AS Level

Business
BOOK –– 2
REVISION NOTES
NEW SYLLABUS 2022–23 / 9609

USMAN AKHTER

CELL PHONE: 0300 6161330

 SYLLABUS CONTENTS

BUSINESS 9609 AS-LEVEL REVISION NOTES

Unit 1: Business & Its Environment

1. Enterprise 01

2. Business Structure 13

3. Size of Business 27

4. Business Objectives 41

5. Stakeholders in a Business 52

Unit 2: Human Resource Management

10. Human Resource Management 61

11. Motivation 77

12. Management 93

Unit 3: Marketing

17. The Nature of Marketing 103

18. Market Research 118

19. Product and Price 130

20. Promotion and Place 145

Business Resource Prepared By Usman Akhter

Unit 4: Operations Management

23. The Nature of Operations 166

24. Inventory Management 178

25. Capacity Utilization and Outsourcing 186

Unit 5: Finance and Accounting

29. Business Finance 194

30. Forecasting & Managing Cash flows 205

31. Costs 213

32. Budgets 227

As Level Business Contains 19 Chapters

Unit 1
Business and its Environment

Business Resource Prepared By Usman Akhter

Book-2 Chapter 1 | Enterprise 1

Enterprise Chapter 01
( 1.1 ) The Nature of Business Activity

Business activity aims to satisfy people’s needs. In order to do this it requires resources.
Businesses operate in a constantly changing world, but the purpose of business owners and
managers remains the same, to add value to resources while meeting people’s needs.

Purpose of Business Activity

A business is any organization that uses resource to produce goods and services to meet
the needs and wants of the customer profitably. Business activity at all stages involves
adding value to resources, such as raw materials and semi-finished goods, and making more
desirable to final consumers of them.

Customer:
An individual consumer or organisation that purchases goods or services for a business.

What do Businesses do?

o Businesses identify the needs and wants of customers.

o They purchase necessary resources to allow production to take place.
o They produce goods and services which satisfy customers’ needs, usually with the aim
of making a profit.

Consumer Goods:
K These are these are the physical and tangible goods sold to the general

E public. They include cars and washing machines, computers, furniture, which
are referred to as durable goods and food, drinks, sweets, soap, shampoo
Y
and petrol as non-durable goods.
D
Consumer Services:
E
These are non-tangible product that are sold to the general public and
F
include hotel accommodation, banking, education, cargo services, insurance
services and train journeys.

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Book-2 Chapter 1 | Enterprise 2

Capital Goods:
KEY
The physical goods used by industry to aid in the production of other goods
DEF and services, such as machines, components, raw materials and commercial
vehicles.

Factors of Production

Land: This is general term not only includes land itself but all of the natural resources of
nature, such as coal, crude oil, minerals, fertile land, and timber extracted from the earth.

Labour: Manual and skilled labour make up the workforce of the business.

Capital: This is not just the finance needed to set up a business and pay for its continuing
operations but also all of the man-made resources used in production. This includes
computers, machines, factories, fixtures, office and vehicles.

Enterprise: This is the driving force, provided by risk-taking individuals, that combines the
other factors of production into a business that is capable of producing goods and services. The
entrepreneur provides managing, decision making and coordinating role.

The Concept of Adding & Creating Value

K Added Value is the difference between the cost of production and the selling

E price of the finished goods that are sold to customer. Businesses add value to

Y increase profitability and to gain a competitive advantage.

D
Creating Value (Adding Value):
E Increasing the difference between the cost of purchasing bought-in-materials
F and the price the finished goods are sold for.

All businesses aim to create value by selling goods and services for a higher price than the cost
of materials. So creating and adding value is one of the key objectives of any business.

If a customer is prepared to pay a price that is much greater than the cost of materials, then
the business has been successful in ‘adding/creating value’. Added value is the process of
increasing the value or worth of a good or service.

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Book-2 Chapter 1 | Enterprise 3

From the value added by the business,

other costs have to be paid, such as
labour and rent ─ value added is
not same as profit because of
liabilities and other expenses.
(Gross Profit)

Opportunity Cost

Opportunity Cost is the benefit of the next most desired option which is
KEY given up. It is the cost of any activity measured in terms of the best
DEF alternative forgone and a sacrifice related to the second best choice
available to someone who has picked among several mutually exclusive choices.

In deciding to purchase or obtain one item,

we must give up other goods as they cannot
all be purchased. There are insufficient
goods to satisfy all of our needs and wants
at any one time. It is the purpose of
economic activity to provide for as many of
our wants as possible, yet we are still left
wanting more. This ’shortage’ of products
and the resources needed to make them lead
to us all having choices.

Scarcity and Choice:

Governments face the fundamental problem
when deciding how to allocate their limited
funds on what seem to be unlimited demands
for public goods and merit goods. Choices
have to be made as not all wants can be met.
Choice should seek to maximize the benefits
for all and not just a few people.

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Book-2 Chapter 1 | Enterprise 4

The Dynamic Business Environment

Setting up a new business is risky because the business environment is dynamic, or constantly
changing. In addition to the problems and challenges referred to below, there is also the risk of
change, which can make the original business idea much less successful. This problem can be
made worse if the business plan is too inflexible to deal with changes. Changes in the business
environment include:

o New competitors entering the market.

o Legal changes – examples include new safety regulations or limits on who can buy the
product.
o Economic changes that leave customers with less money to spend.
o Technological changes that make the products or processes of the new business
outdated.

Why do some Businesses succeed?

These are the main reasons why some businesses achieve success in meeting their objective:

o Good understanding of customer needs – leads to sales targets being achieved.

o Efficient Management Operations – keeps costs under control.
o Flexible decision making to adapt to new situations – allows investment in new
business opportunities.
o Appropriate and Sufficient Sources of Finance – prevents cash shortages and allows
for expansion.

Why do some Businesses fail?

(1) Lack of Record Keeping

The lack of accurate records is a common reason for business failure. Many small companies
fail to pay sufficient attention to record-keeping. They believe it is less important than
meeting customers’ needs and think that they can remember everything. But it’s very
difficult to manage a business without some written financial records.

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Book-2 Chapter 1 | Enterprise 5

(2) Lack of Case (Working Capital)

Running short of capital to run day-to-day business affairs is the most common reason for
the failure of new businesses to survive in the first year of operation. Working capital is needed
to buy the stocks and fulfilling the necessary day to day expenses of the firm.

The problem can be managed through preparing cash flow statement, establishing good
relationship with suppliers, and banks and with the help of effective credit control process.

(3) Poor Management Skills

Most entrepreneurs have some form of work experience, but not necessarily at a management
level. They may not have gained experience of::

o Leadership Skills;
o Cash Handling and Cash Management Skills;
o Planning and Coordinating Skills;
o Decision Making and Communication Skills;
o Marketing, Promotion and Selling Skills.

Local, National & International Businesses

Local businesses operate in small, well-defined parts of a country. Their owners often do not
aim to expand so do not make attempts to attract customers across the whole country. Typical
examples are small building and carpentry firms, single-branch shops, hairdressing businesses
and car repairing services.

National businesses have branches or operations across a country. They make no attempt to
establish operations in other countries or to sell internationally. Good examples include large car-
retailing firms, retail shops with branches in just one country and national banks.

International businesses sell products in more than one country. This may be done by
using foreign agents or online selling.

Multinational businesses have operations in more than one country. This means they have
an established base for either producing or selling products outside their own domestic economy.

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Book-2 Chapter 1 | Enterprise 6

( 1.2 ) The Role of Entrepreneur

KEY Entrepreneur is someone who takes the financial risk of starting and
DEF managing a new business venture.

New business ventures started by entrepreneurs can be based on a totally new idea or a new
way of offering a service. People who have set up their own new business and have shown skills
of ‘entrepreneurship’. They have:
 Has an idea for a new business and create an effective business plan;
 Invested some of their own savings and capital;
 Accepted the responsibility of managing the business;
 Accepted the possible risks of failure.

Characteristics of Successful Entrepreneurs

Innovation:

The entrepreneur must be able to develop a new innovative ideas in the market, attract
consumers in creative ways and present their business as being ‘different and unique’ from
other in the same market.

Commitment & Self-Motivation:

New business requires hard work and may take up many hours of each day. A willingness to
work hard, commitment, energy and focus are all essential qualities of a successful owner.

Multi-skilled:

Different tasks such as making the products, pricing, and promotion and select the right
place to sell the products, require a person who has many different qualities, such as being keen
to learn technical skills, able to handle people and financial resource of the firm.

Leadership Skills:

The entrepreneur will have to lead by example acting as a role model and must have a
personality encourages people in the business to follow him/her and be motivated.

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Book-2 Chapter 1 | Enterprise 7

Self-confidence & ability to ‘bounce back’:

An entrepreneur should have self-belief in themselves and their business ideas that he or
she would ‘bounce back’ from any setbacks.

Risk Taking Ability:

Entrepreneurs must be willing to take risks in order to obtain the success. Often the risk
they take is by investing their one savings in the new business.

Barriers to Entrepreneurship

(1) Identifying Successful Business Opportunities

Identifying successful business opportunity (idea) is one of the most important stages in
becoming an effective entrepreneur, the idea comes from the following sources:

 Own skills and hobbies such as dress making or car body work repairing.
 Previous employment experiences.
 Franchising contracts and exhibitions.
 Small budget market research using internet or conducting surveys in markets.

(2) Sourcing Capital: (Finance)

Once the entrepreneur has decided on the business idea or opportunity, the next task is to
raise the necessary capital. Why is obtaining finance such a major problem for businesses?
o Lack of sufficient own finance and awareness of the financial support such as grants.
o Lack of any trading record to present to banks as evidence of past business successes.
o A poorly produced business plan that fails to convince potential investors and the
shareholders to invest in the business.

(3) Cost of Good Location

Most important consideration when choosing the location is the need to minimize fixed costs.
When finance is limited, it is very important to try to keep the break-even level of output ─
the output level that earns enough revenue to cover all costs ─ as low as possible. This will
greatly increase the chance of survival.

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Book-2 Chapter 1 | Enterprise 8

(4) Competition

Due to highly competitive nature of the market, a firm must have unique idea related to
product or service. A newly created business will often experience competition from older
established businesses, with more resources, mature procedures and more market knowledge. A
business must offer a better customer service in order to capture the market.

(5) Building a Customer Base

To survive, a new firm must establish itself in the market and build up customer numbers as
early as possible. The long-term strength of the business will depend on encouraging
customers to repeat purchase products again and again. This might include::

o Provide Personal Customer Services;

o Provide Information about the product along with pre and after-sales service;
o Providing promotion offers such as discounts, gifts, reward points and one-off customer
requests on customer complains.

Business Risk & Uncertainty

There are some differences between business risk and business uncertainty. All business
decisions involve risk. For example, there is a chance that a new business selling clothing will
fail. For examples, last 12 months, 10 clothing retailers have been established in a city and 3 fail
by the end of the year, the risk of failure was 30%.

A new entrepreneur could possibly reduce the risk of their new clothing business failing by
studying why these three businesses did not survive. This would allow the entrepreneur to
reduce business risk by avoiding the errors made by the failed businesses. Business planning is
used to reduce risk.

Business uncertainty is different. Uncertainty cannot be foreseen, measured or calculated.

Plans may be made by entrepreneurs for the future, but some events will always be unforeseen
and impossible to predict. The 2020 COVID-19 epidemic caused such a fall in spending by
consumers that many small and newly set-up businesses were forced to close. This is an
excellent example of uncertainty that was impossible to forecast and very difficult for any
business to prepare for.

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Book-2 Chapter 1 | Enterprise 9

Role of Enterprise in a Country’s Economic Development

All governments around the world are making policies that aim to encourage more people to
become entrepreneurs. The claimed benefits are:

Employment Creation:
While setting up a business an owner is employing not only themselves, but creating
employment opportunities to other people too. If the business survives and expands, then
there may be additional jobs created for businesses that raise the employment level.

Economic Growth:
Any increase in output of goods and services from establishment of a business will increase
the gross domestic product (GDP) of the country and this growth lead to increased living
standards for the population and will also lead to increased tax revenue for the government for
public sector spending.

Firm’s Survival and Growth could improve the Gross Domestic Product (GDP):
Moderate proportions of new firms survive and expand to become really important businesses
for the economy, employee thousands of workers and increases the gross domestic product
adds to economic growth.

Innovation and technological Change:

New businesses use Research & Development to become innovative and this creativity adds
technological improvements in an economy. The increased use of IT services can help a
nation’s business sector to become more advance and competitive.

Exports:
Some businesses will expand their operations to the export market, and this will increase the
value of a country’s exports and improve its international competitiveness along with GDP.

Employee Development:
This means employee development through working in professional environment.
Establishing a successful business can aid in the development of useful skills and help to develop
the personalities and well organised social behavior.

Increased social cohesion between the people of the society:

By creating jobs and career opportunities can help to achieve social relationships between
the people in the economy. This will helps to develop an organised culture in the economy.

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Book-2 Chapter 1 | Enterprise 10

The Role of Intrapreneurship

‘Intrapreneur’ is the term given to people who have the same qualities as
KEY
entrepreneurs and are encouraged to demonstrate the same skills as
DEF
entrepreneurs within an existing business.

Many successful businesses allow people to take risks and show initiative – just as
entrepreneurs do – even when the business is established. Businesses must be innovative and
need to keep their best managers. Rapid advances in technology allow new business start-ups to
disrupt existing markets and business operations. The attractions of entrepreneurship can lead to
many dynamic employees leaving a business that does not encourage them to be creative.
Hence the development of intrapreneurship. This is the process of encouraging risk-taking and
enterprise by employees within a business to help create and develop new opportunities.

There are three key differences between an entrepreneur and an intrapreneur:

Entrepreneur Intrapreneur

Developing an innovative product / project

Main Activity Starting up a new business
within an existing business

Risk Taken by the entrepreneur Taken by the business

Reward To the entrepreneur To the business

The benefits of intrapreneurship to existing businesses include:

 Injecting creativity and innovation into the business – developing new products to
increase sales or creating exciting ways of selling existing products.

 Developing new ways of doing business – creativity in solving problems such as low
efficiency can be more successful than continuing to use the] old ways.

 Driving innovation and change within the business – generating excitement within
the business about a new opportunity makes change more acceptable.

 Creating a competitive advantage – by developing more innovative products.

 Encouraging original thinkers and innovators to stay in the business – this is

summed up by the expression: ‘You don’t have to leave our company to become an
entrepreneur!

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Book-2 Chapter 1 | Enterprise 11

( 1.3 ) Purpose & Key Elements of Business Plan

Business Plan is a detailed document giving detailed information about a new

KEY
or existing business that aims to convince external investors and lenders to
DEF
raise finance for the business.

A business plan aims to convince external stakeholders:

(1) Introduction::
This will contain the nature of the business, its main aims and objectives, the amount of
finance required and the specific use to which this finance will be put.

(2) Business Description::

Containing evidence of past performance, legal structure, capital structure and the
background and business experience of the main owners and the board of directors selected from
the shareholders.

(3) Market Research and Marketing Plan::

This section will provide evidence of the research to support the view that the goods and
services will be successful. The business will have to make a sales forecast for the new product.
The marketing strategies such as product, price, promotion and place that will be adopted for
the successful launch and market growth of the product will be outlined.

(4) Production Plan::

This production plan will detail how the firm intends to produce the good or service in sufficient
quantities and to the necessary quality levels. Decision about the method of production such
as job, batch or flow production has to be selected.

(5) Human Resource Planning::

This part of the business plan contains the details about workforce planning, training
programs designed for employees and other employee benefit schemes such as PRP, bonus,
fringe benefits and employee welfare.

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Book-2 Chapter 1 | Enterprise 12

(6) Financial Information::

Financial information contains forecasted cash flow budgets, a projected profit & loss

account and balance sheet and even a forecasts break-even analysis will all help to
convince investors that this business proposal is worth supporting.

Without this detailed business plan the banks and financial institutes will be reluctant to provide
money to the business.

Limitations of Business Plans

Even a detailed business plan does not guarantee a successful business. In fact, it could create
a false sense of certainty in business owners. They might rely so much on the plan that they
overlook the fact that it is based on forecasts and predictions.

The business plan must be detailed and supported by evidence such as market research. If it
is not, then prospective creditors and investors can delay in making a finance decision until the
plan is brought up to the required standard.

The plan might lead entrepreneurs to be inflexible. If the dynamic business world throws up
new opportunities that are not in the plan, these could be rejected. This could mean that options
for future profits and growth are rejected. The best business plans allow for some flexibility as
external events change.

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Book-2 Chapter 2 | Business Structure 13

Business Structure Chapter 02

( 2.1 ) Classification of Business Activity

Firms produce a vast range of different goods and services, but it is possible to classify these
into three broad types of business activity.

Primary Sector Business Activity

(Stage 1)

Those firms engaged in farming, mining, fishing,

foresting, oil extraction and all other industries
that extract natural resources so that they can
be used and processed by other firms.

Secondary Sector Business Activity

(Stage 2)

Those firms that manufacture and process

products from natural resources, including
computers, baking, clothes making, car
manufacturing, food processing, cloth making,
furniture production and construction.

Tertiary Sector Business Activity

(Stage 3)

Those firms that provide services to consumers

and other businesses, such as retailing, education,
cargo, transport, insurance, banking, hotels,
software development, medical and tourism.

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Book-2 Chapter 2 | Business Structure 14

Changes in Relative Importance of Economic Sectors

The importance of each sector in an economy changes over time. Industrialization is the term
used to describe the growing importance of the secondary sector manufacturing industries in
developing countries. The relative importance of each sector is measured in terms either of
employment levels or of output levels (GDP) as a proportion of the whole economy.

Benefits of Increase in Industrialization:

o Total national output (GDP) increased and this raises average living standards.
o Increasing output of goods can result in lower imports and higher exports of such
products improve the countries balance of payment.
o Expanding manufacturing businesses will result in more jobs being created which
reduced the level of unemployment.
o These firms pay more taxes to government.
o Value is added to countries output of raw materials, rather than just exporting these as
basic, unprocessed products.

Problems of Increase in Industrialization:

o The chance of work in manufacturing can encourage a huge movement of people from
the country to the towns, which leads to housing and social problems.
o Imports of raw materials and components are often needed, which can increase the
country’s import costs.

Public & Private Sector of the Economy

The Private sector comprises businesses owned and controlled by private individual or groups
of individuals. The objective of private sector is to earn maximum profits and increasing the
size of the firm. In nearly every country, most business activity exists in the private sector.

The public sector comprises organizations accountable and controlled by central or local
government. The objectives of this sector are to provide low cost or even free services to
everyone living in the economy. In most countries, certain important goods and services are
provided by these state-run organizations include health and education services,
infrastructure facilities, defense and public law.

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Book-2 Chapter 2 | Business Structure 15

P
P
R
U
I
B
V
L
A
I
T
C
E

S S
E E
C C

Public Corporations

Public Corporation ▬
KEY
Public corporation is a business enterprise owned and controlled by the state
DEF
of the country usually managed by the central government.

In every country there will be some enterprises that are owned by the state ─ usually central
or local government. These organisations are therefore in the public sector and they are referred
to as public corporations. The do not often have profit as a major objective. Such as TV,
Radio, Electricity, Water Supply, Health and Education Services, Road Construction.

Advantages of Public Corporations:

o Managed with social objectives rather than running with profit objectives.
o Loss-making services might still be kept operating if the social benefit is great enough.
o Finance raised mainly from the central government through taxation.

Disadvantages of Public Corporations:

o Tendency toward inefficiency due to lack of strict profit maximization targets.

o Subsidies from government can also encourage inefficiencies.
o Government may interfere in business decisions for political reasons.

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Book-2 Chapter 2 | Business Structure 16

( 2.2 ) Business Ownership

Business Organisations

Private Sector Public Sector

Sole traders Partnership Companies Cooperatives Other forms Public Municipal

(Unlimited Liability & Corporations Corporations
Unincorporated Businesses)

Private Limited Public Limited

(Limited Liability & Incorporated Businesses) Design by Usman

Sole Trader

Sole trader in which one person provides the permanent finance and in
KEY
return, has full control over the business and is able to keep all of the
DEF
profits.

This is the most common form of business organization. Although there is a single owner in this
business organization, it is common for sole traders to employ others, but the firm is likely to
remain very small, and the owner has unlimited liability, no separate legal identification
and lack of continuity.

Many sole trades remain small because the owner wishes to remain in control of their own
business; another reason is the limitations that they have in raising additional capital. This
type of business organization is most commonly established in the construction, retailing, and
hairdressing, car-servicing, retailing and catering trades.

Unlimited Liability:
All sole traders have unlimited liability. This means that the owner’s personal possessions
and property can be at risk and taken to pay off the debts of the business.

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Advantages of Sole Trader:

o Easy to set up ─ very few legal formalities and restrictions.

o Owner keeps all the profits.
o Able to choose times and patterns of working.
o Able to establish close personal relationships with staff and customers leading to direct
feedback. Sole trader can offer personal services to their customers.
o The business can be based on the interests or skills of the owner.
o It is easier to keep overall control, because the owner has a hands-on approach to
running the business and can make decisions without consulting anyone else.

Disadvantages of Sole Trader:

o The sole trader has no one to share the problems and responsibilities of running the
business with.
o Unlimited liability ─ all of owner’s assets are potentially at risk.
o Often faces competition from bigger firms.
o Owner is unable to specialize in different areas of the business, personally responsible
for all aspects of management.
o Difficult to raise additional capital for expansion and other activities.
o Long hours often required to make business successful.
o Lack of continuity ─
As the business does not have separate legal status, the business rely on the ability
and drive of one person. If that person loses interest or dies then the business will
cease.

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Partnership

Partnership a business formed by two or more people to carry on a business

together, with shared capital investment and, usually, shared responsibilities
KEY
with a view to making a profit.
DEF
A Partnership Agreement is the written and legal agreement between
business partners.

When planning to go into partnership it is important to choose business partners carefully ─ the
errors and poor decisions of any one partner is considered to be the responsibility of all.

A Partnership Deed between all partners. This would provide agreement on issues such as
voting rights, the distribution of profits, and the management role of each partner and who has
authority to sign contracts.

Advantages of Partnership:

o Partners may specialize in different areas of business management; they may improve
the running of the business by dividing the tasks and the responsibilities.
o Shared decision making improves the efficiency of the business.
o More people are also contributing capital, which allows for more flexibility in running the
business.
o Partners can share the workload. They will be able to cover each other for holidays and
illness. They can also exchange ideas and opinions when making decisions.
o Business losses shared between the partners.
o Greater privacy and fewer legal formalities then corporate organisations.

Disadvantages of Partnership:

o Unlimited liability for all partners.

o Profits are shared between the partners.
o There is no continuity and the partnership will have to be reformed in the event of the
death of one of the partner.
o All partners are bound by the decisions of any one of them acting as a representative; any
decision made by representative is legally binding on all other partners.
o Not possible to raise capital from selling shares.

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o A sole trader, taking on partners, will lose independence of decision making.

o Disputes can arise over decisions that have to be made, or about the effort that one
partner is putting into the firm compared with another.

Limited Companies

A limited company differs from other organisations because it has a separate legal personality;
exist separate from that of its shareholders and has limited liability.

There are three distinct and important differences between companies and the two forms of
‘unincorporated’ business organisations.

(1) Limited Liability:

The ownership of companies is divided into small units called shares. People can buy these shares
and becomes ‘shareholders’ ─ part owners of the business. All shareholders benefit from the
advantage of limited liability. It means the shareholders are not personally liable for the
payments of debts of the company, and their personal possessions are not at risk.

(2) Legal Personality:

A company is recognized in law as having a legal identity separate from that of its owners. This
means if the product sold by a company is found to be dangerous or faulty, the company itself
can be liable and taken to court. A company can be sued and the current directors can be
legally responsible if they knowingly continue trading with a company that is illiquid.

(3) Continuity:

The death of an owner or director does not lead to its break up or dissolution. A limited
company will continue to operate for as long as there is a board of directors from the
shareholders taking the responsibility to continue the business operations. The ownership
continues through the inheritance of the shares, and there is no break in ownership at all.

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Private Limited Companies (PVT)

Private limited company a small to medium-sized business that is owned

KEY by shareholders who are often members of the same family. This company
DEF cannot sell shares to the general public, but has an incorporated status
with limited liability, separate entity and continuity.

The word ‘Limited’ or ‘Ltd’ tells us that the business has this legal form. The shares of a private
limited company will be owned by the original sole trader relatives, friends and employees.
The former sole trader often still has a controlling interest by accruing 51% shares of the
company. New issues of shares cannot be sold to the open market and existing shareholders
may only sell or transfer their shares with the agreement of the other shareholders.

Advantages of Private Limited Companies:

o All Shareholders from friends and family members have limited liability.
o Separate legal personality for all shareholders.
o Continuity in the event of the death of a shareholder.
o Original owner is still often able to retain control.
o Able to raise capital from sale of shares to family, friends and employees.
o Greater status as compared to unincorporated business.
o A limited company is able to gain access to a wider range of borrowing opportunities.
This makes funding the growth of the business potentially easier.

Disadvantages of Private Limited Companies:

o Legal formalities involved in establishing the business are much more complicated,
such as by law, company accounts must be audited by independent external auditors.
o Capital cannot be raised by sale of shares to general public. (Article of Association)
o Quite difficult for shareholders to sell shares.
o End of year accounts must be sent to all the shareholders after inspection by the
financial auditors.
o Profits have to be shared out amongst a much larger number of shareholders.
o Firms are not allowed to sell shares to the public. This restricts the amount of capital
that can be raised. (Article of Association)
o Number of stockholders cannot exceed a fixed figure (commonly 50). (Article of Association)

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Public Limited Companies (Plc)

Public limited company a limited company, often a large business, with the
KEY
legal right to sell shares to the general public ─ share prices are quoted on
DEF
the national stock exchange.

These can be recognized by the use of ‘plc’ after the company name. A plc has all the advantages
of private company plus the right to advertise their shares for sale and have them listed or
quoted on the Stock Exchange. Existing shareholders may quickly sell their shares if they wish
to. This flexibility of share buying and selling encourages the public to invest into the company
through buying the shares. The directors are appointed by the shareholders in the annual
general meeting (AGM) held at the end of every year.

Advantages of Public Limited Companies:

o Limited liability for all shareholders, they are not liable for the debts of the business;
they can lose no more than the sum they invested.
o Separate legal identification for all shareholders.
o Continuity in case of death of shareholders.
o Ease of buying and selling of shares for shareholders.
o Access to substantial capital sources due to the ability to issue shares in stock
exchange and prospectus to the general public.
o Production costs may be lower as firms may gain economies of scale due to large scale
production of goods and services.
o Bankers and suppliers are likely to offer listed companies more attractive credit facilities.

Disadvantages of Public Limited Companies:

o Legal formalities involved in establishing the business are much more complicated,
such as by law, company accounts must be audited by independent external auditors.
o High Cost of business consultants and financial advisers when running such a company.
o Share prices subject to fluctuate according to the market conditions.
o Legal requirements concerning disclosure of information to shareholders and the
public, for example annual publication of detailed report and accounts.
o Risk of takeover due to the availability of the shares on the Stock Exchange, this risk is
called divorce of ownership and control.
o Become too large resulting in poor labour relations leads to diseconomies of scale.

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Book-2 Chapter 2 | Business Structure 22

Shareholders

Shareholders are owners of an incorporated business who have invested their capital in the
business by means of buying shares. They have the right to vote in the annual general meeting,
have limited liability and receive dividends at the end of every year.

Prospectus: (Published Accounts of a Public Limited Company)

A PROSPECTUS is a detailed audited annual document issued by the directors of a public

limited company. This prospectus containing an annual report that shows the financial position
of the company at the end of the year. These are also called published accounts of a limited
company.

Dividends

Dividends are payments made to shareholders from the profits of a company after it has paid
corporation tax. They are the return to shareholders for investing in the company.

Legal Formalities in Setting up a Company

A company is formed when certain documents such as memorandum and articles of

associations are registered by people, with the Registrar of Companies and various fees and
duties are paid to the Registrar.

(1) A Memorandum of Association must be completed. This states the name of the company,
the address of the head office, the maximum share capital for which the company seeks
authorization and the declared aims of the business. The form of the company such as private
limited company or public limited company is written, and a statement that the liability of the
company is limited.

(2) Article of Association is a document that defines the rights and duties of a company’s
shareholders and directors. It contains regulations for calling meetings of shareholders, members’
voting rights, and the names of directors.

When these documents have been complete satisfactorily. The Registrar of Companies will issue a
certificate of incorporation.

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Book-2 Chapter 2 | Business Structure 23

Co-operatives

Co-operatives are jointly owned business operated by members, agree to

KEY
work together and share their resources with the objective of providing
DEF
mutual benefits to their members.

Co-operatives are organizations that are owned by their member. This is a very common form of
organization in some countries where group of people join together to provide benefits to the
members, especially in producer co-operatives, retailers
co-operatives, agriculture co-operatives, consumer co-operatives, workers co-operatives and
social co-operatives (NGO’s).

Certain features are common to all co-operatives:

o All members can contribute to the running of the business, sharing the work load,
responsibilities and decision making.
o All members have one vote at important meetings.
o Profits and benefits are shared equally amongst members.

Advantages of Co-operatives:

o Buying in bulk.
o Working together to solve problems and take decisions.
o Good motivation of all members to work hard as they will benefit from shared profits.
o In most cases, the liabilities of the members are limited to the extent of capital
contributed by them.

Disadvantages of Co-operatives:

o Poor management skills unless professional managers are employed.

o Capital shortages because no sale of shares to the non-member general public is
allowed.
o Slow decision making if all members are to be consulted on important issues.
o Co-operative financial strength depends on the contributions made by the members and
loan raising capacity from banks. The funds are limited, thus, cooperative are not
suitable for the large scale business which require huge capital.

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Book-2 Chapter 2 | Business Structure 24

Franchise Business

A FRANCHISE is a business based upon the legal right to use the brand
KEY names, promotional logos and trading methods and procedures of an existing

DEF successful business.

For example: McDonald’s, KFC, Tessco Retail and Levis.

Franchiser: (Owner):
The franchisor sells the license to the franchises, and allows the use of brand name.

Franchisee (Employee):
The franchisee buys the license to operate this business from the franchisor and responsible for
operating the firm according to the policies of company.

The franchisee will provide most of the investment for a small scale operation, and in return for
a payment to the franchisor, a royalty on revenue paid. The franchisee will be able to use the
name and logos as well as benefiting from the marketing, productions and human resources
of the main company.

A franchise is not strictly a form of legal structure

for a business but it is a legal contract between
two firms. This contract allows one of them, the
franchisee, to use the name, logo, working
procedures of the franchiser. The franchisee can
separately decide which form of legal structure
to adopt such as sole trader, partnership, private
or public limited company.

Franchise helps multinational to become household names, to expand much rapidly.

For examples McDonald’s and body shop.

Examples of Multinational Companies offer Franchise Contracts:

Dunkin’ Donuts, Star Bucks, Pizza Hut, Subway, The UPS Retail Store, Cherry Berry,
One Potato Two Potato, Popeye’s Lousiana Kitchen, Hardees, Nestle, FedEx Logistics, 7-Eleven.

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Joint Ventures

Joint Venture ▬ A joint venture is when two or more businesses agree to

KEY
start a new project together, sharing the capital, risks and profits and
DEF
create a separate business division and corporate identity.

This is not the same as a merger; but it can lead to mergers of the businesses if their joint
interests matched and if the joint venture is successful.
Such as Soni and Ecricson, Tata and Land Rover for making cars.

Advantages of Joint Ventures:

o Costs and risks of a new business venture are shared ─ for example developing a new
product and completing a particular project.
o Different companies might have different strengths and experiences and they therefore
fit well together;
o They might have their major markets in different countries and they could exploit these
with the new product more effectively than if they both decided to ‘go it alone’.

Disadvantages of Joint Ventures:

o Styles of management and culture might be so different that the two teams do not
blend well together; such as Crysler and Mercedeez Benz.
o Errors and mistakes might lead to one blaming the other for mistakes.
o The business failure of one of the partners would put the whole project at risk.

Nishat Group of Companies Signed a Contract of Joint Venture with Hyundai:

Hyundai Nishat is a Pakistani automobile

manufacturer and signed a contract of joint
venture with Hyundai based in Faisalabad,
Pakistan.

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Social Enterprise

Social Enterprise is a business with mainly social objectives that reinvests

KEY
most of its profits into benefiting society rather than maximizing profits
DEF
and providing returns to owners and shareholders.

Social Enterprise is a proper private sector business that makes its money in socially
responsible ways and uses most of any surplus spends to providing benefit to society.

 They directly produce goods or provide services, with social aims and ethical ways.
 They need surplus or profit to survive as they cannot rely on donations and charities.

Objectives of Social Enterprise (TBL)

Social enterprises often have three main aims. These are called Triple Bottom Line:

Economic -- Make a profit to reinvest back into the business for providing benefits
to society.

Social -- Provide jobs and support such as education, food subsidies, health
care and job training opportunities for poor people.

Environmental - To protect the environment and to manage the business in an

Environmentally friendly and sustainable way.

UNICEF, also the United Nations Children’s Emergency Fund, is a United

Nations agency responsible for providing humanitarian and
developmental aid to children worldwide. The agency is recognizable
social welfare organizations, with a presence in 200 countries. UNICEF's
activities include providing immunizations and disease prevention,
enhancing childhood and maternal nutrition, promoting education, and
providing emergency relief in response to disasters.

Changing the form of Business Ownership

Most businesses do not change their form of business ownership over time, but many do. The
most likely advantages of changing from one form of ownership to another (for example, sole
trader to private limited company) can be summarised as:

 Access to more finance, Gaining legal identity, protecting owners’ capital using limited liability.
`

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Book-2 Chapter 3 | Size of Business 27

Size of Business Chapter 03

( 3.1 ) Measuring of Business Size

It is common to compare businesses by their size. Who wants to know how large a particular
business is? Internal and external stakeholders are interested in making the comparison
between the firms for the sake of their stake in businesses.

Difference Measures of Size for the Firms

( 1 ) Number of Employees

The number of employees is an easy way of measuring the size of a business. It is easy to
understand to everyone that shops with just the owner with few workers is small, and a firm
employing many staff is likely to be large.

It can be difficult to compare businesses in different markets using this measure, for
example, a retail business may employ more people than a car manufacturer, but this does not
mean the retailer is larger. This is because the car manufacturer uses a large amount of
machinery, which required fewer workers. This method is suitable for labour-intensive firms
which hire workers to produce products, and not suitable for automated factories which use
the machines in the replacement of labour.

( 2 ) Capital Employed

Capital Employed is the total value of all long-term finance invested in the
DEF
business.

Generally, the larger the business enterprises the greater the value of capital needed for long-
term investment. The value of capital employed calculates the value of everything the
business owns in the form of assets.

Problem: Two firms employing the same number of staff may have very different capital
equipment needs, such as a hairdresser and an optician. The optician will need expensive
diagnostic and eyesight measuring machines.

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( 3 ) Sales Turnover

Sales Turnover is the total value of sales made by a business in a given

DEF
time period.

The level of sales turnover can be used to measure the size of the business ─ especially when
comparing firms in the same industry such as retailers. It is less effective when comparing
firms in different industries because some might be engaged in ‘high-value’ production, such
as precious jewels, and another might be in ‘low-value’ production, like cleaning service.

( 4 ) Market Capitalisation

Market Capitalization is the total market value of a company issued

KEY
shares, calculated by multiplying the price of its shares on the Stock
DEF
Exchange by the number of shares issued.

