opened its first factory in Asian countries. Canada achieved its high ranking of sixth due to it
China. The factory, based in Jiangsu, was built in partnership being a relatively ‘risk-free’ country. Malaysia was top because of
with the Chinese company, Chery Automobile. It was expected its low costs and relatively low risks. The UK was ranked 18th.
to produce 130,000 cars a year. Between 2000 and 2014, JLR
had seen sales of its vehicles rise rapidly in the Chinese market. Table 1 The top ten best countries for a production location, 2014
By 2014, China accounted for almost a quarter of JLR’s sales. Ranking Country
Building cars in China will give JLR a number of advantages. 1 Malaysia
The main benefit is that cars produced in the Jiangsu factory will 2 Taiwan
not be subject to Chinese import duties. JLR has invested over 3 South Korea
£1 billion in the plant. 4 Thailand
5 China
Source: adapted from www.jaguarlandrover.com 6 Canada
Give reasons why JLR has located a production plant in China. 7 Russia
Do you think that other UK businesses will do the same as JLR? 8 Indonesia
9 United States
10 Mexico
Locating production Sources: adapted from www.cushmanwakefield.co.uk and
A new business organisation, or an existing business that is www.economist.com
expanding its operations, will need to consider in which country
it wishes to locate production. French car manufacturer Renault, Costs of production
for example, has factories in Morocco, Slovenia, Turkey, Russia, Many businesses locate factories in countries that have low
Romania and Argentina. Only about 25 per cent of Renault’s cars production costs. By keeping these low, a business may gain a
are now produced in France, its original production location. competitive edge in the market. Some of the main production
There are several factors that have to be taken into account when costs, such as labour, energy, raw materials and land, are a lot
choosing a suitable location. These are discussed in this unit. lower in Asia than in many other parts of the world, hence the
high position of five Asian countries in Table 1.
442
 Global business

Low wage costs are often an important factor in attracting Question 1

businesses, particularly for businesses that employ a large
labour force. For example, Dyson moved production of their In 2014, German company BASF, the world’s largest chemical
bagless vacuum cleaners from the UK to Malaysia in 2003 where producer, announced that it would be expanding overseas, rather
production costs were 30 per cent lower. Dyson said that wages in than at home. The reason for this decision was the rising cost of
Malaysia were £3 per hour compared with £9 per hour in the UK. energy in Germany. BASF has production facilities in the US where
As a result profits more than doubled from £18 million in 2002 to plunging gas prices made production there very attractive relative
£40 million in 2003. to its more expensive European plants. In 2015 natural gas prices in
Labour costs in some countries that were traditionally low, the US were around one quarter of those in Europe, mainly because
such as China, have started to rise and look set to continue their of contributions made by the growing shale gas industry in the US.
upward trend. In 2015, the lowest wages were to be found in Between 2009 and 2014, BASF invested around $5.7 billion in
Burma, Bangladesh and Cambodia, but such locations have a the US and in 2015 was building a formic acid plant in Louisiana.
developing infrastructure and political instability. The rising cost An increasing number of energy-intensive businesses, such as steel
of energy and land is having an increasing impact on the location and chemical producers, are looking at the US as a possible location
plans of some businesses. For example, energy prices in Europe for their production. Figure 1 shows the natural gas prices in Japan,
were rising fast in 2013 and this was beginning to impact on Europe and the USA between 2004 and 2012.
business location decisions. Figure 1
Skills and availability of labour Natural gas prices
nominal US$ per billion British Thermal Unit (BTU)
When a business is considering locations for its production 20
facilities it is not just the cost of labour that is important, it is
also the quality of human capital. A business is not likely to
locate a factory in another country only for cheaper labour. A
15
business has to consider whether the labour force in a country
has the skills required to maintain quality standards. Businesses
cannot afford the consequences of poor-quality work. In some
countries where labour is cheaper, workers might be unskilled 10
April 2012
and poorly educated. Consequently, a business locating USA prices bottom
at $1.95 to Europe’s
production in that country may have to invest substantial sums of $11.42, the widest
gap in recent times.
money in training, unless all the work on offer is unskilled. 5
Key
Between 2012 and 2015, a number of businesses moved Japan
production back from the Far East to the West in a process called Europe
USA
reshoring, often because of poor quality control in Far Eastern 0
factories. For example, according to a report by Civitas (an 2004 2005 2006 2007 2008 2009 2010 2011 2012
Year
independent think tank), the quality of work undertaken in China Sources: adapted from www.rt.com/business and
is good to begin with, but in later production runs the quality www.washingtonpost.com
might decline. Figure 2 shows that the main reason for bringing
manufacturing back to the UK is to improve the quality of work. (a) Assess the extent to which production costs have influenced the
decision by BASF to expand its production facilities in the USA
rather than in Germany.

Figure 2
Reasons for reshoring – SMEs and large companies
More certainty on delivery times

Minimise logistics costs Key

Reduce inventry costs Large

SME
Reduce product delivery time

Minimise supply chain risk

Improve quality of outputs

Wage inflation overseas

Improve enviromental credentials

Improve customer collaboration

0 10 20 30 40 50
Source: adapted from EEF/GfK Make it in Britain Survey, 2014 $ Billion

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Assessment of a country as a production location Unit 73

Any business that locates production in a particular country Location in a trade bloc
will have to ensure that there are enough workers near to the Some businesses locate production facilities in certain countries
chosen site. The business will also have to consider whether to avoid trade barriers, such as tariffs and quotas. This can be
there would be enough workers in the future if the facilities achieved by siting a plant inside a trade bloc. Trading blocs are
needed to expand. In 2014 it was widely reported that some discussed in detail in Unit 70. The output of a business located
businesses were beginning to find recruitment difficult in China. inside a trade bloc will be free from trade barriers when sold to
For example, Jenlo Apparel Manufacturing, a Canadian-owned any member of that bloc. For example, one of the reasons why
clothing company, opened a factory in southern China in 2008 Japanese car manufacturers, such as Nissan, Honda and Toyota,
but had recruitment problems because China’s 30-year one-child have located car factories in the UK is to avoid EU trade barriers.
policy means there is now a shortage of workers. In addition, Cars made in the UK, even though the business owners are
economic commentators noted that increasingly workers did not Japanese, can be sold in France, Germany, Italy and all other EU
want to work in factories, nor did they want to work for exporters member countries without attracting tariffs. This makes the cars
because the quality standards are more challenging than those cheaper when sold in these countries.
for goods produced for the domestic market.
Government incentives
Infrastructure Governments may be able to influence the location of business.
When considering a suitable country for a location, the quality of They are usually keen to attract foreign direct investment (FDI)
infrastructure is important. In some countries the infrastructure because of the benefits it brings, such as income and employment.
might be poor. In some developing countries, for example, where They can do this by providing incentives to businesses to locate
labour might be cheap, the quality of infrastructure might be their production facilities in their country. Generally, governments
inadequate to support a large production facility. Any of the may offer financial incentives, such as tax breaks, lower rates of
following factors might be encountered. company tax, interest-free loans, cheap land and preferential rates
●● Roads might be poorly constructed and inadequately maintained.
on business premises. The UK, which has the highest level of FDI
In some countries they may be unsealed. This slows down the in Europe, offers foreign businesses a wide range of guidance and
transportation of finished goods to customers, and raw materials support services. UK Trade & Investment (UKTI), a government
and components to the site from suppliers. Some areas might be department responsible for helping UK businesses to establish
prone to natural disasters, such as flooding, which may cause a links abroad, is also tasked with attracting FDI. It offers a range
break in the supply of vital components, for example. of specialist advisory services to businesses that are considering
●● Increasingly, access to good broadband networks is of vital
the UK as a possible location. For example, UKTI provides
importance to businesses when considering locations for quite detailed industry-based information to foreign investors.
production. Some countries may still be developing their Publications are available for industries, such as aerospace,
broadband networks, while other networks might be slow communications, financial services, nuclear power, food and drink,
and unreliable. railways, creative industries, and electronics and IT hardware. In
●● Some countries may not have modern airports and ports. This
addition to the printed information foreign businesses can get
might make it difficult for business personnel to travel to and specialist advice direct from industry experts.
from production facilities and to ship goods out of the country. Tax regimes are very important to businesses when
●● Railway networks may be undeveloped or non-existent. This
considering location. According to research published in 2014 by
might be a problem if bulky or heavy goods need to be PwC, a large financial services company, around 63 per cent of the
transported in large quantities. 1,344 CEOs surveyed worldwide said tax policy was an important
●● There may be a lack of investment in education, which can
consideration when choosing a location. The UK government
affect the quality of human capital and may discourage recognised this and in April 2015 lowered the rate of corporation
managers and other senior staff from locating near to the site. tax to just 20 per cent. This is the lowest rate in the whole of the
Families moving to the location would desire good-quality G20 (the 20 most advanced economies in the world).
schools for their children. Financial incentives may also be offered to businesses locating
●● There may be a difference in the quality of hospitals. Again this
in developing countries. For example, governments in Kenya,
may discourage senior employees from moving away from their Tanzania, Uganda and Rwanda in East Africa have offered a wide
home country. The quality of health care generally might also range of tax incentives. Examples include corporation tax holidays
impact on the quality of human capital. and reductions in standard taxes, such as VAT and customs duties.
●● A lack of commercial services and suppliers may discourage a

business from locating in some countries. Businesses may need Ease of doing business
access to printers, IT support, bankers, insurance providers, When choosing a suitable location the commercial environment
advertising agencies, cleaners, maintenance companies is a very important consideration. This is often referred to as the
and manufacturers of components. Some countries cannot ‘ease of doing business’. It is a lot easier to do business in some
guarantee such facilities. countries than others. It is important to choose a location where
it is relatively easy to do business because trading restrictions
Generally, before locating a factory overseas, a business will and additional costs can be both frustrating and expensive for
need to identify its infrastructure needs and determine whether businesses. The ‘ease of doing business’ may depend on factors
a particular country is able to meet them. like the following.
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 Global business

●● The ease with which businesses can be started and are not reliable, but reports estimate them to be between 5,000
closed down. and 10,000 per year.
●● The efficiency with which contracts are enforced. In some countries political systems are corrupt and bribery is
●● The amount of bureaucracy, e.g. the ease with which permits commonly reported as an accepted feature of ‘doing business’.
can be obtained for construction projects. Most Western businesses are likely to avoid countries where this
●● The availability of trade credit. is the case. However, some may try to overcome these obstacles.
●● The efficiency of tax collection. In 2013, the most commonly recorded issues by the Institute of
●● The ease of resolving insolvency. Business Ethics media monitoring were bribery, corruption and
facilitation payments.
Table 2 shows the top ten easiest places in the world to do Finally, businesses may avoid locating operations in some
business in 2015. Singapore is ranked number one while the UK countries due to their human rights records. One of the main reasons
is ranked number eight. The UK scores particularly well when for this is to avoid consumer boycotts or shareholder disapproval.
it comes to protecting minority investors in business. These
rankings are likely to provide a very useful guide to businesses Natural resources
looking for a suitable overseas location. They will also provide Some types of business activity require large quantities of natural
some incentive to governments to introduce measures that might resources. The obvious example is mining. Mines can only be
improve their ranking – that is if the government is concerned sunk in locations where there are proven mineral deposits.
about flows of FDI into the country. Consequently, mining companies can only choose locations where
these deposits exist. Up until 2014, when commodity prices were
Political stability booming, Africa attracted a number of mining companies. For
Some countries are politically unstable. This might mean that it is example, Rio Tinto acquired a coal mining project in Mozambique
too dangerous to do business in such countries. Alternatively, the for $2.7 billion in 2011. However, following a fall in commodity
exposure to possible financial loss might be far too high due to prices even Africa suffered a drop in foreign business interests.
political tensions. Examples of ‘hotspots’ that might be avoided by Businesses that use substantial natural resources in their
foreign businesses looking for an overseas location include, for production processes are also likely to set up in proximity to their
example, Libya, Yemen, Ukraine, Syria, Pakistan, Iraq, Afghanistan, sources. For example, steel producers may locate production
Somalia and parts of Latin America, to name but a few. plants near iron ore mines or coal mines. ArcelorMittal, the
One of the problems in some of these countries is the risk of Luxembourg-based multinational steel producer, has operations
kidnapping. It is widely reported that Western business people in more than 60 countries around the world. It is the largest steel
are common targets for kidnappers aiming to extract ransoms company operating in South Africa, where it has several mines and
from employers and relatives. Latin America is reported as steel works producing long and flat steel for a range of different
one of the most dangerous places for kidnapping, with Mexico industries. Steel producers are keen to locate close to mines as
reported as the most dangerous of all. Statistics on kidnapping the transportation of iron ore and coke can be very expensive
because these materials are bulky and heavy.
Question 2
Singapore claims to have an excellent infrastructure, transparent (a) Businesses prefer to locate operations where it is ‘easy to do
laws, a sound economy and convenient online portals. In 2015 business’. Explain what this might mean.
it was ranked the ‘easiest place in the world to do business’ by a (b) Assess the possible attractions of Singapore to a business looking
World Bank survey. for a suitable overseas location.

Table 2 Ease of doing business – top ten world rankings, 2015 (from 189 countries)
  Singapore New Zealand Hong Kong Denmark Korea Norway US UK Finland Australia
Ranking 1 2 3 4 5 6 7 8 9 10
Starting a business 6 1 8 25 17 22 46 45 27 7
Dealing with construction permits 2 13 1 5 12 27 41 17 33 19
Getting electricity 11 48 13 14 1 25 61 70 33 55
Registering property 24 2 96 8 79 5 29 68 38 53
Getting credit 17 1 23 23 36 61 2 17 36 4
Protecting minority investors 3 1 2 17 21 12 25 4 76 71
Paying taxes 5 22 4 12 25 15 47 16 21 39
Trading across borders 1 27 2 7 3 24 16 15 14 49
Enforcing contracts 1 9 6 34 4 8 41 36 17 12
Resolving insolvency 19 28 25 9 5 8 4 13 1 14
Source: www.doingbusiness.org, World Bank Group

445
Assessment of a country as a production location Unit 73

Likely return on investment value of the cost savings falls the further into the future it
Businesses looking for locations are likely to consider a number occurs. When it is totalled up, the net present value of the
of different options before making their final decision. Many of cost savings at location A don’t cover the initial investment
the factors above are likely to be taken into account, depending needed. So moving to location A is unprofitable at this rate
on the nature of the industry in which a business operates. of discount. On the other hand, moving to location B shows
During the decision-making process SWOT analysis and a positive net cash flow. The cost savings outweigh the initial
PESTLE analysis can help to assess the suitability of different cost of the investment by £1.9 million. So this would suggest
locations. Also, quantitative techniques might be used to help that the company should move to location B. Whatever the rate
make the final location decision. Quantitative techniques can of discount used, location B would always be preferred over
aid evaluation of the financial costs and benefits of investing in location A. However, if the rate of discount were much higher
particular locations. than 15 per cent, the discounted cash-flow technique would
suggest that even location B would give overall negative cash
Quantitative methods flows and therefore moving would not be profitable.
Table 3 shows two possible sites for a business which is
considering relocating its premises. It gives the initial cost of Table 3 Initial costs and cost savings of two new locations
the move and then the cost savings to be made in each year £ million
compared with the existing site. Three investment appraisal Location A Location B
methods can be used to show which, if any, site should be Initial cost 12 15
chosen. It is assumed that at the end of five years, the business Annual cost savings/increased cash flow
will be relocating again. So no cost savings will be taken into Year 1 3 5
account after the end of five years.
Year 2 3 5
Payback method: With the payback method, the business Year 3 3 5
calculates how long it will take to recoup the initial investment. Year 4 3 5
In location A, the initial cost is £12 million and with annual Year 5 3 5
savings (the equivalent of increased cash flows) of £3 million,
the investment will be recouped in 4 years. With location B, Table 4 Initial costs and cost savings of two new locations
the initial cost is higher at £15 million, but the cost savings are discounted at 15 per cent
£5 million per year. The result is that the investment will be £ million
recouped in 3 years. So on the payback method, location B is Location Location Discount Location Location
the preferred location. A B table A B
£ millions £ millions 15% £ millions £ millions
Average rate of return (ARR): With the average annual Initial cost 12 15 1.00 12.0 15.0
rate of return method, the net return is divided by the initial Annual cost savings/
investment and expressed as a percentage. With location A, increased cash flow
there will be a total cost saving (i.e. increased cash flow) over Year 1 3 5 0.87 2.6 4.4
5 years of £15 million. With an initial cost of £12 million, this Year 2 3 5 0.76 2.3 3.8
gives a return of £3 million (£15 million – £12 million). So the Year 3 3 5 0.66 2.0 3.3
ARR is [(£3 million ÷ £15 million) ÷ 5 years] × 100 per cent, Year 4 3 5 0.57 1.7 2.9
which is 4 per cent. With location B, the cost saving is £25
Year 5 3 5 0.50 1.5 2.5
million over 5 years with an initial cost of £15 million. So the
Total cost savings 15 25 10.1 16.9
ARR is [(£10 million ÷ £25 million) ÷ 5 years] × 100 per cent,
which is 8 per cent. On the average rate of return method, Net cash flow 3 10 –1.9 1.9
location B is also the preferred location.
Exam tip
Discounted cash flow: With discounted cash flow, the When answering questions on assessing countries as business or
value of future cash flows must be discounted back to the production locations, you need to remember that you are not
present. The important point about discounted cash flow is discussing assessment of a country as a market in the context of
that, just as money invested today will grow in value because exporting, for example. This is dealt with in Unit 72. There is quite
of compound interest, so the reverse is true: the value of a difference between selling in different countries and setting up
cash available in the future is worth less today. In Table 4, the factories in different countries. A huge financial commitment is
necessary when setting up production plants in different countries.
cost savings (or net cash flows) have been discounted back There can be far more at stake.
assuming a discount rate of 15 per cent. The net present

446
 Global business

Case study
example, there were no suitable suppliers of shoe soles and

NEW WING FOOTWEAR cardboard. A trip to India also ended in frustration for Mr
Leung. He visited Chennai but was upset by the poverty in
Frank Leung owns New Wing Footwear, a manufacturer of the area.
women’s footwear. In 2011, he began a search for a new Other business people have looked to move their factories
manufacturing base. It was reported that production at away from China. For example, David Lui, the owner of a
his factory in Dongguan in South China was becoming too handbag manufacturer, was reported as visiting Vietnam,
expensive. Wages were rising every year and profit margins but the supplier networks and rates of productivity were
were being squeezed. The value of the yuan renminbi (the better in China. Mr Lui has also experienced a squeeze
Chinese currency) had also been rising, which was making in profit margins, although some of the rising costs of
his shoes more expensive for buyers overseas. As a result manufacturing in China were reported to have been passed
of these factors he had been forced to reduce his workforce on to his European customers.
from 8,000 to 3,000 in just three years. The increase in wages in China is likely to continue because
During his search Mr Leung looked at Bangladesh. Here the government wants to double workers’ wages over a ten-
labour was much cheaper – about 20 to 30 per cent the year period by raising the national minimum wage. However,
cost of Chinese labour. Also, the normal working week in despite this, many Chinese business owners are reported
Bangladesh was 48 hours compared to 40 hours in China. as remaining in China for the time being. China has a huge
The Bangladeshi government was also offering a ten-year workforce with higher productivity and far superior ports and
tax holiday to businesses locating in the country. However, highways compared with many other developing countries.
Mr Leung was concerned by the congestion in the city of Source: adapted from the Financial Times 08.11.2011.
Dhaka and was also worried about the intermittent power All rights reserved.
supply. He said that most factories had to buy their own
power generators.
Mr Leung also travelled to Addis Ababa. Here wages (a) Explain one way in which governments can influence
were even lower than in Bangladesh. However, he was business location overseas. (4 marks)
concerned about the location in relationship to the lack of (b) Evaluate the factors that businesses like New Wing
infrastructure. Although there was much less congestion in Footwear take into account when assessing a country as a
the country, there was a lack of support for his industry. For production location. (20 marks)

Links Knowledge check

The information in this unit may be of use when demonstrating 1. Why are labour costs in China starting to rise?
your synoptic skills when answering questions on global 2. For which industries are energy costs likely to be important
competitiveness. For example, you could explain how when looking for an overseas location?
government incentives to locate in a particular country could 3. Explain why the quality of human capital in a potential location
lower costs and give a business a competitive edge. Other units might be important to a business looking for a new site.
that link effectively to this unit include Production, productivity
4. How might the quality of a nation’s infrastructure be an
and efficiency (Unit 37), Economic influences (Unit 41), SWOT
important factor in factory location?
analysis (Unit 46), Impact of external influences (Unit 47),
Investment appraisal (Unit 53), Business ethics (Unit 59), 5. What sort of incentives might a government offer to
Protectionism (Unit 69), Trading blocs (Unit 70) and The impact encourage a business to locate a site in its country?
of MNCs (Unit 79). 6. What is meant by the ‘ease of doing business’ when looking
for a suitable country to locate production?
7. Why is political stability an important issue when locating
Key terms plants overseas?
Reshoring – bringing production back home after using 8. For which types of industry is the availability of natural
foreign production facilities for a period of time. resources an important location factor?
Trade bloc – a group of countries situated in the same 9. State three quantitative methods that might be used when
region that join together and enjoy trade free of tariffs, choosing production locations abroad.
quotas and other forms of trade barrier. 10. What is the main advantage of using quantitative methods
when making a location decision?

447
 74 Reasons for global mergers
58 4.2.4
Theme 4

Key points
or joint ventures
1. Spreading risk over different countries/regions.
2. Entering new markets/trade blocs.
3. Acquiring national/international brand names/patents.
4. Securing resources/supplies.
5. Maintaining/increasing global competitiveness.

Getting started Table 1 shows the number of cross-border sales and

purchases of companies in 2014. There are many reasons
The Brazilian aircraft manufacturer, Embraer, has pursued a why cross-border deals are completed, and some of these are
strategy of growth through acquisitions. It began as a maker explained below. However, it is important to remember that
of military aircraft and then moved into the small private and every investment decision is specific to the firms involved and
commercial plane sector. It was privatised in 1994, and entered the particular circumstances that each firm faces. Moreover,
into a series of strategic alliances in order to gain access to in the decision-making process, the personal role that senior
technology, resources and brand recognition. Next, it began to managers play also needs to be considered, taking into account
base production facilities in other countries, including China, factors of confidence or uncertainty.
France, the USA and Portugal. By 2012, 90 per cent of its global
sales were outside of Brazil. Table 1 Numbers of cross-border mergers and acquisitions
by country in 2014
Source: adapted from the Financial Times 22.10.2013
Country (2014) As seller As purchaser
Why do you think acquiring or allying with other firms was Australia 355 244
important to Embraer? What benefits do you think they gained
Brazil 219 28
from becoming an international company? What risks do you
think were involved? Canada 512 573
China 337 331
France 422 481
Reasons why businesses join together Germany 616 423
As discussed in Unit 66 (see also Units 14 and 63), there are
Hong Kong 145 222
many reasons why a firm might wish to make a direct equity
investment in another country. Exporting may not make sense if, India 225 130
for instance, other countries can produce the product or service Indonesia 68 18
more cheaply. Arrangements such as licensing or franchising Ireland (Republic) 96 92
may not make commercial sense either. Italy 240 118
Japan 179 440
Licensing: A firm enters into a licensing contract with another
firm to use its brand, intellectual property or to produce its Malaysia 91 98
product or service in return for a fee. For example, Disney Mexico 82 48
licenses its brand name for merchandise and inventors license The Netherlands 219 236
their patents to manufacturers. Nigeria 20 10
Poland 156 63
Franchising: Franchising involves a long-term co-operative
relationship whereby one party, the franchisor, contracts with Russia 302 135
another, the franchisee, to run its business. McDonald’s is a Singapore 135 233
well-known example of a franchise. South Africa 71 71
South Korea 119 76
Rather than licensing or franchising, firms may opt for joint Turkey 95 17
ventures or cross-border mergers and acquisitions. In fact, these
UK 879 859
two forms of investment are the main foreign investment routes
for most international companies. US 1545 2061
Source: adapted from www.unctad.org

448
 Global business

With this in mind, the rest of the unit looks at some of the Acquiring national and international
reasons why acquiring another firm or arranging a joint venture
might be a sensible move. Often these reasons overlap, for brand names or patents
instance the need to spread risks will be connected to a desire A business may want to become a global player in the
to enter a new market or trade bloc. Further, what is often international market. However, it may lack brand recognition or a
referred to as a merger is actually a takeover or acquisition, patent that prevents other businesses from copying its product or
though sometimes this is not obvious until well after an producing similar products. By purchasing a business or a product
agreement is completed. with a strong brand name, it could obtain both quickly.

Spreading risk over different countries Question 1

or regions
During economic downturns, even companies with strong balance In 2004, Lenovo, a Chinese firm listed in Hong Kong, had 27 per
sheets can face serious difficulties, as outlined in Unit 36. Thus it cent of its home market and dreamt of being a big player on the
makes sense to try and insulate the firm from the consequences global market. It decided on two possible routes: either creating
of a downturn or crisis by locating in markets where these risks a foreign subsidiary or buying an existing global player. Since it
are less likely to occur – or at least less likely to occur at the same had little experience of foreign markets itself, and didn’t have
time as they occur in the home market. any distribution channels or a well-recognised brand, it chose to
For example, Pingo Doce, founded in 1980, but with its acquire another firm.
origins going back two hundred years, is a Portuguese no-frills
In 2005, it bought the personal computer business of IBM, the
supermarket chain. It began its expansion in the 1990s in order
to diversify away from the Portuguese market. Though its first iconic American computer giant, for £1.75 billion. With the
venture in Brazil failed, its second one in Poland succeeded. purchase, the company gained instant presence outside of China,
Instead of building huge stores like Tesco and Carrefour, it chose access to IBM’s markets and sales channels, to its technology, and
to focus on small, local shops, and bought the discount chain its well-known ‘ThinkPad’ and ‘ThinkCentre’ brands. It also found
Biedronka, which is now Poland’s biggest food retailer. In 2012, cost savings through economies of scale and many experienced
Pingo Doce began trying to diversify away from the struggling researchers, technicians and managers. Lenovo overnight became
European market and into the growth markets of Latin America. one of the largest computer makers in the world. The deal was
also good for IBM as its PC division had been losing money for
Entering new markets and trade blocs some time. Some experts believe that Lenovo brought a fresh
Instead of growing organically, businesses can take a shorter outlook as well as a young, ambitious workforce to inject new
route to international growth through mergers and acquisitions. thinking into the established computer firm.
For example, Tata Motors purchased Jaguar Land Rover from
the Ford Motor Company. This route appears increasingly
popular. From Figure 1, we can see how investment has been
increasingly flowing from developing and transition economies.
China, Thailand, Mexico and India are leading this trend.
Equally, firms in maturing industries may find that the only
way that they can grow is through merging with or acquiring
firms in other markets. For example, the international market for
beer is quite mature, with slow growth in the most developed
markets. Consequently, in a quest for new markets and for
economies of scale, there have been many cross-border
mergers in the last decade. As a result, four big brewers
(AB-InBev; SABMiller; Heineken and Carlsberg) now have over
50 per cent of the global market by volume.
Firms may want to tap into markets that are growing, but
they do not always find it easy to gain access. For example, the
Chinese auto firm Shanghai Automotive Industry Corporation
(SAIC) operates factories with Volkswagen (VW) and General
Motors (GM). This long-running joint venture began solely Sources: adapted from the Financial Times 02.11.2007.
because of limits that the Chinese government placed upon All rights reserved.
foreign firms entering the Chinese market. In order to gain
access to the billions of Chinese consumers, VW and GM had (a) Explain the factors that Lenovo would have taken into account in
to work with SAIC through a joint-venture arrangement. VW their decision to create a foreign subsidiary or buy an existing
and GM count the agreement as a success and much of SAIC’s global player.
profits come from the joint venture. Some commentators feel (b) Why do you think Lenovo succeeded where IBM had seemed
that SAIC would benefit from developing further their own to struggle?
technology and capabilities.
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Reasons for global mergers or joint ventures Unit 74

Using mergers, acquisitions and joint ventures is quite an of the best coffee beans, it bought its own coffee farm in
effective way to gain a reputational foothold or to get access to Costa Rica.
intellectual property. It can have a number of benefits for
a business. Maintaining or increasing global
●● There is likely to be strong brand recognition. competitiveness
●● There will be brand loyalty. Merging or joining another firm can provide bigger markets,
●● It limits competition for the product. scale and scope economies and cost savings. This in turn
●● A business will not face the high risk, cost and uncertainty could make the firm much more competitive in terms of its
of launching a new product. pricing power over customers and suppliers. Where there is
It is important to realise how easily a brand can be a lot of competition in the market, or where a firm is hoping
destroyed if care is not taken post-merger to ensure that to become a dominant player on a global scale, merging or
employee morale and customer satisfaction are looked acquiring another firm can be part of a successful strategy.
after. It may be that the strongest brand is adopted over the For example, a proposed merger between Applied
weakest one, or some sort of portfolio of brands can be Materials and Tokyo Electron came down to a need for scale.
created as part of a differentiation strategy. There is an increasing demand for computer chips, but the
machines that make the chips are extremely expensive.
Gaining access to intellectual property This merger gives the two firms a quarter of the market
Developing intellectual property internally, through in-house and strengthens their hand against their customers (Intel,
research and development, can take a very long time and Samsung, Taiwan Semiconductor). In summary, the objective
involve a lot of financial risk. Intellectual property involves a of the merger was to acquire scale and cut costs, thereby
creation of the mind, such as an invention, literary work or reducing downward pressure on prices. In turn this would
artwork, that the law protects from unauthorised use by others. allow for long-term planning (research and development is
This protection occurs through such legal mechanisms as: hugely expensive).
●● patents for inventions
Alternatively, two firms can cross-sell product ranges
●● copyrights for literary works or computer programs
or services, thereby increasing overall sales and perhaps
●● trademarks for brand names or designs.
lowering internal costs. For example, mergers of banks or
Since establishing intellectual property can be expensive, it financial services firms have occurred in order to provide
is often easier to gain access to intellectual property by buying one contact point for customers to a range of financial
it in an acquisition or through a joint-venture agreement. services products.
Table 2 shows some examples of acquisitions in agriculture Likewise, engaging in a geographically diverse
and biotechnology, all of which were completed in order to collaboration can improve a firm’s tax position. For instance,
acquire scale in intellectual property. a firm may select a merger partner that is located in a
country where the overall tax take is lower. The merged
Table 2 Mergers and acquisitions in agriculture firm can then relocate its headquarters to the lower tax
and biotechnology venue in order to save money. Such moves are a source of
Year Companies Merged company considerable political controversy, but there is little question
1996 Ciba and Sandoz Novartis that a firm, where it can do so legally and ethically, will want
to minimise its overall taxation. The money saved from lower
1997, 1999 Zeneca, Astra and Mogen Zeneca Agrochemicals
tax bills can be used to invest and to further improve the
2000 Novartis Agri and Zeneca Agro Syngenta firm’s competitive position.
In 2014, Facebook spent $22 billion on buying WhatsApp,
Securing resources or supplies a mobile messaging service. WhatsApp had made $10.2
Firms may often choose to merge with another firm to million the year before, and was reported as loss-making.
secure resources or supplies further back in the supply So why would Facebook want to buy the firm and pay that
chain. This is known as backward vertical integration (see much for it? Partly it may have been to eliminate a competitor
Unit 49). A firm may want, or even need, to merge with in the market, but equally important was that WhatsApp is
another firm because: a resource, with a superior form of messaging. However,
●● the resources used in the creation of its product or service another important reason for such a takeover might be
are scarce or hard to acquire, and it needs to ensure defensive: if Facebook hadn’t bought it, one of its competitors
reliable sourcing might have. Time will tell how Facebook’s purchase of
●● it needs to ensure that the inputs are of a suitable quality WhatsApp develops commercially or whether it may have also
or price. been more of a defensive purchase.
For example, Starbucks’ rapid international expansion, Nevertheless, there is an old saying: ‘Two dogs do not
coupled with several disease threats to coffee plants, has make a tiger’. Put another way, a purchase might turn out
meant that it faces intense competition for supplies of high- to be mistaken and waste money, but at its worst it might
quality coffee beans. In order to help secure a reliable supply severely impact on a firm’s competitiveness.

450
 Global business

Exam tip Thinking bigger

You may be asked to ‘assess’ or ‘evaluate’ in an exam question When German Daimler (the makers of Mercedes-Benz) merged with
about global mergers and joint ventures. Both of these require you American company Chrysler in the late 1990s, it was called a ‘merger
to consider a variety of factors and then make a judgement. For of equals’. Daimler was reported as paying $37 billion for Chrysler. A
example, you may be asked to evaluate the success of a global few years later it was reported as a merger that struggled. The company
merger or joint venture. In this case you could make a judgement cultures were different and it was reported that the two divisions started
about whether the merger has been a success or failure based on to battle with each other.
data provided about the businesses involved. You might evaluate Differences between the companies included their level of formality,
whether another form of merger or joint venture might have been philosophy on issues such as expenses, and operating styles. The
more successful, if appropriate data is provided. Alternatively, you German culture became dominant. Employee satisfaction at Chrysler
may be asked to assess the reasons for a merger or joint venture. dropped and by 2000 major losses were projected and layoffs began.
In this case you could consider the main influences from data In 2007, it was reported that Daimler sold Chrysler for $6 billion –
provided and then make a judgement about the most important $31 billion less than they had paid out. This ‘failed’ merger
influence or influences, or those that have had the greatest effect. demonstrates that mergers need to do more than make business sense.
You might also be asked to assess the costs and benefits of a A range of dynamics will influence success.
particular type of merger or joint venture. In this case you could You could use this information in a variety of ways. Obviously, it can be
consider the main costs and benefits to the firm or firms involved, used when answering questions on mergers. But it might also be useful
make a judgement on which have had the most effect and then when discussing motivation, business efficiency, and the causes and
indicate whether the costs would outweigh the benefits. effects of change.
Source: www.economist.com

Question 2
Links
In April 2015 it was announced that Royal Dutch Shell had There are a variety of reasons for mergers and joint ventures. To
agreed to buy the British oil and gas exploration firm BG Group demonstrate your synoptic skills, you could use information from
in a deal that valued the business at £47 billion. The deal could other units to support your arguments about the main reasons for
be one of the biggest of 2015, and could produce a company mergers and takeovers in a global context. This could include using
with a value of over £200 billion. In 2015, BG was the UK’s information about the reasons why businesses want to invest in
third largest energy company and in spring 2015 employed other countries (Unit 68), how mergers can change and improve
5,200 people. It was created in 1997 when British Gas was channels of distribution (Unit 12), how entering new markets
demerged into two separate companies: BG and Centrica. through mergers can help a business overcome trading blocs
(Unit 70), how mergers might improve marketing globally (Unit 76),
Investors received a 50 per cent premium on BG April 2015
global competitiveness (Unit 75) or the effect on economies of scale
share prices. Shell said the deal would add 25 per cent to its
(Unit 48). The effect that mergers and joint ventures might have on
proven oil and gas reserves and 20 per cent to production
globalisation could be considered when answering questions in
capacity, particularly in Australia’s liquid natural gas market and
Unit 68 or when considering types of business growth (Unit 49).
deep water exploration off the Brazilian coast. Commentators
have pointed out that there is great uncertainty for the industry
as oil prices fell by 50 per cent in late 2014 to spring 2015. BG Key terms
warned in early 2015 that they had written down the value of Franchising – establishing a long-term co-operative
their assests by £6 billion and Shell by £10 billion. relationship whereby one party, the franchisor, contracts
The industry had been expecting such a tie-up but this defensive with another, the franchisee, to run its business. McDonald’s
merger may to lead to job cuts. In 2015, it was reported that is a well-known example of a franchise.
Shell took on more debt to finance the deal which will put Intellectual property – a product that is a creation of the
pressure on dividends. BG made a loss in 2014 and reportedly mind, such as an invention, literary work or artwork, that the
struggled in some of its markets. Some say that Shell has law protects from unauthorised use by others. Types include
estimated that buying access to new reserves is quicker than patents, copyrights and trademarks.
Licensing – a contract with another firm to use its intellectual
finding them itself. In 2015, BG was reported as one of the
property or to produce its product or service in return for a fee.
biggest suppliers of natural gas to China, which Shell has found
attractive. Some believe that there will be further mergers and
that BP could be a target from a predator. Knowledge check
Source: adapted from the Financial Times, 08.04.2015, 1. Why might firms choose to join together?
30.04.2015. All rights reserved. 2. What benefits are there to a business of merging?
3. Briefly explain how an acquisition is carried out.
(a) In what ways do you think that this defensive merger makes
4. What is the difference between a joint venture and a merger?
sense for Royal Dutch Shell?
5. Explain why it often makes more sense for businesses to acquire
(b) Why might commentators think that there might be further intellectual property rather than developing it themselves.
mergers in the industry?
6. Explain how mergers can lead to increasing competiveness.

451
Reasons for global mergers or joint ventures Unit 74

Case study
CEMENT AND CEMEX

The cement industry has been relatively mature for some factories in new markets, it bought cement firms in the US,
time, so one of the few ways of staying competitive is to Spain, Venezuela, Columbia and throughout Latin America.
ensure that costs are kept low. However, inefficient plants Later, it expanded into South East Asia.
and transport costs are particular problems for firms making CEMEX’s expansion strategy allowed it to lower its
cement. Consequently, cement firms must continuously look dependence upon the Mexican market while growing
for scale economies in their path to growth. Another issue internationally. However, this strategy was not without risk,
for such firms is that demand for their products tends to be and CEMEX has faced many issues in its various markets.
cyclical. That is, demand for cement goes up and down in As a result of the 2008 downturn, many countries built less
line with GDP and other economic factors. Thus, in order property and roads, and therefore required less cement.
to remain competitive, the industry needs to consolidate in Consequently, CEMEX experienced a stagnation in sales,
order to gain economies of scale and limit the risks from an alongside debt from its acquisitions.
economic downturn in key markets.
Source: adapted from the Financial Times 22.10.2012.
By 2000, global cement production involved just seven big All rights reserved.
firms, but the consolidation was continuing. Firms merged
or acquired other firms in order to achieve scale, expand
cash flow, enter new markets or spread their risks. During (a) Explain one reason why mature industries such as cement
this period, the Mexican firm CEMEX, through a strategy of need to worry about their costs. (4 marks)
growth through acquisitions, became one of the main global (b) Assess the potential costs and benefits of CEMEX’s strategy
cement companies. Rather than export or build its own of ‘growth through acquisitions’. (10 marks)

452
 75 Global competitiveness
58 4.2.5
Theme 4

Key points
1. The impact of movements in exchange rates.
2. Competitive advantage through:
●● cost competitiveness

●● differentiation.

3. Skill shortages and their impact on international competitiveness.

Getting started Achieving global competitiveness

Being multinational can help an enterprise to develop
competitive advantages that are not open to single-nation
companies. Multinational corporations (MNCs) often benefit from
the following.
●● Global operations can bring much bigger economies of scale.

●● Global sourcing can give firms more scope to find the best-

quality sources at the right prices.

●● Global operations allow companies to get closer to their

international customers, both before and after sales.

●● MNCs can tap into a much bigger range of knowledge and

scope for innovation.

●● MNCs can diversify risk.

