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E1 Managing Finance in a Digital World

Overview of Paper E1 3

1. The Finance Function in the Digital Age 5

2. The Finance Functions 11

3. Technology and Information 19

4. Operations Management 35

5. Management of Relationships Within the Supply Chain 41

6. Process Technology and Quality control 45

7. Marketing – its Nature and Purpose 51

8. Marketing Tools 63

9. Human Resource Planning (1) 73

10. Human Resource Planning (2) 77

11. Ethics 85

November 2019 Examinations Watch free CIMA E1 lectures 1

https://opentuition.com/cima/cima-e1/







OVERVIEW OF PAPER E1

The syllabus consists of the following sections

A The role of the finance function

The finance function splits into a number of categories: financial accounting, management accounting, treasury, financial planning etc. This section introduces the role of the various components of the finance function.

B Technology in a digital world This section looks at new technologies, what they are and how they affect the finance function.

C Data and information in a digital world

How the finance function can use data and communicate information.

D Shape and structure of the finance function

The various new technologies alter the shape of the finance function. Fewer employees are needed for the routine recording of transactions and more are employees are engaged in interpreting and using the results of information technology operations.

E Finance interacting with the organisation

Finance sits at the centre of a web and interacts and communicates with every other function and department, in particular supply chain management, marketing, human resources and IT.









Chapter 1

THE FINANCE FUNCTION IN THE DIGITAL

AGE

1. The digital mindset

1.1. What is a mindset?

A mindset is an established set of attitudes and assumptions that is held by someone.

At one time, a single, static mindset could do you for life. Nothing in the environment, the marketplace or technology changed very much so a single set of rules would be suitable for your thought processes and business activities throughout your life.

That static environment has changed to a very dynamic one where markets, competitors, economies and technology all rapidly and continually change and the old fixed mindset will not do. Instead it must be willing to learn, adapt and change. It can be called a ‘growth mindset’ where the term ‘growth’ applies to individuals being willing to learn, develop, respond to challenges and to solve new problems.

A digital mindset is simply one where accountants are continually aware of and alert to how digital technology will affect both them and the organisations they work for. Many of the potential effects are covered later in these notes, but a short list of relevant technology would certainly contain topics such as:

๏ Big data

๏ Automation

๏ 3D printing

๏ Artificial intelligence

๏ Connectivity

๏ Social media





1.2. Skills needed by accountants

Accountant’s carry out a range of functions and not all are equally susceptible to automation. McKinsey, a firm of management consultants, in their July 2016 quarterly bulletin have suggested the following:

Function Data collection

Data processing

Applying expertise

Stakeholder interactions

Managing others

Potential for automation

64% 69% 18% 20% 9%

Almost certainly these percentages would be changed if the investigation were carried out today. In particularly, the rapidly advancement of artificial intelligence will undoubtedly have raised the amount of automation that can be expected in the ‘Applying expertise’ section.

CGMA briefing paper “Changing competencies and mindsets” suggests that Accountants will require:

๏ Technical skills relating to finance and accounting. Not only will accountants have to apply these skills themselves, but if a task is automated or executed using artificial intelligence, accountants will have a say in whether the automation and AI processes are being carried out correctly and are producing useful information for decision-making. Roughly, technical skills cover the first two functions set out above (data collection and data processing) and also some of applying expertise.

๏ Business skills, such as judgement, commercial acumen, awareness of market development and of environmental and technical changes. Roughly, business skills will align with applying expertise as expertise can only be properly applied within particular business contexts.

๏ People skills. For example, technical skills of an accountant might produce an analysis that clearly shows that the production of a component should be outsourced. Obviously, that will have an impact on managers and employees currently involved in producing the component in-house. Therefore, the accountant needs to exercise diplomacy, persuasion and consensus-building if the logic of the analysis is to be accepted (though perhaps still with reluctance). This pretty well aligns with stakeholder interactions, above.

๏ Leadership skill. Ideally, these skills follow on directly from people skills: most good leaders (but not all) have good people skills. Leadership skills can be summed up as the ability to motivate and inspire staff so that the organisation can be enthusiastically transformed, when necessary, to deal successfully with changed futures. This aligns with managing other, above.





2. The shape of the finance function

2.1. The triangle

The early shape was a triangle that represented a simple hierarchy.

At the top was the finance director then, as you descend through the triangle, there would be the chief accountant, heads of accounts receivable, accounts payable, wages and salaries all the way down to junior accounting staff who would be recording and posting the transactions. Essentially, the triangle represents a traditional organisation chart:

Finance director

Chief financial accountant TreasuryChief management accountant

Accounts

Receivable

.

.

Accounts

staff

Accounts ......

Payable

.

.

Accounts

staff

Budgets

.

.

.

Accounts

staff

Capital projects ....

.

.

.

Accounts staff

Foreign

exchange

.

.

Accounts

staff

It can be developed to represent groups or divisions, in which case it could look like:

Finance director

Division 1

Financial controller

Accounts staff


Accounts staff


Accounts staff

Division 2 Division 3 etc





2.2. The segregated triangle

Here, the split in the triangle represents the idea that as businesses grew, perhaps becoming global, they could make use of communications and IT technology to set up shared service centres (the lower part of the triangle). For example, a global company could decide to handle all transaction recording in India or Germany etc. This can make the processing more efficient and cheaper because of benefits that should arise from economies of scale.

2.3. The hexagonal structure (CGMA “The changing shape of the finance

function”)

Level 1

Level 2

Level 3

Level 4

Leading the finance team

Partnering for value to influence and shape how the organisation

creates and preserves value

Specialists generating further insights in their areas of specialism

Assembling and extracting data and

providing limited insight

The tasks at Level 3 and Level 4 are mostly clerical. For example:Level 4’s collecting, assembling and extracting data could be describing the production of an aged analysis of the receivables ledger. This level is primarily concerned with gathering the information needed.

Level 3’s uses data processing to generate of further insights into the data. For example, it could include tasks like carrying out ‘what-if?’ experiments or sensitivity analysis on investment projects. This level helps decision-making and makes intense use of analytical techniques.





It is claimed that many of these Level 3 and Level 4 tasks are already automated or will soon be automated. Note that managers still need to be involved at these levels so that the further use of technology can be promoted.

Level 2, uses the results arising from Level 3. This requires the application of expertise and experience so that good decisions can be made based on the data analysis. Stakeholders have to share in understanding the financial information and might have to be persuaded to support certain decisions.

Level 1, is the management layer. Organisational change will be a constant feature and management must keep the structure, skills, processes and and technology under review

Unlike the traditional triangular shape where most people are at the bottom, often performing relatively menial tasks, Level 4 and Level 3 are now smaller (because of automation) and the greatest number of people in the finance department are now at Level 2: higher level functions where decisions are made using the information collected, recorded and prepared lower down the structure.

The flat top of the structure implies more collaboration at that level.

The change in structural shape have been driven by:

๏ Changes in the role of the finance department, where there is now more emphasis on management (and management accounting) and less emphasis on (financial) accounting. Because the finance department is involved in almost every aspect of a organisation it can have a unique holistic view of the business: manufacturing, purchasing, invoicing, cash flow, investment appraisal, performance measurement etc. Hence the use of the term ‘partnering for value’: this can refer to external partners but it certainly refers to internal partners such as departmental heads who have to embrace decisions and plans.

๏ Technology. Routine processes are automated, big data analytics help the organisation to make more accurate predictions. Artificial intelligence will continue to make in-roads into the demand for accountants’ higher skills, or at any rate, the number of skilled accountants who will still be needed.









Chapter 2

THE FINANCE FUNCTIONS

1. Introduction

This chapter covers:

๏ The purpose of the finance function and its relationships with other parts of the organisation

๏ How the finance function supports the organisation’s strategies and operations.

Overall the finance function is responsible for:

๏ Accounting operations

๏ Analysis

๏ Planning

๏ Decision making

๏ Control

2. The components of the finance function

2.1. Introduction

The components of the finance function are, in general:

๏ Financial accounting

๏ Management accounting

๏ Financial planning and analysis

๏ Project management and appraisal

๏ Treasury

๏ Internal audit





2.2. Financial accounting

This function is responsible for producing the organisation’s financial statements (statement of financial position, statement of profit or loss, cash flow statements, notes and movements on equity).

It is also responsible for maintaining the double entry system (and memorandum items) of the organisation:

๏ Nominal or general ledger.

๏ Cash book (and perhaps petty cash book also. These are books of prime entry also).

๏ Receivable ledger (details of customers who owe money).

๏ Payables ledger (details of suppliers to whom money is owed).

๏ Non-current asset register (details of non-current assets).

๏ Sales day book (a book of prime entry in which credit sales are first recorded).

๏ Purchases day book (a book of prime entry in which credit purchases are first recorded).

Transactions are recorded in these books more or less as they occur and the financial accounting system deals with the recording of historical transactions.

The financial statements are produced from the nominal ledger as each account ends up on either the statement of financial position or the statement of profit or loss.

In most countries, businesses have to produce annual financial statements. These are needed for tax purposes but also they are published so that shareholders of the company (the company’s owners) can see how it has been doing. To add credibility to the financial statements, they will often be audited (ie checked over) by independent outside auditors.

The financial statements have to follow detailed rules and regulations about lay-out and disclosures made.

It is generally the financial accounting department which is closely associated with the organisation’s system of internal control. The internal control system is there to try to prevent, detect and correct errors that might occur and also to ensure that the organisation’s assets are safeguarded. The last function is sometimes known as ‘stewardship’. The directors, managers and other employees have a responsibility to look after the company’s assets on behalf of the shareholders. Examples of typical internal controls in place to do this are:

๏ Inventory should be locked in store rooms and only issued upon proper authorisation

๏ Cash should be banked soon after receipt

๏ Purchase invoices need to be checked to ensure that goods were ordered and received

๏ Payments to suppliers should be authorised only after the company is sure proper goods have been received.

๏ Overtime should be authorised by managers not self-certified.

๏ Credit should be given to customers only after credit checks.

๏ The price of shares is often affected by the information in the financial statements, so a better than expected profit will usually increase the share price.





2.3. Management accounting

Unlike the documents and reports produced for the financial accounting system, management accounting reports are not governed by regulation. Also, whereas financial accounting deals with the recording of transactions that have happened, much of management accounting also looks to the future, for example, by drafting budgets.

Typical management accounting functions are:

๏ Drafting budgets for profits, statement of financial position and cash flow. Budgets are rarely for less than a year and will normally be broken down month by month. Often, longer range budgets are also estimated, such as for three years. These are useful in the long-range planning and funding of the business.

๏ Comparing actual results to budgets and investigating the reasons for differences. The differences between budgets and actual result are known as variances.

๏ Working out the cost of units produced and controlling those costs.

๏ Advising on the selling prices of units produced (should be greater than cost!)

๏ Working out the effects of business decisions such as outsourcing production, setting up an overseas operation or closing a factory.

๏ Calculating break-even points for products.

Management accounts (results so far, variance analyses and budgets) are usually prepared and presented to the board once a month so that timely action can be taken if something is going wrong.

Management accountants are also responsible for evaluating capital investments. For example, if a new factory is built now that should produce income over the next 10 years, special investment appraisal techniques such as discounted cash flow calculations are needed to deal properly with the long time-scale of the investment. Often there is insufficient funds available to take on all worthwhile capital projects so the management accountant can become involved in helping the board to decide on how best to invest.

Budget-setting and analysis are a key functions of management accounting. Budgets can be regarded as quantified plans and they achieve or force, the following:

๏ Forecasting: if you are going to draft a budget you are forced to look ahead. You won’t see every problem, but forecasting should alert you to some future difficulties. Forewarned is forearmed.

๏ Planning: based on the forecast, plan can be made. For example, is there enough production capacity to meet forecast sales. If not, create more facilities or arrange to buy in products.

๏ Co-ordination: a sub-set of planning. There is no point in having production capacity of on million units if distribution can handle only 500,000 units.

๏ Communication: the budget, as it is gradually broken down into smaller and smaller sections, communicates exactly what is expected to each division, department, cost centre and person.

๏ Control: if there is no budget how does the company know that costs are being incurred properly?

๏ Authorisation: a budget figure can be authorisation to send and can be a way of delegating responsibility. For example, if the advertising budget is $3.5m, then the advertising department knows it can spend up to that amount and can get on with using that money in the best way it can.

๏ Motivation: a budget acts as a target and, provided it is not impossibly difficult, this can motivate employees to hit their budgets.





๏ Evaluation: compare actual results with the budget (target) and this can be used to evaluate performance.

2.4. Financial planning and analysis (FP&A)

Closely linked to the functions of traditional management accountant as listed above. Analyse what’s happening in the company and its markets, then plan for the future: what products? Which markets? In-house or outsource? Which products are profitable? Which markets and customers are profitable?

2.5. Project management and appraisal

The term ‘project’ implies a discrete, once-off, endeavour. For example, renewing the IT system, building a new factory, moving production facilities abroad.

Planning involves first estimating the costs and benefits of the project. If costs > benefits, why embark on it. Both sides of this equation require accountants to make estimates and to test the estimates of others. Whereas many of the costs are up-front and relatively easy to estimate, benefits do not usually arise until the future and are therefore much more difficult to estimate. Furthermore, the differences in timing between costs and benefits means that specialist investment appraisal techniques must be used, such as calculating net present values.

Once the project begins it is vital to monitor and control:

๏ Costs. As part of the initial project appraisal, costs will have been estimated. It is important that costs are then carefully monitored and controlled. Obviously a job that would be part of the finance function.

๏ Time. This part of project management is not particularly relevant to accountants, though accountants should be alert to cost and revenue implications if projects are delayed.

๏ Quality. Again not directly relevant to accountants but cutting quality is one way of reducing costs. However, the ongoing implications of that might need to be quantified (for example, more product failures imply more warranty costs).

๏ Scope. The scope of the project is the description of precisely what will be achieved: the deliverables. Defining the scope should have been carefully done as part of the initial approval for the project, but projects often go adrift because the scope keeps changing. This usually adds more costs and that might bring more benefits, but accountants must carefully estimate the effect of each change in scope, Changes should only be permitted if incremental costs are less than expected incremental benefits.





2.6. Treasury

This department is found only in larger organisations. It is concerned with:

๏ Company finance. Does the company need to raise a loan or issue more shares?

๏ Where to deposit temporary surpluses of funds so that they can earn some interest.

๏ Where to arrange temporary borrowing.

๏ How to reduce the risk from currency movements when importing or exporting.

๏ How to reduce the risk from interest rate movements on borrowing or deposits.

๏ Taxation management eg one subsidiary making losses available to another.

2.7. Internal audit

The Chartered Institute of Auditors defines internal audit as:

“..an independent, objective assurance and consulting activity designed to add value and

improve an organisation's operations. It helps an organisation accomplish its objectives by

bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk

management, control, and governance processes.”

Most of the work of an internal audit department is making sure that the organisation’s system of internal control is operating as it should be.

