AQA GCSE (9-1) Business, Second Edition

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BUSINESSAQA GCSE (9–1)

Malcolm Surridge, Andrew Gillespie

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Acknowledgements

pg. 4, Reproduced with the permission of Fatface (www.fatface.com); pg. 14, Department of Business, Innovation and Skills:© Crown Copyright; pg. 17, Reproduced with the permission of Honest Burgers (www.honestburgers.co.uk); pg. 27–28, Reproduced with the permission of Sport England (www.sportengland.org); pg. 61, Reproduced with the permission of eMarketer; pg.65, From ‘WhatsApp: the secret weapon for small businesses’, The Telegraph, 29/01/15 (Rebecca Burn-Callendar) © Telegraph Media Group Limited; pg. 88, ONS © Crown Copyright; pg. 89, Trading Economics data © Crown Copyright; pg. 93, Trading Economics data, Source U.S. Bureau of Economic Analysis; p95, World Bank, Global exports 1960-2015; p96, CIA World Factbook pg. 100, Reproduced with the permission of Merrythought Ltd; p120, Ofcom © Crown Copyright; pg. 147, Reproduced with the permission of Warwick Business School; pg. 155, Reproduced with the permission of Center Parcs UK; pg. 221, Reproduced with the permission of Sport England (www.sportengland.org).

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ISBN: 9781471899386

© Malcolm Surridge and Andrew Gillespie

First published in 2009

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ContentsIntroduction v

1 Business in the real world1.1 The purpose and nature of businesses 21.2 Business ownership 101.3 Setting business aims and objectives 201.4 Stakeholders 301.5 Business location 351.6 Business planning 411.7 Expanding a business 46

2 Influences on business2.1 Technology 582.2 Ethical and environmental considerations 682.3 The economic climate of business 822.4 Globalisation 942.5 Legislation 1072.6 The competitive environment 117

3 Business operations3.1 Production processes 1323.2 The role of procurement 1403.3 The concept of quality 1483.4 Good customer service 153

4 Human resources4.1 Organisational structures 1644.2 Recruitment and selection of employees 1754.3 Motivating employees 1894.4 Training 198

5 Marketing5.1 Identifying and understanding customers 2125.2 Segmentation 2185.3 The purpose and methods of market research 2245.4 Elements of the marketing mix 2345.5 Using the marketing mix: product and pricing 2395.6 Promotion and distribution 251

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6 Finance6.1 Sources of fi nance 2646.2 Cash fl ow 2766.3 Financial terms and calculations 2866.4 Analysing the fi nancial performance of a business 298

Glossary 314

Index 320

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Welcome to your AQA GCSE Business course.

1. What you will studyYour GCSE is divided into six parts which we have presented as separate chapters.

Chapter 1: Business in the real world. This part of the course is designed to introduce you to the subject. It considers the purpose of business activity, the role of business enterprise and entrepreneurship, and the dynamic nature of business. While studying this unit you will encounter the different legal forms a business can take, the goals they set themselves, how they decide where to locate and how they plan their activities. Both this chapter and chapter 2 relate to the four functional areas of business (business operations, human resources, marketing and finance) that are covered within chapters 3 to 6.

Chapter 2: Influences on business. All businesses are influenced by external factors and this unit considers some of the most important of these, including technology, the economic climate, globalisation and the law.

Chapter 3: Business operations. Discover the different ways that businesses produce goods and services, how they manage their stock and their suppliers and how they attempt to produce high quality products and provide excellent customer service.

Chapter 4: Human resources. Topics within this chapter include how businesses structure their organisations, how they recruit and select new employees and how they motivate and train those employees once they start work.

Chapter 5: Marketing. This chapter encompasses the ways in which businesses identify, understand and target their customers with advertising and other methods of promoting their products. This chapter will help you to understand how businesses discover the needs of their customers using market research.

Chapter 6: Finance. This final chapter will help you to understand how businesses raise the finance they need to establish and expand their businesses. It will also show how businesses manage their cash, calculate their profits (or losses) and use financial data to judge their performance.

IntroductionIntroductionIntroduction

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2. The benefits of using this bookEach chapter within this book is divided into a number of sections to give you a series of short topics to study. Included throughout are the following:➜ Key terms have been defi ned to help you to use business terminology to

identify and explain business activity as required by the specifi cation.➜ Regular ‘Business insight’ boxes link the theory that you study to examples of

actual businesses. It is important that you can see how different businesses are affected by issues and topics from throughout the GCSE course.

➜ ‘Maths moment’ features will help you to use numbers effectively. Using quantitative data effectively is an important skill within GCSE Business.

➜ The book is illustrated with a large number of pictures and diagrams to help you to understand the subject. Many of these have questions which are intended to make you think more deeply about the issue.

➜ ‘Study tips’ give you advice on a range of topics to enhance your understanding of this subject.

➜ At the end of each section there are short answer and data response questions. These allow you to test your knowledge and understanding.

➜ At the end of each chapter there are further practice questions and some sample answers showing you the ways to tackle (and sometimes how not to tackle) these types of questions.

3. What examinations will you have to take?Your GCSE course is assessed through two examinations.

Paper 1: Influences of operations and HRM on business activity. This examination is worth a maximum of 90 marks and comprises 50% of your GCSE result. It lasts for one hour and 45 minutes and covers:➜ Business in the real world➜ Infl uences on business

➜ Business operations➜ Human resources

Paper 2: Influences of marketing and finance on business activity. This examination is worth a maximum of 90 marks and comprises 50% of your GCSE result. It lasts for one hour and 45 minutes and covers:➜ Business in the real world➜ Infl uences on business

➜ Marketing➜ Finance

Both examination papers have three sections:➜ Section A: multiple choice and short answer questions worth 10 marks.➜ Section B: a short case study with questions worth approximately 40 marks.➜ Section C: a short case study with questions worth approximately 40 marks.

Good luck with your GCSE Business course.

Malcolm Surridge & Andrew Gillespie

April 2017

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1Business in

the real world

The purpose and nature of every business is different. In this chapter, we look at the very beginning of starting a business. We consider the reasons that you might choose to start one, the types of business that exist, setting aims and objectives to measure how successful the business is, and how a business can grow and expand. We also look at how location can affect a business, the different stakeholders that have an interest in the business and the kinds of activities that businesses carry out.

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1.1 Topic

There are many different forms of business and many different reasons why businesses exist. In this topic, we will consider why people set up in business and the typical objectives that organisations have. We will also examine the environment in which businesses operate and how this can affect their behaviour.

By the end of this topic, you should know:

● the purpose of business

● the reasons for starting a business

● the basic functions and types of business

● business enterprise and entrepreneurship

● the dynamic nature of business.

● The purpose of businessA business is an organisation that produces a good or supplies a service. A good is a physical product, such as a car. A service is an intangible item (that is, it is something that you cannot physically touch), such as fi nancial advice or a yoga lesson. A business involves people – sometimes one and sometimes thousands – and aims to provide something that is demanded by others. Businesses provide a range of products for customers. A customer is someone who buys a product. Products are used by consumers. For example, if you buy a mobile phone for yourself, you are the customer and the consumer. If your parents buy it for you, they are the customer and you are the consumer.

A business is successful if it can meet the needs and wants of customers effectively. A need is a basic human requirement – we need to eat and drink, for example. A want is the desire for a particular product. We need to drink, but we want Coca-Cola. We need to get from A to B, but we want to do so in a Ferrari.

Key terms

A good is a physical product, such as a car.

A service is an intangible product (that is, you cannot touch it), such as fi nancial advice or a bus journey.

A customer is someone who buys a product from a business.

A consumer is someone who uses goods and services produced by businesses.

The purpose and nature of businesses

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1.1 The purpose and nature of businesses

● Reasons for starting a business

People who start up their own business are called entrepreneurs. Entrepreneurs are willing to take risks to set up on their own. They see an opportunity and have the determination, motivation and focus to start their own businesses rather than working for someone else. The ability to be an entrepreneur – to take risks to develop a business idea – is known as entrepreneurship.

What are the objectives of entrepreneurs?There are many reasons why people might want to be entrepreneurs. For example:➜ They want to be their own boss and make their own decisions (rather than

being employed by, and reporting to, someone else). ➜ They want to keep all the profi ts of a business for themselves (rather than

working for owners who keep the profi ts) so they earn more money than if they were employed by someone else.

➜ They need a job and starting their own business is one way of making sure that they are employed and, hopefully, that they earn money.

➜ They have an interest or hobby and this grows into a business.➜ They want to prove something to themselves (and possibly others) by

showing they can start a business for themselves. This may give them a sense of satisfaction.

➜ They are unhappy with their present job and want to do something different.➜ They want more fl exible working hours. They want to be able to work when

they want to, rather than having to work the hours that an employer wants them to work.

➜ They have spotted a business opportunity and believe they can make profi ts from providing this good or service.

➜ They want to provide a service for others. Some businesses are set up to help other people, for example, a shop set up for and run by the local community or a local centre set up to help the homeless. These are known as social enterprises and are not necessarily profi t-making.

Setting up in business creates many exciting opportunities for people – they can make their own decisions and create something new. If the business is successful, there is likely to be a sense of personal achievement. Establishing a business gives people an opportunity to show their skills and possibly make more money than they could by working for someone else.

Key terms

An entrepreneur is someone who is willing to take the risks involved in starting a new business. Entrepreneurship refers to the ability to be an entrepreneur – to take risks to develop a business idea.A social enterprise is a business that is set up to help society rather than to make a profi t.

Sir Stelios Haji-Ioannou has set up many different businesses, such as easyJet, easyCar, easyCinema, easyCruise, easyJobs, easyBus and easyHotels.

We may need to move around for our work. We want to do so in a sports car!

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1 Business in the real world

Factors of production – land, labour, capital, enterpriseFactors of production are the resources (or materials) that businesses use to provide their goods or services. These include:➜ land – the physical land and the site on which the business is located, and

other natural resources a business might use➜ labour – the skills and numbers of employees employed by a business➜ capital – the equipment used to provide the goods or services, such as

machinery and equipment ➜ enterprise – the skills of the people involved in the business to identify

business opportunities and bring together resources to meet these opportunities.

What a business is able to produce will depend on the quantity and quality of its resources and the way in which these resources are combined and managed.

Opportunity costThe opportunity cost is the sacrifi ce we make whenever we decide to do anything. If we decide to go out tonight, we sacrifi ce the work we could have done. If we stay in, we sacrifi ce the enjoyment of going out. There is always a trade-off when we do anything. Whenever you make a decision, it is important to consider the opportunity cost – what are you giving up? For example, if you decide to set up a business, you may be giving up a more secure income in your existing job. If you decide to invest your savings in a business, then you are not using these savings to earn money, which is known as interest, in the bank.

Key terms

Resources are the inputs that businesses use to provide their goods or services.

An enterprise is another word for a business. It also refers to the skills of the people involved in the business to identify business opportunities and bring together resources to meet these opportunities.

Interest is the money paid by banks as a reward to attract people to save with them.

Business insight

FatFace

Here is a description from the FatFace website of the company’s approach and how it was founded:

‘It was 1988. Two young British guys were skiing in the French Alps, had an idea, and started to

talk. What if they started selling tees and sweats, and made enough money to carry on skiing? And what if it was possible to live their dreams by setting up a small business with a big heart?

Their favourite ski run was ‘La Face’ in Val D’Isere, a ‘black-run’ which inspired our company name FatFace. Over 25 years later we still love adventure, love life and have the same strong values. We still make clothes that refl ect the happy, healthy and active lifestyles of our customers.’

Source: www.fatface.com

The founders of FatFace set up a business because it was a hobby that they loved and wanted to pursue. Analyse two other reasons why people might set up a business. (6 marks)

http://www.fatface.com

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What are the characteristics of entrepreneurs?There are thousands if not millions of entrepreneurs in any country and so, not surprisingly, the characteristics of these people differ in many ways. However, most entrepreneurs are:➜ Innovative. This means an entrepreneur is good at spotting an opportunity.

They can see a problem with the way things are done and can imagine a better way of doing things. They have a vision of how things could be.

➜ Risk takers. An entrepreneur takes a risk that their idea is going to work. In reality, many new ideas fail. Setting up a business involves time, money and emotional effort. If you get it wrong, you may have lost your savings and you may feel as if you have failed. So you need to be prepared for this.

➜ Hard working and determined. If you are setting up a business, you need to be prepared for it to be a struggle. As a new business, you will not be well known and will probably have to bargain hard to get a good deal with suppliers. You need to work hard to get your business known and, in many cases, it will just be you at the start and so it can be quite exhausting.

➜ Organised. Running your own business involves many skills and many decisions. You will often have lots to do and will usually have to be good at meeting deadlines. You will have to organise materials, people, production, orders, deliveries and fi nances. So you need to be good at managing things.

Study tip

In order to decide whether or not a business is successful, it is always important to know why someone started up the business in the fi rst place. If the original aim of the organisation was to help others, then even if it does not make a profi t it may still be a success.

Business insight

Richard BransonRichard Branson, the founder of Virgin, set up his fi rst business – a magazine called Student – in the 1960s when he was still at school. He used to run it from the school phone box. Since then, he has gone on to create hundreds of businesses under the Virgin name, involving music, nightclubs, trains, planes, taxis, bridal wear, cola, insurance and pensions.

Analyse the characteristics that might explain Branson’s success. (6 marks)

● Types of business and their basic functions What sectors do businesses operate in?Whatever you can think of, some business somewhere is probably providing it. There are many different types of business and they can be classifi ed in different ways. For example, some businesses offer physical goods, such as furniture. Others provide a service, such as education. Many businesses provide a combination of the two: we may choose to go to a restaurant because of the atmosphere and environment (a service) as well as the food (a good).

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Businesses can also be classified in terms of their stage in the production process:➜ The primary sector is made up of organisations that are at the fi rst stage

of production and use raw materials. Farms, oil exploration companies and fi shing fl eets are primary businesses.

➜ The secondary sector is made up of organisations that are at the second stage of the production process. They are involved in using primary resources and converting these into products. Examples of secondary businesses are manufacturers and printers.

➜ The tertiary sector is the fi nal stage and is made up of organisations that provide services, for example, fast food stores, estate agents and delivery companies.

Maths moment

About 2 per cent of workers in the UK are employed in the primary sector. About 22 per cent are employed in the secondary sector.

1 What percentage of employees are employed in the tertiary sector?

2 What are the biggest businesses in your area? Are they primary, secondary or tertiary?

The functions of a businessA business transforms resources into outputs. To be successful, it must understand its customers effectively and make sure it provides products that are in demand. It needs to think about the nature of the product, how to promote the benefi ts of the product to potential customers, what price to set and how and where customers will want to buy it. These activities are all part of the marketing function (see Chapter 5).

The business must produce the good or service. For example, running a hotel involves activities such as taking bookings, cleaning rooms, managing the restaurant, organising check outs. The activities involved in the production of the product are part of the operations function (see Chapter 3).

To provide the product will involve people. In many cases, there may only be one person in the business, but some organisations have hundreds or thousands of people working for them. Managing people (for example, recruiting and

Figure 1.1 The four business functions

Marketing Operations

FinanceHuman

resources

The primary, secondary and tertiary sectors

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training staff and deciding how to reward them) is known as the human resource function (see Chapter 4).

A business will also have to manage money. It may need to raise finance, it will need to monitor what is spent in different parts of the business and it will need to calculate whether the business has enough money. These activities are part of the finance function (see Chapter 6).

Whether the business is small or large and whatever products it provides, it will have marketing, finance, human resource and operations functions.

● The dynamic nature of businessThe business environmentA business will be affected by changes in the ‘business environment’. This refers to all the factors outside a business that can affect it.

Changes in the business environment can be described under the following headings:➜ Technological change. Technology is changing at a rapid rate. This

creates new markets and products. Snapchat is relatively new, for example. Technology also changes the way we shop and how and what we buy. Think of the challenge to hotels provided by AirBnB, which now allows people to search online to fi nd somewhere to stay in someone else’s house or fl at so they do not need a hotel. See Topic 2.1 for more on the infl uence of technology.

➜ Economic change. This involves a range of economic factors outside a business, such as the cost of borrowing money from banks (the interest rate), the rate at which prices are increasing (which is called infl ation) and the income in the economy (which is called Gross Domestic Product or GDP). The term ‘economic environment’ is sometimes used to refer to these economic factors outside a business (see Topic 2.3).

➜ Legal change. These are new laws and regulations (legislation). These may affect costs (for example, by insisting businesses pay a minimum wage to their employees) or demand for a product (for example, by preventing tobacco companies advertising their products). See Topic 2.5 for more about the infl uence of legislation on business.

➜ Environmental expectations. Customers and consumers are increasingly interested in the impact of a business on the environment. What resources is it using? How is it producing the product? How does it transport its product? The impact of the actions of a business can infl uence whether a customer uses that business or not. Even if demand was not affected, some business people would still be concerned about the environmental impact because it affects what the world will be like for future generations. See Topic 2.2 for more about environmental considerations.

The business environment is constantly changing (that is, it is dynamic). Just look at any newspaper or news site and you will appreciate how much change

Key terms

Interest rates refer to the cost of borrowing money or the reward for saving money, expressed as a percentage.

Infl ation refers to the rate at which prices are increasing. For example, if infl ation is 2 per cent, prices are generally growing by 2 per cent that year.

Gross Domestic Product (GDP) measures all the income earned in a country’s economy in a year.

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there is – changes in incomes, changes in the number of people working, new laws, new competitors, and so on. A business has to keep adapting. You may once have made money from selling typewriters, but you would struggle to do so these days. You are unlikely to experience increased demand for cigarettes in the UK and so you would need to look for other opportunities. Businesses cannot stay still. They need to be nimble.

Study tip

Try not to confuse the business environment, which includes legal change, economic change, social and technological change, with environmental issues, which refer to factors such as pollution and global warming.

Business insight

Coca-Cola Zero SugarIn 2016, Coca-Cola spent around £10 million advertising its Coca-Cola Zero Sugar. The message of its advertising was ‘Tastes more like Coke, looks more like Coke’. Over 4 million samples of the new product were also given away to help launch it.Zero Sugar has been developed to make the taste even closer to classic Coke than Coke Zero, which it replaced. It is part of a campaign to encourage more classic Coke drinkers to switch to a low- or no-calorie version.Coca-Cola, along with its soft drink rivals, has now been given an economic incentive to move its consumers over, after Chancellor George Osborne announced the so-called ‘sugar tax’ in the 2016 budget.

The tax charges soft drinks manufacturers a levy (tax) per litre of sugary drink packaged for sale, at two rates. The higher rate includes drinks with more than 8 g of sugar per 100 ml, such as classic Coke. The lower rate covers those with 5–8 g, including mid-calorie version Coke Life. Those under 5 g are exempt.A growing number of people in society want to reduce their sugar intake but have been reluctant to try a no-sugar option because they do not think it tastes as good as the original.Analyse the factors in the external environment that have led to the launch of Coca-ColaZero Sugar. (6 marks)

Business insight

Analysing trends in societyRecent trends in society that might create market opportunities include:● greater interest in the environment● greater interest in healthy eating

● greater interest in personalised services, such as tailor-made holidays or advice on what books you might like

● more families where both partners go out to work● an ageing population.

Analyse how any one of these trends might affect a business. (6 marks)

Economicfactors

Technologicalfactors

Socialfactors

Legalfactors

Marketing Operations

FinanceHumanresources

Figure 1.2 External factors influencing business functions

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SummaryThere are many different reasons why people start up in business. Some do it for money, some because they want to achieve something for themselves and some

because they want to help society. Ideas come from their own experiences, from things they have seen elsewhere and from problems they want to solve.

Case study

Elon MuskBorn in 1971, Elon Musk is known as a serial entrepreneur – he just keeps setting up businesses! He began at school selling a computer program he had produced. He went on to set up technology businesses such as Zip2 and X.Com. In 1999, he established PayPal and built this into a very

successful business – when it was sold, he earned around $180 million at the age of 32.

In 2002, Musk set up SpaceX aimed at developing space travel to colonise Mars. In 2003, he established Tesla Motors, a producer of electric cars. Both of these projects were initially thought to be uncommercial but are now attracting a lot of interest. Tesla cars are becoming more familiar on the roads and winning many awards for their technology. Meanwhile, the US space agency is using SpaceX to carry space cargo.

Musk keeps looking for new ideas. He is chairman of the solar energy developers Solar City and has published design studies of a solar power ‘hyperloop’ transport system that will provide extremely fast travel. Musk has been named business person of the year by Fortune magazine and, as of 2017, is said to be personally worth over $13.9 billion.

Musk has been described as a disrupter – he likes to challenge things and change them. He says he is simply trying to make things better. Along the way, he has invested all of his money into SpaceX and Tesla – at times, it looked like he would lose it all because the technology was not working. Many thought he was foolish to risk all his wealth, but Musk says that he felt someone had to try it!

1 Identify two reasons for someone setting up their own business. (2 marks)

2 Explain two possible characteristics of a successful entrepreneur such as Musk. (4 marks)

3 Analyse the possible reasons why Musk wants to be an entrepreneur. (6 marks)

4 Evaluate the reasons why a government should help entrepreneurs set up in business. (12 marks)

Quick questions 1 State two possible sources of new ideas for

a business. (2 marks)

2 What is meant by an ‘entrepreneur’? (2 marks)

3 Explain one reason why someone might start their own business. (3 marks)

4 What is meant by ‘opportunity cost’? (2 marks)

5 What is meant by the ‘primary sector’? (2 marks)

6 State two possible characteristics of an entrepreneur. (2 marks)

7 State two examples of businesses in the tertiary sector. (2 marks)

8 State two changes in technology that can affect a business. (2 marks)

9 State two changes in the economic situation that can affect a business. (2 marks)

10 State two factors of production. (2 marks)

C

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1.2

There are many different types of business in the UK, including sole traders, partnerships and private limited companies. This topic looks at the different forms of business ownership and considers the advantages and disadvantages of each.


● what a sole trader is

● what a partnership is

● what a private limited company (ltd) is

● what a public limited company (plc) is

● what a not-for-profi t organisation is

● the advantages and disadvantages of the different types of business ownership.

● Business ownershipAnyone starting up in business needs to think about what type of business they will have in the eyes of the law (that is, what form of business ownership it will have). There are various options, as shown in Figure 1.3.

Business ownership

Topic

BusinessownershipBusiness

ownership

Sole trader Partnership Company Not-for-profit

Figure 1.3 Types of business ownership

● Sole traderA sole trader is a form of business that is owned and managed by one person. For example, if you set up your own business fi xing people’s computers, you are a sole trader. Setting up as a sole trader is easy. You do not need to register with the government or fi ll in lots of forms. All you have to do is start trading. This

Key term

A sole trader is someone who sets up in business on his or her own.

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1.2 Business ownership

is why it is such a popular form of business and why this method is the one that many famous business people fi rst experienced. Sole traders are owned and managed by the same person, although they may employ other staff.

Advantages of being a sole trader➜ It is quick and easy to set up as a sole trader. Other forms of business, in

comparison, involve registering with the government.➜ You make all the decisions for yourself so you do not need to consult lots of

other people. This can mean that decision-making is fast and you can get things done the way you want them.

➜ You keep all the profi ts yourself, so if your business is successful you do not have to share the rewards with other people.

Disadvantages of being a sole trader➜ It can be quite stressful making all the decisions yourself. Some people will

fi nd it diffi cult to cope with this amount of pressure.➜ A sole trader needs to handle all aspects of the business: the fi nances, the

marketing and the running of the business itself. Some people may not be good at all of these things.

➜ If the business goes wrong, you have unlimited liability. This means that you can lose everything you own.

➜ There is usually a tremendous amount of work to do as a sole trader. For example, when you are working hard to build the business up, it can be diffi cult to take a proper holiday. If you are ill, the whole business may come to a standstill.

➜ If the sole trader dies, the business ends as well, even if he or she has been running the business for many years.

➜ As a sole trader, you may fi nd it diffi cult to raise as much money as you would like in order to get the business going. Sole traders often have to rely mainly on their own fi nances, or those of friends and family, to set up their business. It may be possible to borrow from a bank but, because so many new businesses fail, banks tend to charge a lot of money in the form of high interest rates on loans.

➜ A sole trader business is likely to be small and will not have the power of a large business over other businesses such as those that it buys its supplies from. This may mean higher costs and lower profi ts.

Advantages of a sole trader Disadvantages of a sole trader

You are your own boss Unlimited liability

Can decide things quickly May lack fi nance

Easy to set up Heavy workload

Keep all the profi ts May not have all the skills required

Make your own decisions Diffi cult to take a holiday

Table 1.1 Summary of the advantages and disadvantages of being a sole trader

Key terms

Profi t measures the difference between the values of a business’s revenue (sales) and its total costs.

Unlimited liability means that the personal possessions of the owners of a business are at risk if there are any problems. There is no limit to the amount of money the owners may have to pay out.

12


● PartnershipUnder the 1890 Partnership Act, a partnership is created when two or more people set up in business to pursue a common purpose, such as profi t. For example, a group of designers may set up a studio together, or a group of doctors might set up a practice. Partnerships are usually allowed to have a maximum of 20 partners, although exceptions include solicitors, accountants, auctioneers and estate agents.

Deed of PartnershipWhen setting up a partnership, the people involved (the partners) are advised to write a legal document called a Deed of Partnership. This sets out the rules of the partnership. The Deed of Partnership will usually include details of: ➜ how to divide up profi ts – for example, this may be related to how much

money each partner puts in at the start or how much work they do in comparison to the others

➜ how decisions are to be made (voting rights)➜ how to value the business if someone wants to leave➜ how to decide on whether someone else can join the

partnership.

The purpose of the Deed of Partnership is to avoid disputes. If there is no Deed of Partnership, the profits must be paid out equally, regardless of how much input each person has had.

Advantages of partnership ➜ Several people are involved in a partnership so each one can

contribute money. This should mean more funds are available compared with sole traders who may have to rely on their own funds.

➜ In a partnership, there are more people involved as owners than there are with a sole trader. Therefore, there can be more people involved with discussing problems and deciding on strategies. This may lead to better decisions being made. The partners can benefi t from each other’s experience and insight into problems.

➜ Each of the partners can specialise in a particular aspect of the business, which can mean a better and broader service is provided. For example, in a legal partnership someone may focus on company law, someone may deal with consumer law and someone may deal with property law. This can provide specialist knowledge in more areas than a sole trader may be capable of.

➜ Partners can cover for each other, for example, if someone is ill or wants a holiday. This can mean that being in a partnership is less stressful than running a business on your own.

Disadvantages of partnership➜ The partners may have different ideas about how to solve a problem. This

can lead to disputes. By bringing in partners, the owners are bringing in stakeholders who have a direct role in the business and who will want to express their views.

Key terms

A partnership occurs when two or more people join together in a business enterprise to pursue profi t.

A Deed of Partnership is an agreement between partners that sets out the rules of the partnership, such as how profi ts will be divided and how the partnership will be valued if someone wants to leave.

Key term

Stakeholders are individuals and organisations that are affected by, and affect, the activities of a business.

In a partnership, more people own, and are involved in, the business.

13


➜ Decisions may be slower than for a sole trader because all the partners are consulted, rather than just making a decision for yourself.

➜ The rewards are divided between partners rather than being kept by one person. ➜ The partners normally have unlimited liability. Even if a mistake is made by

one partner, all the partners must pay the price.

Advantages of a partnership Disadvantages of a partnership

Share workload May disagree with the other partners

More sources of fi nance than a sole trader Unlimited liability

Share skills Liable for the actions of the other partners and share profi ts

Table 1.2 Summary of the advantages and disadvantages of forming a partnership

● CompaniesA company is owned by its investors, who are called shareholders. There are different types of shares, but the most common ones are called ‘ordinary shares’. Owners of ordinary shares have one vote for every share they have. If you have 51 per cent of the shares, for example, you have 51 per cent of the total votes.

A company has its own existence in law. This means that it can own things such as land and equipment. It also means that when you, as a member of the public, buy products, you buy them from the company rather than the individuals who own it. By creating a company, the shareholders are showing the difference between what they own as private individuals and what the company owns. This means that they have limited liability. This is very important because it means that people can invest in companies and be fully aware of the most that they can lose if it all goes wrong. Without this, it would be more difficult to attract investors because they would be worried about losing everything they owned if there were problems.

The owners of a company are the shareholders. The people who control the company and make the decisions every day are called managers. In many private limited companies (see below), the shareholders are the managers. However, in public limited companies, the shareholders and managers are often different groups of people and this creates a separation between ownership and control. It is possible that the owners and the managers have different objectives. The managers, for example, may want to invest in long-term projects, such as developing a new product, whereas the owners may prefer to take money out of the business now. This can cause conflict.

Advantages of a company Disadvantages of a company

Limited liability Have to register

Better status in the eyes of some customers Have to disclose information on sales and profi ts

Continues after the death of the founders Have to have accounts independently checked

Can bring in investors If there are other investors the original founder is not in full control of the business

Table 1.3 Summary of the advantages and disadvantages of forming a company

Key terms

A company is a business that has its own legal identity. It can own items, owe money, sue and be sued.

A shareholder is a person or an organisation that owns part of a company. Each shareholder owns a ‘share’ of the business.

14


Company typesUnder the 1980 Companies Act, there are two types of company in the UK: private limited companies (which put ‘ltd’ after their names) and public limited companies (which put ‘plc’ after their names). Both types of company are owned by shareholders and both have limited liability. However, there are differences:➜ A private limited company (ltd) cannot publicly advertise its shares for sale

and is often owned by family members. In a private company, it is possible to place restrictions on whom shares can be sold to, for example, in order to keep a business owned by family members.

➜ A public limited company (plc) can advertise its shares and can be listed (also called ‘quoted’) on the Stock Exchange. It must have a share capital of over £50,000. In a plc, it is not possible to place restrictions on whom the shares are sold to. This means that, if you own some of the shares of a plc, you can sell them to whoever you want and other people can buy them easily via the Stock Exchange.

A flotation occurs when a private limited company decides to become a public limited company. To do this, shares must be sold to the general public and the firm must meet the regulations of the Stock Exchange.

Maths moment

0

Partnerships

Companies

Sole traders

0.5Number of businesses (millions)1.0 1.5 2.0 2.5 3.0 3.5

Source: Department of Business, Innovation and Skills: www.gov.uk

Figure 1.4 Number of businesses in the UK private sector with and without employees, by legal status, at the start of 2015

1 Estimate the total number of businesses in the UK at the start of 2015.

2 Calculate the proportion of businesses in the UK that were companies at the start of 2015. Comment on your � ndings.

Key terms

The Stock Exchange is a market for buying and selling shares of public limited companies. Large numbers of shares are being bought and sold all the time.

A fl otation occurs when a private limited company (ltd) becomes a public limited company (plc) and has its shares listed on the Stock Exchange.

http://www.gov.uk

15


Private limited companiesA private limited company:➜ is owned by shareholders – when a business is starting up, its shareholders

tend to be the business founders, although they may bring in outside investors if they need more funding. The shareholders of many private limited companies are family members

➜ has ‘ltd’ after its name➜ cannot advertise its shares to the general public – if shares are sold, this will

be done privately➜ can include certain restrictions in its Articles of Association to limit who the

shares are sold to (for example, only family members). This helps to make sure that one owner of the business does not sell shares to someone the others do not want.

Advantages of setting up as a private limited company➜ Liability is limited. This means that the shareholders’ personal possessions

are safe, and can help businesses to gain access to funding from investors. Investors would be unlikely to take the risk of putting their money into a start-up if there was unlimited liability. But with limited liability, they are guaranteed a limit to their losses if things go wrong.

➜ For many customers, a company seems to have more status than a sole trader. People assume that a company is better in some way. Setting up as a company may, therefore, be a good marketing move.

➜ If the business founders die, the company still exists and whoever owns the shares now continues with the business.

➜ Managers can be employed to run the day-to-day business while the owners retain control and the profi ts are distributed among the shareholders.

Disadvantages of setting up as a private limited company➜ Various legal procedures need to be completed, such as registering the

company, which take a little time and some money.➜ A summary of the business’s fi nancial accounts must be produced and these

have to be available to the general public. In making information available to other people, including competitors, the business will lose some privacy.

Study tip

You might be asked to compare the advantages of one business legal structure with another. Think about:● the liability of the

business (Is it limited or unlimited?)

● the control of the business (Do the owners want to keep complete control or are they willing to bring in other people?)

● the skills and experience required (Do the owners have enough skills or would they benefi t from other people’s experience?)

● whether or not the owners want to work with others.

Examples of private limited companies in the UK

16


➜ Accounts must be checked by an independent accountant (called an auditor), which will create additional cost.

➜ The business must pay corporation tax (individuals pay income tax) and this may be more than an individual would pay personally.

➜ Any additional investors in the business become important stakeholders. For every share they own they will have a vote, and so they have a direct infl uence on the business. They may not necessarily have the same values and objectives as the original owners. Some entrepreneurs fi nd it diffi cult to work with other investors in a company as their styles clash.

Public limited companiesA public limited company is one that has shares that are sold to the general public. These shares can be bought and sold easily on the Stock Exchange. The share price changes when there is more or less demand for them.

Advantages of becoming a public limited company➜ A public limited company can advertise its shares to the general public. This

means it has access to a greater number of potential investors than a private limited company and therefore it may be possible to raise very large sums of money by selling shares. These could be used to fi nance expansion.

➜ Public companies attract more media coverage because they usually have more shareholders. By becoming a plc, a business is likely to attract more interest from television and newspapers, which provides a good form of cheap publicity.

➜ Public limited companies are usually thought of as having more status than private companies (and are often bigger). This can impress customers.

➜ Investors may be willing to buy shares because they should be able to sell them later on relatively easily. There are usually many shares in public limited companies and these are traded regularly. So if as an investor you decide you want to sell your shares, you should be able to fi nd someone who wants to buy them.

Disadvantages of becoming a public limited company➜ Although more media coverage can be good, it can also be bad. If a plc makes

a mistake or does something wrong, the media are more likely to cover the story than if the business was a private limited company.

➜ A plc cannot control who buys its shares, so managers may fi nd that a competitor buys control of the company and takes it over.

➜ A plc is more regulated than a limited company – it has more things it must do according to the law. For example, it must produce more detailed information on its fi nances each year and send it to shareholders. This can be expensive as well as giving information away to potential competitors and the media.

➜ When a private company becomes a public limited company, it brings in more outside investors. The original owners may not agree with the views and objectives of the new owners – they may clash when trying to agree what the business should be doing.

Study tip

Private limited companies do not have to become public companies unless they want more investment from outside investors. During the process of fl otation, companies have to be sure that there will be demand for their shares at the price they set. This cannot be guaranteed – it depends on what investors think the business will earn in the future.

17


Share ownershipMany of the shares of public limited companies are owned by fi nancial institutions, such as insurance companies and banks. Only around 14 per cent of plc shares in the UK are owned by individuals. The fi nancial institutions often put pressure on the managers of plcs to pay out a lot of their profi ts in the short term; this is so that the fi nancial institutions can reward their own owners, but this does mean that the plcs have less funds to invest.

Maths moment

Look at the data for Honest Burgers in Table 1.4. What is the amount of sales per employee? Use this formula:

sales per employee = sales

number of employees

Business insight

Fitbit The Fitbit company produces wearable technology. For example, it produces a wristband that monitors how many steps you have taken during the day, how many calories you have burned and how far you have travelled. In 2015, Fitbit sold its shares to the general public to become a public company in the USA.

Fitbit had imagined its shares would sell for between $14 and $16, but when they were put on sale the price went up to $20. Having sold these shares, the company was valued at over $4.1 billion. The funds the company raised from the sale will be used for research into new products. Fitbit made losses for many years, but in 2014 made profi ts of $131.8 million. In 2015, it sold over 10 million devices.

Analyse two factors that might have determined the price of the shares Fitbit put on sale. (6 marks)

Business insight

Honest BurgersIn 2011, Tom Barton, 29, and Philip Eeles, 32, who were friends from university, joined up with an experienced restauranteur, Dorian Waite, 48, to start a business together. The three of them wanted to create an upmarket burger chain. They spotted that there was a growing demand for ‘premium burgers’, using high-quality ingredients, and decided to target this market segment with their restaurants. The three of them set up Honest Burgers Ltd and within four years had grown their business to ten sites. Sales had grown to £6.9 million by 2015, making it one of the fastest growing companies in the UK. The company’s

objective is to continue to grow quickly over the next few years.

Annual sales rise over 3 years 205.67%

2015 sales (£000s) 6,900

Number of employees 252

Source: www.honestburgers.co.uk

Table 1.4 Key data for Honest Burgers

Analyse the possible reasons why Tom, Philip and Dorian created a company rather than forming a partnership. (6 marks)

http://www.honestburgers.co.uk

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● Not-for-profit organisationsNot-for-profi t organisations are set up to achieve objectives other than profi t. For example, a charity may be set up to help the homeless or people abroad after an earthquake or someone might set up a youth club to provide facilities for young people in their area. Not-for-profi t organisations will still have to raise funds and invest just like companies. However, the purpose of the business is not to make profi t for investors. A not-for-profi t organisation often has social objectives – it is set up to help society rather than focusing on profi ts; any profi ts made are invested into the business to help society further.

● Which is the right form of business?

The right form of business will depend on the situation of the organisation. For example, when fi rst setting up a business, many individuals will operate as a sole trader. This is because this form of business does not need to be registered and you can simply start trading. At this stage, the entrepreneur probably does not have many assets at risk and protecting these through limited liability is not essential. As the business grows, the owner has more personal assets that could be lost and he or she may want to attract outside investors. At this point, the entrepreneur may want to sell shares to raise fi nance to help the business grow. To attract investors, limited liability is likely to be important so that those buying shares know there is a limit to their risk.

If the people have social objectives (that is, they want to help society) rather than to make profits, it would make sense to set up as a not-for-profit organisation.

SummaryThere are many different legal structures of a business. Each has advantages and disadvantages. For example, a sole trader is easy to set up, but has unlimited liability. A partnership has the benefi t of the input of several different people, but there is a danger that they will not agree. A company has limited liability, but has to make information more public. Choosing the right legal structure is an important business decision when starting up.

When a business wants to grow, it may change its status from a private limited company to a public limited company. This has advantages (for example, shares can be sold to the general public) and disadvantages (for example, the business is more vulnerable to takeover). Owners will have to decide whether the benefi ts of plc status outweigh the disadvantages.

Key term

A not-for-profi t organisation is set up to achieve objectives other than profi t; for example, a charity.

What is theliability of those

who ownthe business?

Limited orunlimited?

Comparingforms

of businessownership

Who are theowners? Arethey different

from themanagers?

How are profitsdistributed?

Who receivesthem?

How can thebusiness raisefinance? Canit sell shares?

Figure 1.5 Factors to consider when comparing forms of business ownership

19


Quick questions 1 State two reasons why an entrepreneur

might want to be a sole trader. (2 marks)

2 State two possible problems of being a sole trader. (2 marks)

3 What is meant by ‘limited liability’? (2 marks)

4 What is a 'shareholder’? (2 marks)

5 State two differences between a private limited company and a public limited company. (2 marks)

6 State two advantages of a partnership compared to being a sole trader. (2 marks)

7 What is a ‘partnership’? (2 marks)

8 State two possible problems of a partnership. (2 marks)

9 What is meant by a ‘Deed of Partnership’? (2 marks)

10 Why might someone buy shares in a company? (2 marks)

Case study

Snapchat

Snap is the company that owns Snapchat, the picture- and video-sharing app. It is planning to sell its shares to the general public. It is estimated that the company will be worth $25 billion, depending on the price people are willing to pay for the shares.

The founder and Chief Executive Offi cer Evan Spiegel, 26, is said to be worth $2.1 billion. The company was founded in 2011 and was expected to generate $366.7 million in worldwide revenue from advertising in 2016. In 2015, the company’s total revenue was a fraction of that number at $60 million.

The service, notably popular with younger people, allows users to send pictures and videos of them looking like dogs, zombies or with other strange effects. It has around 58 million users. The Snapchat app is designed so messages delete once they are read or expire. With 10 billion videos being watched every day, the site has seen a 350 per cent increase in use between 2015 and 2016.

In September 2016, the company announced that it was going to expand and launch Spectacles, glasses that can record ten-second clips that can be sent to smartphones. Its fi rst hardware product became available at the end of 2016.

1 What is meant by a ‘private limited company’? (2 marks)

2 Explain two benefits to Snap of launching products that are not apps. (4 marks)

3 Analyse the factors that might affect the price of the shares if Snapchat decided to float. (6 marks)

4 Imagine the managers of Snapchat are considering how to raise funds for investment. Should they:

● float the company on the Stock Exchange, or

● borrow from a bank?

Evaluate which option you would choose. (12 marks)

C

20

Setting business aims and objectives

1.3 Topic

Whenever you set out to do something, it helps if you have a clear idea of what you are trying to achieve. What grade do you want in your Business GCSE, for example? If you are clear about what you want to achieve, you will fi nd it easier to sort out your priorities and make decisions, such as how much time and effort to devote to a project.


● the difference between aims and objectives

● the purpose of setting objectives

● the types of business objectives

● the role of objectives in running a business

● how and why objectives may differ between businesses

● how and why the objectives set may change as businesses evolve

● how a business might use objectives to measure its success

● how the success of a business can be measured in other ways than just profi t.

● What are aims and objectives?An aim is a general goal of the business; for example, the owners may aim to grow the business or make it more profi table.

An objective is a specific target that turns the aim into something that is easier to measure and assess progress. For example, the aim may be to grow, whereas the objective set from this might be to grow sales by 25 per cent within three years. The aim may be to be more profitable, whereas the objective set from this may be to increase profits by 30 per cent within five years. The aims and objectives provide a focus for everything you do and will enable you to look back and see whether you have done what you wanted to. You may, at any given moment, have more than one objective. As a student, for example, you may have

Key terms

An aim is a general goal of a business.

An objective is a specifi c target that is set for a business to achieve.

21

1.3 Setting business aims and objectives

an objective to do well in your exams, while also continuing with your sports and having a part-time job to earn money for your holidays. Entrepreneurs may want to make sure that they provide a good service and earn enough money to live on, while also having some time for their interests and their families. Managers in bigger businesses may be trying to make enough profit for their shareholders, while also looking after their employees and helping their communities.

● The purpose of setting objectivesBy setting objectives, managers will be clear about what they are trying to achieve. This is important for the following reasons:➜ It helps with decision-making and with establishing priorities. For example,

if the objective is to grow the business overseas, then there should be a focus on looking for new orders abroad. If the objective is to stay local, there should be a focus on potential customers nearby.

➜ It helps investors to understand the direction in which the business is heading. This might mean they are more willing to agree to certain decisions. For example, if there is an objective of doubling sales, investors might be more willing to agree to an investment in a new factory. Having clear objectives might help, therefore, when trying to raise money to set up a business.

➜ It provides a target so that everyone can compare the actual results with the planned results to decide how successful the business has been.

➜ It can motivate everyone connected with the business because they know what they are trying to do and how they can measure their success.

Business insight

Google’s ‘10 things’

The founders of Google wrote ‘10 things’ when the company was just a few years old. They think these aims are still relevant to the business today:

1 Focus on the user and all else will follow.

2 It’s best to do one thing really, really well. We do search.

3 Fast is better than slow.

4 Democracy on the web works.

5 You don’t need to be at your desk to need an answer.

6 You can make money without doing evil.

7 There’s always more information out there.

8 The need for information crosses all borders.

9 You can be serious without a suit.

10 Great just isn’t good enough.

You can fi nd out more about Google’s aims at www.google.com/about

Analyse the benefi ts to Google of setting out its ten aims. (6 marks)

http://www.google.com/about

22


● The role of objectivesThe precise objectives of businesses will vary between organisations and over time. In the same way, your objectives may be different from your friends and what you are aiming to achieve may be different at different stages of your life. However, objectives typically centre on the following areas.

SurvivalSurvival is particularly important when a business is being set up. Starting a business is risky and presents many challenges. In the short run, at least, simply surviving is an achievement. To get the business’s name known, it may be necessary to charge lower prices and make lower profi ts than the entrepreneur would like to make in the long run. Survival may also become important when the economy is doing badly. If people are earning less money and spending in the economy falls, some businesses may focus on surviving. For example, they may accept lower prices (and profi ts) to get some sales.

Earning a profitAlthough there may be times when a business does not make a profi t, in most cases this will be one of its long-term objectives. Profi t occurs if the value of what a business sells over a given time period is greater than the costs of providing and selling these products. If a profi t cannot be made, the owners of businesses would usually take resources out of this business and use them elsewhere. Of course, it may take time to generate profi t – companies such as Ocado have taken several years to build the brand and become profi table – but if a profi t simply cannot be generated in the long term, the business is likely to close. However, it is not just making a profi t; the business needs to make enough profi t to cover the opportunity cost of these resources. How much is enough will vary depending on the owners and what they are looking for.

Business insight

Tesla The US electric carmaker Tesla is widely admired as one of the most highly innovative companies in the world, but has yet to make a profi t. It has had 13 consecutive quarters (three-month periods) of losses.

Tesla has been criticised recently for accidents that have occurred in its autopilot cars. Computer hackers have also managed to disrupt the cars from a distance of 12 miles away. However, demand is up and it is now producing over 100,000 cars a year.

Analyse why Tesla would carry on producing cars if it is making a loss. (6 marks)

23


Shareholder valueA company is owned by its shareholders. The shareholders employ managers to run the business on their behalf. Managers will aim to reward their shareholders by:➜ generating profi ts to pay dividends – a fi nancial reward paid on each share➜ running the business well so that people want to buy the shares. This

increases the demand for them and makes the price of them go up. The people owning the shares, therefore, now own something worth more than when they bought it and could sell it for more than they paid for it. By increasing the price of the shares, managers will have increased the shareholder value.

Customer satisfactionBusinesses may set targets that focus on achieving a particular level of customer satisfaction by providing a better service or a wider range of products than their competitors. This should hopefully lead to more profi ts in the long run. If customers are satisfi ed, they are more likely to come back and buy more products. They will also tell their friends to try the products as well. However, ensuring features such as fast delivery, excellent customer information, a wide variety of products and services may involve high costs and lower profi ts in the short run.

Market shareBusinesses may set themselves a target in terms of the share of the market they hope to achieve. The market share measures the sales of one product or business as a percentage of the total market sales. A business may set out to achieve, say, 20 per cent or 30 per cent of a market’s sales within fi ve years.

Business insight

Next

According to its website, the main objective of the Next group is to earn long-term returns for its shareholders through the profi ts earned for each share and the dividends paid.

It aims to achieve this through activities such as:● improving and developing Next product ranges –

the success of this is measured by the sales● increasing its sales space, provided it is profi table● increasing the number of profi table Next Directory

customers and their spending● making sure the business is effi cient through

effi cient product sourcing, stock management and cost control

● focusing on customer service and satisfaction levels.Source: Next: www.nextplc.co.uk

Analyse the possible reasons why Next sets the objective of earning long-term returns for its shareholders. (6 marks)

http://www.nextplc.co.uk

24


Growth Many businesses will have an objective of growth. The owners and managers may want the business to open more stores, sell more products or increase its revenue. Growth may come within the local region, for example, an independent café gaining more customers, nationally (such as Costa opening more stores in the UK) or internationally (such as Costa opening up in Asia). In each case, a business must consider the likely demand and costs, and whether it is likely to succeed. Operating abroad, for example, can be diffi cult due to differences in people’s lifestyles, shopping habits and values. Sometimes it can be diffi cult for an overseas business to understand these unless it changes what it does. McDonald’s, for example, changes its menu in different countries.

For more about growth, see Topic 1.7.

Being ethicalThe ethics of a decision are what is regarded as right or wrong. Some businesses will want to behave in an ethical manner – for example, paying their staff reasonable wages, treating their suppliers and customers with respect and being honest with them about what is happening in their business. Unethical businesses may be criticised by the media and lose customers.

By being ethical, a business may benefit by:➜ getting favourable media coverage➜ using the ethical message in its marketing➜ attracting customers, investors and employees.

Acting ethically may sometimes increase costs, for example, when paying employees more than the minimum required by the law, or when maintaining production in the UK to protect jobs rather than relocating production to a cheaper location overseas. Such increased costs must be weighed against the likely costs of less ethical behaviour – the business could suffer a loss of demand if employees and customers do not approve of its actions.

For more about ethical considerations, see Topic 2.2.

Environmental and sustainability targetsBusinesses might want to make sure that their activities do not damage the environment. They may set targets to limit the energy they use, to limit their carbon footprint, to achieve certain recycling targets, to reduce wastage or to reuse more of their supplies. They may also be interested in making sure the materials are from sustainable sources (this means the sources are renewed or will not run out). For example, a furniture company might only use wood from a supplier that replants whenever it cuts down a tree; a retailer might try to use wind or solar power to provide the energy for its stores. Resources such as oil are non-sustainable (they cannot be used forever) and are running out. This is why some businesses are trying to fi nd alternative resources.

For more about environmental considerations, see Topic 2.2.

25


Maths moment

The equation for market share is:

market share = sales of a product

total market sales× 100

If your sales are £20,000 and the total market sales are £400,000, your market share is:

market share = £20,000

£400,000× 100 = 5%

What would your market share be if your sales increased to £50,000 and the market stayed the same size?

Business insight

M&S’s Plan A 2020According to Marks & Spencer (M&S), its customers are increasingly aware of the impact of business actions on the world and so companies need to work hard to build and maintain customers’ trust. Increased pressure on natural resources and a failure to look after these resources can increase costs and make accessing raw materials more diffi cult.

M&S believes a successful business needs to be environmentally and socially sustainable. It launched

Plan A in 2007. This is a business plan, designed to prepare the business for the future requirements of its customers.

Having achieved many of its targets in the original Plan A – including carbon-neutral operations, sending zero waste to landfi ll and reducing packaging by 25 per cent – in 2014, M&S launched Plan A 2020. This has 100 new, revised and existing environmental commitments.

Aim to inspire andexcite our customers

INSPIRATION

PLAN A

Listen and actthoughtfully

IN TOUCH

Generating stakeholder returnsthrough effective management of

our financial resources

FINANCIAL

OUR RESOURCES& RELATIONSHIPS

OUR RESOURCES& RELATIONSHIPS

THE M&S DIFFERENCE

Sourcing responsibly andusing natural resources

efficiently

NATURAL

Building and nurturing relationshipswith our customers and suppliers,and in the communities in which

we operate

SOCIAL & RELATIONSHIP

Developing people andtheir knowledge

HUMAN

Maintaining our channels andsupply chain infrastructure to

meet customer demand

MANUFACTURED

Strengthening our brand throughcreation and protection of our

intellectual properties

INTELLECTUALStrive to do

the right thing

INTEGRITY

Aim to improvethings for the

better

INNOVATION

MA

RKET

& S

ERVE

> L

ISTEN & UNDERSTAND > STRATEGY & PLA

NN

ING

>

< R

EAC

HIN

G O

UR CUSTOMERS < STRONG RELATIONSHIPS

< T

RUST

ED B

RA

ND

COREPURPOSE

ENHANCINGLIVES

EVERY DAY

PLAN A 2020

Source: Marks & Spencer: https://corporate.marksandspencer.com/plan-a/our-approach/delivering-plan-a

Figure 1.6 M&S’s Plan A 2020

Analyse why M&S might want to become a sustainable business. (6 marks)

https://corporate.marksandspencer.com/plan-a/our-approach/delivering-plan-a

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Effective objectivesTo be effective, an objective should clearly state:➜ what the target is – for example, to increase profi ts by 20 per cent➜ when it has to be achieved – for example, to achieve the target within two

years➜ who is to achieve it – who is in charge of making sure the target is hit➜ how to achieve it – what is and what is not acceptable behaviour.

To be successful, businesses must set objectives that are achievable and involve only those resources that are available. The resources involved may include the following:➜ Time. Managers often have many different tasks to complete so they must

feel they have a suffi cient amount of time available to focus on a given target.➜ People. Does the business have the staff it needs?➜ Money. Does it have the necessary fi nance to buy the resources and materials

required?➜ Equipment. Does it have the machinery and facilities needed to achieve the

target?

Not-for-profit organisationsFor most private sector organisations, profi t is an important objective. However, not all organisations aim to make profi ts. For example, public sector organisations, such as schools and hospitals, aim to provide a free service for the public. Within the private sector, not-for-profi t organisations include social clubs and charities. There are over 180,000 registered charities in the UK, including Macmillan Cancer Support and the Isle of Wight Donkey Sanctuary. Charities in England and Wales are monitored by the Charity Commission and their objectives are to benefi t the particular cause that they were set up to help.

● Changing objectivesWhen an entrepreneur starts a business, the objectives are usually to survive the fi rst few months or years. Establishing a business can be diffi cult and so surviving is often quite an achievement. It may be enough to win some orders, prove the business idea works and begin to build a reputation. Given the costs of starting up and of promoting the business to gain customers, as well as the diffi culty of gaining customers early on, it is likely that a new business will make losses at fi rst. Over time, it will be expected to make profi ts to cover the opportunity cost (see Topic 1.1) of the resources involved.

As a business becomes more established, its objectives may change. For example, it may want to grow. Managers and owners often want the business to get bigger in order to have more sales and profits. This growth may involve developing more products so the range of goods and services it

Key terms

Private sector organisations are owned by individuals.

Public sector organisations are owned by the government.

One not-for-profit social enterprise, with the profits going to help the homeless, is The Big Issue.

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offers may become wider. It may also involve expanding overseas to target new customers.

Bigger, more established organisations are also usually open to more scrutiny (attention) from the media and government than other businesses. Bigger businesses will employ more people, have more suppliers and have a bigger impact on the community. This means they may want to accept greater responsibilities and be more likely to have environmental and social targets.

● Using objectives to measure successYou can only know whether someone is being successful if you know what they are trying to achieve. Consider a football match in which a team at the top of the Premiership scores a draw with a team at the bottom. At fi rst, you may think they have done badly. However, when you discover they only needed a draw to win the league this season, you can understand what they were doing. Only when you know what the desired result is can you make a proper judgement about whether or not things are going well. The same is true in business. A business making profi ts of £25,000 a year may be a tremendous success to the 18-year-old who started it up as a hobby and was only hoping to make a maximum of £10,000 a year. However, it may be a major disappointment to a team of experienced investors who had set themselves a target of £200,000 profi t a year.

Business objectives provide a point of focus, helping businesses to make decisions about what to do and to review how things are going. This enables them to take appropriate decisions if things get off track. Imagine you decide to take a year out and go travelling. You will probably set targets about what you hope to have seen and done by particular moments during the year. In reality, you might spend longer than you imagined in various places. By having objectives, you can see how to catch up the time to make sure you do everything you want in the year. In the same way, in business, if sales are 10 per cent lower than expected, it is possible to analyse the likely reasons for this and then take steps to boost sales again.

Study tip

Always look for the objectives of the people starting up a business. Only then can you judge properly whether or not they have succeeded. You may not be happy with earnings of £20,000 a year, but someone else might be.

Business insight

Sport EnglandSport England is an organisation set up to build an active nation with more people taking part in sport, whether this is going to the gym, walking or taking part in team sports. Sport England’s mission is to enable everyone in England, regardless of their age, background or ability, to take part in sport or an activity.

It wants to:● increase the number of people in England taking part in sport and activity

and decrease the number of people who are physically inactive● increase the proportion of young people (11–18) who have a positive attitude to

sport and being active

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SummaryA business should have objectives. The objectives set out what the business wants to achieve. They can be used to measure performance and assess progress. The nature of the objectives depends on factors such

as who owns the business and whether it is a new or established business. The nature of the objectives may change over time, for example, if the business has new owners.

Quick questions 1 What is an ‘objective’? (2 marks)

2 State two features of an effective objective. (2 marks)

3 State two advantages for a business of setting an objective. (2 marks)

4 State two possible objectives of a business. (2 marks)

5 State two reasons why a business might change its objectives. (2 marks)

6 What is meant by ‘profit’? (2 marks)

7 What is meant by ‘market share’? (2 marks)

8 How can objectives be used to measure performance? (2 marks)

9 What is meant by an ‘aim’? (2 marks)

10 Why might a business have environmental targets? (2 marks)

● ensure public facilities are used fully and effectively to get maximum use from communities● increase the number of adults using the great outdoors for exercise and wellbeing.

324.9million

75.8m 200.3m

14.8m18.9m

15.1m Participation in sportFacilities

Developing talentAdministrationSports development

Key

Source: Sport England: www.sportengland.org

Figure 1.7 How Sport England spent its funds in 2014–15

1 Four things that Sport England wants to do are stated above. Explain why the way they are written means they are not actually ‘objectives’. (4 marks)

2 Analyse how setting objectives might be useful for Sport England. (9 marks)


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Case study

Ben & Jerry’sBen & Jerry’s, the US company that makes ice-cream, was founded in Vermont in 1978 by Ben Cohen and Jerry Greenfi eld, who described themselves as hippies. The two friends started their ice-cream careers with a $5 ice-cream-making correspondence course from Pennsylvania State University and a $12,000 investment ($4,000 of which was borrowed). Their ice-cream is now world famous but, despite the growth, both Ben and Jerry have always maintained their links with their community and promoted a number of good causes. It is known as a very ethical business.

One of the company’s mottos is: ‘Business has a responsibility to the community in which it operates.’

The actions the company takes include reducing waste, trying to adopt environmentally friendly methods of production and respecting their employees. It sets objectives in these areas.

Ben & Jerry’s believe it is important to make a profi t as a business, but that it can do it ethically.

1 What is meant by 'business ethics’? (2 marks)

2 Explain two benefits to a business of setting objectives. (4 marks)

3 Analyse the reasons why businesses set profit as an objective. (6 marks)

4 Evaluate the benefits of acting ethically to a business such as Ben & Jerry’s. (12 marks)

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1.4

Stakeholders

Topic

In this topic, we consider the various individuals and groups (called stakeholders) that will be affected by the activities of a business. We examine the impact a business can have on stakeholders and the way in which stakeholders might affect business decision-making.


● who the main stakeholders of businesses are

● what the objectives of stakeholders are

● what the impact of business activity is on stakeholders

● what impact and infl uence stakeholders have on businesses.

● The main stakeholders of businesses

Stakeholders

Shareholders

Customers

The government

Suppliers

Employees

Community

Figure 1.8 The main stakeholder groups

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1.4 Stakeholders

The objectives of a business should be set by the owners. It is their business and everyone working within it should aim to meet their needs. If the owners want more profi ts, this is what everyone should aim for. However, the fi nal decisions the owners take are likely to be infl uenced by the different stakeholders connected to the business.

A stakeholder is an individual or organisation that affects and is affected by the activities of an organisation. Stakeholders include the owners, employees, customers, suppliers, the local community and the government.

All of these groups will have their own objectives and these may influence the targets set by businesses. For example:➜ Owners may want to maximise their returns. For example, they may want

to be paid high dividends.➜ Employees may want to earn more as a reward for their efforts. They may

also want the business to grow so they have promotion opportunities. ➜ Suppliers may want to be paid on time. The business may, therefore, set a

target to pay all bills within a given period of time.➜ The community may want the business to behave responsibly. The business

may, therefore, set a target in areas such as recycling, noise, waste reduction and even try to employ local people. The local community may want to reduce the environmental impact of the activities of a business.

➜ The customers can also have an important role to play. For example, small fi rms may be reliant on relatively few customers and, therefore, these buyers become quite powerful. A small fi rm selling to a large supermarket may have to accept the terms offered by the supermarket if it wants to win the order. This means the buyers can affect what constitutes a realistic objective for a business in terms of, say, the likely level of sales and profi ts.

● The objectives of stakeholdersTable 1.5 shows the typical objectives of different stakeholder groups.

Stakeholder group Typical objectives

Employees Secure jobs, higher earnings

Owners/Shareholders High dividends and share price

Local community Local jobs, minimise environmental impact on the community (for example, little pollution or congestion, investment in the community)

Government Legal behaviour, taxes paid, growth

Suppliers Paid on time, kept informed of any changes to the business (for example, any proposed reduction in output)

Customers Useful, accurate information on the product, good service, value for money

Table 1.5 Objectives of different stakeholder groups

Key term

Dividends are the fi nancial rewards paid out to shareholders each year.

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● How does a business have an impact on stakeholders?

The activities of a business will have an impact on many stakeholders. For example:➜ The success of the business will affect the number of people employed and

how much they earn.➜ The values of the owners and managers will affect how well treated

employees are and how much attention is given to the quality of their life at work and their future careers; for example, does the business invest in training and giving them skills for the next stage of their career?

➜ A business is likely to have an impact on the local community; for example, it may decide to try to employ local people, it may invest in local facilities and it may affect congestion levels in the area.

➜ The way a business treats its suppliers will affect their success. Does it pay them on time? Does it pay them a fair price or does it try to use its power to push down the price? Does it try to build a positive relationship with suppliers or does it try to force suppliers to compete against each other for orders?

➜ The success of the business may affect its share price and the dividends that can be paid out affecting the rewards to shareholders.

➜ A business may try to reduce the amount of tax it pays by using whatever legal means it can; companies such as Amazon have done this. Or a business may decide to pay what it regards as a ‘fair’ amount of tax, even if it could legally pay less. This will affect the government's revenue.

● How stakeholders can influence a business

Stakeholders can infl uence a business in many ways:➜ Negotiation. Employees may negotiate for better pay. Suppliers may demand

better terms and conditions. ➜ Direct action. Customers can stop buying the products of a business if they

are unhappy with the way it behaves. Employees can go on strike and refuse to work if they do not get what they want.

➜ Refusal to co-operate. Local councils can refuse to co-operate with a business if they do not like its behaviour. For example, they could refuse planning permission for it to redevelop or expand its operations. Employees could resist any changes that the owners suggest and could show they are unhappy by not working hard.

➜ Voting. The owners of a business can make their views clear and can vote on what the organisation should do next. For example, if three people set up a business, it may be that two of the owners outvote the other one when deciding what should be done.

Key term

Negotiation occurs when two sides discuss what they want and try to reach a solution.

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1.4 Stakeholders

SummaryA stakeholder is any person or organisation that is affected by the activities of a business. Stakeholders will have their own objectives. Sometimes these

will overlap with each other but sometimes they will confl ict.

Quick questions 1 What is meant by a ‘stakeholder’? (2 marks)

2 State two stakeholders in a business. (2 marks)

3 Are all stakeholders also shareholders? Explain your answer. (2 marks)

4 Show, with an example, how stakeholders might have different objectives. (2 marks)

5 Show, with an example, how stakeholders might have the same objectives. (2 marks)

6 Explain one way in which a stakeholder might influence the business objectives. (2 marks)

7 Explain one possible objective of suppliers. (2 marks)

8 Explain one possible objective of employees. (2 marks)

9 Explain one possible objective of shareholders. (2 marks)

10 Explain one possible objective of the local community around a business. (2 marks)

Business insight

Post Offi ce workers strikeIn 2016, thousands of Post Offi ce workers went on a 24-hour strike (that is, they did not go to work) in a dispute over management decisions to close branches, reduce the number of jobs and change their pension entitlements. This led to the closure of around

118 of 305 offi ces in city and town centres due to a lack of staff. Across the country as a whole, almost 99 per cent of the 11,600 Post Offi ce branches remained ‘open for business as usual’.

Analyse the possible impact of a 24-hour strike on the business and its stakeholders. (6 marks)

When dealing with stakeholders, a business may think about:➜ how it communicates with stakeholders. Does it need to keep them informed?

If so, how should it do this? Through newsletters? Organise meetings (such as the Annual General Meeting (AGM), which is a meeting that companies must have each year for their shareholders)?

➜ whether it should involve different stakeholders in discussions. For example, it may want to hold meetings where stakeholders can raise their points of view. Managers may want employee representatives on committees and in meetings to make sure their views are heard.

Study tip

To decide how particular stakeholders can affect the objectives of a business, you need to consider what power that group has and what actions they could take to affect the business if it does not pay attention to them.

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Case study

Unilever

Dove is one of many Unilever brands

Paul Polman is Chief Executive of Unilever, one of the world’s biggest companies. Unilever produces a wide range of products from washing powders to food. The company employs over 170,000 people and has a market value of almost £90 billion.

Polman has encouraged all his team at Unilever to take a long-term view when making decisions. He has stopped updating investors every three months because he thinks this is a distraction and leads to too much of a short-term focus. He has made everyone in the business focus on environmental issues. For example, the company is committed to reducing the calories in its ice-cream and is aiming to remove coal from its energy usage within fi ve years.

However, although Polman may want to focus on long-term global issues, he also has to consider the demands of the company’s shareholders who want dividends. Polman admits this is something of a balancing act with the various stakeholder groups, but believes that investors are increasingly understanding the benefi ts of a long-term approach. He believes that acting now to save the planet will

save money later and will increasingly prove popular with investors. Polman says that around 70 per cent of the shareholders of Unilever have been with the business since he has and that he is deliberately encouraging long-term investors.

Polman is determined to prove that, whatever the economic or political situation in the world, Unilever can deliver revenue growth and profi tability. He believes Unilever can have a positive impact on the environment while also meeting the needs of its shareholders.

1 What is a ‘shareholder’? (2 marks)

2 Explain one possible reason why Polman stopped updating investors every three months. (4 marks)

3 Analyse the possible impact that a company such as Unilever can have on its environment. (6 marks)

4 Evaluate Polman’s view that looking after your stakeholders can improve the long-term profits of a business. (12 marks)

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1.5

Business location

Topic

One of the key decisions a business faces is the choice of its location. Location can affect costs and demand, and have a big impact on its overall success. In this topic, we examine the factors infl uencing the location decision for start-up businesses.


● why location is important

● the factors affecting location.

● Why is location important?You have a brilliant business idea. You know there is a market and are sure you can deliver good value for money. But where do you locate your business? Your location decision is very important because it can affect the following:➜ Costs. The amount to be paid in rent or to buy a premises varies according

to location. The rent for premises in the centre of London, for example, is greater than for offi ces in central Wales. The costs of facilities can affect the level of profi t a business makes.

➜ Sales. Location may affect whether or not the business gets customers. A hotel or theme park in the wrong location may struggle to attract visitors, for example.

➜ Image. For some products, where they are produced can have an important impact on their image. A perfume from Southampton or a wine from Bradford may struggle to sell. A language school on the coast or a gift shop in a tourist town may be more successful.

● Factors influencing locationFactors that infl uence where a business should locate include the following.

The type of businessThe type of business will have a big impact on where it should or where it can be located. A web design business could probably be set up from a bedroom (and, indeed, many have been). A shop, on the other hand, needs to be near potential customers. A service delivering fl owers to people’s homes would need to take

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account of the road system. Generally speaking, factories are more concerned about supplies and transport systems, whereas shops are more interested in being close to their customers.

The proximity to the marketA business will want to know where its customers are located and ensure that it can reach them easily. This is more important in some industries than others. For example, an online price comparison site does not need to be near its customers as they access its services via the internet. However, a service business will often need to be near its customers. For example, a hairdresser, a pub or a café will want to be easily accessible.

CompetitorsIt is important to consider the location of competitors. In some cases, a business will not want to be too close to its rivals. Petrol stations, for example, may be located some distance apart from each other. However, in other cases, competitors do want to be relatively close to each other. A new hotel business, for example, is likely to be more successful if it opens in an existing tourist area, perhaps with other hotels nearby, as this draws in the visitors. A new restaurant may want to be in an area of town known for its good eating places. When visitors come to that part of town, they may end up choosing the new restaurant.

Availability of raw materialsSome businesses rely on raw materials. A wine business will want to be near the grape vines that it uses to produce wine. A dairy business will want to be near its cows.

Availability and cost of labourSome businesses, such as Microsoft and Google, want highly skilled and able individuals. Such workers can often be recruited from the best universities, and so these businesses often set up near, and make good links with, these institutions. Other businesses have relocated production to countries, such as China and Vietnam, where wages are lower.

Transport linksBusinesses aiming to export (that is, sell abroad) might need to be near an airport or a port so they can transport goods easily. If you want to do business in London but cannot afford London rents, you might choose to locate somewhere outside the city (with cheaper rents) but where the road or train links are effective so you can get to London quickly.

TechnologyMany businesses these days rely on good communications systems, such as internet access and mobile communications. The availability of such good communications

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1.5 Business location

means more businesses can be run from home. Anything that can be done online, such as designing, writing, editing and programming, can be done from home.

Costs Location decisions are often affected by costs and the amount of money the business can afford. Start-up businesses often have limited funds available and this restricts their options. For example, you may have to start your cleaning business from home to begin with to save money. Later on, if the business works, you may move into offi ce premises. A business will compare the costs of any location with the likely revenue it can earn. It may be that choosing a higher-cost location actually leads to more profi t; a prime site for a cafe, for example, can lead to more visitors and more profi ts.

Factorsaffectinglocation

Proximity tothe market

Costs

Technology

Type ofbusiness

Availabilityof resources

Transportlinks

Figure 1.9 Factors influencing choice of location

Overseas locationAdvantages of locating overseas➜ Cheaper labour. Wages in countries such as China and India are much

lower than in the UK.➜ Access to resources that are not easily available in the UK. For example,

growing bananas is easier in South America than in England.➜ Financial incentives from foreign governments. Some governments are

keen to attract foreign businesses to their country and so offer money or lower taxes to attract them. This may make it cheaper for the business to operate in that country.

➜ Avoids protectionist measures by foreign governments. Some governments want to help their own fi rms and so they protect them from overseas competition. This can done through taxes on foreign goods (called tariffs) or

Key terms

Protectionist measures are policies that governments use to protect their own businesses against foreign competition.

A tariff is a tax on foreign goods imported into a country.

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by limiting the number of foreign goods (imports) allowed to enter the country (this is called a quota). By locating within the country, a business can usually avoid these barriers and so can fi nd it easier to sell in that country.

➜ The market overseas may be growing fast. If the market in the home country is experiencing slow growth, or if the company cannot get much bigger in the home country, moving abroad allows faster growth. Tesco is already very big in the UK and sales of food are not likely to grow very quickly. This is why Tesco has expanded abroad into countries such as the USA, China, Poland and Hungary.

Key terms

Imports are goods and services purchased from overseas by consumers of businesses.

A quota is a limit on the number of foreign goods imported into a country.

Business insight

Disneyland opens in Shanghai

Disneyland Shanghai

In 2016, the entertainment business, Disney, opened a theme park in Shanghai. It had taken over ten years of planning and involved an investment of around $5.5 billion. The company is planning on China’s growing middle class spending more on travel, tourism and leisure.

The theme park includes two hotels, a shopping district and six themed areas – Mickey Avenue, Gardens of Imagination, Fantasyland, Adventure Isle, Treasure Cove and Tomorrowland.

The park features storytelling and design features that Disney hopes will appeal to a Chinese audience. Shanghai’s traditional Shikumen-style architecture will be highlighted, as will themes from the Chinese zodiac.

Analyse the factors Disney will have considered before deciding on Shanghai as a location for one of its parks. (6 marks)

Disadvantages of locating overseas➜ There may be different rules and regulations in other countries. These

can affect how a business treats its staff or advertises its products, and what safety tests must be passed. Managers must understand these differences, but it may be expensive to change what you do.

➜ Customers may have different tastes. Products may need to be changed to suit different markets, which can be expensive.

Business insight

Burberry In 2007, the British clothing brand Burberry decided to stop production in the Rhondda Valley in Wales and relocate to China. Three hundred workers lost their jobs. The company describes itself as a ‘luxury brand with a distinctive British sensibility’. It claimed that the manufacturing cost of each individual polo shirt in Wales was £11, compared to a potential £4 in China. Each year that the factory was kept open in Wales, Burberry argued, would reduce its profi ts by £2 million.

Analyse the case for and against Burberry moving production to China. (6 marks)

Study tip

When thinking about a business’s decision to relocate abroad, you need to consider how different stakeholders are affected. Some may be worse off and some may be better off. Consider a business relocating to a low-cost location in Vietnam. Employees in the UK may lose their jobs and the UK government may lose tax income. However, shareholders may make more profi ts and the community in Vietnam may benefi t.

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1.5 Business location

Business insight

ToyotaFor over 50 years, Toyota vehicles have been sold in over 170 countries and regions across the world. As the company has exported more, it has also produced more in many countries; it has a policy of producing vehicles where the demand exists. It now has 51 production bases in 26 different countries and regions.

One of the challenges this creates is ensuring that the quality is not affected. Wherever you build a Toyota car, it must be the same quality. The company does not put a label on vehicles which says ‘Made in the USA’ or ‘Made in Japan’; it simply says ‘Made by Toyota’. This means that it must ensure quality is the same wherever a car is produced.