However, global competitiveness is not just something that

firms seek strategically. As examined below, the competitiveness
of a firm is also affected through the global market in which
it operates.
The Gherkin is one of the world’s most instantly recognisable
buildings and is a symbol of the global dominance of London’s Effect of exchange rate fluctuations on
financial district. In April 2014, it was put up for sale by receivers business
Deloitte after they were called in by its creditors, a consortium of The exchange rate between currencies is important for
German banks. This was no ordinary victim of the credit crunch. businesses that export and import goods and services. A
The Gherkin was in good shape and fully let with its original depreciation in the exchange rate will make exports cheaper and
tenant, Swiss Re, the global insurance group, still in occupation so exporters could benefit. An appreciation will make exports
and a further 17 years on its lease. Experts say that it is a good more expensive and will have an impact on the competiveness
building with a bad finance deal. of exporting firms.
As the global financial crisis took hold in 2007–2008, investors
around the world sought safety in the Swiss franc, sending its Table 1 Exchange rate of GBP to Yen
value soaring. The sudden currency appreciation caught the Year GDP to Yen exchange rate
Gherkin’s new owner unawares as they had borrowed in Swiss 4/1/2011 128
francs. They could have survived a 10–15 per cent fluctuation, 2/1/2012 119
but nobody expected a 60 per cent appreciation. Critics 2/1/2013 141
suggested that they may have struggled from trying to beat the 3/1/2014 172
market by taking on foreign exchange risk. The losses amounted
3/1/2015 184
to £240 million and falling property prices meant that the value
of the Gherkin fell to £480 million. The owners had paid Imagine a British firm that makes car parts for the automotive
£600 million, and defaulted on their loans. industry. Suppose a particular car part costs £90 to make in
Source: adapted from the Financial Times 01.08.2014. its factory in Sunderland and it then sells for £100 in the UK.
All rights reserved. In 2011, this component, if exported and bought by a
Japanese automaker, would cost 12,800 Yen. However, every
Describe the impact of these events. Could they have been year thereafter more yen are needed to obtain one pound, so
predicted? What possible measures might businesses take to that by 2015, this same car part would cost 18,400 Yen to buy.
prepare for such events? The Japanese manufacturers now find the British product much

453
Global competitiveness Unit 75

more expensive, and may need to buy from elsewhere in order associated with this come in several forms. The most serious
to control their costs. The British firm must therefore decide how is the long-term risk that a strategy of locating in a low-cost
to keep its product competitive so that its customers in Japan production area is undermined by the appreciation of the target
continue to buy it. It could keep its price the same and ensure that country’s currency. For example, in the 1990s many firms built
its quality remains an advantage, even though the high price may factories in China where the costs of production were low and
cost it sales. Or it could lower the price for the Japanese market, cost savings could therefore be made. These savings depended,
and make a smaller profit margin. at least in part, on the Chinese government’s policy of pegging
The appreciation in the pound may have advantages for the its currency to the US dollar. Over time, for a variety of political
manufacturer, however. The rising buying power of the pound reasons, this peg has relaxed and the yuan has steadily
might allow it to pay a lower price for the raw materials to make appreciated. This has eroded these low-cost advantages.
its products. This could help it to lower its costs from £90 thereby The risk described above is known as economic risk, which
giving it room to lower prices. It may then be able to maintain is defined as a risk that future cash flows will change due to
its profit margin. Of course, where the pound depreciates, the unexpected exchange rate fluctuations. This is one of the gravest
outcomes above are reversed: the demand for the manufacturer’s financial risks facing an international firm because future cash flows
products may increase, but so might also the costs of making form the basis of a business’s overall value. Consequently, managing
them. It is therefore essential that a business considers all of the economic risk requires careful analysis of the political, regulatory
potential implications of changing exchange rates upon its current and cultural environments affecting the currency over time.
and future competitiveness. For example, the US dollar is the most important international
currency. Besides having one of the largest economies in
The significance of changes in the the world, the dollar has a role in almost every international
exchange rate on business transaction, either directly or indirectly. As a consequence, any
movement in the dollar will have an impact on international trade.
Elasticity of demand: If there is a depreciation in the value of At the start of 2015, with the US economy recovering and
the pound the effect it will have on a business and its products
interest rates likely to rise, the dollar looked set to appreciate
depends on price elasticity of demand. If UK businesses sell goods
against most other currencies. The areas that are most likely to
where demand is price inelastic, then the fall in price would have
feel the impact of any rise in the dollar are the emerging market
only a relatively small increase in demand. If demand for exports
economies. This is because many companies from the developing
is price elastic, then there will be a bigger percentage increase in
world take out loans in dollars.
demand. The evidence is that the demand for British exports tends
For example, Petrobras, the Brazilian state-owned oil
to be price inelastic, which is good news for exporters if there is
company, issued billions in bonds that were denominated in
appreciation, but bad news if there is depreciation.
dollars. With falling energy prices, Petrobras is reportedly not
Economic growth in other countries: In 2009/10 the making as much income as it expected when it took on the debt,
pound depreciated in value, but the EU economy in particular and is now finding it hard to repay it. It will find it harder still if the
was in recession and so the demand for UK exports was weak. dollar continues to appreciate against its home currency, the real.

Significance of the cause of the fluctuation in exchange

rate: If there is an appreciation in the pound because there Question 1
have been improvements in efficiency and productivity, then Walkmill Industries is based in Wales and makes specialist
businesses will be able to absorb the stronger pound more monitors used in intensive care facilities in hospitals. One of
easily. However, if the pound rises due to speculation or due its major clients is based in South Africa and one of its most
to weaknesses in other countries, then businesses could be successful products sells in the UK for £5,000.
uncompetitive because the rise in the pound is not related to
either improved competiveness or productivity. In 2013 the exchange rate was 13.50 rands to the pound.
In 2015 the exchange rate was 18.50 rands to the pound.
Fixed contracts
Many businesses use fixed contracts to counter fluctuations (a) Has the pound appreciated or depreciated in value against the
South African rand?
in the exchange rate. This means that temporary changes
in the exchange rate will have a smaller impact. The price of (b) Calculate the price the monitor would sell for in South Africa in
2013 and in 2015, assuming the UK price remains the same.
buying raw materials is often set 12 to 18 months in the future.
Exporters may also use future options to hedge against dramatic (c) If price elasticity of demand for Walkmill products is 0.8, what
changes in the exchange rate. It is these fixed contracts that likely impact would the change in exchange rate have on
Walkmill’s revenue?
help to lessen the uncertainty around exchange rate fluctuations.
It also means that there are time lags between changes in
exchange rates and the impact on business.
Competitive advantage
Economic risk As covered in Units 65 and 66, a firm can be said to have a
As covered in Unit 72, firms trading internationally are almost competitive advantage when it has some sort of distinctive
always exposed to movements in exchange rates. Risks strength that its competitors do not, such as cost advantages,

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 Global business

size, technical or managerial expertise, or an ability to innovate. In order to sustain differentiation over the long
Having a competitive advantage is key to entering and term, a firm must fully understand its own strategy and
succeeding in an overseas market. MNCs will want somewhere its customers, as well as keep one step ahead of its
to operate where they can find the resources and capabilities to competitors, who may be following similar strategies
maximize their competitive advantages. themselves. This is where barriers to entry are important: a
The two types of competitive advantage that play a role in large firm would have advantages over a new entrant to the
many international firms’ success are cost competitiveness industry who face barriers to entry because they don’t have
and differentiation. brand recognition for example. The firm needs to either
have brand recognition, intellectual property, or protected
Cost competitiveness: This is where an international firm is supply and distribution chains if it is to use differentiation to
able to achieve scale and scope economies, which may give it a remain competitive.
cost advantage over its competitors. Cost competitiveness allows
the firm to deliver the same product or service as its competitors,
but at a lower cost, which allows it to make more profits.
Question 2
For example, through acquiring ever-increasing economies Product differentiation is a critical strategic marketing
of scale, a company may attempt to create the cheapest process. It is key to building competitive advantage. Firms need
product on the market. This cost leadership strategy can be continually to differentiate their products from their competitors’.
a competitive advantage provided that the firm meets the It is an obvious thing to state, but if there were no differentiation
minimum quality standards of the industry. A good illustration why would a customer buy one product compared to a
of this comes from the discount supermarkets Aldi and Lidl. competitor’s product?
Another example comes from the budget airline easyJet, which
pared its costs down to the bone by, for instance, eliminating Starbucks was formed in 1971 by three entrepreneurs and
tickets, check-ins, and even in-flight meals and cutting initially sold coffee beans. In the 1990s it expanded and there
turn-around times at airports. was rapid growth, with the first store outside the US opening
in Japan in 1996. Starbucks is a common sight on the UK high
Differentiation: Differentiation is where, rather than focusing street, but there are also more than 700 stores across six
on costs, the firm selects certain attributes of its products or countries in South East Asia, including Indonesia, Malaysia, the
services and then tries to match this with specific customers. Philippines, Singapore, Thailand and Vietnam. Starbucks has
The firm may then try to command a higher price for creating managed to take one of the world’s oldest products and turn it
this differentiated product. into a differentiated, lasting and value-added brand.
For example, many of the big beer breweries (ABInBEV, What might the sources of differentiation be? It could be high
Carlsberg, SAB Miller) formed as part of a wave of mergers quality, extraordinary service, innovative design, technological
designed to gain scale economies and compete on cost.
capability or a strong brand image. The key to competitive
However, facing increasing competition in key markets from
advantage is that Starbucks set itself apart from its competitors
small-scale ‘craft brewers’ and makers of cask-conditioned
to justify a price premium that exceeds the cost of differentiating.
ale, most have differentiated their brand portfolios, buying the
There are 21,536 stores worldwide and revenue in 2013 was
small firms, but allowing them to retain their brand names and
independence. They can, therefore, satisfy the tastes of more $15 billion.
local markets that may be very loyal to particular brands as well (a) What is meant by product differentiation?
as offer choice to their more traditional consumers. (b) Explain how Starbucks used the idea of product differentiation to
grow its brand.
(c) What might businesses such as Starbucks need to do to maintain
their competitive advantage?

Skill shortages and their impact on

international competitiveness
Many industries require highly trained engineers, scientists,
technicians or professionals, to compete. Companies that
have long-term access to skilled and low-cost labour have an
advantage over their competitors who do not. Where a firm
owns these advantages in its home market, it may be able
to produce and export more effectively than its competitors.
Where it wishes to expand production and chooses to
locate abroad, it will hope to enhance these competitive
advantages, or at least ensure that they are not eroded.

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Global competitiveness Unit 75

For example, Castle Precision Engineering began making

Thinking bigger
parts for sewing machines in 1951, and then expanded into car
parts, medical equipment and aerospace engineering. It relies on
a skilled workforce for its success. It has made the wheels for the
‘Bloodhound’ car, which aims to hit 1,000 mph in 55 seconds and
hopefully set a new land speed record. Even though Castle exports
at least one third of what it produces, it may remain a small to
medium-sized firm for the foreseeable future as there are similar
firms elsewhere in Britain. One big reason for this is that there has
been a persistent shortage of skilled workers and engineers. In
fact, Castle became involved in the ‘Bloodhound’ project in order
to attract talent to its apprenticeship scheme.
Castle is facing strong competition in Britain, as well as
abroad, for a limited pool of highly trained engineers. Were
Castle Precision Engineering to expand by locating some of its
production abroad, it could perhaps tap into a larger pool. For
instance, in 2013 the USA, India and China produced the most
engineers in the world, so perhaps they would be good locations Muhammad Hazim left Malaysia to come to the UK and pursue an
if Castle decided to locate offshore. accountancy career in Coventry, but now his home nation wants him
Governments and businesses define skills shortages slightly back. The fastest growing South East Asian country is looking for
differently. From the perspective of national comparative advantage, thousands like him to return to address a ‘brain drain’. Malaysia has
a government will be concerned that the relative education and gone to great lengths to counter the high percentage of skilled workers
skills of other countries make them more competitive. However, who leave the country. The same is true in India where the cost of
employers are most concerned when they cannot fill specific Indians studying abroad is as much as $17 billion a year in lost revenue.
The African brain drain is also acute, but the same phenomenon is also
vacancies, or cannot do so at the right skill level. affecting European countries. Some 23,000 German scientists have left
In 2015 a major new survey by specialist recruitment agency the country and in 2015 Chancellor Angela Merkel devised programmes
JAM revealed widespread concerns that a skills shortage could to attract them back. In 2015 over 1.3 million UK university graduates
lead to the UK lagging behind international rivals in food and worked overseas. The US also faces a shortage of IT specialists.
drink manufacturing. It highlighted that the shortage of talented The Malaysian government has run careers fairs in the UK bringing
candidates was threatening future competiveness. The US was together UK-based Malaysian students with Malaysian employers. Over
singled out as the main rival. UK firms were struggling to recruit 4,000 Malaysians attended one fair in London. Their sell is that ‘you can
shift managers and product development specialists. Experts felt have an international career in Malaysia’. The government also offers
that the sector was failing to recruit new talent. tax breaks for five years if they return.
The Border Agency produces a shortage occupation list that is Skills shortage is therefore a global problem and one solution is for
used to guide the granting of work visas into the UK. Guidance on countries to encourage their own skilled workers to return.
salary is given for each skills shortage. Table 2 shows the range of You could use this information in a variety of ways. Obviously, it can be
occupations suffering from a skills shortage in 2014. used when answering questions on skills shortages. It might also be
useful when discussing influences on competitive advantage and the
Table 2 UK border shortage occupation list 2014 impact of a skilled workforce on business.
Occupation Experienced worker salary Source: adapted from the Financial Times 12.06.2014. All rights reserved.
Production managers in mining and energy £37,900
Biological scientists and biochemists £27,000 Links
Physical scientists £27,000 Businesses operating internationally usually began as successful
Natural and social science professionals £27,000 businesses operating in one domestic environment. As such,
Civil engineers £28,700 they understood their market (Units 1−13) and how to operate
Mechanical engineers £31,200 successfully within it (Units 14−18). They managed their
Electrical engineers £32,300 business activities well (Units 26−40) and knew how to assess
Design and development engineers £29,900 their competitive environment (Units 41-43). As they grew,
Business analysts £31,200 they adapted their strategy to suit the evolving business (Units
Software development professionals £29,600 46−50) and planned for where they wanted to be in the future
Medical practitioners £75,000 (Units 63−65). Making the decision to expand internationally
Neonatal nurses £39,200 involves understanding the competitive advantages held by the
Ballet dancers £17,000 firm, and evaluating whether these advantages will apply in the
Maths and science teachers £34,000 international market (Units 65 and 66). Retaining or adapting
Source: www.gov.uk those advantages requires that a business thoroughly understands
the markets in which it is competing (Units 66, 70, 72, 73 and 78).

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 Global business

Case study
THE GLOBAL GROCERY MARKET

As they have grown, many of the biggest names in food Perhaps the UK is the most extreme example with Aldi and Lidl
retailing have decided to take their brand abroad, only to doubling their market share. Aldi has increased its sales density
find that they could not compete successfully in their target from £10 per square foot to £25. This is what a successful
markets. Tesco (UK), for instance, failed in the US, Walmart player might normally expect to achieve in 20 years. Aldi has
(US) failed in Germany and South Korea, and Carrefour also set up in Australia and has quietly amassed 1,350 stores
(France) has left almost 20 of the markets it tried to break into. in the US, though it is bracing itself for the arrival of Lidl in the
Not all grocery stores have failed in the global marketplace, American market. Lidl will focus on brands Americans like.
however. Aldi and Lidl, for instance, two German ‘deep The hallmarks of both retailers are limited ranges and selling
discounters’ have been successful in the global market, predominantly own-label goods. They rely on buying power,
especially in Britain. In 2014, Aldi grew by 22.6 per cent and but adapt to buy locally sourced products and they identify
Lidl by 15.1 per cent, at a time when almost all other grocery stores where customer profiles indicate a demand for more
stores in the UK were contracting. fresh products, which has helped to appeal to a new set of
How did they succeed where others were failing? First, they customers. Lidl UK now sources 60 per cent of it products
were patient and only chose markets where they knew they nationally. There has been a cultural tipping point where both
had a competitive advantage to exploit. For instance, Aldi discounters feel that their brands are now acceptable to high-
invested in countries where there was some concentration in income shoppers. This has reportedly left other UK grocers
the market and the returns of food sales were higher than the floundering. Lidl has stated that its competitors dropping their
global average. Neither firm invested anywhere they might prices will not work. They believe their growth is unrelated to
face corruption or other damage to their reputations. competitor activity and that their brand is now ingrained in
Second, they put an emphasis on quality and low price. In customers’ psyches.
one UK TV advertisement, a group of friends in a country Sources: The Economist, 14.3.15 and the Financial Times
house near London tuck into a sumptuous Christmas dinner. 10.12.2014. All rights reserved.
When the host says that all the food was from the German
discount store Lidl the guests cannot contain their surprise.
The growth of Aldi and Lidl has astonished the industry. (a) Assess the competitive advantages that Aldi and Lidl have
The two are colonising the market with their no-frills over other grocery retailers. (10 marks)
approach to food retailing, taking sales from some of the (b) Evaluate the extent to which competitors can respond to
biggest global grocers. Aldi and Lidl to win back customers. (20 marks)

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Global competitiveness Unit 75

Key terms Knowledge check

Barriers to entry – factors that make it difficult for a 1. What is meant by appreciation of a currency?
company to enter an industry or type of business and
2. What is meant by depreciation of a currency?
compete effectively. These can include incumbents’ high
capital investment and strong economies of scale, restrictive 3. Explain the significance of changes in the exchange rates
government policies, and labour unions. for business.
Competitive advantage – the advantage one company 4. What impact does price elasticity of demand have on
has over another, or several others, in the provision of a businesses facing changes in exchange rates?
particular product or service. For instance, a carmaker may
have a competitive advantage because its cars break down 5. How can firms reduce the risks of fluctuating exchange rates?
less often – in other words are of a higher quality – even 6. What is meant by competitive advantage?
though they may be more expensive. 7. How can a business in a global market improve its
Cost competitiveness – through acquiring ever-increasing
competitiveness?
economies of scale, a company creates the cheapest
product on the market. 8. What impact do skills shortages have on international
Cost leadership – a concept developed by economist and competitiveness?
Harvard professor, Michael Porter, used in business strategy.
It describes a way to establish the competitive advantage
and essentially means the lowest cost of operation in the Exam tip
industry. When considering a question involving global competitiveness, it is
Differentiation – rather than focusing on costs, useful to reflect on all the basic definitions and concepts that
differentiation is when a firm selects certain attributes of its apply to a small, domestic business. They are often the same for a
large multinational firm − it is just that the context is different and
products or services and tries to match these with specific
the application more complex.
customers. The business may then try to command a higher
price for creating this differentiated product. Some students wrongly assume that different rules apply to MNCs
and so they need to be evaluated differently. This is rarely the case.
Economic risk – risk that future cash flows will change due
to unexpected exchange rate changes. For example, the problems (and opportunities) that MNCs face in
trading in different currencies mostly come down to familiar
Global competitiveness – the extent to which a business
concepts: supply and demand, pricing strategies, cash flow and
or a geographical area such as a country, can compete managing risk.
successfully against rivals.
The competitive advantages that they hope to rely upon for
Skills shortages – where potential employees do not have
growth are perhaps more complicated, but they may be derived
the skills demanded by employers. from the same sources as those of domestic firms. The same is
often true for the threats that they face: for instance, all
businesses need suitable employees if their businesses are to
succeed and grow.

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 76 Marketing
58 4.3.1
Theme 4

Key points
1. Global marketing strategy and global localisation (glocalisation).
2. Different marketing approaches:
●● domestic/ethnocentric

●● mixed/geocentric

●● international/polycentric

3. Application and adaptation of the marketing mix (4Ps) and Ansoff’s Matrix to global markets.

Getting started to local expectations in order for a business to succeed in

an international market. The phrase, ‘think global, act local’
Pret á Manger (also known as Pret) is a UK sandwich shop is a good summary of what is meant by glocalisation. The
that focuses on fresh ingredients and prompt service. The phrase suggests that businesses should aim to reach potential
name of the business means ‘ready to eat’ in French, which fits customers around the world, but that, to be successful with
neatly with its emphasis on serving quality food and prompt, those potential customers, businesses need to take account of
friendly service. local tastes, customs and traditions. Global businesses should
be sensitive to the specific preferences of the different markets
Pret opened its first shop in 1986. By 2014, it had 289
in which they want to operate and succeed.
shops in the UK. In addition to its UK growth, the business
developed a global marketing strategy, which involved
opening branches in other countries. In 2015, Pret had 350
shops worldwide. It announced that it would almost double
the number of its shops in France and increase the number
in the USA.
Although the service and approach in its shops is similar
around the world, some products differ to cater for local
tastes. For example, in the UK, the most popular sandwich is
crayfish with rocket. In Hong Kong, however, locals prefer hot
food, so Pret shops in Hong Kong prepare and sell more hot
wraps and soups.
Why has Pret grown so much since opening its first shop?
What is meant by a global marketing strategy? Why might Pret
have wanted to expand into countries such as France, China
and the USA? Why does Pret sell different types of products in
different countries?

Global marketing strategy

Unit 13 explored a marketing strategy as a set of plans that
aim to achieve a specific marketing objective. When some
businesses operate outside their country of origin, they
operate a common global marketing strategy in order to sell
their products beyond their national borders. Global marketing
involves the planning, producing, placing and promoting of a
business’s products in a worldwide market. This process can
involve a business having offices in different countries, but the
process is also facilitated by the growth of the internet.

Global localisation (glocalisation)

The global localisation approach differs from having a
common strategy for all countries. Instead, it involves adapting

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Marketing Unit 76

Different marketing approaches Question 1

When considering entering international markets, businesses use
a range of different marketing approaches for their products. Cath Kidston is a UK-owned chain of home furnishing retail
stores. Despite the fact that the business produces and sells
Ethnocentric (domestic) approach: Overseas markets products that are quintessentially British, it has expanded
are seen as identical or similar to domestic markets, and the successfully into overseas markets.
approach assumes that what is good for the domestic market In 2014, the business announced a plan to open 100 new stores
will be good for global markets. Businesses using this approach in China. This followed a year of growth abroad, in European
make little or no attempt to adapt their product for different markets such as Spain and also in Asia. The new stores planned
markets. For example, Sony’s PlayStation 4 is a very popular to sell largely the same product range for which Cath Kidston is
console worldwide. The console is sold in most countries but famous in the UK. The offering from the business seems to have
it is the same in every market. Compare this approach with the
a global appeal, successfully attracting international consumers
approach of Pret á Manger, where different types of products
with its colourful retro patterns.
are sold to reflect the different tastes of different markets.
Many businesses use an ethnocentric approach, including: Source: adapted from the Financial Times 12.8.2013, 22.07.2014.
●● PizzaExpress, which expanded into China to meet the All rights reserved.
growing taste for western food by Chinese customers (a) Explain two reasons why Cath Kidston has a strategy of global
●● Apple, with products such as the iPhone , iPad and
® ®
expansion.
MacBook ®
(b) Explain one advantage and one disadvantage to Cath Kidston
●● Swatch watches
of adopting an ethnocentric strategy when opening stores in
●● Rolls Royce cars.
different countries.

Polycentric (international) approach: Businesses adapt

their product to the local markets in which they plan to sell
the product. This involves developing and marketing different
products for the demands of local customers in different
markets. For example, car manufacturers will adapt cars and
model names to meet the expectations of their local markets.
One advantage of this approach is that the product should
sell well. By tailoring products to specific customer needs, the
product can be targeted precisely within the particular market.
A disadvantage of this approach lies in the cost involved.
Developing bespoke products is expensive, and these costs
can be so high that the project itself can be jeopardised.
For example, in 2007 Tesco launched a new, UK-style
supermarket, Fresh & Easy, into the US, that was tailored to
meet American consumers’ demands. The stores focused
heavily on fresh ready meals, for example, to cater for the
convenience that American customers expected. They also
chose not to use the Tesco name in the American market.
Using an ethnocentric marketing approach has its However, the project was not as successful as the approach
advantages, such as economies of scale. Because a product in the UK market and Tesco sold its Fresh & Easy stores.
is standardised across markets, the scale of production is The project reportedly cost Tesco billions of pounds.
much larger and so savings can be made on raw materials. In
addition, there are no development costs involved in adapting Geocentric (mixed) approach: Businesses use a
products for different markets. In the case of Pret, market combination of the ethnocentric and polycentric marketing
research and product development had to be carried out to approaches. This ‘glocalisation’ approach is used by many
identify and develop products that served local demand. This multinational corporations, and is summed up by the phrase,
type of research is costly and leads to further costs in product ‘think global, act local’. The business’s strategy is to maintain
development. Where this type of marketing activity is not and promote the global brand name, but to tailor its products
required, average costs can be reduced and this can lead to to local markets. For example, McDonald’s makes sure that its
lower prices and increased competitiveness. Big Mac® burger tastes the same in every country in which it
However, this approach may also have disadvantages, as a is sold. This approach is used by various fast food chains.
product may not sell well if it is not adapted to the local market. Some examples of the type of foods they might use to replace
Where a marketing mix is not geared to a local market, a business what you’re used to are shown in Table 1.
may be taking a risk about the appeal to a new market.

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 Global business

Table 1 Types of foods that could be used in ‘glocal’ meals their products when moving into international markets
Country: Egypt Country: Japan (ethnocentric, polycentric and geocentric).
●● Promotion. When promoting products in global markets,
Food might include kofta meat, fava Food might include teriyaki sauce,
beans and different types of bread, noodles or even sushi. Desserts businesses need to be conscious of language differences.
like baladi bread. might be different with sweets called ●● Place. Businesses need to take account of how local
wagashi. consumers typically buy their products. For example, the
Country: Greece Country: India Tesco Fresh & Easy stores may not have appealed to how
Food might include tzatziki sauce, Food might include breads like roti some US consumers shop, using larger supermarkets.
fried cheese (saganaki) or cheese pie or naans and more rice dishes.
(tyropita). Desserts might be more Drinks might include lassi or Table 3 provides a summary of some questions to ask when
honey-based, like baklava. masala tea. considering the 4Ps.
Table 2 provides a summary of the advantages and disadvantages Table 3 The marketing mix in global markets: a summary
of the different market approaches.
Product Price
Table 2 Advantages and disadvantages of different Should the product be adapted for What price should be charged in
marketing approaches different markets, or can it stay as the global markets? What prices are
it is? charged by local competitors?
Advantages Disadvantages
Ethnocentric Lower cost of development Product may not sell well Promotion Place
and production What are the most effective How do consumers buy their
Does not take account of
Economies of scale national/cultural differences promotion methods in different products in local markets?
countries?
Polycentric Targeted products for Higher cost of development
different markets – higher
Difficult to compete with
sales
established local brands Ansoff’s Matrix
Geocentric Tailoring product to local Higher cost of product Ansoff’s Matrix was discussed in Unit 45. It is a strategic tool to
tastes and needs – higher development help a business achieve growth, which can be applied to global
sales markets and can help to inform decisions around marketing
strategy. It is possible to apply this model to a glocalisation
strategy, as used by multinational brands such as Starbucks,
Adapting and applying the marketing Ford and McDonald’s.
mix and Ansoff’s Matrix to global
markets Figure 1
The marketing mix (the 4Ps) Ansoff’s Matrix
As mentioned earlier in the unit, a marketing strategy is the PRODUCT
set of plans that a business uses to achieve specific marketing
objectives. For example, a local takeaway may aim to become the Existing New
market leader in the town in which it operates. To achieve this
Existing Market Product
objective, the strategy might be: penetration development
●● offering locally sourced, organic ingredients (product) MARKET
●● lowering off-peak prices (price) Market
New Diversification
development
●● establishing a delivery service (place)

●● a loyalty scheme which offers discounts to regular customers

(promotion).
But what about a business that operates on a global scale? As discussed in Unit 45, Ansoff’s Matrix shows four possible
What strategies might a business use when operating in mass strategies that a business might adopt. Risk can become greater
markets? The marketing mix is used in global markets, and must the further a firm extends from its core of existing products
be considered as part of a global marketing strategy. and consumers, i.e. the further it extends from the top left-hand
●● Price. Decisions around price need to take into account corner of the matrix. This can become particularly pronounced
local factors such as incomes, taxes, rents and other costs. when businesses extend into international markets, where
It is unlikely that a business will charge the same price in all expertise of local conditions and tastes might be less secure.
markets. An Apple iPhone® might cost less in the US than When considering global marketing, the focus is on businesses
in Russia, for example. Price will also reflect different local introducing new or existing products into new markets that may
factors, such as wage rates and taxes. have national and cultural differences.
●● Product. To what extent should a business modify or adapt ●● Market penetration: exists where a business adapts

its product for global markets? The section above looked products for markets in which it already operates. For
at the different approaches that businesses can take with example, McDonald’s already operates in Japan. By

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Marketing Unit 76

developing and launching the Teriyaki McBurger® into this

Exam tip
(existing) market, the strategy is clearly one of market If answering a question on this topic, you should feel prepared
penetration. enough to use a wide range of knowledge and concepts from the
●● Market development: involves the marketing of existing whole course. Any discussion of a business wanting to expand
products in new markets. This is not always straightforward should make you think about economies of scale. One benefit that
as customers from different regions of the same country, any business hopes to achieve by expansion – at home or abroad
let alone a different country, may have different tastes and – is the reduction in unit costs that can be achieved by operating
on a larger scale. This might be achieved by being able to
preferences. Unit 45 showed how a market development
purchase components or raw materials on a larger scale, or by
strategy relies heavily on understanding local habits, having one head office serving different markets.
tastes and needs. Even where market development is
Any discussion of this topic in an exam question should not end at
appropriate and successful, it is often necessary to make
the 4Ps or Ansoff’s Matrix. There are many other concepts to
slight modifications to suit the new market, for instance in consider when analysing global marketing strategy, including:
terms of language or labelling. Pret á Manger adapted its
• markets – supply and demand in local markets
products slightly to meet local palates, in France and the
• price and income elasticity of demand – pricing decisions need
US, although retained its model of customer service and to take account of demand factors in local markets
prompt delivery. This refining of an existing product, to fit • recruitment – the presence or lack of skilled staff in the new
into a new – in this case, overseas – market is an example market
of a market development strategy. This is also an example of • ethical considerations
glocalisation, where products are modified for local tastes. • legislation
●● Diversification: occurs when new products are developed • the importance of the internet in marketing.
for new markets, as explored in Unit 45.

Key terms
Economies of scale – savings facilitated by an increased
Thinking bigger
What is the best marketing approach for a business planning to expand
level of production.
into international markets? We live in a global economy, full of global
Globalisation – the process of businesses starting to
brands, and this has largely been facilitated by the spread of the internet.
operate internationally and develop international influence. To what extent is this globalisation a desirable development for
Global marketing strategy – the process of adjusting businesses? The ability to exploit new markets is an obvious advantage.
a company’s marketing strategies to reflect conditions, Some of the regions with the highest rates of economic growth – such as
consumer tastes and demand in other countries. China and India – are also the most populous, and consumers in these
Glocalisation – a combination of the words ‘globalisation’ regions should benefit from having access to a wider range of goods
and ‘localisation’. It involves the development and sale of and services. The internet is also directly impacting on global marketing,
products to customers around the world which reflect effectively reducing the costs involved in operating on a global scale.
specific local customs, tastes and traditions. These regions offer exciting opportunities for western business, but there
Localisation – strategies that adjust products to fit with are also risks for businesses embarking on international expansion.
target customers. These require careful strategic consideration.

Knowledge check
1. What is meant by the term glocalisation?
2. Give three reasons why a business may want to expand into
global markets.
3. What is meant by an ethnocentric marketing strategy?
4. What are the advantages to a business of adopting a
geocentric marketing approach?
5. State the four strategies outlined by Ansoff’s Matrix.

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 Global business

<v_983521_ph_194> [pic of Shanghai>

Case study
THE GLOBAL MARKET

In 2009, the American toy maker, Mattel, opened a new In 2011, Mattel closed House of Barbie, in consideration
flagship store called House of Barbie in Shanghai, China. of the sales figures. Some analysts suggested that this was
The store was intended to celebrate and promote the iconic partly because Chinese girls and parents preferred dolls to
doll, Barbie, which had recently been launched in China. be cute rather than fashionable. Others pointed out that, in
Mattel was keen to expand into international markets. the USA, the Barbie brand was established enough to be a
China was regarded as an ideal market for Mattel to enter cultural icon, but in China Barbie may have been considered
in order to establish Barbie as a successful product. China’s as just another doll. There were also questions around the
economy was growing strongly and there was a growing prices of products and accessories in House of Barbie. Some
middle class with a taste for western culture. Shanghai in felt that they were too expensive for local consumers who
particular was regarded as an innovative, cosmopolitan may not have recognised the Barbie brand or know what it
city with an aspirational population, and it represented stood for.
a significant proportion of China’s GDP. Mattel’s market
research also indicated that Barbie was popular with (a) What is meant by ‘international market’? (2 marks)
local girls.
(b) Using Ansoff’s Matrix model, explain which strategy
Mattel invested millions of dollars in launching House of Mattel used when opening House of Barbie in Shanghai.
Barbie, which was located in Shanghai’s luxury shopping (4 marks)
area. The store included a restaurant and spa as well as its
extensive ranges of Barbie dolls and accessories. Although (c) Explain which marketing approach – ethnocentric,
the Barbie dolls sold in Shanghai were essentially the same polycentric or geocentric – Mattel used when launching
as those sold throughout the world, some changes were House of Barbie. (4 marks)
made. For example, one model had black hair and wore (d) Assess the marketing strategy Mattel used with House
Chinese clothes. of Barbie in Shanghai. (10 marks)

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 77 Niche markets
58 4.3.2
Theme 4
Key points
1. Cultural diversity: recognition that groups of people across the globe have different interests and values.
2. Features of global niche markets.
3. Application and adaptation of the marketing mix (4Ps) to suit global niches.

Getting started of customers. Customers in niche markets have very particular

needs that are sometimes not catered for by local businesses.
Ties.com is an internet-based retail company that focuses Higher prices can be charged for products in niche markets
exclusively on neckties and related products. The business than can be charged in mass markets, and this is a very
claims to have the most comprehensive selection of neckwear desirable position for a business. The reason for this is that
anywhere in the world and stresses the quality of its operation the products cater for very particular needs. The features of
on its website: businesses that operate in global market niches are:
We’re not some fly-by-night company. In fact, we’ve been ●● a clear understanding of the needs and wants of the

a leader in the industry for more than 15 wonderful (and market segment
crazy) years. We’ve got real humans answering phones, we ●● an emphasis on quality

gingerly pack our boxes by hand and we take absolute pride ●● excellent customer service

in everything we do. ●● expertise in the product area

●● prioritising profit rather than market share

From neckties and skinny ties, to bow ties, socks, tie racks and
●● innovation.
more — nearly everything you’ll find at Ties.com is designed
by our talented team in sunny Southern California. That’s
a level of intimacy and attention to detail that few can match. Question 1
Besides the best selection of premium neckwear on the Virgin Atlantic is an airline that operates to destinations in
internet, you can expect a fast & secure checkout, a no-hassle North America, the Caribbean, Africa and Asia. It also operates
return policy and a 100% satisfaction guarantee. That’s domestic flights in the UK. The airline operates within the broad
how confident we are that you’re going to find something market for air travel, and competes with other airlines to fly
you love. passengers to holiday destinations.
Source: www.ties.com Virgin Atlantic also caters for a niche market in passengers who
Why do some businesses choose to produce or sell a small range of are prepared to pay more for a much more luxurious experience.
products? To what extent does Ties.com operate in a niche market? The Virgin Upper Class offer includes:
Why might Ties.com not be a popular business in every country?
• chauffeur driven pick-up for the airport and transfers from
Describe how the internet has enabled businesses like Ties.com to
airport to destination
expand into different countries.
• a private security channel at the airport to avoid queues
• exclusive clubhouses at airports with free restaurants and bars
Global niche markets • leather seats and luxury beds in-flight
Global niche markets are similar to the niche markets covered
• extensive entertainment services in-flight.
in Unit 13 in the sense that they target a very specific range of
people, often referred to as subcultures. These are groups of The price of such luxury is several times higher than competitors.
customers with common interests or hobbies. In global niche This is aimed at business travellers, whose businesses may be
markets, the customers live in more than one country and have paying for the flight, or at individuals for whom a ticket price may
particular needs that are not met fully by the global mass market. not be such a significant expenditure.
For example, the toy market has millions of different products
(a) Describe three different market segments that Virgin Atlantic
aimed at all age groups. But the market for interlocking toy
targets.
bricks is much smaller. The case study in this unit considers how
(b) Explain why Virgin Atlantic offers different types of ticket for
Lego® operates in this global niche market.
different customers.
Features of global niche markets (c) Explain how Virgin Atlantic demonstrates that it has a clear
The opposite of niche markets are mass markets. As discussed understanding of the needs of its customers.
in Unit 1, mass markets are huge, often global and have millions

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 Global business

Virgin Atlantic does not only offer flights to customers in its

Question 2
home country – the UK. It has identified a global niche, where
customers in different countries are prepared to pay for the Mercedes-Benz is a German car manufacturer and focuses
luxury flight experience. This is the key to global market on luxury cars, coaches and trucks. Although it is a German
niches. It does not matter whether the customer who is company, Mercedes-Benz manufactures its vehicles in over
prepared to pay a higher price is in the home country 30 countries, from Argentina to Russia to Vietnam.
or abroad.
Mercedes-Benz cars meet the needs of global customers
Why, though, are customers prepared to pay higher prices
who value the luxury of the product and who have a strong
for these global brands, rather than local equivalents? The
answer partly lies in the global nature of the world economy. sense of brand loyalty to the business. The business works
Aspirational, niche brands in the UK are likely to be similarly hard to ensure that its brand is distinguished from other car
aspirational in other countries. This transmission of desirability manufacturers. This stems from a strong emphasis on quality
is the function of a range of factors. drawn from expertise in the area of luxury car-making.
●● The internet and e-commerce – these have proved an Mercedes-Benz cars can be more expensive than other
important marketing tool and an opportunity to spread cars in the same sector. Customers in this global niche are
information. With the advent of e-commerce, businesses prepared to pay for the brand name and the luxury this
have been able to spread into foreign markets, and create brings. Demand for such luxury products is often price
and meet local demands that would otherwise have inelastic. This is a real advantage for businesses that serve
been impossible. such niche markets.
●● Social media – the rise of platforms such as Facebook,

Twitter and YouTube has given birth to a new brand of (a) Explain what is meant by ‘global niche’.
commentators known as ‘vloggers’. These are people who (b) Why is the demand for Mercedes-Benz cars price inelastic?
use video to comment on a range of current topics, issues (c) Explain one advantage to Mercedes-Benz of demand for its cars
and – crucially – products. Vloggers are a growing group being price inelastic.
who promote niche brands to subscribers.
●● Ease of travel – facilitated by low-cost airlines. The world,

in a real sense, has become a smaller place. Visitors to

foreign countries are exposed to well-known global brands, Application and adaptation of the
in places far away from their home country. marketing mix to suit global niches
Businesses that operate in global niche markets need to
Cultural diversity distinguish themselves from the mainstream (or mass) market.
One difference, which in the past may have caused problems This can be done through adaptations to the marketing mix (4Ps).
for British businesses, is that English was not the main or even
the second language in many countries. In Eastern Europe, for Product: Global niche products often place an emphasis on
example, German and Russian may have been more widely quality. Examples include luxury cars, watches and perfumes. For
spoken than English. The expansion of the EU has led to example, Montblanc produces and sells exclusive pens, watches
English being spoken in more countries, helping to solve this and luggage products that are sold around the world and are
problem to some extent. marketed as exclusive, desirable products. For Virgin Atlantic, the
Other cultural differences may influence the way a product key is to differentiate its standard product into something that
is marketed. For example, a product name suitable in one demonstrates it is meeting the needs of niche customers.
country may have a totally different meaning in another – the
French lemonade Pschitt would require a new name were it Price: The point of niche marketing is to charge higher prices
to be sold in the UK. The example of Ties.com at the start by providing a product not intended for mass market. The point
of this unit suggests how a brand can grow into different behind such markets is the ability to charge premium prices.
countries, but would neckties be successful in all countries? Virgin Atlantic has the ability – through its Upper Class package
Some cultures and traditions do not wear ties at all, and so – to charge prices much higher than for its standard flight ticket.
expanding into these markets is less likely to be successful.
Colours have different meanings throughout the world. Promotion: Strategies to promote products to global niches
In the Far East, white rather than black is associated with are often based around the brand name and reinforcing the
mourning. In India, fashion models of the sort used to promote exclusivity of the brand, and need to be more targeted than in
products in the West might be considered too thin. In some mass market promotion. Consideration has to be given to the
countries, what may be regarded as a possible ‘bribe’ in language differences that might exist between countries. For
the UK might be common business practice. Payments to example, Dublin-based drinks distributor, C&C Group, marketed
government or industry officials may be required to get things a brand of golden whiskey liqueur called Irish Mist to Germany.
done, from electricity connection to securing contracts. However, in Germany the word mist is translated into a form of
manure! The product needed to be rebranded. Car companies

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Niche markets Unit 77

often give different names to the same cars in different

Exam tip
countries. One problem with this need to be sensitive to national When considering global niche markets as an extension of
and cultural differences is that promotion costs will be higher, domestic niche markets, you need to consider why a business
and this may impact on price and ultimately competitiveness. might want to extend its reach beyond its own national borders.
A key benefit of targeting a niche market, rather than a mass
Place: Businesses serving niche markets are often more market, is the opportunity to charge higher prices than an
careful when selecting distribution channels for their equivalent, mass-market product. Why, though, are customers in
different countries prepared to pay higher prices for such
product. This is particularly important where exclusive
products? Concepts such as price elasticity of demand can be
brands are involved. Networks of exclusive dealers are a used to explain this appeal. If a product is desirable and has few
common method of selling products to global customers. close substitutes due to its quality or features, then consumers
Mercedes-Benz has exclusive dealerships around the world. are likely to be less price sensitive, so the demand is likely to be
Montblanc sells its products through an exclusive network price inelastic. With the latest iPhone, for example, it does not
of authorised retailers, jewellers and over 360 Montblanc matter whether the consumer is in New York, London or Tokyo. The
Boutiques worldwide. product has such niche appeal that relatively high prices do not
deter demand. For a business, having a product with low price
With the 4Ps in mind, Table 1 summarises the advantages
elasticity of demand is a very appealing position. But how can this
and disadvantages of niche marketing. be achieved? One way is by identifying and filling global niches.
If answering a question on
Table 1 Advantages and disadvantages of niche marketing global niche markets, it is
Advantages Disadvantages crucial to take account of
Prices are higher than in mass Products sell in relatively low the appropriate context. You
markets – demand is more price volumes (compared with mass must apply your answer to the
inelastic. markets), so profits need to be high case study and the product
enough to make it worthwhile. being considered. Using the
The product is distributed through The niche market must be large mobile phone example, you
specialist retailers or directly to the enough to support the business and could contextualise your
consumer. This has advantages specialist distribution. The small size response by comparing to
in terms of image. For example, may prevent economies of scale that competitors (Samsung, HTC),
the Billabong surfer image might compete with larger competitors. or referring to alternative
be compromised if sold widely in methods of communication
supermarkets. (telephone, email).