The internal control system is the system which should:

๏ Prevent

๏ Detect, and

๏ Correct

errors in the accounting system (and in other systems such as IT and quality control). Examples of internal control procedures include:

๏ Ensuring that all purchases are authorised by a manager

๏ Ensuring that claims for overtime have been authorised by a supervisor or manager

๏ Carrying out reconciliations between suppliers’ accounts in the payables ledger and suppliers’ statements.

๏ Ensuring that valuable assets are safeguarded (such as banking cash promptly or locking storage areas)

๏ Cancelling invoices once they are paid so that the same invoice is not paid twice

๏ Counting inventory regularly and reconciling it to the book records of inventory.

Internal auditors go round the various departments and check that employees are following the laid down procedures. For example, they might select a sample of employee time sheets and ensure that all had been authorised by the appropriate manager. Or, they might make a surprise visit to the factory stores to count some items and compare their result to the amount of inventory shown in the inventory records.





It might sometimes be discovered that the laid down internal control system is inadequate and internal audit would then recommend improvements to accounting procedures.

Ideally, the internal audit department will have its work determined and will report findings to the audit committee. The audit committee is composed of non-executive directors who are independent of the day-to-day running of the company. So, if very poor internal control was discovered, this would be reported to the audit committee who could then raise the matter at a board meeting. If internal audit report to the finance director, the finance director could well suppress the findings to save face.

The internal audit department is sometimes given special assignments such as trying to establish the efficiency of a department (value for money) or perhaps they are asked to investigate the extent of a fraud that was discovered.

3. Relationships within the organisation

The finance function can be thought of as sitting at the middle of the organisation. Not much goes on without some aspect of finance being involved

Finance function

Purchasing and suppliers

Sales and customers

Research and development

Treasury Marketing

Production

Capital projects Wages and salaries





Examples of interactions are:

๏ Purchasing and suppliers: negotiating prices and terms, maintenance of the payables ledger, receiving discounts, payment of amounts owing.

๏ Production: estimating costs of production – material, labour, indirect costs.

๏ Sales and customers: negotiating prices and terms, credit checks, issuing invoices, credit control, receiving payment.

๏ Wages and salaries: processing leavers, joiners and wage rate changes, dealing with clock cards, income tax, calculation of pay (basic and bonuses) payment to employees.

๏ Marketing: agreeing marketing budgets, paying amounts due. Perhaps negotiating advertising rates.

๏ Research and development: approving budgets, monitoring expenditure, estimating future expenditure needed.

๏ Treasury: raising funds, depositing surplus funds, dealing with exchange rate and interest rate risk.

๏ Capital projects: calculation of investment measured such as NPV and ROCE. Estimating expenditure and income.





4. Potential conflicts of interest within the finance role

The finance function is responsible for:

๏ Accounting operations

๏ Analysis

๏ Planning

๏ Decision making

๏ Control

Each of these can give rise to conflicts of interest and pressure not to record or interpret information accurately or to make incorrect decisions.

Here are some examples:

Accounting operations: items of expense reduce profits whilst capital expenditure does not. An accountant could come under pressure to deal with expenditure incorrectly so as to boost profits (ie treat it as capital expenditure rather than revenue expenditure).

Analysis: conceal the reasons for underperformance in one area. For example, the treatment of fixed overheads is often arbitrary and shifting these about can alter the apparent performance of different departments or branches.

Planning: If the directors want to close down one part of the operations, there could be adverse knock-on effects in another. Management accountants might be pressured do conceal this effect.

Decision-making: directors, particularly directors of listed companies, usually want to produce increasing profits or at least profits close to those forecast. It is possible to boost short-term profits at the expense of long-term profits. For example, cutting research and development will increase current profits. However, this will mean that in a few years profits will suffer because there are no new products available to market.

Control: a fraud has been discovered. This can be embarrassing for the finance director, so there is pressure to conceal it.





Chapter 3

TECHNOLOGY AND INFORMATION

1. The fourth industrial revolution

1.1. Introduction

1st industrial revolution 2nd industrial revolution 3rd Industrial revolution 4th industrial revolution

Mechanisation: steam, water power. Eg the cotton and steel industries

Mass production: electricity to power assembly lines such as car production

Computers and automation. For example, process automation and digital machines,

Digital assets: artificial intelligence, robotics, 3d printing (additive manufacturing) autonomous vehicles, biotechnology, connectivity

You will be familiar with the effects of the first three of the above and we now stand on the brink of the fourth industrial revolution.

The World Economic Forum digital transformation initiative (DTI) suggests several key technologies; in addition, there are several other emerging digital technologies. The complete list is:

๏ Artificial intelligence: machines can learn and machines can make deductions based on data supplied. For example, playing games such as Go, facial recognition, predicting customer purchasing requirements and tastes, recommending music (like Pandora) that each consumer should like.

๏ Autonomous vehicles: Taxis, private cars and particularly delivery vehicles. When such vehicles can communicate with each other they should, in an emergency, all be able to coordinate braking or taking evasive action.

๏ Big data analytics: See below.

๏ The cloud: See below.

๏ Process automation: A whole process is automated. For example, when you order goods on Amazon, once you click on ‘Buy’ the goods are automatically picked in the warehouse, brought together and packed then despatched with very little human intervention. Similarly, car manufacturing allows different components to be automatically delivered to the production line so that the precise vehicles specified by customers can be made.

๏ Custom manufacturing and 3D printing (additive manufacturing): Instead of drilling holes in a piece of metal or cutting it to shape, the material is gradually built up. The process is automated allowing the quick production of prototypes or one-off components

๏ Internet of things and connected devices: Your phone tells your heating system when you come in and go out so that heating is automatically switched on and off. Smart locks that you can unlock using an App. Radio Frequency Identification (RFID) allow all components and finished goods to be tracked (and therefore located) individually.





๏ Robots and drones: Robots offer sophisticated, reliable manufacturing. They can also be used in human interactions. Drones allow cheap surveillance and surveying from the air. For example, the health of crops can be analysed and based on findings an autonomous tractor can be used to spread nutrients just where they are needed.

๏ Social media and platforms: Twitter, Facebook, Uber, Instagram. Particularly useful (and potentially very damaging) when used for marketing.

๏ Blockchain: This technology uses a mathematical techniques to keep data secure. Information can be added, but then it cannot be changed so that an indelible record is build up of transactions, share transfers property registers and so on. The technology also makes use of distributed ledgers meaning that the information is simultaneously held on many computers on a network.

๏ Data visualisation: charts and diagrams, both animated and static help users to understand, interpret and remember data.

๏ Mobile: laptops, tablets and mobile phones allow data to be received and uploaded from almost anywhere. So, sales reps can take orders from customers at customers’ premises, check on inventory and upload the orders immediately.

2. The nature of information

2.1. Introduction

Good decision-making implies looking at the available data and information and trying to respond to it rationally. Decisions made from a position of ignorance are little more than gambling.

Already this Chapter has made use of two technical terms: data and information. These can be described as:

Data = raw fact.

For example a list of all the heights of a city’s population or a list all sales invoices still outstanding. The data could be perfectly accurate but if it merely exists as lists it is not of much use. A list of 1 million people’s heights is of little use; similarly a random list of all invoices outstanding is difficult to use.

Information = data with meaning.

The data has been processed in some way so that it becomes useful and informative. For example:

People’s heights: average heights of male and female, standard deviations of heights, average height of children of different ages, bar or pie charts showing the data graphically. The data is now much more useful and informative.

Invoices outstanding: sort and total by customer so that you know who owes what. Also sort by date so that you know which debts are older and may need to be chased.

The real challenge of information technology is not collecting data: it is displaying it in a useful format at the right time to the right people.

Knowledge = information ‘in someone’s head’.

Only then can the information be used.





Explicit knowledge: captured (written down or otherwise recorded) and searchable. ‘We know what we know’. For example, product specifications, receivables ledger, inventory quantities and turnover.

Tacit knowledge: not formally captured and recorded; not safeguarded; not shareable nor searchable. For example, a sales person’s skills with customers or a designer’s approach to successful design. When the employee goes, so does their tacit knowledge.

The challenge is to transform tacit knowledge into explicit knowledge so that it can be widely used in the organisation and is not dependent on one person’s presence.

3. The qualities of good information

Good information is often said to have the following properties (mnemonic = ACCURATE)

๏ Accurate: sufficiently accurate not to be misleading. Not all information has to be accurate to the last dollar or cent and increasing accuracy usually introduces delays increases costs.

๏ Complete: incomplete information is likely to be misleading.

Note: “Cleaning data” or “data cleansing” are the terms used to describe the process of

detecting, correcting or removing corrupt and inaccurate records. Incomplete,

inaccurate, irrelevant and out-of data must be detected, corrected or removed. Not

only is this process important for the purposes of analysing data and making

decisions but there are ethical and legal reasons why inaccurate or irrelevant data

should not be held.

๏ Cost-beneficial: the benefit arising from using the information should be greater than the cost of providing it.

๏ User-targeted: ensure that the information helps the user to make decisions and to perform his or her job well. Avoid information overload.

๏ Relevant: relevant to the person and to the organisation.

๏ Authoritative: the provenance of the information should be stated and should be reliable. Note that much of the information on the Internet is not authoritative. You might be unsure about its source, whether it is still relevant and has been updated or whether it is deliberately distorted.

๏ Timely: the information should be provided soon enough to be of use in decision-making. Sometime information needs to be provided almost instantly (for example when controlling machines). Sometimes it might not be needed for days or weeks. Again, faster provision of information will usually increase the cost of providing it.

๏ Easy-to-use: well laid out, well labelled, convenient menu systems and short-cut keys.





It should be realised that people at different levels in an organisation require different types of information

Operational staff

Middle management /

supervisory

Top

management

/ board

Information for top management is often forward-looking (for planning purposes) as well as historical, makes use of many estimates, and needs to be sourced externally as well as internally (eg what are our competitors doing?). It is often highly summarised and presented in graphical formats. It is often ‘ad hoc’ meaning that very different reports and information can be required at short notice.

Information for operational staff is almost always internal, historical and very detailed and very accurate. It is almost always routine. It is primarily used for recording transactions and making simple decisions.

Middle managers have a mix of informational needs.

A good IT system has to be capable of supplying suitable information to every level.





4. IT Choices

4.1. Introduction

The choices available can be classed under:

๏ Configuration

๏ Wired or WiFi or 3G/4G?

๏ Local or cloud?

๏ Centralised or decentralised?

At one time most computers were stand-alone ie they had no communication with other computers. This was of limited use in business because there is usually a need to cooperate on tasks, to share information and to send emails.

4.2. Configuration

Soon, the concept of networks emerged:

๏ Local area networks (LANs): these operate over a restricted area such as an office, hospital or university campus. Special wiring is installed to connect up the machines. There is usually a special machine called a file server where shared information is held and there might be a print server which allows a printer to be shared between many users.

๏ Wide area networks (WANs): these operate over national and international distances, linking users in different cities and countries. They rely on public networks to transmit information from one local area network to another. This, of course, can increase the chance of the information being intercepted or altered whilst in transit. It is vitally important that information is encrypted before it is transmitted then decrypted by the authorised recipient.

4.3. Wired or WiFi or 3G/4G?

In the early days of networked systems all the components were connected by cables. Increasingly connections between machines are made by

๏ WiFi (radio) using WiFi hotspots; or

๏ Over mobile phone networks using 3G (third generation) or 4G (fourth generation) technology).

These technologies are not so important for office based employees but have become vital to employees, such as sales personnel and service engineers, who are often away from the office at customers’ premises. Sales can now be booked remotely when orders are placed, or technical information on the network server can be easily accessed.

4.4. Local or cloud?

By and large, until relatively recently all computers, whether stand-alone or in a network had their own copies of every program they used and they performed their own processing. Often results and files were stored locally also.

A new and increasingly important approach is for each machine simply to act as an interface for the data and processing that are stored and executed elsewhere. This is the ‘cloud’ approach.





For example, if you are word processing using Word, instead of Word operating on your machine, Word is operating on a large, remote server and the local machine simply acts as an input-output interface. Local users have the impression of local processing but it is done remotely. The Word file will also usually be stored remotely, but it could be printed locally.

The advantages of this approach are:

๏ Cheaper software. The company pays for a licence which is costed according to use not per machine.

๏ Access to powerful processing. If there is an application requiring intensive processing (like graphics in a design company), then that processing can be performed on a powerful machine in the cloud. Local machines simply have to show the finished image. Without this approach every machine used by designers would have had to perform the graphics processing and would have to be powerful (and expensive).

๏ Easier software updates. If an updated copy of the software becomes available only the cloud version needs to be updated. Previously every user’s machine had to be brought up-to-date and inevitably machines often began to run different versions of the software.

๏ Easier maintenance. The complex processing runs centrally and that is likely to be where problems occur. So maintenance and trouble-shooting is easier.

๏ Because the software and data are held in the cloud, it can be accessed from any location by anyone who is authorised to do so. No longer will users be inconvenienced because they forgot to copy a file to their lap-top as they went to visit a client.

Disadvantages:

๏ It is completely reliant on the data communication system working and users having access to communications.

๏ Another company has custody of the software and the data and some users are uneasy about confidentiality and security risks.

4.5. Centralised or decentralised?

In a centralised system, a large computer does all the processing and this is connected to smaller ones which really only act as user interfaces.

In a decentralised system each computer in the system does its own processing. A decentralised system is sometimes known as a distributed system because processing power is distributed, or spread, over many machines.

The advantages of one system tend to be the disadvantages of the other.

Advantages of centralised/disadvantages of decentralised

๏ All data and processing is centralised so is easier to control and safeguard. For example, access and regular backups are centrally controlled. In a decentralised system you would be relying on many users to back-up their files and to ensure that passwords were changed as necessary.

๏ Generally cheaper than a distributed system.

๏ Data is all in one place so is easy to share.

๏ Centralisation will mean that there is less risk of incompatible hardware or software being added.





Disadvantages of centralised/advantages of decentralised

๏ Faster and more flexible response to user needs. Each user can be given power to install suitable software. In a centralised system budget and administration processes can slow down the adoption of new centralised applications.

๏ More resilient to breakdown. If a centralised computer breaks down no user will be able to work. In a decentralised system a machine breakdown will probably affect only one user.

5. The ‘web’, the Internet, intranets and extranets

The terms ‘Internet’ and the ‘Web’ are often used interchangeably. Strictly they are different.

The Internet is a vast network of interconnecting networks spanning the globe in which any computer can communicate with any other computer as long as they are both connected to the Internet. Information that travels over the Internet does so via a variety of languages known as protocols.

The World Wide Web (or Web) is a way of accessing information over the Internet. One of the languages used to send information over the Internet is HTTP (Hypertext Transfer Protocol). Web services, which use HTTP to allow applications to communicate in order to exchange and share information. Email uses the internet but is not part of the Web. It uses a language called SMTP (Simple Mail Transfer Protocol)

The Web uses browsers such as Internet Explorer or Firefox to access web-pages that are themselves linked to each other.

Intranets are ‘internal internets’. The only data accessed and displayed is data from within the organisation, but the distribution of the data is via HTTP and is displayed through a browser.

An extranet is when one intranet is given access to another. For example a supermarket system might be given access to a supplier’s system so that stock and orders can be more easily managed.