Analyse the factors Toyota might consider when deciding where to locate a factory. (6 marks)

Study tip

The ‘right’ location for a business will depend on the nature of the business. Make sure you think about the particular business. Does it need to be near raw materials? How close does it have to be to its customers?

Business insight

Hewlett Packard

The original location of Hewlett Packard

The global computer business Hewlett Packard (HP) began in a garage in Palo Alto, California. In 1938, Bill Hewlett and Dave Packard decided to take the risk and start out in business for themselves. Dave left his job at General Electric in New York and returned to Palo Alto while Bill looked for rented accommodation for them to live and work. He found one place that seemed perfect on Addison Avenue. The property had a ground fl oor fl at for Dave and his wife, an 8 × 18-foot shed for Bill to live in and a garage Bill and Dave could use as their workshop. They shared the rent of $45 per month. The garage served as a research laboratory, development workshop and manufacturing facility for early products, including the Model 200A audio oscillator. By 1940, the company already needed more space and HP moved into larger quarters nearby on Page Mill Road.

The garage was dedicated as the ‘Birthplace of Silicon Valley’ in 1989, and HP acquired the property in 2000 and restored it back to the way it was in 1939.

Analyse the reasons why Hewlett and Packard might have chosen this location for their fi rst business venture. (6 marks)

Study tip

The ‘right’ location for a business will depend on the nature of the business. Make sure you think about the particular business in the exam question. Does it need to be near raw materials? How close does it have to be to its customers?

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Case study

Relocating to ChinaZak Lilly has just told his workforce that he is closing the factory. His business makes plastic pipes and tubing that are used by plumbers across the UK. Zak was born in Manchester and had tried to keep production there for as long as possible, but he knows he can no longer make a profi t with a UK base. The market is very competitive and, unless he produces abroad, he knows he will make a loss and go out of business fairly soon. Zak feels sad about shutting the UK factory down but feels he has no choice. He has found a cheap site in China and is moving production there in the next few months.

1 What is meant by ‘loss’? (2 marks)

2 Explain how moving production to China might help Zak’s business to survive. (4 marks)

3 Analyse the objectives Zak might set for his business in the short and long term. (6 marks)

4 Discuss the ways in which the stakeholders of Zak’s business will be affected by the relocation. (12 marks)

SummaryThe location of a business can affect its costs and the demand for its product, which in turn can have a big impact on its profi ts. Choosing the right location is therefore an important business decision. Where the

right location actually is depends on many different factors including costs, demand, technology, suppliers and competitors.

Quick questions 1 Explain one reason why technology might

affect the location of a business. (2 marks)

2 Explain one reason why the labour market might affect the location of a business. (2 marks)

3 Explain one reason why the infrastructure might affect the location of a business. (2 marks)

4 State two businesses that would need to locate close to their customers. (2 marks)

5 Explain one factor that might influence the location of a retail outlet. (2 marks)

6 Explain one factor that might influence the location of a theme park. (2 marks)

7 Explain one factor that might influence the location of a coal mining business. (2 marks)

8 Explain one factor that might influence the location of a caravan site. (2 marks)

9 Explain one factor that might influence the location of a computer games design business. (2 marks)

10 State two types of business that need to be located near their supplies. (2 marks)

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Whenever you are thinking of doing something, it can help to write out a plan fi rst. This can help you to remember what exactly you are supposed to do, plus when and in what order you are supposed to do it. A business plan sets out where a business is heading and how it intends to get there. This can be helpful to many groups both inside and outside the business. This topic examines the benefi ts and also the problems associated with a business plan.


● the purpose of business planning

● the main sections within a business start-up plan

● the basic fi nancial terms used in a business plan

● the basic fi nancial calculations useful to interpret a business plan.

● The purpose of business planningA business plan states what a business is trying to achieve over the next few years and how it intends to accomplish these aims. A business plan may be created to:➜ help set up a business successfully. Establishing a new business involves many

decisions and often the person making them is relatively inexperienced. By planning, entrepreneurs have to think ahead and gather data. This helps them to assess the risk of various decisions and hopefully make better decisions. Business planning is important to anticipate any problems. If problems are identifi ed in advance, the business should be better able to deal with them.

➜ raise fi nance. A business plan is useful to show to possible investors. If someone was thinking of investing money into a business, for example, he or she would want to see what the managers intended to do with it and when they were likely to see a return on their investment. They would want to understand why the managers think the business will succeed. For example, they might want to know by how much sales are expected to increase, what the profi t target is

Key terms

A business plan is a document setting out what a business does and what it hopes to achieve in the future.

Business planning is the process of producing a business plan.

Business planning

1.6 Topic

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and how the business will attract customers. A bank, therefore, will usually require a business plan before deciding whether to give a loan.

➜ set objectives. A plan will set out what a business wants to achieve. This can help provide a clear target for everyone in the business. Having a target can be motivating and helps people to make decisions because they know what they are trying to achieve. The effectiveness of actions can be assessed against the objectives that have been set.

➜ co-ordinate actions. A plan should set out how an objective is going to be achieved – what resources are needed, what the time frame is, what the targets for the different parts of the business are. A plan, therefore, helps to co-ordinate the activities within the various parts of the business to achieve the objective.

Problems of business planningSome of the diffi culties about business planning include:➜ Uncertainty. It is not always easy to look ahead and predict what is going to

happen in a market or to estimate future sales fi gures with any degree of accuracy. Plans might not be totally accurate. Market conditions can change very quickly (for example, a new competitor might start up), which means that plans can easily become out of date. Managers may decide to target a part of the market that does not end up growing or their plan may be unsuccessful. Simply having a business plan may reduce the risk of getting it wrong, but does not remove the risk altogether.

➜ Lack of experience. People starting up their own business may not have the necessary skills to plan ahead effectively. An entrepreneur may be a good hairdresser or good at running a shop, but that does not automatically mean they will be able to look ahead and effectively imagine changes in the future of the market. Bigger businesses can use experts and have access to more resources, such as expensive market research, to help them; new businesses may not have these advantages.

➜ Change. A business plan must not be produced once and then used forever. Business plans need to be regularly reviewed and updated – managers always need to know where the business is going and how it is going to get there. This is because conditions are always changing, with new laws, new competitors and changes in customer tastes.

A business plan can, therefore, help managers to look ahead. However, there are considerable risks when starting up. Having a business plan does not guarantee success. The business may not succeed, and entrepreneurs may lose

A business plan can be shown to the bank to help raise finance.

Key terms

Uncertainty occurs where there is a lack of information about a situation. This means the outcome or consequences are very diffi cult to predict.

A risk is the possibility of something going wrong.

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1.6 Business planning

their original investment. Nevertheless, having a plan means that entrepreneurs know what they are trying to achieve; if things turn out differently, they can take action to get things back on track.

Reducing the risk of business planningTo try to reduce the risk of business plans going wrong, businesses can:➜ research the market thoroughly➜ talk to experts and consultants (if they can afford it)➜ plan for a variety of possible outcomes➜ regularly review and update the plan so that it remains relevant and any

problems are spotted quickly.

No one can remove all risks of doing business, but it is possible to reduce them or at least prepare for them and better planning helps to do this.

● The main sections of a business planThe sections that are usually found within a business plan include:➜ background information on the founders and investors and their previous

experience➜ an analysis of the market and the fi rm’s expected position within it; this

should include a detailed analysis of the customers that will be targeted➜ the fi rm’s objectives➜ details of the price it will set and expected sales➜ an explanation of how the business will compete against its rivals – how it

will be competitive, and what makes it better than the competition➜ an analysis of the fi nancial position of the business, including forecasts of

profi ts and cash fl ow.

● What is included in the financial section of a business plan?

A business plan will usually set out how much profi t a business is expected to make. Profi t can be calculated using the equation:

pro� t = revenue – total costs

Profit is calculated for a given period; for example, we often measure the profit of a business over a year.➜ The revenue of a business is the value of its sales. For example, if 200 units of

a product are sold at £5, the revenue would be:

200 × £5 = £1,000

➜ The total costs of a business are made up of fi xed costs and variable costs:➜ Fixed costs are costs that do not change with output. For example, the

rent of a building will be set for a given period. During that time, the rent will not change regardless of how much is being produced. This does not

Study tip

Producing a business plan can help a business to organise its activities, but it does not guarantee success. To judge how useful a particular plan is, you need to look at who produced it, how it was produced and what research they did. If things have gone wrong, was it the result of bad luck, or should the managers have predicted that these problems might have occurred?

Key terms

Revenue is the income that a fi rm receives from selling its goods or services. It is also referred to as ‘turnover’. It is measured by the number of units sold multiplied by the price.

Total costs are fi xed costs plus variable costs.

Fixed costs are those costs that do not change when a business changes its output.

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mean that fi xed costs never change – the rent might be increased at some point, for example – but the key point is that the fi xed costs do not change with the amount produced.

➜ Variable costs are costs that do change with output. For example, in a café the more sandwiches that are produced, the more bread that will be used. The cost of bread is, therefore, a variable cost.

If revenue is greater than total costs, a profit is made. The value of the sales more than covers the costs for that period.

If revenue is less than costs over a given period, a loss is made. The value of the sales is less than the costs of producing and selling the product.

Maths moment

The selling price of a product is £20. The variable costs per unit are £12. The fi xed costs are £150,000.

If the business sells 200,000 units:

1 What is its total revenue?

2 What are the variable costs?

3 What are the total costs?

4 What is the profit of the business?

Key term

Variable costs are the costs that vary directly with the business’s level of output.

Business insight

Royal Dutch ShellBetween 2015 and 2016, the Royal Dutch Shell company cut over 12,000 jobs around the world. These cuts were mainly due to Shell’s takeover of oil and gas exploration fi rm BG Group and major falls in oil prices. The company has said that it needed to reduce its costs, improve its production effi ciency and have a business that meets the needs of the future. Its profi ts fell from $19 billion in 2014 to $3.8 billion in 2015.

The company has been hit hard by the fall in the price of oil which has fallen from more than $110 a barrel since mid-2014 to below $40 per barrel.

Analyse factors that affect the profi ts of Shell. (6 marks)

SummaryA business plan sets out what a business wants to do and how it intends to do this. Having to produce a plan makes businesses think about what might happen

and what they need to do. A good business plan can also help a business to raise fi nance. A plan should be regularly reviewed and updated as conditions change.

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1.6 Business planning

Quick questions 1 The selling price of a product is £25. The

variable costs per unit are £10. The fixed costs are £150,000. What are the profits of the business if it sells 300,000 units? (2 marks)

2 Explain two elements of a business plan. (2 marks)

3 Explain one reason why a business might produce a business plan. (2 marks)

4 Explain one reason why things may not work out in the way the plan forecast. (2 marks)

5 How can a business reduce the risk of a business plan failing? (2 marks)

6 State two stakeholders who might be interested in the business plan. (2 marks)

7 Explain one reason why a business plan needs reviewing regularly. (2 marks)

8 Explain one reason why a business plan might help a business to raise finance. (2 marks)

9 A business plan might include sales forecasts. Explain one reason why having a sales forecast is important. (2 marks)

10 Explain one reason why the business plan should state the target customer group. (2 marks)

Case study

Susie’s JewellerySusie Emslie left school aged 18 and, rather than going to university, she decided she wanted to set up her own business making jewellery. Susie was very environmentally aware and her jewellery would be made out of recycled products and materials. Unfortunately, Susie did not have suffi cient savings herself to fi nance the business. Her family could not help, so she decided she would have to bring in an investor or borrow the money. Having taken business studies at GCSE and A-level, she knew it was important to produce a business plan.

1 What is meant by a ‘business plan’? (2 marks)

2 Explain two items that should be included in Susie’s business plan. (4 marks)

3 Analyse how having a business plan might help Susie’s business to be more successful. (6 marks)

4 Evaluate the factors that a bank would look for in Susie’s plan before lending to her. Justify your answer. (12 marks)

C

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1.7

In this topic, we will examine why businesses want to expand and how they might do this. We will also consider the advantages and disadvantages of growth.


● the methods of business expansion

● the benefi ts and drawbacks of expansion

● the economies of scale

● the diseconomies of scale.

● Business expansionThe expansion or growth of a business is a common objective. A business may want to become the biggest airline in the UK or the biggest seller of soft drinks, for example. To achieve this, it may have to spend money on new equipment or new premises. Bigger fi rms are more powerful in their markets, so can often get cheaper materials because they are such important customers. Big companies are also more well known; this can help when they want to launch new products because shops may be more willing to stock their products and customers may be more willing to try them. By getting bigger, fi rms may be safer from hostile takeovers because they will be worth a lot more and will be more expensive to buy. Some investors will also be keen for the business to grow because this provides a sense of achievement.

Expanding a business

Topic

Amazon was set up in 1994, Google in 1998 and Facebook was launched in 2004. Just think how much these businesses have grown since then.

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1.7 Expanding a business

● Methods of business expansionA business may expand through:➜ internal growth (also called organic growth) by selling more of its own

products➜ external growth (also called integration) by joining with another business.

Internal growth tends to be slower than external growth, but may be more manageable because of this. When businesses join together, their size changes suddenly and it can be difficult to manage with new staff and different ways of doing things.

Measuring the size of a businessBusiness expansion occurs when the fi rm gets bigger. This is usually measured in terms of an increase in the value of sales. However, it could be measured using other indicators, such as the value of the business, number of employees or number of outlets.➜ Value of sales. The value of a fi rm’s sales is

also called its revenue or turnover (see Topic 1.6). The bigger the turnover, the bigger the business. Increasing sales may also increase a fi rm’s market share. Market share measures the sales of one fi rm as a percentage of the total market.

➜ Value of the business. The size of a business can be measured by calculating the value of its assets (what it owns) minus its liabilities (what it owes). The higher the value of the business, the more its owners are worth. Another way of measuring the value of a business (if it is a company) is to calculate the value of its shares. This is called its market capitalisation.

➜ Number of employees. Some organisations do not sell their products (for example, the National Health Service) so it is impossible to measure revenue. The size of these businesses may be measured using the number of employees.

The most appropriate measure of the size of an organisation depends in part on the type of business being considered. When comparing taxi companies, for example, you might look at how many taxis they have. When measuring the size of supermarkets, you might look at how many stores they have. When measuring the size of a charity, you might measure how much money it raises or the number of staff it has.

Maths moment

A business sells 250,000 units at an average price of £12.

What is its turnover?

Key terms

Internal growth (also known as organic growth) occurs when a business gets bigger by selling more of its products.

External growth (also known as integration) occurs when a business gets bigger by joining or buying other businesses.

Key term

The market capitalisation of a company measures the value of all its shares:

market capitalisation = market price of a share × the number of shares

Growth

Internal(organic)

External(integration)

Figure 1.10 Growth can either be internal or external

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● Internal growthInternal (or organic) growth can occur in several different ways. These include franchising, opening new stores, e-commerce and outsourcing.

FranchisingFranchising occurs when one business sells the right to another business to use its name and sell its products. For example, many McDonald’s fast food outlets are franchises. This means that someone has bought the right from McDonald’s to use its name and sell its products.

Advantage of selling a franchise The advantage of selling a franchise is that the business can grow faster because it does not need to be able to fi nance the opening of every store. The person buying the franchise (called the franchisee) provides the fi nance to set up the business and also pays for the right to do so. This means the business selling the franchise (called the franchisor) generates revenue from selling the franchise as well as having its growth fi nanced by the franchisee.

However, the franchisor will want to maintain the standards and quality of its products and services and will, therefore, want to monitor the activities of the franchisees.

Advantages of selling a franchise Disadvantages of selling a franchise

Can grow quickly Lose some control

Franchisee provides some of the fi nance

Danger of problems with one franchisee affecting the whole brand

Franchisees motivated as they are running their own businesses

Have to share profi ts

Table 1.6 Advantages and disadvantages of selling a franchise

Advantages of buying a franchise➜ The franchisee is buying a product that has a track record. It can assess

the success of the product to date and hopefully make a better decision on whether it should buy it or not.

➜ The franchisee will have access to the experience of the other franchises and the franchisor. For example, McDonald’s will provide expert advice and training on how to run one of its stores.

Advantages of buying a franchise Disadvantages of buying a franchise

Established brand Have to share profi ts

Access to training and supplies May have to work within franchisor’s guidelines

Share marketing costs Have to contribute to group marketing

Learn from other franchisees Sales may suffer if another franchisee gets a bad reputation

Table 1.7 Advantages and disadvantages of buying a franchise

Key terms

A franchise occurs when a franchisor sells the rights to its products to a franchisee; this is usually in return for a fee and percentage of turnover.

A franchisee buys a franchise usually in return for a fee and percentage of turnover.

A franchisor sells a franchise usually in return for a fee and percentage of turnover.

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Business insight

McDonald’sA McDonald’s franchisee owns his or her own business and typically manages a team of over 70 employees. The franchisee will gain most of the rewards if the business is successful. The management of the store is down to the franchisee, but he or she is supported by McDonald’s in many areas, for example, in terms of training or if a franchisee needs advice on how to work best in the community. A McDonald’s franchisee requires at least £85,000 to invest. A store will usually cost between £150,000 and £400,000 to buy. Franchisees will get nine months’ training if they are

accepted and are introduced to the world-famous McDonald’s operating system.

Franchisees pay McDonald’s between 10 and 18 per cent of sales, plus a 5 per cent service fee for using the McDonald’s system. A franchisee is also required to contribute 4.5 per cent of sales to the group marketing campaign.

Source: McDonald’s: www.mcdonalds.co.uk

1 Analyse why McDonald’s grows by selling franchises. (6 marks)

2 Analyse the advantages of buying a McDonald’s franchise. (6 marks)

Opening new storesA business can grow by opening new stores. Just think of the number of Costa coffee stores opened in the last few years. Opening a store will require research to identify the right location and investment to get the stores up and running.

E-commerceRather than opening a physical store, a business might start to sell online. For example, businesses such as ASOS have been very successful at generating sales without physical stores. For other businesses that have physical stores already, going online can add another channel to access the market. The major supermarkets, for example, have both physical and e-commerce operations. E-commerce can allow a business to access customers across the globe 24 hours a day. However, it is not without its issues. If the business has physical products, it has to fi nd ways of distributing these in the markets it is covering and doing so at a cost that does not outweigh the benefi ts of going online. It also has to be sure that going online does not affect its other sales; people may simply switch to buying online and stop using their stores. A growing trend in recent years is ‘click and collect’. Customers like the ease of shopping online, but also like collecting the goods that they have bought online from the shop.

Outsourcing Outsourcing occurs when a business uses other organisations to produce its products for it. If demand is growing, but the business does not have time or does not want to take the risk of expanding its own production facilities, it can outsource its production to another organisation. For example, a clothes retailer may use other producers to make its clothes. This enables a business to grow quickly because it does not have to invest in expanding its own facilities. However, it does mean it has to be careful to control the quality and it may cost more than producing the items itself.

Key terms

E-commerce (or electronic commerce) is the act of buying or selling a product using an electronic system such as the internet.

Outsourcing occurs when a business uses another business to produce for it.

http://www.mcdonalds.co.uk

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● External growthExternal growth (also called integration) occurs when fi rms join together. ➜ A merger occurs when two or more fi rms join together and create another

joint business. ➜ A takeover (or acquisition) occurs when one fi rm gains control of another

and buys it up.

Types of integrationFigure 1.12 shows some different types of integration.

Businessintegration

Horizontal ConglomerateVertical

Figure 1.11 Types of business integration

➜ Horizontal integration occurs when one fi rm joins with another fi rm at the same stage of the same production process.

➜ Vertical integration occurs when one fi rm joins with another fi rm at a different stage of the same production process. This can be backward vertical integration, when a fi rm joins with its suppliers, or forward vertical integration, when a fi rm joins with its distributors. For example, Pepsi bought Kentucky Fried Chicken, the fast-food chain, so it could sell its drinks there; this is an example of forward vertical integration.

➜ Conglomerate integration occurs when one fi rm joins together with another fi rm in a different type of production process. For example, Rentokil Initial’s businesses include offi ce cleaning, security, pest control and parcel delivery.

Business insight

Steinhoff International takes over Poundland In 2016, the discount retail chain Poundland agreed to a £597 million takeover by South African retail group Steinhoff International. This would enable Steinhoff to expand in the UK and the rest of Europe. This is partly to reduce its reliance on South Africa, where the economy is not doing well.

Poundland operates more than 900 stores across the UK, Ireland and Spain, and employs 18,000 people.

Steinhoff’s headquarters are in South Africa. It has:● 6,500 retail outlets in 30 countries● 22 manufacturing facilities

● 40 retail brands, including Bensons for Beds and Harveys in the UK, Conforama in Europe, Pep and Ackermans in South Africa and Snooze in Australia.

Steinhoff paid 227 pence per share for Poundland. The discount retailer’s share price had fallen from 418p in February 2015 to below 200p before the deal was announced.

1 Analyse the possible reasons why Steinhoff wanted to buy Poundland. (6 marks)

2 Analyse the factors that might have infl uenced the price Steinhoff was willing to pay for Poundland. (6 marks)

Key terms

A merger occurs when two or more businesses join together to form a new business.

A takeover occurs when one business buys control of another one.

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● Advantages of business expansion➜ It can lead to economies of scale, which are benefi ts that come with a larger

size.➜ It can lead to more power in the market. For example, retailers are likely to

be more willing to stock the products of a well-known brand. ➜ Big fi rms have more status and the people in charge will feel more important,

especially if it has grown while they were in charge. If a business is well known, it will also be easier to launch more products in the future.

➜ Big fi rms are more expensive to take over so those in charge might feel safer.➜ The rewards for staff are often linked to the size of the business so they may

be eager for growth.

Key term

Economies of scale occur when a business’s unit costs of production fall as its output rises and the business expands.

Business insight

YouTube is sold to GoogleThe founders of YouTube, Chad Hurley and Steve Chen, sold the business to Google for $1.65 billion 20 months after they set it up. Hurley and Chen were both aged under 30 years and set up the business in a garage in California. Google had its own service showing people’s fi lms, but YouTube was much more popular and had a market share of over 60 per cent. People watch fi lms on YouTube more than 100 million times daily.

Analyse the factors Google would have considered when deciding on the amount it paid for YouTube. (6 marks)

● Disadvantages of business expansion➜ Decision-making becomes slower because there are so many people to

consult in a big business. There are likely to be many levels of hierarchy and this means messages have to pass between these levels, (that is, there are long chains of communication). Not only is this slow, but it may also mean that messages get distorted as they pass from one person to another.

➜ Employees may feel isolated because there are so many of them and they no longer feel special and an important part of the organisation. This may mean they become demotivated.

➜ Controlling and co-ordinating a business that has many clients or products and that is possibly based in many different places can be diffi cult and may be less effi cient.

These disadvantages are called diseconomies of scale. They occur because of the difficulties of managing a big business.

Key term

Diseconomies of scale occur when the cost per unit increases as a business expands.

Study tip

When deciding whether internal or external growth is better for a business, think about the following:● How rapidly does the business want to grow?● What are the two businesses like? Will the two fi rms and their employees get on? Will their policies and

approaches be very different?● If a takeover is being considered, how much will it cost to buy the other business? Is it worth it?● How well could the managers control a business that suddenly became much bigger?

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Study tip

If you are asked whether or not a business should grow, you need to weigh up the advantages of growth against the disadvantages. Will the company be able to cope with managing a bigger business? Is it likely to experience diseconomies of scale?

● Economies and diseconomies of scaleEconomies of scale occur when the cost per unit (or unit cost) falls with greater scale of production. One type of economy of scale is bulk buying. Big fi rms buy in bulk and so they can negotiate better prices with suppliers. This keeps unit costs down. Another economy of scale is known as technical economy of scale. This occurs when large-scale production enables a business to make effi cient use of technology. For example, a production line is very expensive to set up. If only one car a day was produced, this would be extremely expensive. However, if the production line is used to produce hundreds of cars a day, the costs of the production line can be spread over more units reducing the cost per car (the unit cost).

An example of economies and diseconomies of scaleAs the name suggests, unit costs measure the cost of a unit. These are also called average costs. To calculate unit costs, use this equation:

unit cost = total costs ÷ output

Table 1.8 illustrates economies and diseconomies of scale:➜ The unit cost falls as the output of the business increases from 100 units to

400 units. The business is experiencing economies of scale. ➜ As the business expands further from 400 units to 500 units, the unit costs

increase. The business is now experiencing diseconomies of scale.

Output (units)

Total costs(£)

Unit cost = Total costs ÷ Output(£)

100 1,000 1,000 ÷ 100 = 10

Economy of scale200 1,600 1,600 ÷ 200 = 8300 2,100 2,100 ÷ 300 = 7400 2,400 2,400 ÷ 400 = 6500 4,000 4,000 ÷ 500 = 8 Diseconomy of scale

Table 1.8 An example of economies and diseconomies of scale

Maths moment

Output (units)

Total costs(£)


100 100

200 150300 180400 200500 300

Table 1.9 Calculating unit costs from outputs and total costs

1 Complete Table 1.9 by calculating the unit costs.

2 At what level of output does the business experience diseconomies of scale?

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● Expanding abroadOne option facing businesses when they grow is to expand abroad. This enables the business to target more customers and potentially sell more. However, entering new markets brings many challenges:➜ The law and regulations facing businesses may differ.➜ The existing businesses may resist new entrants to the market.➜ Customers’ buying habits and expectations may be different.

Although there are many highly successful businesses selling globally, such as Coca-Cola and Apple, there are also a number of businesses that have struggled abroad.

SummaryExpansion is a common business objective. It can bring many advantages, such as economies of scale and market power. However, it can also bring disadvantages, such as diseconomies of scale. Owners and managers will have to decide on the right size for their business.

As businesses expand, their aims and objectives will change. For example, they may want to expand overseas or become dominant in their market. They also need to be more conscious of the ethics of their behaviour and of environmental issues because their activities will be monitored very carefully by their stakeholders.

Quick questions 1 State two ways the growth in the size of a

business can be measured. (2 marks)

2 What is meant by ‘external growth’? (2 marks)

3 What is meant by ‘internal growth’? (2 marks)

4 What is meant by ‘economies of scale’? (2 marks)

5 What is meant by ‘unit cost’? (2 marks)

6 State two benefits of expansion. (2 marks)

7 State two drawbacks of expansion. (2 marks)

8 State two types of economies of scale. (2 marks)

9 State two types of diseconomies of scale. (2 marks)

10 Explain the difference between a merger and a takeover. (2 marks)

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54

Chapter review – Business in the real worldRead question 1, the sample answers and the comments. Then try question 2.

1 Read Item A and answer the questions that follow.

➜ Item AIn 2016, the UK government approved the building of a third runway at Heathrow Airport to expand the capacity of UK airports. The government said this would help UK businesses to trade abroad more easily and to create jobs. The Department for Transport stated a new runway at Heathrow would bring economic benefi ts to passengers and the wider economy worth up to £61 billion. It said it would create as many as 77,000 additional local jobs over the next 14 years.

Heathrow Airport Ltd said the expansion would mean it could now offer more direct fl ights to UK destinations as well as up to 40 new cities abroad. Construction is unlikely to begin before 2020, if it begins at all! This is because there is still considerable opposition from many stakeholders who would like to stop the project actually happening. Some of these stakeholders complain about the noise the runway would lead to; some are upset they would lose their homes for the runway to be built; others are unhappy with the impact on pollution levels and the possible increase in traffi c congestion.

Case study

Tyrrells and AmplifyIn 2016, the upmarket snack business, Tyrrells, was taken over by a US fi rm called Amplify Snack Brands. The Herefordshire-based producer of hand-cooked crisps was sold for £300 million. Tyrrells does not sell in North America and Amplify has no business in the UK, so it was felt to be a good fi t.

Amplify will roll out the Tyrrells brand in America and Tyrrells will do the same with Amplify’s SkinnyPop brand in the UK. Tyrrells includes the Australian fi rm Yarra Valley Snack Foods, which it acquired in 2015 and the German-based company Aroma Snacks, which it acquired in 2016.

Tyrrells was founded in 2002 by potato farmer William Chase. He decided to move into making crisps where he felt he could make more profi ts than selling

potatoes to the big supermarkets. Mr Chase sold the company in 2008 for nearly £40 million. He used some of the money he raised from the sale to set up a distillery producing premium vodka and gin.

1 What is meant by a ‘private limited company’? (2 marks)

2 Explain how Amplify would take over Tyrrells. (4 marks)

3 Analyse the factors that might determine the value of Tyrrells when it was sold. (6 marks)

4 Amplify bought Tyrrells as a means of expanding. Evaluate whether a takeover is a better way of expanding than organic growth. (12 marks)

C

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Chapter review – Business in the real world

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Chapter review – Business in the real world

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

(a) A stakeholder is an owner of a company.

The de� nition given is a shareholder; while a shareholder is an example of a stakeholder. This is not an appropriate de� nition.

(b) Explain one benefi t for investors of setting up a business as a company. (4 marks)

(b) By setting up as a company, the investors will have limited liability. This means that the investors can lose the money they have invested into the company but they cannot lose their personal assets. This provides investors with protection and reduces the risk of investment.

This shows a precise understanding of limited liability which is a bene� t of establishing a company. A clear and relevant response.

(c) Analyse how the activities of two of the business functions within Heathrow Airport help the business to make a profi t. (6 marks)

(c) The business functions are marketing, operations, fi nance and human resources. Human resources will involve recruiting and training staff. It may do this to run all the different aspects of the airport such as the security, the running of the shops, and the parking.

The marketing function will try and understand what customers want and help ensure they provide for this. This may mean ensuring it is easy to book, there are places to stay nearby and there are the right range of shops to buy things from.

The operations function runs the actual airport. It will make sure that the airport runs effi ciently. This means that planes land and take off on time. And that passengers move around the airport easily and without queues. They will make sure things work from the parking to the shops to the aircraft.

The fi nance function will raise money if required for investment and will measure spending and costs.

This answer shows that the student understands the different functions of a business. He or she shows insight into what these functions might involve at an airport. However, the answer covers four functions when the question only asked for two; this means time is wasted on producing four points rather than selecting and developing two. Also the answer does not analyse how these functions help the business to make a pro� t. This is missing an important aspect of the question. The answer shows understanding but does not analyse.

(d) Analyse the case for and against the opening of a new runway at Heathrow. Recommend whether it should be opened or not. (12 marks)

(d) Opening up a runway at Heathrow will create jobs. It will create jobs for those building the runway and all the materials used in its building. Once it is open, it will create more jobs at the airport. It will also help tourism and British businesses to sell their things abroad and so this

56


will create even more jobs. With more people working, this will lead to more spending and this should lead to even more jobs and growth in the economy. This is why opening a new runway at Heathrow may be a good thing.

However, it will also cause pollution and noise problems. There may be increased traffi c around the airport slowing up car travel for others. There may be more noise for those living nearby and some may have to give up their houses so it can be built. This means that socially and environmentally the costs may be great and outweigh the benefi ts of building it.

Overall, it will depend on the size of the costs and these can be diffi cult to measure. It is diffi cult to know exactly how many extra jobs there will be and what the environmental impact will be. How do you measure things like people’s unhappiness with moving? It will be a trade-off and depends on the size of these things. Perhaps the recommendation should be to go ahead if the benefi ts exceed the costs and this may happen if steps are taken to reduce the costs, e.g. controls over when fl ights happen and the pollution they are allowed to generate. It may be that the recommendation is to have another runway but not at this location if the costs would be lower elsewhere.

The answer considers both sides and brings them together very well.

2 Read Item B and answer the questions that follow.

➜ Item BFran Watts is the managing director of The Book Experience, a private limited company. Fran set up her fi rst bookshop ten years ago and since then her business has grown and grown. Fran has always been ambitious and she is determined to make The Book Experience one of the largest chains of bookshops in the UK with a large market share. Until fi ve years ago, she had grown the business via organic growth. She then decided that she could grow faster by external growth and has already taken over two other chains of bookshops based in different parts of the country. She had considered selling franchises but decided against it. The Book Experience is rapidly establishing itself as a real competitor to companies such as Borders and Waterstones. Fran is a bit worried how they might react to her success. She is also worried about the criticism her business is getting in the media. Many people claim that once her stores set up in an area it becomes impossible for smaller, independent bookshops to survive because they cannot compete on price. The local bookshops say that The Book Experience is acting unethically and leading to the closure of shops all over the country.

Last year Fran decided that The Book Experience would do better as a public limited company so she fl oated the business. As part of the fl otation, she had to produce a document to show to potential investors. In this, she set out new objectives for the growing business that included international expansion.

(a) State two features of a public limited company. (2 marks)

(b) Explain two problems for Fran of becoming a public limited company. (4 marks)

(c) Analyse why expanding abroad may be diffi cult for The Book Experience. (6 marks)

(d) Do you think Fran was right to decide against franchising? Explain your answer. (9 marks)

1 Business in the real world Business in the real world

will create even more jobs. With more people working, this will lead to more spending and this will create even more jobs. With more people working, this will lead to more spending and this will create even more jobs. With more people working, this will lead to more spending and this should lead to even more jobs and growth in the economy. This is why opening a new runway at should lead to even more jobs and growth in the economy. This is why opening a new runway at should lead to even more jobs and growth in the economy. This is why opening a new runway at should lead to even more jobs and growth in the economy. This is why opening a new runway at Heathrow may be a good thing.Heathrow may be a good thing.

However, it will also cause pollution and noise problems. There may be increased traffi c around However, it will also cause pollution and noise problems. There may be increased traffi c around the airport slowing up car travel for others. There may be more noise for those living nearby and some may have to give up their houses so it can be built. This means that socially and environmentally the costs may be great and outweigh the benefi ts of building it.

Overall, it will depend on the size of the costs and these can be diffi cult to measure. It is diffi cult to know exactly how many extra jobs there will be and what the environmental impact will be. How do you measure things like people’s unhappiness with moving? It will be a trade-off and depends on the size of these things. Perhaps the recommendation should be to go ahead if the benefi ts exceed the costs and this may happen if steps are taken to reduce the costs, e.g. controls over when fl ights happen and the pollution they are allowed to generate. It may be that the recommendation is to have another runway but not at this location if the costs would be lower elsewhere.

The answer considers both sides and brings them together very well.


➜➜ Item B Item BFran Watts is the managing director of The Book Experience, a private limited company. Fran set up her fi rst bookshop ten years ago and since then her business has grown and grown. Fran has always been ambitious and she is determined to make The Book Experience one of the largest chains of bookshops in the UK with a large market share. Until fi ve years ago, she had grown the business via organic growth. She then decided that she could grow faster by external growth and has already taken over two other chains of bookshops based in different parts of the country. She had considered selling franchises but decided against it. The Book Experience is rapidly establishing itself as a real competitor to companies such as Borders and Waterstones. Fran is a bit worried how they might react to her success. She is also worried about the criticism her business is getting in the media. Many people claim that once her stores set up in an area it becomes impossible for smaller, independent bookshops to survive because they cannot compete on price. The local bookshops say that The Book Experience is acting unethically and leading to the closure of shops all over the country.

Last year Fran decided that The Book Experience would do better as a public limited company so she fl oated the business. As part of the fl otation, she had to produce a document to show to potential investors. In this, she set out new objectives for the growing business that included international expansion.expansion.

(a)(a) State two features of a public limited company. (2 marks)

(b) Explain two problems for Fran of becoming a public limited company. Explain two problems for Fran of becoming a public limited company. (4 marks)

(c) Analyse why expanding abroad may be diffi cult for The Book Experience. Analyse why expanding abroad may be diffi cult for The Book Experience. (6 marks)

(d) Do you think Fran was right to decide against franchising? Explain your answer. Do you think Fran was right to decide against franchising? Explain your answer. (9 marks)

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In this chapter, we will look at a range of external infl uences that can affect the way businesses operate. One of these infl uences is changes in technology, which can affect the products that businesses supply and the way that they make them. Changes in the economy, such as reductions in consumers’ incomes impact on businesses as do changes in laws. Businesses have also been affected by pressures to be ethical (i.e. to do the ‘right’ things) and to protect the environment. A key external infl uence has been globalisation which has led to highly effi cient rivals from overseas for many UK businesses. Globalisation has also offered businesses more chances to sell products overseas. This chapter also considers how businesses have responded to these external factors by, for example, producing new products, using new methods of production or relocating overseas.

2In� uences on

business

58

Topic 2.1

Technology is playing an increasingly important role in the activities of many businesses nowadays, and not just those directly involved in selling technology products such as Apple. This topic considers how developments in information and communication technology (ICT) have infl uenced important aspects of business activity.


● what information and communications technology is

● the ways in which businesses use e-commerce

● the ways in which businesses use digital communications to communicate with stakeholders such as customers and suppliers.

● What is information and communications technology?

You may be familiar with information and communications technology (ICT) as one of the subjects that you have studied at school. ICT is of great value to all businesses whether they are large or small. ICT is the computing and communications systems that a business might use to exchange information with stakeholders such as customers, suppliers, the government and employees. The technologies that may be used as part of ICT are summarised in Figure 2.1.

ICT, e.g. tablets, smartphones, PCs,cloud computing networks allowingmore information to be exchanged

more quickly

The business

Exchanges information with stakeholders, e.g.

• Prices and product details (customers)

• Resources required (suppliers)

• Customer needs and complaints

• Ideas and suggestions (employees)

Stakeholders, e.g.suppliers, government,customers, employees

Figure 2.1 ICT and business communications

Key term

Information and communications technology (ICT) is the computing and communications systems that a business might use to exchange information with stakeholders.

Technology

59

2.1 Technology

The technology used within ICT by businesses is developing over time. The development of the internet transformed ICT as businesses developed websites. These are used to promote and sell their products and to collect information from customers and other stakeholders.

Many larger businesses operate intranets which are private communication networks only accessible by the business’s employees; some businesses use extranets which are similar, but accessible by other selected stakeholders, such as suppliers. These mini-internets can be used by employees to communicate with each other, to monitor production and the quality of goods and services, and to place orders with suppliers. Intranets can provide access to many types of information that employees need and replace vast amounts of paperwork. For example, intranets might include training videos or discussion groups aimed at improving how the business operates. Some hospitals use extranets to give local doctors access to a booking system so they can make appointments for their patients.

Businesses use a variety of devices to access their ICT systems. Initially these were mainly desktop computers, but more recently technological developments have seen the increasing use of smaller and more portable devices such as laptops, tablets and smartphones.

The impact of ICT on business activitiesRapid developments in technology have led to changes in the ways in which ICT is used, with implications for the way businesses operate.

The location of employeesDevelopments in communications have meant that businesses are able to employ people in a wide range of different locations, not just in the business’s offi ces, factories or shops. Many UK businesses have increasing numbers of employees working from home. They are connected to the business through electronic systems including the business’s intranet.

A number of UK businesses have located their call centres (which provide customer services) and other administrative activities overseas. This use of ICT helps to increase profits as wages and other operating costs are lower overseas. Cheap telephone and internet communications make this a practical option for many organisations. Developments in ICT software help make call-centre workers more efficient. Employees can quickly retrieve and display customers’ data, reducing the need to transfer callers to other departments.

However, further developments in ICT may see a reduction in the use of employees located in overseas call centres. Increasingly, businesses are developing software which can carry out many of the tasks previously performed in call centres.

Key terms

Stakeholders are individuals and organisations that are affected by, and affect, the activities of a business.

Intranets are communication networks which can only be accessed by an organisation’s employees.

Extranets are similar to intranets but can also be accessed by other organisations such as suppliers.

Study tip

This chapter considers a range of factors which can infl uence business activities: technology, ethics and the environment, the economic climate, globalisation, legislation and competition. You should understand the nature of these infl uences and how they impact on the four functional areas of business:● business operations● human resources● marketing● fi nance.

Using people who work from home has become increasingly possible as communication systems based around the internet (such as web chat) have improved.

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2 Influences on business

Collecting, storing and analysing information Businesses are able to collect huge amounts of varied data using the latest ICT systems. This is the area where much advanced technology has been developed. Technology companies such as Google and Facebook are able to collect huge amounts of data about the users of their services. This data can be used to target customers with appropriate goods and services. It can also be used to improve the services offered by businesses, helping them to meet customers’ needs as fully as possible.

Businesses do not need to own equipment (called servers) to store the information that they collect. Many companies, for example, Microsoft, Amazon and Google, provide cloud computing services. Cloud computing services allow organisations to store data on another business’s computing system and to have access via the internet. Google’s Cloud Platform offers powerful computers to analyse data alongside databases for storage.

Cloud computing services can also analyse data and help to identify important trends, such as changes in consumer behaviour, quickly and accurately. This allows the businesses concerned to make swift and efficient responses to changes in their markets.

Key term

Software robots are advanced computer programs that can operate a range of administrative activities previously carried out by employees.

Business insight

Blue Prism Group plcUK businesses employ people to carry out millions of routine administrative tasks. For example, when a customer of a mobile phone service provider (such as Vodafone) wants to move an old phone number to a new SIM card, a lot of simple tasks have to be carried out. Someone has to update numerous databases, often by cutting and pasting information. Such routine tasks can often be completed more quickly and accurately by a machine.

Blue Prism describes itself as a company that develops software robots – a virtual workforce for businesses. Software robots can, for example, be designed to respond to enquiries from customers and other stakeholders. The most advanced software robots send diffi cult questions to employees and learn from the responses. The software is programmed taking into account the human answers. As a result, the performance of the software improves over time – and the business’s labour costs are reduced.

The Blue Prism Group works with over 100 businesses in a range of industries including O2, World Hotels and the National Health Service.

Analyse why Blue Prism’s products are likely to be very popular with many businesses in the UK. (6 marks)

The Business insight on the Blue Prism Group below provides examples of such developments.

Key term

Cloud computing is a general term for the delivery of specialist computing services, such as the storage of very large amounts of data, provided by businesses using the internet.

Servers such as these are able to store immense amounts of data for businesses. They can also analyse this data to assist managers in decision-making.

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2.1 Technology

Progress in the field of ICT has led to particularly important and large-scale changes in two aspects of business activity. These are the use of e-commerce and of digital communication. We shall look at these in more detail below.

● E-commerceE-commerce, or electronic commerce, takes place when goods and services are sold using an electronic system such as the internet. That part of e-commerce which involves the use of handheld wireless devices such as smartphones is termed mobile commerce or m-commerce. We look at how businesses use e-commerce and m-commerce to improve their marketing on page 256.

E-commerce includes the following types of sales using electronic systems:➜ businesses selling to customers or to other businesses using their websites➜ individuals selling to other people directly through websites such as eBay.

In the UK, it is possible to buy the following products online using e-commerce:➜ goods such as food, clothing and furniture➜ digital products including audio books, music tracks and downloaded TV

programmes ➜ a range of services including car and home insurance ➜ products related to entertainment such as festival tickets and fl ights.

An increasing number of businesses are using the internet to sell products to their customers. As a result, the percentage of total retail spending by consumers in the UK conducted through businesses’ websites is rising steadily (as shown in Table 2.1) and reached 16.8 per cent in 2016.

Year

Online sales as a percentage of total retail sales (%)

Annual growth rate of online sales (%)

2014 13.5 17.1

2015 15.2 16.2

2016 16.8 14.9

2017* 17.0 10.0

2018* 18.1 9.0

2019* 19.3 8.3

*forecasts

Source: Smart Insights: www.smartinsights.com

Key terms


M-commerce (or mobile commerce) is the buying and selling of products through wireless handheld devices such as smartphones.

Table 2.1 UK e-commerce retail sales as a percentage of total UK retail sales and the growth rate of online sales

http://www.smartinsights.com

62


Source: Twenga Solutions: www.twenga-solutions.com

Table 2.2 The top ten e-commerce websites in the UK (by visitor numbers), 2016

To be effective in the field of e-commerce, businesses depend on operating websites which are clear, easy to navigate and have payment systems which are secure and easy to use. Many businesses engaging in e-commerce use payment systems operated by businesses such as PayPal, which can reassure consumers.

Using e-commerce to access more marketsMany businesses are placing greater emphasis on e-commerce as it offers a means of accessing wider markets. For example, the UK’s supermarkets, such as Morrisons and Sainsbury’s, can sell groceries online to consumers who live in areas where they do not have a shop nearby. Customers simply order using the supermarket’s website and the goods are delivered to their homes.

E-commerce can provide much of a business’s growth in sales by letting it sell to new groups of customers. Arcadia, a UK clothing retailer that owns Topshop and Burton, increased its online sales to other businesses. In 2015, Arcadia’s online sales rose by 23.9 per cent, while its sales through its stores fell by 0.9 per cent. In addition, businesses can encourage consumers to rate products which they sell. This helps businesses’ managers to monitor the needs of consumers and to provide popular goods and services.

Importantly, e-commerce allows the smaller businesses to target national or even global markets with their products. The business is able to advertise its products widely without spending large sums of money on advertising. If the business operates a good-quality website, it makes its products accessible to customers throughout the world. Arran Aromatics, discussed below, is an example of a small business which has been able to sell to a much wider market using e-commerce.

Position Company Products sold

1 eBay General merchandise

2 Amazon General merchandise

3 Tesco Groceries, clothing, household products

4 Argos General merchandise

5 ASOS Clothing

6 Next Clothing

7 John Lewis General merchandise

8 Marks & Spencer General merchandise

9 IKEA Furniture

10 B&Q Home and garden products

http://www.twenga-solutions.com

63

2.1 Technology

● Digital communicationDigital communication uses devices such as laptop computers, tablets and smartphones to transfer information. This information is encoded into a digital form. Digital communication can take a number of different forms:➜ email➜ texts➜ webchat➜ teleconferencing and video-conferencing➜ apps (or applications)➜ the use of social media websites, such as Facebook, Twitter, WhatsApp or

Instagram, designed mainly to encourage digital communication.

Digital forms of communication have transformed the ways in which businesses communicate with their stakeholders. We consider how digital methods have changed the ways businesses communicate with some key stakeholder groups below.

Customers and potential customersDigital communication means that businesses have far more contact with customers and possible customers than in the past. They help businesses to communicate in different ways. For example, customers can communicate with businesses using texts, email or social media websites, such as Twitter or

Key terms

Digital communication is the transmission of information electronically between computing devices.

Webchat is a simple means of communicating in real time (that is, instantly) using only web browsers such as Firefox or Internet Explorer.

Apps (or applications) are pieces of software designed for a specifi c purpose and for use on smartphones and tablets.

Social media are methods of online communication such as websites and applications. They share information and help to develop social and professional contacts.

Business insight

Arran AromaticsArran Aromatics manufactures cosmetics, perfumes and candles on the Isle of Arran, off the west coast of Scotland. The company was established in its founder’s kitchen in 1989. Since then, the company has grown quickly.

The business uses its location on Arran to inspire the creation of new products. Its website says:

‘The rich colour palette of this unique blend of landscapes and the diversity of its herbs and fl owers fuel our creativity and passion for beautiful things, beautifully made.’

The business uses its website to advertise and sell its products. It produces cosmetics for a number of leading UK hotel chains, including Malmaison. It also sells its cosmetics, candles and perfumes through ten outlets in Scotland. Source: Arran Aromatics: http://wholesale.arranaromatics.com/our-story

Analyse how Arran Aromatics' website helps the business to advertise its products. (6 marks)

http://wholesale.arranaromatics.com/our-story

64


Facebook. They can ask questions, place orders or make complaints. Businesses have had to respond by training employees to manage these new forms of communication and by creating social media accounts on key websites.

Businesses such as Vodafone conduct enormous amounts of communication with stakeholders such as existing and potential customers as well as employees, the general public and suppliers.

The rise in popularity of social media has resulted in many businesses appointing people with specific responsibility to manage the business’s contacts with customers through social media. Managing the business’s profile effectively on social media is vital to maintain a good reputation. Not responding quickly and positively to criticism on Twitter or other social media sites can damage a business’s reputation.

Equally, using social media effectively can help to maintain (or repair) a business’s reputation. In 2012, O2, the UK telecommunications company, received criticism on social media when its mobile phone services crashed. The company’s social media department responded honestly and with humour, answering a suggestion to ignore offensive tweets by saying (of their critics): ‘They’re not so bad. Sometimes all they need is a bit of care and attention :) ...’. This was an important use of digital communication by O2 as research reveals that 17 per cent of all Twitter users in the UK received information about the company’s problems.

All businesses, whatever their size, are able to use digital communication to engage in new and potentially valuable ways with customers. For example, large businesses can use it to keep huge numbers of customers aware of important developments such as the launch of a new product. Similarly, small businesses, with limited resources, may use it to promote their services to potential customers.

65

2.1 Technology

Business insight

Amazon’s instant ordering systemIn 2016, Amazon launched its Dash instant purchase buttons in the UK. The Dash buttons allow consumers to buy products such as coffee, dishwasher tablets and washing powder by simply pushing a button on a digital device connected wirelessly to the internet. Amazon has only recently started selling groceries to UK consumers.

Consumers buy a separate digital button for each brand (examples include Andrex, Play-Doh, Listerine and Dettol). Pushing the button places an order for

a specifi ed quantity of the branded product, which is delivered by Amazon.

Amazon initially offered 40 buttons for different product brands to UK consumers. Each Dash button costs £4.99 to purchase, but this amount is taken off the customer’s fi rst order. The Dash buttons are linked to an Amazon account and instantly order replacement items from specifi c suppliers with whom Amazon has agreements.

Analyse the possible benefi ts to Amazon from the use of this type of ICT. (6 marks)

The global online retailer, Amazon, is using the latest ICT to provide a very simple ordering system for its customers, as described in the Business insight below.

This use of ICT enables Amazon to improve its operations and to use less labour, thus saving wage costs. Using technology in this way is cheap, reliable and efficient.

Suppliers and employeesICT allows businesses to manage their relationships with suppliers more effi ciently. Many businesses operate systems to automatically re-order supplies when necessary. This can be effi cient, allowing the business to hold a low level of supplies. This reduces storage charges but ensures the business has suffi cient supplies.

Some enterprises have created new business models based on the use of digital communication, for example, the use of apps. They are able to communicate more effectively with suppliers and employees to deliver services efficiently and at low cost. Uber is an example of such a business.

Business insight

WhatsApp and Taylor & HartWhatsApp is a social messaging service which was bought by Facebook in 2014. It is one of the world’s fastest-growing communication apps. It has more than 1 billion users and carries 30 billion messages each day. WhatsApp allows users to chat in real-time and supports multimedia, including video and voice messages.

Taylor & Hart is a diamond ring design and manufacturing business. It offers online consultations to customers

looking for unique, individually designed rings. Co-founder Nikolay Piriankov uses WhatsApp to build relationships with his customers. ‘Customers asked for it,’ he says. ‘Now every design consultant has WhatsApp on their work phone. We make sure they can reach their consultant, 24 hours a day.’

Source: Adapted from the Telegraph, 29 January 2015

Explain one reason why every design consultant at Taylor & Hart has WhatsApp on their work phone. (4 marks)

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Digital technology can also provide vital information to managers of a business, helping to improve decision-making. For example, this technology can provide data on the number of visitors to a shop, how long they spend in the store and whether they are repeat customers. Managers can compare trends over time which, for example, could be used to monitor the effectiveness of a particular marketing campaign. Other advantages to managers follow from the use of this digital technology. If managers can predict the number of customers at specific times, they can ensure that sufficient staff are available.

Other stakeholdersA number of high-profi le companies, including PayPal and Intel, have decided to hold online shareholder meetings. In the past, these meetings have been at specifi c locations and can be poorly attended. Hosting these meetings online improves the companies’ communications. More shareholders can ‘attend’ as they do not have to travel. The company can monitor shareholder attendance and participation. It can also benefi t from knowing the views of a larger number of its shareholders.

Key term

A shareholder is a person or organisation that owns part of a company. Each shareholder owns a ‘share’ of the business.

SummaryRapid advances in technology, especially those relating to the internet, have resulted in businesses using ICT in different ways. Businesses of all sizes have benefi ted from engaging in e-commerce, not least as it enables them to sell goods and services

effi ciently to much wider markets. Alongside this, developments in digital technology have helped businesses to communicate more fully with stakeholders.

Business insight

Uber Uber is an American company that provides taxi services in cities across the world. Customers have the Uber app on their smartphones and use this to request a taxi. This is displayed to Uber’s drivers. When a driver accepts the request, the customer receives information including the time of arrival, driver’s name and the registration number of the taxi.

Payment for the taxi service is automatically taken from the passenger’s credit card. Uber uses digital software linked to its app to calculate fares according to the number of customers and the number of taxis available. During periods of high demand, fares can rise sharply.

Uber’s drivers are connected to the same app. When they sign on for work, they connect to the app and requests from passengers, their locations and destinations appear on their smartphones.

Satellite technology is used to guide drivers to their passengers’ locations.

Analyse the benefi ts Uber receives from communicating with passengers and drivers using digital technology. (6 marks)

67

2.1 Technology

Quick questions 1 What is meant by the term ‘information and

communications technology’ or ‘ICT’? (2 marks)

2 Give two examples of information that a business might exchange with its customers using ICT. (2 marks)

3 Explain one reason why a business might decide to use software robots as a form of business technology. (2 marks)

4 State two reasons why a business might decide to use cloud computing services such as those offered by Google. (2 marks)

5 Which of the following is the best definition of e-commerce?

(a) The buying and selling of products through wireless handheld devices such as smartphones

(b) The act of buying or selling a product using an electronic system such as the internet

(c) The transmission of information electronically between computing devices

(d) A means of communicating in real time (that is, instantly) using only web browsers such as Firefox or Chrome (1 mark)

6 State two reasons why increasing numbers of retailers are using e-commerce. (2 marks)

7 What is meant by the term ‘digital communication’? (2 marks)

8 Explain one reason why a business might use social media websites to communicate with its customers. (2 marks)

9 What is meant by the term ‘app’ (or ‘application’)? (2 marks)

10 State two reasons why a large company might decide to hold meetings with shareholders online. (2 marks)

Case study

BTBT is the UK’s largest telecommunications company. It employs over 88,000 people, many of whom use its intranet. Its employees in the UK are well paid. BT’s products include telephone and broadband services. It faces tough competition from powerful rivals such as Sky.

BT has 18 million customers in the UK. The company has been criticised at times for providing poor quality customer service, for example, being slow to respond to customer problems. It now provides a web chat service to help deal with customer enquiries and problems.

Since 2003, BT has operated call centres in Delhi and Bengaluru in India. These have been unpopular with some of its UK customers, who say the accents are diffi cult to understand. Some call centres have returned to the UK. BT’s customers can use the BT mobile phone app to check their bill or track an engineer ahead of an appointment for a repair or to install a phone line.

BT operates BT Cloud Compute giving business customers individually designed cloud computing services. These integrate with the business customer’s own computer systems. Its cloud services include storing and analysing data.

1 Identify two ways in which BT communicates with its stakeholders using digital technology. (2 marks)

2 Explain why BT uses web chat to communicate with its customers. (4 marks)

3 Analyse the benefi ts to BT’s business customers of being able to use its cloud computing services. (6 marks)

4 Analyse the ways in which BT’s use of digital technology allows it to reduce its costs of production. You should consider:● its use of call centres● its use of mobile apps.

You must evaluate which approach has had the greatest impact. Use evidence to support your answer. (12 marks)

C

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Topic 2.2 Ethical and environmental considerations

Ethical and environmental issues attract a lot of attention in the media and have become increasingly important issues for businesses’ stakeholders. Some businesses use ethical or environmental policies as a means of differentiating themselves from competitors.


● how ethical considerations affect the activities of businesses and how a trade-off between ethics and profi t may exist

● how environmental factors affect the behaviour of businesses and consumers and affect their decisions

● the meaning and importance of sustainable methods of production – we will focus on the costs and benefi ts to businesses of behaving ethically and in an environmentally friendly manner

● the advantages and disadvantages to businesses from behaving ethically and in an environmentally responsible manner.

● Businesses and ethical considerationsWhat are ethics?Ethics refers to whether a business decision is thought to be morally right or wrong. Customers, employees, shareholders and other stakeholders are becoming increasingly interested in all aspects of a business’s activities. They are no longer simply interested in a business’s products and the prices at which it sells. They want to know how and where the goods and services are produced, what materials are used and how the business treats its suppliers and its employees. A business’s stakeholders want to know whether the business is ethical. This means whether it makes decisions that are morally right or, for example, those that result in the highest profi ts.

Key terms

Ethics refers to whether a business decision is thought to be morally right or wrong. An ethical decision is made on the basis of what is judged to be morally right.


Topic

69

2.2 Ethical and environmental considerations

Stakeholders such as consumers, employees, shareholders and people who live close to the business may ask questions such as:➜ Are suppliers (especially small businesses) paid on time, or is payment

delayed?➜ Are employees treated fairly? Are they paid well? Is child labour used in

overseas factories?➜ Are consumers aware of the materials used to make products? ➜ Is the business’s advertising truthful and fair? Are its products harmful?

Figure 2.2 illustrates the differences between business activities that are ethical and legal, but may be considered unethical, and illegal activities.

Environmental issues are a part of ethical behaviour by businesses. We will consider these in detail later in this topic.

Legal activities

Range of business activities

Ethical business activities,e.g.

• donating significant amounts of profits to charities

• setting up businesses in areas of high unemployment to create jobs

Legal business activities,but judged unethical bysome stakeholders, e.g.

• selling foods high in fat and sugar

• paying managers very high salaries while many employees only receive the living wage

Illegal activities, such aschild labour or payingbelow the living wage(the legal minimum wagein the UK)

Illegal activitiesStudy tip

Do think about how ethical decisions by businesses can affect all types of business activities (such as marketing and fi nance) as well as the way in which they produce goods and services.

Business insight

LushLush is on high streets across the UK and is regarded by many as an ethical business. The chain of shops sells cosmetics and a large range of soaps. Lush’s soaps, shampoos and shower gels are manufactured using vegetarian or vegan recipes. The company encourages consumers to recycle containers.

Lush does not buy supplies from businesses that use animals to test products and supports many charities, especially those protecting the environment. For example, Lush is a supporter of Sea Shepherd, an organisation that seeks to protect whales, seals and other aquatic animals.

Lush wants people to enjoy working for the company. All employees receive wages above the minimum wage rate and discounts on company products. If an employee’s birthday falls on a normal working day, they are given an extra day’s paid holiday.

Explain two reasons why many people might consider Lush to be an ethical company. (6 marks)

Figure 2.2 Ethical, unethical and illegal business behaviour

70


How can businesses behave ethically?Businesses can behave ethically by considering the whole community and not just the business’s profi ts when making decisions. Some businesses, such as Apple and BP, are huge and their decisions impact on many individuals and groups. If businesses consider the impact of their decisions on the wider community, they are more likely to be ethical.

Businesses can behave in ethical ways in each of their functional areas – that is in the areas of marketing, operations, human resources and finance. We consider these functional areas in Chapters 3–6.

Ethical marketing Businesses that engage in ethical marketing seek to behave honestly, fairly and responsibly in all marketing activities. This might involve decisions such as:➜ designing new products to reduce the damage they do to the environment –

Tesla, an American car manufacturer, has designed a range of electric cars to reduce emissions that cause pollution

➜ avoiding targeting children with advertisements for products with potentially harmful side-effects, such as junk food

➜ not using a dominant market position to set unacceptably high prices – some pharmaceutical (drug) companies have been criticised for charging very high prices for essential medicines for which they are the only producer.

Ethical business operationsThe operations function of a business converts inputs (such as labour and raw materials) into fi nished products. It is sometimes called the production function. There are a number of ways a business can have ethical operations:➜ Managers might choose not to buy resources from suppliers that are involved

in unethical practices, such as destroying the rainforest or the employment of child labour.

➜ An ethical business is likely to manufacture products that can be recycled (and not thrown away) once their useful life is over. Jaguar Land Rover, the UK car manufacturer, announced plans in 2016 to make its cars from aluminium which can be recycled an unlimited number of times.

Ethical human resourcesFor many businesses, people are their most important resources. This is especially true of businesses that supply services such as healthcare. Managers can take decisions to manage their human resources ethically. This may include not using zero-hours contracts. Using zero-hours contracts means employees do not know how many hours, if any, they will be asked to work each week. Other examples of ethical behaviour include:➜ offering employees the opportunity of high-quality training, despite its cost ➜ paying wages suffi cient to allow employees a decent standard of living.

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Ethical fi nanceEthical fi nancial decisions may involve a business spending on community facilities which will not directly boost the business’s profi ts. Some businesses invest in facilities for the local community or pay their employees to undertake charitable work during normal working hours.

Many large companies, such as Apple, Amazon and Starbucks, have received a lot of criticism for arranging their finances so as to pay very small amounts of tax. Google responded to criticism of its tax arrangements by paying £130 million in taxes to the UK government, although this was thought to be too little by some critics.

Business ethics and profi tsIf a business takes a decision to behave ethically, it may be that its profits will decline, at least in the short-run. Ethical decisions often make it more expensive for businesses to produce and sell goods and services. This can lead to lower profits. Any of the following ethical actions can result in lower profits:➜ using environmentally friendly resources or fair trade products, which are

more costly➜ providing employees with high-quality training (after which they may take

a job elsewhere)➜ offering lower-priced products to certain groups such as pensioners➜ acting in a socially responsible way by taking into account the needs of all

stakeholders when making decisions and not just those of shareholders.

Business insight

Sports DirectSports Direct is a UK clothing retailer established by Mike Ashley in 1982. The company operates 670 sports clothing stores of which approximately 420 are in the UK.

Sports Direct has received widespread criticism in 2016 for some of the working practices within the company. ● About 90 per cent of the company’s workers were

employed on zero-hours contracts, meaning they have no guaranteed hours of work.

● The company’s employees have been fi ned 15 minutes’ pay for being one minute late.

● Employees have had to wait for security searches at the end of their shifts and have not been paid for this time.

Mike Ashley has said the company needs to improve the way it treats its workers.

Analyse the benefi ts that Sports Direct might receive from treating its employees more ethically. (6 marks)

Key terms

Fair trade products are those for which customers pay higher prices and offer better trading terms, such as payments with orders. The aim is to improve the living standards of people in poorer countries where the products are produced.

Social responsibility is an approach to managing businesses in which the interests of all groups in society are taken into account when making decisions.

Starbucks is under pressure from the European Union to pay billions of euros in taxes which it allegedly owes.

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Business insight

UK retailers and MyanmarThe fashion clothing retailer H&M has faced claims that its suppliers used children as young as 14 in factories in Myanmar. Some children worked 12-hour days. The claims have raised new fears about conditions in Myanmar. A number of UK retailers including Marks & Spencer, Tesco, Primark and New Look also have suppliers in the country.

H&M said it had taken action with factories over both ID cards and overtime after being made aware that a group of 14–17-year-olds had been working long hours. Other UK fashion retailers say a move to pay workers £1.82 for an eight-hour day will help Myanmar’s clothing industry to thrive.

Analyse the reasons why H&M uses suppliers in Myanmar where children may be employed. (6 marks)

Businesses can, therefore, face a trade-off between taking ethical decisions and generating the highest possible profits.

However, this may not always be true. Having a reputation as an ethical business can help a business to attract large numbers of customers, despite relatively high prices. Ben & Jerry’s ice-cream is very popular with consumers in the UK and elsewhere, despite its relatively high prices. In part, this is because the business takes well-publicised ethical decisions. Similarly, some businesses benefit from offering good wages and high-quality training. This helps them to attract the best-quality employees as well as motivating existing workers. These positive effects on the workforce can boost the business’s efficiency and profits. Many businesses, for example, the Co-operative Bank, publicise their ethical behaviour in their advertising.

Businesses that are seen to behave unethically can suffer from bad publicity. This can damage the business’s reputation, reducing its sales and profits. Sports Direct is at risk of this occurring following public criticisms of the way in which it treats its employees (see the Business insight on page 71).

We consider the advantages and disadvantages of ethical behaviour for businesses at the end of this section.

● Businesses and the environmentWhen we use the term the environment in this chapter it refers to the natural world: the landscape in which we live and its natural features such as the seas, rivers, forests and mountains.

The effects of business activity on the environmentBusiness activity can result in damage to the environment. For example, building a major shopping centre such as Bluewater in Kent can result in traffi c congestion and air pollution. This is the result of thousands of cars, vans and lorries travelling to and from Bluewater. The environmental consequences of business activity are an example of what is known as external costs. External costs of production arise when a business’s activities result in harmful effects on other people not directly involved in production. In other words they impose costs on others in society and not just the business concerned.

Key terms

The environment is the natural world in which we live. It is the landscape and its natural features such as the seas, rivers, forests and mountains.

External costs of production arise when a business’s activities result in harmful effects on other people not directly involved in production.

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Traffi c congestionTraffi c congestion in the UK and other countries is very costly in terms of pollution. In 2013, almost 70 per cent of the UK’s workforce commuted to work by car during peak times. The average driver spent 124 hours a year in traffi c jams, with engines producing pollutants such as carbon dioxide and nitrogen oxide. Air pollution is the worst in cities such as London where traffi c is regularly caught in jams. Traffi c congestion causes huge amounts of air pollution and causes enormous external costs. Table 2.3 summarises these effects.

Country/City Amount of carbon dioxide produced by traffi c congestion (kilotonnes)

External costs of traffi c congestion (£ billion)

2013 2030* 2013 2030*

UK 1 931 2 401 10.5 286.3

London 658 937 3.6 111.7

France 1 917 2 175 13.9 308.4

Germany 3 010 3 032 21.8 429.9

USA 8 576 10 351 300.2 538.2

* forecast data

Source: www.inrix.com

Table 2.3 Air pollution by country or city: the amount of carbon dioxide and associated external costs resulting from traffic congestion for a selection of countries and London, 2013 and 2013

Maths moment

Using the data in Table 2.3, calculate the percentage increases in the amount of carbon dioxide produced by the UK and USA between 2013 and 2030 (a forecast). Which is higher?

In 2016, the Glastonbury Festival caused very severe traffic congestion as poor weather made access to the site difficult. Many people not attending were caught up in the congestion, which took up to 12 hours to clear.

http://www.inrix.com

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Air and noise pollutionFigure 2.3 summarises the potential sources of air pollution. Many of these are the result of business activities:➜ Agriculture. Research has shown that agriculture is the major cause of air

pollution in Europe. Nitrogen fertilisers that are used to grow crops and animal waste cause the pollution.

➜ Manufacturing industries. These cause air pollution by emitting gases during the production of goods.

➜ Transport. Cars and lorries emit huge amounts of polluting gases as do aircraft.

➜ Power stations. Many power stations in the UK and elsewhere use coal and gas to generate electricity. This causes huge emissions of carbon dioxide and other gases.

Naturalpollutants,

e.g. wildfires, volcanoes, lightning

Agricultural pollutants,e.g. fertiliser, animal waste

Industrial pollutants,

e.g. factories, power plants

Transport pollutants,

e.g. cars, aeroplanes, trains, buses

Air pollution

Figure 2.3 The sources of air pollution

Pollution can also take the form of noise. Noise pollution is any disagreeable sounds that cause discomfort to people and animals. The major cause is machinery and particularly cars, lorries and aircraft. Noise pollution can have negative effects on the environment. A number of studies suggest that wildlife is stressed by noise pollution, which can affect the breeding patterns of many wild animals and threaten their long-term survival.

The use of scarce resourcesMany resources used by businesses are either scarce or non-renewable. Natural resources such as oil, coal, gold and zinc are non-renewable. This means that a limited amount exists in the world and once used, an alternative has to be found. For example, forecasts suggest that the world’s resources of natural gas could be used by 2050. Other resources are renewable, for example, some timber or solar energy.

Key term

Non-renewable resources are those of which only a limited amount exists such as coal and oil.

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If businesses and consumers take decisions to produce and buy products that use up limited or non-renewable resources, problems may occur in the future. Future generations will not have access to oil, for example, to power engines. Decisions by businesses and consumers based on the use of limited resources are not sustainable in the long term. We look at the idea of sustainability on page 76.

Global warmingGlobal warming is the gradual heating of Earth’s surface, oceans and atmosphere. It leads to rises in average temperatures. This can have many harmful effects for the environment including:➜ melting of ice in the polar regions, causing rising sea levels➜ changes in patterns of weather, meaning different crops have to be grown➜ shortages of water and drought.

The concept of global warming is controversial. However, many scientists believe that business activities result in the release of carbon dioxide, nitrous oxide and other harmful gases. The cutting down of the rainforests, the use of fossil fuels such as oil to produce and transport products and the use of artificial fertilisers to grow crops all contribute to global warming.

Consumers contribute to global warming by deciding to buy products which are known to contribute to global warming. For example, decisions to fly to another country on holiday or to buy a car that produces high levels of emissions contribute to the release of carbon dioxide and other gases. Global warming is the result. Figure 2.4 offers some indication of a sharp rise in average temperatures since 1980.

Key term

Global warming is the gradual heating of Earth’s surface, oceans and atmosphere.

380

360

340Part

s p

er m

illio

n

320

300

280

14.6

14.4

14.2

Deg

rees

C

14.0

13.8

13.62601880 1900 1920 1940

CO2 Concentration and Surface Temperature

1960 1980 2000

CO2 concentration

Average surface temp

Key

Source: Market Calls: www.marketcalls.in

Figure 2.4 Average global temperatures, 1880–2005

http://www.marketcalls.in

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How businesses and consumers can show environmental responsibilityBusinesses are able to make decisions designed to protect the environment from their activities. These decisions are more likely if consumers and pressure groups, such as Greenpeace, take action to encourage environmental responsibility by businesses.

SustainabilitySustainable methods of production are those that can continue in the long term without damaging the environment. Without sustainable production, future generations could have to cope with a damaged environment as a consequence of decisions taken today.

Sustainable production methods include:➜ the use of renewable sources of energy such as solar and wind power➜ means of transport that do not cause pollution, for example, electric vehicles➜ making products from recycled or renewable materials such as sustainable

timber➜ producing goods and services without the use of chemicals and other

products that damage the environment.

Marks & Spencer, one of the UK’s best-known businesses, is committed to become ‘the world’s most sustainable retailer’ by 2020. This will require the company to:➜ select its suppliers very carefully to ensure they are not damaging the

environment➜ build environmentally friendly stores using, for example, solar power and to

reduce carbon emissions from transport.

Key terms

A pressure group is a group of people with a common interest who infl uence public opinion and decisions by businesses and governments.

Environmental responsibility refers to the taking of decisions by businesses, consumers, governments and other groups with the intention of protecting the environment.

Sustainability refers to methods of production which can be continued in the long term without damage to the environment.

Business insight

Palm oil and deforestation

Palm oil is found in approximately 50 per cent of products on supermarket shelves in one form or

another. These products include foods, cosmetics, animal foods and medicines. Palm oil is linked to the destruction of the world’s rainforests. The creation of new oil palm plantations to meet the rising demand for palm oil has resulted in the destruction of many rainforests. Many are located in Indonesia and Malaysia where incomes are relatively low.

Today there are about 13 million hectares of palm oil plantations in the world. The use of the rainforest in this way damages the environment. It destroys the biodiversity in these forests, along with the habitat of species such as the orangutan.

Analyse one reason why businesses in Malaysiaand Indonesia destroy the rainforest when it causes severe damage to the environment. (4 marks)

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Disposing of wasteModern societies produce huge amounts of waste. Waste can be unused food, packaging or old products. Europe produces 1.8 billion tonnes of waste every year.

Disposing of the waste from production carefully can avoid a range of environmental problems, such as water pollution and air pollution, as products emit gases as they degrade. Hazardous chemicals can also remain in the soil threatening the health of humans and animals.

The two major methods of disposing of waste are landfill (burying it) and incineration (burning it). Both can result in damage to the environment.

Environmentally responsible businesses aim to reduce the amounts of waste that result from the production and consumption of their products. This may involve the use of reduced amounts of packaging or products that last longer – so fewer are produced. In 2016, Tesco announced that it had redesigned its packaging to keep meat products (for example, chicken fillets) fresher for longer. It expects this to reduce the amount of food that becomes waste.

RecyclingOne major method of reducing waste is through recycling which reuses materials to produce new products. While it is commonplace for bottles and cans to be recycled, businesses are increasingly designing products that can be recycled. For example, buildings are now dismantled, rather than demolished and buried, with a view to reusing the bricks and metal, as well as fi xtures and fi ttings such as windows.

Key term

Recycling is the reuse of raw materials used in making products, often for many times. Examples include the reuse of glass, paper and metals.

Business insight

Levi StraussLevi Strauss is an American clothing manufacturer, perhaps best known for its range of jeans. It is introducing a clothes recycling operation in the UK, based on a model that is successful in the USA. It offers a 10 per cent discount on Levi’s products for consumers who donate old clothes and shoes. This operation has attracted a lot of publicity in the USA. Some other retailers, such as H&M, have similar schemes.

Collection boxes are being installed in Levi’s stores in the UK, and customers who bring in any brand of clean, dry clothing or shoes for recycling will be given a voucher. This can be traded in for a discount on new clothes.