Global niches exist where the local market for a product is

too small to be profitable but at a global level the market is
Key terms
very viable. These trends may be present due to international
perceptions about certain goods being the same (for example, Global niche market – customers who live in more than one
agreement that Mercedes is a good car). Firms large and small country and have particular needs that are not met fully by
may exploit these niches as part of a global marketing strategy. the global mass market.
Niches are particularly present in high-end goods or high-tech
medical or computing goods.
Knowledge check
Thinking bigger
Wider business ideas can be applied to the topic of global market 1. What is meant by a
niches. To what extent should a business seek to extend a niche product niche market?
into global markets? The fact that a niche product is successful in one 2. Distinguish between a niche market and a mass market.
country is no guarantee of success with consumers globally. Indeed, one
of the reasons for the success at home may well be due to the fact that 3. What is a global niche market?
the business has identified a particular need of domestic consumers
4. Give three examples of products that are targeted at global
and meets this need with a bespoke product. This can be the case with
restaurants. A strong reputation for quality using local food may work niche markets.
in a regional setting, but can this be translated to another country? The 5. Describe how social media can encourage the growth of a
nature of the restaurant business, with quality being overseen by an global brand.
owner, may be changed through expansion and seeking out global niche
markets. Gordon Ramsay, a well-known UK chef, successfully opened 6. How does cultural diversity affect global niche markets?
Maze restaurant in New York after the success of the UK equivalent by 7. How do businesses responsible for luxury products ensure their
the same name in London. Careful marketing, operations and leadership
brand is maintained in different global markets?
are needed to translate a local niche market into a global niche market.

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 Global business

Case study

GLOBAL NICHES
“Scandinavian countries [Denmark, Sweden and Finland]
have an impressive number of globally competitive companies.
Denmark is a world leader in hearing aids (Oticon), shipping
(Maersk), toys (Lego®), drink (Carlsberg) and wind power
(with more than 200 companies that account for a third of the
world’s wind-turbine market). Novo Nordisk is at the centre
of a biotech cluster, dubbed Medicon Valley, that stretches from
Copenhagen to Malmö in neighbouring Sweden and has an
annual turnover of €13.4 billion.
“Sweden boasts some world-class manufacturing companies,
particularly in mining equipment and machine tools (Sandvik 19th century in the small town of Sandviken, two hours north
and Atlas Copco), as well as retail stars such as IKEA and H&M. of Stockholm. It is now a global giant that produces everything
Finland’s Kone is one of the world’s leading lift and escalator from machine tools to steel rods for nuclear reactors. Sandvik’s
companies. Nokia’s problems are being offset by the rise of small-town roots have not prevented it from becoming a
electronic-games makers such as Rovio, the creator of global leader in its core businesses. ‘Expanding abroad is how
Angry Birds. Norway is a world leader in oil services and we save jobs at home’ is a common refrain.
fish farming.”
Sandvik is obsessed by promoting productivity – both its own
These globally competitive companies thrive in well-defined and its customers’. A giant factory that produces steel rods
global niches. Here are some examples. looks as if it is run by ghosts: four people monitor computer
• “Lego® dominates the market for interlocking bricks.” It screens in a command centre and a few others patrol the
began producing them in 1949 and has since grown to floor. A productivity centre is devoted to pushing forward the
be one of the world’s most successful companies. By 2015 frontiers of technology – making the world’s fastest drills, for
Lego® had replaced Ferrari as ‘the world’s most powerful example – and training employees to help customers. The
brand’. This is a niche market as there are not many different company’s mantra is ‘we sell productivity not products’.
types of such bricks. The global niche for Lego® can be Haldor Topsøe founded the company that bears his name
defined as a brick-based construction toy within a larger back in 1940 [and as at 2015] … he remains chairman.
toy market. His company, meanwhile, has grown into a global giant...
• “Volvo Trucks produces the world’s best high-quality lorries.” Mr Topsøe ascribes its success to two things. He found a
• ”Sandvik is a machine-tool superpower.” perfect niche in catalysis. Catalysts accelerate lots of chemical
“Nichification protects high-cost companies from emerging- processes that are vital to a modern economy. They are also
market competitors. Nobody wants the cheapest machine tool extremely hard to copy. So demand is growing and barriers
when a defective one can cause millions of pounds worth to entry are high. He believes that his company benefits from
of damage.” being a family affair, which allows it both to invest for the
long term and to take advantage of the global market.”
There are four qualities that explain the success of these
companies in exploiting these global niches. Source: www.economist.com
1. Relentless innovation of products.
2. Taking long-term growth into consideration. (a) Explain one advantage to a business of identifying a global
3. Consensus-based approaches to management, where market niche. (4 marks)
flat organisational structures and democratic systems of (b) Explain one example of how ‘replacing labour with
corporate leadership promote trust and co-operation. machines’ might increase productivity for a business such as
4. A passion for replacing labour with machines to increase Lego®. (4 marks)
productivity.
(c) Assess the importance of the global market to Lego®,
“To see these forces in action, consider two companies in making reference to the niche in which it operates.
different industries. Sandvik started making steel in the late (12 marks)

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 78 Cultural/social factors
58 4.3.3
Theme 4
Key points
Considerations for businesses:
1. Cultural differences.
2. Language.
3. Unintended meanings.
4. Inappropriate/inaccurate translations.
5. Differing tastes.
6. Inappropriate branding and promotion.

Getting started to view their own cultures, ethics and norms as superior. For
example, people tend to accept the values of the culture around
According to the US Commerce Department, doing business in them as absolute values. Since each culture has its own set of
Russia mixes formality with a personal touch. Business people values, often quite divergent from those values held in other
are expected to dress formally and conservatively. In the initial cultures, the concepts of proper and improper, foolish and
meeting, it is recommended that Western business people lean wise, and even right and wrong become blurred. In international
more towards formality. Russian business people also consider business, questions arise regarding what is proper by which
written material important. They may expect slides, brochures culture’s values, what is wise by which culture’s view of the
and samples. According to the Australian Trade Commission world, and what is right by whose standards.
such written materials, as well as websites and business cards,
should look to be high-quality. Russian business people expect Question 1
agreements and deals to be written and signed.
Having said this, the Russian approach can be to chat and get to Cordex, a British shoe making firm,
know potential business partners on a personal level before any decided to expand internationally
discussion of hard details. It is noted that once a Russian partner by acquiring a Vietnamese firm,
becomes more familiar with western business people, they may Vetex. In planning the takeover,
show more emotion such as a positive pat on the shoulder, or Cordex’s senior managers had
show emotions of displeasure more openly. not given enough thought to the
process of integrating Vetex after
Russian business people are reported to expect western
the merger. Once the deal was
counterparts to be on time for appointments. However, the
International Business Centre advises that the Russian themselves complete, Cordex selected staff
may be late in order to test the patience of their partner. Russian from its London headquarters to
business people also expect a prompt and comprehensive follow- relocate in Hanoi and began the
up of the meeting from the western negotiators in order to keep process of moulding Vetex into
the business deal positively moving forward. Cordex’s way of doing business, a
process that was hugely expensive.
Source: adapted from www.ibtimes.com
After six months, it was clear
What might people from other countries think of your own that the process of integration had not been handled well. One
cultural and social factors? Why might being aware of cultural member of staff returned home as her family did not like living in
factors help or hinder business? Vietnam. The remaining members of staff were finding it difficult to
understand the business culture and did not speak Vietnamese or
French and so were having trouble communicating effectively. Two
key Vetex staff members quit and many of the remaining managers
Cultural and social factors affecting found the situation so challenging they were also considering
global marketing leaving. The CFO of Cordex was deeply concerned at the escalating
Doing business across cultures can be challenging. Without an costs, and the CEO was worried that Cordex’s international
understanding of national and corporate cultures and languages, expansion strategy might fail.
the potential to offend is very real. These cultural and social
factors and how they affect global marketing are examined in (a) Explain how Cordex was ethnocentric in its approach to the
this unit. process of integrating the two firms.
In order to market effectively in other countries, businesses (b) Explain the approach that Cordex could have taken.
must overcome ethnocentrism. This is the tendency of people
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 Global business

Cultural differences The recipient should pause upon taking the card, study it
Unit 57 explained how corporate culture can affect how thoroughly and then place in their special case. All of this
a business operates. However, working across differing is done with great formality. Failure to treat a business card
national cultures can add levels of complexity. Each step in with respect can cause grave offence.
conducting business needs to be carefully prepared for and Every country in every region will have its own norms
considered, to take account of cultural differences and build governing introductions, so it is important to conduct
trust. To understand how, companies need to think about thorough research before the first meeting.
each level of the business relationship: the introductions, the
negotiations and communicating on a day-to-day level.
Language
Although much of international business is conducted
Meeting someone from a different culture is often
in the English language, understanding other languages
awkward, but in a business setting there can be elaborate
makes communication much easier and helps to cement
formal and informal procedures that have developed over
relationships. Over-reliance on one language is also risky,
time and, if not followed, can cause much offence. For
in that it may lead to miscommunication and less sensitivity
example, in Asian cultures, such as Vietnam, a person
towards other cultures. Communication is much more
is expected to shake hands when first entering a room.
than simply language, however. For instance, there are
Participants are expected to shake using both hands, upon
differences in the nature of communication between
meeting and when saying goodbye and need to nod the
high-context and low-context cultures. Low-context
head slightly while doing so as a sign of respect. The two
cultures, such as those of North America and much of
parties must then exchange business cards. The etiquette
Europe, tend to say what they mean. That is, in discussions,
surrounding these is also extremely important. Business
what is said can usually be taken at face value. Firms ‘get
cards are thoughtfully crafted, giving an individual’s name
down to business’ and view socialising as being for after
and contact details, and always kept in a special case to
the deal is done. Agendas, letters, contracts and other
ensure they are in perfect condition when handed out.
formal documentation are essential and relied upon during
The card must be given and received with both hands.
negotiations as well as after they are completed.

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Cultural/social factors Unit 78

However, in high-context cultures, ‘yes’ often does not Unintended meanings

mean ‘yes’. In Saudi Arabia, for example, ‘Yes, I agree’ might Verbal communication has many pitfalls, but so does physical
mean, ‘I hear you’ rather than ‘I agree with you’. Much of communication. Gestures common in one region, may have
Arab and Asian communication is high-context, and this differing meanings in other regions and cultures.
has big implications for conducting business. For instance,
after making a pitch for business in Japan the Japanese Table 1 Some examples of gestures common in Britain that
negotiator might close the long meeting saying, ‘We are can cause offence in cross-cultural business settings
going to study your proposal and get back to you.’ Far from
Gesture Examples of countries or
expecting to hear from them in a few days or weeks with regions where gesture might be
a positive response, as might be the norm in a low-context considered offensive
culture, in Japan – a high-context culture – such language Thumbs-up gesture, meaning ‘well Australia, Greece, Middle East
may mean ‘no’. However, the Japanese never use that word done’
in negotiations. Initial meetings are there to build trust, and The OK sign made with forefinger Brazil, Uruguay, Germany, Russia
socialising is used to create relationships for the next stage and thumb
of negotiations. This is very different from what might take Pointing with the index finger China, Japan, Indonesia, Latin
place between, for instance, a British firm negotiating with a America, Africa, parts of Europe
Danish one. Beckoning by curling the index finger Greece, Pakistan, parts of Africa and
with the palm facing up, to indicate Asia
‘come here’
Question 2 Use of left hand Never shake hands with left hand in
a Muslim country and try to avoid
LI2, a Chinese business, purchased Mobi-Nev, a North using it if at all possible
American mobile communications business in 2001. The deal Snapping fingers Latin America
involved a developing understanding of cultural contexts.
For example, L12 was based in Shanghai and Mobi-Nev Differing tastes
in Phoenix, Arizona, where no-one in the company spoke Depending on the product and the country, there may
Chinese. However, the company carried out a cultural be the need for more or fewer adaptations. For example,
UK products for the Australian market may require fewer
audit of its employees and this highlighted some cultural
adaptations than those for the Chinese market since the
considerations, most of which concerned communication.
cultural and social differences between Australia and the UK
An illustration of this came in 2003, when the Human are relatively small.
Resources Officer (HRO) was taking forward her role in the Some differences in taste are due to local variants – for
Phoenix office. The process of updating a diversity policy example, Coca-Cola has the same base concentrate in
seemed to be running smoothly, yet it became apparent every country, but due because it is mixed with the water
that there were some cultural differences and some Chinese in local countries it has a slight variation in taste depending
colleagues felt she was being disrespectful when organising on location. This sort of adaptation is not something that
meetings. This was due to the Mandarin translation of the a business can control and not something that they would
word ‘request’, which implied that she was asking to meet implement themselves.
Other differences can be based on religious beliefs.
someone below her in status and caused offence to some
The use of halal meat is common in fast-food restaurants
Chinese colleagues. To develop understanding and establish
in Middle Eastern countries. In India, many international
trust and a common culture for the future, the company fast food restaurants will not sell pork or beef due to the
HRO worked for a period in the Shanghai office. This gave prevailing religious beliefs of that country. By respecting
her the opportunity to to learn first hand the subtleties of these beliefs and catering to their market in these countries,
Chinese language and culture.. businesses ensure that they adapt sufficiently to gain a
(a) Explain what problems could have emerged if the HRO hadn’t market share from local businesses who may be better suited
decided to go and work at the Chinese headquarters. to understand the regional specifications.
(b) Assess the importance of understanding the language and
Some adaptations to products are based upon legal
culture of countries when taking over a business in another requirements. For instance there are many food products
territory. used in the US that are banned for use within the European
Union. Brands that want to transfer their products from, for
example, the US to the UK will have to adapt them to meet
the necessary legal requirements. For example, brands such
as Pringles and Starburst have had additives removed from
their US ingredients list to be able to be sold in the UK.

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 Global business

Table 2 Product adaptations for different cultures some found it sexist. During the 1994 World Cup, bottles of
Product Adaptation Heineken beer displayed flags of all the participating countries,
including those of Muslim countries where alcohol is forbidden.
Cadbury In the US, Cadbury chocolate tastes markedly different from
chocolate its UK counterpart. The same is true of the version found in This prompted numerous complaints.
Australia. This can be put down to the difference in taste of the Not considering your new market will be costly to businesses
milk used to make the chocolate. – not only is there outlay on any advertising campaigns or
McDonald’s There are significant variations in what is sold in different packaging costs, but also there can be a greater cost to the
parts of the world. These are often due to religious beliefs but business if sales of the product are adversely affected in that
there are variants based on the tastes of different countries country for its entire life cycle.
as well – Japanese branches offer a Chicken Katsu burger
and in Finland you can have your burger served on a rye bun.
In France you can have doughnuts for breakfast, whereas in Table 3 Examples of inappropriate brand naming
Hong Kong you can have pasta soup for breakfast. Product Issue
Samsung Samsung have created products that meet specific local Irish Mist, a whiskey An Irish product that exports internationally – in
demands. For example, in China the number 8 and the colour liqueur German, ‘mist’ means ‘manure’.
red are considered lucky, so some products have been fitted
with red covers and TV stands have been shaped into the Nokia Lumia, a This brand name could not be used in Spain as the
figure eight. In Korea, a specialised refrigerator has been mobile phone direct translation for ‘Lumia’ is ‘prostitute’.
built to be perfect for kimchi, a local delicacy; and the demand Pee cola, a soft drink A popular soft drink in Ghana, this product would not
for sparkling water in the US has been met by installing a be suitable for sale in the UK.
dispenser in certain refrigerator models.
Barf, a detergent An Iranian product where its name means ‘snow’. It
powder has less pleasant connotations in English.
Inappropriate branding and promotion
There are many accounts of mistakes involving language,
mistranslations and unintended meanings when businesses Thinking bigger
operate abroad. It has been a mantra in business that international companies must
‘think global, act local’. This suggests that operating as they do in
Sometimes this can be due to laziness and poor efforts a global marketplace they should respect local norms, values and
to check with native speakers of a language that a translation expectations or face the consequences. The same has applied to the
is correct. Here are two well-known examples that caused management practices of top employers. International branches might
embarrassment: have the same logo above the door, but what happens behind it, from
●● the beer maker Coors translated its slogan ‘Turn it loose’ into
pay and benefits to leadership styles and attitude toward diversity, can
vary widely from country to country. However, organisations such as
Spanish, where it meant ‘Drink Coors and get diarrhoea’ international bank Santander are rejecting such localised approaches and
●● General Motors sold its branded ‘Nova’ car in Latin America, instead are unifying their global operations under one banner of ‘the way
where its name in Spanish means ‘No go’. Not a very good we do things’. In 2014, Santander had banking operations in more than
name for a car! 40 countries with 182,000 employees, primarily in Europe and North
However, mistakes can also be due to one language not having and South America. They were moving towards having more corporate
policies and ensuring that the same experience is felt in all places.
any direct translation for particular words in another. Transferring
brand names even just across from the UK to the US or vice Javier Bugallo, its head of corporate policies said: ‘Some of the really
recognisable values, such as the focus on the client, compliance and
versa can still cause issues – cultural, dialectal and grammatical
ethics – all these have to be truly the same and cannot be changed.
differences can all be a barrier to the brand name being accepted It is important that the employee experience, the employee value
and not becoming a joke. One example of transferring a brand proposition is similar… and harmonised.’
without considering the new market was when Gerber, a Nestlé- While some scope remains for local differences, the idea is that a
owned baby food company, replicated the packaging on their Santander manager can step into a branch in Argentina and feel a
products in Africa, displaying an image of a smiling baby. However, culture similar to that of the US or Portuguese offices.
most African products include an image of what is found inside Source: adapted from the Financial Times 25.03.2014. All rights reserved.
the product due to high levels of illiteracy in the country.
Promotions must also be versioned across different
international markets. Many brands want to create a global Links
image and become an internationally recognised brand – this Unit 57 explores how corporate culture affects business operations,
does not mean that the same marketing campaign that worked while the focus of Unit 78 is making sense of culture in the context
so successfully in the US will work as successfully in an entirely of international businesses. This builds on your understanding of
different market. how culture affects marketing and people (Theme 1) and impacts
Audience is key when crafting marketing campaigns, and directly upon business decisions and strategy (Theme 3). You will
if you do not consider the cultural norms of your audience need a thorough grasp of the relevant cultural and social factors
then your expansion into that region will not be successful. when you focus on global business (Theme 4) as this will inform
For example, a Proctor and Gamble television advert was your understanding of a market or location (Units 72, 73, 76 and
originally made for the American market. It featured a husband 77), helping you to assess the impact of MNCs and how to control
and wife in a bathroom and intended to show how soap could them (Unit 79 and 81) and to evaluate the ethical issues that may
make the woman more attractive. However, it was considered be involved (Unit 80).
inappropriate when transferred to the Japanese market where
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Cultural/social factors Unit 78

Case study

BRIDGING THE investor Americans welcome simplicity rather than multi-

slide presentations that are ineffective for a US audience.
CULTURAL GAP The advice when doing business in the US is to keep the
proposition simple and to the point. Cut to the chase in
presentations or you will lose the audience. This is even more
On the 24th floor of a building on New York’s Avenue vital when pitching to customers rather than co-workers.
of the Americas a group of British entrepreneurs are While some of these differences may not be deal breakers
attending a master class in how to do business in the US. A and the English accent can be a welcome part of the culture,
more mature start-up scene and access to a large English- it is important for executives to make adjustments to their
speaking market are two factors tempting UK start-ups business style each time they pass border control.
in the US. UK digital companies have opened US offices
while a number of British executives are relocating to At the New York master class Londoner Nikhil Shah, the
head US businesses. As the UK and the US share the same founder of a music-sharing website, has been doing business
language there is an assumption that the countries make in the US for several years. His assessment of the cultural
obvious partners. But this assumption may come unstuck divide is that ‘in the States they are louder, more upfront and
when trying to do business. For instance, there are different more direct. We tend to be more reserved, more tentative
approaches to hiring staff – US executives can be more self and certainly more modest. However you’ll find there’s a lot
confident than their UK counterparts. A consideration is to more hot air out here and it requires careful filtering’.
evaluate between candidates where some may have been Source: adapted from the Financial Times 16.05.2015.
trained from a young age to put forward that they are the All rights reserved.
best. UK firms may be more used to evaluating candidates
who are culturally more measured in putting forward their
achievements. The advice for Britons working in the US is to (a) Assess the reasons for master classes for those thinking of
be confident and self-assured. doing business in the US. (10 marks)
Alex Kelleher, founder of internet marketing provider (b) Evaluate the importance of being aware of cultural
Cognitive Match, relocated the business from London differences in the success of a company or brand.
to New York. He says that as soon as he arrived he (20 marks)
found attitudes different. When pitching ideas to an

Key terms Knowledge check

Cultural audit – study and examination of an organisation’s 1. Give two examples of ethnocentrism.
cultural characteristics (such as its assumptions, norms,
2. Explain how cultural differences can impact on business.
philosophy, and values) to determine whether they hinder or
support its vision and mission. 3. Why is over-reliance on one language risky?
Ethnocentrism – the tendency of people to view their own 4. What are the pitfalls of verbal communication?
cultures, ethics and norms as superior. The evaluation of
5. How do differing tastes impact on marketing
other cultures according to preconceptions originating in the
standards and customs of one’s own culture. 6. Why must care be taken in transferring brand names?
High-context cultures – cultures, including much of the
Middle East, Asia, Africa, and South America, that are
relational, collectivist, intuitive, and contemplative. This
means that people in these cultures emphasise interpersonal Exam tip
relationships. Developing trust is an important first step to Working across differing national cultures adds a new dimension
to any assessment or evaluation. You must be able to define
any business transaction.
what you mean by culture in particular contexts, and you also
Low-context cultures – cultures such as those of North need a balanced understanding of how a variety of cultures and
America and much of Europe, that tend to say what they societies might differ from your own. Independent reading and
mean. A communication style that relies heavily on explicit reflection will help you to provide evidence in support of your
and direct language. judgements.

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 79 The impact of MNCs
58 4.4.1
Theme 4
Key points
1. Impact of multinational companies (MNCs) on the local economy:
●● local labour, wages, working conditions and job creation
●● local businesses
●● the local community and environment.

2. Impact of MNCs on the national economy:

●● FDI flows

●● balance of payments

●● technology and skills transfer

●● consumers

●● business culture

●● tax revenues and transfer pricing.

Getting started
Impact of MNCs on the local economy
The arrival of MNCs in local communities is generally
welcomed. This is because a new factory is likely to create
employment, provide work for businesses in the supply
chain, give a boost to the local economy and provide an
opportunity for people to learn new skills.

Local labour and job creation: One of the main impacts

of MNCs on local economies is the creation of jobs. For many
people the opportunity to work for a large MNC is welcomed
and valued. Full-time jobs with the possibility of training, a
regular income, financial security and the opportunity to build
a career, is very appealing. For example, in 2014 Tenneco-
Walker, part of Tenneco Inc., a global US headquartered
company, opened a new factory in Merthyr Tydfil, South
Wales. The new plant, which makes exhausts for a range of
car manufacturers, including Jaguar Land Rover, was expected
to create 220 local jobs, providing a boost for the area where
unemployment has tended to be high. For example, in 2014
it was reported as 8.3 per cent, which was above the then
In 2012, a Japanese company, Arata Dairy Ltd, opened a factory national average of around 6 per cent.
on the South Island of New Zealand. Arata Dairy is owned by a
large multinational company (MNC). The plant, which produces Wages and working conditions: When a large new
infant formula and other processed milk products, cost NZ$206 business is opened, wages in the locality may rise. This is
because the demand for workers in the local economy is
million to build and at its opening the company promised to
likely to drive up rates. If unemployment is relatively low, and
invest another NZ$300 million over the following five years.
if other employment opportunities already exist in the area,
The factory employs 60 people and processes 150 million litres
wages are much more likely to go up. It is also possible that
of milk per season, which is supplied by about 40 local farms.
the jobs created will have favourable working conditions
A further 125 jobs were expected to be created in the future. because MNCs often have a modern approach to business
What are the possible benefits to the community of the new development. Their facilities are likely to be new and up to
factory? How might the New Zealand national economy benefit date, adopting the latest technologies, and their working
from the development? What might be the drawbacks to the practices are likely to be modern and efficient. Most MNCs
new development? are also likely to adopt internationally recognised standards
of health and safety, and employee welfare.

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The impact of MNCs Unit 79

●● Improvements in infrastructure. MNCs might invest some of

Thinking bigger
their own money to help develop roads, electricity, water and
Some MNCs get criticised for creating low value jobs. For example,
sometimes the majority of jobs in a new factory may be unskilled, gas supplies, schools, hospitals and other public amenities.
requiring little training or expertise. Where there is a need for highly They might do this to help build trust with the community, but
skilled personnel, some MNCs transfer or recruit staff from their home also because a better infrastructure is likely to improve the
countries. As a result, there are often limited opportunities for local quality of human capital in the area. Better roads and improved
workers to develop high-level skills. In the past some MNCs have also transport links would also benefit MNCs.
been criticised for exploiting people in local economies. For example, in ●● Contributions to local government taxes. In the UK
2012, workers in some factories in China have been reported to suffer businesses have to pay rates to local authorities. Similar
mistreatment and exploitation at the hands of MNCs. Issues reported
included incidents such as the correct safety measures not being followed,
payments are likely to be paid by MNCs when they operate in
workers being forced to work standing up and even workers being both other countries. This money can be used by local governments
physically and verbally abused. When MNCs are made aware of these to help fund spending in the area.
issues the backlash against them can be rightfully harsh. They will often ●● Help in local communities. Some MNCs make an effort
instigate immediate reviews of the situation and make pledges around to build strong links with the local community. They might
future working. participate in local cultural or sporting events. They may
give money to local charities, organise fundraising events or
give locals access to the company’s facilities. For example,
Local businesses: MNCs can have a positive impact on local Scotiabank, the Canada-based global financial services
businesses when they arrive. Initially, local businesses may provider, has a 175-year history of making contributions to local
be involved in the construction of the new plant. There may communities around the world. One of its initiatives, called the
be jobs for builders, carpenters, plumbers, electricians and Scotiabank Bright Future program, involves supporting children
welders, for example. Once a new facility is ‘up and running’ and children’s causes. In 2013, as part of the Bright Future
there may be a need for local businesses to supply materials, program, Scotiabank presented 81 grants to primary schools in
components, commercial services and utilities. As a result Belize to help pay for tuition fees and books.
businesses in the area may benefit from an increase in trade, Some MNCs may have a negative impact when operating
higher revenues and more profit. They may also need to overseas. As a result of environmental damage, communities may
recruit more workers of their own to meet demand. There will
be other benefits to local businesses. People who take up jobs Question 1
created by the MNC will have income to spend. This spending
will provide more demand for local businesses in general.
For example, retailers, restaurants, service providers and the
entertainments industry in the area are likely to enjoy a boost
in trade.
However, when MNCs develop operations overseas, there
may also be a negative effect on local businesses. This is
most likely to happen if MNCs lure workers away from other
businesses by offering better conditions or higher wages, or
supply products that compete directly with those produced
The MNC Panasonic is one of Japan’s largest producers of
by local businesses. For example, in 2015 Marks & Spencer
electronic goods. In 2014 it opened a new factory in Binh Duong
announced plans to open 250 new stores in locations
including Russia, China, India, the Middle East and France. province, Vietnam, making wiring devices and circuit breakers.
Although these new developments were likely to create It said it expected the initial operating output to double after
employment in those locations, they would also take trade four years.
away from local rivals, who may struggle to compete and be The factory is large, occupying nearly 9,000 square metres and
forced out of business. This means that some people will employing 670 people. It has an environmentally friendly design,
lose their jobs. However, the competition from MNCs might adopting Panasonic’s energy-saving and energy-creating products
put pressure on local businesses to make improvements. including solar power generation systems, LED lighting products,
This might provide some longer-term benefits, such as more and motion sensor lighting control systems. It also uses fast and
efficient and more innovative local enterprises. flexible Japanese processes and technologies. Panasonic planned
to use the factory as a showroom to allow visitors to experience
The local community and environment: Residents in high-quality manufacturing. Panasonic is committed to the
local communities are likely to welcome the location of MNCs principle of using local production for local consumption, with
in their area, provided the benefits outweigh the drawbacks. In products from this factory helping to meet the increasing demand
addition to employment opportunities and a boost to the local
for electrical construction materials and equipment in Vietnam.
economy, MNCs might also provide the following benefits.
(a) Assess the impact on the local community of the new Panasonic
factory in Binh Duong province, Vietnam.

474
 Global business

be left struggling to survive in areas where farming and other message to the rest of the world that it is more financially
subsistence activities are almost impossible. Mining industries stable. As a result interest payments might be reduced and
in particular can have an impact if there are oil spills that lead the country should find it easier to borrow in the future.
to environmental harm from oil pollution. This can have a
significant impact on the health and activities of local people, Balance of payments: Investment by MNCs will have a
especially farming and fishing. positive impact on the host nation’s balance of payments. There
will be a double impact. Initially, the flow of FDI when a project
is being established will improve the balance of payments
Impact of MNCs on the national because money will flow into the host nation’s account. For
economy example, the £489 million spent by Honda when building
The overwhelming majority of governments around the the new car plant in Guanajuato will improve the balance of
world are in favour of MNCs setting up operations in their payments for Mexico.
countries. This is because they are likely to generate Once a facility is ‘up and running’ there may be a further
income, employment, wealth and prosperity. boost to the balance of payments. This is because if any of
the output from a new factory is sold abroad, there will be a
FDI flows: When an overseas business locates a new further flow of money into the balance of payments account
facility in a foreign country, the amount of money spent
of the host nation. For example, if some of the cars produced
on establishing that facility is classified as foreign direct
in Guanajuato are sold to the US, the value of those sales
investment (FDI). For example, it was widely reported that
represents a flow of money into Mexico’s account (even
in 2014 Honda, the Japanese vehicle producer, opened
though the company has a Japanese owner). This boost in
a factory in Guanajuato, Mexico, costing Honda around
the balance of payments will help a host nation to ‘pay its way’
£489 million. The factory employed 3,200 workers and
when trading internationally. In the UK, car sales to the rest
produced around 200,000 cars per annum. This inflow
of the EU from Japanese-owned producers, such as Nissan,
of money from an overseas business into a country, such
Honda and Toyota, help to improve the UK’s balance
as from Honda to Mexico in the above example, is likely
of payments.
to be welcomed by the host country. This is because
For some less developed countries the impact on the
the national economy will benefit. Examples of specific
balance of payments from MNC investment may be even more
benefits to the economy include the following.
significant. This is because they often find it difficult to get
●● Increase in income. Generally, flows of FDI should
established in global markets and FDI allows them to boost sales
result in higher levels of GDP (the total level of income
of goods overseas.
for a country) for the host nation. The extra output
If MNCs buy resources from overseas, such as machinery,
and employment resulting from new FDI will increase
tools and equipment, this will have a negative effect on the
economic growth and should help to raise the living
balance of payments of the host country. This is because there
standards for people in the host country.
will be a flow of money out of the country. There will also be
●● Increase in tax revenue. The profits made by MNCs are
a negative impact if profits are repatriated to the MNC’s base.
taxed by the host nation. This increases tax revenue for
Repatriated profits represent a flow of money away from the
the government. This money can be spent on improving
host country.
government services, such as healthcare, education,
housing and transport networks. Technology and skills transfer: MNC investment in foreign
●● Increase in employment. The flow of FDI creates new countries often means that new technologies and modern
jobs in the host nation. For example, the single investment working practices are introduced into the host nation. This
by Honda in Mexico created 3,200 jobs in the Guanajuato might result in the transfer of technologies and knowledge to
region. This helps to reduce unemployment and save local businesses. This transfer may be horizontal or vertical.
money that would otherwise be paid out in benefits to ●● Horizontal transfers are when knowledge is transferred
the unemployed. Businesses in the host country may also across the same industry. For example, new technologies and
get a boost when an MNC invests in a project because working practices used by Japanese car manufacturers, such
a range of local suppliers will be needed. For example, as Nissan and Toyota, when these companies established
the Honda factory in the above example is likely to need production in the UK, were copied by other car producers in
supplies of raw materials, car components, utilities, the UK.
telephone services, commercial services, distribution ●● Vertical transfers may be forward or backward. For example,
services, maintenance crews and cleaning contractors. MNCs often provide technical assistance, training and other
Such demands will help to sustain and expand businesses information to their suppliers located in the host country.
in Mexico and therefore create even more jobs in the Many MNCs also assist local suppliers in purchasing
national economy. resources and in modernising production facilities. These are
●● Reduce national debt. Some of the money received examples of backward vertical transfers.
by the government from FDI might be used to reduce ●● Forward vertical transfers are likely to occur when businesses
national debt. This has a positive impact on a country’s in the host nation purchase goods and services from the
finances. If a country can reduce its debt it sends out a MNCs. For example, a domestic business assembling

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The impact of MNCs Unit 79

washing machines using components made by a multinational may be cheaper because they use modern and efficient
may adopt and adapt technologies, working practices and production techniques. Since their costs will be lower, they
managerial methods used by the MNC. can offer products at lower prices. This competitive pressure
may also force domestic producers to lower their prices.
The transfer of technology and skills from an MNC to businesses ●● Improved quality. If MNCs use ‘state-of-the-art’
in the host nation will help to improve efficiency and productivity. technologies, modern materials and more efficient working
This will help to make domestic producers more competitive and practices, such as total quality management, the quality of
generate sales both at home and abroad if the improvements are products might also be improved. For example, they may
significant. In some cases, the copying of technologies, products be better designed, more durable, more efficient and more
and working practices can lead to domestic producers posing a aesthetically pleasing.
real threat to MNCs in their markets. Through a process called ●● Better living standards. In general, it is possible that many
reverse engineering some businesses analyse a rival’s product people in the host nation will enjoy better living standards
very closely by taking it apart to see how it has been produced. when MNCs set up operations. Initially, they may benefit from
They then identify those features of the product that they think employment opportunities and enjoy higher incomes. They
are worth copying. For example, it was reported that China built will have more choice and enjoy access to cheaper and better
its first stealth bomber using technology based on a US fighter quality products. If products are generally cheaper then they
plane that was shot down over Serbia years previously. Military will have more income left over to fund other expenditure.
officials were reported as saying it was likely that the Chinese
developed the stealth technology used in the Chengdu J-20 from Some MNCs are very powerful. In some cases the annual
parts of an American F-117 Nighthawk. revenue of a multinational can be greater than the GDP of an
entire country. This can give them a formidable presence. If
too many domestic producers leave the market due to intense
Question 2
competition, this could result in less choice for consumers in
Jones Construction is a leading manufacturer of construction the long term. Also, if MNCs are left with little or no competition,
machinery and equipment. In 2012 it opened a new factory in they may come to dominate the market and exploit consumers.
Malaysia to add to the one it already operated in the country.
The new plant cost £25 million to construct. Business culture: There is some evidence to suggest that the
proliferation of MNCs can have an impact on the business culture
The investment by Jones Construction is expected to generate in the countries where they set up operations. In some cases,
around 500 new jobs and the company’s chairman commented people who are employed by MNCs may eventually leave their
that he could never have imagined that our family business jobs and start their own businesses. This might happen because:
would employ 2,000 people in Malaysia making our products, ●● individuals may have saved some money from employment,
with thousands more employed elsewhere in the supply chain. which can be used for start-up capital
The new factories mean our contribution to the Malaysian ●● workers may have developed skills that they think could be
economy will grow and I am grateful to the Pengang put to better use working for themselves
Government for their support in helping Jones Construction ●● multinationals may encourage workers to set up businesses

make our investment ambitions a reality.’ and become suppliers. If quality standards can be maintained,
MNCs might welcome this development because it can
(a) Explain the benefits to Malaysia of FDI like the investment made
provide them with more flexibility.
by Jones Construction.
(b) Explain the possible impact on the Malaysian balance of As more MNCs develop enterprises around the world, and the
payments of the investment by Jones Construction. pace of globalisation accelerates, it will become more culturally
acceptable for people in a wide range of countries to set up their
own businesses. MNCs may help to foster a culture of enterprise
Consumers: Consumers are likely to benefit from the arrival and encourage entrepreneurs to set up new businesses.
of MNCs in their countries. This is because they will be free to It is also possible that business cultures in the host country
buy some of the goods that they produce. Specific benefits to will be influenced by the cultures in MNCs. For example, when
consumers include the following. Japanese MNCs started to build factories in the UK they used
●● More choice. The products supplied by MNCs will add to modern production methods and developed different corporate
the choice already available in the host country. For example, cultures to those in UK businesses. As a result, over a period of
MNCs like Coca-Cola, Starbucks and McDonald’s set up time, many UK businesses reflected the production techniques
in many countries around the world to sell their products. and working practices of the Japanese. This eventually led to
However, not all MNCs produce consumer goods. Some make a change in corporate cultures. In many UK organisations the
components or provide services for other businesses. culture became more open and less confrontational. Arguably,
●● Lower prices. The arrival of MNCs is likely to increase managers began to recognise the wider talents of their
competition in the host country. The products made by MNCs employees, which also had an impact on the workplace culture.