6. Big data

There are many definition the term ‘big data’ but most suggest something like the following:

“Extremely large collections of data (data sets) that may be analysed to reveal patterns, trends, and associations, especially relating to human behaviour and interactions.”

In addition, many definitions also state that the data sets are so large that conventional methods of storing and processing the data will not work.

In 2001 Doug Laney, an analyst with Gartner (a large US IT consultancy company) stated that big data has the following characteristics, known as the 3Vs:

๏ Volume

๏ Variety

๏ Velocity

These characteristics, and sometimes additional ones, have been generally adopted as essential qualities of big data.

Characteristics of big data

(Laney)

Variety: disparate non-uniform data of different sizes, sources, shape, arriving irregularly,

some from internal sources and some from external sources, some structured, but

much of it is unstructured

Velocity: data arrives continually and

often has to be processed very quickly to yield useful results

Volume:a very large amount of data. More

than can be easily handled by a single computer, spreadsheet or conventional database system

The commonest fourth ‘V’ that is sometimes added is Veracity: is the data true? Can its accuracy be relied upon?





6.1. Volume

The volume of big data held by large companies such as Walmart (supermarkets), Apple and eBay is measured in multiple petabytes. What’s a petabyte? It’s 1015 bytes (characters) of information. A typical disc on a personal computer (PC) holds 109 bytes (a gigabyte), so the big data depositories of these companies hold at least the data that could typically be held on 1 million PCs, perhaps even 10 to 20 million PCs.

These numbers probably mean little even when converted into equivalent PCs. It is more instructive to list some of the types of data that large companies will typically store.

๏ Retailers

Via loyalty cards being swiped at checkouts: details of all purchases you make, when, where, how you pay, use of coupons.

Via websites: every product you have every looked at, every page you have visited, every product you have ever bought. (To paraphrase a Sting song “Every click you make I’ll be watching you”.)

๏ Social media (such as Facebook and Twitter)

Friends and contacts, postings made, your location when postings are made, photographs (that can be scanned for identification), any other data you might choose to reveal to the universe.

๏ Mobile phone companies

Numbers you ring, texts you send (which can be automatically scanned for key words), every location your phone has ever been whilst switched on (to an accuracy of a few metres), your browsing habits. Voice mails.

๏ Internet providers and browser providers

Every site and every page you visit. Information about all downloads and all emails (again these are routinely scanned to provide insights into your interests). Search terms you enter.

๏ Banking systems

Every receipt, payment, credit card payment information (amount, date, retailer, location), location of ATM machines used.





6.2. Variety

Some of the variety of information can be seen from the examples listed above. In particular, the following types of information are held:

๏ Browsing activities: sites, pages visited, membership of sites, downloads, searches

๏ Financial transactions

๏ Interests

๏ Buying habits

๏ Reaction to ads on the internet or to advertising emails

๏ Geographical information

๏ Information about social and business contacts

๏ Text

๏ Numerical information

๏ Graphical information (such as photographs)

๏ Oral information (such as voice mails)

๏ Technical information, such as jet engine vibration and temperature analysis

This data can be both structured and unstructured:

๏ Structured data:

This data is stored within defined fields (numerical, text, date etc) often with defined lengths, within a defined record, in a file of similar records. Structured data requires a model of the types and format of business data that will be recorded and how the data will be stored, processed and accessed. This is called a data model. Designing the model defines and limits the data that can be collected and stored, and the processing that can be performed on it.

An example of structured data is found in banking systems, which record the receipts and payments from your current account: date, amount, receipt/payment, short explanations such as payee or source of the money.

Structured data is easily accessible by well-established database structured query languages.

๏ Unstructured data:

Unstructured data refers to information that does not have a pre-defined data-model. It comes in all shapes and sizes and this variety and irregularities make it difficult to store it in a way that will allow it to be analysed, searched or otherwise used. An often quoted statistic is that 80% of business data is unstructured, residing it in word processor documents, spreadsheets, PowerPoint files, audio, video, social media interactions and map data.





6.3. Velocity

Information must be provided quickly enough to be of use in decision making. For example, in the above store scenario, there would be little use in obtaining the price-comparison information and texting customers once they had left the store. If facial recognition is going to be used by shops and hotels, it has to be more-or less instant so that guests can be welcomed by name.

You will understand that the volume and variety conspire against the third, velocity. Methods have to be found to process huge quantities of non-uniform, awkward data in real-time.

7. Software for big data

Without getting too technical on this issue, a library of software known as Apache Hadoop is specifically designed to allow for the distributed processing of large data sets (ie big data) across clusters of computers using simple programming models. (Clusters of computers are needed to hold the vast volume of information.) Hadoop It is designed to scale up from single servers to thousands of machines, each offering local computation and storage.

The processing of big data is generally known as big data analytics and includes:

๏ Data mining: analysing data to identify patterns and establish relationships such as associations (where several events are connected), sequences (where one event leads to another) and correlations.

๏ Predictive analytics: a type of data mining which aims to predict future events. For example, the chance of someone being persuaded to upgrade a flight.

๏ Text analytics: scanning text such as emails and word processing documents to extract useful information. It could simply be looking for key-words that indicate an interest in a product or place.

๏ Voice analytics: as above with audio.

๏ Statistical analytics: used to identify trends, correlations and changes in behaviour.

8. Extraction, transformation and loading (ETL)

8.1. Introduction

Data is often collected in a number of different database systems, perhaps managed by different organisations, but could be particularly useful if pieces of it were brought together into a single database.

For example, a supermarket will record purchases of products every hour of every day for every branch. A meteorological company will, similarly, record weather conditions and forecasts. It might be interesting to look for relationships between these two repositories of data. Perhaps it would show something like:

๏ Sunny weather or sunny weather forecasted = a strong demand for barbecue supplies

๏ Cold weather or cold weather forecasted = strong demand for ‘comfort food’.

๏ Bringing together elements from separate databases is the heart of ETL





8.2. Extraction

Data from different sources will inevitably come in many different forms and patterns so extraction has to be carefully tailored for each source. For example, one database might hold dates as ddmmyy, another as mmddyy, another as ddmmyyyy and so on. All of these formats will have to be catered for - and dates are relatively simple (almost standardised) data compared to most of the data that is held in databases.

The data also needs to be validated ie is it correct? There is no point extracting data for future use if it is obviously incorrect.

8.3. Transformation

This process converts the data that has been extracted from its original, probably varied, format into the strict format needed by the new database. So, for example, all dates might be changed into the format dd/mm/yyyy. Similarly, address data might have both ZIP codes (USA) and postal codes (UK) and these will both need to be recorded the new records.

8.4. Loading

This is the process of writing the data to the new database. It might be a relatively simple process to write the data if it a once-off exercise, but often the ETL process will be carried on every day or every month so that the information is up-to-date. Also, historical data must be preserved so that trends and patterns can be investigated. How much historical information is to be retained? For example, two-year monthly comparatives imply 24 sets of data and when a new month is loaded the oldest is lost and every month’s data moves back one month.

9. Business intelligence

Business intelligence is the technology driven process of:

๏ collecting data

๏ analysing data

๏ presenting information

to help directors, managers all employees to make informed business decisions.

Generally, the information presented will have historical, current and predictive elements. So, for example, to make an informed business decision about whether or not a production facility should be closed down, managers would need to know:

๏ Historical sales figures, revenues and costs

๏ Current sales figures, revenues and costs

๏ Future, predicted sales figures, revenues and costs.

To complete the picture, information would also be needed about competitor activity, new products that might supplant current production, customers’ preferences, economic outlook





10. Dangers of big data

Despite the examples of the use of big data in commerce, particularly for marketing and customer relationship management, there are some potential dangers and drawbacks.

๏ Cost: It is expensive to establish the hardware and analytical software needed, though these costs are continually falling.

๏ Regulation: Some countries and cultures worry about the amount of information that is being collected and have passed laws governing its collection, storage and use. Breaking a law can have serious reputational and punitive consequences.

๏ Loss and theft of data: Apart from the consequences arising from regulatory breaches as mentioned above, companies might find themselves open to civil legal action if data were stolen and individuals suffered as a consequence.

๏ Incorrect data (veracity): If data is incorrect or out of date incorrect conclusions are likely. Even if the data is correct, some correlations might be spurious leading to false positive results.

๏ Employee monitoring: Data collection can allow employees to be monitored in detail every second of the day. For example, sensors in name badges so that employee movements and interactions at work can be monitored. The badged monitor to whom each employee talks and in what tone of voice. Stress levels can be measured from voice analysis also. Obviously, this information could be used to reduce stress levels and to facilitate better interactions but you will see how it could easily be used to put employees under severe pressure.Ethical and social issues; privacy and security

Around the 1990s many governments became worried about the amount of information being held about their citizens and the potential for damage or misuse. Many countries therefore enacted data protection legislation to govern the collection and use of data.

For example, the UK Data Protection Act (which implements the European General Data Protection Regulations) imposes obligations to not hold data for longer than needed, to allow individuals to see information about themselves and to ask for it to be corrected.

Obviously the huge amount of data now being collected and held (see Section 7 above) mean that this problem is potential more serious.





In addition to the obvious privacy issues, the following are ethical, social and security dangers:

๏ Incorrect data leading to incorrect decisions. For example, incorrect information on financial affairs can lead to individuals being refused credit.

๏ Theft of information (such as the theft of credit card information, the hacking of emails and industrial espionage).

๏ Unauthorised alteration of information.

๏ Fraudulent websites (eg ‘phishing’ sites can look like legitimate bank sites and can induce people to enter their account and PIN numbers).

๏ Time-wasting by employees as they browse the internet.

๏ Downloading or sending offensive material.

๏ Violations of copyright laws.

๏ Denial of service attacks (DoS) where there are attempts to make a machine or network unavailable to its intended users. For example, a site is bombarded with automated requests for access and the site fails.

๏ Computer viruses which might simply be a nuisance or which are designed to cripple machines and systems.

๏ Physical dangers, such as floods, fire or terrorist attacks can mean that organisations cannot continue to function.

๏ Innocent harm being done. For example, there have been several recent cases of banks updating their software and errors in the updates caused on-line banking and cash machines to fail for several days.

It is therefore essential that organisations:

๏ Ensure that data is collected legally.

๏ Ensure that the data is input completely and accurately.

๏ Ensure that data is held safely and securely – including physical security.

๏ Ensure that data can be accessed only for authorised purposes by authorised individuals

๏ Ensure that software is properly tested.

๏ Arrange regular backups of data.

๏ Use virus checkers.

๏ Use firewalls to prevent unauthorised access from outside (by hackers).

๏ Have suitable standby arrangement (disaster recovery plan) should the computer system be severely damaged.





11. Monetising data; from data to impact

11.1. Introduction

Profit seeking organisations should be making use of data and information technology to enhance the long-term profitability and sustainability of their businesses. IT is not an end in itself. Similarly, not-for-profit organisations should be using IT to save costs or to improve their efficiency and services they are providing. The term ‘monetising’ will be used for both types of organisation.

There are several levels of data analysis and use and these can lead to different opportunities for the monetisation of data:

๏ Data reporting: ie what happened?

๏ Data analysis: ie why did it happen?

๏ Monitoring: ie what’s happening now?

๏ Prediction: ie what might happen in the future

11.2.Monetising data

These different level of analysis allow data to be used to produce economic benefits in the following ways:

๏ Increasing efficiency. For example, automating processes, using 3D printing to economically produce low-volume items, moving to just-in-time inventory.

๏ Developing and monitoring key performance indicators. (KPIs). For example, a common KPI for a supermarket is gross margin and real-time reporting and analysis of sales allows this to be monitored continuously

๏ Forecasting. Better forecasting leads to less wastage and production or purchasing being more closely aligned to demand.

๏ More accurate customer segmentation ie understanding better the requirements and behaviours of different sections of customers.

๏ Better coordination with suppliers, logistics companies and customers

๏ Adding new products or services to existing offerings. For example, analysing consumer behaviour can provide insights into which current products are preferred by which type of customer and from that new, targeted products can be developed. Computer aided design and manufacture can accelerate new product launch.

๏ Developing entirely new business models. For example, the move from high street stores to internet based mail-order operations, or the rise of companies like Netflix which deliver entertainment on demand and for subscriptions compared to traditional TV stations.

๏ Joining with similar companies to share data so that these large amounts of relevant data can be exploited.

๏ Selling data to other companies. Obviously care is needed when selling or transferring personal data, but there are large amounts of data that do not have these constraints. For example, there are huge geographical data-sets available with information including satellite images, population statistics, geological surveys.





11.3. Data to impact

If the aim of a profit-seeking business is to maximise profits (and for a non-profit organisation to increase efficiency), then the involvement of the finance department is key. It is for the finance department to determine the financial and operational data needed, to ask relevant questions, to analyse the data and then to ensure that insights discovered are actually used to improve the organisation’s performance. It is the last step that means the data has impact.

The finance department therefore can act as a link between data and its implications. To this end the finance function must have close links:

๏ With the IT department. It is the finance department which knows which data is needed and it is the IT department which knows how to capture and supply the data.

๏ With specialist data scientists. Although the data scientists have sophisticated analytical skills they know little about finance and their analytical skills have to shepherded by the finance department so that the right questions are asked and the results are interpreted correctly.and to interpret results

๏ With other managers throughout the business as they will probably need assistance in understanding and using the data.

๏ The following shows how management accountants link the business to data analytics so that the data actually impacts on performance:

Need for performance improvement

Commercial insight

InfluenceImpact

Analytics findings

Big data initiatives/analytics

The business Management accountant Data scientist

Seek guidance Ask the questions

Question the logic

Produce

Build the hypothesis

Align with KPIs, budgets and forecasts

Quality control/verify findings

Analysis/validation against business model

(CGMA Report, From Insight to Impact)





Chapter 4

OPERATIONS MANAGEMENT

1. What is operations management?

1.1. Introduction

Operations management refers to the activities required to make and deliver products or to deliver services. For a manufacturing organisation these activities include

๏ Procurement/purchasing

๏ Receipt of raw material

๏ Warehousing of raw material

๏ Issuing material to the production lines

๏ Manufacturing the product

๏ Warehousing the finished goods

๏ Receiving orders

๏ Despatching goods

1.2. The value chain

Michael Porter, a professor at Harvard Business School, introduced the concept of the value chain, which shows many of these activities:

Firm Infrastructure

Technology Development

Human Resource Management

Procurement

Inbound

Logistics

Operations Outbound

Logistics

Marketing

& SalesService

Profit, or margin

Support/

secondary

activities

Primary activities

This model represents organisations by setting out the activities they carry out.





By carrying out these activities organisation can make profits. However, it is essential for the organisation to know what gives the right (or ability) to make profits. Why do customers pay enough to allow a profit to be made? It might be because:

๏ The organisation possesses knowhow that customers pay for.

๏ The organisation offers flexibility.

๏ The organisation offers economies of scale.

๏ The organisation take on risks.

Whatever it is that customers value is the key to an organisation’s success and its performance there needs to be carefully managed. If an organisation is carrying out tasks that are not valued by customers, performance could well improve if these were changed or discontinued.