The company has plans to expand the recycling operation throughout Europe by December 2017.

Analyse why Levi Strauss is introducing its recycling operation into the UK. (6 marks)

Landfill sites can create a number of environmental problems, including the production of dangerous gases such as methane.

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Creating and using different methods of transportWe saw earlier that transport is a major cause of environmental damage. Businesses that manufacture cars, lorries and planes are all seeking to produce vehicles that can be recycled and produce fewer emissions of harmful gases. For example, many car manufacturers are producing increasing numbers of electric cars.

At the same time, businesses are seeking to use methods of transport that are less damaging to the environment. In 2016, easyJet, the low-fare airline, announced that it was to trial the use of hydrogen fuel cells on the aircraft it uses. This could reduce its use of aviation fuel by 50,000 tonnes per year. Over 30 per cent of London buses were using biofuels in 2016, substantially reducing carbon emissions in the capital.

Consumers’ decisions and the environmentIt is easy to think that businesses are solely responsible for environmentally responsible methods of production. Of course, they do have a signifi cant responsibility, but so do consumers.

Consumers can take a range of decisions that can help to protect the environment:➜ They can recycle products at home to reduce the amount of waste they

produce.➜ They can buy environmentally friendly products whenever possible. This

encourages businesses to produce these products.➜ They can also complain to businesses (possibly using social media) whenever

they are seen to cause damage to the environment.

Many consumers become members of pressure groups, such as the RSPB, Greenpeace or Friends of the Earth. These groups campaign to protect the environment.

Study tip

Do make sure that you understand how businesses and consumers show environmental responsibility in the decisions that they make. It can be helpful to know examples of such decisions. This topic gives you several examples.

Pressure groups such as the RSPB do a great deal of work to encourage businesses and governments to behave in environmentally responsible ways.

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● The advantages and disadvantages of environmentally friendly and ethical policies

The advantages➜ An increasing number of businesses have adopted at least some

envir onmentally friendly policies. Many produce an annual environmental report which publicises their environmentally friendly actions. This can result in some positive publicity for the business, especially if its competitors are not reporting in this way. Many businesses that are environmentally friendly use this in their advertising. Marks & Spencer has used its environmentally friendly policies (known as Plan A) prominently in its advertising since 2007 (see Topic 1.3, page 25). Similarly ethical businesses use their moral behaviour strongly in advertising and other marketing.

➜ Ethical and environmentally friendly businesses can frequently charge higher prices for their products. Consumers place a greater value on their goods and services as they do less damage to the environment or to other stakeholder groups. Thus they are willing to pay more for them. This can help to increase the business’s profi ts.

➜ Introducing ethical and environmentally friendly methods of production can help a business to win new customers by being different from its competitors. The Co-operative Bank presents itself as an ethical and environmentally friendly business. This helps to distinguish it from other banks.

The disadvantages➜ Implementing ethical and environmentally friendly policies can increase

costs. Using materials that do not damage the environment or paying employees higher wages can be more costly. It is often cheaper for a business to use new rather than recycled resources or to pay minimum wage rates. We saw earlier that Levi Strauss operates a recycling scheme. This will involve administrative costs and it will lose revenue as it is giving customers vouchers to pay in part for its products. Unless environmentally friendly policies attract more customers, or allow higher prices, they can lower profi ts.

➜ Businesses that present themselves as ethical or environmentally friendly have to ensure that they are just that! If they are found not to be so, they can receive very damaging publicity. Sales and profi ts may fall sharply as a consequence. Volkswagen, the German car manufacturer, is suffering reduced sales in many markets following revelations that it ‘cheated’ in tests of its cars’ emissions.

Key term

Environmental reporting is the publication of a business’s environmental performance to the general public.

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SummaryBusinesses have to take into account ethical and environmental infl uences when taking decisions. Being seen to behave more ethically by taking morally correct decisions and seeking to protect the

environment can attract customers. However, such ethical and environmentally friendly actions can be costly and, therefore, threaten businesses’ profi t levels. It can be a tricky balancing act.

Quick questions 1 What is meant by the term ‘ethics’? (2 marks)

2 State two questions that might be asked to decide whether a business is ethical or not. (2 marks)

3 Explain one way in which a business could engage in ethical marketing. (2 marks)

4 Which of the following is most likely to be judged an ethical decision?

(a) Paying employees the legal minimum wage

(b) Setting prices to make maximum profi ts

(c) Using zero-hours contracts for most employees

(d) Providing all employees with high-quality training (1 mark)

5 Explain one reason why ethical decisions may reduce a business’s profits. (2 marks)

6 What is meant by the term ‘environment’? (2 marks)

7 Which of the following business activities is least likely to result in an external cost?

(a) Using coal to generate electricity

(b) Manufacturing products using recycled materials

(c) Importing products using aircraft to transport them

(d) Using large quantities of artifi cial fertilisers to grow crops (1 mark)

8 Which of the following is a renewable resource?

(a) Oil

(b) Iron ore

(c) Tidal power

(d) Coal (1 mark)

9 What is meant by the term ‘sustainable production’? (2 marks)

10 Give two examples of environmentally responsible decisions that consumers can take. (2 marks)

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Case study

DeliverooDeliveroo is an online food delivery company that operates in the UK and 11 other countries. It delivers food from restaurants which do not have their own delivery service, for example, Pizza Express and Wagamama. It has grown quickly, earning revenues of £130 million in 2015–16. Deliveroo has just received £212 million from investors to fi nance further expansion of the company.

The company has been involved in a pay dispute with its delivery drivers. It sent an email to its workers telling them they would be paid £3.75 per delivery instead of an hourly rate of £7 plus £1 per delivery. The new scheme could see the employees earn less than the living wage, particularly when the company has few orders. This could cause diffi culties for the company and may lead to a change of plan.

Deliveroo has said it will enforce the pay terms and claimed that its drivers had responded positively

in early trials. It is expecting to face increasing competition from companies such as Uber in the near future.

1 Identify two stakeholders who may be affected if this new pay deal is agreed. (2 marks)

2 Explain why this decision may be considered to be unethical. (4 marks)

3 Analyse how Deliveroo’s activities might harm the environment. (6 marks)

4 Analyse the consequences for Deliveroo from its decision to change its pay system. In your answer, you should consider:● the advantages to the business ● the disadvantages to the business.

You must evaluate whether the advantageswill be greater than the disadvantages. Use evidence to support your answer. (12 marks)

C

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2.3 The economic climate of business

Topic

● What is the economic climate?Before describing the economic climate, it is important to understand what is meant by ’the economy’. The UK and other economies are made up of millions of consumers and many thousands of businesses, as well as the national and local governments. All these people and organisations take decisions on what to buy, sell, produce, import from overseas, where to work and many other matters. All together the actions and decisions taken by these individuals and organisations decide what is to be produced, bought and sold. This is ‘the economy’.

The economic climate is a term that refers to the state of an economy. This term considers whether an economy is:➜ producing a greater or a smaller quantity of goods and services➜ providing consumers with falling or rising incomes

The economic climate can change relatively quickly from one which provides a good trading environment for businesses to one in which trading is diffi cult. The economic climate for businesses is a signifi cant external infl uence on a wide range of decisions taken by managers.


● what is meant by the economic climate

● how changes in the rate of interest might affect businesses and spending by consumers

● the impact on businesses of changes in the level of employment

● how consumers’ incomes and levels of spending can change.

Key terms

The economy is made up of millions of individual consumers, many thousands of businesses and governments. All take decisions on what to buy and produce.

Consumers are individuals who buy goods and services from businesses.

The economic climate describes the state of key factors within a country such as the level of goods and services produced and the number of jobs available.

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➜ experiencing a rise or a fall in the amount that consumers can spend on goods and services

➜ offering more or fewer jobs for people.

As Figure 2.6 shows, it is possible to describe a change in the economic climate as improving or weakening, depending on what is happening to key factors such as production levels and the number of jobs available. Generally speaking, a rise in these key economic factors indicates an improving economic climate.

Resourcemarkets,

e.g. labourmarkets

Consumerspay taxes

Businessespay taxes

Governmentssupply some products,

e.g. healthcare

Consumerspending on

goods and services

Governmentsbuy goods

and services

Businesses sellgoods and servicesto consumers and

governments

Businesses buyresources to

produce goodsand services

Manyconsumers

sell labour andservices tobusinesses

Governmentssupply some products,

e.g. road network

Some resourcesare imported, some

are bought fromother firms

Markets forgoods and

services, e.g.groceries or cars

Businesses ConsumersLocal andnational

governments

Figure 2.5 A simplified view of an economy Rising levels ofemployment, production,

consumer incomesand spending

Falling levels ofemployment, production,

consumer incomesand spending

An improving economic climate

A weakening economic climate

Figure 2.6 Changes in the economic climate

Business insight

Brexit leads to concerns about a weakening economic climateMany small and medium-sized businesses had concerns about the UK’s future economic climate following the decision to leave the European Union.

Research showed that over 25 per cent of small and medium-sized businesses believed that the economic climate would worsen. Only 20 per cent of these

businesses expected to expand in 2016–17, while 57 per cent anticipated zero growth in the production of goods and services. About 10 per cent feared that their businesses would produce a smaller amount of goods and services in 2016–17, and some forecasted shutting down.

Analyse the likely consequences for businesses if the economic climate in the UK does weaken. (6 marks)

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● Interest rates and the economic climateInterest rates are the cost of borrowing money, expressed as a percentage rate. Thus, if a business or consumer borrows money, they have to repay the amount borrowed plus an additional amount – the interest payment. The additional amount is stated as a percentage to make it easier to understand. A higher percentage rate means a larger ‘extra’ payment. Equally, if a consumer or business saves money (by putting it into a bank account, for example), they receive an extra amount in the form of an interest payment.

Changes in interest rates can affect the economic climate of a country. They have this impact because they affect decisions taken both by consumers and businesses.

Consumers and changes in interest ratesA change in interest rates will have two broad effects on consumers’ decisions. It may affect the amount they decide to save and the amount they choose to spend. The impact can be signifi cant if there are large changes in interest rates.

Let’s assume that there is a fall in interest rates – as happened in the UK in August 2016. This will be likely to have the following effects:➜ Saving by consumers. A fall in interest rates will lead to some consumers

deciding not to save, as the interest they receive will have been reduced. They may decide to spend existing savings on goods and services and save less in the future.

➜ Spending by consumers. As well as spending their savings, consumers will be more willing to borrow money to buy more expensive items such as houses and cars. They will do this because lower interest rates reduce the additional amount they have to repay.

A rise in interest rates will have the opposite effects.

Key term

Interest rates refer to the cost of borrowing money or the reward for saving money, expressed as a percentage.

Initialamount

borrowed

£

Large ‘extra’repayment

Less borrowing(and more saving)

Weakeningeconomic climate

High or risinginterest rates

£More borrowing(and less saving)

Small ‘extra’repayment

Improvingeconomic climate

Low or fallinginterest rates

Figure 2.7 Different interest rates and the economic climate

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Businesses and changes in interest ratesSome businesses rely heavily on borrowed money to fi nance their activities. Sometimes this money is just borrowed for a short period of time, for example, to pay for raw materials. On other occasions, it may be borrowed for a long period of time, for example, to pay for a new factory or offi ces.

Some businesses rely on borrowing to finance their businesses. For example, some fee-paying schools may rely on short-term borrowing as they only receive fees from parents at the start of each term. However, they have to pay teachers’ wages and other costs throughout the term. They may use a flexible short-term loan, called an overdraft, for this purpose. An overdraft is a flexible loan which businesses can use, whenever necessary, up to an agreed limit.

Borrowing large amounts of money, especially over long periods of time, means that businesses can be affected significantly by changes in interest rates.➜ Rising interest rates. In this situation, a business may face a large increase

in the amount of interest it pays on its existing loans. This could increase its costs, reducing profi ts. In extreme cases, a large rise in interest rates may result in a business being unable to repay its loans. In this case, it will probably stop trading.

➜ Falling interest rates. This is a more favourable situation for many businesses with borrowings. It may be that borrowing costs will be reduced, helping to improve the business’s profi ts. However, those businesses with large savings may receive reduced returns.

One way in which a business can protect itself against changes in the cost of its borrowing is to negotiate loans with fixed rates of interest. This means the rate of interest is unchanged throughout the period of the loan. However, fixed rate loans may have higher rates of interest from the start.

Key term

An overdraft is a fl exible loan which businesses can use, whenever necessary, up to an agreed limit.

Banks try to persuade customers to save money with them by offering higher interest rates than their competitors.

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Businesses, interest rates and consumer spendingBusinesses can also be affected following a change in interest rates by consumers’ decisions to spend less or more on their goods or services. If interest rates rise, some consumers may decide to save more. Other consumers may choose not to take out loans to buy new cars or technology, such as televisions or computers. These decisions could result in a business selling fewer products and receiving less revenue from its sales. The outcome is likely to be lower profi ts.

Businesses that sell luxury goods will be affected most when interest rates rise. Similarly, they benefit most from interest rate reductions.

Lower interest rates can prompt reductions in saving and higher levels of borrowing and spending by consumers. This should help to increase a business’s profits.

Business insight

New car sales rise as interest rates reducedSales of new cars in the UK rose in August 2016, recording a total of 81,640 for the month. During the fi rst eight months of 2016, sales of new cars reached 1.68 million. This matched 2015, which was a record year.

In early August 2016, interest rates were reduced, despite already being at the lowest level for over 300 years.

Explain why sales of cars might have reached record levels in 2015 and 2016. (4 marks)

It is important to remember that the effects of any change in interest rates will be greater if it is a large change and results in rates going to very high, or very low, levels.

Study tip

You should focus on the effects of changes in interest rates. You are not expected to know the reasons why interest rates are changed or the methods by which they are changed.

Few consumers can buy houses without loans, often needing to borrow large amounts. Thus, sales of houses can be very sensitive to changes in interest rates.

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Rising interest rates Falling interest rates

Generally result in a weakening of the economic climate for many businesses

Usually result in improvements in the economic climate for businesses

The effects include:● Businesses may suffer falling sales as

consumers save more of their incomes.● Sales of goods purchased using borrowed

money (such as houses) may fall signifi cantly.● Businesses are likely to reduce production to

match sales.● Businesses may postpone expansion plans,

such as opening new shops.

The effects include:● Sales may rise, especially of luxury and

non-essential products.● Production of goods and services will rise,

possibly increasing consumers’ incomes.● Businesses may need to employ additional

workers, also helping to increase consumer spending.

Table 2.4 A summary of the effects of changing interest rates on consumers and businesses

● Levels of employment and consumer spending

Businesses employ workers to produce goods and services for sale. If the economic climate is strong and improving, there is likely to be a rising level of employment as more workers are needed. Wages may also rise. On the other hand, during a period in which the economic climate is weakening, employment levels and wages may fall.

The effects on businesses of changes in the level of employmentAt the time of writing (September 2016), the UK has enjoyed rising levels of employment since around 2010. A common way of measuring the level of employment is to calculate the employment rate. This measures the percentage of people aged 16–64 in employment. It thus allows for changes in the size of the population.

Rising levels of employment in the UKFigure 2.8 shows that the level of employment rose steadily between 2011 and 2016. In the middle of 2011, the employment rate was 70.1 per cent. This meant that just over seven out of every ten people aged between 16 and 64 in the UK had a job. Some of the remaining three out of ten may not have wanted employment; they may have been students or had childcare responsibilities. Nevertheless, some of them would have been unemployed and looking for a job. By the summer of 2016, the employment rate in the UK had reached 74.5 per cent. The UK’s population had also increased over the fi ve years. As a result, the number of people in employment had risen from 29.10 million in 2011 to 31.75 million in 2016.

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Increases in the level of employment, such as that in the UK between 2011 and 2016, can have two significant effects on businesses:➜ The possibility of higher sales.

Because more people have jobs, it is likely that consumer spending will rise. We have seen that in 2016 approximately 2.65 million more people were in work in the UK than in 2011. This represents many extra customers for businesses. In addition, real wages may have risen – that is after allowing for any increases in prices. As a result, consumers have greater spending power and can buy more goods and services. This is good news for many businesses, especially those that sell luxury items.

➜ Increased employment costs. The UK’s employment rate of 74.5 per cent in 2016 is a high fi gure. This means that some types of labour, especially skilled workers, may become scarce. As a result, wage rates can rise as businesses compete to employ available workers. The outcome is higher employment costs. This can reduce a business’s profi ts if it is unable to raise the prices of its goods and services.

75

74

73

%

72

71

70

69Apr–Jun

2011Apr–Jun

2012Apr–Jun

2013Apr–Jun

2014Apr–Jun

2015Apr–Jun

2016

Source: Offi ce for National Statistics – The UK Labour Market, August 2016

(page 7): www.ons.gov.uk

Figure 2.8 The rate of employment in the UK, 2011–2016

Maths moment

Use the information above to calculate the change in the number of people in the UK aged 16–64 between 2011 and 2016.

High levels of employment provide consumers in the UK with more money to spend, increasing the sales of most businesses.

http://www.ons.gov.uk

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However, there are times when the employment rate, and the number of people in work, falls. This happened in the UK between 2008 and 2010. This can pose problems for businesses, despite the possibility of falling wages and salaries. Consumer spending is likely to fall and may do so sharply. This results in falling sales for many businesses, especially those selling luxury items such as jewellery and foreign holidays.

We consider the effects of changes in consumer spending on UK businesses more fully below.

The effects on businesses of changes in consumer spendingConsumer spending refers to the value of goods and services bought by consumers over a time period, usually a month or a year. This spending will be on essential products such as food, housing and heating, as well as on non-essential products including restaurant meals, designer clothing and alcohol. Non-essential items are luxury products that consumers want rather than those they need.

It is normal for consumer spending to fall at times when consumers’ incomes are lower. Figure 2.9 shows the level of consumer spending in the UK between 2006 and 2016. It is clear that consumer spending fell sharply between 2008 and 2010. This occurred because the UK experienced a financial crisis and the economic climate became significantly worse. Employees lost their jobs or worked fewer hours each week. As a result their incomes fell giving them less money to spend on goods and services.

However, since 2012, the economic climate has improved along with the level of employment. As a consequence, consumer incomes and spending have risen.

Key term

Consumer spending refers to the value of goods and services bought by consumers over a time period, usually a month or a year.

310,000

290,000

285,000

£ (m

illio

ns)

280,000

275,000

270,000

02006 2008 2010 2012 2014 2016

295,000

300,000

305,000

Source: Trading Economics: www.tradingeconomics.com

Figure 2.9 Consumer spending in the UK, 2006–2016

Maths moment

Look at the data shown in Figure 2.9. When was consumer spending in the UK:

(a) rising most quickly?

(b) falling most quickly?

http://www.tradingeconomics.com

90


The effects on businesses supplying essential and non-essential products

Figure 2.9 shows us that there was a sharp fall in consumer spending during the years 2008–2010, when the financial crisis occurred and consumers’ incomes fell. It also shows that consumer spending rose steadily from 2012 to 2016, when the incomes of many consumers were rising. It is apparent, therefore, that there is a direct link between consumers’ incomes and the level of their spending. This is not surprising. If consumers receive higher incomes, they are likely to spend more and businesses’ sales will rise. If consumers’ incomes fall, so will their spending and the sales of businesses.

The effects of lower consumer incomes and falling sales can be felt by all functions within a business. It may affect business operations as they have to cut production levels. Human resources may have to employ fewer people. The marketing department may have to cut the prices of its products and to develop cheaper versions.

However, the levels of sales of all businesses are not affected equally by changes in consumers’ incomes. Some businesses, which produce or sell essential products such as basic foods, do not experience large falls in sales when consumers’ incomes fall. Equally, they do not enjoy significant increases in sales when consumers’ incomes rise.

On the other hand, some businesses do sell goods and services whose sales vary considerably when consumers’ incomes change. These products are likely to be luxury and non-essential items. Examples include designer handbags and organic foods. These products are called income elastic products as their sales are sensitive to changes in consumers’ incomes.

Thus, businesses that produce some products may experience significant fluctuations in their sales as consumers’ incomes change. Others may experience fewer changes as their products are not income elastic, or perhaps are less income elastic.

Key term

Income elastic products are those whose sales are sensitive to changes in consumers’ incomes.

Products that are income elastic Products that are not income elastic

The sales of income elastic products are sensitive to changes in consumers’ incomes. For example, a fall in incomes is likely to result in a substantial fall in sales of these products. Many of these products are luxury products.

The sales of products that are not income elastic are relatively unaffected by changes in consumers’ incomes. Many of these products are essential for consumers; some may be addictive.

For example:Luxury travelFine winesNew kitchens and bathroomsGym membershipsSports cars such as Ferraris

For example:Basic foods, such as bread, milk and eggsTobacco productsBus travelPetrol and diesel for carsTap water

Table 2.5 Examples of products that are income elastic and those that are not income elastic

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Business insight

Ryanair’s sales unaffected by consumers’ income levelsRyanair is best known for providing cheap fl ights throughout Europe. Its website advertises fl ights to European cities such as Aarhus (Denmark) and Warsaw (Poland) for as little as £10 one-way. The company has successfully lowered its prices over time.

By selling fl ights very cheaply, it has increased its sales enormously. In 1990, it had 745,000 passengers. By 2016, the fi gure had risen to 117 million. Its passenger numbers have grown steadily since 2000, even when consumers’ incomes were falling.

Explain why Ryanair’s sales continued to rise even when consumers’ incomes were falling. (4 marks)

Rising incomes normally lead to higher sales of luxury products, such as sports cars, while demand for other products, such as travelling by bus, can fall.

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Quick questions 1 What is meant by the term ‘economic

climate’? (2 marks)

2 Which of the following is most likely to be a sign of an improving economic climate?

(a) A rise in the number of people who do not have jobs but are looking for one

(b) A rise in the number of businesses that are forced to cease trading as they cannot repay loans

(c) A rise in the number of people in employment

(d) A rise in the number of people moving overseas for work (1 mark)

3 What is meant by the term ‘interest rates’? (2 marks)

4 Which of the following best describes an overdraft?

(a) A fl exible loan which businesses can use, whenever necessary, up to an agreed limit

(b) The extent to which a business uses borrowing to fi nance its activities

(c) The long-term borrowing of an agreed amount by a business

(d) A situation in which a business raises the price of its products (1 mark)

5 Explain one possible effect of falling interest rates on a business. (2 marks)

6 Which of the following is most likely to be the result of rising interest rates?

(a) Rising sales of expensive foreign holidays

(b) Rising production of all goods and services

(c) Rising levels of employment

(d) Rising levels of saving by consumers (1 mark)

7 Explain one possible effect of falling levels of employment on UK businesses. (2 marks)

8 What is meant by the term ‘consumer spending’? (2 marks)

9 Which of the following products might be described as essential?

(a) Milk

(b) LED television

(c) Overseas holiday

(d) Restaurant meal (1 mark)

10 Explain why a bakery’s sales of bread may not be affected significantly by a fall in consumers’ incomes. (2 marks)

SummaryBusinesses are infl uenced by changes in the economic climate. Fluctuations in the level of interest rates or the level of employment are likely to affect most

businesses. Changes in consumers’ income will affect many. Those selling income elastic products will be affected most.

93


Case study

The USA increases its interest ratesIn December 2015, interest rates in the USA were increased from 0.25 per cent to 0.50 per cent (or half a percent). This was the fi rst increase for nearly ten years. Further increases in interest rates in America are expected over the following year or two.

The higher interest rates have already had a number of effects. Some industries, such as house building, have been affected as consumers normally buy houses using loans. Despite this, the news on wages and salaries is positive, as shown in Figure 2.10.

6.0

4.0

3.5

Perc

enta

ge

gro

wth

3.0

2.5

2.0

0Jan 2015 Jul 2015 Oct 2015 Jan 2016 Apr 2016 Jul 2016

4.5

5.0

5.5

Apr 2015

1.5

1.0

0.5

Source: Trading Economics: www.tradingeconomics.com

Figure 2.10 The percentage increase in wages and salaries in the USA, 2015–2016

However, consumers in America do have high levels of debt. In 2015, the average American household owed $260,000 (approximately £195,000).

1 State two other examples of products other than houses that consumers often buy using borrowed money. (2 marks)

2 Explain how this increase in interest rates might affect the fi nance function of a large company. (4 marks)

3 Analyse the likely effects of this rise in interest rates on the level of spending by American consumers. (6 marks)

4 Analyse the effects of the rise in interest rates on American businesses. In your answer, you should consider:● businesses that may be affected by this rise in

interest rates● businesses that may not be affected by this

rise in interest rates.

You must evaluate whether or not American businesses will be affected signifi cantly by this interest rate rise. Use evidence to support your answer. (12 marks)

C

http://www.tradingeconomics.com

94

The world economy has become much more interconnected over the past 50 years through a process known as globalisation. This has resulted in advantages and disadvantages for businesses in the UK. In response to globalisation, UK businesses have had to improve product design and quality while keeping prices low to compete internationally. Globalisation has meant that exchange rates have become an important factor for many businesses in the UK. Changes in exchange rates can have important effects on the sales and profi ts of many businesses.

By the end of this section you should know:

● what is meant by globalisation

● the benefi ts and drawbacks of globalisation for UK businesses

● how UK businesses compete internationally in response to globalisation

● the impact of exchange rates on businesses.

● What is globalisation?Globalisation is the process through which world economies have become steadily more interconnected since the 1970s. This has changed the ways in which many businesses operate, as:➜ the volume of trade between countries has increased➜ people have moved overseas to live and work and money has fl owed between

different countries➜ multinational companies (MNCs) have grown in importance and have

supplied products to markets across the world.

The pace of globalisation has increased in recent years because:➜ incomes have risen, allowing consumers in many countries to buy goods

and services produced by multinational companies➜ the cost of transporting products has fallen sharply, making it possible to

move raw materials and fi nished goods around the world➜ electronic communications have allowed even small businesses to sell

products to global markets.

Key terms

Globalisation is the trend for markets to become worldwide in scope.

A multinational company (MNC) produces goods and services in more than one country. They are also called transnational corporations (TNCs).

2.4 Globalisation

Topic

95

2.4 Globalisation

Increased international tradeOne of the most signifi cant features of globalisation is that it has resulted in increased trade between countries. This type of trade is called international trade. Figure 2.11 shows the huge rise in the global value of exports between 1960 and 2015. In 1960, the total value of exports by all countries was $125 billion; by 2015 the fi gure had reached $16,600 billion.

1960 1965 1970 1975 1980 1985Year

$ (b

illio

ns)

1990 1995 2000 2005 2010 2015

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Source: The World Bank

Figure 2.11 Global exports 1960–2015 ($ billion)

This increase in international trade has occurred because incomes have risen in many countries over this time period. This has led to increasing demand for many products such as mobile phones, cars and foods such as beef and palm oil. Frequently these products are produced in other countries and exported to where consumers live. At the same time, incomes have risen particularly quickly in countries such as China, India and Brazil leading to especially large increases in trade with these countries.

Reductions in the cost of transporting products have also contributed to the rise in international trade. Much larger cargo ships have been designed and built, thus reducing the cost of transporting goods internationally. In 2014, the CSCL Globe, the world’s largest cargo vessel, was launched. It can carry over 19,000 containers. Its size helps to reduce the cost of transporting products by increasing the quantity carried and reducing operating costs. This has helped MNCs to locate at least some of their operations in countries where costs are lower. We consider this in detail over the next two pages.

Finally, more trade agreements have been reached between countries, allowing the exchange of goods and services with fewer barriers to trade. The World Trade Organisation (WTO) is an international organisation that has played an important part in reducing barriers to trade, such as tariffs (taxes on imports of goods and services).

Key terms

International trade is the selling of goods and services across national borders.

Exports are goods and services produced by a business in one country and sold in another.

The CSCL Globe, the world’s largest cargo vessel

Key term

A tariff is a tax on foreign goods imported into a country.

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People have moved more freely across international bordersGlobalisation has encouraged the movement of people between different countries seeking to improve their standard of living. In particular, it has resulted in a fl ow of migrants to higher-income countries (HICs) in Europe and North America. These countries are attractive to migrants as businesses need employees and wages are relatively high. Figure 2.12 shows some of the major international fl ows of migrants.

< –10

2011 RatePer 1,000 Residents

Major migration flowsLesser migration flows

–9.9 to –5–4.9 to –0.10 to 55.1–10> 10.1

Source: The CIA World Factbook

Figure 2.12 Global flows of migrants

In addition, globalisation has been associated with increased international flows of money. These financial flows have helped MNCs to invest in establishing factories, offices and shops in other countries. This has been an important part of globalisation.

Development of multinational companiesGlobalisation has led to markets becoming more international. Many businesses have adapted to this trend by trading internationally, rather than just operating in a single market. MNCs produce goods and services in more than one country, taking advantage of countries where production costs are lower. Their products are normally sold in many countries. Apple, Lenovo and Tesco are all examples of MNCs.

Business insight

StarbucksStarbucks is a US multinational company that operates nearly 24,000 coffee shops in 70 countries throughout the world. Starbucks’ coffee shops sell hot and cold drinks, cakes and biscuits as well as light meals. Some of its shops are licensed to sell alcoholic drinks.

Starbucks has differentiated itself from other coffee shop chains by emphasising the quality of its coffee (especially its dark roasted coffee) as well as the quality of its customer experience.

Explain why Starbucks is a suitable business to operate as a multinational company. (4 marks)

97

Most MNCs were originally based in high-income countries such as the US, France and the UK. However, in recent years rapidly growing economies such as India, Mexico and China have developed their own MNCs. These large companies are able to create and promote well-known brands. Some have been successful by selling their products at low prices. Others, such as Lenovo, have developed brands noted for their quality.

MNCs have been successful where a global demand exists for their products and if they are affordable to large numbers of people. Merlin Entertainments, a British-based MNC, plans to open a Legoland theme park in Shanghai. It expects the theme park to be popular with Chinese consumers who are enjoying rising incomes.

Globalisation has made it easier for MNCs to buy resources cheaply from other countries. For example, in 2015 Nestlé bought about 420,000 tonnes of palm oil from Indonesia and Malaysia. It uses the oil in manufacturing confectionery. Some MNCs have established factories in countries where labour is cheaper to help them to minimise production costs. Since 2003, Dyson, a UK engineering company, has carried out much of its production in Malaysia where wage costs are substantially lower than in the UK.

Inward investment

Cheaper resources

Threat of takeover

New competitors

Fierce competition

Rapid growth

Drawbacks

Benefits

GLOBALISATION:The trend for marketsto become worldwide

in scope

Figure 2.13 Benefits and drawbacks of globalisation to UK businesses

McDonald’s is one of the world’s best-known MNCs. In 2015, it operated over 36,000 outlets in 119 countries, including this one in China.

2.4 Globalisation

98


● Benefits and drawbacks of globalisationGlobalisation brings a number of benefi ts and drawbacks to UK businesses.

Benefits of globalisationRapid growthGlobalisation has helped some UK businesses to grow rapidly by providing opportunities in overseas markets. Growth offers businesses a range of benefi ts including economies of scale. For example, buying large quantities of supplies enables businesses to pay lower prices per unit. We looked at economies of scale in more detail on pages 51–52. Growth also helps to generate higher profi ts and better returns for shareholders. Cath Kidston, a UK designer and retailer known for its fl oral designs, is opening stores in India in 2016. This will bring its total number of overseas stores to 158.

Inward investmentGlobalisation has helped the UK to attract very large sums of inward investment. In 2015 alone, the UK received £25,500 million from foreign governments, business and individuals. Inward investment has fi nanced the expansion of some industries such as motor car manufacturing. It has also helped to fi nance improvements in infrastructure, including transport systems and energy supplies, such as Hinkley Point power station in Somerset. Some UK businesses have been bought by foreign companies. This can help to improve the performance of these businesses as, for example, the foreign company might invest in training the workforce to improve their skills.

Cheaper resourcesGlobalisation means that UK businesses have access to cheaper resources. For example, much of the UK’s coal is imported as it is cheaper than that produced in the UK. Some businesses take advantage of cheaper sources of labour overseas. In 2016, HSBC, a UK-based bank, announced that it was to use Polish, Indian and Chinese employees to fi ll 800 IT jobs as wage rates would be lower. This can help to increase a business’s profi ts as well as to make businesses more price competitive.

Key terms

Growth occurs when a business sells increased quantities of its products.

Economies of scale occur when the cost of producing a single unit falls as output increases.

Inward investment occurs when governments, businesses and individuals invest capital into another country, for example, building new factories or buying companies.

A takeover occurs when one business buys control of another one.

Business insight

AmazonAmazon is one of the world’s best-known e-commerce businesses, and its value is estimated to be $65.4 billion. In 2015, its sales revenue totalled $107 billion; its profi ts for the year were $596 million. The company has a reputation for being highly price-competitive and has established its websites in 15 high-income countries.

Amazon was initially an online retailer of books, but has steadily expanded its operations. It now sells electronic products, software, furniture, food, toys and jewellery. Amazon has taken over many smaller businesses in other countries. It operates joint ventures with other businesses including Toys R Us, Marks & Spencer and Mothercare.

Analyse the benefi ts that Amazon receives from operating as a multinational company. (6 marks)

Maths moment

Using the information in the Business insight below, calculate what percentage of Amazon’s sales were profi ts in 2015.

99

Drawbacks of globalisationNew and fi erce competitionUK businesses are exposed to fi erce competition from overseas fi rms as a consequence of globalisation. This can place them under pressure to sell at lower prices. The prices of many products such as clothing have fallen in UK shops in recent years. This makes it more diffi cult for UK businesses to compete, especially when some foreign businesses have the advantage of lower labour costs. Thousands of jobs in the UK’s steel industry have either been lost, or are at risk, because imports of steel from China are more price competitive.

New competitors are also emerging as a result of globalisation. The Chinese technology company Huawei only entered UK markets in 2001, but now employs over 1,100 people. It competes against UK businesses in a range of markets including the installation of superfast broadband and networks for 4G mobile phones. The emergence of new competitors makes it more difficult for UK businesses to increase, or even maintain, their market shares.

Threat of takeoverUK businesses are under increased threat of takeovers as a result of globalisation. Buying a UK business is a quick way for a MNC to acquire a well-known brand and gain a foothold in the UK market. In 2010, the UK chocolate manufacturer Cadbury was bought by the US multinational Kraft. The outcome of this takeover was that Cadbury’s factory in Bristol was closed and production was moved to Poland with the loss of 400 UK jobs. Former suppliers to the Cadbury factory have also lost sales following the takeover.

● How UK businesses compete internationallyGlobalisation means that UK businesses face more intense competition from foreign rivals in both national and international markets. UK businesses can use two major approaches to allow them to compete internationally.

2.4 Globalisation

Tesla is a US company that is designing and manufacturing very modern electric cars. The Model X shown continually scans the surrounding roadway with camera, radar and sonar systems, providing the driver with real-time feedback to help avoid collisions.

100


Improving the design of their productsProduct design involves the planning and production of a good or service and may lead to adjustments to an existing product or the creation of an entirely new one. Product design includes a range of factors such as appearance, durability and features. For example, car manufacturers continuously improve their existing product ranges by adding features such as automatic braking systems that help to avoid collisions. At the same time they are developing new products such as self-driving electric cars.

By improving the design of its products a business can gain a number of benefits, especially if its products are perceived to be superior to those produced by competitors. A business can charge a higher price if consumers prefer the design of their products. Alternatively, the company may seek to maximise sales by offering a product with a better design at a similar price to rival products.

Quality and priceQuality measures the extent to which a consumer is satisfi ed with a product. A high-quality product does not need to be expensive or highly sophisticated: it merely has to meet consumers’ needs. If a consumer is satisfi ed that a product meets his or her needs fully, they are more likely to buy the product. This decision is even more likely if the product is not sold at a higher price than those charged by competitors for products of lower quality.

Business insight

MerrythoughtMerrythought Ltd is a UK soft toy manufacturer which has been highly successful in selling its products in international markets, especially in Japan. Recently, its products have fallen in price overseas as the pound has fallen in value. Below is an extract from the company’s website.

‘Merrythought has handmade traditional teddy bears in Ironbridge, Shropshire, UK since 1930. Merrythought is a family business famous for crafting the fi nest, jointed, mohair teddy bears. Every bear is lovingly made by hand in our factory in the heart of England, giving them a unique character and superior quality that can last a lifetime. Every one of our bears is a unique Merrythought design, artistically brought to life using over 85 years of skills. Merrythought teddy bears have universal appeal making them the perfect gift for a christening, wedding or birthday as well as special collectors’ items; our quintessentially British teddy bears make a truly special lifelong gift. We also make personalised teddy

bears and bespoke corporate teddy bears. You can personalise our Traditional teddy bears to include someone’s name, date of birth, anniversary or other special date.’

Source: adapted from the Merrythought Ltd website

Merrythought teddy bear

1 Identify one way in which Merrythought Ltd provides high-quality products. (1 mark)

2 Analyse the possible reasons why Merrythought Ltd is able to compete successfully in international markets. (6 marks)

Key terms

Quality is the extent to which a consumer is satisfi ed with a product.

Price is the amount a business asks a customer to pay for a single product.

Key term

Product design translates the needs of consumers, or the inventiveness of entrepreneurs, into a saleable product.

101

However, quality and price work together to shape consumers’ buying decisions. If a business can match the quality provided by a rival but sell at a lower price, it is more likely to succeed in competitive international markets.

Mar

ket

Shar

e (%

)

0

2.5

5

7.5

10

12.5

Aldi Lidl

Nov-1

3

Feb-

14

Apr-1

4Ju

l-14

Oct-14

Jan-

15

Mar-

15

Jun-

15

Sep-

15

Dec-1

5

Feb-

16

May

-16

Aug-1

6

3.1

3.9

3.1

4.1

3.5

4.7

3.6

4.8

3.7

4.8

3.5

4.8

3.7

5.3

3.9

5.5

4.2

5.6

4.4

5.6

4.2

5.8

4.4

6

4.5

6.2

Source: Management Today

Figure 2.14 The share of the UK grocery market held by Aldi and Lidl, November 2013–August 2016

Long-established UK supermarkets such as Tesco and Sainsbury’s have lost market share to competitors from Europe such as Aldi and Lidl, who have been selling at lower prices. Aldi and Lidl have developed a reputation for low prices and are termed ‘discounters’. Because of this reputation Aldi and Lidl have emphasised the quality of their products in their advertising. Selling products judged to be good quality at low prices is a reason for Aldi and Lidl’s success, which can be clearly seen in Figure 2.14.

Some UK businesses have also been successful in using low prices as a means of winning customers in international markets. This approach is likely to be more effective when price (rather than non-price factors such as design) is a key part of a consumer’s decision to buy a product. In these circumstances low prices can result in rapid increases in sales. The budget airline easyJet is noted for its low prices and has been very successful in increasing sales for its flights throughout Europe and North Africa. In 2004, the airline carried 26 million passengers; by 2015 this figure had risen to over 70 million.

Maths moment

In August 2016, total sales revenue of supermarkets in the UK was estimated to be £15,000 million.

Use the information in Figure 2.14 to calculate the sales revenue for Aldi and Lidl in August 2016.

2.4 Globalisation

102


● Exchange ratesAn exchange rate is the price of one currency expressed in terms of another. For example, at the time of writing, the value of the UK’s currency, the pound, could be expressed as follows:

£1 = $1.31 (US dollars)

£1 = €1.17 (euros)

£1 = ¥8.76 (Chinese yuan)

Effects of exchange rate changes on export and import pricesExchange rates are very important to businesses that engage in international trade. Any UK business that imports raw materials or components from overseas or that exports its products in foreign markets will be affected by a change in exchange rates. Exchange rates are an important factor for many UK businesses as most are involved in international trade in some way.

Rise in the exchange rateIf the exchange rate of the pound rises against other currencies, it means that fewer pounds are needed to purchase goods and services from other countries. Consequently, products imported from other countries become cheaper. However, at the same time, more units of foreign currency have to be exchanged for each pound. This makes UK exports overseas more expensive. Export sales are, therefore, likely to decline.

Fall in the exchange rateIf the exchange rate of the pound falls against other currencies, this results in the opposite effects to those described above. Imports to the UK become more expensive as more pounds are required to buy a unit of the foreign currency. At the same time, UK exports of products become cheaper as fewer units of foreign currency are required to buy them.

The effects of these changes in the exchange rate of the pound (or any other currency) are shown in Table 2.6.

The exchange rate (in pounds)

Example Prices of UK exports overseas (in foreign currencies)

Prices of imported products in the UK (in pounds)

Rises £1 originally worth US $1.20; increases in value to be worth US $1.50

Increase in prices Fall in prices

Falls £1 originally worth US $1.20; decreases in value to be worth US $1.05

Fall in prices Increase in prices

Table 2.6 Effects of changes in the pound’s exchange rate on the prices of exports and imports

Key term

An exchange rate is the price of one currency expressed in terms of another.

Study tip

You will not be required to calculate the effects of exchange rate changes on a business’s revenue from sales or costs of production.

Key term

Imports are goods and services purchased from overseas customers in the domestic market.

103

Figure 2.15 shows that the pound fell against the two major currencies over the year up to September 2016. In June 2016, the UK held a referendum which resulted in a vote to leave the European Union (EU) and, in response to this, the exchange rate fell sharply. The effects of the changes shown in the figure would be as follows:➜ Goods and services imported from the USA and the 19 countries that use

the euro as their national currency would be more expensive in September 2016 compared to September 2015, ignoring any other changes.

➜ Products exported from the UK to those countries in September 2016 would be cheaper than they would have been in September 2015, again assuming no other changes occur.

1.25

1.3

1.35

1.4

1.45

1.5

1.55

1.6

Sep 15 SepNov Jan 16 Mar May Jul1.1

1.15

1.2

Pou

nd

’s e

xch

ang

e ra

te

US dollarEuro

Figure 2.15 The exchange rate of the pound against the US dollar and the euro, September 2015–September 2016

Effects of exchange rate changes on a business’s sales and profitsChanges in exchange rates mainly affect businesses that buy imports from overseas for use in production, or those that sell goods and services in other countries. However, a rise or a fall in the exchange rate can affect the sales and profi ts of most businesses.

Effects on a business’s salesA fall in the exchange rate, as shown in Figure 2.15, offers benefi ts to a business that exports as the price of its products would fall when converted into a foreign currency. The exchange rate of the pound fell by about 10 per cent against the US dollar in June 2016. As a result, the price of UK exports in dollars in the USA would have fallen by approximately 10 per cent. A fall in price can be expected to increase sales of exports.

Key term

Profi t is the amount by which a business’s revenue from all its sales exceeds its total costs.

2.4 Globalisation

104


However, people and businesses do not decide whether or not to buy goods and services just on price. Other factors such as design, brand name, durability and reliability all affect buying decisions. Therefore, a fall in price may not always lead to a large rise in sales. Many UK exports are thought by overseas consumers to be high quality. This means that sales of UK exports are probably not affected greatly by changes in the exchange rate.

Changes in the exchange rate of the pound can also affect businesses selling in the UK only. A rise in the exchange rate makes imports cheaper. This gives a price advantage to firms that sell imports, for example, cars manufactured overseas. UK car manufacturers such as Jaguar Land Rover may find it more difficult to compete against these firms. In contrast, a fall in the exchange rate makes imported products more expensive, offering an advantage to UK businesses.

Effects on a business’s profi tsA fall in the exchange rate, as shown in Figure 2.15 on page 103, could be expected to increase the profi ts of a UK business that exports its products. Its products would be cheaper overseas and it could expect sales to rise. The business’s revenue from sales should rise, helping to increase its profi ts.

However, it is likely that some of the resources used in production will be imported. A fall in the exchange rate makes imports of any kind more expensive. The firm’s costs of production may rise. This could be balanced by the increase in profits to some extent.

A rise in the exchange rate could be expected to have broadly the opposite effects on a business’s profits. Its products would become more expensive overseas, possibly reducing its profits. However, it may be that an increase in price has a limited effect on UK export sales, as many are bought for reasons other than low prices.

Business insight

Profi ts fall at BurberryThe UK fashion clothing manufacturer and retailer Burberry recently announced that it had suffered a large fall in profi ts. Its profi ts for the year to 31 March 2016 were £415.6 million, compared to £444.6 million for the previous year.

Burberry, which is noted for its check design as well as its trench coats, is seen as a classic UK luxury product by consumers overseas. Burberry manufactures its clothing in the UK as well as in several other countries including China, Italy and Romania.

The pound fell in value signifi cantly in the second half of 2016. Analyse the possible effects of this fall in the exchange rate on Burberry’s profi ts. (6 marks)A Burberry store

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SummaryGlobalisation is the process through which many markets have become more international in scope. This offers benefi ts and drawbacks to UK businesses.

Changes in exchange rates affect the sales and profi ts of most businesses, particularly those that engage heavily in international trade.

Quick questions 1 What is meant by the term ‘globalisation’? (2 marks)

2 Which of these businesses is a multinational company?

(a) A UK manufacturer that exports its products to 12 countries

(b) A UK business that imports raw materials and components from Asia and Africa

(c) A UK business that competes against overseas companies in the UK market

(d) A UK manufacturer with factories in the UK, France and the USA (1 mark)

3 Explain one reason why a UK company might want to engage in international trade. (2 marks)

4 Which of the following is not a result of globalisation?

(a) Higher prices for products in international markets

(b) Higher levels of migration between countries

(c) Greater fl ows of fi nance between countries

(d) Increased numbers of multinational companies (1 mark)

5 What is meant by the term ‘inward investment’? (2 marks)

6 Explain one benefit of globalisation to UK businesses. (2 marks)

7 Explain one drawback of globalisation to UK businesses. (2 marks)

8 What is meant by the term ‘quality’? (2 marks)

9 If the exchange rate of the pound rises, which of the following will be true, assuming no other changes?

(a) The price of UK exports in foreign currencies will fall.

(b) The price of imported products into the UK will fall.

(c) The sales of UK exports overseas will rise.

(d) The sales of imports into the UK will fall. (1 mark)

10 State two reasons why a fall in the value of the pound may not increase the profits of a UK business. (2 marks)

Case studyTata Steel Tata Steel, the UK’s major steel manufacturing company, announced the loss of 1,100 jobs in 2016. The whole UK business was put up for sale by its Indian parent company. This could result in the closure of its UK factories and the loss of 15,000 jobs in total.

Tata Steel is making a loss of £1 million every day as it is trading in a market in which prices have dropped very sharply. This is the result of cheap imports

of steel from Chinese producers. China’s steel manufacturers produce over 1 billion tons of steel each year and enjoy economies of scale. Some people have criticised the Chinese government for holding down the exchange rate of its currency, the yuan.

Tata Steel has struggled to sell its products in the UK. Many major manufacturers such as Nissan and Honda have taken advantage of global car markets to locate their businesses in the UK, but buy imported steel.

2.4 Globalisation

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Some economists hope that the substantial fall in the exchange rate of the pound in 2016 might help Tata Steel to survive. Businesses in Europe buy large quantities of steel.

Questions 1 Identify two actions which Tata Steel might

take to help it to sell more steel. (2 marks)

2 Explain why a fall in the exchange rate of the pound might help Tata Steel to survive. (4 marks)

3 Analyse the possible reasons why Chinese steel manufacturers are successful in selling their products in international markets. (6 marks)

4 Analyse the effects of globalisation on Tata Steel. In your answer you should consider:● the benefi ts of globalisation for the

company● the drawbacks of globalisation for the

company.

Do you think that globalisation has benefi ted Tata Steel overall? Justify your answer. (12 marks)

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2.5 Legislation

There are many laws (also called legislation) that affect businesses. A large number of these are intended to protect a business’s employees at work. Other laws are intended to protect consumers who buy businesses’ goods and services. In this topic, we look at a selection of these laws and explain how they affect businesses and the ways in which they can operate.


● what legislation is

● how employment and health and safety laws affect businesses

● the effects of laws designed to protect consumers on businesses.

● What is legislation?The law is a framework of rules controlling the way in which society is run. These rules apply to businesses and individuals. Laws (or legislation) relating to employees attempt to strike a balance in the workplace between the rights of employers and the rights of employees. The aim is to allow employers to use labour effi ciently while preventing the unfair treatment of employees. Similarly, consumer protection laws prevent businesses treating their customers unfairly, while allowing them to sell goods and services profi tably. When a law comes into operation it is known as an Act of Parliament.

● Employment lawLaws protecting the rights of employees have increased greatly over the last 30 years. Some of the most important ones are explained below.

The National Minimum Wage and the National Living Wage The UK has had laws relating to minimum wage rates since April 1999. Initially, this was called the National Minimum Wage and the rates were updated to at least match rising prices. However, in 2015 the government decided that a new and higher minimum wage was to be introduced from April 2016 for workers aged 25 or over. This is called the National Living Wage.

Key term

Legislation is a set of rules that governs the way society operates. It is another term for ‘laws’.

Study tip

This topic outlines a number of laws that apply to businesses. You do not have to quote the names of these laws in your examination, or the dates they were introduced, but you should aim to understand how they can affect businesses.

Topic

Key term

The National Living Wage is an hourly rate of pay which is set by the government. All employees above a certain age must receive at least this rate of pay.

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The key elements of minimum wage laws from 2016 onwards are as follows:➜ Workers aged 25 or over must receive the National Living

Wage of at least £7.20 per hour. This rate is expected to increase steadily to £9 an hour by 2020.

➜ For workers aged under 25, the National Minimum Wage rates (and not the living wage rates) continue to apply. These range from £3.30 an hour to £6.70 an hour, depending on the employee’s age and status.

➜ All employees must receive the appropriate rate of pay as a minimum. This includes temporary and part-time employees.

National Minimum Wage rates change every October. National Living Wage rates change every April. Table 2.7 summarises the minimum rates of pay that different types of employee must receive.

Year Aged 25 and over Aged 21–24 Aged 18–20 Aged under 18 Apprentice

2016 £7.20 £6.70 £5.30 £3.87 £3.30

Source: UK Government: www.gov.uk

Table 2.7 National and Living minimum wage rates in the UK in 2016

Business insight

Businesses failing to pay the National Minimum WageThe UK government has implemented a policy of ‘naming and shaming’ employers who do not pay the minimum wage. In February 2016, it publicised the names of over 90 employers who have not been paying the National Minimum Wage.

The businesses owe workers more than £1.8 million. Most of this sum is owed by Total Security Services of London. The three businesses who owed their employees the most were:

● TSS (Total Security Services) Limited, London E4, failed to pay £1,742,655.56 to 2,519 employees.

● Abbey House (Cumbria) Ltd, trading as Abbey House Hotel, Barrow-in-Furness, failed to pay £13,468.47 to 13 employees.

● Richard Lewis Communications plc, Southampton, failed to pay £8,751.99 to three employees.

The businesses concerned have to pay their employees the money owed and may face prosecution as well.

Analyse the possible disadvantages to businesses that are ‘named and shamed’ in this way. (6 marks)

Equality Act, 2010The UK government has passed a number of laws to prevent discrimination against employees on the grounds of their race, gender or age. In 2010, the Equality Act brought together all legislation intended to stop discrimination.

Key term

Discrimination is treating one person differently from another without having good reasons to do so.

Some occupations such as waiting staff and shop assistants receive relatively low rates of pay. They are more likely to benefit from increases in the minimum wage.

http://www.gov.uk

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2.5 Legislation

This law says that employees cannot be treated differently in the workplace on the basis of any of the following factors:➜ age➜ disability➜ race➜ gender reassignment (people whose gender is different from that at birth)➜ marriage and civil partnership➜ religion or belief➜ pregnancy or maternity➜ gender➜ sexual orientation.

Other employment lawsThere are a large number of laws giving employees a variety of rights at work (see Figure 2.16). There are too many to identify in full, but the list below will give you some idea of their extent:➜ All pregnant employees are entitled to take 52 weeks’ leave around the

time of the birth of their child. Employers have to pay a minimum level of pay to the worker during this period, but can reclaim most of it from the government. The job has to be kept open for the employee to return to if she wishes.

➜ All employees have a legal right to a paid holiday. Any employee (whether full-time or part-time) in the UK has the right to 5.6 weeks’ paid holiday each year.

➜ Working hours are subject to legal limits – for employees above 18, these are limited to a 48-hour week on average. However, workers can agree to work longer hours if they wish.

➜ Employees have a legal right to choose whether or not they wish to belong to a trade union. The owner of a business cannot say that an employee should (or should not) become a member of a trade union.

➜ Employees have to be given a contract of employment and this must state the amount they are to be paid and when they will receive that payment (weekly or monthly, for example).

➜ Staff are legally allowed to have time off for a range of reasons including trade union activities and because a dependant person (normally a child) is ill.

Key terms

A part-time employee works for a proportion of the working week – for example, three days each week, rather than fi ve.

A trade union is a group of workers who act together to improve their pay and working conditions.

A contract of employment is a legal document stating the hours, rates of pay, duties and other conditions under which a person is employed.

Give maternity payand paid holidays

Allow employees tojoin a trade union

Pay employees as statedin contract of employment

Provide suitabletraining

Provide a safeworking environment

Allow employees timeoff for certain reasons

Employees’rights

Figure 2.16 Some of the effects of employment laws on employees’ rights

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How businesses are affected by employment lawsIt is easy to think that employment and other laws cause disadvantages for businesses, for example, by making it more expensive for them to produce goods and services. However, as we shall see, legislation can bring benefi ts to businesses.

Profi ts The minimum wage and living wage laws increase the costs of production for many businesses, especially those that employ workers who are relatively unskilled, such as cleaners or fruit pickers. In the UK, a business has to pay at least £7.20 an hour for a worker aged 25 or over; without this law, the rate of pay might be lower. This means that the business’s costs are higher than they might be and it may make the business less profi table.

However, it may be that employees are motivated by higher rates of pay to work harder for the business. This may lead to a workforce that is more efficient and less likely to take time off work. Profits could rise as a consequence.

EmploymentIt may be that some businesses decide to employ fewer people because of the high wage costs they have to face. This is more likely to happen if the employees are relatively unskilled and it is easy to use machinery in their place. Research in 2016 suggested that 20 per cent of businesses would employ fewer people following the introduction of the National Living Wage.

Employment legislation, for example, that relating to discrimination, affects all areas of employment. This includes how businesses recruit employees, how they choose who to promote to a more senior position and the rates of pay they offer. The owners and managers of businesses have to make sure that their job advertisements are not discriminatory in any way. All people must be treated equally. Once people are employed by the business, they must be paid the same rate for the same job, irrespective of age, gender or racial group. Laws on discrimination can lead to extra costs for businesses. For example, a business may need advice on the law relating to discrimination and this legal advice may be expensive.

However, discrimination laws may also offer substantial benefits to businesses. Discrimination against older workers, for example, may lead to a business not employing someone who is, in fact, the best candidate for the job. Such discrimination could result in the business not being as efficient as possible.

Key term

Motivation refers to the range of factors which infl uence the way a person behaves at work.

Businesses can gain benefits from employing different groups of employees by recruiting the most talented employees, whatever their backgrounds.

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2.5 Legislation

Employees’ rightsMeeting laws relating to employees’ rights can lead to businesses paying additional costs. For example, a business has to pay maternity pay to female employees from the latter stages of pregnancy onwards. Although much of this pay can be reclaimed from the government, it remains a major fi nancial issue for businesses. Having to pay some maternity pay as well as paying a replacement employee can be costly. Furthermore, the replacement employee may be unfamiliar with the business or job and need training. The total effect of this can be to increase the business’s costs signifi cantly.

Once again, however, there are benefits to businesses from these laws. The main benefit comes from improved motivation of employees. For example, if employees can take time off to look after a child or dependent adult in a crisis, then they are likely to feel respected and valued by the business. This should improve their motivation and job performance when they return to work.

Equally, giving employees time off for trade union meetings may not sound like a cost-effective move, but it may help to create a good relationship with the trade union and its members and help to form a good working relationship. This might mean that damaging disputes are less likely to take place.

● Health and safety lawHealth and safety law prevents businesses putting employees in danger and so protects the workforce. The laws try to stop accidents happening in the workplace.

The Health and Safety at Work Act, 1974The main law in this area in the UK is the Health and Safety at Work Act, 1974. This Act states that employers must ‘‘ensure that they safeguard all their ‘employees’ health, safety and welfare at ‘work’”. The Act covers many business activities:➜ the installation and maintenance of safety equipment and clothing➜ the maintenance of workplace temperatures➜ giving employees suffi cient breaks during the working day➜ providing protection against dangerous substances➜ fi tting guards on dangerous machinery➜ writing and displaying a safety policy.

The Act also requires employees to follow all health and safety procedures and to take care of their own and others’ safety. The Health and Safety Executive (HSE) oversees the operation of the Act and carries out inspections of businesses’ premises. The HSE also carries out investigations following any serious accident in the workplace.

In June 2015, an accident occurred at the Alton Towers theme park when a rollercoaster crashed causing serious injuries to five people. The company operating the ride was fined £5 million for failing to meet health and safety laws.

Study tip

Try to think how employment and the other laws we discuss in this chapter might affect all aspects of business activity. For example, how they might affect the company’s advertising, how it hires its employees or organises the production of its goods or services.

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The Health and Safety Act can be updated at any time to take account of changes in the way that businesses operate. For example, it has been extended to cover the health of employees using computers regularly at work.

What does this law mean for businesses? Meeting the requirements of this law will increase the costs of the business. Businesses are likely to have to invest in training employees in health and safety matters. Installing safety equipment, carrying out health and safety inspections and putting up the notices required by this law will also add to a business’s costs. This is especially true of new small businesses, or those that are expanding into new areas, which have to go through these activities for the fi rst time. This can be time-consuming and costly.

There is a range of benefits to businesses, however, from health and safety laws. Meeting the requirements of the laws means the business avoids having to pay large fines (as in the case of Merlin Attractions Operations Ltd which operates the Alton Towers theme park). As we shall see in Chapter 4, an important element in motivating employees is to make sure that their health and safety needs are met. Health and safety law encourages and guides businesses in meeting those needs.

Business insight

Builders’ merchants fi ned £2 millionTravis Perkins, a company that sells building materials to individual consumers and businesses, has been fi ned £2 million after a customer died in an accident at one of its yards. The customer was forced to load his car in the yard, rather than the designated loading bay as a lorry had parked there. He died after being run over by another of the company’s lorries.

Travis Perkins’ yards are busy places visited by many lorries and vans.

The judge hearing the case said that it ‘was an accident waiting to happen’.

Explain why this accident might affect the training offered to its employees in future by Travis Perkins. (4 marks)

● Consumer lawBusinesses can treat their customers unfairly in a number of ways:➜ by selling goods and services that are not as described – for example, incorrect

quantities stated on the packet➜ by selling products that are unsafe – for example, toys containing unsafe

chemicals such as lead ➜ by selling products that do not work properly or at unfair prices➜ by selling information about consumers to other businesses without their

permission.

The accident at Alton Towers led to the company that operates the theme park receiving a lot of bad publicity. This is an example of a major disadvantage of failing to meet health and safety laws.

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2.5 Legislation

Consumer laws are passed by the government to protect consumers by preventing unfair practices taking place. They are sometimes referred to as consumer protection laws.

Consumer Rights Act, 2015This law marked a major change in consumer laws in the UK. It makes consumer laws simpler, stronger and more up to date. It provides consumers with clear rights and protection when buying goods and services.

The Consumer Rights Act covers:➜ product quality➜ returning goods➜ repairs and replacements➜ delivery rights.

This law requires that all products sold to consumers must be of satisfactory quality (that is, not broken), fit for purpose and as described. Consumers have the right to reject products that do not meet these standards within a reasonable time. As many goods are delivered to consumers’ homes nowadays, this law protects consumers against:➜ products ‘going missing’ before delivery ➜ late delivery.

Finally, the Consumer Rights Act protects buyers against unfair terms in contracts between businesses and customers. Examples include hidden fees and charges, especially when buying products online. This law is being used to challenge airlines who attempt to add on additional fees that are not publicised in their headline fares for flights.

There are a number of other consumer laws that relate to different aspects of selling products, as shown in Figure 2.17.

Key term

Consumer laws are laws that have been introduced to prevent businesses from treating their customers unfairly.

Consumer laws

Productsafety

Productlabelling

Usinginformationtechnology

Sale ofproducts

DataProtection

Act

Labellingof Food

Regulations

ConsumerRights Act

Food andDrugs Act

ConsumerProtection

Act

FoodSafety Act

UnfairTrading

Regulations

Weights andMeasures Act

ComputerMisuse Act

ConsumerCredit Act

Figure 2.17 Consumer laws in the UK

Consumers rely on receiving accurate information about the ingredients in some products such as gluten-free bread.

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Labelling of productsLabels provide consumers with a lot of information and help them to make decisions on whether or not to buy a product.➜ Labelling of Food Regulations, 1970. This law states that packaged food

must contain the ingredients listed on the label.➜ Weights and Measures Act, 1985. This law states that weights and measures

must be stated on packets or containers. It also states that the measures must be correct.

➜ The Consumer Protection from Unfair Trading Regulations, 2008. This law replaced most of the better-known Trade Descriptions Act. It makes it illegal to give consumers incorrect information on packaging and labels. It also outlaws aggressive selling tactics by door-to-door salespeople.

Buying products using loans The Consumer Credit Act of 1974 stops businesses charging very high rates of interest to consumers if they take out a loan when buying expensive products such as cars. It also allows consumers a week during which they have the right to change their minds about agreeing to a loan.

Using information incorrectlyModern businesses collect enormous amounts of data about their customers and much of this is held on computers. It is normal for businesses to have customers’ names, addresses, credit card details and telephone numbers. This information has to be used properly.➜ Computer Misuse Act, 1990. This Act prevents people looking at information

stored on computers that they have no right to read.➜ Data Protection Act, 1998. This is an important law that controls the

use of consumers’ information. Businesses that store information about consumers must do so securely and avoid any theft or loss. It prevents consumers’ personal details being sold or given to other businesses without the consumers’ agreement.

Safety of productsA number of laws protect the safety of consumers:➜ Food Act, 1984. This law lists those things that can, and cannot, be added to

food products. The law also makes it illegal to make or sell food in unclean buildings.

➜ Consumer Protection Act, 1987. This law prevents fi rms from selling dangerous products to consumers. It makes businesses liable for any illness or injury to consumers caused by using their products.

➜ Food Safety Act, 1990. This law makes it illegal to sell food to consumers that is unsafe and may cause illness. The Act covers farmers as well as restaurants and shops.

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2.5 Legislation

How businesses are affected by consumer lawsConsumer laws also offer businesses benefi ts as well as drawbacks. They increase businesses’ costs of production by, for example, imposing standards regarding the quality that products must maintain and requiring businesses to deliver products promptly. Consumer laws also prevent businesses from fi nding extra sources of revenue by, for instance, selling lists of customers’ details to other organisations without permission from the customers concerned.

However, consumer laws do offer benefits to businesses. Firstly, the protection offered by laws can make consumers more willing to make decisions to buy expensive and complex products such as cars, computers and televisions. Without the protection of the law, consumers may be concerned to buy products about which they know relatively little and where they rely on what businesses tell them about the products. As a result, sales are higher than they may be otherwise.

Secondly, consumer laws encourage businesses to produce goods that are safe, fit for purpose and as described. These laws give businesses a clear framework in which to operate and mean that rivals are limited in the same ways. As a consequence, businesses compete on a level playing field when selling products to consumers.

Business insight

The Body ShopThe Body Shop is a UK company which sells over 900 cosmetics products, such as body lotions and shampoo. It operates throughout the UK, selling its products in 263 stores as well as through its website.

The company is well known for its commitment to protecting the environment while supplying consumers with high-quality cosmetics. Among its many commitments, the company intends to:● use resources in its products that can be traced

and seen not to damage the environment● use resources in products that sustain specifi c

species of plants and animals and the livelihoods of local communities.

The Body Shop uses its commitment to protecting the environment in its advertising campaigns.

Explain one way in which consumer law might affect The Body Shop’s advertising. (4 marks)

SummaryAll businesses are affected by legislation. Legislation can restrict activities as well as offer benefi ts. Legislation affecting businesses covers

the employment of people, health and safety and businesses’ relations with consumers.

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Quick questions 1 What is meant by the term ‘legislation’? (2 marks)

2 Which of the following factors is not covered by employment laws relating to discrimination?

(a) Gender

(b) Race

(c) Sexual orientation

(d) Body art such as tattoos (1 mark)

3 Which of the following statements about employment law is the correct one?

(a) Only full-time employees are entitled to paid holiday.

(b) Staff are entitled to time off when a dependent (usually a child) is ill.

(c) There is no legal limit to the number of hours an employee may be asked to work each week.

(d) Employees can only join a trade union with permission from their employer. (1 mark)

4 Explain one way in which employment laws in the UK might affect the profits of a coffee shop chain such as Starbucks. (2 marks)

5 Explain one way in which employment laws in the UK might affect the types of people employed by a supermarket. (2 marks)

6 Explain one way in which a business might benefit from the existence of the UK’s employment laws. (2 marks)

7 State one example of a business’s activities that are covered by the Health and Safety at Work Act. (1 mark)

8 State two ways in which a business can treat its customers illegally. (2 marks)

9 Explain one way in which consumer laws might increase a business’s costs. (2 marks)

10 Explain how the Data Protection Act helps to protect consumers. (2 marks)

Case study

easyJet plceasyJet plc is one of the UK’s best-known low cost airlines. The company operates fl ights from the UK to 134 destinations in Europe. In 2016, the company had over 10,000 employees and employment costs are a major part of its overall costs. The airline has a fl eet of 233 aircraft and 24 bases throughout Europe of which the largest is at Gatwick. In 2015, it carried 70 million passengers. The company has grown quickly and operates in a highly competitive market with rivals such as Ryanair.

easyJet plc advertises heavily to win customers and promotes its fl ights on the basis of low fares. In 2016, it was possible to fl y from the UK to many of the company’s destinations for less than £40 per person. However, this means that it is important for the company to control its costs tightly. Many laws make it more diffi cult for easyJet to do so.

The company is under pressure, along with other airlines, to remove hidden fees from its charges. One

example is charging signifi cant fees to change names on tickets. These may be in breach of the Consumer Rights Act.

1 Identify two employment laws which might affect easyJet plc’s business activities. (2 marks)

2 Explain why employment laws might increase easyJet plc’s costs. (4 marks)

3 Analyse the possible benefi ts to easyJet plc from having to conform to UK laws. (6 marks)

4 Analyse the effects of legislation on easyJet plc. In your answer you should consider:● the effects of employment legislation on the

company● the effects of consumer laws on the company.

Decide whether employment legislation or consumer laws have greater effects on the airline. Justify your answer. (12 marks)

C

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The competitive environment

Topic 2.6

Most businesses face competition from other businesses which may be larger or smaller. Competition from rivals, along with other factors, can make it risky to run a business, and many fail each year. Despite the risk, an increasing number of entrepreneurs are prepared to start businesses.


● what is meant by a market and competition, and be able to analyse the impact of different levels of competition on businesses

● the risks and uncertainties faced by businesses

● how businesses can minimise the risks that they face

● why entrepreneurs start businesses.

● Markets and competitionWhat is a market?A market exists where there are buyers and sellers. Buyers and sellers come together to exchange goods and services and to set prices for goods and services. For example, at any time in the UK, many thousands of people are selling their houses, while others are wanting to buy houses. Buyers and sellers exchange information such as details of the house for sale and how soon the buyers would like to move in. This and other information (such as the price of similar houses locally) are used to set a price for the house.

Key term

Markets exist where there are buyers and sellers.

People

selling

houses

People

buying

houses

The market for houses

Figure 2.18 The market for houses

The housing market brings together buyers and sellers of houses and sets prices. The internet is playing an increasingly important role in the housing market.

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Markets can be geographical – that is, a specific place where buyers and sellers would meet. Bluewater shopping centre is an example of this type of a market. However, many markets nowadays are online. Buyers and sellers use technology to exchange information and to agree prices. For example, music is commonly bought and downloaded from the internet.

Some markets are local. When someone buys a haircut, they are likely to buy the service from a business nearby. In contrast, other markets are national or global. Car manufacturing companies such as Volkswagen sell vehicles throughout the world. At the same time, someone wishing to buy a new car can buy from producers based in many different countries.

What is competition?Competition exists when more than one business is attempting to attract the same customers. Markets are normally competitive because most businesses that sell goods and services face rivals who are selling similar goods and services. Businesses selling in local markets can face competition from other local fi rms as well as national and international competitors. For example, a local coffee shop may have a number of small rivals but also face competition from multinational businesses, such as Starbucks. Many businesses selling globally, for instance Apple, face competition from other large businesses, such as Samsung.

Different levels of competitionBusinesses face different numbers of competitors. Some businesses trade in markets with many competitors; others face few rivals, although they can offer very strong competition. Very few businesses face no competition. Many companies that supply water to homes and businesses in the UK do not face competition, as each region has its own supplier. Table 2.8 summarises the different types of competition that exist.

Number of fi rms

A large number of small (or possibly medium-sized) businesses

A few larger fi rms A single business (known as a monopoly)

Examples Indian restaurantsPainters and decorators

Mobile phone manufacturersSupermarkets

Water supply Railways between some destinations

Products Products can be similar or different from each other

Products will be different or advertised to appear as if they are different

Only one main product is available

Prices Generally low, especially if the products are similar

Can be high, especially if fi rms compete in other ways

Prices can be high as little or no competition

Other means of competing

AdvertisingHigh-quality service Convenient locations

AdvertisingLaunching new products

These businesses face little or no direct competition

Table 2.8 Different types of competition that can exist in markets

Key terms

Competition exists when more than one business is attempting to attract the same customers.

A monopoly exists when a business does not face any competition in a particular market.

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2.6 The competitive environment

A competitive firm is able to attract and keep its customers. The customers of a competitive firm are normally satisfied and feel that they are getting value for money. At the same time, a competitive firm normally aims to make a profit.

Competition in markets with many businessesSome markets have many small or medium-sized businesses. An example of such a market in the UK is estate agents, who sell houses for their customers. Many estate agents are small businesses, with just a few branches. However, the UK has some larger estate agents, such as Countrywide Estate Agents.

Businesses selling in markets made up of many small firms may compete on price, especially if they provide similar products. Painters and decorators, for example, may try to keep prices to a minimum to give an advantage over rivals. In other cases, prices may vary because the products sold are different. Many restaurants are small businesses, and the price of their meals can vary because they sell different products. A pizza restaurant sells very different food to a Michelin-starred restaurant.

Globalisation is the trend for markets to become more worldwide in nature. It has changed many markets that once had mainly small firms. Nowadays, multinational firms have entered some of these markets, and sometimes dominate them. The coffee shop market in the UK has changed. Global businesses such as Starbucks have become major sellers in this market. Smaller coffee shops try to compete with multinational rivals by providing something different. This may be a distinct range of products or very high standards of customer service.

Restaurants selling Indian food often compete by having their own ‘special’ dishes.

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Competition in markets with few businessesMany UK markets are dominated by a small number of large businesses. Partly, this is a result of globalisation, which has led to many businesses selling their products worldwide. Many UK markets are dominated by a small number of businesses, which each hold a large market share. These markets include banking and mobile telephone services. Figure 2.19 shows that the UK market for broadband services to landlines is dominated by four fi rms.

Maths moment

In 2015, there were 23.7 million customers in the UK with a broadband service.

Use the data in Figure 2.19 to calculate the difference between the numbers of customers who buy broadband services from BT and Sky.

Business insight

Premier Inn opens new hotels in EdinburghPremier Inn operates more than 700 budget hotels throughout the UK. It is known for its competitive prices: it advertises its rooms for as little as £29 per night. Premier Inn was the fi rst major budget hotel chain in the UK to advertise its hotels on prime-time television.

In 2016, Premier Inn announced that it was opening three new hotels and updating two others in

Edinburgh. The hotels are in locations across the city. Following this investment, Premier Inn now operates 14 hotels in Edinburgh. Edinburgh has several small independent hotels, as well as other chains of hotels, for example, Holiday Inn.

Analyse how other hotels in Edinburgh might compete with Premier Inn. (6 marks)

Source: Ofcom: http://media.ofcom.org.uk/facts/

Figure 2.19 The market shares of businesses selling broadband services in the UK in 2015

32%

22%20%

14%

4%8%

BTSkyVirginTalkTalkEEOtherbusinesses

Key

Key term

Market share is the percentage of sales in a particular market recorded by a business.

Firms in markets with a small number of rivals compete in different ways:➜ Price competition. Facing other large rivals in a market might mean that

fi rms avoid competing too strongly on price. They may do this because they wish to avoid a price war (where businesses aggressively lower prices), as the outcome is likely to be lower profi ts for all businesses.