476
 Global business

Tax revenues and transfer pricing: Multinationals pay Key terms

taxes to national economies. This can then pay for government
spending in areas such as health and education. Multinationals Reverse engineering – a method of analysing a product’s
are often accused of paying as little tax as possible and seeking design by taking it apart.
out locations where taxes are low. A common technique to Transfer pricing – a system operated by MNCs. It is an
avoid tax on profits is transfer pricing. Assume a multinational attempt to avoid relatively high tax rates through the prices
company has to make a product in country A, a country which which one subsidiary charges another for components and
charges high taxes on profits. The company will therefore want finished goods.
to make as little profit as possible in country A. The company
also has operations in country B, a country which charges low
taxes on profits. By selling the product made in country A at an
Knowledge check
artifically low price to its operations in country B, it can minimise
its profits in country A. It then sells the product from country B 1. What might be the main advantage to a local economy
at the market price, perhaps even back to customers in country when an MNC arrives?
A. But then it makes high profits in country B because it has
2. How might wage rates rise as a result of MNC operations in
bought the good at an artifically low price from country A. It
a local economy?
still has to pay taxes on profits in country B, but its overall tax
liability in countries A and B is much lower because of transfer 3. How might local businesses benefit from the arrival of an
pricing. Inevitably, because multinationals are profit-seeking MNC?
companies, they will seek to minimise their tax liabilities. If 4. How might local businesses be adversely affected by the
Slovakia offers lower taxes than the UK, this will be one factor arrival of an MNC?
which a US multinational will take into account when deciding
5. State two impacts an MNC might have on the local community.
where to put a new plant in the EU. Governments therefore need
to weigh up the benefits of attracting investment by offering low 6. How might the arrival of an MNC impact on the local
taxes against loss of tax revenues. They also need to be robust environment?
in their dealings with multinationals to ensure that they pay their 7. How does an MNC influence the flow of FDI into a country?
fair share of taxes.
8. How might the location of an MNC improve the balance of
payments for a nation?
Exam tip 9. How might consumers be affected by the arrival of an MNC?
The impact of MNCs is often very positive for a country.
However, it is important to remember when discussing the 10. Explain how technologies and skills might be transferred from
impact of MNCs that they can have negative effects. For an MNC to a country.
example, some MNCs might damage the environment, exploit
local workers and have a detrimental impact on local businesses,
causing them to fold.

Links
There may be a number of opportunities for you to
demonstrate your synoptic skills when discussing MNCs. For
example, there is a very strong link between the impact of
MNCs and their control (Unit 81). Information in this unit might
also be linked with Distribution (Unit 12), Legislation (Unit 42),
Theories of corporate strategy (Unit 45), Growth (Unit 48),
Corporate culture (Unit 57), Business ethics (Unit 59), Scenario
planning (Unit 65) and many of the units in Theme 4.

477
The impact of MNCs Unit 79

Case study

GlaxoSmithKline (GSK) GSK announced that the move would create at least
500 jobs in Africa and help to build upon the skills of the
African workforce across the continent. He also suggested
that it was time for businesses to contribute more to the
development of Africa by investing in infrastructure,
developing skills and creating employment.
Some of the £130 million investment was to create the
first R&D lab for non-communicable diseases (NCDs) in
Africa that would also support the training and education of
African researchers, and help to develop a new generation
of African NCD experts. GSK also announced that it would
create up to 25 academic Chairs in African universities in
subjects such as pharmaceuticals, logistics, public health and
engineering. GSK said that it hoped that these academic
roles would ‘facilitate the development of new courses
as well as internships and student exchanges, and will
be pivotal to ensuring manufacturing capability is locked
into the continent to help attract further manufacturing
investment.’
In addition, GSK announced plans to set up regional
supply hubs so that products, such as medicines, could be
distributed to more isolated communities across Africa.
The company said that it hoped that working in partnership
with local people would help to reduce shortages and
improve the security of Africa’s medical supplies. It would
also lower production costs, cut prices and reduce Africa’s
reliance on imports.
Finally, GSK said it would remain committed to the training
of healthcare workers in Africa. It aimed to develop
partnerships with charities and local organisations to
GSK, a UK-based MNC, is a science-led healthcare company. train around 10,000 community healthcare workers in
It employs around 100,000 people in over 115 countries. countries such as Kenya, Ghana and Nigeria. GSK said: ‘The
It produces vaccines, medicines and consumer healthcare investment will be targeted at supporting the most remote
products. In 2014 the company’s turnover was £23 billion. and marginalised communities to help address healthcare
It made a total operating profit of £3.6 billion. inequalities that exist even in fast-growing countries.’
In 2014 GSK announced plans to invest around £130 million Sources: adapted from www.gsk.com
in its operations in Africa, £100 million of which was
earmarked to expand existing manufacturing facilities
(a) Explain how MNCs like GSK can help to foster a business
in Nigeria and Kenya and to construct five new factories
culture in the countries where they locate operations.
in places such as Rwanda, Ethiopia and Ghana. The
(4 marks)
investment was expected to create hundreds of jobs.
The plan was for the new factories to produce antibiotics, (b) Evaluate the impact that GSK might have on the national
respiratory and HIV medicines. At the same time the economies of some African states. (20 marks)
technology, skills and knowledge would be transferred to
help local manufacturers make more complex products in
the future.

478
 58 Ethics
80 4.4.2
Theme 4
Key points
1. Stakeholder conflicts.
2. Pay and working conditions.
3. Environmental considerations:
●● emissions

●● waste disposal.

4. Supply chain considerations:

●● exploitation of labour

●● child labour.

5. Marketing considerations:
●● misleading product labelling

●● inappropriate promotional activities.

As explored in Unit 58, a stakeholder in a firm is an individual

Getting started or a group that is affected by – and in turn can affect – an
A firm makes parts for oil wells and exports them overseas. organisation. The types of stakeholders in an international firm
A customs official in a capital city says there is a big delay in clearing are listed in Figure 1.
their shipment through customs, but if they pay him an ‘expediting
fee’, the shipment will be moved further up the queue. Figure 1
Types of stakeholders in an international firm
Is this situation a question of law or of ethics? What should the
company do? Governments Shareholders
and NGOs

Ethics Communities Stakeholders Managers and

Ethics refers to the principles and norms that govern behaviour. employees
Business ethics at the company level was introduced in Unit 58,
which looked at the trade-off between profit and ethics and how
Customers Suppliers
ethics might affect pay and rewards, as well what is meant by
corporate social responsibility. At the international level, ethics may
or may not be reflected in a country’s laws and regulations. If a firm
establishes in a country, it will have to work within the institutional Stakeholder issues can arise in any area of a business, including
framework of both the home and the host country. Consequently, the following.
a firm may be acting within the law of its home country and Consumers:
nevertheless be deemed to be acting unethically in the other. ●● Conflicts of interest, such as where an energy firm
Equally, although a business may be matching the ethical norms manipulates the markets, resulting in consumers paying
abroad, its activities could breach the ethics of its domestic base. more than they otherwise would have. This is done by using
Generally, ethics involves respecting human rights and local a different measure to report on their profit margins to the
traditions, but avoiding corruption. Corruption is using public public, which can mean that an increase in household bills
power for personal benefit. Bribery is the most common example could be made to seem justifiable.
of a corrupt practice, but what constitutes a bribe is often not ●● Product safety, such as involving tainted meat that reaches
easy to figure out. For instance, gift-giving between business consumers in the supply chain.
colleagues is very common in most Asian and some Arab ●● Misleading advertising.
cultures, but considered wrong or even illegal in North America
and Europe. In fact, if you work for a British firm, you could face
Employees:
●● Employee safety, ensuring healthy and safe conditions,
prosecution for offering or accepting a bribe. Consequently, many
avoiding failings that might lead to injury or death, for
international businesses have written codes of conduct that set
example at refineries and oil rigs, including the Deep Water
out policies to guide employees’ decision making.
Horizon oil spill in the Gulf of Mexico in 2010.
Stakeholder conflicts ●● Employee redundancies. A company may need to reduce
Many people have a stake in the decisions that firms make. staff numbers to regain profitability or they may choose to
That is, they have an interest in it or a right associated with it. outsource some work for cheaper returns.
●● Pay and conditions.
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Ethics Unit 80

Shareholders: ●● Resource depletion, where a company’s extraction objectives

●● Conflicts of interest between the management and the conflict with the best possible future for that country. For
shareholders. instance if resources are depleted before they are able to be
●● Short-term versus long-term returns on shares. Shareholders replenished or are exploited to the detriment of the country’s
invest for a variety of reasons, but one of the major factors is environment. An example of this is the pollution associated
seeking a return on their investment through dividends. The with the extraction of rare earths, such as yttrium and
business will make a decision on how much profit it will retain lanthanum. There is a high demand for these elements for
each year for investment and how much to return in dividends electrical components and other hi-tech applications, but they
to the owners – the shareholders. The business will take a are only found in certain countries.
long-term view in that it needs to invest in new equipment
or expand its branches. Reinvesting profit can finance future Pay and working conditions
growth. Using retained profits is the cheapest way to reinvest A major problem for business ethics involves the complexities of
and it needs to persuade shareholders that investing to earn global supply chains and the working conditions of employees
profits in the future is in their long-term interests, rather than in other countries. UK law covers pay and working conditions of
paying out more in dividends in the short term. local suppliers, employees and managers. Thus, all employees
have certain defined rights at work governing their pay,
Countries or communities: conditions, holiday entitlement, sickness and time off work,
●● Safety, where people’s well-being is compromised, such as health and safety, discrimination and bullying, and there are
the reported pesticide chemical leak at the Union Carbide detailed procedures and protections for dismissing an employee.
plant in Bhopal, India, that poisoned over 300,000 people However, such clear guidance does not always exist in many
and caused 5,200 deaths. countries. As a result of globalisation, many MNCs have their
●● Environmental concerns, where the activities of the business manufacturing operations in other countries. The business
pollute or damage the environment. For example, the mining of rationale for this is often the availability of cheap labour in less
tar sands impacts on the local wildlife and air and water quality. economically developed countries (LEDCs). Because some of
these countries do not have the same level of legislation to
Question 1 protect employees as countries such as the UK, the standard
of working conditions is low. Work is primarily done by women,
Ten people are sitting around a table giving feedback to
who are not necessarily paid a living wage as there is no legal
Vodafone, one of the world’s biggest mobile operators by
revenue, on its UK corporate responsibility report. Discussion requirement to do so.
ranges across the company’s handling of controversial issues, These factories are sometimes referred to as sweatshops
such as the siting of masts and the protection of children from and can be hazardous with poor ventilation, little space and, in
adult content on their phones. The debate is polite but lively and some cases, exposure to dangerous chemicals. The buildings
Vodafone’s representative quietly takes notes. Seeking the views themselves can also be poorly built, as evidenced by the collapse
of stakeholders has become accepted practice among larger of a factory in Dhaka, Bangladesh in 2013 that killed over 1,000
companies, especially multinationals. They are concerned to people. These working conditions could not occur in the UK due
understand external expectations of their business and to manage to tight controls on the environment in which people work.
their impact on society and the environment. So what does a As MNCs can locate anywhere in the world, the market for
company do when stakeholder interests collide, either with each their business is very competitive – this is why the practice of
other or with the interests of the business? Vodafone believes offering below the living wage can continue. The lower the wage,
that an effective stakeholder programme is essential. It has many the less money the MNC needs to invest in that manufacturing
meetings with stakeholders and it commissions in-depth opinion area and so it can increase its revenues. This practice has
surveys and holds detailed discussions with specific interest groups. become less prevalent in recent years due to international outcry
over whether it is ethical to pay workers in LEDCs a lower wage
Marks & Spencer agrees with this approach. Its engagement with
than their equivalent in, say, the UK. For example, clothing
stakeholders charts the shifts in consumer attitudes. Through this
manufacturers may outsource the manufacturing of their products
engagement it has realised that the vast majority of customers
to overseas factories in order to increase their profits. However, if
have quite strong expectations of issues such as fair trade
the factories in developing countries do not pay a decent wage,
and animal welfare. Marks & Spencer believes that talking to
this may provoke criticism. Some companies try to reduce the
stakeholders is vital to help it define bad and good practice.
negative attention by annually publishing list of the factories that
Some critics, however, feel that there is a danger of allowing they use and an audit of these factories’ ethical practices. This is
pressure groups too much power. an example of conflicting interests, not only between the larger
Source: adapted from the Financial Times 28.11.2005. All rights business and their employees, but also between the business and
reserved. its customers, due to consumers being unhappy with its practices.
(a) Describe the types of conflict that could emerge between There are a number of initiatives and organisations that are
Vodafone stakeholders. working to ensure fair working practices for all. The Ethical
(b) Why do Vodafone and Marks & Spencer establish stakeholder
Trading Initiative is a British NGO concerned with the employment
programmes? practices of multinationals, and is supported by Marks & Spencer,

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 Global business

The Body Shop and Inditex. It is concerned with the following. Environmental considerations
●● Employment is freely chosen.
Companies today are concerned about the environment for many
●● Freedom of association and collective bargaining is freely chosen.
reasons, including the effect on all of their stakeholders, the
●● Working conditions are safe and hygienic.
ramifications of increasing government regulation and how to
●● Child labour is not used.
reduce operating costs. Consequently, businesses will evaluate
●● Living wages are paid.
the level of concern of host governments and of consumers, as
●● Working hours are not excessive.
well as how environmental issues will affect the firm’s operations
●● No discrimination is practised.
in the short, medium and long term.
●● Regular employment is provided.
HSBC is active in a Climate Partnership with the World Wildlife
●● No harsh or inhumane treatment is allowed.
Fund and belongs to various forest stewardship schemes. Yet it’s
Pay can also be an issue between different structural levels within reported that HSBC also funds unsustainable logging in Malaysia
companies. Managers are responsible for trying to balance the that has denuded more than 90 per cent of the old growth forests
interests of stakeholders (in this instance, their employees), yet on the island of Sarawak. NGS Global Witness suggests that over
they are themselves stakeholders, and this can lead to numerous three decades, loans and financial services to logging interests
conflicts. Where a manager is in a position of power, the balance have generated close to $120 million in revenue for the bank.
between interests is an important consideration, especially in
relationship to, for example, executive pay. Emissions: Climate change is an important international issue.
Question 2 Since emissions cross borders, it involves many institutions and
stakeholders. The US Department of Energy’s Carbon Dioxide
Starbucks, an American coffee retailer, emphasises the role of ethics Information and Analysis Centre puts global industrial emissions
in its operations. It has a Corporate Social Responsibility Department at 1,450 gigatonnes since 1751. Research has suggested that
and works with NGOs to ensure its coffee is sourced fairly. However, two-thirds of greenhouse-gas emissions have been caused by
in 2000, an NGO named Global Exchange suggested that it was just 90 companies, based in countries around the world.
not providing a living wage for its coffee producers. Global Exchange There is strict legislation in the UK governing the environmental
put forward that Starbucks should pay the ‘living wage’ of US$1.26 output of a business, including legislation that requires all UK
per pound (the market price at the time of 64 cents per pound). quoted companies to report on their greenhouse gas emissions.
They planned a protest at Starbucks’ stores if the firm did not agree. This strict legislation is a result of requirements made in the
Starbucks was already paying $1.20 per pound so the wage increase Climate Change Act 2008. This sort of legislation does not always
was not substantial and the impact to the quality assurance of the exist in LEDCs where many MNCs base their manufacturing
business could be significant. Its customers expect only the best coffee industry. As they are creating employment within the LEDC,
from Starbucks and any changing perceptions of the quality of how
environmental protection may not be a key concern.
the business operates might have affected its brand.
The highly urbanised areas that develop around industry in
This example illustrates the difficulties of ensuring that the LEDCs can suffer from bad air pollution and issues with waste
expectations of stakeholders are met. Starbucks’ stakeholders disposal. This was the case, for example, with the Bhopal
include its suppliers, especially the people who grow its coffee, but chemical leak in India, mentioned earlier. A lot of those affected
also social organisations, such as Global Exchange, who have an were living in slum towns surrounding the plant.
impact not only upon the treatment of the supplier-stakeholders,
but also upon operations and future strategy. Waste disposal: As with the guidance surrounding air
Managers must try and balance the interests of stakeholders, emissions, the UK government enforces legislation regarding how
and obviously this is difficult and can lead to balancing different companies dispose of waste. This sort of legislation is also often
viewpoints. For instance, with Starbucks, many of its suppliers and missing or not enforced in LEDCs. There are many barriers to
the NGOs supporting them, wanted higher payments for coffee effective waste disposal in LEDCs, such as the lack of a proper
beans. This was a different perspective than some of its consumers infrastructure to allow for efficient waste removal – poor roads
who wanted to pay less while also ensuring the consistent quality can mean that lorries are not able to remove waste effectively.
of their brew. Consequently, the managers must prioritise to ensure There are huge environmental considerations when looking at
that, whatever the conflict, the firm continues to survive and grow. the ways companies dispose of waste – the UN’s Step Initiative
Starbucks addressed the issue by increasing its purchases of Fair Trade estimated that by 2017 there will be enough ‘e-waste’ (discarded
Coffee, which meets an international standard for pay and conditions electrical products) to fill a 24,000 kilometre line of 40 tonne
of suppliers. It also created guidelines for the purchase of the most lorries. This waste contains toxic elements that deteriorate over
ethically sourced coffee that it could and made this process fully
time and are being dumped illegally in LEDCs, causing a huge
transparent in its annual Corporate Social Responsibility Report.
environmental concern.
Source: adapted from the Financial Times 27.08.2014, all rights For example, Trafigura, a Swiss commodities-trading firm was
reserved. reportedly fined one million euros by a Dutch court in 2010 for
(a) Is the quality assurance of how a business operates to provide dumping toxic waste on waste tips in the Ivory Coast. The waste
a quality brew more important for a quality coffee retailer than was supposed to have been processed in the Netherlands, but
paying more for coffee beans? after a Dutch firm demanded a higher price, the unprocessed waste
(b) ‘You can never keep all stakeholders happy.’ Discuss this statement. was taken to the Ivory Coast, risking the health of local people.

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Ethics Unit 80

Supply chain considerations The issue of child labour in the supply chain is not as
Global businesses have global supply chains. Numerous ethical clear-cut as it may first appear. From a western-centric point of
issues come with the increasing complexity involved in global view child labour is clearly not ethical and in 1973, Convention
sourcing and logistics. For instance, if you have a mobile phone, 138, ratified by 135 countries, banned all forms of child labour.
it is very likely that at least some of the components within it have However, in 1999, Convention 182 changed this to cover only
been sourced from conflict zones. Many of the world’s rarest the worst examples of labour. Some suggest that stopping child
and most valuable minerals are sourced from The Democratic labour in developing countries can, in fact, be damaging to
Republic of the Congo (DRC). It is reported that in some of the families: where the child’s earnings are a key source of income
DRC mines, illegal armed gangs enslave workforces (including for the family, the loss of that income can be devastating.
very young children) and commit human rights abuses. Yet many Additionally, there may not be a formal education system that
of the firms buying these minerals may be reluctant to look more the child can join and, as in the case of Bangladesh, it may force
closely at their supply chains because of the costs of doing so. children into worse situations.
To try and address the issue, the Organisation for Economic However, MNCs do not have to passively accept child labour
Co-operation and Development (OECD) has drawn up guidelines as normal. They can choose to locate elsewhere, in places where
designed to minimise the use of so-called conflict minerals. child labour is not acceptable. Alternatively, they can take the
approach of IKEA, and help the families to support their children
Exploitation of labour: From the number of cases by providing working mothers with a good wage and their
that appear in national courts and are documented by the children with an education while they work.
International Labour Organisation, it appears that exploitation
of labour is common throughout the world. The ILO, part of the Question 3
United Nations, estimated that in 2014 there were around
21 million people being exploited by their employers.
Boehm Clothing is a clothing manufacturer. It uses factories
A life as a ‘modern slave’ often begins when an individual in in Bangladesh where child labour has been common, and
a LEDC seeking work contacts a recruiter. The recruiter charges businesses including Boehm, have been the subject of
the employee fees to find them a job, then once a position is campaigns against the use of child labour. However, Boehm
found the employing firm will repay the recruiter, but insist that has collaborated with international organisations to provide
the new employee pay them back. This is called ‘bonded labour’ training for unskilled child labourers in Bangladesh who became
and it binds the worker to the employer until the hefty debt, plus unemployed due to international pressure to eradicate child
interest, is repaid. labour. Boehm has established training centres in Bangladesh
For example, in 2014 NGO Verite found that around 30 per to teach young people the skills required by sewing machinists
cent of workers in Malaysia’s electronics industry were forced and to help combat child labour. On completing their vocational
to work. In Thailand, according to Freedom Fund, another NGO, training courses, as long as they are old enough, young people
most of the workers in the seafood industry are bonded labourers. can then take work in Boehm’s suppliers’ factories. In most
Newspapers in the UK have highlighted concerns about the cases, as a result of the skills gained from their training, they
treatment of migrant workers employed in Qatar on World Cup have secured better positions and salaries. These child labourers
construction. can be their families’ sole breadwinners, and so simply making
Businesses are taking steps to keep products free from it illegal for them to work might push them into taking more
exploited labour. The British Retail Consortium has guidelines dangerous employment.
for its members’ supply chains that ban bonded labour and set
(a) Why do you think Boehm Clothing has invested in the training
minimum working conditions.
centres?

Child labour: Many businesses who outsource production (b) How do you think families in Bangladesh might view measures
to combat child labour?
overseas rely on local suppliers who follow local traditions
and norms, some of which are not acceptable practice in
developed economies. Nowhere is the ethical dilemma more
difficult than with child labour. In most cases, child labour has Marketing considerations
nothing to do with MNCs, but rather may be commonplace in There are a number of issues that companies must consider
local area businesses and on farms, where very young children when they are looking to market their products. These will be
are put to work as soon as they are able. dependent upon the type of business and their type of product
While child labour is unacceptable in Britain, it has not been as well as the specific market. Often elements will need to be
– until very recently – in Bangladesh. But there can be altered to be suitable for the market. Cultural and social factors
undesirable consequences to clamping down on child labour that could affect this are considered in Unit 78.
without further protection for the young workers. For instance,
when Bangladesh was forced to stop employing children in Misleading labelling: Businesses should ensure that the
some of its factories or face trade sanctions, the reported labels on their products are not misleading, so that consumers
result was that up to 7,000 young girls went from being factory can make a fully informed choice as to whether to purchase
workers to becoming prostitutes. their products and how to use them once bought. In the UK,

482
 Global business

this is enshrined in the Trade Descriptions Act and enforced by

the Trading Standards Authority. Labels must be accurate, and
so cannot contain false information on price, quantity or size,
materials the product is made of, what it can do, or who might
have endorsed it. They must also explain if there is any aspect
of the product that could be hazardous.
However, the Trade Descriptions act does not apply outside
the UK, so businesses have to be aware of local legislation and
ensure that they comply with the laws that apply. What does a
firm do when there is no law governing labelling? This is an ethical
question. Should it abide by the highest standards of all of the
countries that it operates in, the minimum ones, or none at all?
The United Nations Economic and Social Council has
published guidance on this, at least with respect to food labelling.
False labelling is not permitted, but it may be difficult for a
consumer to distinguish between labels that are ‘truthful and
non-misleading’ or ‘truthful but misleading’. Moreover, one culture
may find a label to be misleading while another might not.
Links
Ethical considerations run through almost every aspect of
An example of a misleading statement might be: ‘Contains
international business, including: what motivates people
only 1 gram of sodium’. This seems to imply that the product is
low in salt (sodium chloride), when it is actually very high in salt.
(Unit 17); what areas governments choose to legislate
(Units 42 and 81); how corporate and national cultures impact
Inappropriate promotional activities: Product and upon operations (Units 57, 78 and 81); and what might drive
business promotion can cover a broad range of different change or choices of markets (Units 63, 72 and 73).
activities, such as advertising, publicity and direct marketing.
These can be considered inappropriate if they are actually illegal
or are offensive. In 2013, the Chinese government suggested Thinking bigger
that GlaxoSmithKlein (GSK), a British pharmaceutical firm, was The corporate world has many examples of where ethics within business
involved in ‘illegal marketing activities’ in order to increase are key considerations. For example, when two children tragically died
from carbon monoxide poisoning from a faulty boiler at a hotel on
drug sales. These activities supposedly included generous a Thomas Cook holiday, the travel company could have been more
entertainment, including all expenses paid conferences for sympathetic. The group was not directly responsible for the deaths but
doctors, gift-giving and case payments. the media reported their somewhat corporate manner as heartless
Promotional activities in China can follow the Chinese cultural and the way that it handled the case didn’t put it in a good light. It
tradition of guanxi, involving the use of personal connections in was reported that the management stuck narrowly to a legal brief and
business activity that can include gift-giving, doing favours and executives were silent at the children’s long delayed inquest. It took
socialising. In England, for example, practices such as these 10 years to offer an apology and Thomas Cook reportedly received £3m
in compensation, nearly ten times the amount received by the parents
might be deemed unethical and may be illegal. However, many
of the children who died. The group was criticised for the approach
businesses acknowledge that these cultural aspects are part of taken. Yet some reports also said that by the standards of most modern
their business context when operating in a global environment corporations, Thomas Cook did little out of the ordinary. The board was
with China and many other countries. reported as acting in a way to protect its investors’ interests. However,
Unit 71 explores factors to consider, including aspects such the shareholders’ near-term interest was in direct conflict with the
as corruption, when assessing whether a country is an attractive company’s wider commercial one. It was reported that management
place for investment. had not appreciated how the company’s behaviour would be viewed,
and that it should have shown compassion and not only paid attention
to its lawyers, as consumers have their own logic and it is in the eyes of
Exam tip the paying public not the law, that it will ultimately be judged. In this
When you see the command word ‘Assess’, you know that you way it would also have balanced the needs of all its stakeholders.
must give a balanced answer, often employing competing
You could use this information in a variety of ways. Obviously, it can be
arguments. Therefore, when looking at ethics in the context of
used when answering questions on business ethics but it might also
international business, you should be aware of the differing
be useful when discussing corporate governance and the influence of
corporate and national cultures that may affect business and
stakeholders.
employee behaviour. Reading widely about different countries and
their cultures will help you to draw on examples in support of Source: adapted from the Financial Times 18.05.2015. All rights
your points. reserved.

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Ethics Unit 80

Case study

TIPTREE TEXTILES opinion heard. Pressure groups used social media to spread
the word and to encourage people to boycott the company’s
products.
Tiptree Textiles is an American company that produces Tiptree could not deny that their suppliers were treating
clothing for customers around the world. It is well-known their workers very badly. There was a lot of evidence to
for its unusual print designs and styles. About five years show that workers were not paid fairly or compensated
ago, Tiptree became a focus for considerations around for doing overtime; that factories were using child labour
ethical treatment of workers in their overseas factories. and, in some cases, forced labour; that workers were not
Tiptree had outsourced its production to factories in permitted to join trades unions; and that the health and
developing countries, in order to reduce manufacturing costs safety standards in the factories were shockingly low. Tiptree
and gain economies of scale. However, it was alleged by responded that other clothing companies used similar
some that Tiptree would manufacture in a particular country factories with similar working conditions.
until local workers demanded higher wages and safer In response to the issues arising, Tiptree drew up a code
working practices, and then Tiptree would move production of standards for its suppliers. The company will not work
out of that country and into another location where their with suppliers who refuse to sign up to and implement the
costs would be lower. standards. Tiptree also started to report annually on ethical
Tiptree responded that it couldn’t be held responsible issues in its supply chain, and appointed independent factory
for the treatment of the workers at the factories that it inspectors to audit working standards with no warning.
used. It said that, as it had outsourced the work to a third In the last nine months, Tiptree also announced that it
party, it had no control over the working conditions in the intends to set up a training programme for young people
factories. However, the issue was taken up by a number of in the countries where their suppliers’ factories are located.
British and American news outlets and non-governmental This programme will train them how to become skilled
organisations, who campaigned to influence Tiptree’s sewing machinists and therefore ensure that they will earn a
attitude towards working practices. higher wage in the future.
News coverage of Tiptree at this time was almost entirely
negative. Journalists focused on the issue and conducted
undercover investigations of conditions in the factories (a) Assess the impact of the publicity surrounding child labour
run by Tiptree’s suppliers. Some of these reports showed on Tiptree. (10 marks)
that child labour was used in some of the factories run (b) Evaluate the influence of pressure groups on changing the
by Tiptree’s suppliers. As popular opinion turned against behaviours of a business. (20 marks)
Tiptree, people also took to social media to make their

Key terms Knowledge check

Ethics – moral rules or principles of behaviour that should 1. How might a business be operating within the law, but be
guide members of a profession or organisation and make acting unethically?
them deal honestly and fairly with each other and with their
2. How might stakeholder conflicts arise?
stakeholders.
Institutional framework – the system of formal laws, 3. How might conflict be avoided?
regulations and procedures, and informal conventions 4. Why are MNCs criticised for their activities in developing
customs and norms that shape activity and behaviour. countries?
Code of conduct – a set of rules outlining the proper
practices of an organisation that contributes to the welfare of 5. What incentives exist to ensure fair working practices for all?
key stakeholders and respects the rights of all affected by its 6. Why does the existence of global supply chains create
operations. ethical issues?
Stakeholders – groups or individuals who can affect or be
affected by the actions of a business.

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 81 Controlling MNCs
58 4.4.3
Theme 4
Key points
Factors to consider:
1. Political influence.
2. Legal control.
3. Pressure groups.
4. Social media.

Getting started
Control of MNCs
The English East India Company (EIC) was founded in 1600 when Controlling companies that operate across borders has been an
Queen Elizabeth I granted merchants a monopoly on trade in many issue since the 17th century and the founding of the East India
basic commodities, including cotton, salt, silk and tea. At first the Company (EIC). However today, with interconnected international
company docked its ships wherever it could, then it began establishing markets and globalised businesses, controlling multinational
trading posts along the Indian coast, and eventually started building companies (MNCs) is much more complex. Queen Elizabeth I,
factories and establishing commercial and political relationships with and the monarchs and governments who followed her, could
the Mughal rulers. The EIC was a huge money-making machine possibly have exerted some control over the EIC had they
for the English economy well into the 19th century, at one point understood the risks of allowing it autonomy. Today, however,
controlling nearly half of all global trade. many modern global companies have huge economic power
The EIC is considered to be the first modern company as it was and can relocate their headquarters with relative ease, giving
the first to be granted limited liability. Before limited liability, an national governments less direct control over their behaviour.
investor could lose everything that they owned if something went These ‘footloose’ MNCs can simply threaten to relocate out of
wrong on a trading voyage. With limited liability, their losses were a country – and take their FDI, tax revenues and employment
limited to the amount they had actually invested. The EIC was with them.
given a monopoly over trade, since, even with limited liability, the
voyages were risky and consequently the returns needed to be
high to encourage people to invest. Having a monopoly meant
that the firm did not have to compete on price, at least not against
English firms.
However, like some big firms today, the EIC was also supported by
the state, with the result that the company served two masters: its
investors and the political rulers. This was to create many problems
over time. The instructions for those running the company appeared
to be strict, with prospective employees having to post a large bond
guaranteeing the quality of their service before they left England.
However, once an employee arrived in India, he could choose to
fulfil these instructions in pretty much any way that earned the
company money. Although at first managers avoided politics and
respected the local culture, their reportedly unchecked and increasing
power, coupled with individual greed, eventually led to conflict. The
autonomy of the managers and the great distances involved meant
that the headquarters and politicians back in England did not realise
that the EIC was creating the toehold of an empire. And once they This raises very big questions about who is in control over
did, it was too late to regain control. the actions of a company. The shareholders? The managers?
What do you think were the political and legal controls that had to The home or host governments? And furthermore, how is
be imposed on the East India Company? Considering how the EIC’s control enforced?
activities developed in India, do you think these were effective? Do Unit 79 explained how, when a firm establishes in a country, it
you think any of these controls are still relevant when looking at has to work within the institutional frameworks of both the home
MNCs today? and the host country. An MNC will have to abide by all of the
applicable laws and regulations established by these institutions.

485
Controlling MNCs Unit 81

Table 1 illustrates just a few of the many institutions that and 54 others were accused of taking illicit payments from
might exert political and regulatory control over a business the company in return for facilitating outcomes that were
based in the UK, but operating internationally. favourable to the company. Petrobras has lost much of its
market value since the allegation became public.
Table 1 A selection of institutional controls on British ●● State owned operations may soak up the capital that other
businesses that cross international borders firms might better employ. This is because politicians or
Area of National – UK International regulators, rather than the market, decide where funding
jurisdiction should go. Consequently, inefficient businesses may be given
Financial Bank of England International Monetary more money than they need while also not being subjected
Treasury Fund to competitive forces that would otherwise drive down price
Financial Conduct Authority World Bank and improve efficiency.
European Banking Authority ●● Shareholders’ and other investors’ rights may be reduced

Commercial Competition and Markets World Trade Organization or ignored because they are not the true beneficiaries
Authority European Commission of the business. The actual beneficiaries, as may be the
Trading Standards Institute Regional trade blocs case with Petrobras, may be the politicians themselves.
Department for Business, However, some state enterprises benefit the population
Innovation & Skills as a whole. For example, the international oil company
UK Trade & Investment Statoil, mostly owned by the Norwegian government,
UK Export Finance puts a percentage of proceeds into its government
HM Revenue & Customs pension fund, known as the ‘Oil Fund’. The remainder of
Employment Department for Business, International Labour the shares in Statoil are publicly traded.
Innovation & Skills Organization ●● Investment expenditure, especially on research and

Department for Education European Commission development, may be ignored. With state ownership,
Department for Work and there is likely to be less competitive pressure from
Pensions other firms. Consequently, there will be less incentive to
Environmental Department of Energy and United Nations Environment undertake expensive research to create new or better
Climate Change Programme products or services.
Department for Environment, European Commission Even where a firm is not owned or controlled by the
Food & Rural Affairs state, political influence may nevertheless still be important.
Department for International There could be national strategic priorities, such as energy
Development independence or the development and preservation of key
Legal Ministry of Justice International Criminal Court industries. Governments may want to boost employment or
Attorney General’s Office European Court of Justice regulate financial institutions.
Crown Prosecution Service European Court of Human Privately owned businesses can be controlled using a
Serious Fraud Office Rights number of political initiatives.
●● Tariffs, quotas, regulations and local content requirements

can be used to protect domestic businesses from

Political influence international competitors. For instance, Nigeria has a law
Queen Elizabeth I sanctioned the creation of the EIC, and stipulating the ‘minimum amount’ (by value) of ‘Nigerian
today many countries have similar policies encouraging the content’ that must exist in equipment used for the extraction
creation and protection of state owned enterprises (SOEs). of oil and gas in the country.
For example, in China, over 120 companies are owned or ●● Many countries even place direct or indirect ownership

controlled directly by the state, involving almost all sectors, restrictions on businesses that they consider to be key. Thus,
including manufacturing, banks, telecommunications, transport, political opposition prevented the Chinese state oil company,
agriculture and basic commodities. State ownership is a very CNOOC, from taking over Unocal, a private US firm.
effective method of control, as political power can be exercised ●● Countries can also support domestic industries through

to create, manage and end a business. Political influence over subsidies or tax breaks. Subsidies can be designed to:
these organisations is therefore extensive, and this can lead to o help create factories to produce and distribute goods
numerous commercial and ethical issues. o help consumers to buy products
State ownership or control is not very efficient, however, and so o assist domestic firms in exporting their goods
the drawbacks often outweigh the benefits. and services.
●● Corruption can be a problem as SOEs might be favoured by There are many other forms of political influence that can
powerful politicians. For example, in spring 2015 the state serve to direct the behaviour of businesses, including the
oil company of Brazil, Petrobras, was reportedly mired in a following.
scandal that threatened the entire political establishment. A Lobbying by politicians to influence the decisions of
former president, the speakers of both Chambers of Congress businesses. For example, a politician may wish to prevent the

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 Global business

foreign direct investment of a competitor that might threaten Competition policy: Competition policy exists to promote
jobs in his or her constituency. competition and ensure that markets operate as efficiently
Politicians ‘retiring’ to seats on the boards of plcs. It is not as is possible. In the UK, the Office of Fair Trading and the
clear whether having former politicians on a board adds value Competition and Markets Authority protect producers and
because of the extent of their knowledge or because of their consumers from unfair or anti-competitive practices. The EU
influence or connections, but many businesses hire politicians as Competition Commission takes on this role across Europe.
soon as they leave office. These institutions ensure that firms do not abuse their market
Some benefits and drawbacks of using political influence to power, do not attempt to fix prices or use pricing strategies
control MNCs are shown in Table 2. to drive out competition, and do not collude against other
producers or the consumer.
Table 2 Benefits and drawbacks of using political influence For example, over the years, Microsoft has faced many
to control MNCs legal challenges asserting that it has abused its market
Benefits Drawbacks position through the global operation of its Windows operating
system. One particular issue arose over the way the operating
Can create, manage and end a Facilitates corruption
system prevented interoperability with other firms’ systems
business
and applications. The EU Treaty prevents the abuse by a firm
Helps elected officials to challenge Entrenches inefficiencies, such as of a ‘dominant market position’, and in March 2004 the EU
the power of private business and to the misallocation of capital and lack Competition Commissioner ruled against Microsoft, ordering
address issues of concern, such as of research and development it to offer information to rivals so that their systems could
ethics and the environment
work with Windows software. Microsoft eventually gave up its
appeals and agreed to allow access to open-source software
Question 1 developers. However, in this case, as elsewhere, tension
can exist between national laws. The US disagreed with the
‘Global network banks’ do everything that a multinational ruling, putting forward that the EU ruling would not encourage
might need from a bank: they lend money, move money around competition and would actually discourage innovation.
the world, provide advice and trade in bonds and currencies. Similar issues arose in 2015 with EU regulatory challenges
These big MNCs, such as HSBC (UK), Santander (Spain), to internet giant Google in response to issues surrounding tax
Citigroup (US) and Deutsche Bank (Germany), all grew through avoidance. Britain and the EU were unhappy with Google’s
a series of acquisitions mainly since the turn of the 21st century, complex structures for avoiding tax, and took steps to ensure
but they are now facing threats to their global competitiveness. that Google could not avoid paying tax in the European
countries in which it operates. The US objected, countering
As the firms grew, they found it increasingly difficult to create
that Google was a victim of commercially driven protectionism
common management cultures, or develop workable IT
on the part of the EU.
platforms and consistent business practices. They also faced
Tension may also exist between the various national and
more competition. With the financial crisis of 2008, smaller international laws. Nowhere is this more obvious than in the
firms that were being squeezed at home began to expand case of taxation policy.
internationally in a search for new markets. Also, big regional
banks, often backed by the state, began to emerge. Finally, Taxation policy
the big banks faced much tighter regulation in all aspects of Governments use taxation policies to raise the revenue to run
their business. Thus, they have had to update their operating their countries. However, these policies can also be employed
systems to ensure they meet capital requirements for operating to help control the activities of MNCs. For example, Ireland
as a bank, and they have to police their customers to ensure maintains a policy of low corporate taxation in order to attract
that they are not supporting money laundering, tax evasion or huge amounts of foreign direct investment. This policy can
unsustainable debt. For instance, HSBC had to pay huge fines for upset politicians in other countries who see it as an unfair
breaking new rules imposed by the US and UK regulators. practice that allows businesses to avoid paying their fair share
of tax. Thus, Ireland’s corporation tax in 2013 was 12.5 per
(a) Explain how the activities of the ‘global network banks’ can be cent compared to the US’s 35 per cent.
controlled, using the above information.
Related to this are concerns that many big companies can
(b) Assess the effectiveness of using tighter regulation on the use countries’ differing systems to avoid tax. Tax avoidance
control of banks.
involves using legal methods to reduce the amount of tax that
a company pays. This differs from tax evasion, which is the
illegal avoidance of tax. Tax avoidance is an issue of ethics that
Legal control can bring bad publicity, as was the case with Google. In 2011
One of the best mechanisms for controlling large international it was revealed that it had paid £6 million in tax on a turnover
businesses is through regulation, competition laws and of £395 million. (See the case study at the end of this unit.)
taxation policies.