For example, in the UK many financial institutions moved their call centres to other countries. Many customers disliked this – particularly elderly customers whose less acute hearing gave them problems with foreign accents. The operations carried on by the financial institutions were therefore less acceptable to customers who began to move their business elsewhere. Many institutions have begun to reverse their call centre off-shoring.

2. The supply chain

2.1. Suppliers – company - customers

A useful view of SCM is suggested by Meyer, Wagner and Rohde (2004):

Sales SalesDistributionProductionProcurement Procurement

Collaboration Collaboration

Here, in contrast to Porter:

๏ Procurement is seen as a primary activity. It is a central part of the supply chain and not merely a support function. Wise and skilled purchasing will be capable of creating value.

๏ Customer-facing activities (previously, sales, marketing and services) are combined into sales.

๏ Inbound and outbound logistics activities are combined in distribution.

๏ Operations in Porter’s value chain are more precise (but perhaps more restricted) with the term ‘production’.

Concluding, the supply chain and supply chain network concept extends Porter’s value chain towards cross-company networks in order to improve efficiency and delivery service, minimise costs and inventories.

The important additional emphasis in this presentation is on collaboration between up-stream suppliers and the down-stream customers.





๏ Upstream = the supply chain before materials and goods reach the manufacturer

๏ Downstream = the supply chain for products after they leave the manufacturer and are on their way to customers.

Together, they form the value network that creates value through the appropriate operation of the whole chain to improve efficiency, delivery accuracy and times, cost reduction and inventory minimisation.

You will readily understand that collaboration can often be greatly facilitated by the use of information technology, which can integrate online orders received from customers with manufacturing inventory management and purchases of raw materials and components from suppliers.

2.2. Push/pull supply chain models

A push model (build-to-forecast) of the supply chain relies on manufacturers producing according to historical demand patterns and pushing products out to distributors and customers. Inventory is held at various points as a buffer against unexpected demand or production delays. By contrast, in a pull model (build-to-order) demand stimulates production and delivery. Essentially, just-in-time inventory control is a pull model as ordering and production are triggered by customers’ orders. No orders are raised nor production started until there is downstream demand.

In demand-driven systems it is a customer who activates flow by ordering from the retailer, who in turn reorders from the wholesaler, who reorder from the manufacturer, who reorders raw materials from the suppliers. Orders flow backward, up the chain, in this structure. Great care is needed to ensure that, because there is no buffer stock, delays occurring as orders flow up the supply chain do not jeopardise the delivery of the final products.

Many companies are trying to shift from a build-to-forecast to a build-to-order discipline. The property of being demand-driven is variable:

๏ Being 0% demand-driven means all production/inventory decisions are based on forecasts and all products available for sale to the end user are there because of the forecast. This could be the case of fashion goods, where the designer may not know how buyers will react to a new design (and the article of clothing cannot be ordered before manufacture), or the beverage industry, where products are produced based on a given forecast.

๏ A “100 percent” demand-driven is one in which the order is received before production begins. The commercial aircraft industry match to this description. In most cases, no production occurs until the order is received.

Of course, pure push or pull models exist only in theory: demand for a product will never cause a supply chain to start mining iron ore and producing steel. Nor will a push model guarantee that products made will be bought. At some point, in every supply chain, demand push will meet demand pull, and inventory will accumulate there. Note that large geographical distances between suppliers and customers, or processes that take time (such as growing crops) make pull systems more difficult to organise.

However, inventory can be minimised and customer service improved if all parties in the supply chain can be better synchronised and have the ability to react quickly. For example, a traditional model of replenishing inventory in supermarkets would rely on each supermarket issuing an order to suppliers, probably by electronic data interchange (EDI), once inventory falls below reorder level. However, orders then arrive ‘out-of-the-blue’ at suppliers, who either have to have sufficient production capacity or who have to hold inventories to respond quickly.





A better way is to give suppliers access to supermarkets’ inventory records through an extranet so that inventory levels and rates of change can be monitored. Supplies can be dispatched even without having to wait for an order. In this way, suppliers will be much better able to anticipate demand and produce accordingly. Better synchronisation and lower inventory levels have been achieved.

2.3. Supply chain pathways and networks

Supply chain networks shows the links between organisations and how information and materials flow between these links. For example:

ORGANISATIONUltimate Supplier

Supplier

Third Party Logistics Company

CustomerUltimate Supplier



As with many other functions, outsourcing is increasingly used in supply chain management. Logistics companies can perform many supply chain functions more efficiently and economically than they can be done in-house.

These can be complex. For example, here is the supply chain network for an orange juice company:

Bottler

Orange grower

Juicing plant

Label producer

Plastic bottle manufacturer

Oil company

Juice marketer

/supplier

Supermarkets

Logistics firms

Wholesalers

Airlines etc

Restaurants

Retailers

C

O

N

S

U

M

E

R

S

Upstream

Outbound logistics

Downstream

Inbound logistics





3. Supply portfolios

3.1. Introduction

Not all supplies and raw materials are of equal importance. A supply portfolio approach (Kraljic) allows organisations to display their supplies according to:

๏ The profit impact or annual expenditure relating to the supply.

๏ The supply difficulty (number of suppliers, internal constraints).

3.2. The supply portfolio matrix

Profit impact

Supply

difficulty

Low

Low

High

High

Acquisition Leverage

Critical/bottleneck Strategic

๏ Acquisition/non-critical: Low profit impact; low market difficulty. Example: stationery.

๏ Critical/bottleneck: Low profit impact; high market difficulty. Example: unique components or components with erratic supplies.

๏ Leverage: High profit impact; low market difficulty. Example: packaging.

๏ Strategic: High profit impact; high market difficulty. Example: special software.

By segmenting the market in this way, it becomes possible to decide on the required approach to suppliers and the most effective way to purchase the resources.

๏ Acquisition/non-critical quadrant.

Items in this quadrant have a profile of low market difficulty and a low profit impact (expenditure). Buyers might be tempted to spend a lot of time in this quadrant. However, that would not be a wise business decision as the return on the time invested would be small.

Items in this quadrant should be bought in a standardised, simplified way to minimise costs.

๏ Critical/bottleneck quadrant.

Items here have the profile of high market difficulty and low profit impact (expenditure). Typically, the supply market is difficult because there is only a small number of suppliers. These items do not have a high profit impact until they are not available.





A risk analysis with respect to supply should be carried out. A cost reduction strategy is inappropriate in the critical quadrant in case supplies dry up. One way of reducing risk might be to over-order when supplies are good.

๏ Leverage quadrant.

The items in this quadrant have low supply market difficulty and high profit impact (expenditure). The return on time invested in this area will result in profit maximisation.

A planned cost reduction strategy for items in this quadrant. For example, there are many suppliers who can be played off against one another.

๏ Strategic Quadrant.

Items in this quadrant have the profile of high market difficulty and high profit impact (expenditure). These items lend themselves to a strategy such as taking over a supplier or forming very close links with one. Cost reductions in this area require a long term strategic plan to ensure continuity of supply in these expensive items.

Suitable strategies are those that reduce risk and maximise profit. These strategies can take two directions: a partnering strategy with a suppliers or a strategy to create competition (eg by self-supply) and drive the item to the Leverage Quadrant.

Some of the main choices to be made in supply chain pathways are as follows.

๏ Who transports the goods? The main solutions are:

• the buyer transfers them using own transport

• the seller transfers them using own transport

• a logistics company transfers them

๏ What delivery pathways are best?

๏ Who stores the goods? The organisation, the supplier, or a logistics company.

๏ Which manufacturing, packaging, labelling, kitting, or completion tasks are carried out by the organisation and which by other parties? (Kitting relates to processes such as adding batteries).

๏ Who is responsible for quality assurance and proper handling of the goods?

๏ How should returns be handled?

๏ How can fast and responsive deliveries by arranged?

๏ Who handles customs clearance?





Chapter 5

MANAGEMENT OF RELATIONSHIPS

WITHIN THE SUPPLY CHAIN

1. Lean synchronisation

Lean synchronisation means that products and services are always delivered to exactly match what customers want, in exact quantities and at the required time and place for delivery. Lean synchronisation should achieve these objectives at the lowest possible cost and it should result in items flowing rapidly and smoothly through manufacturing processes and supply networks.

In a traditional manufacturing approach, each stage in the process will place its production in an output inventory that buffers that stage, helping to isolate it from the next process downstream. The next stage of manufacturing will the take outputs from the inventory, process them and pass the more complete items to the next buffer inventory, and so on.

The intermediate inventories insulate each stage from its neighbours, making each stage relatively independent. The system is also more resilient if there should be a problem at one stage as buffer inventory can be used to keep subsequent processes going. However, this safety and flexibility has to be paid for in terms of:

๏ inventory holding costs

๏ relatively slow throughput times

๏ possibly less flexibility to change production quickly because buffer inventories have to be held for even longer.

2. Supply chain relational management (SRM)

SRM is concerned with the management of the supplier relationship. This:

“Involves managing the interfaces between organisations supplying goods and/or services to an organisation in order to maximise their value”. It is about building relationships that work towards supporting an “effective, financially beneficial environment”.

Within SRM there are several types of relationships observed.

These are often classified as

๏ Transactional

๏ Contractual

๏ Value Added

๏ Collaborative

๏ Partnership





These are summarised below:

๏ A transactional relationship is based on the exchange of services or products within an agreed timescale for an agreed price. Some transactional relationships are sustained over considerable periods of time, and these demonstrate commitment. However there is little trust between supplier and customer. The relationship is essential adversarial.

๏ A contractual relationship is very similar to a transactional approach but it is a relationship which is built around delivering the terms of the contract. The supplier will deliver neither more nor less than the contract and the customer will use the contract to manage the supplier. There is still little trust between the two parties. Again, a rather defensive outlook.

๏ A value added relationship is usually adopted by suppliers when they move to a strategy to retain customers and therefore they develop customised solutions to meet the customer’s needs. This helps to lock together supplier and customer

๏ A collaborative relationship can be described as a close working between the supplier and customer, which delivers value and benefit to both organisations. There is also a structure of shared responsibility, accountability, resources and rewards. They cooperate and collaborate for the good of each party.

๏ Partnership based relationships have many similarities to collaborative SRM styles in that both parties derive mutually beneficial value from the relationship. The intention with a partnership approach is that the association will be over a long period of time with both parties looking to develop a two way rapport. There is a recognition of mutual dependency, even more so than with collaborative ventures. Partnership relationships are seen as strategic alliances, where skills and resources are shared to achieve mutual benefits which cannot be achieved working individually. They could produce joint venture structures where the legal ownership and management of organisations are shared.





3. Materials resource planning (MRP I) and manufacturing

resource planning (MRP II)

A materials resource planning information system is one which uses sales orders and sales forecasts to schedule raw material orders, deliveries and quantities.

For example, if an order is received for 100 units of a product, the system expands this into the parts needed, can check inventory and work out what orders have to be placed with suppliers in order to fulfil the sales order. Many systems will place the purchase orders automatically.

Materials resource planning is sometimes known as MRPI to distinguish it from MRPII, which means manufacturing resource planning where not only materials but also labour and machine resources are integrated into the production plan.

4. Statistical process control

Statistical Process Control is a methodology for measuring and controlling quality during the manufacturing process. Quality data (for example, measuring the sizes or weights of components) are obtained in real-time during manufacturing. Sometimes all components will be measured; sometimes only a sample. The data is then plotted on a graph that has pre-determined control limits. Control limits are determined by the nature of the process and the client's needs.

Corrective action needed

Upper control limit

Lower control limit

Data that falls within the control limits indicates that everything is operating as expected and that the small variations with control limits are likely due the natural variations that occur as part of the process. If data falls outside of the control limits, this indicates that a specific cause is likely the source of the product variation. For example, the setting on a machine might have slipped. Something within the process should be changed to fix the problem.









Chapter 6

PROCESS TECHNOLOGY AND QUALITY

CONTROL

1. Computer numerical control (CNC)

Instead of a worker controlling a machine, such as a lathe, drill or saw, the machines are controlled by computer. This technology has the following advantages:

๏ Increases the speed with which articles can be processed.

๏ Increases precision.

๏ Can link to computer aided design (CAD) software so that designs can be quickly manufactured.

๏ The machines can work for long hours without deterioration in performance (or the need for overtime payments).

2. Robots

Robots extend the flexibility first seen in CNC technology. Industrial robots usually consist of a jointed arm with a gripping tool at the end that can lift move and rotate articles. They are commonly seen in car manufacturing plants.

3. Automated guided vehicles (AGV)

Automated guided vehicles are now commonly found in warehouses and factories.

AGVs safely transport all kinds of products without human intervention within production, warehouse and distribution environments and offer ways to reduce costs and to increase efficiency and profitability. They can lift, rotate and move goods, fetch goods from racks and deliver them onto conveyors. They can also store goods onto shelving.

Some navigate by following wires burying the floor, some use lasers and some GPS. All have radio connections to assign task and to continually report where they are to speed flow and to avoid collisions with other vehicles. All have safety mechanisms which will stop the vehicle if something is blocking its path – such as an employee.





4. Flexible manufacturing systems (FMS)

A Flexible Manufacturing System is one that can be changed or adapted rapidly to manufacture different products or components at different volumes of production. Sometimes the production needed has been predicted, sometimes not.

Flexibility comes from two sources:

๏ Machine flexibility: a machine can quickly be reset to perform different tasks. For example different patterns and sized of holes being drilled.

๏ Route flexibility: the ability to send different items through different processes. For example, if a component didn’t need holes drilling it would miss out the drilling machine.

Potential advantages from an FMS are:

Reduced WIP Inventory. FMS allows units to be made as needed rather than being produced in batches so can enable pull-systems and JIT (Just in Time) inventory management.

๏ Increased machine use. Highly automated FMS can reduce tool changeover time and machine tool-setting times. This both increases machine utilisation and reduces manufacturing lead-time.

๏ FMS reduces transportation times because a single machine can carry out multiple tasks.

๏ Shorter lead times. Because transportation, scheduling and set-up times are all reduced, there can be a significant reduction in the lead-time for production.

๏ Ability to handle a variety of configurations of a part ie tailor made parts.

๏ Reduced labour costs. The number of employees needed to manage machines in FMS is much lower than the conventional set-up.

Potential disadvantage from an FMS is:

๏ Cost. A widely-quoted case is that of Yamazaki Machinery Company in Japan. Which installed an FMS system costing $18 million. The results were:

๏ Number of machines reduced from 68 to 18

๏ Employees were reduced from 215 to 12

๏ Floor space from 103,000 square feet to 30,000 square feet

Despite these impressive figures the return on investment was only 10% even when total savings after two years were close to $7.0 million and a projected savings of $1.5 million per year for next 20 years was envisaged. This is why many companies have trouble justifying investment in FMS, as the target on ROI for many is 15%





5. Computer integrated manufacturing (CIM)

This is the use of computers to control the production process. For example, if you go to most car company websites you will be given options as to:

๏ Engine size and type

๏ Body type

๏ Body colour

๏ Interior colour

๏ Level of trim and accessories

๏ Wheel styles

๏ Options for built-in GPS etc

To make the specified cars reliably and economically requires a high degree of IT involvement to ensure that the correct parts come together on the production line to make the specified vehicle.