➜ Competing by developing new products. In some markets, businesses will compete by introducing new products regularly to win customers. This is very common in markets based on technology or where fashions are important. For instance, companies such as Apple and Samsung regularly introduce new mobile phones.

➜ Competing through advertising. Some businesses respond to a small number of competitors by advertising heavily. This is more effective in markets where consumers change brands or suppliers frequently. Suppliers of gas and electricity, such as npower and EDF, make a lot of use of advertising and special offers to attract new customers.

http://media.ofcom.org.uk/facts/

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Markets where businesses face little or no competitionA business that is the only supplier to a market is called a monopoly. There are few markets in the UK where monopolies exist. An example is the supply of water to homes and businesses. Each region in the UK has a single supplier of water. Thus, most people who live in East Anglia buy their water from Anglian Water. The London Underground and the National Grid (which operates the national networks used to supply gas and electricity in the UK) are other examples of markets supplied by a monopoly. Local monopolies can also exist. A small village may only have one shop, or a town may have just a single hotel.

In other markets a single business may dominate the market and only face competition from much smaller rivals. In 2016, Google had a 71 per cent share of the market for search engine usage by desktop computers.

Dominating a market in this way offers businesses the chance to set high prices as they face little or no competition. Consumers could potentially be charged very high prices. For this reason, the activities of monopolies are controlled by governments. For example, businesses supplying water in the UK can only raise their prices with the approval of Ofwat. Ofwat is a government watchdog that makes sure that water companies look after their consumers and do not, for example, charge prices that are too high.

● Businesses, uncertainty and riskUncertainty and risk are different things. Risk is the possibility of something going wrong and this possibility can be measured. Businesses often take decisions which are risky. In 2016, a company called Dong Energy took a decision to invest £6 billion to build a series of large offshore wind farms near the coast of Yorkshire. The company will have measured the risks associated with this investment. For example, it will have judged the risk of electricity prices falling. If a decision is judged to be risky, a business may only go ahead if it is likely to be very profi table. Profi ts are the rewards for taking risks.

Key terms

An uncertainty occurs where there is a lack of information about a situation. This means the outcome or consequences are very diffi cult to predict.

Risk is the possibility of something going wrong.

Study tip

Try to think of examples of markets which have different levels of competition. Consider which ones are best for important stakeholders such as employees or customers. This will help you to understand the differences.

Business insight

Small shops, risk and uncertaintySmall shops in the UK face several challenges over the next few years. A survey in Cambridge, in 2016, showed that high and increasing rents threaten the survival of many of the city’s small shops. High parking charges and more online shopping are other challenges to small shopkeepers.

Research by Retail Futures 2018 forecasts that high streets throughout the UK will change: ● Total shop numbers will fall by 22 per cent by 2018. ● Online retail sales will rise from 12.7 per cent of

total sales (in 2012) to 21.5 per cent by 2018.

The decision by the UK to leave the EU (Brexit) led to a mixed response from owners of small shops. For many the consequences of the decision are diffi cult to forecast. The situation will remain unclear until the negotiations between the UK government and the European Union are fi nished. For example, if leaving the EU causes job losses, spending in small shops may fall.

Using examples from the text above, explain the difference between risks and uncertainty. (4 marks)

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Uncertainty occurs when there is a lack of information about a situation. Following the decision to leave the European Union, many businesses in the UK have delayed major decisions. These may be on whether to open new factories or whether or not to start a business. Until the terms under which the UK leaves the EU are negotiated and made public, businesses lack information on key issues. Managers do not know, for example, how easy it will be for them to sell goods and services to consumers in the EU after the UK leaves. They will take these decisions when they have more information and can judge the risk involved.

The risks faced by businessesBusinesses face many risks. These can be separated into two groups: internal risks and external risks.

Internal risksInternal risks come from within the business itself. These types of risk are easier to manage. The following are examples of such risks:➜ A business’s employees may refuse to work – known as ‘going on strike’.

This happened to Southern Railways in 2016 when the trade union RMT announced strikes over the number of employees staffi ng each train.

➜ A business may suffer fi re or theft. Many businesses are concerned about the security of their IT systems. There have been a number of instances of hackers stealing the personal and fi nancial data of businesses’ customers. These are sometimes sold to criminals. In 2015, the telecommunications company TalkTalk had the data of more than 150,000 of its customers stolen.

➜ A company may suffer falling profi ts due to bad publicity. This may be for many reasons, such as treating employees badly. Sports Direct, which sells sports clothing, announced in 2016 that its profi ts had fallen by 8.4 per cent compared to the previous year. The company had been heavily criticised over working conditions in its warehouses.

➜ Businesses can lose their most talented employees to competitors. This can reduce their effi ciency. It is common, for example, for highly paid entertainers to move to a different television company.

External risksThese are risks that arise outside the business. They are more diffi cult for businesses to control.➜ A business may be faced by a new competitor. Businesses tend to enter

markets which are growing and where existing businesses are very profi table. In 2016, Apple and the motor racing company McLaren announced they were in talks to jointly produce luxury cars. This would provide new competition for companies such as Ferrari.

➜ Natural disasters such as fl oods and earthquakes can pose serious risks for businesses. In December 2015, Storm Frank caused severe fl ooding in northern England and southern Scotland. Many small and large businesses had to cease trading temporarily as a result.

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How businesses can minimise risksThere are a number of actions that businesses can take to minimise risk. These actions cannot remove all risk, however.

Prepare business plansA business plan sets out what a business does currently and what it hopes to achieve in the future. To prepare a business plan, managers will research the views and opinions of customers as well as the expected behaviour of competitors. This will provide greater understanding of what might happen in the market in the future and allow the business to be prepared for likely events. This will reduce the chance of something going wrong in the future.

➜ Governments can pass laws that can impact adversely on businesses. For example, the introduction of the National Living Wage in 2016 increased the costs of many UK businesses.

Key term

A business plan is a document setting out what a business does and what it hopes to achieve in the future.

Risk is the possibilityof something goingwrong:

• lower sales• reduced profits

Internalrisks

Externalrisks

Employeesrefuse to

work

Fire ortheft Bad publicity

Loss of ‘best’employees

LawsNew

competitorsNaturaldisasters

Figure 2.20 Factors creating internal and external risks for businesses in the UK

Flooding is expected to become an increasing risk for businesses in the UK due to climate change. How might these businesses respond to this risk?

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Invest in training Businesses can reduce risks by investing in training their employees. This training might be used to reduce a number of risks:➜ to deal with insecure IT systems and cybercrime➜ to deal sensitively with dissatisfi ed customers➜ to manage crises such as fl ooding.

Using experts and consultantsAn important part of minimising risks is to identify them. Using experts or consultants with specialist knowledge can help to do this. This reduces the chance of businesses making major errors. For example, a business might use public relations experts to improve its reputation. This can help to reduce the risks of falling sales as a result of bad publicity.

Selling in different marketsA business that sells in just one market is at risk of sales falling if a new competitor emerges or if consumers’ tastes or fashions change. This risk can be reduced by moving into new markets. This is known as diversifi cation.

Samsung is probably best known for its smartphones, tablets and televisions. However, Samsung’s managers have reduced the company’s risk from falling sales by selling goods and services in other markets. The company also makes military equipment and ships, and it operates an amusement park.

Why all businesses face uncertaintyMost businesses face uncertainty as the factors that cause it are becoming more common. A number of forces can cause uncertainty.

Economic uncertaintyIn early 2008, the UK experienced an unexpected fi nancial crisis. This caused a major recession for the economy, and the value of goods and services produced by businesses in the UK fell. The recession was not forecast and was very severe. Most businesses in the UK are affected by this type of economic uncertainty.

The decision in June 2016 to leave the European Union added to the uncertainty felt by most businesses in the UK. A major cause of this uncertainty is the lack of knowledge about the UK’s future trading relationships, especially with the European Union. UK businesses are unsure whether they will be able to sell goods and services freely to customers in the European Union.

Key term

A recession occurs when the value of an economy’s output of goods and services falls for six months or longer.

Key term

Diversifi cation occurs when a business starts selling new products in new markets.

Cath Kidston’s business has reduced the risk of suffering falling sales by opening stores in different countries. This store in Malaysia is one of 130 stores that the company had outside the UK in 2016.

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Competitors and uncertaintyWe saw earlier that most businesses are subject to some competition. Businesses have great diffi culty in predicting what their competitors will do. A business’s competitors might:➜ cut their prices signifi cantly➜ introduce a new and popular product➜ attempt to buy their rivals.

Actions such as these by competitors can cause difficulties for any business. It is hard for any business to be prepared to respond to so many possible challenges.

Social changes and uncertaintyChanges in society are not always easy to predict. Changes in tastes and fashions can have major implications for a wide range of businesses. Social changes are not always easy to forecast, making it diffi cult to estimate future sales accurately. Soft drinks manufacturers such as Coca-Cola have experienced falling sales of many products as consumers have become more aware of the dangers of sugary products.

● Entrepreneurs and new businessesEntrepreneurs have to be able to manage risks. They also have to show determination and motivation, as well as having a good idea for a new business. Entrepreneurs start businesses for a variety of reasons, including the desire to be their own boss, the need to have work or just because they want to develop an interest or a hobby.

Starting a new business can be very risky and many do not survive beyond a year or two; only 50 per cent are still trading after five years. Entrepreneurs who plan their new enterprise carefully and have previous experience of running a business are more likely to succeed. We looked at entrepreneurs in more detail in Chapter 1.

Key term

An entrepreneur is someone who is willing to take the risks involved in starting a new business.

Business insight

Peter Roberts and Pure GymPeter Roberts started his chain of gyms in 2009. At fi rst, the business had four sites in Edinburgh, Leeds, Manchester and Wolverhampton. As of 2016, it has more than 170 gyms throughout the UK. Pure Gym has 822,000 members. Gym fees are very low compared to competitors. Pure Gym members pay between £11.99 and £34.99 each month.

Peter Roberts has set up other businesses in the leisure industry, including nightclubs and hotels. He came up with the idea of Pure Gym when he saw low cost gyms operating overseas. He said that he spotted a gap in the market as most other gyms charged much higher fees.

Many new businesses fail. Explain one reason why Pure Gym has survived. (4 marks)

Pure Gym has been very successful in attracting customers, partly because its membership fees are relatively low.

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Case study

Mercia Probiotic Skincare (MPS)Sarah Marsh likes taking decisions (and not orders from others!). She recently became unemployed and has decided to set up Mercia Probiotic Skincare (MPS) – her fi rst business! She plans to create beauty products from all-natural ingredients, guaranteed free from harmful substances.

Sarah has not researched the opinions of possible customers before starting her business. The market for skincare products is very competitive with large fi rms (L’Oreal, for example) and many small ones selling products. She was worried how competitors might respond to her business. There are also many safety laws relating to making and selling skincare products.

Sarah knows little about how to raise money to start a business. She hopes to be able to use the internet to sell her products. However, she wants to minimise the risks in starting her business. She is considering preparing a business plan and asking an experienced consultant to give her advice.

1 State two reasons why Sarah wants to set up her business – Mercia Probiotic Skincare (MPS). (2 marks)

2 Explain why Sarah faces some uncertainty before starting her business. (4 marks)

3 Analyse how Sarah might be able to compete with established businesses that produce skincare products. (6 marks)

C

Quick questions 1 What is meant by the term ‘market’? (2 marks)

2 Explain, using an example, why most markets in the UK are competitive. (3 marks)

3 A monopoly exists in which of the following situations?

(a) There are a small number of large businesses selling products in a market.

(b) There are many small businesses selling products in a market.

(c) There are a few large businesses and some small fi rms selling products in a market.

(d) There is a single business selling products in a market. (1 mark)

4 Explain one way in which businesses may compete in markets made up of a few large firms. (2 marks)

5 Explain one reason why selling products that are similar or identical to those sold by rivals makes prices an important form of competition. (2 marks)

6 Identify one market supplied by businesses facing little or no competition. (1 mark)

7 Explain the difference between risk and uncertainty. (3 marks)

8 State one internal risk and one external risk that a business may face. (2 marks)

9 Explain one way in which a business might minimise the risks it faces. (2 marks)

10 Explain what is meant by the term ‘entrepreneur’. (2 marks)

SummaryAll businesses trade in markets and most compete with other sellers to attract buyers (or customers). The amount of competition a business faces can vary and this has signifi cant implications for how the business operates. Businesses face both risks and

uncertainty, and managers take a variety of actions to minimise risks. Despite the existence of risks, a large number of entrepreneurs start businesses each year in the UK.

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Chapter review – In� uences on businessRead question 1, the sample answers and the comments. Then try question 2.


➜ Item A D&C Ltd operates bus and coach services in Devon and Cornwall. The company offers two types of services:

● regular bus services throughout the two counties – used mainly by people for essential reasons such as going to work, school or shopping in local towns

● holidays – coach tours to all parts of the UK and Europe.

D&C Ltd has had to pay the National Living Wage since April 2016. A number of its employees have received a pay rise. Several commented that a pay rise was overdue. The company’s profi ts have been very low and the very competitive market makes it diffi cult to raise prices. At the same time, it is forecast that the level of unemployment in Devon and Cornwall will rise signifi cantly over the next two years.

D&C Ltd is considering converting its fl eet of buses and coaches to use hydrogen as a fuel. This will be more environmentally friendly and will reduce fuel costs by £1 million a year. Research shows the plan is approved by 95 per cent of local people. The company will have to borrow £5 million to pay for the conversion.

(a) Identify two ways in which D&C Ltd’s activities affect the environment. (2 marks)

(a) The company affects the environment in lots of ways. Its buses and coaches can cause congestion as they are likely to run at busy times in the morning and evening. Also D&C Ltd’s buses and coaches will cause air and noise pollution as they travel through towns and cities in Devon and Cornwall which could cause some health problems for local people.

4 Analyse how Sarah might minimise the risks involved in starting her business. In your answer, you should consider:

● the benefits of creating a business plan

● the possible use of a consultant with experience of the skincare products industry.

You must evaluate which factor will be most effective in reducing the risks she will face. Use evidence to support your answer. (12 marks)

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2 Influences on business Influences on business

The response does contain all the necessary information, but is much too long for a question only worth two marks. Also the question only asked for two ways to be identi� ed whereas this answer explains them. It is important to understand that questions ask for different types of responses. If a question asks you to identify or state something, it does not need an explanation.

(b) Explain one effect that paying the National Living Wage might have on D&C Ltd. (4 marks)

(b) Those employees who have received a pay rise because of the National Living Wage will be happy and may be more motivated and work harder. This could improve the performance of the workforce. This could have quite a big impact as the employees felt that they should have had a pay rise earlier, so might be quite motivated by this increase.

This answer is of a suitable length and has done exactly what was called for. It has explained just one effect and has used information from the case study to help to develop the explanation. It is an effective answer in that it combines relevant knowledge with evidence from the Item.

(c) Analyse how the demand for D&C Ltd’s bus and coach services might change if unemployment does rise. (6 marks)

(c) If unemployment in Devon and Cornwall rises as forecast, the incomes of people in the area can be expected to fall. This will reduce demand for bus and coach services as people will have lower incomes. As they have less money to spend, they will reduce spending on most things, including travel.

But D&C Ltd has two services. It provides bus services, which are essential for many people. So this might not be affected as much as coach services which are for people going on holiday. If people lose their jobs and incomes, they stop buying luxuries like holidays. Demand for coach travel could fall a lot, while that for bus services may only fall a little.

The answer also uses relevant and carefully selected knowledge and uses the correct information from the Item to support it. One particular strength is recognising that the impact on demand for the company’s services will be different for bus and coach services. This is a thoughtful answer. Thinking carefully and planning before writing answers is always a good idea.

(d) Recommend whether or not D&C Ltd should convert all its buses to run on hydrogen. Give reasons for your advice. (9 marks)

(d) There are reasons why D&C Ltd should convert its buses. It is not earning high profi ts as it faces tough competition, and it cannot increase its prices. The conversion to environmentally friendly hydrogen as a fuel is supported by 95 per cent of local people. Making this conversion may allow the company to increase prices without losing too many customers. It might be able to increase its prices signifi cantly for its coach tours which would help to improve its profi ts.

On the other hand the company might struggle to pay for the conversion as it will require it to borrow £5 million. It may be diffi cult for the company to do this when it is only making small profi ts, and the policy may be too expensive. If it has to repay the loan, it may not be able to pay its employees more wage increases.

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Overall, I recommend that the company should make this investment. It will improve the company’s image and is popular with local people and could be used in adverts. Most importantly it is fi nancially sensible. As using hydrogen will reduce the company’s fuel costs by £1 million a year, it will pay for the investment within fi ve years.

The arguments made are clear, developed fully and think about how a decision to convert the buses and coaches to run on hydrogen will affect different parts of the business, such as advertising and employees’ pay. It also includes some valuable numerical data by calculating the time taken to repay the investment. It is always answering the question. It makes effective use of the information given in the Item to develop its arguments. Finally, the recommendation that is offered is sensible given the earlier arguments and is justi� ed fully.


➜ Item BReston Ltd in the UK manufactures electric bicycles. It sells about 60 per cent of the bicycles it makes in America, where its brand is very fashionable. The rest are sold in the UK, where many are bought using loans. Reston Ltd buys its steel and other components from China.

It is facing a major decision. Its current factory is old and expensive to operate. It is not large enough if the company achieves the 25 per cent increase in sales it hopes for over the next two years. It would need to recruit 25 new employees and is keen to increase the number of females in its workforce.

Its new factory would be large enough to allow it to produce twice as many electric bicycles as is currently possible. However, the company would need a large loan to pay for the factory.

Two economic issues need to be considered by the company. The exchange rate of the pound has recently fallen by 10 per cent against other major currencies such as the American dollar and the Chinese yuan. Interest rates are also forecast to rise by 3 per cent over the next year.

(a) Explain two ways in which employment laws might affect Reston Ltd. (4 marks)

(b) Analyse one way in which the change in the exchange rate might affect Reston Ltd’s profi ts and sales. (6 marks)

(c) Analyse whether Reston Ltd should build its new factory. In your answer, you should consider:

➜ the effects on Reston Ltd’s costs of production

➜ how the economic changes might affect demand for Reston Ltd’s bicycles.

Should Reston Ltd’s managers decide to build the new factory? Justify your answer. (12 marks)

Overall, I recommend that the company should make this investment. It will improve the company’s image and is popular with local people and could be used in adverts. Most importantly it is fi nancially sensible. As using hydrogen will reduce the company’s fuel costs by £1 million a year, it will pay for the investment within fi ve years.

The arguments made are clear, developed fully and think about how a decision to convert the buses and coaches to run on hydrogen will affect different parts of the business, such as advertising and employees’ pay. It also includes some valuable numerical data by calculating the time taken to repay the investment. It is always answering the question. It makes effective use of the information given in the Item to develop its arguments. Finally, the recommendation that is offered is sensible given the earlier arguments and is justi� ed fully.


➜➜ Item B Item BReston Ltd in the UK manufactures electric bicycles. It sells about 60 per cent of the bicycles it makes in America, where its brand is very fashionable. The rest are sold in the UK, where many are bought using loans. Reston Ltd buys its steel and other components from China.

It is facing a major decision. Its current factory is old and expensive to operate. It is not large enough if the company achieves the 25 per cent increase in sales it hopes for over the next two years. It would need to recruit 25 new employees and is keen to increase the number of females in its workforce.

Its new factory would be large enough to allow it to produce twice as many electric bicycles as is currently possible. However, the company would need a large loan to pay for the factory.

Two economic issues need to be considered by the company. The exchange rate of the pound has recently fallen by 10 per cent against other major currencies such as the American dollar and the Chinese yuan. Interest rates are also forecast to rise by 3 per cent over the next year.

(a) Explain two ways in which employment laws might affect Reston Ltd. (4 marks)

(b) Analyse one way in which the change in the exchange rate might affect Reston Ltd’s profi ts and sales. (6 marks)

(c) Analyse whether Reston Ltd should build its new factory. In your answer, you should consider:

➜ the effects on Reston Ltd’s costs of production

➜ how the economic changes might affect demand for Reston Ltd’s bicycles.

Should Reston Ltd’s managers decide to build the new factory? Justify your answer. (12 marks) (12 marks) (12 marks)

Chapter review – Influences on business

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3Business

operations

In this chapter, we look at production and production processes, procurement, customer service and quality. We look at the different methods of production and examine the advantages and disadvantages of each method. We consider how the right (or the wrong) suppliers of goods can have an impact on businesses, and how a business might choose the right supplier for them. Linked to this, we examine the concept of quality – and how good quality can be achieved. Finally, we look at the importance of customer service, and the benefi ts that good customer service can bring to a business.

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3.1 Topic

All businesses produce something. Manufacturing businesses produce goods, such as furniture, clothing or clocks. Other businesses provide services, such as hairdressing, dental care or cleaning. All types of business involve production – bringing together the resources needed to supply the good or service. This topic introduces you to the production methods and looks at how operations can be undertaken effi ciently, using as few resources as possible. We will look at the issue of quality and consider how businesses can produce goods and services that satisfy their customers. We will also consider the factors infl uencing good customer service and how this can help a business.


● the advantages and disadvantages of different methods of production, such as job and fl ow production

● how production can be made more effi cient

● how lean production can increase effi ciency.

● Production managementProduction (or operations) management refers to all the activities in managing the transformation process. Production takes inputs and turns them into outputs and delivers these to the customer.

Inputs Transformation Outputs

Figure 3.1 Production transforms inputs into outputs

● Methods of productionProduction is the process of changing inputs, such as raw materials, energy and labour services, into goods and services that can be sold. We often think of production in the sense of manufacturing, but it is also a central part of

Key terms

Production (or operations) management refers to all the activities in managing the transformation process.

Production is the process of changing inputs such as labour services into goods and services that can be sold.

Production processes

133

3.1 Production processes

supplying services. To supply a service, such as offi ce cleaning, it is necessary to bring together the following resources:➜ people to organise the business and to do the actual cleaning➜ cleaning materials and equipment, such as vacuum cleaners➜ vans or cars to transport cleaners to the offi ces that need to be cleaned➜ fuel to put in the vans or cars.

The production process brings together these resources and gives the result of a clean office.

There are many different forms of production, but they all involve transforming resources into outputs.

Job productionJob production is a method of production in which a product is supplied to meet the exact requirements of a customer. For example:➜ Garden design. Businesses designing (or redesigning) gardens will discuss

the customer’s needs, offer their own ideas and supply a product that is unique to that customer.

➜ Tailors. Many tailoring businesses will make clothes, such as suits, to meet the needs of their customers. Clothing is made to the customer’s size and choice of design and material.

➜ Personal trainers. Some people have personal trainers to improve their individual fi tness and health. The trainer will provide a diet and exercise programme to suit the individual customer’s needs.

➜ Restaurants. In many restaurants, meals are prepared and cooked to meet specifi c customers’ needs. For example, someone ordering a steak would say how they want it cooked and might choose a particular combination of vegetables to go with it.

Key term

Job production is a method of production in which a product is supplied to meet the exact requirements of a customer.

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3 Business operations

Job production is used by businesses to gain an advantage over larger rivals. For example, a small tailoring business cannot expect to supply clothing as cheaply as a large company. However, the business may be able to justify its higher prices because it supplies a personal service. Job production is also an appropriate way to supply some personal services, such as hairdressing, dental care and healthcare, where each customer’s needs are different. Job production may also be the best approach when it is not possible to use technology to produce large quantities of similar products.

Job production is an expensive method of production as each product is different and may involve changes in the production process. Unless the business is sure that it can charge high prices, it may find it difficult to make a profit. A further disadvantage of job production is that it often requires skilled employees and, therefore, considerable amounts of training.

Business insight

The Flower ShopThe Flower Shop provides fl owers for special occasions such as weddings, birthdays and anniversaries.

According to its website:

‘We are a family run business located in Codsall, Wolverhampton. The Flower Shop is a well-established business within Codsall, and has been trading since 1951.

We’re sure that our continued effort and passion for fl oristry enables us to continue designing your fl oral gifts to the highest level and assuring you of our quality assurance at all times. We aim to take every care in each order, ensuring that it is unique and designed to suit the occasion. By keeping up to date with modern designs, techniques and expertly gift-wrapped in our signature presentation packaging, we aim to ensure that your order surpasses your expectations.’

Source: www.thefl owershoponline.co.uk

Analyse why this business uses job production as its method of production. (6 marks)

Flow productionSmall businesses often use job production, producing one-off items that are made specifi cally for their customers. For example, a business may produce kitchens made exactly to each customer’s requirements or a personalised birthday cake. This approach to production is fl exible and can meet customer needs very precisely, but tends to be quite expensive.

As demand increases and businesses have to produce thousands or millions of items, a different approach to production is required. McDonald’s could make a different meal for each of its customers tailored to each individual’s taste, but this would slow up the production process and the business would no longer be producing fast food. Innocent Drinks could have someone

http://www.theflowershoponline.co.uk

135


personally filling each bottle, but it wouldn’t be able to produce many bottles a year. Typically, when firms are producing on a large scale, they will use flow production techniques. This involves continuous production; each item moves continuously from one stage of the process to another. Imagine a bottling plant filling thousands of bottles with juice every day. Each bottle is cleaned and filled, a cap is fitted, a label is added and it moves on to be packaged without stopping.

Advantages of fl ow productionAdvantages of fl ow production include:➜ It allows fi rms to produce huge volumes of output and, therefore, enables

them to sell in large numbers (assuming the demand is there).➜ It allows for specialisation. This means the process is broken down into a series

of stages and individuals specialise in each one. By specialising, individuals can become more effi cient at what they do through repetition. This can speed up the process and make people more productive. Specialisation is also called ‘division of labour’. Specialisation can make it easier to recruit and train people because recruits have fewer tasks to learn.

➜ It is relatively cheap per unit. Although it is expensive to buy the equipment to begin with and to set up the process, the costs are spread over millions of units of production so the cost of each one is actually low. Imagine you spend £5 million on a fl ow production process and produce 50 million units; the cost for each unit is only 10p.

Disadvantages of fl ow productionThe disadvantages of fl ow production include:➜ The initial costs are high. A production line can cost millions of pounds and

the business may not be able to afford this.➜ It is risky. Businesses need to invest a lot of money to be able to

produce on a large scale. The danger is that demand will fall and the expensive equipment will not be used efficiently. If the business ends up producing only a few items, the process works out as being very expensive per item.

➜ It may lack fl exibility. A fl ow process can produce millions of items, but these are all fairly similar. However, recent advances in technology do mean that, even with fl ow production, it is possible to make slightly different products to meet customer orders (for example, different colours and different features). Even so, fl ow production is not as fl exible as job production, and it is not possible to produce to the particular tastes of each customer.

➜ Specialisation and division of labour can lead to boredom and dissatisfaction. Employees may tire of doing the same limited number of tasks and may leave the business. Absenteeism and a high proportion of people leaving can be expensive and disruptive for a business.

Key term

Specialisation occurs when individuals focus on a limited number of tasks.

Study tip

When considering whether a business should introduce fl ow production, you need to consider issues such as:● the cost● the likely level of

demand● the need for fl exible

production.

Key term

Flow production occurs when an item moves continuously from one stage of the process to another.

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Business insight

The Model T Ford

● EfficiencyThe effi ciency of a business refers to how well it is using its resources to produce. If a business uses a high level of inputs to produce its output, it is ineffi cient compared to another business that uses fewer inputs to produce the same output. If it produces its output using relatively few inputs, then it is regarded as effi cient. The effi ciency of a business can be measured by looking at the cost per unit. If a business does not use many resources to produce, then its cost per unit should be low. An ineffi cient business will have higher unit costs.

One of the most famous cars ever made is the Model T Ford, which was produced by Ford from 1918. The car is famous because it was the fi rst to be made using fl ow production techniques. The cars moved along the assembly line and at each stage another part of the car was fi tted. The introduction of fl ow production increased the number of cars being made and meant they were much cheaper to produce. Ford cars were sold at a price much lower than anyone else’s and meant this was the fi rst car that was affordable for millions of people.

Analyse how fl ow production helped the success of the Model T Ford. (6 marks)

Maths moment

A business uses a production line with high fi xed costs. Assume that the variable cost per unit is £2.

Output(units)

Variable costs(£)

Fixed costs(£)

Total costs = Fixed costs + Variable costs(£)


1,000 £5,000,000

2,000 £5,000,000

5,000 £5,000,000

10,000 £5,000,000

20,000 £5,000,000

50,000 £5,000,000

100,000 £5,000,000

Table 3.1 The impact on unit cost as production increases

Complete Table 3.1 and calculate the impact on unit cost as it increases the scale of its production.

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The efficiency of a business will depend on factors such as:➜ how well employees are managed – if they are managed well and motivated

they should produce more and, therefore, the cost per unit should be lower➜ how good suppliers are – if suppliers are reliable and provide good-quality

supplies, then this helps to keep costs lower➜ investment in machinery and technology – if a business has good-quality

equipment and up-to-date technology, this should help to keep the costs of production low

➜ the way in which the products are produced – if items are handmade, this is likely to be expensive; if products are made on a mass scale using fl ow production, this can mean production is much more effi cient. Businesses can also reduce the cost per unit by reducing the amount of waste; this is called lean production.

Lean productionLean production techniques aim to reduce the amount of waste in a business. Waste is ineffi cient; if a business can reduce waste, it can reduce costs. There are many forms of waste in a business:➜ If production exceeds demand, then items may have to be thrown away.➜ Wasted time is ineffi cient and costs money. In fl ow production, if workers

have to wait to start work because the stage before has not been fi nished, they are wasting time.

➜ Any faulty products will have to be re-made, costing money.➜ Holding stocks can be wasteful because they can get damaged or stolen.

In addition, holding stocks costs money (for example, warehouse costs for storage of materials and components) that could otherwise have been earning interest in the bank – so there is an opportunity cost.

Lean production techniques were first developed by Toyota, one of the world’s largest car companies, in Japan. They include just-in-time production and kaizen production.

Just-in-time productionJust-in-time (JIT) production means producing to order – the business only makes an item when there is a customer for it. This reduces the waste caused by throwing unwanted items away and also means the business should not hold any stocks (or at least as few as possible). When a customer places an order, the business orders from suppliers and starts producing. However, for just-in-time to work, suppliers must be able to respond very quickly to orders and must deliver products that work – to respond to customers’ orders quickly, you cannot afford for anything to go wrong.

Kaizen Kaizen means ‘continuous improvement’. It is an approach in which all employees are involved in improving how things are done. Every day, employees (usually in teams) think about what happened the day before and look for

Key term

Lean production is an approach to production that aims to minimise waste.

Key terms

Just-in-time (JIT) production holds as little stock as possible. Items are ordered just in time to be used.

Kaizen means ‘continuous improvement’. It is an approach to production that aims to achieve change from a series of small steps.

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ways of improving the production process. The changes that come out of these discussions are often very small, but over time they can add up to signifi cant improvements in the way that work is done. By involving employees, a business learns from the people who actually do the work and who are most likely to know how to improve things.

Lean production and employeesA lean approach to production requires employees to be involved in helping the business to improve. For example:➜ There will be no stocks with just-in-time production so any disruption by

staff (for example, a strike) can be very damaging. Managers must work closely with employees to make sure that relations between them are good and there are no stoppages.

➜ Kaizen requires employees to fi nd better ways of doing things. This means they need to be motivated and want to help. Again, this means relations between managers and staff need to be good.

➜ To avoid waste, employees need to check the quality at every stage of the process. This means they must be trained in how to check the work properly, and they must be willing to send work back if it is faulty.

Overall, the lean production approach requires employees to be committed to the same goals as managers, to feel part of the business and to want its success. Being more involved in improving and checking things can motivate employees, although some may resist the approach and think it represents more work.

Business insight

ToyotaToyota is known worldwide as a lean producer. It has pioneered many techniques to reduce waste. It produces cars to order. It aims to build and deliver a car that has been ordered by a customer as quickly as possible.

Its process is:

1 A vehicle order is received and a production instruction is issued.

2 The assembly line has the parts needed to assemble the vehicle.

3 The assembly line replaces the parts used (by the preceding process).

4 The preceding process is stocked with small numbers of all types of part.

Analyse why the Toyota production process described above is lean. (6 marks)

SummaryAs businesses grow, they might introduce fl ow production techniques. These have advantages, such as low unit costs, but also disadvantages, such as

less fl exibility than job production. Flow production can help a business to become more effi cient. Lean production can help effi ciency by reducing waste.

Study tip

To be effective, lean production needs a workforce that is co-operative and wants to help the business. This means the management style must encourage involvement and participation. The business will also need to focus on preventing mistakes rather than fi xing them and on working with suppliers that can produce just in time. Adopting a lean approach is not easy – it requires everyone to focus on reducing waste.

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Case study

BonobosThe Bonobos store in Manhattan is located next to well-known brands such as Zara and Gap. Shoppers can look at the rows of clothes before deciding what to buy. However, the difference with Bonobos compared to most stores is that customers cannot take the clothes they want to buy home! The company has no stock, apart from display items. This business model has been used for big items that are diffi cult to take home such as furniture; however, it has not been used a lot by clothes retailers.

Bonobos now has 20 shops like this in the USA. It plans to open at least seven more. Its outlets have many different styles of clothing in many sizes, but not every style in every size. Sales staff have the sole job of helping each shopper fi nd clothes he or she likes, identify the proper fi t and help customers order the clothes online.

All of Bonobos’ stock is held at one central warehouse. This allows Bonobos to rent far less store space because it does not need an area for stock. It also does not:

● need staff to unpack deliveries and spend lots of time refi lling the shelves

● get left with stock that it then has to discount to sell, reducing its profi t margins.

Other stores like Bonobos are Paul Evans and Jack Erwin, two shoe companies which have showrooms in York, where shoppers can inspect the shoes and then order online. Warby Parker does the same for glasses.

The companies that are testing out such showrooms began online. Big, established retailers are unlikely to convert stores to showrooms, at least in the foreseeable future. They have customers used to seeing and buying rather than ordering and waiting. Delivering to individuals rather than shipping in large quantities to stores would also require the established retailers to change their distribution networks signifi cantly. However, because these showrooms are cheaper to run than conventional shops, they can open more of them, more quickly. Will this be the future of retailing?

1 What is meant by ‘stock’? (2 marks)

2 Explain why a clothes retailer may want to hold stock. (4 marks)

3 Analyse the potential benefi ts of holding relatively little stock. (6 marks)

4 Evaluate whether it is better for a business to hold high levels of stock or low levels. Justify your answer. (12 marks)

Quick questions 1 What is meant by ‘job production’? (2 marks)

2 Explain one advantage of job production. (2 marks)

3 Explain one disadvantage of job production. (2 marks)

4 What is meant by ‘flow production’? (2 marks)

5 Explain one advantage of flow production compared to job production. (4 marks)

6 Explain one disadvantage of flow production compared to job production. (4 marks)

7 What is meant by ‘efficiency’? (2 marks)

8 What is meant by ‘lean production’? (2 marks)

9 What is ‘just-in-time production’? (2 marks)

10 What is meant by the term ‘kaizen’? (2 marks)

C

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3.2

The role of procurement

Topic

This topic will examine the relationship between a business and its suppliers. We will analyse the importance of suppliers and how signifi cant it is for a business to manage them effectively.


● the difference between just-in-time and just-in-case approaches to managing stock

● the factors that might infl uence the choice of suppliers

● the effects of procurement and logistics on a business

● the value of effective supply chain management.

● Managing stocksAll businesses hold stocks of some form. These may be day-to-day supplies, such as paper and pens, raw materials, components or semi-fi nished products. The nature and importance of stock will vary from business to business. A supermarket, for example, will hold signifi cant amounts of products on its shelves. This represents money that is tied up in stock – there are millions of pounds worth of goods on the shelves of Tesco and Sainsbury’s at any moment. In a school by comparison, the stock may be items such as paper, printer ink, and light bulbs. In a car factory, there will be stocks of components needed to produce the cars, as well as many cars at different stages of the production process and even some that are fi nished and ready to sell.

Stocks are important because a business needs them to operate and produce. A sandwich shop without any sandwiches will have difficulty operating. A car manufacturer without any engines to install in the cars would also be in trouble. Having stocks can also be attractive because it may mean you have a wide range of products to show customers. Customers can wander up and down the aisles of the supermarkets enjoying the amount of choice they have.

At the same time, they do represent an investment – all the money that is invested into stock could be in the bank earning interest; this means stock has an opportunity cost (see Topic 1.1). Businesses also worry that they may get left

141

3.2 The role of procurement

with stock they cannot sell. Imagine you are managing a fashion retailer and decide that the ‘in’ colour this year is green and, therefore, buy in thousands of clothes coloured green. It turns out you misread the market and the ‘in’ colour is red, leaving you with millions of pounds of unsold stock. You either have to discount it or simply get rid of it, leading to far less profits than you had imagined. There are, therefore, reasons why businesses might not want to hold stock or, at least, want to hold as little as possible.

Just-in-time stock controlAs we saw in Topic 3.1, one approach to stock control is known as just-in-time (JIT). This attempts to minimise the amount of stock held. Stock arrives just in time to be used in the production process. In manufacturing, for example, this means there are very regular deliveries of supplies which are used in the process rather than buying in large quantities and stockpiling components.

This approach means there is less stock held and so:➜ there is less money tied up and a lower opportunity cost➜ there are fewer materials to be damaged (or even stolen) while waiting

to be used➜ less space is needed to warehouse the stocks, so this land can be sold off or

put to another use.

However this approach does mean that:➜ there are more deliveries, so this may have an environmental impact and

cost more➜ the business is vulnerable to any delays from suppliers, as this will halt

production.

Just-in-case stock controlIn the past, businesses have tended to adopt a just-in-case (JIC) approach. They have held stocks just in case they might be needed. This is good in terms of always having stock available for production or sales. It also means the business is likely to be buying large quantities of supplies in bulk. This may lead to lower prices due to purchasing economies of scale and may mean there are fewer deliveries, leading to lower delivery costs. However, a just-in-case approach may be quite ineffi cient in terms of factors such as storage costs. The trend in recent years has been towards a JIT approach.

Just-in-time v. just-in-caseBusinesses need to balance the advantages of a just-in-time approach (which means the business is leaner) with a just-in-case approach (which means the business has spare stock if demand suddenly increases). Businesses will adopt different strategies. For example:➜ Zara orders smaller amounts of stock very frequently. This means it can

respond quickly to changes in fashion and change its stocks regularly. It has very little stock at any moment so rarely has to reduce the price to sell it. This

Study tip

Remember the importance of context. In some industries, such as manufacturing, retailing and restaurants, stocks are extremely important. In an accountancy or design business, they are probably less signifi cant.

Key terms

Just-in-case (JIC) production holds stocks just in case there is a delay from supplies or a sudden unexpected increase in demand.

Purchasing economies of scale occur when the cost per unit falls if large orders are placed with suppliers due to a bulk discount.

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helps improve profi ts. However, it does have to pay for frequent deliveries. This is a just-in-time approach.

➜ Uniqlo holds large quantities of relatively few product lines. It orders ‘classic and timeless’ items in bulk, enabling it to benefi t from economies of scale and relatively few deliveries. This is more of a just-in-case approach.

Neither of these approaches is necessarily better, but they are different approaches to stock.

Just-in-time Just-in-case

Advantages Low stockholding costs as it minimises the stock held

Can meet sudden increases in demand as has spare stock

Does not need as much space to store stock

Lower risk if there are problems with suppliers

Less danger of theft or having to reduce price to sell the stock

Buy bigger quantities and may get price reductions (bulk discount); less transport costs as less frequent deliveries

Disadvantages Buy small quantities so less likely to get bulk discount (economies of scale); more transport costs for more frequent deliveries

Holds stock that might go out of date or need to have price reduced to sell

At risk if there are diffi culties with suppliers

Higher stockholding costs as it hold stocks just in case of an increase in demand or problems with suppliers

Table 3.2 A comparison of just-in-time v. just-in-case approaches to stockholding

Business insight

The Toyota Production System The Toyota Motor Corporation’s way of making cars, known as the Toyota Production System (TPS), has the objective of ‘making the vehicles ordered by customers in the quickest and most effi cient way, in order to deliver the vehicles as quickly as possible’. It is based on:● Jidoka. This means that when a problem occurs,

the production line stops immediately, preventing defective products from being produced.

● Just-in-time. This occurs when each process produces only what is needed by the next process in a continuous fl ow.

Based on the basic philosophies of jidoka and just-in-time, the TPS can effi ciently and quickly produce vehicles of sound quality, one at a time, that fully satisfy customer requirements.

See www.toyota.co.jp for more about the TPS.

Analyse the benefi ts to the company of the Toyota Production System. (6 marks)

● Working with suppliersThe success of a business depends on many factors including the choice of its suppliers.

All businesses will use supplies. These supplies may be:➜ general items used to keep the business going, such as energy, telephones

and cleaning products

http://www.toyota.co.jp

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➜ materials used in the production process – for example, a car will include thousands of different supplies, such as engine parts, tyres, paint and seats

➜ major purchases used to create the production process – for example, the production line equipment in the car factory.

The purchase, or procurement, of supplies is an important part of operations management. In big business, millions of pounds may be spent on suppliers, and there will be specialist managers responsible for the procurement of supplies. Managers will want to make sure their money is used wisely and not wasted and that the right suppliers are chosen. Procurement involves selecting suppliers, establishing the terms of payment and negotiating the contract.

The supply chainThe supplier of a business will also tend to have its own suppliers and this creates a supply chain.

The supply chain refers to all the businesses, people and activities that take part in the production processes from the start until it gets to the customer. For example, a supermarket may sell a packaged meal that was produced by a business that bought its vegetables from another business that bought this from a farmer who bought tractor equipment from another supplier. These businesses are all part of the supply chain.

Businesses now trade all over the world and so the supply chain can be very complex. Just look at the shelves of your local supermarket and think of how many different businesses have been involved all over the world to get those products on the shelves. Deciding what to stock, where to buy it from and then co-ordinating the orders and deliveries with what needs to be on the shelves on any given day is a very complex business.

Why suppliers matterThe suppliers of a business can affect its success in many ways. For example:➜ If suppliers can deliver products on time, this means the business has the

stocks that it needs and can meet its own customer requirements. It will not run out of supplies or be unable to produce or sell. The reliability of suppliers is, therefore, very important as it helps a business to plan its own activities effectively.

➜ If suppliers can produce and deliver quickly and reliably, a business can hold relatively little stock because it can be replaced; this reduces its stockholding costs.

➜ If a supplier provides good-quality products, this will help the reputation and quality of the business. It will not have problems with defects and returned items.

➜ If the supplier can produce effi ciently, this will help reduce the costs of the business and enable it to provide its products at a better price or increase its own profi t margins.

Key terms

Procurement (or purchase) involves selecting suppliers, establishing the terms of payment and negotiating the contract.

The supply chain refers to all the businesses, people and activities that take part in the production processes from the start until it gets to the customer.

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Choosing suppliersThe choice of suppliers is a critical one for businesses because it will affect the success of what they do. The choice will involve a number of factors, such as:➜ the costs➜ the quality➜ the range of products that can be supplied➜ the speed of delivery➜ the fl exibility of the supplier (for example, in terms of the quantities that can

be produced and the time of deliveries)➜ the reliability (that is, the ability to deliver within a given time slot)➜ the reputation (that is, what have others said about working with this business)➜ the payment terms (for example, how long would the business have to pay)➜ the contract terms (for example, what fi nancial compensation would be paid

if deliveries were late).

Business insight

Unilever and TescoIn 2016, Unilever and Tesco were in a dispute over the price of many leading brands, such as Marmite. Unilever produces a range of very well-known brands, such as Persil washing powder, Ben & Jerry’s ice-cream, Dove, Lipton and Marmite. Unilever is the UK’s biggest grocery manufacturer, but many of its products are made outside the UK. Unilever argued that the fall in the value of the UK exchange rate made it more expensive to buy many supplies from

abroad and that this meant that higher prices needed to be charged to supermarkets. Unilever had wanted to raise its prices by about 10 per cent, but Tesco refused to pay. This led to Unilever stopping supplies for a while and this resulted in a shortage of their products in some Tesco stores. After negotiations, the companies reached an agreement.

Analyse the factors Tesco might consider when deciding whether to carry on buying from Unilever. (6 marks)

Business insight

Inditex’s supplier code of conductInditex is the company that owns clothes shop Zara. Inditex has a code of conduct for all of its suppliers. It wants its suppliers to work ethically and responsibly.

The code covers many areas including:● no forced labour● no child labour● no discrimination● respect for freedom of association and collective

bargaining● no harsh or inhumane treatment

● workplace health and hygiene● the right to remuneration● reasonable working hours● documented employment● production traceability● product health and safety● an environmental pledge.

Source: www.inditex.com

Analyse why Inditex has a code of conduct for its suppliers. (6 marks)

LogisticsLogistics refers to the movement of goods, services, information and money throughout the production process. It involves managing and ensuring everything is in the right place when it should be. Think of the importance of

Key term

Logistics refers to the movement of goods, services, information and money throughout the production process.

http://www.inditex.com

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logistics to a business such as Amazon. It has to get items from producers to its warehouses and from there to customers. It aims to do this in an effi cient and as fast a way as possible. Consider what is involved to get the product you ordered from Amazon delivered to your door 24 hours later and you can imagine what logistics involves. When your order is placed, Amazon will fi nd the relevant items in one of its huge warehouses as quickly as possible, dispatch it to a local distribution centre and then organise for it to be picked up and delivered to you. Effective logistics is time-effi cient, cost-effi cient and reliable.

Business insight

Amazon’s fulfi lment centresAmazon has 12 fulfi lment centres in the UK. This is where orders come to and are then distributed from (fulfi lled). These fulfi lment centres have the capacity to ship up to 1.5 million items a day.

SCOTLAND

WALES ENGLAND

DunfermlineGourock

Doncaster

Leicester

Manchester andLeicester plannedfor 2016

Peterborough

Manchester

Rugeley

Swansea Bay

Milton KeynesDunstable

Hemel Hempstead

Figure 3.2 Amazon’s fulfi lment centres

Analyse the factors that might infl uence where Amazon locates its fulfi lment centres. (6 marks)

Trade-offs in the supply chainDeciding which suppliers to work with may have trade-offs. For example, it may cost more to get better quality (although this may save money later on as it may lead to fewer problems with customers). It may cost more to get supplies quicker.

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For example, the Emma Maersk carries thousands of containers around the world. It does this very efficiently, but slowly. If a business wanted supplies more urgently, it might fly them in; this would be quicker but more expensive.

Suppliers and qualityA quality production system is one that meets its targets consistently. A poor quality system does not meet its targets. McDonald’s, for example, develops processes that enable it to deliver burgers that meet set standards time and time again all over the world. This is a high-quality process. Amazon can promise to deliver within a set time frame, and if it achieves this consistently, it is achieving quality in its operations.

The role of suppliers in helping a business meet quality targets should be clear. A poor supplier may be late or may send items that have defects. This can lead a business to run out of stock or sell items that are not as good as promised.

SummaryAll businesses buy in supplies and the nature of these will affect many aspects of the performance of a business, such as its costs and the quality of what it does. Businesses need to consider carefully

which suppliers they work with and how they manage them. They need to weigh up factors such as the price charged by suppliers with the quality and fl exibility of what they do.

Quick questions 1 What is meant by ‘procurement’? (2 marks)

2 State two factors a business might consider when choosing a supplier. (2 marks)

3 Explain one way in which suppliers affect the quality of a business. (3 marks)

4 What is meant by ‘logistics’? (2 marks)

5 Why might there be a trade-off when choosing suppliers? (2 marks)

6 Explain two ways suppliers might affect the performance of a business. (4 marks)

7 State two types of supplies a car manufacturer might buy. (2 marks)

8 Explain what is meant by ‘purchasing economies of scale’. (2 marks)

9 What is the difference between the just-in-time and just-in-case approaches to managing stock? (4 marks)

10 Explain one benefit of a just-in-time production system. (2 marks)

The Emma Maersk

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Case study

The production of Wimbledon’s tennis ballsTo produce a product that is seemingly so simple as a tennis ball actually involves a number of producers all over the world. The complex supply chain involves clay being shipped from South Carolina in the USA, silica from Greece, magnesium carbonate from Japan, zinc oxide from Thailand, sulphur from South Korea, glue and rubber from the Philippines and rubber from Malaysia to Bataan, where the rubber undergoes a chemical process that makes it more durable.

Wool travels from New Zealand to Stroud in Gloucestershire, where it is turned into felt and then sent back to Bataan in the Philippines.

At the same time, petroleum naphthalene from Zibo in China and glue from Basilan in the Philippines are brought to Bataan, where Slazenger actually manufacture the ball. Lastly, tins are shipped in from Indonesia, and once the balls have been packaged, they are sent to Wimbledon.

Total journey: 50,570miles

01 03

0506

09

04

02

0714

1310

1211

08MATERIALS:01USAClay8,710miles

02New ZealandWool11,815miles

03UK (Stroud)Felt weaving6,720miles04ChinaPetroleumNaphthalene2,085miles

05SouthKoreaSulphur1,630miles06JapanMagnesiumCarbonate1,880miles07GreeceSilica5,960miles

08ThailandZinc Oxide1,335miles09Philippines(Basilan)Glue560miles

10MalaysiaRubber1,505miles

11Philippines(Basilan)Rubber560miles

PRODUCTION:12Philippines(Bataan)

PACKAGING:13IndonesiaTins1,710miles

DESTINATION:14Wimbledon6,660miles

Source: www.wbs.ac.uk

Figure 3.3 Wimbledon’s tennis ball production miles

1 What is meant by a ‘supply chain’? (2 marks)

2 Explain why logistics is important in the production of a tennis ball. (4 marks)

3 Analyse the factors considered when choosing suppliers used in the production of a tennis ball. (6 marks)

4 To what extent do you think managing the supply chain affects the success of a business? (9 marks)

C

http://www.wbs.ac.uk

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3.3

This topic considers the meaning and importance of quality in business. We will also examine how quality can be achieved and the costs involved in doing so.


● the meaning of quality

● the importance of meeting customer expectations

● how businesses measure quality and identify quality problems

● the consequences of quality problems

● the methods of maintaining consistent quality: Total Quality Management (TQM)

● the costs and benefi ts of maintaining quality.

● The meaning of quality To achieve quality, managers must defi ne what they are trying to achieve, and this means they must defi ne what they think the customer wants. A quality product is one that meets the customer’s requirements. A business should set targets for it operations: for example, it will be produced by a set time, it will have certain features, and it will be delivered by a given day within a given slot.

● Meeting customer expectationsAchieving quality involves hitting targets that have been set by the business in order to meet customer expectations. The targets set will depend on the nature of the business. For example:➜ A hospital might set targets for the length of time patients are kept waiting

before being seen, how long it takes to treat patients and how many operations are successful.

➜ An airline might set targets relating to the percentage of planes taking off on time, the percentage of planes landing on time, the percentage of people who have their bags lost and customer satisfaction ratings of the quality of the service on the plane.

The concept of quality

Topic

149

3.3 The concept of quality

➜ A chocolate manufacturer might measure the number of products meeting the right weight targets, the number of products meeting the taste targets, the number of deliveries leaving the factory on time and the number of customers who were billed correctly.

● Measuring quality and identifying problems

Once a business has set standards for quality, it can then measure whether or not these have been achieved. To measure performance it may ask different groups. For example:➜ Customers. Many businesses ask their customers to complete surveys. Many

also have telephone lines that customers can ring to let them know what they have done well or badly. Businesses like Starbucks and Pret A Manger encourage customers to speak to the store manager if they have a complaint or an idea for improvement. This way the business fi nds out directly what its users think. If the number of people fi lling in these forms or making contact is not enough, the business might undertake other forms of primary market research to fi nd out what they think.

➜ Mystery visitors. Some businesses, such as hotels and restaurants, employ mystery visitors to use the product in secret to test the quality of service. This may give a good outsider’s view of the business, although staff may feel that they are being spied on.

➜ Staff. Staff can be asked to check the quality of the work done, either at each stage of the process or at the end. Staff can check to see if any mistakes have been made. A quality control system, for example, checks products to see if there are any defects. This might involve taking samples of the product to check how well they work. Quality assurance focuses on preventing mistakes occurring. This involves training employees to inspect their own work, choosing the right suppliers to make sure the supplies have no faults and checking the work at each stage to make sure faulty work is not passed on.

● The consequences of quality problemsIf products do not meet the standards set, this will lead to:➜ customer dissatisfaction – customers may not buy the product again or

recommend it to others; if customers are unhappy, they tend to tell others and this damages the brand

➜ the cost of recalling faulty products – customers need to be told about any mistakes, and the business must pay to get the products handed back in

➜ the cost of replacing goods – new items may have to be produced to replace the old ones

➜ the cost of waste – if there is poor quality, then items may have to be thrown away

➜ the cost of goods that are produced but no one wants➜ the cost of legal action if the business is sued for poor quality.

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● Maintaining consistent qualityTo maintain quality, a business should:➜ make sure its suppliers are reliable and that the products they use are of

good quality and meet their needs➜ train staff so they know how to do their jobs properly and what the desired

standards are➜ invest in equipment so that staff have the equipment they need to do the job

well➜ inspect the products at each stage of the process to make sure there are no

defects – it is easier and cheaper to catch any problems along the way than to rely on fi nding them at the end

➜ involve staff in improving the process (for example, through kaizen groups) to fi nd ways of doing things better and removing errors.

Total Quality ManagementOne approach to achieving better quality is to focus on inspection. If faults are there, you make sure you fi nd them. This is known as quality control.

Another approach is known as Total Quality Management (TQM). TQM requires everyone in the business to be working towards ensuring the quality targets are met. It focuses on preventing any mistakes occurring rather than fixing them later. It is called ‘total’ quality because it regards quality as everyone’s job. You cannot produce something and expect someone else to check whether it is acceptable – you need to do this yourself. This approach stresses that everyone has a customer – whatever you do, you pass your work on to someone else and they are your customer. Customers may be internal (that is, colleagues within the business) or external (customers who buy the product), but whoever your customer is, you need to give them work that meets their requirements. This means that everyone needs to be clear what the targets are and have the training and resources to be able to meet them. TQM recognises that all employees can help the business to improve and that quality is not just something that the quality control department should worry about.

However, not every employee will like the introduction of a TQM approach because this means they have to monitor their own work and be prepared to send work back to the person who passed it on to them if it is not good enough. Not everyone will want this extra responsibility.

● The costs and benefits of maintaining quality

The costs of improving qualityPoor quality can be very expensive. However, it may be worth spending more to improve quality and prevent problems occurring later.

Key term

Total Quality Management (TQM) is an approach to quality in which everyone is focused on preventing errors occurring and ensuring quality at each stage of the production process.

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3.3 The concept of quality

The costs of achieving better quality include:➜ the costs of inspection and checking – known as quality control➜ the costs of training staff to check their own quality➜ the costs of selecting better suppliers.

The benefits of maintaining qualityGood quality is important for several reasons:➜ Customers are more likely to come back and recommend a business if

they know they can trust the quality. One of the benefi ts of McDonald’s or Starbucks is that customers know what they are going to get. By comparison, you are never sure when you try a new café what the food will be like and whether it will be the same next time you visit – you are taking a risk. If you have a bad experience at a business (for example, your fl ight is cancelled and you miss a day of your holiday), you may not use the business again if you can help it. Maintaining quality will make it easier for the business to launch more products in the future because the brand name will be known and trusted.

➜ Avoiding mistakes saves money. If a fi rm sells a product that is faulty it has to take the product back and replace it. If there is a design problem, the fi rm may have to redesign the product or change how it is made. If the product is dangerous, the company may even be sued by customers. It is cheaper to get it right the fi rst time.

➜ A business should be able to charge more for a quality product because customers will pay for reliability and for the reassurance that what they buy will work and do what it is supposed to.

➜ It may improve the brand and reputation of the product.

Problems achieving consistent qualityTo achieve good quality requires good suppliers, well-defi ned ways of doing the work and regular monitoring of performance. This can be diffi cult as a business grows because it may franchise its operations or outsource some of its production. In order to grow quickly, the business is giving up control over some aspects of production and this can mean that quality may suffer.

Business insight

Samsung’s Galaxy 7In 2016, Samsung stopped selling its Galaxy 7 smartphone and offered replacements for anyone who had already bought one. A number of phones had exploded due to problems with the battery. The company used several suppliers, and there seemed to be a problem with one of them. The company introduced extra quality checks, but ultimately decided to withdraw the product.

Analyse the possible costs to Samsung of the problems with its Galaxy 7. (6 marks)

Study tip

Remember that good-quality products are not necessarily expensive – they simply do what they are expected to and are excellent value for money. To achieve quality, managers must set the targets that customers want and then make sure they achieve these targets time and time again. To achieve good quality, the fi rm may have to spend money at fi rst, but it can save money in the long run.

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SummaryThe quality of a product depends on whether it meets the customers’ needs. To achieve good quality, managers must defi ne what they want, introduce ways of making sure these targets are achieved

and measure how well they are doing against these targets. It is important to maintain consistent quality, which can be achieved in various ways such as training, investment and working with suppliers.

Quick questions 1 What is meant by ‘quality’? (2 marks)

2 State two ways quality may be measured in a hospital. (2 marks)

3 State two ways quality may be measured in a car manufacturer. (2 marks)

4 State two problems caused by poor quality. (2 marks)

5 State two costs of improving quality. (2 marks)

6 State two benefits of having good quality. (2 marks)

7 What is meant by ‘Total Quality Management’? (2 marks)

8 Explain one reason employees might resist the introduction of Total Quality Management. (2 marks)

9 State two ways in which a business might measure the level of quality it is achieving. (2 marks)

10 Why might McDonald’s be described as a high-quality food provider? (2 marks)

Case study

Sounds AliveJohnny Cash is the managing director of Sounds Alive, a producer of digital radios, which are sold worldwide. The company produces these using fl ow production techniques. The work is organised using specialisation and the division of labour. Over the last few years, Johnny has introduced some aspects of lean production to the business to improve its effi ciency, such as just-in-time production, but Johnny knows there is more work to do. His main focus at the moment is to improve the quality of the company’s products. There has been an increasing number of products being returned as faulty in the last few months, and Johnny is determined to sort this out. The business has a quality control department, but Johnny wants to introduce a Total Quality Management approach.

Johnny thinks the quality problems might be connected with the rapid growth of the company in the last couple of years. Big orders from abroad mean he has expanded production signifi cantly. While getting bigger has brought many advantages, there is no doubt it has also caused some problems.

1 Explain two possible problems to Johnny’s business of using division of labour. (4 marks)

2 (a) Analyse the case for Johnny introducing Total Quality Management. (6 marks)

(b) Analyse the case for him not introducing Total Quality Management. (6 marks)

(c) Recommend whether Johnny should introduce Total Quality Management. Explain your answer. (12 marks)

C

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3.4

This topic looks at what is meant by customer service and the ways in which businesses can offer these to a high standard. It also covers the ways in which the use of ICT can help businesses to offer high standards of customer service.


● what good customer service is

● the methods of good service

● the benefi ts of good customer service

● the dangers of poor customer service

● how ICT can help businesses to offer good customer service.

● What is good customer service?Good customer service means keeping customers happy. Customer service can occur before you buy an item (for example, advice online), when you buy (for example, help in-store) and after you have purchased an item (for example, when asking for further help and support).

● Methods of good serviceThe productGood customer service depends on the quality of the products themselves. Businesses can provide high-quality customer service by making sure that the goods or services they supply meet the needs of customers. This depends on a number of factors.

ReliabilityGoods should be reliable and do exactly what is expected of them; for example, customers expect painters and decorators to paint houses in such a way that the work will last for years without fading or peeling.

SafetyCustomers worry about safety when buying some products; for instance, airlines have to take great care to protect passengers who fl y with them.

Key term

Customer service is the part of a business’s activities that is concerned with meeting customers’ needs as fully as possible.

Good customer service

Topic

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Customer engagementPositive customer engagement occurs when the business build a relationship with the customer by providing a good customer experience. The customer feels positively about the business and is therefore more likely to buy from it and recommend it to others.

Good product informationCustomers expect clear information about goods and services. This helps them to make the right decision about which product to buy. As an example, many customers expect to read nutritional information about foods as this helps them to eat a balanced diet. So, businesses producing products such as jams, cakes and beers will list nutritional information on the labels. It is important that customers understand what they are buying. Customer engagement will also be helped by well-trained staff who understand the features and benefi ts of each of the products and so can provide useful advice and guidance to customers. Employees should be helpful and respond quickly and in a friendly way to enquiries from customers. This will help ensure customers feel positive about their buying experience.

Post-sales (after-sales) servicePost-sales (or after-sales) service is an important feature of customer service. Post-sales service includes:➜ dealing quickly and fairly with complaints➜ delivering products without delays – this is important when products are

perishable, such as fresh foods➜ exchanging goods that are faulty or do not meet customers’ needs➜ repairing goods (free of charge if under guarantee).

PremisesHotels, shops and restaurants must maintain their premises well to keep customers happy:➜ Premises should be clean, especially where food is prepared, cooked and eaten.➜ Customers should be able to fi nd their way around the business. For example,

it is very important that hospitals should be clearly signposted.➜ Disabled customers will be dissatisfi ed if they are unable to use a business’s

products. A recent change in the law means that all businesses have to make ‘reasonable’ changes to allow disabled people to buy their products.

➜ Customers expect good facilities, for example, rooms for changing babies’ nappies in high-street shops.

Different methods of paymentBusinesses may benefi t from meeting customers’ needs by offering a variety of ways of paying for goods and services. Small businesses can increase sales by

Key terms

Positive customer engagement occurs when customers have a good experience from their contact with the business.

Post-sales (or after-sales) service is the meeting of customers’ needs after they have purchased a product, for example, by repairing or servicing the product.

Premises are the buildings used by businesses – these may include offi ces, shops and factories.

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3.4 Good customer service

accepting cheques and credit cards and also by providing small quantities of products at proportionally low prices.

Managing customers’ expectationsAn important part of customer service involves managing customers’ expectations. If you expect a shop to be open at 9 a.m. and it opens at 9.15, you may be annoyed. If you were told from the start it would be 9.15 you may not have minded. If you were told in a restaurant that you would be served in 15 minutes and the food comes in 10 minutes you might be impressed. If you were told that the food would arrive in 5 minutes and it came in 10 minutes, then you may be disappointed. Businesses need to think carefully about what they promise and make sure they meet or exceed their promises. A golden rule of customer service is: never over-promise!

● Benefits of good customer serviceGood quality customer service is important because it helps businesses to be competitive. It is one way in which businesses can make themselves distinctive and compete successfully with their rivals.

Business insight

Center ParcsCenter Parcs operates a number of short-break holiday villages in the UK. It is highly rated for its customer service. It is rated above world class level for customer service according to the Institute of Customer Service. According to the company, it achieves this through investing in staff training and investment in improving accommodation, leisure facilities and restaurants.

2015–16 2014–151

Occupancy (%) 97.7 96.9

Sleeper nights (m) 7.2 6.8

Number of guests (m) 2.1 2.0

Capital investment (£m) 63.2 42.9

Revenue (£m) 420.2 385.2

Profi t before tax (£m) 57.3 22.8

Average daily rate (£) (net of VAT) 167.31 159.43

Accommodation bookings via web (% of total) 84 82

Guest satisfaction (% of guests ranking their break as excellent or good) 96 96

Employee turnover (%) 30 24

1 All fi gures relate to 52 weeks of trading for the four original Villages and 44 weeks of trading for Woburn Forest, which

opened in June 2014.

Source: www.centerparcs.co.uk

Table 3.3 Center Parcs’ fi nancial highlights for 2014–15 and 2015–16Analyse the reasons why high levels of customer satisfaction are important for Center Parcs. (6 marks)

Study tip

When answering questions on this topic, try to think of features of customer service that are relevant to the type of business on which the question is based. For example, a restaurant might offer high-quality customer service by providing attentive waiters and a menu that gives a lot of information about the food and wine.

http://www.centerparcs.co.uk

156


Increase in customer satisfactionGood customer service should increase customer satisfaction and lead to more repeat business. It should help to:➜ attract new customers – if a new business is supplying a similar good or

service to those that are already on the market, then good customer service can make it distinctive and help it to gain new customers. New customers may be attracted by the recommendation of others.

➜ increase the customer spend – satisfi ed customers will be attracted to the business and spend more as a result. They may buy more of a given product and/or try some other products produced by the business.

➜ increase the market share – the market share is the percentage of sales in a particular market that is achieved by a given business. If the customers of the business are satisfi ed (or more than satisfi ed) by the service they receive, they may tell friends about it, and the business may have good publicity. This may lead to increased sales and a bigger share of the market.

➜ increase customer loyalty – a new business that gives its customers what they want in terms of customer service is less likely to lose them to other businesses. This is referred to as customer loyalty.

➜ increase profi tability – if good customer service leads to more customers, more sales and greater brand loyalty, it should result in greater profi tability for the business.

Business insight

First DirectFirst Direct is an online and telephone banking service that regularly wins customer service awards.

According to its website, what makes it different is not what it does (it offers savings accounts and so on, like all banks), but the way it does it. When you contact the company, it listens, it talks to you and it is always aware that it is your money! It does not have an automated system. It does not ask you to press 1 for X

and 2 for Y; it respects its customers and knows they like talking to real people.

To make sure customers get the service they need they are on the phone and online 24 hours a day, including bank holidays. It has anticipated the growth in phone banking and internet banking and has been ahead of its competitors in these areas. And they say they love what they do!

Analyse the ways in which excellent customer service might benefi t a bank. (6 marks)

● Dangers of poor customer serviceWhy does poor customer service occur?Poor customer service occurs in the following situations:➜ Businesses promise too much. They raise customers’ expectations and

then do not provide. For example, an online shop promises 24-hour delivery and the item comes after three days. A business needs to ensure it has the resources it needs to meet the promises it makes. If it cannot do this, it must promise less or invest in more resources.

Key term

Customer loyalty means that a business’s customers make repeat purchases because they prefer the business’s products to those of its rivals.

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➜ Poor communication. It may not be made clear to customers what the level of service is. You may turn up to a theme park expecting to go straight on the rides. If it is clear there will be some delays, then you expect that and will not be upset by it. If the delays are not communicated to you in advance, you may not expect them and will be upset by queuing.

➜ Poor management. The business may have the resources to fulfi l its promises and meet the expectations created, but it may not manage its resources properly. Perhaps staff are not allocated the right jobs, or the equipment is not scheduled to be used effectively.

➜ External factors. Poor service may occur due to external problems, such as delays from suppliers.

The effects of poor customer servicePoor customer service is likely to lead to:➜ dissatisfi ed customers – they will not return to buy from the business➜ problems attracting new customers➜ a loss of revenue and profi ts➜ costs, if a business has to reimburse customers because they have been sold

the wrong items, given the wrong information or sold the wrong products.

● How ICT can help businesses to offer good customer service

Information and communications technology (ICT) is important to businesses. This technology can help businesses to improve their customer service in many ways, and in many cases, the amount of money that has to be invested in ICT is relatively small.

Using websitesEven very small or newly set up businesses can have their own website. Websites offer customers up-to-date information about businesses and the products that they sell. They can be a relatively cheap form of advertising. A website can be set up for several hundred pounds, and a web designer can be hired fairly cheaply to spend a few hours each week maintaining and updating it.

A website can help to offer good customer service in a number of ways:➜ It can give the customer information about the business and can include

pictures and videos to tell them more about the product and the business. This helps the customer to make a well-informed decision about whether or not to buy the product.

➜ It can help to advertise a small business to a much larger group of customers, leading to increased sales.

➜ It can include answers to frequently asked questions (FAQs). This can be a quick way for customers to fi nd out answers to simple questions such as ‘What are the business’s opening hours?’

Key term

Information and communications technology (ICT) are the computing and communications systems that a business might use to help to exchange information with stakeholders.

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➜ It can offer advice to current customers if they have problems with a product that they have bought. They might be able to fi nd the solution to their problem or can use the website to contact the business to ask for help. Using email allows customers to contact businesses immediately with any problems or complaints..

E-commerce and m-commerceMany businesses have developed their websites further and use them not only to advertise their products but also to engage in e-commerce and m-commerce to sell their products directly to customers through the internet.

E-commerce and m-commerce offer many advantages to customers: ➜ Customers can view products at any time of day from all over the world.➜ Customers can see other peoples’ reviews of the products.➜ Customers may be able to ask questions to an online support team.➜ Customers may receive suggestions of other products they may like from the

company.➜ Customers may benefi t from lower prices as online businesses do not have to

pay high street rents.

Social mediaSocial media involves the use of websites and applications that allow people to create and share content or to participate in social networking. Examples of social media include Facebook, Twitter, Snapchat and Pinterest; these are now very important aspects of communicating about your business, your customers and your products. It is a way of accessing large numbers of existing and potential customers and helping build awareness of the business and its products, informing them about development and persuading them of the benefi ts. It is a very powerful means of communication and promotion. Businesses can also get feedback from customers and monitor their satisfaction.

Data analysis Data analysis involves gathering and examining data to provide useful information that can be used for decision-making. Improvements in information and communications technology mean businesses can now gather much more information about their customers than ever before. They can also analyse the data faster and more effectively. Amazon knows what you have looked at on its site, when, where you searched from and what you bought in the past. It can identify trends from this and change its marketing accordingly. For example: ➜ It can remarket products to you so that when you are using the internet

relevant advertisements about the things you have been searching for will appear to promote action.

➜ It can recommend products it knows you will like because it has tracked your shopping and browsing history.

Key terms


M-commerce (or mobile commerce) is the buying and selling of products through wireless handheld devices such as smartphones.

Global markets are made up of customers from across the world.

Social media involves methods of online communication such as websites and applications; they share information and help to develop social and professional contacts.

Data analysis involves gathering and examining data to provide useful information that can be used for decision-making.

Study tip

Remember that the owners and employees of businesses might not have the skills needed to use new technology. The costs of using technology can be high at fi rst, as it may mean that employees need training or outside expertise may need to be paid for.

159


➜ It can change the price according to the day, the time or the month to encourage you to buy based on what you have done in the past.

By using ICT, businesses can now understand their customers and their buying behaviour much more than they could in the past. They can also track the effectiveness of their marketing activities more closely. For example, businesses can change the design and content of their website and see exactly what it does to how customers use the site and the purchases they make.

Improvements in ICT also allow businesses to combine data sets and analyse the results in ways that were simply not technologically possible in the past. A supermarket chain such as Walmart (which owns Asda), for example, has invested enormously in ICT. It can bring together data that considers what day of the month it is, what events are happening in a region, what the weather will be like and what else is happening in the business environment (such as competitor actions) in order to predict sales and, therefore, know what to stock. The computing ability these days is immense allowing business to get a much deeper understanding of what drives demand and behaviour. This can all improve customer service because businesses can deliver what we want, when we want it, where we want it and at the price we want. These days, they may even know what we want, where we want it, when we want it and the price we are willing to pay before we do!

SummaryCustomer service means meeting the needs of customers as fully as possible and is very important for small businesses. It helps them to compete effectively with much bigger rivals. Businesses can improve their customer service by making products that are reliable and by offering clear information

about their products, by having well-trained and well-informed staff and by providing effective post-sales service. Advances in technology have helped businesses to improve their customer service through the use of websites and by permitting e-commerce and m-commerce.

Quick questions 1 What is meant by the term ‘customer

service’? (2 marks)

2 State two ways in which a business might offer good customer service. (2 marks)

3 What is meant by ‘customer engagement’? (2 marks)

4 What is meant by the term ‘post-sales service’? (2 marks)

5 Give two benefits of good customer service. (2 marks)

6 What is meant by ‘m-commerce’? (2 marks)

7 State two dangers of poor customer service. (2 marks)

8 Explain one way in which ICT has allowed businesses to improve their customer service. (2 marks)

9 What is meant by the term ‘e-commerce’? (2 marks)

10 Give two benefits to a business of using e-commerce. (2 marks)

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160

Chapter review – Business operationsRead question 1, the sample answers and the comments. Then try question 2.


➜ Item ASamsung, the consumer electronics giant that produces a wide range of different products, recently had to recall its Galaxy Note 7 mobile phone handsets because some of the batteries in them were catching fi re. This was a disaster for the company in terms of its impact on the brand image. There have been other major incidents of phone recalls in the industry – for instance, in 2007, Nokia had to recall 46 million batteries because of concerns that they may overheat. However, in the past the batteries could be taken out of the handsets and returned separately. With the Galaxy Note 7 phones, the whole handset had to be recalled, costing millions.