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Controlling MNCs Unit 81

Table 3 Benefits and drawbacks of using laws to control support business interests. For example, the Confederation of
MNCs British Industry (CBI) is Britain’s biggest business lobbying group,
Benefits Drawbacks with over 190,000 business members. Its role is to promote
businesses’ interests, and it does so by lobbying and advising the
Can be used to It is difficult to achieve consistent legal practice
improve competition between countries, so businesses have an incentive government on issues of importance to its members. Pressure
in the domestic to find the most friendly legal environment, where groups have several methods that they can use to control MNCs.
market the laws and tax policies are the best for them ●● Naming and shaming. Business ethics can be promoted

Helps to check It is relatively easy for big footloose international through publicity and naming and shaming, which involves
corporate power firms to move to friendly environments and avoid publicising behaviour that is considered to be unethical as
treatment that they consider to be unfavourable to widely as possible and thereby threatening the business’s
their business
reputation. For example, in 1977 the Swiss food company
Facilitates consumer Even where there is agreement over laws, policies Nestlé was ‘named and shamed’ for aggressively marketing
protection and standards, they are often not easy to enforce
its baby milk formula in lesser-developed countries. Pressure
groups highlighted research that indicated that breast milk is
Question 2
not only better for babies, but it is also safer given sanitation
In 2014, a tobacco industry funded lobby group attempted to derail issues associated with making the formula. Moreover, breast
a World Health Organization (WHO) summit aimed at agreeing milk is free. A variety of pressure groups started a boycott
increased taxes on smoking, according to leaked documents seen by of Nestlé’s products, and continue to monitor the company’s
the Financial Times. The International Tax and Investment Center international sales of baby milk formula.
(ITIC), sponsored by all of the major tobacco groups, met on the Starbucks, Google and Amazon have also been ‘named
eve of the WHO’s global summit on tobacco policy in a bid to and shamed’ in the British media for what some have seen as
head off unwanted duty increases. The ITIC meeting occurred their complex tax avoidance schemes, in which they paid less
in spite of rules aimed at banning tobacco companies from than some considered to be their ‘fair share’ of taxes. In the
interfering with anti-tobacco policies. The WHO sent a letter to past, the mining firm DeBeers was ‘named and shamed’ in
film and print media for contributing to the problem of ‘conflict
delegates warning them about the activities of the ITIC and their
diamonds’, which were being used to finance civil wars and
obligations not to let the tobacco industry influence policy.
helping to increase bloodshed in parts of Africa. Perhaps
The four largest tobacco multinationals sponsor the ITIC, whose even better known historically was the policy of naming and
meeting was closed to the media. Anti-smoking advocates shaming firms that continued to trade in South Africa when
argued that increased excise duty is the most effective way of the official ‘Apartheid’ policy was still in place. Apartheid was
reducing cigarette consumption. The ITIC argued that it provides a government-supported system of racial segregation that
independent advice to governments on tax policy. In April 2015, existed between 1948 and 1994. The system provoked
British American Tobacco raised cigarette prices to offset decline many worldwide protest movements against firms, such as
in smoking. Sales in Russia had fallen by 11 per cent, in Brazil by Coca-Cola, that continued to trade with or in South Africa.
6 per cent and in Vietnam by 5 per cent. They threatened legal ●● Direct action. Direct action is the use of demonstrations,

action in the UK if plain packaging went ahead. protests, strikes or even sabotage to achieve a political or
social goal. Environmental protection can receive a boost
Source: adapted from the Financial Times, 6.10.2014. All rights
from pressure groups such as Greenpeace, which uses
reserved
direct action. Interventions have included using its ships to
(a) Explain why the tobacco companies might want to head off interfere with whaling or to disrupt drilling in the Arctic. Direct
unwanted duty increases. action can be controversial, as is the case with Greenpeace’s
(b) Assess the effectiveness of using tighter regulation on active opposition to so-called ‘golden rice’, strains that have
multinational tobacco companies. been genetically modified or enhanced to contain additional
nutrients. Greenpeace opposes any genetically modified food
entering the food chain, while on the other hand many non-
Pressure groups governmental organisations and health organisations believe
Companies’ behaviours may violate what many people consider that golden rice could help save millions of undernourished
to be acceptable standards, but nevertheless those behaviours children in the developing world.
may not break any laws. Pressure groups act as another control ●● Lobbying. This is the taking of issues directly to government
on MNCs in that they can publicise undesirable behaviour and in an effort to influence change. Organisations such
thereby threaten to damage the image of the firm. Pressure as Amnesty International and the World Development
groups are generally voluntary organisations that operate at Movement frequently lobby governments on human rights
all levels of society, including international levels, and aim to and development issues in addition to publishing their own
change either political or commercial decision-making. For research. They also make detailed suggestions for addressing
example, organisations like Corporate Watch investigate such the issues of concern, actively lobbying for change. As noted
areas of concern as tax avoidance and payday lending, and above, businesses also engage in lobbying. In addition to
attempt to provide information on the unethical practices the CBI, many large firms lobby politicians on issues of
of corporations. However, pressure groups can also act to importance to them.
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 Global business

Table 4 Benefits and drawbacks of using pressure groups has so far not achieved its aims. However, Greenpeace met
and social media to control MNCs with greater success in its campaign to stop Nestlé’s use of
Benefits Drawbacks palm oil from producers linked to deforestation. Nestlé vowed
to remove all potentially offending companies from its supply
Enlists committed people, including Campaigns may be ill-informed or
volunteers misguided chain.
As noted in Table 4, the benefits and drawbacks of using
Particularly where social media is When information goes ‘viral’, it
involved, activists can be enlisted may be impossible for a pressure social media to control MNCs are similar to those for pressure
incredibly quickly to engage in group to influence the message groups, but the speed with which something can now go ‘viral’
information gathering or protest that is ultimately communicated means that it is increasingly hard to control the message that
Raises issues that may otherwise Direct action can lead to violence or the pressure group may want to convey.
not become public knowledge miscarriages of justice
Alerts politicians and authorities to
issues of concern to the public Thinking bigger
Who won the 2014 World Cup? For footballers the answer is a matter
Social media of record; Germany beat Argentina in the final. For the companies
involved in the World Cup, the success of brands is not so clear-cut.
Social media can be defined as an interaction between Adidas, the German brand, has been a long-time sponsor of the
electronic and mobile devices, applications and people, that World Cup. Nike, the US-based sportswear brand, was not a sponsor,
allows users to create content. Such media include online yet sponsored ten of the World Cup teams. However, local brands
magazines, weblogs, social blogs (Twitter), podcasts and in South America – who also were not sponsors – are fighting back
wikis (YouTube, Wikipedia), and social networking (Facebook, against multinational brands. One example is Peru’s Inca Kola, which
Instagram). has now overtaken Coca-Cola with a 30 per cent market share against
As well as being a tool for the promotion of a business’s 20 per cent for the American giant. It now exports to Asia. Falabella,
the Chilean retailer, is now expanding across the continent and South
objectives, social media also can act as a means of controlling American brands are now selling widely in Europe. Brahma beer, based
its behaviour by: in Brazil, is now the fifth largest brewery in the world and their brand
●● making the collection of information from a variety of can be bought at Asda, Sainsbury’s and Tesco in the UK.
sources easier South Americans are switching away from multinational brands to local
●● increasing social awareness through communication
cheaper ones as South American companies consolidate their brand
●● ensuring greater transparency access across the region. More local icons will appear in the top 50
●● bringing together people in order to create a kind of social South American brands. If so, that will spell good news for local brand
authority to challenge the power of large companies. enthusiasts but tougher times for the multinationals. Perhaps encouraging
For example, Greenpeace has used social media local brand buying is the best control of multinational behaviour.
extensively in its ‘Save the Arctic’ campaign, which included Source: adapted from the Financial Times, 23.9.2014. All rights reserved
efforts to thwart Lego’s partnership with the oil company You could use this information in a variety of ways. Obviously, it can be
Shell. The campaign began with an animated film using Lego used when answering questions on the influence of multinationals but
and showing the Arctic being flooded with oil. Though the it might also be useful when discussing factors influencing globalisation
film has been watched by millions of viewers, the campaign and global competitiveness, and the impact of multinationals.

489
Controlling MNCs Unit 81

Case study
The issue was raised after several newspapers revealed the
practice. This galvanised several pressure groups, including
CONTROLLING TAX UKUncut, and War on Want, and protests followed.
Arriving at the depth of a very bad recession, this was
AVOIDANCE an issue that the public cared about, and social media
began to reflect some of the public’s condemnation for the
Senior managers may feel that they have a duty to tax-avoiding firms. The issue soon posed a threat to the
minimise the taxes that their company pays to a host companies’ reputations as well as their business, since tax
government, so that they can maximise their revenues and avoidance quickly became a political issue.
returns to shareholders. It has been widely reported that Sources: adapted from the Financial Times 02.05.2013, all
Google has taken this approach in the UK, paying only rights reserved
£6 million in tax on £395 million of revenue in 2011,
while in the same year Amazon made £3.35 billion and
had a tax bill of £1.8 million. (a) Assess the role that social media and pressure groups
played in bringing the issue of corporate tax avoidance to
None of this was illegal, but some consider it to be unfair. the attention of the public. (10 marks)
The firms avoided the taxes through all sorts of ways, but
chiefly by locating parts of their businesses in low-tax (b) Evaluate the arguments for and against the government
jurisdictions, and then moving money around so that profits changing tax policy so that businesses are not able to avoid
were declared there and not in higher tax places. paying their ‘fair share’ of UK tax in future. (20 marks)

Exam tip Links

When evaluating the method used to control MNCs, you could
consider the extent and impact of control from different areas. For
To demonstrate your synoptic skills, you could use information
example, is political and legal control or consumer pressure coming from other units to help support your answers. For example,
from the country of origin of the MNC, which may be a Western you might use the information about the impact that tariffs
developed country, or from other countries in which the MNC is and quotas, protectionism and trading blocs (Units 69 and 70)
operating? Are these controls consistent or are there conflicting can have on the countries in which MNCs operate to assess the
objectives? Further, you could consider the effect that the
types and extent of control. Further, you might consider to what
controls can have on both the country of origin/country in which
the MNC has its headquarters, and other countries in which it extent MNCs take into account ethical practices and how these
operates. Again, consider to what extent these effects may differ might affect controls of MNCs (Unit 59 and Unit 80). Unit 79,
and whether there is any conflict. which focuses on the impact of MNCs, could also be used to
support arguments for controlling their activities.
Key terms
Competition policy – government policy that exists to Knowledge check
promote competition and ensure that firms don’t abuse their
market power, do not attempt to fix prices or use pricing 1. Why are there legal controls on the activities of
strategies to drive out competition, and do not collude multinationals?
against other producers or the consumer. 2. What are the benefits of multinationals in the global
Direct action – the use of demonstrations, protests, strikes market place?
or even sabotage to achieve a political or social goal.
3. How are multinationals’ global activities controlled?
Naming and shaming – publicising behaviour that is
considered to be unethical as widely as possible and 4. What political influences do multinationals possess?
thereby threatening a business’s reputation. 5. How can taxation policies influence the activities of
Pressure groups – generally voluntary organisations multinationals?
that operate at all levels of society, including international
levels, and aim to change either political or commercial 6. What role can social media have on controlling
decision-making. multinationals’ behaviour?
Tax avoidance – using legal methods to reduce the amount
of tax that a company pays.
Tax evasion – using illegal means to avoid paying taxes that
are owed.

490
 Preparing for your
A Level Paper 1 exam
Advance planning • You should familiarise yourself with the layout of the paper by
1. Draw up a timetable for your revision and try to keep to it. looking at the examples published by Edexcel. The questions
Spread your timetable over a number of weeks, and aim to within each section are followed by lined spaces where you
cover a chosen number of topics each week. should write your answer. Use the mark allocation as a guide
2. Spend longer on topics that you have found difficult, and to how much time to spend on each question.
revise them several times. Skills required when answering questions
3. Do not try to limit your revision by attempting to ‘question If you are entered for the A Level qualification you will be
spot’. Revise so that you are confident about all aspects of required to sit three examinations. You should be aware of the
your work. skills that you need to demonstrate when answering questions.
Paper 1 overview: You will need to demonstrate four different skills referred to as
A Level Paper 1: Marketing, people and global business: assessment objectives (AOs):
2 hours (Themes 1 and 4)
AO1 – Knowledge: this means you have to show that you:
Section A, Question 1 2 × 4 mark questions
1 × 10 mark question • recognise and understand business terms, concepts and theories
1 × 12 mark question • understand how individuals and organisations are affected by
and respond to business issues.
1 × 20 mark question
Total marks for Section A 50 marks All questions will test knowledge to some extent. A minority of
questions will test knowledge alone. These can be recognised by
Section B, Question 2 2 × 4 mark questions the mark allocation. They will tend to carry just four marks.
1 × 10 mark question AO2 – Application: this means that you have to apply
1 × 12 mark question knowledge and understanding to various contexts to show how
1 × 20 mark question individuals and organisations are affected by and respond to
Total marks for Section B 50 marks issues. This might involve:
• using a business formula in appropriate circumstances, for
Total marks = 100 marks
example, calculating the price elasticity of demand for a product
Paper 1, Marketing, people and global business, will assess • using a theory to show why a business has chosen a particular
your knowledge and understanding of Themes 1 and 4, course of action
marketing, people and global business. It is a written examination • using a theory to show the impact on a business of choosing a
and the paper is divided into two sections. The duration of Paper 1 particular course of action.
will be 2 hours. You have to answer ALL questions. There is no Most questions in the examination will require you to
choice. However, this can be an advantage because it means you demonstrate application. This means that you have to ensure that
do not have to waste time deciding which questions to answer. your answers relate directly to the context given in the question.
Section A questions You must discuss the implications of issues to the particular
In Section A you will be given Extracts A–C as a stimulus and business or industry in the context you are given.
you will need to answer Question 1, a–e. The parts of Question AO3 – Analysis: this means you have to show that you can
1 require a range of depths in your responses, depending on the break down information and understand the implications of the
mark allocation. Question 1e is an extended question. information presented in the question. You will need to show an
Section B questions understanding of the impact on individuals and organisations of
In Section B you will be given Extracts D–F as stimulus and you external and internal influences. This might involve:
will need to answer Question 2, a–e. The parts of Question 2 • explaining causes and effects and interrelationships, for
require a range of depths in your responses, depending on the example by recognising from a graph that sales are falling and
mark allocation. Question 2e is an extended question. could be the result of new competition in the market
491
A Level Paper 1

• breaking down information to identify specific causes or ‘right’ answer, so examiners are likely to be more interested in
problems, for example by realising that a business is suffering whether your judgement is plausible and in the quality of your
from inefficiency because staff motivation has fallen as a argument in support of that judgement. Questions that carry eight
result of a pay cut marks or more are likely to test evaluation.
• using appropriate techniques to analyse data, for example using Quantitative skills
the net profit ratio to assess the performance of a business. In all three A level examination papers you will need to
You will often be required to construct an argument, for example demonstrate your numeracy and quantitative skills. The specific
by explaining the possible reasons for events or discussing the tasks you might be asked to complete are shown below. Note
advantages or disadvantages of particular courses of action. that QS 6, calculate investment appraisal outcomes and interpret
Those questions that carry more than four marks will require results, does not form part of the GCE AS level core content.
analysis in the answer. Some questions that carry four marks may
Quantitative skills that you need to demonstrate
also require you to demonstrate some analytical skills.
QS 1 Calculate, use and understand ratios, averages and
AO4 – Evaluation: evaluation involves making a judgement. fractions
You will need to evaluate both qualitative and quantitative QS 2 Calculate, use and understand percentages and
evidence to make informed judgements and propose evidence- percentage changes
based solutions to business issues. This might involve:
QS 3 Construct and interpret a range of standard
• showing judgement when weighing up the relative importance graphical forms
of different points or sides of an argument in order to reach a QS 4 Interpret index numbers
conclusion QS 5 Calculate cost, revenue and break even
• drawing conclusions from the evidence that you present
QS 7 Interpret values of price and income elasticity of
• assessing the relative importance of particular issues to a
demand
business
QS 8 Use and interpret quantitative and non-quantitative
• suggesting a course of action for a business, supported by
information in order to make decisions
plausible motives or evidence.
QS 9 Interpret, apply and analyse information in written
When evaluating, it is often possible to draw a number of graphical and numerical form
different conclusions. Very often in business studies there is no

492
Preparing for your A Level exams
Sample answer with comments
Paper 1: Marketing, people and global business
These questions will help you prepare for your A Level Business Paper 1 examination. Some sample answers and comments are
provided for you to review and you will have the opportunity to answer some questions yourself.

Section A, Question 1
Read the following extracts (A to C) before answering Question 1.

Extract A
Global confectionery market
The global confectionery market is worth hundreds of millions
of dollars, and the size of the market is growing. One important
part of the total confectionery market is chocolate. It was reported
in 2014 that rural India had become a target market for many 8%
chocolate producers. It was felt that improved infrastructure and 3% Key
3%
rising incomes would help to boost demand for chocolate in rural Mondelez
India where it is reckoned that 68 per cent of India’s 1.2 billion 6%
Nestlé
population live.
Mars
Cadbury, the UK confectionery company owned by the Chinese Ferrero
18%
multinational Mondelez, was one of the first entrants into the 62% Amul
market. Intense competition in urban India pushed Cadbury Others
towards rural customers. Cadbury was quick to realise an
important feature in the market. The regular 42g size Cadbury
chocolate bar, priced at 45 rupees, was too expensive for the
India chocolate market shares (%)
market. As a result the company launched a 15g bar priced at 5
rupees to make the product more accessible. Source: Chocolate Industry in India 2014-19,
The pie chart shows the market shares for chocolate in India. www.valuenotes.biz

Sources: adapted from www.confectionerynews.com

Extract B
Rising cocoa prices
In 2014 it was reported that chocolate prices were expected to rise. This was due to problems with the supply of cocoa. Poor weather
conditions in the Ivory Coast, where 40 per cent of the world’s cocoa is produced, was said to be a key factor. In 2013 the price of cocoa
beans was about $2,447 per tonne. This was expected to rise to about $3,000 in 2014.
Some producers said that they would reduce the size of their chocolate bars rather than raise the price, an approach used by Mars in the
UK with its Mars and Snickers brands.
Source: adapted from www.confectionerynews.com

493
A Level Paper 1

Extract C
Booja-Booja
Norwich-based Booja-Booja is a relatively small independent
UK chocolate maker that produces a range of organic
chocolate truffles and ice cream alternatives. Suitable for
vegetarians and vegans, Booja-Booja’s range is organic.
It is also dairy, gluten, wheat and soya-free, and free of
genetically modifed organsims.
Booja-Booja distributes its products through a range of
channels. They are stocked in independent health food stores,
farm shops and delis nationwide, along with Waitrose, Holland
& Barrett and Ocado. The company also uses select online
distributors that have a commitment to vegetarian, fairly traded,
organic and natural products. Examples include Planet Organic,
Wholefoods Market, Earthfare, EcoLife Global, Animal Aid,
Ethical Treats and Greenlife.
Source: adapted from www.boojabooja.com

1 (a) Using a supply and demand diagram, illustrate the impact on the global market for chocolate of the rising cost of cocoa.
(4 marks)

Question 1 (a), student answer

The global market for chocolate
Price
S2

S1
P2

P1

D
Q2 Q1 Quantity

Comment, Question 1 (a)

It is not unusual to be asked to draw a supply and demand (more expensive cocoa). Another mark might be given for
diagram in the examination. You may be awarded 1 mark for showing the new equilibrium price and quantity. Price has
correctly showing the supply and demand curves. You may get risen from P1 to P2 and the quantity traded in the market has
another mark for labelling the axis correctly and another mark for fallen from Q1 to Q2. Note that the impact on price and quantity
shifting the supply curve to the left. This shows that producers depends on how elastic/inelastic demand is. If demand is
reduce the supply of chocolate because costs have increased relatively elastic then the impact on price would be less.

494
 Preparing for your exams

1 (b) Explain one possible disadvantage to Booja-Booja of operating in a niche market. (4 marks)
No sample answer has been provided for question 1 (b) so that you can answer it yourself, for exam practice.
1 (c) Assess the importance to a business like Cadbury of carrying out primary market research. (10 marks)

Question 1 (c), student answer

Market research involves gathering, presenting and analysing the market. This position of strength may have been aided
information about the marketing and consumption of goods by gauging the needs of potential customers by carrying out
and services. Businesses spend money on market research primary market research.
because it helps to reduce the risk of failure. Products that However, there are limitations to market research, which
are well researched are more likely to be successful. Market companies like Cadbury need to be aware of. Businesses need
research data can help to quantify the likely demand for a to be sure that the data they collect is reliable. For example,
product and provide an insight into consumer behaviour. that they have chosen a representative sample from which
Primary research involves collecting primary data. This is to gather information. If there is a sampling discrepancy, any
information that did not exist before. This has to be collected predictions based on the information in the sample would be
by a researcher either by the business itself or an agent. flawed. The greater the sampling discrepancy, the less reliable
Primary research is arguably more useful than desk research will be the data obtained. Companies must also appreciate
because the information gathered can be tailored to that respondents’ answers may not match their behaviour. This
the precise needs of the business. In this case, Cadbury is because human behaviour is unpredictable and there may be
may have carried out some research before entering the a difference between what people say they will do and what
rural market for chocolate in India. For example, Cadbury they actually do. Consequently the information gathered may
discovered an important feature in the market. The regular again be unreliable.
42g size Cadbury chocolate bar, priced at 45 rupees, However, companies like Cadbury, or their agencies, will
was too expensive for the market. As a result the company be experienced in conducting market research and should
launched a 15g bar priced at 5 rupees to make the product therefore be aware of such pitfalls. It is likely that the benefits
more accessible. This information may have been gathered of carrying out primary research outweigh any potential
using primary research. This valuable information meant that drawbacks. Cadbury’s position as market leader in India might
Cadbury could adapt its product to suit the needs of a help to support this view. Primary market research is likely
specific market. This would help to reduce the risk of venturing to be very important to companies like Cadbury operating
into a completely new market. According to the information in highly competitive markets. It might help them to get a
in the pie chart Cadbury, which is owned by Mondelez, is competitive edge. Therefore, it can be concluded that primary
currently the market leader in India with 62 per cent of market research is very important to a company like Cadbury.

Comment, Question 1 (c)

Questions like this require you to demonstrate knowledge, limitations of primary market research. Three marks might
application, analysis and evaluation. Two marks might be be awarded for evaluation. An example of evaluation in this
awarded for demonstrating knowledge, such as defining primary answer is the judgement made weighing up the importance
market research and identifying one benefit of carrying out of primary market research to a company like Cadbury. This
primary research. Two marks might be awarded for application. argument is clear and well supported with evidence from
This answer is focused on the use of primary market research by the case and business theory. In this answer counterbalance
Cadbury in the market for chocolate in rural India. An example is arguments are also raised. For example, although there are clear
used of how Cadbury identified a particular customer need in this benefits of conducting primary research, there are also some
rural market (the need for smaller and cheaper chocolate bars). limitations. These are identified, analysed and then explained
away. The final judgement is that the benefits of primary
Three marks might be awarded for analysis. Examples of
research to an experienced company like Cadbury exceed
analysis in this answer are the explanation of how primary
the limitations.
research can benefit a business and the explanation of two key

1 (d) Assess the possible factors that might be taken into account by a company like Cadbury before selling into a new overseas
market. (12 marks)
No sample answer has been provided for question 1 (d) so that you can answer it yourself, for exam practice.
1 (e) Evaluate how changes in social trends might affect the choice of distribution channels used by businesses like Booja-Booja.
(20 marks)
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A Level Paper 1

Question 1 (e), student answer

Booja-Booja is a small operator in the global market for Although it is important to reflect social trends when
confectionery. It is an independent company that produces selecting distribution channels, companies like Booja-Booja
organic chocolate truffles. All of Booja-Booja’s products are are also likely to consider other factors. For example,
organic; free of dairy, wheat, soya and gluten. Booja-Booja different types of products may require different distribution
distributes its products using a range of channels. They are channels. Fast moving consumer goods such as breakfast
stocked in independent health food stores, farm shops and cereals, confectionery, crisps and toilet paper cannot be
delis nationwide, along with Waitrose, Holland & Barrett and sold directly by manufacturers to consumers. Wholesalers
Ocado. The company also uses select online distributors that and retailers are needed because they break bulk. Booja-
have a commitment to vegetarian, fairly traded, organic and Booja is a small chocolate manufacturer and could not
natural products. Examples include Earthfare, EcoLife Global, easily distribute its products without the help of retailers.
Animal Aid, Ethical Treats and Greenlife. Businesses producing high quality ‘exclusive’ products such
as perfume and designer clothes will choose their outlets
In recent years there have been a number of changes
very carefully. The image of their products is important,
in the way goods and services are sold. Some of these
so they are not likely to use supermarkets, for example.
methods reflect changes in social trends. For example,
Information in the case suggests that Booja-Booja has
large US-style shopping malls have been built, such as
selected its online partners carefully. The company uses
the Trafford Centre, many sellers use call centres to sell
distributors that have a commitment to vegetarian, fairly
products, such as financial services, many supermarkets
traded, organic and natural products, such as Earthfare,
have extended their product ranges and opening hours
EcoLife Global and Animal Aid.
and for many people shopping has become more of a
leisure activity. However, from Booja-Booja’s point of view, Businesses will also choose the cheapest distribution
one recent social change is important. There has been a channels, and prefer direct channels. This is because if
huge growth in online shopping and online distribution. It intermediaries are used they will take a share of the profit.
is often called e-commerce because it involves the use of Large supermarkets will try to buy direct from manufacturers.
electronic systems to sell goods and services. Booja-Booja This is because they can bulk buy and get lower prices.
uses select online distributors, such as Planet Organic, Independents are more likely to buy from wholesalers. They
Wholefoods Market, Animal Aid, Ethical Treats and Greenlife have to charge higher prices as a result. Many producers
to help ensure that it can get its products to those now sell direct to consumers from their websites. This
customers who like to shop online. helps to keep costs down. However, producers selling to
mass markets are likely to use intermediaries. In contrast,
There are a number of benefits to businesses of selling online.
businesses targeting smaller markets are more likely to
For example, e-tailers may not have to meet the costs of
target customers directly. For example, a building contractor
operating stores, such as rent, fixtures and fittings, customer
in a small town will deal directly with customers. Producers
service staff and other store overheads. They also have
selling in overseas markets are likely to use agents because
lower costs when processing transactions – many systems
they know the market better. Businesses selling goods to
are automated and less paper is needed for documents,
other businesses are likely to use more direct channels.
such as invoices and receipts. Businesses selling online can
Booja-Booja uses a range of retailers and online distributors
offer goods to a much wider market – e.g. global. Businesses
because it would not be cost effective to sell directly to
can serve their customers 24/7 and collect payments online
their target market.
using credit cards or PayPal, for example. However, despite
these advantages of online distribution, there are some To conclude, there is a range of factors that will influence
drawbacks. Businesses will face increasing competition since the choice of distribution channels. It could be argued
selling online is a relatively cheaper method of distribution that Booja-Booja has responded to social changes in the
and can be organised from any location in the world. distribution of its products by making its products available
Consequently, businesses will face more competition from online. However, since Booja-Booja is a small chocolate
overseas. There may also be technical problems online. For maker with a limited product range its choice of channels is
example, websites may crash, viruses may be contracted limited. It does not have enough products to sell directly
and internet connections can get lost. Also, there is the or operate retail outlets. It is likely that these factors have
problem of making yourself known. How do people find out influenced the choice of distribution channels rather than
about you among a large number of other online sellers? One changes in social trends. Nevertheless, Booja-Booja is
way is through social media, another is through using online exploiting one important social trend.
distributors, as Booja-Booja has done.

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Comment, Question 1 (e)

This question requires an extended answer and you need to benefit small businesses like Booja-Booja and the different
demonstrate knowledge, application, analysis and evaluation. methods of distribution that might be used. Six marks might be
Four marks might be awarded for demonstrating knowledge, awarded for evaluation. In this case, one approach is to weigh up
such as understanding the meaning of social trends in business, the extent to which social trends have influenced the choice of
distribution channels and the factors that influence the choice distribution channel used by Booja-Booja. The judgement made
of distribution channel. Four marks might be awarded for is that social trends may be influential but not as much as other
application. This answer focuses throughout on the distribution factors, such as cost and the nature of the product. As a small
channels used by Booja-Booja and draws on a range of relevant business, Booja-Booja’s choice of channel is a little restricted.
examples, such as the distribution channels that are available to a There is also an attempt here to discuss both the advantages and
small chocolate maker in the confectionery industry. the disadvantages of online selling. This provides an argument
with a counterbalance.
Six marks might be awarded for analysis. Examples of analysis
in this answer are explanations of how online selling will

Section B, Question 2
Read the following extracts (D to F) before answering Question 2.

Extract D Global hotel industry revenue from 2008 to 2016

The global hotel market Revenue ($ billions)
600
550
Following a dip in 2009, possibly the result of a global downturn
500 457
in demand, revenue in the global hotel market has shown 447 419
400 395
consistent growth. It was expected to generate around $550
billion in 2016. 300
200
100
0
2008 2009 2010 2011 2016*
*Estimate Year

Source: adapted from www.statista.com

Extract E
InterContinental Hotels Group
In 2014, InterContinental Hotels Group (IHG®) a giant multinational, operated around 4,800 hotels worldwide and employed over
350,000 people across its ten brands, which included InterContinental®, Holiday Inn®, Holiday Inn Express®, Crowne Plaza®,
Candlewood Suites® and Hotel Indigo®. The company’s head office is located in Buckinghamshire, UK.
IHG opened a new Holiday Inn in Jaipur, India, in 2014. The 172-room hotel is located in the city centre, close to the main shopping
centre, railway station, multinational companies and cultural venues. It also has access to tourist attractions, such as Amber Fort,
Hawa Mahal and Birla Temple. Each room is equipped with a 37-inch LED TV, iPod docking station and a media hub, with hi-speed
complimentary internet access across the hotel. The hotel also provides a gym and roof-top pool.
For an initial period rooms could be booked at a discount when it first opened. In 2014, IHG operated 19 hotels across 10 cities in
India. It also expected to open another 45 hotels across India over the next three to five years.
Sources: taken from IHG’s Annual Report 2014, IHG news release 2014 and www.ihg.com

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A Level Paper 1

Extract F
Red Carnation Hotels
Red Carnation Hotels (RCH) was founded by Stanley and Beatrice
Tollman. The small chain of 17 five- and four-star boutique
luxury hotels has a reputation for taste and excellence in dining,
accommodation and service. The business has won a number of
prestigious industry awards and also operates a gastro-pub and
a South African inspired London restaurant. Beatrice Tollman
believes that much of their success has come from listening
to guests. She reads every guest comment from every source
because that is where she can learn how to improve. Beatrice says:
‘Our guests teach us our business.’
Beatrice also believes that if you look after employees they, in turn, will look after the guests. In her opinion, caring for the workforce
is simply good business practice. In a 2015 survey by the Sunday Times, RCH was ranked second in the 100 best companies to work
for. Staff gave her an 87 per cent positive score for being an inspiring leader. About 53 per cent of the workforce has been with RCH
for five years or longer and more than 90 per cent of the managers have been promoted from within the company. This is a testimony
to the company’s commitment to employees.
Sources: adapted from www.redcarnationhotels.com and www.belleabouttown.com
2 (a) Explain how social media could be used by a business like Red Carnation Hotels to help meet customer needs. (4 marks)
No sample answer has been provided for question 2 (a) so that you can answer it yourself, for exam practice.
2 (b) Explain one possible reason for the pattern of consumer spending on hotel accommodation shown in Extract D. (4 marks)

Question 2 (b), Student answer

Since 2008 revenue in the global hotel industry has grown money and having extra to spend on non-essentials, such
significantly. By 2016 it is expected to have grown by as hotel accommodation. The expansion in India planned
23 per cent from $447 billion to $550 billion. One possible by InterContinental Hotels (IHG) supports this view. IHG
reason for this pattern of spending on hotel accommodation currently operates 19 hotels across 10 cities in India. It also
could be the growth in global incomes. There is usually a expects to open another 45 hotels in the country over the
strong link between consumer incomes and the demand next few years. The company is likely to be responding to
for products. In recent years the BRIC countries of Brazil, rising demand for hotel accommodation in India resulting from
Russia, India and China, have enjoyed relatively high levels of growth in incomes. The hotels are likely to serve both Indians
economic growth. This has resulted in people earning more and overseas tourists visiting the country.

Comment, Question 2 (b)

Questions like this require you to demonstrate knowledge, for keeping the answer in context. This answer focuses on the
application and possibly analysis. One or two marks might be hotel industry. Finally, credit may be given for analysis. In this
awarded for identifying one factor that might have led to more case, explaining how economic growth in developing nations has
spending on hotel accommodation over the time period, i.e. resulted in higher spending on hotel accommodation.
growing incomes. Up to two application marks might be awarded

2 (c) Assess the impact good leadership might have on a business such as Red Carnation Hotels. (10 marks)
No sample answer has been provided for question 2 (c) so that you can answer it yourself, for exam practice.
2 (d) Assess the benefits to a company like Red Carnation Hotels of treating staff like assets. (12 marks)

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Question 2 (d), Student answer

Different businesses have different approaches to their staff. If employers treat staff as assets, they will also make an
Some businesses view their staff as assets, while others effort to retain them. They know employees want to be
view them as costs. These approaches are very different challenged, acknowledged and rewarded. These employers
and might have implications for their levels of productivity. know that while money may not be the motivator for many
Evidence in this case suggests that the Red Carnation Hotel employees, it is still important and they are likely to provide
is an employer that treats its staff as assets. Employers above average wages. This approach is likely to help recruit,
who view their staff as assets will value their employees and retain and motivate high-quality staff. About 53 per cent of
have concern for their welfare. Staff will be valued because the workforce has been with RCH for five years or longer and
employers recognise that their efforts will help the business more than 90 per cent of the managers have been promoted
to perform more effectively. Such employers will therefore from within the company. This is a testament to RCH’s
try to meet the needs of employees. This might involve commitment to employees.
providing adequate remuneration, reasonable holidays, sick In contrast, some employers view their staff as a cost and
leave, maternity leave, pensions and a safe and comfortable their focus is completely different. Like any other cost, they
working environment. Employers taking this approach will also will try to minimise it wherever possible. This might involve
be prepared to invest in training so that staff can develop paying the minimum legal wage, using zero hours contracts,
skills and carry out work tasks competently and safely. They neglecting investment in training, providing the minimum legal
will also provide job security and opportunities to interact ‘employee rights’ in relation to sick leave, holiday pay and
with colleagues, recognition and professional relationships working conditions and using cheap and inferior recruitment
and opportunities to solve problems. Staff might be methods. This approach might lower employment costs but
encouraged to work in teams and be creative and they might it may also be a ‘false economy’. This is because productivity
be clearly and effectively led. The Red Carnation Hotel group might be lower due to poor motivation. Staff turnover and
is run by Beatrice Tollman. She is perceived to be a good absenteeism may also be higher and there may be more
leader by employees. Indeed, in a survey carried out by the conflict between staff and management. Treating staff as
‘Sunday Times’, staff gave Beatrice an 87 per cent positive a cost may leave workers feeling exploited, neglected,
score for being an inspiring leader stressed and unhappy in their work. At RCH it is clear that
Beatrice also believes that if you look after employees they, Beatrice Tollman recognises the talents of staff and values
in turn, will look after the guests. In her opinion, caring for them. Using this approach the business has flourished
the workforce is simply good business practice. This is clear and has a reputation for taste and excellence in dining,
evidence that she treats staff as assets. accommodation and service. The business has also won a
number of prestigious industry awards.

Comment, Question 2 (d)

Questions like this require you to demonstrate knowledge, treated as assets and the nature of the benefits to the hotel group
application, analysis and evaluation. Two marks might be of adopting this positive approach. The answer also considers a
awarded for demonstrating knowledge, such as explaining what contrasting approach whereby staff are treated as a cost, which is
is meant by treating staff as assets or identifying the benefits of explained in detail.
such an approach like lower staff turnover and higher labour Four marks might be awarded for evaluation. An example of
productivity. Two marks might be awarded for application. This evaluation in this answer is the judgement made weighing up
answer focuses on the two possible approaches to staff in the the benefits of treating staff as assets. Although a contrasting
hotel industry and in particular by Red Carnation Hotels. In this approach might result in lower costs for a business, this answer
case it is the leader, Beatrice Tollman, who is responsible for the clearly shows that the Red Carnation Hotel Group has definitely
positive approach to staff management. benefited from treating staff as assets. The final judgement in the
Four marks might be awarded for analysis. Examples of analysis answer uses the examples of the hotel’s reputation for taste and
in this answer are the detailed explanations of how staff might be excellence and its prestigious awards to support the argument.

2 (e) Evaluate the possible impact on India’s national economy of multinational developments, such as that planned by
InterContinental Hotels (IHG®). (20 marks)

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A Level Paper 1

Question 2 (e), Student answer

Most governments around the world are in favour of from an MNC like IHG to businesses in India will help to
multinational companies (MNCs) setting up operations in improve efficiency and productivity.
their countries. This is because they are likely to generate Consumers are likely to benefit from the arrival of MNCs
income, employment, wealth and prosperity. In this case, in their countries. This is because they will be free to buy
InterContinental Hotels Group has recently opened a new some of the goods and services that they provide. In this
Holiday Inn in Jaipur, India. It also plans the development of case, they will be free to use the facilities provided by
another 45 hotels in the next few years. the Holiday Inn and any other hotels built by IHG. This will
When an overseas business like IHG locates a new facility in extend the choice of hotels in India. The arrival of MNCs
a foreign country, the amount of money spent on establishing is likely to increase competition in the host country. The
that facility is classified as foreign direct investment (FDI). products made by MNCs may be cheaper because they
So the money spent by IHG opening the Holiday Inn in Jaipur use modern and efficient production techniques. Since
represents an inflow of money from IHG to India. This is their costs will be lower, they can offer products at lower
likely to be welcomed by the Indian government because the prices. This competitive pressure may also force domestic
national economy will benefit. For example, the FDI should producers to lower their prices. For example, when IHG
result in higher levels of GDP for India. The revenue resulting opened the Holiday Inn in Jaipur, for an initial period rooms
from the new hotel will increase economic growth and help could be booked at a discount. Other hotels may have
to raise the living standards for people in the host country. been forced to lower their prices as a result. If MNCs
Also, the profit made by IHG is likely to be taxed, unless the use ‘state-of-the-art’ technologies, modern materials and
company has negotiated tax breaks with the government. more efficient working practices, such as total quality
This increases tax revenue for the Indian government, which management, the quality of products might also be
can be spent improving public services, such as health improved. For example, they may be better designed, more
care, education, housing, and transport networks. The IHG durable, more efficient and more aesthetically pleasing. In
investment in Jaipur will also create local jobs. This will help this case, the hotels being opened by IHG are modern with
to reduce unemployment, poverty and hardship in the area. good facilities. For example, the Jaipur hotel had access
Businesses in India may also get a boost when a multinational to tourist attractions such as Amber Fort, Hawa Mahal and
invests in a project. This is because a range of suppliers will Birla Temple. Each room was equipped with a 37-inch LED
be needed. For example, the hotel in Jaipur is likely to need TV, iPod docking station and a media hub, with hi-speed
supplies of furniture, fittings, raw materials, utilities, telephone complimentary internet access across the hotel. The hotel
services, commercial services, gardeners and cleaning also provides a gym and a roof-top pool. In general, it is
contractors. Such demands will help to sustain and expand possible that many people in the host nation will enjoy
businesses in India and therefore create even more jobs in better living standards when MNCs set up operations.
the national economy. There may also be a boost in tourism, Initially, they may benefit from employment opportunities
which will help boost GDP. and enjoy higher incomes. They will have more choice and
enjoy access to cheaper and better quality products.
Investment by MNCs will have a positive impact on the host
nation’s balance of payments. There will be a double impact. In contrast, some MNCs are very powerful. In some cases
Initially, the flow of FDI when a project is being established the annual revenue of a MNC can be greater than the
will be classified as an export. For example, the money used GDP of an entire country. This can give them a formidable
to construct and furnish the hotel. Once the hotel is ‘up presence. If too many domestic producers leave the market
and running’ there may be a further boost to the balance due to intense competition, this could result in less choice
of payments. This is because India’s exports will rise if the for consumers in the long term. Also, if MNCs are left with
hotel is used by overseas tourists. This boost in the balance little or no competition, they may come to dominate the
of payments will help India to ‘pay its way’ when trading market and exploit consumers. There is also the possibility
internationally. that profits will be repatriated to the MNC’s home country
and therefore the benefits to the host will be reduced. The
MNC investment in foreign countries often means that new
impact of MNCs, when they first arrive, is often very positive
technologies and modern working practices are introduced
for a country. However, it is important to remember that the
into the host nation. This might result in the transfer of
impact of MNCs can have negative effects. For example, they
technologies and knowledge to local businesses. For
may damage the environment, exploit local workers and force
example, new working practices in IHG’s hotels may be
local businesses to fold. In this case there is no evidence
copied by domestically owned hotels in India. IHG may also
to suggest that IHG has had a negative impact as a result
provide technical assistance, training and other information to
of their investments in India. IHG already owns many hotels
their suppliers located in India. Many multinationals also assist
in the country and plans a further 45 in the next few years.
local suppliers in purchasing resources and in modernising
These investments are likely to benefit India and its economy
production facilities. The transfer of technology and skills
significantly.