These systems can also integrate computer aided design to the manufacturing process. This means that the technical drawings specifying the size, shape and other details of a component can be used to control the machinery used in production.

It is worth just mentioning here the new technique of additive manufacturing or 3D printing. In this process the material is extruded to form complex shapes which harden to produce sophisticated components that can be difficult or expensive to make in any other way.

6. Quality management

6.1. Definitions

Quality can be defined as: “Fitness for use” (Juran)

Or

“ …the totality of characteristics…ability to satisfy customers’ stated or implied

needs..” (ISO 9000 handbook.)

๏ Quality control refers to the processes (such as sampling and testing) that an organisation employs to check on quality.

๏ Quality assurance is the sum of the management allow an organisation to dependably achieve a stated level of quality.

๏ Quality management is the overseeing of all the activities needed to achieve and maintain the required quality. It includes establishing the required quality level, setting quality control procedures and also considering quality improvement.





6.2. Costs associated with quality

Costs of conformance (i.e. of improving quality)

๏ Prevention costs

๏ Appraisal costs

Costs of non-conformance (i.e. of allowing poor quality)

๏ Internal failure costs

๏ External failure costs

Moving effort towards the top of this list should save costs.

๏ If there is no quality at all, all failures will happen once the customer receives the goods (external failure). That is very expensive in terms of goodwill lost and replacing goods.

๏ If goods are tested when finished but before leaving the factory some will fail (internal failure). The faults have to be found and the faults have to be repaired, but at least customers are not affected. This should be cheaper than external failures.

๏ If goods are inspected after every operation is completed, faults can be diagnosed immediately and repaired (appraisal costs).

๏ Cheapest of all is to prevent any quality control problems at all. This will involve careful design, the purchase of good quality components and staff training. However, these costs will more than compensate the cost of finding and repairing costs later in the process.

Hence the claim that ‘quality is free’: better quality control at earlier point in the process will, overall save costs.





6.3. Total Quality Management (TQM)

TQM is defined as:

“The continuous improvement in quality, productivity and effectiveness obtained by

establishing management responsibility for processes as well as outputs. In this, every

process has an identified process owner and every person in an entity operates within a

process and contributes to its improvement”.

Any manufacturing company will want to deliver goods to the customer that are of sufficiently high quality to avoid goods being returned. To check this the company will have some form of quality control checks on goods leaving the factory. However, even though good quality control will results in poor quality goods being rejected, and therefore not reaching the customer, there remain the costs associated with waste and poor quality work.

It is therefore important that all possible steps are taken not only to check quality at each stage, but to design processes and educate the workforce to facilitate good quality production. If everything is done right first time, there will be no quality control problems and no waste of materials or time.

TQM does not apply only to the manufacturing system. It will also apply to phone answering, provision of information, the organisation’s web-site, order processing, invoicing, recruitment and training.

The implementation of TQM is never really complete and there is a culture within the organization of never being satisfied and of continually achieving improvements. Often these are small, but nevertheless will add up to be significant. The process of a continuous series of small improvements is known as ‘Kaizen’.

The improvements can be to cost, quality, efficiency, less wastage, better service ie all aspects of operations. Note that unlike quality control which aims to maintain quality and control costs, kaizen aims to improve these all the time.





6.4. Six sigma

Six sigma is an approach to quality control that was originally devised by Motorola, a high tech electronics company that manufactures, amongst other products, microprocessor chips. The aim of the company was to achieve very low rejection rates, < 3.4 defects/million, though that specific objective is not as important as their methodology, known as DMAIC: define, measure, analyse, improve, control.

๏ Define: define what is meant by quality. For example, reliability, style, fast response, helpful service.

๏ Measure: ways of measuring the quality factors have to be devised. For example, failure rate for reliability, customer surveys for style. Measure both current performance and use the measurement methods to better define what is meant by quality i.e. set targets.

๏ Analyse: investigate why current performance falls short of required performance.

๏ Improve: attempt to improve performance. Repeat the D, M, A, I cycle until the required standards have been achieved.

๏ Control: This is continuously applied to ensure, for example, that definitions are still relevant, that costs are within budget and that progress is being made.

DMAIC fits in with Kaizen ie a continuous series of improvements to improve quality and reduce costs.

7. Reverse logistics

Reverse logistics refers to all operations related to the reuse of products and materials. It is:

"the process of planning, implementing, and controlling the efficient, cost effective flow of raw materials, in-process inventory, finished goods and related information from the point of consumption to the point of origin for the purpose of recapturing value or proper disposal. …Remanufacturing and refurbishing activities also may be included in the definition of reverse logistics."

The reverse logistics process also includes the management and the sale of surplus as well as returned equipment and machines from the hardware leasing business.

A manufacturer's product normally moves through the supply chain network to eventually reach the distributor or customer. Any process or management after the sale of the product involves reverse logistics.

๏ If the product is defective, the customer would return the product. The manufacturing firm would then have to organise shipping of the defective product, testing the product, dismantling, repairing, recycling or disposing the product.

๏ At the end of the product’s life it can be returned to the manufacturer for refurbishment or recycling. For example, photocopier toner cartridges can be sent back for refilling.

๏ At the end of the product’s life it could be sent back to the manufacturer for safe disposal after the manufacturer arranges the salvaging of valuable material. For example, electronic products contain valuable rare earth metals that can be recovered, reprocessed and reused.





Chapter 7

MARKETING – ITS NATURE AND

PURPOSE

1. What is marketing?

To understand the marketing concept or the marketing approach it’s useful to contrast this with certain other approaches that might be available.

๏ The product-led approach

For this, imagine a company which was started by a couple of engineers, clever and successful people, who are very interested in the technical qualities and the cleverness of the products they produce. They get enormous satisfaction in well-engineered, clever innovative products. Unfortunately, just because the product is well-engineered, innovative and clever doesn’t mean that product will sell. No matter how much those engineers appreciate the fine details of that product it may be a product that no one wants, or a product which is too expensive.

๏ The sales-led approach.

This might sound okay, but what it means is that there is great emphasis on selling what you have, even if customers don’t really want it. The sales-led company will have a very high-powered sales team, skilled in the arts of persuasion and getting people to sign contracts which they may later regret.

๏ The marketing-led approach.

This is quite different. What’s important about that is that it is very outward looking. It looks to see:

‣ What will potential customers want?

‣ What do they appreciate?

‣ What amount of money do they think it’s worth paying for the product or service we are providing?

Through market research we will establish the needs of potential customers and then develop an appropriate product to match those needs. It will stress to those customers the ability of the product or service to satisfy their needs and it will profit through customer satisfaction because it fulfils the needs of its customers.

In many ways it’s a very humble approach. It’s saying that the customer knows best. There is no point in making a product which we think is good if customers think it’s not very satisfactory. It doesn’t mean, of course, that it’s an entirely passive process, only just taking input from customers. You can’t always expect customers to be innovative and it will certainly be part of the market research process to develop prototype products to show those to customers, to see whether the customers will be interested, or to find out how those products could be changed in some way to better match the requirements of the customers. But at the end of the day, the marketing concept means finding out what do customers want and developing products or services to fulfil customer’s needs.





2. The macro-environment (PESTEL)

The goods that organisations decide to market and how they market them very much depends on the environment they are in. It is therefore important to analyse the environment and a common approach is to use PESTEL: political, economic, social, technological, ecological/environment and legal). These factors affect whole countries.

๏ Political factors: political factors such as a potential change of government, enlargement (or reduction!) of the European Union, the threat of war will affect buying habits. For example, unrest in certain areas of the world will reduce the number of holidays that can be sold there and tour companies will have to market different products.

๏ Economic factors: changes in, say sales tax (VAT) will affect expensive items like cars more than cheap every-day items. If sales tax increases car manufacturers might offer a period where the selling price to the customer will be held constant and the manufacturer absorbs the increase. If a country is facing an economic recession then it is clear that this will have to be taken into account when deciding which products to market and their prices,

๏ Social factors: these cover population changes, fashion, habits and fads. For example, over the last 10 years or so, in the UK more and more men grow beards. This has affected sales of razors and firms like Gillette would have to alter their marketing approach to try to overcome the decrease in sales. A big change in many countries is the increasing proportion of older people in the population and marketing departments must pay attention to the needs and preferences of a growing segment.

๏ Technology: the internet has made huge differences in how products and companies are advertised, how products are ordered and delivered, and the amount of information that is known about customers. It is also important for businesses to be aware of technological advances so that their products and service offerings stay up-to-date and competitive.

๏ Ecology/environment: emphasising the ‘green’ credentials of products and your company has become increasingly important in generating favourable customer impressions.

๏ Legal: laws and regulations can affect how marketing can be used. For example, in the UK advertising cigarettes is almost impossible. Laws and regulations also affect the products themselves, for example their safety. Occasionally governments intervene to set prices.

3. Market segmentation

We have said that marketing is finding out what customers want and designing products and services to meet customers’ needs. The first stage to find out whether all potential customers want the same thing or can the market be broken down into different sections or segments. Market segmentation looks in how a market can be split up.

Commonly, it can be split up according to:

๏ Age

๏ Sex

๏ Lifestyle

๏ Wealth

๏ Geography

For example in the fashion market, there are quite different fashions which are bought by younger and older people. Obviously there are different fashions depending whether you are selling to male or





female. Lifestyle is important, are we addressing the leisure market or are we addressing a more formal market? Wealth and disposable income are important, and it’s normal for most ranges of fashions to have cheaper ‘diffusion lines’ and also the more expensive luxury goods. Geography, for example simply whether people live in the north of the country or the south of the country can make a difference in the type of clothing they want to buy.

Companies might decide not to sell to all segments of the market. They may find a segment is too small, or too unprofitable, likely to decline because of PESTEL factors or that there is too much competition there already.

4. Market targeting

After investigating market segmentation, the next stage is market targeting, that is deciding which segments of the market to attack.

๏ Undifferentiated market targeting

The first type of market targeting is known as undifferentiated market targeting. This means that your research has shown that the market is effectively not segmented and that one product will suit all potential buyers.

Product Market

This is extremely rare; in fact, it is very difficult to think of an example. Even the sale of basic products like water is to a segmented market. Some people are perfectly happy with tap water, others want mineral water, but some want still, some want sparkling. It is sold in different quantities of small bottles, large bottles, and there is whole range of flavours.

๏ Differentiated market targeting

By far the most common type of market targeting is known as differentiated market targeting. Here the firm perceives that the market is segmented and designs a different product or service to suit each segment of that market.

Market Segment 1

Market Segment 3

Market Segment 2Products

You only have to try to buy a common consumable such as shampoo or toothpaste to see how the manufacturers have differentiated their products. There are probably dozens of products to choose from, and the manufacturers hope that by changing the product and a number of other variables that they make their product particularly suitable and attractive to one segment of the market.





๏ Concentrated market targeting

Finally there is concentrated market targeting. This may be known as niche marketing.

Market Segment 1

Market Segment 3

Market Segment 2Product

The company perceives the market as being segmented, but for some reason decides to target only one, or a limited number of segments of that market. It could be that the company is too small to have a wide range of products, so concentrates on one segment. Or, the company may believe that it has particular expertise to fulfil the needs of one segment or that the company perceives that segment as being the only one that is profitable. But for whatever reason, the firm concentrates its resources in addressing the very specific needs of one or a very limited number of segments.

A good example of concentrated market targeting can be seen in a holiday industry. In the UK, a company known as the Crystal Holiday concentrates on skiing holidays. It has made to that segment of the market its own and designs holidays making use of its expertise there.

5. Product positioning (the 7Ps)

5.1. Introduction

‘Positioning’ means make a product or service address specific segments of the market.

Originally there were four variables or levers that could be used. These were known as McCarthy’s marketing mix, or the Four Ps. Now 7 Ps are often shown:

๏ Product

๏ Price

๏ Promotion

๏ Place

๏ People

๏ Process

๏ Physical evidence

The first four (product, price, promotion, and place) were the original components of the marketing mix and relate to the marketing of both services and products.. The three last ones (people, process, and physical evidence) are specifically to do with positioning services. The three additional Ps are sometimes known as the service extension to the marketing mix

When services are provided there is no physical product and so there is a growing importance in skills and attitudes of the people who provide the service.





The process by which a service is provided, and the physical evidence that something has actually happened are also important.

For example, if you are booking an airline flight, you may ring up the airline and you expect to be dealt with in a helpful and friendly way by the representative. The process has to be convenient to you, you don’t want to be waiting too long before your phone call is answered. Finally you expect some sort of physical evidence, such as an e-mail, to show you that the service is actually going to be provided.

5.2. Product

The first of the Four Ps is product, and this includes:

๏ The features of the product (what it does)

๏ Quality,

๏ Design,

๏ Brand,

๏ Packaging.

For example, take calculators. Some have got simple arithmetic functions whereas others have trigonometric, scientific or statistical functions; some have rolls of paper on which calculations can be displayed. These are all different features of the product. Some calculators will be relatively cheap and perhaps very durable whereas others will be of high quality for everyday office use. Design might not be very important in calculators, but some are marketed on the basis of having a sleek futuristic looking design whereas others are more commonplace. Brand and packaging are probably not particularly important for calculators, but are very important when considering something like cosmetics or perfume where the packaging might possibly be more expensive than the contents.

5.3. Pricing

The second of the Four Ps is price. This includes not only the price itself (the price level or price point), but also discounts for bulk buying which is particularly important in business-to-business sales. Price also includes the terms, ie how long a customer has to pay. There are also various types of strategic pricing, described below.

Pricing can be more sophisticated than it first looks. For example if your customer had a very seasonal business, perhaps in agriculture, you might be able to make your product attractive to that customer if your terms of sale were arranged to match that customer’s cash flow. Perhaps the customer could buy in the spring and not have to pay until the autumn when crops are harvested.

Price skimming is when a very high initial price is set for a product, for example a new electronic product. You might know that there will be a certain number of people who will be prepared to pay, let’s say $1000. After they have all bought the product you can then lower the price, say to $900, and there will another layer of people who will be willing to pay that, and so gradually you work your way down. Price skimming is nearly always a temporary phenomenon. Prices usually fall, if for no other reason because other manufacturers will join in and bigger volumes that have to be sold.

Penetration pricing means going in with a very low initial price in a hope of getting a very high market share. With luck the high market share will give you very high volume and consequently a low cost per unit for production, and you may be able to sustain a very low market price indefinitely. Indeed, this can be a strategy to protect yourself against new entrants to the market. If you are going with a low price and win, let’s say a 70% market share, it will be quite expensive for anyone else to come into the market and make as good profits as you are.





Related product pricing aims to get someone ‘hooked’ by a low initial price, then follow up prices are high. A good example of related product pricing can be seen with inkjet printers. Typically a new inkjet printer might cost around $100, but then to renew the ink cartridges might be costing about $70. The initial printer is almost a lost leader, the rationale being that once you have bought that, the follow-on cost of maintaining and replenishing the supplies is where the profit is going to be made.