Samsung had to shut down its production lines and offer compensation to customers, who could get their money back or have a partial refund and get an older model. Samsung has not been clear as to how many Note 7s were involved, but it is likely to be around 4 million. Around 35 are said to have overheated but, because of the risk, they were all recalled. The company had hoped the Galaxy Note 7 was going to be a big seller and had the capacity to produce 6 million a year. It had wanted to benefi t from large-scale production.

Case study

The ExcelsiorRomily Jones did not want to open her emails – she was worried they would contain yet more complaints. For the last few weeks, she had been receiving customer complaints almost every day about the quality of the service or the quality of the food they had received while staying at Romily’s hotel.

The hotel, called the Excelsior, was (or at least it had been) one of the top hotels in Oxford. It had been owned by Romily’s family for several generations and Romily had taken over as the manager last year. The fi rst few months had gone well but, in the busy summer months, the complaints had started to come in. It was diffi cult to manage the business at that time because the hotel was busy and so many extra part-time staff, usually students, were hired to help out and everyone was very stretched.

At fi rst, Romily thought it was just that customers were quicker to complain than they used to be, but she employed a mystery visitor to check how things were. His report had been scary to read – things were defi nitely looking bad. She was even getting terrible reviews online now. She was offering refunds to anyone who complained, to try to improve their view of the hotel, but this was hitting the hotel’s profi t margins.

1 What is meant by ‘profi t margin’? (2 marks)

2 Explain two reasons why good customer service is important to the Excelsior. (5 marks)

3 Analyse ways in which Romily could improve the customer service at the hotel. (9 marks)

4 To what extent do you think poor reviews online matter to a hotel? (12 marks)

C

161

Chapter review – Business operations

161

Chapter review – Business operations

Many consumers had also bought cases, keyboard covers, wide-angle lens attachments and spare styluses and power packs for their Note 7s; these are now worthless.

(a) What is meant by ‘capacity’? (2 marks)

(a) Capacity measures the sales of the business compared to the maximum output.

This answer is not accurate. Capacity is the maximum output given existing resources. It is measured in terms of number of units.

(b) Explain two economies of scale that Samsung might experience by producing its phones on a large scale. (4 marks)

(b) Economies of scale measure the unit cost per unit. These may be due to bulk buying, technology, specialisation or division of labour.

This answer shows an understanding of economies of scale. It identi� es some economies of scale, but does not explain how Samsung may experience them. The answer should be expanded.

(c) Analyse the possible consequences for Samsung of the poor quality. (6 marks)

(c) Poor quality means that the product does not meet the targets required in terms of customer requirements. In this case, it means problems with batteries that caught fi re. This is bad for the company because it damages its reputation and brand image. This can lead to lost sales now and in the future. The poor quality may also mean that the company has to take back the phones. It is expensive to co-ordinate the recall and physically get them back, and the company may also need to compensate its customers. All of this can lead to higher costs and lower profi ts.

However, it depends on how many phones are affected and how many have to be recalled. It also depends on how bad the damage is to customers and so how much the compensation will cost. If the company reacts quickly and effectively, it may be seen to care about the customers and the brand damage may not be as much.

The answer analyses the effects of poor quality well. However, it then goes on to discuss these effects. It is evaluating the question set. This is not required for this question. The question requires analysis only. The student may have used up time that could have been used to answer another question.

(d) To what extent do you think this recall of the Note 7 will damage Samsung’s overall profi ts in the long run? (12 marks)

(d) This product can damage profi ts because the company will have to pay to recall the phones. This will cost money. It will have paid to develop the phone, but now will have no sales – so it will have costs but no revenue. The incident may damage the brand and so this might affect sales of other products damaging profi t even more.

However the company is a ‘giant’ and has many products so its overall profi ts depend on how its other products, such as its televisions, its tablets or even its other phones, are doing. This fall in profi ts as a result of the Note 7 may be relatively small compared to what is being gained elsewhere.

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3 Business operations Business operations

The impact may also depend on how it handles the incident. If it is seen to act quickly and generously in terms of compensation, customers may quickly regain confi dence in the brand and feel secure buying again. If it proves diffi cult to return the items, customers may be more wary. Also, it depends on how far ahead we are looking. This incident will be in our minds for some time, but probably will have been overtaken by an issue somewhere else in a few years’ time and so the effect will have diminished depending on the actions Samsung takes.

Overall, this is a big issue for Samsung and is likely to damage profi ts. However, the key now is how it manages the situation and whether it can regain confi dence and whether it has other products that it can launch and be successful.

This answer highlights the dangers of the recall in terms of its impact on pro� ts but also appreciates that the effect on the overall pro� ts of Samsung depends on many other factors.


➜ Item BA recent Citizens Advice league table shows that SSE energy company had the lowest level of complaints of any energy business in the UK at just 22.5 per 100,000 customers. EDF, British Gas and E.ON were second, fourth and fi fth respectively. These are examples of good customer service.

Others such as npower and Scottish Power were less successful. One small supplier, Extra Energy, was the worst of all the 21 fi rms measured, with a complaints rate that was 80 times greater than that of SSE.

Extra Energy, which was established in 2014, apologised to customers and said it was now dealing with more complaints by its target of the end of the next working day. Analysts said that Extra Energy appeared to have struggled to maintain its desired customer service levels during its expansion. The number of customers rose fast and analysts say it has been catching up in terms of having the resources to deal with them.

Complaints are usually about late or inaccurate bills, or the diffi culty some customers experience while simply trying to contact their gas or electricity supplier.

According to one commentator, almost 4 million customers were overcharged due to billing errors last year.

(a) What is a ‘company’? (2 marks)

(b) Explain the factors that may affect why people choose one energy company rather than another. (4 marks)

(c) Analyse the benefi ts of good customer service to an energy company. (6 marks)

(d) To what extent is more investment in training the key to better customer service? (9 marks)

163

Every business uses people in some way to produce goods and services. This chapter will consider how businesses organise their employees to supply products in the most effi cient ways. The organisational structure is an important infl uence on the jobs that people are asked to do. It affects their freedom to make decisions. We will also examine how businesses recruit new employees and the techniques they use to choose the best applicants for jobs. Once employed, it is important that employees are motivated to work as hard as possible for the business. Employee motivation can be an important factor in making a business successful. Finally, we shall discuss how businesses can improve the performance of their workforces through training and analyse the benefi ts and drawbacks of different types of training.

4Human resources

164

Topic 4.1

Organisational structures

All businesses have organisational structures. This means that all the employees are given a role in the business and that these fi t together to help the organisation to achieve its aims. Some people have senior roles and are responsible for many people; others are more junior. The structure sets out the relationships between people in the business. We shall see that different businesses use different organisational structures and that a business’s organisational structure may change over time.


● why businesses have organisational structures

● the different job roles and responsibilities within an organisation

● the internal organisational structures a business may use

● why businesses use different organisation structures

● how organisational structures affect the way a business is managed and communication within it

● the advantages and disadvantages of centralisation and decentralisation.

● Why businesses have organisational structures

Businesses have to organise themselves to be able to carry out their activities effectively. It is important that everyone in the organisation knows:➜ what their duties are➜ the person or people that they have to report to➜ the other employees in the organisation for whom they are responsible.

An organisational structure sets this out so that everyone in the business knows this information. Without this internal structure, a business would be very chaotic and not very productive.

Key term

An organisational structure is the way a business arranges itself to carry out its activities.

165

4.1 Organisational structures

● Job roles and responsibilities within organisational structures

All businesses have an internal organisational structure. The organisational structure shows the roles played by each employee in the business and who reports to whom within the business. The roles and working relationships in a business are shown in an organisational chart (see Figure 4.1).

Key term

An organisational chart is a plan showing the roles of, and relationships between, all the employees in a business.Chief executive (1)

Shop-floor workers (256)

Team leaders (64)

Managers (16)

Directors (4)

Figure 4.1 An organisational chart

In Figure 4.1, it can be seen that: ➜ shop-fl oor workers are responsible to and report to team leaders, who are

their line managers➜ in turn, the team leaders report to managers, with each manager being

responsible for a group of team leaders (in this case, there are four)➜ managers report to individual directors who report to the chief executive or

managing director➜ the chief executive offi cer (CEO) or managing director has ultimate authority

(or power) within the business.

Organisational charts show how each individual employee fits into the business. They show each employee’s line manager and the people for whom managers and others are responsible (see Table 4.1).

Job role Responsibilities

Directors ● Establish the business’s overall goals ● Set long-term plans and targets for the business

Managers ● Work to achieve the short- and long-term targets set by the directors● May be responsible for a function within the business, for example, marketing or fi nance● Use employees and other resources in the best possible ways

Team leaders (or supervisors)

● Help managers to achieve their targets by reporting any problems and passing on instructions● Take simple decisions, such as allocating jobs among different employees

Shop-fl oor workers or operatives

Carry out the business’s basic duties or activities. These could be working on a production line, serving customers in a shop or basic offi ce duties

Table 4.1 Different job roles within a business

Key terms

A line manager is an employee’s immediate superior or boss.

Authority is the power to control others and to make decisions.

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Features of organisational structuresThere are a number of features of internal organisational structures that can be altered to suit the business’s particular circumstances.

Spans of control and levels of hierarchyThe span of control is the number of employees managed directly by a manager. This means that the manager is the immediate boss or line manager of these employees. In Figure 4.2, Manager A has a span of control of four and Team Leader 4 has a span of control of fi ve.

Manager A

Teamleader

1

Teamleader

2

Teamleader

3

Teamleader

4

Manager B

Teamleader

5

Teamleader

6

Teamleader

7

Teamleader

8

Operative Operative OperativeOperative Operative

Figure 4.2 Different spans of control

A director, manager or team leader should not have a span of control that is too wide. If this happens, he or she will find it difficult to manage the employees properly as there will be insufficient time to spare for each employee. Experts recommend that the maximum span of control for a manager should be no more than six, though this is commonly exceeded in many businesses.

Levels of hierarchy are the layers of authority in a business. The business in Figure 4.1 has five levels of hierarchy. This means that the employees at the bottom of the organisational structure have four layers of authority above them.

Chains of commandA chain of command is the line of authority within a business along which communication passes. Thus, directors might decide on a target for the business and issue instructions to managers about achieving this target. In turn, instructions will be passed down to team leaders and eventually to shop-fl oor workers on actions to take to meet this target. Similarly, each level of hierarchy within the organisation will report to the level above on the progress made in achieving the target. This shows how communication can fl ow up and down the chain of command.

Key terms

The span of control is the number of employees managed directly by another employee.

Levels of hierarchy are the layers of authority within a business.

Key term

The chain of command is the line of authority within a business along which communication passes.

Managers can struggle if they have a wide span of control. Some experts do not recommend a span of control of more than six people.

Managers have different responsibilities to shop-floor employees. They are normally responsible for using employees and other resources to achieve the business’s targets.

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DelayeringWhen a business delayers, it removes of one or more levels of hierarchy from its organisational structure. This is most commonly done to reduce the organisation’s costs. In 2016, Rolls-Royce plc, a manufacturer of engines for planes and ships, announced it was delayering its organisational structure as part of a plan to reduce its costs by £200 million a year. Many businesses have used delayering to reduce the number of managers they employ.

Delayering does have consequences beyond reducing costs:➜ Junior employees might have to take on some of the duties previously carried

out by employees who were their line managers.➜ Some senior employees may have very wide spans of control when a level of

hierarchy is removed.

Key term

Delayering is the removal of one or more levels of hierarchy from a business’s organisational structure.

Business insight

Delayering at Boots UKThe chemist shops owned by Boots are in most towns and cities across the UK. They sell health and beauty products, as well as dispensing medicines. In 2016, the company announced plans to cut up to 350 jobs in the UK to reduce costs, especially in its larger stores. The job losses involve the removal of a layer of management in the stores – the jobs lost are those of assistant managers in the stores. These job losses

are part of a move to simplify the organisational structure within the chemist’s stores.

This move follows a decision by the company to remove 700 offi ce-based jobs just seven months earlier. Boots was recently bought by an American company which is seeking to improve its profi ts.

Explain one advantage and one disadvantage to Boots from its decision to delayer its organisational structure in its larger stores. (6 marks)

Key term

Delegation is the passing down of authority to more junior employees.


DelegationDelegation is the passing down of authority to more junior employees. In very small businesses, the entrepreneur would probably take all necessary decisions. However, as a business grows, this becomes impossible. There are too many decisions to be made and some might be very specialist, for example, on creating software for the business’s IT system. Delegation gives authority to junior employees to take decisions in a specifi c area. For example, a store manager in a supermarket might delegate authority to more junior employees to order supplies of vegetables or fi sh when necessary.

● Using organisational structures

Not all businesses use the same organisational structure. Some businesses may opt to use ‘tall’ organisational structures, while others use ‘fl at’ structures.

Some businesses such as John Lewis involve employees heavily in decision-making.

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Tall and flat organisational structures The senior managers in a business can choose the structure for their organisation (see Figure 4.3). The managers might decide to:➜ use a wide span of control. This means that each director, manager or team

leader/supervisor will have a large number of people reporting directly to them. If the organisation has a wide span of control, it is likely to have fewer levels of hierarchy, and the organisation’s structure can be described as ‘fl at’.

➜ use a narrow span of control. In this case, the business gives each director, manager or team leader a small number of employees for whom they are responsible. It may be necessary, therefore, for such a business to have more layers of hierarchy. This type of organisational structure is called ‘tall’, for obvious reasons.

Study tip

Try not to forget that a span of control refers to the number of employees who are directly managed by a more senior employee. This means that these employees are on the next level of hierarchy down and report to this particular manager.

A flat organisationalstructure – this haswide spans of controland few levels ofhierarchy

A tall organisationalstructure – this hasnarrow spans ofcontrol and a largernumber of levels ofhierarchy

Figure 4.3 Flat and tall organisational structures

Management styles and organisational structuresThe managers of a business can use different approaches to manage their employees. Some give little freedom to junior employees to take decisions at work and control them closely. This means that most important decisions are taken by senior employees.

On the other hand, some businesses take a completely different approach to managing staff. Employees are given greater freedom within their job roles to take decisions and to organise their work. Line managers, therefore, give up some control over their team.

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We have seen that organisations can have two different types of structures: flat and tall. The type of structure used has implications for the management style that is used in the business:➜ Delegation. As we saw earlier, a fl at structure means that managers and

team leaders have to work with wide spans of control. This means that they have to be responsible for a relatively large number of junior employees. As a result of this heavy workload, those responsible for managing people have to give them more independence in their working lives. This means that junior employees are able to take more decisions on their own and are not controlled so closely by their line managers. Passing down authority to more junior employees in this way is called delegation.

➜ Authority. Using a tall organisational structure means that most line managers have narrow spans of control and are able to monitor the work of their juniors very closely. This means that juniors have little independence or authority at work. Senior managers have the authority to control decisions that are made in the business, and little freedom is given to junior employees on how to organise themselves at work.

A tall organisational structure is usually associated with a management style where little use is made of delegation and managers take most decisions. In contrast, a flat organisational structure encourages a management style which relies on delegation, giving more authority to junior employees.

Using the appropriate organisational structureThere are a number of factors which might infl uence a decision by managers on whether to use a tall or a fl at organisational structure:➜ The skills of the workforce. Skilled workers are more able to take decisions

on their own and need less supervision from managers. Thus, if a workforce is highly skilled, managers may choose a wider span of control and a fl at organisational structure. This approach may be used in a hospital where many employees are highly skilled.

➜ The management style used in the business. We saw earlier that organisational structures have implications for the management style that is used. Managers that like to retain control over employees will be more likely to use a tall organisational structure. This gives a smaller span

Business insight

Martin’s coffee shopsMartin Fisher’s business has grown steadily. He started by running one coffee shop in London. This coffee shop had four employees – as do most of the business’s shops. Martin has opened 11 more around the city, giving a total of 12 shops. When he only had three coffee shops, he managed them all himself. He took the major decisions and his employees followed

his instructions. However, the business is now so large that he has had to appoint branch managers for each of the coffee shops and a senior manager to be responsible for half of the branch managers. Martin is the line manager for the other branches. He has found that he is less involved in day-to-day issues in his coffee shops.

Analyse the effect of the growth of the business on Martin’s span of control. (6 marks)


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of control, making close supervision easier. Those managers who do not wish to control employees closely will delegate and use a fl atter organisational structure.

➜ The business’s competitive environment. A business in a competitive environment may wish to keep its costs to a minimum and to have the best possible performance from its workforce. This may lead to the use of a fl at organisational structure. This type of structure requires fewer managers, helping to reduce wage costs. Flat structures can also motivate workforces as junior employees are given more authority and possibly more interesting jobs.

Organisational structure and communicationThere are numerous ways in which individuals and groups within organisations communicate with one another. These include:➜ meetings, such as a meeting of a company’s board of directors to agree its

long-term plans➜ video-conferencing in which video links are used, for example, to allow a

business’s employees in different locations to talk to and see one another➜ telephone conversations, for example, an employee might use this method to

place an order with a supplier➜ emails are increasingly used for many communication purposes, for instance

advising customers of special offers that are available➜ business intranets – a form of internal internet – to communicate within the organisation and with suppliers➜ other forms of written communications, such as

letters, which are still widely used.

There are three types of communication that take place within a business:➜ downward communication from senior

employees to more junior ones ➜ upward communication from junior employees

to their line managers and other more senior employees

➜ horizontal communication, which takes place between employees at the same level in the organisation, for example, a discussion between managers.

Key term

Communication is the exchange of information between two or more people.

Figure 4.4 Different types of communication

Many people who work in the UK’s legal system (solicitors and barristers, for example) are highly skilled and require little management.

CEO

Directors

Managers

Supervisors/team leaders

Horizontal communication

Dow

nwar

d co

mm

unica

tion Upw

ard comm

unication

Shop-floor employees

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Flat organisational structures can have the following effects on communication:➜ Downward and upward communication may become easier as there are

fewer levels of hierarchy for messages to pass through.➜ However, wider spans of control may mean that line managers are

responsible for large numbers of people. This may result in more emails and fewer meetings. The quality of communication may suffer as a result.

➜ Giving employees greater authority within a fl at organisational structure can encourage upward communication as they are more likely to exchange information with line managers.

➜ Horizontal communication may become more diffi cult as there are more people on each of the levels of hierarchy.

Tall organisational structures may have the following effects on communications:➜ Organisations with many levels of hierarchy often experience problems in

passing information through these levels. Messages can become garbled or may not be passed on.

➜ Tall organisational structures operate with smaller spans of control. This can lead to good communication between line managers and subordinates as the manager is directly responsible for relatively few employees.

● Centralisation and decentralisation Many businesses in the UK have become larger over recent years. Larger businesses normally have more employees, more sales and possibly operate in more locations. These changes might make it diffi cult for a small number of senior managers to take all the decisions needed to keep the business running smoothly. Senior managers might decide to decentralise the organisation because the business is getting larger or for other reasons, such as improving the effectiveness of the workforce. Decentralisation is illustrated in Figure 4.5.

Key term

Decentralisation allows employees working in all areas of the business to take decisions.

Small businesses like this are less likely to decentralise than larger ones.


De c e n t r a l i s a t i o n

Offices, shops, factories to take decisions

Authority given to branches

Head office

Senior

managers

and directors

Figure 4.5 Decentralisation

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Decentralisation means that employees working in branches, departments or factories across the business are given more authority to take decisions at work. For example, a manufacturer with a number of factories might allow the managers in each factory to take decisions about hiring new employees, which products to manufacture on a particular day and how to look after the needs of certain customers.

Decentralisation can lead to some major changes in a business. Some employees may have to move to work in another part of the business. For example, decentralisation might mean that managers who understand finance must work in each of the business’s branches or divisions, rather than together at the business’s head office. This can mean that those employees with financial skills move to a different part of the UK.

Advantages of decentralisation➜ Decentralisation can reduce the pressure on the senior managers in a

business. This can let them concentrate on the key issues, such as raising fi nance and negotiating with customers.

➜ It can motivate employees throughout the business if they are given the authority to take decisions. This may mean that the employees become better at their jobs and that the whole business performs better as a result.

➜ Decentralisation may also lead to better decisions. For example, a retailer with many shops in different parts of the UK may benefi t from employees taking decisions that are correct for their area. So, if some products are selling well in a certain area, local employees would know to order more from suppliers.

➜ It can also allow faster decision-making. Employees do not have to consult with senior managers and can take decisions immediately. This might benefi t a business by, for example, allowing it to buy supplies at a bargain price.

Challenges of decentralisation Businesses need to plan for the introduction of decentralisation. The managers of a business thinking of decentralising should consider a number of important issues if the change is to be a success:➜ All the business’s employees must understand its aims or goals. This will help

ensure that they take decisions in the best interests of the whole business and not just their branch, factory or shop.

➜ Training may be needed. If employees are asked to take on new duties such as negotiating with suppliers, they may not have the skills they need. The business may have to invest in the necessary training, which can be costly.

➜ Good communication is very important. Senior managers must be aware of key decisions taken in all parts of the business and must be able to send messages to all employees in the business.

Study tip

Try not to confuse decentralisation and delegation – many students do. Delegation means giving authority to junior employees. Decentralisation means senior managers passing authority out to branches, shops, offi ces or other divisions of the business.

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Business insight

La RedouteLa Redoute is a French-owned company that sells fashion clothing online and through mail-order catalogues. It has 10 million customers and operates in 26 countries including the UK. The company has recently opened its fi rst store in the UK in Liverpool. This may be followed by stores elsewhere.

Explain one reason why La Redoute may decide to decentralise if it opens a large number of stores. (4 marks)

A La Redoute stockroom. This primarily web-based company may have to decentralise if it decides to open a large number of stores.

Businesses often decide not to decentralise. There are reasons why they may choose to remain centralised instead. For example, it may be that the business’s employees do not have the right skills to make a decentralisation policy successful. Alternatively, the business may not be able to afford to pay for training. In addition, if the senior managers believe that they will not be overworked if the business remains centralised, they may choose to retain control over the important decisions in the business.

Key term

Centralisation occurs when a small number of senior managers in a business take all the important decisions.

SummaryBusinesses have to organise their employees to make the most effective use of them. Key parts of a business’s structure are spans of control and levels of hierarchy. A business with a wide span of control is likely to have a fl at organisational structure. One with a narrow span of control will probably have more

levels of hierarchy and a tall structure. It is common for a growing business to decentralise, though not all choose to do so. Decentralisation can offer a business a number of advantages, but it also poses challenges for managers.

Quick questions 1 What is an ‘organisational structure’? (2 marks)

2 A business has four levels of hierarchy: a CEO, 4 directors, 16 managers and 64 team leaders. Which of the following is the CEO’s span of control?

(a) 84

(b) 20

(c) 4

(d) 5 (1 mark)

3 Explain the difference between a narrow and a wide span of control. (4 marks)

4 Explain the difference between a tall and a flat organisational structure. (4 marks)

5 A business has moved from a tall to a flat organisational structure. Which of the following statements will be true?

(a) Its typical span of control will be wider.

(b) Its typical span of control will be narrower.

(c) It will have more levels of hierarchy.

(d) It will have more employees. (1 mark)


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4 Human resources

6 Explain one reason why a business with a tall organisational structure might have a narrower span of control. (3 marks)

7 Explain why the use of delegation is more likely within a flat organisational structure. (3 marks)

8 Explain the difference between centralisation and decentralisation. (4 marks)

9 State two benefits of decentralisation. (2 marks)

10 State two challenges that might be faced by a business that is decentralising. (2 marks)

Case study Apple’s organisational structureApple sells a range of technology products (laptops, watches and mobile phones, for example) in markets throughout the world. It is famous for developing many successful new products.

Since Tim Cook became the leader or CEO of Apple in 2011, his span of control has increased signifi cantly. When fi rst appointed as CEO, Tim Cook had a span of control of nine. By 2016, this was 17, according to information on Apple’s website. The CEOs of many other major companies have wide spans of control. Recent research suggests the average CEO’s span of control has risen from about fi ve in the 1980s to ten.

Apple is more decentralised nowadays, an approach favoured by Tim Cook. He has decentralised to make the best use of the company’s skilled and creative employees. Apple’s employee numbers have doubled from around 60,000 at the start of 2012 to approximately 120,000 in 2015.

In 2016, Apple announced profi ts of £14.15 billion over just three months’ trading – the highest profi t fi gure for three months ever achieved by a company!

1 State two ways in which Tim Cook might communicate with the people for whom he is directly responsible. (2 marks)

2 Explain one benefi t that Apple might gain from operating a fl at organisational structure. (4 marks)

3 Analyse why Tim Cook may have decided to make the company more decentralised. (6 marks)

4 Recommend whether Tim Cook should reduce his span of control. Give reasons for your advice. (9 marks)

C

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Topic

Recruitment and selection of employees

4.2

Nearly all businesses have employees, and they can play a vital part in the success of a business. It is important that businesses operate an effective recruitment and selection process. This will enable them to recruit the best employees.


● why businesses need to recruit employees

● the main methods of recruitment

● the main stages in the recruitment and selection process

● the benefi ts to a business from having an effective recruitment and selection process

● the different types of employment, such as full- and part-time employment, and the difference between them

● what a contract of employment is.

● Why businesses need to recruit employees

Businesses need to recruit employees in a range of circumstances.

Starting a new businessA new business will need to recruit employees if its owners cannot carry out all the necessary tasks and duties themselves. An entrepreneur may not have the skills needed to carry out specialist roles. For example, the owner of a new café may need to recruit two types of employees:➜ a chef to cook the customers’ meals if the entrepreneur is not a skilled

cook➜ waiters or waitresses to serve customers because the owner has other duties

such as buying food and drinks and completing paperwork.

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4 Human resources

Expanding a business If a business is expanding, it may need to recruit employees for two main reasons:➜ Increasing production. The business may be increasing production of

its existing goods and services, possibly to sell them in new markets. The business will need more employees similar to those already employed. For example, in 2016, the supermarket Aldi announced it was opening 80 additional stores in the UK and would be recruiting 5,000 new employees.

➜ Diversi� cation. Some businesses decide to produce different goods and services, sometimes selling them in new markets. This is called diversifi cation. As a result, they need to recruit employees with the knowledge and skills required to produce these goods or services. Rolls-Royce plc, a manufacturer of engines for ships and aircraft, is to design cruise ships for a Norwegian business. The company may have to recruit marine designers to allow it to enter this market successfully.

Key term

Diversifi cation occurs when a business starts selling new products in new markets.

When employees leaveMost businesses have employees who leave their jobs at some stage during a year. Employees may leave because:➜ they have been offered another job; this could be a promotion or perhaps

have a higher rate of pay➜ they are retiring or stopping working for reasons such as caring for children.

The importance of recruiting the right people and keeping themRecruiting the right people is important for all businesses. The ‘right’ people will have the necessary skills to do the job successfully and be willing to work hard. If the wrong people are recruited, a business may lose customers who are unhappy at receiving poor quality service or goods. The business may also have to spend time and money recruiting other people.

Business insight

Equinox Fitness clubsEquinox operates a chain of health and fi tness clubs. It has 80 clubs in the USA, UK and Canada, and almost doubled in size during 2015, from 7,000 to 13,000 employees. It expected to expand rapidly in 2016. The company is using the latest technology, based on its website, to help it to recruit new employees.

Explain why Equinox might have used technology on its website to help it to recruit employees. (4 marks)

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4.2 Recruitment and selection of employees

Once a business has recruited the right employees, it usually tries to keep them. High rates of retention mean that only a small proportion of a business’s workforce leaves over a time period, normally one year. Low rates of retention help to reduce businesses’ expenditure on recruiting and training new employees.

● How businesses recruit and select employees

Recruitment and selection are normally the responsibility of a business’s human resource (HR) department and its human resource managers. However, businesses may use specialist employment agencies to help to recruit and select their employees. This is common with small businesses and those that are seeking highly specialist employees.

There are two major ways to recruit employees: internally from inside the business, or externally from outside. A new business will have to recruit externally at first as it does not have any existing employees; established businesses can choose between the use of internal and external recruitment.

Internal recruitmentFirms often recruit internally by promoting their existing employees to a more senior role or by transferring employees to a different job at a similar level in the business. A business might recruit internally by putting notices up in the workplace inviting suitable employees to apply for the position. A senior employee might recommend someone for a post – this is known as a personal recommendation. In slightly larger businesses, posts may be advertised on the business’s internal website or in the newsletter circulated to all employees. In very small businesses, the owner may simply tell employees that there is a job vacancy.

Internal recruitment offers a number of benefits to businesses:➜ Candidates will have experience of the business and will be familiar with its

methods of working.➜ Candidates will know many of the people with whom they will be

working.➜ Internal recruitment provides employees with the chance of promotion,

which may help to motivate them.➜ Internal recruitment is cheaper as it avoids the need for expensive external

advertising.

On the other hand, it is common for firms to have to pay for training when promoting or transferring employees, as they might not have the right skills for the new job. A business can only choose from a limited number of employees when recruiting internally, and the skills and experience of this group may not be exactly what the business is looking for.

Key terms

Retention is the proportion of a business's workforce who remain with the business over a period of time, usually one year.

Recruitment is the process of fi nding and appointing new employees.

Selection is choosing the right employees from among those who have applied for a job.

Internal recruitment takes place when a job vacancy is fi lled from within the existing workforce.

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4 Human resources

External recruitmentExternal recruitment means that a business looks to hire employees who do not already work for the business. This type of recruitment is frequently used when a business is expanding or moving into new markets or supplying new products.

This type of recruitment is normally done by using one of the following methods:➜ Advertising. This is a common technique. Businesses advertise externally

in newspapers and magazines, or on the internet or radio, and invite interested people to apply by a certain date.

➜ Jobcentre Plus. These centres are located throughout the country. Their role is to bring together businesses looking for workers and suitably skilled people. They are run by the government’s Department for Work and Pensions.

➜ Employment agencies. These are privately owned businesses that help businesses to recruit employees. Employment agencies provide employers with details of suitable applicants for posts they may have vacant and might help to choose the most suitable employee. They are paid fees for these services.

Key term

External recruitment is fi lling a job vacancy from any suitable person not already employed by the business.

External(recruiting employees from

outside the business)

Advertising – newspaper,radio, internet

Jobcentre Plus

The owner or managertells employees aboutthe job vacancy

Certain employees areinvited to apply

Advertisements are placedin the business’s employeenewsletter

Advertisements are placedon noticeboards, the internalwebsite, or sent by email

Methods ofrecruitment

Employment agencies

Internal(recruiting employees from

within the business)

Figure 4.6 Methods of internal and external recruitment

Business insight

Weavers Academy job advertisementThis advertisement appeared in the Times Educational Supplement, a weekly newspaper sold throughout the UK. It is well known for carrying advertisements for teaching positions in the UK.

‘Head of ICT and Business, Northamptonshire

The rapidly growing demand for places at Weavers Academy presents us with this opportunity to increase our staffi ng in a number of different subjects. We are seeking to appoint enthusiastic and inspirational lead

teachers which would equally suit experienced professionals or those early in their career.

The successful candidate will join a collaborative and committed staff team that have a vision to strive for success through focusing on learning. Outcomes for 2016 have signifi cantly improved and we have a growing reputation in the local area as a caring school with high expectations of learning, behaviour and attendance. The academy is part of the growing multi-academy trust “CET” and is well supported by leaders in education across the country.

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A job description and application form can be found on our website:

http://www.weaversacademy.org.uk/contact-us/vacancies

Please send your completed application form and covering letter to our HR Manager,

Mrs S Cirelli at Weavers Academy, Brickhill Road, Wellingborough, NN8 3JH.

Applications by email are welcomed and should be sent to:

[email protected].’

Source: Times Educational Supplement: www.tes.com

Analyse the reasons why this school’s managers may have decided on external recruitment to fi ll this job vacancy. (6 marks)

Businesses need torecruit because of:• growth• entering new markets• employees leaving

1 Business needsnew employees

2 Job descriptionsand person

specificationsdrawn up

Data fromjob analysis

External advertsin newspapers

and on theinternet

Internal advertswithin business,e.g. on intranet

3 Job positionsare advertisedinternally orexternally

4 Applications arereceived andkept until theclosing date

Figure 4.7 Stages in the recruitment process

Recruiting employees externally offers a number of advantages to a business:➜ Managers will have a wider choice of candidates and this can result in

applications from higher-quality candidates, especially if the job is advertised nationally.

➜ Businesses sometimes recruit external candidates in the hope that they will bring fresh ideas and enthusiasm into the business.

➜ External recruitment provides new employees who have the right skills immediately. Training existing employees can take time.

Although external recruitment offers the benefits of a greater number of candidates, it is likely to be very expensive. The business will also know less about the person or people they appoint. This means there is a greater chance of making a mistake.

● The recruitment and selection processMost businesses have job vacancies at some point – that is, they need to recruit some employees. We saw earlier that it is important for businesses to appoint the right people. To do this, businesses have to have effective processes to:➜ recruit the best possible applicants➜ select the right person or people from those who have applied.

The stages in the recruitment process are shown in Figure 4.7.



http://www.tes.com

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4 Human resources

Documents used in the recruitment processBefore any recruitment documents can be prepared, it is necessary for a business to conduct job analysis. Job analysis is the collection and interpretation of information about a job. The analysis of a job helps managers to make effective recruitment and selection decisions.

To identify the best person for the job, managers must understand what the job involves. Job analysis provides this understanding by examining the tasks performed within a job and the skills that are needed to carry it out efficiently. This information is essential if the ‘right’ person or people are to be appointed.

Once job analysis has been completed, it is possible for managers to draw up the documents used in the recruitment process.

Job descriptionA job description is a document stating information about the duties and tasks that make up a particular job. It usually includes:➜ the title of the job➜ the hours and place of work➜ the main tasks that make up the job➜ the employees for whom the person will be responsible.

Person specifi cationA person specifi cation is a document setting out the qualifi cations and skills required by an employee to fi ll a post that is advertised. A person specifi cation might include:➜ educational qualifi cations➜ vocational or professional qualifi cations➜ ability to work as part of a team➜ experience of similar jobs.

A person specification may list some qualities and qualifications as essential and others as desirable. Managers make a lot of use of person specifications in the process of recruiting and selecting new employees. Person specifications can be used to judge applications. If an applicant’s qualities and qualifications match the person specification closely, he or she may be a good person to recruit.

Job advertisementThese can be placed in local or national newspapers, in magazines or on the internet. A job advertisement would normally include:➜ the title of the job➜ some information about the business➜ the location of the job➜ working hours expected and holidays offered➜ pay rates➜ how to apply and the closing date for applications.

Key terms

A job description states information about the duties and tasks that make up a particular job.

A person specifi cation sets out the qualifi cations and skills required by an employee to fi ll a particular job.

Key term

Job analysis is the collection and interpretation of information about a job.

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Businesses often use employment agencies to draw up their job descriptions and person specifications and to place their job advertisements.

The way in which the job is advertised will depend on the type of job that is available. For junior positions in a business, an internal advertisement on the company’s noticeboards or in its newsletters or magazines may be used. Alternatively, the job might be advertised in local newspapers. For more senior positions, such as a company accountant or a production manager, a business might advertise more widely. It may choose to do this because it needs a large pool of potential candidates to attract high-quality applicants. This may lead the company to advertise in national newspapers or specialist national magazines.

Application form and curriculum vitae (CV)To apply for a job, it is necessary for applicants to give some information about themselves. This will include personal information such as their address, employment history and qualifi cations. This information is essential so that a business can match the candidate’s qualities and qualifi cations with those set out in the person specifi cation. In this way, the business’s managers can choose which of the candidates are suitable.

Sometimes applicants for a job do not fill in an application form, but provide a curriculum vitae (CV). This is a document that sets out information about a person’s qualifications, employment history and interests.

SelectionChoosing an employee from those people who have applied for a job is called selection. We saw earlier that it is costly to choose the wrong person. As a result, businesses aim to have thorough selection procedures. The stages of this process are summarised in Figure 4.9.

All job advertisements include a closing date by which all applications should be received. On that date, the company’s managers will look at all the applications that have been received and decide which ones they are interested in. They will compile a shortlist of applicants from which to select the successful candidate or candidates.

An employer can use a number of techniques to select the best candidates from the shortlist.

Key term

A curriculum vitae (CV) provides information about a person, including qualifi cations, employment history and interests.

McCURDY ENGINEERING LIMITEDDiesel MechanicOur busy Heavy Transport Service Department requires a qualifi ed Diesel Technician to join our team. Experience in the Heavy Automotive Industry is essential.Full off- and on-site regular and modern training is offered with our franchise groups including Paccar trucks, Kenworth and DAF and also Volvo Truck, Bus & Construction equipment, Cummins and Detroit engines. Other up-skilling opportunities are available if desired also. Tasks involve a good variety of mechanical repairs and truck body repairs and some servicing, etc.Overtime available if desired. Very good remuneration available for the right person.

We are a great team to be working with: we pride ourselves on the service that we provide to the Heavy Transport Industry. We have a genuine interest in our customers and our staff; we can offer an exceptional working environment with modern equipment and facilities.

Please apply without delay in the strictest confi dence by phone or post to: Jim McCurdy, PO Box 1212, PlymouthPhone 02 768 6609 or Jim’s mobile 0785 449 236

Figure 4.8 A job advert. If you were thinking about applying for this job, what extra information would you require?

Many businesses advertise vacant jobs at the local Jobcentre Plus branch. These are located throughout the UK.

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InterviewsInterviews remain the most common form of selection. Candidates may be interviewed by panels of up to ten people, but one or two people conducting an interview is more common. It is quite cheap for a business to stage a series of interviews, but they are not always a reliable way of selecting the best people for a job. Some people are very good at interviews, but that does not always mean that they will be good at the job.

Psychometric testsThese are multiple-choice tests designed to show the personality of the candidates who have applied for a job. The results of these tests can help the managers of a business to judge which of the applicants has the most suitable personality for the job. These tests can also show which candidate is most likely to fi t in with the team of people with whom he or she will be working.

Assessment centresOver recent years, businesses have made increasing use of assessment centres to avoid appointing the wrong people. Assessment centres are more likely to be used in making senior appointments. In an assessment centre, a candidate is likely to be involved in a variety of activities:➜ role plays simulating the job itself➜ psychometric tests➜ a number of interviews➜ practical tasks for candidates to complete.

Candidates can find the tasks they carry out in assessment centres demanding and stressful. This can help a business to select people who perform well under pressure. Thus, although they are expensive to operate, assessment centres can help businesses to choose the best person or people for a particular job.

The benefits of an effective recruitment and selection processAn effective recruitment and selection process is one that appoints the best and most suitable employees. This gives the business the most skilled and experienced employees and reduces the chances of them leaving within a short space of time. Although operating an effective process for recruiting and selecting employees can be costly, it offers businesses signifi cant benefi ts. These may become more apparent in the longer term and should result in increased profi ts for the business.

Figure 4.9 The selection process

3 Invite applicants to attend the selection process

This can be done byletter and/ortelephone call

6 Inform all candidates of the decision taken

1 Match application forms or CVs against the job specification

After the closing datefor job applications

2 Draw up a shortlist of candidates (perhaps 8–10)

References will becalled for at this stage(or at stage 5)

4 Selection process: • interviews • psychometric tests • assessment centre

Senior staff may berequired to play a partin the selection process

5 Choose the best applicant(s) on the basis of performance in the selection process

This is likely to involvea meeting of all thoseinvolved in the selectionprocess

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Maths moment

BusinessAverage number of items produced by an employee each year

Average annual pay per employee (£)

A 240 20,160

B 200 19,000

Table 4.2 Average annual production per employee and average annual pay per employee for two businesses

Use the information in Table 4.2 to calculate which business (A or B) has lower labour costs for each unit of output produced.

High levels of productivityAppointing the best employees can help a business to achieve high levels of productivity. This means that employees produce relatively large quantities of goods or services over a period of time, such as one year. If an employee is productive, this means that the labour cost of producing a single unit of output is likely to be lower. This can help a business to be more competitive, as it helps it to sell products at lower prices. This can increase sales. Alternatively, the business may sell at higher prices and enjoy increased profi ts as its costs of production are low.

Key term

Productivity is the quantity of goods or services produced by an employee over a period of time, such as one year.

High-quality products or customer serviceAppointing the very best people will help a business to supply good quality products. This means that the products will meet the needs of customers as fully as possible. Employing people with appropriate knowledge and skills means they are able to supply goods or services with which customers are satisfi ed. ➜ Quality. A car manufacturer, such as Nissan, will seek to employ the most

skilled engineers to enable it to supply fuel-effi cient and environmentally friendly cars to satisfy its customers.

➜ Customer service. A restaurant which employs a knowledgeable and skilled chef will be able to deal with very busy periods when large numbers of customers are expecting meals. The same person will be able to cook a meal for someone with special dietary needs.

Improved levels of quality and customer service can be very important for some types of businesses, such as those who pursue objectives other than profits. For example, a charity providing day trips for the elderly may particularly value improvements in its customer service.

Key terms

Quality is the extent to which customers’ requirements are met.

Customer service is that part of a business’s activities that is concerned with meeting customers’ needs as fully as possible.

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Employee retentionEmployee retention measures the proportion of employees with a given length of service (typically one year or more) expressed as a percentage of overall workforce numbers. This is often measured by calculating the number of people who have worked for the business for a certain period of time (perhaps one year or more) as a percentage of the total workforce. For example, if a business has 1,500 employees and 1,350 have worked for the business for a year or longer, its employee retention rate will be:

1,350 × 100 ÷ 1,500 = 90%

An effective system of recruitment and selection should increase a business’s level of employee retention because it is more likely to result in the best and most suitable person being appointed. As a result, the employee is more likely to be satisfied with the job as they feel they are a success in this role. Equally, the business’s managers will be content that the person works well with other employees and has good levels of productivity. Thus, they will want to retain the employee.

Having poor rates of retention because large numbers of employees are leaving can pose problems for a business:➜ Higher costs. Research shows that the cost of replacing an employee

who leaves is up to £30,000. Recruiting and selecting employees is costly (for example, advertising posts and paying other staff to recruit and select employees) as well as training costs for the new employee.

Figure 4.10 A summary of the benefits of an effective recruitment and selection process

Reduced costsof production

More satisfiedcustomers

Increasedprofits

Improved ratesof employeeretention

Increasedproductivity

Improved qualityand/or customer

service

An effectiverecruitment andselection process

Business insight

Nissan leads the wayThe Japanese car manufacturer, Nissan, produces one in three cars that are made in the UK. It faces tough competition from other car manufacturers such as Volkswagen and Ford. The company’s managers say that it is important for it to keep production costs to a minimum.

The company’s factory in Sunderland is the largest car factory in the UK. It has the highest rates of productivity of any car factory in Europe or North America. It manufactured 476,589 cars in 2015, building them at a rate of one car every minute, 24 hours a day. The factory employs more than 6,800 people, and a lot of technology is used on the production lines.

Analyse why it is important for Nissan to operate an effective recruitment and selection process at its factory in Sunderland. (6 marks)

Nissan employs some highly skilled workers in its factory in Sunderland.

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➜ Reductions in quality and customer service. Even experienced and skilled employees can take time to settle into a new job. In the meantime, the quality of their work may be relatively low. Customers may be unhappy if they are expected to deal with a new employee. For example, some customers may have valued a particular hairdresser highly and be less happy with a replacement.

➜ Reduced rates of productivity. A new employee will probably be less productive until they are familiar with the business and have possibly received training. Research shows it takes a new employee up to six months to reach their maximum level of productivity. In the meantime, the business’s costs are higher.

● Contracts of employmentEmployees have to be given a contract of employment within two months of starting work. A contract of employment is a legal agreement between an employer and an employee, setting out the employee’s conditions of employment. It is common for a contract of employment to include:➜ normal working hours➜ rates of pay➜ holidays➜ duties at work➜ place of work.

Businesses can recruit employees on different types of contracts to meet their need for workers. There are a number of different types of contracts of employment in use in the UK at the moment.

Full- and part-time employmentA business may employ a mixture of full-time and part-time employees. Full-time employees work for the standard number of hours in the working week. This can vary from business to business. However, in 2015, the average number of hours worked by a full-time employee in the UK was 39.1 hours.

Many businesses also employ part-time employees who work fewer than the standard number of hours. It is common for part-time employees to work two or three days a week, or just afternoons or mornings. Some part-time jobs are allowed to help parents to look after school-age children. Thus, this group of part-time employees may start later and finish earlier than full-time employees each day. In 2016, there were 8.43 million part-time employees in the UK – this is approximately 25 per cent of those at work.

Key terms

A contract of employment is a legal document stating the hours of work, rates of pay, duties and other conditions under which a person is employed.

Full-time employment occurs when someone works a number of hours equal to the normal working week, normally between 35 and 40 hours.

Part-time employment takes place when an employee works for fewer than the normal number of working hours per week.

Many parents work part-time to allow them to look after their children outside school hours.

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4 Human resources

The benefi ts of full- and part-time employmentTable 4.3 summarises the benefi ts to employers and employees of full- and part-time working.

Benefi ts to employers Benefi ts to employees

Full-time ● Employers may benefi t from having employees at work throughout a normal working week. This can result in better communication as employees are more likely to be able to speak directly to one another.

● Full-time employees may be more skilled and experienced as a result of being at work for more hours each week. This can improve their performance at work.

● Full-time employment means workers are paid for more hours each week. This can improve living standards and reduce the need to fi nd a second job.

● Employees are more likely to be able to gain promotion as a full-time employee. Full-time working can allow them to attend more training courses and to gain more experience.

Part-time

● Part-time employees can help businesses to cope with busy periods during the week. For example, some shops may attract large numbers of customers at the weekend. Having part-time employees at work can help to provide good customer service.

● Some businesses need employees with specialist skills, but do not need them throughout the working week. For example, a small business might need an accountant to organise the payment of employees and to update fi nancial records. This might only require one or two days’ work each week.

● Employees can fi t in work with other commitments, such as caring for older relatives or for children. Many employees only work during school hours or for half days. This allows them suffi cient and suitable hours to care for their relatives.

● Some older employees may not want a full-time job, but do not want to retire. Part-time work can be a ‘half-way’ solution on the road to full retirement.

Table 4.3 The benefits of full- and part-time working to employers and employees

Job sharing and zero hours contractsJob sharing occurs when two or more people combine to fi ll a single job role. For example, some teaching posts are fi lled by two people. One might work Monday to Wednesday each week, with a second person at work on Thursdays and Fridays. For employees who job share, it can offer many of the benefi ts of part-time work set out in Table 4.3. Employers can benefi t in terms of having a broader range of skills. However, there are disadvantages in that the people sharing the job may not communicate well.

Zero hours contracts are used widely in the UK economy. A person with a zero hours contract is not guaranteed a set number of hours of work each week. They may get no hours, or be offered a large number. Employees on these contracts do not have to accept any hours of work they are offered. However, they may feel that turning down work might mean that they are not offered any hours in the future. In 2016, just over 900,000 people in the UK had a zero hours contract – this is about 3 per cent of the country’s total workforce.

Study tip

You only need to know the benefi ts of full- and part-time working and not the drawbacks as well.

Key terms

A job share exists when two or more employees agree to share the responsibilities of a single job.

A zero hours contract allows employers to hire staff without any guaranteed hours of work.

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Over 25 per cent of people employed in the hotel and food industries were on zero hours contracts in 2016.

SummaryBusinesses can recruit employees from inside the business (internal recruitment) or from elsewhere (external recruitment). Both approaches have advantages and disadvantages. To recruit an employee, a business needs to conduct a job analysis,

draw up relevant documents, advertise the position and select the best person or people. Businesses benefi t in a number of ways from having an effective recruitment and selection process They can use a range of different contracts of employment.

Quick questions 1 What is meant by the term ‘recruitment’? (2 marks)

2 State two circumstances in which a business might need to recruit new employees. (2 marks)

3 Which of the following is a benefit of the use of internal methods of recruitment?

(a) It allows the business to recruit from a wider pool of applicants.

(b) It offers the business new ideas.

(c) The business is likely to have an employee with the right skills immediately.

(d) It offers employees opportunities for promotion. (1 mark)

4 State two pieces of information that a business is likely to include in a job advert. (2 marks)

5 The use of which of the following is a method of selection?

(a) Job analysis

(b) Assessment centres

(c) Person specifi cations

(d) Job descriptions (1 mark)

6 Which document used in the recruitment and selection process lists the

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Case study

Swaledale Hotel Group LtdThe Swaledale Hotel Group Ltd (SHG Ltd) operates 20 luxury hotels in locations across the UK. It expects very high standards of its employees and trains them carefully to provide hotel guests with outstanding customer service. As a result, it has developed an excellent reputation.

SHG Ltd has grown steadily since 1996, opening approximately one new hotel a year. The company’s sales and profi ts have fallen slowly over the last three years. It has seen a large number of its employees leave over this period.

The company is about to open four new hotels in northern England and is seeking to appoint managers and assistant managers for each of these hotels. SHG Ltd’s HR managers expect that these posts will

prove popular and should attract a large number of applicants, whether advertised internally or externally. One HR manager is concerned that they might have diffi culty choosing the best applicants.

1 State two methods of selection that SHG Ltd might use over the coming months. (2 marks)

2 Explain why the HR managers at SHG Ltd should use person specifi cations as part of their recruitment and selection process. (4 marks)

3 Analyse why it is important for SHG Ltd to have an effective process for recruitment and selection. (6 marks)

4 Recommend whether SHG Ltd should use internal or external recruitment to appoint its new managers and assistant managers. (9 marks)

qualifications and skills required by an applicant for a job?

(a) Job description

(b) Curriculum vitae (CV)

(c) Person specifi cation

(d) Application form (1 mark)

7 State one advantage and one disadvantage of using interviews as a method of selection. (2 marks)

8 Explain one reason why a business might use psychometric tests as a method of selection. (3 marks)

9 State two benefits a business may receive from operating an effective recruitment and selection process. (2 marks)

10 What is the difference between a job share and a zero hours contract? (4 marks)

C

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Topic

Motivating employees

4.3

Most managers seek to motivate their employees, although there is disagreement on the best way to do this. Managers do agree, however, that motivation is important because a motivated workforce can help to make a business very competitive.


● what is meant by the term ‘motivation’

● the benefi ts to businesses of having motivated staff

● the methods of motivation used by businesses.

● The importance of motivation

What is motivation?Motivation is the range of factors that infl uence people to behave in certain ways. It can be described as the will to do something. In business, motivation is the force that drives an employee to work very hard and to carry out his or her job as effectively as possible. There are different views on where motivation comes from. However, most writers agree that different people will be motivated by different things:➜ Motivation using money. Some people believe that motivation is achieved

through the use of money. They argue that offering employees higher play or bonuses for reaching targets will result in increased levels of motivation.

➜ Motivation through non-� nancial factors. However, others view motivation as the result of a non-fi nancial factor. Thus they believe that factors such as praise or the opportunity to carry out a more interesting job are more likely to motivate employees.

Why do people work?Everyone who works is motivated to do so by one or more factors. However, people are all different and this means that they are motivated by different factors. Abraham Maslow, a psychologist, tried to explain this through a theory that has become known as ‘Maslow’s hierarchy of needs’. Maslow identifi ed fi ve human needs, and he said that if people could meet these needs by working, then this would motivate them at work. Maslow’s hierarchy of needs is set out below and illustrated in Figure 4.11:

Key term

Motivation is the range of factors that infl uence people to behave in certain ways.

Study tip

These two views on the different causes of motivation explain the different techniques or methods used by businesses to motivate staff. Try to remember this when explaining why businesses use different techniques or when thinking about what might be the best method in a given situation.

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➜ Physiological needs. These are the most basic needs that a person has and relate to the needs of the human body. Physiological needs include keeping warm, having shelter and enough food to eat – failure to meet these needs leads, ultimately, to death. Physiological needs are mainly met by receiving pay, which allows people to buy food and a home. However, they can also be met at work by having a warm offi ce or a lunch break so that employees can eat.

➜ Safety needs. People need to be safe and secure in their lives and not at risk of a threat to the quality of their lives. There are two ways in which this need can be met at work. Employees want security in their jobs and to know that they will not lose their jobs and their incomes. They also need to be safe from accidents and injury at work. This second need is more important in dangerous working environments, such as farms.

➜ Love and belonging needs. Workers want to be part of a group and accepted as part of that group. They want to be trusted by the people they work with and to enjoy their company and friendship. This need can be satisfi ed at work by arranging social events such as parties and outings and, more frequently, by organising people to work in teams.

➜ Ego or self-esteem needs. It is normal for people to want to feel good about themselves and to know that the people they work with respect them for their ability to do the job. Employees may know that they are good at their job if, for example, they achieve high levels of sales or their customers are complimentary. However, this need can also be met at work by praise and by recognising an employee’s achievements, by paying a bonus, for example.

➜ Self-actualisation. This is Maslow’s top-level need. It is the need to be given the opportunity to stretch yourself and to work to your full potential. This might be met by an employee being given a demanding task to complete or by being given the power to organise his or her working day. In both cases, there are more demands being placed on employees, which will help to stretch them.

Higher level needs aresatisfied by the way thejob is organised – mainlynon-financial benefits

Lower level needsare satisfied mainlyby pay and workingconditions

Self-actualisation(working to

full potential)

Ego/self-esteem needs(valued by others

and yourself)

Love and belonging needs(friendship and trust at work)

Safety needs(secure job and safe workplace)

Physiological needs(food, shelter, clothing)

Figure 4.11 Maslow’s hierarchy of needs

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4.3 Motivating employees

Maslow argued that people would steadily move up through these five levels of need. Once one level was satisfied they would try to satisfy the next level. The central point of his theory is that if employees are given the opportunity to satisfy the next level of needs at work, they will be motivated by this. Their level of effort and commitment to the job is likely to increase.

The benefits of a motivated workforceMost managers would say that to have employees who are motivated is a very important factor in making the business successful. There are a number of reasons why this is the case.

Increased productivity levelsAs we saw in Topic 4.2, productivity measures the quantity of goods or services produced by an employee over a period of time, such as one year. Motivated employees normally work hard and try to do their jobs as effi ciently as possible. The manager of a business might fi nd that motivated employees always arrive at work on time, use their time at work as effectively as possible and do not, for example, stand around chatting. This means that the business will produce a large quantity of goods or services with relatively few employees. In other words, its employees will have high productivity levels.

High levels of productivity can offer considerable benefits to businesses. It allows them to produce goods and services relatively cheaply because the labour cost involved in producing each product is lower. Hence, the goods or services can be sold at lower prices making the business more competitive. This is very important in industries where low prices are important to customers. For example, the airline Ryanair benefits from a productive workforce and low labour costs. The company’s labour costs were less than 10 per cent of the income it received from selling flights in 2013. This is lower than many other airlines and enabled Ryanair to sell flights very cheaply.

Improved employee retention ratesEmployees who are motivated are more likely to be loyal to a business and to remain with it even if there are tempting jobs available with other businesses. A business has a high retention rate if a large proportion of its workforce remains with the business over a period of time, usually measured over one year.

Employees can be motivated by working with others and by having their safety needs met.

Study tip

While you may not need to know about the specifi c theories of motivation by name, such as the one written by Abraham Maslow, you may fi nd this theory (and others) helpful in explaining why employees can be expected to behave in certain ways.

Most businesses can enjoy higher levels of productivity if employees are motivated. Ryanair’s employees are very productive, which helps the airline to set very low prices for its flights.

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Having a high retention rate offers two major advantages to a business:➜ It avoids the cost of recruiting and selecting new employees. Research shows

that the cost of replacing an employee who leaves is up to £30,000.➜ It removes the need to train new employees, which can be costly. Even if

new employees do have the right work-related skills, they take time to get to know a new job and to work as a team with their colleagues.

Higher levels of sales

A business with a motivated workforce can be expected to achieve higher levels of sales than would be possible otherwise. Motivated employees will work hard and seek to meet the needs of customers as fully as possible. Customers treated in this way are more likely to buy goods and services.

Productiveworkers

High levelsof sales

Easier to attractnew employees

Few peopleleave – highretentionrates

Motivatedworkforce

£

Figure 4.12 The benefits of a motivated workforce

Levels of employee motivation can be an important factor affecting sales in service industries such as retailing. In 2016, research revealed that motivated employees working in shops produce an average 2.5 times more revenue from sales than those who are less motivated.

Improved recruitment and selectionHaving a motivated workforce helps to give businesses a good reputation as an employer. This can be a signifi cant benefi t when recruiting new employees as the business is viewed as a good place to work. This makes it easier for the business to recruit the best workers, helping to improve its sales and profi ts.

Replacing an employee can cost a business up to £30,000. Well-motivated employees are less likely to leave.

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Business insight

Jaguar Land Rover is Britain’s best employerTable 4.4 shows the top fi ve employers in Britain in 2016, following a survey of 15,000 employees and over 400 businesses.

Jaguar Land Rover (JLR) enjoyed further success in 2016 as its sales fi gures were very impressive. Its annual sales of vehicles rose 13 per cent to 521,571. This was principally due to rising demand, such as the Jaguar XE. Its revenue for the fi nancial year was £22.2 billion, £342 million higher than in the previous year. JLR has created over 20,000 new jobs in fi ve years and invests heavily in training its employees.

Analyse the possible benefi ts to Jaguar Land Rover from being voted as Britain’s best employer.

(6 marks)

Rank CompanyType of business

Score (Maximum = 10)

1 Jaguar Land Rover (JLR)

Vehicle manufacturing 8.56

2 AstraZeneca Drugs and biotechnology 8.51

3 Harrods Retailer 8.49

4Adidas Clothing

manufacturer and retailer

8.47

5Dyson Engineering

and manufacturing

8.46

Source: Bloomberg: http://bbe.trunky.net/

Table 4.4 Britain’s top fi ve best employers, 2016

● Methods of motivation used by businesses

The methods of motivation that are commonly used by businesses can be divided into two groups: those that use money and those that use other methods.

Non-financial methods of motivationIncreasing authority through job enrichment Some employees may lack motivation because they are bored. They fi nd their job simple to do and so lose interest in it. Job enrichment can help to correct this by making the jobs more demanding and challenging. It can give employees more diverse duties as well as more authority to take decisions at work. For example, a receptionist for a small business might be motivated by receiving extra tasks such as planning a marketing campaign. This would be done alongside normal duties. Job enrichment often involves delegating authority to junior employees. (Topic 4.1 discusses delegation and authority in more detail.)

TrainingHowever, an employee may not be able to take on more demanding duties (via job enrichment) without being trained. The receptionist referred to above may need some training in the basics of marketing before he or she can design a campaign successfully. The training itself is likely to motivate because it shows that the business owner values the employee and this should increase self-esteem. Training can help to motivate in other ways, for example, by making the workplace safer following health and safety training. Training is covered in greater detail in Topic 4.4.

Key term

Job enrichment is designing a job to give interesting and challenging tasks.

http://bbe.trunky.net/

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4 Human resources

Management stylesManagers use different styles within the workplace. Although there are many different management styles in use, it is possible to separate these into two broad categories:➜ Managers who retain authority. Some managers use a style that is based

upon their use of authority to make most, if not all, decisions. Some of this group of managers may ‘sell’ their decision to junior employees. However, the common factor is that this group of managers take decisions, no matter how they present it.

➜ Managers who allow junior employees freedom to make decisions. This group of managers give much more freedom to more junior employees to make, or at least contribute to, decisions. Some will allow juniors a great degree of freedom to make their own decisions, within some limits. Others grant less freedom, but still allow junior employees to offer suggestions and ideas.

Many employees will be more motivated from working with managers who use the second style. This style provides opportunities to fulfil many of the needs of employees that were identified by Maslow. For example, giving employees freedom to make decisions can offer the opportunity for junior employees to meet their needs for self-esteem as well as self-actualisation.

Business insight

Virgin Group’s ‘horrible day’Sir Richard Branson is a well-known supporter of a relaxed working environment. The Virgin Group recently held a ‘corporate day’, to highlight the ways in which the company motivates its employees.

Virgin Group’s workforce was asked to: ● wear traditional offi ce dress, not casual

clothes● abandon fl exible working hours and arrive at

9 a.m.● use the titles Mr and Mrs or Ms for colleagues in

their and other teams● not look at social media or make personal phone

calls.

In an interview with the BBC, Branson explained why the company had held the day. He said that the purpose of the exercise was to give his employees ‘a taste of what a lot of the world is still run like. It was a horrible experience for everybody.’ It was a shock for a workforce that normally benefi ts from job enrichment and unlimited leave.

Explain one way in which the Virgin Group motivates its employees. (4 marks)

Fringe benefi tsBusinesses may offer employees a range of additional benefi ts to supplement their pay. Examples of fringe benefi ts include:➜ health insurance➜ a company car ➜ discounts when buying the company’s products.

Key term

Fringe benefi ts are the ‘extras’ that employees may receive in addition to their pay, for example, a company car.

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The use of fringe benefits can help to make employees more loyal and improve retention rates. However, if offered to large numbers of employees, they can become very expensive.

Financial methods of motivation It is very common for businesses to use money as a method of motivation. The belief that money has the power to motivate employees is based on the theories of a number of writers who believe motivation is caused by external factors. Frederick Taylor is probably the best known of these writers. He argued that:➜ employees were only motivated by money ➜ pay systems should be linked to the amount produced➜ managers should retain authority and employees should be supervised

closely.

The work of Taylor and others has meant that businesses use a number of methods of payment to reward their employees. Many of these methods have been designed to motivate employees.➜ Salaries. A salary is the income received by an

employee, stated as an annual fi gure. For example, an accountant’s annual salary might be £47,500. Employees receiving salaries are not normally required to work a set number of hours per week. Employees paid in this way may be motivated by an increase in salary, perhaps alongside some fringe benefi ts.

➜ Wages. Wages are usually paid each week and employees normally work an agreed number of hours. A higher hourly rate (called overtime) is paid for any additional hours worked. An increase in the hourly rate may be used to motivate employees.

➜ Piecework. Under the piecework system, which is also called piece-rate, employees are paid according to the amount they produce. They are paid an agreed fi gure for each unit of output they produce, subject to them receiving the National Living Wage as a minimum rate of hourly payment.

➜ Commission. This is a payment made to an employee based on the level of sales he or she has made over a time period. It is normally paid in addition to a wage or salary. In effect, it is a form of piecework paid to people employed to sell goods and services.

➜ Pro� t sharing. Under this method of payment, employees receive a share of the business’s profi ts alongside their normal wages or salaries. This can motivate as employees benefi t directly from an increase in the business’s profi ts. Many well-known companies such as John Lewis and Zara operate profi t-sharing schemes.

Piecework is more common in certain industries, such as picking fruit and laying bricks.

Key terms

Piecework is a method of payment under which employees are paid according to the quantity of products they produce.

The National Living Wage is an hourly rate of pay which is set by the government. All employees above a certain age must receive at least this rate of pay.

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Maths moment

Sarah has just fi nished training as a veterinary nurse and is looking for her fi rst job. She has seen two possibilities:● a job which pays her a salary of £17,500 ● a similar post working 35 hours each week and receiving £10 per hour.

Which one will give Sarah the higher pay?

There is much disagreement about the extent to which money can motivate employees. Some writers on motivation, such as Frederick Taylor (who was mentioned earlier), think it is the major factor motivating workers. Others give it a limited role. Abraham Maslow, for example, believes that it can enable employees to meet some basic needs such as those for food and housing, as well as self-esteem needs. However, other writers argue that it is not motivational, and that non-financial methods should be used. This is supported by a recent survey showing that 59 per cent of employees in the UK believe that ‘an interesting job’ is the most important motivational factor. This result suggests that non-financial factors, such as job enrichment, play a vital role in motivating employees.

Study tip

Do think about how different groups of employees can be motivated or whether the existing way is the best. What methods of motivation could fulfi l the needs that are not currently being met? Maybe fi nance is not the best method and non-fi nancial methods could be more effective.

Business insight

Tom’s fi rst dayTom was excited at the prospect of starting a new job with a new website design company that had just opened. However, his fi rst day at work came as a shock. Tom was given a small, unclean offi ce to work in on his own, while the two owners of the business worked in a separate, larger and much smarter room.

Tom had little contact with them and they did not offer many comments on the work he produced. He wasn’t sure whether he was doing well or not. Despite the high rate of pay, Tom left the job after the fi rst week.

Explain the possible actions the two owners of the business might have taken to improve Tom’s motivation at work. (4 marks)

SummaryPeople are motivated in different ways. Some are motivated from within and others by external factors, such as the promise of a reward. People have different needs that can be met by working, and meeting these needs can help their level of motivation. There are signifi cant benefi ts to

businesses from having motivated staff: they are more loyal, more productive and usually achieve higher levels of sales. Businesses may motivate staff by paying them more, but also by giving them more interesting and demanding jobs, by giving training or through the use of fringe benefi ts.

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Quick questions 1 What is meant by the term ‘motivation’? (2 marks)

2 What is meant by the term ‘piecework’? (2 marks)

3 State two types of needs that employees can meet through work. (2 marks)

4 State two benefits to a new business of having well-motivated employees. (2 marks)

5 What is meant by the term ‘job enrichment’? (2 marks)

6 Which of the following is a financial method of motivation?

(a) Commission

(b) Job enrichment

(c) Training

(d) Delegation (1 mark)

7 Which of the following is not a fringe benefit?

(a) Health insurance

(b) A company car

(c) Discounts when buying the company’s products

(d) Piecework (1 mark)

8 Explain one reason why training can improve the motivation of a workforce. (3 marks)

9 Explain the difference between salaries and wages. (4 marks)

10 Explain how a business uses financial rewards to motivate its employees. (3 marks)

Case study

Amil’s workforceAmil Khan owns a small factory mixing and roasting seeds. Roasted seeds are becoming increasingly popular as a healthy snack and Amil wanted to be part of a growing market. His business is making a small profi t each month at the moment, although its sales are rising steadily.

Amil has seven employees in his factory. He has decided that paying them well is important. He believes that fi nancial rewards are the best way to motivate people and that those who produce more should be paid more. He thinks the business will benefi t from having a well-motivated workforce.

Each employee has a simple job to do within the factory and little responsibility. Amil has to leave the business regularly to talk to shopkeepers about

stocking his products. Sometimes, while he is away, production stops because employees face problems that they do not know how to solve.

1 State two methods of payment that Amil would be likely to use for his workforce. (2 marks)

2 Explain one benefi t that Amil’s business may receive from a well-motivated workforce. (4 marks)

3 Analyse the reasons why Amil should spend more money on training his employees. (6 marks)

4 Do you think that Amil used the best method of motivation with his staff? Give reasons for your answer. (9 marks)

C

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Topic

● The importance of trainingTraining gives employees job-related skills and knowledge. It can bring many benefi ts to businesses. UK businesses clearly recognise its importance as they spent over £45 billion training 17.4 million employees during 2015.

Improvements in productivityTraining results in employees learning new skills and gaining knowledge that can make them better at their jobs. For example, training given to employees on a production line may enable them to use new technology. This means that they can make products more quickly and with fewer errors.

Training can help improve productivity by teach-ing employees how to do their jobs as efficiently as possible. This should reduce time wasted on unnecessary tasks and time spent correcting mistakes and allow more time to be spent on the most important activities. Training also makes a business more attractive to potential employees. This makes it easier for the business to attract the best, and most productive, workers.

4.4 Training

Training employees can bring a range of benefi ts to businesses, such as increased levels of motivation and productivity. It can help a business to be more competitive than its rivals. However, training can be costly and highly trained employees may leave the business.


● what is meant by the term ‘training’

● why training can be important to a business

● the main types of training provided by businesses and their advantages and disadvantages.

Key term

Training is a range of activities giving employees job-related skills and knowledge.

Using technology can result in huge improvements in employees’ productivity, but training is required if it is to be used efficiently.

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4.4 Training

More motivated employeesWe saw in Topic 4.3 that levels of motivation can be an important part of creating an effective workforce. Training can improve employees’ motivation:➜ Training can make employees feel valued. This will help to motivate them

and make them more committed to the business and their jobs.➜ Training allows employees to carry out duties which are more challenging

and more interesting – this is known as job enrichment. This can improve their enjoyment of the work and their performance at work.

Improved rates of employee retentionTraining can make employees feel more loyal to a business. It also gives them additional skills, which may mean that they can be promoted or take on more challenging work. Both these factors mean employees are less likely to leave.

Businesses with good employee retention rates keep experienced staff and do not have to pay the costs of recruiting and training new staff. Research suggests that 75 per cent of recruitment costs relate to replacing employees who have left the business. Thus, businesses can reduce recruitment costs significantly by improving employee retention.

Employee retention is discussed in greater detail in Topic 4.2.

Business insight

TalkTalk fi ned £400,000TalkTalk is one of the UK’s largest telecoms companies. It has been fi ned £400,000 for security failings that allowed a computer hacker to access its customers’ data ‘with ease’. An investigation found that the cyber-attack in October 2015 was possible because of weaknesses in TalkTalk’s IT systems.

Criminals were able to gain access to the names, addresses, dates of birth, phone numbers and email

addresses of nearly 157,000 customers and the bank account details of over 15,000 customers.

Research by the UK government shows that 75 per cent of large companies suffered IT security breaches in 2015. Half of these were caused by employees lacking suitable skills.

Analyse why large companies in the UK might spend more on IT training for their employees. (6 marks)

Production of high-quality goods and high levels of customer serviceTraining is essential if all employees, including those newly appointed, are to provide high-quality products and high levels of customer service. Training reduces the risk of faulty goods being produced as employees are less likely to make errors.

Similarly, training in customer service can give employees a clear understanding of how to meet customers’ needs and to use the business’s systems to do this. In 2016, Vodafone, one of the UK’s largest mobile phone service companies, received a large number of complaints about poor customer service, such as

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improvementsin productivity

more motivatedemployees

improved rates ofemployee retention

high-quality goodsand high levels ofcustomer service

Training is important because …

… mean businesses become more competitive.

Figure 4.13 Why training is important

incorrect bills and problems transferring phone numbers. Vodafone responded by spending £15 million on an additional 72,000 hours of customer service training for its employees. It publicised its response to reassure its customers and its performance has improved.

The popularity of social media (such as Twitter and Facebook) means that businesses can receive widespread criticism when things go wrong. This increases the value of training.

● Types of trainingTraining is made up of a range of activities that give employees job-related skills and knowledge. There are three major types of training that a business can provide for its employees (see Figure 4.14).

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4.4 Training

Induction trainingInduction training is the fi rst type of training that an employee will receive once he or she has started a new job. It is intended to help new employees to become more familiar with the business and the job that they are to do. Induction training might involve meeting the other employees at the business with whom the candidate will work closely. The new employee will also learn key information about the business, such as how its IT systems work, as well as more about their role in the business. This type of training normally occurs within the workplace. After induction training, employees may be offered other types of training.

Induction training offers a number of benefits:➜ Induction training helps new employees to integrate with existing workers

and to learn how to carry out their new jobs effectively. Induction training can help new employees to become more productive earlier.

➜ Some employees may leave after a very short period of time if they do not feel that they are supported. Induction training can help to avoid low rates of staff retention. As a result, businesses do not face the costs and disruption that can accompany replacing employees.

On-the-job trainingUsing on-the-job training means that the employees do not leave the workplace. This type of training means that employees may learn from more experienced workers. It is popular in the UK with 48 per cent of businesses using it in 2015.

There are a number of types of on-the-job training:➜ Work shadowing. Here, experienced and skilled employees are observed

during the working day. They may offer advice and guidance as well.➜ Formal training sessions. These can be led by experienced employees or

by specialist trainers from outside the business. These sessions can update

Key term

Induction training is the training given to an employee when he or she fi rst starts a job.

Key term

On-the-job training is given in the workplace.

Is a relativelycheap formof training

On-the-jobtrainingTraining

Inductiontraining

Off-the-jobtraining

Training outsidethe workplace

May not beright for the

business

Can beexpensive

May take place atcolleges or at

training companies

For newemployees

Training withinthe workplace

Will not bringnew ideas intothe business

Gives the precisetraining that thebusiness requires

Figure 4.14 Types of training

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Business insight

Folly Farm Adventure Park and ZooFolly Farm is an adventure park and zoo in Pembrokeshire – a very quiet part of Wales. It is committed to looking after its employees, in part through providing training. The company relies on on-the-job training to give employees skills in catering and customer service, as well as on how to care for over 90 different types of animals.

Folly Farm is a small business with a big reputation and highly skilled and experienced employees. In 2016, it was voted the best business in Pembrokeshire.

Explain why Folly Farm uses on-the-job training for its employees. (4 marks)

employees on changes that have taken place, for example, in health and safety laws. Alternatively, they may be used to prepare employees to take on new roles within the business.

➜ Computer-based training. It is becoming increasingly common for employees to receive training in the workplace using computer programs. In 2015, 30 per cent of businesses in the UK used computers to deliver training in the workplace.