This can only be used for business which have shares ‘quoted’ on stock exchange called
public limited companies. Markets are very volatile and share prices change every day does
it alter the size of the business every day.

It is calculated by this formula:

Market Capitalisation = Current Share Price × Total Number of Shares Issued

( 5 ) Market Share

Market Share is the sales of the business as a proportion of total market

DEF
sales.

The market share of the business is normally measured as a percentage. Obviously, the larger
the percentages share of the market the larger the business.
This is calculated using the following formula:

Sales of the Business

Market Share = × 100
Total Market Sales

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Book-2 Chapter 3 | Size of Business 29

This is a relative measure. If a firm has

a high market share it must be
among the leaders in the industry and
comparatively large and considered to
be the market leader. Market share
method is mostly suitable for highly
competitive businesses.

Other Measures that can be used

These will depend very much on the industry. The number of guest beds is used to compare
hotel businesses. The number of shops could be used for retailer. The number of student is
used to compare the school industry.

Which form of measurement is best?

There is no ‘best’ measure. The one used depends on what needs to be established about
the firms being compared. This could depend on whether we are interested in absolute size or
comparative size within one industry.

This will also depend on the type of the product, market size of the industry, nature of the
target audience form of business, capital and labour intensive nature of the firm.

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( 3.2 ) Significance of Small Business

Small firms are designation for firms of a certain size which fall below
KEY
certain criteria (that varies from country to country) in terms of annual
DEF
turnover, number of employees, total value of assets.

It will be easy to identify small businesses. They will employee few people and will have a low
turnover compared to other firms.

Small firms are very important to all economies. Encouraging the development of small
business units can have the following advantages:

Benefits of Small Businesses for the Economy

 Small firms create employment even though each firm may not employ many staff;
collectively the small business sector employs a very high proportion of the working
population in most countries.

 Small businesses are often run by dynamic entrepreneurs with flexible approach and
new ideas and innovations for consumer goods and services. This helps to create
variety in the market and choice for the consumers.

 All great businesses were small at one time and grow with the passage of time such as
Microsoft and Apple Corporations.

 Small firms did not enjoy economies of scale, but some of the overheads are less then
the large scale firm, this could lead to lower average cost and this benefit could be
passed on to the consumer too for example advertisement expenditure.

 Small firms supply specialist goods and services to important industries in a country,
such as raw materials and components, auditing, cleaning, repairing, advertisement and
IT services.

 Small firms are able to quickly adapt the market changing needs, taste and fashion of
the customers, so they increase the competitiveness for the larger organisations.

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Advantages of Small Businesses

o Small firms can be managed and controlled directly by the owners, little risk of losing
control.
o Small firms are able to adapt quickly to meet changing customer needs.
o They offer personal and better services to customers to help build customer loyalty.
o Easier to know each worker increasing the motivation level and overall productivity.
o Can be started up and operated with low capital investment.

Problems Faced by the Small Businesses

o Lack of Specialist Management Expertise:

Often the owner has to undertake all management functions ─ such as marketing,
operations and keeping accounts because the business cannot afford to employ
specialists for each department.

o Problems in Raising Both Short and Long-Term Finance:

Small firms have low status and little security to offer banks in exchange for loans
and this makes obtaining finance much more difficult as compared to larger firms.

o Marketing Risks from a Limited Product Range:

Many small firms produce just one type of good or service and offering small product
portfolio ─ so they have marketing risk of offering very limited range of the products.

o Difficulty in Finding Suitable and Reasonable Priced Premises:

The best location is tend to be expensive and often only affordable by larger firms.

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Strengths & Weaknesses of Family Businesses

Family-owned businesses are those that are actively owned and managed by
DEF
at least two members of the same family.

Strengths of Family Businesses

Commitment ▬

The family owners often show dedication in seeing the business grow, prosper and get passed
to the future generations, and reinvest profits to allow the firm to grow.

Reliability & Pride ▬

Family businesses have their reputation associated with their products and strive to increase
the quality to maintain good relationship with their stakeholders.

Knowledge Continuity ▬

Families make it a priority to pass their accumulated knowledge, experience and skills to the
next generation.

Weaknesses of Family Businesses

Informality ▬

Most families run their businesses themselves may lack some professional business practices
and procedures.

Traditional ▬

There is quite often a reluctance to change systems and procedures, preferring to continue with
old procedures, and lack of innovative ideas.

Conflict ▬

Problems within the family may reflect on management of the business and make effective
decision less likely.

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Book-2 Chapter 3 | Size of Business 33

( 3.3 ) Business Growth

Business growth can be achieved in a number of ways and these different forms of growth can
lead to various effects on stakeholder groups, such as customers, workers, suppliers and
competitors. The different forms of growth can be grouped in to internal and external
growth.

Figure illustrates the concept of business growth:

Business Expansion

Internal Growth External Growth through Integration

Mergers Takeovers

Possible Reasons for Growth

o Increased profits ▬

if the main aim of the owners is profit, then expanding the business and achieving
higher sales is one way to becoming more profitable.

o Increased market share ▬

This will give a business a higher market profile and greater bargaining power with
both suppliers and retailers.

o Increased economies of scale which reduce the average cost of production.

o Increase power and status of the owners and directors.

o Reduce risk of being a takeover.

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Internal Growth

Internal growth means expansion of a business by means of opening new

DEF
branches, shops and factories. It also called organic growth.

Such as opening new branches in different areas, hire more sales staff or develop
additional products, extending the premises and buying some more advanced equipment.

This growth can be quite slow and leads to shortages of capital and management problems.
Internal growth can be best achieved by using retained profits of the firm.

Benefits of Internal Growth

The main advantage is that the business is able to maintain a healthy gearing and
marketing position, because it is not building up external debts. In addition ownership and
control of the business is more likely to be retained by the existing shareholders.

Drawbacks of Internal Growth

Internal growth is typically a slower process, and can be financed by asking shareholders to
contribute more capital, or by ploughing back profits into the business. The main
disadvantage of such an approach is that it takes time, and in the meantime competitors
may be expanding and gaining competitive advantage.

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External Growth

External growth is achieved by means of merging with or taking over another

KEY
business, from either the same or a different industry, also referred to as
DEF
‘integration’ as it involves bringing together two or more firms.

The problems of integration are caused by the need for different management systems to
deal with a bigger organization. There can also be conflict between the two teams of managers
─ Conflict of Culture, Production Methods and Business Ethics.

Merger

Merger is an agreement by shareholders and managers of two businesses to

KEY
bring both firms together under a common board of directors with
DEF
shareholders in both businesses owing shares in the newly merged business.

A MERGER is when the owners of two businesses agree to join their firms together to make one
business. Two firms join together and have equal ownership. For example a merger of two
car manufacturing company Daimler Benz and Chrysler.

Disney and Pixar: (A successful merger between two companies)

Mickey & Nemo, Pinocchio & Toy Story, Cinderella & Cars. The merger of legendary Walt
Disney and Pixar was a match made in cartoon heaven. Disney had released all of Pixar’s
movies and the merger made perfect sense. With the merger, the two companies could
collaborate freely and easily.

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Takeover

Takeover is when a company buys over 50% of the shares of another

KEY
company and becomes the controlling owner of it. It is often referred to as
DEF
‘acquisition’.

A TAKEOVER is when one business buys out the owners of another business because the other
firm is not doing well. It has the ownership of that business. It could be ‘friendly’ or
‘hostile’, that is actively buys as many shares as possible from shareholders to get the majority
of shareholding.

Facebook announced its plans to acquire WhatsApp in February 2018; whatsApp's founders
offered a price of $16 billion; $4 billion in cash and $12 billion remaining in Facebook shares.

Facebook created a holding company

named Meta, under which all of the
applications working as business
units, such as Whatsapp, Instagram,
Facebook, Messenger, and Oculus.

Horizontal Integration

When one firm merges with or takes over another one in the same industry at the same
stage of production. Example: A food restaurant buys another food restaurant.

Vertical Integration

When one firm merges with or takes over another one in the same industry but at a
different stage of production. Vertical integration can be forward or vertical.

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Forward Vertical Integration

Forward Vertical Integration ▬ When a firm integrates with another firm at a later stage
of production, closer to the consumer. The merger gives an assured outlet for their product.
The profit margin made by the retailer is absorbed by the expanded business.
For example, a car manufacturer takes over a car retailing business.

Backward Vertical Integration

Backward Vertical Integration ▬ When a firm integrates with another firm at an earlier
stage of production. Closer to the raw material suppliers, in case of manufacturing firm. The
merger gives an assured supply of important components.
The profit margin of the supplier is absorbed by the business.
For example, a car manufacturer takes over a firm supplying car body panels.

Conglomerate Integration

Conglomerate Integration ▬ is when one firm merges with or takes over a firm in a
completely different industry. This is also known as DIVERSIFICAITON.

Example: (1) A business building houses merges with a business making clothes.

Exampl e: (2) A pizza shop merges with a shoe making company.

Examp le : (3) A toy manufacturing company starts a furniture making firm.

Different types of integrations are given below:

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Type of Integration Advantages Disadvantages

KEY DEFINITIONS o Rationalization may bring

o Eliminates one competitor.
bad publicity for firm.
Horizontal Integration o Possible economies of scale,
─ with firms in the same and scope of rationalization. o May lead to monopoly

industry and at same establishing if the combined

o Increase power over
stage of production. business exceeds certain size
suppliers through bulk buying.
limits.

KEY DEFINITIONS o Consumers may suspect

o Business is now able to
uncompetitive activity and
Vertical ─ forward: control the promotion and
may have less choice because
Integration with a pricing of its own products.
competitor’s products may not
business in the same
o Possibility to make outlets be available.
industry but a customer
for the firm’s products ─ may
of the existing o Lack of experience in this
exclude competitor’s products.
business. sector of the industry.

o Gives control over quality,

KEY DEFINITIONS o May lack experience of
price and delivery times of
managing a supplying
Vertical ─ backwards: supplies.
company.
Integration with a
o Encourages joint research
business in the same o Other firms may become
and development into
industry but a supplier unsatisfied due to having a
improved quality of supplies of
of the existing business. guaranteed supplier.
components.

o Lack of management

KEY DEFINITIONS experience in the acquired

business sector.
Conglomerate
o This should spread risk and o There could be a lack of
Integration:
may take the business into a clear focus and direction
Diversifies the business
faster-growing market. now that the business is
away from its original
spread across more than one
industry and markets.
industry, corporate objectives
may become diverse.

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Synergy & Integration

DEF Synergy means that the ‘the whole is greater than the sum of parts’.

When two or more firms are integrated the arguments is that the bigger firm created in this way
will be more effective, efficient and profitable then the two separate companies.

Firstly, it is argued that the two businesses

might be able to share research facilities
and pool ideas that will benefit both of the
businesses.

Secondly, economies of operating a larger

scale of business, such as buying supplies in
large quantities, should cut costs through bulk
buying, marketing and managerial economy.

Lastly, the new business can save on marketing and distributing costs by using the same
sales outlets and sales teams.

External Growth
(Integration)

Horizontal Vertical Conglomerate

Same industry — Backwards — Forwards — With different

same stage of same industry Towards the industries /
production towards previous consumers / markets

processes markets

Joint Ventures & Strategic Alliances

Strategic Alliances are agreements between firms in which each agrees to

DEF
commit resources to achieve an agreed set of objectives.

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These are the forms of external growth that do not involve complete integration and change
of ownership. It is a formal agreement between two companies which is to pursue a set of
agreed objectives to meet the critical business need while remaining independent
organizations. These alliances can be made with a wide variety of stakeholders.

With a University ▬ Finance provided by the business to allow new specialist training
courses that will increase the supply of suitable staff for the firm.

With a Supplier ▬ To join forces in order to design and produce components and
materials that will be used in a new range of products; this may help to reduce the total
development time for getting the new products to market, gaining competitive advantage.

With a Competitor ▬ To reduce risks of entering a market that neither firm currently
operates in. in some cases, the actions are not seen as being ‘anti-competitive’.

Problems with Rapid Expansion

Business expansion can be expensive and some additional fixed

Financial plus working capital will be required for rapid expansion. These
Problems factors could lead to negative cash flow and an increase in long-
term borrowing.

Existing management may be unable to cover the management

Managerial responsibilities and face problems of controlling larger operations
Problems and there may be lack of co-ordination between divisions. This is
actually a real problem for expanding and integrating businesses.

There is a need to constantly review and update the marketing

strategy while expanding. High promotion expenditure will required
Marketing
to cover the marketing of range of products.
(Product Portfolio)

Change Hands Most likely to occur if a sole trader takes on partners or if a private
limited company converts to a public one. This concept is called
(Divorce of
divorce of- ownership in public limited companies, and considered
Ownership &
to be one of the most major drawbacks of converting companies in
Control)
to public limited.

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Book-2 Chapter 4 | Business Objectives 41

Business Objectives Chapter 04

( 4.1 ) The Importance of Business Objectives

A business aim and objectives helps to direct, control and review the success of business
activity. For any aim and objective to be successfully achieved; there has to be an appropriate
strategy ─ which is a detailed plan of activities in place to ensure that resources are correctly
directed towards the final goal.

Vision Statement:
Vision Statement is a statement of what the organization would like to achieve or accomplish
in the long term.

Objectives:
Objectives are the goals or targets that the business wants to gain in order to achieve its aim.

Benefits of establishing Corporate Objectives

o They become the starting point for the entire set of objectives on which effective
management is based.
o They can help develop a sense of purpose and direction for the whole organization.
o They allow an assessment to be made, at a later date, of how successful the business
has been in achieving its objectives.
o With establishing corporate aims, each manager and subordinate will know exactly what
they have to achieve.
o They provide the framework within which the strategies of plans of the business can be
drawn up.

A business without a long-term corporate plan is likely to drift from event without a clear sense
of purpose and the right direction.

Common Corporate Objectives

Corporate aims need to be turned into goals or targets which are quite specific to each
business and which can themselves, be broken down into strategic departmental targets.
Corporate objectives are designed to do just this. They are expressed in terms that provide a
much clearer guide for management action and strategy.
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Book-2 Chapter 4 | Business Objectives 42

( 1 ) Maximising & Satisficing Profits

Profits are essential for rewarding investors in a business and for financing further growth.
Profit maximisation means producing at that level of output where the greatest positive
difference between total revenue and total costs is achieved. Profit maximization may will be
the preferred objective often owners and shareholders.

Profit Satisficing means aiming to achieve enough profit, because owners of smaller
businesses may be more concerned with ensuring that leisure time, independence and work–life
balance are protected rather than just earning more money.

( 2 ) Growth

Owners and the managers will be motivated by the desire to see the business achieve its full
potential, from which they may gain higher salaries and other fringe benefits. Growth leads to
increase the status, profits, economies of scale and competitiveness of the business.

( 3 ) Increasing Market Share

Increasing market share indicates that the marketing mix of the business is proving to be
more successful than that of the other competitors. Benefits resulting from having the highest
market share ─ being the brand leader and retailers will be keen to stock and promoted the
best-selling brand.

( 4 ) Survival

This is likely to be the key objective of most new business start-ups. The high failure rate of new
businesses means that to survive for the first two years of trading is an important aim for
entrepreneurs. Once the business has become firmly established, then other longer-term
objectives can be established such as profit and growth.

( 5 ) Maximising Short-term Sales Revenue

Many businesses seek to maximise sales in order to secure the greatest possible market
share, rather than to maximise profits. This could benefit workers when salaries and bonuses are
dependent on sales revenue levels. If increase sales are achieved by reducing prices, the actual
profits of the business might fall.

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( 6 ) Sales Growth

Sales growth is where the business tries to make as many sales as possible. This may by the
managers believe that the survival of the business depends on being large. Large businesses
can also benefit from economies of scale.

( 7 ) Maximizing Shareholder Value

This means pursuing strategies to increase returns to shareholders. By increasing profit, the
business will be able to pay out higher dividends, which should lead to higher share prices. This
shareholder value objective puts the interests of shareholders above those of other stakeholders.

( 8 ) Improving Quality & Customer Services

Customer service is all about building relationships with the customers. Consumers enjoy doing
business with companies that offer quality customer experiences, so businesses should always be
looking for ways to improve quality and customer services.

Corporate Social Responsibility (CSR)

Corporate Social Responsibility is a concept applies to those businesses that

KEY consider the interests of society by taking responsibility for the impact of

DEF their decisions and activities on stakeholders such as customers, employees,

government, suppliers, local communities and the environment.

Firms should have

objectives about social,
environmental and
ethical issues, and must
adopt a wider
perspective when setting
their objectives and not
just be aiming for
profits or expansion.
One reason for this is the
much greater adverse

publicity given to business activity that is perceived as being damaging to stakeholder groups. Pressure
groups are also plays a very important role.

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Book-2 Chapter 4 | Business Objectives 44

Objectives of Public Sector Businesses

Public sector businesses are public corporations can have a number of objectives, depending on
the political motives of the government. Typical objectives include:

o To provide an efficient, reliable service to the public, water supply and postal service.
o To encourage economic and social development, especially in deprived areas.
o To create employment or prevent major job losses if industry is making a financial loss.
o To meet financial targets set by the government, but not necessarily make a profit.

It is often argued that public sector businesses are less efficient than many private-sector
businesses. This is because they do not have the profit motive as their main objective. However,
if they achieve other social or environmental objectives, this might help the government achieve
its overall political objectives.

SMART: (Smart Objectives)

The most effective business objectives usually meet the following ‘SMART’ criteria:

S ▬ Specific:
Objectives should be stating exactly what is trying to be achieved. The objective specifically
states that the firm would like to increase its market share instead of making variety of
objectives. A hotel may an objective of 75% bed occupancy over the winter period. This objective
is specific to this business.

M ▬ Measurable:
Objectives that have a quantitative value are likely to prove to be more effective targets for
directors and staff to work towards. For example increase sale by 15% this year.

A ▬ Achievable (Agreed)
Before setting the objective the firm should have assessed its capabilities to ensure that the
objectives are achievable, and have the approval and understanding of everyone.

R ▬ Realistic: Able to be achieved by the business taking into account its resources,
competition, markets.

T ▬ Time Specific: A time limit should be set when an objective is established ─ by when
does the business expect to increase profits by 5%. Without a time limit, it will be impossible to
assess whether the objective has actually been met. Remember the Slogan: (SMART)

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Book-2 Chapter 4 | Business Objectives 45

Factors that determine Business Objectives

(1) Business Culture

(2) The size and legal form of the business

(3) Public or Private sector businesses

(4) The number of years the business has been operating

Corporate Culture:
Corporate culture can be defined as the code of behavior, attitudes, values, beliefs and
leadership style that are shared by people and groups in the organization.
The culture of a business and its senior managers impacts greatly on the decisions made. If senior
managers aggressively pursue only the profit objective, their decisions will be different to those of
the managers of a business with a people based or society based culture.

The Size and Legal form of the Business:

Owners of small businesses may be concerned only with a satisfactory level of profit ─ called
‘Profit Satisficing’. Larger businesses, perhaps controlled by director rather than owners, such
as most public limited companies, might be more concerned with rapid business growth and
developing the brand image in order to increase the status and prestige of the business.

Public and Private Sectors:

State-owned organizations tend not to have profit as a major objective. The aims of these
organisations can be providing low cost services to everyone, but this objective leads to
inefficiencies. Private sector has profits as a main aim so they try to provide the best possible
goods and services in order to achieve their financial targets.

The Number of Years the Business has been Operating:

Newly formed businesses are likely to be driven by the desire to survive at all costs. The failure
rate of new firms in the first year of operation is very high. Later, once well established, the
business may pursue other objectives, such as growth, market share and profits.

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Book-2 Chapter 4 | Business Objectives 46

Aims, Mission Statements, Objectives, Plans & Strategies

The links between these concepts can be made

clearer by studying this
‘Hierarchy of Objectives.

Divisional, Departmental &

Individual Objectives

Corporate objectives needed to be broken down into specific targets for separate divisions,
departments and ultimately division of the business to create strategies for action until they have
been broken down into meaningful targets focusing on divisional goals. These divisional objectives
have been further divided into departmental objectives and targets for individual workers. This
process is called management by objectives (MBO).

Aims: Broad statement of where a business wants to get to in the future.

Mission Statement: Overall principles on which the business operates.

Corporate Objectives:
Detailed goals for the whole business, which are set to achieve the aims.

Department Objectives:
Corporate objectives broken down as targets for individual departments.

Team Objectives: Departmental objectives broken down for individual teams.

Individual Objectives: Day-to-day objectives for each person.

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Book-2 Chapter 4 | Business Objectives 47

Mission Statement

This is an attempt to condense the central purpose of a business existing into one statement.
It is not concerned with specific, quantifiable goals but tries to sum up ─ often in rather woolly
language, it must be said ─ the aims of the business in a motivating and appealing way.

Mission Statement ▬ A statement phrased in a way that makes clear the

KEY
organization’s core aims, purpose, principle business aims, identity,
DEF
policies and values to motivate the stakeholders.

Nestlé: Our Aim is to become world's leading nutrition, health and wellness company, with
"Good Food, Good Life" is to provide consumers with the best tasting choices in a wide range of
food categories.

Engro Foods: “Build branded food business to improve quality of life by offering tasty, affordable
and high nutritional products to our consumers while maximizing stakeholder's value.

Arguments used in Favor of Mission Statement

o They quickly inform groups outside the business what the central aim and vision is.
o They can prove motivation to stakeholders, especially where an Organisation is working
as a caring and environmental friendly body.
o When they include moral statements or values to be worked towards, then these can help
to guide and direct individual employee behavior at work.
o They are not meant to be detailed working objectives but they help to establish in the
eyes of other groups’ what the business is about’.

Arguments Against the Mission Statement

o Too vague and general so that they end up saying little which is specific about the
business and its future plans;
o Based on a public relations exercise to make stakeholder groups ‘feel good’ about the
organisation;
o Virtually impossible to really agree or disagree with the mission statement.
o Similarity with other organisation’s mission statements.

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Book-2 Chapter 4 | Business Objectives 48

Communicating the Mission Statement

Businesses communicate their mission statements in a number of ways. They often feature in
the published accounts to communicate with the shareholders. Internal company
newsletters and magazines may draw their title from part of the mission statement.
Advertising slogans or posters and internet websites are frequently based around the
themes of the mission statements.

Condense meaning: compress, pack into. Vague meaning: Not clearly expressed, unclear.

Objectives, Strategies & Tactics

The aims and mission statement of a business share the same problems: they lack specific
detail for operational decisions and they are rarely expressed in quantitative terms. They need to
be turned into SMART objectives. These can then be broken down into strategic departmental
targets. Business objectives must be based upon the aims of the business. They are expressed in
terms that provide a much clearer guide for business strategies and tactics.

Aims and objectives provide the focus for business strategies – the long-term plans of action
of a business. Without a clear objective, managers will be unable to make important strategic
decisions for the business.

Once a strategy has been decided,

then small-scale tactical decisions
must be taken. For example, once
the strategic decision to market a
product has been taken, tactical
decisions about the methods of
promotion and the level of pricing
must be made.

The links between objectives, strategies

and tactics are shown in Figure.

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Book-2 Chapter 4 | Business Objectives 49

( 4.2 ) Objectives & Business Decisions

Setting objectives is the starting point of business decision making. Without having a clear
sense of direction, it is impossible to take effective business decisions.

The Role of Objectives in the Stages of Business Decision Making

This essential link between decision-making, strategies and objectives is shown in Figure.
All the following stages are based upon setting clear objectives:

1) Set objectives to provide focus for strategic

decisions.
2) Assess and clarify the problem that
requires strategic action.
3) Gather data about the problem and identify
possible strategic solutions.
4) Analyse the likely impacts of all decision
options on the chance of achieving business
objectives.
5) Make the strategic decision.
6) Plan and implement the decision.
7) Review its success against the original
business objectives. Has the business, through its decisions, achieved its objectives?

How Objectives might change overtime

There are many reasons of businesses changing their business objectives over time:

 A newly formed business may have satisfied the survival objective by operating for
several years, now owners wish to pursue objectives of growth or increased profit.

 The competitive and economic environment may force a business to change business
objective.

 A short-term objective of growth in sales or market share might be converted to a

longer-term objective of maximising profits from the higher level of sales.

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Book-2 Chapter 4 | Business Objectives 50

Communicating objectives with Employees and other Stakeholders

There is no point in setting objectives and then telling no one about them. Companies
communicate with shareholders and other external stakeholders through the annual published
report. This contains details of the objectives the senior managers have established for the
business.

Business objectives must be explained to employees. If employees are unaware of the business
objectives, how can they contribute to achieving them? Communicating business objectives, and
translating them into individual targets, are essential for the effective motivation of employees.

Benefits of Communicating Objectives with Employees:

 Employees and managers have a greater understanding of corporate aim, objectives,

and strategies.
 Employees share responsibility for targets and objectives by interlinking their goals with
those of others in the company.
 Managers stay in touch with employees’ progress more easily, as regular monitoring of
employees’ work allows for praise or training to keep performance and deadlines on track.
 If managers fail to communicate with employees on objectives or changes in objectives,
fear and uncertainty might spread amongst the workforce. This could lead to resistance to
change and potential industrial action.

Ethical Influences on Business Objectives & Activities

Business Ethics includes a wide range of moral and ethical values that
DEF
arise in a business environment related to different stakeholder groups.

The growing acceptance of corporate social responsibility has led to businesses adopting an
‘ethical code’ to influence the way in which decisions are taken.

 Some businesses decide to provide better social conditions by improving local economic
conditions, offering opportunities to low-income people or serving people in need.

 The companies ethically responsible for not to hire child labour, and provide health
and safety at work, safe working environment with fair wages.

 The company should not advertise its products to young children so that they force
their parents into buying them.

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Book-2 Chapter 4 | Business Objectives 51

 Banks and other financial institutes make an ethical decision when deciding to provide
loan money to companies that damage the environment and producing de-merit
products such as drugs and weapons.

 An ethical decision to reduce pollution by purchasing less polluting advanced production

machines and equipment.

Evaluating Ethical Decisions

Adopting and keeping to a strict ethical code in decision making process can be expensive in
the short term:

o Using ethical business practices can add to business’s costs, being ethical a firm may
not get the competitive advantage.
o Business ethics reduce a company's freedom to maximize its profit in the short-term.
o Being ethical to workers such as buying expensive machinery, workers health and safety,
paying fair wages, substantially increase the costs of the business.
o Practices acceptable in that country, such as child labor, poor health and safety, poverty-
level wages and coerced employment, will not be tolerated by an ethical company.

However, in the long-term benefits the businesses will obtain through ethical towards
employees, customers, government and environments, can create good image for the business.

 Business ethics offer companies a competitive advantage and customer loyalty.

Consumers learn to trust ethical brands and remain loyal to them.
 Avoiding potentially expensive court cases can reduce costs of fines, reduced risk of
negative publicity
 Customers, who are aware of the ethical issues will become brand loyal and prefer the
products of those businesses that are aware of their corporate social responsibility.
 While bad publicity from being ‘caught’ acting unethically can lead to lost consumer
loyalty and long-term reductions in sales.
 Ethical businesses are more likely to be awarded government contracts. The
government will be keen on lending money or giving incentives to the business having
ethical objectives.
 Well-qualified and experienced staff may be attracted to work for the companies with the
most ethical and socially responsible policies. Business will look after workers welfare,
health & safety; this will make the workers more loyal, committed and productive.
 Improved public awareness, marketing opportunities leading to long-term profits.

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Book-2 Chapter 5 | Stakeholders in a Business 52

Stakeholders in Business Chapter 05

In recent times, the shareholders’ responsibility has been extended to include the interest of
suppliers, employees, government, bankers, customers and local community.

( 5.1 ) Stakeholder Concept

Stakeholders are the people or groups of people who can be directly or

KEY
indirectly affected with the decisions of the business and therefore have an
DEF
interest in the activities by a business organisation.

KEY Stakeholder Concept is the view that businesses and their managers have

DEF responsibilities to a wide range of stakeholders, not just shareholders.

Who are the Stakeholders?

The main stakeholders of a business are therefore:

o Owners / Shareholders
o Customers
o Suppliers / Banks
o Employees and their Families / Managers
o Local Communities
o Government and State Agencies

Stakeholders & Shareholders

A stakeholder is an individual or group with a direct interest in the performance of a

business. The reasons for groups having a stake in any business are so different that there will
be many occasions when their interests diverge and even conflict.

Shareholders:
Investors clearly want to be rewarded for their stake in the business. This reward must be at
lest equal to that which would be available elsewhere. Shareholder reward comes from the
annual dividend and increased prices (capital gain) for the shares they own.

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Book-2 Chapter 5 | Stakeholders in a Business 53

Roles Rights Responsibilities

O o Invest their capital o A share of the profits o To conduct the

W into the business so that they gain a business using
N with risk taking required rate of appropriate skills

E ability along with return on the money and organize all the

R an objective of they invested into resources along

expansion. the business. with risk taking

S
ability.

o Purchase goods o To receive goods and o To be honest and

C and services services that meet pay for goods and

U produce by the local laws regarding service bought from

firm. health and safety, business.

S
design, performance.
T
O o Provide revenue o Not to make false
o To be offered value
M and profit from sale, claims about poor
of money, repairs,
E that allows the service demanded,
replacements,
R business for further or failed products.
compensation in the
operations and
S event of failure of the
expansion plans.
product or service.

S o To be paid on time,

U according to the

P o Supply goods and agreement between

services to allow business and supplier. o To supply goods in
P
the business to time according to
L
produce and offers o To be treated fairly the condition, and
I
its products to its and not to have lower according to the
E agreement.
own customers. prices forced by the
R
powerful customer.
S

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Book-2 Chapter 5 | Stakeholders in a Business 54

o To be paid on time, o To be honest and

E receive health and should meet the
o Provide manual and
M safety, good conditions and
other labour
P working conditions, requirements of
services to the
L motivation and job the employment
business to allow
O satisfaction. contract.
goods and service to
Y be provided to
o To be treated and o To co-operate with
E customers.
paid in the ways management in all
E
described in the reasonable requests.
S
employment
contract.

L
o Local communities o Local Community has o To co-operate with
O living close to the right that the the business where
C businesses and have business should care required and
A raised concerns of the environment reasonable to do so.
L over their health and reduce the level
and safety. of pollution and o To meet

C wastages by buying reasonable

O o Provide local least dirty plant and requests from

services to the equipments and not business for local
M
business to allow it to have the services such as
M
to operate, produce community’s lives developing markets,
U
and sell within legal badly affected with organising public
N
boundaries. the negative transport to allow
I externalities. staff to get to work
T and necessary
Y waste disposal.

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Book-2 Chapter 5 | Stakeholders in a Business 55

o Passes laws that o Businesses have the o To treat businesses

restrain many duty to government to equally under the
aspects of business meet all legal law.
G
activity. constraints, such as
O
producing only merit
V o To establish good
o Provides law and goods, and to pay
E trading links with
order to allow legal taxes on time.
R other countries to
business activity to
N encourage
take place.
international trade.
M o Businesses are also
E o Achieves responsible to pay

N Economic Stability taxes on time so that

T and GDP to the government

encourage business should continue the
activity. public sector
spending.

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Book-2 Chapter 5 | Stakeholders in a Business 56

( 5.2 ) Importance & Influence of Stakeholders on Business

Business activity always has an impact on at least one stakeholder group. On the other hand,
some stakeholder groups are so powerful and influential that they can influence business activities
and business decisions.

Decision Employees Local Community Customers

Impact: Impact: Impact:

o Create Job o More jobs for local o Greater efficiency
Opportunities. residents and might result in lower
increased spending in prices.
o Getting expertise
other local businesses.
about new
Building a Reaction:
production methods. o Disruption caused by
o Buy more products if
new
increased traffic and
prices are lower for
Factory to Reaction: pollution and loss of
the same quality.
Expand o Trade unions might site for amenity use
Business demand higher pay
for more skilled Reaction:
work. o Can refuse planning
permission or even
organize petition &
boycotts.

Decision Employees Local Community Customers

Impact: Impact: Impact:

o Training & o Local suppliers of IT o more efficient and
promotion services could benefit flexible production
Purchase
opportunities will be from increased orders. methods resulting in
of IT
offered. improved quality
Controlled
and more product
Reaction:
Automated variety.
Reaction: o Demand retraining
Machines
o Possible job losses programmes for o Reaction: Increased
and can cause unskilled unemployed. demand if product
industrial action. quality is high.

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Book-2 Chapter 5 | Stakeholders in a Business 57

Decision Employees Local Community Customers

Impact: Impact: Impact:

o Combined business o Business expansion o More efficient and
is more secure and leading to more jobs flexible production
offer career for local people, and methods resulting in
opportunities. help to raise income. improved quality
and more product
Horizontal
o Rationalization may variety.
Integration Reaction:
occur leading to job
o Encourage
- Takeover losses. Reaction:
government to ban
o Increased demand if
takeovers and
product quality is
Reaction: mergers.
high.
o Possible job losses
and can cause
industrial action.

Responsibility & Accountability of Businesses to its Stakeholders

Responsibilities of Businesses to its Customers

Business is responsible to satisfy customers’ demands in order to stay in business in the long
term. Decisions about quality, design, performance, durability and customer service should
consider in order to operate the firm in a responsible manner.
Businesses also have responsibilities to customers not to break the law concerning consumer
protection, merit products and accurate advertising and promotion offers.

Benefits for business of accepting these responsibilities:

Consumer loyalty; repeat purchases; good publicity for the firm when customers give ‘word
of mouth’ recommendations to others; good customer feedback, which helps to improve
further quality of goods and services.

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Book-2 Chapter 5 | Stakeholders in a Business 58

Responsibilities of Businesses to its Suppliers

Good, reliable suppliers must be found and given clear guidance on what is required by the
business. In return, the business should pay promptly, place regular orders and offer long-
term contracts.

Benefits for business of accepting these responsibilities:

Supplier loyalty ─ prepared to meet deadlines and request for special orders; reasonable
credit terms, and discounts more likely to be offered.

Responsibilities of Businesses to its Employees

Business is responsible for providing training opportunities, reasonable working hours, job
security, paying more than minimum wages and offering good working conditions,
involving staff in some decision making are some of the examples of responsibilities of business
towards its workers.

Benefits for business of accepting these responsibilities:

Employee loyalty and low labour turnover; easier to recruit goods staff; employee
suggestions for improving efficiency and customer service; improved motivation and more
effective communication leads to higher productivity and profits.

Responsibilities of Businesses to its Local Community

Business is responsible for reduce the level of pollution and keep the adverse environmental
effects to a minimum on society, and also meet the following responsibilities to the local
population such as offer secure employment so that there is less local fear of job losses, spend
as much as possible on local supplies to generate more income, reduce the transport impact
of business activity.

Benefits for business of accepting these responsibilities:

Local councils will give planning permission to expand the firm; and accept some of the
negative effects such as pollution caused by business operations.

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Responsibilities of Businesses to the Government

All businesses should meet their legal responsibilities as defined by government legislation.
Business should pay taxes on time, complete government statistical records, provide
employment opportunities and seek export markets to contribute in GDP.

Benefits for business of accepting these responsibilities:

Good relations with government might lead to success with expansion projects receiving
planning permission and also receive valuable government contracts; subsidies to expand
businesses and licenses to set up new operation are awarded to businesses.

Conflicts Arising from Different Stakeholder Aims

According to the traditional shareholder concept, attempts to meet obligations to other

stakeholders will conflict with the business’s legal duty to its shareholders and can reduce
profits. Taking the stakeholder approach, the objectives of different groups may be satisfied in
ways that also result in benefits to shareholders in the long term.