5.4. Influences on prices

The prices that can be charged depend on:

๏ Costs

๏ Competitors

๏ Consumers

๏ Controls

Costs

Ultimately revenue must cover costs. Often cost plus pricing is carried out to give an indication of the desired cost. For example:

Cost + desired mark-up = selling price

If the mark-up required is 30% then if an item costs $150 to make it will be sold for:

$150 + 30% = $195

This is an easy calculation, but there is no guarantee that the goods will sell at the price that is calculated. There might be cheaper competing goods or customers might baulk at the high price demanded.





Competitors

There are four competitive environments:

There are four main types of market, each giving rise to a particular type of competition:

๏ Perfect competition. Many small suppliers and customers none of which can influence the market. There is free entry and exit from the market and all supply identical products. Here, suppliers must charge the market price. They cannot charge more because, as the products are identical, every customer would move to cheaper suppliers; there is no point in reducing their prices because all output can be sold at the market price. It is worth noting that the Internet has tended to make price and competition much more transparent and that there are sites which specialise in comparing suppliers’ prices.

๏ Oligopoly. A small number of suppliers supplying identical products. An example is found in petrol companies. If a supplier increases prices, the others simply have to maintain theirs to gain market share. If a supplier reduces prices, the others must follow suit to maintain their market share. There is therefore little incentive to reduce prices as competitors will follow.

๏ Monopoly. One supplier of a product. The supplier can charge whatever is wished, though demand is likely to vary as a result. This is the great freedom a monopolist has: choose the price to charge so that profits can be maximised. Note that despite that statement, being a monopolist does not guarantee that a profit is made. You might be the sole suppliers of something no one wants.

๏ Monopolistic competition. This is an almost self-contradictory term. It means that there are a number of suppliers supplying similar but not identical goods. Essentially, the products are being differentiated in some way and therefore can command different prices. Suppliers are competing, but with different offerings.

Price competition means that consumers are motivated primarily by price and usually suppliers will have to offer low prices to succeed. Very often organisations which use a cost leadership strategy adopt price competition. Their products are ordinary, but because their costs are very low (if not actually the lowest) prices can also be kept down.

Many laptop producers use price competition because, for most, their products have been commoditised: they all do the same things, with the same operating systems, run the same application software and have similar reliabilities.





Non-price competition means that consumers pay attention not only to the price of the goods but are also influenced by other marketing mix variables such as the:

๏ Quality, brand and features of the goods

๏ Promotion activities

๏ Place (where the goods or services are obtained).

Essentially, organisations which follow a differentiation or focus strategy will be making use of non-price competition. They seek to make their products different so that they are particularly attractive to consumers, who in turn are willing to pay premium prices. Considering again the laptop producers mentioned above, we could probably argue that Apple uses non-price competition. Its laptops look different and unique, they have a different operating systems and run different (but often compatible) software. This can make it different to directly compare prices, but many people have the impression that, insofar as it’s possible to compare like with like, Apple machines are more expensive than others. Nevertheless, they sell well and profitably.

Consumers

Suppliers have to keep in mind both what the end consumers are willing to pay and also the profits that will be expected by intermediaries in the supply chain. Many industries have ‘rules of thumb’ about the mark-ups they expect to be able to apply. It is common to segment markets according to wealth so that a company will have a ‘value’ range of goods for poorer or thriftier customers who might respond to price competition, and a more exclusive range for better-off customers, who might respond to non-price competition.

Even if there are not different lines of goods for different customer groups, it can still be possible to charge different prices for the same product to different groups. This is known as price discrimination. For example, it is often cheaper to buy electronic goods in the USA than in Europe. Leakage of goods from the cheaper to the more expensive market must be prevented in some way, so the groups have to be sufficiently separate (or un-informed).

The perceived value of goods is a concept which is also related to non-price competition and, indeed, to price. We have all, no doubt, been influenced by the thought that a higher price implies goods of a higher value even though we are often essentially ignorant about the merit of those goods. For example, when buying a T shirt there is a very wide range of prices for a range of garments which are very similar looking. We assume that the expensive T shirt with the fashionable label is ‘better’ than the cheaper, more basic lines. However, often we really don’t know, and might even be paying for the kudos we feel an exclusive label gives us.

Whether goods are necessities or luxuries also influences consumers’ reactions to prices and price changes. This affects the elasticity of demand of the product, which is a measure of how a change in sales volume is caused by a change in price. Goods that have a high elasticity of demand are very price sensitive and are likely to be luxury products that consumers are prepared to do without if the price rises too much. Raising prices will be more than offset by a rapis fall in volume and revenue will decrease.

Goods with a low elasticity of demand are relatively unaffected by price changes and are likely to be necessities. As prices rise, demand will stay high and revenue will rise because customers need the goods.





Controls

Some industries are closely regulated by statute and regulation, and they have little power to choose their own prices. Other industries are able to, or try to, dictate final prices charged to consumers. For example, exclusive perfume and cosmetic producers resist price competition by insisting in their supply contracts that their retailers do not discount their products. Note that not all contractual arrangements are legal. Pricing cartels (competitors fixing prices) are frowned upon by most governments.

5.5. Promotion

There are four main types of promotion:

๏ Advertising

๏ Sales promotion

๏ Personal selling

๏ Public relations.

We are all familiar with advertising and we know that it can take place on a number of different media. For example, television, magazines, newspapers, billboards by the side of roads. Television addresses a mass audience and it wouldn’t be particularly sensible to advertise a specialist product there. Those types of products would be better advertised in specialist magazine.

Billboards by the side of roads can’t contain huge amounts of technical information. People can’t and won’t stop to read them. They can only give a very brief impression of the product and to spread knowledge of its existence and perhaps its brand name.

The internet is now a very important and powerful advertising medium. With television advertising you broadcast to all viewers but only some of whom might be interested and you are never sure who they are. Internet advertising, however, is often started when a user visits a particular web-site or enters a search term. The user’s activities can then be tracked and measured.

Sales promotion is something which happens very close to the point-of-sale. You may have been in supermarkets where staff offer small portions of cheese or small glasses of wine for you to try in a hope that you will then go and purchase. Buy one get one free offers and coupons which give you money off the next purchase are also forms of sales promotion.

Personal selling is when a salesman or saleswomen, a sales representative in other words, goes around spending time with customers or potential customers trying to persuade them to buy. This is very important in business-to-business sales and, of course, it is economically justified there because often the orders placed in business-to-business sales are quite large and valuable. It only happens in business-to-consumer sales where the value of the product is particularly high.

Public relations usually means good mentions in the press. Sometimes there are charitable endeavours where a local firm has made some sort of donation or lent some sort of equipment. Perhaps sponsoring the local amateur football team also falls into the category of public relations. Public relations doesn’t particularly advertise a product, it tends to be rather more orientated towards giving a good impression of your organisation.





Promotion can be divided into two categories:

๏ Push promotion

๏ Pull promotion

Imagine a new product is about to be launched. Push promotion is concerned with getting the product into the shops and would use, for example, personal selling. Pull promotion is getting the public to demand that product, to go into shops and ask to buy it. That promotion could be done by advertising. For the whole promotional campaign to be successful, you need both push promotion and pull promotion to match up. There is no point in people knowing about a product if it is not available; there is no point in the product being available if nobody wants to buy it.

5.6. Place

The last of the four Ps is ‘Place’, meaning the place you go to buy or acquire the product. It really means distribution. Considerations to bear in mind there are:

The length of the distribution chain. The shortest distribution chain is going directly from manufacturer to consumer and this is sometimes seen in mail order businesses. Some computer manufacturers such as Dell operated in this way for many years. It doesn’t work quite so well when you come to distributing something like clothing

By contrast, many consumer goods have a very long distribution chain, going from manufacturer to wholesaler to retailer and ultimately to the consumer. Everyday products such as sugar, milk, butter, cigarettes follow this sort of distribution chain because it gets the goods very, very deeply and widely distributed within a community. They become available in almost every outlet. Those types of goods are sometimes called convenience goods, goods that you expect to be available in a convenient way and where you probably won’t bother getting in your car to travel across the city to buy a particular brand.

Things like carpets, furniture, large electrical items. These represent significant amounts of money, they are rare purchases, which, we hope, will last for many years. There, we would bother to travel across the city to go to a major outlet which offers us comparisons of many different brands of product. So those types of goods tend to be sold through a smaller number of larger outlets.

Suitability of the outlet. For example, if you are selling very, very high quality audio equipment, you would expect the people in the shop to be able to explain the pros and cons of different systems. Perhaps the shop should be equipped with soundproof rooms where could try different speakers out in. You wouldn’t expect to buy very high quality audio equipment in your local supermarket.





6. Social media

Social media such as Facebook and Twitter have become very important promotional tools. Be-friending a supermarket allows you to receive up-to-date offers, recipes and news. Similar effects are obtained through Twitter accounts where consumers can follow brands and suppliers.

Note that some Twitter campaigns have backfired on companies where consumers have been disappointed or feel that the organisation is being unfair. Angry ‘tweets’ can be ‘retweeted’ and soon multiply potentially damaging a brand.

Social media can be used for guerrilla and viral marketing:

๏ Guerrilla marketing is designed to allow small businesses to promote their products or services in an unconventional way with only a small budget. It involves focusing on grabbing the attention of the public in a personal and memorable way. Some large companies also use unconventional advertisement techniques

The main point of guerrilla marketing is that the activities are done exclusively in public places, such as shopping centres, parks and streets. The hope is to attract a crowd which in turn attracts other people who wonder what the fuss is about.

๏ Viral marketing is an approach which relies on information about a product being spread by people, particularly if they post links on the internet (for example to YouTube), send emails, post Facebook ‘Likes’ or tweet to their friends and followers. Often the subject matter is an amusing picture or video featuring the product to encourage propagation of the message. Hand held devices such as smart phones and tablets are important in this marketing so that the volume of recipients and visitors to a site grows quickly.

An example of Viral Marketing is the Cadbury Gorilla campaign. This was a 90 second film sequence, aired in cinemas, TV and the Internet, of a gorilla passionately playing the drums to Phil Collins’ 1981 hit “In the Air Tonight”. The sequence was uploaded the YouTube shortly after its public release in August 2007, and received over 500,000 views in its first week. Cadburys reported a 9% increase in sales on the year before and, interestingly.

7. The impact of E-business

7.1. Introduction

The terms e-business and e-marketing are often user interchangeability but strictly e-commerce refers to the customer-facing side of the operation (web-site, sales, order delivery) whereas e-business includes e-commerce plus internal processes such as inventory, human resources, production and finance

E-commerce implies marketing, buying and selling over the Internet. Most businesses now have a web presence even if not buying and selling through their website. A simple web-site can provide customers and potential customers with details about the company. Furthermore, a well-designed web-site should be findable by Google and other search-engines and this can be a valuable source of new business.

Strictly, e-commerce means entering into transactions over the Internet. For example a company like Amazon trades exclusively in this way. Other companies, like many supermarkets, have a mix of physical outlets plus they allow customers to buy through their web-site for delivery by courier or post.





7.2. The 6Is of e-commerce and e-marketing

E-business has the following characteristics, known as the 6Is which differentiate this approach from conventional commerce:

๏ Intelligence: this is collected every time a user visits a web-site.

๏ Individualisation: based on the intelligence collected each user can be given a unique experience by the supplier. For example, Amazon will make recommendations about which other books or films you might like.

๏ Interactivity: users are encouraged to review products etc. They can also often customise the product they want to buy.

๏ Integration: once an order is placed over the internet, much of the subsequent processing and despatch of goods is automated.

๏ Independence (of location): E-business can give even small companies a global presence.

๏ Industry (structure changed): think how iTunes has altered the music business. E-books are altering the conventional publishing industry.

Social media, such as Facebook, have become very important tools in e-marketing.





Chapter 8

MARKETING TOOLS

1. Marketing research

1.1. Introduction

Good marketing depends on good information, and this comes from marketing research.

Who are our customers? What do they want/need/appreciate/respond to?

Information is needed, not guess-work, on all of the marketing mix

There are three types of marketing research:

๏ Desk research

๏ Field research

๏ Test markets

1.2. Desk research

Desk research uses information that has already been collected. This approach is usually relatively quick and cheap, but might not answer all your questions.

Sources of information are:

๏ Internal – accounting department

๏ Internal - data warehousing and data mining

๏ Government – national and local

๏ Market research consultancies

Internal sources

First of all, the accounting department can supply enormous amounts of information, provided the information with properly coded originally. For example, if instead of simply crediting one sales account in a nominal ledger, there are various different categories of sales account. One can easily see how the sales of different products may be increasing or decreasing perhaps seasonally or perhaps in responds to competitor action. The process of keeping track of sales goes in further if the company sets up a data warehousing system.

As explained in Chapter 5, ‘big data’ has become a vital marketing tool. A good example of this is seen when supermarkets provide their customers with loyalty cards. This may encourage customers to go back and accumulate points which can then be traded in for some product later on, but the real benefit of the supermarket is that the shopping habits of their customers can be carefully recorded.





Every purchase made at the supermarket using the loyalty card is recorded and this information can be kept for many years. That’s the data warehousing part of the operation.

Data mining means that data is then examined in the hope of finding something useful or unexpected which would help the marketing of the products or services of the supermarket. It may uncover certain patterns or seasonality of the sales of products. It may uncover unexpected correlations of sales of different products, so by putting these products together near each other on the shelves overall sales are increased.

External sources

Some companies find valuable external data from the information which is routinely collected by governments, both national and local. For example, most countries run a census perhaps every 10 years, so governments know very precisely how many children there are, for example under the age of five. This could be useful to a company producing educational equipment or educational publications, they need to know whether the school population is going to be increasing or decreasing and by roughly how much. Local governments frequently know how many people lie within a certain radius of the centre of the city and this can be useful when, for example deciding where to position a supermarket. Often for detailed government information the company may have to pay, an information can be available more or less instantly.

Finally, there are market research consultancies which collect information routinely in the hope of selling it to suppliers of products and services. For example in the motor industry, research consultancies routinely collect information about the number of new cars registered in the period, the average price of second hand cars, and probably something about the profile of customers buying each model. If you were for example working in Ford Motor Company, it might be very useful to you to purchase this information if they gave you some insight in the success or otherwise of a say cars manufactured and sold by Volkswagen, Renault, and General Motors.

1.3. Field research

Field research means going out and collecting specific information. The first and perhaps commonest method is the use of questionnaires. In fact, you may well have been stopped by someone who is carrying out a market research survey. It may ask you about your consumption habits, it may ask you what adverts you remember seeing in television the previous night, they might ask you what well-known brands of beer or cars or petrol that you remember and they may show you sometimes examples of marketing initiatives to get your opinion or whether or not you think they might be successful or desirable. Sometimes market research companies get together panels of users who can then discuss between themselves various ideas and views while it’s been monitored and recorded by the market researcher.

At some stage it may be important to actually test products before they are released. For example new food products, new chocolate bars are often given to families to consume and several weeks later the researcher comes back and asks what people’s opinions were of these products. Product testing is also important to establish the safety and durability of certain products and that type of testing is often done on research lab.