The benefi ts of on-the-job training➜ It can be a relatively cheap way of providing training,

as employees do not have to travel and other employees may be able to give the training. Many businesses cannot afford to spend heavily on training. Using this form of training means that more employees can benefi t from a limited amount of spending. This can result in major improvements in a workforce’s productivity.

➜ On-the-job training is also targeted to the exact needs of the business, especially as it is often given by other employees. This means that employees will receive the precise knowledge and skills they require to carry out their roles effi ciently. For example, employees receiving IT training can receive it on the business’s IT system, rather than a different system.

➜ Businesses are making increased use of computers to provide on-the-job training. This is called e-learning. It enables businesses to use computer programs to give training which meets the business’s needs. This can be delivered at any time and is a relatively cheap method of training, especially if used by a large number of employees.

The drawbacks of on-the-job training➜ On-the-job training is unlikely to bring new ideas into the business unless

an outside trainer is used. As a result, on-the-job training may not lead to dramatic improvements in the performance of a business’s employees.

➜ Using this type of training can result in more employees being unavailable to work within the business for a period of time. The business might, for example, lose the services of those providing the training, as well as those receiving it.

Computers are increasingly used to provide on-the-job training. Some companies specialise in writing computer programs to be used in this way.

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4.4 Training

Off-the-job trainingOff-the-job training takes place outside the place of work. It might involve attending a course at a college or university, studying at home or going on a course run by a training company. Sometimes, off-the-job training can last for a considerable time. For example, an accountancy fi rm may pay for its employees to gain accountancy qualifi cations. This could involve several years’ part-time study at a local college.

The benefi ts of off-the-job training➜ Off-the-job training can help to bring new ideas and approaches

into a business. This can be valuable in industries, such as developing computer software, in which change is rapid.

➜ Off-the-job training is expensive and can be used to motivate employees as we saw earlier in this chapter. Receiving off-the-job training can make employees feel valued as their employer is spending signifi cant sums on improving their skills. This may result in substantial improvements in the employee’s performance at work.

The drawbacks of off-the-job training➜ This type of training can be expensive so, for businesses

making only small amounts of profi t, it may not be affordable. Many small businesses may not consider this as a realistic option.

➜ All businesses who provide off-the-job training for their employees take a risk. There is every possibility that the newly trained employee will leave the business for a new job once the training programme is complete. Off-the-job training can prepare employees to work in a range of different businesses. Thus, a business may spend heavily on training an employee, but receive little or no benefi t in return.

Factors influencing decisions on types of trainingOnce an employee is settled in a job, businesses can opt to improve their skills using off-the-job or on-the-job training. These two types of training are used fairly equally by employers. In 2015, around 71 per cent of UK businesses used some form of off-the-job training, such as attending courses at a local college. In comparison, 48 per cent used on-the-job training. Some businesses use both methods, which is why the total is greater than 100 per cent.

There are several factors which would influence which of these two types of training is used.

The business’s fi nancial positionTraining, and especially off-the-job training, is expensive. Businesses in weak fi nancial positions will be more likely to choose on-the-job training, if they train their employees at all. The average business in the UK spends only about £300 a year on training each employee. Those in poor fi nancial positions will spend less and would be unlikely to be able to afford the cost of off-the-job training.

Study tip

You may fi nd it helpful to be able to distinguish between on-the-job and off-the-job training and what the benefi ts and drawbacks are of using these types of training.

Key term

Off-the-job training is provided outside the employee’s place of work.

Local colleges provide a huge range of off-the-job training programmes, including those in marketing, plumbing, accountancy and catering.

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The type of training requiredSome businesses require very specifi c training to meet their particular needs. This might be provided best through on-the-job training. Training provided by local colleges or other training organisations might not suit the business’s precise needs and could be too general. For example, on-the-job training might be used by companies using employees to develop computer games or other software. Similarly, relatively simple training, such as that required to operate some production line machinery, may also be provided on the job.

Off-the-job training may be more suited to training that is long term and requires the passing of examinations. The costs of this may be reduced if it takes place outside working hours.

The skills and experience of the business’s workforceIt is easy to forget that the ability to train other people is a skill. Not all employees have this skill, meaning that businesses that make widespread use of on-the-job training may have to train their workforces to do this. Without suitable employees to train others, businesses may opt for off-the-job training.

Rapidly growing businesses, or those with low employee retention rates, will have large numbers of new employees. This can make it difficult to provide training on the job and may result in training being provided by external organisations.

The fast-food retailer McDonald’s spends heavily on training its employees, but makes a lot of use of on-the-job training. The company believes its employees benefit by learning and practising the skills needed within its restaurants.

Business insight

Training for engineers on overhead power linesAn overhead line engineering training centre in Penrith, Cumbria, offers training to engineers responsible for maintaining power lines. The off-the-job training course has been designed to provide skills that are in short supply.

The training is provided by Newton Rigg College, part of Askham Bryan College. It is a three-year, part-time course. Teaching begins with off-the-job training in the classroom and in a purpose-built training fi eld on the Newton Rigg site. Off-site learning exercises also take place at a number of UK locations managed by SPIE, a European technical services company.

Analyse the possible reasons why these engineers are receiving off-the-job training. (6 marks)

Employees working on overhead power lines need thorough training to do their job safely and effectively.

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4.4 Training

SummaryTraining can be an important way for a business to improve the performance of its workforce. Businesses may give induction training, as well as on-the-job and

off-the-job training. This can make the business more successful in its markets. However, training can be expensive, especially if off-the-job training is used.

Quick questions 1 What is meant by the term ‘training’? (2 marks)

2 Explain why training might help to improve the level of productivity of a business’s workforce. (3 marks)

3 Explain one reason why training might help to improve a business’s employee retention rates. (3 marks)

4 Using examples, explain the difference between on-the-job and off-the-job training. (4 marks)

5 Which of the following is an example of off-the-job training?

(a) Work shadowing a colleague

(b) Completing a computer-based training course at home

(c) A session led by an external training provider in the factory

(d) A talk in the offi ce by a senior manager (1 mark)

6 Explain one benefit of induction training. (3 marks)

7 Which of the following is not a benefit of on-the-job training?

(a) It brings new ideas into the business.

(b) It is a relatively cheap way of providing training.

(c) It can be designed to meet the business’s exact needs.

(d) It avoids the need to pay for travelling for employees. (1 mark)

8 Explain one benefit of on-the-job training. (3 marks)

9 Explain why providing off-the-job training might be a risk for a business. (3 marks)

10 Which of the following businesses is most likely to offer its employees only on-the-job training?

(a) A business that is growing very quickly and whose employees are overworked

(b) A business that is not in a strong fi nancial position

(c) A business that does not have employees with the skills to train others

(d) A business whose employees need long-term training and have to pass national examinations (1 mark)

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Case study

John Lewis PartnershipThe John Lewis Partnership (JLP) is a UK retail company which is owned by its employees. It operates the John Lewis department stores and the Waitrose supermarkets. JLP employs over 91,000 people. Its staff stay twice as long with the JLP as employees normally do with other retailers.

JLP is heavily committed to training its employees and spends 56 per cent more than similar organisations on training. This is despite a 14 per cent fall in profi ts in 2016 and plans to reduce the size of its workforce.

The company provides induction training to all new employees and promotes from within whenever possible. It has a reputation for outstanding customer service and spends heavily on customer service

training. The company provides on-the-job training for management trainees, many who have just graduated from university.

1 State two benefi ts that JLP might receive from giving its employee off-the-job training. (2 marks)

2 Explain one benefi t JLP may receive from providing induction training to its employees. (4 marks)

3 Analyse the possible drawbacks that JLP might experience from the use of on-the-job training for its management trainees. (6 marks)

4 Do you think that the benefi ts of JLP spending heavily on training outweigh the drawbacks? Give reasons for your answer. (9 marks)

C

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Chapter review – Human resources

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Chapter review – Human resourcesRead question 1, the sample answers and the comments. Then try question 2.


➜ Item A West Norfolk Farms Ltd grows bulbs such as daffodils and also cut fl owers that are supplied to shops and businesses throughout the UK. The company’s profi ts last year fell 20 per cent to £125,000. Despite this, it is expanding and plans to recruit 12 employees to work in its greenhouses and fi elds. Many of the jobs are simple and repetitive. Each new employee will receive induction training and further on-the-job training. West Norfolk Farms Ltd has a fl at organisational structure.

The company encourages its employees to take decisions and to organise their own work. The company’s managers use a style of management that allows all employees to make at least some decisions.

However, the company’s employees are not happy with their rates of pay. One commented that other local fl ower farms ‘pay at least 5 per cent more’. The managers at West Norfolk Farms Ltd think that a pay rise might improve the workforce’s motivation.

(a) Identify two documents that West Norfolk Farms Ltd might use to recruit and select its new employees. (2 marks)

(a) Most businesses use a number of documents to recruit and select employees and this can help them to choose the best people. The documents they might use are job adverts, person specifi cations and job descriptions.

This answer shows knowledge, but it is too long and gives unnecessary information. All that was required was to write down the names of two documents used in the recruitment and selection process. This question could have been answered with just a single sentence giving more time to answer other, more demanding, questions.

(b) Explain what is meant by West Norfolk Farms Ltd having ‘a fl at organisational structure’. (4 marks)

(b) A fl at organisational structure means that the diagram is a fl at triangle. This means that there are not many employees in the business between top and bottom. This makes it easier for the managers to pass messages to employees and shop-fl oor workers normally like this type of structure.

This candidate should have spent longer thinking before starting to write the answer. The answer does not contain the right information – perhaps the candidate’s revision was not thorough enough. He or she should have said that the company would not have many levels of hierarchy and have explained that this may mean that spans of control are wider. This makes it easier for the workers in the greenhouses to communicate with the manager.

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(c) Analyse the possible reasons why West Norfolk Farms Ltd prefers to use on-the-job training. (6 marks)

(c) On-the-job training is teaching employees skills and knowledge at the place of work and is often given by other experienced workers.

The company has many jobs which are ‘simple and repetitive’ and, therefore, this makes it easy for them to be taught by other employees. It is not necessary for West Norfolk Farms Ltd to send its employees on expensive off-the-job training courses to learn this type of skill. The use of on-the-job training is also helpful to the company as it suffered a 20 per cent fall in profi ts last year and a profi t of £125,000 does not justify paying for 12 new employees to receive expensive training away from the workplace.

The candidate has relevant subject knowledge and uses this with information from the case study to develop arguments explaining clearly why this company, in these circumstances, prefers to use on-the-job training. It is not a long answer, but it is well focused and thoughtfully constructed and is an effective use of time. It is very likely that the candidate planned this answer before writing it.

(d) Recommend whether West Norfolk Farms Ltd should increase its employees’ pay to improve the motivation of its workforce. Give reasons for your advice. (9 marks)

(d) Increasing employees’ pay could make them work harder as they feel more rewarded and it meets some of their needs, such as those for food, shelter and clothing. West Norfolk Farms Ltd should increase the pay of its employees as at least one is unhappy and is complaining about low rates of pay. As the company is about to recruit 12 new employees, a pay rise might make the company a more attractive employer and help to attract more talented and hard-working people.

However, there are lots of reasons not to do this. The company motivates its employees in different ways using non-fi nancial methods of motivation. It allows employees to make decisions and to organise their own work. This can make the work much more enjoyable and helps to make workers more productive.

I would not recommend that the company raises its employees’ pay at the moment. The company’s profi ts have fallen, and it will have the costs of recruiting and training 12 new workers. It also offers a range of non-fi nancial methods of motivation, and its wages are only 5 per cent lower than its rivals. It should investigate what motivates its workers more and what their needs are before committing itself to an increase in pay which it cannot really afford.

This is another thoughtful answer and it is focused on the question throughout. It analyses the reasons why the company might give its workers a pay rise and the reasons why it might not. Both sides of this argument use material from the case study in support. The � nal paragraph offers a clear decision and gives reasons for this advice – exactly what the question called for.

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➜ Item BJim O’Grady is the owner and manager of Volume, a chain of bookshops in southern England. Initially, he had just one bookshop in Chichester, but his company now operates 33 stores.

Volume’s employee retention rates (at 68 per cent) are much lower than those of other retailers. He wants to expand the business to have over 100 stores across the UK.

Jim knows he needs to make some changes as he is struggling to manage the growing business. He is considering the following:

● decentralising the business as most decisions are currently made in Chichester

● introducing a profi t-sharing scheme for all employees as its wages are lower than those of other bookshops

● reviewing the recruitment and selection process used by the business to make it more effective – in particular, he wants to appoint talented and ambitious store managers

● improving the company’s training by offering regular on-the-job training as well as induction training.

(a) State two benefi ts to Volume from its use of induction training. (2 marks)

(b) Explain why Jim might be keen to introduce a system of profi t sharing into the business. (4 marks)

(c) Analyse the benefi ts to Jim of having an effective recruitment and selection process for Volume. (6 marks)

(d) Recommend whether or not Jim should decentralise his business. Give reasons for your advice. (9 marks)

Chapter review – Human resources

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In this chapter, we look at the importance of a business understanding its customers and meeting their needs and wants. We show the benefi ts of understanding your customers well and the dangers of not meeting their needs effectively. We will look at how businesses achieve this by identifying the particular needs and wants of a group of people, called segmentation. We also look at the methods of carrying out market research that businesses use to get to know their customers and the different elements of the marketing mix. This involves studying pricing decisions, the way businesses communicate (promote) their products, the nature of the product itself and the way in which products are distributed to reach customers. We consider the factors that infl uence decisions relating to the marketing mix and the need for these decisions to be linked to each other.

5Marketing

● An exchange processA business is involved in an exchange process. It provides a good or service in exchange for something – often money. To be successful, this exchange must be worthwhile and benefi cial for both sides. Those investing in, running and managing the business must feel that the rewards generated by the exchange process are worthwhile and better than rewards that could be gained elsewhere (the opportunity cost). The customers must feel the benefi ts justify the price paid.

● Identifying a business opportunityTo sell its products, a business must offer something that customers value and are willing to pay for. To do this, businesses must identify a business opportunity. Is there something the business can do better than others? Is there something that customers are unhappy with at the moment? Is there something that customers are missing and want?

Key term

An exchange occurs when someone gives up something in return for something else, e.g. a business exchanges a product for money.

●●To sell its products, a business must offer something that customers value and are willing to pay for. To do this, businesses must identify a business opportunity. Is there something the business can do better than others? Is there something that customers are unhappy with at the moment? Is there something that customers are missing and want?

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Topic

Identifying and understanding customers

5.1

A business can only be successful if it meets its customers’ needs and wants effectively. This means it must understand these needs and wants and have in place the skills, resources and processes to satisfy these, hopefully better than its competitors.

By the end of this topic, you should know the importance of identifying and satisfying customer needs, in order to:

● identify a business opportunity and provide a product or service that customers will buy

● increase sales

● select the correct marketing mix

● avoid costly mistakes

● be competitive.

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5.1 Identifying and understanding customers

A business must identify what its proposition is – what it is that it is offering that customers will buy, what is the benefit provided? For example:➜ UPS will deliver your parcel safely and quickly.

This is its benefi t.➜ L’Oreal will make you feel more confi dent

when you use their products. This is a benefi t.➜ Amazon provides you with access to a wide

range of products and fast delivery. These are benefi ts.

➜ A Harley-Davidson motorbike makes you feel younger and you can remember your youth. This is a benefi t!

People pay for the benefits provided by a good or service. A business has to identify these and promote them. They may not always be obvious. Some people buy chocolate to reward themselves – of course they eat it, but the underlying motive is to congratulate themselves. Others buy it when they are feeling sad about something – the chocolate makes them feel better. Some people buy chocolate to give as a gift. Some buy it to share. Businesses need to identify the different opportunities that exist and develop products accordingly.

Needs and wantsPeople have needs. A need is something that needs to be fulfi lled for us to survive. We need to eat and we need to drink, for example. Needs are what we must have to exist. We also have wants – this is what we would like to satisfy our needs. For example, we need to eat, but we want a sandwich from Pret A Manger. We need to drink; we want to buy a particular brand of water. Businesses have to understand the basic need they are fulfi lling and try to turn this into a want for their particular product. They can do this by developing a product or brand that people want.

Consumers and customersThe person or organisation buying the product is the customer. The person using it is the consumer. These may be the same person. For example, you may buy and eat your lunch in which case you are the customer and consumer. However, there are many occasions when the buyer and the person consuming the product are different. Your parents may have bought the cereal you eat in the morning or the phone you use. This means businesses have to think about the needs and wants of the customer as well as the consumer. For example, when you go to upgrade your mobile phone, you may fi nd the questions you ask are different to what your parents ask when deciding what phone to buy, and what you are looking for may also be different.

Key terms

A need is something that needs to be fulfi lled for us to survive.

A want is what we would like to satisfy our needs.

A customer is someone who buys a product from a business.

A consumer is someone who uses goods and services produced by businesses.

Many buyers of Harley-Davidson motorbikes are older men wanting to remember the excitement of being younger!

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● Increasing salesBy providing more benefi ts and doing something better than competitors, the sales of a business should rise. Consider the following examples:➜ In the taxi market, Uber allows us to identify on our mobile phones the

nearest taxi, to see the details of the car, to see the rating of the driver and to pay directly from our account. This gives us, the buyer, much more information about our options and is more convenient than ordering a taxi the traditional way and not knowing where it is, how long it will take or what the driver is like. Uber, therefore provides additional benefi ts and people will switch to this, increasing sales.

➜ The Amazon Kindle has enabled us to access and store many books on one device – this is much easier (and lighter!) than taking many different books on holiday. It is a benefi t many are willing to pay for, which has led to high sales.

➜ The iPhone is just a phone, but it also isn’t. It says something about you as a person and your sense of style. There is something about the way we use it, the features it has, the style of it that add up to this being the phone of choice for many people. This distinctiveness and its strong design boost sales.

● Selecting the correct marketing mixThe marketing mix is the combination of factors that infl uence a customer’s decision to purchase a product. You go to your favourite clothes shop because, for example: ➜ you like the clothes there ➜ you think the clothes are value for money➜ you like the layout and feel of the store➜ it is easy to get to➜ you like the staff➜ you want people to know you shop there

Business insight

Hotel Chocolat Hotel Chocolat has been keen to push the idea of giving chocolates as a present. It is particularly promoting its online services so you can order a present and have it delivered without even leaving your home. The business’s sales online rose by 20 per cent last year, with overall sales rising to £91.5 million. Evidence suggests that, in uncertain economic times, more people buy extravagant presents. In particular, the company has been successful at stimulating people to buy chocolates to give to others. The company has also been promoting the high cocoa and relatively lower sugar content of its products to meet the demand for healthier eating.

Analyse how Hotel Chocolat is increasing its sales. (6 marks)

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➜ they have an easy refund and returns policy

➜ there is a sale on.

These are all aspects of the marketing mix. Our decision to buy is influenced by these and many other factors. The more we understand our customers, the more we, as a business, know how to appeal to them. For example, if people are buying a fountain pen as a present for someone else rather than for themselves, then the business needs to make sure it is wrapped well and looks like a gift. If people judge wine partly by the price, then we do not want to sell it too cheaply, or this might send out the wrong messages.

When buying a car, for example, are people looking for a car that is:➜ fuel-effi cient?➜ stylish?➜ fast?➜ affordable?➜ environmentally friendly?➜ reliable?

They may, of course, want all of these things, but which are the elements that really matter? Which do you need to promote and make people most aware of?

For more about the marketing mix, see Topic 5.4.

● Avoid costly mistakesIf businesses don’t understand their customers, they will suffer. If a political party does not understand its customers (its voters), it loses the election. If a publisher does not understand its readers, it publishes books that don’t sell. If a travel company offers holidays to Peru when customers want to go to Malta, it does not get the business. So understanding customers is the key to getting sales and to avoiding costly mistakes.

If a business gets it wrong and produces the wrong products it may have:➜ to withdraw the product because sales are too low➜ to amend the product in some way, which may cost money➜ to lower the price, which may reduce the profi ts➜ damaged the brand name, which may affect the company’s future success.

Just think of the time and the cost of producing a new computer game and finding it is not popular.

Study tip

Remember that the nature of the marketing mix will vary from product to product. For some products, you may think for some time about the price being asked; in other cases, you hardly notice it. The brand of clothes you buy may be very important to you, but you may not care what brand of fruit or light bulb you buy.

There are many factors that influence your decision to buy from a particular shop.

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5 Marketing

● Be competitiveThe competitiveness of a business refers to its ability to offer better value for money than its competitors. It is relative, that is, it relates to what one business offers in relation to other competitors. To be competitive, a business must offer more benefi ts in relation to the price charged than rivals do. To do this, it must understand what it is that customers want. The better you understand your customers, the more you can offer them the benefi ts they want. Do customers want a three-hour dining experience or fast food? Do they want to sit down to a cooked breakfast or buy and eat their breakfast when they are on the move?

If a business understands what exactly customers want to buy, when they want to buy it, how much they are prepared to pay for it and where they are likely to look for it, it will be able to develop its marketing activities more effectively and be more competitive. Offer the wrong thing, at the wrong time, with the wrong message and price and you are not competitive.

Quick questions 1 What is a ‘consumer’? (2 marks)

2 What is a ‘customer’? (2 marks)

3 What is a ‘need’? (2 marks)

4 What is a ‘want’? (2 marks)

5 What is meant by an ‘exchange process’? (2 marks)

6 State two ways of measuring sales. (2 marks)

7 Explain one possible problem that might occur if a business does not understand a customer effectively. (3 marks)

8 Explain one way that a business understanding its customers effectively can lead to more sales. (3 marks)

9 Explain one way a business understanding its customers effectively can reduce costly mistakes. (3 marks)

10 Explain one way a business understanding its customers effectively can lead to the correct marketing mix. (3 marks)

SummaryTo succeed in business it is no good just having an idea – you need customers as well. Many businesses have failed when there have not been enough customers buying the product. Understanding your customer is essential to being competitive, that is, to offering

better value for money than your competitors. You can adjust your product better to meet their needs; you can get the price just right; you can make the product available at just the right place and time; and you can promote the right messages to appeal to customers.

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Case study

BHSIn 2016, the retail business BHS closed down after 88 years on the UK high street. The company had run out of money and could not fi nd a buyer to save it.

One of the problems facing BHS was that in recent years customers did not know what BHS was or why they should shop there. There were other stores that seemed to have a much clearer offering in a particular range of products. BHS had many different departments – including clothes and home furnishings – but did not seem to specialise in any one and had no particularly strong offering in any one anymore. It had lost its competitiveness, and it was not clear why customers would go there. Added to this, the stores felt tired and lacked enough investment compared to competitors. It had large stores, often rather quiet and with what looked like dated stock. In areas where it once had some strengths, such as bedding and towels, others such

as Ikea, TK Maxx and Tesco had improved their offerings.

Other department stores, such as House of Fraser and Debenhams, responded to customer demands by bringing in some concession areas where other well-known brands could sell their products; these were ways of getting customers into the store. BHS did not manage to do this successfully.

1 What is the difference between a customer and consumer? (2 marks)

2 Explain one way that you think customers' shopping habits may have changed in the last ten years. (4 marks)

3 Analyse how understanding customer needs and wants in retailing benefi ts the business. (6 marks)

4 Evaluate the possible reasons why BHS lost its competitiveness. (12 marks)

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5.2

● ’The market’The marketing function of a business is interested in the nature of the potential buyers of the products of the business. When marketing managers talk of ‘the market’, they usually focus on what demand there is for their product and what the sales are.

Managers will consider factors such as: ➜ The size of the market. How big the market is in terms of the number of

sales (this is known as the sales volume) and how big it is in terms of the sales value. For example, the size of a market may be 200,000 units sold and a total value of £1,000,000. It is possible for the volume of sales to increase but the value decrease, if the price in the market is falling. Equally, the volume may fall, but the value could increase if prices are rising.

➜ The growth of a market. For example, if the sales in the market last year were 200,000 units and this year are 220,000 units, the market has grown by 10 per cent.

Marketing managers will want to understand what is happening within different parts of a market (known as segments) as well as the market as a whole. For example, while the overall sales of cereals might be growing, we may find that sales of cold cereals are falling and hot cereals are rising. In the market for theme parks, we may find the numbers of 14–24-year-olds falling, while the number of families visiting may be rising. It is important for marketing managers to understand the different aspects of their market in detail.

Key terms

Sales volume measures the number of items sold.

Sales value measures the revenue generated.

Segmentation

Topic

In this topic, we will examine the ways in which businesses divide up their markets and how they decide which parts (or segments) to target.


● what is meant by ‘the market’

● the meaning and benefi ts of segmentation

● the different ways of segmenting a market, including by gender, age, location and income.

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5.2 Segmentation

Benefits of segmentationBy identifying segments within a market, a business can:➜ develop its products to fi t customer needs more closely – for example, a

bigger car with more seats and more boot space for the family car buyer➜ target its customers more precisely – for example, the buyers of family cars

may watch different programmes on television, read different magazines, and visit different websites than the buyers of sports cars; if the manufacturer of family cars knows this, it can promote its products in the right places at the right time to boost sales

➜ set the price appropriately – for example, if the business knows that there is a high demand for family cars and relatively few good providers, it may be able to charge more for its family cars.

Maths moment

To calculate the growth of a market, we use this equation:

market growth = change in market size

original market size × 100

For example, if the market was worth £50,000 and is now worth £60,000, the change in market size is £10,000 (that is, £60,000 – £50,000). The market growth is, therefore, calculated as:

market growth = £10,000

£50,000 × 100

Last year, the number of sales was 300,000 and the average price was £12.

This year, the number of sales is 330,000 and the average price is £15.

1 What is the growth in sales volume?

2 What is the growth in sales value?

● What is segmentation?Segmentation occurs when a market is divided into different groups of needs and wants. For example, within the car market, there may be some buyers who are looking for a family car, some who want a sports car, some who want a small car to drive around the city, and others who want a larger car for rougher terrains. Each of these groups of needs and wants are segments within the overall car market.

Key term

Segmentation occurs when a market is divided into different groups of needs and wants.

Study tip

Make sure you get the units right. Sales volume is measured in terms of the number of units sold, whereas market share is measured as a percentage.

Car manufacturers produce different cars for different segments of the market.

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5 Marketing

Obviously, there may be limits to how much a business wants to segment a market because ultimately everyone has slightly different tastes, and in most cases a business cannot completely tailor-make a product for each customer.

● Ways of segmenting a marketWays of segmenting a market include:➜ By gender. For example, a clothes retailer may have some products

specifi cally targeting women and other products targeting men. A company may produce aftershaves for men and perfumes for women.

➜ By age. For example, a toy company may offer some toys for younger children (such as Duplo) and some aimed at older consumers (such as computer games). A theme park may offer a children’s area for younger visitors and some particularly scary rides for older ones!

➜ By location. For example, a food business may change its recipes according to where the product is being sold. McDonald’s changes it menus in different countries around the world.

➜ By income. For example, a business might target high-income earners with some products and lower-income earners with others. A bank may offer savings products to higher-income earners and loans to those with less income. In relatively low-income areas, a company such as Unilever might sell a basic washing powder; in high-income areas, it might sell a more expensive powder with a fragrance and conditioner.

➜ By the stage someone has reached in their life cycle. For example, a housing company may produce fl ats for young single people, bigger houses with gardens for families with children and bungalows for those who are retired.

Effective segmentation allows a business to decide which segments it wants to target. It can then focus its marketing activities more effectively on its customers. This should make marketing more cost-efficient and more focused and successful.

Maths moment

If a particular market segment is worth 40 per cent of total sales and the turnover in the whole market is £2.6 million, what is the value of the segment?

TargetingOnce a business has identifi ed relevant segments in its market, it will need to decide which ones to focus on. This is called targeting. A business will target segments where it thinks:➜ it can make a high enough return; some segments may be too small or not

profi table enough➜ it can compete effectively, that is, it has the skills and resources to win market

share➜ it covers the opportunity cost, that is, there are no better alternatives.

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5.2 Segmentation

Business insight

Sport EnglandSport England exists to encourage more participation in sports in the UK. It segments the market. One segment Sport England identifi es with is known as ‘Chloe’.

‘About Chloe

Chloe is around 23 and works in human resources for a large fi rm. She shares a house with ex-university friends. Without the pressures of family or a mortgage, Chloe is not worried about her student loan. She likes to spend her income on clothes, nights out and holidays with friends.

Chloe and her housemates go to classes at their local gym a couple of times a week, and like to swim afterwards. At weekends, Chloe likes to go for a big night out, including a nice meal and a few drinks with her friends.

Chloe is reasonably health conscious, watching what she eats and exercising to stay trim. She is not fanatical though, wanting to live a fun-packed life while she is young, free and single.

What else does Chloe like to do?

In common with other adults, friends and family, listening to music and TV all compete for Chloe’s free time.

As a younger segment, Chloe is more likely than the overall adult population to use the internet and email, to go to the cinema and to visit pubs, bars and clubs.

Sport is not the top priority for Chloe’s free time. However, 62 per cent of this segment do sport and exercise in their spare time, compared to 52 per cent of all adults.

How to reach Chloe

TV/RADIO: Chloe is a light TV viewer, but enjoys chat shows and reality TV. Chloe is a heavy radio listener, favouring national programmes over local commercial stations, although she will struggle to recall general advertising messages.

INTERNET: Chloe is a heavy internet user, both at work and at home. She uses the internet for personal email, downloading music, social messaging and making purchases.

POSTERS/DIRECT MAIL/NEWSPAPERS: Chloe reads broadsheet newspapers and is a heavy reader of women’s lifestyle magazines.

TELEPHONE: As a heavy mobile phone user, Chloe likes to keep in contact with friends and family, preferring this to her landline. Chloe has a new phone which provides internet access but is still likely to use text as her fi rst source of information.

Chloe’s favourite brands are Topshop, Zara, Virgin Active, Maybelline and Wagamama.’

Source: Adapted from: http://segments.sportengland.org/

querySegments.aspx

Analyse how the above information on the Chloe segment might infl uence the marketing activities of Sport England. (6 marks)

SummarySegmentation involves identifying different groups of needs in a market. Businesses will want to identify the segments they want to target so that they can focus their marketing mix on these groups. A good

understanding of your target market means that businesses can be more effective in their marketing activities.

http://segments.sportengland.org/querySegments.aspx

http://segments.sportengland.org/querySegments.aspx

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Quick questions 1 State two ways of measuring the size of a

market. (2 marks)

2 What is meant by ‘market growth’? (2 marks)

3 What is meant by ‘segmentation’? (2 marks)

4 Explain two ways of segmenting a market. (4 marks)

5 Explain one benefit of segmenting a market. (3 marks)

6 Explain how the sales volume can increase but the sales value decrease. (3 marks)

7 A market has sales of £400,000. If it grows by 5 per cent, how big is it? (2 marks)

8 Give the equation to calculate market growth. (2 marks)

9 If a market had sales of £400,000 and now has sales of £420,000, how much has the market grown? (2 marks)

10 What is meant by ‘targeting’? (2 marks)

Case study

NintendoNintendo became a household name in the 1980s when its game Super Mario Bros. became popular across the world. However, after that it struggled to keep pace with the growth of smartphone gaming and until recently seemed to have fallen behind its competitors. It did have a boost to its popularity with Pokémon Go (the location-based game where players catch virtual creatures on their screens as they go from place to place), but much of the rights to this game are actually owned by its developer Niantic. More recently, Nintendo has announced that its Super Mario games would be developed for the fi rst time for smartphones. This seems to be something of a breakthrough for the company.

Until this development, Nintendo’s own games could only be played on Nintendo hardware. The company’s strategy has been to get consumers to buy its consoles as well as the latest games. It has deliberately avoided, for a long time, producing and selling games for mobile phones.

Nintendo’s target market has been the casual gamer, and it has had real success in the past. Nintendo Wii was a best seller. Its successor, the Wii U which targeted families, was less successful because by this time the players were already using their tablets

and smartphones and did not want or need to pay for a console. By comparison Sony and Microsoft, which make the PS4 and the Xbox, have targeted hard-core gamers who want much more power and better graphics to enable them to play their games. Between 2011 and 2013, Nintendo reported losses.

Nintendo has kept away from smartphone games on the grounds that they are too cheap and disposable compared to their consoles that sell for less than £200 and their games that sell for less than £60. Producing games for mobiles relies on in-app

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Figure 5.1 Nintendo’s revenues, 2006–16

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5.2 Segmentation

purchases of virtual goods. Nintendo was reluctant to get involved in this as it wanted to be seen as family friendly and selling apps might be seen to be taking advantage of children buying extras online and spending parents’ money without permission. The company was also reluctant to let anyone else use its characters to develop games because they wanted to keep control.

Nintendo now realises this was a mistake, and it has missed out on a generation of potential customers. It now seems to appreciate to some extent that selling the rights to use its games and characters could generate huge incomes. Even so, the company is still closely attached to its consoles strategy and plans to launch a new one code-named NX. This is said to be a mixture of a console and a handheld device to be played on the go or docked at home. If this does not work, the company may need to close its hardware business.

Continued success for Nintendo will depend on creating new, compelling characters and staying ahead in terms of consumer hardware, which still accounts for a lot of its revenues. The move into mobile does bring risks. One is the power that Apple and Google have in smartphone-gaming. Nintendo will have to pay Apple 30 per cent of the revenues that Super Mario Run earns via its app store, for example.

Its partnerships with DeNA and Niantic mean that it is relinquishing at least some control over game development too, which could dilute quality. It is unclear that casual gamers paying small amounts on their phones will fork out the money for a pricey Nintendo device.

Nevertheless, the potential strengths of Nintendo should not be underestimated. It has great skills on the software side and is a brilliant maker of games. Of the world’s 25 all-time, best-selling video games, it owns 17. It also has shown the ability to survive change in the market and adapt to it. The fi rm began in 1889 with the production of handmade hanafuda playing cards decorated with fl owers, and was one of the fi rst to move into arcade games in the 1970s. It also likes to remind people that it invented the whole business of hand-held games played on the go.

1 What proportion of Nintendo’s revenue was from hardware sales in 2007 and in 2016? (2 marks)

2 Explain the different segments that exist in the computer games market. (4 marks)

3 Analyse how Nintendo’s decision to target the segment it did affected its activities. (6 marks)

4 Evaluate the view that Nintendo should continue to develop consoles. (12 marks)

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5.3 Topic

The purpose and methods of market research

● The purpose of market researchWithout information on their products, their markets and their competitors, a business is operating ‘blind’, in which case it is taking major risks and faces a lot of unknowns. Alternatively, businesses can try to ‘turn the light on’ by undertaking market research so they understand the market and its conditions and are in a better position to make decisions. Market research is the process of gathering, analysing and presenting information relevant to marketing.

Market research will help gather information about:➜ Demand. For example, the size and growth of the market and the different

segments that exist within the overall market➜ Market share. That is, the sales of each producer as a percentage of total

sales in the market➜ Competition. For example, the number and size of competitors and their

share of the total market sales – research might identify which businesses are growing and help managers understand why

Imagine entering a room that is pitch black. You are likely to be nervous and not know what you are doing. If you move about, you will do so slowly because you cannot see what is around you. You will not know where you should be going because it is so dark. Now imagine a light is turned on and you can see. A lot of the stress you had before has gone and you can move around much more confi dently. Which situation would you prefer? The answer, presumably, is the second scenario, where you can see what is going on around you and what lies ahead of you. This topic looks at how businesses ‘turn on the light’ to see what is going on in their markets, by using market research.


● the purpose of conducting market research

● some maths used in market research

● how businesses use market research to inform decision-making

● the different primary and secondary research methods.

Key term

Market research is the process of gathering, analysing and processing data relevant to marketing decisions.

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5.3 The purpose and methods of market research

➜ Target market. A business is unlikely to want to target everyone in a market; it will want to focus on particular groups. It will have its own target market that it wants to focus on. For example, it might target older buyers, male buyers or higher-income groups. By focusing on specifi c market segments, the business can make its marketing activities more targeted. It can also give itself a different position in the market compared to competitors. For example, an airline might position itself as a budget airline (such as Ryanair) or a premium airline (such as Emirates). It may clearly be a shop for people wanting to do sports (such as Decathlon) or more of a fashion business (such as JD Sports).

Types of data used in market researchMarket research may involve:➜ Quantitative data. This involves the use of numbers such as the size of the

market, the growth of the market or the number of customers a business has.➜ Qualitative data. This involves views and opinions, but does not provide

statistically reliable information. For example, by talking to a small group of customers you may get an insight into how they view the brand or how the product is viewed in relation to competitors. This data focuses on why people do things – what motivates them to buy the products, what their experience of the business is and how they felt having bought and used the products.

● Marketing research mathsMarket sizeMarket size can be measured by the value or the volume of sales. The volume of sales is the number of units sold. The value of sales can be calculated using the equation:

value of sales = number of units sold × price per unit

If the number of units sold is 50 million and the average price is £3 per unit, this means that the volume of sale is £150 million:

value of sales = 50 million × £3 = £150 million

Key term

A market segment is a group of buyers with similar needs within the overall market.

Maths moment

Now calculate the volume and value of sales if 30 million units are sold at a price of £2 each.

Market growthMarket growth can be measured using this equation:

market growth = change in market size

original market size × 100

For example, if market sales were £400 million and are now £500 million, the change in market size is £100 million (that is, 500 million − 400 million). This means that the market growth is 25%:

market growth = £100 million

£400 million × 100 = 25%

Maths moment

Now calculate the market growth if the market increases in size from £500 million to £700 million.

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Market shareThe market share of a product is given by this equation:

market share = sales of the product

total market sales × 100

For example, if product sales are £40,000 and total market sales are £800,000, this means that the product’s market share is 5%:

market share = £40,000

£800,000 × 100 = 5%

From market share to market sizeIf market research shows the market share of a product and its sales, it is possible to calculate the total market size.

For example, if a product has 30% of a market and has sales of £60,000, this means that 30% = £60,000.

1 Calculate 1%. To do this, divide both sides of the equation by 30:

30% = £60,000

30% ÷ 30 = 1%

£60,000 ÷ 30 = £2,000

So 1% = £2,000

2 Calculate the size of the whole market (100%) by multiplying both sides by 100:

1% = £2,000

1% × 100 = 100%

£2,000 × 100 = £200,000

So 100% = £200,000

Maths moment

Now calculate the market share of a product that has sales of £25,000 in a market which has total sales of £800,000.

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Maths moment

1 Imagine that the market share of a product is 5% and it has sales of £80,000. Calculate the total sales in the market.

2 The pie chart in Figure 5.2 shows the sales of four products that make up the total market. Calculate the market share of Product B.

Product A£40,000

Product D£80,000

Product C£20,000

Product B£120,000

Figure 5.2 The sales of four products that make up the total market

3 Table 5.1 shows the sales of Product A and the total market sales for 2014–17.

YearMarket sales (£ million)

Product A sales(£ million)

2014 300 30

2015 350 35

2016 400 50

2017 450 90

Table 5.1 Product A sales and total market sales, 2014–17

(a) Calculate the growth in the size of the market between 2014 and 2017.

(b) Calculate the growth in the sales of product A between 2014 and 2017.

(c) Calculate the market share of product A in 2014 and in 2017.

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● Methods of market research There are different ways of gathering data. These can be divided into:➜ primary market research (also called ‘fi eld research’), which involves

gathering information for the fi rst time, for example, using questionnaires to conduct a survey of potential customers

➜ secondary market research (also called ‘desk research’), which involves using data that already exists, for example, using information in a newspaper or published on a website.

Key terms

Primary market research uses data gathered for the fi rst time.

Secondary market research uses data that has been gathered already.

Business insight

Innocent DrinksIn 1998, Richard Reed, Adam Balon and Jon Wright developed their fi rst smoothie recipes. They were nervous about giving up their jobs so they bought £500 worth of fruit, turned it into smoothies and sold them from a stall at a music festival. They put up a big sign saying ‘Do you think we should give up our jobs to make these smoothies?’ and put out a bin labelled ‘Yes’ and a bin labelled ‘No’. Customers were asked to put their empty smoothie bottles in the right bin. At the end of the weekend, the ‘Yes’ bin was full, so they resigned the next day and set up Innocent Drinks. Within three years, their brand was a national name.

Analyse the advantages of this form of market research by the founders of Innocent. (6 marks)

Marketresearch

Primary marketresearch

Secondary marketresearch

Figure 5.4 Methods of market research Figure 5.3 The uses of market research

Identifyopportunities

Assesseffectiveness

of actions

Weigh upoptions

● Uses of market researchMarket research will help managers to:➜ identify opportunities in markets – for example, is there demand for a new

fl avour of the company’s drink? ➜ weigh up different possible actions – for example, is it best to promote the

product launch online or in print?➜ assess the effectiveness of actions that have been taken – for example, how

successful was the price promotion that the business ran last week?

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Secondary market researchAdvantages of secondary market research➜ It can be gathered quickly and cheaply. There is a great deal of information

available from newspapers, books, magazines, journals and the internet. The Economist magazine and the Financial Times newspaper regularly carry good business surveys that are useful for exploring general trends in markets. The government also regularly produces information on issues such as the economy and social trends. Data gathered by specialist market research companies, such as Mintel, are also available for a fee.

➜ It can provide information on large sections of the population. It is unrealistic to expect a business to gather detailed information on the whole of the economy, but the government can afford to do this.

Disadvantages of secondary market research➜ The existing data may not be exactly what the business wants. For example,

you may want information on the population of one area of Oxford, but can only fi nd data on the whole of the city. You may be interested in the buying habits of 17–30-year-olds, but can only fi nd information on 18–25-year-olds.

➜ The existing data may be out of date. The latest secondary research may be for last year or even a few years ago. Given that some markets change rapidly, such as the market for music, the fact that the research is not up to date may mean the business makes the wrong decisions.

Maths moment

The line graph in Figure 5.5 shows the sales of Product B and the total market sales for 2014–17.

1 Calculate the market growth from 2014 to 2017.

2 Calculate the market share of Product B in 2016.

Sale

s (£

000s

)

£30,000

£5,000

£40,000

£8,000

£50,000

£10,000

£80,000

£20,000

90

80

60

40

20

10

02014 2015 2016 2017

70

50

30

Market salesProduct B sales

Key

Figure 5.5 Product B sales and total market sales, 2014–17

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5 Marketing

Maths moment

£m

2014 1,669

2015 1,602

2016 1,537

2017 1,493

2018 estimate 1,509

2019 estimate 1,558

2020 estimate 1,600

Table 5.2 Sales and forecast sales revenue of breakfast cereals in the UK, 2014–201 Use Table 5.2

to calculate the percentage change in sales each year.

2 Analyse the possible value of this data for someone thinking of setting up as a producer of breakfast cereal.

Despite the potential problems, businesses should try to use secondary market research wherever possible because it is cheap and it provides a useful starting point. This should then highlight what other research needs to be done (if any) to get the required information. Any ‘new’ information can be gathered using primary research.

Table 5.2 shows the sales and forecast sales revenue of breakfast cereals in the UK.

Primary market research Primary research can be tailored to meet the business’s needs and is up to date. This can make it more useful than secondary research. However, it can be expensive (for example, organising a large-scale survey) and, if not done correctly, can give misleading results (for example, if the people surveyed do not represent the whole group of customers).

Primary data may be gathered by:➜ Observing. For example, watching how people walk around a supermarket

to see what attracts their attention. In some shopping centres, they have shape recognition sensors – they can recognise a person’s body shape and follow them around to see exactly where they shop during their visit.

➜ Experimenting. For example, trying out a new form of advertising and measuring the response. A business might try out a new product in a test market to assess customers’ reaction before launching nationally. Many fi lms have several endings fi lmed and these are shown to different groups to see how the audience reacts before releasing the fi nal version.

➜ Surveying. For example, interviewing people who might buy your products to understand their motives. This is often done online these days, when to access some information you are asked to answer some questions fi rst.

Forms of surveySurveys can include:➜ Telephone surveys. Phoning customers to obtain their views is relatively

cheap. Also, it can be conducted from the offi ce (it does not require additional travel expenses). However, not everyone has a telephone and some people are suspicious of answering telephone surveys. It can also be diffi cult to fi nd the best time to contact people.

➜ Questionnaires. Questionnaires can be posted, but the response rate is usually quite poor. Surveys can also be carried out in the street, but the people interviewed may not be representative. If people are out shopping in the middle of the afternoon, for example, they are not at work so you may not get the views of people in work. Care must also be taken to ensure that the people who conduct the questionnaire surveys are properly trained. If untrained people conduct the survey, they may lead the respondents to give them the answer they think they want.

➜ Customer/supplier feedback. Some businesses ask their customers what they think. Many products, for example, include a helpline or customer

231

feedback telephone number on the packaging so the customer can contact them directly. The only problem with this is the people who ring up may not be typical customers. Customer feedback also relies on existing customers, rather than potential ones or those who at the moment would not even consider the product. Suppliers may also give feedback on various aspects of a business, such as the speed of its response, how it deals with stakeholders and how it compares with other businesses.

➜ Focus groups. Focus groups are small groups of people selected to give their views on a particular business issue, such as a brand name or brand image, whether the business is better or worse than competitors, a proposed advert, etc. These groups may not represent the market as a whole because they only contain a few people. However, a focus group does give the opportunity to discuss a range of issues in great detail. Quite often, a focus group will bring to light an issue that can then be explored in more depth by surveying more people (if the business can afford it).

➜ Internet research. Many businesses have their own website and this provides an additional route for customer feedback. It is also possible to track the number of visitors to a website, how they found the site, what search engine they used – and this sort of information can provide a useful insight into potential customers. The internet can also be used to fi nd secondary information, for example, from websites such as The Times and the Guardian newspapers, The Economist magazine, government sites such as the Offi ce for National Statistics and competitor websites.

➜ Printed press, such as newspapers and magazines. Simply reading the newspapers and various articles in the press can help provide insights into markets, the economy and competitors.

Internetresearch

Telephonesurveys

Customerand supplier

feedback

Focusgroups

Printedpress

Questionnaires

Surveys

Figure 5.6 Forms of survey


Study tip

Do not assume that, because some market research has been undertaken, it will automatically be useful. Always check how it has been gathered. Asking a few of your friends what they think, for example, could give misleading results – they may just tell you what they think you want to hear.

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5 Marketing

Form of primary market research Advantages Disadvantages

Telephone survey Can call when it is convenient to the business

Cannot see how people respond, e.g. their body language responsesPeople may not answer their phones or be reluctant to give answers

Door-to-door survey Can see how people react and people may be more likely to tell the truth

Can be time-consuming

Focus groups Can get in-depth responses Small groups may not refl ect all your target customers

Internet research Cheap, quick May not fi nd the views of your target customers if they are not online

Table 5.3 Some advantages and disadvantages of different forms of primary research

SummaryBusinesses need information in order to make good decisions. To do this, they may undertake market research. There are many forms of market research, such as questionnaires, focus

groups and online research. The right method of research depends on what you are trying to find out. However, research does cost money, use up resources and can take time.

Quick questions 1 How is the size of a market measured? (2 marks)

2 How is market share measured? (2 marks)

3 What is meant by ‘primary market research’? (2 marks)

4 What is meant by ‘secondary market research’? (2 marks)

5 Explain one reason why a business conducts market research. (2 marks)

6 Explain one factor a business might consider when choosing which method of market research to use. (2 marks)

7 Explain one potential benefit of primary market research compared to secondary. (2 marks)

8 Explain one potential benefit of secondary market research compared to primary. (2 marks)

9 What is meant by ‘qualitative research’? (2 marks)

10 What is meant by ‘quantitative research’? (2 marks)

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Case study

Anna’s GardensAnna Boulton loves gardening. Ever since she was small, she had helped her mother in the garden and she had become something of an expert on fl owers and gardens. To earn money while she was at school, she had helped friends of the family with their gardens by mowing the lawns, weeding and planting new fl owers. She was never short of work to do, although she did not charge very much so never made a lot of money.

After school she had gone to agricultural college and received proper training. Now, she has the offer of a job working for a big chain of garden centres, but she really wants to run her own business if she can. She remembers how easy it had been to get work a few years ago and her mother says there are still plenty of people needing help in their gardens, so she is sure it would work. She had seen some data for the UK while studying for her course that showed the demand for employing gardeners was increasing, so she feels

fairly confi dent of starting up a business where she had grown up. However, it would be quite a risk turning down the secure job at the garden centre to go it alone and she wants to make sure she can earn enough money. She decides to undertake some more market research.

1 What is meant by ‘market research’? (2 marks)

2 Explain two things Anna might want to fi nd out from further market research. (4 marks)

3 Analyse two factors Anna should consider when deciding how to carry out market research. (6 marks)

4 Do you think that, if Anna does some more research, this will guarantee the success of her new business? Justify your answer. (9 marks)

C

234

Topic 5.4

● What is the marketing mix?Think of the last item of clothing you bought. What made you buy that particular product? The chances are that it was a combination of factors. It may have originally come to your attention because you were told about it by a friend or saw a friend wearing it. Alternatively, you may have noticed it in the store by the way it was displayed, or you may have seen an advert. You may have liked the design, the colour or the brand name. Would you have paid anything to buy it? Probably not. Before buying it you probably looked at the price and compared it with other items and clothes you had seen elsewhere. All the different factors that combine to infl uence your decision to buy are called the marketing mix – or the four Ps (see Figure 5.7).

● The elements of the marketing mixProductProduct refers to all the factors relating to the design, the specifi cations and the features of the product. Products such as the Dyson vacuum cleaner and the Apple iPhone have distinctive designs that have attracted a great deal of customer interest. Toyota cars are known for their reliability. McDonald’s burgers are consistent wherever you are in the world. Duracell batteries are long-lasting. Innocent Drinks do not contain any additives. These are all aspects of products that help them to sell. A business may alter its products to increase

Elements of the marketing mix

Topic

A crucial element of a successful business is not only understanding your customers, but also generating demand for your products. In this topic, we examine how fi rms use marketing activities to satisfy customers’ needs.


➜ the meaning of the marketing mix

➜ the elements of the marketing mix

➜ factors that infl uence the appropriate marketing mix.

Price Place

PromotionProduct

Figure 5.7 The four Ps of the marketing mix are interlinked.

Key term

The marketing mix refers to all the activities infl uencing whether or not a customer buys a product. The elements of the mix can be analysed using the four Ps: price, place, product and promotion.

235

5.4 Elements of the marketing mix

their appeal for different customers (for example, Harry Potter books had one cover to appeal to adults and one to appeal to children) but must make sure the money they will earn will cover the costs of doing this.

PromotionPromoting a product means communicating something about it. You might be letting people know your business exists, telling them about a new product or a special offer, or highlighting the difference between what you offer and what else is on the market. There are many ways of communicating about a product, for example, advertising in a local newspaper, advertising online, sponsoring a sports event or using posters around town. The right form of promotion depends on the product. For example, a café might advertise in the local newspaper, whereas a car manufacturer might advertise on national television. Red Bull sponsors extreme sports events, whereas Ryanair relies on a lot of online offers.

PriceThere are many different aspects to pricing. For example, there are the payment terms. Does the customer have to pay the full amount now or can they pay in instalments? Can they pay with a credit card or do they have to pay cash? Can they get a discount if they buy in large quantities? Businesses must also consider what amount the customer will be asked to pay for the product. How does the price compare with that of competitors? All of these factors will infl uence whether a customer thinks a product represents value for money. Good value for money does not necessarily mean it is a low-priced product. Customers may be willing to pay a lot of money for something provided they think the product and brand are worth it. The Xbox is not cheap, but you may think it is good value for money because of all the benefi ts it provides.

When setting its prices, a business will have to think about its costs – it will want to cover its costs to make a profit. However, it must also think about the effect that the price will have on demand. Generally, increasing the price will lead to fewer products being sold; you may make more profit on each one, but if sales fall a lot you can be worse off. Sometimes, it is better to reduce the price. Although the profit per item may be lower, if you sell a lot more you can make more profit. Stores such as Primark and Asda do not make a large profit on each product they sell, but their relatively low prices mean they sell so many items that they make a large profit overall.

PlacePlace refers to the way in which products are distributed. Are they sold direct to customers (for example, via the internet) or via shops? Do they come direct from the factory to the shop or are they bought by a wholesaler fi rst? What are the stores like where they are sold? Apple has some distinctive and elegant stores where its latest products are displayed. Aldi is a more basic store selling cheap, good value food.

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5 Marketing

● Choosing the best marketing mix Managers must make decisions on each of the elements of the marketing mix. However, they must also remember that the different elements of the mix need to work together to be effective. For example, a high-quality product might lead to the selection of a high price, with sales in quite exclusive outlets and promotion to relatively high-income earners.

Business insight

Call of DutyThe Call of Duty video game has been on Amazon’s best-selling lists since 2009. Players are playing a shooting game either individually or against other players around the world.

Analyse the elements of its marketing mix that make it so successful. (6 marks)

The choice of marketing mix will depend on factors such as:➜ The product. Is it distinctive? Is it a product that needs a unique design?

How long does a customer expect it to last? Something unique and long-lasting might justify a higher price.

➜ Competitors’ products. What do they offer and how does it compare with what you have?

➜ The target customers. Who are you trying to sell to? How much do they earn? Why are they likely to buy your product? How much do they need it? What do they do with their time (so you know how to reach them with your promotion)? Some hotels aim to be luxury and have lots of facilities such as a swimming pool, gymnasium, bar and restaurant. Others, such as Travelodge, aim to be more basic and are clean and relatively cheap. These hotels are serving different types of customers and so the marketing mix is adjusted accordingly.

➜ Business approach. Are you trying to match what your competitors do? If so, you might try to develop a similar but cheaper product. Or are you trying to be different from and better than the competition and have more distinctive features? If so, you might be able to justify being more expensive.

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5.4 Elements of the marketing mix

Study tip

Remember that the different elements of the marketing mix must work together. They all combine to make a customer buy a product. If you have an exclusive brand of handbags and shoes, you will want them sold in smart shops at relatively high prices, and you will want to advertise them in fashion magazines. If you sell cheap clothing, you will target price-sensitive customers with your promotion and distribution.

SummaryThe different elements of marketing that affect a customer’s decision to buy a product are called the marketing mix. The marketing mix involves the four Ps: the product, the price, the place and the promotion. The ‘right’ marketing mix will depend on

many factors, such as the nature of the product, the target customers and competitors. ICT has helped small businesses because they can now reach worldwide markets relatively cheaply.

Quick questions 1 What is meant by ‘marketing’? (2 marks)

2 What is meant by the ‘marketing mix’? (2 marks)

3 If you were launching a new shop in your town selling musical instruments, state two ways of promoting it. (2 marks)

4 State two factors that might influence the price of a new product. (2 marks)

5 State two ways of distributing clothes from the manufacturer to the customer. (2 marks)

6 Think of your ideal mobile phone. State two aspects of the product that you like. (2 marks)

7 Think of a brand you like. State two things you think the brand represents. (2 marks)

8 Think of a shop to which you often go to buy clothes. State two reasons why you choose this store. (2 marks)

9 Do you prefer Pepsi or Coca-Cola (or neither)? State two reasons for your choice. (2 marks)

10 Think of a shop you do not go to. State two reasons why you do not shop there. (2 marks)

Business insight

Buying a houseImagine you are looking for a house to buy. How would you fi nd out what is for sale (this depends on promotion)? What features would you look for, such as the number of rooms and the location (this is the product)? What would determine how much it costs (the price)? Would you expect to buy direct from the seller or through an estate agent (this is the place)? The marketing mix is important in infl uencing which house you buy. How do you think the marketing mix would vary for someone looking to buy his or her fi rst house and for a 35-year-old couple, both of whom are working, with two children aged eight and ten?

Analyse the factors that might infl uence your decision to buy a particular house. (6 marks)

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5 Marketing

Case studyFantastic Beasts and Where to Find Them

The fi lm Fantastic Beasts and Where to Find Them was released in cinemas across the UK in November 2016. The fi lm is a spin-off from the Harry Potter books and fi lms. It was written by J.K. Rowling and starred Eddie Redmayne.

The fi lm earned a total of £15.3 million in revenue on its opening weekend in the UK. It also took an

estimated £61 million in North America over the same weekend – more than the rest of the US box offi ce top ten combined.

The opening weekend earnings in the USA and Canada were lower than for any of the Harry Potter fi lms and not as high as two of the Harry Potter fi lms in the UK. The eight Harry Potter fi lms have taken more than $7 billion (£5.7 billion) worldwide. The opening weekend is usually critical in terms of determining the fi nancial success of a new fi lm because the product life cycle is relatively short. However, fi lm companies will try to extend the sales of a fi lm in various ways.

This fi rst Fantastic Beasts fi lm is set in New York and tells the story of a fi ctional author mentioned in the Harry Potter stories. Redmayne plays the role of the animal-loving ‘magizoologist’, Newt Scamander, who visits New York’s secret community of witches and wizards. The fi lm is set about 70 years before the Harry Potter fi lms. J.K. Rowling has plans for a total of fi ve fi lms in the series.

1 State two ways you think a fi lm company could extend the sales of a fi lm such as Fantastic Beasts and Where to Find Them. (2 marks)

2 Explain two factors that might infl uence the price of a cinema ticket. (4 marks)

3 Analyse the ways in which a fi lm company might promote a new fi lm such as Fantastic Beasts and Where to Find Them. (6 marks)

4 To what extent do you think the product is the most important element of the marketing mix for a fi lm? Justify your answer. (9 marks)

C

239

Topic 5.5

● The productThe product is what customers actually buy. Not surprisingly, it is an important element of the marketing mix. If the product is wrong, then it is diffi cult to imagine that the marketing overall will be successful. Customers will be interested in the overall nature of the product. This includes its design, its performance, its features and its reliability. For example, if it is a washing machine, what size is it? What is its capacity? What is its energy usage? What is the brand? What functions does it have? If it is a hotel, which services does it provide? Where is it located? Is there parking? What are the rooms like? Other factors are considered next.

The service If you are buying a product, is it easy to order in store or online? Are the sales staff well informed? Is there any post-sales service? Is there a delivery service? Does the product come with a guarantee?

The performance of the product Does the performance of the product match what was promised in the advert? Is the holiday the same as it was described? Does the item you bought on eBay or Amazon fi t the description online?

The priceDoes the product represent better value for money than the competition? This does not mean it is cheap – people will pay high prices for some products (think of a Ferrari), but the perceived benefi ts have to justify it.

Using the marketing mix: product and pricing

Topic


➜ the importance of product in the marketing mix

➜ the factors infl uencing the price of the product

➜ the signifi cance of price in the marketing mix.

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5 Marketing

Product developmentWhen developing a new product, a business will consider: ➜ The design. What does it offer in terms of features, design, look, ease of use

or reliability compared to competitors? What needs and wants does it fulfi l?➜ The price. What will customers be willing to pay for the product? How

much are the benefi ts worth?➜ The expected sales. What is the likely demand for this product?➜ The cost of development and of production. Given the expected sales and

the price, will this product make a return that justifi es the risk in producing and launching it?

Product differentiationMany businesses will want to make their products stand out as different from the competition – this is known as ‘product differentiation’. For example, Pepsi and Coca-Cola are both cola drinks, but people may regard them as very different products. Manchester United and Manchester City are both football clubs, but to their supporters there is a world of difference. A business may differentiate its products by:➜ building the brand image. Through its logo, its design and its communications a

business will try to differentiate itself from its rivals. For example, JD Sports is more of a fashion business than Sports Direct, although they both sell sports equipment. This is shown by the clothes it stocks, the design of its stores and the way it advertises and promotes itself.

➜ its Unique Selling Point (USP). A business will try to develop some aspect of the product or the service it offers that makes it unique. It could be a feature (‘Made in X’), a service (‘2-hour delivery’) or even a guarantee (‘no-questions-asked refund’).

By differentiating its products a business can hope to attract more sales and may even be able to charge more.

● New productsA business will want to change its products over time as customer needs and wants evolve. For example, Lucozade was originally a drink bought to help people who were feeling ill to recover – you would buy it to take to people in hospital. As the market changed, Lucozade bottles were redesigned, and the advertising changed to focus on it as an energy drink. Businesses may modify the product itself (for example, by changing the recipe of a chocolate bar), its packaging (for example, introducing a family-size pack of a box of cereal) or its promotion (for example, to stress different benefi ts of the product to target a different audience).

Dyson is known for its innovative design and advanced technology in many different product areas, such as bagless vacuum cleaners, air hand-dryers and bladeless fans.

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5.5 Using the marketing mix: product and pricing

Businesses will also want to develop new products to add to their existing ones or to replace them altogether. New product development is an investment and involves quite high risks. This is because many new products do not actually go on to succeed, and the investment may have been wasted.

The stages of new product development The stages of new product development typically follow this process:

1 Generate an idea. This may be a genuinely new idea or simply improving a product that exists.

2 Check the idea. This involves testing the idea to see what it would cost to develop and what possible returns it might earn; this is to check it is fi nancially worthwhile.

3 Develop the product. This will involve testing and putting together different versions of the product to see what works. This can take many years of research and testing to make sure the product works and is safe.

5 Trial the product. A trial launch may be used to see if the sales are as expected.

6 Launch it!

A business may decide not to go ahead with a product at any of these stages because, for example, it is proving more expensive or too difficult than imagined to develop. Even when the product has launched this does not guarantee success – many new products on the market fail and are withdrawn. New product development, therefore, can bring with it a great deal of risk. On the other hand, standing still and not innovating can also be risky.

● Product portfolioWhen a business fi rst starts up it is likely to have only one or two products. As it grows it will usually develop more products. A company like Coca-Cola, for example, sells many different types of drink. The marketing manager of a company will want to check how the products are doing and decide whether anything needs to be changed. This can be done using product portfolio analysis. A ‘portfolio’ is a collection, so a product portfolio analysis looks at a fi rm’s collection of products in order to decide what to do next.

Product portfolio analysis A famous way of analysing a business’s product portfolio is called the Boston Box or the Boston Matrix (see Figure 5.8). This model looks at products in terms of their share of the market and the growth of that market. It consists of four categories of products.

1 ‘Dogs’ are products that have a low share of a low-growth market. They are not doing very well in a market that is not growing very fast. These products are not much use to a business. The business should either get rid of them because they are not selling enough or try to improve them to make them

Key terms

A product portfolio is the collection of products that a fi rm produces.

The Boston Matrix is a way of analysing a product’s share and growth in their market.

A dog product has a low market share in a low-growth market.

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5 Marketing

much more attractive. The drinks Tango and Lucozade were dogs at one point, and then their businesses redesigned the cans and spent millions of pounds promoting them differently to make them successful.

2 Cash cows are products that are doing very well in that they have a high share of the market. The market itself, however, is not growing very fast; this could be because it has already grown and is now as big as it is likely to get. A product like Heinz tomato ketchup is a cash cow. The market for ketchup is quite big but not growing very fast, and Heinz has a big market share. Cash cow products are well known and shops want to stock them on their shelves. Customers know these products and buy them in large quantities.

The name cash cow refers to the fact that, although the product was heavily promoted in the past, the business can now gather revenue from it with comparatively little promotional expense. Given that sales are high, this means that profi ts from the product are very good. Cash cows are great news, therefore, and tend to earn lots of money for the business. The business should use the money earned from cash cows to develop products for the future.

3 Question marks are products that have a small market share of a fast-growing market, for example, a new brand in the computer games market. These products could turn out to be very successful, and the market is attractive because it is growing so fast. However, the business cannot be sure whether or not the product will succeed (that is why they are like a problem child – they may turn out well, but they may not). Businesses need to spend money promoting and developing question marks to make sure they are successful. The money for this could come from the revenue from cash cows.

4 Stars are products that have a big share of a fast-growth market, like the Sony Playstation or Apple iPhone. Star products are doing well in an attractive market. Businesses need to keep improving and promoting stars with the aim of turning them into the cash cows of the future.

Market share

Mar

ket

gro

wth

High

Hig

hLo

w

Stars Question marks

DogsCash cows

Low

Figure 5.8 The Boston Matrix

Key terms

A cash cow product has a high market share in a low-growth market.

A question mark product has a low market share in a fast-growth market.

A star product has a high market share in a fast-growth market.

Maths moment

Complete Table 5.4 to identify the type of product in the Boston Matrix.

Product’s market share

Market growth rate Type of product

70% 25%

0.001% 0.1%

0.005% 30%

65% 0.2%

Table 5.4 Identifying products in the Boston Matrix

243


A balanced portfolio All businesses want a balanced portfolio of products. This means they will want an appropriate mix of different types of products: the cash cows provide ongoing fi nance that can be used to develop new products (question marks and stars) for the future.

Problems arise if a business has too many cash cows. If there aren’t enough products in growing markets, the firm should worry about the future. Equally, if a firm has a high number of question mark products, then it is taking a risk as it is likely that some of these may not succeed. Businesses pursuing only new products may run out of money if they do not have cash cows to provide valuable finance.

Product life cycleProduct portfolio analysis looks at all of a business’s products to take an overview of how things are going. However, managers will also want to track the progress of each individual product over time, monitoring sales from the launch until a decision is taken to stop production. The product life cycle model describes the typical stages a product goes through during its life. Each product is likely to go through fi ve main stages.

1 Development. In this initial stage, the idea for the product is developed and tested to see if it will work. This may involve building a prototype (a trial version). James Dyson built over 5,000 prototypes of his vacuum cleaner before he got it right. New medicines are tested for many years before they are allowed to be sold to the general public. During the development stage, businesses spend money but have no money coming in because there are no sales.

2 Introduction. Introduction is when the product is launched and sales begin. It can involve a lot of expenditure on promotion and publicity. At this stage, a business needs to convince distributors they should stock the new product

Key term

The product life cycle shows how the sales of a product may change over time.

Business insight

Procter and Gamble has some of the best-known brands in the world, including Ariel, Crest, Tide, Vicks, Olay, Gillette, Braun, Bold and Head and Shoulders.

Analyse the benefi ts to Procter and Gamble of having a portfolio of products. (6 marks)

Analyse the elements of its marketing mix that make it so successful. (6 marks) Safeguard, another well-known Procter

and Gamble product

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5 Marketing

rather than existing brands – this can be diffi cult as they will not want to take a risk.

3 Growth. Growth is experienced when the product starts to sell faster. People are beginning to buy more of it and it is becoming successful. A business may need to fi nd more outlets for the product at this stage.

4 Maturity. At this stage, the sales rate begins to slow down. Perhaps a competitor has launched something similar that is affecting sales, or perhaps customers simply want something new. During maturity, a business should consider introducing some different versions of the product to keep sales up.

5 Decline. Decline occurs when sales start to fall. Businesses need to make diffi cult decisions at this stage. Should sales be boosted again by spending more on marketing, or should the product be taken off the market?

Variation within the product life cycleThe length of time it takes for the life cycle to move from development to decline can vary enormously from product to product. Some products, such as new cars or new planes, will spend years just in the development phase. Some products, such as a new fi lm, can be launched and enter the decline phase within weeks. Some brands have been around for many years (think of Kellogg’s Corn Flakes, Coca-Cola, Ford and Cadbury Dairy Milk); other products last for only a few years.

The marketing mix changes at different stages of the product life cycle. For example, during the introduction stage, promotion may focus on making people aware that the product exists. Over time, promotion may start to concentrate on why the product is better than the competition. A high price may be set during the launch, particularly if the business is using price skimming (for example, if demand is very high initially). Over time, the product price may need to come down in order to keep sales growing.

Extension strategiesIf possible, a business will want to stop sales falling and avoid the decline phase of the product life cycle. Extension strategies make this possible.

Extension strategies include:➜ cutting the price to make the product better value for money➜ spending more on advertising to make the product more popular➜ updating the packaging of the product➜ adding more or different features➜ trying to get people to buy more of the product; for example, shampoos say

on the label that you should always wash your hair twice ➜ trying to get people to buy the product on more occasions; for example, we

tend to buy turkey mainly at Christmas in the UK – could you get people to eat it at other times during the year?

➜ trying to fi nd new customers; for example, a business might try to target a new market by selling its product abroad.

Study tip

Remember that the marketing mix will change at the different stages of the product life cycle. For example, you might launch with a high price if demand is high for a new product; over time the price may be lowered to increase sales. When a product is fi rst launched, the promotion might focus on raising customer awareness; once it is established, the promotion may focus on the product’s benefi ts compared to those of competitors.

Key term

Extension strategies are attempts to maintain the sales of a product and prevent it from entering the decline stage of the product life cycle.

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● Introduction to pricingWhenever we buy something we are usually interested in the price. How much does it cost? Is it worth the money? Can we afford it? We don’t always buy the cheapest product, but we do look for the best value for money. For example, we might buy a shirt that is more expensive than another because we like the design and the brand. There are some brands we would not want to buy however cheap they were. (Can you think of an example?) We are, therefore, very interested in the price in the context of the other elements of the mix. Get the price wrong, for example, by making it too high given the quality of the product, and a business’s sales will suffer.

Price and demandIn general an increase in price is going to lead to a fall in the quantity demanded assuming nothing else has changed. However, the extent to which sales fall can vary signifi cantly. If a product has a strong brand image or a USP, it may be that the fall in sales is relatively small compared to the price increase. This is why businesses try to differentiate their products to make demand less sensitive to price increases. If the fall in sales is relatively small, a business can actually make more revenue with a higher price.

In other cases demand may be very sensitive to price. If, for example, a customer has many cheaper and similar products to choose from, then if one firm puts its prices up sales may fall significantly. In this situation a business may decide to reduce its prices to try and gain significant numbers of customers from rivals. Businesses such as Poundland, for example, use lower prices to attract large numbers of customers.

Business insight

McDonald’sMcDonald’s sales have recently been higher than expected due in part to an improvement in its all-day breakfast menu. The company has been launching a number of initiatives to boost sales. For example, it has introduced new items to its all-day breakfasts, including biscuits, McMuffi ns and McGriddles.

McDonald’s is also keen to target younger consumer segments, many of whom are choosing other businesses they see as more premium such as Shake Shack.

Analyse the marketing actions McDonald’s might take to boost its sales. (6 marks)

Business insight

MarsThe MARS bar has been on sale since 1923. Over 3 million are produced every day at the UK Mars factory in Slough.

Analyse the actions a business such as Mars might take to prevent sales of one of its products falling. (6 marks)

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Maths moment

1 The price of a product is £10 and sales are 200 units. Imagine the price increases to £18 and sales fall to 198 units, i.e. demand is not very sensitive to price.

(a) Calculate the revenue of the business originally and following the price increase.

(b) What does this suggest a business might want to do if demand is not very sensitive to price?

2 The price of a product is £10 and sales are 200 units. Imagine the price increases to £11 and sales fall to 100 units, i.e. demand is very sensitive to price.

(a) Calculate the revenue of the business originally and following the price increase.

(b) What does this suggest a business might want to do if demand is very sensitive to price?

Types of pricing decisionThere are many ways of pricing products. The following gives a summary of the ways a product may be priced.

Price skimmingPrice skimming is when a high price is set for a product when it fi rst enters a market. This strategy is used when there is high demand. For example, when a business launches a new computer console or a new model of laptop, it hopes that there will be people who are desperate to buy this product. It, therefore, sets a high price knowing that this group of people will be willing to pay it (ideally they are queuing up outside the shop waiting for the new product to be released). We can say that such buyers are not sensitive to price.

Price skimming helps businesses to obtain the money needed to repay development costs. Once the first group of customers has paid the high price, the price is then reduced in order to attract new customers who need a lower price to get them interested. With a price skimming approach, the price starts high and is gradually reduced over time. The strategy works best if the product is unique in some way and, therefore, people are willing to pay more.

Price penetrationThis approach is used to launch a product with a low price in order to get sales quickly. Penetration pricing is a way of trying to get market share very quickly and of trying to establish a product as the market leader. The strategy works best if customers are very sensitive to price. By producing on a larger scale, a business may get its name known quickly and may also benefi t from lower costs by buying supplies in bulk and from other economies of scale.

Key terms

Price skimming is setting a high price for a product when it fi rst enters the market.

Penetration pricing is launching a new product at a low price to achieve fast sales.

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Competitive pricingBusinesses using competitive pricing try to match the price that others are charging. This approach is used a lot by supermarkets and insurance companies, which openly compare their prices with those of other businesses to show customers that they offer good value. Competitive pricing is common in markets where there are a few big fi rms competing directly against each other and where customers can compare their products easily. If the products are similar, then the price becomes an important factor that will infl uence a customer’s decision to buy the product.

Loss leaderA business sometimes sells a product at a loss, called a loss leader, so that the customer will buy more of something else where the fi rm makes a profi t. For example, a company might sell computer printers cheaply and then charge a lot for the ink cartridges. Similarly, a company might sell razors cheaply and charge a lot for replacement blades. Supermarkets also use this approach by selling some products at a loss and advertising these in the shop windows. This gets customers into the shop, and the supermarkets then hope they will buy some of the higher-priced items.