How do businesses deal with these conflicts of stakeholder aims? A compromise is often the
answer. Clearly, senior management must establish its priorities in these situations. Which are
the most important stakeholders in each case? What will be the extra cost of meeting the needs
of each stakeholder group? Taking such difficult decisions, which are based on weighing up the
conflicting interests of these groups, is one of the reasons why managers and directors are often
paid more than other employees.

Impact on Stakeholders of Changing Business Objectives

The dynamic business environment often means that directors or senior managers might be
forced to change corporate objectives that impact stakeholders.

‘Social and environmental change’ is one of The Body Shop’s major objectives but, due to
difficult trading conditions, forced to focus on cost-cutting by closing some shops to ensure
survival and achieve profitability. Making employees redundant goes against The Body Shop’s
original objectives.

Different stakeholder groups will be affected in different ways by these changes in objectives.
Employees’ jobs will be lost and customers will have less choice.

Business Quick Revision Book, As-Level

 Unit 2
People in Organisation

Business Studies Resource Prepared By Usman Akhter

Book-2 Chapter 10 | Human Resource Management 61

Human Resource Management Chapter 10

( 10.1 ) Human Resources Department (HRM)

Human Resource Management (HRM)

KEY The Department with strategic approach within an organization, designed to

DEF effectively manage and maximize employee performance so that they

help the business gain a competitive advantage.

Human Resource Management — Purpose and Role

The central purpose of HRM is to recruit, train and utilize a business’s employees in the most
productive manner to assist the organisation in the achievement of its objectives. HR tries to
ensure that conflicts are minimized with high motivation. HRM aims to recruit capable,
flexible and committed people, managing and rewarding their performance and developing their
key skills to the benefit of the organisation.

Responsibilities of Human Resource Department

Human Resource Management focuses on:

o Recruiting and selecting appropriate staff, using a variety of techniques;;

o Training and developing staff at every stage of their careers;;

H o Developing appropriate pay systems for different categories of staff;;

o Dealing with Discipline, Dismissal and Redundancy Procedures;;
o Career Development and Welfare of the employees;;
R o Offering Fringe Benefits;;
o Planning the workforce needs of the business;; (A2 Syllabus)
o Measuring and Monitoring staff performance;; (A2 Syllabus)
M
o Developing employer and employee relationship;; (A2 Syllabus)
o Acting as a Conciliator between Labour and Management and Dealing,
Negotiating with Trade Unions and their Representatives;; (A2 Syllabus)

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Book-2 Chapter 10 | Human Resource Management 62

( 10.2 ) Workforce Planning

Workforce Planning ▬
KEY
Workforce planning means thinking ahead and establishing the number
DEF
and skills of the workforce required by the business in the future.

KEY Workforce Audit ▬

DEF A check on the skills and qualifications of all existing workers/managers.

Workforce Planning is the process of analyzing, forecasting, and planning workforce required
by the firm for foreseeable future, and assessing gaps, to ensure that an organization has the
right people ▬ with the right skills in the right places at the right time ▬ to fulfill its mandate
and strategic objectives.

Human Resource Departments need to calculate the staffing needs of the business over
future time periods, so that they have sufficient number of qualified people to ensure
business success.

Failure to do this can lead to too few or too many staff or staff with inappropriate skills.

These two factors needs careful study:

(1) The number of staff required in the future will depend on many factors:

o Forecast Demand for the Firm’s Product:

It depends on the sales of the firm and influenced by market and external conditions,
seasonal factors, competitors’ actions, trends in consumer tastes and so on.

o The Productivity Levels of Staff:

If productivity is forecast to increase ─ as a result of more efficient machinery ─
then fewer staff will be needed to produce the same level of output.

o The Objectives of the Business:

Firstly, if the business plans to expand over the coming years then employee numbers
will have to rise to accommodate this growth. Secondly, if the firm intends to improve
customer-service levels, then more workers need to be recruited.

o Changes in the Law Regarding Workers Rights: If

the government of a country decided to pass laws which established a shorter
maximum working week or introduced a minimum wage level then there will be a
considerable impact on the workforce plan.

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Book-2 Chapter 10 | Human Resource Management 63

o The predicted labour turnover and absenteeism Rate:

The higher the rate at which staff leaves a business then the greater will be the
firm’s need to recruit replacement staff. The higher the level of staff absenteeism
then the greater will be the firm’s need for higher staffing levels to ensure adequate
numbers are available at any one time.

(2) The Skill of the Staff Required:

The need for better-qualified workers or for workers with different skills should be included in the
workforce plan. The skill levels required will depend on:

o The pace of technological change in the industry, such as production methods and the
complexity of the machinery used.
o The need for flexible or multi-skilled workers as businesses tries to avoid excessive
specialisation.

Labour Turnover

KEY Labour Turnover ▬ This is a measure of the rate at which staff leaves a

DEF business over a certain time period.

Number of Staff Leaving in 1 Year

Labour Turnover (%) = × 100
Total Number of Staff

If this result is high and increasing overtime, then it is an indicator of staff de-motivation
and discontent, low morale and possibly, due to low financial rewards, poor working
conditions, poor esteem needs, and a recruitment policy that leads to the wrong people being
employed.

Costs of High Labour Turnover: Benefits of High Labour Turnover:

o Costs of recruiting, selecting and
o Low-productive staff might be leaving.
training new staff.
o New workers bring new ideas and
o Poor output levels and customer services.
practices in to the business.
o Difficult to establish loyalty, familiarity
and team spirit.

Contract of employment are legally binding documents and care needs to be taken to ensure
that they are fair and accord with current legislation.

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Book-2 Chapter 10 | Human Resource Management 64

( 10.3 ) Recruitment & Selection of Employees

Effective recruitment and selection of employees should meet the needs of business and increase
the chance of achieving its long-term objectives.

Recruitment ▬ The process of attracting, selecting and appointing suitable

KEY
employee, defining the job to be filled and the type of person needed to fill
DEF it, short listing suitable candidates for the job and selecting the best one.

KEY Selection ▬ The series of steps by which candidates are interviewed, tested

DEF and screened to choose the most suitable person for a vacant post.

Organisation need to obtain the best workforce available if they are to meet their objectives
and compete successfully. There are various stages in the recruitment process:

( 1 ) Establishing Exact Nature of the

Job Vacancy & Drawing up a Job Description

KEY A JOB DESCRIPTION outlines the roles, responsibilities and duties to be

DEF carried out by someone employed to do a specific job and held responsible for.

Job description is a written statement that describes the duties, responsibilities, most
important contributions and outcomes needed from a position, required qualifications of
candidates, and the reporting relationship of a particular job. It helps to attract the right
candidate with describing the major areas of an employee’s job or position.
This provides a complete picture of the job and will include::

(1) Job Title;;

(2) Details of the Tasks to be Performed;;
(3) Responsibilities Involved;;
(4) Working Conditions and Working Hours;;
(5) Place in the Hierarchical Structure;;
(6) How the Job will be Assessed and Performance Measured.

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( 2 ) Drawing up a Person Specification ( Job Specification )

Job Specification is a detailed list of the qualifications, skills, experience

KEY
and personal qualities that a successful applicant will need to have to
DEF
fulfill the role effectively.

The analysis of the type of qualities and skills being required in suitable applicants. It is
clearly based on the job description because these skills can only be assessed once the
nature and complexity of the job have been identified. It is like a ‘person profile’.

( 3 ) Preparing a Job Advertisement Reflecting the Requirements

This can be displayed within the business premises using notice board, company news letter,
and prospectus or company website for Internal Recruitment of Employees.

Job advertisement can also be placed in newspapers, magazines, specialist journals and
government job centers for External Recruitment of Employees.

( 4 ) Drawing up a Shortlist of Applicants CV or Resume

A shortlist of applicants is drawn up from the application forms and personal details, often
contained in CV (curriculum vitae). References may have been obtained in order to check the
character and previous work performance of the applicants.
A Curriculum Vita (CV) is a written document provides a summary of employee educational
details, work experience, skills, background information, achievements and reference.

( 5 ) Conducting Interviews

Interviews are conducted which will be designed to question the applicant on their skills,
qualification, experience and character. Candidates are assessed according to
achievements, intelligence, skills, interests, personal manner, and physical appearance.

Assessment Centres

Assessment centres are increasingly popular for selecting well-qualified applicants for high-
profile jobs. A group of applicants undergo a series of personality tests, group problem-
solving exercises, written tests and role play situations.

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Internal & External Recruitment

INTERNAL RECRUITMENT is when a vacancy is filled by someone who is an

KEY
existing employee of the business and post could be filled from inside the
DEF
organisation.

Advertisement of the Job:

Company News Paper, Notice Board, Prospectus, Website Links.

Advantages of Internal Recruitment:

 It saves time and money, compared with recruiting someone working from outside the
business.
 Applicants may already familiar and known to the organisation and the corporate
culture of the organisation.
 It can be very motivating for other workers to see their fellow workers being promoted
and rewarded, it also give career structure and chance of progress.

Disadvantage: Internal recruitment can cause line management problems for the promoted
person if they now supervise former colleagues.

EXTERNAL RECRUITMENT is when a vacancy is filled by someone who is not

KEY
an existing employee and will be new to the business and hired from an
DEF
outside source.

This involves advertising the vacancy using different sources such as, news papers,
magazines, advertisement billboards, recruitment agencies and job centers.

Advantages of External Recruitment:

 External applicants will bring in new ideas and practices to the business.
 Should be a wide choice of potential applicants ─ not just limited to internal staff.
 Avoid resentment sometimes felt by existing staff if one of their former colleagues is
promoted above them.

Resentment Meaning:
Resentment is the painful feeling when someone does something wrongs to you; it is a feeling of
displeasure about something unfair.

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Employment Contract

Employment Contract
DEF
A legal document that sets out the terms and conditions leading a worker’s job.

Contract of employment are legally binding documents and care needs to be taken to ensure
that they are fair and accord with current legislation.

The contract imposes responsibilities on businesses to provide the conditions of employment

such as working hours, working conditions, rate of pay, holiday entitlement, the number of
days notice that must be given by the worker before leaving, and regular salaries and wages.

Contract of Employment contains three main documents, Job Description, Code of behavior and
Working Conditions.

( 10.4 ) Discipline, Dismissal & Redundancy of Employees

Discipline: On occasions it will be necessary for an HR manager to discipline an employee for

continued failure to meet obligations laid down by the contract of employment. There should
be support and, if necessary, provide training for the person concerned.

Dismissal:
Dismissal could result from the employee being unable to do the job to the standard that the
organisation requires. It may also be that the employee has broken one of the crucial
conditions of employment. HR department tries to support all that which can help the
employee to reach the required standard and stay within conditions of employment.

Dismissal ▬ being dismissed or sacked from a job due to incompetence,

dissatisfactory performance or behavior, or breach of discipline.
KEY

DEF Unfair Dismissal ▬

Ending worker’s employment contract for a reason that the law regards as
being unfair.

Sometimes employees become involved in gross misconduct, which may be stealing or some
other serious offence. If this happens, organization can dismiss with immediate effect without
giving the warnings.

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Reasons for Unfair Dismissal

o A discriminatory reason, race, color or religion;

o Being a member of a trade union;
o A non-relevant criminal record;
o Due to pregnancy.

Reasons for Fair Dismissal

o Inability to do the job in a situation where required and sufficient training has been
already given;;
o A continuous negative attitude at work, which has affected the employees or the work
of others adversely;;
o Continuous disregard of required health and safety procedures;;
o Deliberate destruction of an employer’s property and harassment of other employees.

Redundancy

Redundancy is when a job is no longer required by the business, so the

DEF
employee doing this job becomes redundant through no fault of his or her own.

Redundancy occurs when workers jobs are no longer required, perhaps because of a fall in
demand or a change in technology. Often, this is part of a company policy of retrenchment
to save on costs to remain competitive. Redundancy may also happen due to budget cuts, the
firm needs to reduce its workforce. This process is handled by the HR department. It must
always ensure that the redundancies are lawful and that all correct procedures are followed.

Redundancy Payment:
“When an employee is made redundant,
they are given some money to
compensate them for losing their job”,
this is called redundancy payment.

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( 10.5 ) Employee Morale & Welfare

Employee Morale ▬

KEY Overall outlook, attitude and level of satisfaction of employees when at work.

DEF Employee Welfare ▬

Employees’ health, safety and level of morale when at work.

Welfare means the health and happiness of the people employed by a business. Most HR
departments will offer counseling and other services to staff that are in need of support,
perhaps because of family or financial problems these support services can reflect well on the
caring attitude of the business towards its workforce.
Example:: Medical, surgical, hospital care, benefits in the event of sickness, accident,
disability, death or unemployment, or vacation benefits, training programs, or day care
centers, scholarship funds, and loans.

Work-Life Balance

A situation in which employees are able to give the right amount of time and effort
DEF
to work and to their personal life outside work, for example to family and friends.

Some analyst suggests that HR departments should assist employees to achieve a better work-
life balance that will reduce stress and increase efficiency.
The following methods are used to create a balance between work life and personal life.

 Flexible working ▬ offering different type of working pattern to different employees.

 Teleworking ▬ working from home for some of the working week, such as such as
with the help of phone, fax, Internet teleconferencing, e-mail, to perform work duties
from a remote location.
 Job Sharing ▬ is a flexible work option in which two or possibly more
employees share a single job, it allowing two people to fill one full-time vacancy, and will
receive a proportion of the full-time pay.
 Sabbatical Periods ▬ sabbatical leave is defined as a time period in which a person
does not report to his regular job but who remains employed with that company. An
extended period of leave from work, up to 12 months. Some businesses do not pay
employees during this period but guarantee to keep the job open for them on return.
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Policies for Diversity & Equality

Equality Policy ▬

KEY Practices and processes aimed at achieving a fair organisation where everyone
DEF is treated in the same way and has the opportunity to fulfill their potential.

Most organisations have policies which try to ensure equality & diversity in the workforce.
Businesses that promote equitably in the workplace do not base recruitment and dismissal
decisions, pay, promotions and other benefits on employees’ race, gender, age, religion and
nationality. The benefits gain by the businesses is high employee morale, developing a good
business reputation.

Diversity Policy ▬

KEY Practices and processes aimed at creating a mixed workforce with placing
DEF positive value on diversity in the workplace.

Workplace diversity relates to acknowledging differences among employees and deliberately

crating an inclusive environment that values those differences. A workplace that encourages
diversity employs individuals from various races ethnicities, religions and genders. The
benefits gain by the businesses are capturing a greater consumer market as consumer will
be attracted to a diverse sales force, employing a more qualified workforce and reducing
employee turnover.

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( 10.6 ) Training, Developing & Appraising Staff

Training is an educational program offered by the firm to employees in order to enhance skills,
competencies, and performance.
HR department must ensure that the workers are well equipped to perform the duties and
undertake the responsibilities expected of them. This will always involve training in order to
develop the key skills and full abilities of the worker. There are different types of training::

Induction Training

Induction training is given to all new recruits to familiarize them with the business and their
role in it. It has the objectives of introducing them to the fellow workers that they will be
working with most closely, explaining the internal organizational structure, explaining the
company’s rules and regulations, working procedures, outlining the layout of the premises
and making clear essential health and safety issues, canteen and first aid facilities, such
as procedures during a fire emergency.

Outcome: The purpose of induction training is to make new worker more comfortable with
the work environment and the culture of the business organisation.

On-the-Job Training

On-the-Job training involves instruction at the place of work by watching more experience
and senior workers performing the responsibilities. Watching or working closely with
existing experienced members of staff or a professional trainer serves as the course instructor
is a frequent component of this form of training. It is cheaper then sending the workers outside.

Outcome: The purpose of the on-the-job training is to train workers to be skilled and
productive and to reduce the costs of external training. It is cost effective for the employer
because the person continues to work during the regular working hours.

Off-the-Job Training

Off-the-Job training entails any course of instruction away from the place of work. This
could be a specialist training centre belonging to the firm itself or it could be a course
organized by an outside body, such as training centers, university or computer manufacturer to
introduce new ideas that no one in the firm currently has knowledge about it.

Outcome: A wider range of skills and qualifications can be obtained, and employees can
learn from outside specialists and experts along with working in normal routine hours.

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Benefits of Providing Training

By providing training, staff becomes more competent at their job with greater skills and more
flexible approach. Training improves the productivity and reduces the chance of accidents
and wastages. It will improve the company image with providing quality services to
customers.

Draw Back of Providing Training

One of the biggest potential problems with employee training is high cost of the process. It can
also lead to well-qualified staff leaving once they have gained qualifications and skills from a
business with a good training structure. New employees do not find enough time to learn new
skills and knowledge about the job.

Cost of Not Providing Training

The costs of not providing training are also substantial such as additional recruitment costs.
Untrained staff will be less productive with poor response rate, less able to do a variety of
tasks; will give a less satisfactory customer service and increases the chance of accidents. They
will be unable to deal with change because their skills are specific to the present situation.

On-the-Job Training Off-the-Job Training

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Development and Appraisal of Employees

Development Process ▬

Development Process provide opportunities for learning and training

KEY facilities for growth and development to help employees expand their
DEF knowledge, skills and abilities, and apply the competencies they have
gained to new situations.

Development and Appraisal of staff should be a continuous process. Development might take
in the form of new challenges and opportunities, additional training courses to learn new
skills, promotion with additional delegated authority and chances for job enrichment. HR
department should work closely with the workers to establish a career plan that helps to
develop their skills and abilities. These opportunities to gain new skills and experiences can
increase employee motivation and job satisfaction and help workers to more effectively
manage the job stress.

Staff Appraisal ▬

Staff Appraisal is the process of assessing the effectiveness of an

DEF
employee assessed against pre-set targets.

Appraisal is a formal assessment of the performance of a member of staff. It involves

establishing clear objectives for each employee and evaluating actual performance in the
light of these pre-set goals.

Appraisal is often undertaken annually, monthly or even weekly basis. It is an essential

component of staff-development program. The analysis of performance against pre-set and
agreed targets combined with the setting of new targets allows the future performance of the
worker to be linked to the objectives.

The main objectives of Appraisal System:

o To recognize the future training needs of the employee and to improve the performance.
o To provide feedback to individual about his or her performance.

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( 10.7 ) Management and Workforce Relations

The relations between mangers and the workforce have a great impact on the success or failure
of a business. In most countries, employees are able to join trade unions to discuss and
negotiate financial and non-financial rewards with the support of Human Resource Department.

Benefits of Co-operation between

Management & Workforce

Co-operation can result in real benefits to managers and workers:

o Fewer days are lost through strikes and other forms of industrial action.
o Easier to introduce change in the workplace, such as automation.
o The contribution of workforce is likely to be recognised and pay levels and other benefits
might reflect this.
o Agreement on more efficient operations will increase the competitiveness of the firms.
o Workers’ practical insight into the way the business operates can contribute to more
successful decisions.

Impact of Trade Union Involvement in the Workplace

Trades Unions are groups of working people with the objective of improving
KEY
pay and working conditions of their members and providing them with
DEF
support and legal services.

‘Power Through Solidarity’ has been the basis of union influence and this is best described by
their ability to engage in ‘Collective Bargaining’. This is when trades unions negotiate on
behalf of all of their members in a business. This puts workers in a stronger position than if
they negotiated individually.

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Advantages to Employees of Trade Union Membership

(1) Workers have strong bargaining power because they have strength in numbers.

(2) Improved conditions of employment, for example, rates of pay, holidays, hours of work
and other fringe benefits.

(3) Improved environment where people work, for example health and safety, noise, heating.

(4) Improved benefits for members who are not working because they are sick, retired.

(5) Improved job satisfaction by encouraging training.

(6) Being treated fairly by their employer.

(7) Advice and provide financial support if a member thinks that he has been unfairly
dismissed or made redundant or has been asked to do something that is not part of his job.

(8) Trade unions provide members with the opportunity to access the benefits of collective
bargaining; they collectively negotiate better pay and conditions on behalf of their members.

Collective Bargaining

Collective Bargaining:
KEY
The process of negotiating terms of employment between an employer and a
DEF
group of workers who are usually represented by a trade union official.

Trade Union Recognition: when an employer formally agrees to conduct

KEY
negotiations on pay and working conditions with a trade union rather than
DEF
bargain individually with each worker.

Benefits of Collective Bargaining

 Employees can negotiate with one trade union officer rather than with individual
workers. This saves time and prevents workers from feeling that one individual has
obtained better pay and conditions than others.
 Union officials can provide a useful channel of communication with the workers. This
two-way communication through the trade union allows workers’ problems to be raise
with management and employers’ plans could be discussed with workers.

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 Unions can impose discipline on members who plan to take hasty industrial action that
could disrupt a business. This reduces the impact of industrial actions.
 The growth of responsible, partnership unionism has given employers a valuable forum
for discussing issues of common interest and making new workplace agreements.
These discussions should lead to increased productivity, helping to secure jobs and raise
profits.

Disputes between Trade Union & Management

When cooperation between management and employees does not exit, there is a great chance of
industrial action, different types of industrial actions are given below:

 Continue Collective Bargaining, perhaps with the help of an independent arbitrator.

 Go Slow  a form of industrial action in which workers keep working but at the
minimum pace demanded by their contract of employment.

 Work-to-Rule  a form of industrial action in which employees refuse to do any work

outside the precise terms of contract of employment.

 Overtime Ban  Workers refuse to work more than the contractual number of hours.

 Strike Action  the most extreme form of action in which employee totally withdraws
their labour for a period of time, leading to stop production.

Employers can use various methods to try to resolve an industrial dispute:

 Negotiations to reach a compromise solution with the aim of avoiding industrial action.

 Public Relations Campaign to gain public support for the employer during a dispute
and put pressure on the union to settle for a compromise.

 Treats of Redundancies to pressurize unions to agree to settle the dispute.

 Changes of Contract, which require workers to work overtime, accept more flexible
working or agree not to take industrial action.

 Lock-outs  short term closure of the firm to prevent employees from working and
being paid.

 Closure of the business, leading to the redundancy of all workers.

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Motivation Chapter 11
( 11.1 ) What is motivation — and why does it matter?

Motivation is the internal and external factors that stimulate people to

KEY
work hard and committed to a job that lead to achieving a goal. It is a feeling
DEF
of commitment and satisfaction that the employees want to do something.

Motivation is the desire to see a job done quickly and well. It is resulted from the individual’s
requirement to achieve objectives and to satisfy needs and has a direct impact on productivity
and business efficiency. Managers need to understand the factors that motivate employees
to achieve excellent performance. Businesses that manage and motivate staff effectively
will gain a loyal and productive workforce ─ this can be a real competitive advantage.

The best-motivated workers will help an organization to achieve its objectives as cost
effectively as possible. Motivated workers will also trying to reach their own personal goals.
They also keen to stay with the firm, reducing the costs of labour turnover.

Unmotivated staff will be reluctant to perform effectively and quickly and will offer nothing
other than the absolute minimum of what is expected. This could lead to the following
drawbacks. Absenteeism, Lateness, Poor Performance, Accidents, Labour Turnover, Grievances,
Poor Response Rate, Low Productivity, Wastages of Resources.

( 11.2 ) Human Needs

People work to satisfy some or all of their

needs. Which human needs can be satisfied at
work?
Obviously, people need money to be able to
satisfy basic wants for food, housing and
other consumer goods. But what other needs
do people have and how far can these needs
be met at work? See Figure.

If employment does not provide the conditions for these human needs to be met, workers are
likely to be very de-motivated.

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( 11.3 ) Motivational Theories

Motivation Theories are guidelines which help managers in understanding the behavior of
the people and try to build the most healthy and productive working environment. These
approaches focus on these human needs that energies and direct human behavior and to
guide the way that how managers can create conditions that allow workers to satisfy them.

F.W. Taylor’s Theory: ( Scientific Management )

The techniques Taylor used ― of establishing an idea or a hypothesis, studying and recording
performance at work, altering working methods and re-recording performance. This
approach has become known as ‘scientific management’ which is based on rationalization and
standardization of work by division of labour, time and work measurement with piece-rate.

Taylor’s main aim was to reduce the level of inefficiency exist in manufacturing industry. Most
of the workers were untrained and non-specialized. They were poorly led by supervisors and
managers with no formal training in dealing with people.

How to improve productivity: (Taylor’s Scientific Approach)

(1) Select workers to perform a task.

(2) Observe them performing the task and note the key elements of it.

(3) Record the time taken to complete each part of the task.

(4) Identify the best and quickest method recorded.

(5) Train all workers in this quickest method and do not allow them to make any changes in it.

(6) Supervise workers to ensure that this ‘best way’ is being carried out and check that the

set time is not being exceeded.

(7) Pay workers on the basis of performance ─ based on the theory of ‘Economic Man’.

Theory of Economic Man ─ Taylor still believe that money is the only way to motivate staff
according to the theory of economic man, and the only factor that could improve further effort
is the chance of earning extra money.
However, the more general view is that workers have a wide range of needs, not just money.

Results of Taylor’s Work:

The implementation of Taylor’s theory leads to increasing efficiency and productivity as a
route towards greater profits. Workers leaders were more suspicious as they believed that it
would lead to more work but no more pay and benefits.

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Taylor approach was widely used by the manufacturing industry. Workers specializing in one
task, strict management control over work methods and payment by output levels were
important features of successful production line techniques.

Mayo (Hawthorne Effect)

Elton Mayo is best known for his ‘Hawthorne Effect’ conclusions. These were based on a
series of experiments conducted on the behavior of a group of assembly workers over five-
year period at the Hawthorne factory in Chicago, and these are referred to Hawthorne
experiments.

His work was initially based on the assumption that working conditions ─ lighting, heating, rest
periods, working hours, temperature and monitored how the change in working conditions
affected the workers morale and productivity. Experiments are conducted to establish the
optimum working conditions and the output of control group was also recorded and this group
experienced no changes in working conditions at all.

The results surprised all observers ─ as working conditions were changed, both improved and
worsened, so productivity rose in all groups indulging the control group. This forced Mayo to
accept that:

o Working conditions in themselves were not that important in determining productivity

levels.
o Other motivating factors needed to be investigated further before conclusions could
be drawn.

Subsequent experiments were carried out with a group of assembly-line workers. Changes to
rest periods, payment systems, assembly-bench layout and canteen food were made at 12-week
intervals. Before every major change, the researchers discussed the new changes with the
workgroup. At the end of the experiments, the working conditions were returned to how they
had been before the start of the trial. Output rose far above the original level. Clearly, other
motivational factors were operating to increase productivity.

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The Hawthorne Effect ─ The Conclusions of Mayo’s Work

o Changes in working conditions and financial rewards have little effect on productivity.
o When management consults with workers and takes an interest in their work, then
motivation is improved.
o Working in teams and developing a team spirit can improve productivity.
o Groups can establish their own targets or norms and these can be greatly influenced by
the informal leaders of the group.

Evaluation of Mayo’s Research for Today’s Businesses

Since Mayo’s findings were published, there has been a trend towards giving workers more of a
role in business decision making ─ this is called participation.

Team working can be applied in many types of modern businesses and these offer the greatest
opportunities for workers and firms to benefit from the ‘Hawthorne Effect’. The idea of
involving workers, taking an interest in their welfare and finding out their individual goals has
opened up new fields of research.

Hawthorne Effect will state that the motivation can be improved through improving
relationships and social interactions between people working in an organisation.

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Maslow’s Theory: (Hierarchy of Needs)

Maslow trying to identify and classify the main needs that humans have. The importance of his
work to business managers is this, ‘our needs determine our actions’ ─ we will always try to
satisfy them and we will be motivated to do so.
Maslow summarized these human needs in the following hierarchy:

Physical Needs: Income from employment ─ high enough to meet essential needs.

Safety and Security Needs:

Offering a contract of employment with some job security. A structured organization that gives
clear lines of authority to reduce uncertainty. Ensuring health and safety conditions are met.

Social Needs:
Working in teams or groups and ensuring good communication to make workers feel involved.

Esteem Needs: Offer recognition for work done well, give status, advancement and
responsibility will gain the respect of leaders and other fellow colleagues, the need to feel
good about themselves, and the need to be recognised for their achievement.

Self-actualization:
Offer challenging tasks and responsibilities that stretches the individual ─ this will give a
sense of achievement, scope of developing new skills and chance of promotion.

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Limitations of Maslow’s Approach:

(1) Not everyone has the same needs as is assumed by the hierarchy;;

(2) In practice it can be very difficult to identify the degree to which each need has been

met and which level a worker is on;;

(3) Money is necessary to satisfy physical needs yet it might also play a role in satisfying the

other levels of needs, such as status and esteem needs;;

(4) Self-actualization is never permanently achieved.

Herzberg’s Two Factors Theory

Herzberg research was based around questionnaires and interviews with employees with the
intention of discovering:

(1) Those factors that led to them having very positive feelings about the jobs.

(Job Satisfactory).

(2) Those factors that led to them having very negative feelings about the jobs.

(Job Dissatisfactory).

His conclusions were that:

Job Satisfaction resulted from five main factors:

o Sense of achievement and growth in a job,

o Recognition for Achievement,
o Nature of the Work itself, Suits to the Particular Skills of an Employee,
o Level of Responsibility, Authority and Delegation,
o Opportunity for Promotion and Advancement.

Job Dissatisfaction resulted from five different factors: (Hygiene Factors)

o Strict Company Policy and Administration,

o High Supervision,
o Low Salary,
o Poor Relationships with others, (Social Needs)
o Poor Working Conditions.

He termed these ‘Hygiene Factors’.

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These were the factors that surround the job itself (extrinsic factors) rather than the work
itself (intrinsic factors). Herzberg considered that the hygiene factors had to be addressed by
management to prevent dissatisfaction.

The Results of Herzberg’s Two Factor Theory for Business:

The motivators need to be in place for workers to be prepared to work willingly and to always
give of their best, and businesses could offer higher pay, improved working conditions and less
heavy-handed supervision of work. This help to remove dissatisfaction.

McClelland Achievement Theory

A Doctor of Psychology, David McClelland developed achievement–based motivational theory

and promoted improvements in employee assessment methods. He describing there types of
motivational needs.

Achievement Motivation:
A person with the strong motivational need for achievement will seek to reach realistic and
challenging goals and job advancement. There is a constant need for feedback regarding
progress and achievement to develop a sense of accomplishment.

Authority / Power Motivation:

A person with this dominant need is ‘authority motivated’. The desire to control others is
a powerful motivating force and it brings personal status and prestige.

Affiliation Motivation:
The person with need for affiliation as the strongest motivator has a need for friendly
relationships and is motivated towards interaction with other people. These people tend to be
good team members and to be held in high regards.

Results of McClelland Theory:

McClelland believed that ‘achievement-motivated’ people are generally the ones who make
things happen to show progress and get results.

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( 11.4 ) Motivation Methods in Practice

Financial rewards are the monetary incentives given to an employee in the form of cash. Pay is
necessary to encourage work effort. If pay is accepted as sufficient then it will ensure that
workers are motivated to work to their full potential and some other non-financial rewards
need to be considered.

Payments or Financial Reward System

 Wages, Hourly or Time Wage Rate,  Commission,

 Piece Rate,  Performance-Related Pay,
 Salary,  Profit Sharing / Share Ownership.

Wages

WAGES are often paid every week. The worker gets paid on a regular weekly basis and does
not have to wait long for the whole month to receive their wages.

If the employee works longer than their normal working hours, they will usually be paid
overtime. This is their regular amount per hour plus an extra amount usually calculated using
double the actual hour formula.

Hourly Wage Rate ( Time Rate )

DEF Hourly Wage Rate is the payment to a worker made for each hour worked.

An hourly ‘time rate’ is set for the job ─ perhaps by comparing with other firms or similar jobs
─ and the wage level is determine by multiplying this by the number of hours worked. This is the
most common way of paying manual, clerical and non-management workers.

Advantages of Hourly Wage Rate:

(1) Workers will not rush their work and this could lead to high quality.

(2) Gives workers some security of payment if there are unavoidable production hold ups.

(3) Wage rates can be adjusted easily to reflect different skill levels required to do a job.

Disadvantages of Hourly Wage Rate:

(1) Too much time may be taken to do a job as there is no additional reward for extra effort.

(2) Higher ‘overtime rates’ are paid after a contractual number of hours has been worked.

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Piece Rate

Piece Rate means payment by results, it is a wage determination system

DEF
in which the employee is paid for each unit of production at a fixed rate.

A rate is fixed for the production of each unit, and the workers wages therefore depend on the
quantity of output produced. The piece rate can be adjusted to reflect the difficulty level of
the job and the standard time needed to complete it.

Advantages of Piece Rate:

(1) It motivates workers to increase output.

(2) The labour cost for each unit is determined in advance and this helps to set a price

for the product.

Disadvantages of Piece Rate:

(1) Required output to be measurable and standardized, so mostly suitable in secondary

manufacturing industries.
(2) May lead to falling quality and safety levels as workers rush to complete units.

(3) Provides little security over pay level, for example in the event of production breakdown.

Salary

Salary is an annual sum that is paid on monthly basis. It is the most common form of
payment for professional, supervisory and management staff (white collar) gives employee
some level of security regarding the amount they will earn each month. The salary level is fixed
each year and it is not dependent on the number of hours worked or the number of units
produced, but according to the experience, skills and status of an employee.

In most organisations, all jobs will be put into one of a number on salary bands and the
precise income earned within each band will depend upon experience and progress.

Job Grade Salary Band

E, e.g. Regional Heads $50,000 ─ $75900

D, e.g. Departmental Heads $30,000 ─ $49,900

C, e.g. Office Managers $20,000 ─ $29,900

B, e.g. Secretaries $10,000 ─ $19,900

A, e.g. Junior Clerical Staff $5,000 ─ $9,900

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Advantages of Salary:
(1) It offers the security of income and considered to be a high status job.

(2) Gives status compared to time rate or piece rate payment systems.

(3) Aids in costing ─ The salaries will not vary for one year, so it is considered to be

the fixed cost which is easily calculated for the whole year.

Disadvantages of Salary:

(1) Income is not related to effort levels or productivity levels.

(2) No overtime payment ─ There is no payment for extra hours worked.

(3) Regular appraisal may be needed to assess whether an individual performing well

and should move up a salary band.

Commission

Commission ▬
KEY
A fee charged by an employee for providing services and facilitating a
DEF
business transaction, such as the buying or selling the goods and services.

This is the most frequently used in personal selling, where the salesperson is paid a commission
as a proportion of the sales gained. This method will inspire employees to achieve the highest
possible level of sales. It can make up 100% of the total income ─ reducing security ─ or it can
be in addition to a basic salary. Such as Sales Representatives, Property Dealers, Commission
Agents and Marriage Beuros.

Benefits of Commission:

o It creates the incentive to increase sales.

o It may be in addition to a basic salary so it could offer some security of pay too.

Drawbacks of Commission:

o It discourages teamwork amongst sales employees.

o It may lead to pressurised selling which damages customer relationships.

Bonus Payment

A bonus payment is one that is made to employees in addition to their contracted wage or
salary. While the base salary is usually a fixed amount per month, bonus payments may be
based on criteria agreed between managers and workers, such as an increase in output,
productivity or sales.

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Performance Related Pay: ( PRP )

Performance Related Pay ▬

KEY
Performance-related pay is money paid to someone relating to how well
DEF
he/she works at the workplace, dependent on the employee’s performance.

It is usually in the form of a bonus payable in addition to the basic salary. The main aim is to
provide further financial incentives and to encourage staff to meet agreed targets. It
requires the following procedures award the performance related pay.

o Regular target setting, establishing specific objectives using MBO.

o Annual appraisals of the worker’s performance against the pre-set targets;
o Paying each worker a bonus according to the degree to which targets have been
exceeded.