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Comment, Question 2 (e)

This question requires an extended answer and you need to Indian national economy of MNCs establishing themselves.
demonstrate knowledge, application, analysis and evaluation. These include more employment, more tax revenues, more
Four marks might be awarded for demonstrating knowledge, exports, and the transfer of skills. These will all help to raise
such as understanding the meaning of a multinational company living standards in India. There will also be more consumer
and identifying some of the possible effects an MNC might have choice, which will also improve the quality of life for Indians.
when it sets up operations in a new country. Six marks might be awarded for evaluation. In this case, one
approach is to weigh up the benefits and the drawbacks of an
Four marks might be awarded for application. This answer
MNC arriving in a country. This approach is taken here. The
focuses throughout on the impact that IHG might have on
final judgement clearly suggests that the benefits outweigh the
the Indian national economy when it opens new hotels in the
drawbacks. Indeed, in this case there is no evidence that the
country. For example, it explains that new jobs will be created
arrival of IHG has had a negative impact on the Indian national
when the new Holiday Inn opens in Jaipur.
economy. Another approach that could have been used would be
Six marks might be awarded for analysis. An example of analysis to rank in order of importance the benefits to the Indian economy
in this answer is the detailed explanation of the benefits to the of MNC activity.

Practice question – A Level, Paper 1: Marketing, people and global business

Paper 1 – Marketing, people and global business
The more you practise for your examination, the more confident you will feel. The following question provides practice for Section A,
Question 1.

Section A, Question 1
Read the following extracts (A–C) before answering Question 1.

Extract A
Success at iOutlet
Entrepreneurs Liam James and Matthew Green set up iOutlet
in 2012. The business sells second-hand refurbished iPhones
and carries out repairs to smartphones. The pair recognised that
although the global demand for iPhones was rising, not everyone
could afford to pay for a brand new handset. The business uses
eBay to sell its products, which helps to keep costs low and gives
the brand access to the wider global market.
Since its inception, iOutlet has enjoyed astounding financial
success. It managed to grow revenue to £2.4 million in its second
year – a 400 per cent increase on year one. The business now
has 16,000 clients in over 40 countries across six continents.
The owners believe that good customer service has helped
the business to succeed. Liam James said, ‘We don’t have any
negative reviews with both accounts we sell from having 100 per
cent positive feedback, something which proves our hard work
before and after the sale is working and also something we are
immensely proud of.’
Source: adapted from www.startups.co.uk

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A Level Paper 1

Extract B
Working conditions at Chess Telecom
Chess Telecom, based in Alderley Edge, Cheshire, provides services including line rental, broadband, mobile and telephone systems
to UK businesses. It has a reputation as a very good employer. For example, the company has created a special team, selected
because of their commitment to the company’s vision and culture, who help new recruits to settle in to their new work environment.
According to a survey 89 per cent of staff say they go out of their way to help each other and that events such as the summer
conference, the Chesstival family fun day and sports clubs help to bond employees. Some 90 per cent of employees said that people
within the company care a lot about each other.
There is also evidence that the owner consults staff on important issues. For example, a share-option scheme was introduced in
response to staff suggestions. According to 80 per cent of employees Chess Telecom is run on strong principles by its boss. He takes
part in fundraising challenges for the Prince’s Trust and has climbed Kilimanjaro and Mont Blanc for charity.
Source: www.b.co.uk

Extract C Percentage of people who own a mobile phone or smartphone

in a selection of developing countries
The globalisation of mobile phones
In 2014, it was thought that there were around 3 billion users of %
mobile phones worldwide. More than half of those users were 100
located in developing countries. 90

In many developing countries, where average incomes are 80

considerably lower than those in the developed world, mobile 70
phone rates are also lower. Telecoms companies have adapted 60
to this market environment and managed to maintain their
50
profitability. As a result, a sizable number of people on very low
40
incomes now have access to mobile telecommunications and the
30
telecoms market.
20
Source: adapted from www.pewglobal.org
10
0
China

Chile

Tunisia

Venezuela

Kenya

Brazil

Nigeria

Mexico

Pakistan
Key Countries
Own a mobile phone (%)
Own a smartphone (%)

Source: Spring 2013 Global Attitudes Survey. Q66-Q68.

Pew Research Center.

1 (a) Explain one method used by iOutlet to add value to their service. (4 marks)
(b) Use the information in Extract A to calculate iOutlet’s revenue in year 1. (4 marks)
(c) Assess the characteristics and skills needed by entrepreneurs, such as Liam James and Matthew Green, to help run a
successful business. (10 marks)
(d) Assess the importance of team working to a company like Chess Telecom. (12 marks)
(e) Evaluate the factors that have contributed to increased globalisation in recent years. (20 marks)

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A Level Paper 2 exam
Advance planning Section B questions
1. Draw up a timetable for your revision and try to keep to it. In Section B you will be given Extracts E–H as stimulus and you
Spread your timetable over a number of weeks, and aim to will need to answer Question 2, a–e. The parts of Question 2
cover a chosen number of topics each week. require a range of depths in your responses, depending on the
2. Spend longer on topics that you have found difficult, and mark allocation. Question 2e is an extended question.
revise them several times.
You should familiarise yourself with the layout of the paper by
3. Do not try to limit your revision by attempting to ‘question
looking at the examples published by Edexcel. The questions
spot’. Revise so that you are confident about all aspects of
within each section are followed by lined spaces where you
your work.
should write your answer. Use the mark allocation as a guide to
Paper 2 overview: how much time to spend on each question.
A Level Paper 2: Business activities, decisions and strategy: Skills required when answering questions
2 hours (Themes 2 and 3)
If you are entered for the A Level qualification you will be
Section A, Question 1 2 × 4 mark questions required to sit three examinations. You should be aware of the
1 × 10 mark question skills that you need to demonstrate when answering questions.
1 × 12 mark question
You will need to demonstrate four different skills referred to as
1 × 20 mark question
assessment objectives (AOs).
Total marks for Section A 50 marks
AO1 – Knowledge: this means you have to show that you:
Section B, Question 2 2 × 4 mark questions • recognise and understand business terms, concepts and theories
1 × 10 mark question • understand how individuals and organisations are affected by
1 × 12 mark question and respond to business issues.
1 × 20 mark question All questions will test knowledge to some extent. A minority of
Total marks for Section B 50 marks questions will test knowledge alone. These can be recognised by
the mark allocation. They will tend to carry just two or four marks.
Total marks = 100 marks
AO2 – Application: this means that you have to apply
Paper 2, Business activities, decisions and strategy, will assess knowledge and understanding to various contexts to show how
your knowledge and understanding of Themes 2 and 3. It will individuals and organisations are affected by and respond to
assess business finance and operations, business decisions and issues. This might involve:
strategy. You will need to make connections between Themes 2
and 3 when appropriate. For example, when discussing growth • using a business formula in appropriate circumstances, for
strategies (Theme 3) you could mention the possible need to raise example calculating the break-even point for a product
further finance (Theme 2) to help fund growth. It is a written • using a theory to show why a business has chosen a particular
examination and the paper is divided into two sections. The course of action
duration of Paper 2 will be 2 hours. You have to answer ALL • using a theory to show the impact on a business of choosing a
questions. There is no choice. However, this can be an advantage particular course of action.
because it means you do not have to waste time deciding which Most questions in the examination will require you to
questions to answer. demonstrate application. This means that you have to ensure that
your answers relate directly to the context given in the question.
Section A questions
You must discuss the implications of issues to the particular
In Section A you will be given Extracts A–D as a stimulus and business or industry in the context you are given.
you will need to answer Question 1, a–e. The parts of Question 1
require a range of depths in your responses, depending on the AO3 – Analysis: this means you have to show that you can
mark allocation. Question 1e is an extended question. break down information and understand the implications of the

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A Level Paper 2

information presented in the question. You will need to show an AO4 – Evaluation: evaluation involves making a judgement.
understanding of the impact on individuals and organisations of You will need to evaluate both qualitative and quantitative
external and internal influences. This might involve: evidence to make informed judgements and propose evidence-
based solutions to business issues. This might involve:
• explaining causes and effects and interrelationships, for
example by recognising from a graph that sales are falling • showing judgement when weighing up the relative importance
and could be the result of new competition in the market of different points or sides of an argument in order to reach a
• breaking down information to identify specific causes or conclusion
problems, for example by realising that quality has improved • drawing conclusions from the evidence that you present
as a result of introducing continuous improvement • assessing the relative importance of particular issues to a
• using appropriate techniques to analyse data, for example by business
calculating the return on capital employed (ROCE). • suggesting a course of action for a business, supported by
plausible motives or evidence.
You will often be required to construct an argument, for
example by explaining the possible reasons for events or When evaluating, it is often possible to draw a number of
discussing the advantages or disadvantages of particular different conclusions. Very often in business studies there is no
courses of action. Questions that carry more than four marks ‘right’ answer, so examiners are likely to be more interested in
will require analysis in the answer. Some questions that whether your judgement is plausible and in the quality of your
carry four marks may also require you to demonstrate some argument in support of that judgement. Questions that carry eight
analytical skills. marks or more are likely to test evaluation.

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Preparing for your A Level exams
Sample answer with comments
Paper 2: Business activities, decisions and strategy
These questions will help you prepare for your A Level Business Paper 2 examination. Some sample answers and comments are
provided for you to review and you will have the opportunity to answer some questions yourself.

Section A, Question 1
Read the following extracts (A–D) before answering Question 1.

Extract A
The popularity of fish and chips
Fish and chips is still one of the UK’s favourite takeaway meals.
In 2014, there were around 10,500 fi sh and chip shops in the
country compared with about 1,200 McDonald’s outlets. It is
estimated that £1.2 billion is spent on fi sh and chips every year,
with 80 per cent of the UK population visiting a specialist fi sh
and chip shop at least once a year. About 22 per cent of the UK
population visit a shop at least once a week.
One possible reason for the popularity of fi sh and chips is the
nutritional value of the food. Fish and chips are said to be a
source of vitamins, iron, fi bre and protein. It is also reckoned
that a portion of fi sh and chips contains less saturated fat, just
2.8 per cent, than a pork pie, which contains 10.8 per cent.
An average portion also has less than 1,000 calories.
The National Fish & Chip Awards’ number one fi sh and chip shop in the UK in 2015 was Frankie’s, a shop and restaurant located in
the Shetland Isles. The price of a fi sh and chip supper (muckle haddock with chips) in the shop was £6.70.
Source: adapted from www.federationoffi shfriers.co.uk

Extract B Extract C
Takeaway expenditure in the UK GDP growth forecasts
%
The amount of money UK consumers spent on takeaway food 3.0
in 2014 was around £29.4 billion, according to research by
2.5
vouchercodes.co.uk. The study identifi ed laziness as an important
2.0
determinant when selecting fast food options. Around 25 per cent
1.5
of British people say that laziness is the main reason for their
expenditure on takeaway food. 1.0
0.5
Source: adapted from www.vouchercodes.co.uk
0.0
2010 2011 2012 2013 2014 2015 2016 2017 2018
Key Year
Actual growth
Budget forecast

Source: ONS, Offi ce for Budget Responsibility

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A Level Paper 2

Extract D
Business closure
In 2014, Wallace & Co, a restaurant run by Gregg Wallace,
the MasterChef host, closed down after trading for four years.
Based in Putney, southwest London, the restaurant closed owing
its suppliers thousands of pounds. Wallace was not personally
responsible for paying back the money because the debts were
in the business’s name, not his. After the business was liquidated
and the assets sold off, creditors received less than half the
amount they were owed. Companies House records show that
Wallace was once a director of nine fi rms. As of July 2015, seven
had been dissolved.
It was thought that one of the reasons for the closure of Wallace & Co was a lack of customers. The restaurant also suffered poor
restaurant reviews in national newspapers.
Source: adapted from www.gov.uk
1 (a) Use Extract A and Extract B to calculate the percentage of the takeaway food market that is served by fi sh and chip shops.
(4 marks)

Question 1 (a), student answer

The total market for fast food in 2014 was £29.4 billion.
The amount spent on fish and chips in 2014 was £1.2 billion.
The proportion of the market served by fish and chips is given by:
£1.2 billion x 100% = 4.08%
£29.4 billion

Comment, Question 1 (a)

There will always be calculation questions on Paper 2. This percentage so you must show the % sign. You must also show the
one involves calculating the share held by fi sh and chips in the working out in case you make a simple calculation error using
fast food market. Your answer should be expressed as a your calculator.

1 (b) Explain the advantage of limited liability to an entrepreneur like Gregg Wallace. (4 marks)
No sample answer has been provided for question 1 (b) so that you can answer it yourself, for exam practice.
1 (c) Assess the possible internal factors that might have been responsible for the closure of Wallace & Co. (10 marks)

Question 1 (c), student answer

Businesses fail for a wide variety of reasons. In some cases Also, Wallace & Co may not have spent enough money
the cause of failure comes from within. One common internal promoting the restaurant.
cause of business failure, especially for new businesses, is a It seems from information provided that the quality of the
lack of planning. A plan will provide a roadmap that shows a product was also at fault. This is clearly an internal factor.
clear direction for the development of the business and helps The restaurant received poor reviews in national newspapers,
to identify potential problems in advance so that solutions which would have affected its reputation and made it difficult
can be found. In this case, it might be argued that insufficient for the enterprise to survive. If businesses serve poor-quality
planning went into marketing. One of the reasons why Wallace products, customers will go elsewhere. The restaurant industry
& Co failed was due to lack of customers. It is possible that is very competitive and it is easy for customers to find
potential customers were not aware of the business. substitutes nearby.

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There may have been other internal reasons for the failure skills in communication, IT, marketing, negotiating, financial
of Wallace & Co. For example, financial management may have management and probably much more. It is perhaps not
been inadequate, there may have been a lack of funding or surprising that willing entrepreneurs are sometimes lacking
leadership may have been poor – it is possible that the in the skills required to be successful. In the case of
person in charge lacked the necessary skills to run a business Wallace & Co, some of the skills required to be successful
successfully. Inevitably many small businesses fail because in the restaurant industry may have needed enhancing.
their owners do not have all the competencies required. To conclude, the failure of Wallace & Co was almost entirely
Running a business is challenging and requires a multitude the result of internal factors – ineffective marketing and
of skills. Entrepreneurs have to be creative, numerate, a poor-quality product in an industry where competition
motivational and good decision makers. They also need is ruthless.

Comment, Question 1 (c)

Questions like this require you to demonstrate knowledge, the explanation of how a business might fail if the owner lacks
application, analysis and evaluation. Two marks might be the expertise needed to run a business successfully. Three marks
awarded for demonstrating knowledge, such as identifying two might be awarded for evaluation. An example of evaluation in
internal factors that might result in business failure, in this case this answer is the judgement made relating to the reasons for
poor-quality products and ineffective marketing. Two marks failure in this extract. It states in the answer that failure is clearly
might be awarded for application. The whole of this answer is to do with internal factors. This argument is clear and well
focused on the restaurant industry, and in particular the failure supported with evidence from the extract and business theory.
of Wallace & Co. The reasons for business failure are linked In this answer counterbalance arguments are also raised. For
entirely to the failure of Wallace & Co. Three marks might be example, other internal causes of failure are identifi ed but ruled
awarded for analysis. One example of analysis in this answer is out. In this case, the cause of failure is fairly clear.

1 (d) Evaluate the benefi ts of using SWOT analysis for a business considering entry into the restaurant industry. (12 marks)
No sample answer has been provided for question 1 (d) so that you can answer it yourself, for exam practice.
1 (e) Evaluate the possible impact of economic infl uences, such as economic growth, on businesses like Frankie’s in the next fi ve
years. (20 marks)

Question 1 (e), student answer

Business activity is influenced by a number of external to buy more non-essential products. Spending money in
influences. These are factors beyond the control of restaurants is regarded by most as non-essential, therefore
businesses. In some cases they constrain a business’s demand for the services provided by restaurants is likely to rise.
decisions and may prevent its growth and development. However, in this case, the impact on Frankie’s fish and chip shop
Economic influences, such as inflation, exchange rates, may not be clear cut. Fish and chips is regarded by many as an
interest rates, taxation, government expenditure and the affordable takeaway option – something that people will still buy
business cycle, can have many effects on a business. The even when incomes are squeezed. However, when incomes rise,
government is responsible for the management of the some people may spend less on fish and chips and more on
economy. The aim of many governments is to keep prices ‘up-market’ takeaway food. If fish and chips are income elastic
stable, reduce unemployment, keep borrowing down and help and considered to be an inferior good, then demand may fall.
the economy grow. The measures a government might use to Consequently Frankie’s may suffer a loss in trade.
achieve these aims can have an impact on businesses. Another possible economic influence on businesses like
The current state of the economy can have a big impact Frankie’s in the next few years is taxation. If governments
on many businesses. In this case, the restaurant industry in promise to reduce the amount they borrow each year, this
general is likely to be affected by levels of national income is likely to mean cuts in government expenditure, rises in
and economic growth. Extract C shows that the UK’s taxation, or a combination of both. Cuts in government
economy is expected to grow up to 2018. According to the expenditure are not likely to have a direct impact on the
budget statement, growth rates are predicted to be around restaurant industry, but there may be an indirect impact if
2.5 per cent per annum. This is steady and sustainable cuts in government expenditure mean that people have to
growth. It means that national income is expected to carry spend more of their income on services that were once
on rising and as a result people’s incomes should also rise. funded or subsidised by the state. For example, if people have
This is likely to have an impact on the restaurant industry in to pay more for rail transport or dental treatment, they might
the next few years. When people have a higher income and have less to spend on leisure and entertainment, in which
consequently more money to spend, they are likely case the restaurant industry might be adversely affected.

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A Level Paper 2

If the government increases taxes, the restaurant industry To conclude, the overall impact of economic influences on
could be adversely affected. For example, if income tax is businesses like Frankie’s depends on a range of factors. If the
increased then disposable incomes will be reduced. This influence of economic factors is favourable, such as higher
could result in a fall in demand for restaurant services. economic growth, the restaurant industry is likely to benefit.
Frankie’s might be affected by such a measure (depending on However, cuts in government expenditure and higher taxes will
the income elasticity of fish and chips). Restaurants will also have a negative effect. The overall impact is very difficult to
be affected if the government decides to raise VAT. This will assess because it is impossible to predict with any accuracy
increase costs for restaurants and marginal operators will be how economic influences will develop. The effect on Frankie’s
squeezed. Some may go out of business. However, Frankie’s might also depend on the income elasticity of demand for
is the number one fish and chip shop in the UK, so it could fish and chips. But, since Frankie’s is the number one fish and
probably cope with higher VAT. Finally, government might chip shop in the UK, it is probably strong enough to survive a
increase business taxes, such as corporation tax. This would range of negative influences, and would probably do very well
have a negative impact on restaurants that trade as limited in a strengthening economy.
companies or plcs.

Comment, Question 1 (e)

This question requires an extended answer and you need to in government expenditure and higher taxes are likely to impact
demonstrate knowledge, application, analysis and evaluation. on the restaurant industry and Frankie’s in particular. Six marks
Four marks might be awarded for demonstrating knowledge, might be awarded for evaluation. In this case, one approach is to
such as understanding the meaning of economic infl uences weigh up the possible economic infl uences and decide which is
like economic growth and identifying other possible economic most likely to have an impact on businesses like Frankie’s. It is
infl uences, such as taxation and government expenditure. an impossible task to draw a defi nitive conclusion because the
Four marks might be awarded for application. This answer possible economic infl uences cannot be predicted – some might be
focuses throughout on the impact of economic infl uences on the positive (economic growth) and some negative (cuts in government
restaurant industry and Frankie’s fi sh and chip shop in particular. expenditure and higher taxes). However, this is clearly stated and
Income elasticity is also applied to the demand for fi sh and chips. there is still an attempt to make a judgement. It is recognised that
Frankie’s is in a good position because it is the UK’s number one
Six marks might be awarded for analysis. Examples of analysis in
fi sh and chip shop. However, overall, the impact might depend on
this answer are the explanation of how economic growth, cuts
the income elasticity of demand for fi sh and chips.

Section B, Question 2
Read the following extracts (E–H) before answering Question 2.

Extract E
Rapid growth at Concrete Canvas Ltd
Concrete Canvas Ltd produce a concrete impregnated fabric that was developed by Peter Brewin and Will Crawford when they were
at the Royal College of Art together. In 2014, according to a survey by the Sunday Times, Concrete Canvas Ltd was ranked the
16th fastest-growing company in the UK. Between 2010 and 2013 sales grew at an average annual rate of
118 per cent. In 2013 it employed 26 people and enjoyed sales of £5.1 million.
Concrete Canvas is a concrete impregnated fabric that hardens when sprayed with water, creating a waterproof and fi re resistant
concrete layer. It was fi rst developed as a material from which concrete shelters could be made. The idea was to design shelters
that could be dropped into disaster zones or areas of military confl ict and swiftly assembled. However, the pair discovered that the
material technology itself was the marketable product.
The material is sold in small (batched) and large (bulk) rolls, which can be manipulated to shape, unrolled onto the ground, on slopes
and on existing concrete. It is used in mining, civil infrastructure and the petrochemicals industry.
Source: adapted from www.concretecanvas.com

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Extract F
Raising finance at John Laing
In 2015, infrastructure investment group John Laing announced that
it would raise around £130 million by selling some new shares on
the stock market. It was explained that the money would be used
to help finance international investment. John Laing was already
involved in a range of construction projects around the world such
as the building of a 60,000-seat stadium in Perth, Australia, roads in
the US, wind farms across Europe, prisons in New Zealand and the
construction of the second Severn Crossing, which links England
and Wales.
Source: adapted from the Financial Times 29.01.2015. All rights
reserved.

Extract G
Barratt Homes’ financial position
Barratt Homes’ is an established housebuilder. It has been building homes since 1958. Like other builders it struggled during the
financial crisis and recession between 2008 and 2013. However, in 2014 the company increased its revenue and made a profit of
£305.4 million.
Selected information from Barratt Homes’ statement of financial position 2014
2014
£ million
Revenue 3,157.0
Gross profit 529.4
Operating profit 305.4

Non-current assets 1,248.4

Current assets 3,895.9
Current liabilities 1,160.1
Non-current liabilities 630.2
Source: www.barrattdevelopments.co.uk

Extract H
Wates takeover?
In March 2015, it was reported that Wates, one of the UK’s largest family-owned construction businesses, was involved in
preliminary talks to take over one of its rivals, Shepherd Construction. Shepherd has suffered some disruption due to disappointing
results. Peter Lewis, who was described as an inspirational leader, left Shepherd Construction at the beginning of 2015.
Financial and other information for Wates and Shepherd 2013
Wates Shepherd
Revenue £931 million £686 million
Profit £22 million £11 million
Staff 2,074 3,235
Established 1897 1890
Source: www.wates.co.uk

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A Level Paper 2

2 (a) Calculate the return on capital employed for Barratt Homes in 2014. (4 marks)

Question 2 (a), student answer

The return on capital employed for Barratt Homes is given by:
Net profit is £305.4 million
Capital employed = total assets – current liabilities
= (£1,248.4m + £3,895.9m) – £1,160.1m
= £5,114.3m – £1,160.1m = £3,984.2m
ROCE = Operating profit x 100% = £305.4m x 100% = 7.7 %
Capital employed £3,984.2

Comment, Question 2 (a)

You need to remember the formula for calculating return on capital formula and show all your working out. Even if you get the wrong
employed (ROCE) in this question. You also need to remember answer you may still be awarded some marks for stating the
how to identify capital employed. You should write down the correct formula and identifying some relevant information.

2 (b) Explain one reason why Wates might want to take over Shepherd. (4 marks)

Question 2 (b), student answer

A takeover occurs when one business buys another from its competitors. This means that it will increase its revenue by
its current owners. Once the business has been bought, its over 70 per cent and have less competition in the construction
resources are absorbed by the buyer and the name usually market. This will make Wates stronger and more resourceful. It
disappears. There are several motives for takeovers. In this case, might be able to win bigger contracts, raise prices or be more
Wates may take over a close rival in the construction industry, selective when bidding for contracts, i.e. choosing those that
Shepherd Construction. If the takeover is agreed, Wates will are most lucrative. This should help the business improve its
have a bigger market share since it will have absorbed one of financial performance in the long term.

Comment, Question 2 (b)

Questions like this require you to demonstrate knowledge, awarded for keeping the answer in context. This answer focuses
application and possibly analysis. One or two marks might be on the construction industry. Finally, credit may be given for
awarded for showing that you understand the nature of a takeover analysis. In this case, explaining how the fi nancial performance
and identifying one reason why Wates may want to take over of Wates might be improved as a result of the takeover is an
Shepherd Construction. Up to two application marks might be example of analysis.

2 (c) Assess two possible growth objectives for Concrete Canvas. (10 marks)

Question 2 (c), student answer

Most businesses start small and then grow. In this case, be cost-effective to employ specialist managers, such as
Concrete Canvas grew very quickly in the three years accountants, marketing managers and production managers.
between 2010 and 2013. Indeed, the annual growth rate was These people will be experts in their fields and will help to
118 per cent. Generally, businesses like to grow because the raise productivity and therefore reduce average costs.
benefits can be very attractive. For example, revenues will be Another growth objective might be to increase market share.
higher, unit costs are likely to be lower and the business will Concrete Canvas is a relatively new company so its market
have a higher profile with a larger market share. share would be low to begin with. A higher market share will
One specific growth objective is the ability to enjoy eventually give Concrete Canvas more power, which means it
economies of scale. As Concrete Canvas gets larger it will might be able to raise price. However, it will also benefit from
be able to secure lower unit costs. Costs might fall for a having a greater brand recognition. This might be because
number of reasons. For example, there may be purchasing customers are more likely to see the brand advertised or on
economies. This means that Concrete Canvas will probably business websites. As the brand becomes stronger, Concrete
get discounts for buying larger quantities of inputs such as Canvas may be able to charge higher prices, differentiate the
fabric, cement and other raw materials. The company may also product from those of other producers of concrete products,
experience managerial economies. This means that it will create customer loyalty in the construction industry, develop

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an image and launch new products more easily. A business is because the company is new and needs to establish
with a larger market share is also more likely to attract media itself in the industry. Other growth objectives, such as
attention. In this case, because the product is a fairly new economies of scale, might become more important once
innovation, the business might attract quite a lot of media Concrete Canvas has established a solid market share.
attention – particularly if the product is considered unique and Evidence suggests that Concrete Canvas is already making
used throughout the whole of the construction industry. very good progress in this respect. Its average annual
growth rate in the last three years has been a huge
It might be argued that the main growth objective for
118 per cent.
Concrete Canvas would be to increase market share. This

Comment, Question 2 (c)

You will need to demonstrate knowledge, application, analysis One example of analysis in this answer is the explanation of how
and evaluation. Two marks might be awarded for demonstrating Concrete Canvas might benefi t from specifi c economies of scale,
knowledge, such as identifying two specifi c growth objectives – such as purchasing economies and managerial economies. Three
economies of scale and increased market share. Two marks might marks might be awarded for evaluation. An example of evaluation
be awarded for application. The whole of this answer is focused in this answer is the judgement suggesting which growth
on the growth objectives of Concrete Canvas and the construction objective might be most important to Concrete Canvas.
industry. For example, there is the suggestion that the media It is suggested that building market share is most important
might be interested in Concrete Canvas because its product is because the business is relatively new in the market. The
innovative. Three marks might be awarded for analysis. judgement here is clearly supported with an argument.

2 (d) Assess the usefulness to companies like Wates and John Laing of using quantitative investment appraisal techniques before
investing their money in new projects. (12 marks)
No sample answer has been provided for question 2 (d) so that you can answer it yourself, for exam practice.
2 (e) Evaluate the importance of external sources of funding, such as issuing shares, to a company like John Laing. (20 marks)

Question 2 (e), student answer

Few businesses can rely entirely on internal financing to fund One drawback of selling shares is the initial cost of the share
all business activity. Initially, external finance, which is finance issue. A number of costs will be incurred, such as fees to an
from sources outside the business, may not be available. This investment bank to process share applications. The share
is because business start-ups have no trading record and issue has to be underwritten (which means that the company
present too much risk for many lenders. However, once a must insure against the possibility of some shares remaining
business has survived the initial ‘uncertain’ stages of business unsold) and a fee is paid to an underwriter who must buy
development, external sources of finance are likely to become any unsold shares. Finally, the company will also have to meet
a realistic option. In this case, John Laing is an established advertising and administrative costs. However, once these
business. It plans to raise £130 million by selling some costs have been met, there are no further charges on the
shares. finance, except for dividends.
Issuing shares is a common external source of finance for John Laing could have used other external sources of
companies. Issuing shares can raise huge amounts of money. finance, such as bank loans, debentures, venture capital or a
In this case, £130 million is being raised to help finance new mortgage. However, these sources may have been considered
overseas construction projects. Share capital is permanent unsuitable by John Laing. This might be because they incur
capital, which means that it is never repaid by the business. costs. For example, if bank loans and mortgages are taken out,
Once John Laing has sold the shares and raised the interest has to be paid. Interest charges will reduce profits.
£130 million, the money will never be repaid. If shareholders Also, any money borrowed will eventually have to be repaid.
want their money back from buying the shares they must sell This places a financial burden on the company. The advantage
them on the stock market. This is one of the main advantages of share capital is that it does not have to be paid.
of raising money by issuing shares – there is no debt burden. Another option that may have been open to John Laing is
However, shareholders will expect a return and John Laing internal finance. This usually comes from retained profit or the
will be obliged to pay dividends to shareholders when the sale of assets. The main advantage of using internal sources
company makes sufficient profit. Shareholders would also is that there is no financial cost – there is no interest to pay
hope that the share price increases in the future. This means because the money used belongs to the business. However,
they can make a capital gain if they sell them. The share price there is an opportunity cost when using internal sources.
is likely to rise if John Laing grows and performs well. For example, if John Laing used retained profit to fund the

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A Level Paper 2

development of its overseas construction projects, it would to help grow businesses and generate higher profits in the
have less money to return to the shareholders. Reducing future. When raising very large amounts of money, such as
dividend payments may attract a negative reaction from the £130 million in this case, external sources are crucial. The sale
shareholders. There is also the likelihood that John Laing did of shares to raise money keeps the gearing of the business
not have £130 million available to invest. Neither was the lower, avoids interest payments and ensures that the
company inclined to sell off any assets to raise the cash. business is not undercapitalised. Consequently, the benefits
of using external sources of finance are likely to outweigh the
To conclude, external sources of finance are very important
drawbacks for companies like John Laing.
to companies like John Laing. These sources are needed

Comment, Question 2 (e)

This question requires an extended answer and you need to Six marks might be awarded for analysis. One example of
demonstrate knowledge, application, analysis and evaluation. analysis in this answer is the explanation of how John Laing will
Four marks might be awarded for demonstrating knowledge, benefi t from selling shares, i.e. by raising permanent capital and
such as understanding the meaning of external sources of fi nance avoiding interest charges. Analysis is also demonstrated when
and share capital. Marks might also be awarded for identifying explaining the drawbacks of issuing shares, i.e. the initial cost and
other sources of external fi nance, such as bank loans and the company’s permanent commitment to dividend payments. Six
debentures, and showing that you understand the advantages marks might be awarded for evaluation. In this case, evaluation
and disadvantages of raising money by issuing shares. Four can be demonstrated by weighing up the benefi ts and drawbacks
marks might be awarded for application. This answer focuses of using share capital as external fi nance to raise £130 million.
throughout on John Laing and its legal status as a plc. The implications of using external sources as opposed to internal
Only companies can raise money by issuing shares. sources is also debated, and so are the implications of using share
capital as opposed to other sources of external fi nance. A clear
conclusion is drawn and it is supported with coherent argument.

Practice question – A Level, Paper 2: Business activities, decisions and strategy

The more you practise for your examination, the more confident you will feel. The following question provides practice for Section
A, Question 1.

Section A, Question 1
Read the following extracts (A–D) before answering Question 1.

Extract A
Working at Foxconn
Foxconn is a multinational electronics manufacturer that
carries out contract work for high-profi le customers.
Microsoft’s Xbox, Nintendo’s Wii U and the Sony’s
PlayStation are examples of the products made by
Foxconn. The Taiwanese company is owned by Hon Hai
Precision Industry Company Ltd and has factories in
many countries, employing over a million people.
In 2012, the Financial Times reported that workers at a
Chinese Foxconn factory ‘threatened collective suicide
in a pay dispute gone wrong’. Workers who took part
tried to ‘force the company to agree a wage raise by
threatening to jump off a building’. They said they ‘took
the drastic step because the company denied them a pay
raise it had promised earlier when transferring them to
Wuhan from another plant.’
Foxconn had made a lot of changes over time. It ‘set up a range of counselling systems’ and ‘raised wages especially for those willing
to stay longer in order to lower turnover rates’.

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 Preparing for your exams

In 2013, the Financial Times reported that, ‘an inspection by the Fair Labour association, a monitoring group brought in by Apple
to help the company improve working conditions, said in its final verification that “Foxconn, also known as Hon Hai Precisions
Industries, is adhering to earlier agreed upon plans to improve working conditions. Although overtime remains a problem, the
company made progress reducing working hours and improved factory facilities”. The report also found that ‘workers still do more
overtime than permitted by Chinese labour law’. In a statement, ‘Apple said the average workweek at Foxconn … was… below the
limit in the brand’s code of conduct’. The Financial Times also noted that ‘limiting overtime is a particularly challenging issue in
Chinese factories as many workers…. prefer to do overtime as a way to improve their often low base pay’.
Source: adapted from the Financial Times 12.01.2012, 12.12.2013. All rights reserved.

Extract B
Nintendo cuts sales forecast
In 2015 Nintendo, the computer games company, was forced to cut its annual sales forecast in half. Despite strong Christmas sales
in 2014, the company lowered its annual sales forecast to £112 million, half of the original forecast. Despite Nintendo’s problems,
its reported software sales were more promising, where Super Smash Bros generated sales of 6.19 million copies in the third quarter
of 2014.

Extract C
GameGirl new product development
GameGirl Ltd is a computer games designer. It is owned by the Charles family and based in Cambridge. Sally Charles is the ‘brains’
behind the business. She and her small team of software designers produce software for video games and apps.
In 2013, a new game called Harbour was developed. The fixed costs of development were £190,000. The variable costs per unit were
100p. Harbour, which can be downloaded online, was sold for £20 per unit.

Extract D
Computer hackers
On Christmas Day in 2014, computer hackers claimed to have taken the personal details of around 13,000 users of PlayStation,
Xbox and online stores, including Amazon. Details, such as passwords and credit card data, were leaked according to the hackers,
who claimed to be linked to the anarchist group Anonymous. As a result of the security breach, thousands of people, including
children, were unable to play with their new games online. The hackers, a group called Lizard Squad, said it carried out the hack for
amusement and to expose poor online security.
Source: adapted from the Financial Times, 26.12.2014. All rights reserved.

1 (a) Use the information in Extract C to calculate the number of units Harbour must sell to break-even. (4 marks)
(b) E xplain how businesses such as Amazon and Microsoft might use risk assessment to help deal with the threat of computer
hackers. (4 marks)
(c) Assess the factors that might affect the sales forecasts made by Nintendo. (10 marks)
(d) Assess the possible stakeholder conflict that might exist at Foxconn. (12 marks)
(e) Evaluate the possible impact of tighter employment legislation on businesses like Foxconn. (20 marks)

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 Preparing for your
A Level Paper 3 exam
Advance planning This means that you need to work across different parts of
This paper is a little different from Papers 1 and 2 because you the specification and show your accumulated knowledge and
will be given some pre-released information in advance of the understanding of a topic or subject area. You will need to
examination to help you prepare. The information will suggest demonstrate your ability to combine skills, knowledge and
areas for closer scrutiny and research in your revision. Their understanding with breadth and depth of the subject. You will
purpose is to provide a context in which questions will be asked. also need to identify and discuss links between the different topic
The context will be broad, such as an industry or market in which areas on the specification. For example, if you are answering a
businesses operate. You cannot take any records of your research question on the impact that economic growth might have on a
into the examination with you. business, you could discuss the possible effects on the:
Paper 3 overview • marketing strategies used by the business (Theme 1)
A Level Paper 3: Investigating business in a competitive • aims and objectives of the business (Theme 1)
environment (pre-release): 2 hours (Themes 1–4) • sales and the financial performance of the business (Themes 2
Section A, Question 1 1 × 8 mark question and 3)
1 × 10 mark question • production department in the business (Theme 2)
• growth and investment strategies of the business (Theme 3)
1 × 12 mark question
• global outlook of the business (Theme 4).
1 × 20 mark question
Total marks for Section A 50 marks Section A and Section B questions
In both Section A and Section B you will be given a range of
Section B, Question 2 1 × 8 mark question unseen stimulus material (several pieces of information about
1 × 10 mark question business and industry) and you will need to answer a number of
1 × 12 mark question questions. The questions will require a range of depths in your
1 × 20 mark question response, depending on the mark allocation. One of these will be
Total marks for Section B 50 marks an extended question.
Section A questions
Total marks = 100 marks In Section A you will be given Extracts A–D as a stimulus and
you will need to answer Question 1, a–d. The parts of Question 1
Pre-release
will focus on the broad context of the materials provided.
Paper 3 will assess your knowledge and understanding of
Section B questions
all four themes and is called Investigating business in a
competitive environment. You will be given some pre-released In Section B you will be given Extracts E–H as a stimulus and
information in advance of the examination to help you prepare, you will need to answer Question 2, a–d. The parts of Question 2
which provides a context in which questions will be asked. will focus on at least one strand within the context provided, such
The context will be broad, such as industry or market in which as a particular business.
businesses operate. You will be given areas for closer scrutiny You should familiarise yourself with the layout of the paper by
and research in your revision. looking at the examples published by Edexcel. The questions
This is a written examination and is divided into two sections. within each section are followed by lined spaces where you
The duration of Paper 3 will be 2 hours. You have to answer should write your answer. Use the mark allocation as a guide to
ALL questions. There is no choice. However, this can be an how much time to spend on each question.
advantage because it means you do not have to waste time Skills required when answering questions
deciding which questions to answer. You cannot take any records If you are entered for the A Level qualification you will be
of your research into the examination with you. required to sit three examinations. You should be aware of the
Synoptic skills skills that you need to demonstrate when answering questions.
You will also be required to demonstrate synoptic skills. You will need to demonstrate four different skills referred to as
514
assessment objectives (AOs).
 Preparing for your exams

AO1 – Knowledge: this means you have to show that you: • breaking down information to identify specific causes or
problems, for example by realising that a business is suffering
• recognise and understand business terms, concepts and
from inefficiency because staff motivation has fallen as a
theories
result of a pay cut
• understand how individuals and organisations are affected by
• using appropriate techniques to analyse data, for example by
and respond to business issues.
calculating the net profit ratio.
All questions will test knowledge to some extent. A minority
You will often be required to construct an argument, for example
of questions will test knowledge alone. These can be recognised
by explaining the possible reasons for events or discussing the
by the mark allocation. They will tend to carry just two or
advantages or disadvantages of particular courses of action.
four marks.
Questions that carry more than four marks will require analysis
AO2 – Application: this means that you have to apply in the answer. Some questions that carry four marks may also
knowledge and understanding to various contexts to show how require you to demonstrate some analytical skills.
individuals and organisations are affected by and respond to
AO4 – Evaluation: evaluation involves making a judgement.
issues. This might involve:
You will need to evaluate both qualitative and quantitative
• using a business formula in appropriate circumstances, for evidence to make informed judgements and propose evidence-
example calculating the price elasticity of demand for a based solutions to business issues. This might involve:
product
• showing judgement when weighing up the relative importance
• using a theory to show why a business has chosen a particular
of different points or sides of an argument in order to reach a
course of action
conclusion
• using a theory to show the impact on a business of choosing a
• drawing conclusions from the evidence that you present
particular course of action.
• assessing the relative importance of particular issues to a
Most questions in the examination will require you to business
demonstrate application. This means that you have to ensure that • suggesting a course of action for a business, supported by
your answers relate directly to the context given in the question. plausible motives or evidence.
You must discuss the implications of issues to the particular
When evaluating, it is often possible to draw a number of
business or industry in the context you are given.
different conclusions. Very often in business studies there is no
AO3 – Analysis: this means you have to show that you can ‘right’ answer, so examiners are likely to be more interested in
break down information and understand the implications of the whether your judgement is plausible and in the quality of your
information presented in the question. You will need to show an argument in support of that judgement. Questions that carry eight
understanding of the impact on individuals and organisations of marks or more are likely to test evaluation.
external and internal influences. This might involve:
• explaining causes and effects and interrelationships, for
example by recognising from a graph that sales are falling and
could be the result of new competition in the market

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Sample answer with comments
Paper 3: Investigating business in a competitive environment (pre-release)
These questions will help you prepare for your A Level Business Paper 3 examination. Some sample answers and comments are
provided for you to review and you will have the opportunity to answer some questions yourself.