Cost plus pricingCost plus pricing is an approach that aims to ensure the business covers its costs and makes a profi t. It works by calculating the costs of providing the product and adding a percentage on to this to decide on the price. This is known as mark-up. Mark-up is the amount added on to costs to determine the price. For example, if an item costs £10 and you add on 20 per cent you will sell it at £12. Cost plus pricing is quite common for retailers. They buy at a certain price, add on a percentage and then sell it on. This approach is simple to apply but does not take account of demand in the market – it does not directly consider what people are willing to pay.

Key terms

Competitive pricing is matching the prices that competitors charge.

A loss leader is a product sold at a loss in the hope that the customer will buy other items from the business where they make a profi t.

Cost plus pricing is where products are priced by covering the cost of it to the retailer and adding a percentage on top.

Business insight

Apple The Apple iPhone 7 was launched in 2016 and sold for around £600 for the cheapest option.

Analyse the factor that might have affected the price originally set for the Apple iPhone 7. (6 marks)

Analyse the reasons why the price of the iPhone 7 might have changed since it was launched. (6 marks)

Maths moment

Imagine you buy an item at £20 and add on 25 per cent.

To calculate 25 per cent of £20 we use:

25

100 × £20 = £5

The new price will be £20 + £5 = £25.

What if the mark up is 30 per cent? What would the price be?

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● Factors influencing the price

Demand

Costs

Strength ofthe brand

Stage in theproduct life

cycle

Competitors'pricing

The business'sobjectives and

approach topricing

Nature of themarket and rest ofthe marketing mix

Factorsinfluencing

the price of aproduct

Figure 5.9 Factors that influence the price of a product

The price of a product depends on many factors.

CostsTo make a profi t, the price must cover the costs. There are fi xed costs (such as rent) and variable costs (such as materials and components).

DemandDemand determines what people are willing and able to pay for a product. If demand is high, then a business can increase the prices it charges. If demand is low, the business will probably have to lower the prices of the product. In 2008, the UK economy was not doing well and many people lost their jobs or had lower incomes. Many businesses had to cut their prices to sell their products.

The nature of the marketIf a market contains many fi rms selling similar products then prices have to be competitive. In such markets, customers can directly compare the prices being offered by rival fi rms and will choose to buy from the cheapest. Offering a product that is very different from the competition gives the ability to charge more.

A business’s objective and approach to pricingIf a business aims to gain a large share of the market and to make its product well known, then it may use penetration pricing and have a relatively low price. If it aims to promote its product as very high quality and top of the range, it will probably charge a high price.

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Position in the product life cycleThe price that can be charged will probably change at different stages in the product life cycle. For example, when demand is rising fast in the growth phase, it is probably feasible to keep the price high. When demand falls in the decline phase, the price may need to be reduced.

Rest of the marketing mixPrice is just one element of the marketing mix and must fi t with the other elements. Clothes with a well-known fashion design label, which are sold in exclusive shops in London and are promoted in expensive fashion magazines, should have a high price to fi t with the rest of the mix. If the product is mass-produced, basic and sold in many outlets next to other similar brands, then the price is likely to be more competitive.

Study tip

Many different factors infl uence the price of a product. You will need to think about the precise context of the business. Does it have an innovative product? If so, the price might be high. Is it a basic product? If so, the price may be lower. Is the owner keen to get a lot of sales quickly or not? The right price will depend on the position of the business.

Business insight

AldiAldi is a discount store. It sells fewer types and brands of products than some other supermarkets, such as Sainsbury’s and Tesco, but buys these in bulk so it can get them for lower prices. It has sites in cheaper locations outside city centres to keep rents down. It does not have that many refrigerated items because these are expensive to store and its displays are basic. Aldi aims to offer a limited range of products at low prices.

Analyse the reasons why other supermarkets do not charge prices as low as Aldi. (6 marks)

SummaryAs a business grows, it will have many new products and managers need to think about what price they will charge for these. There are many options, such

as price skimming and penetration pricing. The right price depends on factors such as the costs, demand and competitors.

Quick questions 1 What is meant by a ‘product portfolio’? (2 marks)

2 What is a ‘cash cow’? (2 marks)

3 What is a ‘dog product’? (2 marks)

4 Explain the stages of the product life cycle. (4 marks)

5 What is an ‘extension strategy’? (2 marks)

6 What is meant by ‘price skimming’? (2 marks)

7 What is meant by ‘penetration pricing’? (2 marks)

8 Explain one factor that might influence the price of a product. (2 marks)

9 The costs of producing a product are £30. The mark-up is 20 per cent. What is the selling price? (2 marks)

10 The cost of a product is £12. The sales price is £15. What is the percentage mark up? (2 marks)

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Case study

RyanairThe budget airline Ryanair expects its average fares to fall by 7 per cent this year as it cuts prices to increase its market share when faced with increasing competition. Analysts said rival airlines were likely to follow Ryanair’s lead. The price cuts were made as Ryanair announced 43 per cent rise in its profi t to €1.2 billion for the year.

The CEO of Ryanair said that if others now cut their price, Ryanair would cut its prices even further. Rival airlines include British Airways' owner IAG, Lufthansa and Air France-KLM. Ryanair uses a ‘load factor active/yield passive’ model; this means that it will cut fares as much as is needed to keep its aircraft full and capacity utilisation high.

Despite the fare cuts, Ryanair said it expected profi ts for 2017 to rise 13 per cent, with falling fares balanced by an increase in passenger numbers. But falling fares could hit profi tability in 2018.

1 What is meant by 'market share'? (2 marks)

2 Explain one factor other than price that might affect whether customers choose a particular airline. (4 marks)

3 Analyse the factors that might infl uence demand for travel. (8 marks)

4 To what extent do you think Ryanair is right to lower its prices? (12 marks)

C

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TopicTopic 5.6

● Introduction to promotion The marketing mix is made up of the four Ps: the price, the product, the place (distribution) and promotion. Promotional activities are ways of communicating about the business and its products.

A business may communicate about its products in order to:➜ inform customers about the business➜ try to persuade customers to buy a product➜ remind customers of the advantages of a product.

Types of promotional activityThere are many ways of communicating with customers, such as:➜ Advertising. Advertisements can appear on television, in magazines, in

newspapers and on posters. These forms of communication have to be paid for. Advertisements can occur in many forms. For example: ➜ in print such as newspapers, magazines and billboards➜ online ➜ on the radio ➜ on television and in cinemas➜ on vehicles such as buses.

Key term

Promotional activities are the different ways in which a fi rm tries to communicate with its customers.

Promotion and distribution

In this section we look at promotional and distribution activities in more detail and consider their importance to a growing business.


➜ how promotional activities enable growth

➜ how to select the right promotional mix

➜ infl uences on distribution

➜ the importance of distribution.

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➜ Sales promotions. These are short-term incentives to encourage customers to buy the product. They include:➜ discounts – reducing the price to give more incentive to buy➜ buy one get one free offers ➜ competitions and coupons➜ point of sales displays, i.e. in-store displays to attract buyers➜ free gifts ➜ free samples.

➜ Public relations activities. These are the actions used by a business to arrange free media coverage of its activities and/or products. The boss of Virgin, Richard Branson, is very good at getting coverage of his business for free. When he opens a new store, for example, he often puts on a big show that gets media coverage; this is cheaper than advertising. Similarly the boss of Ryanair often says controversial things to get coverage of his brand. The problem with public relations is that you cannot control what will be said by the media.

➜ Personal selling. Many businesses will have a sales force to help promote their products. Members of the sales team might visit different stores to get them to stock their products. They will let the businesses know about new offers, new products and the benefi ts of their products compared to those of competitors.

Business insight

Red BullThe Red Bull energy drink is sold all over the world. Over 4 billion cans are bought each year. Rather than spend millions of pounds on traditional poster or television advertising, Red Bull uses a range of different promotional activities. For example, it sponsors extreme sports events such as

snowboarding, cliff diving and surfi ng. It also gives cars featuring large Red Bull cans to students to drive around universities and get others interested. Its slogan is Red Bull ‘gives you wings’.

Analyse the possible reasons why Red Bull uses these different forms of promotion rather than the more usual advertising. (6 marks)

● What is promotion used for?Promotional activities are about communication. Businesses may want to communicate to:➜ inform customers or remind them about some aspect of the product; for

example, a business may want to announce that it has a new product on the market, or it may want to remind you about an event

➜ create or increase sales; a business may want to try and promote more sales by telling potential customers about a special offer or sale

Maths moment

A business sets a promotional budget of 5 per cent of expected turnover. Its expected turnover is £2 million.

What is its promotional budget?

Key terms

Sales promotions are short-term incentives to encourage customers to buy.

Advertising involves paid for communications.

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5.6 Promotion and distribution

➜ create or change the image of the product; to extend sales a business may want to change customers’ perceptions of a product; for example, it may want customers to think of it as a more premium product and worth paying extra for

➜ show the benefi ts of a product; a business may want to explain why its product is so good; this can involve highlighting what its particular strengths are; for example, how it is more effective than it used to be or better than the competition.

Factors influencing the promotional activities of a growing business

Nature of themarket

and product

Factorsinfluencing the

promotionalmix

Targetaudience

Competitors’actions

Finance

Figure 5.10 Factors that influence the promotional mix

The following are factors that infl uence how the promotional mix is used.

Costs and fi nanceSome forms of promotion are much more expensive than others. Advertising on television is more expensive than advertising in a local newspaper. The amount of fi nance a business has available can affect the different forms of promotion it can afford.

Target marketIf a business is trying to communicate with people all over the world, then the internet might be a good form of communication. A local newspaper, by contrast, is not appropriate because it will not reach enough people. For a business simply trying to reach a local audience, national television is too expensive and not targeted enough; local radio might make more sense. Businesses also need to think about what their target audience does. What do they read? What do they watch? What do they listen to? Only when you understand their habits will you know the best way of reaching them.

Key term

The promotional mix is the combination of promotional methods used by a business to communicate with its customers.

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5 Marketing

Competitors’ actions If competitors are very visible in terms of advertising, there may be pressure on a business to respond to this. If competitors run a particular promotional campaign very successfully, a business may want to adopt similar promotional methods.

Nature of the marketFactors such as the size of the market, the total amount spent in the market and where customers are based will all affect the best way to promote the product. For example, if the market is a mass market with many sellers, forms of promotion such as television advertising may be cost effective. If the market is relatively small, then this would not justify the costs of such a campaign. In this situation a business may rely more on other incentives. If customers are located in a relatively clear area, then a poster campaign might work, but if they are located in very different areas, this might not be a particularly good way to reach them. If they are price sensitive, discounts might work. If price is not a key issue, a gift might be better.

Nature of the productThe brand image and type of product may infl uence what promotion is suitable. For example, if a product is a premium brand, then discounting the price, having competitions or two for the price of one would not fi t with the brand and customers’ perceptions. A two for the price of one offer may work well for fast food restaurants.

Reasons for promotion

Reasonsfor

promotion

Toinform

Toremind

Topersuade

Figure 5.11 Reasons to use a method of promotion

Choosing the right method of promotion is very important for any business. If you want to communicate with words, sound and pictures, then television is a good form of communication. If you only need words and images, then a poster campaign can work. Every form of communication has advantages and disadvantages. For example, a printed advert can be read several times, whereas a radio advert may only be heard once. On the other hand, someone may remember sounds more than they would notice a printed advert. A growing business may be able to afford promotional activities that have a variety of communication methods.

Study tip

The right mix of promotional activities depends on a number of factors and you will need to think about the context of the business. Is it trying to reach high-income earners? Young people or old people? How much money does it have to spend?

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Overall, when selecting which promotional activities to undertake, businesses need to think about:➜ the coverage of a promotion – how many people will see it?➜ the quality of the promotion – how effective is it likely to be?➜ the cost➜ the different media options – for example, print, fi lm or sound.

Business insight

Eggxactly

An Eggxactly, a waterless egg cooker

The Eggxactly was designed by James Seddon. James often overcooked his daughter’s boiled eggs and decided that cooking eggs should be as easy as making toast. He experimented a lot and then came up with the idea of using soft stretchy heating elements instead of boiling water. By stretching the elements over the egg and controlling them with a

microprocessor, he was able to cook eggs accurately and just the way his daughter likes them.

Although the idea seems relatively simple, the technology has proved diffi cult to develop in a way that can make a high enough fi nancial return. It has taken over ten years since the idea was launched on the BBC TV show Dragons' Den in 2006 to bring the product to the market.

The product is now ready to launch with a retail price of around £30.

Eggxactly claims to use just 1 per cent of the energy required to cook an egg in a pan with water. The inventor claims that most people use a pint of water to boil an egg; if you have an egg a day, the Eggxactly pays for itself within a year!

Source: www.eggxactly.com

Analyse the ways in which Eggxactly might be promoted. (6 marks)

● The distribution channel The marketing mix is made up of the four Ps: price, product, promotion and place. By ‘place’ we mean the way in which the product is distributed. The distribution channel (or chain of distribution) describes how the ownership of the product passes from the producer to the fi nal customer. The distribution channel may include the following:➜ Producers. A producer supplies goods or services. For example, Cadbury

produces chocolate and Direct Line provides insurance.➜ Wholesalers. Wholesalers buy products from producers in bulk and supply

in smaller quantities to retailers (this is known as ‘breaking bulk’). Some wholesalers sell through cash and carry stores. These are warehouses where goods are displayed for retailers to choose the products they want. Wholesalers can offer advice and transport services to retailers. Selling to a few big wholesalers reduces the transport costs for manufacturers (because it is a lot cheaper than transporting to lots of retailers). It also means the manufacturer has fewer deals to negotiate.

Key terms

The distribution channel describes how the ownership of a product passes from the producer to the fi nal customer.

Wholesalers break bulk; they buy in large quantities from a producer and sell to retailers.

http://www.eggxactly.com

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5 Marketing

➜ Retailers. Retailers are the shops that sell goods and services to the fi nal customers. Supermarkets such as Asda, chain stores such as Waterstones, franchises such as McDonald’s and small independently owned shops are all examples of retailers who are at the end of the chain of distribution. Some services (insurance, for example) are sold through other outlets and online such as branches of banks and building societies.

Connecting the distribution channel The following are ways that the distribution channel connects to the customer.➜ Mail-order businesses. Mail-order businesses produce catalogues and

customers order from these. The businesses do not have physical retail outlets.

➜ Telesales. This is where businesses sell their products over the telephone. They may telephone people hoping to convince them to buy their product (for example, double glazing) or simply take orders over the telephone rather than having a shop.

➜ Online selling via e-commerce and m-commerce. Many businesses now sell a range of producers’ products online. This is called e-commerce. Think of Amazon, Zappos, ASOS and eBay. They do not necessarily have a physical shop where people can go – they simply have a website where orders can be placed in the same way that customers place orders from a mail-order catalogue. The rapid growth in the use of smartphones means that more online selling is via mobile phones; this is called m-commerce. Many retailers now have physical stores and an online operation as well. This gives customers different ways of accessing products. In some cases businesses offer click and collect services so customers can order items online and pick them up in store. Providing physical and online options is known as a ‘multi-channel’ operation.

Mail order, telesales and online selling are all examples of direct marketing. The business sells direct to the customer.

Advantages Disadvantages

Customers can order any time Need to be able to distribute to a much wider range of destinations; logistical and cost issues

Customers can order from home Need to be able to handle returned goods; because customers cannot try on or touch items, they are more likely to return them

Customers can order from anywhere in the world potentially

Need to ensure the security of the site and protect customers' data; logistical and cost issues when distributing overseas raises the price of products and can impact on competitiveness

Table 5.5 Advantages and disadvantages of e-commerce and m-commerce

Key terms

Retailers are shops that sell direct to the customer.

E-commerce involves online trading.

M-commerce involves online trading via a mobile phone.

Direct marketing occurs when there is a direct link from the producer to the customer with no intermediaries.

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Levels of distribution Wholesalers and retailers are parts (or intermediaries) of the distribution channel. They are organisations that provide a service and help get the products from the producer to the customer.

There are various types of distribution channel:➜ Zero level. This means there is no intermediary between the producer and

the customer. The maker of the product sells direct to the fi nal buyer. Dell computers used to sell only online so they dealt with the customers directly.

➜ One level. This occurs when there is one intermediary between the producer and customer. For example, a business may sell to a retailer who then sells to the customer.

➜ Two level. This occurs when there are two intermediaries between the producer and the customer. For example, a producer sells to a wholesaler who sells to a retailer who sells to the customer. A wholesaler buys from a number of businesses in bulk. A retailer then buys a combination of products from the wholesaler to stock for the customer. It is easier for the retailer to go to the wholesaler than to contact many different producers directly.

Advantages of using intermediaries in the distribution channelA producer can access many thousands of customers by selling to retailers that then distribute to their own stores, or by selling to wholesalers that then sell them on. The intermediaries help to distribute the products widely and can save the manufacturer the costs of trying to distribute direct to many different customers in many different places.

By selling its products in other businesses’ stores, the producer enables the customers to compare what is on offer. If you only produced one brand of washing machine, for example, it is unlikely you could operate your own retail stores for these profitably. Customers want to go somewhere to compare a range of different brands.

Disadvantages of using intermediaries in the distribution channelIntermediaries will want to make a profi t so the price is increased at each stage. This makes the fi nal product more expensive than if the producer sells directly to customers.

By selling the product on to someone else, the producer loses control. An intermediary can promote the product as they choose – the producer may not approve of their displays, descriptions, or even their store layout.

Selecting the right channel of distributionIn order to select the right channel of distribution, businesses need to think about the following:➜ Costs. What are the costs of distributing via other intermediaries compared

to selling directly?

Key term

An intermediary is a link in the distribution chain between the producer and the customer.

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5 Marketing

➜ Lack of control. To what extent does this matter? In the case of some products, the way the shop looks, the way the products are displayed and the way the brand is described are very important, for example, exclusive fashion labels. The producers of such goods might want to sell through their own stores rather than handing over to someone else. In the case of newspapers or mint sweets, the nature of the store may not matter as much, so using intermediaries does not create problems.

➜ The product. Some products, such as milk and chewing gum, are called convenience products. Customers will not travel very far to buy them; they will go to the nearest store. In order to sell, convenience goods need to be distributed widely in lots of shops. You could not rely on your own shops for these as there would not be enough different products on offer. Other products are more ‘speciality items’. These are products that customers do not buy very often and which are often expensive and not widely available. Customers will travel some distance to fi nd these and when they get there, the nature of the store and the training of the staff will be very important. Examples include expensive music systems, fashion brands or sports cars. These products will probably be distributed in a few specialist stores, possibly owned by the producer.

Business insight

BetterwareBetterware is one of the UK’s most successful home shopping companies. It is best known for its extensive homeware and housecare cleaning products, although its range has grown over the years to include gifts, personal care and beauty, as well as outdoor products. It has over 5,000 distributors who visit houses door to door and has

a purpose-built offi ce and warehousing complex in the Midlands that handles around 5 million customer orders every year. Customers can order products through the network of distributors, by post, or over the phone and online.

Analyse the advantages and disadvantages for Betterware of having a door-to-door sales force. (6 marks)

Many businesses use a range of distribution channels. Can you think of products that you can buy through more than one distribution channel, for example, direct from the producer and via their own retail outlets? Using more than one distribution channel may increase sales and reduce the risks if there was ever a problem with one of the channels.

Importance of getting distribution rightGetting the right distribution can infl uence the success of the business because it can affect:➜ Sales. If a product is not available when and where customers want it, they

may buy something else instead.➜ Image. If a product is sold in the wrong place then it may damage the brand

and affect its sales over time. Perfume companies such as Chanel will not allow their products to be sold in some stores (such as Superdrug) because they think it cheapens the value of the brand.

259


➜ Costs. How a product is distributed will affect costs and the fi nal price. The more intermediaries there are, the higher the fi nal price because all the fi rms involved want to make a profi t.

The internet and distributionThe growth of the internet has made it much easier for businesses to reach their customers directly. By using company websites, customers may be able to order from anywhere in the world, 24 hours a day. This makes direct distribution much more possible than it was in the past. Why go to a retailer if you can buy direct from the manufacturer? There are advantages to the customer of using a retailer, such as the advice received and the range of different brands on offer, but the disadvantage is that retailers are likely to be more expensive. The future is likely to see a further increase in direct zero-level distribution channels.

Study tip

The ‘place’ is often forgotten when students write about the marketing mix – they nearly always focus on promotion and the importance of advertising. But place can be crucial. When you are hungry and want a snack, you go to the nearest shop to buy something. You immediately see a brand of crisps you like and buy a packet. Just think how important it is to get these crisps into thousands of shops all over the UK and displayed in a good place. If that brand was not there, you would simply have bought something else. Good distribution is essential for you to buy it.

SummaryAs a business grows, it will have more customers and will look for different ways of delivering its products and services to them. This may be via intermediaries such as wholesalers or retailers or via online sales.

Choosing the right distribution channel depends on many factors, such as the nature of the product itself, the costs, the actions of competitors and where the customers are based.

Quick questions 1 Describe two types of promotional

activity. (2 marks)

2 Give two examples of messages that a business might want to communicate to its customers. (2 marks)

3 State two advantages of advertising in a newspaper compared to radio advertising. (2 marks)

4 Explain one factor that might affect the type of promotion that might be chosen by a business. (2 marks)

5 Explain one way the internet changed the way in which businesses can promote their products. (2 marks)

6 What is meant by a ‘distribution channel’? (2 marks)

7 What is the difference between a wholesaler and a retailer? (2 marks)

8 What is meant by ‘m-commerce’? (2 marks)

9 Explain one benefit of distribution directly to customers. (2 marks)

10 State two reasons firms sell through intermediaries. (2 marks)

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Chapter review – MarketingRead question 1, the sample answers and the examiner’s comments. Then try question 2.


➜ Item AWhitbread plc is the UK’s largest hotel, restaurant and coffee shop operator. It has 50,000 employees and serves millions of customers both in the UK and overseas. Whitbread plc’s product portfolio includes Costa coffee shops, Premier Inn hotels and restaurants such as Brewers Fayre, Beefeater Grill and Table Table.

In 2016, Whitbread plc announced an increase in profi ts. This increase was helped by growing sales at Costa coffee shops and its Premier Inn hotels. Costa has seen amazing growth in recent years.

Case study

ZalandoIn Westphalia in Germany there is a warehousing facility the size of 13 football pitches. This is the logistics centre of Zalando, Europe’s biggest online vendor of clothing and footwear. Inside the warehouse, staff are packing boxes with shoes, clothes and accessories on a 14-kilometre conveyor belt where they are weighed, sorted and labelled. They are then distributed to 15 countries. Zalando ships over 55 million orders (that is over 100 per minute) from three of these warehouses each year.

The company was set up by David Schneider and Robert Gentz in their Berlin fl at in 2008 where they sold fl ip-fl ops online. While sales of clothing in physical stores are fairly fl at, online sales are increasing by around 15 per cent a year in the countries where it is operating.

Selling fashion clothing and accessories is not easy. Around half of what Zalando sells (in terms of the value of sales) is returned because it is the wrong style or does not fi t. Customers can order as much as they like and have 100 days to return items at no cost. The company is even trialling collecting returns from customer’s homes and offi ces.

Zalando has relationships with 1,500 brands that supply 150,000 articles. It sells mostly well-known labels. Another online fashion retailer, ASOS, sells only 850 brands of clothing and shoes and relies heavily on its own label. One appeal for retailers and brands is that Zalando saves them from having to invest in e-commerce themselves.

Zalando argues that Amazon is targeting a more price-conscious shopper, whereas it is targeting a higher-value, more brand-conscious segment. The company believes that for such customers, shopping for clothes, shoes and accessories is an emotional activity; shopping on Amazon is just a transaction. ‘Amazon lists prices, we give advice,’ says Zalando.

1 What is meant by ‘e-commerce’? (2 marks)

2 Explain what is meant by targeting a ‘higher-value, more brand-conscious segment’? (4 marks)

3 Analyse how Zalando might promote its services. (6 marks)

4 To what extent do you think e-commerce is a good distribution channel for all businesses? (12 marks)

C

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The company says that the success of its brand has been due to its ability to consistently deliver great value for money. It claims this is due to a combination of service, price and quality of the product. Whitbread plc plans to open between 230 and 250 new Costa coffee shops worldwide, as well as 3,700 new Premier Inn rooms in the UK. It is also developing new premium coffee products to sell in Costa, introducing a new fresher food range and making good progress rolling out Costa Drive Thru formats.

Both Costa and Premier Inn have had to cope with higher wage costs due to government legislation that increased the National Minimum Wage in 2015. Costa has also had to cope with higher costs to buy in the coffee. Costa is, therefore, considering an increase in the price of its coffee. This means customers are going to have to pay much more for their coffee or Costa is going to have to absorb some of the costs.

(a) What is meant by ‘profi t’? (2 marks)

(a) Profi t is calculated using the equation total revenue − total costs.

This is a precise, focused answer to the question.

(b) Explain why Costa is developing new products such as Drive Thrus and more premium coffee and food products. (4 marks)

(b) Costa wants more sales. The Drive Thrus and premium coffee will attract customers. This means they will sell more. If they sell more, they can make more profi t. New products bring customers. Customers bring sales. Sales bring profi ts.

This answer has some value in that it identi� es that new products are launched to boost sales. However, the point is not explained. Why has the business developed these products? For example, customers tastes are changing and people want more convenience; this is why Drive Thrus are proving more popular. Or with growing competition in the coffee market, Costa needs to differentiate its product and producing premium coffee helps do this.

(c) Analyse the benefi ts to Whitbread plc of having a portfolio of products. (8 marks)

(c) A portfolio of products is a collection. Whitbread has hotels, coffee shops and restaurants. This means it operates in different markets which can help to spread risks. If there are falls in demand for hotels, for example, the demand for coffee shops may still increase, reducing risks for the business. These businesses are all to do with serving food and drink and serving customers so they have something in common and can share some experiences and resources. However, the fact they have different customers means the business can spread risks.

This answer shows a clear understanding of the product portfolio.

(d) Analyse the case for and against Costa increasing the price of its coffee. Based on your analysis, recommend whether increasing its price is a good idea. (12 marks)

Chapter review – Marketing

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The company says that the success of its brand has been due to its ability to consistently deliver great value for money. It claims this is due to a combination of service, price and quality of the product. Whitbread plc plans to open between 230 and 250 new Costa coffee shops worldwide, as well as 3,700 new Premier Inn rooms in the UK. It is also developing new premium coffee products to sell in Costa, introducing a new fresher food range and making good progress rolling out Costa Drive Thru formats.

Both Costa and Premier Inn have had to cope with higher wage costs due to government legislation that increased the National Minimum Wage in 2015. Costa has also had to cope with higher costs to buy in the coffee. Costa is, therefore, considering an increase in the price of its coffee. This means customers are going to have to pay much more for their coffee or Costa is going to have to absorb some of the costs.

(a) What is meant by ‘profi t’? (2 marks)

(a) Profi t is calculated using the equation total revenue − total costs.

This is a precise, focused answer to the question.

(b) Explain why Costa is developing new products such as Drive Thrus and more premium coffee and food products. (4 marks)

(b) Costa wants more sales. The Drive Thrus and premium coffee will attract customers. This means they will sell more. If they sell more, they can make more profi t. New products bring customers. Customers bring sales. Sales bring profi ts.

This answer has some value in that it identi� es that new products are launched to boost sales. However, the point is not explained. Why has the business developed these products? For example, customers tastes are changing and people want more convenience; this is why Drive Thrus are proving more popular. Or with growing competition in the coffee market, Costa needs to differentiate its product and producing premium coffee helps do this.

(c) Analyse the benefi ts to Whitbread plc of having a portfolio of products. (8 marks)

(c) A portfolio of products is a collection. Whitbread has hotels, coffee shops and restaurants. This means it operates in different markets which can help to spread risks. If there are falls in demand for hotels, for example, the demand for coffee shops may still increase, reducing risks for the business. These businesses are all to do with serving food and drink and serving customers so they have something in common and can share some experiences and resources. However, the fact they have different customers means the business can spread risks.However, the fact they have different customers means the business can spread risks.

This answer shows a clear understanding of the product portfolio.

(d) Analyse the case for and against Costa increasing the price of its coffee. Based on your analysis, Analyse the case for and against Costa increasing the price of its coffee. Based on your analysis, Analyse the case for and against Costa increasing the price of its coffee. Based on your analysis, recommend whether increasing its price is a good idea. (12 marks)(12 marks)

Chapter review – Marketing

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5 Marketing

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5 Marketing Marketing

(d) Costa may want to increase the price of its coffee because its costs have increased. It is paying more for coffee and for wages and so to cover its costs and still make the same profi t per item it will need to put the price up.

However, if it puts the price up, sales may fall because customers may switch away from coffee completely or switch to another coffee shop. There are now many other businesses selling coffee and so customers can easily fi nd somewhere else to buy their drinks. This means Costa may not want to put up prices for fear of sales falling quite a lot.

Overall, Costa should put up the price because of the higher costs. To make profi t with higher costs, you need more revenue. To make more revenue, you need higher prices.

This answer raises relevant points. Yes, Costa will need to consider costs and yes, it will also worry about the loss of sales. The conclusion does not build on all the arguments made earlier. It ignores the argument about falling sales. It assumes the � rst argument is right without referring back to the counter-argument. The conclusion (recommendation) needs to come back to the earlier arguments. In this case, it might argue that the danger of losing sales is less likely, given the strength of the Costa brand or the quality of its coffee and, therefore, it would be able to push up prices.


➜ Item BAccording to a recent market research report, the number of smartwatches sold fell by over 50 per cent in 2016. Apple Watch still had the largest market share within the smartwatch market, but the number sold was just over 1 million between July and September 2016, down from 39 million the year before.

Of the fi ve leading brands (Apple, Garmin, Samsung, Motorola and Pebble), only Garmin showed growth, but its fi gures remained low. One factor may be that new versions of these smartwatches are expected soon, but nevertheless sales seem slow. Some customers seem unsure why to buy a smartwatch. To address this issue, manufacturers are looking at what segments they are targeting and refi ning their promotional messages. Most are focusing on measuring fi tness as the key benefi t the watch can provide. Apple’s most recent promotional activity concentrates on the Apple Watch and its ability to address health issues, rather than it being a fashion accessory. It has discontinued the gold edition of its original ‘wearable’, which retailed at $10,000 (£8,000). The latest Apple Watch version can track swimming activity, and the company is working on a special edition, in partnership with fi tness giant Nike.

Smartwatches face growing competition from traditional watchmakers, such as Fossil. These traditional makers are producing new models sold through watch retail channels rather than technology stores.

(a) What is meant by ‘market share’? (2 marks)

(b) Explain one benefi t to smartwatch producers of segmenting the market. (4 marks)

(c) Analyse the factors a traditional watch manufacturer might consider when deciding whether to use retailers to sell its products. (8 marks)

(d) Sales of smartwatches are falling. To what extent do you think it is inevitable that sales of smartwatches will continue to fall? (9 marks)

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6Finance

Finance is an important infl uence on the activities of a business. This chapter looks at the role of fi nance within a business starting with the sources of fi nance that a business can use. We will consider the benefi ts and drawbacks of the main sources of fi nance that are available to businesses in the UK. Many businesses fail because they do not manage their cash fl ows effectively. This chapter will consider why cash is important to businesses, how fl ows of cash can be forecasted and how cash differs from profi t. We will also introduce many of the key fi nancial terms used by businesses and conduct a range of fi nancial calculations which help managers to make decisions. Finally, we shall look at two vital fi nancial documents produced by businesses and analyse what they can tell us about the fi nancial performance of a business.

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Both new and established businesses need to raise fi nance. A new business needs to raise money to buy raw materials and to pay rent or buy buildings. An established business may plan to expand or to install new equipment to improve the effi ciency of its production methods. It will need money to do this. This topic considers why businesses need to raise money and the sources that can be used to do this.


● why businesses need to raise fi nance

● the sources of fi nance used by new and established businesses

● the advantages and disadvantages of using these sources of fi nance

● which sources are most appropriate for given circumstances.

● Why do businesses need to raise finance?Understanding why a business needs to raise fi nance (money) makes it much easier to select the most appropriate source of fi nance. Businesses need fi nance for a number of reasons.

New businessesA new business will need fi nance to purchase a range of items that are essential if it is to be able to start trading. An entrepreneur will need to spend money on at least some of the following in order to start a business:➜ Renting or buying a building. This might be a shop, an offi ce or a factory

and is likely to be relatively expensive.➜ Vehicles. Many businesses will require cars to visit customers and suppliers,

as well as vans or lorries to deliver products.➜ Advertising the business. Potential customers will not know about a new

business unless it promotes itself. Many new businesses spend quite large amounts of money on advertising, even before they start trading.

Key term

An entrepreneur is someone who is willing to take the risks involved in starting a new business.

Sources of � nance

Topic 6.1

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6.1 Sources of finance

➜ Equipment and machinery for the business. Most businesses require some equipment or machinery, especially if they are planning to manufacture products. For example, a new furniture-making business will need equipment to cut, sand and polish wood.

➜ Inventories of raw materials. A shop will need inventories if it is to have anything to sell. So, for example, a greengrocer will need to buy inventories of fruit and vegetables to sell. The furniture maker referred to above will need to have inventories of wood, nails, screws and wood stains to construct the furniture.

Established businessesEstablished businesses that have been running for some time often need to raise fi nance for a number of reasons:➜ To expand. It is common for businesses

to decide to increase the scale of their enterprise, possibly by entering new markets or selling more in existing markets. To do this, businesses may need to raise fi nance to pay for additional shops, factories or offi ces as well as to recruit new employees. For example, Spotify, a company that supplies music, podcasts and video streaming services, attempted to raise $500 million in 2016 to fund further global expansion.

➜ To improve ef� ciency. Businesses can raise money to spend on training employees or to purchase technology to use in production. Better trained employees or production-line technology can help businesses to produce goods and services more quickly and with fewer resources. However, this can be expensive and require large sums of money.

➜ To develop new products. Developing new products is an important way for many fi rms to compete, but it can be costly. To develop new products, businesses may have to pay for scientifi c research or for new production facilities, as well as for advertising to inform customers. In 2015, Nissan, the Japanese car manufacturer, spent £100 million at its factory in Sunderland to enable it to make its new Juke car there.

Key term

Inventories are raw materials that have not yet been used or products that have been made, but not sold. These are also called stocks.

Even starting a small business, such as the one shown in the photo, means that an entrepreneur has to spend significant sums of money before starting trading.

The Japanese company Nintendo has invested heavily in developing its latest games console – the Nintendo Switch.

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6 Finance

● Sources of finance

Internal sources of finance

• Owners’ funds

• Sale of unwanted assets

• Trade credit

• Retained profits

External sources of finance

Family andfriends

Overdrafts

Governmentgrants

Bank loans andmortgages

Hire purchase

Share issues

Figure 6.1 A summary of the sources of finance available to businesses

Internal sources of financeAn internal source of fi nance is money that is available from within the business. Using internal sources of fi nance means that a business does not face possibly high interest charges. It also means that other organisations, such as banks, do not have a say in how the business is run. However, many businesses only have limited internal sources of fi nance.

Owners’ fundsOwners’ funds is the name given to money put into the business by its owners. There might be one or more owners of a business, depending on whether the business is set up as a sole trader, a partnership or a private limited company. The greater the number of owners in a business, the more potential the business has to use this as a source of fi nance. The owners of a new business may use their savings to invest in their business – if they have any.

Owners’ funds are normally used as a source of finance when the business is first set up, but they can also provide money for well-established businesses. Owners’ funds are a major source of finance for sole traders and partnerships, which are not allowed to sell shares to raise money. A major benefit of using this source of finance is that the business does not have to pay any interest on it.

Retained profi tsThis is profi t made by the business in earlier years (see Figure 6.2). A profi table business may build up a large sum by saving its profi ts from previous years. One major advantage of using retained profi t is that the business will not have to pay interest as it is not borrowing money. This source of fi nance may be available immediately to a successful business. Retained profi ts form the most important

Key terms

An internal source of fi nance is money that is available from within the business, for example, retained profi ts from previous years.

Owners’ funds is money put into a business by its owner or owners.

Interest is a payment made in order to borrow money. It means a business pays back more than it borrows.

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source of fi nance for large businesses. It is estimated that between 80 per cent and 90 per cent of funds raised by large fi rms in the UK for investment come from retained profi ts.

However, this source of revenue is only available to successful firms that have made a profit. In addition, there is a downside to using retained profits – a company’s shareholders may be disappointed if profit is kept within the business and is not paid to them as dividends.

DividendsRetainedprofits

Salesrevenue

minus Costs ofproduction

givesProfits

paid toshareholders

kept withinthe business

Figure 6.2 A company’s retained profits

Maths moment

Use the information in Figure 6.2 to calculate the retained profi ts available to the company in the following circumstances:● Costs of production = £19.5 million● Dividends = £1.5 million● Sales revenue = £23.4 million.

Study tip

There is often evidence in examination questions as to whether retained profi ts are a suitable source of fi nance for a large business. If the business on which the question is based is described as successful or profi table, then retained profi ts may be a good source of fi nance. An examination question may also give information about a business’s profi ts in the form of fi gures.

Selling assetsSelling assets can provide a business with large sums of money, depending on what is sold. Assets can be sold in two ways:➜ selling assets such as buildings for cash➜ selling an asset and leasing it back, so that it is

still available for use. In 2015, the supermarket Morrisons raised £175 million by selling property and has leased it back from the new owner.

Selling assets can provide a business with money without having to pay interest charges. However, there are disadvantages to using this source of finance. A business may sell an asset that it will need later. If it sells the asset and leases it back, the business will

Key term

A shareholder is a person or organisation that owns part of a company. Each shareholder owns a ‘share’ of the business.

Key term

An asset is something that is owned by a business. Examples include land, buildings, vehicles and machinery.

Tesco plc, the UK’s largest supermarket, sold the Dobbies chain of garden centres for £217 million in 2016. It needed the money to invest in its supermarkets.

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6 Finance

have to pay a sum of money regularly to the new owner. This may reduce the business’s long-term profits.

Trade creditTrade credit is a period of time which suppliers allow customers before payment for supplies must be made. Many businesses are able to negotiate trade credit to allow a period of 30, 60 or even 90 days before payment has to be made for supplies. In effect, this is a short-term loan.

This is a source of finance for which no interest is charged. However, it is very short term and only relatively small sums of money can be raised in this way.

Business insight

Liverpool Football Club’s record profi tsIn 2016, Liverpool Football Club announced that its fi nancial performance over the previous year had been very strong. The club revealed that its annual fi nancial results showed a record yearly revenue of nearly £300 million and profi ts of £60 million. Liverpool Football Club is owned by the Fenway Sports Group. The Fenway Sports Group paid £300 million to buy the club and wants to make profi ts from its ownership.

The club has said that the manager, Jürgen Klopp, will be able to spend heavily on new players using these profi ts. However, a single top class footballer can cost up to £50 million.

Analyse the advantages and disadvantages to Liverpool Football Club of using its profi ts as a source of fi nance to buy new players. (6 marks)

Liverpool Football Club invested £34 million to buy Sadio Mané from Southampton in 2016.

External sources of financeAn external source of finance refers to money that comes from outside the business. Using external sources of finance offers firms the opportunity to raise large sums of finance, but can bring disadvantages such as heavy interest charges.

Bank loansIf a bank believes that an entrepreneur has a good business idea and will be able to repay any money it lends, it may agree to create a loan to help start the business. A bank loan involves a bank giving a business a large sum of money in return for the business agreeing to repay the amount in instalments over the next few years. The business will also be charged interest on the loan. This is an extra payment that the borrower has to make to the bank and allows the bank to make a profi t on its lending activities.

However, there are disadvantages with bank loans. The bank may ask for collateral – an asset belonging to the business that is

Businesses often use mortgages to buy property, which is very expensive. Mortgages can be repaid over very long periods of time.

Key term

An external source of fi nance refers to money that comes from outside the business, for example, a loan from a bank.

Key term

Trade credit is a period of time which suppliers allow customers before payment for supplies must be made.

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borrowing the money. Banks are more likely to ask new businesses for collateral as they often represent a greater risk. The bank has control of the collateral asset and the right to sell it if the business fails to repay the loan. In addition, if the bank charges a high interest rate for the loan, this may make it an expensive source of finance.

Mortgages A mortgage is a special type of loan. It is used by businesses to buy property such as offi ces, shops and factories. A mortgage may be for a large sum of money and is normally paid back over a long period of up to 30 years. The business is given the sum of money by a bank or building society and has to make regular payments until the money and any interest has been repaid.

The amount of money borrowed is often large because land and buildings are usually very costly. The building or land purchased with the mortgage is normally used as collateral (or security) for the loan. If the business fails to make repayments on the mortgage, the bank or building society will sell the building or land to regain its money.

OverdraftsOverdrafts give entrepreneurs and businesses the right to borrow variable amounts of money up to an agreed limit. Overdrafts are very fl exible loans as businesses only use them when required.

Ban

k ac

cou

nt

bal

ance

(£)

Time (months)

Posi

tive

Neg

ativ

e

2,500

2,000

1,500

1,000

500

021

Balance whenbusiness starts

trading Balance falls andbecomes negative

in early monthsof trading

Business spendsheavily on advertising

and supplyingproducts

Customers payfor supplies

Times when the businessis using its overdraft

9876543 10 11 12 13 14 15 16 17

Agreedoverdraft

limit

−500

−1,000

−1,500

−2,000

−2,500

−3,000

Figure 6.3 How a new business might use its overdraft

Figure 6.3 shows how a new business might be able to benefit from the use of an overdraft. The business has agreed an overdraft of £2,000 with its bank. This means that the business can borrow any amount up to £2,000 from the bank for any period it chooses. An overdraft is a flexible loan in that a business uses it only when it needs to do so, in this case between months 4 and 8, and 11 and 16. At other times, the business does not need to borrow any money. In this way, the business only pays interest for the few months that it needs to do so.

Key terms

Collateral is an asset that a bank holds as security for the repayment of a loan.Mortgages are loans from banks and building societies that are used to buy land and buildings, such as offi ces and shops.Building societies are organisations that offer a range of fi nancial services. However, their major business is providing savings accounts and lending money for the purpose of buying property.An overdraft is a fl exible loan which businesses can use, whenever necessary, up to an agreed limit.

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6 Finance

Overdrafts do have disadvantages for businesses, however. First, a bank may not agree to grant some businesses an overdraft or may charge very high rates of interest. This can make it a very expensive source of finance. Also, a bank may withdraw a business’s overdraft with little notice, leaving it with serious financial problems.

New share issuesOnly companies can sell shares. Shares can be sold in return for a payment, which can be used in a variety of ways. The people who buy the shares are called shareholders and each owns a part of the company. It is much easier for public limited companies to sell shares as they can use the Stock Exchange – a market through which companies can sell shares. Selling shares means that the company is not committed to pay interest as it would be if it arranged a loan.

However, there are disadvantages for companies of using the sale of shares as a source of finance. First, if the business sells a large quantity of shares, it may mean that the new owners (shareholders) have enough shares to take control of the business from the current owners. Second, the new shareholders will expect to have a share of the company’s profits (as dividends).

Business insight

CentricaCentrica plc is a large public company that supplies gas and electricity in the UK and North America. It owns several companies, including British Gas and Scottish Gas.

In 2016, Centrica raised money by selling new shares worth more than £700 million. The money raised is to

be used to repay some of the company’s loans as well as to buy another company. Centrica’s share price fell 12 per cent following the announcement.

Analyse the advantages and disadvantages to Centrica of using the sale of new shares as a source of fi nance. (6 marks)

Loans from friends and family Borrowing money from friends and family is a popular source of fi nance for many entrepreneurs who are setting up a small business. This source of fi nance has the advantage of being easy to arrange and often the money will be lent free of interest payments. It may also be a source of fi nance for a small business seeking to grow.

There are disadvantages, however. Friends and family may not be able to lend enough money or may need to have it returned suddenly, leaving the business short of finance. Also, and importantly, friends and family will be less likely to look closely at the entrepreneur’s business plan and to make the entrepreneur think carefully about the proposed business.

Why might an entrepreneur be worried about borrowing a large sum of money from a family member as a source of finance?

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Hire purchase Hire purchase is a method of purchasing assets and paying in instalments. It is really a special form of a loan. Hire purchase can be an expensive way of buying something, and the business will not own the item until it is completely paid for. Businesses will not be able to raise large sums of money from this source.

Government grantsA grant is a sum of money given to an entrepreneur or a business for a specifi c reason. The government encourages people to start or to expand businesses because this creates jobs. In addition, businesses pay taxes and this helps the government to pay for its own spending plans.

Grants from the UK government are usually given if a business will create jobs, especially in areas where many people do not have jobs. Government grants will only cover part of the money needed – the business concerned usually has to put in a sum of money equal to the government grant. The UK government offers a range of grants for new and existing businesses.

Grants can be difficult to obtain. Businesses may have to meet a number of conditions, such as creating a certain number of jobs, in order to qualify. The application for grants can also involve completing a lot of forms and an interview. However, most grants do not have to be repaid and also do not lead to any interest payments.

Business insight

Travelodge’s expansionTravelodge, the budget hotel chain, announced that it was to open 19 new hotels in the UK in 2016, bringing its total to 542. This expansion required an investment of £140 million. The company’s profi ts rose by £40 million in 2015 to £261 million.

The company has also just completed a modernisation programme of its existing hotels, which cost £100 million. It also plans to open a further 250 hotels over the next few years.

Explain one advantage to Travelodge if it was to use a mortgage as a source of fi nance to buy its 19 new hotels. (4 marks)

Source of fi nance Advantages Disadvantages

Retained profi ts ● No interest payments● Can be arranged immediately

● Only available to profi table businesses● Shareholders may oppose the decision

Selling assets ● No interest payments● May keep assets (if leased back)

● Many businesses do not have suitable assets● Leasing assets back means regular payments

Bank loans and mortgages

● Can be arranged quickly● Allows repayment over a long period of time

● Interest has to be paid● Banks may require an asset as collateral

Selling shares ● No interest payments ● The owners may lose control of the company● Only available to companies

Government grants

● Many government grants do not have to be repaid

● A business may have to meet strict conditions to receive a grant

● Businesses may have to invest money alongside the grant

Table 6.1 Advantages and disadvantages of the major sources of finance available to businesses

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6 Finance

● Choosing an appropriate source of financeThere is no single ‘best’ source of fi nance for a business. The most appropriate source of fi nance will depend on the circumstances. The factors that infl uence decisions on which source or sources of fi nance to use can vary between new and established businesses. These are summarised in Figure 6.4.

The amount ofpersonal finance

available

How risky thebusiness is

judged to be

The amount offinance needed

The legal structureof the business

Past history andfuture prospects

The business’sprofitability

New businesses

Assets owned bythe business

Existing businesses

Factors influencingthe choice of

sources of finance

Figure 6.4 Factors influencing the choice of sources of finance for new and established businesses

Influences on the choice of sources of finance for new businessesAn entrepreneur starting a new business will take a number of factors into account when choosing how to fi nance a business, but is likely to have less choice than an established business. For example, the entrepreneur cannot use retained profi ts from the business. Bank loans may be more diffi cult to negotiate because the business is unknown and may be judged to be risky.

The amount of personal fi nance available to the entrepreneurIt is common for entrepreneurs to use their own money to fi nance the new businesses, at least in part. The more personal fi nance an entrepreneur has, the less he or she needs to raise from other sources.

Some entrepreneurs set up businesses when they become unemployed. If someone loses a job, they may receive compensation known as redundancy pay,

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which can be used to start a business. In other circumstances, entrepreneurs sell their homes to raise funds.

The legal structure of the businessOnly companies can sell shares as a source of fi nance. A new business may be a private limited company (ltd). This means that raising funds by selling shares is possible. However, private limited companies may only be able to make limited use of shares to raise money as all shareholders have to agree for this source to be used.

How risky the new business is judged to beIf a new business is thought to be very risky, this will reduce the sources of fi nance available. Banks and building societies may not be willing to offer mortgages, loans or overdrafts for fear of not being repaid. In these circumstances, an entrepreneur may be forced to rely on his or her own fi nance as well as that provided by friends and family. Alternatively, the entrepreneur may form a company and sell shares in it.

Influences on the choice of sources of finance for established businessesEstablished companies generally have a larger range of sources of fi nance. For example, they may be able to use retained profi ts or to sell shares on the Stock Exchange. However, a range of factors will infl uence which sources of fi nance are most appropriate in any given circumstances.

Profi tability of the businessA profi table business will be more able to use retained profi ts as a source of fi nance because it has the money available. However, a profi table business will also be more likely to persuade a bank to agree to a loan as it should be able to make the repayments.

Assets owned by the businessA business that owns assets such as buildings and property may choose to raise fi nance by selling the assets and perhaps leasing them back if necessary. A business that owns valuable assets may also fi nd it easier to persuade a bank to lend it money, as it has suitable collateral as security for the loan.

Past history and future prospectsA business that is expected to make a profi t in the future may be in a strong position to take out a bank loan, as it is more likely to be able to pay back the loan on time. Equally, a business with a good record for paying loans on time may be in a better position to agree a bank loan or a mortgage.

Even small businesses can persuade banks to lend them money if they own valuable assets such as property.

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6 Finance

Legal structure of the businessOnly companies can sell shares as a source of fi nance. Many established businesses are companies – either private or public. It is easier for public limited companies (plc) to use shares as a source of fi nance, as they do not have to gain the agreement of the existing shareholders, and they can use the Stock Exchange as a market to sell the shares. This can make this a very attractive option for a profi table public company.

Amount of fi nance that has to be raisedIt is likely that, if a business needs a large sum of money, it will use more than a single source of fi nance. This may be because a bank would not be prepared to lend such a large sum, or because selling the required number of shares would mean that the owners lose control of the business. Using several sources in this situation helps to avoid the worst disadvantages of any one source of fi nance.

SummaryBusinesses can raise fi nance from a number of sources. The most important are retained profi ts, the sale of assets, bank loans, mortgages, and the sale of shares. However, new businesses can rely upon loans from friends and family, as well as the entrepreneur’s own money. Each of these sources of fi nance has

advantages and disadvantages. The best source of fi nance depends on the circumstances. Entrepreneurs and managers might take into account the past and expected profi tability of the business, the assets available to the business, its legal structure and the amount of money that the business needs to raise.

Quick questions 1 State two reasons why a new business

might need to raise money. (2 marks)

2 Explain, with the aid of an example, the difference between internal and external sources of finance. (4 marks)

3 Which of the following sources of finance will not need to be repaid at some stage?

(a) A bank loan

(b) A mortgage

(c) An overdraft

(d) Retained profi ts (1 mark)

4 Which of the following is a possible disadvantage of using a bank loan as a source of finance?

(a) The need to provide collateral

(b) Making repayments in instalments

(c) Only companies can use this as a source of fi nance

(d) This source of fi nance is only suitable for short periods of time (1 mark)

5 Which source of finance allows businesses to borrow variable amounts of money up to an agreed limit?

(a) Mortgages

(b) Overdrafts

(c) Hire purchase

(d) Government grants (1 mark)

6 Explain one disadvantage to a business of using government grants as a source of finance. (3 marks)

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Case study

Mantra LtdMantra Ltd is a private limited company that manufactures sheds, bird tables and other garden furniture. It has a factory in Buckinghamshire and two shops in towns nearby, where it sells its products. The company regularly uses its overdraft as a source of short-term fi nance, even though interest rates have risen recently.

The company has two shareholders, who are brothers and who run the business. Mantra Ltd has enjoyed rising sales over recent months, and its profi ts have risen steadily. Last year, the company’s profi ts were £20,000.

Mantra Ltd needs to build an extension to its factory and to buy new equipment for the enlarged factory. The cost of the factory extension and the new equipment is estimated to be £190,000. The shareholders plan to use a bank loan to raise the

entire £190,000, although collateral will be required. However, the company’s accountant has suggested that the company sells one of its shops rather than taking out a loan.

1 Identify two assets that Mantra Ltdmight use as collateral for the bank loan. (2 marks)

2 Explain why Mantra Ltd should not rely on its overdraft as a source of fi nance. (4 marks)

3 Analyse the disadvantages to Mantra Ltd of borrowing £190,000 from a bank. (6 marks)

4 Mantra Ltd’s accountant has advised the company to raise its funds by selling one of its shops rather than taking out a loan. Recommend which source the company should use. Give reasons for your answer. (9 marks)

7 ‘It is really a special form of a loan. It can be an expensive way of buying something and the business will not own the item until it is completely paid for.’ Of which of the following sources of finance is this a description?

(a) A loan from friends and family

(b) A mortgage

(c) Hire purchase

(d) An overdraft (1 mark)

8 Which of the following sources of finance can only be used by companies?

(a) Trade credit

(b) An overdraft

(c) A new share issue

(d) Hire purchase (1 mark)

9 State two factors that might influence a decision on the most appropriate source of finance by a new business. (2 marks)

10 State two appropriate sources of finance for a profitable public limited company. (2 marks)

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Topic 6.2

● What is cash flow? Cash fl ow is the money that fl ows into and out of a business on a day-to-day basis. There are a number of reasons why a business would receive cash infl ows as well as many likely causes of outfl ows of cash from the business.

Cash inflowsCash infl ows mean that money fl ows into a business and becomes available to it. There are several reasons why a business might receive cash infl ows:➜ Income from sales. The money businesses earn from selling goods and

services creates an infl ow of cash to the business. This is called sales revenue or income (see Topic 6.3).

➜ Loans from banks. It is common for a business to borrow money in order to buy new items such as vehicles, machinery or property. When the loan is given to the business, this becomes a cash infl ow for the business.

➜ Money invested by the business’s owners. When a business is fi rst started, its owners may invest money into the business resulting in a cash infl ow. Later, an established company might sell new shares causing a cash infl ow.

Cash outflowsWhen a business makes a payment, it causes an outfl ow of cash. A number of actions can lead to a cash outfl ow:➜ Buying raw materials. Most businesses need to buy some raw materials to

allow them to trade normally. For example, a restaurant will need to buy

Key term

Cash fl ow is the money that fl ows into and out of a business on a day-to-day basis.

Cash � owManaging cash fl ow effectively is an important part of the successful management of new and existing businesses. This topic introduces you to cash fl ow and cash fl ow forecasts and explains their importance.


● what cash fl ow is

● why cash fl ow is important to all businesses

● how and why cash fl ow forecasts are constructed

● how to interpret cash fl ow forecasts and to overcome cash fl ow problems

● the difference between cash and profi t.

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ingredients to make into meals, as well as buying a stock of alcoholic and non-alcoholic drinks to sell to its customers.

➜ Wages. All businesses, particularly those selling services (where wages are usually a higher percentage of costs), suffer an outfl ow of cash due to the payment of wages to employees.

➜ Rent or mortgage. Many businesses rent the buildings in which they are located. These may be shops, offi ces or factories. This means they have a regular outfl ow of cash to pay their rent (or mortgage if they have a loan to buy the property).

➜ Interest on loans. We saw earlier that a bank loan leads to an infl ow of cash. Paying interest on the loan, however, leads to regular (possibly monthly) cash outfl ows.

➜ Taxes. Businesses have to pay sales taxes and taxes on profi ts. Both of these cause cash outfl ows. Why might house builders experience a large time gap between cash outfl ows and cash infl ows?

● Why is cash flow important?Managing a business’s cash fl ow effectively is a very important task for managers. If a business does not have enough cash available to pay its bills, it could fail. A business that is unable to pay its suppliers will probably not receive any further supplies. It may be unable to pay its workers. The business will probably be forced to stop trading in these circumstances.

Poor management of cash flow is the main cause of the failure of small businesses. It is estimated that 70 per cent of businesses that fail in their first year of trading do so because of cash flow difficulties. More than 20 per cent of business failures in the UK in 2015 were caused by late payments or non-payment by customers.

Time is a very important issue in relation to cash flow. Managers need to be aware that if outflows of cash occur before inflows take place, the business is likely to be short of cash. When managing cash flow, it is vital to ensure that cash inflows take place in time so that the funds are available for cash outflows.

Study tip

Do not write about profi ts if the question is on cash fl ow. These are two very different concepts as we shall see later in this topic.

House builders can experience a large time gap between cash outflows (while building houses) and cash inflows when the houses are sold. This can lead to shortages of cash.

6.2 Cash flow

Buying a van can cause a major cash outflow for a small business. Why might a new business choose to lease (rent) a van?

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6 Finance

Business insight

Small fi rms do not chase up bad debtsSmall businesses in the UK face a tough fi ght to survive given that 60 per cent fail within fi ve years of starting trading. Recent research by the insurer Direct Line has shown that the UK’s small businesses are losing £5.8 billion a year by not chasing up customers who do not pay their bills. The money owed by these customers is often written off, meaning that they are never paid. These are called ‘bad debts’.

Explain why bad debts can cause a small business to have cash fl ow problems. (4 marks)

The benefits of having a positive cash flow positionIf a business has a positive cash fl ow position, it means that it avoids periods in which it has a negative cash balance. This offers a business a number of benefi ts:➜ The business does not need to borrow and can avoid paying interest charges.

Many businesses borrow using overdrafts to cover periods of cash fl ow diffi culties. Overdrafts can be an expensive way of borrowing.

➜ A business will be more able to arrange long-term loans if it has a positive cash fl ow position. Banks and other potential lenders will have greater confi dence that the business has the ability to make repayments of the loan on time.

➜ Cash fl ow problems are a major cause of business failure. A positive cash fl ow position helps to reduce the risk of a business failing.

● Interpreting cash flow forecasts and statements

It is possible to construct a table of the infl ows and outfl ows of cash that are expected by a business’s managers. When such tables are drawn up as part of the process of planning a business’s activities, they are called cash fl ow forecasts.

However, when completed as a record of trading, they are called cash flow statements. A business may use a cash flow statement to look at what happened to cash flows over a previous trading period and use this to help it plan its future management of cash. For example, it might see that last year it was very short of cash during the Christmas period. Knowing this, managers can take actions to avoid the same problem occurring again this Christmas.

Key terms

A cash fl ow forecast is a plan of the expected infl ows and outfl ows to and from a business over a period of time.

A cash fl ow statement is a record of the cash infl ows and outfl ows that took place over an earlier period of time.

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The cash flow forecast in Table 6.2 was drawn up by Peter and Sue, who are planning to open a restaurant.

December January February

Cash infl ows

Peter and Sue’s savings 5,000

Bank loan 7,500

Sales revenue 3,800 6,000 8,800

Total cash infl ow (A) 16,300 6,000 8,800

Cash outfl ows

Purchase of inventories of food and drink 8,000 4,250 3,900

Wages 4,000 3,500 3,700

Interest on bank loan 250 250 250

Rent (for three months) 4,250 – –

Electricity and gas 250 220 210

Total cash outfl ow (B) 16,750 8,220 8,060

Net cash fl ow (C = A – B) (450) (2,220) 740

Opening balance (D) 1,000 550 (1,670)

Closing balance (E = D + C) 550 (1,670) (930)

Table 6.2 Peter and Sue’s cash flow forecast

Cash flow forecasts are normally organised into three sections:➜ Cash infl ows are normally at the top. When added together, the cash infl ows

equal the ‘Total cash infl ow’ (A).➜ The second section is cash outfl ows. These are added together to give the

‘Total cash outfl ow’ (B).➜ The third section includes the net cash fl ow, the opening balance and the

closing balance:➜ The row called ‘Net cash fl ow’ (C) shows the net fl ow of

cash into and out of the business. It is calculated by taking the ‘Total cash outfl ow’ (B) from the ‘Total cash infl ow’ (A).

➜ The amount of cash held by the business at the start of the month is shown by the ‘Opening balance’ fi gure (D). This is the fi gure the business had as cash on the last trading day on the previous month. In the example above, this date was 30 November. So the closing balance for one month becomes the opening balance for the next month.

➜ Finally, the amount of cash the business has at the end of the month is shown by the ‘Closing balance’ fi gure (E). The closing balance is calculated by adding together the opening balance (D) and the net cash fl ow (C).

Buying supplies of food and drinks and paying staff wages are major causes of cash outflows for restaurants.

6.2 Cash flow

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All negative figures are shown in brackets. For example, in Peter and Sue’s forecast the net cash flow for January and the closing balance for February are negative.

Maths moment

Assume that Peter and Sue revise their cash fl ow forecast for February. The restaurant’s forecast sales revenue is increased to £10,000. The amount of outfl ows for the purchase of inventories of food and drink is £4,750.

Recalculate the cash � ow forecast for February after these changes.

Business insight

The Cathedral BookshopLeverett Books Ltd has drawn up a cash fl ow forecast for its new bookshop which opens at the University of Warwick in January. This is for the fi rst four months of trading and is shown in Table 6.3.However, the forecast is not complete.

Complete the cash fl ow forecast for the Cathedral Bookshop by fi lling in the blank spaces A, B, C and D. (4 marks)

January February March April

Cash infl ows

Retained profi ts 12,500

Bank loan 30,000

Sales revenue from books 4,800 6,000 8,500 10,500

Total cash infl ow A 6,000 8,500 10,500

Cash outfl ows

Purchase of stocks of books 36,000 15,000

Wages 2,000 2,000 2,200 2,200

Interest on bank loan 350 350 350 350

Rent (for three months) 10,000

Telephone charges 750

New machinery, e.g. computers 1,500 2,500

Total outfl ow 38,350 12,350 19,050 5,800

Net cash fl ow 8,950 B (10,550) 4,700

Opening balance 0 8,950 C (7,950)

Closing balance 8,950 2,600 (7,950) D

Table 6.3 Cash fl ow forecast for the Cathedral Bookshop, January–April

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Interpreting Peter and Sue’s cash flow forecastWhat can Peter and Sue learn from their cash fl ow forecast? The major piece of information it contains is that their business will be short of cash in January and February. The forecast shows that by the end of January they will have spent £1,670 more than the business has available. This poses a real problem for the business, as it will not have enough cash to pay its suppliers of food and drinks or possibly the wages of staff. In February, the cash position is little better – they will again not have enough cash, although this time the negative fi gure is smaller at £930.

The cash flow forecast also gives Peter and Sue detailed information about what is causing the cash inflows and outflows. This information will help them to make decisions on how to improve the cash position of their business. We will consider this later in this topic.

The importance of cash flow forecasts It is common for a business to experience cash fl ow problems. These can be managed if the managers and entrepreneurs are aware of the possibility and are prepared to take the necessary actions to overcome them.

Constructing cash flow forecasts helps to do this in two main ways:➜ Managers can identify times when the business might be short of cash.➜ Managers can take suitable actions to avoid cash shortages becoming a

major problem.

The causes of cash flow problemsA cash fl ow problem arises when a business struggles to pay its debts as they become due. If a business experiences negative net cash fl ow over a period of time, its cash position can become very weak.

Businesses encounter cash flow problems for a variety of reasons:➜ Poor management. This is a surprisingly common cause of cash fl ow

problems. Managers may not be aware of the importance of managing cash fl ow and may not plan carefully. This is more likely with small businesses, which may not employ specialist managers of fi nance. Even experienced managers may take decisions that weaken a business’s cash fl ow position. For instance, a manager may spend too much on inventories of raw materials causing an outfl ow of cash long before infl ows result from sales.

➜ The business is making a loss. A business makes a loss when over a period of time its costs of production are greater than the revenue it receives from sales. A business making a loss will be at risk of running out of cash at some point. This will occur because more cash is fl owing out of the business than it is receiving.

Study tip

Try not to always think that cash fl ow problems will lead to a business having to stop trading. In many cases, entrepreneurs and managers can take actions to overcome the problems.

6.2 Cash flow

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➜ Offering customers too long to pay. When a business allows a customer time to pay for goods or services, it is known as giving trade credit (see Topic 6.1). Managers may be too generous in offering customers trade credit, especially if they are keen to increase the business’s sales. Offering, say, 60 days’ trade credit to a major customer means that the business has to wait two months for the agreed cash infl ow. In the meantime, it may be unable to pay its own bills on time.

Solutions to cash flow problemsWhen faced with cash fl ow problems, managers may use a range of solutions to cash fl ow problems, including the following.

Reschedule paymentsIt may be possible for a business to agree with its suppliers, or others to whom it owes money, to delay its payments (outfl ows). If this gives suffi cient time for the business to receive infl ows of cash, the problem may be solved. Alternatively, a business may be able to persuade customers to pay more quickly, thereby speeding up cash infl ows. Businesses often offer customers a discount for early payment. Similarly, customers who owe the business money could be chased up and persuaded to pay promptly.

Cut costs If a business can lower its costs, the result should be reduced cash outfl ows. This could mean employing fewer staff or holding smaller stocks of raw materials. Alternatively, the business could seek to use cheaper sources of fuel or raw materials. This may, however, result in the business supplying goods and services of lower quality. In the long term, it may lose customers as a consequence.

Use overdrafts An overdraft is a short-term, fl exible loan that can provide the business with the cash that it needs. In effect, arranging an overdraft provides an immediate infl ow of cash. Overdrafts can, however, be a relatively expensive form of borrowing. If a business uses them extensively, it may damage their profi ts. Banks can also ask for an overdraft to be repaid immediately.

Find new sources of cash infl owsIt may be possible for a business to generate extra cash infl ows. Many public houses offer meals and some provide accommodation, especially if they are in locations popular with tourists. This can generate signifi cant cash infl ows. However, this solution can take time to implement and may involve further cash outfl ows as the new enterprise is developed.

Study tip

Solutions to cash fl ow problems often bring their own problems and you may need to discuss these.

Many businesses allow consumers to buy now and pay later. This can help to attract customers, but might cause cash flow difficulties.

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6.2 Cash flow

Business insight

Fastjet is expected to run out of cashFastjet is an airline that operates in the African country of Tanzania. It is noted for its low fares. However, the company is not profi table: it made a loss of $25 million in 2015. This was mainly due to revenues from fares ($65 million) being lower than forecast.

One of the company’s shareholders has been very critical of the company’s managers. Sir Stelios Haji-Ioannou has said that it does not make sense for the company to have an expensive head offi ce at Gatwick in Sussex, when it operates in Tanzania. He has said he expects the company to run out of cash.

Explain one possible reason why Fastjet might suffer from cash fl ow problems. (4 marks)

Operating an airline requires large amounts of cash.

Selecting the ‘best’ solutionAll of the proposed solutions above have disadvantages. Managers have to take these into account when deciding how to tackle a cash fl ow problem. Two key factors may infl uence managers’ decisions on how to overcome cash fl ow problems:➜ The cause of the cash � ow problem. Managers need to consider carefully

why the business is facing cash fl ow problems. For example, if the cause is giving customers too long to pay, then the best solution would be to reduce the amount of trade credit that is offered. An overdraft could overcome this problem, but this means the business will incur extra interest payments and thus may not be the best solution.

➜ The business’s circumstances. The business’s circumstances also play an important part. In the above example, the business may be new to a market and need to offer very generous terms for trade credit to attract customers. In these circumstances, using an overdraft might be the best way to overcome the cash fl ow problems.

● The difference between cash flow and profit

Cash fl ow is entirely different from profi t. Profi t is the extent to which a business’s revenue exceeds its total costs over some period of time. Profi ts can be paid to the owners of a business as a reward for taking the risk of investing into the business. Alternatively, profi ts might be reinvested into the business.

Key term


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In contrast, cash flow is the way in which money moves through the business. Cash flow shows the balance between cash moving into and out of the business. Cash is essential for all businesses to ensure that they can pay debts on time.

Businesses can survive for some time without making a profit. For example, Amazon, the world’s largest online retailer, hardly made a profit from 2004 to 2014, preferring to offer very competitive prices. Cash flow is vital in the short term. If a business does not have enough cash to pay its bills, it is likely to be forced to stop trading. A business can survive for some time without profits; it will not do so without cash.

SummaryCash fl ow is the money fl owing into and out of a business over a period of time. Businesses forecast their cash fl ows to reduce the chance of facing cash fl ow problems. Businesses with poor management and those making losses commonly suffer from

cash fl ow problems. Businesses can take a number of actions to improve their cash fl ow position, including rescheduling payments and arranging overdrafts. Finally, cash fl ow is entirely different from profi t.

Quick questions 1 What is the difference between a cash

inflow and a cash outflow? (3 marks)

2 Which of the following would be likely to lead to a cash inflow for a restaurant?

(a) Payment for supplies of food

(b) Payment for a meal by diners

(c) Payment of the hotel’s electricity bill

(d) Payment of the chefs’ wages (1 mark)

3 State two possible sources of cash outflow for a bakery. (2 marks)

4 A business has the following data for February:• Opening balance: (£250,000)• Cash infl ows: £3,250,000• Cash outfl ows: £3,150,000

What is the business’s net cash fl ow for February?

(a) £3,500,000

(b) £3,000,000

(c) (£150,000)

(d) £100,000 (1 mark)

5 Using the data provided in question 4, what is the business’s closing balance for February?

(a) (£150,000)

(b) £150,000

(c) (£350,000)

(d) £100,000 (1 mark)

6 State two reasons why cash flow forecasts are important to businesses. (2 marks)

7 Explain why offering very generous trade credit terms to customers might cause cash flow problems. (3 marks)

8 State two possible disadvantages to a business of the use of an overdraft as a solution to a cash flow problem. (2 marks)

9 State two factors that managers should take into account when deciding on the best solution to a cash flow problem. (2 marks)

10 What is the difference between cash flow and profits? (3 marks)

Many small enterprises, such as this taxi business, are set up in the hope of making a profit.

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6.2 Cash flow

Case study

Kimmi’s GarageKimmi owns and manages a garage repairing and servicing cars. Kimmi has just agreed to buy her supplies from a different company. Its prices are low, but payment has to be made when placing an order. Her previous supplier allowed her two months to pay. Kimmi allows her customers one month to pay their bills.

Although the business had been successful in the past, she is worried about the business’s future, especially its cash fl ow. The fi gures in her latest cash fl ow forecast are worrying. Kimmi is an experienced car mechanic, but knows relatively little about fi nance. She is not sure what to do.

1 Complete the following fi gures on Kimmi’s cash fl ow forecast:

(a) the net cash fl ow for February

(b) the closing balance for April. (2 marks)

2 Explain why Kimmi might have been worried by the fi gures in her cash fl ow forecast. (4 marks)

3 Analyse factors that might have caused the cash fl ow problems for Kimmi’s business. (6 marks)

4 Kimmi’s business is forecast to suffer cash fl ow problems during the next four months. Recommend whether she should reschedule her payments or take out an overdraft. Give reasons for your advice. (9 marks)

January February March April

Cash infl ows

Sales revenue 3,500 4,250 3,950 3,750

Total cash infl ow 3,500 4,250 3,950 3,750

Cash outfl ows

Wages 1,500 1,800 1,800 2,000

Interest on bank loan 450 450 450 450

Purchase of materials 1,500 1,400 1,200 1,300

Telephone and heating 350 150 150 160

Advertising 900 600 300 300

Total outfl ow 4,700 4,400 3,900 4,210

Net cash fl ow (1,200) ? 50 (460)

Opening balance 245 (955) (1,105) (1,055)

Closing balance (955) (1,105) (1,055) ?

Table 6.4 Kimmi’s cash fl ow forecast

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Topic 6.3 Financial terms and calculations

● Basic financial termsRevenueA business’s revenue is the income that it receives from selling its products. It is calculated by multiplying the quantity of products that are sold by the average selling price. As an example, a car manufacturer may produce 10,000 cars in a year, which it sells for an average selling price of £20,000. Its revenue for the year would be:

revenue = number of units sold × price

revenue = 10,000 × £20,000 = £200 million

Apple sold 232 million iPhones in 2015. If it received an average price of £500 for each one, its revenue would have totalled £116 billion!

Key term

Revenue is the income that a fi rm receives from selling its goods or services. It is also referred to as ‘turnover’. It is measured by the number of units sold multiplied by the price.

Managers and entrepreneurs need to have a basic understanding of business fi nance or their businesses are very unlikely to be successful. This topic introduces you to some important terms and shows you, with a number of examples, how managers can calculate their business’s costs, decide whether an investment is worthwhile and determine whether it will make a profi t or a loss.


● some basic fi nancial terms and calculations, including the difference between variable costs, fi xed costs and total costs

● the reasons why businesses invest

● how to calculate the average rate of return for an investment

● how to interpret break-even charts and the value of break-even analysis to a business.

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PricePrice is the amount a business asks a customer to pay for a single product. Deciding what price to charge for a product is an important decision for managers. The price that is chosen generally depends on two factors:➜ the prices set by other businesses for similar products➜ how much it costs to produce the good or service that the business sells.