Advantages of Performance Related Pay:

(1) Motivates staff to improve performance if they are seeking increase in financial rewards.

(2) Target setting can help to give purpose and direction to the work of an individual.

Disadvantages of Performance Related Pay:

(1) Team spirit can be damaged by the rivalry generated by the competitive nature of PRP.

(2) Claims of manager favoritism can harm manager/subordinate relationships.

Profit Sharing

Profit Sharing is an employee motivation plan under which employees

DEF
receive a share of the firm's profits at the end of the year.

This scheme shares some of the company profits not just with the shareholders but also with
the workers. The essential idea behind these arrangements is that staff will feel more
committed to the success of the business and will strive to achieve higher performances
and cost savings.

Some shareholder groups claim that profits should be the return to the owners of the
business.

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Share Ownership:
Some profit-sharing schemes do not offer cash but shares in the business to each worker
when the firm declares a profit. This is designed to establish the workers as part owners of the
business and reduce the conflict that might exist between them.

Advantages of Profit Sharing Schemes:

(1) Reduces the potential conflict between owners and workers as everyone now has

an objective to maximize the profits.

(2) Business is likely to attract better recruits drawn by the chance of sharing profits

and owning shares in the firm.

Disadvantages of Profit Sharing Schemes:

(1) The reward offered is not closely related to individual effort.

(2) The schemes can be costly to set up and operated, especially in large scale firms with

thousand of employees.

Fringe Benefits

KEY Fringe benefits are collection of various benefits provided by the company
DEF to their workers, in addition to basic pay in the form of non-financial reward.

These are non-monetary forms of reward and they are used by business in addition to normal
payment systems in order to give status to lower and higher level employees and to retain the
best staff. These fringe benefits are also called perks. List of fringe benefits:

 Health & Medical Facilities  Retirement / Pension Plans

 Medical Insurance  Company Transportation Benefits
 Children’s Education Fee  Discount on Company Products
 Child-Care Services  Disability Benefits
 Generous Expense Account  Flexible Work Schedule and Hours
 Free Trips/Local/Abroad  Free Accommodation
 Free Refreshments  Employee of the Month Recognition
 Subsidized Meals  Utility Bills (only for managers)

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Non-Financial Methods of Motivation

These are non-monetary from of rewards as it is now recognized that money alone will not
motivate the people and create the job satisfaction. The range of non-financial motivators is very
extensive and useful to encourage the workers to participate more effectively in achieving
the goals and objectives of business organization.

Job Rotation

Job Rotation increasing the flexibility of the workforce and the variety of
DEF
work they do by switching form one job to another.

This is simply encouraging a worker to do more than one task by switching from one job to
another. Rotation may relieve the boredom of doing one task and it can give the worker multi-
skills, which makes the workforce more flexible, but it does not increase empowerment or
responsibility of the work being performed, and depends on the scope of the job.

Job Enlargement

Job Enlargement attempting to increase the scope of a job by adding

KEY
extra tasks to the workers job, these responsibilities should be matched
DEF
with the employee’s previous job.

It also refers to increasing the ‘horizontal loading’ of tasks on existing workers and also
includes job rotation. Some times shortage of staff or redundancies also leads to job
enlargement for some employees. Job enlargement is an effective utilization of worker’s free
time. Neither the extra payment nor the training is required for the job enlargement.

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Job Enrichment

Job Enrichment is the process that involves a reduction of direct

KEY
supervision as workers take more responsibility for their own work and are
DEF
allowed some degree of decision-making authority.

Benefits of Job Enrichment:

o Complete units of work are produced so that the worker’s contribution can be identified
and more challenging work can be offered by using team.
o Direct feedback on performance allows each worker to have an awareness of their own
progress.
o Challenging tasks are offered as part of a range of activities, some of which are beyond
the worker’s recent experience. These tasks will require training and the learning of new
skills, adding status and recognition.

Limitations of Job Enrichment:

o Lack of employee training or experience to cope with the greater depth of tasks can
result in lower productivity. It is important not to take a worker too far from the type of
work they are comfortable with.
o Employees may see the enrichment process as just an attempt to get them to do more
work.
o If employees are just not able to cope with the additional challenges imposed by job
enrichment, then this can lead to frustration and de-motivation.

Job Redesign

Job Redesign involves the restructuring of a job ─ usually with employees’

KEY
involvement and agreement ─ to make work more interesting, satisfying and
DEF
challenging.

Journalists now have to be IT experts to communicate through t he wide rang of technological

media. Bank employees are encouraged and trained to sell financial products to customers.

Job redesign process, involves revising the job contents, reformation of job description and job
specification and reshuffling the job-related tasks and duties.

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Training & Development

Most businesses offer schemes for the training and development of their employees.
Benefits of Providing Training & Development:
o Improving and widening the skills of employees can increase the productivity and
flexibility of the workforce and its ability to deal with change.
o Training and development increase the status of workers and give them access to more
challenging, and probably better-paid, jobs within the business.
o Developing employees and encouraging them to reach their full potential increase the
opportunities for self-actualisation.
o Training and development are often important incentives for employees to stay with a
business as they feel that they are being recognised and appreciated by the company.

Opportunities for Promotion & Increased Status

There are benefits to both the employee and the employer if the business offers a clear career
structure. It allows employees to work towards advancement to a higher level within the
business. Employee promotion to a higher-level job is seen as a reward for hard work.
Promotion results in increased employee status, which satisfies a key human need. If
employees think there is no career structure and no opportunity for promotion, they will not be
motivated to perform to the best of their abilities. Businesses that do not recognise hard work
and exceptional performance through promotion always risk losing a talented employee.

Employee Participation

Employee Participation means workers are actively encouraged to become involved in decision
making within the organisation. Democratic leadership is the best way to involve workers in
decision making. Opportunities for worker participation might include involvement in decisions
on break times, job allocations to different workers, job redesign, ways to improve quality and
ways to cut down wastage and improve productivity.

Delegation & Empowerment

Delegation involves passing down of authority and responsibility to perform tasks to

workers. Empowerment is a management practice of sharing information, rewards, and power
with employees so that they can take initiative and make decisions to solve problems. It is based
on the concept of giving employees the skills, resources, authority, opportunity,
motivation, as well holding them responsible and accountable for outcomes of their actions, this
gives a feeling of importance and of being valued and trusted by managers.

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Team Working

Team Working in which production is organized so that groups of workers

KEY taking the responsibility of complete units of work and each team member
DEF is responsible for his/her performance and quality. People can be more
productive when working in groups than when working alone.

This approach to work place, each member of staff into a small team of employees:
Some traditionalists argue that moving away from pure division of labour, where one worker
performs just one simple task all of the time, will result in lower productivity and time-
wasting ‘team’ meetings. Benefits of Developing Teams:

(1) Lower labour turnover and absenteeism.

(2) Better ideas from the workforce on improving the product
and the production process.
(3) Consistently higher-quality of goods and services.

(4) When a team works together, it has a huge range of skills

available that it can utilize to deliver extraordinary results.

Quality Circles

A quality circle (QC) is a group of five to ten employees who have experience in a particular
work area. They meet regularly to identify, analyse and solve the problems arising in their area
of operation. Quality circles are used to identify problem areas in business processes and
members work on these to improve product quality and productivity.

Quality circles are not just concerned with quality, although improving quality of the product or
service can be a major benefit. The meetings are not formally led by managers or supervisors.
They are informal and all workers are encouraged to contribute to discussions.

Benefits of Quality Circles:

o Workers have hands-on experience of work problems and they suggest the best solutions.
o The results of the meetings are presented to management. The most successful ideas are
often adopted across whole organisation, acting as effective participation of employees.

Limitations of Quality Circles:

o Quality circles may not have the management power to make the changes that they
recommend. Ignoring the proposals from quality circles too often, employees will become
discouraged and unwilling to participate.

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Book-2 Chapter 12 | Management Roles & Leadership Styles 93

Management Roles & Leadership Styles Chapter 12

( 12.1 ) Management & Managers

Manager responsible for setting objectives, organizing resources and

KEY
motivating staff and for directing the progress of an organization so that
DEF
the organization’s aims and objectives are met.

Managers ‘get things done through workers’ ─ not by doing all jobs themselves but by
working with and through other people. Management is the development of people and the
process of decision making to control activities of the people working in an organisation.

A Manager is the person responsible for planning and directing the work of people, monitoring
their work, and taking corrective action when necessary. For many people, this is their first
step into a management career.

Traditional 5 Functions of Managers

(Fayol & Mintzberg)

(1) Setting Objectives and Planning:: (Planning)

Planning is the ongoing process of developing the business aim and objectives to drives
business towards its long-term success. Planning involves defining a goal and determining the
most effective strategies needed to reach that goal. Typically, planning contains flexibility,
as the planner must co-ordinate with all levels of management and leadership in the
organization.

(2) Organising Resources to meet the Objectives:: (Organising)

Organizing involves delegating tasks and responsibilities to employees along with the required
resources with the specific skill needed to complete the tasks. Organizing also involves
developing a complete organizational structure to ensure that the culture of the business
allows the effective allocation of the resources in the most efficient way possible.

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(3) Directing and Motivating Staff:: (Motivating)

This means guiding, leading, motivating and overseeing of employees to provide clear
direction about what they are expected to do so that a business is able to achieve its objectives.
Managers are also responsible for encouraging all the employees in order to use their full
abilities. The main purpose of directing is to hire the right people for the right jobs to
achieve the objectives of the organization.

(4) Co-ordinating Activities:: (Co-ordinating)

Co-ordinating means ‘Bringing & Binding People and Resources Together’. The goals of each
branch, division, region and even all staff must be welded together to achieve a common
sense of purpose, within the same time scale. Co-ordinating typically takes place in meetings
and other planning sessions with the departmental heads of the company to ensure all
departments are on the same objectives and goals. Co-ordinating involves communication,
supervision and direction by management.

(5) Measuring and Controlling Performance Against Targets:: (Controlling)

The controlling function of management is useful for ensuring all other functions of the
organization are in place and operating successfully. Its management’s responsibility to
appraise performance against the preset targets. Management by objectives establishes
targets for all groups, division and individuals and making performance standards to
monitoring the output of employees. If certain groups are failing to perform what is expected of
them, then managers may have to take some corrective action.

Remember the Word (POMCC)

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The Role of Managers by Mintzberg

To carry out these functions, managers have to undertake different roles. Henry Mintzburg
identified ten roles common to the work of all managers and divided into three groups.
Interpersonal Roles:
Dealing with and motivating staff at all levels of the organisation related with the personality
of entrepreneur.
Informational Roles: Acting as a source, receiver and transmitter of information.
Decisional Roles:
Taking decisions and allocating resources to meet the organisation’s objectives.

Role Title Description of Role Activities

1 Interpersonal Roles

Figurehead Acting as representative, provide guidance, leadership & Inspiration.

Provide direction, motivating subordinates; selecting and training

Leader
other managers and staff and acting as a role model.

Linking with managers and leaders of other division of the business,

Liaison
and developing the co-ordination to weld all the people together under
(Co-ordination)
a common aim.

2 Information Roles

Monitor Collecting & processing data relevant to the business operations.

Sending information collected from external and internal sources to

Disseminator
the relevant people and department within the organisation.

Communicating information about the organisation, making all the

Spokesperson
important announcements within the firm.

3 Decisional Roles

Looking for new ideas & opportunities to develop the business,

Entrepreneur
acting as a driving force for the business organisation.

Disturbance Handler Responding to changing situations that may put the business at risk.

Resource Allocator Deciding on the spending of the organization’s financial resources.

Representing the organisation in all important negotiations with

Negotiator
employees, suppliers, customers and the government.

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The Contribution of Managers to Business Performance

Effective managers lead successful businesses. The key indicators that managers are having a
positive impact on business performance are:
o The business regularly meets its objectives.
o High level of customer satisfaction.
o High employee motivation levels and low labour turnover.
o A respected brand name.
o High regard of external stakeholders in terms of environmental sustainability.
o Excellent communication both within the business and with external stakeholders.

Management Styles

Chief Executive Officer (CEO):: (Formal Leaders)

A CEO is the highest-ranking executive in a company. The primary responsibilities include:
making major corporate decisions, managing overall operations, managing company resources.

Directors:: (Formal Leaders)

These senior managers called board of directors are elected from shareholders in a limited
company responsible for establishing and implementing the corporate policies. Because of
their specialized knowledge about the inner workings of the company, a strong board of inside
directors is a key element in its success.

Managers:: (Formal Leaders)

Any individual responsible for people, resources or decision making, can be termed a manager.
They are usually head of a major functional department, such as marketing department and
responsible for delegating the tasks and responsibilities within their department and meeting
the corporate objectives. They will have some authority over other staff below them in the
hierarchy. They will lead, motivate and discipline the staff in their authorized areas.

Supervisors:: (Formal Leaders)

These are appointed by management to supervise and watch over the work of others. This is
usually not a decision-making role, but they will have responsibility for leading a team of
people in working towards pre-set goals. The modern role of these members of staff is less of an
inspector and much more of a work colleague who is appointed to help and provide
guidance to staff to achieve objectives in a co-operative spirit and team working.

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Workers’ Representatives:: (Informal Leaders)

These representatives are elected by the workers, as trade union representatives, in order to
discuss area of common concern such as financial and non-financial rewards with managers
and to protect their rights within an organisation.

Note: Workers’ Representatives are not the part of Organisational Hierarchy.

Leadership & Management Styles

Leadership style is the manner and approach of providing direction,

KEY
implementing plans, and motivating people, leadership style also refers to the
DEF
way in which managers take decisions and deal with their staff.

There are four distinct management styles:

o Autocratic (Authoritarian)
o Laissez-Faire (Delegative)
o Paternalistic (Father’s Like)
o Democratic (Participative)

Autocratic Leadership Styles: (Take or Leave)

Autocratic leaders take decisions on their own with no discussion with anyone. They set
business objectives themselves, issue instructions to workers and check to ensure that the
instructions are carried out. Workers can become so familiar to this style that they are
dependent on their leaders for all guidance and will not show any initiative. Motivation levels
are likely to be low so supervision of staff will be essential. Autocratic leaders use one-way
communication link.

Autocratic leaders typically make choices based on their own ideas and judgments and rarely
accept advice from followers. The autocratic leadership style is best used in situations where
quick decisions are required and control is necessary, often where there is little margin for
error. Many times, the subordinate staff is inexperienced or unfamiliar with the type of work
and heavy oversight is necessary.

Example:
Armed Forces and the Police, Railway Accident, Construction Projects, Rescue 1122, Fire
Services, Strategic Decisions of the Business, emergency situations.

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Benefits:
Experience leaders take all the decisions and supervise workers closely. Effective
supervision can be provided through detailed orders and instructions improve the
progress of the business organisation. Quick decision making, there is not always time to
consult employees.

Drawbacks:
It De-motivates staffs who want to
contribute and have valuable ideas,
and fails to develop the worker's
commitment to the objectives of the
organisation. Autocratic style can
create an environment of fear and
resentment, leading to poor

productivity, high turnover and absenteeism. Better decisions might be made if

employees are consulted as they might have some good ideas for improving products and
ways of working.

Paternalistic Managers: (Father’s Like)

Paternalistic Managers will listen, explain issues and consult with the workforce, but will
not allow them to take decisions. The paternalistic managers will decide ‘what is best’
for the business and the workforce but the delegation of decision making will be most
unlikely.

Real Application Examples:

This style could be suitable in a situation with unskilled,
untrained or newly appointed staff, but it may lead to
disappointment in more experienced staff.

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Laissez-Faire Leadership Styles: (Let Them Do It)

This style of leadership allows workers to carry out tasks and take decisions themselves
within very broad limits. There will be a little guidance and direction from management and the
tasks and responsibilities to subordinates. However, the leader is still responsible for the
decisions that are made. Laissez faire leadership relies heavily on the competence, honesty,
and enthusiasm of the team to be successful.

The laissez-faire leadership style is also known as the “hands-off” style. It is one in which the
manager provides direction and gives employees as much freedom as possible and allow them
to work under their own method to achieve common set of goals. All authority and power is
given to the employees and they must determine goals, make decisions, plan strategies and
resolve problems on their own.

Some people might respond very well to the freedom to decide on how to spend their working
lives; others may become frustrated.

Real Application Example:

Effective in Research and Development Projects, Quality Control and Assurance Department, also
use where employees are highly Skilled, Experienced, Competent and Educated.

Benefits:
Leader’s shows trust on workers and delegate all authority and decision making powers to
the workers and this will increase motivation and productivity levels of the business and help
employee to develop self-discipline. This leadership style also gives the team members a greater
sense of responsibility, which can increase the team spirit.

Drawback:
Leaving workers to take their own decisions with
little direction might lead to a lack of
confidence, increasing the chance of errors, poor
decisions and poor motivation as they are never
sure if that they are doing is ‘right’. The biggest
risk is if the team is not competent and
trustworthy enough to make the decisions
needed, then the ability to achieve targets is
seriously spoiled.

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Democratic Leadership Styles: (Participative)

Democratic managers will engage in discussion with workers before taking decisions.
Communication links will be established on the ‘two-way’ method with every opportunity for
staff to respond and participate in discussion. Managers using this approach need good
communication skills to be able to explain issues clearly and understand the response from
the employees. Full participation in the decision making process is encouraged. This may lead
to better final decisions as the staff has much to contribute and can offer valuable ideas and
work experience to new situations.

Real Application Example:

This is normally used when managers have part
of the information, and employees have other
parts where the manager is not expected to
know everything. When situations change
frequently, democratic leadership offers a
great deal of flexibility to adapt to better
ways of doing things in a team by collecting suggestions from colleagues.

Benefits: Participation encourages workers to give their ideas and suggestion using two way
communication, this involvement increases the level of motivation power of decision making so
that creativity is encouraged and rewarded.

Drawbacks: Consultation can be time consuming and not suitable where the quick decision
will be required, some issues might be sensitive and not possible to share with workers.

The ‘Best’ Leadership Style Depends on the following factors

 The training and experience of the workforce and the degree of responsibility that
they are prepared to take on.
 The amount of time available for consultation and participation.
 The attitude of managers, or management culture influenced by the personality and
business background of the mangers.
 The importance of the issues under consideration, different styles may be used in the
same business in different situations.
 The culture and tradition of the organisation ─ A business may develop its own
culture according to the pattern of behavior of employees and the attitude of the
managers.

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( 12.2 ) McGregor’s Theory X and Theory Y

Douglas McGregor identified two distinct management approaches to the workforce and he
called these Theory X and Theory Y.

Theory X:
According to Theory X, manager view their workers as lazy, disliking work and unprepared to
accept responsibly, need to be supervised strictly and demand high level of financial rewards.
Managers with this view will be likely to adopt an autocratic style of leadership. People must be
forced, controlled, directed, or threatened with punishment and need to be supervised at
every step in order to get them to achieve the organizational objectives. They use autocratic style
of leadership and feel hesitate to delegate authority as they believe the workers are not capable
of performing the task.

Theory Y:
According to Theory Y, managers believed that workers did enjoy work and they found it as
natural as rest or play. They would be prepared to accept responsibility, are creative and they
would take an active part in contributing ideas and solutions to work related problems. Theory Y
manager is more likely to involve employees in decision and give them greater responsibility and
adopt democratic leadership style.

Evaluation: McGregor’s did not suggest that there are two types of workers, X and Y, but that
the attitudes of management to workers could be described by these two theories.
“Some experts believe that workers will behave in a particular way as a result of the attitudes
management have towards them”.

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Unit 3
Marketing

Business Studies Resource Prepared By Usman Akhter

Book-2 Chapter 17 | What is Marketing 103

The Nature of Marketing Chapter 17

( 17.1 ) Role of Marketing

Most people think of marketing as just being about advertising and selling of products.
Marketing contains much more than just telling people about a product and selling it to
them. Marketing involves a number of related management functions. These include:

 Market Research;  Distribution;

 Product Design;  Customer Sale and Service;
 Pricing the Products;  Packaging;
 Advertising and Promoting Products;  Research & Development.

One shortest definition of marketing is ─ Marketing is the management process responsible for
identifying, anticipating and satisfying consumers’ requirements profitability.

Marketing

Marketing is the management process that links the business to the

KEY customer by identifying and meeting the needs and wants of customers
DEF profitably ─ it does this by getting the right product at the right price to the
right place at the right time.

Market research is needed to identify and analyze customer demands, with this information;
strategic decisions must then be taken about product design, packaging, pricing, promotion
and distribution.

Marketing Objectives & Corporate Objectives

K Marketing Objectives are the goals set by the marketing department to help to
E achieve the corporate objectives of the firm.
Y

D Marketing Strategy is the long-term plan of activities established for achieving

E marketing objectives. The strategic plan therefore is the detailed planning involving
F marketing research, and developing a marketing mix for the targeted customers.

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Marketing objectives are the aims which organisation is trying to achieve through its
marketing activities during a specified period, closely linked with corporate objectives.

o Achieving a higher market share; (Objective)

o Maximizing sales and profitability of the firm. (Objective)
o Market penetration ─ increasing sales in existing markets; (Objective)
o Market development ─ selling existing products or introducing innovative ones ─ to
new markets; (Objective)
o Increase product awareness among the target audience though advertisement and
offering promotion deals; (Strategy)
o Offering a huge product portfolio in order to provide the greater choice to consumers.
(Strategy)

Marketing objectives should be specific, measurable, relevant, and achievable completed

within a given time frame. (SMART Marketing Objectives)

Why are Marketing Objectives so Important?

o They provide a sense of purpose and direction for the marketing department.
o Progress can be assessed against these targets. It is clear that, if there is likely to be an
underachievement, then corrective action required.
o They can be broken down into limited short-term targets and also divided between
different product and geographical regions of the firm.
o The objectives will be used as the starting point for the businesses marketing strategy –
the plan for action that it must adopt.

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Co-ordination of Marketing Department

with other Departments

The links between the marketing department and other functional departments — such as
finance, operations and human resource are an essential component of a successful marketing
strategy.

Marketing  Finance

o The finance department will use the sales forecasts of the marketing department to help
construct cash flow forecasts and budgets and ensure that the required capital is
available.

Marketing  Human Resource

o The sales forecasts will be used by human resource to help devise a workforce plan and
ensure that the qualified and experienced staff is recruited to achieve the
organisational objectives.

Marketing  Operations

o Market research data will play a key role in new product development and the sales
forecasts will be used to plan for the production, capacity needed, the purchase of
raw materials and machines required for the output.

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( 17.2 ) Demand & Consumer Behavior

Demand for a product is the quantity that consumers are willing and able
DEF
to buy at a given price in a particular time period.

Successful businesses need to be aware of the factors that determine consumer demand. If the
business can produce the product at this market price, it should be profitable. In free markets
the equilibrium price is determined when demand equals supply.

Demand

(1) This varies with price ─ for all normal goods the quantity bought rises with a price fall
and the quantity bought falls with a price increase.

(2) Factors other than Price:

o Changes in incomes caused by rising wage levels;

o Increasing population size or an increase in the size of the population in the age
range at which the product is targeted;
o An increase in the prices of substitute goods, for example an increase in the price of
minidisks could increase the demand for CDs;
o A reduction in the price of complementary goods, for example a fall in the price of
CD players could again raise the level of demand for CD’s;
o An effective advertising or promotion campaign might lead to increased numbers of
consumers trying the product.

(3) All these factors lead to a new demand curve.

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Supply

Supply is the quantity of a product that firms are prepared to supply at a

DEF
given price in a particular time period.

(1) This varies with price ▬ firms

will be more willing to supply a
product if the price rises and will
supply less as the price falls. This
is shown in figure:

(2) Apart from changes in price ▬ which cause a new position on the supply curve ─ the level
of supply of a product can vary due to a change in any of these determinants of supply::
o Costs of production, change in labour or raw material costs;
o Taxes imposed on the suppliers by government, which raises costs;
o Subsidies paid by government to suppliers, which reduce their costs;
o Weather condition and other natural factors;
o Advances in technology to make costs of production lower.
(3) All of these changes lead to a new supply curve.

Determining the Equilibrium Price

Equilibrium Price is the market price that equates supply and demand for a
DEF
product.

Market equilibrium is the situation where demand is equal to supply, and there is no
shortage or surplus in the market. This is called equilibrium point, and the price and quantity
at that level is called equilibrium price. When demand and supply are combined, the equilibrium
price will be detrained. This will be at the point where Demand = Supply.

If the price were higher than this, there will be unsold

stocks ─ excess supply. Suppliers do not want this, so
will lower the price.

If the price lowers than the equilibrium, then stocks will

run out ─ leaving excess demand. Suppliers could
make a higher profit by raising the price.

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( 17.3 ) Market

The term market has two different meanings:

The first and most obvious meaning of market is the ‘place or mechanism’ where buyers and
sellers meet to engage in exchange’. Such as shopping centers, high street retail stores.

Secondly the term market also refers to the group of consumers that is interested in a
product, has the resources to purchase the goods and services offered and are permitted by law
to purchase it.

Industrial & Consumer Markets

Industrial Markets ▬ the selling of products by businesses to other businesses, also known as
B2B need promotion.
The intended purchaser of industrial goods is much more likely to refer to specialist magazines,
journals and websites and advertising in these is going to be clearly focused to the target
audience such as producers of other industries.

Trade promotions will be used instead of consumer sales promotions, and these could take the
form of financing deals to aid firms with the purchase of expensive equipment. Trade
exhibitions and trade magazines are the most useful way of promoting industrial products.

Consumer Market ▬ the selling of products by businesses to the final user, also known as
business to consumer or B2C. These include mobile phones, holidays and fashion clothing.

Local, National & International Markets

Local Businesses ▬

Some businesses just operate locally – they sell products to consumers in a short
geographical area where the business is located. Firms that just sell in these local markets
include laundries, florist shops, hairdressers and car repairing workshop.

National Markets ▬

Local markets have limited sales potential. This process might then extend to national
markets and try to sell to the whole national market. Common examples include: banking firms,
supermarket chains and large clothing retailers. Habib Bank with 1650 branches all over the
country in Pakistan.

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International Market ▬

Offer the greatest sales potential. The rapid rise of multinationals that operate and sell in
many different national markets illustrates the sales potential from exploiting international
markets in different tastes, cultures and laws. KFC, HSBC, Nestle, Toyota.

Market Orientation / Customer Orientation

Market-Orientated businesses having an outward-looking approach which

KEY carries out market research to find out consumer wants before a product

DEF is developed and produced, and tries to satisfy and develop the long-term
relationship with customers.

Most businesses would today describe themselves as being ‘market oriented’ or ‘market led’.
This means that the firm focuses on consumer needs and wants and devotes production and
marketing resources to satisfying them. Market orientation refers to the actual implementation
of the marketing concept.

This approach requires market research and analysis to indicate present and future
consumer demand. The consumer is put first and the business will attempt to produce what
consumer want rather than try to sell them a product they may not really want to buy.

Examples:
Fast Food, Clothes.

The benefits of market orientation are:

o The chances of newly developed products failing in the market are much reduced ─ but
not eliminated.
o If consumer needs are being met with appropriate products then they are likely to
survive longer and make higher profits.
o Constant feedback from consumers ─ market research never actually ends ─ keep
regular contact with the customers, and adapted the changing tastes before it is too
late and before competitors ‘get there first’.

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Product Orientation

Product Orientation is an inward-looking approach that focuses on

KEY
developing products using Research & Development techniques ─ and
DEF
then trying to market them.

Product-oriented businesses invent and develop products in the belief that they will find
consumers to purchase them. The development of the Hybrid car is driven more by technical
innovation than by consumer needs ─ consumers were not aware that such versatile products
were likely to be made available until the basic concept had been invented and developed into an
innovative new product.

Production-oriented businesses concentrate their efforts on efficiently producing high-

quality products. They consider that if the product is of high quality then it will be purchased
by consumers who value this feature above market fashion. Such quality-driven firms do still
exist, especially in product areas where quality or safety is of great importance.

Examples:
Memory Cards, Hybrid Cars, Iphone, Wifi Internet, 3D LED’s.

Market Size

Market Size is the total number of buyers and sellers of a product in a

DEF
particular market.

This is especially important for companies that wish to launch a new product or service, since
small markets are less likely to be able to support a high volume of goods. Large markets could
bring in more competition, for example total number of cars sold in one year. Total number of
SIMS issued by all cellular companies.

Benefits of measuring market size:

o It allows a marketing manager to assess whether a market is worth entering or not.

o It allows a business to calculate its own share of the market.

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Market Share

Market Share ▬ The market share of a business is the proportion which

KEY
its sales represent of total market size. It shows how successful the business
DEF
is in relation to its competitions.

Sales of the Business

Market Share = × 100
Total Market Sales

‘Firm’s sales’ and ‘total markets sales’ can be measured in either units (volume) or sales
value (revenue) in this market. Market share, and increases in it, is often the most effective
way to measure the relative success of one business’s marketing strategy against that of its
competitors. If a firm’s market share is increasing, then the marketing of its products has been
relatively more successful than most of its competitors.

The benefits of high market share:

o Sales are rising faster than those of any competing business in the same market, that
considered to be the market leader.
o Retailers will be keen to stock and promote the best selling brands.

The fact that an item or brand is the market leader can be used in advertising and other
promotional material.

Market Growth

Market Growth means the rate at which total sale in the market are
DEF
rising each year ─ or falling if growth is negative called market shrinking.

Different markets grow at different annual rates. Market growth is the percentage increases in
the size of the whole market it. Market growth can be measured in two ways::

o By Volume ─ the market has risen form 23 to 26 million units, an increase of

12.5%.

o By Value ─ the revenue has risen from $768 million to $936 million,
an increase of 21.87%.

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Consumer Marketing (B2C) &

( 17.4 )
Industrial Marketing (B2B)

Consumer Products ▬ Consumer products are made and marketed for

KEY
use by the customer for personal use. They are purchased by customers for
DEF
purposes like hygiene, entertainment, or home maintenance.

Industrial Products ▬

KEY Industrial products are materials and services used to operate a business.

DEF This can include everyday equipment for the operation of a business, like
machines to manufacture products meant for ultimate use by the consumer.

Consumer products are often classified into:

o Convenience Products  purchased frequently, often bought on impulse and sold to

a large target market, such as milk drinks, chocolates.
o Shopping Products  usually require some planning and research by consumers
before being purchased; consumers do not buy these frequently, such as washing
machines.
o Specialty Products  bought infrequently, often expensive with strong brand loyalty,
such as cars, furniture, designer clothes.

Industrial products are often classified into:

o Materials & Components  needed for production to take place such as cotton, steel,
electric motor for machines.
o Capital Items  equipments, machinery, computers, and vehicles.
o Services & Supplies  business services and utilities such as IT support, electricity,
gas, machine maintenance services.

The key differences between selling to businesses rather than consumers are:

 Most industrial products are much more complex than many consumer products so
specialist sales employees and support services will be more important with B2B selling.
 Industrial buyers often have much more market power and are better informed than the
average consumer. They need to be sold products by well-trained and experienced sales
employees.

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( 17.5 ) Mass Marketing & Niche Marketing

Mass Marketing

Mass Marketing involves selling a very large number of the same

KEY
standardized products to the whole market with not attempt to target
DEF
groups within it and there is no market segmentation carries out.

Examples include Coca-Cola and household products such as soap, shampoo, olive oil, grocery
products.

Mass marketing is exact opposite. ‘One product for the whole market’ such as household
products.

Advantages of Mass Marketing:

o A mass-market strategy with high sales of a standard product can lead to lower average
costs of production.
o Mass market strategies run fewer risks and cost advantages can lead to lower prices to
consumers which help to reinforce the position of the product in the market.
o Mass marketing can result in extensive publicity for the business and its product
leading to clear brand identity.

Disadvantages of Mass Marketing:

o Lack of differentiated products and differentiated marketing does not appeal to many
consumers.
The focus on low prices does not help to establish a premium brand image for the
product.

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Niche Marketing

Niche Marketing involves identifying and exploiting a segment of a larger

KEY
market, which is not previously identified by any other competitor; it
DEF
involves offering unique products to customers.

Niche segment can be a very small section of the whole market and may be one that has not
yet been identified and filled by competitors.
Example: Mercedes-Benz, Toyota Perius Hybrid, Sony Xperia Waterproof Mobile Phone.

Advantages of Niche Marketing:

o By offering Niche products, small firms may be able to survive easily in markets that
are dominated by larger firms.
o Filling a niche can offer the chance to sell at high prices and high profit margins ─
until the competitors copy the niche feature.
o Consumers will often pay more for an exclusive product.
o Niche market products can also be used by large firms to create status and image ─
their mass market products may lack these qualities.

Disadvantages of Niche Marketing:

o Small market niches do not allow economies of scale to be achieved.

o There is limited scope for business growth if the niche market has few customers.
o If selling in a niche market is profitable, this is likely to attract competitors. This could
lead to lower prices and profitability.

( 17.6 ) Marketing Segmentation

Market Segment ▬
K
A market segment is a sub-group of a whole market in which consumers have similar
E
characteristics. Each market segment is unique and marketing managers decide on
Y
various criteria to create their target markets.
D
Market Segmentation ▬
E
Identifying these different groups and marketing different products to them is
F
called market segmentation. This helps the business to select the right customers.

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The process of splitting customers, in a market into different segments, within which customers
share a similar level of interest. Sometimes segmentation is referred to as differentiated
marketing, instead of trying to sell just one product to the whole market; different products are
targeted and offered to different segments. To be effective, firms must analyze the total
market size carefully to identify the specific consumer groups that exist within it.

Example  HP produce PCs for office and home users, but also make laptop models for
business people who travel. Coca-Cola also producing Diet Coke for weight-conscious consumers.

Market Segmentation ─ Identifying Different Consumer Groups

Successful segmentation requires a business to have a very clear picture of the consumers in
the target market it is aiming to sell in. A ‘picture’ of the typical consumer needs to be built up
to help with market research sampling, designing the product, pricing and promoting the
product. This is called the consumer profile. The main characteristics of consumers contained
in a consumer profile are income levels, age, gender, social class and region.

Advantages of Market Segmentation

o Businesses can define their market precisely and design products goods that are
specifically focused on target groups of consumers.
o Marketing strategies can be focused on the target market groups and this avoids
wasting resources on trying to sell products to the whole market.
o Small firms, that may not be able to compete in the whole market, are able to specialize
in one or two market segments; it is a valuable tool for increasing profits.

Disadvantages of Market Segmentation

o Production and stock holding costs may be higher than for the option of just producing
and stocking one undifferentiated product.
o Promotional costs may also be higher as different strategies will be required for
different segments.
o Research and development and production costs could be high in order to produce
several different product variations.

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Methods of Segmentation

(1) Demographic Differences

In demographic segmentation, the market is divided into groups on the basis of different
variables. Demography is the study of population data and trends, and demographic factors,
such as age, gender, income, family size and ethic background, all factors be used to
separate markets. Some demographic segmentation variables include:

(1) By Age (2) By Gender (3) By Income

(4) By Family Size (5) By Family Life Style (6) By Religion & Culture

(2) Geographic Differences

Geographic segmentation is dividing the market into different geographical units such as
nations, states, regions, countries, cities and offer products according to local variations.
Consumer tastes may vary between different geographic areas and it may be appropriate to
offer different products and market them in ‘location-specific’ ways.

Geographical difference might result from cultural differences ─ for example alcohol cannot be
promoted in Arab Muslim countries. McDonald’s geographically segment their market according
to the taste, culture and religious constraints.