1.4. Test markets

The final piece of marketing research comes just before a new product is launched. The company might decide to experiment in a test market. So, rather than a full national or international launch, the product is tried out in a relatively small area. Test markets should be:

๏ Small

๏ Representative of the full customer population

๏ Stable population (a university town would often be unsuitable the population varies radically from as terms change)

๏ Suitable facilities. So, if you were aiming to sell you product through supermarkets and advertising it on a local radio station, your test market should have these facilities also.

The company will watch carefully how the launch goes in the test market. Frequent additional market research should be carried out and the test market gives the company its last opportunity to get things right before it goes to the expense of launching nationally. Remember not only is an obvious loss of money if a product launch is unsuccessful. There will also be damage to the company’s reputation and it may mean that the company will find it difficult to get into that segment of the market in the future had they once failed.

2. Business to Consumer, Business to Business and Business to

Government marketing

The group to whom marketing efforts are addressed will affect the approaches taken. For example:

๏ Business to consumer (B2C):

Inexpert buyers so susceptible to promotional messages. Promotion often by TV, newspapers and the Internet. Products are used domestically so often don’t need to be as sturdy as products used in business. Styling will often be different so as to suit a domestic environment. Small quantities bought, on-line or from retail outlets.

๏ Business-to-business (B2B)

Very expert buyers so they will bargain very hard to get discounts and lower prices. Promotion typically by catalogue and by sales representatives visiting. Quality often very important. Styling can be office-like.

Large orders mean that certain buyers will be very important and must be looked after carefully.

๏ Business-to-government (B2G)

Often huge orders so prices will reflect this. Often specialised negotiation tactics and promotion needed. Decision on purchasing often very slow so representatives need patience.





3. The marketing of services and products compared

The nature of what is provided by service orientated businesses is often different to what manufacturing businesses provide in the following respects:

๏ Heterogeneity: manufacturing often produces many identical units; service industries often produce tailored products eg an audit. Costing information and efficiency measurement will be quite different. Pricing will be very different as customer (or clients) will find it more difficult to judge prices.

๏ Perishability: many services are perishable ie they lose their value after a certain time. An example is airline seats: once the aircraft departs the seats have no value. Again, this presents interesting pricing challenges. Performance will be improved by attracting each extra passenger at the maximum marginal price, but if everyone knows that prices will fall near the departure date, passengers will be encouraged to postpone booking until prices reduce.

๏ Intangibility: it is difficult to show potential customer what they will get for their money. Auditing firms cannot show clients an audit or audit file so how can potential clients judge value for money?

๏ Simultaneity: in manufacturing, production and sale can be separated. This allows products to be quality checked before dispatch and allow flexibility in timing. For example, production can be carried out steadily throughout the year and inventory can be stored until busy sales periods. Services cannot be stored and are often instantly delivered. This places additional demands on scheduling, pricing and quality control information

๏ No transfer of ownership: Often services or the use of a service provider is for a limited period of time. Pricing and demand information has to reflect this. For example, the pricing of hotel rooms will vary from week-days to weekends. In addition because a service is being provided for a limited period only, consumers are likely to be very demanding during that period.

The information needed to perform well when providing a service will often be more related to qualitative than quantitative aspects. For example, reputation, customer satisfaction, availability of the service when required,

4. Relationship marketing

Relationship marketing is a form of marketing that emphasises customer satisfaction and retention, rather than simply living from sales transaction to sales transaction.

Relationship marketing has been aided by software that allow tracking and analysing of each customer's preferences, activities, conversations with the seller, tastes, likes, dislikes, and complaints. For example, a car manufacturer that maintains a database of when and how customers buy their products, the options they choose, the way they finance the purchase etc., is in a powerful position to develop one-to-one marketing offers and product benefits. The aim is to turn a casual customer into a client (a repeat customer) and eventually to be an advocate of the company.





Obviously when customers access the company’s web-site visit pages and perhaps eventually make a purchase, relationship data can be built up easily.

5. Experiential marketing

Experiential marketing, sometimes called "engagement marketing," "event marketing", "on-ground marketing", "live marketing" or "participation marketing," is a marketing approach that directly engages consumers and invites and encourages them to participate in the evolution of a product or brand. The objective of experiential marketing is to create a closer bond between the consumer and the brand by involving them in a fun, exciting and memorable experience.

For example:

Zappos (on-line clothing): on one of the busiest travel days in the USA, Zappos sprung a surprise on one of its most loyal markets, Houston. Zappos turned one of the baggage carousels at George Bush Intercontinental Airport into a "Wheel of Fortune"-style game that awarded travellers the prizes upon which piece of the carousel their luggage landed on.

Coca Cola and the Fort Lauderdale Convention & Visitors Bureau created bus shelters in some northern cities that warm shivering commuters in wintry weather while promoting brand messages. Coke brought "happiness" and Fort Lauderdale, Florida pointed out that they could be sun bathing elsewhere.

6. Brands

A brand is a unique design, sign, logo, symbol (or combination of these) used to create an image that identifies a product and differentiates it from competitors.

Over time, successful brands become associated with desirable qualities of the product such as quality, reliability, price, taste. This enables consumers to quickly identify and buy products that they like and trust.

For example, supermarket shelves are crowded with competing products, but when shopping we often simply grab the familiar (for example a packet of toothpaste like ‘Colgate’). The packaging, colours and graphical devices allow us to quickly find and buy the product without much thought – except we know that the brand has pleased us previously.

Brands owners often work hard to associate a particular image with their brands (for example, up-market or down-market) and defend the image strongly. For example, some manufacturers will allow their luxury brands to be stocked by only exclusive outlets.

Brand value (or brand equity) considers the additional income a company can make from a product with a recognisable brand name as compared to its generic equivalent. If consumers are willing to pay more for a generic product than for a branded one, however, the brand is said to have negative brand equity. This might happen if a company had a major problem or scandal associated with a brand (think of Volkswagen in 2015 with the diesel emission scandal).





7. Product life cycles

7.1. Introduction

The product lifecycle is a well-known diagram which purports to show how the sales revenue and net cash flows of a product change as it moves from the introductory phase through growth to maturity and then decline. It is always shown as follows but not every product life will follow this shape.

Sales

Introduction Growth Maturity Decline Senility

time

Profit

The problem with this diagram is that no product is guaranteed to follow this pattern and even if it does the lengths of the various phases on the diagram will show tremendous variation. For example, the mature phase of some products can last for decades, but for others may last only a few years. What we would really like to know for product planning purposes is when irrevocable decline sets in. This diagram doesn’t predict that. What it does do is provide us with a set of labels which can be used as a kind of shorthand.





7.2. The phases explained

๏ Introductory phase: if we know that a product is in the introductory phase we know that we should want to watch sales very carefully to see whether the product is likely to succeed or not.

๏ Growth phase: here, many competitors will start coming into the market, encouraged by our success. We might therefore want to keep advertising the product strongly so that we can stay ahead of the field.

๏ Mature phase: at the mature phase there are likely to be many suppliers, and buyers of this established product are likely to be well-informed and demanding. Generally at this phase there is price pressure and buyers demand more for their money as they are more aware of the different features of the product. In extreme cases, there may be over-capacity in the industry and this will cause very extreme price pressure indeed.

๏ Decline phase: businesses must be careful not to misinterpret a temporary dip in the sales as the start of the decline phase. Relatively cheap upgrades and facelifts can extend product life for a few years and that is important because usually development costs will have been already covered, as will depreciation of machinery bought for the production of that product. The additional years can be very profitable despite the product being in decline. Decline phases can last for very long times for some businesses and plenty of money can still be made there. A strategic decision has to be made as to whether or not to get out of the product quickly or whether to be the last player remaining standing, effectively becoming a monopoly player in a declining market.





7.3. Life cycle costing

Although not all product life cycles necessarily follow a predictable bell shaped curve, all products do have a life that can be described as:

๏ Initial costs - before production

๏ Operating costs - during production

๏ Disposal costs - after production

๏ The concept of life cycle costing recognises that, if a profit is going to be made, revenue has to cover all costs, not just the production costs.

๏ For example:

๏ Initial research and development cost $2m

๏ 100,000 units would then be made with each cost $10 to manufacture.

๏ Demolishing the factory at the end of its useful life cost $0.5m

Total life cycle cost = $2m + $10 x 100,000 + $0.5m = $3.5m

Life-cycle cost per unit = $3.5m/100,000 = $35.

The selling price would have to be set above this for a profit to be made.

8. Boston Consulting Group Matrix (BCG)

The Boston Consulting Group Matrix is another very well-known analysis. Note that it is sometimes known as a portfolio analysis and it really makes sense to use the BCG Matrix if there is more than one product (or product line) in a company’s portfolio. The axes of the matrix are relative market share and the market or industry growth rate.

Question mark/ problem child

Star

Dog Cash cow

Low

Low

Market growth

rate

High

High

Relative market share

We’ll go through each quadrant in turn.

๏ Question mark/problem child. This product has a high growth rate but a low market share. Why is it known as a question mark or problem child? Well, the BCG analysis suggests that there is no long-term future for this product if it has only a small market share. Suppliers who have large market shares have much greater economies of scale and could easily dominate the small supplier. The question therefore is: should we get out of this product or should we try and grab a large market share? If we go for the large market share, this will require investment. It will be a heavily negative cash flow and losses will be made because money has to be spent on





promotion, research and development or investing the margin (that is reducing the selling price to win a higher market share).

๏ Star products. If the quest by the problem child for high market share is successful, the product will become a star. This isn’t as good as it sounds. Although we now have a high market share (and therefore would enjoy economies of scale and are well down the experience curve), because we have one of the highest market shares, and highest profiles, competitors will be trying to steal market share from us. We will be the target for competitors also wanting to gain a high market share. Remember, if the market has a high growth rate this product is perceived as a product with a future and many companies will be anxious to get a large share of the action. Therefore, cash flow with the star product is usually soon to be roughly zero.

๏ Cash cows. The initially high growth rate of products will always slow down, perhaps to zero or even becoming negative (a declining market). The product then becomes a cash cow. It’s a cash cow because we still have a high market share but nearly all the initial expenses will have been written off. Also because this is now perceived as an old product, competitors will not be keen in stealing market share from us. Essentially they leave us alone. We therefore enjoy high cash inflows without having to spend a lot on promotion, or research and development, or defending our market share. At this stage there will be great emphasis on cost control in order to to maximise profits.

๏ The dog sector is on its own. Cash cow products do not turn into dogs! This is a product which has a low growth rate and we don’t have much of a market share. Therefore, get out of it, divest. There’s no point spending time effort and money achieving a high market share in an old product. So, close down the production facilities or try to sell them to another company.

Finally let’s return to the name “portfolio analysis”. If we have lots and lots of problem children they will all require financing and where is that money going to come from? If we have almost exclusively cash cows we have a very positive cash flow now, but a few years down the line the market for those cash cows could have declined rapidly and what are we going to replace those cash flows with?

A well-balanced portfolio has some cash cows and some question marks. The cash generated from the cash cows can be used to invest in the question marks, so securing the long-term future of the company.









Chapter 9

HUMAN RESOURCE PLANNING (1)

1. The importance of human resource management (HRM)

1.1. Introduction

Human resource management can be defined as:

“Human resource management is defined as a strategic and coherent approach to the

management of an organisation’s most valued assets the people working there who

individually and collectively contribute to the achievement of its object.”

(Armstrong)

HRM views people as an important resource or asset to be used for the benefit of the organisation and its employees with mutual benefit to the achievement of both organisational and individual goals. HRM is as important as cash management, ensuring that there are enough raw materials and that customers are happy with the products provided.

1.2. HRM difficulties

It’s worth noting the following particular difficulties with HRM:

๏ Changes in population, higher skill levels, a move from manufacturing to service industries, more frequent job changes, and potential changes in the work-life balance. All of these mean it is more difficult for an organisation to ensure that it has adequate human resources to fulfil its strategic plans.

๏ An organisation’s human assets leave the premises each evening and there is no guarantee that they will come back to that they won’t voluntarily relocate themselves to a competitor. You do not get that sort of behaviour with computer equipment or other assets!

๏ People are not machines and their performance varies depending on their mood and on how they are managed and treated within an organisation.





2. The HR cycle

2.1. Introduction

The whole human resources cycle is summarised in this diagram.

Selection:

• Advertising

• Shortlisting

• Interviewing

• Testing

• References

InductionPlanningPerformance

• Motivation

• Job design

Development,

training

Appraisal

Rewards: fixed,

performance

2.2. Planning stage

Human resource planning should be based on the strategic plan of the organisation. If the strategic plan suggests that the organisation is going to be opening in most countries in Europe it will need people with the proper language skills. If the organisation is moving organisation up market, it may need better people or at least people who are trained differently.

In essence, there has to be a budget:

๏ Assess the current position: what people are there? With what skills?

๏ Look at the future requirements. This will depend on the organisation’s strategy, growth, the environment it is going to be trading in, and technological changes.

๏ Adjust the current position for estimated leavers, estimated number of people who will retire, the aspirations and hopes of the people already employed, and the sort of skills they have.

๏ Essentially, there is going to be a gap which has to be filled.

Current human resources:

adjust for leavers, retirees,

internal job changes

Future human

resource needs Recruitment

Let’s say the current position showed 100 people with adequate skills, but the future requirements, suggested 500 people of those skills would be required. That’s a gap of 400, but then take into account those who may leave and retire, let’s say that’s another 50 people over the five years. Therefore, the company will have to recruit around 450 people. Of course, that won’t be an accurate figure, it’s an estimate, but the company needs to know whether our recruitment burden is something like 100 people, 1,000 people or only 10 people.





2.3. Selection

Selection covers a large number of steps:

๏ Job analysis to find out what the job entails. For example, will it involve customer contact, supervision of a team, travel, budgeting, and IT competencies?

๏ A job description will be the result of the analysis: it sets out what the person will be doing.

๏ A person specification can then be prepared. This sets out the type of person, skills a person who could carry out the job: skills, experience, intelligence, personality, physical attributes such good eyesight.

๏ Next advertise to attract candidates. The advert must be worded so as to attract a reasonable number of potentially suitable applicants. Sometimes a business will make use of a recruitment agency to help with the wording. Also recruitment agencies often have lists of people on their books who are looking for jobs and they can quickly select candidates for interview. Applicants are shortlisted for the next stage.

๏ The interview stage is usually next. Interviewing well is a skilled process if it to be of any use identifying good candidates. Often it is done badly and is not successful at discovering better candidates.

Closed questions (ie can be answered with ‘Yes’ or ‘No’) should be avoided. For example “Can you work to deadlines?” will almost certainly produce the answer ‘Yes’. Instead, ask open questions such as ‘How do you deal with work pressure and tight deadlines”.

Increasingly frequently tests are given to candidates as part of the interviewing process:

๏ Ability: if someone claims to be able to type at 80 words per minute, it won’t take long to prove that claim.

๏ Intelligence: might be needed for candidates who have few formal qualifications

๏ Aptitude: often used to select trainee computer programmers.