SalesSales is the number of products sold by a business over some time period, normally a week, a month or a year. For example, a dentist might treat 125 patients in a week. In each case, the number given is the sales achieved by the business. It is important to remember that sales are not stated in terms of money. Revenue is sales expressed in monetary terms.

CostsCosts are the spending that is necessary to set up and run a business. A business normally has to pay two main types of costs: fi xed costs and variable costs.

Fixed costsFixed costs do not alter when a business changes its output. For example, a shopkeeper has to pay the same amount of rent whether the business is attracting large or small numbers of customers. Other examples of fi xed costs include insurance for the business’s buildings and fees paid to the business’s accountant. Fixed costs can be a burden for a small business as they have to be paid even if the business is not producing and not selling large amounts of its products.

Variable costsVariable costs vary directly with the business’s level of output. If a shopkeeper is serving an increasing number of customers, then the business will have to buy more inventories to sell. The shopkeeper might also have to hire more staff to serve in the shop. So, costs such as raw materials and wages vary with output and are called variable costs.

It is possible to calculate a business’s total variable costs by calculating the variable cost of producing a single unit and multiplying this by the number of units of output produced by the business. For example, if the variable cost of manufacturing one kettle is £15 and a business makes 30,000 in a year, its total variable costs for the year will be:

total variable costs = variable costs of a single unit × number of units

total variable costs = £15 × 30,000 = £450,000

Key terms

Sales refers to the number of products sold by a business.

Costs are the spending that is necessary to set up and run a business.

Fixed costs are those costs that do not change when a business changes its output.

Variable costs are the costs that vary directly with the business’s level of output.

During busy times, the variable costs of fast-food restaurants will rise because they need more burgers, buns and may need to pay for additional employees. However, the restaurant’s fixed costs will be unchanged.

6.3 Financial terms and calculations

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Total costsTotal costs are a business’s expenditure over a time period. Adding together fi xed and variable costs gives the total costs that a business has to pay over a certain time period, such as a month or a year. Total costs are calculated using the following formula:

total costs = fi xed costs + variable costs

Total costs are a very important figure for managers and entrepreneurs. As we shall see, they are an important part of calculating whether or not a business has made a profit. Figure 6.5 shows the differences between total costs, fixed costs and variable costs. It shows that when a business’s production is at zero, total costs are equal to fixed costs because there are no variable costs. We shall look again at this when we discuss break-even charts later in this topic.

Co

sts

(£)

0 Amount produced by a business

Fixed costs do not change as a

business produces more or less

Total costs = Fixed costs +

Variable costs

Variable costs rise and fall according to

how much a business produces

Figure 6.5 Fixed, variable and total costs

ProfitsProfi t is the amount by which a business’s revenue from all its sales exceeds its costs. A loss is the amount by which a business’s costs are larger than its revenue from all sales. The formula used to calculate profi ts (or losses) is simple:

profi ts (or losses) = revenue − total costs

If a business’s revenue is greater than its total costs over some period of time, such as a month or a year, then the business will make a profit. However, if the total costs are greater than the revenue earned by the business, it is said to make a loss. Figure 6.6 illustrates the relationships between revenue, total costs, losses and profits.

Key term

Total costs are fi xed costs plus variable costs.

Key terms


Loss is the amount by which a business’s costs are larger than its revenue from all sales.

289

Revenue

from

selling

products

Total

costs

Profit

Total

costs

Loss

Revenue

from

selling

products

Figure 6.6 Revenue, total costs, profits and losses

Profit is an important measure of success for many businesses. Most managers hope that their business will make a profit, although some have objectives other than profits, as we saw in Chapter 1. Profit is the reward for taking the risk of investing in a business.

● Investment and the average rate of returnWhy do businesses invest?Businesses need assets such as buildings, machinery and vehicles to produce goods and services. They buy these assets to use in producing goods and services and in the hope of making a profi t.

Land and buildingsMost businesses require land and buildings to be able to supply goods and services. For example, farms, clothing manufacturers and hospitals all need land and buildings to engage in production. Businesses invest in additional land and buildings when they wish to expand production of existing goods and services or to produce new ones. In 2016, the luxury car manufacturer Aston Martin announced it was to build a second factory in Glamorgan to build a new car. The company would require land and buildings for its new factory.

Machinery and vehiclesMachinery is used by businesses that supply services as well as on manufacturers’ production lines. Advances in technology mean that more productive machinery becomes available for most industries over time. Investing in such machinery can help businesses to become more competitive and profi table.


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6 Finance

Business insight

Investment in liver scanner saves timeNew technology that can check the condition of a patient’s liver in minutes has been made available to patients from across west Suffolk. The £70,000 Fibroscan machine helps doctors and nurses at West Suffolk Hospital to diagnose liver diseases. The machine scans from outside the body and quickly gives clear, accurate results.

Before the equipment was introduced, patients needed to have a biopsy to monitor the severity of their liver disease, which meant they would have to be admitted as a day case. The new machine is portable, which means it can be used during outpatient appointments.

Explain why the £70,000 investment in the new machine should improve productivity at West Suffolk Hospital. (4 marks)

Similarly more efficient vehicles can help to reduce a business’s costs and thus make it more profitable. Buses in Aberdeen in Scotland have been fuelled by hydrogen since 2015. They are nearly four times more fuel-efficient than diesel buses, reducing operating costs significantly.

New productsTo remain competitive, businesses invest in developing new products. In some industries such as computing, software development and pharmaceuticals, continuous investment is essential for a business to compete with rivals. The Association of the British Pharmaceutical Industry estimates that a new medicine requires an average investment of £1,150 million.

The average rate of returnThe average rate of return (ARR) is a method of deciding whether an investment is likely to be worthwhile. It compares the average yearly profi t from an investment throughout its life with the cost of the investment. The ARR is stated as a percentage.

For example, if a new delivery van costs £40,000, but increases a business’s profits by £6,000 a year, the ARR would be calculated as follows:

ARR = average yearly profit × 100 ÷ cost of investmentARR = £6,000 × 100 ÷ £40,000 = 15%

As a further example, a pharmaceutical company may invest £500 million in developing a new medicine to help to control diabetes. The new drug is expected to produce annual profits of £40 million. Here the ARR would be calculated as:

ARR = average yearly profit × 100 ÷ cost of investmentARR = £40,000,000 × 100 ÷ £500,000,000 = 8%

Cadbury launched its new Medley bar in 2016 and hopes that it will be very popular.

Key terms

Investment takes place when a business buys an asset, such as a factory, in the hope of making a profi t from its use.

The average rate of return (ARR) compares the average yearly profi t from an investment with the cost of the investment and is stated as a percentage.

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The calculation of the ARR from an investment project is a little more complicated if the average yearly profits have to be calculated first. Figure 6.7 summarises how to calculate the ARR for an investment project and the Business insight on AES Ltd provides an example of this.

Step 1: Calculate average yearly profit

Total profits

divided by

Number of years

gives

Average yearly profit

Step 2: Calculate ARR

Average yearly profit x 100

divided by

Cost of investment project

gives

ARR

Figure 6.7 How to calculate the ARR for an investment project

Interpreting the result of an ARR calculationA higher fi gure for an ARR calculation is preferred as it shows the return on the investment is greater. Managers will simply choose the investment which offers the highest percentage return. So, in the case of AES Ltd above, if the 7.5 per cent return on its investment was higher than an alternative, it would decide to invest in the production line machinery. This does, however, assume that profi ts are the sole factor infl uencing the decision.

One major advantage of calculating the ARR to help to make a decision on whether or not to invest in a project is that the answer is stated as a percentage. This makes it easy to compare with the returns from an alternative investment, such as holding the funds in a savings account.

Average rate of return calculations are not always accurate. For example, if the forecast for yearly profits is wrong, the ARR will also be wrong.

Maths moment

An entrepreneur is considering a project which will require an investment of £250,000. She wants an average rate of return of 10 per cent to go ahead with the investment.Calculate the average yearly pro� t her investment project would need to make to achieve an ARR of 10 per cent.

Business insight

AES Ltd calculates its ARRAES Ltd is planning to invest in some new production line machinery. The machinery will cost the company £200,000 and will have a working life of ten years. Over the ten years, the company’s profi ts will rise by £150,000 because the machine is more productive and fuel-effi cient. In this case, the calculation of the ARR would be:

average yearly profi t = total profi t ÷ number of yearsaverage yearly profi t = £150,000 ÷ 10 = £15,000ARR = average yearly profi t × 100 ÷ cost of investmentARR = £15,000 × 100 ÷ £200,000 = 7.5%

Suppose that AES Ltd’s new machinery costs £250,000 and that it will produce profi ts totalling £125,000 over the ten years of its working life. Calculate the ARR in these circumstances. (4 marks)


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6 Finance

● Break-even analysisA business can only make a profi t when its sales revenue is greater than its costs. If revenue is less than costs, the fi rm will make a loss. Break-even is a level of production (or output) at which revenue from sales equals the total costs of production. In this situation, a business will not make a loss or a profi t.

If total revenues are greater than total costs …

… the business will make a profi t.

If total revenues are less than total costs … … the business will make a loss.

But if total revenues equal total costs … … the business will break-even.

Table 6.5 Profit, loss and break-even

Break-even chartsIt is possible to illustrate a business’s break-even output on a break-even chart as shown in Figure 6.8. This chart illustrates the position of Viv Burns, who owns a business making glass paperweights. She sells her paperweights for £25 each. The variable cost of making a single paperweight is £10. Her business’s fi xed costs are £7,500 a year.

Co

sts

and

rev

enu

es (

£000

s) 25

20

10

0100 200 300 400 500 600 700 800

Break-evenlevel of production

Fixed costs

Loss-making levelsof production

Profit-making levelsof production

Total revenue

Total costs =

Fixed costs + Variable costs

Variable costs

900 1,000

15

5

Yearly output of paperweights

Figure 6.8 A break-even chart for Viv Burns’ business

Key terms

Break-even is the level of production at which a business’s total costs and revenue from sales are equal.

A break-even chart shows a business’s costs and revenues and the level of production needed to break-even.

Study tip

You will not be expected to calculate the level of break-even production or output in an examination.

293

A break-even chart, such as the one shown in Figure 6.8, is made up of four lines: ➜ Fixed costs. These do not change as the level of production rises or falls.

Viv’s business has fi xed costs of £7,500 each year. These remain the same no matter how many paperweights she makes. Her fi xed costs are £7,500 if she makes 10 paperweights or if she makes 100 paperweights. This is why it is drawn as a straight and horizontal line.

➜ Variable costs. We saw earlier that variable costs rise and fall directly with the level of production. This means that, at a higher level of output, Viv’s business will have to pay higher variable costs. For example, if we look at her variable costs when she produces 500 paperweights, we can see that her variable costs are £5,000. As a result, the variable costs line slopes upward from left to right.

➜ Total costs. As we saw earlier, total costs are simply fi xed costs and variable costs added together. So, for example, at a production level of 1,000 paperweights each year, the total costs of Viv’s business would be £17,500. This is made up of fi xed costs (£7,500) plus variable costs (£10,000). The fi gures are added together in the same way as other levels of production.

➜ Total revenue. This is also called ‘revenue from sales’. This is calculated by multiplying the level of output by the selling price of the product. Thus, Viv’s business would have no revenue if production did not take place and would have a revenue of £12,500 if it produced 500 paperweights (500 × £25). Finally, at an output of 1,000 paperweights, the business’s total revenue would be £25,000.

The level of break-even outputBreak-even output occurs when the total costs of production equal the revenue from sales. In a break-even chart, this occurs at the level of production at which the total costs line intersects the total revenue line. In Figure 6.8, break-even output is achieved at a production level of 500 paperweights per year. At this level of production, the total cost line intersects the total revenue line. ➜ Levels of output below break-even. At these levels of production, total

costs will be greater than total revenue. As a consequence, the business will make a loss.

➜ Levels of output above break-even. At these higher levels of production, total revenue will be higher than total costs meaning that the business will make a profi t.

This break-even chart shows that Viv’s business will make a profit if it produces and sells more than 500 units. If it produces and sells fewer than 500 units, the business will make a loss.

Viv Burns’ business will break-even if she produces and sells 500 paperweights in a year.


Maths moment

What fi xed costs have to be paid by Viv’s business when she produces:

(a) 400 paperweights?

(b) 800 paperweights?

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6 Finance

The margin of safetyThe margin of safety measures the amount by which a business’s current level of production exceeds its break-even level of output. For example, if Viv produced and sold 750 paperweights in a year, her business would make a profi t. Its margin of safety would be 250 paperweights – as production and sales of 750 paperweights exceed break-even output by 250 units. This means that Viv’s production and sales could fall by 250 paperweights before her business started making a loss. Viv’s margin of safety is shown on Figure 6.9.

Having a high margin of safety can be reassuring for the managers of a business. It means that sales and production can fall significantly before the business is at risk of making a loss.

25

Total costs =Fixed costs + Variable costs

Total revenue

Fixed costs

Margin ofsafety = 250paperweights

Viv’s currentlevel of production

Break-evenlevel of production

Co

sts

and

rev

enu

es (

£000

s)

Yearly output of paperweights

20

15

10

5

100 1,0009008007006005004003002000

Figure 6.9 Viv Burns’ margin of safety (This chart has omitted the variable cost line for reasons of simplicity).

Business insight

Break-even and BPBP is one of the world’s largest oil companies. Analysts think that the company can break-even if the price of a barrel of oil is $60. At the time of writing, the price of a barrel of oil on world markets is $52.

Explain what these fi gures mean for BP’s profi ts from selling oil. (4 marks)

Key term

The margin of safety measures the amount by which a business’s current level of production exceeds its break-even level of output.

Study tip

A question may ask you to interpret a break-even chart that has already been provided, identifying the level of break-even output and the margin of safety rather than asking you to draw a break-even chart yourself.

295

The value of break-even analysisManagers use break-even charts to help to analyse the business’s future fi nancial performance. They have a number of advantages and disadvantages.

The advantages of using break-even analysis➜ Break-even charts help managers to see the effects of any changes in costs.

A rise in costs will increase the level of output and sales a business will need to break even. It will also reduce or eliminate the business’s margin of safety. A fall in costs will have the opposite effects. This helps managers to prepare for future changes in costs.

➜ Break-even charts show the effects of changes in price. A rise in the price at which the business sells its products will reduce the business’s break-even output and increase its margin of safety. A fall in price has the opposite effects. For example, managers can use break-even charts to analyse whether a fall in price might lead to the business making a loss rather than a profi t.

➜ Many businesses use bank loans and overdrafts as a source of fi nance. Banks are more likely to agree to a loan if the business’s managers provide evidence of planning future fi nances. This helps the bank to judge whether its loan will be repaid. A break-even chart can be an important part of fi nancial planning.

The disadvantages of break-even analysis➜ The main disadvantage of break-even analysis is that it assumes that a

business sells all of the output it produces. This is unlikely, even for a well-known business. Break-even charts are of much greater value to managers if supported by market research showing that future sales will match production levels.

➜ Many businesses operate in markets where costs and prices change rapidly and frequently. This makes break-even charts of less value as they are inaccurate almost as soon as they are prepared. For example, businesses that import raw materials and components may face changing costs when the exchange rate of the pound changes. This happens regularly and some of the changes can be large.

The UK imports huge quantities of raw materials and components from overseas. Movements in the exchange rate of the pound can result in firms that use them facing different costs.


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6 Finance

SummaryBusinesses’ total costs of production are made up of fi xed costs and variable costs. Businesses invest in a range of assets including new buildings and machinery. It is possible to measure the return on these investments by calculating the average rate of return. Break-even output is a level of production

at which total costs are equal to total revenue from sales. Businesses can receive a number of benefi ts from using break-even analysis. For example, its use can help to persuade a bank to grant a loan to a business.

Quick questions 1 Explain the difference between costs

and profit. (3 marks)

2 At a certain level of production, a business has fixed costs of £100,000 and total costs of £240,000. Which of the following is its variable costs?

(a) £340,000

(b) £240,000

(c) £140,000

(d) £40,000 (1 mark)

3 A business increases its production by 5 per cent; no other changes occur. Which of the following statements will be true following the increase in production?

(a) The business’s fi xed costs will not change.

(b) The business’s fi xed costs will rise.

(c) The business’s variable costs will be unchanged.

(c) The business’s variable costs will fall. (1 mark)

4 State two assets in which businesses might invest. (2 marks)

5 Explain what is meant by the ‘average rate of return’ or ‘ARR’. (3 marks)

6 A business plans to invest £5 million in new machinery. This will make a total profit of £2 million over four years. Which of the following is the ARR on this investment project?

(a) 400%

(b) 40%

(c) 10%

(d) 0.5% (1 mark)

7 What is meant by the term ‘break-even’? (2 marks)

8 Which line on a break-even chart is drawn parallel to the x-axis (the axis which shows the business’s level of production)?

(a) The fi xed costs line

(b) The variable costs line

(c) The total costs line

(d) The total revenue line (1 mark)

9 Explain the benefits of a high margin of safety to a business. (2 marks)

10 State two advantages to managers from the use of break-even analysis. (2 marks)

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Case study

A sweet businessNigel Gilpin has recently retired and is considering starting a business to supply honey to local shops in the area in which he lives. He has attended bee-keeping classes and has done a little market research with possible customers.

He has the following fi nancial forecasts for his business:

● Investment required – £40,000

● Average yearly profi t – £4,500

● He has forecast sales of 7,000 jars of honey a year.

● He expects to set a price of £2.50 per jar of honey, though prices do vary a lot.

He has also prepared the break-even chart shown below.

25

Total costs

Total revenue

Fixed costs

Variable costs

Co

sts

and

rev

enu

es (

£000

s)

Yearly output of jars of honey (000s)

20

15

10

5

1 10987654320

Figure 6.10 Nigel’s break-even chart

Nigel plans to ask his bank for a loan of £15,000, as he has only £25,000 of the money needed to start the business. It is currently in a savings account receiving interest of 5 per cent a year.

1 Calculate the average rate of return from investing in the business, if Nigel’s forecasts are correct. (3 marks)

2 Explain how knowing the average rate of return on the new business might help Nigel to make a decision. (4 marks)

3 Analyse how using his break-even chart might help Nigel to decide whether or not to start the new business. (6 marks)

4 Recommend whether Nigel should use break-even analysis to help him to decide whether or not to start the business. (9 marks)


C

298

Topic 6.4 Analysing the � nancial performance of a business

● Why businesses prepare financial statements

Two of the most important fi nancial statements prepared by businesses are the income statement and the balance sheet. Businesses need to prepare these fi nancial statements for a number of reasons:➜ The law. Publishing fi nancial statements in the UK is a legal requirement

under the Companies Acts. If a company fails to prepare these statements in the agreed format, it may be fi ned or, in extreme cases, forced to cease trading. Smaller businesses, such as sole traders and partnerships, do not have to follow the same legal rules.

➜ To help the business’s managers make decisions. These two fi nancial statements are very helpful to the business’s managers. They assist the managers in making a range of decisions on how to improve the business’s performance. For instance, if the business’s profi ts were lower than expected, the managers might take action to improve profi tability, possibly by raising prices.

Key terms

An income statement is a fi nancial statement showing a business’s revenues and costs, and thus, its profi t or loss over a period of time.

A balance sheet sets out the assets and liabilities that a business has on a particular day.

Most businesses have to draw up fi nancial statements. This is a legal requirement, and the law sets out how these statements should be structured. This topic looks at the two most important fi nancial statements that large businesses keep: the balance sheet and the income statement. It will look at ways in which these fi nancial statements can be useful to stakeholders such as managers and owners.


● why businesses prepare fi nancial statements

● the components of fi nancial statements

● how to interpret fi nancial statements

● the importance of fi nancial statements.

299

6.4 Analysing the financial performance of a business

➜ To guide investors. People and other businesses that are planning to invest money into a business will gain a lot of information from its income statement and its balance sheet. This will help them to judge how safe the investment is and whether the investment will earn a profi t.

● Components of financial statements

Components of income statements An income statement shows three key pieces of information for a business over a period of trading, normally one year:➜ the revenue earned by the business – revenue is also called ‘sales income’➜ the costs of production that have been paid by the business➜ the amount of profi t earned by the business or the loss it has made.

Figure 6.11 shows the main components of an income statement as well as its structure. An income statement has six main sections:➜ Revenue. This is the income received by a business from the sale of its

goods and services over the period covered by the income statement. As an example, Marks & Spencer’s income statement would include the revenue the company received from selling food, clothes and other products.

➜ Cost of sales. These are the costs involved in directly supplying the good or service. Marks & Spencer’s cost of sales include the costs of:➜ the wages of employees involved in transporting and selling products➜ buying the products which are sold in its shops➜ energy costs such as gas and electricity.

➜ Gross pro� t. Gross profi t is revenue minus the cost of sales. A restaurant would calculate its gross profi t as follows:

gross profi t = revenue − cost of sales

➜ Revenue is the income received from selling meals and drinks to customers.➜ Cost of sales is the cost of buying food, etc. and employees’ wages.

➜ Overheads. They are costs that do not alter when the level of production changes. Overheads will include the salaries of managers, insurance costs, interest on loans and also the cost of maintaining buildings. Overheads are sometimes called ‘expenses’.

➜ Operating pro� ts. A business’s operating profi ts are calculated by subtracting its overheads from its gross profi ts.

➜ Net pro� t. Net profi t is the fi nal component of the income statement. It is calculated by taking taxes and interest payments from operating profi ts. Net profi t is a good measure of the performance of a business.

Key terms

Gross profi t is a business’s sales revenue minus its cost of sales over a period of time, normally a year.

Net profi t is a business’s sales revenue minus its cost of sales, its overheads and other costs over a period of time, normally a year.

Marks & Spencer’s expenditure includes paying its staff and buying goods to sell. It receives revenue from its customers when they buy its products.

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6 Finance

Revenue

Minus

Cost of sales

Gives

Gross profit

Minus

Overheads

Gives

Operating profit

Minus

Tax and interest

25.0

Example(£ millions):

–

16.1

=

8.9

–

3.7

=

5.2

–

2.7

Gives

Net profit

=

2.5

Figure 6.11 Basic structure of an income statement

Components of the balance sheet A balance sheet sets out the assets and liabilities that a business has on a particular day (see Figure 6.12). It shows where a business’s fi nance has come from and how the business has spent the money that it has raised. It shows this fi nancial information for a business on a particular day. It thus provides a snapshot of the business’s fi nancial position.

We shall consider the structure of balance sheets as used by companies. Sole traders and partnerships prepare balance sheets slightly differently. A balance sheet is sometimes called ‘a statement of financial position’.

A company’s balance sheet will contain the following information about the business.

Business insight

Starlight in CoventrySusie West runs Starlight, one of Coventry’s most popular nightclubs. Starlight has two bars and a large dance fl oor.

Susie runs her business as a private limited company and her main business objective is to make profi ts. Her accountant is preparing her income statement for last year. This is shown below, with her income statement for the year before.

Last year£

The year before last£

Sales revenue 940,200 939,125

Cost of sales 438,130 434,050

Gross profi t 502,070 505,075

Overheads 225,500 247,925

Operating profi t 276,570 257,150

Tax and interest payments

98,425 101,100

Net profi t 178,145 156,050

Table 6.6 Starlight Ltd’s income statement

Susie thinks that, looking at the two income statements, Starlight’s fi nancial performance was better last year than in the year before last.

Use the income statement in Table 6.6 to analyse why Susie thinks that Starlight’s fi nancial performance was better last year than in the year before last. (6 marks)

Key term

A liability is a sum of money that is owed by a business to another business or an individual.

Operating this ship results in many costs that will appear on the business’s income statement. The cost of food for passengers, the cost of fuel for the engines and the crew’s wages will all be included under cost of sales. However, the cost of insuring the ship and the cost of maintaining it in top condition will be overheads.

301


AssetsAn asset is anything that is owned by a business. Assets can be divided into two types:➜ Non-current assets. A business will normally keep this type of asset for

many years. Examples of non-current assets include shops and vehicles. Non-current assets create revenue for the business and enable it to earn profi ts.

➜ Current assets. These are assets that the business only expects to have for a short time (normally less than one year). Examples of current assets include cash and inventories of raw materials. Current assets (especially cash) are used by the business to settle debts such as paying for raw materials.

Fixed assets(e.g. buildings, machinery)

plus

Current assets(e.g. cash, stock)

minus

Current liabilities(e.g. money owed to suppliers)

minus

Long-term liabilities(e.g. bank loans, mortgages)

equals

Net assets

and this equals

Total equity

8,525

Example(£000s):

+

1,560

–

2,010

–

4,100

=

3,975

=

3,975

These two figuresare equal (orbalance) whichis why thisstatement iscalled the‘balance sheet’

Figure 6.12 Components and structure of a balance sheet

LiabilitiesLiabilities are the amounts owed by a business to other businesses and individuals. There are two types of liabilities:➜ Non-current liabilities are debts that will be paid back over many years.

Loans from the bank or a loan to buy property (called a mortgage) are examples of this type of liability.

➜ Current liabilities are debts that a business will pay within a year. Examples of current liabilities include money owed to suppliers and tax the business has to pay.

Total equityTotal equity is the part of a company’s money that belongs to shareholders. If a company stops trading and sells all its non-current and current assets, it would normally have a large sum of money remaining. This would be used to pay all the company’s liabilities (its debts). The money that is left once this is done is called ‘total equity’.

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Balancing assets and equityA balance sheet gets its name because the two parts of the document will equal each other. The value of the assets owned by the business (once it has paid its liabilities) is called ‘net assets employed’. This will exactly equal the amount of money put into the business by the company’s shareholders, which, as we saw, is called ‘total equity’. Thus, the reason that the balance sheet balances is because:

net assets = total equity

If the shareholders of a business raised extra finance to buy, say, new vehicles, then the value of the business’s non-current assets and the shareholders’ total equity will increase by the same amount. As Figure 6.13 shows, this means that the balance sheet will continue to balance.

Net assets£3,975,000

+

Total equity£3,975,000

+

New vehicles£125,000

=

New funds raisedby shareholders

£125,000=

New net assets£4,100,000

=

=New total equity

£4,100,000

Money invested in thisway shows up on bothhalves of the balance sheet

Figure 6.13 Why the balance sheet balances

● How to interpret financial statementsA business’s stakeholders such as its managers, suppliers and owners will be very interested in the information that is set out in its balance sheets and income statements. They may look, for example, at trends in profi ts to see if the business is making higher levels of profi t than in previous years.

On the other hand, they may consider the figure for ‘net assets employed’ to see if the value of the business has increased over time.

To make better judgements about businesses’ performances, it is important to compare a profit figure to something else to understand how successful the business has been. There are a number of possible comparisons that can be made.

A comparison with previous yearsAn obvious way to judge a business’s profi ts is by a simple comparison with profi ts in previous years. However, it is important to note that not all businesses operate with the aim of making the largest possible profi ts.

Key indicators of a business’s performance over time from its income statement are:➜ the revenue from sales of goods and services➜ gross and net profi ts.

303


If profits are higher than in previous years, the business is likely to consider that it has had a successful year in financial terms. Table 6.7 shows the net profits for AstraZeneca plc, a pharmaceutical company that develops and sells drugs throughout the world.

Year2015£m

2014£m

2013£m

Revenue from sales 20,252 21,760 21,152

Gross profi ts 16,444 16,971 16,840

Net profi ts 2,316 1,012 2,107

Source: AstraZeneca plc’s Annual Report, 2015: www.astrazeneca.com

Table 6.7 AstraZeneca plc’s revenue from sales and net profits, 2013–2015

AstraZeneca plc’s revenue was significantly lower in 2015 than in 2014 and its gross profit fell as well. However, the company’s managers would have been pleased with the company’s net profits for 2015 as it was more than double that achieved in 2014. The company must have reduced its overheads as well as the amounts paid for interest.

In 2014, AstraZeneca’s revenue increased compared with 2013, but its net profits were much lower. The company spent heavily on overheads, interest payments and taxation in 2014.

Business insight

ASOS’s profi ts riseASOS plc is an online retailer of fashion clothing. The company is based in the UK. It sells its own brand clothing as well as that supplied by other companies.Table 6.8 shows the company’s revenues and profi ts for 2014 and 2015.

Year2015£m

2014£m

Revenue from sales 1,150.78 975.47

Gross profi ts 575.80 485.01

Net profi ts 36.85 36.59

Source: ASOS plc: www.asosplc.com

Table 6.8 Financial information for ASOS, 2014 and 2015

Analyse the changes in the performance of ASOS plc between 2014 and 2015. (6 marks)

WaterAid UK is a charity that improves access to safe water, hygiene and sanitation. Its aim is to transform people’s lives rather than to make profits.

http://www.astrazeneca.com

http://www.asosplc.com

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6 Finance

A comparison with the performance of competitorsAn effective way to judge the fi nancial performance of a business is to compare information from its income statement with that of competitors. If a business can increase its revenues and profi ts more quickly than others in the same industry, it is a good sign that the business is performing strongly in fi nancial terms.

Table 6.9 compares the financial performance of AstraZeneca plc and GlaxoSmithKline plc in 2014 and 2015.

AstraZeneca plc GlaxoSmithKline plc

Year2015£m

2014£m

2015£m

2014£m

Revenue from sales 20,252 21,760 23,923 23,006

Net profi ts 2,316 1,012 8,372 2,831

Sources: (1) AstraZeneca plc Annual Report, 2015: www.astrazeneca.com

Table 6.9 Financial information for AstraZeneca plc and GlaxoSmithKline plc for 2014 and 2015

Although AstraZeneca’s financial performance in 2015 looked quite good in comparison to 2014, it is not as impressive when compared to that of its rival, GlaxoSmithKline (GSK). GSK’s revenue rose in 2015 and was higher than that achieved by AstraZeneca. However, the most significant figure is GSK’s net profits for 2015. They are nearly four times higher than those of AstraZeneca, from sales revenue that are only a little smaller. This suggests that GSK managed to control its costs much better than AstraZeneca.

Using profit ratiosThere is internal data that can be used to compare a business’s fi nancial performance. Managers can use information from the business’s income statement to calculate fi nancial ratios. Financial ratios compare two fi gures from a business’s fi nancial statements.

It is common for managers and other stakeholders to calculate profits ratios. These ratios compare a business’s profits to another figure from the business’s financial statements. One of the most obvious figures to compare with a business’s profit figure is the revenue that it has earned.

There are two profit figures we can use in such a calculation: gross profit and net profit. The figures for gross and net profit are on the business’s income statement. Using the gross and net profit figures allows us to calculate two profits ratios: the gross profit margin and the net profit margin.

Key term

A fi nancial ratio compares two fi gures from a business’s fi nancial statements.

http://www.astrazeneca.com

305


Gross profi t marginThis profi t ratio compares a business’s gross profi t for a trading period with the revenue fi gure for the same year. It is calculated using the formula below and the answer is a percentage:

gross profi t margin = gross profi t

revenue × 100

As an example, if a business’s gross profit for a year was £30,000 and its revenue for the same period was £120,000, its gross profit margin will be:

gross profi t margin = £30,000

£120,000 × 100 =

£3,000,000

£120,000 = 25%

A gross profit margin of 25 per cent means that 25p in each £1 of revenue is gross profit. Is 25 per cent a good figure for a gross profit margin? This can only be answered by comparing the figure to one of the following:➜ the business’s target for its gross profi t margin➜ the business’s gross profi t margin for earlier years➜ the gross profi t of other similar businesses.

Net profi t marginThis profi t ratio compares a business’s net profi t for a trading period with the revenue fi gure for the same year. It is calculated using the formula below and the answer is a percentage:

net profi t margin = net profi trevenue × 100

As an example, if a business’s net profit for a year was £12,000 and its revenue for the same period was £120,000, its net profit margin will be:

net profi t margin = £12,000

£120,000 × 100 =

£1,200,000

£120,000 = 10%

The net profit margin can be a better indicator of a business’s financial performance as its calculation includes all the costs paid by a business. In contrast, the gross profit margin only includes a business’s cost of sales.

Is 10 per cent a good figure for a net profit margin? As with the gross profit margin, it needs to be compared with figures for the business from earlier years, the expectations of the business’s managers and owners, and the net profit margin achieved by similar businesses.

Study tip

It is important for you to learn the formulae for calculating gross and net profi t margin.

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6 Finance

Judging financial performance from the perspective of different stakeholdersThere are numerous stakeholders who look at the fi nancial statements of a business to judge its fi nancial performance.

Shareholders and ownersThe owners of businesses (shareholders and partners, for example) will be interested in a business’s profi tability. This is because profi t is the reward to business owners for taking a risk by investing in the enterprise. The income statement provides vital information on:➜ the level of sales achieved➜ the costs the business has had to pay➜ the amount of profi t or loss that has been made.

In addition, a balance sheet can show whether or not the value of a business has increased.

Key term

Stakeholders are individuals and organisations that are affected by, and affect, the business.

Business insight

Profi ts ratios in the pharmaceutical industryTable 6.9 showed the profi ts and revenues for AstraZeneca plc and GlaxoSmithKline plc for 2014 and 2015. The fi gures for 2015 are shown again in Table 6.10.

AstraZeneca plc GlaxoSmithKline plc

Year2015£m

2015£m

Revenue from sales 20,252 23,923

Net profi ts 2,316 8,372

Table 6.10 Financial information for AstraZeneca plc and GlaxoSmithKline plc, 2015

In 2014, AstraZeneca’s net profi t margin was:

£1,012 million × 100 ÷ £21,760 million = 4.65%

In 2014, GSK’s net profi t margin was:

£2,831 million × 100 ÷ £23,006 million = 12.31%

1 Calculate the net profi t margins for AstraZeneca plc and GlaxoSmithKline plc for 2015. (6 marks)

2 Explain which company might be more satisfi ed with its fi nancial performance on the basis of these net profi t margin results. (4 marks)

307


Owners such as shareholders would hope that a business’s sales and profits will grow over time. If a business’s financial performance is better than that of a rival in the same industry, then owners such as shareholders will most probably be impressed. Such positive financial performance may persuade the owners to invest more money into the business.

ManagersManagers use the information in fi nancial statements to assess whether or not their decisions are effective. Thus, the managers of GlaxoSmithKline might have thought at the end of 2015 that their decisions had been effective (see Business insight above). The company’s profi ts had risen strongly, as had its net profi t margin.

The balance sheet also gives managers further information, especially when looked at over a period of time and if compared to competitors’ balance sheets. For example, it shows the amount that the businesses are borrowing – this is shown by liabilities, especially non-current liabilities. This can help managers to judge whether borrowing is too high.

SuppliersSuppliers will be interested in the business’s fi nancial performance as revealed by a business’s fi nancial statements. A business’s income statements show whether or not it has made a profi t and this can guide a supplier on whether it is likely to be paid in the future. A business that is recording a large loss may not be able to pay for supplies of raw materials and components in the future.

EmployeesEmployees will also be interested in a business’s fi nancial performance, and especially the information on its income statement. We saw in Topic 4.3 that some businesses operate profi t-sharing schemes. Therefore, employees’ pay may depend on the business’s level of profi ts. It can also guide employees regarding job security. A business that records a substantial loss on its income statement may seek to cut costs to improve its performance. This might mean that it employs fewer people and that some employees lose their jobs.

Transport companies are dependent on the financial performance of other businesses. If businesses perform less well financially, they are likely to need fewer goods to be transported.

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6 Finance

● The importance of financial statementsThe income statement and the balance sheet are important documents to a business’s stakeholders for two main reasons.

Assessing business performanceWe have seen that fi nancial statements provide information on a business’s fi nancial performance. They show the business’s revenue from sales, its profi ts and increases in the value of the business. Financial statements often show this data for several years, making it possible to judge the trend of the business. For example, if a business’s revenue and profi ts are rising over a period of time, it provides evidence that the business’s performance is improving. This is especially true if the performance of competitors over the same time period has not improved.

Financial statements allow managers and other stakeholders to conduct ratio analysis. By comparing two pieces of financial information, it is possible to make a better judgement of a business’s performance. A rise in profits is a good sign for a business. If the business also has a rise in its net profit margin, this shows that the business is being run more efficiently. This happened in the case of GlaxoSmithKline plc in the Business insight feature earlier.

Helping managers to make effective decisionsFinancial statements provide a great deal of information which can help a business’s managers to make better decisions. For example, they may be able to uncover the reasons for falling profi ts and take appropriate action to improve the situation. The income statement will show whether costs have risen and whether it is the cost of sales or overheads (or both) that has risen. Managers can take decisions to cut costs as necessary – or perhaps to increase prices.

Alternatively, it may be a fall in sales that has caused the decline in profits. This is shown by the data on the income statement. In this case, managers may take a decision to increase advertising to provide a boost to the business’s sales figures.

SummaryFinancial statements such as income statements and balance sheets provide a business’s stakeholders with a lot of information about the business. This helps them to make judgements about the business’s performance and to make decisions, such as whether or not to invest in the business. Income statements

record a business’s revenues, costs and profi ts over a trading period. Balance sheets record a business’s assets and liabilities on a particular day. The information in an income statement allows the calculation of gross profi t margins and net profi t margins.

Managers rely on the information in financial statements to make well-informed decisions.

309


Quick questions 1 State two reasons why UK companies

might prepare financial statements. (2 marks)

2 Name three stakeholders who may want to look at a business’s financial statements. (3 marks)

3 If a business’s cost of sales is deducted from its revenue from sales, the resulting figure is which of the following?

(a) Gross profi t

(b) Operating profi t

(c) Net profi t

(d) Net assets employed (1 mark)

4 Using examples, explain the difference between a business’s assets and its liabilities. (4 marks)

5 Which of the following is an example of a non-current asset?

(a) Inventories

(b) Cash

(c) Vehicles

(d) Total equity (1 mark)

6 State two ways a business’s profits can be judged by using comparisons. (2 marks)

7 What is meant by the term ‘financial ratio’? (2 marks)

The following information relates to a business and is used for questions 8 and 9.

● Net profi ts – £250,000

● Cost of sales – £900,000

● Revenue – £1,900,000

● Overheads – £700,000

8 Which of the following is the business’s gross profit margin?

(a) 52.63%

(b) 47.37%

(c) 27.78%

(d) 26.55% (1 mark)

9 Which of the following is the business’s net profit margin?

(a) 52.63%

(b) 47.37%

(c) 27.77%

(d) 13.16% (1 mark)

10 State two reasons why financial statements are important to a business. (2 marks)

Case study

Winter LtdWinter Ltd is a private limited company that owns and operates two garden centres in Essex. It competes with larger competitors such as Wyevale Garden

Centres. Winter Ltd has completed its income statement for the fi nancial year which has just fi nished. An extract from this is shown in Table 6.11.

£

Revenue 750,000

Cost of sales 440,000

Gross profi t 310,000

Overheads, tax and interest 222,500

Net profi t 87,500

Table 6.11 Winter Ltd’s income statement

C

310

6 Finance

310

Chapter review – FinanceRead question 1, the sample answers and the comments. Then try question 2.


➜ Item A Rio Ives is the largest shareholder in Super Smoothies Ltd – she has 51 per cent of the shares. The company has been very successful, and Rio has been very satisfi ed with its profi ts. However, at times, it has faced cash fl ow diffi culties. Rio’s bank manager has advised her that it is very important for her to prepare cash fl ow forecasts for the company.

The company owns and runs six smoothie bars in the north of England. Rio is planning to open two new bars in Sheffi eld. To do so, her company needs to raise £400,000 to buy property and equip it. Rio is unsure which source (or sources) of fi nance to use. She has considered using a mortgage or selling more shares in her company. She has to consider a lot of factors including the views of other shareholders who want increased profi ts and are not sure about the expansion into Sheffi eld. Also, she is worried that interest rates may rise signifi cantly over the next few years.

Rio thinks that Super Smoothie Ltd’s latest income statement may help her to make a decision as to how to raise the fi nance for the two new smoothie bars. Key fi gures from this are shown in Table 6.12.

The year before last:

● Winter Ltd’s net profi t was £85,000.

● Its gross profi t margin was 45.52%.

● Its net profi t margin was 15.16%.

The company is planning to buy a third garden centre in Braintree. It has raised some of the fi nance needed for this, but has asked its bank for a loan of £200,000 to enable it to complete the deal. However, Winter Ltd’s major shareholder is concerned about her company’s recent fi nancial performance.

1 Calculate Winter Ltd’s gross and net profi t margins for the fi nancial year which has just fi nished. (4 marks)

2 Use the information in Table 6.11 to explain the difference between gross profi t and net profi t. (4 marks)

3 The case study shows information relatingto Winter Ltd’s income statements. Analysethe other fi nancial information that the bank might want before deciding whether or not to lend the company £200,000. (6 marks)

4 Recommend whether or not Winter Ltd’s major shareholder is correct to be worried about the company’s recent fi nancial performance. Give reasons for your answer. (9 marks)

311311

£

Sales revenue 500,000

Cost of sales 305,000

Gross profi t 195,000

Overheads, tax & interest 95,000

Net profi t ?

Table 6.12 Key fi gures from Super Smoothie Ltd’s income statement

Rio thinks that the income statement is important in making this decision as well as the company’s balance sheet.

(a) State two assets that Super Smoothies Ltd would need to carry out its business successfully. (2 marks)

(a) Super Smoothies Ltd would need a lot of assets if it is to carry out its business successfully and to make sure that its customers were satisfi ed. These assets would be shops, machines to make smoothies, tables and chairs for customers and cash in its tills.

The student uses the term ‘assets’ and is able to give examples of the types of assets that this business would need. This is a very long answer for two marks and much unnecessary detail is given.

(b) Calculate the following fi gures for Super Smoothies Ltd for the period shown by the income statement:

(i) net profi t

(ii) net profi t margin. (4 marks)

(b) (i) Net profi t is revenue less all costs of production.

Net profi t = £500,000 − (£305,000 + £95,000) = £100,000

(ii) Net profi t margin = net profi ts × 100 ÷ sales revenue

Net profi t margin = £100,000 × 100 ÷ £500,000 = 20

By including formulae, especially when calculating pro� t margins, shows knowledge and helps to structure answers. The answer to (i) is entirely correct. However, (ii) is incomplete. The formula and the calculation that follows is � ne. The � nal answer, however, should have a percentage sign as all pro� t margins are percentages.

(c) Analyse why Rio’s bank manager has said that ‘it is very important for her to prepare cash fl ow forecasts for the company’. (6 marks)

Chapter review – Finance

312

6 Finance

(c) Cash fl ow is the money that fl ows into and out of a business every day. Without cash a business cannot continue to trade as it will not be able to pay its bills when they are due for payment. The bank manager may be worried that Rio’s business is at risk of being short of cash as it has had cash fl ow problems before. Also Rio is planning a big expansion and to buy two new smoothie bars. This will involve a lot of cash outfl ows and could make the business’s cash position weak. Forecasting cash fl ow will help to show when problems might take place and to have solutions ready.

The student has combined subject knowledge with the information from the case study and is focused closely on the question. The student understands what is meant by cash � ow (and does not confuse it with pro� t) and why it is important for any business to prepare cash � ow forecasts. He or she also uses material from the case study selectively to support the arguments – such as the fact that the business has had cash � ow dif� culties in the past.

(d) Rio is planning to open two new smoothie bars and needs to raise £400,000 to do this.

Analyse the sources of fi nance she might use. In your answer, you should consider:

● the advantages and disadvantages of using a mortgage

● the advantages and disadvantages of selling more shares.

Should Rio use a mortgage or sell more shares as a means of raising capital? Justify your answer. (12 marks)

(d) A mortgage is a long-term loan used to buy property and can be for up to 50 years. If Rio decides to use a mortgage, this will be suitable as she is planning to buy property and this can be used as collateral for the mortgage. She is also planning to borrow a lot of money – £400,000 – and a mortgage can be arranged over a long period of time. This means that the company will not have to pay too much back each month. This will help to keep it profi table. However, interest rates are forecast to rise and this could make the repayments of the mortgage more expensive over time. Profi ts could be damaged.

Selling more shares means that the business will not have to make repayments on a mortgage each month and this could help the business’s profi ts. This is something that the other shareholders are keen to see. However, Super Smoothies Ltd is a private company and Rio and the other shareholders would have to agree, and this might be diffi cult as they are unsure about the expansion anyway.

Rio would be better making a decision to arrange a mortgage. The other shareholders might be happier with this as they would receive a larger proportion of the profi ts as they would not have to share them with new shareholders. It is also a better option for Rio. She has 51 per cent of the shares at the moment. If she sells more shares, she is bound to lose control and the business might end up making decisions which she does not agree with.

The student has followed the structure suggested by the question and has developed arguments for and against the two sources of � nance. The � nal paragraph offers a clear decision and reasons for the choice. The student also makes good use of the information in the case study to develop arguments and support the judgement. For example, the fact that Rio owns 51 per cent of the company’s shares is used effectively.

312

6 Finance

(c) Cash fl ow is the money that fl ows into and out of a business every day. Without cash a business Cash fl ow is the money that fl ows into and out of a business every day. Without cash a business Cash fl ow is the money that fl ows into and out of a business every day. Without cash a business cannot continue to trade as it will not be able to pay its bills when they are due for payment. The cannot continue to trade as it will not be able to pay its bills when they are due for payment. The cannot continue to trade as it will not be able to pay its bills when they are due for payment. The cannot continue to trade as it will not be able to pay its bills when they are due for payment. The bank manager may be worried that Rio’s business is at risk of being short of cash as it has had bank manager may be worried that Rio’s business is at risk of being short of cash as it has had cash fl ow problems before. Also Rio is planning a big expansion and to buy two new smoothie cash fl ow problems before. Also Rio is planning a big expansion and to buy two new smoothie bars. This will involve a lot of cash outfl ows and could make the business’s cash position weak. Forecasting cash fl ow will help to show when problems might take place and to have solutions ready.

The student has combined subject knowledge with the information from the case study and is focused closely on the question. The student understands what is meant by cash � ow (and does not confuse it with pro� t) and why it is important for any business to prepare cash � ow forecasts. He or she also uses material from the case study selectively to support the arguments – such as the fact that the business has had cash � ow dif� culties in the past.

(d) Rio is planning to open two new smoothie bars and needs to raise £400,000 to do this.

Analyse the sources of fi nance she might use. In your answer, you should consider:

● the advantages and disadvantages of using a mortgage

● the advantages and disadvantages of selling more shares.

Should Rio use a mortgage or sell more shares as a means of raising capital? Justify your answer. (12 marks)

(d) A mortgage is a long-term loan used to buy property and can be for up to 50 years. If Rio decides to use a mortgage, this will be suitable as she is planning to buy property and this can be used as collateral for the mortgage. She is also planning to borrow a lot of money – £400,000 – and a mortgage can be arranged over a long period of time. This means that the company will not have to pay too much back each month. This will help to keep it profi table. However, interest rates are forecast to rise and this could make the repayments of the mortgage more expensive over time. Profi ts could be damaged.

Selling more shares means that the business will not have to make repayments on a mortgage each month and this could help the business’s profi ts. This is something that the other shareholders are keen to see. However, Super Smoothies Ltd is a private company and Rio and the other shareholders would have to agree, and this might be diffi cult as they are unsure about the expansion anyway.

Rio would be better making a decision to arrange a mortgage. The other shareholders might be happier with this as they would receive a larger proportion of the profi ts as they would not have to share them with new shareholders. It is also a better option for Rio. She has 51 per cent of the shares at the moment. If she sells more shares, she is bound to lose control and the business might end up making decisions which she does not agree with.

The student has followed the structure suggested by the question and has developed arguments for and against the two sources of � nance. The � nal paragraph offers a clear decision and reasons for the choice. The student also makes good use of the information in the case study to develop arguments and support the judgement. For example, the fact that Rio owns 51 per cent of the company’s shares is used effectively.

313


➜ Item B Ritula Shah has a decision to make. She is an experienced baker and has worked for a well-known company for many years. She has the opportunity to buy her own bakery in nearby Corbridge and is unsure whether or not to buy it.

She has calculated the following costs and revenues for her bakery for its fi rst year of trading:

● Revenue – £ 200,000

● Fixed costs – £60,000

● Variable costs – £115, 000

● Amount needed as an investment to start the bakery – £200,000.

Some of these fi gures are uncertain as existing businesses may change their prices, and the costs of ingredients such as fl our can alter rapidly.

Ritula has £200,000 available to invest in the business – it is in a bank account receiving just 2 per cent interest. She would not need to use any other source of fi nance. A friend has advised her that using break-even analysis might help her to reach a decision. Ritula is worried that her forecast might not be very accurate, and she does not like risk. It is a big decision to make as she currently has a well-paid job.

(a) Identify two examples of variable costs that Ritula will have to pay if she opens the bakery. (2 marks)

(b) Calculate the expected average rate of return for the bakery in its fi rst year of trading. (4 marks)

(c) Analyse how using break-even analysis might help Ritula to make a decision. (6 marks)

(d) Recommend whether or not Ritula should open the bakery. (9 marks)


➜➜ Item B Item B Ritula Shah has a decision to make. She is an experienced baker and has worked for a well-known company for many years. She has the opportunity to buy her own bakery in nearby Corbridge and is unsure whether or not to buy it.

She has calculated the following costs and revenues for her bakery for its fi rst year of trading:

● Revenue – £ 200,000

● Fixed costs – £60,000

● Variable costs – £115, 000

● Amount needed as an investment to start the bakery – £200,000.

Some of these fi gures are uncertain as existing businesses may change their prices, and the costs of ingredients such as fl our can alter rapidly.

Ritula has £200,000 available to invest in the business – it is in a bank account receiving just 2 per cent interest. She would not need to use any other source of fi nance. A friend has advised her that using break-even analysis might help her to reach a decision. Ritula is worried that her forecast might not be very accurate, and she does not like risk. It is a big decision to make as she currently has a well-paid job.

(a) Identify two examples of variable costs that Ritula will have to pay if she opens the bakery. (2 marks)

(b) Calculate the expected average rate of return for the bakery in its fi rst year of trading. (4 marks)

(c) Analyse how using break-even analysis might help Ritula to make a decision. (6 marks)

(d) Recommend whether or not Ritula should open the bakery. (9 marks)

Chapter review – Finance

314

Glossary

Glossary Advertising – involves paid for communications

Aim – a general goal of a business

Apps (or applications) – pieces of software designed for a specifi c purpose and for use on smartphones and tablets

Asset – something that is owned by a business; examples include land, buildings, vehicles and machinery

Authority – the power to control others and to make decisions

Average rate of return (ARR) – compares the average yearly profi t from an investment with the cost of the investment and is stated as a percentage

Balance sheet – sets out the assets and liabilities that a business has on a particular day

Boston Matrix – a way of analysing a product’s share and growth in their market

Break-even – the level of production at which a business’s total costs and revenue from sales are equal

Break-even chart – shows a business’s costs and revenues and the level of production needed to break even

Building societies – organisations that offer a range of fi nancial services; their major business is providing savings accounts and lending money for the purpose of buying property

Business plan – a document setting out what a business does and what it hopes to achieve in the future

Business planning – the process of producing a business plan

Cash cow – a product with a high market share in a low-growth market

Cash fl ow – the money that fl ows into and out of a business on a day-to-day basis

Cash fl ow forecast – a plan of the expected infl ows and outfl ows to and from a business over a period of time

Cash fl ow statement – a record of the cash infl ows and outfl ows that took place over an earlier period of time

Centralisation – when a small number of senior managers in a business take all the important decisions

Chain of command – the line of authority within a business along which communication passes

Cloud computing – a general term for the delivery of specialist computing services, such as the storage of very large amounts of data, provided by businesses using the internet

Collateral – an asset that a bank holds as security for the repayment of a loan

Communication – the exchange of information between two or more people

Company – a business that has its own legal identity; it can own items, owe money, sue and be sued

Competition – exists when more than one business is attempting to attract the same customers

Competitive pricing – matching the prices that competitors charge

Consumer – someone who uses goods and services produced by businesses

Consumer laws – laws that have been introduced to prevent businesses from treating their customers unfairly

Consumer spending – the value of goods and services bought by consumers over a time period, usually a month or a year

Contract of employment – a legal document stating the hours, rates of pay, duties and other conditions under which a person is employed

Cost plus pricing – products are priced by covering the cost of it to the retailer and adding a percentage on top

Costs – the spending that is necessary to set up and run a business

Curriculum vitae (CV) – provides information about a person, including qualifi cations, employment history and interests

Customer – someone who buys a product from a business

Customer engagement – when customers have a positive experience from their contact with the business

Customer loyalty – when a business’s customers make repeat purchases because they prefer the business’s products to those of its rivals

315

Glossary

Customer service – that part of a business’s activities that is concerned with meeting customers’ needs as fully as possible

Data analysis – gathering and examining data to provide useful information that can be used for decision-making

Decentralisation – allows employees working in all areas of the business to take decisions

Deed of Partnership – an agreement between partners that sets out the rules of the partnership, such as how profi ts will be divided and how the partnership will be valued if someone wants to leave

Delayering – the removal of one or more levels of hierarchy from a business’s organisational structure

Delegation – the passing down of authority to more junior employees Digital communication – the transmission of information electronically between computing devices

Direct marketing – a direct link from the producer to the customer with no intermediaries

Discrimination – treating one person differently from another without having good reasons to do so

Diseconomies of scale – when the cost per unit increases as a business expands Distribution channel – how the ownership of a product passes from the producer to the fi nal customer

Diversifi cation – when a business starts selling products in new markets

Dividends – the fi nancial rewards paid out to shareholders each year

Dog – a product with a low market share in a low-growth market

E-commerce – the act of buying or selling a product using an electronic system such as the internet (also referred to as electronic commerce)

Economic climate – the state of key factors within a country such as the level of goods and services produced and the number of jobs available

Economies of scale – when a business’s unit costs of production fall as its output rises and the business expands

Economy – made up of millions of individual consumers, many thousands of businesses and governments; all take decisions on what to buy and produce

Enterprise – another word for a business; it also refers to the skills of the people involved in the business to

identify business opportunities and bring together resources to meet these opportunities

Entrepreneur – someone who is willing to take the risks involved in starting a new business

Entrepreneurship – the ability to be an entrepreneur – to take risks to develop a business idea

Environment – the natural world in which we live; it is the landscape and its natural features such as the seas, rivers, forests and mountains

Environmental reporting – the publication of a business’s environmental performance to the general public

Environmental responsibility – the taking of decisions by businesses, consumers, governments and other groups with the intention of protecting the environment

Ethics – whether a business decision is thought to be morally right or wrong; an ethical decision is made on the basis of what is judged to be morally right

Exchange – when someone gives up something in return for something else, e.g. a business exchanges a product for money

Exchange rate – the price of one currency expressed in terms of another

Exports – goods and services produced by a business in one country and sold in a different one

Extension strategies – attempts to maintain the sales of a product and prevent it from entering the decline stage of the product life cycle

External costs of production – when a business’s activities result in harmful effects on other people not directly involved in production

External growth – when a business gets bigger by joining or buying other businesses (also known as integration)

External recruitment – fi lling a job vacancy from any suitable person not already employed by the business

External source of fi nance – money that comes from outside the business, for example, a loan from a bank

Extranets – similar to intranets, but are also accessible to other organisations such as suppliers

Fair trade products – those for which customers pay higher prices and offer better trading terms, such as payments with orders; the aim is to improve the living standards of people in poorer countries

Financial ratio – compares two fi gures from a business’s fi nancial statements

316

Glossary

Fixed costs – the costs that do not change when a business changes its output

Flotation – when a private limited company (ltd) becomes a public limited company (plc) and has its shares listed on the Stock Exchange

Flow production – when an item moves continuously from one stage of the process to another

Franchise – when a franchisor sells the rights to its products to a franchisee; this is usually in return for a fee and percentage of turnover

Franchisee – someone who buys a franchise usually in return for a fee and percentage of turnover

Franchisor – someone who sells a franchise usually in return for a fee and percentage of turnover

Fringe benefi ts – the ‘extras’ that employees may receive in addition to their pay, for example, a company car

Full-time employment – when someone works a number of hours equal to the normal working week, normally between 35 and 40 hours

Global markets – markets made up of customers from across the world

Global warming – the gradual heating of Earth’s surface, oceans and atmosphere

Globalisation – the trend for markets to become worldwide in scope

Good – a physical product, such as a car

Gross Domestic Product (GDP) – measures all the income earned in a country’s economy in a year

Gross profi t – a business’s sales revenue minus its cost of sales over a period of time, normally a year

Growth – when a business sells increased quantities of its products

Income elastic products – those whose sales are sensitive to changes in consumers’ incomes

Income statement – a fi nancial statement showing a business’s revenues and costs and thus its profi t or loss over a period of time

Induction training – the training given to an employee when he or she fi rst starts a job

Infl ation – the rate at which prices are increasing; for example, if infl ation is 2 per cent, prices are generally growing by 2 per cent that year

Information and communications technology (ICT) – the computing and communications systems that a business might use to exchange information with stakeholders

Imports – goods and services purchased from overseas by consumers of businesses

Interest – a payment made in order to borrow money; it means a business pays back more than it borrows

Interest rates – the cost of borrowing money or the reward for saving money, expressed as a percentage

Intermediary – a link in the distribution chain between the producer and the customer

Internal growth – when a business gets bigger by selling more of its products (also known as organic growth)

Internal recruitment – takes place when a job vacancy is fi lled from within the existing workforce

Internal source of fi nance – money that is available from within the business, for example, last year’s profi ts

International trade – the selling of goods and services across national frontiers

Intranets – communication networks which can only be accessed by an organisation’s employees

Inventories – raw materials that have not yet been used or products that have been made, but not sold (also called stocks)

Investment – takes place when a business buys an asset, such as a factory, in the hope of making a profi t from its use

Inward investment – when governments, businesses and individuals invest capital into another country, for example, building new factories or buying companies

Job analysis – the collection and interpretation of information about a job

Job description – states information about the duties and tasks that make up a particular job

Job enrichment – designing a job to give interesting and challenging tasks

Job production – a method of production in which a product is supplied to meet the exact requirements of a customer

Job share – when two or more employees agree to share the responsibilities of a single job

Just-in-case (JIC) production – holds stocks just in case there is a delay from supplies or a sudden unexpected increase in demand

Just-in-time (JIT) production – holds as little stock as possible; items are ordered just in time to be used

Kaizen – ‘continuous improvement’; an approach to production that aims to achieve change from a series of small steps

317

Glossary

Lean production – an approach to production that aims to minimise waste

Legislation – a set of rules that governs the way society operates (another term for ‘laws’)

Levels of hierarchy – the layers of authority within a business

Liability – a sum of money that is owed by a business to another business or an individual

Line manager – an employee’s immediate superior or boss

Loss – the amount by which a business’s costs are larger than its revenue from all sales

Loss leader – a product sold at a loss in the hope that the customer will buy other items from the business where they make a profi t

Margin of safety – measures the amount by which a business’s current level of production exceeds its break-even level of output

Market capitalisation – measures the value of all a business’s shares: market price of a share × the number of shares

Market research – the process of gathering, analysing and processing data relevant to marketing decisions

Market segment – a group of customers or buyers with similar needs

Market share – the percentage of sales in a particular market recorded by a business

Marketing mix – all the activities infl uencing whether or not a customer buys a product; the elements of the mix can be analysed using the four Ps: price, place, product and promotion

Markets – exist where there are buyers and sellers

M-commerce is the buying and selling of products through wireless handheld devices such as smartphones (also referred to as mobile commerce)

Merger – when two or more businesses join together to form a new business

Monopoly – exists when a business does not face any competition in a particular market

Mortgages – loans from banks and building societies that are used to buy land and buildings, such as offi ces and shops

Motivation – the range of factors which infl uence the way a person behaves at work

Multinational company (MNC) – produces goods and services in more than one country (also called transnational corporations)

National Living Wage – an hourly rate of pay which is set by the government; all employees above a certain age must receive at least this rate of pay

Need – something that needs to be fulfi lled for us to survive

Negotiation – when two sides discuss what they want and try to reach a solution

Net profi t – a business’s sales revenue minus its cost of sales, its overheads and other costs over a period of time, normally a year

Non-renewable resources – those of which only a limited amount exists such as coal and oil

Not-for-profi t organisation – set up to achieve objectives other than profi t; for example, a charity

Objective – a specifi c target that is set for a business to achieve

Off-the-job training – training outside the employee’s place of work

On-the-job training – training given in the workplace

Organisational chart – a plan showing the roles of, and relationships between, all the employees in a business

Organisational structure – the way a business arranges itself to carry out its activities

Outsourcing – when a business uses another business to produce for it

Overdraft – a fl exible loan which businesses can use, whenever necessary, up to an agreed limit

Owners’ funds – money put into a business by its owner or owners

Partnership – when two or more people join together in a business enterprise to pursue profi t

Part-time employee – works for a proportion of the working week, for example, three days each week, rather than fi ve

Part-time employment – when an employee works for fewer than the normal number of working hours per week

Penetration pricing – launching a new product at a low price to achieve fast sales

Person specifi cation – sets out the qualifi cations and skills required by an employee to fi ll a particular job

Piecework – a method of payment under which employees are paid according to the quantity of products they produce

318

Glossary

Post-sales (or after-sales) service – the meeting of customers’ needs after they have purchased a product, for example, by repairing or servicing the product

Premises – the buildings used by businesses; these may include offi ces, shops and factories

Pressure group – a group of people with a common interest who infl uence public opinion and decisions by businesses and governments

Price – the amount a business asks a customer to pay for a single product

Price skimming – setting a high price for a product when it fi rst enters the market

Primary market research – uses data gathered for the fi rst time

Private sector organisation – owned by individuals

Procurement (or purchase)– selecting suppliers, establishing the terms of payment and negotiating the contract

Product design – translates the needs of consumers, or the inventiveness of entrepreneurs, into a saleable product

Product life cycle – shows how the sales of a product may change over time

Product portfolio – the collection of products that a fi rm produces

Production – the process of changing inputs such as labour services into goods and services that can be sold

Production (or operations) management – all the activities in managing the transformation process

Productivity – the quantity of goods or services produced by an employee over a period of time, such as one year

Profi t – measures the difference between the values of a business’s revenue (sales) and its total costs

Promotional activities – the different ways in which a fi rm tries to communicate with its customers

Promotional mix – the combination of promotional methods used by a business to communicate with its customers

Protectionist measures – policies that governments use to protect their own businesses against foreign competition

Public sector organisation – owned by the government

Purchasing economies of scale – when the cost per unit falls if large orders are placed with suppliers due to a bulk discount

Quality – the extent to which a consumer is satisfi ed with a product

Question mark – a product with a low market share in a fast-growth market

Quota – a limit on the number of foreign goods imported into a country Recession – when the value of an economy’s output of goods and services falls for six months or longer

Recruitment – the process of fi nding and appointing new employees

Recycling – the reuse of raw materials used in making products, often for many time; examples include the reuse of glass, paper and metals

Resources – the inputs that businesses use to provide their goods or services

Retailers – shops that sell direct to the customer

Retention – the proportion of a business’s workforce who remain with the business over a period of time, usually one year

Revenue – the income that a fi rm receives from selling its goods or services; it is also referred to as ‘turnover’; measured by the number of units sold multiplied by the price

Risk – the possibility of something going wrong

Sales promotions – short-term incentives to encourage customers to buy

Sales – the number of products sold by a business

Sales value – measures the revenue generated

Sales volume – measures the number of items sold

Secondary market research – uses data that has been gathered already

Segmentation – when a market is divided into different groups of needs and wants Selection – choosing the right employees from among those who have applied for a job

Service – an intangible product (that is, you cannot touch it), such as fi nancial advice or a bus journey

Shareholder – a person or organisation that owns part of a company; each shareholder owns a ‘share’ of the business

Social enterprise – a business that is set up to help society rather than to make a profi t

Social media – methods of online communication such as websites and applications; they share information and help to develop social and professional contacts

319

Glossary

Social responsibility – an approach to managing businesses in which the interests of all groups in society are taken into account when making decisions

Software robots – advanced computer programs that can operate a range of administrative activities previously carried out by employees

Sole trader – someone who sets up in business on his or her own

Span of control – the number of employees managed directly by another employee

Specialisation – when individuals focus on a limited number of tasks

Stakeholders – individuals and organisations that are affected by, and affect, the activities of a business

Star – a product with a high market share in a fast-growth market

Stock Exchange – a market for buying and selling shares of public limited companies; large numbers of shares are being bought and sold all the time

Supply chain – all the businesses, people and activities that take part in the production processes from the start until it gets to the customer Sustainability – methods of production which can be continued in the long term without damage to the environment

Takeover – when one business buys control of another one

Tariff – a tax on foreign goods imported into a country

Total costs – fi xed costs plus variable costs

Total Quality Management (TQM) – an approach to quality in which everyone is focused on preventing errors occurring and ensuring quality at each stage of the production process

Trade credit – a period of time which suppliers allow customers before payment for supplies must be made

Trade union – a group of workers who act together to improve their pay and working conditions

Training – a range of activities giving employees job-related skills and knowledge

Uncertainty – occurs where there is a lack of information about a situation; this means the outcome or consequences are very diffi cult to predict

Unlimited liability – the personal possessions of the owners of a business are at risk if there are any problems; there is no limit to the amount of money the owners may have to pay out

Variable costs – the costs that vary directly with the business’s level of output

Want – products we would like to have that are not essential

Webchat – a simple means of communicating in real time (that is, instantly) using only web browsers such as Firefox or Internet Explorer

Wholesalers – break bulk; they buy in large quantities from a producer and sell to retailers

Zero hours contract – allows employers to hire staff without any guaranteed hours of work

320

Index

IndexA

advertising 120, 178–79, 180–81, 251, 253, 264

ARR 290–91

assessment centres 182

assets 267, 289-90, 301, 302selling 267–68, 271, 273

B

balance sheets 298, 300–02

break-even 292–95, 297

business environment 7–8

business expansion 46–54, 265

business integration 47, 50

business opportunities 212–14

business plans 25, 41–45, 123

business sectors 5–6

business size 47

C

cash cows 242, 243

cash fl ow 276, 277–78, 284forecasts 278–81, 285statements 278

cash infl ows 276, 282–83

cash outfl ows 276–77

centralisation 173

cloud computing 60, 67

commission 195

communication 170–71, 172

companies 13–17, 18

Companies Act (1980) 14, 298

competition 36, 118–20, 122, 124overseas 99, 101performance of 304

competitive pricing 247

Computer Misuse Act (1990) 114

consumer laws 112–16

Consumer Rights Act (2015) 113, 116

consumer spending 84, 86–91, 93

contracts of employment 70–71, 109, 185–87

convenience products 258

cost plus pricing 247

curriculum vitae (CV) 181

customer feedback 149, 231

customer loyalty 156

customer service (satisfaction) 23, 153–60, 183, 199–200

D

data analysis 60, 158–59, 225

Data Protection Act (1998) 114

debts 278, 281, 284, 301

decentralisation 171–74

Deed of Partnership 12

delayering 167

delegation 167, 169, 172

demand 245–46, 248

digital communication 63–67

direct marketing 256

diseconomies of scale 51–52

distribution channels 235, 255–60

diversifi cation 123, 176

dogs 241–42

E

e-commerce 49, 61–63, 256

e-learning 202

economic climate 82–91, 124

economies of scale 51–52, 141

effi ciency 136–38, 265

employee retention 177, 184–85

employment 87–89, 107–11

employment agencies 178

entrepreneurs 3, 5, 124–25, 264–65, 272–73

environment 7, 24–25, 72–80

environmental reports 79

environmental responsibility 76, 78, 115

Equality Act (2010) 108–09

established businesses 265, 273–74

ethics 24, 68–72, 79–81, 144

exchange rates 102–04, 295

exports 95, 103–04

extension strategies 244–45

external costs 72, 73

F

factors of production 4

fi nance 41–42, 71, 85–87, 264–75

fi nancial ratios 304–06

fi nancial statements 298–308

fi xed costs 43–44, 287, 292

fl ow production 134–36

franchises 48–49

fringe benefi ts 194–95

full-time employment 185–86

G

global warming 75

globalisation 94–106, 119

government grants 271

gross profi t 299, 304–05

growth 24, 47–50, 98, 225–26

H

Health and Safety at Work Act (1974) 111–12

hire purchase 271

human resources 6–7, 70–71, 164–209

I

ICT 58–67, 121, 157–59

imports 38, 102-03, 104, 295

income elastic products 90–91

income statements 298–300

induction training 201

Bold numbers denote pages with key term defi nitions.

321

Index

interest rates 7, 84–87, 93

intermediaries 257

international trade 95, 102

internet 231, 232, 259

interviews 182

intranets 59, 67, 170

inventories 265

inward investment 98

J

JIC production 141–42

JIT production 137, 141–42

job analysis 180

job descriptions 180

job enrichment 193, 196

job production 133–34

job sharing 186

Jobcentre Plus 178, 181

K

kaizen 137–38

L

labour costs 36, 37, 88, 98–99

lean production 137–38

liabilities 300, 301

loans 114, 268–69, 270, 272

local community 3, 31, 32, 71

location 35–40, 59, 249

logistics 144–46, 147

loss leaders 247

M

m-commerce 61, 158, 256

management style 168–70, 194

margin of safety 294

market 36, 117–18, 248, 254

market capitalisation 47

market growth 218–19, 225–26

market research 224–25, 227primary 228, 230–32secondary 228–30

market share 23, 119-20, 226–27

market size 218, 225, 226–27

marketing 6, 70

marketing mix 214–15, 234–38

Maslow’s hierarchy of needs 189–91, 194, 196

migration 96

MNCs 94, 96–97, 99

monopolies 118, 120

mortgages 269, 271, 273, 277

motivation 110, 111, 189–97

mystery visitors 149

N

National Living Wage 107, 108, 110, 123, 195

National Minimum Wage 107, 108

net profi t 299, 305–06

new products 240–41, 265, 290

new stores 49, 252

non-renewable resources 74–75

not-for-profi t organisations 18, 26

O

objectives setting 20–29, 248

off-the-job training 203, 204

on-the-job training 201–02, 203–04

opportunity cost 4

organisational charts 165

organisational structures 164chain of command 166–67fl at 168, 169, 170, 171levels of hierarchy 166span of control 166, 168, 169tall 168, 169, 171

outsourcing 49–50

overdrafts 85, 269–70, 282

overheads 299

overseas locations 37–39, 53, 59

owners’ funds 266, 272, 276

P

part-time employees 109, 185–86

partnership 12–13, 18, 298

payment terms 154–55, 282

penetration pricing 246

performance measurement 27, 149, 298–310

person specifi cation 180

piecework 195

pollution 73–74

post-sales service 154, 239

premises 154

price 100-01, 235, 245–50, 286–87

price skimming 246

private limited companies 14–16

producers 255

product design 99–100, 234–36

product development 240, 241

product differentiation 240

product information 114, 154

product life cycle 243–45, 249

product portfolio 241–43

production management 70, 132–39, 141–42, 146, 176

productivity 183, 191, 198, 290

profi t sharing 195

profi ts 22, 266–67, 268, 283–84, 288–89, 299

promotion 235, 251–55, 260

promotional mix 253–54

protectionist measures 37–38

psychometric tests 182

public limited companies 14, 16–17, 18

public relations 252

publicity 121–22, 123, 156, 243

Q

quality 100–01, 146, 148–52control 149, 150, 151, 152

question marks 242

R

recruitment 175–84, 185–88

recycling 70, 76, 77, 78, 79

resources 4, 37, 74–75, 98

retailers 256

retained profi ts 266–67, 268

revenue 43, 47, 286, 299

risk 5, 42, 120–23

322

Index

S

salaries 195

sales 47, 214, 252, 287, 299

segmentation 218–23, 225

selection 177, 179, 181–84

shareholders 13–15, 22, 66, 270, 306–07

shares 13, 16, 17, 270, 273

social media 63–64, 158, 200

software robots 60

sole traders 10–11, 266, 298

specialisation 135

stakeholders 12, 30–34, 59

stars 242

stocks 137, 139, 140–42

strikes 32, 33, 121, 138

suppliers 65–66, 142–44, 146, 231, 307

supply chain 143, 145–46, 147

sustainability 24, 76

T

takeovers 44, 50, 98, 99

target market 220, 225, 236, 253

taxes 8, 32, 71, 277

technology 7, 36–37, 58–67

total costs 43–44, 288, 293

total equity 301–02

total revenue 293, 294, 297

TQM 150

trade credit 268

trade unions 109, 111, 121

training 123, 149, 172, 193, 198–206

transport (traffi c) 36, 73, 74, 78, 95, 146

U

uncertainty 42, 120–21, 124

V

variable costs 44, 248, 287, 293

W

wages 195, 277

waste disposal 77

websites 157–58, 176

wholesalers 255

Z

zero-hours contracts 70, 71, 186–87

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