Geographic Segmentation:
The following are some examples of geographic variables.

o Region  By continent, country, state, or even neighborhood.

o Size of metropolitan area  Segmented according to size of population.
o Climate  According to weather patterns common to certain geographic regions.

(3) Psychographic Segmentation

Psychographic Segmentation performs according to people’s lifestyles, personalities, values and

attitudes. Attitudes are set of feelings, beliefs, and behaviors. Lifestyle is a very broad term
which often related to activities undertakes interests and opinions rather than personality.
Personality characteristics are consists of different purchasing patterns, aggressiveness of
the people and consumption decisions.

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( 17.6 ) Customer Relationship Marketing (CRM)

CRM  Using marketing activities to build and establish good customer

DEF
relationships so that the loyalty of the customers can be maintained.

At the heart of CRM is communication with the customer to gain information. This includes
income, product preferences, and buying habits. Using this information, marketing tactics
can then be adapted to meet the customer’s needs. This is virtually segmenting each customer
and is the complete opposite of mass marketing.

o Targeted marketing  giving each customer the products and services they have
indicated, from records of past purchases that they most need.

o Customer service and support  after-sales service and effective call centres are
good examples of the support essential to building customer loyalty.

o Communicate regularly with customers  to give frequent updates on new products

/ special offers / new features / new promotions and support services.

o Using social media 

CRM systems use social media sites to track and communicate with customers.

Costs of Customer Relationship Marketing:

o IT systems and software are needed and employees need to be trained to respond to
customer feedback.
o It may be costly to respond to each customer’s feedback, especially if it contains special
requests or requirements.

Benefits of Customer Relationship Marketing:

o For businesses with an existing customer base, CRM has proved to be cost-effective.
o It is a sustainable strategy creating long-term customers unlike short term sales
promotions.
o Loyal customers often recommend the business to friends and family, providing
additional marketing benefit at no cost.
o It costs less per customer than trying to attract new customers.

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Market Research Chapter 18

( 18.1 ) Market Research

Market Research ▬

Gathering data about the market size and trends, competitors, consumer
KEY
buying habits, economic conditions and likely sales levels through
DEF
primary and secondary research. It is the process of collecting and analyzing
data relating to demand for a good or service in a specific market.

It is concerned not just with finding out, as accurately as possible, whether consumers will buy a
particular product or not but also with attempting to analyze their reaction to:

 Different price levels;

 Alternative forms of promotion;
 Types of packaging;
 Preferred means of distribution;

The Purpose of Market Research

 Identify the main features of the market:

Such as overall market size, consumer tastes, fashion and trends, effective method
to promote the products, market growth potential and the number of previous
competitors exit in the market.

 To reduce the risks associated with new product launches:

By investigating potential demand for a new product or service the business should be
able to assess the likely chances of a new product achieving satisfactory sales.

 Predict future changes:

Demand levels for existing products may change. Unless a business tries to forecast these
changes with market research, it may overproduce or under produce a product.

 Identify Consumer Characteristics:

By identifying the profile information of potential consumers, products can be targeted at
the appropriate market sector, based on factors such as age range, income level and
social class.

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 Explain patterns in sales of existing products and market trends:

Market research needs to be conducted for existing products as well as new ones, it also
helps to analyse the causes of decline in sales of existing products.

 Assess the most popular designs, flavors, styles, promotions and packages:
Different versions of the products are tested to consumers and it will enable a business
to focus on the aspects of design, colors and performance that consumers mostly
prefer to buy.

( 18.2 ) Secondary Market Research

Secondary Research is the use and analysis of data that already exist,
KEY
and was collected by another organisation, often for a different purpose
DEF
referred to as ‘second-hand’ data.

Which one of these research methods should be conducted and used first by a business
undertaking marketing research for the first time, for example data gathering for a new product
launch?

Surprisingly, it is secondary research that should be undertaken first. Why is this? It is

because of the benefits that secondary research offers over primary methods and in case of
gathering certain type of information such as Calculating Total Population, GDP, Per Capita
Income and Rate of Inflation, which is not possible to conduct through primary research.

The data referred to above could be obtained from several of the following well-known sources
of secondary data:

(1) Internet:
Internet and search engines are the most effective way to collect and conduct the secondary
market information in this modern era of technology. Internet is a quick way of getting
massive amount of data in a very cost effective way.

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(2) Government Publications:

o Population Census; (counting the total o Economic Trends of GDP;
population in an economy) o Annual Abstract of Statistics;
o Social Trends; o Family Expenditure Survey.

(3) Local Libraries and Local Government Offices:

Local population census returns with details of total numbers, age, average income and
occupation distributions, and number of households in the area, the proportions of the
local population for different religious and cultural groups.

(4) Trade Organizations produce regular reports on the state of the markets and the
conditions of different industries growing in the economy:
o Society of Motor Manufactures and Traders;
o Surgical Manufacturer Association;
o Engineering Employer’s Federation; o Chamber of Commerce and Industry.

(5) Newspaper Reports and Specialist Publications:

o Marketing Journal ─ provides weekly advertising about different products and services
and consumer feedback about the adverts;
o Motor Trader, The Financial Times, Spider for Computers, Readers Digest.

(6) Internal Company Records:

If the business has been trading or some time a great quantity of secondary data will
already be available for further analysis:
o Customer Sales Records, and Guarantee Claims;
o Daily, Weekly and Monthly Sales Trends;
o Feedback from customers on Product, Service, Delivery and Quality.

(7) Market Intelligence Reports:

Market Intelligence Reports is the process of acquiring and analyzing information in order to
understand the market for target audience. These are detailed reports by specialist market
research agencies. In other words market intelligence is the information, gathered and analyzed
specifically for the purpose of accurate and confident decision making for determining market
opportunity, market penetration strategy, and market development opportunities.

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Advantages of Secondary Research

o It can provide information about the population, the economy, the market conditions
that a business operates in or plans to operate in and major trends in that market.
o It can help identify the key areas of market information that primary research needs to
focus on.
o It provides evidence that can be used as a baseline against which primary research data
can be compared.
o Large samples are often used, which increases accuracy and reliability.
o Many of the sources of secondary data can be accessed via the internet.
o If time or finance is very limited, secondary research might be the only option.
o There is so much of this data, which opens up new business possibilities if it is analysed
carefully.
o ‘Big data’ is a term used to describe the vast amounts of publicly available data on
websites, social media posts, retail purchase records and healthcare records.
o There are many sources of secondary data, which allows information from one source to
be checked against another for accuracy.

Disadvantages of Secondary Research

o Data may be out of date as not all sources update every year. This could lead to
inaccurate conclusions based on old data.
o Data is unlikely to have been collected for the specific needs of the business. It might
not be directly relevant or may not use the population samples that the business really
wants.
o Not all secondary data is available to all potential users. Even if it is available, it can be
expensive to obtain, for example, from market research agencies.
o Secondary data might indicate the potential for a new market, but primary research
will be needed to gather specific information for potential consumer profiles and their
product preferences.

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( 18.3 ) Primary Research & Methods of Primary Research

Primary Research is defined as original data gathering from people within

KEY
the firm’s target market. This research is called ‘first-hand’ data as they are
DEF
being collected by the Organisation for the first time of its own needs.

Primary research can itself be divided into quantitative and qualitative research. The first
category refers to finding out the number of consumers who might buy a product and in what
quantities, and the second category is about the quality required by the consumers.

Quantitative Information ▬
K This type of research answers questions about the quantity of something, for

E example, how many liters of petrol sold in the month of December? This research
is suitable for household products such as oil, rice and salt.
Y

Qualitative Information ▬
D
This type of research answers questions about the quality of the products
E required by the people and an opinion or judgment is necessary, for example,

F ‘What do customers like about a particular product?’ This research is suitable for
certain products such as perfumes, laptops, mobile phones, designer clothes.

Qualitative Research Focused On Target Audience Only

The main technique of qualitative primary research is interviews with individual consumers or
groups of them. Different pricing levels and alternative advertisements might be discussed with
the consumers and their reactions will be noted and analyzed.

Focus Groups ▬ A group of people who are asked about their attitude
KEY towards a product, service, advertisement or new style of packaging.
DEF Focus groups aim at a discussion instead of individual response to formal
questions, produce quantitative data.

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Qualitative & Quantitative Primary Research Techniques

Consumer Surveys

Survey is a general word that describes the process of collecting information by using
questionnaires, interviews and using experiments. These involve directly asking consumers
for their opinions, demand and preferences. They can be used to obtain both qualitative and
quantitative market research. Consumer surveys help businesses make better decisions about
the types of products and services they offer, deciding the best prices, guide a way to deal
with competitors and whether to enter or exit markets. Consumer Surveys could be
conducted using Interviews, Questionnaires, Observations and Test Marketing.

Interviews

Interviews consist of ready-prepared questions for the people and usually collected face-to-
face using direct contact with the customers. Interviews allow businesses to get complete
information about attitudes, taste, fashion, trends, income level, family size and opinions
of the people. Experts can conduct face-to-face interviews with selected consumers in
their homes, workplace, by stopping people on the street or targeting respondents at an event
in a shopping mall.

Questionnaires

Questionnaires are one of the main tools in the use of field research. A questionnaire contains a
series of questions which gather primary market research data for business. Questionnaires
need to be designed carefully. Businesses questionnaires are very important tools as they are
representative of the opinions of the customers about the existing and proposed products and
services which can be analyzed to estimate likely performance of a product/service.

Test Marketing

Test marketing involves testing, prompting and selling the samples of the product in a
limited geographical area and then recording consumer reactions and sales figures.

Test marketing reduces the risks of a new product launch failing completely but the evidence is
not always completely accurate if the total population does not share the same preferences
and characteristics as the region selected.
Examples such as Pampers, Soft Drink, Chocolates, Head & Shoulder, Test Drive of Cars.

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Observations

Using this approach market researchers observe and record how consumers behave. This may
be done via CCTV camera in a store, or by an observer standing in a place taking notes, and
also they can count the number of people and cars that pass a particular location in order to
assess the best site for a new business. Researches can also observe people in shops to see
how many people are look at a new display and buy a product from the shelves. A simple stock
check from retailers can also be used to record sales over a period of time.

Limitation:
Observation does not give researchers the opportunity to ask for explanations of behavior
and the details about the consumer taste and fashion.

Sampling Methods

Sampling is the process of selecting a suitable target audience for conducting the market
research, which is preferred to ask the question from the whole pollution.
There are several techniques of sampling:

The Need for Sampling

In nearly all market research situations, it is impossible to seek evidence from the total
population or target market. This is either because that market is so extensive that contacting
everyone in it would be too expensive or time-consuming, or because it is impossible to
identify everyone in that market. Therefore, a sample of the total audience will need to be
chosen. The larger the sample, the more representative of the total population it is likely to be.

Risk of Sampling / Questionnaire Bias

The only really accurate method of primary research is to ask the entire target population, but
this is expensive and time-consuming. Results from a sample may be different from those
that would have been obtained if the whole target population had been questioned. This is called
sampling bias. The less representative the sample, the greater the statistical bias that will
exist. Questionnaire occurs when questions tend to lead respondents towards one particular
answer.

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Advantages of Primary Market Research

Primary research data is most useful in the following situations:

o To find out about completely new markets, such as innovative products for which no
secondary data exists.
o To collect data for the specific purposes of the business. The information gathered will
provide direct answers to the questions the business is asking.
o To focus research on market reaction to specific changes made by the business, such as
lower prices or increased advertising.
o To gain up-to-date information from a particular target group of consumers.
o When data needs to be cross checked for accuracy – different methods of primary data
collection allow for results to be verified and for different types of information to be
gathered.

Disadvantages of Primary Market Research

1) High Cost and more number of resources are required:

Collecting data using primary research is an expensive activity as market research experts has to
be involved throughout and design everything.

2) Time Consuming: The time required to do research accurately is too long as compared to
secondary data, which can be collected in much lesser time duration.

3) Inaccurate Feed-backs: In case the research involves taking feedbacks from the targeted
audience, there are high chances that feedback given is not correct.

Market Research Developments

Businesses are increasingly using electronic means to gather the data needed before deciding
on their marketing strategies. Questionnaires can be sent out, answered and returned via tablets
and mobile (cell) phones.

Businesses can also access the vast quantity of information that electronic data retrieval
methods offer them. Such as supermarkets can have a complete picture of what each consumer
purchases, how often they buy, each consumer’s age, gender and possibly their income.
This allows retailers to target each consumer with advertisements and special offers about the
goods they are most interested in. This form of targeted marketing is cost-effective.

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( 18.4 ) Analysing Quantitative Research Results

This section looks at how statistical research data can be analysed to get advantage. The need to
find the analysis of numbers, such as market research results. Interpreting and analyzing
statistical data can start with an attempt to identify key trends or key features of the data.
For example, Table 18.1 contains the results of two small market research surveys. Theses
were conducted to find out more about the number of hours radio listeners tuned into one
particular radio station per day.

In this raw form, the make little sense and are of no value. This section will show how
numerical data might be summarized using basic statistical techniques:

Last year 1, 5, 10, 15, 3, 6.5, 6, 4, 7.5, 16, 12, 4, 0, 2, 20, 18, 12, 10, 11, 10.

This year 15, 12, 4, 5, 12, 6, 0, 2, 3, 10, 7, 8, 3, 12, 22, 18, 20, 14, 11, 8.

Table 18.1 Shows The Number of Hours Respondents Listened to Radio Station

Averages

An average is a representative measure of a set of data. Averages tell us something about

the ‘Central Tendency’ of data. There are several different types of average that can be
calculated from any set of data. The three most frequently used are:
 Arithmetic Mean
 Mode
 Median

Arithmetic Means

Arithmetic Mean is calculated by totaling all the results and dividing by

KEY DEF
the number of results.

The mean of the ‘Last Year’ results in Table 15.1 is 172/20 = 8.65 hours, while the mean of
the ‘This Year’ result in the table is 192/20 = 9.6 hours. The mean number of hours per week
of listening to the station increased from 8.65 to 9.6 hours.

Uses of Arithmetic Mean:

Often used for making comparisons, absenteeism rate and labour turnover of employees would
be the most suitable examples.

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Mode

KEY DEF Mode is the value that occurs most frequently in a set of data.

To identify the mode, it is wise to puts that the data into ascending or descending order. Table
18.2 shows the data from Table 18.1 put into ascending order:

o 10 hours was the most frequently occurring of listening time last year.
o 12 hours is the most frequently occurring of listening time this year.

Last year 0, 1, 3, 4, 4, 5, 6, 6.5, 7.5, 10, 10, 10, 11, 12, 12, 15, 16, 18, 20

This year 0, 2, 3, 3, 4, 5, 6, 7, 8, 8, 10, 11, 12, 12, 12, 14, 15, 18, 20, 22

Table 18.2 Research Data in Ascending Order

Uses of Mode:
As the most frequently occurring, the result could be used for stock-ordering purpose.

Medians

Median is the value of the middle item when data have been ordered
KEY DEF
or ranked. It divides the data into two equal parts

The median is the middle item in a range of ordered data. The median item may be identified by
using the following formula when the number of values is an odd number:

Number of Values + 1

If the number of values is 15, then 15 + 1 divided by 2 gives the eight value as the median
item. When there is an even number of values, the mean of the middle two results will give the
most accurate measure of the median.

Number of Values

2
In the ‘Last Year’ data above, the median will be the tenth result, given by 20/2. This gives the
median as 7.5 hours.

Uses of Median: Could be used in wage negotiations, ‘Half of our union members earn less
than $50 per week, also used for advertising.

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Analysis of Qualitative Market Research Data

Numerate data might be presented in the form of a table, graphs and charts. This allows
ease of reference and tables can be used to present a mass of data in a precise way.

Bar Charts

A diagram used to present quantitative

data, such as market research results –
the height of the bar represents the
relative value of each item recorded.
They show trends and use bands of equal
width but of varying length of height to
represent relative values. They allow easy
comparison over time.

Uses of Bar charts:

Bar charts are useful to show sales levels, profits and wastages level. When the absolute size
of results needs to be presented and compared.

Line Graphs

Line graphs are most commonly used for

showing changes in a variable over
time. The line graph formed by joining the
co-ordinates together allows easy
references to trends in the data and
shows up seasonal or other fluctuations
clearly.

Uses of Line Graph:

When the trend and regular variations need to be identified with the help of single line. It is
useful for sales forecasting & future decisions.

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Pie Charts

A Pie chart consists of a

circle with segments. Each
segment represents the
size of a particular part
relative to the total. Each
section of the ‘pie’ shows
how relatively significant a
part of the data is of the
whole allow easy comparison
between sets of results.
Pie chart is calculated in the
following way:

Uses of Pie Charts:

Useful to show the relative importance of sections or segments out of a total result ─ these
can then be visually compared with other time periods. It is helpful to show market share,
sales and profitability of different products.

Appropriateness of
Methods of Presentation

Managers will always find it easier to use and apply data to help in decision making if they are
presented in the most appropriate form.

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The Marketing Mix — Product & Price Chapter 19

( 19.1 ) The Elements of the Marketing Mix

Marketing Mix:
KEY
The four key decisions on product, price, promotion and place that must be
DEF
taken to enable the effective marketing of a product.

The marketing mix also called 4ps by the marketing department is a range of tactical decisions
influencing whether a business can sell its products profitably.
These are product design and performance, price, promotion including advertising and place,
where and how a product will be sold to consumers.

 Product: Consumer requires the right product, newly developed or existing product.

 Price: The right price is very important too. If set too low, the consumers might lose
confidence and if too high, then many will be unable to afford it.

 Promotion must be effective, telling consumers about the product specifications and
convincing through attractive advertisements and promotion deals.

 Place refers to how the product is distributed to the consumer using different channel
of distributions. The place should be right that suits to the nature of the product.

It is vital that these elements fit together into a coherent and integrated plan. Some extra
elements of marketing mix are 5th, 6th and 7th P’s. 5th for packaging, 6th for people and 7th
for process. Combining all these P’s are called integrated marketing.

( 19.2 ) Why is product a key part of the marketing mix?

It is sometimes said that a business can sell any product to consumers once, but to establish
loyalty, good customer relationships and repeat purchase, the product must be right.’ It
should satisfy customer expectations regarding quality, durability, performance and
appearance.

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What is meant by the term Product?

The term ‘product’ includes consumer and industrial goods and services. This includes the
design, features, functionality, color, level of service and lifespan of a product.

Goods ▬ Products which have a physical existence, such as washing machines

KEY and chocolate bars.

DEF Service ▬ Products which have no physical existence, but satisfy consumer
needs in other ways, such as hairdressing, car repairs, child minding and banking.

Tangible & Intangible Attributes

Tangible attributes of a product are measurable features of a product that can be easily
compared with other products.

Intangible attributes of a product are subjective opinions of customers about a product that
cannot be measured and compared easily.

Marketing managers should try to understand what ‘intangible features’ are looking for when
making their purchasing decisions, along with the tangible attributes such as color, size, design
and performance of a product.

The Importance of Product Development

New product development (NPD) is crucial to the success of some businesses, such as the
rapidly changing world of computer games.

New Product Development (NPD) ▬

DEF
The design creation and marketing of new goods and services.

Why is new product development so important? There are several reasons:

 Changing customer tastes and preferences  Risk diversification

 Increase competition  Improved brand image
 Technological advancement  Use of excess capacity
 New opportunities for growth

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Product Differentiation
& Unique Selling Point (USP)

Unique Selling Point ▬ The special feature and unique qualities of a

KEY DEF
product that makes it different from competitor’s products.

The most successful new products are those that are differentiated from competitors’ products
and offer something ‘special’. The best form of product differentiation is one that creates a
unique selling point (USP).

Examples of Effective USP:

o Domino’s Pizza Deliveries: ‘it arrives in 30 minutes or it’s free’.
o Mercedes ‘center of gravity concept’.

The Benefits of Effective USP:

o Effective promotion that focuses on the differentiating feature of the product.
o Opportunities to charge higher prices due to exclusive design/service.
o Free publicity from business media reporting on the USP, increases the sales.
o Higher sales capered to undifferentiated products.

Products & Brands

Mobile phone networks are an example of a product, but Apple is an example of a brand. The
product is the general term used to describe the nature of what is being sold.

The brand is the distinguishing and unique name or symbol that is used to differentiate one
manufacturer’s products from another, branding can have real influence on marketing. It can
create a powerful image or perception in the minds of consumers. Brand can give one firm’s
products a unique identity.

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Product Positioning

Before deciding on which product to develop and launch it is common for firms to analyze how
the new brand will relate to the other competing brands in the market. This is called
positioning the product by using a technique such as market mapping.

Product Positioning ▬
DEF
Consumers’ view of a product or service as compared to its competitors.

This analysis could be used in a number of ways:

Advantages of Market Mapping ▬

It clearly displayed the position of the product offered by business and shows the overall
structure of the whole market. It is the way to see how competitors are doing in market. It helps
to identify a potential market gap for a cheaper drink with a healthy image, and to win attention
and interest of consumers.

Weakness of Market Mapping ▬

A potential weakness of product positioning is that every company wants to position its products
favorably in the minds of consumers, so there is usually a high level of competition.

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( 19.3 ) Product Portfolio Analysis

Product Life Cycle ▬ A marketing procedure in which products or brands follow a
K sequence of stages including: introduction, growth, maturity, and sales decline.

E
Product Portfolio ▬
Y Product portfolio is defined as the range of products which is being offered by the

D firm to its market, using market sales, market share, position on the product life cycle
and segmentation in order plan the most appropriate product mix to meet objectives.
E

F Portfolio Analysis ▬ analyzing the range of existing products of a business to help

allocate resources effectively between them.

Introduction:
This is when the product has just been launched after development and testing. Sales are
often quite low to begin with and may increase only quite slowly ─ but there are
expectations for the high sales.

Growth:
If the product is effectively promoted and well received by the consumers in market then
sales should grow rapidly. This stage cannot last forever, although all firms wish that it would.
This may take days, weeks or even years; at the end of this stage, sales growth will begin to
slow which leads the product into the next stage.

Maturity or Saturation: At this stage sales fail to grow but they do not decline
significantly. This stage can last for years, for examples Coca Cola, which are called life time
products. The saturation of a market is caused by most consumers who want a certain product
having already bought one. The best recent example is mobile phones, cars and computers.

Decline:
During this phase sales will
decline steadily. Either no
extension strategy has been tried,
or it has not worked or the
product is so ’past it’ that the only
option is replacement.
New competitor’s products are the most likely cause of declining sales and profits ─ when the
product becomes unprofitable and the replacement is ready for the market it will be
withdraw.

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Stage Price Promotion Place Product

May be high High levels of

In restricted
(skimming) or informative
outlets, possibly
low (penetration) advertising are Basic model with
Introduction selling directly
compared to needed to make few variations.
through company
competitors’ consumers aware
outlets.
prices. of the products.

Adverts can be In growing Product

converted to numbers of improvements
Firm can increase
persuasive form, outlets in areas and
prices according to
Growth and use methods indicated by the developments to
the success rates
of appeal to strength of maintain
of the product.
capture consumer consumer consumer
intention. demand. appeal.

Brand imaging
As competitors
continues to Highest New models,
enter the market,
stress the geographical colours,
prices for the
Maturity/ positive spread possible, accessories as
product need to
Saturation differences including new part of extension
stay at
compared to distribution strategies.
competitive
competitors’ channels.
levels.
products.

Lower prices Slowly

Advertising is
may be needed to withdraw
likely to be very Unprofitable
sell off inventory, product from
limited and may outlets for the
Decline but if the product markets and
just be used to product are
has a small niche prepare to
inform of lower eliminated.
following, prices launch new
prices.
could even rise. products.

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Extension Strategies:

These are marketing plans to extend the

maturity stage of the product before a brand
new one is needed. These strategies are
applied at maturity or saturation stage of
the product life cycle. Such strategies include
adding new features, change packaging,
developing new markets for existing products
such as export markets, and re-launches with
change design and additional advertisement.

Applications of the product life cycle

The life cycle concept has three main uses:

 Assisting with planning marketing mix decisions, which helps to decide the price and
promotion on each stage of product life cycle;
 Identifying how cash flow might depend on the cycle and calculation of profits on each
stage of product life cycle;
 Recognizing the need for a balanced product portfolio.

Identifying the Need for a Balanced Product Portfolio

As one product declines so other products are being

developed and introduced to take its place. Cash flow
should be reasonably balanced so there are products at
every stage and the positive cash flow of the
successful ones can be used to finance the cash
deficits of others.

Factory capacity should be kept at roughly constant levels as declining output of some goods
is replaced by increasing demand for the recently introduced products. This is said to be a
balanced portfolio of products.

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Boston Matrix ─ Product Portfolio Analysis

Boston Matrix is a method of analyzing the product portfolio of a business

DEF
in terms of market share and market growth.

Boston matrix is mostly suitable for businesses that have a relatively large number of
products. It is a way of analyzing the market standing of a firm’s products and the firm’s
overall product portfolio and this process is called the Boston Matrix.

This highlights the position of each of a firm’s product in terms of market share and market
growth. This allows not only an analysis of the existing product portfolio but also what steps
the firm could take next. The four sectors created by the matrix can be analyzed in the
following way:

Low Market Growth ─ High Market Share: Product A

This is a well-established product in a mature market. This type of product creates a high
positive cash flow and is profitable. Sales are high relative to the market and promotional
costs are likely to be low, as a result of high consumer awareness. The cash from this
product can be ‘milked’ to inject into some of the other products such as product exists in
problem child category in the portfolio ─ hence, this product is often referred to as a ‘Cash
Cow’.

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High Market Growth ─ High Market Share: Product B

This is clearly a successful product as it is performing well in an expanding market with

higher market share and market growth. So this is called a ‘Star’. The firm will be keen to
maintain the market position of this product in what may be a fast-changing market —
therefore, promotion costs will be high to help differentiate the product and reinforce its
brand image.

High Market Growth ─ Low Market Share: Product C

This product has a low market share but a big and growing market potential and called
‘problem child’. If it is a newly launched product it is going to need heavy promotion costs to
help become established — this finance could come from the ‘Cash Cow’. The future of the
product may be uncertain and quick decisions may need to be taken if sales do not
improve, such as revised design, re-launch or even withdrawal from the market.

Low Market Growth ─ Low Market Share: product D

These are mostly outdated products and are called ‘dogs’. They seem to offer little to the
business either in terms of existing sales and cash flow or future prospects, because the
market is not growing. They may need to be replaced shortly, or the firm could decide to
withdraw from this market sector altogether, and position itself into faster growing sectors.

Uses of Boston Matrix

By identifying the position of all of the firm’s products a full analysis of the portfolio is
possible. This should help focus on which products need support or which need corrective
action. This action could include:

Building:
Supporting ‘Problem Child’ products with additional advertising or further distribution outlets.
The finance for this could be obtained from the established cash cow products.

Holding:
Continuing support for ‘Star’ products so that they can maintain their good market position.
Work may be needed to ‘freshen’ the product in the eyes of the consumers so that high sales
growth can be sustained.

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Milking:
Taking the positive cash flow from established products and investing in other products in
the portfolio.

Divesting:
Identifying the worst performing ‘Dogs’ and stopping the production and supply of these.
This will possibly involve other issues, such as the impact on the workforce and whether the
spare capacity freed up by stopping production can be used profitably for another product.

Evaluation of these ‘Product Portfolio’ Techniques

These Boston Matrix can be of use to marketing managers when:

o Analyzing the performance and current position of existing products;

o Planning corrective action to be taken with existing products;
o Planning the timing of the introduction of new products.

No techniques can guarantee business success ─ this will depend on the accuracy of the
analysis by the marketing manager and the skills they possess in employing appropriate
marketing strategies.

Detailed and continuous market research will help ─ but at all times, decision makers must
be conscious of the potential dramatic effects of competitors’ decisions, technological changes
and the fluctuating environment.

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( 19.4 ) Why is price a key part of the marketing mix?

Price is the amount paid by customers for a product. Price can have a great impact on the
consumer demand for the product. Get the pricing decision wrong can be put the whole
business at risk. The pricing level set for a product will also determine the degree of value
added, marketing objectives of a business and profit gain due to demand of the product.

Price Determinants ( Pricing Decisions )

There are many determinants of the pricing decision for any product, such as:

 Costs of Production::
If the business is to make a profit on the sale of a product then, at least in the long
term, the price must cover all of the costs of production such as fixed and
variable costs.

 Competitive Conditions in the market::

If the firm is a monopolist then is likely to have more freedom in price setting
then if it is one of many firms making the same type of product.
The more competition there is the more likely it is that prices will be fixed similar
to those fixed by other competitors businesses.

 Competitors Prices::
Related to the previous point, it may be difficult to set a price very different from
that of the ‘market leader’ and other competitors unless true product
differentiation can be established such as niche features.

 Business and Marketing Objectives::

If the aim is to become market leader using mass marketing then this will require a
different price level as compared to price charged for niche products. Pricing
decisions will depend on the current objectives such as profit, growth, capturing a
high market share and survival.

 Price Elasticity of Demand::

The price elasticity of demand measures how responsive the quantity demanded of a
good is to a change in its price, so setting the price is depending on whether the
product is elastic or inelastic demand in the market.

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 Whether it is a new or an existing product::

If the product is new in the market, then the business decide whether a ‘skimming’
or a ‘penetration’ strategy is to be adopted. Existing products might be sold using
competitive or promotional pricing strategies.

Pricing Methods

There are several different pricing methods that can be used and these are broadly categorized
into cost-based method, competition-based methods and new product based methods.

( A ) Cost-based Methods of Pricing

These are the methods used by the business based on calculating the cost of production.
The basic idea is that firms will assess their costs per unit, and then add an amount in
calculated cost. There are a number of different methods of cost-based pricing of products that
may be adopted:

( 1 ) Mark-up Pricing

Mark-up Pricing ▬
DEF
Adding a fixed mark-up for profit to the unit price of a product.

Mark-up Pricing is usually carried out by retailers, who take the price that they pay the
producer and then just add a percentage mark up. The size of the markup usually depends
upon a combination of the strength of demand for the product, the number of other suppliers,
and the age and stage of life of the product.

For example:

Total cost of brought in materials $40

Selling Price $60
50% mark-up on cost $20

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( 2 ) Cost-plus Pricing

Cost-plus pricing is often used by manufacturers. The business calculates or estimates the total
cost per unit. The price is then this cost plus a fixed profit mark-up. However, it is less easy for a
manufacturer to calculate the cost of each product.

Total Output Costs for 10,000 units $400,000 Total Return $480,000
Profit mark-up 20% $80,000 Price per unit 480,000/10,000 = $48

( 3 ) Contribution Cost: ( Marginal Cost )

Contribution-Cost Pricing ▬ Setting prices based on calculating

KEY
variable costs of making a product in order to make a positive
DEF
contribution towards covering fixed costs and making profit.

Contribution Cost (or Marginal Cost) pricing does not try to allocate the fixed costs to specific
products. Instead of this, the firm calculates a unit variable cost for the product in question and
then adds an extra amount that is known as a contribution to fixed costs. If enough units
are sold, the total contribution will be enough to cover the fixed costs and to return a profit.

Contribution is the money available to pay for the business overheads, when the overheads
covered at the break-even level of output, the contribution becomes the profit.

( 4 ) Loss Leaders

This is a common tactic used by retailers. It involves the setting of very low prices for some
commonly sold related products ─ possibly even below variable costs in the expectation
that consumer will buy other goods too. The firm hopes that he profits earned by these other
goods will exceed the loss made on the low-priced ones.
Example: Cheap Razors could lead to additional sales of razor blades. Loss leaders strategy can
also be used to attract customers, sell unwanted stocks and building a unique brand name.

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( B ) Competition Based Pricing Methods

This is the situation that exists when a firm will base its price upon the price set by its
competitors. However, there are a number of different possible scenarios:

( 1 ) Price Leadership

Price Leadership often exists in markets where there is one dominant firm who has the highest
market share and other firms simply charge a price based upon that set by the market leader.

( 2 ) Price War

A period of perfect competition in which sellers cut prices in an attempt to increase their
market share. Some markets have a number of firms the same size, but prices are still similar
in order to avoid a price war. An example of this would be the large petrol companies.

( 3 ) Dynamic Pricing

The dynamic pricing method involves setting constantly changing prices when selling
products to different customers, especially online through e-commerce. E-commerce has become
a hot spot for dynamic pricing models, due to the way consumers can be separated by and
communicated with over the internet. Businesses can vary the price according to demand
patterns or knowledge that they have about a particular consumer and their ability to pay.

( 4 ) Price Discrimination

Price Discrimination takes place in markets where it is possible to charge different groups of
consumer’s different prices for the same product. An example of this would be airline firms,
who charge many different rates for the same journey. (Economy Class and Business Class)
Cinema offered different prices according to sitting arrangements. Electricity Unit price is
different for domestic and commercial unit. Age discounts offered to children’s and students.
Occupational discounts offered to army, teachers, and doctors.

( 5 ) Psychological Pricing

Psychological pricing is a pricing strategy based on the theory that certain prices have a
psychological impact on consumers. This has two aspects.

Firstly, it is very common for sellers to set prices just below key price levels in order to make
the price appear much lower than it is. For example $999 is used instead of 1000.

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Psychological pricing also refers to the use of market research to avoid setting prices that
consumers consider to be inappropriate for the product. A very low price for cosmetics will not
create the status and image that the firm is trying to create.

( C ) New Product Pricing Strategies

New Product Pricing strategies are normally split into two different approaches:

Penetration Pricing ▬
KEY Setting a relatively low price often supported by strong promotion in
DEF order to achieve a high volume of sales and tries to enter in to a new
market.

Penetration pricing a relatively low price is

set and strong promotion takes place in
order to achieve a high volume of sales. Firms
tend to adopt penetration pricing because they
are attempting to use mass marketing and
gain a large market share. If the product gains
a large market share, then the price could
slowly be increased.

Skimming Pricing ▬
KEY
Setting a high price for a new product when a firm has a unique or highly
DEF
differentiated product with low price elasticity of demand.

The second approach is market skimming, which usually occurs when a firm has a unique
product that competitors will try to copy, so it attempts to make relatively high short-term
profits by charging a high price for as long as the product can hold its strong position.

An example of this is pharmaceutical firms, who are often given a legal monopoly for a certain
number of years for new drugs. They are able to charge high prices in order to recoup their
considerable investments in research and to make high profits.

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The Marketing Mix – Promotion & Place Chapter 20

( 20.1 ) Promotion Methods

Promotion is about communicating and attracting customers. Effective promotion not only
increases awareness of products, but can create image and product ‘personalities’.

Promotion ▬

The use of Advertising, Sales Promotion, Personal Selling, Direct Mail, Trade Fairs,
KEY
Sponsorship and Public Relations to inform consumers and persuade them to buy.
DEF
Direct Promotion ▬ A range of promotion activities aimed directly at target
customers. It is also known as direct marketing.

Promotion is designed to encourage new and repeat sales. Loyalty cards, free gifts,
competitions and voucher schemes are the most popular. Companies use sponsorship and public
relations to improve their image, financing sports and public information services.

Promotion Objectives

Promotional campaigns can be designed to achieve several objectives. These are all about
communicating with the target consumers. These aims can either be focused on the short
term ─ such as an increase in sales next month ─ or for the longer term ─ such as to develop
the brand image of the business. Promotional objectives include::

o Increasing sales by raising awareness of a product ─ especially important for newly

launched ones as well as the existing products.

o To recall, remind and reinforce consumers of the existence of a produce.

o To encourage increased purchases by consumers by offering discount offers, and

promotion deals such as “Buy One Get Free”.

o Demonstrating the superior specification and qualities of a product compared to

competitors ─ often used when the product has been updated in some way.

o Correcting misleading reports about the product or to reassure the sales of the
products after a scare or an accident involving the product.