๏ Psychometric tests: used to assess candidates skills, knowledge and personality. For example, will the person show initiative or be good at working in a group.

๏ Work sample tests replicate the work tools and environment associated with the vacancy, to assess the level of the candidate’s current skills and knowledge as accurately as possible. This involves looking at a sample of the skills and behaviours that can be used to predict future performance in a similar work situation.

Sometimes employers use an assessment centre to provide an extended period of interviews, tasks and assessment exercises. The process can last for several days. This method of assessment is expensive and usually confined to candidates who will be expected to progress quickly through management levels in the organisation.

Appointment: the favoured candidate is offered the job. There might be some negotiation about terms, conditions and the starting date. After the candidate accepts, it is recommended that references are taken from their existing employer to confirm their job title there, dates of employment and salary.









Chapter 10

HUMAN RESOURCE PLANNING (2)

1. Appraisal

Employees’ performance must be monitored to identify and evaluate:

๏ Inadequate standards of work

๏ Where training or additional experience might be needed

๏ Where promotion might be in order (progression)

๏ To determine pay and bonuses

It is important that managers prepare properly for appraisal interviews by collecting information about each employee’s performance and also looking at previous appraisal records where the employee might have been told areas where improvement is needed.

3600 appraisal is becoming increasingly common where employees are appraised by their boss, their subordinates and their colleagues.

It is also important that good two-way communication is encouraged rather than the manager simply doing all the talking. Employees might have legitimate complaints or reasons why their performance seemed to be inadequate. Finding out employees’ preferences is also important for the employees’ promotion and movement through the organisation.

Most appraisal processes make use of a form listing the important aspects of performance such as: technical ability, punctuality, ability to get on with customers etc. Scores are allocated to these elements of performance (eg – 5 to + 5).

The most effective way of doing this is using an open appraisal process in which the form is initially blank and the manager and employee go through it together discussing what the mark should be. This forces the parties to communicate. Less successful is where the manager has already filled in the form and then goes through it with the employee. Managers will rarely change a score no matter what the employee says.

The appraisal approaches are sometimes described as:

๏ Tell. Your manager tells you how you have got on with little room for discussion or disagreement.

๏ Tells and sells. Your manager tells you how you got on and tries to persuade you that view is correct

๏ Problem-solving where employer and employee cooperate in arriving at a fair appraisal.

A number of problems can arise from poorly-executed performance appraisals. Indeed some writers and practitioners dislike the term ‘performance appraisal’ because of its judgemental and critical overtones. They prefer to use the term ‘performance management’ so that emphasis is placed on improving the performance of the employee – which should benefit both employer and employee.





J Lockett suggested six barriers of human performance appraisal. These are:

๏ Confrontation: angry disagreement and emotions block any useful communication and the employee feels persecuted.

๏ Judgement: one-sided criticism by the manager with no employee input.

๏ Chat: too informal and doesn’t lead to conclusions or targets

๏ Bureaucracy: form-filling the appraisal form so that the manager can say that task is done – but no other purpose.

๏ Event: a traditional, annual ceremony carried out every year with little thought about its purpose

๏ Unfinished business: no proper to-do lists or follow up. Promises might have been made in the meeting but they are then forgotten.

2. Competency frameworks

Competency frameworks are a method of describing the values, skills and abilities that are required to perform given roles. They also provide clear focus to support the development of staff in order to deliver the best possible performance. They can also be used as recruitment tools.

Typically, to define a framework for a given role, there will be a general description of the competency followed by a list of attitudes, behaviours, skills and abilities that would indicate competence in the relevant area.

There can also a negative statement at the end of each competency to indicate the sort of behaviour that is actively discouraged, as it works against the principle of continual improvement an organisation is striving for.





Competency frameworks serve several purposes which help organisations to improve and develop their staff, products and services. They:

๏ Inform prospective recruits what is expected of them

๏ Inform staff of the sort of attitudes, behaviours and skills the organisation encourages when carrying out their duties

๏ Inform staff of what they can expect from their managers

๏ Can be used to shape and define the organisational culture based around strong principles of acceptable and expected behaviour

๏ Supports and guides staff at all levels in their development in order maximise their potential

๏ Should link to some of the key strategies that drive the objectives of the organisation as these are crucial to success.

Target

performance

Actual

performance

Generic competences

Fire safety 80 50

First aid 0 0

Ethics 75 75

Specialist skills

Excel 100 80

Accounting package 80 80

Competence definition:

Skill description

Skill aims and objectives

Competency levels and their

definition

Evidence of employee

competency:

Date competency attained

Trainer/assessor data

Assessment method





3. Training and development

3.1. Introduction

•Training: very specific and dealing with current employees needs for their current job.

•Development: less specific and more aimed at equipping employees for future jobs.

3.2. Delivering training and development

Training and development can be delivered by:

๏ Formal, face-to-face courses, sometimes in-house and sometimes delivered by external trainers.

๏ Coaching, where a junior watches, accompanies and is helped by a more senior employee whilst the junior is doing their job.

๏ Shadowing, whereby a trainees follows and observes a more senior person doing the job.

๏ Computer based training software.

๏ Self-study of manuals.

๏ Being sponsored by employers to undertake external qualifications, such as MBAs.

Training and development can be expensive. Trainers have to be paid and trainees are devoting time to being trained rather than doing their main jobs. Furthermore, if the training is wrongly pitched, the trainees will not be more able to do their jobs after training than before. So training has to be designed carefully and the following steps are typical:

๏ Establish analyse training and development needs for each person.

๏ Set training objectives eg what the person should be able to do afterwards that was not possible before.

๏ Plan the training and arrange for trainees to have time in which to undertake the training.

๏ Deliver the training.

๏ Review the success of the training that has taken place and update training records.





4. Motivation of employees

Identifying how employees can be motivated is of great importance to employers. Motivation was once described as getting employees to run towards a target rather than amble towards it.

A motivated employee is fired-up to try hard and to do better.

There are many theories of motivation. One famous one that is easy to understand is Herzberg’s Hygiene Theory.

Herzberg was using the word “hygiene” as an analogy with hospitals. If the hospital is going to make you well it must be hygienic; in other words, clean. If it’s not hygienic you’ll get worse. But hygiene itself doesn’t make you well: hygiene is just a starting point.

Herzberg argued that an organisation must get its hygiene factors correct before it can start motivating employees. If a hygiene factor is missing then people become dissatisfied.

Examples of hygiene factors would be enough money to live on, reasonable relations with colleagues and your superiors, reasonable physical conditions in which you’re working, a feeling that you’re being fairly treated. If any of these is missing you are likely to be so upset that none of the other motivating factors that the organisation tries will work.

Once the hygiene factors are in place then you can have the motivating factors such as recognition, praise, a feeling that you are advancing and getting better skills, a feeling that what you’re doing is worthwhile interesting work, and a feeling of having responsibility.

In his first version of the theory, money was only present as a hygiene factor; later versions had money as both a hygiene factor and a motivation factor. The Herzberg theory is sometimes known as a two-factor theory (hygiene factors + motivation factors).





5. Job design

5.1. Introduction

Most theories of motivation suggest that there is more to successful work environments than simply requiring people to unthinkingly repeat simple tasks: challenge, variety, initiative, recognition and team-work are all seen as valuable contributors to motivation and productivity. Undoubtedly there will be some situations where traditional production lines, in which each person does only a repetitive simple task, will minimise the marginal cost of production. However, those calculations would not take into account:

๏ The costs of recruitment and training caused by high staff turnover that is likely to result if employees dislike their jobs.

๏ The costs of staff shortages.

๏ Poor quality because employees do not identify with what they are producing.

๏ Disengagement of employees from trying to improve production methods.

In the 1960s and 1970s these considerations gave rise to the job design movement which attempted to improve jobs (and employee performance) by deliberately designing ‘better’ jobs with characteristics that should produce the following outcomes:

๏ High intrinsic motivation, leading to high productivity

๏ High job performance (quality)

๏ High employee satisfaction

๏ Low absenteeism

๏ Low employee turnover

5.2. Job design in practice

The practice of deliberate improvement in a job’s characteristics is called ‘job design’ of which there are three types:

๏ Job enlargement means allowing an employee to take on more tasks, but still at the same level. So if you were working on a car assembly line, instead of merely fitting the front wheels, you are now asked to fit the front and rear wheels and the bumpers (fenders). The job cycle time is increased (you would spend longer on each car), there is some more variety and therefore less boredom. Note however, that all of these tasks are at the same level: basic, repetitive assembly tasks.

๏ Job rotation moves employees round, perhaps on a daily basis, from one simple task to another. So, one day the car worker might be on wheels and bumpers, the next day the worker might be fitting the front and rear windows. The third day would be a different set of tasks. Again this introduces the employee to some additional skills (though all at the same level) reduces boredom and is perhaps beginning to give more insight into task identity: building a car.

๏ Job enrichment is a vertical change because it gives an employee some responsibility, discretion and authority that would previously been exercised by supervisors and managers. So now the car worker might be expected to perform some quality control checks as the car is being worked on, or might be responsible for reporting production problems. Not only does this





increase task significance but it adds to challenge and autonomy. Feedback can also become more comprehensive.

6. Reward systems

Rewards can be:

๏ Extrinsic: rewards that arise outside the employee and include pay, praise by a manager and promotion.

๏ Intrinsic: rewards that arise from psychological enjoyment and the satisfaction of challenge and a feeling of having done well.

This section deals with extrinsic rewards arising from an employee’s pay structure.

Pay can be divided into three parts:

๏ Base pay: such as a monthly salary, or a rate per hour

๏ Performance pay: which relates to performance, such as a sales representative’s commission.

๏ Indirect pay: which relates to benefits such as pension contributions and employee life assurance.

Performance pay can be:

๏ Performance-related pay: this links additional payments directly to the performance of an individual or team.

๏ Incentive pay: offered before setting performance targets to encourage acceptance of the targets or changes in work practice.

๏ Profit-related pay: where additional payments are made based on the organisation’s profits.

๏ Share-based plan: where shares in the employer are given to employees. The hope is that if employees own shares in their company they will want the company to do well.

๏ Merit pay: for exceptional past performance.

๏ Commission: a financial incentive typically based on sales performance.

๏ Team-based pay: rewards members of a team according to performance of the team. This should encourage members of the team to cooperate and to be mutually supportive.

For performance pay to be an effective motivator for employees it is essential that any objectives given in order to qualify for additional remuneration are SMART:

๏ Specific: precise achievements and targets that are easy to understand.

๏ Measurable: necessary to prevent pay being arbitrary

๏ Agreed/achievable: employees must believe that with effort the target can be achieved otherwise they are liable to give up.

๏ Time-limited: targets should be achieved by a specific time.









Chapter 11

ETHICS

1. What are ethics?

1.1. Definition

Ethics is concerned with distinguishing between good and evil, between right and wrong human actions, and between virtuous and non-virtuous characteristics of people and organisations, and the rules and principles that ought to govern behaviour.

Ethics pervades business. For example:

๏ Technology usage: issues about privacy, surveillance, collecting information secretly, monitoring employees.

๏ Business strategy: moving operations abroad, approach to competition, monopoly building.

๏ Finance: paying suppliers on time, realistic forecasts and proper accounting

There are a number of philosophical approaches to ethics. For example:

๏ Absolutists: believe that certain actions are always wrong – no ‘ifs’ or ‘buts’.

๏ Relativists/pluralists: believe that that nothing is objectively right or wrong and that ‘right’ or ‘wrong’ depend on the prevailing view of a particular individual, culture, or historical period.

๏ Consequentialism: whether something is right or wrong depends on the consequences, or outcome, of the act.

But these terms are not of great importance to this syllabus as the importance of good ethics can be demonstrated using arguments about good, sustainable business decisions leading to profit maximisation.

2. The importance of ethics in business

Different stakeholders are likely to have different ethical views. For example, on a crowed train some standard class passengers might see nothing unethical about sitting in first class (“I’ve bought a ticket I should have a seat”); some other passengers and managers of the train company might see this as unethical (“You can buy extra comfort if you want to”). Some shareholders might have ethical objections to their company taking part in arms manufacturing whilst directors and employees might have no ethical objections.

Perhaps what is most important is that stakeholders are informed about a company’s ethical position on a number of issues so that there is openness and that everyone understands the company’s ethical stance. Corporate codes of ethics can help to achieve this. These are documents issued to employees that attempt to establish ethical rules or guidelines so that employees know how to behave if, for





example, offered a bribe by a supplier or they see a machine in a dangerous condition, or they are considering whom promote.

Often these guidelines are made available to outside stakeholders to advertise the company’s ethical stance. For example, the Coca Cola ethical guide can be found at:

http://assets.coca-colacompany.com/45/59/f85d53a84ec597f74c754003450c/COBC_English.pdf

Here is a short extract from the section dealing with treatment of customers, suppliers and consumers:

“Always deal fairly with customers, suppliers and consumers, treating them honestly and with respect:

๏ Do not engage in unfair, deceptive or misleading practices.

๏ Always present Company products in an honest and forthright manner.

๏ Do not offer, promise or provide anything to a customer or supplier in exchange for an inappropriate advantage for the Company.”

Even if stakeholder disagrees about what appropriate ethics are, the importance of an organisation being ethical can be linked to its profitability or its financial viability. Organisations might obtain short-term advantages by being unethical (for example to encourage sales a pharmaceutical company could conceal a drug’s side effects) but most ethical breaches are discovered and then huge long-term damage is done both financially and reputationally.

Good ethics therefore:

๏ Reduce the risk for shareholders.

๏ If risk is reduced then capital can be raised more cheaply (the cost of capital and risk are linked).

๏ Goodwill towards the company is increased – improving sales.

๏ Regulatory compliance is easier to achieve, reducing the cost of damages and fines.

๏ Good candidates are attracted to companies with good reputations

๏ Joint ventures are easier if the company has a good reputation







3. CIMA’s ethical guidelines

CIMA’s ethical guidelines are based on those of the International Ethical Board for Accountants (IESBA), part of the International Federation of Accountants (IFAC).

The fundamental ethical principles are:

๏ Integrity: be straightforward and honest in all professional work. Stand up for what you believe to be right. Do not ‘turn a blind eye’.

๏ Objectivity: do not allow bias, self-interest or conflicts of interest to influence professional judgements and conclusions.

๏ Professional competence and due care: carry out work to proper standards; don’t skimp; keep up to date with changes in legislation, methodology and regulations.

๏ Confidentiality: do not disclose information received through professional work without permission or if there is a legal duty or right to disclose it.

๏ Professional behaviour: comply with laws and regulations and do not act in a way that brings CIMA or the wider accountancy profession into disrepute.

Compliance with the ethical guidelines is continually threatened. For example, integrity and objectivity can be threatened by personal relationships which could mean that an accountant does not want to report errors made by colleagues. Accountants have to ensure that threats are reduced to acceptable levels.








Documents

A Managing Finance in a Digital World (E1)opentuition.com/files/securepdfs/2019/07/New-CIMA-E1...Overview of Paper E1 3 1. The Finance Function in the Digital Age 5 2. The Finance