Pre-released information
Context
This year the context is the market for fashion accessories and the businesses operating in this market in the UK.
Research
To prepare for this context you should research:
� trends in the market for fashion accessories
� influences on the market for fashion accessories, such as marketing and income
� major businesses and niche operators in the fashion accessories market
� the competitive environment facing fashion accessory businesses.
You cannot take any of your research or investigation data carried out as part of the pre-release into the examination. Answer all
questions.
Section A, Question 1
Read the following extracts (A–D) before answering Question 1.

Extract A
Market research in the fashion accessories industry
Market research agency Mintel reckoned that UK consumers spent about £2.5 billion on fashion accessories in 2013. Around
£1.2 billion of this expenditure went on handbags – an increase of 11 per cent on the previous year. Research showed that more than
13.5 million women bought at least one new handbag in 2013. However, sales of handbags to men also rose and in 2013 one in ten
men bought a ‘manbag’.
The market for handbags is highly competitive with companies like Chanel, Gucci, Louis Vuitton, Hèrmes, Burberry and Michael
Kors operating at both global and regional levels. It seems that sales and special offers help to generate sales of fashion accessories,
with nearly 60 per cent of women responding positively to discounts. Impulse buying is common in the fashion accessories market,
with the over 55s being the most likely group to buy on impulse. Finally, about 50 per cent of the people who bought fashion
accessories in 2013 used online shopping methods, with 25 per cent buying from internet specialists.
Source: adapted from www.mintel.com

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Extract B
Men’s fashion accessories
The men’s accessories market is dynamic and fast growing. In the 12 months ending May
2014, global sales of men’s accessories grew 9 per cent, reaching $13.6 billion according to
market research. This trend is unlikely to be reversed any time soon and the fashion industry
is clamouring to cash in on the rapid expansion in the market. For example, designers
such as Michael Kors are recruiting new menswear executives and investing highly in this
growing market, thought to be worth billions of dollars.
Shifting social attitudes is one reason for the market growth. In the 1990s the only males
that would regularly wear jewellery, for example, were rock stars and celebrities. The
emergence of metrosexuals and the influence of role models, such as David Beckham, have
helped to drive demand.
Source: adapted from www.businessoffashion.com

Extract C
Final consumption expenditure (% of GDP) in BRIC countries, 2005–2013

Country Name 2005 2006 2007 2008 2009 2010 2011 2012 2013
Brazil 79.17 79.25 78.65 78.39 81.45 79.24 78.96 81.01 81.65
Russian Federation 66.23 66.10 67.21 65.26 73.63 69.31 66.48 68.17 71.30
India 68.47 67.29 65.98 69.54 69.08 67.84 67.54 70.40 70.44
China 53.61 50.76 51.02 49.74 48.54 49.64 50.75 49.95 49.58

Source: www.data.worldbank.org

Extract D Growth in wearable technology 2012 to 2020

Smartwatches Units millions
16,000
A smartwatch is a wrist-worn device that shows the time and has Key
14,000
a wireless internet connection. In 2013 the market was worth Smart bands
Smart watches
$700 million. By 2020 the market is expected to be worth 12,000
Smart glasses
around $33 billion. In 2014, Samsung dominated the market 10,000 Transformables
Other
with 34 per cent share. However, in 2015 Apple launched its 8,000
version of a smartwatch and expected to generate sales of around 6,000
19 million – 56 per cent of the global market. The development 4,000
of wearable technology, such as smartwatches, may become a 2,000
threat to traditional watchmakers.
0
2012 2013 2014 2015 2016 2017 2018 2019 2020
Year

Source: www.analysysmason.com

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A Level Paper 3

1 (a) Assess the importance of the design mix to products in the fashion accessories industry. (8 marks)
No sample answer has been provided for question 1 (a) so that you can answer it yourself, for exam practice.
1 (b) Assess the implications of using sales and special offers in the market for fashion accessories. (10 marks)

Question 1 (b), student answer

An important element in the marketing mix is promotion. This Businesses that sell larger volumes during sales have to
involves businesses drawing attention to their products, ensure that stocks at the point of sale are adequate to
services or companies. Generally, businesses use promotion meet the sharp increase in demand. This might mean that
to obtain and retain customers. In this case, promotions, such manufacturers have to step up production in the run up to
as sales and special offers, are used to drive up sales of sales. Alternatively they may just accumulate stocks for
fashion accessories. They are both examples of below-the-line a period of time in preparation. It is important to provide
promotion, which refers to any form of promotion that does effective co-ordination between suppliers and the retail
not involve advertising. In the fashion accessories market, sales outlet. Customers are likely to get very frustrated if they
often coincide with the end of buying seasons for clothes. For cannot buy a product in the sale because they have sold out.
example, just before the end of summer, many retailers have This could damage customer loyalty.
sales to sell off unsold stocks of summer clothes to clear In some cases, up-market producers of fashion accessories,
the way for the autumn season’s stock. Businesses selling such as Gucci, may be very reluctant to use sales and special
fashion accessories are likely to do exactly the same. There offers as a means of promotion. This is because their goods
are also one or two special sales periods in the UK. One is the are often very high in quality and targeted at the ‘top end’ of
‘January sales’, which start on Boxing Day, and more recently the market. As a result sharp discounting could suggest a fall
‘Black Friday Sales’, an idea imported from the US. Since the in quality and adversely affect their image.
early 2000s, sales in the US have begun on the day after
Thanksgiving Day (the fourth Thursday of November). This has Finally, companies that rely heavily on sales for their business
been regarded as the beginning of the Christmas shopping might have to pay special attention to financial management.
season in the US, and most major retailers open very early In particular, they will have to manage their cash flow carefully.
and offer promotional sales. During sales, products are often This is because cash flow is likely to be irregular. For example,
heavily discounted and can generate large volumes of business. during sales periods cash inflows will be very high but at
other times they will be much lower and could cause cash
The use of sales and discounts can have a number of shortages.
implications for a business. One is that profit margins will
be squeezed if prices are cut sharply to generate sales. To conclude, businesses in the fashion accessories market
For example, if the price of a handbag is cut from £199 to are probably very experienced at dealing with some of the
£49, this suggests that a huge amount of profit is being issues discussed above. The sale of such products has
conceded by the seller. However, it is very likely that the always been linked to specific buying seasons and individual
margins on many fashion accessories are so high to begin businesses have probably learned to live with these problems.
with that businesses are able to tolerate dramatic price cuts. However, they will still need to be vigilant and monitor any
Such drastic price cuts are also what drives sales because changes that occur in the market.
consumers think they are getting a real bargain.

Comment, Question 1 (b)

You will need to demonstrate knowledge, application, analysis Three marks might be awarded for analysis. Examples of analysis
and evaluation. You also need to remember that information from in this answer include the explanation of how the use of sales and
all four themes can be used. Answers that make links between discounts will squeeze profit margins, cause cash-flow problems or
the different themes are likely to be better. Two marks might be tarnish the image of the business. Three marks might be awarded for
awarded for demonstrating knowledge, such as defining below- evaluation. An example of evaluation in this answer is the judgement
the-line promotion and identifying implications of using sales and suggesting that businesses in the fashion accessories market are
special offers to generate business. Two marks might be awarded probably used to the problems discussed throughout the answer.
for application. The whole of this answer is focused on the use However, they still need to be vigilant in case there are sudden
of sales and special offers in the fashion accessories market and changes in market conditions. Finally, notice that information from
the implications of their use. For example, sales and discounting a range of topics in the specification are being linked here – sales
are used by the fashion industry in general at the end of buying promotions, profit margins, financial management, production and
seasons and during traditional sales like the January sales. business image, for example, are all mentioned.

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1 (c) Assess the possible impact of globalisation on the operations of businesses in the fashion accessories market. (12 marks)
No sample answer has been provided for question 1 (c) so that you can answer it yourself, for exam practice.
1 (d) Evaluate the impact on businesses in the fashion accessories industry of operating in a dynamic market. (20 marks)

Question 1 (d), student answer

Most markets do not remain the same over time. Markets What might help businesses adapt to market changes?
tend to be dynamic, which means they are likely to change. One way is to develop a culture of flexibility in an
They may grow, shrink, fragment and emerge, or completely organisation. A business will need flexible working practices,
disappear. For example, there is no longer a market in the UK flexible machinery, flexible pricing and flexible staff. This might
for cassettes. Most people buy DVDs or download material mean that staff have to be trained in a variety of skills and
from the internet if they want to listen to music. The market be prepared to change the tasks they undertake in the
for fashion accessories is very dynamic. The extracts in this workplace. This might help businesses to serve customers
case provide some evidence. For example, the size of the more effectively when changes occur. If businesses have
market is growing. Market research agency, Mintel, reckoned flexible operations it will be a lot easier for them to adapt to
that UK consumers spent about £2.5 billion on fashion market changes.
accessories in 2013. Around £1.2 billion of this expenditure Businesses must keep in touch with developments in the
went on handbags – an increase of 11 per cent on the market. One way to do this is to undertake regular market
previous year. research. Research might be aimed at current customers
New markets are always developing in the fashion accessories or potential customers in the fashion accessories market.
industry. One big source of new markets is from the Firms need to be aware of any changes in customer needs
development of the so-called ‘emerging markets’. These include or tastes. Communication with customers and potential
the BRIC countries (Brazil, Russia, India and China) countries. In customers should be an ongoing process if firms want to
this case, the information in Extract C shows that consumption keep completely up to date. For example, it was reported
has risen in three of four of these countries, indicating that that designers such as Michael Kors are recruiting new
there will be new opportunities for firms operating in the fashion menswear executives and investing highly in this growing
accessories industry. market, thought to be worth billions of dollars.
Also in this case, the market for men’s fashion accessories Those businesses that invest in new product development
looks set to boom. In the 12 months ending May 2014, are likely to survive for longer in the market. Although
global sales of men’s accessories grew 9 per cent, reaching expenditure on research and development is expensive, a
$13.6 billion according to market research. This trend is unlikely failure to innovate could be costly. A unique new version of
to be reversed and the fashion industry is clamouring to cash in a product or a brand-new model could rejuvenate sales and
on the rapid expansion in the market. Shifting social attitudes is help win a larger share of the market. In this case, the next
one reason for the market growth. In the 1990s the only males ‘big move’ could be the introduction of wearable technology.
that would regularly wear jewellery, for example, were rock This is a very new development and already the smartwatch
stars and celebrities. The emergence of metrosexuals and the market is dominated by Samsung, with around a third of
influence of celebrities, such as David Beckham, have helped to the market. If people divert their expenditure away from
drive demand. traditional fashion accessories to wearable technology, many
firms could lose out.
New markets also appear when completely new products are
launched. In this case, the introduction of the smartwatch To conclude, operating in a dynamic market puts pressure
is likely to have an impact in the market. In 2013 the market on businesses. Some of the information in the extracts
was worth $700 million. However, by 2020 it is predicted suggests that the market is ‘throwing up’ some interesting
that the global smartwatch market will grow to around opportunities. The growth in demand for men’s fashion
$33 billion. The development of wearable technology, accessories and the rising consumption of emerging
such as smartwatches, may become a threat to traditional economies means that all firms could enjoy rising sales.
watchmakers very soon. However, there is threat from wearable technology. If firms do
not look at this new development effectively they could lose
Dynamic markets can have a huge impact on businesses.
market share to technology companies that diversify into
If businesses do not adapt to market changes, they are
fashion accessories.
likely to lose market share. At worst they could collapse.

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Comment, Question 1 (d)

This question requires an extended answer and you need to Six marks might be awarded for analysis. An example of analysis
demonstrate knowledge, application, analysis and evaluation. in this answer is the explanation of the measures a business
Again, you need to remember that information from all four might adopt to cope with existence in a dynamic market, such
themes can be used. Answers that make links between the as carrying out regular market research and investment in
different themes are likely to be better. Four marks might be new product development. Six marks might be awarded for
awarded for demonstrating knowledge, such as understanding evaluation. In this case, evaluation can be demonstrated by
the meaning of a dynamic market. Marks might also be awarded weighing up the approaches businesses might use to cope with
for identifying ways in which a business might deal with a a dynamic market and suggesting which might be the best in the
dynamic market, such as improving flexibility, carrying out given context. In this case, the final judgement is that firms in
market research and investing in product development. Four the fashion accessories industry must be wary of developments
marks might be awarded for application. This answer focuses in wearable technology. The main reason for this is because such
throughout on the dynamic market for fashion accessories and products are likely to come from another industry, which clearly
developments in that market, such as increasing demand for poses a threat.
men’s accessories and the smartwatch.

Section B, Question 2
Read the following extracts (E–H) before answering Question 2.

Extract E
Production at Émile
Émile is a French luxury fashion house. It produces a range of ready-to-wear fashion accessories, such as handbags, shoes,
luggage, wallets and sunglasses. It employs over 10,000 people and has about 150 stores in 60 countries.
Émile charges extremely high prices for some of its products. For example, many of its handbags for sale online cost more
than £1,000. These high prices reflect the quality of Émile’s products. The company is committed to producing high quality
goods and uses the very best materials in its manufacturing processes. Its designs are exclusive and made to very detailed
specifications. Since Émile can guarantee very large orders it receives priority attention from the world’s best fabric makers,
furriers and tanners. Products are made in state-of-the-art facilities by highly skilled craft workers, and most of Émile’s core
production workers have an average of 15 years’ experience.

Extract F
Business ethics
Many of Émile’s products are made from animal skins. As a result it has been criticised by animal rights groups. For example,
in 2014 animal rights activists protested outside Émile’s Paris headquarters. Protestors also picketed stores across Europe that
stocked Émile’s products. These protests were part of a global campaign against the apparent resurgence of fur in fashion.

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Extract G
Government intervention
Émile saw its sales in Asia fall in 2014. One of the reasons for this was the clampdown by the Chinese government on conspicuous
consumption (where consumers buy expensive products to overtly demonstrate their wealth). The clampdown was part of an overall
policy to reduce corruption in China. It involved scaling back lavish ceremonies, celebrations and extravagant gift-giving among
Chinese officials and other elite members of society. Ms Rose Martel, Émile CEO, said that Émile Éclat was considering whether to
slow down its expansion plans in Asia. It was also exploring ways of reducing costs to protect profit margins.

Extract H
Selected information from Émile’s Annual Reports and Accounts – 2014
2014 2012
(€ billion) (€ billion)
Revenue 3,228.50 2,300.00
Gross profit 2,383.74 1,645.20
Operating profit 845.28 566.01
Profit for the year (net profit) 565.00 388.71

2 (a) Assess the possible disadvantages to a business like Émile of using animal skins in the manufacturing of its products.
(8 marks)

Question 2 (a), student answer

The use of animal skins in the manufacturing of consumer Another disadvantage of using animal skins in production is
products is likely to be controversial. A significant number their high cost. There are lots of synthetic substitutes that
of consumers would not purchase such products for ethical could be used in production instead of animal skins. These
reasons. Ethics is about morality and doing ‘what is right’ man-made fabrics are usually much cheaper than leathers and
and not ‘what is wrong’. Many people would argue that furs, which would help to reduce costs. Consequently, by
killing an animal to make fashion accessories such as a using animal skins firms such as Émile have higher costs and
handbag is wrong. have to charge higher prices.
Businesses that use animal skins in production have been However, despite these disadvantages, Émile chooses to use
targeted by animal rights groups in the past. For example, in animal skins in production and appears to make a success of
2014 animal rights activists protested outside Émile’s Paris it. In the market for fashion accessories there is a significant
headquarters, as well as outside stores that stocked Émile’s market segment that contains enough consumers who seem
products. These protests formed part of a global campaign not to care about the ethical issues surrounding the use
against the use of fur in fashion. This type of action usually of certain animal skins. They are even prepared to pay the
attracts media attention and can sometimes do damage very high prices that are often charged to cover the higher
to the image of companies. If the image is badly tarnished production costs. At the moment, the bad publicity and
this might result in customers boycotting stores that sell higher production costs resulting from the use of animal
products made from animal skins. As a result revenues and skins does not seem to outweigh the commercial benefits in
profits could fall. terms of higher prices, higher revenues and higher profits for
businesses like Émile.

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A Level Paper 3

Comment, Question 2 (a)

You will need to demonstrate knowledge, application, analysis animal skins in production will impact on the image, sales, costs,
and evaluation. You also need to remember that information from revenues and profits of companies in the fashion accessories
all four themes can be used. Answers that make links between industry. Two marks might be awarded for evaluation. An
the different themes are likely to be better. Two marks might be example of evaluation in this answer is the judgement suggesting
awarded for demonstrating knowledge, such as defining ethics that businesses in the fashion accessories market seem to have
in business and identifying two commercial disadvantages of overcome the problems associated with the use of animal skins.
using animal skins in production. Two marks might be awarded Despite the clear disadvantages, the counterbalance is that
for application. This answer is focused on the use of animal skins enough people do not care and are prepared to pay very high
in the fashion accessories industry. For example, it mentions the prices for such products at the moment. Notice that topics from
impact of what many would consider to be unethical behaviour different themes are used in this answer, such as ethics from
by businesses in the fashion accessories industry. Theme 3, costs, revenues and profits from Theme 2, and market
segments from Theme 1.
Two marks might be awarded for analysis. An example of
analysis in this answer is the explanation of how the use of

2 (b) Assess the importance of Émile’s commitment to quality. (10 marks)

No sample answer has been provided for question 2 (b) so that you can answer it yourself, for exam practice.
2 (c) Use ratio analysis to assess the profitability of Émile between 2012 and 2014. (12 marks)

Question 2 (c), student answer

Three ratios could be used in this case to assess Émile’s profitability: the gross profit margin, operating profit margin and the
Profit for the year (net profit) margin.
For 2014
Gross profit margin = Gross profit x 100% = €2,383.74 bn x 100% = 73.8%
Revenue €3,228.50 bn
Operating profit margin = Operating profit x 100% = €845.28 bn x 100% = 26.2%
Revenue €3,228.50 bn
Profit for the year (net profit) margin = Profit for the year (net profit) x 100% = €565.00 bn x 100% = 17.5%
Revenue €3,228.50 bn
For 2012
Gross profit margin = Gross profit x 100% = €1,645.20 bn x 100% = 71.5%
Revenue €2,300.00 bn
Operating profit margin = Operating profit x 100% = €566.01 bn x 100% = 24.6%
Revenue €2,300.00 bn
Profit for the year (net profit) margin = Profit for the year (net profit) x 100% = €388.71 bn x 100% = 16.9 %
Revenue €2,300.00 bn
The calculations above show that the profit margins for Émile have all increased between 2012 and 2014. The gross profit
margin, which measures the gross profit made on revenue/turnover, has risen from 71.5 per cent to 73.8 per cent. Higher
gross margins are usually preferable to lower ones. It may be possible to increase the gross profit margin by raising revenue
relative to cost of sales, for example by increasing price. In this case, Émile charges very high prices for most of its products.
This might help to explain why its gross margins are so good. Gross profit margins will tend to vary in different industries. As
a rule, the quicker the turnover of stock, the lower the gross margin that is needed. In this example, gross margins are often
high in the fashion industry – particularly for businesses like Émile, which focus on quality products.
The operating profit margins for Émile, which show the operating profit made on sales revenue, have also increased over the
two years from 24.6 per cent to 26.2 per cent. Operating margin is used to measure a company’s pricing strategy and
operating efficiency. It gives an idea of how much a company makes (before interest and taxes) on each euro of sales. A high or
increasing operating margin is preferred. If the operating margin is increasing, the company is earning more per euro of sales.

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Operating margin shows the profitability of sales resulting from regular business. The improvement between 2012 and 2014 is
likely to be welcomed by Émile.
The profit for the year (net profit) margin takes into account all business costs, including interest, other non-operating costs
and exceptional items. It is also usually calculated after tax has been deducted. Between 2012 and 2014 the profit for the
year (net profit) margins have increased slightly from 16.9 per cent to 17.5 per cent. Again, higher margins are better than
lower ones. The profit for the year (net profit) margin focuses on the so-called ‘bottom line’ in business. The ‘bottom line’
refers to the very last line in the income statement, which shows the profit left after all deductions have been made. It is the
final amount of profit left over for the shareholders.
Émile stakeholders are likely to be pleased with the slight improvement in all profit margins. Compared with other industries
the margins are probably very favourable. For example, the profit for the year (net profit) margins for supermarket chains
are usually in low single figures. However, supermarket chains may have much higher turnovers so lower profit margins are
acceptable. Finally, even though the improvements in margins are quite small, if they are continuous over a long period of time,
they will add up and result in quite significant improvements in profitability for Émile.

Comment, Question 2 (c)

You will need to demonstrate knowledge, application, analysis improvements were continuous over a long period of time, the
and evaluation. You also need to remember that information from impact of Émile’s profitability would be significant. Another
all four themes can be used. Answers that make links between approach taken here is to compare the margins with those of
the different themes are likely to be better. another industry. This helps to reinforce the argument you make.
In this case it is argued that the margins are good compared
Around five marks can be awarded for the quantitative elements
with the supermarket industry. A counterbalance, though, is that
in this question. You will need to know the formulae for the
revenues in the supermarket industry are likely to be much higher
ratios and carry out the calculations correctly. Remember to write
and therefore lower margins can be tolerated. Overall, Émile is
down the formulae and show all your working out.
likely to be very pleased with its performance. You could also
You also need to demonstrate that you understand what you have say that a more rigorous analysis of performance could have been
calculated and draw some conclusions about your findings. In made if you’d had access to information about Émile’s capital
this case, you need to understand that Émile’s profit margins employed. This would have allowed you to calculate ROCE.
have improved slightly over the two years and that if such

2 (d) Evaluate the possible impact of political, economic, social, technological, legal and environmental (PESTLE) influences on a
business like Émile. (20 marks)
No sample answer has been provided for question 2 (d) so that you can answer it yourself, for exam practice.

523
 Index
A below-the-line promotion 51–2, business choices 144 business plans 163–4, 169
above-the-line promotion 55 opportunity costs 141–2, 144 business process reengineering
49–50, 55 bias 12 trade-offs 142–3, 144 (BPR) 100
absenteeism 381–2, 384 bonuses 103, 108 business continuity plans 398, business to business (B2B) 66, 74
accounting rate of return (ARR) boom 238, 240 399 business to consumers (B2C) 66, 74
326 Boston Matrix 71–3, 76, 277 business costs 177 business/trade/economic cycles
acid test ratio 198, 202 brand names 2–3, 6, 20, 449–50 business culture 347, 352, 392 238–9, 240
acquisitions. see mergers and branding 25 see also corporate culture buyers, bargaining power of 288
takeovers added value 52 business ethics
added value 20–1, 22, 52 advertising 53 availability of products 359 C
administration of failing business benefits of strong 52–3 codes of practice 360, 366 capacity utilisation 217
207 building a brand 53 corporate social responsibility defined 215
administrative barriers 422 emotional branding 54, 55 (CSR) 361, 366 excess/surplus capacity 215, 217
advertising 25, 49–50, 53, 55 generic brands 52, 55 corruption 359 full capacity 215, 217
aesthetics of products/services 45 and growth of businesses 295 ethical objectives 360–1 improving 216–17
age 15, 25 inappropriate in different countries ethics defined 359, 366 measuring 215
agents 65, 68 471 living wage 366 mothballing 216, 217
aims, business 126, 129, 269, manufacturer brands 52, 55 National Minimum Wage 362, 366 outsourcing 217
271 own-label brands 52, 55 new technologies 359 over-utilisation 216, 217
amortisation 195 price elasticity of demand 36, 53 pay and rewards 361–2 rationalisation 216, 217
angels, business 153–4, 160–1 and prices 52 profit/ethics, trade-offs between under-utilisation 215–16, 217
animal rights 359 social media 53, 54 363–4 capital 149, 152, 196, 202, 369
Ansoff’s matrix 274–5, 461–2 social trends 54 remuneration 361–2, 366 capital cost 326
anti-competitive practices sponsorship 53 sanctions 360, 366 capital expenditure 149, 152
246–7, 249 strength of and pricing 59 strategic decisions 359–60 capital gain 155, 157
appreciation of currencies 234, types of 52 trade embargoes 366 capital intensive 213, 214
240, 453–4 unique selling points 53 workers in developing countries 359 capital productivity 210, 211,
articles of association 131–2, 136 viral marketing 54 business failure 214
assessment objectives 255–6, break-even 184 administration 207 cartels 251, 253
503–4 analysis 183–4 cash-flow problems 204 cash 199
asset stripping 342, 345 break-even output 182 competition 205 cash-flow, business failure and
assets 77, 196, 202, 369, 370 chart 182–3, 184 consumer tastes 206 problems with 204
Association of Southeast Asian contribution 181, 182, 184 economic conditions 206 cash-flow forecasts 164–8, 169
Nations (ASEAN) 426, 427 margin of safety 183, 184 external factors 205–6, 207 cash inflows 164, 169
auction sites 60 output 184 financial factors 206 cash outflows 164, 169
audits, internal/external 281, point 182, 184 innovation, lack of 205 causal modelling 317–18
284 break-even charts 182–3, 184 internal factors 203–5, 207 cell production 210, 214
authorised share capital 155, break-even output 182, 184 legislation 205 centralisation 95, 97
157 break-even point 182, 184 market prices 206 centring 322
authority 94, 97 breaking bulk 64, 68 and marketing 205 certificates of association 132,
autocratic leadership 112 brokers 65, 68 non-financial factors 206 136
average, moving 314, 322 budgetary control 187, 189 overtrading 204, 207 chain of command 94, 97
average costs 179 budgets 189 planning, lack of 203–4 change
average rate of return 322–3, budgetary control 187, 189 poor leadership 205 causes of 386, 387, 388
325, 326, 446 defined 185 in the UK 203 effects of 386, 387, 388
difficulties of 189 business ideas, finding 114–15 management of 391–2, 395
B historical figures 185, 189 business objectives 129 market and other external factors
backward vertical integration production costs budgets 185, 189 aims 126, 129 387–8
300, 302 sales 185, 189 cost efficiency 127–8 organisational change 386, 390
balance sheet 196–7, 202 setting 189 customer satisfaction 128 organisational culture 392
bank overdrafts 155, 157, 160 types of 185–7 market share 127 ownership of the business 388
banks 153 using 187 need for 126 poor business performance 387
bargaining power of suppliers/buyers variance 187–8, 189 objectives defined 126, 129 resistance to 393
288 variance analysis 187–8, 189 profit maximisation 126–7 size of the organisation 386,
barriers to entry 246, 249, 251, zero-based budgeting 186–7, sales maximisation 127, 129 392–3
253, 458 189 SMART 126 speed of 393
base rate 235, 240 buffer stocks 220, 223 social 128 transformational leadership 388,
batch production 209, 214 bundling 20 survival 126–7 390
behavioural segmentation 16 business angels 153–4, 160–1 welfare of employees 127–8 charities 134

524
 Index

child labour 482 consumer tastes and business failure SMART 270, 271 cultural/social factors in international
China 402–3 206 corporate social responsibility trade
choices in business. see business consumer trends 171–2, 175 (CSR) 361, 366 adaptation of products for
choices consumers corporate strategy 274, 280 different cultures 470–1
classical consultation 382 and business competition 5 Ansoff’s matrix 274–5 branding/promotion, inappropriate
codes of conduct 484 ethics 479 Boston matrix 277 471
codes of practice 360, 366 multinational companies 476 cost leadership 276 cultural audits 472
collateral 161 protection of 242–3 development of 274–7 cultural differences 469
collective bargaining 81–2, 83 continuous improvement 5, 228, differentiation 276 ethnocentrism 468, 472
collusion 249, 251, 253 229 distinctive capability 276–7, 280 gestures, unintended meanings of
commission 103, 108 contracts of employment 243, diversification 275, 280 470
common market 425, 429 249 focus 276 global niche markets 465
company websites, use of for market contribution 181, 182, 184 market penetration 275, 280 high-context cultures 469–70, 472
research 12 cooperatives 134, 136 penetration of markets 280 language 469–70
comparative advantage 408, 411 corporate culture 341 Porter’s strategic matrix 275–6 low-context cultures 469, 472
comparison websites 4, 60 advantages of 347 portfolio analysis 277, 280 taste differences 470–1
competition basic assumptions 348 product development 275, 280 culture, organisational 392
barriers to entry 251, 253 and change 392 tactical decisions 278 see also corporate culture
and business failure 205 changing 350 correlation 322 currency appreciation 234, 240,
cartels 251, 253 classification of 348 correlation coefficient 322 253–4
collusion 251, 253 core values 347–8 corruption 359, 479 currency depreciation 234, 240,
competition policy 487, 490 cultural dimensions 349, 352 Corruption Perceptions Index 439 253–4
degree of 9 culture defined 352 cost competitiveness 455, 458 current assets 197, 202
determinants of competitiveness defined 347 cost efficiency 127–8 current liabilities 197, 202, 370
250–1 discrepancies between factors of cost leadership 458 current ratio 197, 202
differentiation of products 251 348 cost of sales 191, 195 curriculum vitae 84, 90
environment of 250 effects of 349–50 cost-plus pricing 57, 62 customer loyalty 75
as external influence 286–7 formation of 350 costs customer satisfaction 128
impact on businesses 251–2 management, changes in 349 and design of products/services customer service 19, 21, 252, 309
interrelationships between mergers and takeovers 349–50 45 customers
businesses 251 motivation 349 and distribution 66 income of, changes in 24
knowledge, buyers’ and sellers’ organisational structure 349 and pricing 60 resistance to change 393
251 person culture 348 of production 28 and shareholders 357
legal factors 251 power culture 348 staff as costs 77–8 speed of response to 21
market size 252–3 role culture 348 countries as stakeholders 354, 355
market structures 250, 253 strong culture 347–8, 352 Corruption Perceptions Index 439 customisation 21
and markets 5 surface manifestations of 347 disposable income 436–7, 441 customs duties 407, 411, 420–1,
markets, change in 387–8 task culture 348 ease of doing business 437–8, 422
mergers and takeovers 450 corporate influences 444–5 customs union 425, 429
number and size of businesses in asset stripping 342, 345 exchange rate 439–40, 441
market 250–1 business ethics 341 infrastructure 438, 441, 444 D
ownership of the business 388 corporate culture 341 as markets 436–41 databases 13, 16
poor business performance 387 evidence-based decision making natural resources 445 date of consumption 16
Porter’s five forces 288–9 341, 343–4, 345 political stability 438–9, 445 debentures 157, 160
price elasticity of demand 36 long term decisions 341, 342–3, as production locations 442–7 decentralisation 95, 97
and pricing 59 345 creaming 58, 62 decision making
and productivity 211 short term decisions 341, 342, 345 credit 156 business ethics 359–60
and quality management 230 stakeholders 341 critical path analysis evidence-based 343–4, 345
size of the organisation 386 strategic decisions 345 critical path defined 338, 339 shareholder approach 356
trade, conditions prompting 432 subjective decision making 341, earliest start time 337 stakeholder approach 356
see also global competitiveness 345 floats 338 subjective 344–5, 345
competition policy 487, 490 corporate objectives 271 free floats 338 tactical decisions 278
competitive advantage 19–20, aims of a business 269 latest finish time 338 decision trees 333
22, 408–9, 411, 454–5, 458 departmental 270, 271 limitations of 339 advantages of 332
competitive pricing 58–9, 62 departmental objectives 271 nature and purpose of 335–6 decision-making 326
complementary goods 24, 26 development of 270 network diagrams 339 decisions, outcomes and costs
consultation 104, 108, 382 example 272 networks 336–7 330–2
consumer durables 47 functional 270, 271 nodes 339 expected values 329
consumer income 173, 175 hierarchy of objectives 270 total float 338, 339 features of 328–9
consumer panels 11, 16 mission statements 269, 271 crowd funding 154, 157, 160 limitations of 332
consumer price index (CPI) 233, objectives defined 269, 271 cultural audits 472 numerous outcomes 329
240 small and large firms 270–1 cultural dimensions 349, 352 probabilities 329

525
Index

deeds of partnership 130, 136 differentiation of products 251, 309 base rate 235, 240 intrapreneurs 117, 119
deferred shares 155 differentiation strategy 276 boom 238, 240 and leadership 145–8
deflation 240 direct action 488, 490 consumer price index (CPI) 233, mindset 146
delayering 97, 212 direct mailings 51–2 240 motivation of 123–4
delegation 95, 97, 104, 108, 147 direct selling 52, 64, 68 deflation 240 profit maximisation 124
delivery times 20 directors depreciation of currencies profit satisficing 114
demand 26 and shareholders 357 234–5, 240 risks/rewards for 114, 119
advertising and brands 24 as stakeholders 354, 355 depression/slump 238, 240 role of 114
changes in 32, 33 and statement of comprehensive downturn 238, 240 running and expanding a business
changes in, factors leading to income 368 economic/trade/business cycles 116
24–5 statement of financial position 372 238–9, 240 skills of 122–3
complementary goods 24, 26 discounted cash flow (DCF) exchange rates 234–5, 240 stress 146
customers’ income, changes in 24 323–5, 326, 446 fiscal policy 237, 240 environment
defined 23 discretionary expenditure 41, 43 government expenditure 237–8, business ethics 359
demand curves 23 discrimination 243, 249 240 corporate social responsibility
demographics 25 diseconomies of scale 295–6, 297 gross domestic product (GDP) (CSR) 361
excess demand 33, 34 disequilibrium in markets 33 238, 240 emissions 481
excess supply 33 dismissals 80 impact of 285–2 ethics 481
external shocks 25 disposable income 436–7, 441 index linked 233, 240 influences from 286
fashion, taste and preferences 24 distinctive capability 276–7, 280 inflation 232–3, 240 multinational companies 475
inferior goods 24, 26 distribution 68 interest rates 235–6 protection of 244–6
interest rates 236 agents/brokers 65, 68 monetary policy 235, 240 and shareholders 357
normal goods 24, 26 breaking bulk 64, 68 recession 238, 240 as stakeholder 354, 355
seasonality 25 business to business (B2B) 66 recovery/upswing 238, 240 waste disposal 481
substitute goods 24, 26 business to consumers (B2C) 66 taxation 237, 240 equal pay 243
and supply, interaction of 31 channels 63, 65–6, 68 uncertainty, effect of 239 equilibrium price 31, 34
demand curves 23, 26 control over 66 economic risk 454, 458 equities 155, 157
democratic leadership 110–11, defined 63 economic/trade/business cycles equity 371
112 direct selling 64, 68 238–9, 240 ergonomics 44–5, 47
demographic change 5 e-commerce 66–7, 68 economic union 425, 429 ethical sourcing 47
demographic segmentation 15 intermediaries 63, 68 economic variables 172–4, 175 ethics 20, 484
demographics 25 online 66–7 economies of scale 20, 292, 297, child labour 482
departmental objectives 270, retailers 64, 68 433, 435, 460, 462 codes of conduct 484
271 and social trends 66–7 efficiency 211–12, 214 consumers 479
depreciation of currencies wholesalers 65, 68 electric cars 7 as corporate influences 341
234–5, 240, 453–4 distribution channels 63, 65–6, 68 embargoes 360, 366, 421, 422 countries/communities 480
depression/slump 238, 240 distributor brands 52, 55 emerging economies 401–2, 405 defined 366
design mix 44–7, 47 diversification 275, 280 emissions 481 employees 479
design of organisations. see division of labour 211, 214, 407, emotional branding 54, 55 environment 481
organisational design 411 employees institutional framework 479, 484
design of products/services 19 donations 51 ethics 479 international trade 479–84
aesthetics 45 downsizing 212, 214 protection of 243–4 labour exploitation 482
consumer durables 47 downturn 238, 240 share ownership by 383 marketing 482–3
costs 45 dumping 422 and shareholders 356 pay and rewards 480–1
defined 44 dynamic markets 3 as stakeholders 353 shareholders 480
design briefs 44 dynamic pricing 60 and statement of comprehensive stakeholders 479–80, 484
design mix 44–7, 47 income 368 supply chain 482
ergonomics 44–5, 47 E see also staffing working conditions 480–1
ethical sourcing 47 e-commerce 3–4, 6, 66–7, 68, employer/employee relationship see also business ethics
fit for purpose 44 310 81–2 ethnicity 15
function 44–5 e-tailing 3–4, 6 employment ethnocentric approach to marketing
product design 47 earliest start time 337, 339 in growing economies 403 460, 461
re-use of resources 46 ease of doing business 437–8, multinational companies 473 ethnocentrism 468, 472
recycling 46, 47 444–5 employment contracts 243, 249 Eurasian Economic Union 430
resource depletion 47 economic and monetary union employment tribunals 243, 249 European Union 426–7
safety 45 425, 429 empowerment 104–5, 108 evidence-based decision making
social trends 46–7 economic growth 4, 173, 175, entrepreneurs 119 341, 343–4, 345
unique selling point 45 402, 403–5 barriers for 117–19 examinations, preparation for
waste minimisation 46, 47 see also growth of businesses business ideas, finding 114–15 assessment objectives 255–6,
desk research 11–12, 16 economic influences characteristics of 121–2 262–3, 503–4
destroyer pricing 58 appreciation of currencies 234, creating and setting up a business overview of papers 255, 262,
differentiation 455, 458 240 114–15 503, 514