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o Improving the public image of the business ─ rather than the product ─ through
corporate advertising. For example Rolex, Cross Roads, River Stone.

Promotion Mix

KEY Promotion Mix ▬

The combination of all forms of promotion used by a business for any

DEF
product is known as ‘promotion mix’.

It is most unlikely that just one method of promotion will be sufficient to achieve promotional
objectives. They include all of the marketing tools that can be used to communicate with
consumers along with offering promotion deals.

Advertising (Above the Line Promotion)

K Above-the-line Promotion ▬

A form of promotion that is undertaken by a business by paying for

E
communication with consumers.
Y

D Advertising ▬

Paid-for communication with consumers to inform and persuade, for

E
promoting the sale of commercial products., using TV and billboard advertising
F
and is referred to as ‘Above-the-Line Promotion’.

This is the term used in connection with advertising of a product or business through the media,
such as TV, Radio, Billboards, Broachers, Leaflets, Newspapers and Websites. These
advertisements are usually directed towards the appropriate target market by selecting certain
media ─ but it is possible that many people are unlikely to purchase the product may see the
advertisements too. Successful advertisements have led to increases in consumer awareness
and increase sales.

Advertisements are often classified into two types.

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Informative Advertising

Informative Advertising ▬
KEY
These are adverts that give information to potential purchasers of a
DEF
product, rather than just trying to create a brand image.

This information could include price, technical specifications, main features and places where the
product can be purchased. This style of advertising could be particularly effective with
promoting a new product that consumers are unlikely to be aware of it, and also suitable for
technological products such as mobile phones, microwaves, laptops and electronic appliances.

Persuasive Advertising

Persuasive Advertising ▬ This is trying to create a distinct image or

KEY
brand identity for the products and it may not contain any details at all
DEF
about materials or ingredients used, prices or places to buy it.

This form of advertising is very common, especially in those markets where there might be little
actual difference between products and where advertisers are trying to create a perceived
difference in the minds of consumers.

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Advertising Agencies

These are specialists that advise businesses on the most effective way to promote products.
Advertising agencies can offer a complete promotional strategy and this can be invaluable
to a business without its own marketing experts such as small scale firms.

 Research the market, establish consumer tastes, buying habits and preferences and
identify the typical consumer profile.
 Advise on the most cost-effective forms of media to be used to attract the potential
consumers.
 Use their own creative designers to design adverts appropriate to the media to be
used and according to the target audience.
 Film or print the adverts to be used in the campaign.
 Suggest a complete promotional strategy for below-the-line promotion activities.
 Monitor public reaction to the campaign and feed this back to the client to improve
the effectiveness of future advice on promotion.

Advertisement Methods

The following seven advertising methods are the most frequently used:

Print Advertising

This includes advertising in newspapers, magazines and specialist publications:

o It can be directed at particular towns or regions, or consumers who read particular

special interest magazines.
o It provides hard copy, which can be cut out and kept by the consumer for future
reference.

Print advertising has limitations:

o It is expensive to gain national coverage.

o Evidence suggests that it is now much less effective with younger consumers than
digital.

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Broadcast Advertising

This is advertising on TV and radio, and in cinemas:

o Adverts have visual appeal and can create a brand image through the actors used.
o National or even international coverage is possible.
o It can stay in the memory of consumers for a long time if visually dramatic.

Broadcast advertising has limitations:

o It is expensive to buy media time.

o It is expensive to design and produce the adverts.
o There is no permanent hard copy.

Outdoor Advertising

This includes advertising on billboards and bus shelter posters.

o It is low cost compared to other media.

o It can be located in prime positions with many potential consumers passing by.
o It can be read/seen more than once.

Outdoor advertising has limitations:

o The best locations are the most expensive.

o Many passers-by will not notice this type of advertising.

Product Placement Advertising

Products are featured in TV shows and films:

o The chosen shows or films will be targeted at a particular type of consumer.

o This creates a desirable image if the product is associated with famous actors or shows.
o It is not explicit advertising. Some consumers assume the product is being used because
it is desirable, not because a business has paid for the placement.

Product placement advertising has limitations:

o The show, film or actors may become less popular.

o It is very expensive if the show or film is well known.

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Guerrilla Advertising

Products are advertised at surprising and unconventional events to make the public take notice:

o It is low cost: graffiti paint on walls is low cost, but it is best to gain permission first!
o It can be creative, inventive and can appeal to young consumers.
o It encourages word-of-mouth communication between potential consumers.
o A staged event can receive free publicity from the media.

Guerrilla advertising has limitations:

]

o The message may be misunderstood.

o It may be considered irresponsible and lead to a negative backlash.
o It may be remembered for the wrong reasons.

Sponsorship

This involves payment by a business to become associated with an event, an individual or a

sports team. It could lead to the business logo appearing on a team’s shirts.

Advantages include:
o The good publicity of being associated with big sporting and other events.
o Global press and TV coverage of the largest events.
o The success of the team or individual can lead to greatly increased interest in the
brand.

Sponsorship has limitations:

o Sponsoring the events can be very expensive.

o Failure of the event, team or individual can reflect badly on the brand.

Digital Advertising

Digital advertising is marketing to a target audience through digital platforms, including social
media, email, search engines, mobile apps, affiliate programs, and websites. One of the main
benefits of digital advertising is an advertiser can track in real time the success of the campaign.

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Advertisement Decisions ─ Which Media to Use?

Most expensive forms of communication are not always the most effective. The choice of
media requires consideration of the following factors:

(1) Cost ▬

Marketing managers must compare the cost of each method, including the cost per target
consumer and it will also depend on the time of day that the advertisements are to be placed
and the size of the potential audience.

(2) Size of Audience ▬

This will allow the ‘cost per person’ to be calculated.

(3) The Profile of the Audience in terms of age, income levels, interests and so on. This

should reflect as closely as possible the target consumer profile of the market being aimed for.

(4) The Message to be Communicated using Verbal or Written Methods ▬

Verbal forms are mostly used by household products where quick information is needed to
provide in the form of visual effects such as TV and Radio.
Written forms of communication are likely to be most effective for giving detailed
information about a product that needs to be referred to more than once.

(5) The Other Aspects of the Marketing Mix ▬

The need for integration of the marketing mix is link between the other parts of the mix such
as price and the media chosen for adverts could be crucial to success. It is difficult to
advertise the low price candies, match box and paper clips.

(6) Legal Constraints ▬

A widespread ban on tobacco and other de-merit goods advertising. Restrictions on the use of
TV advertising aimed at children, clamming that it exercises too much influence over young
minds.

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Sales Promotion Methods

K
Below-the-line Promotion ▬

Promotion that is not a directly paid-for means of communication, but based

E
on short-term incentives to purchase.
Y

D Sales Promotion ▬

Incentives such as special offers and special deals directed at consumers or

E
retailers to achieve short-term sales increases and repeat purchases by
F
consumers. This form of promotion is also called ‘below-the-line’ promotion.

This the term used in connection with all forms of promotion, other than advertising, over
which the business will have some direct control. Examples include::

‘Money off’ Coupons and Rebates:

Money off coupons, rebates and other consumer incentive offered to consumer on purchase.
These can be immediate incentives, for example free samples and trail packs as an immediate
incentives, or delayed incentives.

For example KFC offers

money off coupons deals
to provide immediate
incentive to customers.

Reward Points Using Loyalty Card:

Promotions that offer customers a reward, such as price discounts and free products, for
frequent purchasing the products are called loyalty programs. These are now widely used by
retailer around the world. By scanning electronically the customer’s loyalty card at the same
time as the items bought, the shopper receives a delayed incentive in the form of a future
discount.

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Competition and Prizes:

Sales promotions devised by businesses that involve the customer participating in a prize draw
or competition. Such schemes can be important strategies in advertising and promoting goods
and increasing sales. Promotion offers such as “Your Chance to Win...” or “Enter our competition
to win...”.This increase brand awareness amongst the target consumers and helps to increase
sales.

Gifts:
Sometimes small gifts are placed in the packaging of a product to encourage the consumer to
buy it. For example ‘Toy with breakfast cereals, or McDonald’s happy meal offer aimed to
encourage children’s’ to buy the products.

Cross Promotions:
Involves using one brand to advertise another non-competing brand. Such as a pack of biscuit
attached with the pack of tea bags, KFC offer Pepsi as a soft drink.

Buy One Get One Free (BOGOF):

Some promotional methods offer free products but with the condition that a purchase must be
made. This could be buy one, get one free. These are called purchase incentives.

After-sales Service:
With expensive products, like Cars, LCD’s and Computers, providing an after-sales service are
very useful way of encouraging the customer to buy and repeat purchase.

Point of Sale Display:

Producers are very keen to obtain the best position for their
products in retail shops and will develop eye-catching
displays to draw consumer’s attention. The advantage of
such preferred position tends to be reserved by retailers for
‘brand leader’ products with the highest market share.
People prefer big retail outlets rather than small retail shops.
Most of the decisions of buying are taken by looking at the
point-of-sale display in these retail outlets.

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Direct Promotion Methods

Direct Mail

Direct Mail ▬ This directly send information to potential customers

KEY
through email, sms messages, by post, identified by market research, who
DEF
have a potential interest in this type of product.

Direct Mail Shots:

These can contain a great deal of detailed information, such as sales next week at retail shops,
costs effective and delivered to well defined areas or regions.

Drawbacks:
Mail shots can suffer from poor image and lead to resentment at ‘junk mail’.

Telemarketing

This includes all marketing activities conducted over telephone often from customer call
centres, including selling, market research and promoting products.
Benefits:: Telemarketing can be outsources by an agency, with some amount of fee paid for
contacting customers for advertisement script. Telemarketing is low cost and enables easy
monitoring of response by the customers.

Personal Selling

Personal Selling ▬
KEY A member of the sales staff communicates with one consumer with the aim
DEF of selling the product and establishing a long-term relationship between
company and consumer.

Employing a sales person to sell to each individual customer directly. Firms must be careful to
ensure that sales staff are well trained and provide full necessary information to consumer
about the products and their features. Example door to door selling, home delivery, selling
directly through company outlet and company official website.

Limitations:
Customers may complain about being pressured into buying, especially if the sales employees
are paid a high bonus for each sale made.

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Developments in Digital Promotion

Digital marketing, also called online marketing, is the promotion of brands to connect with
potential customers using the internet and other forms of digital communication. This includes
not only email, social media, and web-based advertising, but also text and multimedia
messages as a marketing channel.

Methods of Digital Promotion

These methods use the latest technology to get their messages to customers:

Social Media Marketing

The term social media marketing (SMM) refers to the use of social media
DEF
and social networks to market a company's products and services.

Social media is not just a marketing channel but also a way for people to keep in touch with
friends and family, read the latest news or follow topics they are interested in. Business need to
consider Face book, Twitter, Instagram, hash tag campaigns and influencer marketing
are among the most famous methods of social media marketing.

Email Marketing

Email marketing connects with customers within their own mailboxes. It is a well-established
method of increasing brand loyalty and selling more products to existing customers.
There are many different ways businesses can reach out to customers through email marketing,
such as newsletter campaigns, purchase confirmation emails, thank you emails, and email
notifications about new products.

Smartphone Marketing

Displaying pop-up banners or advertisements on other websites aiming at the same niche is the
most common form of online advertising. Businesses can use online platforms such as Google
allows adverts to be automatically delivered to other content sites.

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Smartphone Marketing

This is becoming one of the most important methods of digital promotion, especially to
younger consumers. It is claimed that 94% of all emails are opened and – once open – the
sender has the reader’s attention. As well as sending text messages to subscribers, businesses
can further appeal to potential consumers by providing them with free apps for all phone types.

Messaging platforms such as Messenger and Telegram also allow marketing teams to create
marketing bots which are used to gain new customers.

Search Engine Optimisation ( SEO )

Businesses that use e-commerce locate their websites on search engines such as Google, Bing,
Yahoo and msn. They need to use SEO to make sure that their content appears among the first
results of a search. Without SEO, it is very difficult indeed for a business trading online to remain
competitive.

Several SEO methods can be used to ensure a high ranking on a search engine results page,
such as optimising the content for specific keywords. Search engine algorithms are constantly
changing and businesses need to update their SEO methods accordingly.

Viral Marketing

Viral marketing makes use of all types of digital marketing. The essence of viral marketing is to
create a post, video, meme or similar short form of content that spreads across the web like a
virus. To make a successful viral marketing campaign, businesses promote the same content
across multiple channels such as Twitter, YouTube, blog posts and newsletters over a short
period of time.

Marketing managers try to identify individuals with high social networking potential, called
influencers. The managers create viral messages that appeal to the influencers. These have a
high chance of being passed on to many people who may be impressed that the influencer has
contacted them about the product.

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Benefits of Digital Promotions

 Worldwide coverage  a website allows businesses to find new markets and trade
globally, increasing potential market size.
 Relatively low cost  a well-planned and well-targeted digital marketing campaign can
reach the right customers at a much lower cost.
 Easy to track and measure results  web analytics and other techniques of measuring
response rates make it easy to establish how effective a promotion campaign has been.
Detailed information about how customers use a website or respond to advertising is
available, which helps to improve the effectiveness of future campaigns.
 Personalisation  Each customer can be made to feel that only they are being sent a
special offer. Whenever someone visits site, the business can greet them with targeted offers.
 Social media communication builds customer loyalty  involvement with social media
and quick responses to customers’ messages can build customer loyalty and create a
reputation for being easy to converse with.
 Content marketing  Campaigns of content marketing means producing images, videos
and articles, which can help a business gain social currency, especially if it goes viral.
 Website convenience increases sales  It is more convenient too, unlike other forms of
media which require people to get up and make a phone call or go to a shop.

Limitations of Digital Promotions

 Time-consuming  unless a digital promotion agency is used (which can be high cost),
tasks such as optimising online advertising campaigns and creating marketing content can be
time-consuming. The success of promotions needs to be judged against the cost of preparing
them.
 Skills and training  employees must have up-to-date knowledge and expertise to carry
out digital marketing with success. Tools, platforms and trends change rapidly. Employees
may need training to keep their skills at the right level.
 Global competition  reaching a worldwide audience is easy but this means competitors
can do so too! Standing out clearly against a large number of competitors can be difficult and
costly. Search engine optimisation is one way of trying to do this.
 Complaints and feedback  unhappy customers can quickly send out negative messages
about a business or its products. Any negative feedback or criticism of a brand can be visible
to the target audience through social media and review websites. It is essential for a business
to respond quickly and effectively to such criticism.

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Measuring Success of Promotion

Businesses must calculate the success of promotion campaigns to make better decisions in the
future. The best ways of assessing the success of promotions are:

o Sales performance before and after the promotion campaign:

By comparing the sales of the product before the campaign was launched, with the daily
and weekly sales during and after the campaign.
o Consumer awareness data:
Each week, market research agencies publish results of consumer recall or awareness
tests, based on answers to a series of questions concerning the advertisements they have
seen and responded to raise feedback.
o Consumer panels: These are useful for giving qualitative feedback on the impact of
promotions and the effectiveness of advertisements.
o Response rates to advertisements:
Newspaper and magazine adverts often have tear-off slips for consumers to request more
details. TV adverts can ask for consumers to ring in, websites can record the number of
hits and video-sharing sites can record the number of times advert has been viewed.

The Role of Packaging in Promotion

Packaging is the physical container or wrapping for a product. It is also

DEF
used for promotion and selling appeal.

The quality, design and color of materials used in packaging of products can have a very
supportive role to play in the promotion of a product.

Packaging can perform the following functions:

o Protect and contain the product.

o Give information, depending on the product, to consumers about contents, ingredients,

cooking instructions, assembly instructions and so on.

o Support the image of the product created by other aspects of promotion.

o Packaging is used for promoting the product. It has to appeal to the consumer.

o Aid the recognition of the product by the consumer such as red packing of Kit Kat.

o It has to be suitable for transporting the product from producer to people.

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Cheap and nasty packaging of products, such as clothes or chocolates, will destroy the quality
and status image that the firm is attempting to establish.

The Role of Branding in Promotion

Branding ▬
KEY
The strategy of differentiating products from those of competitors by
DEF
creating an identifiable image and clear expectations about a product.

A brand is the name given by a firm to a product or a range of products. The aims of branding
products include  aiding consumer recognition, making the product distinctive from
competitors and giving the product an identity and personality.

The benefits of branding the products are:

o It increases the chances of brand recall by consumers.

o It clearly differentiates the product from competitors products.
o It allows for the establishment of a family of closely associated products with the same
brand name.
o It reduces the responsiveness of consumer demand to a price increase. Consumers
often have references for well-known brands and are prepared to pay a high price for
them. This gives the business a high profit margin.
o It increases consumer loyalty to brands, which is a major marketing benefit.

A recent development has been the growth of own-label brands. These are product ranges
launched by retailers under their own store name. It is rare for the retailers to actually
produce the goods. They purchase them from producers who add on the retailers’ labels and
brand names.

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( 20.2 ) Place: An Important Part of the Marketing Mix

‘Place’ decisions are concerned with how products should pass from manufacturer to the final
customer. Several different ‘channels of distribution’ are available for firms to use. Some of
the important factors:

o Consumers need easy access to a firm’s products to try them and see them before they
buy, to make purchasing easy and convenient.

o Manufactures need outlets for their products that give as wide market coverage.

o Retailers ─ firms that sell goods to the final consumer - will sell manufacturers’ goods but
will demand a ‘mark up’ to cover their costs and to provide for a profit.

Channel of Distribution ▬
KEY This refers to the chain of intermediaries a product passes through from
DEF producer to final consumer, by using several interconnected intermediaries
such as wholesaler, distributors, agents and retailers.

Concept of Distribution

Getting the right product to the right consumer at the right time in a way that is most
convenient to the consumer is a good definition of distribution. Any business needs to establish
a distribution strategy that will define how it is going to move products from the point of
creation to points of consumption.

Customer Service as Objective of Distribution

The main purpose of distribution is

not necessarily to aim for lowest cost
but would it be most convenient for
consumers. Good customer service is
the key objective of distribution.

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Channel of Distribution 1 (Direct Selling)

Channel of Distribution 1 ▬

Direct selling to consumers with

KEY
no involvement of
DEF
intermediaries with personal
services.

Advantages of Channel of Distribution 1:

o Cuts out the profit margins of ‘middle men’ or intermediaries;
o The manufacturer has full control over the pricing and marketing of products;
o Direct marketing can be selective and targeted at the most likely potential consumers
by using computer data bases.

Disadvantages of Channel of Distribution 1:

o Manufacturer is personally responsible for holding stocks;
o Due to distance from the manufacturer the consumer is unlikely to have any chance to
see or try the product ─ after sales service could be a problem too;
o Direct marketing involving ‘mail shots’ has a poor image and can lead to resentment at
‘junk mail’ which has not been specifically requested.

Channel of Distribution 2
(Single-intermediary Channel)

Channel of Distribution 2 ▬

One-intermediary channel such

as retailer used for consumer
KEY
goods, this is where the
DEF
producer sells directly to the
retail outlets and then they sell
the product to the consumer.

Advantages of Channel of Distribution 2:

o Retailer undertakes stock holding for the manufacturer and distributes the product
to consumers over a wide geographical area;
o Manufacturer can concentrate on ‘making’ and not spend time or resources on
selling to consumers directly.

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Disadvantages of Channel of Distribution 2:

o Retailer will expect a profit margin which either raised from the manufacturers profit
margin or leads to higher prices then using the direct selling route;
o Final decisions on marketing policy are under the control of retailers such as price and
promotion.

Channel of Distribution 3
(Two-intermediary Channel)

CHANNEL OF DISTRUBUTION 3
involves using a wholesaler that buy
KEY in bulk from the producers, hold
DEF goods in warehouse and deliver
small quantities to retailers who
sell to final consumer.

Advantages of Channel of Distribution 3:

o Wholesaler performs important stock holding and ‘breaking bulk’ functions ─ they
order in large quantities but sell to retailers in smaller quantities;
o Can provide a wider coverage, to national or international markets.

Disadvantages of Channel of Distribution 3:

o Slows down the overall distribution chain; and increase the price for consumers.
o Wholesaler will expect to make a profit which will reduce profit margin for
manufacturer.

Integrated Marketing Mix

The key marketing decisions complement each other and work together to
DEF
give customers a consistent message about the product.

The best-laid marketing plans can be destroyed by just one part of marketing mix not being
consistent or working with the rest. The most effective marketing-mix decisions will be::

o Based on marketing objectives and affordable to marketing budget.

o Integrated and consistent with each other and targeted at the appropriate consumers.

If the most exclusive shop in your town sold expensive gifts and wrapped them in newspaper,
would you be surprised?

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Online Marketing (e-Commerce)

Online Marketing is the part of marketing techniques that uses the internet
KEY
and online based digital technologies such as computers, mobile phones and
DEF
other digital media platforms to promote products and services.

Benefits of Online Marketing:

o It is relatively inexpensive if the cost is compared to the number of consumers reached.

o Companies can reach a worldwide audience for a small proportion of traditional
promotion budgets.
o Consumers interact with the websites and raise awareness.
o The internet is convenient for consumers to use if they have access to a computer.
o Businesses can keep accurate records on the number of clicks or visitors, and quickly
measure the success rate of different web promotions.
o Computer and smart phone ownership is increasing in all countries of the world.
o Selling products on the internet involves lower costs than retail stores.
o Dynamic pricing  charging different prices to different consumers is easier.

Limitations of Online Marketing:

o Some countries have low speed internet connection.

o Consumers cannot touch, smell, feel or try on tangible goods before buying.
o Product returns may increase if consumers are dissatisfied with their purchases.
o The cost and unreliability of postal services in some countries may reduce the cost
advantage of internet selling.
o Websites must be kept up-to-date and user friendly.

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Factors Influencing the Choice of Distribution Channel

In deciding on an appropriate channel, a business must answer questions such as:

o Should the product be sold directly to customers or through retailers? Many

industrial products are sold directly due to complexity.
o If the market is very widely dispersed geographically, having more than one
intermediary can be an advantage.
o Depend on the cost to keep the product inventory in warehouses. If inventory costs are
high, then direct selling might be the preferred option.
o The level of control does the business want to have over the marketing mix; direct
selling gives much more control over pricing, for example.
o The channel of distribution must be integrated with other marketing-mix components.

Digital & Physical Distribution

Products that can be converted into digital format are now being widely distributed to consumers
by digital means over the internet rather than in a physical form.

Digital distribution bypasses the traditional physical distribution formats, such as paper,
optical discs and film cassettes. The processes involved in digital distribution include streaming
and downloading of content. The key difference is that a streaming file is simply played as it
becomes available, while a download is stored onto a computer’s memory. Both processes
involve the act of downloading, but only a download leaves the consumer with a copy that can be
accessed at any time from the device without having to download the data again.

The promoters of this form of distribution claim that music writers or music performers of the
content can distributed globally on platforms such as iTunes Google Play, avoid the costs of
physical distribution.

Business Quick Revision Book, As-Level

 Unit 4
Operations &

Project Management

Business Studies Resource Prepared By Usman Akhter

Book-2 Chapter 23 | The Nature of Operations 166

The Nature of Operations Chapter 23

( 23.1 ) The Production Process (Transformation Process)

Operations management used to be known simply as production management. Operation

management is concerned with the use of resources ― land, labour and capital ― to provide
goods and services that will satisfy the demands identified by the market research
department.

Factors of Production Required by Production

All business operations require resources or factors of production, such as:

Land ▬
All businesses need a location to operate. Some businesses require large sites for the
extraction of minerals and other natural resources for the production.

Labour ▬
This can be manual labour such as the blue collar production worker and mental skills of
engineers and scientists. Businesses provide effective training & development to improve
the specific skills and knowledge of the staff.

Capital ▬
This refers to the tools, machinery, computers and other equipment that businesses use to
produce the goods and services they sell. Intellectual capital is becoming increasingly important
in knowledge-based economies. Efficient production operations are more productive leads to
greater chance of business success.

K Intellectual Capital ▬
E Intellectual capital is acting as Intangible capital of a business that includes
Y human capital such as well trained employees, structural capital consists of
D expert procedure and policies and relational capital means goods links with

E supplier and customers. This could help business to get a competitive advantage

F over its competitors.

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The Stages of the Transformation Process

The way businesses change factors of production into finished goods is called the transformation
process. The role of production department is to produce the products using factors of
production.

KEY Transformation Process ▬ An activity or group of activities that transforms

DEF one or more inputs, adds value to them, and produces outputs for customers.

This process applies to both manufacturing and service industries. By production, we mean the
making of tangible goods, such as cars, and the provision of service, such as banking, insurance.
The aim, in all cases, is to achieve added value. This means selling the finished products for a
higher value than the cost of the inputs.

Contribution of Operations to Added Value

Operations managers can increase added value y effectively managing:

o Efficiency of Production:
Keeping costs as low as possible will help to give competitive advantage;
o Quality: The good or service must be suitable for the purpose and satisfy customer
needs and wants;
o Flexibility: The need to adopt to new methods of working and new products is
increasingly important in today’s world, such as ability to produce multiple products
and change production methods according to demand patterns.

Essentially, operations managers are aiming to produce goods and services of the required
quality, in the required quantity, at the time needed, in the most cost effective way.

The degree of value added to the inputs will depend on a number of factors:

o The design, quality, durability and appearance of the product;

o The efficiency with which the input resources are combined and managed;
o The effectiveness of promotional strategy and whether this convinces for consumers.

Land
Finished Goods

Labour
Production Process Services
Input Output
Components for
Capital
other Firms

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( 23.2 ) Efficiency, Effectiveness, Productivity & Sustainability

Operations management aims to covert inputs into outputs. The resources needed are costly
and their use can result in some of the undesirable consequences, such as pollution. Operations
managers must constantly consider how to make the best use of the resources at their disposal
and how to minimize the impact of production process on future generations.

The Importance of Productivity

Productivity is not the same as the level of production. Productivity can be defined as a measure
of the ratio of output to any of the firm’s inputs ─ such as labour and capital productivity.

DEF Production means converting inputs into outputs.

DEF Level of Production is the number of units produced during a time period.

Productivity is the ratio of outputs to inputs during production, output per

DEF
worker per time period.

Productivity is important as it is one of the main factors that determine the competitiveness of
a business. Raising the level of productivity will reduce the average cost of making each unit
of output. This lower cost might allow the business to reduce prices to customers.

Measuring Labour Productivity

If a firm becomes more productive, then it has become more efficient. The most common
measures of productivity are:

Labour Productivity:

Total Output in a Give Time Period

Output Per Worker =
Labour Employed
Capital Productivity:

Total Output in a Give Time Period

Output of Capital Equipment =
Value of Capital Employed

Production is the measured quantity of output that a firm produces in a given period of time,
it means that the total capacity of the business in a particular time period. This production
capacity increase by hiring more factors of production.
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Raising Productivity

(1) Improve the training of staff to raise skill levels:

Staff with higher and more flexible skill levels should be more productive, as well as being
able to perform variety of tasks more efficiently, they could become more motivated and
interested in work due to their ability to perform different jobs.
However training can be expensive and time consuming.

(2) Purchase More Technologically Advanced Equipment:

Modern machinery ▬ such as automatic plants, computers and high tech flow production
machines and equipments ─ should allow increased production with fewer staff. Such
expensive investment will only be worthwhile, if high output be maintained.

(3) Improve Employee Motivation:

Increasing pay, providing good working conditions, health and safety at work and other fringe
benefits as identified by different research analyst are likely to have permanent effects on the
productivity of the workforce.

(4) More Efficient Management:

More efficient management along with good leadership style could go a long way to
improve productivity levels and reduces the average cost of production.
There are many ways in which ineffective management can reduce the overall productivity of a
business. Poor attitude with workers, failure to purchase the correct materials, poor maintenance
schedules for machines are just some of the reasons.

(5) Improve the Working Conditions:

Many firms may have objectives to provide the best working conditions to their employees as
a part of their corporate social responsibility. Providing a healthy working environment is not only
beneficial for the workers, but increases the efficiency and productivity of the company as a
whole leads to greater profits.

(6) More Financial Rewards:

Financial rewards are advantageous to employees first and foremost because extra income is

always useful. Workers will be less likely to look for another job and shows progress within
the organisation in the form of greater productivity.
Examples such as Commission, Bonus, PRP, and Profit Sharing.

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Advantage:
Creating favourable circumstances for employees that increase the chances of success and effectiveness.

Is Raising Productivity always the Answer?

o Increasing productivity will only acceptable if the quality of the goods and services will be
maintained.
o Greater efforts and contributions from workers to increase productivity could lead to
much higher wage demands.
o Increasing productivity does not guarantee business success. If the product is
unpopular with consumer it may not sell profitably no matter how efficiently it made,
such as increasing productivity in producing traditional TV’s.

The Importance o f Efficiency & Effectiveness

A distinction needs to be made between these two terms. Efficiency is measured by productivity,
but effectiveness is rather different and is achieved only if the customer’s needs are met.

Efficiency ▬
K Making the best use of the resources available to the business. Efficiency can
E be measured in several ways, such as output per worker or cost per unit

Y produced, it means producing output at the highest ratio of output to input.

D Effectiveness is the degree to which the products produced by the business

E are related to the needs and wants of the customers and external

F
environment and meeting the objectives of the business by using inputs
productively to meet customers’ needs.

Efficiency is measure by productivity.

Effectiveness is achieved only if the business and customer’s needs are met. Effectiveness is
about putting them to productive use to achieve the objectives of the business. Effectiveness
also means meeting objectives other than just being efficient in operations, and meeting
customer’s need profitably. Customer needs are concerned with:

o Value of Money, which combines the design and performance of the product, price and
promotional opportunities, related with the cost of production.

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The Importance of Sustainability of Operations

Sustainability of Operations ▬
KEY
Business operations that can be maintained in the long term, by protecting
DEF
the environment and not damaging the quality of life for future generations.

Sustainability is one of the key business issues of the twenty-first century. Growing global
concern about pollution and climate change has put pressure on businesses to clean up their
operations. Businesses are becoming increasingly focused on achieving sustainability of
operations.

Ways to achieve environmental sustainability:

o Use sustainable and recycle maters, produce recyclable products, and reduce waste.

Benefits of Adopting Environmental Sustainable Way:

o Buying from sustainable suppliers helps to ensure that operations are sustainable and
minimize the risk of bad publicity.
o Reduce waste from operations will reduce production costs, and costs of waste disposal.

Limitations of Adopting Environmental Sustainable Way:

o Increasing sustainability might require capital investment, and development of
recyclable products and buying sustainable sources of materials can be expensive.
o It also requires investment in worker training and more accurate equipment.

( 23.3 ) Labour Intensity & Capital Intensity

Operations managers must decide what combination of factors of production they will use. There
are two main approaches which are substitutes for each other:

Labour Intensive

Labour Intensive is involving a high level of labour input compared with

DEF
capital equipment.

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Labour intensive means that the firm uses a high level of labour input compared to the
amount of capital. This might be the case with a furniture company that specializes in making
‘antique’ reproduction of furniture by hand. Some machines will be used for sawing and shaping
the wood but the assembly and finishing may be done by manual labour. Some firms insist on
maintaining labour intensity – to gain marketing advantages of a ‘hand-built’ image or due to
lack of finance.
In general terms, job production tends to be labour
intensive and flow production is nearly always capital
intensive. For example surgical industry, luxury hand-
build car industry such as ‘Rolls Royce’.

Capital Intensive

Capital Intensive is involving a high quantity of capital equipment

DEF
compared with labour input.

Capital intensive production uses a high value of capital equipment compared to labour.
Many industries are capital intensive due the nature of the production process they are involved
in. For instance, Textile Miles, Car Production Plant, Packed Food Production, Electricity
Generation and Aluminum Smelting can only be undertaken by using vast and expensive
capital intensive plants.

Some other businesses may choose to be capital intensive even though labour intensive
production is still possible. An example would be in the baking of bread. All over the world craft
bakers still exists, who bake bread in traditional way using simple and inexpensive capital tools.

The advantages are the opportunities for economies of scale and unit cost reductions offered
by large-scale capital utilization make this the first choice for many business managers.

Capital intensity brings its own problems. Fixed costs

tend to be high and the cost of financing the purchase
of equipment can be beyond some businesses.
Maintenance costs are often high too and skilled
engineers with computer programmers might be needed.
Firms needed to pay high training costs to retrain the
workers to come up with the required standards.

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( 23.4 ) Production Methods

There are several different ways in which goods and services can be produced:

o Job Production o Flow Production

o Batch Production o Mass Customization

Job Production

Job Production ▬
KEY Producing a one-off item specially designed for the customer. Job production
DEF is performed by skilled experts to a high standard and usually allows
flexibility and customization in the product.

This is normally used for the production of single, one-off, products. These products are
frequently small or large and are often unique in their nature.

Individual birthday or wedding cakes and made-to-measure suits from tailor, Channel
Tunnel in the UK are also examples of job production. In order to be considered job production,
each individual product has to be completed before the next product is started. Thus, at any
one time, there is only one product being made. An individually designed house is another
example of job production.

The best example is ‘Aston Martin’ which is designed according to the exact requirements of
the customers.

Benefits:
New, small firms often use job production, before they get the chance to expand. Job
production enables specialized products to be produced and ends to be motivating for workers,
because they produce the whole product and can take pride in it. (complete unit of work)

Drawback:
This sort of production tends to be
expensive, often takes a long time to
complete, and is usually labour intensive. The
labour force should be highly skilled.

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Batch Production

Batch Production is producing a limited number of identical products —

KEY
each item in the batch passes through one stage of production before
DEF
passing on to the next stage.

Batch production involves the production of products in separate batches, where the
products in the batch go through the whole production process together. The production
process involves a number of distinct stages and the defining feature of batch production is
that every unit in the batch must go through an individual production stage before the batch as
a whole moves on to the next stage.

Example:
Bakery, Production of Medicines, Cloths Manufacturing, School Uniforms, Cricket Bat
Production, Furniture Making, Books Printing, Building Constructions.

Bakery making batches of rolls, first the dough is mixed. Then, after being left for a time, the
dough is separated in to individual amounts, the right sizes for rolls, After this, the rolls are
baked together and then they are left to cool. When they have cooled, they are put on display in
the shop and another batch can be prepared.

Benefit:
Batch production allows firms to use division of labour in the production process and it enables
some gain from economies of scale. Batch production allows for efficient use of equipment
by moving batches around in patterns to different areas of specialty.

Drawback:
Batch production tends to have
high levels of work-in-
progress stocks at each stage
of the production process and the
work may well be boring and
demotivating for the workers.
There is a need to keep high
level of stocks of raw materials
in secure warehouse.

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Flow Production

Flow Production involves a continuous movement of items through the

KEY production process. This means that when one task is finished, the next task
DEF must start immediately. Therefore, the time taken on each task must be
the same.

The process of flow production is used where individual products move form stage to stage
of the production process as soon as they are ready, without having to wait for any other
products. Flow production systems are capable of producing large quantities of output in a
relatively short time and so it suits to medium scale or large scale industries where the
demand for the product is high and consistent. As a business grows the scale of its operations, it
often needs to change its method of production to allow greater production capacity and cover up
the increased demand of the market.

This method is used when there is a mass market for a large number of identical products,
for example, Cars, Computers, Chocolate Bars, Lays or LCD’s. The product passes from one
stage of production to another along a production line.

Example:
Coca Cola production plant, each product is standardized in that it is a can of soft drink and
produce using flow production system because the cans move through the various stages
independently. However, the firm can make changes to the contents of the cans and the labeling
on them without having to alter the flow production system.

Benefits:
Labour costs tend to be relatively low, because much of the process is mechanized and there
is little physical handling of the products. The constant output rate should make the
planning of inputs relatively simple and this can lead to the minimization of input stocks
through the use of just-in-time stock control.

Drawback:
Flow production is capital intensive so high technology, production lines are going to cost a
great deal of money. The work involved tends to be boring, demotivating and repetitive. If
equipment breaks down, the entire process is halted.

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Note:
It is essential that the flow production process be
very carefully planned and managed, so that
there are no disruptions in the system.

Mass Customization

Mass Customization is the use of flexible computer-aided marketing and

KEY
production systems to produce items to meet individual customers’
DEF
requirements at mass-production with low unit costs.

Mass customization combines the personalization and flexibility of custom-made

manufacturing in mass production, which offers a lower unit cost. This process combines
the latest technology with multi-skilled labour forces to use production lines to make a
range of varied products. This allows the business to move away from the mass marketing
approach with high output of identical products.

Example:
Dell computers can make a customized computer to suit your specific needs in a matter of
hours. By changing just a few of the key components ─ but keeping the rest the same, low
unit costs and maintained with greater product choice.

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Production Methods — Making the Choice

The following factors will influence whether a business adopt which one of the above four
production methods:

Size of the Market:

For small firms such as designer clothes, job production is likely to be used. Batch is useful for
producing a large number of units in different varieties. Flow production is most efficiently
adopted when market for similar products is very large and consistent.

The Amount of Capital Available:

Flow production is expensive to construct. Small firms are able to afford job or batch
production methods.

Availability of Other Resources:

Large-scale flow production often requires a supply of relatively unskilled workers and a large,
flat land area. Job production needs skilled crafts people.

Market Demand Exists for Products Adapted to Specific Customer Requirements:

If firms want the cost advantages of high volumes combined with the ability to make slightly
different products for different markets, the mass customization would be most
appropriate for adding customer requirements.

Problems of Changing Production Methods

Job to Batch:

 Cost of capital equipment needed to handle large numbers in each batch.

 Additional working capital needed to finance stocks and work in progress.
 Staff de-motivation — less emphasis placed on an individual’s craft skills.

Job or batch to Flow:

 The cost of capital equipment needed for flow production may be too high.
 Employee training needs to be flexible and multi-skilled — if this approach is not
adopted, then workers may end up on one boring repetitive task, which could be
demotivating.
 Accurate estimates of future demand to ensure that output matches demand.

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Inventory Management Chapter 24

( 24.1 ) Managing Inventory

Stock (Inventory) materials and goods required to allow for the production
DEF
and supply of products to the customer.

Operations efficiency can be improved if a business manages inventory well by balancing the
holding costs against the cost of running out of essential supplies.

Reasons for Holding Inventory

All businesses hold stocks of some kind. Banks and insurance companies will also hold stocks
of stationery and retailers have stocks of goods on display and in their warehouses.
Manufacturing businesses will hold stocks in three distinct forms::

(1) Raw Materials and Components:

The basic material and components from which a product is made held in the business so that
production can take place when required. These will have been purchased from outside
suppliers. They will be held in stock in warehouse until they are used in the production
process to produce the physical goods.

(2) Work in Progress: (Semi-finished products)

At any one time production process will be converting raw materials and components into
finished goods. During this process there will be ‘Work in Progress’ and for some firms, such as
building and construction businesses, this will be the main form of stocks held.

(3) Finished Goods:

Having been through the complete production process goods may then be finalized and held in
stock until sold and dispatched to the customer. These stocks can be displayed to potential
customers and increase the chances of sales. Many businesses sell products from inventory
so they must have them ready for when an order arrives.

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Inventory Management

(Q) Why do stocks need to be ‘managed’ effectively?

Without effective stock management several serious problems can arise for firms:

 There might be insufficient stocks to meet unforeseen changes in demand.

 Out-of-date stocks might be held if an appropriate stock rotation system is not used. For
example for fresh foods so business is needed to use FIFO inventory control method to
managed the stock.
 Stock wastage might occur due to mishandling or incorrect storage conditions.
 Very high stock levels may result in excessive storage costs and a high opportunity
cost for the capital tied up.
 Poor management of the stock purchasing function can result in late deliveries, low
discounts from suppliers or too large a delivery for the warehouse to cope with.

Costs of Holding Inventory

The stock holding costs include:

(1) Opportunity Cost:

Working capital tied up in stocks could be put to another use. It might be used to pay off
loans, buy new machines and equipment or pay of suppliers early to gain a cash discount. The
most favorable alternative use of the capital tied up is called its ‘opportunity cost’.

(2) Storage Costs:

Stocks have to be held in secure warehouses. They often require special conditions, such as
refrigeration and heating. Staff will be needed to guard a transport the stocks. Insurance
of stock is recommended in case they are stolen or damaged in case of fire or flood.

(3) Risk of Wastage and Obsolescence:

If stocks are not used or sold as rapidly as expected then there is an increasing danger of
goods deteriorating or becoming outdated. This will lower the value of such stocks.

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Benefits of Holding Inventory

There are real risks and costs of holding very low stock levels — and these risks may have
financial impacts for the firms. These costs are often called ‘stock-out’ costs, on the other
hand, the benefits of holding inventory are:

(1) Reduces Risk of Lost Sales:

If a firm is unable to supply products to customers ‘from stock’ of finished goods, then sales
could be lost to businesses with higher stock levels. This might lead to future lost orders too.
Holding high inventories not only gives customers more choice but reduce the risk of losing sales.

(2) Allows for Continuous Production:

If stocks of raw materials and components run out then production will have to stop. This will
leave expensive equipment idle and labour with nothing to do.

(3) Avoids the Need for Special Orders from Suppliers:

If a business runs out of inventory, an urgent order is given to a supplier to deliver additional
materials due to shortages then extra costs might be incurred in administration of the order
and in special delivery charges.

(4) Large Orders of New Supplies Reduce Costs:

To keep low stock levels may mean only ordering goods and suppliers in small quantities. The
larger the size of each delivery then the higher will be the average stock level held. By ordering
in small quantities the firm may lose out on bulk discounts, credit facilities and increases
the transportation cost.

Optimum Order Quantity (EOQ)

Economic Order Quantity is the level of inventory that minimizes the total
DEF
inventory holding costs and ordering costs.

Purchasing stocks is not as easy as it sounds. The

purchasing manager must ensure that supplies of
the right quality are delivered at the right time
in sufficient quantities to allow smooth and
unbroken production.

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Inventory Control Charts — Lead Time Diagram

Stock control charts or graphs are widely used to monitor a firm’s stock position. These charts
record stock levels, stock deliveries, buffer stocks and maximum stock levels over time.
They aid a stock manager in determining the appropriate order time and order quantity.
The key features::

(1) Buffer Stocks:

These are the minimum stocks that should be held to ensure that production could still take
place in case of delay in delivery occur or production rates increase.

(2) Maximum Stock Level:

This is the maximum level of stocks and may be limited by space or by the financial costs
of holding even higher stock levels. EOQ is use to calculate the maximum stock levels.

(3) Re-Order Stock Level:

This is the level of stocks that will trigger a new order to be sent to the supplier.

(4) Re-Order Quantity: The number of units ordered each time.

(5) Lead Time:

This is the normal time taken between ordering new stocks and their delivery. The longer this
period of time then the higher will have to be the re-order stock level.

Note: The stock control chart can also be prepared by the computer and shows the sale of
products over ten week period.

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Importance of Supply Chain Management

K Supply Chain ▬ The network of all the businesses and activities involved in

E creating a product for sale, starting with the delivery of raw materials and

Y finishing with the delivery of the finished product.

D
Supply Chain Management ▬
E
Handling the entire production flow of a product from raw materials to finished
F
product, to minimize costs but improve customer services.

Operational efficiency can be improved by managing the supply chain with the aim of
minimising costs and improving customer service.

Businesses of any size will benefit from reducing the time it takes to convert raw materials into
completed products available for sale. SCM aims to reduce this time period by:

o Establishing excellent communications with supplier companies, which help to ensure

the right number of goods of the right quality, is received exactly when needed.
o Cutting the time taken to deliver all materials required for production by improving
transport systems.
o Speeding up the new product development process to improve the competitiveness of
the business, with technology and flexible workforces.
o Minimising waste at all production stages to cut costs.

Benefits of Effective Supply Chain Management

o Improves customer service:

Customers expect products to be delivered quickly and on time. Good supply chain
management ensures that customers receive products more quickly and of the
appropriate quality. This increases customer satisfaction.

o Reduces operating costs: effective SCM allows a business to reduce costs. In

particular, purchasing costs and inventory costs should fall. Also, production costs are cut
as time is saved in converting raw materials into finished products.

o Improves profitability: By reducing wasted time, improving inventory management and

creating a low-cost but efficient supply chain, business profits should increase.

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( 24.2 ) Just-in-Time (JIT) Stock Control

K Just-in-Time is the stock-control method aims to avoid holding stocks by

E requiring supplies to arrive just as they are needed in production process

Y and completed products are produced just they are sold and dispatched
according to customer requirements.
D

E Just-in-Case (JIC) Inventory Management: aims to reduce the risk of

F running out of inventory to the minimum by holding high buffer inventory levels.

JIT requires that no buffer stocks are held,

components arrive just as they are needed on the
production line, work in progress being kept to an
absolute minimum and finished goods are delivered
to customers as soon as they are completed.

The purpose of JIT stock control method:

1) Reducing the stock holding costs.

2) Making customized products according to

the requirements of customers.

For JIT to be successfully introduced there are certain very important requirements that
business must ensure are met::

(1) Relationships with suppliers have to be excellent as they must always be prepared to
supply the components required with a very short lead time. This often means that a firm will
only have one, or at most two, suppliers for each component so that a relationship of mutual
benefit can be built up.

(2) Production staff must be multi-skilled and prepared to change jobs at short notice.
For producing products according to the consumer requirements, business should make
workforce plan to hire multi-talented workers so that products could be modified according
to the need.

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(3) Equipment and Machinery must be flexible:

New technological advance machines are able to produce variety of goods in a very short time
period along with the addition of customer requirements.

Old-fashioned manufacturing equipment designed to produce one range of very similar

products it might have taken days to adapt it to making other types of products.

(4) Accurate Demand Forecasts will make JIT a much more successful policy. The concept of
just-in-time (JIT) helps to keep just enough inventories on hand to meet demand with
accurate sales forecasts. Demand forecasts can be converted into production schedules that
allow calculation of the precise number of components needed over a certain time period.

(5) The Latest IT Equipment will allow JIT to be more successful. Accurate data-based records

of sales, sales trends, re-order levels, lead time using a computer database system and so on
will allow very low stocks to be held in warehouse.

(6) Excellent Employee - Employer relationships:

This relationship essential for JIT to operate smoothly, any industrial relations problem could
lead to a break in production and supplies which result in late deliveries and poor consumer
services.

(7) Quality must be everyone’s priority:

As there are no spare stocks to fall back on it is essential that each component and product
must be right first time. Any poor-quality goods that cannot be used will mean that a customer
will not receive goods on time.

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Advantages of JIT

o Reduces capital invested in stocks and reduces the opportunity cost of stockholding.

o Costs of storage and stockholding are reduced.

o Space released from holding of stocks can be used for a more productive purpose.

o Much less chance of stock becoming outdated or obsolescent.

o The greater flexibility that the system demands leads to quicker response times to
changes in consumer demand and tastes.

o The multi-skilled and adaptable staff required for JIT to work may gain from
improved motivation.

Disadvantages of JIT

o Any failure to receive supplies of materials or components in time caused by a strike

at the supplier’s factory, transport problem or IT failure can halt the production process.

o Delivery costs will increase as frequent small deliveries are an essential feature of JIT.

o Order administration costs may rise because so many small orders need to be
processed.

o There could a reduction in the bulk discounts offered by suppliers because each order
is likely to be very small. (Purchasing Economy)

JIT Evaluation

JIT requires staff to be much more accountable for their performance and suppliers to be very
reliable as any failure to meet targets will lead to production stopping.

There is no surplus or buffer in the JIT system to cover up for inefficient workers, inflexible
people and equipment, unreliable suppliers or poor production planning. JIT requires a
very different organisational culture to that is often referred to as ‘JIC’ — holding inventories
‘just in case’ they might be needed.

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Book-2 Chapter 25 | Capacity Utilization 186

Capacity Utilization Chapter 25

( 25.1 ) Measurement & Significance of Capacity Utilisation

D Capacity Utilisation is the proportion of maximum output capacity currently

E
F being achieved, calculated as a percentage of total productive capacity.

A firm’s productive capacity is the total level of output that could produce in a given time
period. Capacity utilization is the percentage of firm’s total possible production capacity
that is actually being used. This is the major factor in determining the operational efficiency of
a business. It is measured by using the following formula;

Current Output
Capacity Utilization = × 100
Maximum Capacity

Maximum capacity is the total level of output that a business can achieve in a certain time
period and it is a major factor in determining the operational efficiency of a business.
Maximum capacity for a hotel will be the number of room nights available during a period. For a
factory it will be the total level of output that all of the existing resources ─ land, capital
equipment and labour can produce. If a firm is working ‘flat out’ at full capacity it is achieving
100% capacity utilization.

Greater utilization means greater production. This means there is potential for more sales which
will lead to higher profits, and the business valuable assets do not stay unused.

Capacity Utilisation ▬ Impact on Average Costs

When utilization is high rate, average fixed costs will be spread out over a large number of
units ─ unit fixed costs will be relatively low. When utilization is low, fixed costs will have to be
borne by fewer units and unit fixed costs will rise.

It might be assumed that all firms will be aiming to produce at 100% capacity at all times.
This could gain a cost advantage.

100-bed hotel All bedrooms occupied (100% capacity) 50 bedrooms occupies (50%)

Hotel Fixed Costs per day $2500 $2500

Average Fixed Costs $25 $50

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Drawbacks of Working at Full Capacity

There are also potential drawbacks to operating at full capacity for a period of time:

o Staff may feel under pressure due to the work load and this could raise stress levels.
Production managers cannot afford to make any production mistakes as there is no slack
time to make up the lost output.

o Regular customers who wish to increase their orders will have to be turned away or
kept waiting for long periods. This could encourage them to use other suppliers
with the danger that they might be lost as long-term clients.

o Machinery will be working flat out and there may be insufficient time for maintenance
and preventative repairs.

Excess Capacity ▬ What are the Options?

KEY Excess Capacity exists when the current levels of demand are less than
DEF the full capacity output of a business ─ also known as spare capacity.

Low levels of capacity utilization lead to high unit fixed costs ─ so what options do firms have
when attempting to reduce excess capacity? Answer:

(1) Is Spare Capacity just a Short-term, seasonal problem such as might exist for ice
creams in the colder months? The main options for businesses in this case would be to:

 Adopt a more flexible production system allowing other goods to be made that might
be sold at other times of the year. For example offering ice-cream in summer season and
coffee in winter.

 Maintain high output levels but add to stocks, it is an expensive and risky strategy if
sales do not recover. This option is suitable for durable products.

(2) Is Spare Capacity a Long-term problem resulting from a fashion change, technological
development of competitor’s products or an economic recession? In this situation, if demand
cannot be revived by means of promotion, a cut in production capacity should be considered.
This is often referred to as process of rationalization.

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Short Run Treatment of

Excess Capacity

(1) Excess Capacity in Short-term:

These are the options available to operations managers ─ the business may concentrate on
marketing solutions to the problem such as cutting prices or entering overseas markets in
an effort to increase sales or using flexible production operations.

Short-Term Problem ─ Seasonal Downturn

Advantages Disadvantages

o Improves the job o Unsuitable for perishable

Option 1: security for all workers stocks that go out of date
and no need to hire part- quickly, such as butter.
Continue producing the
time workers. o Stock holding costs can be
durable products and add
o No need to change very substantial.
to stocks.
production schedules and o Demand may not increase
(Suitable of durable
orders from suppliers. as expected ─ the goods may
goods, such as fans,
o Stocks may be sold at have to be sold at a
heaters)
times of rising demand. substantial discount.

Option 2:

o Staff may be de-motivated

Introduce greater
o Production can be reduced by not having full-time,
flexibility into the
during slack period and permanent contracts.
production process:
increased when demand is o Fully flexible and
o Part-time, high. adaptable equipment can
temporary labour or o Other products can be be expensive.
Short-term working produced that may follow o Staff may need to be
contracts. a different demand pattern. trained in producing more

o Flexible equipment o Avoids stock build up. than one product ─ may add

that can be switched to to training costs.

making other products.

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Book-2 Chapter 25 | Capacity Utilization 189

Long Run Treatment of

Excess Capacity

(2) Excess Capacity in Long-term:

This might be caused by an economic recession, technological changes that make existing
products less competitive, or by promotional campaigns by competitors. The precise cause
of the excess capacity will be important to identify as it could indicate a range of products that
require updating rather than a general recession in demand.

Long-Term Problem ─ Economic Recession or Technological Changes

Advantages Disadvantages

Option 1: o Redundancy costs for staff

o Reduces overheads of
payments.
Rationalise existing excess capacity.
o Staff uncertainty over job
operations and cut o Higher capacity utilization
security.
capacity, by closing because of the reduction in
o Capacity may be needed
factory/offices. total capacity.
later if economy picks up.

o May prove to be expensive

o Will replace existing
and take too long to prevent
products and make business
Option 2: cut backs in capacity.
more competitive.
o Requires long-term
Research & o If introduced quickly then
planning as new products
might prevent
Development into New introduced in a very short
rationalization and the
Products. time period, without a clear
problems associated with
market strategy, may be
this.
unsuccessful.

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Capacity Shortages

Capacity Shortage is when a firm faced the demand for its products
DEF
exceed current output capacity, exact opposite to excess capacity.

When business is operating at close to full capacity then other decisions have to be taken:

o Should the firm increase its scale of operation by acquiring more production resources?
o Should it retain existing capacity but ‘Outsource’ of sub-contract more work to other
firms? Could the quality of products obtained from sub-contractors be assured?
o Should it retain working at full capacity and not expand, perhaps because of the danger
that demand might fall back in the near future?

Short & Long Run Treatment of

Capacity Shortage

As with the opposite situation of excess supply capacity, it is essential to analyse the cause
of the excess demand and the time period it is likely to last. For instance, if it results from a
reduction in output caused by a faulty machine that will be repaired next month, then drastic
action to raise capacity is unlikely. If the firm has been producing at 100% capacity for some
time and there seems to be no sign of demand falling, then two options need to be weighed up.

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Short-Term Capacity Shortage

Advantages Disadvantages

o Less control over quality of

o No major capital investment is
output.
required.
Option 1: o May be uncertainty over
o Should be quite quick to
Use sub-contract delivery times and
arrange.
or outsourcing of reliability of delivery.
o Offers much grater flexibility
supplies, components o Unit cost may be higher
than expansion of facilities ─ if
or even finished than ‘in-house’ production
demand falls back then the
goods in short-run. due to the supplier’s profit
contracts with other firms can
margin, and extra
be ended.
transportation costs.

Long-Term Capacity Shortage

Advantages Disadvantages

o Long-term increase in o Capital cost may be high.

capacity. o Problems with raising

Option 2: o Firm is in control of quality and capital.

Capital investment final delivery times. o Increases total capacity

into expansion of o New facilities should be able to but what happens if demand

use latest equipment and should fall for a long

production facilities
methods. period?
in long-run.
o Economies of scale should be o Takes time to build and

possible too. equip a new facility ─

customers may not wait.

These decisions should not be taken lightly as the success of an expansion decision could lead
to the future profitability.

Failure to expand capacity in a growing market could leave the business with a shrinking
market share or becoming increasingly dependent on external contractors.

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( 25.2 ) Outsourcing

Outsourcing ▬
KEY
Using another business (a ‘third party’) to undertake a part of the production
DEF
process rather than doing it within the business using the firm’s own employees.

There are the other major reasons for outsourcing:

Reduction and Control of Operating Costs: Instead of employing expensive specialists, it

could be cheaper to ‘buy in’ specialist services as and when required.

Increased Flexibility: Additional capacity can be obtained from outsourcing only when
needed and contracts can be cancelled if demand falls.

Access to Quality Services or Resources: Many outsourcing firms employ quality

specialists that small and medium sized businesses could not afford to employ directly.

There are Potential Drawbacks to Outsourcing too:

Quality Issues:
Internal processes will be monitored by the firm’s own quality-assurance system. This will not
be so easy when outside contractors are performing important business functions. The company
needed to ensure that product quality and customer-service standards are met.

Loss of Managerial Control: Your outsourcing company will not be driven by the same
standards and corporate culture that drives your company. They will be driven to make a
profit from the services that they are providing to you and other businesses like yours.

Security: Using outside business to perform IT function may be a data security risk.

Negative Reputation: Outsourcing has gained a negative reputation and customers may
object to dealing with outsourced operations. Bought-in components and functions may raise
doubts in customers’ minds about quality and reliability.

Outsourcing Evaluation

The global trend towards outsourcing will continue as firms seek further ways of improving
operational effectiveness and as more opportunities arise due to globalization.

The process is not without its risks, the company must take a substantial cost-benefit analysis
of the decision. Outsourcing would be time consuming and expensive.

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Unit 5
Finance &
Accounting

Business Studies Resource Prepared By Usman Akhter

Book-2 Chapter 29 | Business Finance 194

Business Finance Chapter 29

( 29.1 ) The Need for Business Finance

Business activity cannot take place without some finance ─ it is needed for purchasing the
materials and assets required for the production of a good and services provided by the
business.

Why Businesses Requires Finance

Finance is required for many business activities:

o Setting up a business will require cash injections from the owners and shareholders to
purchase essential assets.
o All businesses will have a need to finance their working capital ─ the day-to-day finance
needed to pay bills and other expenses and to build up stocks.
o When businesses expand, further finance will be needed to increase the capital assets
held by the firm ─ and often required higher working capital needs.
o Expansion can be achieved by taking over other businesses.
o Special situations will often lead to a need for finance, such as run out of cash.
o Finance is often used to pay for research and development into new products or to
invest in new advertisement and marketing strategies.

The Distinction between

Short & Long-term need for Finance

Some of these activities and situations will need finance for many years or even permanently.
Other cases will need only short-term funding. No single source of finance is likely to be suitable
for all business needs, and deciding the best source is the responsibility of finance managers.

Short-term finance is the money required for short periods of time. It is helpful to experience
seasonal demand, and to resolve the liquidity problems.

Long-term finance is the money required for more than one year. It is useful for buying long-
term fixed assets such as building, machines and vehicles.

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Cash & Profit — What’s the Difference?

‘If a business is profitable the firm is certain to have a cash surplus too’. A profitable business
may run out of cash ─ called insolvency ─ whilst a business recording a loss may have a
cash surplus.

o A business may be selling more of its output on credit then previously. Therefore, a
profit is being made as the goods are being recorded as sold, but the cash payment
form customers will be received after some time in the future.

o Capital expenditure is recorded in the profit and loss account by including depreciation
as an expense.

Administration, Bankruptcy & Liquidation

Lack of finance is the single most common reason of business failure. Specialized
administration accountants are appointed to try to keep the business operational and to
resolve the financial issues. If this proves impossible, the bankruptcy will result. This means
that a legal process begins which will lead to liquidation of the assets to pay back the creditors
and lenders.

Administration ─

When administrators accountants manage a business that is unable to pay its

K
debts with the intention of selling it as a going concern.
E

Y Bankruptcy ─
The legal procedure for liquidating a business which cannot fully pay its debts
D out of its current asses.

E
Liquidity is the ability of a business to repay its short term debts.
F
Liquidation is when a firm ceases trading and its assets are sold for cash to
pay suppliers and other creditors.

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( 29.2 ) Working Capital

Working capital is often described as the ‘life blood’ of a business. It is the finance needed for
everyday expenses, such as the payment of wages and buying of stock. Without sufficient
working capital a business will be illiquid.

Current Assets ─
KEY Assets that either are cash or likely to be turned into cash within 12 months.

DEF
Current Liabilities ─

Debts that usually have to be paid within one year.

Meaning & Importance of Working Capital

Sufficient working capital is essential to prevent a business from becoming illiquid and unable
to pay its debts. Too high a level of working capital is also a disadvantage; the opportunity cost
of too much capital tied up in stocks, debtors and idle cash in the return that money could
earn elsewhere in the business. The working capital requirement for any business will depend
upon the ‘length’ of its ‘working capital cycle.’ The simple calculation for working capital is
current assets less current liabilities.

A Permanent Increase in Working Capital

When businesses expand, they generally need higher stock levels and will sell a higher value
of products on credit. This increase in working capital is likely to be permanent, so long-term
permanent sources of finance will be needed, such as long-term loans or even share capital.
The purpose of maintaining a specific amount as a permanent capital is to pay the supplier on
time in order to develop good trading relationships and building firm’s goodwill.

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Capital Expenditure & Revenue Expenditure

Capital Expenditure

Capital Expenditure involves the purchase of assets that are expected to

KEY
last for more than one year, such as building, machinery, vehicles, plant
DEF
and fixtures.

An amount spent to acquire or upgrade productive assets (such as buildings, machinery

and equipment, vehicles) in order to increase the capacity or efficiency of a company for more
than one accounting period. It is also called capital spending. Common examples::

o Purchase of new land and building for the establishment of a business.

o Purchase of additional fixed assets such as furniture or machinery.
o Purchase of patent right, copy rights etc.

Revenue Expenditure

Revenue expenditure is spending on all costs and assets other than fixed
KEY
assets and includes wages, salaries and materials bought for stock, shown in
DEF
income statement.

Expenditure which is not for increasing the value of fixed assets, but for running the business
on a day-to-day basis, is known as revenue expenditure. For example Wages or Salaries paid to
Factory Workers, Depreciation of Fixed Assets, Freight, Fuel and Electricity Charges.

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( 29.3 ) Sources of Finance

Companies are able to raise finance

from a wide range of sources, and
classify these into:
o Internal Money raised from the
business’s own assets or from
Profits left in the business.

o External Money raised from

sources outside the business.

Internal Sources of Finance

This is money which is obtained from within the business itself. The most common examples for
internal sources of finance are:

( 1 ) Retained Profit

If a company is trading profitably, some of these profits will be taken in tax and some always
paid in the form of dividends. If any profit remains, this is kept in the business and becomes
an internal source of finance for future activities. These retained profits will be reinvested
back to business for the expansion plans and will not be paid out to shareholders. It is often
called ploughed back profit.

( 2 ) Sale of Assets

Established companies often find that they have some of the assets that are no longer fully
employed. These could be sold to raise cash. Some businesses will sell assets that they still
intend to use but which they do not need to own, the assets might be sold to a leasing
specialist and leased back by the company.

( 3 ) Reductions in Working Capital (Reduction in Stocks)

When businesses increase stock levels or sell goods on credit to customers they use a source of
finance. When companies reduce these assets such as stocks ─ by reducing their working
capital ─ capital is released, which acts as a source of finance for other uses.

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Evaluation of Internal Sources of Finance

This type of capital has no direct cost to the business, if assets are leased back once sold,
there will be leasing charges. Internal finance does not increase the liability or debts of the
business.
However, it is not available for all companies, for example newly formed ones, small scale
or unprofitable business organisations.

Plough Back: to put any profits made by a business back into it in order to make it more successful.

External Sources of Finance

( a ) External Sources of
Short-Term Finance

This short-term finance provides the working capital needed by businesses for day-to day
operations and obtained from individuals or institutions outside of the business. It is finance
which is needed for one to three year. There are three main sources:

o Bank Overdrafts o Debt Factoring

o Trade Credit

( 1 ) Bank Overdrafts

A bank overdraft is the most ‘flexible’ of all sources of finance. This means that the amount
raised can vary from day to day, depending on the particular needs of the business.

The bank allows the business to ‘overdraw’ its account at the bank by writing cheques to a
greater value than the balance in the account, spend more money from the account than is
currently in it. This amount should always be agreed with the bank manager in advance and
always has a limit beyond which the firm should not exceeded.

( 2 ) Trade Credit

By delaying the payment of bills for goods or services received, a business is actually
obtaining finance. Its suppliers or creditors are providing goods and services without receiving
immediate payment and this is as good as ‘lending money’, but it can harm the relationships
with suppliers.

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( 3 ) Debt Factoring

When a business sells goods on credit it creates debtors. Businesses try to sell these debts to
a specialist debt factoring institute. In this way immediate cash is obtained, but not for the
full amount of the debt. This is because the debt-factoring company’s profits are made by
discounting the debts such as 10% reduction in payment.

( b ) External Sources of
Medium-Term Finance

This finance which is available for between three to ten years. It is usually needed to purchase
machinery and vehicles, which often have useful lives for this period. The common methods are::
o Hire Purchase & Leasing; o Medium-term Bank Loan.

( 1 ) Hire Purchase & Leasing

Hire Purchase ▬ This allows a business to buy a fixed asset over a long
KEY period of time with monthly payments which include an interest charge,
DEF agrees to pay fixed installments over an agreed time period along with a
down payment — the asset belongs to the company.

These methods are often used to buy fixed assets with a medium life span to spread the
payment of asset over a stated period of time ─ three to ten years. Hire purchase is a form of
credit for purchasing an asset over a period of time. This avoids making large initial cash
payment to buy the asset. This avoids making large initial cash payment to buy the asset.

Leasing an asset allows the firm to use an asset such as machines, equipment
KEY or vehicles but it does not have to purchase it, and paying a rental or
DEF leasing charges over a fixed period. The business could decide to purchase
the asset at the end of the leasing period.

Leasing involves a contract with a leasing or finance company to acquire, without having to
purchase, assets over the medium term life span. A periodic payment is made over the life of
the agreement, but the business does not necessary have to purchase the asset at the end.
The risk of unreliable or outdated equipment is reduced as the leasing company will repair and
update as part of the agreement. This avoids the need for the business to raise long-term
capital to buy the asset. Ownership remains with the leasing company.

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( 2 ) Medium-term Bank Loan

This will have the same advantages and disadvantages as long-term loans referred to below,
and often secure with a particular immovable fixed asset. These are payable over a fixed period
of time and could be suitable for medium term activities such as buying machines, equipments
or vehicles.

( c ) External Sources of
Long-Term Finance

The main sources are equity or debt finance.

Equity finance is raised though selling the shares by limited companies which are acting as a
permanent source of finance.

Debts finance increases the liabilities of a company. It can be raised in two main ways::
o Long-term Loans from Bank.
o Debentures (also known as loan stock or corporate bonds).

( 1 ) Long-term Loan from Bank –

Business Mortgages

These loans may be offered at either a variable or a fixed interest rate. Companies borrowing
from banks will often have to provide security or collateral for the loan; this means that the
right to sell an asset. Businesses with few assets will find it difficult to obtain long-term loans.

( 2 ) Sale of Shares ― Equity Finance

All limited companies issue shares. Private and public limited companies sell shares in order to
raise permanent finance. Both of these companies are able to sell further shares – up to the
limit of their authorized share capital ─ in order to raise additional permanent finance. This
capital never has to be repaid unless the company is completely wound up as a result of
ceasing to trade.

Public issues by prospectus ▬

This advertises the company and its share sale to the public and invites them to apply for the
new shares.

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( 3 ) Debentures

Debentures ▬ Long-term bonds issued by companies to raise debt finance,

DEF
often with a fixed rate of interest.

A debenture is a document given by a company to someone who has lent it money. It states
the amount of loan, the annual amount of interest payable, and the dates on which interest is to
be paid. It also includes the date on which the loan is to be repaid by the company. A company
wishing to raise funds will issue or sell these debentures to interested investors.

The company agrees to pay a fixed rate of interest each year for the life of the debenture,
which is often 15-25 years. The buyers may resell to other investors. Debentures are often
secured on a particular asset, which means that the investors have the right, if the company
ceases trading, to sell asset to gain repayment. This is called mortgage debenture.

Debt or Equity Capital ─ An Evaluation

Which method of long-term finance should a company choose?

Debt finance has the following advantages:

 As no shares are sold, the ownership of the company does not change or diluted.
 Loans will be repaid so there is no permanent increase in the liabilities.
 Lenders have no voting rights at the AGM.
 Interest charges are an expanse of the business and are paid out before taxation.

Equity Capital has the following advantages:

 It never has to be repaid; it is permanent source of capital raised from the

shareholders.
 Dividends do not have to be paid every year other then the profitable years.

Other Sources of Finance

Grants

There are many agencies that are prepared, under certain circumstance, to grant funds to
businesses. The two major sources are central government and trade associations. Grants
often come with conditions attached, such as location and the number of jobs to be created.

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Venture Capital

These are specialist organisation, or sometimes wealthy individuals, who are prepared to
lend risk capital, or purchase shares in small to medium sized businesses that might find it
difficult to raise capital from other sources. Small companies that are not listed on the Stock-
Exchange ─ ‘unquoted companies’ ─ can gain long-term investment funds from venture
capitalists.

Micro Finance for Unincorporated Businesses

(Sole Trader & Partnership Businesses)

Microfinance providing financial services for poor and low income customers
DEF who do not have access to the banking services, such as loans and overdrafts,
offered by commercial banks or specialized microfinance banks.

Sole traders and partnerships are unincorporated businesses. They cannot raise finance
from the sale of shares and selling debentures. Owners of these businesses will have access
to microfinance, bank overdrafts, loans and credit form suppliers. They may borrow from family
and friends, use personal savings and retained profits.

Crowd Funding

Crowed funding is when business finance is acquired from a ‘Crowd’. The use of small amounts
of capital from a large number of individual to finance a new business venture.

The basic idea behind it is that entrepreneurs rarely have sufficient finance to set up their own
business. Banks may be unwilling to lend because of lack of previous trading records. Crowd
funding allow an individual to promote their new business idea to many thousands of people
who may be willing to each invest a small sum, $10 for example.

The internet has provided a vehicle for entrepreneurs to reach out to people who might be
willing to provide finance and there are many websites that facilitate the raising of finance in
this way. The entrepreneur will explain with the aid of video and graphics, what the business is
about, what its objectives and why finance is needed. Investors can commit small sums of
money to the new venture until the ‘target sum’ is reached.

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However, they must keep accurate records of thousands of investors to payback a share of
profits. Also, exposing a new project idea on the Internet means that it could be copied by
others.

Some schemes ▬ such as social

enterprises like shoukat khanum, the
crowd funding is the best way to collect a
huge amount of donation to build the hospital.

Factor Influencing Finance Choice

Cost of Financing:
Loans may be very expensive because of high interest rates, even internal finance may have an
opportunity cost. Finance raised from selling share is also expensive due to flotation of
share price and cost of promoting the shares in stock exchange.

Amount Required:
Share issues and sale of debentures are useful for long-term activities. Leasing and hire
purchase are needed when buying the fixed assets such as machines and equipments, while the
short-term financing may be suitable for short-term activities such as paying creditors.

Flexibility:
For short-term requirements, more flexible financing modes are suitable that will be varied
according to the needs.

Size of existing borrowing:

The higher the existing debts the greater the risk of lending more.

Legal structure and desire to retain:

Issuing shares can raise permanent finance, but the existing owners can loose control over
the limited company. Small firms often able to raise from internal sources or borrow from close
people because of their weak legal structure.