526
 Index

planning 255, 262, 503, 514 Porter’s five forces 288–9 forms of business Ansoff’s matrix 461–2
practice questions 261, 268, rivalry between firms 289 articles of association 131–2, ethnocentric approach 460, 461
512–13, 523 social 286 136 geocentric approach 460, 461
sample answers 257–60, 264–7, substitutes for products 288 certificates of association 132, marketing mix 461
505–12, 516–23 technological 286 136 polycentric approach 460, 461
skills for exams 255–6, 262–3, external recruitment 86–7, 90 charities 134 global niche markets 464, 466
503–4, 514–15 external shocks 25, 29–30 cooperatives 134, 136 cultural diversity 465
exceptional costs 195 external stakeholders 358 deeds of partnership 130, 136 features of 464–5
excess demand 33, 34 extrapolation 174, 175 franchises 132–3, 136 marketing mix 465–6
excess supply 33, 34 growth of businesses 137 globalisation 413, 418
excess/surplus capacity 215, 217 F initial public offering (IPO) 138 factors contributing to 414–18
exchange rates 173, 234–5, 240, failure of businesses. see business lifestyle businesses 134, 136 foreign direct investment (FDI)
439–40, 441, 453–4 failure limited companies 131–2, 136 416–17, 418
exhibitions 52 family and friends 153 limited liability 136 investment flows, increase in
expected values 329 fashion, changes in 24 limited partnerships 131, 136 416–17
exports 407, 411 finance 160 memorandum of association labour force, growth of global
extension strategies 76 appropriate, choosing 159–61 131–2, 136 417
external audits 281, 284 and business failure 206 mutual organisations 134, 136 liberalisation of trade 414–18
external data 11 cash-flow forecasts 164–8 online businesses 134–5, 136 marketing 462
external diseconomies of scale external 153–7 partnerships 130–1, 136 migration 417
296 internal 149–52 primary sector 130, 136 political change 414–15
external economies of scale long-term 161 private equity companies 140 structural change 417–18
293–4, 297 markets, change in 387–8 public limited companies 137–9, transnational/multinational
external factors 205–6, 207 mergers and takeovers 301 140 companies 415–16, 418
see also external influences ownership of the business 388 secondary sector 130, 136 transport and communication 415
external finance poor business performance 387 sleeping partners 136 World Trade Organisation (WTO)
authorised share capital 155, 157 short-term 161 social enterprises 134, 136 414, 418
bank overdrafts 155, 157 size of the organisation 386 sole traders 130, 136 glocalisation 459, 462
banks 153 see also break-even; budgets; stock market flotation 140 government expenditure 237–8,
business angels 153–4 financial statements, interpretation tertiary sector 130, 136 240
capital gain 155, 157 of; liquidity; profit; ratio analysis unlimited liability 130, 136 government policies and legislation
crowd funding 154, 157 finance cost 368, 373 forward vertical integration 300, 29–30, 487–8
debentures 157 finance income 373 302 governments as stakeholders 354, 355
defined 153, 157 financial rewards for staff 381–2 franchises/franchising 132–3, grants 156, 160
equities 155, 157 financial statements, interpretation of 136, 448, 451 gross domestic product (GDP)
family and friends 153 finance cost 368, 373 free floats 338, 339 238, 240, 404
grants 156 finance income 373 free trade area (FTA) 424, 429 gross profit 191, 195
issued share capital 155, 157 statement of comprehensive frequent buyer offers 21 gross profit margin 192, 195
leases 156, 157 income 367–8 full capacity 215, 217 growing economies
loans 154–5 statement of financial position functional objectives 270, 271 China 402–3
from other businesses 154 369–72 economic growth 402, 405
peer-to-peer lending (P2PL) 153, statements required 367 G emerging economies 405
157 fiscal policy 237, 240 gearing ratios 374–5, 378 employment patterns 403
permanent capital 155, 157 fixed costs 177, 179 gender 15, 25 gross domestic product (GDP)
secured loans 157 flexibility generic brands 52, 55 404
share capital 155, 157 of businesses 5 geocentric approach to marketing health 404–5
sources of 153–6 and production 211 460, 461 Human Development Index (HDI)
trade credit 156 of services 20 geographic segmentation 15, 25 405
unsecured loans 157 flexible workforce 78, 79–80, gestures, unintended meanings of 470 implications of 403
venture capitalism 155, 157 83, 105 global competitiveness 453, 458 indicators of growth 404–5
external influences floats in critical path analysis 338 barriers to entry 458 literacy rate 404, 405
bargaining power of suppliers/ flow production 209–10, 214 competitive advantage 454–5, Purchasing Power Parity (PPP)
buyers 288 focus 276 458 404, 405
competition 286–7 focus groups 11, 16 cost competitiveness 455, 458 trade opportunities 403
environmental 286 forecasts cost leadership 458 UK/emerging economies
legal 286 cash-flow forecasts 164–8 differentiation 455, 458 comparison 401–2
market structures 286–7 defined 175 economic risk 454, 458 growth of businesses 292
monopolies 287, 289 foreign direct investment (FDI) exchange rates 453–4 brand recognition 295
new market entrants 288 409–10, 411, 416–17, 418, 475 multinational companies 453 diseconomies of scale 295–6, 297
oligopolies 287, 289 formal organisation 92, 97 skills shortages 455–6, 458 economies of scale 292, 297
PESTLE analysis 285–6, 289 formality and growth of businesses global marketing strategy 459, external diseconomies of scale
political 285 145 462 296

527
Index

external economies of scale hygiene factors 101, 108 capital 149, 152 limitations of techniques 325
293–4, 297 capital expenditure 149, 152 net cash flow 321, 326
internal communications 296 I defined 149, 152 net present value (NPV) 324–5,
internal diseconomies of scale import quotas 421, 422 need for finance 149 326
295 imports 407, 411 owner’s capital 149 non-financial considerations 326
internal economies of scale 293 income 15 retained profit 150, 152 payback period and method
law of diminishing returns 292 income elastic 40 revenue expenditure 149, 152 321–2, 325, 326
market power 294–5 income elasticity of demand 43 sale and leaseback 150, 152 present value 326
market share 295 calculation of 40 sale of assets 150 investment by businesses 5
minimum efficient scale 292, 297 defined 40 internal recruitment 86, 90 issued share capital 155, 157
organic growth 304–6 discretionary expenditure 41, 43 internal stakeholders 353–4, 358 IT systems failure 397
overtrading 296–7 high 41 international trade 407, 411
problems from 295–6 income elastic 40 adaptation of products for J
profitability 295 income inelastic 40, 43 different cultures 470–1 job description 85, 86, 90
rapid growth, problems with 301–2 influences on 41 branding/promotion, inappropriate job enlargement 106, 108
synergy 298 interpretation of numerical values 471 job enrichment 102, 105, 108
see also international trade of 40–1 comparative advantage 408, 411 job production 208–9, 214
low 41 competitive advantage 408–9, 411 job rotation 106, 108
H luxuries 41 cultural audits 472 joint ventures
Hawthorne effect 100–1, 108 necessities 41 cultural differences 469 reasons for 448–52
headhunting 87 price relative to income 41 cultural diversity 465 see also mergers and takeovers
health 404–5 production planning 41 division of labour 407, 411 just-in-time production (JIT) 212, 221
health and safety legislation 247–8 significance of for businesses ethics 479–84
Herzberg’s two-factor theory 101–2 41–2 ethnocentrism 468, 472 K
hierarchy 92–3, 97 income inelastic 40, 43 exchange rates 173, 234–5, 240 Kaizen 212, 214, 228–9
hierarchy of needs 101, 108 incorporated businesses 158, exports 407, 411 Kanban 223
hierarchy of objectives 270 161 foreign direct investment (FDI)
high-context cultures 469–70, index linked 233, 240 409–10, 411 L
472 induction training 88, 90 gestures, unintended meanings of labelling, misleading 482–3
historical figures 185, 189 industrial action 81, 83 470 labour force
holiday market 1 infant industries 422 high-context cultures 469–70, child labour 482
home workers 79, 83 inferior goods 24, 26 472 exploitation of 482
horizontal integration 300, 302 inflation 173, 232–3, 240 imports 407, 411 growth of global 417
human behaviour 12 information and communications language 469-70 multinational companies 473
Human Development Index (HDI) technologies (ICT) 12–14 low-context cultures 469, 472 skills and availability of 443–4
405 information gathering about the marketing approaches 460–2 labour intensive 212–13, 214
human relations, Mayo’s theory of business 295 mergers and joint ventures labour productivity 210, 214,
100–1 informative advertising 49 448–52 379–80, 384, 433, 435
human resources infrastructure of countries 438, niche markets 464–7 labour retention 381, 384
absenteeism 381–2, 384 441, 444 specialisation 407, 411 labour turnover 380–1, 384
consultation strategies 382 initial public offering (IPO) 138 supply chain ethics 482 laissez-faire leadership 111, 112
corporate social responsibility innovation 4 tariffs 407, 411 language 469–70
(CSR) 361 and competition 252 taste differences 470–1 latest finish time 338, 339
employee share ownership 383 lack of and business failure 205 see also countries; globalisation; law of diminishing returns 292
empowerment strategies 383–4 inorganic growth 304, 306 multinational companies; lead time 219, 223
financial rewards 381–2 institutional framework 479, 484 protectionism; trade, conditions leadership
labour force, growth of global intangible assets 197, 202 prompting autocratic 112
417 integration 300, 302 interrelationships between businesses characteristics of 109–10
labour productivity 379–80, 384 integrative consultation 382 251 cost 458
labour retention 381, 384 intellectual property 449–50, interviews 10 cost leadership 276
labour turnover 380–1, 384 451 intrapreneurs 117, 119 democratic 110–11, 112
locations for production, countries interest rates 173, 235–6 inventories 197, 202 entrepreneurs and 145–8
as 443–4 intermediaries 63, 68 investment 321, 326 laissez-faire 111, 112
loss of key staff 397–8 internal audits 281, 284 investment appraisal 321, 326 management, comparison with
motivating staff 382–4 internal data 11 accounting rate of return (ARR) 109
performance-related pay 383 internal diseconomies of scale 326 paternalistic 110, 112
rate of absenteeism 381–2, 384 295 average rate of return 322–3, poor, and business failure 205
scientific management 382 internal economies of scale 293 325, 326 styles of 110–11
succession planning 398–9 internal factors 203–5, 207 capital cost 326 transformational 388, 390
see also staffing internal finance discounted cash flow (DCF) see also motivation
human rights 361 advantages and disadvantages of 323–5, 326 lean production 212, 214, 222–3
hybrid cars 7 150–1 investment defined 321, 326 leases 156, 157

528
 Index

legislation 30 liabilities 196, 202 approaches used 18 defined 73

anti-competitive practices 246–7, measuring 197–8 competitive advantage 19–20 extension strategies 76
249 net assets 202 consumer perceptions 18 hybrid 74
barriers to entry 246, 249 non-current assets 197, 202 product differentiation 20 inbound 74
and business failure 205 non-current liabilities 202 repositioning 18, 19 mass markets 73
changes in 4 shareholder’s equity 197, 202 market research 5, 16 niche markets 73–4
collusion 246, 249 statement of financial position bias 12 outbound 74
competition 251 196–7, 202 company websites, use of for 12 product life cycle 69–71
consumer protection 242–3 trade and other payables 197, and competition 252 product lines 76
contract of employment 243, 249 202 consumer behaviour 10 product portfolio 71–3, 76
discrimination 243, 249 trade and other receivables 197, databases 16 markets 6
employee protection 243–4 202 demand for products 10 brand names 2–3, 6
employment tribunals 243, 249 working capital 198–9, 202 ICT, use of for 12–14 change in 4–5, 387–8
environmental protection 244–6 literacy rate 404, 405 limitations of 12 and competition 5
equal pay 243 living wage 366 market orientation 8–9, 16 countries as, assessment of
as external influence 286 loans 154–5, 157, 160 needs and wants of customers 10 436–41
health and safety 247–8 lobbying 488 primary research 10–11, 12, 16 decline in 4
impact on businesses 243–4, local community as stakeholders 354 product orientation 8 demand, changes in 32, 33
245–6, 247 localisation 462 purposes of 10 demographic change 5
multinational companies 487–8 location for production, countries as qualitative research 12, 16 disequilibrium in 33
national minimum wage 244, 249 average rate of return 446 quantitative research 12, 16 and distribution 66
need for 242 costs of production 442 sampling 12 dynamic 3
protectionism 422 discounted cash flow (DCF) 446 secondary research 11–12, 16 economic growth 4
restrictive practices 246–7, 249 ease of doing business 444–5 social networking 13 equilibrium price 31, 34
unfair dismissal 243, 249 government incentives 444 starting a business 8 excess supply 33
liabilities 196, 202, 369, 370 infrastructure 444 market segment 15, 16 as external influence 286–7
liability natural resources 445 market segmentation growth in 4–5
appropriate choice of finance payback method 446 behavioural segmentation 16 holidays 1
159–61 political stability 445 demographic segmentation 15 innovation 4
collateral 161 reshoring 443, 447 geographic segmentation 15 legislation, changes in 4
incorporated businesses 158, return on investment 446 psychographic segmentation 15 market clearing price 31, 34
161 skills and availability of labour use of 15 market share 2, 6
limited 158, 160–1, 161 443–4 market share 127, 295 mass markets 1, 6
long-term finance 159, 161 top ranking countries 442 market structures 250, 253 new 4, 449
rights issue 161 trading blocs 444, 447 marketing new entrants 288
short-term finance 159, 161 long run 177, 179 activities involved in 1 niche markets 1–2, 5, 6
undercapitalised 161 long term decisions 341, 342–3, Ansoff’s matrix 461–2 number and size of businesses in
unincorporated businesses 158, 345 approaches for international trade 250–1
161 long-term finance 159, 161 460–2 online retailing 3–4
unlimited 160, 161 long-term trends 172 and business failure 205 penetration of 275
unlimited liability 158–9 low-context cultures 469, 472 and competition 252 risk 6
liberalisation of trade 414–18 loyalty 16, 75 cultural/social factors in size of 2, 4, 9, 252–3
licensing 448, 451 international trade 465, 468–72 social change 4
life cycle of products 62, 434, M economies of scale 460, 462 supply, changes in 32–3
435 maintenance factors 101 ethics 482–3 supply and demand, interaction of
lifestyle businesses 134, 136 management, comparison with ethnocentric approach 460, 461 31
limited companies 131–2, 136 leadership 109 geocentric approach 460, 461 total revenue 31, 34
limited liability 136, 158, 160–1, management of change 395 global marketing strategy 459, types of 1
161 managers 462 uncertainty 6
limited partnerships 131, 136 and shareholders 357 globalisation 462 value of 2
line of best fit 315 as stakeholders 354, 355 glocalisation 459, 462 volume of 2
liquidity 197, 202 statement of comprehensive inappropriate activities 483 Maslow’s hierarchy of needs
acid test ratio 198, 202 income 368 localisation 462 101, 108
assets 196 statement of financial position misleading labelling 482–3 mass markets 1, 6, 73
capital 196, 202 372 polycentric approach 460, 461 matrix structures 95–6
cash 199 manufacturer brands 52, 55 viral marketing 54, 55 Mayo, Elton 100–1
current assets 197, 202 margin of safety 183, 184 marketing mix 55, 461, 465–6 memorandum of association
current liabilities 197, 202 mark-up 57, 62 marketing strategy 76 131–2, 136
current ratio 197, 202 market clearing price 31, 34 Boston Matrix 71–3, 76 merchandising 51, 55
improving 199–200 market maps 18–19, 22 business to business (B2B) 74 mergers and takeovers
intangible assets 197, 202 market orientation 8–9, 16 business to consumers (B2C) 74 backward vertical integration 300,
inventories 197, 202 market positioning 22 customer loyalty 75 302

529
Index

brand names/patents, acquisition non-financial techniques 104–6 niche markets 1–2, 5, 6, 73–4, ownership of businesses
of 449–50 payment by results 108 464–7 and growth of businesses 145–6,
competitiveness 450 performance-related pay 104, nodes 339 146
corporate culture 349–50 108 non-current assets 197, 202, 370 resistance to change 393
distinction between 298–9 piece rates 103, 108 non-current liabilities 202, stakeholders, owners as 353
financial risks and rewards 301 and production 211 370–1
forward vertical integration 300, profit sharing 103, 108 normal goods 24, 26 P
302 scientific management 99–100, North American Free Trade packaging 21, 51
franchising 448, 451 108 Agreement (NAFTA) 426, 427 part-time staff 78
global 448–52 self-actualisation 108 partnerships, limited 130–1, 136
horizontal integration 300, 302 teamworking 105, 108 O paternalistic leadership 112
integration 300, 302 see also leadership objectives 126, 129, 269, 271, pay and rewards 361–2, 473,
intellectual property 449–50, 451 motivators 101, 108 360–1 480–1
licensing 448, 451 moving average 314, 322 see also business objectives; payback period 321–2, 325, 326,
mergers defined 298–9, 302 multi-skilling 78, 83 corporate objectives 446
new markets 449 multinational companies observation 11 payment by results 108
number of cross border 448 415–16, 418, 453 off-shoring 433, 435 peer-to-peer lending (P2PL)
rapid growth, problems with balance of payments of host off-the-job training 89, 90 153, 157, 160
301–2 nation 475 oligopolies 287, 289 penetration of markets 275, 280
reasons for 298, 448–52 business culture 476 on-the-job training 89, 90 penetration pricing 58, 62
risk spreading 449 community 474 online businesses 134–5, 136 perceptual maps 18–19, 22
security of resources/supplies 450 competition policy 487, 490 online distribution 66–7 performance appraisals 104
synergy 302 consumers, benefits for 476 online retailing 3–4, 6 performance ratios 375, 378
takeovers defined 299, 302 control of 485–6 online sales and pricing 60 performance-related pay 104,
vertical integration 300, 302 direct action 488, 490 online surveys 12, 14 108, 383
migration 417 environment 475 operating profit 191, 195 permanent capital 155, 157
minimum efficient scale 292, 297 foreign direct investment (FDI) operating profit margin 193, 195 person culture 348
minimum wage 244, 249, 362, 475 opportunity costs 141–2, 144 person specification 85, 90
366 institutional controls 485–6 ordinary shares 155 personal interviews 10
misleading labelling 482–3 labour and job creation 473 organic growth 304–6 personal selling 52
mission statements 269, 271 legal controls over 487–8 organisational change 386, 390 personalised pricing 60
monetary policy 235, 240 lobbying 488 see also change personnel. see employees; human
monopolies 287, 289 local businesses 474 organisational charts 92–3, 97 resources; staffing
mortgages 160 and local economies 473–5 organisational culture 347, 352, persuasive advertising 49
mothballing 216, 217 naming and shaming 488, 490 392 PESTLE analysis 285–6, 289
motivated 108 and national economies 475–7 see also corporate culture piece rates 103, 108
motivation political influences over 486–7 organisational design planning
appraisals 104 pressure groups 488–9, 490 authority 94, 97 business plans 163–4, 169
bonuses 103, 108 reverse engineering 476, 477 centralisation 95, 97 cash-flow forecasts 164–8, 169
commission 103, 108 skills transfer 475–6 chain of command 94, 97 cash inflows 164, 169
consultation 104, 108 social media 489 decentralisation 95, 97 cash outflows 164, 169
corporate culture 349 tax avoidance 487, 490 delayering 97 examinations, preparation for
delegation 104, 108 tax evasion 487, 490 delegation 95, 97 255, 503, 514
empowerment 104–5, 108 tax revenue 476 employee roles 93–4 lack of and failure of businesses
entrepreneurs 123–4 taxation 487 flat structures 95, 96 203–4
financial incentives 103–4 technology 475–6 formal organisation 92, 97 net cash flow 164, 169
flexible working 105 transfer pricing 476, 477 hierarchy 92–3, 97 production 41
and growth of businesses 146 mutual organisations 134, 136 matrix structures 95–6 solvency 167, 169
Hawthorne effect 100–1, 108 organisational charts 92–3, 97 point of sale 55
Herzberg’s two-factor theory N responsibility 94, 97 political influences 285, 486–7
101–2 naming and shaming 488, 490 span of control 94, 97 political stability 438–9, 445
human relations, Mayo’s theory of National Minimum Wage 244, structure of organisations 92, polycentric approach to marketing
100–1 249, 362, 366 95–6 460, 461
hygiene factors 101, 108 natural disasters 397 subordinates 97 populations, characteristics of 25
importance of 99 natural resources 445 tall structures 95, 96 Porter’s five forces 288–9
job enlargement 106, 108 net assets 202, 371 organisational structure 349 Porter’s strategic matrix 275–6
job enrichment 102, 105, 108 net cash flow 164, 169, 321, 326 outsourcing 79, 83, 212, 214, portfolio analysis 277, 280
job rotation 106, 108 net present value (NPV) 324–5, 217, 433, 435 positioning maps 18–19, 22
Maslow’s hierarchy of needs 101, 326 over-utilisation 216, 217 postal surveys 10
108 net profit 191, 195 overdrafts 155, 157, 160 power culture 348
motivated, defined 108 net profit margin 193, 195 overtrading 204, 207, 296–7 practice questions 261, 512–13,
motivators 101, 108 network diagrams 339 own-label brands 52, 55 523

530
 Index

predatory pricing 58, 62 unit costs 57, 62 size of the organisation 386 social media 53, 54
preference shares 155 pricing strategies 57, 62 products sponsorships 51, 55
preferences, changes in 24 primary research 10–11, 12, 16 adaptation of for different cultures trade fairs 52
preferential trade area (PTA) primary sector 130, 136 470–1 viral marketing 54, 55
424, 429 private brands 52, 55 availability of and ethics 359 protectionism 420
present value 326 private equity companies 140 corporate social responsibility administrative barriers 422
press conferences 51 probabilities 329 (CSR) 361 dumping 422
press releases 51 product adjustment 70 differentiation of 251, 309 embargoes 421, 422
pressure groups 488–9, 490 product design 19, 47 nature of 65–6 import quotas 421, 422
price elastic demand 38 product development 5, 275, 280 range of, and competition 252 infant industries 422
price elasticity of demand 38, 59 product differentiation 20, 22, 59 substitutes for 288 legislation 422
branding 36 product life cycle 62, 69–71, 434, profit subsidies 422
and branding 53 435 amortisation 195 tariffs 420–1, 422
calculation of 35–6 product lines 76 cash, distinguished from 194 trade barriers 420–2, 422
competition for same product 36 product orientation 8 and competition 251 pseudo-consultation 382
defined 35 product portfolio 71–3, 76 cost of sales 191, 195 psychographic segmentation 15
influences on 36–7 product quality 19 defined 179, 191 psychological pricing 59, 62
interpretation of numerical values production 214 and ethics, trade-offs between public limited companies 137–9,
of 36 batch production 209, 214 363–4 140
price elastic demand 35 capital intensive 213, 214 exceptional costs 195 public relations 51, 55
price inelastic demand 35, 38 capital productivity 210, 211, 214 gross profit 191, 195 pull factors 433, 435
and pricing 37 cell production 210, 214 gross profit margin 192, 195 Purchasing Power Parity (PPP)
time 36 cost of and locations for growth of businesses 295 404, 405
and total revenue 37–8 production 442 improving profitability 194 push factors 432, 435
price inelastic demand 38 costs 28 measuring profitability 192–3
prices/pricing countries as locations for 442–7 net profit 191, 195 Q
auction sites 60 defined 208 net profit margin 193, 195 qualitative forecasting 318
and brand strength 59 delayering 212 operating profit 191, 195 qualitative research 12, 16
and branding 52 division of labour 211, 214 operating profit margin 193, 195 quality 19, 225, 230
comparison sites 60 downsizing 212, 214 and pricing 60 quality assurance 226, 230
and competition 251 efficiency 211–12, 214 profit and loss account 192 quality chains 227, 230
competitive 58–9, 62 fixed costs 179 retained 150, 152 quality circles 226, 228, 230
competitive markets 59 flow production 209–10, 214 statement of comprehensive quality control 225–6, 230
complementary goods 24 job production 208–9, 214 income 192, 195 quality management
cost-plus 57, 62 just-in-time production (JIT) 212 turnover/revenue 191, 195 competitive advantage from 230
costs and profits 60 Kaizen 212, 214 profit maximisation 126–7 continuous improvement 228,
creaming 58, 62 labour intensive 212–13, 214 profit satisficing 114 229
destroyer pricing 58 labour productivity 210, 214 profit sharing 103, 108 costs of 230
dynamic 60 lean production 212, 214, 222–3 profitability ratios 375, 378 Kaizen 228–9
equilibrium price 34 long run 177, 179 promotions 19, 55 quality 225, 230
factors determining strategies outsourcing 212, 214 above-the-line promotion 49–50, quality assurance 226, 230
59–60 planning 41 55 quality chains 227, 230
flexible 20 productivity 210–11, 214 advertising 49–50, 55 quality circles 226, 228, 230
mark-up 57, 62 sales revenue 176, 179–80 below-the-line promotion 51–2, quality control 225–6, 230
market, and business failure 206 sales volume 176, 179 55 statistical process control 230
penetration 62 semi-variable costs 179 choice of methods 52 total quality management (TQM)
penetration pricing 58 short run 177, 179 defined 49 227–8, 230
personalised 60 specialisation 211, 214 direct mailings 51–2 waste, elimination of 228
predatory 58 standardisation 211–12, 214 direct selling 52 quantitative research 12, 16
price elasticity of demand 59 switching products 42 donations 51 quantitative sales forecasting
and price elasticity of demand 37 technology 212 emotional branding 55 causal modelling 317–18
product differentiation 59 total costs 178, 179 exhibitions 52 centring 322
product life cycle 62 total revenue 176–7, 179 inappropriate activities 483 correlation 322
psychological 59, 62 unit costs 179 inappropriate in different countries correlation coefficient 317, 322
related goods 30 variable costs 178, 179 471 limitations of 316–17, 322
relative to income 41 production costs budgets 185, 189 marketing mix 49, 55 line of best fit 315
skimming 58, 62 productivity 210–11, 214 merchandising 51, 55 moving average 314, 322
social trends 60 labour 379–80, 384, 433, 435 packaging 51 scatter graphs 317, 322
strategies 57, 62 markets, change in 387–8 product life cycle 70 seasonal variations 316
subscription 60 ownership of the business 388 public relations 51, 55 time series analysis 322
unique selling point 59 poor business performance 387 sales promotions 51, 55 questionnaires 10–11

531
Index

R return on capital employed scientific management 108, 382 social networking 13

rate of absenteeism 381–2, 384 (ROCE) 375–6, 378 seasonal variations 171–2 social objectives 128
ratio analysis 374, 378 return on investment 446 seasonality 25 social trends
gearing ratios 374–5, 378 revenue expenditure 149, 152 secondary research 11–12, 16 and branding 54
limitations to 376–7 revenue/turnover 191, 195 secondary sector 130, 136 and design mix 46–7
performance ratios 378 reverse engineering 476, 477 secured loans 157 and distribution 66–7
profitability ratios 375, 378 rights issue 161 segmentation. see market pricing 60
return on capital employed (ROCE) risk 6, 114, 119, 435, 449, 454, segmentation from product to services 67
375–6, 378 458 self-actualisation 108 socio-economic groups 15, 16
window dressing 377, 378 risk assessment 397, 399 semi-variable costs 179 sole traders 130, 136
see also finance risk mitigation plans 398–9, 399 share capital 155, 157, 160 solvency 167, 169
rationalisation 216, 217 rivalry between firms 289 shareholders span of control 94, 97
re-order level 220, 223 role culture 348 conflict with stakeholders 356–7 specialisation 211, 214, 407, 411
re-order quantity 220, 223 rules of origin 429 and customers 357 speed of response to customers 21
re-use of resources 46 and decision making 356 sponsorship 51, 53, 55
reassuring advertising 49 S and directors and managers 357 staffing
recession 238, 240 safety 45 and employees 356 approaches to 77–8
recognition in the market place 20 sale and leaseback 150, 152 employees as 383 asset, staff as 77
recovery/upswing 238, 240 sale of assets 150 and the environment 357 collective bargaining 81–2, 83
recruitment and selection sales budgets 185, 189 ethics 480 cost, staff as 77–8
advertising 84, 86 sales forecasts 175 as stakeholders 354 dismissals 80
applications 84–5 benefits of 171 and statement of comprehensive employer/employee relationship
costs 87–8 competitors’ actions 174 income 368 81–2
curriculum vitae 84, 90 consumer income 173, 175 statement of financial position flexible workforce 78, 79–80, 83
employment agencies 86 consumer trends 171–2, 175 372 home workers 79, 83
external recruitment 86–7, 90 difficulties of 174–5 value, shareholder 358 industrial action 81, 83
headhunting 87 economic growth 173 shareholder’s equity 197, 202 loss of key staff 397–8
internal recruitment 86, 90 economic variables 172–4, 175 short run 177, 179 multi-skilling 78, 83
interviews 85 exchange rates 173 short term decisions 341, 342, outsourcing 79, 83
job description 85, 86, 90 extrapolation 174, 175 345 part-time staff 78
need for 84 fashion 172 short-term finance 159, 161 redundancy 80–1
online 85, 87 forecasting defined 175 single market 425, 429 succession planning 398–9
person specification 85, 90 inflation 173 size of markets 2, 4, 9 temporary staff 78
staffing needs, identification of 84 interest rates 173 size of organisations 145–8, 386, trade unions 81–2, 83
stages in process of 84–5 long-term trends 172 392–3 welfare of employees 127–8
word-of-mouth 86 purpose of 170 see also small businesses zero-hours contracts 79, 83
recycling 46, 47 seasonal variations 171–2 skills shortages 455–6, 458 see also human resources;
redundancy 80–1 time series data 170–1, 175 skills transfer 475–6 motivation; recruitment and
regional trade agreements unemployment 173 skimming 58, 62 selection; training
(RTA) 429 sales maximisation 127, 129 sleeping partners 136 stakeholders 358
religion 15 sales promotions 51, 55 slump/depression 238, 240 conflict with shareholders 356–7
relocation of businesses 212 sales revenue 176, 179–80 small businesses as corporate influences 341
see also location for production, sales volume 176, 179 advantages of 308 customers 354, 355
countries as sample 12, 16 corporate objectives 270–1 and decision making 356
remuneration 361–2, 366 sample answers 257–60, 505–12, customer service 309 employees as 353, 355
reposition 18, 22 516–23 e-commerce 310 environment as 354, 355
research and development 5 sanctions 360, 366 flexibility of response to customers ethics 479–80, 484
reshoring 443, 447 saturation 432, 435 309 external 354, 358
resource depletion 47 scatter graphs 317, 322 growth in 311 government as 354, 355
resources scenario planning 399 product differentiation 309 internal 358
availability of 28 business continuity plans 398, 399 unique selling point 309 internal stakeholders 353–4
ethical sourcing 47 defined 396 see also size of organisations local community as 354, 355
re-use of 46 drawbacks to 398 SMART objectives 126, 270, 271 managers and directors as 354,
resource depletion 47 IT systems failure 397 social change 4 355
respondents 10, 16 loss of key staff 397–8 social class 15 markets, change in 387–8
response to customers 21 natural disasters 397 social enterprises 134, 136 objectives of 355
responsibility 94, 97, 146 possible scenarios 397–8 social factors in international trade. ownership of the business 388
restrictive practices 246–7, 249 risk assessment 397, 399 see cultural/social factors in poor business performance 387
retailers 64, 68 risk mitigation plans 398–9, 399 international trade shareholders 354, 355
retained profit 150, 152, 160 steps in 396 social influences 286 size of the organisation 386
retention of staff 381, 384 succession planning 398–9, 399 social media 53, 54, 489 and statement of comprehensive

532
 Index

income 368 changes in 28–30, 32–3 pull factors 433, 435 trends, long-term 172
statement of financial position 372 costs of production 28 push factors 432, 435 trust and growth of businesses 146,
suppliers as 355 defined 27 risk 433, 435 147
value, shareholder 358 and demand, interaction of 31 saturation 432, 435 turnover/revenue 191, 195
standardisation 211–12, 214 excess supply 33, 34 see also international trade two-factor theory 101–2
statement of comprehensive external shocks 29–30 trade and other payables 197,
income 192, 195, 367–8 indirect taxes 29 202 U
statement of financial position resource availability 28 trade and other receivables 197, uncertainty 6, 119, 239
196–7, 202, 369–72 subsidies 27, 29 202 under-utilisation 215–16, 217
statistical process control 230 supply curve 30 trade associations 281, 284 undercapitalised 161
stock control technology, introduction of 28–9 trade barriers 414, 420–2, 422 unemployment 173
buffer stocks 220, 223 supply chain ethics 482 trade credit 156 unfair dismissal 243, 249
diagrams 220 supply curve 27, 30 trade/economic/business cycles unincorporated businesses 158,
factors influencing 219 surplus/excess capacity 215, 217 238–9, 240 161
just-in-time production (JIT) 212, SWOT analysis 284 trade embargoes 360, 366, 421, unique selling point 18, 22, 45,
221 example 282 422 53, 59, 309
Kanban 223 external audits 281, 284 trade fairs 52 unit costs 57, 62, 179
lead time 219, 223 information gathering 281 trade-offs 142–3, 144 United Kingdom 401–2
lean production 222–3 internal audits 281, 284 trade unions 81–2, 83 unlimited liability 130, 136,
poor 221 opportunities 282 trading blocs 429 158–9, 160, 161
re-order level 220, 223 strengths 282 Association of Southeast Asian unsecured loans 157, 160
re-order quantity 220, 223 threats 282 Nations (ASEAN) 426, 427 upswing/recovery 238, 240
stock rotation 223 trade associations 281, 284 common market 425, 429 usage rate 16
types of stock 219 weaknesses 282 customs union 425, 429
waste minimisation 222 synergy 298, 302 economic and monetary union V
work-in-progress 219, 223 425, 429 value, shareholder 358
stock market 137, 140 T economic union 425, 429 value of markets 2
stock market flotation 140 tactical decisions 278 Eurasian Economic Union 430 values, core, of an organisation
stock rotation 223 takeovers. see mergers and takeovers European Union 426–7 347–8
strategic decisions 345 tariffs 407, 411, 420–1, 422 expansion of 424 variable costs 178, 179
strategy task culture 348 factors in 428 variance 187–8, 189
business ethics 359–60 taste differences 470–1 free trade area (FTA) 424, 429 variance analysis 187–8, 189
consultation 382 tastes, changes in 24 impacts on businesses 428–9 venture capitalism 155, 157, 160
corporate influences 345 tax avoidance 487, 490 integration in 425 vertical integration 300, 302
decision making 345 tax evasion 487, 490 locations for production, countries viral marketing 54, 55
differentiation 276 taxation 237, 240, 477, 487 as 444 vision and growth of businesses 146
empowerment 383–4 taxes, indirect 29 and locations for production, volume of markets 2
and growth of businesses 146 Taylor, Frederick W. 99–100, 382 countries as 447
information gathering for teamworking 105, 108 new, as reason for mergers 449 W
development of 295 technology 212, 286, 475–6 North American Free Trade waste disposal 481
prices/pricing 57, 59–60, 62 telephone interviews 10 Agreement (NAFTA) 426, 427 waste minimisation 46, 47, 222,
see also corporate strategy; temporary staff 78 preferential trade area (PTA) 424 228
marketing strategy tertiary sector 130, 136 preferential trading area (PTA) 429 weather 29
stress 146 test marketing 11 regional trade agreements (RTA) websites
strong culture 347–8, 352 time of consumption 16 429 auction sites 60
structure of organisations 92, 95–6 time series analysis 313, 322 rules of origin 429 comparison sites 4, 60
subjective decision making 341, time series data 170–1, 175 single market 425, 429 use of for market research 12
344–5, 345 total costs 41, 178 training 90 welfare of employees 127–8
subordinates 97 total expenditure 31, 34 benefits of 89 wholesalers 65, 68
subscription pricing 60 total float 338, 339 costs 88 window dressing 377, 378
subsidies 29, 30, 422 total quality management (TQM) government schemes 87 work-in-progress 219, 223
substitute goods 24, 26, 288 227–8, 230 induction training 88, 90 working capital 198–9, 202
succession planning 398–9, 399 total revenue 3–8, 31, 34, 176–7 objectives of 88 working conditions 480–1
suppliers trade, conditions prompting off-the-job training 89, 90 world events 29
bargaining power of 288 competition 432 on-the-job training 89, 90 World Trade Organisation (WTO)
resistance to change 393 economies of scale 433, 435 transfer pricing 476, 477 414, 418
security of resources/supplies 450 historical developments 431 transformational leadership
as stakeholders 354, 355 labour productivity 433, 435 388, 390 Z
statement of financial position off-shoring 433, 435 transnational companies zero-based budgeting 186–7,
372 outsourcing 433, 435 415–16, 418 189
supply 30 product life cycle 434, 435 see also multinational companies zero-hours contracts 79, 83

533
Acknowledgements
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wates.co.uk; p.405 www.who.int; p.106 From Anderton and Bevan (2014) Constrained Work? Job
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www.zenithoptimedia.com.

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Photograph acknowledgements
The publisher would like to thank the following for their kind permission to reproduce their
photographs:

(Key: b-bottom; c-centre; l-left; r-right; t-top)

123RF.com: 30, 116, 120, 163, 266, 279, 281, 327, 341, 346, 378, 452, 455, 473, 506,
30, 116, 120, 163, 266, 279, 281, 327, 341, 346, 378, 452, 455, 473, 506, 30, 116, 120,
163, 266, 279, 281, 327, 341, 346, 378, 452, 455, 473, 506, 30, 116, 120, 163, 266,
279, 281, 327, 341, 346, 378, 452, 455, 473, 506, 30, 116, 120, 163, 266, 279, 281,
327, 341, 346, 378, 452, 455, 473, 506, andrej_sv 65, Darren Bradley 283, Dotschock 165,
Ernest Prim 31, Jens Brüggemann 43, 159, odessa4 190, Pakete 285, Andriy Popov 97; Alamy
Images: A Room With Views 509, 421, ableimages 369, Asia 432, Lee Beel 408, Ira Berger
517, Cernan Elias 6, Thomas Cockrem 456, Construction Photography 290, David R. Frazier
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Michael 222, Peter Phipp / Travelshots.com 91, Radharc Images 48, Simon Turner 47, Kumar
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478, len44ik 56, Tsung-Lin Wu 122, 147, 193, midosemsem 200, MNStudio 273, Monkey
Business 303, oneinchpunch 254, Picture-Factory 128, Science Photo 474, Sean Pavone Photo
512, Maksim Shebeko 460, Robert Wilson 389, 434, xy 103, yolfran 40r; Getty Images: 29,
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223, Emmanuel Dunand 148, Amy Eckert 313b, Mike Harrington 414, iStock / 360 23, 227,
kali9 440, William King 257, Maridav 250, Ben Stansall 225, Stockbyte 410r, Mary Turner 82;
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Australia Pty Ltd 360; PhotoDisc: Brofsky Studio Inc 141, 217, 477, L. Hobbs. Photolink.
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Pressmaster 253, Pressmaster. 418, QQ7 453, racorn 145, Rainer Plendl 214, Rafael Ramirez
Lee 411, Alexander Raths 151, Rawpixel 106, 384, RedTC 208t, Kendall Rittenour 400,
ronfromyork 62, SasinT 219, Adrin Shamsudin. 170, 313t, Sozaijiten 459, ssguy 463, Stanimir
G.Stoev 203, Alex Staroseltsev 369b, James Steidl 218, Syda Productions 305, tandemich
419, Ingvar Tjostheim 438, tratong 196, Tumarkin Igor - ITPS 59, Valentyn Volkov 308,
wavebreakmedia 143, 164, 312, Zurijeta 201; Specialized.com: 44; Volkswagen Group: 18t

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536