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Book-2 Chapter 30 | Forecasting Cash flows 205

Forecasting Cash Flows Chapter 30

( 30.1 ) Cash flow Forecasts: Meaning & Purpose

For any business to survive, having sufficient cash to pay suppliers, banks, and employees is the
single most important financial factor. If a business does not plan the timing of these payments
and receipts carefully it may run out of cash even operating profitably.

K Cash flow is the sum of cash payments to a business (cash inflows) less the

E sum of cash payments (cash outflows) during a period of time; it is the

movement of money into or out of a business.
Y

D
Cash flow Statement ▬
E An accounting statement called the "statement of cash flows", shows the

F amount of cash generated and used by a company in a given period.

Insolvent ▬
D When a business cannot meet its short-term debts and unable to pay short-

E term expenses.

F
Liquidation is when a firm ceases trading and its assets are sold for cash to
pay suppliers and other creditors.

Why cash flow is important to business?

o Without sufficient cash flow a business will not be able to pay its suppliers on time.
These creditors may stop supplying goods in the future or impose strict conditions such as
‘cash on delivery’.
o Wages and salaries may not be paid on time and this will cause poor motivation,
absenteeism, higher labour turnover and looking for work elsewhere.
o Tax bills may not be paid on time.

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Interpretation of Cash Inflows & Cash Outflows

Cash Inflows are the payments in cash received by a business during a

KEY period of time.
DEF
Cash Outflows are the payments in cash made by a business during a period
of time.

Cash Inflows Cash Outflows

Cash Sales Payment of Salaries and Wages

Cash Received from Debtors Payment to Suppliers

Sale of Spare Assets Payment of Utility Bills

Raising from Sale of Shares Payments of Dividends

Bank Overdraft Repayment of Loans

Other Income Payment of Leasing Charges

Government Grants Payment of Corporation Tax

Medium or Long-term Bank Loan Payment of Rentals

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A Cash Flow Forecasts can be Used to Tell the Manager

A CASH FLOW FORECAST contains estimates of future cash inflows and

KEY
outflows of a business, usually on a month by month basis. This will then
DEF
show the expected cash balance at the end of each month.

A cash flow forecast is also known as a cash budget. A cash-flow forecast is an attempt by
management to plan ahead, to prevent future liquidity problems. Cash flow forecasts contain
estimates of cash receipts and payments over the coming months ─ these are taken from
the budgets of the business. Each month or quarter the anticipated cash in hand or cash deficit
is calculated.

Bank managers are much more prepared to arrange loan facilities for organisations that can
demonstrate that they have planned their financial needs by preparing a cash flow
forecasts statement and show that they should be able to repay loans.

Cash flow forecasts can be used to predict times when there might be a shortage of cash in the
business. It includes all payments predicted to be made over a period of time. Actions can be
taken to make sure that any possible shortfall in the cash should be cover.

Benefits of Cash flow Forecasting

o How much cash is available for paying bills, repaying loans or for buying fixed assets?
o How much the bank might need to lend in order to avoid insolvency?
o Whether the business is holding too much surplus cash which could be invested to a more
profitable use.
o They show negative losing cash flows. This means that plans can be made to arrange
additional finance, such as a bank overdraft or owners personal capital injection.
o They indicate periods of time when negative net cash flows are excessive. The businesses can
plan to reduce these by taking measures to improve cash flow.
o They are essential to all business plans, to show to investors and shareholders.

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What uses does this type of financial planning have?

There are several important uses of cash flow forecasting, such as by showing periods of
negative cash flow, plans can be put in place to provide additional finance. If negative cash
flows appear to be too great, then plans can be made for reducing these ─ for example, by
cutting down on purchase of materials or by not making sales on credit, only for cash.

A new business proposal will never progress without the initial planning stage unless investors
and bankers have access to a cash flow forecast.

Cash-flow Forecasting — What are the Limitations?

Here are the most common limitation of them::

o Mistakes can be made in preparing the revenue and cost forecasts or they may be drawn
up by inexperienced managers.
o Unexpected cost increase can lead to major inaccuracies in forecasts.
o Wrong assumptions can be made in estimating the sales of the business, perhaps based
on poor market research, and this will make the cash inflow forecasts inaccurate.

The Structure of Cash flow Forecasts

Due to the crucial importance of cash as the lifeblood of any successful business, all firms should
engage in cash-flow forecasting. This helps to identify future cash flow problems before it too late.

Section 1:
Cash inflows, this section record the cash payments to the business, including cash sales, capital
inflows, loans; payments form debtors and other income.

Section 2:
This section records the cash payments made by the business, including salaries, wages,
materials, rent, repairs, taxes and other costs.

Section 3:
Section three shows that the Net Monthly Cash flow, Opening Balance and Closing Balance
at the end of the month.

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January February March

Cash Inflows (A) 40000 55000 60000

Cash Outflows (B) 25000 85000 40000

Opening Balance (C) 10000 25000 (5000)

Net Cash Flow (D) ( = A — B) 15000 (30000) 20000

Closing Balance ( = C + D) 25000 (5000) 15000

Activity:: Using a Cash flow Forecast

January February March April

Cash Inflows:

Sales 15000 15000 20000 25000

Payments from Debtors 5000 5000 7000 8000

Total Cash Inflows: 20000 20000 27000 33000

Cash Outflows:

Materials 5000 5000 8000 5000

Wages 4000 3000 6000 6000

Rent 4000 4000 4000 4000

Other Expenses 5000 6000 12000 7000

Total Cash Outflows: 18000 18000 30000 z ?

Opening Balance: 3000 5000 7000 4000

Net Cash Flow: 2000 x ? (3000) 11000

Closing Balance: 5000 7000 y ? 15000

Net Monthly Cash flow estimated difference between monthly cash inflows and

D monthly cash outflows, this can be either a positive or a negative figure.

E Opening Cash Balance ▬ Cash held by the business at the start of the month.

F
Closing Cash Balance ▬ Cash held by the business at the end of the month
becomes next month’s opening balance.

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Causes of Cash flow Problems

Lack of Planning:
This form of financial planning can be used to predict potential cash flow problems so that
business managers can take action to overcome them before they happen.

Poor Credit Control:

The credit-control department of a business keeps a check on all customers’ accounts ─ who has
paid, who is keeping to agreed credit terms and which customers are not paying on time. Some of
the bad debts should also be identified which are the unpaid customers’ bills that are now very
unlikely to ever be paid.

Allowing Customers too Long to Pay Debts: (Long credit Period offered)
Businesses will have to offer trade credit to customers in order to be competitive. Assume a
customer has a choice between two suppliers selling very similar products. If one insists on cash
payment ‘on delivery’ and the other allows two months trade credit, the customers will go for
credit terms because it improves their cash flow.

Expanding Rapidly:
When a business expands rapidly, it has to pay for the expansion and for increased wages and
materials months before it receives cash from additional sales. This overtrading can lead to
serious cash flow problems.

Unexpected Events:
A cash flow forecast can never be guaranteed to be 100% accurate. Unforeseen increase in
costs ─ a breakdown of machines and equipments that needs to be replace, a dip in
predicted sales, or a competitor offering low prices unexpectedly ─ could lead to negative
monthly cash flows.

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Methods of Improving Cash flow

There are two ways to improve net cash flow:

(1) Increase Cash Inflows

(2) Reduce Cash Outflow

Increasing Cash Inflows:

Method Details

Flexible loans can be borrowed according to the requirements of the

Bank Overdraft
business but interest should be given on it.

A fixed amount can be borrowed for an agreed time. The interest

Short-term Loan
costs have to be paid, and loan must be repaid.

Cash obtained from selling off redundant assets, but the assets
Sale of Spare Assets
might be required at a later date for expansion.

Assets can be sold and can be leased back; this is an opportunity to

Sale & Leaseback raise liquid cash against assets. The leasing costs add to annual
overheads.

Reduce Credit Terms Cash flow can be brought forward by reducing credit terms, but
to Customers customers may purchase products from other firms.

Debt factoring companies can buy the customers’ bills from a business
Debt Factoring and offer immediate cash, but pay only 90 % of original cash, as
10% is the factors profit.

Reducing Cash outflows:

Method Details

Cash outflows will fall in the short term if bills are paid after
Delay Payments to
some time, but suppliers may reduce any discount offered or
Suppliers (creditors)
refuse to supply further products.

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Delay Spending on Capital By not buying equipment, cash will be saved, but it could lead
Equipment to fall in the efficiency of business and poor customer services.

Use Leasing, not Outright The leasing company owns the asset and no large cash outlay
Purchase, of Capital is required. But the asset is not owned by the firm and this
Equipment contract includes high leasing charges.

Cut Overhead Spending that does

These costs will not reduce production capacity and
not directly affect output, such as
cash payments, but future demand could be reduced
Promotion Costs, Research &
by failing to promote the products effectively.
Development Cost & Fringe Benefits

Methods to Improve & Manage Working Capital

There are business dangers from both too much working capital and too little. Working capital
therefore needs to be managed. It is managed by concentrating on the four main components
of the cycle.

Improving Cash flow by Managing Debtors

Debtors can be managed using these ways:

o Not extending credit to customers ─ or extending it for shorter time periods.

o Selling debts to specialist financial institutions acting as debts factors.

o By being careful to discover whether new customers are creditworthy.

o By offering a discount to clients who pay promptly.

Improving Cash flow by Managing Creditors

Credit can be managed in two main ways:

o Increasing the range of goods and services bought on credit. If a business has a good
credit rating this could be easy.

o Extend the period of time taken top pay. The larger a business is, the easier it is to
extend the credit taken.
o

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Costs Chapter 31
( 31.1 ) The Need for Accurate Costs Information

Effective management decisions would not be possible without cost data. Here are some of the
major uses of cost data:
o Calculation of Profit or Loss: Business costs are a key factor in ‘profit equation’.
Profits or losses cannot be calculated without accurate costs data.
o Pricing decisions: Marketing managers will use cost date to help decide their pricing
decision for new and existing products.
o Measuring Performance: Cost information allows comparisons to be made with past
periods of time. In this way, the efficiency of business may be assessed over time.
o Setting Budgets: Cost information can help to set budgets and plans. These acts for
the targets for departments and branches to work towards. Actual cost levels can then be
compared with budgets.
o Making choice: Costs of different options can assist mangers in their decision-making,
such as costs of different production machinery or alternative locations can
increase the chance of making most profitable decision.

Types of Costs

The financial costs incurred in making a product or service can be classified in several ways:
o Direct Costs, o Indirect Costs,
o Fixed Costs, o Variable Costs,
o Semi-variable Costs, o Marginal Costs.

( 1 ) Direct Costs

Direct Costs ▬ These costs can be clearly identified with each unit of
KEY
production and they vary with the level of output such as raw material and
DEF
components use for producing the goods and costs of direct labour

o One of the direct costs for a garage in servicing a car is the labour cost of the mechanic.
o One of the direct costs of football factory is the costs of raw material used and costs of
stitching each foot ball.

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( 2 ) Indirect Costs

Indirect Costs ▬

KEY These costs cannot be identified with a unit of production because they are

DEF usually associated with performing a range of tasks or producing a range of

products, also called overheads.

Indirect costs are often referred to as overheads, examples are:

o One indirect cost of a farm is to pay the salaries of permanent managers.
o One indirect cost of a supermarket is its promotional expenditure.
o One indirect cost of a garage is the monthly rent.

( 3 ) Fixed Costs

KEY Fixed Costs ▬ A cost that does not vary with the level of production or
DEF sales levels, such as rent, property tax, insurance, or interest expense.

These remain fixed regardless of the level of output and do not vary with the level of
production, and have to be paid whether the firm production has taken place or not.

Examples:
Rent, Insurance Costs, Leasing Charges, Fixed Salaries of the Managers.

( 4 ) Variable Costs

Variable Costs ▬
KEY
A costs of direct labor and the costs of material that changes or vary
DEF
according to the change in the volume of production units.

These vary as output changes, such as direct cost of materials, direct labour wages, direct
overheads. If McDonald’s sells twice as many burger meals this month as it sold last month,
then it will use twice as many bread, rolls, twice as many burgers, twice as many fries, salad
trimmings and sauces.

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( 5 ) Semi-Variable Costs

KEY Semi-Variable Costs ▬ A semi-variable cost is one that contains both

DEF variable and fixed costs elements.

Examples of mixed costs include electricity and telephone bills. A portion of these expenses
are usually consists line rent as basic fixed charges. Line rent normally is fixed for each month.
Variable portion consist units consumed or calls made.

( 6 ) Marginal Costs

Marginal Costs ▬

KEY The cost associated with one additional unit of production, also called

DEF incremental cost, it’s the rise in total cost when output raises one unit.
Marginal revenue is the rise in total revenue when output raises one unit.

These are the additional costs of producing one more unit of output, and will be the extra
variable costs needed to make this extra unit. The value of variable costs per unit is equal to
marginal costs because the fixed costs remains constant and does not change by producing
an extra unit.

Problems in Classifying Costs

It may not be very easy to classify every cost into the categories explained above:

(1) Are labour costs necessarily variable, when it is unoccupied because of a lack of orders,

most businesses will continue to employ and pay workers in the short run. Wages then
become an overhead costs which cannot be directly allocated to output.

(2) Telephone charges in a busy factory could be directly allocated to each range of products

made, as long as an accurate and reliable record was kept of the purpose of each cell. These
charges would normally be considered as an indirect overhead expense.

(3) When businesses produce a range of products it can be difficult to determine how much
of some costs have been incurred by the production of a specific product.

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( 31.2 ) Approaches to Costing

Managers need to know, as accurately as possible, the cost of each product or service produced
by the firm. One reason for this is the need to make a pricing decision.

Managers may also need to decide whether production should be stopped, stepped up or
switched to new methods or new materials. It would be foolish to think about any of these
decisions unless accurate costing was made first.

Managers also need to compare actual costs with original targets and budgets and to
compare the current period with past time periods. Therefore accurate product cost
information is vital and the different approaches to calculating the cost of a product or service
will now be considered.

Important Concepts Related to Costing

Before studying the alternative costing methods, various important concepts need to be
understood. Cost centers and profit centers are treated differently within an organization.

Cost Centres

Cost Centres ▬

A section of a business, such as a department to which costs can be

KEY
allocated or charged. Cost center doesn't produce a profit directly from
DEF
its activities; managers of cost centers are responsible for keeping their
costs in line or below budget.

A cost centre is an area of responsibility, such as a part of production and finance

department, responsible for calculating the costs of each item produce.
Examples of cost centres are:

o In a manufacturing business: products, departments, factories, particular processes

or stages in the production, such as assembly, quality control;

o In a hotel: the restaurant, reception, bar, room letting, and conference section.

Different businesses will use different cost centres, which are appropriate to their own needs.

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Profit Centres

Profit Centres ▬
KEY
A section of a business to which both costs and revenues can be allocated
DEF
─ so profit can be calculated.

A branch or division of a company that is designed for the purposes of profit calculation. A
profit center is responsible for generating its own results and earnings, and as such, its
managers generally have decision-making authority related to product pricing and operating
expenses. Profit centers are crucial in determining which branch, division or products are the
most and least profitable within an organization.
Examples of profit centres are:

o Each branch of a chain of shops;

o Each department of a department store;
o In a multi-product firm, each product line.

Why do Businesses Use Costs & Profit Centres?

Organization is divided into these centres, certain benefits are likely to be gained:
o Managers will have targets to work towards.
o These targets can help to motivate and control a business division.
o The performances of divisions and their managers can be assessed and compared.
o Work can be monitored and decisions made about the future.

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Overheads

They are usually classified into four main groups:

Production Overheads:
These include factory rent and rates, depreciation and repairs of equipment and utility bills.

Selling & Distribution Overheads:

These include marketing and promotion costs, warehouse, transportation, packaging and
distribution costs and salaries of sales staff.

Administration Overheads:
These include office rent, stationary, printing, cleaning, clerical and executive salaries.

Finance Overheads:
These include the interest on loans, costs of financial consultants for auditing the books of
accounts.

Unit Costs: ( Average Cost )

This is the average cost of producing each unit of output:

Unit Cost = Total cost divided by the number of units produced.

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Full Costing Technique (Absorption Costing)

Full/absorption Costing ▬
KEY A method of costing in which all fixed and variable costs are allocated to
DEF products or services. This method ensures that all incurred costs are
recovered from the selling price of a good or service.

Full costing requires all of the costs of a business to be ‘absorbed’ into the costs of the products
made by the business. Using this method, accountants take the total overheads incurred by the
organization and share them on the basis of one simple rule.

For example, total overheads could be divided between products and cost centres on the basis of
the proportion of total direct labour costs each account for. In the case of Heath Electrics Ltd
total direct labour amounts to $220,000. The pump accounts for $150,000 of this total and the
fan for $70,000. They will each have to absorb in the same proportion as they incur labour
costs. The full costing statement now looks like this:

Pump ($) Fan ($)

Direct Materials 100,000 150,000
Total Direct Labour 150,000 70,000
Apportioned Overheads 136,363 63,637
Total Cost 386,363 283,637

Full Costing ── An Evaluation:

Benefits:
o Full costing is relatively easy to calculate and understand.
o Full costing is particularly relevant for single-product businesses such as CNG, Wapda,
and Michelin Tires Manufacture.
o All costs are allocated including fixed and variable costs.
o Full costing is a good and easy basis for pricing decisions in single product firms.

Drawbacks:
o There is no attempt to allocate each overhead costs to cost centres on the basis of
actual expenditure incurred.
o It is sometimes dangerous to use this cost method for making decisions because the
cost figures arrived at can be misleading and unfair by some within the business.
o If full costing is used, it is essential to allocate on the same basis over time; otherwise
sensible year-on-year comparisons cannot be made.

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Contribution Costing (Marginal Costing)

Marginal or Contribution Costing ▬ Costing method that allocates only

KEY
direct costs to cost/profit centres, not overhead costs. All other expenses
DEF
are covered with the help of contribution received from products.

This approach to costing solves the problem of the appropriate sharing out of overhead costs in
a different way ─ it does not apportion them at all! Instead, the method concentrates on two
very important accounting concepts.

o Marginal cost is the cost of producing an extra unit. This extra cost will clearly be a
direct cost. For example, if the total cost of producing 100 units is $400,000 and the
total cost of producing 101 units is $400,050, the marginal cost is $50.
o The contribution of a product is the revenue gained from selling a product less its marginal
costs; this is not the same as profit, which can only be calculated after overheads have also
been deducted. For example, if that 101st unit with contribution towards fixed costs of
$20. The unit contribution is found as the difference between the selling price ($70) and
the marginal cost ($50), $20.

Contribution Costing ── A Summary

o Overhead costs are not allocated to cost centre, so contribution costing avoids
inaccuracies.
o Decisions about a product or department are made on the basis of contribution to
overheads ─ not ‘Profit or Loss’ based on what may be an inaccurate full-cost
calculation.
o Excess capacity is more likely to be effective used, as orders and contracts that make a
positive contribution will be accepted.

Limitations:
o By ignoring overhead costs until the final calculation of the business’s profit or loss,
contribution costing does not consider that some products and departments may actually
incur much higher fixed costs than others.
o It emphasizes contribution in decision making. It may lead managers to choose to
maintain the production of goods just because of a positive contribution, and stop the
production of products making negative contribution, ignoring marketing issues.

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Contributing Costing & Decision Making

Contribution Costing has very important advantages over full costing when management plans to
take important decisions based on cost data. An example of contribution costing is given below:

$000 Novel Textbook

Sales Revenue 50 100

Direct Materials 15 35

Direct Labour 20 50

Other Direct Costs 10 5

Total Marginal Cost 45 90

Contribution 5 10

-Total contribution for both products = $15000

If total overheads amounted to $12000, then:
Profit = Contribution less Overheads
Therefore, the business has made a profit of $3000

( 31.3 ) Uses of Costs Information

Should a Firm Stop Making a Product?

If a business makes more than one product, marginal costing shows managers which product is
making the greatest or least contribution to overheads and profit. If full costing were used
instead, a manager could decide to stop producing a good that seemed to be making a loss,
even though it might still be making a positive contribution, and this ending could reduce the
overall profits.

Should a business accept a contract

or a purchase offer at below full cost?

If a firm has spare capacity or if it is trying to enter a new market segment, marginal costing
assists managers in deciding whether to accept an order at below the full cost of the
product or service.

Example: Hotels often offer very low rates to consumers in off-peak seasons, arguing that it
is better to earn a contribution from additional guest than to leave rooms empty.

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Evaluation of the Costing Approaches

Full Costing

Full costing can be useful for single-product firms and as a quick guideline to the costs of
products, but it does have serious flaws for multi-products businesses the approach does not
apportion overheads on a real basis.

Marginal or Contribution Costing

Marginal or contribution costing is now the most widely used methods for decision making,
because it accepts that fixed overhead costs must be paid during a particular time period.

Final Evaluation of Costs in Operation Management

Production management decisions often require accurate and up-to-date cost data. Managers
need to be aware of the different types of costs in making their decisions. Costs are significant
but the successful operations manager will also consider other data from a wide range of
sources before making decisions on issues such as location, and purchasing of capital
equipment.

Break-even Analysis:

(1) Selling Price ─ Variable Cost = Contribution

(2) Total Revenue ─ Total Variable Cost = Total Contribution

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( 31.4 ) Break-even Analysis

Break-even Point ▬
KEY
The level of output at which total revenue equals total costs. At this level of
DEF
output the business makes neither a profit nor a loss.

Break-even analysis can be undertaken in two ways:

o The graphical method;
o The equation method.

Contribution:
Contribution is the profit from each unit to pay for the business overheads, when the
overheads covered at the break-even point, the contribution becomes the profit.

The Graphical Method ─ The Break-Even Chart

The chart itself is usually drawn showing four pieces of information:

o Fixed costs in the short term, will not vary with the level of output and which must be
paid whether the firm produces anything or not;
o Total costs, which are the addition of fixed and variable costs;
o Sales revenue, obtained by multiplying selling price by output;
o Variable cost, obtained by multiplying per unit variable cost by output.

Margin of Safety

Margin of Safety ▬
KEY
The margin of safety is defined as the amount by which sales exceed from
DEF
the break-even point.

This is a useful indication of how much sales could fall without the firm falling into loss. For
example, if break-even output is 400 units and current production is 600 units, the margin of
safety is 200 units.

Formula: Margin of Safety = Current Output ─ Break Even Point

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The Break-even Equation

A formula can be used to calculate break-even:

(1) Selling Price ─ Variable Costs = Contribution

Fixed Cost
(2) Break Even Point =
Contribution

Example can be helpful to understand the concept of breakeven:

o Fixed costs are $10,000 per year.

o The Variable costs of the business are $8 per unit of output.
o Each unit is sold at $12.
o The factory can produce a maximum output of 6000 products.

Charts are used to identifying the break-even point of production, calculating maximum profit
and safety margins of the business.

Sales ($) = 0 Sales ($) = 6000 Units

Fixed Costs 10,000 10,000

Variable Costs 0 48,000
Total Costs 10,000 58,000
Sales Revenue 0 72,000

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Break-Even Analysis ─ Further Uses

The break-even levels of production, margins of safety and break-even techniques can also be
used to assist managers in making key decisions. The charts can be redrawn showing a
potential new situation and this can then be compared with the existing position and the
performance of the business.
Here are three examples of further uses of the break-even techniques:

(1) A Marketing Decision

The impact of a price increase. The assumption made in this example is that maximum sales
will still be made depends on the elasticity of product.
Performing a break-even analysis is a simple way to determine price levels and to estimate
whether an expansion or cost saving project makes good business sense.

(2) An Operation Management Decision

The purchase of new equipment with lower variable costs. Production managers are able to
calculate the break-even point using different equipments; this calculation helps to decide the
best production methods which reduce the average cost of production.

(3) Choosing Between Two Locations

The break-even analysis will be very helpful for deciding the best suitable and cost effective
priced location in between different opportunities.

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Usefulness of Break-Even

o Comparisons can be made between different options by constructing new charts to

show changed circumstances.

o It provides useful guidelines to management on break-even points, safety margins

and profit / loss levels at different rates of output.

o Charts are relatively easy to construct and interpret.

o Break-even analysis can be used to assist managers when taking important decisions,
such as location decisions, buying of new equipment and which project to invest in.

Evaluation of Break-even Analysis

It is important now to recognize the limitations that this model has in practice:

o The assumption that costs and revenues are always expressed in straight lines is not
always realistic; variable costs may not be plotted in straight line due to changes in
prices of raw materials and components.

o The revenue line could be influenced by price reductions made necessary to sell all
units produced at high output.

o Not all costs can be conveniently classified into fixed and variable costs.

o All output is assumed to be sold and it is assumed that the business does not hold any
inventory. This is not always realistic. Market conditions can be change, and this can
result in sales being lower than anticipated.

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Budgets Chapter 32
( 32.1 ) The Meaning & Purpose of Budgets

Budgets is an estimate of costs, revenues, and resources over a specified

KEY
period, reflecting a reading of future financial conditions and goals, and is
DEF
simply used for balancing expenses with income of the business.

Budgeting:
KEY
Planning future activities by establishing performance targets, especially
DEF
financial targets.

Budgets are the plans of a business which are expressed in financial terms. The process of
making budgets is known as budgeting and a budget is a detailed and financial plan for a
future time period. Budgets provide an opportunity for forward thinking and help in planning
process. It is important to have a clear ‘road map’ of where the business is going.

Planning for the future is important for all business organisations. If no plans are made, an
organization drifts without real direction and purpose, and a business will:

 Be without a direction or purpose.

 Be unable to allocate the resources effectively.
 Have demotivated employees with no targets to work towards.
 Be unable to measure its progress by measuring the plans against actual performance.

The Measurement of Performance

All businesses measure performance. Knowing how the different departments and divisions of a
business are performing helps managers assess the strengths and weaknesses of the
organisation. Management action can then be taken to build up the strengths and correct the
weaknesses. Assessing actual performance against pre-set targets is the best way of
measuring the performance over time.

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Benefits of Using Budgets

Setting budgets and establishing plans for future actions would therefore appear to have six
main purposes:

(1) Planning:
Setting the aims and objectives of the firm and allocating an appropriate financial budget to
achieve these goals. The planning process gives a sense of purpose to the workforce.

(2) Effective Allocation of Resources:

Budgets help to effectively allocate the financial resources to each of the targeted activity,
this helps to improve the efficiency and motivation levels of the workers.

(3) Setting Targets to be Achieved:

Research shows that most people work better if they have a realizable budget target at which
to aim. As well as making work more interesting and rewarding, the purpose of target setting
is to improve the motivation level for making direct contact and feedback to workers on how
their performance compares with the set objectives.

(4) Co-ordination:
Businesses will have to work effectively if the budgets are properly co-ordinated with the
related people.

(5) Controlling & Monitoring:

Budget Plans need to check regularly that the objective is still within reach. All kinds of
conditions may change and business cannot afford to assume that everything is fine.

(6) Modifying:
If there is evidence to suggest that the objective cannot be reached, then either the plan or
the way of working towards it must be changed.

(7) Measuring & Assessing Performance:

Once the budgeted period has ended, variance analysis will be used to compare actual
performance with the original budgets. (Budget Figure with Actual Figure).

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Budget holder is a person responsible for initial setting and allocating

KEY
budgets, and has delegated authority for income and expenditure from the
DEF
budget.

Variance Analysis is a process of calculating differences between

KEY
budgets and actual performance, and analyzing reasons for such
DEF
differences.

Potential Drawbacks of Using Budgets

Lack of Flexibilities:
If budgets are set with no flexibility built into them, then sudden and unexpected changes in
the external environment can make them very unrealistic.

Focused on the Short Term:

Budgets tend to be set for the relatively short term ─ for example, the next 12 months.
Managers may take short term decisions to stay within budget that may not be in the best
long-term interests of the business such as investment decisions.

May Lead to Unnecessary Spending:

When the end of the budgeting period approaches, managers realize that they have under–
spent their budgets, unnecessary spending decisions might be made so that the same level
of budget can be justified next year.

Training Needs Must be Required:

Setting and keeping to budgets is not easy and all managers with delegated responsibility for
budgets will need extensive training and experience in this role.

Setting Budgets for New Projects:

When a major new project is being undertaken, perhaps a one-off building scheme such as a
large bridge or tunnel, setting realistic budgets may be difficult and frequent revisions in
the budgets might be necessary.

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Key Features of Effective Budgeting

 A budget is not a forecast but a plan that business aim to fulfill. A forecast is a prediction
of what could occur in the future given certain conditions.

 Budgets may be established for any part of an organisation. Thus, there may be sales
budgets, capital expenditure budgets, labour cost, rental budgets, repair &
maintenance budgets and so on.

 Co-ordination between departments when preparing budgets is essential. This should

avoid departments making conflicting plans.

 Budget setting should involve participation. Decisions regarding budgets should be made
with the managers who will be responsible for meeting the targets. Those who are to be
held responsible for fulfilling a budget should be involved in setting it, leading to more
realistic targets and motivate them.

 Budgets are used to review the performance of each manager controlling a cost of
profit centre. The managers will be appraised on their effectiveness in reaching targets.
Successful and unsuccessful managers can therefore be identified.

Sales Budgets
KEY A sales budget is management’s estimate of sales for a future financial

DEF period. A business uses sales budgets to set department goals, estimate
revenues and forecast production requirements.

Delegated Budgets
KEY
Giving some delegated authority over the setting and achievement of
DEF
budgets to junior branch and departmental managers.

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Setting & Using Budgets

There are several ways in which the budget level can be set, The most widely used are:

Incremental Budgeting

Incremental Budgeting ▬
KEY
Uses last year’s budget as a basis and an adjustment is made for the
DEF
coming year.

In many businesses that operate in highly competitive markets there may be plans to lower
the cost budget for departments each year, but to raise the sales budgets. This puts
increased pressure on many staff to achieve higher productivity.

Incremental budgeting does not allow for unforeseen events. Using last year’s figure as a
basis means that each department does not have to justify its whole budget for coming year ─
only the change or ‘increment’ according to level of inflation in the economy.

Zero Budgeting

Zero Budgeting ▬
KEY
Setting budgets to zero each year and budget holders have to justify their
DEF
case to receive any finance.

Setting the current year’s budget from a starting point of zero rather than taking last year’s
figure and adding an annual percentage increase. This requires all departments and budget
holders to justify their whole budget each year. This is time consuming, as a fundamental
review of the overall work and importance of each budget-holding section is needed each
year. However, it does provide added incentive for managers to defend the work of their
own section and helps to effectively allocate the sufficient resources to each activity.

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Flexible Budgeting

Flexible Budgeting ▬
KEY
Cost budgets for each expense are allowed to vary if sales or production
DEF
vary from budgeted levels.

If actual output rose or fell above this level, then this could lead to variances ─ but these will
not necessary indicate real efficiency problems.
Flexible budgets are more motivating for middle and lower-level managers as they will not be
criticizes for adverse variances that might occur just because output was lower then budgeted.
The flexed targets they are given are more realistic.

( 32.2 ) Budgetary Control ─ Variance Analysis

At the end of the budgeted period the actual performance of the organization needs to be
compared with the original targets and reasons for differences must be investigated. This
process is known as variance analysis. A variance is the difference between budgeted and
actual figures. This is an essential part of budgeting for a number of reasons:

o Variance measure differences from the planned performance of each department over

a given period, this is the key benefit of budgeting process.

o It assists in analyzing the causes of deviations from budget. For example, if actual

profit is below budget, was this due to lower sales revenue or higher costs.

o An understanding of the reasons for the deviations from the original planned levels can

be used to change future budgets in order to make them more accurate.

o The knowledge of variance analysis could be used to help prepare future budget

plans.

If the variance has the effect of increasing profit, sales revenue higher than budgeted, then it
is termed a favorable variance. If the variance has the effect of reducing profit, for example
direct material costs higher than budget, then it is termed an unfavorable or adverse variance.

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Adverse & Favorable Variance

Adverse Variance exists when the difference between the budgeted and
DEF
actual figure leads to a lower than expected profit.

Causes of Adverse Variance:

(1) Sales Revenue is Below Budget either because units sold is less than planned for or the

selling price had to be lowered due to competition.

(2) Actual Raw Material Costs are higher than planned for either because output was higher

than budgeted or the cost per unit of materials increased.

(3) Labour Costs are above budget either because wage rates had to be raised due to

shortages of workers.

(4) Overhead Costs are higher than budget because of increase in the price of utility bills

and other expenses.

Favorable Variance exists when the difference between the budgeted and
DEF
actual figure leads to a higher than expected profit.

Causes of Favorable Variance:

(1) Sales Revenue is above budget due to higher than expected economic growth or failure

of competitor’s products.

(2) Raw Material Costs are lower either because output was less than planned or the cost

per unit of materials was lower than budget.

(3) Labour Costs are lower than planned for either because of lower wage rates or increase

in the productivity level of staff.

(4) Overhead Costs are lower than budgeted, because advertising rates or fuel prices were

reduced.

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Budgetary Control ▬ Example and Evaluation

Setting, agreeing and controlling budgets is time consuming. Budgets can fail to reflect changing
circumstances and become inflexible. Budget holders can look upon a budget as a limit up to
which they can spend.

Try to think of the alternative: (Evaluation)

 Without a detailed and coordinated set of plans for allocating money and resources of
the business, who would decide ‘who gets what’?

 Without a clear sales budget as the cornerstone of the budgetary process, how much to
produce or to spend on sales promotion or how many people to employ?

Variance Analysis — Activity Example

Favorable &
Financial Variable Budget $ Actual $ Variance $
Adverse
Sales Revenue 15000 12000 (3000) Adverse

Direct Costs 5000 4000 1000 Favorable

Overhead Costs 3000 3500 (500) Adverse

Net Profit 7000 4500 (2500) Adverse

Activity:
Favorable &
Financial Variable Budget $ Actual $ Variance $
Adverse
Sales Revenue 165 150

Costs of Materials 80 70

Labour Costs 22 23

Gross Profit 63 57

Overheads 40 43

Net Profit 23 14

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Formula Sheet For As Level Business Studies

Unit 1: Business & Its Environment

(1) Market Capitalisation = Current Share Price × Total Number of Shares Issued

Unit 2: People in Organisation

Number of Staff Leaving in 1 Year

(2) Labour Turnover (%) = × 100
Average Number of Staff Employed

Unit 3: Marketing

Current Business Sales

(3) Market Share (%) = × 100
Total Market Size / Sales

Value of One Section

(4) Pie Chart = × 360
(Angle of Section) Total Values of all Sections

% Change in Quantity Demanded

(5) Price Elasticity of Demand =
% Change in Price

Unit 4: Operations

Total Output in a given time period

(6) Labour Productivity =
Total Number of Workers

Total Output in a given time period

(7) Capital Productivity =
Capital Employed

Current Output
(8) Capacity Utilization = × 100
Maximum Output Level

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Unit 5: Finance & Accounting

(9) Net Cash flow = Cash Inflow ─ Cash Outflow

(10) Closing Balance = Opening Balance + Net Cash Flow

(11) Total Cost = Fixed Cost + Variable Cost

Total Cost
(12) Average Cost =
Output

(13) Sales Revenue = Selling Price × Unit Produce

Break-even Analysis:

(14) Selling Price ─ Variable Cost = Contribution

Fixed Cost
(15) Break-Even Point =
Contribution

(16) Selling Price = (Fixed Cost / Break Even) + Variable Cost

(17) Margin of Safety = Current Output ─ Break Even Point

Other Exam Based:

Difference
(18) Percentage Change = × 100
Base Value

NUMBER OF PAGES = 240

BUSINESS STUDIES RESOURCE BY ''USMAN AKHTER''

Business Studies Resource Prepared By Usman Akhter